Item 1. Business
OVERVIEW
Stratos International is a leading supplier of shielded electronic and optical interconnects, plus the transceiver conversion and multiplexing components that are used to combine optical and copper signal transmission lines. We design and manufacture interconnect components and subsystems used in military/aerospace, telecommunications, datacom, and video markets for signal networking.
Our company has a rich history of optical, electrical, and mechanical signal interconnect/packaging expertise and has had a continuing positive role in developing innovative products often involving miniaturization. We have an intellectual property portfolio of more than 100 patents. We are a market leader in several niches including specialty optical products such as small form factor transceivers, coax/optical media interface adapters, optical flex circuits, microwave flexible cable and cable assemblies, and radio frequency (“RF”) coax, twinaxial and triax interconnect products. We currently serve several thousand active repeat customers.
On May 14, 2007, we announced a merger agreement, subject to approval by our stockholders and certain other conditions, pursuant to which all of our outstanding stock would be acquired by Emerson Electric Co. Emerson, based in St. Louis, is a global leader in bringing technology and engineering together to provide innovative solutions to customers through its network power, process management, industrial automation, climate technologies, and appliance and tools businesses. Emerson’s sales in fiscal 2006 were $20.1 billion.
Stratos’ fiscal reporting period ends on the closest Saturday to April 30th. For simplicity purposes Stratos refers to its fiscal year end as April 30.
We use rounding in our financial presentations and as a result, certain sums do not foot.
INDUSTRY
Increasing Demand for Higher Bandwidth
Over the last decade, the number of military and commercial communication networks and the amount of data transmitted over networks has increased substantially due to the growth of data intensive applications/uses such as Internet access, e-commerce, photo and other bandwidth intensive attachments in e-mail, streaming video, multimedia downloading, the movement of large blocks of stored data across networks, the increasing need for large amounts of data access and transfer on the modern military battlefield, and the proliferation of high definition video transport in professional and consumer markets. In addition, the expansion of data and storage networks for business over a geographically dispersed user base has increased both the amount of data and the distance it is transmitted over communication networks. This growth has exposed the transmission speed and physical space limitations of existing
networks that are being addressed by higher bandwidth technologies, particularly at the edge of the networks where users are connected.
Growth of High Bandwidth Technology in the Enterprise Market
10 Gigabit Ethernet and Fast Ethernet in Local Area Networks (“LANs”). LANs interconnect computer users within an organization and allow users to share computer resources. Early LANs, which had relatively limited performance requirements, short connection distances and low transmission speeds, were generally interconnected using copper cabling. Most present day LANs use the Ethernet transmission protocol. As performance requirements, transmission distance and bandwidth requirements of network users have increased, transmission protocols have evolved