UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

Form 10-K

 

 

000-27999
(Commission File No.)

 

Registrant’s telephone number, including area code:

408-548-1000

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

None

 

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

Common stock, $.001 par value

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  þ      No  o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o      No  þ

 

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  þ      No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  o      No  o

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

 

As of November 1, 2009, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $473,822,500 based on the closing sales price of the registrant’s common stock as reported on the NASDAQ Stock Market on October 30, 2009 of $7.45 per share. Shares of common stock held by officers, directors and holders of more than ten percent of the outstanding common stock have been excluded from this calculation because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

As of June 10, 2010, there were 75,885,979 shares of the registrant’s common stock, $.001 par value, issued and outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement for its 2010 annual meeting of stockholders are incorporated by reference in Part III hereof.

 

 

INDEX TO ANNUAL REPORT ON FORM 10-K

 

FOR THE FISCAL YEAR ENDED APRIL 30, 2010

 

 

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We use words like “anticipates,” “believes,” “plans,” “expects,” “future,” “intends” and similar expressions to identify these forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events; however, our business and operations are subject to a variety of risks and uncertainties, and, consequently, actual results may materially differ from those projected by any forward-looking statements. As a result, you should not place undue reliance on these forward-looking statements since they may not occur.

 

Certain factors that could cause actual results to differ from those projected are discussed in “Item 1A. Risk Factors.” We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information or future events.

Item 1.   Business

 

Overview

 

We are a leading provider of optical subsystems and components that are used to interconnect equipment in short-distance local area networks, or LANs, and storage area networks, or SANs, and longer distance metropolitan area networks, or MANs, fiber-to-the-home networks, or FTTx, cable television networks, or CATV, and wide area networks, or WANs. Our optical subsystems consist primarily of transmitters, receivers, transceivers and transponders which provide the fundamental optical-electrical interface for connecting the equipment used in building these networks, including switches, routers and file servers used in wireline networks as well as antennas and base stations for wireless networks. These products rely on the use of semiconductor lasers and photodetectors in conjunction with integrated circuit design and novel packaging technology to provide a cost-effective means for transmitting and receiving digital signals over fiber optic cable at speeds ranging from less than 1 gigabit per second, or Gbps, to 100Gbps, using a wide range of network protocols and physical configurations over distances of 70 meters to 200 kilometers. We supply optical transceivers and transponders that allow point-to-point communications on a fiber using a single specified wavelength or, bundled with multiplexing technologies, can be used to supply multi-gigabit bandwidth over several wavelengths on the same fiber. We also provide products that are used for dynamically switching network traffic from one optical wavelength to another across multiple wavelengths without first converting to an electrical signal, known as wavelength selective switches, or WSS. These products are sometimes combined with other components and sold as linecards, also known as reconfigurable optical add/drop multiplexers, or ROADMs. Our line of optical components consists primarily of packaged lasers and photodetectors used in transceivers, primarily for LAN and SAN applications, and passive optical components used in building MANs. Demand for our products is largely driven by the continually growing need for additional bandwidth created by the ongoing proliferation of data and video traffic that must be handled by both wireline and wireless networks.

 

Our manufacturing operations are vertically integrated and we utilize internal sources for many of the key components used in making our products including lasers, photodetectors and integrated circuits, or ICs, designed by our own internal IC engineering teams. We also have internal assembly and test capabilities that make use of internally designed equipment for the automated testing of our optical subsystems and components.

 

We sell our optical products to manufacturers of storage systems, networking equipment and telecommunication equipment or their contract manufacturers, such as Alcatel-Lucent, Brocade, Cisco Systems, EMC, Emulex, Ericsson, Hewlett-Packard Company, Huawei, IBM, Juniper, Qlogic, Siemens and Tellabs. These customers, in turn, sell their systems to businesses and to wireline and wireless telecommunications service providers and cable TV operators, collectively referred to as carriers.

 

We were incorporated in California in April 1987 and reincorporated in Delaware in November 1999. Our principal executive offices are located at 1389 Moffett Park Drive, Sunnyvale, California 94089, and our telephone number at that location is (408) 548-1000.

 

All references to “Finisar,” “the Company,” “we,” “us” or “our” are references to Finisar Corporation and its consolidated subsidiaries, collectively, except as otherwise indicated or where the context otherwise requires.

 

Recent Developments

 

Sale of Network Tools Division

 

We formerly sold a line of network performance test systems through our Network Tools Division. In the first quarter of fiscal 2010, we sold substantially all of the assets of our Network Tools Division to JDS Uniphase Corporation (“JDSU”) for approximately $40.7 million in cash and other consideration. We recorded a net gain on the sale of the business of $35.9 million before income taxes, which is included in income (loss) from discontinued operations, net of income tax, in our consolidated statements of operations. The assets, liabilities and results of operations related to the business have been classified as discontinued operations in our consolidated financial statements for all periods presented. The cash flows associated with the discontinued operations have not been separately disclosed in our consolidated statements of cash flow.

Industry Background and Markets

 

Industry Background

 

Computer networks are frequently described in terms of the distance they span and by the hardware and software protocols used to transport and store data. The physical medium through which signals are best transmitted over these networks depends on the amount of data to be transmitted, expressed as Gbps, and the distance involved. Voice-grade copper wire can only support connections of about 1.2 miles without the use of repeaters to amplify the signal, whereas optical systems can carry signals in excess of 60 miles without further processing. Early computer networks had relatively limited performance requirements, short connection distances and low transmission speeds and, therefore, relied almost exclusively on copper wire as the medium of choice. At speeds of more than 1 Gbps, the ability of copper wire to transmit more than 300 meters is limited due to the loss of signal over distance as well as interference from external signal generating equipment. The proliferation of electronic commerce, communications and broadband entertainment has resulted in the digitization and accumulation of enormous amounts of data. Thus, while copper continues to be the primary medium used for delivering signals to the desktop, even at 1 Gbps, the need to quickly transmit, store and retrieve large blocks of data across networks in a cost-effective manner has increasingly required enterprises and service providers to use fiber optic technology to transmit data at higher speeds over greater distances and to expand the capacity of their networks. There are three principal categories of networks: LANs and SANs, MANs and WANs. According to industry analyst Lightcounting Inc. (“Lightcounting”), total sales of transceivers and transponder products for use in these networks were estimated to be approximately $2.0 billion in 2009. According to industry analyst Ovum, sales of WSS components in 2009 were estimated to be approximately $127 million (which includes only sales of individual WSS components but does not include sales of complete ROADM subsystems).

 

LANs and SANs

 

A LAN typically consists of a group of computers and other devices that share the resources of one or more processors or servers within a small geographic area and are connected through the use of hubs (used for broadcasting data within a LAN), switches (used for sending data to a specific destination in a LAN) and routers (used as gateways to route data packets between two or more LANs or other large networks). LANs typically use the Ethernet protocol to transport data packets across the network at distances of up to 500 meters at speeds of 1 to 10 Gbps.

 

A SAN is a high-speed subnetwork embedded within a LAN where critical data stored on devices such as disk arrays, optical disks and tape backup devices is made available to all servers on the LAN thereby freeing the network servers to deliver business applications, increasing network capacity and improving response time. SANs were originally developed using the Fibre Channel protocol designed for storing and retrieving large blocks of data. A number of new storage technologies have been introduced to lower the cost and complexity of deploying Fibre Channel-based storage networks. Since its introduction in 2003, small and medium size storage networks have been developed based on the Internet Small Computer System Interface protocol, or iSCSI. In 2007, the Fibre Channel over Ethernet standard, or FCoE, was introduced which enables Fibre Channel data packets to be encapsulated within Enhanced Ethernet frames. This standard utilizes the additional bandwidth created at transmission speeds of 10 Gbps and higher to combine different types of data traffic for storage (Fibre Channel), LAN traffic (TCP/IP) and various server clustering protocols (Infiniband) that previously required their own separate infrastructure within a data center. As a result, FCoE enables the creation of a single converged network within a data center, rather than two or three networks as previously required. In addition, the FCoE protocol utilizes recently developed Ethernet-based technology for transmitting signals at speeds of 40 and 100 Gbps.

 

Due to the cost effectiveness of the optical technologies involved, transceivers for both LANs and SANs have been developed using vertical cavity surface emitting lasers, or VCSELs, to transmit and receive signals at the 850 nanometer, or nm, wavelength over relatively short distances through multi-mode fiber. Most LANs and SANs operating today at 1, 2, 4 and 8 Gbps over distances of up to 70 meters, incorporate this VCSEL technology. The same technology is now being employed to build FCoE and iSCSI-based LANs and SANs operating at 10 Gbps.

 

A new market has emerged in recent years for the use of parallel optics technologies for high-capacity telecommunications applications to connect with core internet protocol, or IP, routers, in the data center to

interconnect SANs and servers and for high-performance computing clusters. This technology makes use of an array of lasers and photodetectors, instead of one per transceiver, to boost the amount of data that can be transmitted over a single fiber over very short distances. Optical interconnects provide an attractive alternative to bulky copper cables as data rate and port densities increase allowing for fewer connections. Like the transceivers used for LANs and SANs, parallel optical solutions rely primarily on the use of VCSEL technology. A variation of parallel optics technology called active optical cable, or AOC, was introduced by several vendors in late 2007. These products eliminate the use of fiber connectors used in other parallel optical modules by bonding the fibers directly to the optical subassembly. According to Lightcounting, demand for AOCs is expected to equal or exceed demand for other parallel optical solutions by 2012.

 

According to Lightcounting, sales of transceivers used for LAN and SAN applications incorporating optical technologies to generate and receive signals up to 500 meters were estimated to be approximately $574 million in 2009. Of this total, approximately $536 million represented the market for transceivers and transponders using serial transmission technologies while $38 million represented our addressable market for sales of optical interconnects using parallel optics technology.

 

The demand for optical subsystems and components used in building LANs and SANs is driven primarily by the need of business enterprises to meet the increasing demands for information which must be stored and retrieved in a timely manner and made available to users located within a building or campus. Because SANs enable the sharing of resources thereby reducing the required investment in storage infrastructure, the continued growth in stored data is expected to result in the ongoing centralization of storage and the need to deploy larger SANs. The centralization of storage, in turn, is increasing the demand for higher-bandwidth solutions to provide faster, more efficient interconnection of data storage systems with servers and LANs as well as the need to connect at higher speeds over longer distances for disaster recovery applications.

 

MANs and WANs

 

A MAN is a regional data network typically covering an area of up to 50 kilometers in diameter that allows the sharing of computing resources on a regional basis within a town or city. These Metro networks are typically arranged in a ring configuration that can ultimately transmit data around metropolitan areas over hundreds of kilometers. MANs typically use the SONET and SDH communications standards to encapsulate data to be transmitted over fiber optic cable due to the widespread use of this standard in legacy telecommunication networks. However, MANs can also be built using the Ethernet standard, also known as Metro Ethernet, which can typically result in savings to the network operator in terms of network infrastructure and operating costs.

 

The portion of a MAN that connects a LAN or SAN to a public data network is frequently referred to as the Last Mile or Access portion of a network. There are several means that carriers employ to provide integrated voice, video and data services to customers over this portion of the network. The more popular means include CATV and passive optical networks, or PONs. Both PONs and CATV employ the use of fiber optic technologies in providing these services. Today, there are three standardized versions of PON based on network speeds: Broadband PON, or BPON, operating at .6 Gbps, Ethernet PON, or EPON, operating at 1 Gbps and Gigabit PON, or GPON, operating at 2.5 Gbps. While EPON products currently dominate the market due to their early adoption in Japan and South Korea, according to Lightcounting, the demand for GPON products will surpass all other types by 2011.

 

CATV is a shared cable system that uses RF signals to deliver services over a tree-and-branch topology in which multiple households within a neighborhood share the same cable. While early CATV systems were all coaxial cable, current systems increasingly employ fiber optic cable to overcome attenuation of signals over long distances and problems related to aging components. Fiber optic cable also provides more bandwidth for future expansion. This dual system is called a hybrid fiber coax, or HFC. Due to the shared-nature of a CATV network and the use of RF signal technology, these networks typically utilize analog lasers in conjunction with optical amplifiers to deliver these services.

 

A wide area network, or WAN, is a geographically dispersed data communications network that typically includes the use of a public shared user network such as the telephone system, although a WAN can also be built using leased lines or satellites. Similar to MANs, a terrestrial WAN uses the SONET/SDH communications standard to transmit information over longer distances due to its use in legacy telecommunication networks.

According to Lightcounting, total sales of transceiver and transponder products for longer distance MANs using the Ethernet and Fibre Channel protocols in 2009 were approximately $349 million; sales of transceivers and transponders used in building MANs and WANs that are compliant with the SONET/SDH protocol were approximately $841 million and the addressable market for sales of products used in building fiber-to-the-home/curb networks, or FTTx, was approximately $218 million.

 

According to Ovum, sales of WSS components in 2009 were estimated to be approximately $127 million (which include only sales of individual WSS components, but does not include sales of complete ROADM subsystems) and represents one of the fastest growing product solutions as a result of the ability of ROADMs to enable flexible bandwidth management in MANs.

 

The demand for products used to build MANs is driven primarily by service providers as they seek to upgrade or build new networks to handle the growth in the bandwidth demands of business and residential users. The Cisco Visual Network Index is that company’s ongoing effort to forecast the growth and use of IP networking worldwide. According to this index, the amount of bandwidth usage devoted to transmitting IP traffic is expected to increase by a factor of four from 2009 to 2014, approaching 64 exabytes per month in 2014, compared to approximately 15 exabytes per month in 2009.

 

Demand for Optical Products Used in Wireless Networks

 

Wireless networks typically use fiber optic transmission to backhaul wireless traffic to the central office for switching. According to the Cisco Visual Network Index, mobile data traffic alone is expected to roughly double each year from 2008 through 2013 largely as a result of the deployment of mobile network devices which offer enhanced communication services, including the ability to download video files as well as offering voice, data and internet connectivity. To meet these bandwidth demands, next generation wireless networks, or 3G, are being deployed which expand the use of fiber optic technologies from backhauling mobile traffic out of base stations to being used in cellular towers to reduce the weight of copper-based solutions while expanding their bandwidth capabilities.

 

Business Strategy

 

We have become a leading supplier of optical products to manufacturers of LAN and SAN networking equipment due in part to our early work in the development of the Fibre Channel standard in the mid-1990s as well as our pioneering work in developing transceivers using VCSEL technology. As part of our business strategy, we continue to actively serve on various standards committees in helping to influence the use of new cost-effective optical technologies. In more recent years, we have become a leading vendor in SONET/SDH, WDM and ROADM networking equipment, due largely to our efforts with respect to XFP form factor modules, our expertise in designing tunable modules, and our novel approach to WSS modules using liquid crystal on silicon, or LCoS.

 

We have developed a vertically integrated business model that operates best when our module and laser production facilities are highly utilized. In order to maintain our position as a leading supplier of fiber optic subsystems and components, we are continuing to pursue the following business strategies:

 

 

 

Products

 

Our optical subsystems are integrated into our customers’ systems and used for both short- and intermediate-distance fiber optic communications applications.

 

Our family of optical subsystem products consists of transmitters, receivers, transceivers and transponders principally based on the Gigabit Ethernet, Fibre Channel and SONET/SDH protocols. A transmitter converts electrical signals into optical signals for transmission over fiber optics. Receivers incorporating photo detectors convert incoming optical signals into electric signals. A transceiver combines both transmitter and receiver functions in a single device. A transponder includes an IC to provide the serializer-deserializer function that otherwise resides in the customer’s equipment if a transceiver is used. Our optical subsystem products perform these functions with high reliability and data integrity and support a wide range of protocols, transmission speeds, fiber types, wavelengths, transmission distances, physical configurations and software enhancements.

Our high-speed fiber optic subsystems are engineered to deliver value-added functionality and intelligence. Most of our optical subsystem products include a microprocessor with proprietary embedded software that allows customers to monitor transmitted and received optical power, temperature, drive current and other link parameters of each port on their systems in real time. In addition, our intelligent optical subsystems are used by some enterprise networking and storage system manufacturers to enhance the ability of their systems to diagnose and correct abnormalities in fiber optic networks.

 

For SAN applications which rely on the Fibre Channel standard, we currently provide a wide range of optical subsystems for transmission applications at 1 to 8 Gbps. We currently provide optical subsystems for data networking applications for LANs and MANs based on the Ethernet standard for transmitting signals at 1 to 10 Gbps using the SFP, SFP+, and XFP form factors. We are also qualified for shipping products for 10 Gbps Ethernet solutions using the legacy Xenpak and newer X2 form factors which make use of the XAUI electrical interface. For SONET/SDH-based MANs, we supply optical subsystems which are capable of transmitting at 2.5, 10 and 40 Gbps. We also offer products that operate at less than 1 Gbps for these SONET/SDH networks.

 

We also offer a full line of optical subsystems for MANs using WDM technologies. Our CWDM subsystems include every major optical transport component needed to support a MAN, including transceivers, optical add/drop multiplexers, or OADMs, for adding and dropping wavelengths in a network without the need to convert to an electrical signal and multiplexers/demultiplexers for SONET/SDH, Gigabit Ethernet and Fibre Channel protocols. CWDM-based optical subsystems allow network operators to scale the amount of bandwidth offered on an incremental basis, thus providing additional cost savings during the early stages of deploying new IP-based systems. For DWDM systems, we offer DWDM-based transceivers in the SFP, XFP and 300 pin form factors.

 

As a result of several acquisitions, we have gained access to leading-edge technology for the manufacture of a number of active and passive optical components including VCSELs, FP lasers, DFB lasers, PIN detectors, fused fiber couplers, isolators, filters, polarization beam combiners, interleavers and linear semiconductor optical amplifiers. Most of these optical components are used internally in the manufacture of our optical subsystems. We currently sell VCSELs and limited quantities of other components in the so-called “merchant market” to other subsystems manufacturers.

 

Of the estimated $2.0 billion market for transceivers and transponders in calendar 2009, our sales of transceiver and transponder products for LAN, SAN and MAN applications totaled approximately $463 million, excluding sales of optical components. Of this amount, approximately $217 million was from sales of products for short-distance LAN and SAN applications and $246 million was from sales of products for longer distance MAN networks for Ethernet, Fibre Channel and SONET/SDH network protocols.

 

We recently began to offer products used in building fiber-to-the-home/curb networks and for parallel optics applications such as backplanes for switches and routers. According to Lightcounting, the addressable market for these products was over $256 million in calendar 2009.

 

We offer a WSS ROADM, a dynamic wavelength processor in a highly configurable platform for wavelength management in a DWDM telecommunications network. These capabilities are made possible in part through the use of unique LCoS technology currently used in making microdisplays and certain projection television sets. This technology provides a highly flexible WSS switch capable of operating on both 50 and 100 GHz International Telecommunications Union grids, the capability for in-service upgrades of functionality and integration of additional system functionality, including drop and continue, channel monitoring and channel contouring.

 

Customers

 

To date, our revenues have been principally derived from sales of optical subsystems and components to a broad base of original equipment manufacturers, or OEMs, distributors and system integrators. Sales of products for LAN and SAN applications represented 43%, 44% and 54% of our total revenues in fiscal 2010, 2009 and 2008, respectively.

 

Sales to our top three customers represented approximately 30%, 32% and 36% of our total revenues in fiscal 2010, 2009 and 2008, respectively. Sales to Cisco Systems accounted for 16%, 16% and 22% of our total revenues

in fiscal 2010, 2009 and 2008, respectively. No other customer accounted for more than 10% of our total revenues in any of these years.

 

Technology

 

The development of high quality fiber optic subsystems and components for high-speed data communications requires multidisciplinary expertise in the following technology areas:

 

High Frequency Integrated Circuit Design.   Our fiber optic subsystems development efforts are supported by an engineering team that specialized in analog/digital integrated circuit design. This group works in both silicon, or Si, CMOS, and silicon germanium, or SiGe, BiCMOS, semiconductor technologies where circuit element frequencies are very fast and can be as high as 40 Gbps. We have designed proprietary circuits including laser drivers, receiver pre-and post-amplifiers and controller circuits for handling digital diagnostics at 1, 2, 4, 8, 10 and 49 Gbps. We are also investing in designing LCoS based ICs for our WSS products. These advanced semiconductor devices provide significant cost advantages and will be critical in the development of future products capable of even faster data rates.

 

Optical Subassembly and Mechanical Design.   We established ourselves as a low-cost design leader beginning with our initial Gbps optical subsystems in 1992. From that base we have developed single-mode laser alignment approaches and low-cost, all-metal packaging techniques for improved EMI performance and environmental tolerance. We develop our own component and packaging designs and integrate these designs with proprietary manufacturing processes that allow our products to be manufactured in high volume.

 

System Design.   The design of all of our products requires a combination of sophisticated technical competencies — optical engineering, high-speed electrical design, digital and analog application specific IC, or ASIC design and firmware and software engineering. We have built an organization of people with skills in all of these areas. It is the integration of these technical competencies that enables us to produce products that meet the needs of our customers. Our combination of these technical competencies has enabled us to design and manufacture optical modules and subsystems.

 

Manufacturing System Design.   Hardware, firmware and software design skills are utilized to provide specialized manufacturing test systems for our internal use. These test systems are optimized for test capacity and broad test coverage. We use automated, software-controlled testing to enhance the field reliability of all Finisar products and to reduce the level of capital expenditures that would otherwise be required to purchase these test systems.

 

Optoelectronic Device Design and Wafer Fabrication.   The ability to manufacture our own optical components can provide significant cost savings while the ability to create unique component designs, enhances our competitive position in terms of performance, time-to-market and intellectual property. We design and manufacture a number of active components that are used in our optical subsystems. Our acquisition of Honeywell’s VCSEL Optical Products business unit in March 2004 provided us with wafer fabrication capability for designing and manufacturing all of the 850nm VCSEL components used in our short distance transceivers for LAN and SAN applications. These applications represented approximately 43% of our optical subsystem revenues in fiscal 2010. The acquisition of Genoa Corporation in April 2003 provided us with a state-of-the-art foundry for the manufacture of PIN detectors and 1310 nm FP and DFB lasers used in our longer distance transceivers, although we continue to rely on third-party suppliers for a portion of our DFB laser requirements. These longer distance transceiver products comprised approximately 46% of our optical subsystem revenues in fiscal 2010.

 

Competition

 

Several of our competitors in the optical subsystems and components market have recently been acquired or announced plans to be acquired. These announcements reflect an ongoing realignment of industry capacity with market demand in order to restore the financial health of the optics industry. Despite this trend, the market for

optical subsystems and components for use in LANs, SANs, MANs and WANs remains highly competitive. We believe the principal competitive factors in these markets are:

 

 

Competition in the market for optical subsystems and components varies by market segment. Our principal competitors for optical transceivers sold for applications based on the Fibre Channel and Ethernet protocols include Avago Technologies (formerly part of Agilent Technologies) and JDSU. Our principal competitors for optical transceivers sold for MAN, WAN and telecom applications based on the SONET/SDH protocols include Oclaro (formed with the merger of Bookham and Avanex), Opnext and Sumitomo. Our principal competitors for WSS ROADM products include CoAdna, JDSU, Oclaro and Oplink. Our principal competitors for CATV products include AOI and Emcore. We believe we compete favorably with our competitors with respect to most of the foregoing factors based, in part, upon our broad product line, our sizeable installed base, our significant vertical integration and our lower-cost manufacturing facilities in Ipoh, Malaysia and Shanghai, China. We believe that the recent introduction of a number of products for 10GigE and parallel and recent design-wins with our WSS ROADM products have strengthened our position in the optical subsystem market.

 

Sales, Marketing and Technical Support

 

For sales of our optical subsystems and components, we utilize a direct sales force augmented by one world-wide distributor, ten international distributors, three domestic distributors, 17 domestic manufacturers’ representatives and three international manufacturers’ representatives. Our direct sales force maintains close contact with our customers and provides technical support to our manufacturers’ representatives. In our international markets, our direct sales force works with local resellers who assist us in providing support and maintenance in the territories they cover.

 

Our marketing efforts are focused on increasing awareness of our product offerings for optical subsystems and our brand name. Key components of our marketing efforts include:

 

 

In addition, our marketing group provides marketing support services for our executive staff, our direct sales force and our manufacturers’ representatives and resellers. Through our marketing activities, we provide technical and strategic sales support to our direct sales personnel and resellers, including in-depth product presentations, technical manuals, sales tools, pricing, marketing communications, marketing research, trademark administration and other support functions.

A high level of continuing service and support is critical to our objective of developing long-term customer relationships. We emphasize customer service and technical support in order to provide our customers and their end users with the knowledge and resources necessary to successfully utilize our product line. Our customer service organization utilizes a technical team of field and factory applications engineers, technical marketing personnel and, when required, product design engineers. We provide extensive customer support throughout the qualification and sale process. In addition, we provide many resources through our World Wide Web site, including product documentation and technical information. We intend to continue to provide our customers with comprehensive product support and believe it is critical to remaining competitive.

 

Backlog

 

A substantial portion of our revenues is derived from sales to OEMs and system integrators through hub arrangements where revenue is generated as inventory that resides at these customers or their contract manufacturers is drawn down. Visibility as to future customer demand is limited in these situations. Most of our other revenues are derived from sales pursuant to individual purchase orders which remain subject to negotiation with respect to delivery schedules and are generally cancelable without significant penalties. Manufacturing capacity and availability of key components can also impact the timing and amount of revenue ultimately recognized under such sale arrangements. Accordingly, we do not believe that the backlog of undelivered product under these purchase orders are a meaningful indicator of our future financial performance.

 

Manufacturing

 

We manufacture most of our optical subsystems at our production facility in Ipoh, Malaysia. This facility consists of 640,000 square feet, of which 240,000 square feet is suitable for cleanroom operations. The acquisition of this facility has allowed us to transfer most of our manufacturing processes from contract manufacturers to a lower-cost manufacturing facility and to maintain greater control over our intellectual property. We expect to continue to use contract manufacturers for a portion of our manufacturing needs. We conduct a portion of our new product introduction operations at our Ipoh, Malaysia facility. We manufacture certain passive optical components used in our long wavelength products for MAN applications as well as ROADM linecards at our facility in Shanghai, China which we expanded to 150,000 square feet in October 2008. We also manufacture our WSS products in our 33,000 square foot facility in Waterloo, Australia and certain CATV and telecommunications products in our 81,000 square foot facility in Horsham, Pennsylvania. We continue to conduct a portion of our new product introduction activities at our Sunnyvale, California and Horsham, Pennsylvania facilities. In Sunnyvale, we also conduct supply chain management for certain components, quality assurance and documentation control operations. We maintain an international purchasing office in Shenzen, China. We conduct wafer fabrication operations for the manufacture of VCSELs used in LAN and SAN applications at our facility in Allen, Texas. We conduct wafer fabrication operations for the manufacture of long wavelength FP and DFB lasers at our facility in Fremont, California.

 

We design and develop a number of the key components of our products, including photodetectors, lasers, ASICs, printed circuit boards and software. In addition, our manufacturing team works closely with our engineers to manage the supply chain. To assure the quality and reliability of our products, we conduct product testing and burn-in at our facilities in conjunction with inspection and the use of testing and statistical process controls. In addition, most of our optical subsystems have an intelligent interface that allows us to monitor product quality during the manufacturing process. Our facilities in Sunnyvale, Fremont, Allen, Shanghai, Ipoh, Horsham and Australia are qualified under ISO 9001-9002.

 

Although we use standard parts and components for our products where possible, we currently purchase several key components from single or limited sources. Our principal single source components purchased from external suppliers include ASICs and certain DFB lasers that we do not manufacture internally. In addition, all of the short wavelength VCSEL lasers used in our LAN and SAN products are currently produced at our facility in Allen, Texas. Generally, purchase commitments with our single or limited source suppliers are on a purchase order basis. We generally try to maintain a buffer inventory of key components. However, any interruption or delay in the supply of any of these components, or the inability to procure these components from alternate sources at acceptable prices

and within a reasonable time, would substantially harm our business. In addition, qualifying additional suppliers can be time-consuming and expensive and may increase the likelihood of errors.

 

We use a rolling 12-month forecast of anticipated product orders to determine our material requirements. Lead times for materials and components we order vary significantly, and depend on factors such as the demand for such components in relation to each supplier’s manufacturing capacity, internal manufacturing capacity, contract terms and demand for a component at a given time.

 

Research and Development

 

In fiscal 2010, 2009 and 2008, our research and development expenses related to our continuing operations were $94.8 million, $80.1 million and $63.0 million, respectively. We believe that our future success depends on our ability to continue to enhance our existing products and to develop new products that maintain technological competitiveness. We focus our product development activities on addressing the evolving needs of our customers within the LAN, SAN, MAN and WAN markets, although we also are seeking to leverage our core competencies by developing products for other applications. We work closely with our OEMs and system integrators to monitor changes in the marketplace. We design our products around current industry standards and will continue to support emerging standards that are consistent with our product strategy. Our research and development groups are aligned with our various product lines, and we also have specific groups devoted to ASIC design and test, subsystem design, and software design. Our product development operations include the active involvement of our manufacturing engineers who examine each product for its manufacturability, predicted reliability, expected lifetime and manufacturing costs.

 

We believe that our research and development efforts are key to our ability to maintain technical competitiveness and to deliver innovative products that address the needs of the market. However, there can be no assurance that our product development efforts will result in commercially successful products, or that our products will not be rendered obsolete by changing technology or new product announcements by other companies.

 

Intellectual Property

 

Our success and ability to compete is dependent in part on our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We currently own approximately 1,000 issued U.S. patents and approximately 300 patent applications with additional foreign counterparts. We cannot assure you that any patents will issue as a result of pending patent applications or that our issued patents will be upheld. Any infringement of our proprietary rights could result in significant litigation costs, and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of a competitive advantage and decreased revenues. Despite our efforts to protect our proprietary rights, existing patent, copyright, trademark and trade secret laws afford only limited protection. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, we may not be able to prevent misappropriation of our technology or deter others from developing similar technology. Furthermore, policing the unauthorized use of our products is difficult. We have been involved in extensive litigation to enforce certain of our patents and are currently engaged in such litigation. See “Item 3. Legal Proceedings”. Additional litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. This litigation could result in substantial costs and diversion of resources and could significantly harm our business.

 

The networking industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time to time, other parties may assert patent, copyright, trademark and other intellectual property rights to technologies and in various jurisdictions that are important to our business. Any claims asserting that our products infringe or may infringe proprietary rights of third parties, if determined adversely to us, could significantly harm our business. Any such claims, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel, cause product shipment delays or require us to enter into royalty or licensing agreements, any of which could significantly

harm our business. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In addition, our agreements with our customers typically require us to indemnify our customers from any expense or liability resulting from claimed infringement of third party intellectual property rights. In the event a claim against us was successful and we could not obtain a license to the relevant technology on acceptable terms or license a substitute technology or redesign our products to avoid infringement, our business would be significantly harmed.

 

Employees

 

As of April 30, 2010, we employed approximately 6,893 full-time employees, 658 of whom were located in the United States and 5,827 of whom were located at our production facilities in Ipoh, Malaysia and Shanghai, China. We also from time to time employ part-time employees and hire contractors. Our employees are not represented by any union, and we have never experienced a work stoppage. Certain of our employees in our Waterloo, Australia facility are subject to a collective agreement not involving a union. We believe that there is a positive employee relations environment within the company.

 

Available Information

 

Our website is located at www.finisar.com . Electronic copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available, free of charge, on our website as soon as practicable after we electronically file such material with the Securities and Exchange Commission. The contents of our website are not incorporated by reference in this Annual Report on Form 10-K.

 

OUR FUTURE PERFORMANCE IS SUBJECT TO A VARIETY OF RISKS, INCLUDING THOSE DESCRIBED BELOW. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS COULD BE HARMED AND THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE. YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED IN THIS REPORT, INCLUDING OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES.

 

adversely affect our operating results. Furthermore, our customer agreements typically provide that the customer may delay scheduled delivery dates and cancel orders within specified timeframes without significant penalty. Because we base our operating expenses on anticipated revenue trends and a high percentage of our expenses are fixed in the short term, any delay in generating or recognizing forecasted revenues could significantly harm our business. It is likely that in some future quarters our operating results will again decrease from the previous quarter or fall below the expectations of securities analysts and investors. In this event, it is likely that the trading price of our common stock would significantly decline.

 

As a result of these factors, our operating results may vary significantly from quarter to quarter. Accordingly, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indications of future performance. Any shortfall in revenues or net income from levels expected by the investment community could cause a decline in the trading price of our stock.

 

We may lose sales if our suppliers or independent contract manufacturers fail to meet our needs or go out of business.

 

We currently purchase a number of key components used in the manufacture of our products from single or limited sources, and we rely on several independent contract manufacturers to supply us with certain key subassemblies, including lasers, modulators, and printed circuit boards. We depend on these sources to meet our production needs. Moreover, we depend on the quality of the components and subassemblies that they supply to us, over which we have limited control. Several of our suppliers are or may become financially unstable as the result of current global market conditions. In addition, from time to time we have encountered shortages and delays in obtaining components. We are currently encountering such shortages and expect to encounter additional shortages and delays in the future. Recently, many of our suppliers have extended lead times for many of their products as the result of significantly reducing capacity in light of the global slowdown in demand. This reduction in capacity has reduced the ability of many suppliers to respond to increases in demand. If we cannot supply products due to a lack of components, or are unable to redesign products with other components in a timely manner, our business will be significantly harmed. We generally have no long-term contracts with any of our component suppliers or contract manufacturers. As a result, a supplier or contract manufacturer can discontinue supplying components or subassemblies to us without penalty. If a supplier were to discontinue supplying a key component or cease operations, our business may be harmed by the resulting product manufacturing and delivery delays. We are also subject to potential delays in the development by our suppliers of key components which may affect our ability to introduce new products. Similarly, disruptions in the services provided by our contract manufacturers or the transition to other suppliers of these services could lead to supply chain problems or delays in the delivery of our products. These problems or delays could damage our relationships with our customers and adversely affect our business.

 

We use rolling forecasts based on anticipated product orders to determine our component and subassembly requirements. Lead times for materials and components that we order vary significantly and depend on factors such as specific supplier requirements, contract terms and current market demand for particular components. If we overestimate our component requirements, we may have excess inventory, which would increase our costs. If we underestimate our component requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences could significantly harm our business.

 

If we are unable to realize anticipated cost savings from the transfer of certain manufacturing operations to our overseas locations and increased use of internally-manufactured components our results of operations could be harmed.

 

As part of our initiatives to reduce the cost of revenues planned for the next several quarters, we expect to realize significant cost savings through (i) the transfer of certain product manufacturing operations to lower cost off-shore locations and (ii) product engineering changes to enable the broader use of internally-manufactured components. The transfer of production to overseas locations may be more difficult and costly than we currently anticipate which could result in increased transfer costs and time delays. Further, following transfer, we may experience lower manufacturing yields than those historically achieved in our U.S. manufacturing locations. In addition, the engineering changes required for the use of internally-manufactured components may be more

technically-challenging than we anticipate and customer acceptance of such changes could be delayed. If we fail to achieve the planned product manufacturing transfer and increase in internally-manufactured component use within our currently anticipated timeframe, or if our manufacturing yields decrease as a result, we may be unsuccessful in achieving cost savings or such savings will be less than anticipated, and our results of operations could be harmed.

 

Failure to accurately forecast our revenues could result in additional charges for obsolete or excess inventories or non-cancellable purchase commitments.

 

We base many of our operating decisions, and enter into purchase commitments, on the basis of anticipated revenue trends which are highly unpredictable. Some of our purchase commitments are not cancelable, and in some cases we are required to recognize a charge representing the amount of material or capital equipment purchased or ordered which exceeds our actual requirements. In the past, we have sometimes experienced significant growth followed by a significant decrease in customer demand such as occurred in fiscal 2001, when revenues increased by 181% followed by a decrease of 22% in fiscal 2002. Based on projected revenue trends during these periods, we acquired inventories and entered into purchase commitments in order to meet anticipated increases in demand for our products which did not materialize. As a result, we recorded significant charges for obsolete and excess inventories and non-cancelable purchase commitments which contributed to substantial operating losses in fiscal 2002. Should revenues in future periods again fall substantially below our expectations, or should we fail again to accurately forecast changes in demand mix, we could be required to record additional charges for obsolete or excess inventories or non-cancelable purchase commitments.

 

If we encounter sustained yield problems or other delays in the production or delivery of our internally-manufactured components or in the final assembly and test of our transceiver products, we may lose sales and damage our customer relationships.

 

Our manufacturing operations are highly vertically integrated. In order to reduce our manufacturing costs, we have acquired a number of companies, and business units of other companies, that manufacture optical components incorporated in our optical subsystem products and have developed our own facilities for the final assembly and testing of our products. For example, we design and manufacture many critical components including all of the short wavelength VCSEL lasers incorporated in transceivers used for LAN/SAN applications at our wafer fabrication facility in Allen, Texas and manufacture a portion of our internal requirements for longer wavelength lasers at our wafer fabrication facility in Fremont, California. We assemble and test most of our transceiver products at our facility in Ipoh, Malaysia. As a result of this vertical integration, we have become increasingly dependent on our internal production capabilities. The manufacture of critical components, including the fabrication of wafers, and the assembly and testing of our products, involve highly complex processes. For example, minute levels of contaminants in the manufacturing environment, difficulties in the fabrication process or other factors can cause a substantial portion of the components on a wafer to be nonfunctional. These problems may be difficult to detect at an early stage of the manufacturing process and often are time-consuming and expensive to correct. From time to time, we have experienced problems achieving acceptable yields at our wafer fabrication facilities, resulting in delays in the availability of components. Moreover, an increase in the rejection rate of products during the quality control process before, during or after manufacture, results in lower yields and margins. In addition, changes in manufacturing processes required as a result of changes in product specifications, changing customer needs and the introduction of new product lines have historically significantly reduced our manufacturing yields, resulting in low or negative margins on those products. Poor manufacturing yields over a prolonged period of time could adversely affect our ability to deliver our subsystem products to our customers and could also affect our sale of components to customers in the merchant market. Our inability to supply components to meet our internal needs could harm our relationships with customers and have an adverse effect on our business.

 

We are dependent on widespread market acceptance of our optical subsystems and components, and our revenues will decline if the markets for these products do not expand as expected.

 

We derive all of our revenue from sales of our optical subsystems and components. Accordingly, widespread acceptance of these products is critical to our future success. If the market does not continue to accept our optical subsystems and components, our revenues will decline significantly. Our future success also ultimately depends on

the continued growth of the communications industry and, in particular, the continued expansion of global information networks, particularly those directly or indirectly dependent upon a fiber optics infrastructure. As part of that growth, we are relying on increasing demand for voice, video and other data delivered over high-bandwidth network systems as well as commitments by network systems vendors to invest in the expansion of the global information network. As network usage and bandwidth demand increase, so does the need for advanced optical networks to provide the required bandwidth. Without network and bandwidth growth, the need for optical subsystems and components, and hence our future growth as a manufacturer of these products, will be jeopardized, and our business would be significantly harmed.

 

Many of these factors are beyond our control. In addition, in order to achieve widespread market acceptance, we must differentiate ourselves from our competition through product offerings and brand name recognition. We cannot assure you that we will be successful in making this differentiation or achieving widespread acceptance of our products. Failure of our existing or future products to maintain and achieve widespread levels of market acceptance will significantly impair our revenue growth.

 

We depend on large purchases from a few significant customers, and any loss, cancellation, reduction or delay in purchases by these customers could harm our business.

 

A small number of customers have consistently accounted for a significant portion of our revenues. For example, sales to our top five customers represented 43% of our revenues in fiscal 2010 and 42% of our revenues in fiscal 2009. Our success will depend on our continued ability to develop and manage relationships with our major customers. Although we are attempting to expand our customer base, we expect that significant customer concentration will continue for the foreseeable future. We may not be able to offset any decline in revenues from our existing major customers with revenues from new customers, and our quarterly results may be volatile because we are dependent on large orders from these customers that may be reduced or delayed.

 

The markets in which we have historically sold our optical subsystems and components products are dominated by a relatively small number of systems manufacturers, thereby limiting the number of our potential customers. Recent consolidation of portions of our customer base, including telecommunications systems manufacturers and potential future consolidation, may have a material adverse impact on our business. Our dependence on large orders from a relatively small number of customers makes our relationship with each customer critically important to our business. We cannot assure you that we will be able to retain our largest customers, that we will be able to attract additional customers or that our customers will be successful in selling their products that incorporate our products. We have in the past experienced delays and reductions in orders from some of our major customers. In addition, our customers have in the past sought price concessions from us, and we expect that they will continue to do so in the future. Expense reduction measures that we have implemented over the past several years, and additional action we may take to reduce costs, may adversely affect our ability to introduce new and improved products which may, in turn, adversely affect our relationships with some of our key customers. Further, some of our customers may in the future shift their purchases of products from us to our competitors or to joint ventures between these customers and our competitors. The loss of one or more of our largest customers, any reduction or delay in sales to these customers, our inability to successfully develop relationships with additional customers or future price concessions that we may make could significantly harm our business.

 

Because we do not have long-term contracts with our customers, our customers may cease purchasing our products at any time if we fail to meet our customers’ needs.

 

Typically, we do not have long-term contracts with our customers. As a result, our agreements with our customers do not provide any assurance of future sales. Accordingly:

 

 

Sales are typically made pursuant to inventory hub arrangements under which customers may draw down inventory to satisfy their demand as needed or pursuant to individual purchase orders, often with extremely short

lead times. If we are unable to fulfill these orders in a timely manner, it is likely that we will lose sales and customers. If our major customers stop purchasing our products for any reason, our business and results of operations would be harmed.

 

We may not be able to obtain additional capital in the future, and failure to do so may harm our business.

 

We believe that our existing balances of cash, cash equivalents and short-term investments, together with the cash expected to be generated from future operations and borrowings under our bank credit facility, will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional financing to fund our operations in the future or to repay or otherwise retire our outstanding 5% convertible debt in the aggregate principal amount of $100 million which is subject to redemption by the holders in October 2014, 2016, 2019 and 2024. Due to the unpredictable nature of the capital markets, particularly in the technology sector, we cannot assure you that we will be able to raise additional capital if and when it is required, especially if we experience disappointing operating results. If adequate capital is not available to us as required, or is not available on favorable terms, we could be required to significantly reduce or restructure our business operations. If we do raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our existing stockholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders.

 

The markets for our products are subject to rapid technological change, and to compete effectively we must continually introduce new products that achieve market acceptance.

 

The markets for our products are characterized by rapid technological change, frequent new product introductions, substantial capital investment, changes in customer requirements and evolving industry standards with respect to the protocols used in data communications, telecommunications and cable TV networks. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address these changes as well as current and potential customer requirements. For example, the market for optical subsystems is currently characterized by a trend toward the adoption of “pluggable” modules and subsystems that do not require customized interconnections and by the development of more complex and integrated optical subsystems. We expect that new technologies will emerge as competition and the need for higher and more cost-effective bandwidth increases. The introduction of new and enhanced products may cause our customers to defer or cancel orders for existing products. In addition, a slowdown in demand for existing products ahead of a new product introduction could result in a write-down in the value of inventory on hand related to existing products. We have in the past experienced a slowdown in demand for existing products and delays in new product development and such delays may occur in the future. To the extent customers defer or cancel orders for existing products due to a slowdown in demand or in the expectation of a new product release or if there is any delay in development or introduction of our new products or enhancements of our products, our operating results would suffer. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements, or to license these technologies from third parties. Product development delays may result from numerous factors, including:

 

 

The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. The introduction of new products also requires significant investment to ramp up production capacity, for which benefit will not be realized if customer demand does not develop as expected.

Ramping of production capacity also entails risks of delays which can limit our ability to realize the full benefit of the new product introduction. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Any failure to respond to technological change would significantly harm our business.

 

Continued competition in our markets may lead to an accelerated reduction in our prices, revenues and market share.

 

The end markets for optical products have experienced significant industry consolidation during the past few years while the industry that supplies these customers has experienced less consolidation. As a result, the markets for optical subsystems and components are highly competitive. Our current competitors include a number of domestic and international companies, many of which have substantially greater financial, technical, marketing and distribution resources and brand name recognition than we have. Increased consolidation in our industry, should it occur, will reduce the number of our competitors but would be likely to further strengthen surviving industry participants. We may not be able to compete successfully against either current or future competitors. Companies competing with us may introduce products that are competitively priced, have increased performance or functionality, or incorporate technological advances and may be able to react quicker to changing customer requirements and expectations. There is also the risk that network systems vendors may re-enter the subsystem market and begin to manufacture the optical subsystems incorporated in their network systems. Increased competition could result in significant price erosion, reduced revenue, lower margins or loss of market share, any of which would significantly harm our business. Our principal competitors for optical transceivers sold for applications based on the Fibre Channel and Ethernet protocols include Avago Technologies (formerly part of Agilent Technologies) and JDSU. Our principal competitors for optical transceivers sold for MAN, WAN and telecom applications based on the SONET/SDH protocols include Oclaro (formed with the merger of Bookham and Avanex), Opnext and Sumitomo. Our principal competitors for WSS ROADM products include CoAdna, JDSU, Oclaro and Oplink. Our principal competitors for CATV products include AOI and Emcore. Our competitors continue to introduce improved products and we will have to do the same to remain competitive.

 

Decreases in average selling prices of our products may reduce our gross margins.

 

The market for optical subsystems is characterized by declining average selling prices resulting from factors such as increased competition, overcapacity, the introduction of new products and increased unit volumes as manufacturers continue to deploy network and storage systems. We have in the past experienced, and in the future may experience, substantial period-to-period fluctuations in operating results due to declining average selling prices. We anticipate that average selling prices will decrease in the future in response to product introductions by competitors or us, or by other factors, including pricing pressures from significant customers. Therefore, in order to achieve and sustain profitable operations, we must continue to develop and introduce on a timely basis new products that incorporate features that can be sold at higher average selling prices. Failure to do so could cause our revenues and gross margins to decline, which would result in additional operating losses and significantly harm our business.

 

We may be unable to reduce the cost of our products sufficiently to enable us to compete with others. Our cost reduction efforts may not allow us to keep pace with competitive pricing pressures and could adversely affect our margins. In order to remain competitive, we must continually reduce the cost of manufacturing our products through design and engineering changes. We may not be successful in redesigning our products or delivering our products to market in a timely manner. We cannot assure you that any redesign will result in sufficient cost reductions to allow us to reduce the price of our products to remain competitive or improve our gross margins.

 

Shifts in our product mix may result in declines in gross margins.

 

Our optical products sold for longer distance MAN and telecom applications typically have higher gross margins than our products for shorter distance LAN or SAN applications. Gross margins on individual products fluctuate over the product’s life cycle. Our overall gross margins have fluctuated from period to period as a result of

shifts in product mix, the introduction of new products, decreases in average selling prices for older products and our ability to reduce product costs, and these fluctuations are expected to continue in the future.

 

Our customers often evaluate our products for long and variable periods, which causes the timing of our revenues and results of operations to be unpredictable.

 

The period of time between our initial contact with a customer and the receipt of an actual purchase order may span a year or more. During this time, customers may perform, or require us to perform, extensive and lengthy evaluation and testing of our products before purchasing and using the products in their equipment. These products often take substantial time to develop because of their complexity and because customer specifications sometimes change during the development cycle. Our customers do not typically share information on the duration or magnitude of these qualification procedures. The length of these qualification processes also may vary substantially by product and customer, and, thus, cause our results of operations to be unpredictable. While our potential customers are qualifying our products and before they place an order with us, we may incur substantial research and development and sales and marketing expenses and expend significant management effort. Even after incurring such costs we ultimately may not sell any products to such potential customers. In addition, these qualification processes often make it difficult to obtain new customers, as customers are reluctant to expend the resources necessary to qualify a new supplier if they have one or more existing qualified sources. Once our products have been qualified, the agreements that we enter into with our customers typically contain no minimum purchase commitments. Failure of our customers to incorporate our products into their systems would significantly harm our business.

 

We will lose sales if we are unable to obtain government authorization to export certain of our products, and we would be subject to legal and regulatory consequences if we do not comply with applicable export control laws and regulations.

 

Exports of certain of our products are subject to export controls imposed by the U.S. Government and administered by the United States Departments of State and Commerce. In certain instances, these regulations may require pre-shipment authorization from the administering department. For products subject to the Export Administration Regulations, or EAR, administered by the Department of Commerce’s Bureau of Industry and Security, the requirement for a license is dependent on the type and end use of the product, the final destination, the identity of the end user and whether a license exception might apply. Virtually all exports of products subject to the International Traffic in Arms Regulations, or ITAR, administered by the Department of State’s Directorate of Defense Trade Controls, require a license. Certain of our fiber optics products are subject to EAR and certain of our RF over fiber products, as well as certain products developed with government funding, are currently subject to ITAR. Products developed and manufactured in our foreign locations are subject to export controls of the applicable foreign nation.

 

Given the current global political climate, obtaining export licenses can be difficult and time-consuming. Failure to obtain export licenses for these shipments could significantly reduce our revenue and materially adversely affect our business, financial condition and results of operations. Compliance with U.S. Government regulations may also subject us to additional fees and costs. The absence of comparable restrictions on competitors in other countries may adversely affect our competitive position.

 

During mid-2007, Optium became aware that certain of its analog RF over fiber products may, depending on end use and customization, be subject to ITAR. Accordingly, Optium filed a detailed voluntary disclosure with the United States Department of State describing the details of possible inadvertent ITAR violations with respect to the export of a limited number of certain prototype products, as well as related technical data and defense services. Optium may have also made unauthorized transfers of ITAR-restricted technical data and defense services to foreign persons in the workplace. Additional information has been provided upon request to the Department of State with respect to this matter. In late 2008, a grand jury subpoena from the office of the U.S. Attorney for the Eastern District of Pennsylvania was received requesting documents from 2005 through the present referring to, relating to or involving the subject matter of the above referenced voluntary disclosure and export activities.

While the Department of State encourages voluntary disclosures and generally affords parties mitigating credit under such circumstances, we nevertheless could be subject to continued investigation and potential regulatory consequences ranging from a no-action letter, government oversight of facilities and export transactions, monetary penalties, and in extreme cases, debarment from government contracting, denial of export privileges and criminal sanctions, any of which would adversely affect our results of operations and cash flow. The Department of State and U.S. Attorney inquiries may require us to expend significant management time and incur significant legal and other expenses. We cannot predict how long it will take or how much more time and resources we will have to expend to resolve these government inquiries, nor can we predict the outcome of these inquiries.

 

We depend on facilities located outside of the United States to manufacture a substantial portion of our products, which subjects us to additional risks.

 

In addition to our principal manufacturing facility in Malaysia, we operate smaller facilities in Australia, China, Israel and Singapore. We also rely on several contract manufacturers located in Asia for our supply of key subassemblies. Each of these facilities and manufacturers subjects us to additional risks associated with international manufacturing, including:

 

 

Any of these factors could significantly impair our ability to source our contract manufacturing requirements internationally.

 

Our future operating results may be subject to volatility as a result of exposure to foreign exchange risks.

 

We are exposed to foreign exchange risks. Foreign currency fluctuations may affect both our revenues and our costs and expenses and significantly affect our operating results. Prices for our products are currently denominated in U.S. dollars for sales to our customers throughout the world. If there is a significant devaluation of the currency in a specific country relative to the dollar, the prices of our products will increase relative to that country’s currency, our products may be less competitive in that country and our revenues may be adversely affected.

 

Although we price our products in U.S. dollars, portions of both our cost of revenues and operating expenses are incurred in foreign currencies, principally the Malaysian ringgit, the Chinese yuan, the Australian dollar and the Israeli shekel. As a result, we bear the risk that the rate of inflation in one or more countries will exceed the rate of the devaluation of that country’s currency in relation to the U.S. dollar, which would increase our costs as expressed in U.S. dollars. To date, we have not engaged in currency hedging transactions to decrease the risk of financial exposure from fluctuations in foreign exchange rates.

 

Our business and future operating results are subject to a wide range of uncertainties arising out of the continuing threat of terrorist attacks and ongoing military actions in the Middle East.

 

Like other U.S. companies, our business and operating results are subject to uncertainties arising out of the continuing threat of terrorist attacks on the United States and ongoing military actions in the Middle East, including

the economic consequences of the war in Afghanistan and Iraq or additional terrorist activities and associated political instability, and the impact of heightened security concerns on domestic and international travel and commerce. In particular, due to these uncertainties we are subject to:

 

 

Past and future acquisitions could be difficult to integrate, disrupt our business, dilute stockholder value and harm our operating results.

 

In addition to our combination with Optium in August 2008, we have completed the acquisition of ten privately-held companies and certain businesses and assets from six other companies since October 2000. We continue to review opportunities to acquire other businesses, product lines or technologies that would complement our current products, expand the breadth of our markets or enhance our technical capabilities, or that may otherwise offer growth opportunities, and we from time to time make proposals and offers, and take other steps, to acquire businesses, products and technologies.

 

The Optium merger and several of our other past acquisitions have been material, and acquisitions that we may complete in the future may be material. In 13 of our 17 acquisitions, we issued common stock or notes convertible into common stock as all or a portion of the consideration. The issuance of common stock or other equity securities by us in connection with any future acquisition would dilute our stockholders’ percentage ownership.

 

Other risks associated with acquiring the operations of other companies include:

 

 

Not all of our past acquisitions have been successful. In the past, we have subsequently sold some of the assets acquired in prior acquisitions, discontinued product lines and closed acquired facilities. As a result of these activities, we incurred significant restructuring charges and charges for the write-down of assets associated with those acquisitions. Through fiscal 2009, we have written off all of the goodwill associated with past acquisitions. We cannot assure you that we will be successful in overcoming problems encountered in connection with more recently completed acquisitions or potential future acquisitions, and our inability to do so could significantly harm our business. In addition, to the extent that the economic benefits associated with any of our completed or future acquisitions diminish in the future, we may be required to record additional write downs of goodwill, intangible assets or other assets associated with such acquisitions, which would adversely affect our operating results.

 

We have made and may continue to make strategic investments which may not be successful, may result in the loss of all or part of our invested capital and may adversely affect our operating results.

 

Since inception we have made minority equity investments in early-stage technology companies, totaling approximately $56 million. Our investments in these early stage companies were primarily motivated by our desire to gain early access to new technology. We intend to review additional opportunities to make strategic equity investments in pre-public companies where we believe such investments will provide us with opportunities to gain

access to important technologies or otherwise enhance important commercial relationships. We have little or no influence over the early-stage companies in which we have made or may make these strategic, minority equity investments. Each of these investments in pre-public companies involves a high degree of risk. We may not be successful in achieving the financial, technological or commercial advantage upon which any given investment is premised, and failure by the early-stage company to achieve its own business objectives or to raise capital needed on acceptable economic terms could result in a loss of all or part of our invested capital. Between fiscal 2003 and 2010, we wrote off an aggregate of $26.8 million in six investments which became impaired and reclassified $4.2 million of another investment to goodwill as the investment was deemed to have no value. We may be required to write off all or a portion of the $12.3 million in such investments remaining on our balance sheet as of April 30, 2010 in future periods.

 

Our ability to utilize certain net operating loss carryforwards and tax credit carryforwards may be limited under Section 382 of the Internal Revenue Code.

 

As of April 30, 2010, we had net operating loss, or NOL, carryforward amounts of approximately $485 million for U.S. federal income tax purposes and $160.5 million for state income tax purposes, and U.S. federal and state tax credit carryforward amounts of approximately $14.7 million for U.S. federal income tax purposes and $10.1 million for state income tax purposes. The federal and state tax credit carryforwards will expire at various dates beginning in 2010 through 2029 and of such carry forwards $2.2 million will expire in the next five years. The federal and state NOLs carryforwards will expire at various dates beginning in 2011 through 2029 and of such carry forwards $94.6 million will expire in the next five years. Utilization of these NOL and tax credit carryforward amounts may be subject to a substantial annual limitation if the ownership change limitations under Section 382 of the Internal Revenue Code and similar state provisions are triggered by changes in the ownership of our capital stock. Such an annual limitation could result in the expiration of the NOL and tax credit carryforward amounts before utilization.

 

Because of competition for technical personnel, we may not be able to recruit or retain necessary personnel.

 

We believe our future success will depend in large part upon our ability to attract and retain highly skilled managerial, technical, sales and marketing, finance and manufacturing personnel. In particular, we may need to increase the number of technical staff members with experience in high-speed networking applications as we further develop our product lines. Competition for these highly skilled employees in our industry is intense. In making employment decisions, particularly in the high-technology industries, job candidates often consider the value of the equity they are to receive in connection with their employment. Therefore, significant volatility in the price of our common stock may adversely affect our ability to attract or retain technical personnel. Furthermore, changes to accounting principles generally accepted in the United States relating to the expensing of stock options may limit our ability to grant the sizes or types of stock awards that job candidates may require to accept employment with us. Our failure to attract and retain these qualified employees could significantly harm our business. The loss of the services of any of our qualified employees, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel could hinder the development and introduction of and negatively impact our ability to sell our products. In addition, employees may leave our company and subsequently compete against us. Moreover, companies in our industry whose employees accept positions with competitors frequently claim that their competitors have engaged in unfair hiring practices. We have been subject to claims of this type and may be subject to such claims in the future as we seek to hire qualified personnel. Some of these claims may result in material litigation. We could incur substantial costs in defending ourselves against these claims, regardless of their merits.

 

Our failure to protect our intellectual property may significantly harm our business.

 

Our success and ability to compete is dependent in part on our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality agreements to establish and protect our proprietary rights. We license certain of our proprietary technology, including our digital diagnostics technology, to customers who include current and potential competitors, and we rely largely on provisions of our licensing agreements to protect our intellectual property rights in this technology. Although a number of patents

have been issued to us, we have obtained a number of other patents as a result of our acquisitions, and we have filed applications for additional patents, we cannot assure you that any patents will issue as a result of pending patent applications or that our issued patents will be upheld. Additionally, significant technology used in our product lines is not the subject of any patent protection, and we may be unable to obtain patent protection on such technology in the future. Any infringement of our proprietary rights could result in significant litigation costs, and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of a competitive advantage and decreased revenues.

 

Despite our efforts to protect our proprietary rights, existing patent, copyright, trademark and trade secret laws afford only limited protection. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, we may not be able to prevent misappropriation of our technology or deter others from developing similar technology. Furthermore, policing the unauthorized use of our products is difficult and expensive. We are currently engaged in pending litigation to enforce certain of our patents, and additional litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. In connection with the pending litigation, substantial management time has been, and will continue to be, expended. In addition, we have incurred, and we expect to continue to incur, substantial legal expenses in connection with these pending lawsuits. These costs and this diversion of resources could significantly harm our business.

 

Claims that we infringe third-party intellectual property rights could result in significant expenses or restrictions on our ability to sell our products.

 

The networking industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. We have been involved in the past as a defendant in patent infringement lawsuits, and we were recently found liable in a patent infringement lawsuit filed against Optium by JDSU and Emcore Corporation. This suit involved two of our cable television products, each of which has been redesigned. In addition, in connection with a patent infringement lawsuit that we initiated in January 2010 against Source Photonics, MRV Communications, NeoPhotonics and Oplink, each of Source Photonics and NeoPhotonics raised counterclaims alleging patent infringement by us. The Source Photonics counterclaims were raised against certain of our transceiver products and the NeoPhotonics counterclaims were raised against certain of our WSS products. While, as a result of various procedural events in this lawsuit, these patent counterclaims are not currently being asserted against us, such claims may be re-asserted against us in the future. From time to time, other parties may assert patent, copyright, trademark and other intellectual property rights to technologies and in various jurisdictions that are important to our business. Any claims asserting that our products infringe or may infringe proprietary rights of third parties, if determined adversely to us, could significantly harm our business. Any claims, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel, cause product shipment delays or require us to enter into royalty or licensing agreements, any of which could significantly harm our business. In addition, our agreements with our customers typically require us to indemnify our customers from any expense or liability resulting from claimed infringement of third party intellectual property rights. In the event a claim against us was successful and we could not obtain a license to the relevant technology on acceptable terms or license a substitute technology or redesign our products to avoid infringement, our business would be significantly harmed.

 

Numerous patents in our industry are held by others, including academic institutions and competitors. Optical subsystem suppliers may seek to gain a competitive advantage or other third parties may seek an economic return on their intellectual property portfolios by making infringement claims against us. In the future, we may need to obtain license rights to patents or other intellectual property held by others to the extent necessary for our business. Unless we are able to obtain those licenses on commercially reasonable terms, patents or other intellectual property held by others could inhibit our development of new products. Licenses granting us the right to use third party technology may not be available on commercially reasonable terms, if at all. Generally, a license, if granted, would include payments of up-front fees, ongoing royalties or both. These payments or other terms could have a significant adverse impact on our operating results.

Our products may contain defects that may cause us to incur significant costs, divert our attention from product development efforts and result in a loss of customers.

 

Our products are complex and defects may be found from time to time. Networking products frequently contain undetected software or hardware defects when first introduced or as new versions are released. In addition, our products are often embedded in or deployed in conjunction with our customers’ products which incorporate a variety of components produced by third parties. As a result, when problems occur, it may be difficult to identify the source of the problem. These problems may cause us to incur significant damages or warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relation problems or loss of customers, all of which would harm our business.

 

We are subject to pending shareholder derivative legal proceedings.

 

We have been named as a nominal defendant in several purported shareholder derivative lawsuits concerning the granting of stock options. These cases have been consolidated into two proceedings pending in federal and state courts in California. The plaintiffs in all of these cases have alleged that certain current or former officers and directors of Finisar caused it to grant stock options at less than fair market value, contrary to our public statements (including statements in our financial statements), and that, as a result, those officers and directors are liable to Finisar. No specific amount of damages has been alleged and, by the nature of the lawsuits no damages will be alleged, against Finisar. On May 22, 2007, the state court granted our motion to stay the state court action pending resolution of the consolidated federal court action. On August 28, 2007, we and the individual defendants filed motions to dismiss the complaint which were granted on January 11, 2008. On May 12, 2008, the plaintiffs filed a further amended complaint in the federal court action. On July 1, 2008, we and the individual defendants filed motions to dismiss the amended complaint. On September 22, 2009, the Court granted the motions to dismiss. The plaintiffs are appealing this order. We will continue to incur legal fees in this case, including expenses for the reimbursement of legal fees of present and former officers and directors under indemnification obligations. The expense of continuing to defend such litigation may be significant. The amount of time to resolve these lawsuits is unpredictable and these actions may divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows.

 

Our business and future operating results may be adversely affected by events outside our control.

 

Our business and operating results are vulnerable to events outside of our control, such as earthquakes, fire, power loss, telecommunications failures and uncertainties arising out of terrorist attacks in the United States and overseas. Our corporate headquarters and a portion of our manufacturing operations are located in California. California in particular has been vulnerable to natural disasters, such as earthquakes, fires and floods, and other risks which at times have disrupted the local economy and posed physical risks to our property. We are also dependent on communications links with our overseas manufacturing locations and would be significantly harmed if these links were interrupted for any significant length of time. We presently do not have adequate redundant, multiple site capacity if any of these events were to occur, nor can we be certain that the insurance we maintain against these events would be adequate.

 

The conversion of our outstanding convertible subordinated notes would result in substantial dilution to our current stockholders.

 

As of April 30, 2010, we had outstanding 5.0% Convertible Senior Notes due 2029 in the principal amount of $100.0 million, 2 1 / 2 % Convertible Senior Subordinated Notes due 2010 in the principal amount of $25.7 million and 2 1 / 2 % Convertible Subordinated Notes due 2010 in the principal amount of $3.9 million. The $100.0 million in principal amount of our 5.0% Senior Notes are convertible, at the option of the holder, at any time on or prior to maturity into shares of our common stock at a conversion price of $10.68 per share. The $3.9 million in principal amount of our 2 1 / 2 % Convertible Subordinated Notes are convertible, at the option of the holder, at any time on or prior to maturity into shares of our common stock at a conversion price of $29.64 per share. The $25.7 million in principal amount of our 2 1 / 2 % Convertible Senior Subordinated Notes are convertible at a conversion price of $26.24, with the underlying principal payable in cash, upon the trading price of our common stock reaching $39.36 for a period of time. An aggregate of approximately 9,821,000 shares of common stock would be issued upon the

conversion of all outstanding convertible notes at these exchange rates, which would dilute the voting power and ownership percentage of our existing stockholders. We have previously entered into privately negotiated transactions with certain holders of our convertible notes for the repurchase of notes in exchange for a greater number of shares of our common stock than would have been issued had the principal amount of the notes been converted at the original conversion rate specified in the notes, thus resulting in more dilution. We may enter into similar transactions in the future and, if we do so, there will be additional dilution to the voting power and percentage ownership of our existing stockholders.

 

Delaware law, our charter documents and our stockholder rights plan contain provisions that could discourage or prevent a potential takeover, even if such a transaction would be beneficial to our stockholders.

 

Some provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. These include provisions:

 

 

We are subject to the provisions of Section 203 of the Delaware General Corporation Law which limit the right of a corporation to engage in a business combination with a holder of 15% or more of the corporation’s outstanding voting securities, or certain affiliated persons.

 

In addition, in September 2002, our board of directors adopted a stockholder rights plan under which our stockholders received one share purchase right for each share of our common stock held by them. Subject to certain exceptions, the rights become exercisable when a person or group (other than certain exempt persons) acquires, or announces its intention to commence a tender or exchange offer upon completion of which such person or group would acquire, 20% or more of our common stock without prior board approval. Should such an event occur, then, unless the rights are redeemed or have expired, our stockholders, other than the acquirer, will be entitled to purchase shares of our common stock at a 50% discount from its then-Current Market Price (as defined) or, in the case of certain business combinations, purchase the common stock of the acquirer at a 50% discount.

 

Although we believe that these charter and bylaw provisions, provisions of Delaware law and our stockholder rights plan provide an opportunity for the board to assure that our stockholders realize full value for their investment, they could have the effect of delaying or preventing a change of control, even under circumstances that some stockholders may consider beneficial.

 

We do not currently intend to pay dividends on Finisar common stock and, consequently, a stockholder’s ability to achieve a return on such stockholder’s investment will depend on appreciation in the price of the common stock.

 

We have never declared or paid any cash dividends on Finisar common stock and we do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth.

Therefore, a stockholder is not likely to receive any dividends on such stockholder’s common stock for the foreseeable future. In addition, our credit facility with Wells Fargo LLC contains restrictions on our ability to pay dividends.

 

Our stock price has been and is likely to continue to be volatile.

 

The trading price of our common stock has been and is likely to continue to be subject to large fluctuations. Our stock price may increase or decrease in response to a number of events and factors, including:

 

 

Part of this volatility is attributable to the current state of the stock market, in which wide price swings are common. This volatility may adversely affect the prices of our common stock regardless of our operating performance. If any of the foregoing occurs, our stock price could fall and we may be exposed to class action lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.

 

 

reports on Form 10-Q for the quarters ended October 29, 2006, January 28, 2007, and January 27, 2008, and our annual report on Form 10-K for the fiscal year ended April 30, 2007. On December 4, 2007, we filed all four of these reports which included revised financial statements.

 

Following our announcement on November 30, 2006 that the Audit Committee of the board of directors had voluntarily commenced an investigation of our historical stock option grant practices, we were named as a nominal defendant in several shareholder derivative cases. These cases have been consolidated into two proceedings pending in federal and state courts in California. The federal court cases have been consolidated in the United States District Court for the Northern District of California. The state court cases have been consolidated in the Superior Court of California for the County of Santa Clara. The plaintiffs in all cases have alleged that certain of our current or former officers and directors caused us to grant stock options at less than fair market value, contrary to our public statements (including our financial statements), and that, as a result, those officers and directors are liable to us. No specific amount of damages has been alleged, and by the nature of the lawsuits, no damages will be alleged against us. On May 22, 2007, the state court granted our motion to stay the state court action pending resolution of the consolidated federal court action. On June 12, 2007, the plaintiffs in the federal court case filed an amended complaint to reflect the results of the stock option investigation announced by the Audit Committee in June 2007. On August 28, 2007, we and the individual defendants filed motions to dismiss the complaint. On January 11, 2008, the Court granted the motions to dismiss, with leave to amend. On May 12, 2008, the plaintiffs filed an amended complaint. We and the individual defendants filed motions to dismiss the amended complaint on July 1, 2008. The Court granted the motions to dismiss on September 22, 2009, and entered judgment in favor of the defendants. The plaintiffs have appealed the judgment to the United States Court of Appeal for the Ninth Circuit.

 

Securities Class Action

 

A securities class action lawsuit was filed on November 30, 2001 in the United States District Court for the Southern District of New York, purportedly on behalf of all persons who purchased our common stock from November 17, 1999 through December 6, 2000. The complaint named as defendants Finisar, Jerry S. Rawls, our President and Chief Executive Officer, Frank H. Levinson, our former Chairman of the Board and Chief Technical Officer, Stephen K. Workman, our Senior Vice President, Corporate Development and Investor Relations and our former Senior Vice President and Chief Financial Officer, and an investment banking firm that served as an underwriter for our initial public offering in November 1999 and a secondary offering in April 2000. The complaint, as subsequently amended, alleges violations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(b) of the Securities Exchange Act of 1934, on the grounds that the prospectuses incorporated in the registration statements for the offerings failed to disclose, among other things, that (i) the underwriter had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriter allocated to those investors material portions of the shares of our stock sold in the offerings and (ii) the underwriter had entered into agreements with customers whereby the underwriter agreed to allocate shares of our stock sold in the offerings to those customers in exchange for which the customers agreed to purchase additional shares of our stock in the aftermarket at pre-determined prices. No specific damages are claimed. Similar allegations have been made in lawsuits relating to more than 300 other initial public offerings conducted in 1999 and 2000, which were consolidated for pretrial purposes. In October 2002, all claims against the individual defendants were dismissed without prejudice. On February 19, 2003, the Court denied defendants’ motion to dismiss the complaint.

 

In February 2009, the parties reached an understanding regarding the principal elements of a settlement, subject to formal documentation and Court approval. Under the settlement, the underwriter defendants will pay a total of $486 million, and the issuer defendants and their insurers will pay a total of $100 million to settle all of the cases. On August 25, 2009, we funded approximately $327,000 with respect to our pro rata share of the issuers’ contribution to the settlement and certain costs. This amount was accrued in the financial statements during the first quarter of fiscal 2010. On October 2, 2009, the Court granted approval of the settlement and on November 19, 2009 the Court entered final judgment. The judgment has been appealed by certain individual class members.

 

Section 16(b) Lawsuit

 

A lawsuit was filed on October 3, 2007 in the United States District Court for the Western District of Washington by Vanessa Simmonds, a purported holder of our common stock, against two investment banking firms

that served as underwriters for the initial public offering of our common stock in November 1999. None of our officers, directors or employees were named as defendants in the complaint. On February 28, 2008, the plaintiff filed an amended complaint. The complaint, as amended, alleges that: (i) the defendants, other underwriters of the offering, and unspecified officers, directors and our principal shareholders constituted a “group” that owned in excess of 10% of our outstanding common stock between November 11, 1999 and November 20, 2000; (ii) the defendants were therefore subject to the “short swing” prohibitions of Section 16(b) of the Securities Exchange Act of 1934; and (iii) the defendants engaged in purchases and sales, or sales and purchases, of our common stock within periods of less than six months in violation of the provisions of Section 16(b). The complaint seeks disgorgement of all profits allegedly received by the defendants, with interest and attorneys fees, for transactions in violation of Section 16(b). Finisar, as the statutory beneficiary of any potential Section 16(b) recovery, is named as a nominal defendant in the complaint.

 

This case is one of 54 lawsuits containing similar allegations relating to initial public offerings of technology company issuers, which were coordinated (but not consolidated) by the Court. On July 25, 2008, the real defendants in all 54 cases filed a consolidated motion to dismiss, and a majority of the nominal defendants (including we) filed a consolidated motion to dismiss, the amended complaints. On March 19, 2009, the Court dismissed the amended complaints naming the nominal defendants that had moved to dismiss, without prejudice, because the plaintiff had not properly demanded action by their respective boards of directors before filing suit; and dismissed the amended complaints naming nominal defendants that had not moved to dismiss, with prejudice, finding the claims time-barred by the applicable statute of limitation. Also on March 19, 2009, the Court entered judgment against the plaintiff in all 54 cases. The plaintiff has appealed the order and judgments. The real defendants have cross-appealed the dismissal of certain amended complaints without prejudice, contending that dismissal should have been with prejudice because the amended complaints are barred by the applicable statute of limitation.

 

JDSU/Emcore Patent Litigation

 

On September 11, 2006, JDSU and Emcore Corporation filed a complaint in the United States District Court for the Western District of Pennsylvania alleging that certain cable television transmission products acquired in connection with our acquisition of Optium Corporation, specifically our 1550 nm HFC externally modulated transmitter, in addition to possibly “products as yet unidentified,” infringe two U.S. patents, referred to as the “‘003 and ‘071 Patents.” On March 14, 2007, JDSU and Emcore filed a second complaint in the United States District Court for the Western District of Pennsylvania alleging that our 1550 nm HFC quadrature amplitude modulated transmitter used in cable television applications, in addition to possibly “products as yet unidentified,” infringes on another U.S. patent, referred to as the “‘374 Patent”. On December 10, 2007, we filed a complaint in the United States District Court for the Western District of Pennsylvania seeking a declaration that the patents asserted against our HFC externally modulated transmitter are unenforceable due to inequitable conduct committed by the patent applicants and/or the attorneys or agents during prosecution. On February 18, 2009, the Court granted JDSU’s and Emcore’s motion for summary judgment dismissing our declaratory judgment action on inequitable conduct. We have appealed this ruling.

 

A trial with respect to the remaining two actions was held in October 2009. On November 1, 2009, the jury delivered its verdict that we had infringed the ‘003 and the ‘071 Patents as well as the ‘374 Patent. In addition, the jury found that our infringement of the ‘003 and the ‘071 Patents was willful. The jury determined that, with respect to the ‘003 and the ‘071 Patents, Emcore was entitled to $974,364 in damages and JDSU was entitled to $622,440 in damages, and, with respect to the ‘374 Patent, Emcore was entitled to $1,800,000 in damages. The Court declined to enhance the damages award with respect to the ‘003 and ‘071 Patents as a result of the jury’s determination that our infringement was willful. In addition, the Court declined to issue a permanent injunction against further manufacture or sale of the products found to have infringed the patents-in-suit. We are appealing on several grounds.

 

Based on our review of the record in this case, including discussion with and analysis by counsel of the bases for our appeal, we have determined that we have a number of strong arguments available on appeal and, although there can be no assurance as to the ultimate outcome, we believe that the judgment against us will ultimately be reversed, or remanded for a new trial in which we believe we would prevail. As a result, we have concluded that it is not probable that Emcore and JDSU will ultimately prevail in this matter; therefore, we have not recorded any liability for this judgment.

Digital Diagnostics Patent Litigation

 

On January 5, 2010, we filed a complaint for patent infringement in the United States District Court for the Northern District of California. The complaint alleges that certain optoelectronic transceivers from Source Photonics, Inc., MRV Communications, Inc., Neophotonics Corp. and Oplink Communications, Inc. infringe eleven Finisar patents. As described in further detail below, this suit is no longer pending against MRV Communications, NeoPhotonics or Oplink. The complaint asks the Court to enter judgment (a) that the defendants have infringed, actively induced infringement of, and/or contributorily infringed the patents-in-suit, (b) preliminarily and permanently enjoining the defendants from further infringement of the patents-in-suit, or, to the extent not so enjoined, ordering the defendants to pay compulsory ongoing royalties for any continuing infringement of the patents-in-suit, (c) ordering that the defendants account, and pay actual damages (but no less than a reasonable royalty), to us for the defendants’ infringement of the patents-in-suit, (d) declaring that the defendants are willfully infringing one or more of the patents-in-suit and ordering that the defendants pay treble damages to us, (e) ordering that the defendants pay our costs, expenses, and interest, including prejudgment interest, (f) declaring that this is an exceptional case and awarding us our attorneys’ fees and expenses, and (g) granting such other and further relief as the Court deems just and appropriate, or that we may be entitled to as a matter of law or equity.

 

On March 23, 2010, each defendant filed a first amended answer in which they denied the allegations of the complaint and asserted affirmative defenses including non-infringement, invalidity, statute of limitations, prosecution history estoppel, laches, estoppel and “other defenses.” Each defendant also asserted counterclaims against us seeking declaratory judgment of invalidity for each of the patents asserted in the complaint, declaratory judgment of unenforceability for certain of the patents asserted in the complaint, alleging monopolization of “the Digital Diagnostics Technology Market” in violation of Section 2 of the Sherman Act, attempted monopolization of “the Optical Transceiver Market” in violation of Section 2 of the Sherman Act, breach of contract, and unfair competition. Source Photonics, Inc. also asserted counterclaims alleging that certain of our optoelectronic transceivers infringe two of its patents. NeoPhotonics Corp. also asserted counterclaims alleging that certain of our wavelength selective switches infringe two of its patents. Each defendant asked the Court to enter judgment (a) denying us relief and dismissing the complaint with prejudice, (b) granting declaratory judgment that our asserted patents are invalid, (c) awarding attorneys’ fees and reasonable expenses, (d) awarding compensatory damages for our allegedly anticompetitive conduct, and trebling such damages, (e) permanently enjoining us from allegedly monopolizing or attempting to monopolize the United States markets for optical transceiver and digital diagnostics technology for such transceivers, (f) awarding attorneys’ fees and costs, (g) granting declaratory judgment that certain of our asserted patents are unenforceable, (h) for damages resulting from our alleged breach of contract, (i) permanently enjoining us from engaging in allegedly unfair competition, (j) restoring money and/or property that we have allegedly acquired by means of such unfair competition, (k) awarding all costs, expenses and interest, including prejudgment interest and (l) for such additional relief as the Court may deem just and proper. Source Photonics, Inc. and NeoPhotonics Corp. each asked the Court in addition to enter judgment (m) finding that we have infringed, actively induced the infringement of, and/or contributed to the infringement of each of their respective asserted patents, (n) awarding damages not less than a reasonable royalty, and (o) permanently enjoining us from such alleged infringement. NeoPhotonics Corp. also asked the Court to enter judgment trebling damages for our allegedly willful infringement of one of their two asserted patents. We filed a motion to dismiss the defendants’ non-patent counterclaims or, in the alternative, to sever and stay those counterclaims and to strike certain of the defendants’ affirmative defenses on April 13, 2010. The defendants filed their opposition to our motion on April 29, 2010, and we filed our reply on May 6, 2010.

 

On May 5, 2010, the Court entered an order finding that the defendants had been improperly joined in a single suit and dismissed each of the defendants except Source Photonics, Inc. without prejudice to our re-filing our claims against the other dismissed defendants in separate suits. On May 18, 2010, Source Photonics, Inc. filed a second amended answer that restated certain of its affirmative defenses and counterclaims, omitted the affirmative defenses of prosecution history estoppel and “other defenses,” and omitted both patent counterclaims. The relief Source Photonics, Inc. asks from the Court was revised accordingly. Although Source Photonics did not include its patent counterclaims in its Second Amended Answer, Source Photonics’ trial counsel subsequently indicated that they would attempt to have these claims added back into the suit.

On May 19, 2010, the Court granted Source Photonics, Inc. leave to file the second amended answer, and bifurcated and stayed all discovery and proceedings related to Source Photonics, Inc.’s counterclaims for declaratory judgment of unenforceability for certain of the patents asserted in the complaint, and alleged monopolization of “the Digital Diagnostics Technology Market” in violation of Section 2 of the Sherman Act, attempted monopolization of “the Optical Transceiver Market” in violation of Section 2 of the Sherman Act, breach of contract, and unfair competition pending resolution of our patent infringement claims. The Court allowed us to withdraw our motion to dismiss Source Photonics, Inc.’s non-patent counterclaims without prejudice to our refiling this motion to dismiss after the stay has been lifted.

 

A claim construction hearing is currently scheduled for October 6, 2010, and the case is currently scheduled for trial on July 25, 2011.

 

Export Compliance

 

During mid-2007, Optium became aware that certain of its analog RF over fiber products may, depending on end use and customization, be subject to the International Traffic in Arms Regulations, or ITAR. Accordingly, Optium filed a detailed voluntary disclosure with the United States Department of State describing the details of possible inadvertent ITAR violations with respect to the export of a limited number of certain prototype products, as well as related technical data and defense services. Optium may have also made unauthorized transfers of ITAR-restricted technical data and defense services to foreign persons in the workplace. Additional information has been provided upon request to the Department of State with respect to this matter. In late 2008, a grand jury subpoena from the office of the U.S. Attorney for the Eastern District of Pennsylvania was received requesting documents from 2005 through the present referring to, relating to or involving the subject matter of the above referenced voluntary disclosure and export activities.

 

While the Department of State encourages voluntary disclosures and generally affords parties mitigating credit under such circumstances, we nevertheless could be subject to continued investigation and potential regulatory consequences ranging from a no-action letter, government oversight of facilities and export transactions, monetary penalties, and in extreme cases, debarment from government contracting, denial of export privileges and criminal sanctions, any of which would adversely affect our results of operations and cash flow. The Department of State and U.S. Attorney inquiries may require us to expend significant management time and incur significant legal and other expenses. We cannot predict how long it will take or how much more time and resources we will have to expend to resolve these government inquiries, nor can we predict the outcome of these inquiries.

 

Other Litigation

 

In the ordinary course of business, we are a party to litigation, claims and assessments in addition to those described above. Based on information currently available, management does not believe the impact of these other matters will have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

 

 

Jerry S. Rawls has served as a member of our board of directors since March 1989 and as our Chairman of the Board since January 2006. Mr. Rawls served as our Chief Executive Officer from August 1999 until the completion of the Optium Corporation merger in August 2008. Mr. Rawls also served as our President from April 2003 until the completion of the Optium merger and previously held that title from April 1989 to September 2002. From September 1968 to February 1989, Mr. Rawls was employed by Raychem Corporation, a materials science and engineering company, where he held various management positions including Division General Manager of the Aerospace Products Division and Interconnection Systems Division. Mr. Rawls holds a B.S. in Mechanical Engineering from Texas Tech University and an M.S. in Industrial Administration from Purdue University.

 

Eitan Gertel has served as our Chief Executive Officer and as a director since the completion of the Optium merger in August 2008. Mr. Gertel served as Optium’s President and as a director from March 2001 and as Chief Executive Officer and Chairman of the Board of Optium from February 2004 through the completion of the Optium merger. Mr. Gertel worked as President and General Manager of the former transmission systems division of JDS Uniphase Corporation from 1995 to 2001. JDSU is a provider of broadband test and management solutions and optical products. Mr. Gertel holds a B.S.E.E. from Drexel University.

 

Kurt Adzema has served as the Company’s Senior Vice President, Finance and Chief Financial Officer since March 2010. Mr. Adzema joined the Company in January 2005 and served as the Company’s Vice President of Strategy and Corporate Development prior to his appointment as Senior Vice President, Finance and Chief Financial Officer. Prior to joining the Company, he held various positions at SVB Alliant, a subsidiary of Silicon Valley Bank which advised technology companies on merger and acquisition transactions, at Montgomery Securities/Banc of America Securities, an investment banking firm, and in the financial restructuring group of Smith Barney. Mr. Adzema holds a B.A. in Mathematics from the University of Michigan and an M.B.A. from the Wharton School at the University of Pennsylvania.

 

Mark Colyar has served as our Senior Vice President, Operations and Engineering since the completion of the Optium merger in August 2008. Mr. Colyar served as Optium’s Senior Vice President of Engineering from April 2001 through the completion of the merger and also served as General Manager of Optium’s U.S. operations from February 2004 through the completion of the merger. Mr. Colyar served in various positions at JDSU’s former TSD division from November 1995 to April 2001, including Director of Sales and Marketing, Vice President of Engineering and Vice President of Operations. Mr. Colyar holds a B.S.E.E. from Drexel University.

 

Todd Swanson has served as our Senior Vice President, Sales and Marketing since August 2008. Mr. Swanson joined us in 2002 and served as Product Line Manager, Director of Marketing and Vice President, Sales and Marketing for our Optics Division prior to his appointment as Senior Vice President. Mr. Swanson served as Product Line Manager for Princeton Lightwave, a laser company, from June 2001 until he joined Finisar. Mr. Swanson served as Director of Marketing (on a part-time basis while he was studying for his M.B.A.) for Aegis Semiconductor, a manufacturer of optical semiconductor devices, from December 2000 through June 2001. From July 1995 to August 1999, Mr. Swanson was employed by Hewlett-Packard Company as project leader and project manager in

the Automotive Lighting Group of the Optoelectronics Division. Mr. Swanson holds a B.S. in Mechanical Engineering from the University of Wisconsin and an M.B.A. from the Massachusetts Institute of Technology.

 

Stephen K. Workman has served as our Senior Vice President, Corporate Development and Investor Relations since March 2010. Mr. Workman served as our Senior Vice President, Finance and Chief Financial Officer from September 2002 until March 2010 and as our Vice President, Finance and Chief Financial Officer from March 1999 to September 2002. Mr. Workman also served as our Secretary from August 1999 until August 2008. From November 1989 to March 1999, Mr. Workman served as Chief Financial Officer at Ortel Corporation. Mr. Workman holds a B.S. in Engineering Science and an M.S. in Industrial Administration from Purdue University.

 

Joseph A. Young has served as our Senior Vice President, Operations and Engineering since the completion of the Optium merger in August 2008. Mr. Young served as our Senior Vice President and General Manager, Optics Division from June 2005 to August 2008. Mr. Young joined us in October 2004 as our Senior Vice President, Operations. Prior to joining the Company, Mr. Young served as Director of Enterprise Products, Optical Platform Division of Intel Corporation from May 2001 to October 2004. Mr. Young served as Vice President of Operations of LightLogic, Inc. from September 2000 to May 2001, when it was acquired by Intel, and as Vice President of Operations of Lexar Media, Inc. from December 1999 to September 2000. Mr. Young was employed from March 1983 to December 1999 by Tyco/ Raychem, where he served in various positions, including his last position as Director of Worldwide Operations for the OEM Electronics Division of Raychem Corporation. Mr. Young holds a B.S. in Industrial Engineering from Rensselaer Polytechnic Institute, an M.S. in Operations Research from the University of New Haven and an M.B.A. from the Wharton School at the University of Pennsylvania.

 

Christopher E. Brown has served as our Vice President, General Counsel and Secretary since the completion of the Optium merger in August 2008. Mr. Brown served as Optium’s General Counsel and Vice President of Corporate Development from August 2006 through the completion of the merger. Prior to that, Mr. Brown was a partner at the law firm of Goodwin Procter LLP from January 2005 to August 2006, a partner at the law firm of McDermott, Will & Emery from January 2003 to January 2005 and an associate at McDermott, Will & Emery from March 2000 to January 2003. Mr. Brown holds a B.A. in Economics and a B.A. in Political Science from the University of Massachusetts at Amherst and a J.D. from Boston College Law School.

 

 

factors, including those set forth under “Item 1A. Risk Factors.” The following discussion should be read together with our consolidated financial statements and related notes thereto included elsewhere in this document.

 

Business Overview

 

We are a leading provider of optical subsystems and components that are used to interconnect equipment in short-distance local area networks, or LANs, and storage area networks, or SANs, and longer distance metropolitan area networks, or MANs, fiber-to-the-home networks, or FTTx, cable television networks, or CATV, and wide area networks, or WANs. Our optical subsystems consist primarily of transmitters, receivers, transceivers and transponders which provide the fundamental optical-electrical interface for connecting the equipment used in building these networks, including switches, routers and file servers used in wireline networks as well as antennas and base stations for wireless networks. These products rely on the use of semiconductor lasers and photodetectors in conjunction with integrated circuit design and novel packaging technology to provide a cost-effective means for transmitting and receiving digital signals over fiber optic cable at speeds ranging from less than 1 gigabit per second, or Gbps, to 100Gbps, using a wide range of network protocols and physical configurations over distances of 70 meters to 200 kilometers. We supply optical transceivers and transponders that allow point-to-point communications on a fiber using a single specified wavelength or, bundled with multiplexing technologies, can be used to supply multi-gigabit bandwidth over several wavelengths on the same fiber. We also provide products that are used for dynamically switching network traffic from one optical wavelength to another across multiple wavelengths without first converting to an electrical signal, known as wavelength selective switches, or WSS. These products are sometimes combined with other components and sold as linecards, also known as reconfigurable optical add/drop multiplexers, or ROADMs. Our line of optical components consists primarily of packaged lasers and photodetectors used in transceivers, primarily for LAN and SAN applications, and passive optical components used in building MANs. Demand for our products is largely driven by the continually growing need for additional bandwidth created by the ongoing proliferation of data and video traffic that must be handled by both wireline and wireless networks.

 

Our manufacturing operations are vertically integrated and we utilize internal sources for many of the key components used in making our products including lasers, photodetectors and integrated circuits, or ICs, designed by our own internal IC engineering teams. We also have internal assembly and test capabilities that make use of internally designed equipment for the automated testing of our optical subsystems and components.

 

We sell our optical products to manufacturers of storage systems, networking equipment and telecommunication equipment or their contract manufacturers, such as Alcatel-Lucent, Brocade, Cisco Systems, EMC, Emulex, Ericsson, Hewlett-Packard Company, Huawei, IBM, Juniper, Qlogic, Siemens and Tellabs. These customers, in turn, sell their systems to businesses and to wireline and wireless telecommunications service providers and cable TV operators, collectively referred to as carriers.

 

We sell our products through our direct sales force, with the support of our manufacturers’ representatives, directly to domestic customers and indirectly through distribution channels to international customers. The evaluation and qualification cycle prior to the initial sale of our optical subsystems may span a year or more.

 

Our cost of revenues consists of materials, salaries and related expenses for manufacturing personnel, manufacturing overhead, warranty expense, inventory adjustments for obsolete and excess inventory and the amortization of acquired developed technology associated with acquisitions that we have made. As a result of building a vertically integrated business model, our manufacturing cost structure has become more fixed. While this can be beneficial during periods when demand is strong, it can be more difficult to reduce costs during periods when demand for our products is weak, product mix is unfavorable or selling prices are generally lower. While we have undertaken measures to reduce our operating costs there can be no assurance that we will be able to reduce our cost of revenues enough to achieve or sustain profitability.

 

Our gross profit margins vary among our product families. Our optical products sold for longer distance MAN and telecom applications typically have higher gross margins than our products for shorter distance LAN and SAN applications. Our overall gross margins have fluctuated from period to period as a result of overall revenue levels, shifts in product mix, the introduction of new products, decreases in average selling prices and our ability to reduce product costs.

Since October 2000, we have completed the acquisition of ten privately-held companies and certain businesses and assets from six other companies in order to broaden our product offerings and provide new sources of revenue, production capabilities and access to advanced technologies that we believe will enable us to reduce our product costs and develop innovative and more highly integrated product platforms while accelerating the timeframe required to develop such products.

 

Recent Developments

 

Combination with Optium Corporation

 

On August 29, 2008, we completed a business combination with Optium Corporation, a leading designer and manufacturer of high performance optical subsystems for use in telecommunications and cable TV network systems, through the merger of Optium with a wholly-owned subsidiary of Finisar. We believe that the combination of the two companies created the world’s largest supplier of optical components, modules and subsystems for the communications industry and will leverage the Finisar’s leadership position in the storage and data networking sectors of the industry and Optium’s leadership position in the telecommunications and CATV sectors to create a more competitive industry participant. In addition, as a result of the combination, we expect to realize cost synergies related to operating expenses and manufacturing costs resulting from (1) the transfer of production to lower cost locations, (2) improved purchasing power associated with being a larger company and (3) cost synergies associated with the integration of components into product designs previously purchased in the open market by Optium. We accounted for the combination using the purchase method of accounting and as a result have included the operating results of Optium in our consolidated financial results since the August 29, 2008 consummation date. At the closing of the merger, we issued 20,101,082 shares of Finisar common stock, valued at approximately $242.8 million, in exchange for all of the outstanding common stock of Optium. The value of the shares issued was calculated using the five day average of the closing price of the Company’s common stock from the second trading day before the merger announcement date on May 16, 2008 through the second trading day following the announcement, or $12.08 per share.

 

Sale of Network Tools Division

 

On July 15, 2009, we completed the sale of substantially all of the assets of our Network Tools Division to JDSU. We received $40.6 million in cash and recorded a net gain on sale of the business of $36.1 million before income taxes in the first quarter of fiscal 2010. The assets, liabilities and operating results related to this business, have been classified as discontinued operations in the consolidated financial statements for all periods presented.

 

Following the completion of the sale, we no longer offer network performance test products. These products accounted for $37.3 million, $38.6 million and $44.2 million in revenues during fiscal 2007, 2008 and 2009, respectively. Gross profit and operating profit margins on sales of network performance test products were generally higher than on our optical subsystem and component products.

 

Exchange Offers

 

On August 11, 2009, we completed exchange offers under which we exchanged $33.1 million aggregate principal amount of our outstanding 2 1 / 2 % Convertible Subordinated Notes due 2010 and $14.4 million aggregate principal of our outstanding 2 1 / 2 % Convertible Senior Subordinated Notes due 2010 for an aggregate of approximately $24.9 million in cash and approximately 3.5 million shares of our common stock.

 

Reverse Stock Split

 

On September 25, 2009, we effected a one-for-eight reverse split of our common stock.

 

New Credit Facility

 

On October 2, 2009, we entered into an agreement with Wells Fargo Foothill, LLC to establish a new $70 million senior secured revolving credit facility to finance working capital and to refinance existing indebtedness, including the repurchase or repayment of our outstanding convertible notes. Borrowings under the credit

facility bear interest at rates based on the prime rate and LIBOR plus variable margins, under which applicable interest rates currently range from 5.75% to 7.00% per annum. Borrowings are guaranteed by Finisar’s U.S. subsidiaries and secured by substantially all of the assets of Finisar and its U.S. subsidiaries. The credit facility matures four years following the date of the agreement, subject to certain conditions.

 

Convertible Debt Financing

 

On October 15, 2009 we sold $100 million aggregate principal amount of a new series of 5.0% Convertible Senior Notes due 2029.

 

Repurchase of Convertible Notes

 

Between September 8, 2009 and April 30, 2010, we purchased $51.9 million aggregate principal amount of our 2 1 / 2 % Convertible Senior Subordinated Notes due 2010 and $13.0 million aggregate principal amount of our 2 1 / 2 % Convertible Subordinated Notes due 2010 in privately negotiated transactions.

 

Common Stock Offering

 

On March 23, 2010, we completed the sale of 9,787,093 shares of our common stock at a price to the public of $14.00 per share. Total gross proceeds of the offering were $137.0 million. Net proceeds to the Company after deducting underwriting discounts and commissions and offering expenses were $131.1 million.

 

Critical Accounting Policies

 

The preparation of our financial statements and related disclosures require that we make estimates, assumptions and judgments that can have a significant impact on our revenue and operating results, as well as on the value of certain assets and contingent liabilities on our balance sheet. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements and, therefore, consider these to be our critical accounting policies. See Note 2 to our consolidated financial statements included elsewhere in this report for more information about these critical accounting policies, as well as a description of other significant accounting policies. We believe there have been no material changes to our critical accounting policies during the fiscal year ended April 30, 2010 compared to prior years other than the adoption of authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) for accounting for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). See Note 1 to our consolidated financial statements.

 

Revenue Recognition, Warranty and Sales Returns

 

We recognize revenue when persuasive evidence of an arrangement exists, title and risk of loss have passed to the customer, generally upon shipment, the price is fixed or determinable and collectability is reasonably assured.

 

At the time revenue is recognized, we establish an accrual for estimated warranty expenses associated with our sales, recorded as a component of cost of revenues. Our standard warranty period usually extends 12 months from the date of sale although it can extend for longer periods of three to five years for certain products sold to certain customers. Our warranty accrual represents our best estimate of the amounts necessary to settle future and existing claims on products sold as of the balance sheet date. While we believe that our warranty accrual is adequate and that the judgment applied is appropriate, such amounts estimated to be due and payable could differ materially from what actually transpire in the future. If our actual warranty costs are greater than the accrual, costs of revenue will increase in the future. We also provide an allowance for estimated customer returns, which is netted against revenue. This provision is based on our historical returns, analysis of credit memo data and our return policies. If the historical data used by us to calculate the estimated sales returns does not properly reflect future returns, revenue could be reduced in the future.

Allowance for Doubtful Accounts

 

We evaluate the collectability of our accounts receivable based on a combination of factors. In circumstances where, subsequent to delivery, we become aware of a customer’s potential inability to meet its obligations, we record a specific allowance for the doubtful account to reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, we recognize an allowance for doubtful accounts based on the length of time the receivables are past due and historical actual bad debt history. A material adverse change in a major customer’s ability to meet its financial obligations to us could result in a material reduction in the estimated amount of accounts receivable that can ultimately be collected and an increase in our general and administrative expenses for the shortfall.

 

Slow Moving and Obsolete Inventories

 

We make inventory commitment and purchase decisions based upon sales forecasts. To mitigate the component supply constraints that have existed in the past and to fill orders with non-standard configurations, we build inventory levels for certain items with long lead times and enter into certain longer-term commitments for certain items. We permanently write off 100% of the cost of inventory that we specifically identify and consider obsolete or excessive to fulfill future sales estimates. We define obsolete inventory as inventory that will no longer be used in the manufacturing process. We periodically discard obsolete inventory. Excess inventory is generally defined as inventory in excess of projected usage, and is determined using our best estimate of future demand at the time, based upon information then available to us. In making these assessments, we are required to make judgments as to the future demand for current or committed inventory levels. We assume that the last twelve months demand is generally indicative of the demand for the next twelve months. In addition to the 12-month demand forecast, we also consider:

 

 

Significant differences between our estimates and judgments regarding future timing of product transitions, volume and mix of customer demand for our products and actual timing, volume and demand mix may result in additional write-offs in the future, or additional usage of previously written-off inventory in future periods for which we would benefit from a reduced cost of revenues in those future periods.

 

Investment in Equity Securities

 

For strategic reasons, we may make minority investments in private or public companies or extend loans or receive equity or debt from these companies for services rendered or assets sold. Our minority investments in private companies are primarily motivated by our desire to gain early access to new technology. Our investments in these companies are passive in nature in that we generally do not obtain representation on the boards of directors. Our investments have generally been part of a larger financing in which the terms were negotiated by other investors, typically venture capital investors. These investments are generally made in exchange for preferred stock with a liquidation preference that helps protect the underlying value of our investment. At the time we made our investments, in most cases the companies had not completed development of their products and we did not enter into any significant supply agreements with the companies in which we invested. In determining if and when a decline in the market value of these investments below their carrying value is other-than-temporary, we evaluate the market conditions, offering prices, trends of earnings and cash flows, price multiples, prospects for liquidity and other key measures of performance. Our policy is to recognize an impairment in the value of its minority equity investments when clear evidence of an impairment exists, such as (a) the completion of a new equity financing that may indicate a new value for the investment, (b) the failure to complete a new equity financing arrangement after seeking to raise additional funds or (c) the commencement of proceedings under which the assets of the business may be placed in receivership or liquidated to satisfy the claims of debt and equity stakeholders. Future adverse changes in market conditions or poor operating results at any of the companies in which we hold a minority position could result in an impairment of our investment and/or an inability to recover the carrying value of these investments.

Goodwill, Intangibles and Other Long-Lived Assets

 

Goodwill, purchased technology, and other intangible assets resulting from acquisitions are accounted for under the purchase method. Intangible assets with finite lives are amortized over their estimated useful lives. Amortization of purchased technology and other intangibles has been provided on a straight-line basis over periods ranging from three to ten years.

 

Goodwill is assessed for impairment annually or more frequently when an event occurs or circumstances change between annual tests that would more likely than not reduce the fair value of the reporting unit below its carrying value. Goodwill is tested for impairment at the reporting unit level at adoption and at least annually thereafter, utilizing a two-step methodology. The initial step requires us to determine the fair value of each reporting unit and compare it to the carrying value, including goodwill, of such unit. If the fair value of the reporting unit exceeds the carrying value, no impairment loss would be recognized. However, if the carrying value of the reporting unit exceeds its fair value, the goodwill of the unit may be impaired. The amount, if any, of the impairment is then measured in the second step in which we determine the implied value of goodwill based on the allocation of the estimated fair value determined in the initial step to all assets and liabilities of the reporting unit.

 

We are required to make judgments about the recoverability of our long-lived assets, other than goodwill, whenever events or changes in circumstances indicate that the carrying value of these assets may be impaired or not recoverable. In order to make such judgments, we are required to make assumptions about the value of these assets in the future including future prospects for earnings and cash flows. If impairment is indicated, we write those assets down to their fair value which is generally determined based on discounted cash flows. Judgments and assumptions about the future are complex, subjective and can be affected by a variety of factors including industry and economic trends, our market position and the competitive environment of the businesses in which we operate.

 

At April 30, 2010, goodwill and intangible assets were $0 million and $23 million, respectively. During fiscal 2009, we recorded $150 million of additional goodwill resulting from the combination with Optium. However, we also recorded $238.5 million of impairment charges for goodwill and other intangible assets as discussed under Results of Operation.

 

Stock-Based Compensation Expense

 

Stock-based compensation cost for all stock-based payment awards made to employees and directors including employee stock options and employee stock purchases under our Employee Stock Purchase Plan is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. Compensation expense for expected-to-vest stock-based awards that were granted on or prior to April 30, 2006 was valued under the multiple-option approach and will continue to be amortized using the accelerated attribution method. Subsequent to April 30, 2006, compensation expense for expected-to-vest stock-based awards is valued under the single-option approach and amortized on a straight-line basis, net of estimated forfeitures.

 

We estimate the fair value of stock-based payment awards on the date of grant using the Black-Scholes option pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated statements of operations.

 

The determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the expected term of the awards, actual and projected employee stock option exercise behaviors, the risk-free interest rate, estimated forfeitures and expected dividends.

 

We estimate the expected term of options granted by calculating the average term from our historical stock option exercise experience. We calculate the volatility factor based on our historical stock prices. We base the risk-free interest rate on zero-coupon yields implied from U.S. Treasury issues with remaining terms similar to the expected term on the options. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We

use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest.

 

We measure the fair value of restricted stock units using the market value on the grant date.

 

If we use different assumptions for estimating stock-based compensation expense in future periods or if actual forfeitures differ materially from our estimated forfeitures, the change in our stock-based compensation expense could materially affect our operating income, net income and net income per share.

 

Restructuring Accrual

 

We are required to recognize liability for costs associated with an exit or disposal activity when the liability is incurred. We calculate facilities consolidation charges using estimates that are based upon the remaining future lease commitments for vacated facilities from the date of facility consolidation, net of estimated future sublease income. The estimated costs of vacating the leased facilities are based on market information and trend analyses, including information obtained from third party real estate sources.

 

Accounting for Income Taxes

 

We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. Deferred tax assets and liabilities are recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities and their reported amounts, along with net operating loss carryforwards and credit carryforwards. We reduce the deferred tax assets by recording a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized.

 

We provide for income taxes based upon the geographic composition of worldwide earnings and tax regulations governing each region. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Also, our current effective tax rate assumes that United States income taxes are not provided for the undistributed earnings of non-United States subsidiaries. We intend to indefinitely reinvest the earnings of all foreign corporate subsidiaries accumulated in fiscal 2008 and subsequent years.

 

Our assumptions, judgments and estimates relative to the current provision for income taxes take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. Although we believe our assumptions, judgments and estimates are reasonable, changes in tax laws or our interpretation of tax laws and the resolution of any future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.

 

Our assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations or capital gains income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, thus materially impacting our financial position and results of operations.

 

Pending Adoption of New Accounting Standards

 

In April 2010, the FASB issued revised guidance to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trade should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this guidance are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The amendments in this update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for

all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. The cumulative-effect adjustment should be presented separately. Earlier application is permitted. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

 

In January 2010, the FASB issued revised guidance intended to improve disclosures related to fair value measurements. New disclosures under this guidance require (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This guidance clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing disclosure are effective for us beginning May 2010, except for the disclosure requirements related to the purchases, sales, issuances and settlements in the rollforward activity of Level 3 fair value measurements which will be effective for us beginning May 2011. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

 

In October 2009, the FASB amended the accounting standards for revenue recognition to remove tangible products containing software components and nonsoftware components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to:

 

(i) provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

 

(ii) require an entity to allocate revenue in an arrangement using estimated selling prices (ESP) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (VSOE) or third-party evidence of selling price (TPE); and

 

(iii) eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

 

The accounting changes summarized in this guidance are effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. Adoption may either be on a prospective basis or by retrospective application. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

 

In June 2009, the FASB issued revised guidance to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This guidance must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. It must be applied to transfers occurring on or after the effective date. We are currently evaluating the potential impact, if any, of the adoption of this guidance on our consolidated results of operations and financial condition.

Results of Operations

 

The following table sets forth certain statement of operations data as a percentage of total revenues for the periods indicated:

 

 

Comparison of Fiscal Years Ended April 30, 2010 and 2009

 

Revenues.   Revenues increased $132.8 million, or 26.7%, to $629.9 million in fiscal 2010 compared to $497.1 million in fiscal 2009. The increase reflects the impact of a combination of factors including increased spending on infrastructure by business enterprises and telecommunications companies as they deal with the ongoing growth in bandwidth through their networks as well as improvement in general economic conditions that contributed to an increase in information technology infrastructure spending. Additionally, we believe that we achieved an increase in our market share, particularly for higher speed products, due in part to the qualification of several products for higher speed applications at certain customers and our entry into new markets.

The following table sets forth the changes in revenues by market segment and speed (in thousands):

 

 

Impairment and Amortization of Acquired Developed Technology.   Impairment and amortization of acquired developed technology, components of cost of revenues, decreased $1.4 million, or 22.5%, to $4.8 million in fiscal 2010 compared to $6.2 million in fiscal 2009. The decrease was primarily due to the $1.2 million impairment in the fourth quarter of fiscal 2009 for intellectual property related to our acquisition of Kodeos Communications Inc.

 

Gross Profit.   Gross profit increased $40.9 million, or 29.5%, to $179.7 million in fiscal 2010 compared to $138.8 million in fiscal 2009. The increase in gross profit was primarily due to the $132.8 million increase in revenues. Gross profit as a percentage of total revenues was 28.5% in fiscal 2010 compared to 27.9% in fiscal 2009. We recorded charges of $23.0 million for obsolete and excess inventory in fiscal 2010 compared to $14.4 million in fiscal 2009. We sold inventory that was written-off in previous periods resulting in a benefit of $15.1 million in fiscal 2010 and $8.1 million in fiscal 2009. As a result, we recognized a net charge of $7.9 million in fiscal 2010 compared to $6.3 million in fiscal 2009. Manufacturing overhead included stock-based compensation charges of $4.2 million in fiscal 2010 and $3.3 million in fiscal 2009. Excluding amortization of acquired developed technology, the net impact of excess and obsolete inventory charges and stock-based compensation charges, gross profit would have been $196.6 million, or 31.2% of revenue, in fiscal 2010 compared to $154.5 million, or 31.1% of revenue in fiscal 2009. The slight increase in gross margin percentage primarily reflects the benefits of higher manufacturing unit volume and the increase in sales of higher margin ROADM products offset by the unfavorable impact of lower pricing on some products, lower manufacturing yields on certain new higher speed components and modules and the impact of selling certain lower margin Optium products for the full fiscal year compared to only eight months in fiscal 2009 as the Optium merger closed at the end of August 2008.

 

Research and Development Expenses.   Research and development expenses increased $14.7 million, or 18.3%, to $94.8 million in fiscal 2010 compared to $80.1 million in fiscal 2009. The increase was primarily due to the additional four months of expenses of approximately $6.2 million from Optium operations following the merger which are included in fiscal 2010, higher project costs and increases in employee salaries and bonuses. Included in research and development expenses were stock-based compensation charges of $5.5 million in fiscal 2010 and $5.6 million in fiscal 2009. Research and development expenses as a percent of revenues decreased slightly to 15.0% in fiscal 2010 compared to 16.1% in fiscal 2009.

 

Sales and Marketing Expenses.   Sales and marketing expenses increased $3.0 million, or 10.7%, to $30.7 million in fiscal 2010 compared to $27.7 million in fiscal 2009. The increase was primarily due to increased sales commissions as a result of the increase in revenue, partially offset by cost synergies realized as a result of the Optium merger. Included in sales and marketing expenses were stock-based compensation charges of $1.9 million

in fiscal 2010 and $1.7 million in fiscal 2009. Sales and marketing expenses as a percent of revenues decreased to 4.9% in fiscal 2010 compared to 5.6% in fiscal 2009.

 

General and Administrative Expenses.   General and administrative expenses increased $954,000 or 2.7%, to $36.8 million in fiscal 2010 compared to $35.8 million in fiscal 2009, primarily due to the additional four months of expenses from Optium operations following the merger which are included in fiscal 2010 offset by cost synergies realized as a result of the Optium merger. Included in general and administrative expenses were stock-based compensation charges of $3.4 million in fiscal 2010 and $2.9 million in fiscal 2009. General and administrative expenses as a percent of revenues decreased to 5.8% in fiscal 2010 compared to 7.2% in fiscal 2009.

 

Acquired In-process Research and Development.   In-process research and development, or IPR&D, expenses related to the Optium merger were $10.5 million in fiscal 2009. The were no IPR&D expenses in fiscal 2010.

 

Amortization of Purchased Intangibles.   Amortization of purchased intangibles decreased $117,000, or 5.5%, to $2.0 million in fiscal 2010 compared to $2.1 million in fiscal 2009. The decrease was primarily due to the sale of assets, including all intangible assets, of our Network Tools Division to JDSU.

 

Impairment of Goodwill.   As a result of the financial liquidity crisis, the economic recession, reductions in our internal revenue and operating forecasts and a substantial reduction in our market capitalization, during fiscal 2009, we performed an analysis to determine if there was an indication of impairment of our intangible assets. Based on this analysis, we determined that the goodwill related to our optical subsystems and components reporting unit was impaired and had an implied fair value of $0 compared to its carrying value. Accordingly, we recorded impairment charges of $178.8 million during the second quarter of fiscal 2009. Following the completion of goodwill impairment analyses, we recorded additional charges of $46.5 million in the third quarter of fiscal 2009 and $13.2 million in the fourth quarter of fiscal 2009. As a result of these impairment charges, as of April 30, 2009 the carrying value of our goodwill was zero.

 

Restructuring Costs.   As a result of moving certain manufacturing activities from our facility in Allen, Texas to our lower cost manufacturing facility in Ipoh, Malaysia, we have determined that approximately 32% of the space in the Allen facility is no longer required for manufacturing. As a result, we closed that portion of the facility in the second quarter of fiscal 2010 and are actively searching for a tenant to sublease the vacated space. As a result, we recorded a restructuring charge of $4.2 million in the second quarter of fiscal 2010 which represents the present value of the lease payments for that portion of the facility that we are obligated to make over the remaining lease term. No restructuring charges were recorded in fiscal 2009.

 

Interest Income.   Interest income decreased $1.6 million, or 91.8%, to $144,000 in fiscal 2010 compared to $1.8 million in fiscal 2009. The decrease was due primarily to lower cash balances as a result of the principal repayment of $92.0 million of our 5 1 / 4 % Convertible Subordinated Notes due 2008 in the second quarter of fiscal 2009 and, to a lesser extent, lower interest rates.

 

Interest Expense.   Interest expense decreased $5.6 million, or 38.6%, to $9.0 million in fiscal 2010 compared to $14.6 million in fiscal 2009. The decrease was primarily related to lower outstanding debt due to the principal repayment of $92.0 million on our 5 1 / 4 % Convertible Subordinated Notes due 2008 in the second quarter of fiscal 2009, repayment of $47.5 million of aggregate principal amount of our 2 1 / 2 % Convertible Subordinated Notes due 2010 and our 2 1 / 2 % Convertible Senior Subordinated Notes due 2010 pursuant to exchange offers in the second quarter of fiscal 2010 and repurchases of $13.0 million principal amount of our 2 1 / 2 % Convertible Subordinated Notes and $51.9 million of our 2 1 / 2 % Convertible Senior Subordinated Notes in the second quarter of fiscal 2010. Included in interest expense for fiscal 2010 were non-cash charges of $3.0 million related to the accounting for our senior convertible notes due to the adoption of FASB authoritative guidance which requires us to separately account for the liability (debt) and equity (conversion option) components of our 2.5% senior subordinated convertible notes that may be settled in cash (or other assets) on conversion in a manner that reflects our non-convertible debt borrowing rate. The separation of the conversion option created an original issue discount in the bond component which is to be accreted as interest expense over the term of the instrument using the interest method, resulting in an increase in interest expense. Included in interest expense for fiscal 2009 were a non-cash charge of $4.9 million related to the accounting for our senior convertible notes and a non-cash charge of $1.8 million to amortize the beneficial conversion feature of the convertible notes due in October 2008.

Gain and Loss on Repurchase/Purchase of Convertible Notes.   During fiscal 2010, we recorded a $25.0 million loss related to the repurchase of certain convertible notes. On August 11, 2009, we retired $33.1 million, or 66.2%, of the $50.0 million aggregate outstanding principal amount of our 2 1 / 2 % Convertible Subordinated Notes due 2010 and $14.4 million, or approximately 15.7%, of the $92.0 million aggregate outstanding principal amount of our 2 1 / 2 % Convertible Senior Subordinated Notes due 2010 pursuant to exchange offers which commenced on July 9, 2009. The consideration for the exchange consisted of (i) $525 in cash and (ii) 596 shares of our common stock per $1,000 principal amount of notes. We issued approximately 3.5 million shares of common stock and paid out approximately $24.9 million in cash to the former holders of notes in the exchange offers. The total consideration paid in the exchange was approximately $4.7 million less than the par value of the notes retired. This exchange was considered to be an induced conversion in accordance with FASB authoritative guidance and the retirement of the notes was accounted for as if they had been converted according to their original terms, with that value compared to the fair value of the consideration paid in the exchange offers. The original conversion price of the notes was $30.08 per share. Accordingly, although the trading price of our common stock was $5.04 at the time of the exchange, we recorded a loss on debt extinguishment of $23.7 million in the quarter ended November 1, 2009. The additional $1.4 million of loss on debt extinguishment was primarily due to expenses incurred in connection with the exchange offers.

 

During fiscal 2009, we recorded a $3.1 million gain on the repurchase of certain convertible notes. The gain was related to the repurchase of $8.0 million in principal amount of our 2.5% convertible notes due October 15, 2010 that we purchased at a discount to par value of 50.1%.

 

Other Income (Expense), Net.   Other expense was $1.9 million in fiscal 2010 compared to $3.7 million in fiscal 2009. Other expense in fiscal 2010 was primarily related to a $2 million other-than-temporary write-down of a minority interest investment. Other expense in fiscal 2009 was primarily due to unrealized non-cash foreign exchange losses of $1.6 million related to the re-measurement of a $17.8 million note re-payable in U.S. dollars which is recorded on the books of our subsidiary in Malaysia whose functional currency is the Malaysian ringgit and a $1.2 million other-than-temporary write-down of a minority investment during the period.

 

Provision for Income Taxes.   We recorded income tax benefits of $1.6 million and of $7.0 million for fiscal 2010 and fiscal 2009, respectively. The income tax benefit for fiscal 2010 included minimum state taxes of $400,000, federal refundable credits of $500,000 and foreign income tax benefit of $1.5 million arising in certain foreign jurisdictions in which the Company conducts business. The income tax benefit for fiscal 2009 included a non-cash benefit arising from the reversal of previously recorded deferred tax liabilities related to tax amortization of goodwill for which no financial statement amortization had occurred.

 

Discontinued Operations.   As discussed above, on July 15, 2009, we completed the sale of certain assets related to our Network Tools Division to JDSU. We agreed to perform certain manufacturing activities for JDSU under a transition services agreement entered into at the time of the sale. The expenses associated with the transition services agreement have been classified as results of discontinued operations. During fiscal 2010, we incurred net operating income from discontinued operations of $36.9 million, including a gain of $35.9 million on the sale and a net operating gain of $1.0 million. Net operating expenses associated with the transition services agreement from July 15, 2009 through April 30, 2010 were $142,000, which included an adjustment of $165,000 recorded as an adjustment to the gain on sale of discontinued operations.

 

Comparison of Fiscal Years Ended April 30, 2009 and 2008

 

Revenues.   Revenues increased $95.4 million, or 23.8%, to $497.1 million in fiscal 2009 compared to $401.6 million in fiscal 2008. The increase was primarily due to the inclusion of $91.3 million in revenue in fiscal 2009 as a result of our merger with Optium which was consummated on August 29, 2008.

The following table sets forth the changes in revenues by market segment and speed (in thousands):

 

 

Impairment and Amortization of Acquired Developed Technology.   Amortization and impairment of acquired developed technology, components of cost of revenues, increased $1.5 million, or 31.9%, to $6.2 million in fiscal 2009 compared to $4.7 million in fiscal 2008. The increase was primarily due to the $1.2 million impairment in the fourth quarter of fiscal 2009 for intellectual property related to our acquisition of Kodeos Communications Inc.

 

Gross Profit.   Gross profit increased $23.6 million, or 20.5% to $138.8 million in fiscal 2009 compared to $115.2 million in fiscal 2008. The increase in gross profit was partially due to the inclusion of $23.4 million of gross profits from Optium’s operations for eight months of the twelve month period ended April 30, 2009. Gross profit as a percentage of total revenues was 27.9% in fiscal 2009 compared to 28.7% in fiscal 2008. We recorded charges of $14.4 million for obsolete and excess inventory in fiscal 2009 compared to $12.1 million in fiscal 2008. We sold inventory that had been written-off in previous periods resulting in a benefit of $8.1 million in fiscal 2009 and $6.0 million in fiscal 2008. As a result, we recognized a net charge of $6.3 million in fiscal 2009 compared to $6.1 million in fiscal 2008. Manufacturing overhead included stock-based compensation charges of $3.3 million in fiscal 2009 and $2.9 million in fiscal 2008. Additionally, manufacturing overhead in fiscal 2008 included $1.0 million of other payroll related charges associated with the completion of our previously reported stock option investigation. Excluding amortization of acquired developed technology, the net impact of excess and obsolete inventory charges, stock-based compensation charges and other stock option related charges, gross profit would have been $154.5 million, or 31.1% of revenues, in fiscal 2009 compared to $129.9 million, or 32.3% of revenues, in fiscal 2008. The decrease in adjusted gross profit margin was primarily due to inclusion of Optium’s operating results for the eight months ended April 30, 2009.

 

Research and Development Expenses.   Research and development expenses increased $17.0 million, or 27.1%, to $80.1 million in fiscal 2009 compared to $63.1 million in fiscal 2008. The increase was primarily due to $13.9 million in expenses related to Optium’s operations following the merger and an increase in employee related expenses and costs of materials associated with new product development. Included in research and development expenses were stock-based compensation charges of $5.6 million in fiscal 2009 and $3.5 million fiscal 2008. Additionally, research and development expenses in fiscal 2008 included payroll related charges of $2.6 million incurred in connection with the completion of our stock option investigation. Research and development expenses as a percent of revenues increased to 16.1% in fiscal 2009 compared to 15.7% in fiscal 2008.

 

Sales and Marketing Expenses.   Sales and marketing expenses increased $717,000, or 2.7%, to $27.7 million in fiscal 2009 compared to $27.0 million in fiscal 2008. The slight increase in sales and marketing expenses was primarily due to payroll related expenses related to the Optium merger. Included in sales and marketing expenses were stock-based compensation charges of $1.7 million in fiscal 2009 and $1.3 million in fiscal 2008. Additionally,

sales and marketing expenses in fiscal 2008 included payroll related charges of $676,000 incurred in connection with the completion of our stock option investigation. Sales and marketing expenses as a percent of revenues decreased to 5.6% in fiscal 2009 compared to 6.7% fiscal 2008.

 

General and Administrative Expenses.   General and administrative expenses decreased $2.5 million, or 6.6%, to $35.8 million in fiscal 2009 compared to $38.3 million in fiscal 2008. The decrease was primarily due to a $7.9 million decrease in legal and consulting fees as a result of the completion of our stock option investigation and a $2.0 million reduction in litigation and intellectual property related legal fees. This decrease was partially offset by the addition of $5.4 million in expenses primarily related to Optium’s operations following the merger and other personnel and IT related spending. Included in general and administrative expenses were stock-based compensation charges of $2.9 million in fiscal 2009 and $1.9 million in fiscal 2008. Additionally, general and administrative expenses for fiscal 2008 included payroll related charges of $1.1 million incurred in connection with the completion of our stock option investigation. General and administrative expenses as a percent of revenues decreased to 7.2% in fiscal 2009 compared to 9.5% in fiscal 2008.

 

Acquired In-process Research and Development.   In-process research and development from continuing operations, or IPR&D, expenses related to the Optium merger were $10.5 million in fiscal 2009. There were no IPR&D charges in fiscal 2008.

 

Amortization of Purchased Intangibles.   Amortization of purchased intangibles increased $953,000, or 79.9%, to $2.1 million in fiscal 2009 compared to $1.2 million in fiscal 2008. The increase was primarily due to $1.6 million of amortization of additional intangible assets acquired in the Optium merger, partially offset by a reduction in amortization of certain assets associated with our AZNA and Kodeos acquisitions.

 

Impairment of Goodwill and Intangible Assets.   The number of shares to be exchanged in the Optium merger was fixed at 6.262 shares of our common stock for each share of Optium common stock. The closing price of our common stock on May 16, 2008 was $12.24, while a five-day average used to calculate the consideration paid in the merger was $12.08. The preliminary allocation of the merger consideration resulted in the recognition of an additional $150 million of goodwill which, when combined with the $88 million of goodwill acquired prior to the merger, resulted in a total goodwill balance of approximately $238 million. The actual operating results and outlook for both companies between the date of the definitive agreement and the effective date of the merger had not changed to any significant degree, with both companies separately reporting record revenues for their interim quarters.

 

Between the effective date of the merger and November 2, 2008, the end of the second quarter of fiscal 2009, we concluded that there were sufficient indicators to require an interim goodwill impairment analysis. Among these indicators were a significant deterioration in the macroeconomic environment largely caused by the widespread unavailability of business and consumer credit, a significant decrease in our market capitalization as a result of a decrease in the trading price of our common stock to $4.88 at the end of the quarter and a decrease in internal expectations for near-term revenues, especially those expected to result from the Optium merger. For purposes of this analysis, our estimates of fair value were based on a combination of the income approach, which estimates the fair value of our reporting units based on future discounted cash flows, and the market approach, which estimates the fair value of our reporting units based on comparable market prices. As of the filing of our quarterly report on Form 10-Q for the second quarter of fiscal 2009, we had not completed our analysis due to the complexities involved in determining the implied fair value of the goodwill for the optical subsystems and components reporting unit, which is based on the determination of the fair value of all assets and liabilities of this reporting unit. However, based on the work performed through the date of the filing, we concluded that an impairment loss was probable and could be reasonably estimated. Accordingly, we recorded a $178.8 million non-cash goodwill impairment charge, representing our best estimate of the impairment loss during the second quarter of fiscal 2009.

 

While finalizing our impairment analysis during the third quarter of fiscal 2009, we concluded that there were additional indicators sufficient to require another interim goodwill impairment analysis. Among these indicators were a worsening of the macroeconomic environment largely caused by the unavailability of business and consumer credit, an additional decrease in our market capitalization as a result of a decrease in the trading price of our common stock to $4.08 at the end of the quarter and a further decrease in internal expectations for near-term revenues. For purposes of this analysis, our estimates of fair value were again based on a combination of the income

approach and the market approach. As of the filing of our quarterly report on Form 10-Q for the third quarter of fiscal 2009, we had not completed our analysis due to the complexities involved in determining the implied fair value of the goodwill for the optical subsystems and components reporting unit. However, based on the work performed through the date of the filing, we concluded that an impairment loss was probable and could be reasonably estimated. Accordingly, we recorded an additional $46.5 million non-cash goodwill impairment charge, representing our best estimate of the impairment loss during the third quarter of fiscal 2009.

 

As of the first day of the fourth quarter of fiscal 2009, the Company performed the required annual impairment testing of goodwill and indefinite-lived intangible assets and determined that the remaining balance of goodwill of $13.2 million was impaired and accordingly recognized an additional impairment charge of $13.2 million in the fourth quarter of fiscal 2009.

 

During fiscal 2009, we recorded a total of $238.5 million in goodwill impairment charges. At April 30, 2009, the carrying value of goodwill was zero.

 

Interest Income.   Interest income decreased $4.0 million, or 69.6%, to $1.8 million in fiscal 2009 compared to $5.8 million in fiscal 2008. This decrease was due to decreases in our cash balances, primarily as a result of the principal repayment of $100.0 million on our 5 1 / 4 % convertible notes due October 15, 2008.

 

Interest Expense.   Interest expense decreased $7.3 million, or 33.3%, to $14.6 million in fiscal 2009 compared to $21.9 million in fiscal 2008. This decrease was primarily related to the principal repayment of $100.0 million on our 5 1 / 4 % convertible notes due October 15, 2008. Of the total interest expense for fiscal 2009 and fiscal 2008, approximately $7.9 million and $12.3 million, respectively, was related to our convertible subordinated notes due in 2008 and 2010 and other borrowings, $1.8 million and $4.9 million, respectively, represented a non-cash charge to amortize the beneficial conversion feature of the notes due in 2008, and $4.9 million and $4.6 million, respectively, represented a non-cash charge related to the adoption of FASB authoritative guidance for accounting for convertible debt instruments that may be settled in cash upon conversion.

 

Gain on Debt Repurchase.   During fiscal 2009, we repurchased $8.0 million in principal value of our 2.5% convertible notes due October 15, 2010 at a discount to par value of 50.1% and recorded a gain on the repurchase of $3.1 million.

 

Other Income (Expense), Net.   Other expense from continuing operations was $3.7 million in fiscal 2009 compared to other income of $113,000 in fiscal 2008. The increase in other expense in fiscal 2009 was primarily due to unrealized non-cash foreign exchange losses of $1.6 million related to the re-measurement of a $17.8 million note re-payable in U.S. dollars which is recorded on the books of our subsidiary in Malaysia whose functional currency is the Malaysian ringgit and, a loss of $1.0 million on disposal of fixed assets and a loss of $796,000 on impairment of an investment in equity security.

 

Provision for Income Taxes.   We recorded an income tax benefit of $7.0 million for fiscal 2009 which included a non-cash benefit of $7.8 million from the reversal of previously recorded deferred tax liabilities as a result of the impairment of goodwill in fiscal 2009 and current tax expense of $900,000 for minimum federal, state and foreign income taxes arising in certain foreign jurisdictions in which we conduct business. We recorded an income tax provision of $2.2 million for fiscal 2008. The income tax provision for fiscal 2008 included a non-cash charge $1.8 million for deferred tax liabilities that were recorded for tax amortization of goodwill for which no financial statement amortization has occurred and current tax expense of $500,000 for minimum federal and state taxes and foreign income taxes arising in certain foreign jurisdictions in which we conduct business. Due to the uncertainty regarding the timing and extent of our future profitability, we have recorded a valuation allowance to offset our deferred tax assets which represent future income tax benefits associated with our operating losses. There can be no assurance that our deferred tax assets subject to the valuation allowance will ever be realized.

 

Income/Loss from Discontinued Operations, Net of Taxes.   Income from discontinued operations increased $48.3 million to $2.1 million in fiscal 2009 compared to a loss of $46.2 million in fiscal 2008. Based on our annual goodwill impairment analysis in fiscal 2008, we determined that the goodwill related to our network performance test systems reporting unit was impaired and had an estimated implied fair value of zero. As a result, we recorded an estimated impairment charge of $40.1 million in the fourth quarter of fiscal 2008.

Liquidity and Capital Resources

 

Cash Flows from Operating Activities

 

Net cash provided by operating activities totaled $11.8 million in fiscal 2010 compared to $370,000 in fiscal 2009 and $34.6 million in fiscal 2008. Cash provided by operating activities in fiscal 2010 consisted of net income, adjusted for depreciation, amortization and other non-cash charges and benefits totaling $44.4 million offset by $46.8 million of funding of additional working capital which was primarily related to increases in accounts receivable and inventories offset by an increase in accounts payable. Accounts receivable increased by $45.8 million primarily due to the increase in shipments and no sales of accounts receivable under our non-recourse accounts receivable purchase agreement with Silicon Valley Bank which was terminated in October 2009. We sold $37.7 million of accounts receivable under this agreement in fiscal 2009. Inventory increased by $26.7 million and accounts payable increased by $28.4 million due to an increase in purchases to support increased sales.

 

Net cash provided by operating activities in fiscal 2009 consisted of our net loss of $260.3 million adjusted for goodwill impairment charges, depreciation, amortization and other non-cash related items totaling $310.7 million offset by a $49.9 million increase in working capital levels which were primarily related to an increase in accounts receivable and decreases in other accrued liabilities, accrued compensation and deferred income taxes. In fiscal 2009, accrued liabilities decreased by $9.8 million primarily due to our $11.2 million reduction in financing liability related to the termination of a sale-leaseback agreement with the landlord for one of our facilities located in Sunnyvale, California. This decrease was partially offset by an increase in liability relating to the sales of accounts receivable made under our non-recourse accounts receivable sales agreement with Silicon Valley Bank. Accrued compensation decreased by $4.6 million due to reduced salaries and bonuses under a salary reduction plan that we announced in the fourth quarter of fiscal 2009, lower headcount and the reversal of $800,000 of accrued payroll tax liability relating to the stock compensation investigation which was completed during fiscal 2009. Deferred income taxes decreased mainly because of a $7.8 million reversal of previously recorded deferred tax liabilities as a result of the impairment of goodwill in fiscal 2009. Accounts receivable increased by $33.4 million primarily due to increase in revenues.

 

Net cash provided by operating activities in fiscal 2008 consisted of our net loss of $79.0 million adjusted for goodwill impairment charges, depreciation, amortization and other non-cash related items totaling $95.6 million and a $18.1 million decrease in working capital levels which were primarily related to a decrease in accounts receivable and an increase in other accrued liabilities, accounts payable and accrued compensation partially offset by increase in other assets and inventories. Accounts receivable decreased by $8.9 million primarily due to the sale of receivables, partially offset by an increase in revenues. Accounts payable increased by $1.4 million primarily due to timing of payments. The increase in accrued compensation by $3.8 million was primarily due to employee stock purchase plan withholding and higher payroll related accruals. Inventories increased by $1.2 million due to increases in revenues and unit volume. The $5.5 million increase in other assets was primarily related to an increase in receivables from subcontractors due to an increased volume of business with them.

 

Cash Flows from Investing Activities

 

Net cash provided by investing activities totaled $10.7 million in fiscal 2010 compared to $45.0 million in fiscal 2009 and $5.0 million in fiscal 2008. Net cash provided by investing activities in fiscal 2010 was primarily due to the $40.7 million received from sale of the assets of our Network Tools Division to JDSU on July 15, 2009. We also received $1.2 million in cash in the first quarter of fiscal 2010 from the sale a promissory note and all of the preferred stock that we received as consideration for the sale of a product line in the first quarter of fiscal 2009. These receipts were partially offset by $31.4 million of expenditures for capital equipment. Net cash provided by investing activities in fiscal 2009 was primarily related to $38.4 million in net maturities of available-for-sale investments and $30.1 million of cash obtained as a result of the Optium merger, offset by $23.9 million of purchases of equipment to support production expansion. Cash provided by investing activities in fiscal 2008 primarily consisted of $30.8 million in proceeds from net sales of short-term investments, $1.6 million in proceeds from the sale of an equity investment, $600,000 in proceeds from the sale of property and equipment and $600,000 in maturity of restricted securities which was partially offset by purchases of equipment of $27.2 million to support

increased production volumes and a $2.0 million equity investment in a private company accounted for under the cost method.

 

Cash Flows from Financing Activities

 

Net cash provided by financing activities totaled $147.5 million in fiscal 2010 compared to net cash used in financing activities of $87.7 million in fiscal 2009 and $16.3 million in fiscal 2008. Cash provided by financing activities in fiscal 2010 primarily consisted of $98.1 million in proceeds from the issuance of our 5.0% Convertible Senior Notes due 2029, $131.1 million in proceeds from our common stock offering, $5.5 million from bank borrowings by our Chinese subsidiary and $8.4 million from the exercise of stock options and purchases under our employee stock purchase plan, partially offset by $88.0 million of cash used to purchase outstanding convertible notes and $7.7 million of repayments of long-term debt. Cash used in financing activities in fiscal 2009 primarily reflected repayments of $107.9 million on our outstanding convertible notes and $4.2 million of bank borrowings, partially offset by proceeds of $20.0 million from bank borrowings and $4.5 million from the exercise of stock options and purchases under our employee stock purchase plan. The $107.9 million of repayments on our convertible notes included retirement of $92 million principal amount of our outstanding 5 1 / 4 % convertible subordinated notes, through a combination of private purchases and repayment at maturity, and the repurchase of $8.0 million principal amount of our 2 1 / 2 % convertible notes at a discount resulting in a realized gain of $3.1 million. Cash used by financing activities in fiscal 2008 primarily consisted of repurchases of $8.2 million in principal amount of our outstanding 5 1 / 4 % convertible notes due in October 2008, repayment of $6.0 million of convertible notes issued in conjunction with the AZNA acquisition and repayments of $2.0 million under an equipment loan, partially offset by proceeds from the exercise of employee stock options.

 

 

 

 

At April 30, 2010, total long-term debt and principal amounts due under convertible debt were $148.8 million, compared to $163.4 million at April 30, 2009.

 

Long-term debt principally consists of borrowings by our Malaysian subsidiary under two separate loan agreements entered into with a Malaysian bank in July 2008. The first loan is payable in 20 equal quarterly installments of $750,000 beginning in January 2009 and the second loan is payable in 20 equal quarterly installments of $250,000 beginning in October 2008. Both loans are secured by certain property of our Malaysian subsidiary, guaranteed by us and subject to certain covenants. We and our subsidiary were in compliance with all covenants associated with these loans as of April 30, 2010. At April 30, 2010, the principal balance outstanding under these loans was $13.8 million. Long-term debt also includes borrowings by our Chinese subsidiary under a loan agreement entered in with a bank in China in January 2010. Under this agreement, our Chinese subsidiary borrowed a total of $5.5 million at an initial interest rate of 2.6% per annum. The loan is payable in full on January 6, 2013. Interest is payable quarterly.

Convertible debt consists of a series of convertible subordinated notes in the aggregate principal amount of $3.9 million due October 15, 2010, a series of convertible senior subordinated notes in the aggregate principal amount of $25.7 million due October 15, 2010 and a series of convertible senior notes in the aggregate principal amount of $100.0 million due October 15, 2029. The notes are convertible by the holders at any time prior to maturity into shares of our common stock at specified conversion prices. The notes are redeemable by us, in whole or in part at any time on or after October 22, 2014 if the last reported sale price per share of our common stock exceeds 130% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending within five trading days of the date on which we provide the notice of redemption.. The notes are also subject to redemption by the holders in October 2014, 2016, 2019 and 2024. Aggregate annual interest payments on all series of the notes are approximately $5.7 million.

 

Interest on debt consists of the scheduled interest payments on our long-term and convertible debt.

 

Operating lease obligations consist primarily of base rents for facilities we occupy at various locations.

 

Purchase obligations are related to materials purchased and held by subcontractors on our behalf to fulfill the subcontractors’ purchase order obligations at their facilities. Our policy with respect to all purchase obligations is to record losses, if any, when they are probable and reasonably estimable. We believe we have made adequate provision for potential exposure related to inventory purchased by subcontractors which may go unused. Estimated losses on purchase obligations of $722,000 have been expensed and recorded on the consolidated balance sheet as non-cancelable purchase obligations as of April 30, 2010.

 

Sources of Liquidity and Capital Resource Requirements

 

At April 30, 2010, our principal sources of liquidity consisted of $207.0 million of cash and cash equivalents and an aggregate of $66.6 million available under our credit facility with Wells Fargo Foothill, LLC, subject to certain restrictions and limitations.

 

On October 2, 2009, we entered into an agreement with Wells Fargo Foothill, LLC to establish a four-year $70 million senior secured revolving credit facility to finance working capital and to refinance existing indebtedness, including the repurchase or repayment of our remaining outstanding convertible notes. Borrowings under the credit facility bear interest at rates based on the prime rate and LIBOR plus variable margins, under which applicable interest rates currently range from 5.75% to 7.00% per annum. Borrowings are guaranteed by our U.S. subsidiaries and secured by substantially all of our assets and those of our U.S. subsidiaries. The credit facility matures four years following the date of the agreement, subject to certain conditions. As of April 30, 2010, the availability of credit under the facility was reduced by $3.4 million for outstanding letters of credit secured under this agreement. On October 23, 2009, we terminated agreements with Silicon Valley Bank under which various credit facilities had previously been available to us.

 

We believe that our existing balances of cash, cash equivalents and short-term investments, together with the cash expected to be generated from future operations and borrowings under our bank credit facility, will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional financing to fund our operations in the future or to repay or otherwise retire all of our outstanding 5% convertible notes due 2029, in the aggregate principal amount of $100 million which is subject to redemption by the holders in October 2014, 2016, 2019 and 2024. A significant contraction in the capital markets, particularly in the technology sector, may make it difficult for us to raise additional capital if and when it is required, especially if we experience disappointing operating results. If adequate capital is not available to us as required, or is not available on favorable terms, our business, financial condition and results of operations will be adversely affected.

 

Off-Balance-Sheet Arrangements

 

At April 30, 2010 and April 30, 2009, we did not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

As of April 30, 2010, our exposure to market risk for changes in interest rates related primarily to our long-term debt.

 

The following table summarizes principal cash flows and related weighted average interest rates by expected maturity dates and fair market value of the debt securities issued by us as of April 30, 2010 (in thousands).

 

 

Our variable rate debt were primarily dependent upon LIBOR rates. A hypothetical 10% change in interest rates would not have a material impact on our financial position, results of operations or cash flows.

 

We invest in equity instruments of privately-held companies for business and strategic purposes. These investments are included in other long-term assets and are accounted for under the cost method when our ownership interest is less than 20% and we do not have the ability to exercise significant influence. At April 30, 2010, we had investments in four privately-held companies that totaled $12.3 million and were accounted for under the cost method. For these non-quoted investments, our policy is to regularly review the assumptions underlying the operating performance and cash flow forecasts in assessing the carrying values. We identify and record impairment losses when events and circumstances indicate that such assets are impaired. There were impairment losses on these assets of $2.0 million during fiscal 2010. We concluded that there were sufficient indicators during the second quarter of fiscal 2010 to require an investment impairment analysis of our investment in one of these companies. Among these indicators was the completion of a new round of equity financing by the investee and the resultant conversion of the Company’s preferred stock holdings to common stock. We determined that the value of our minority equity investment was impaired and recorded a $2.0 million impairment loss as other expense during the second quarter of fiscal 2010. No impairment losses were recorded in fiscal 2009 and fiscal 2008. If our investment in a privately-held company becomes readily marketable upon the company’s completion of an initial public offering or its acquisition by another company, our investment would be subject to significant fluctuations in fair market value due to the volatility of the stock market.

 

We have subsidiaries located in China, Malaysia, Europe, Israel, Australia and Singapore. Due to the relative volume of transactions through these subsidiaries, we do not believe that we have significant exposure to foreign currency exchange risks. We currently do not use derivative financial instruments to mitigate this exposure. We continue to review this issue and may consider hedging certain foreign exchange risks through the use of currency forwards or options in future years.

 

 

The Board of Directors and Stockholders

Finisar Corporation

 

We have audited the accompanying consolidated balance sheets of Finisar Corporation as of April 30, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended April 30, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Finisar Corporation at April 30, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended April 30, 2010, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Finisar Corporation’s internal control over financial reporting as of April 30, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 1, 2010 expressed an unqualified opinion thereon.

 

 

San Jose, California

July 1, 2010

FINISAR CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes.

 

See accompanying notes.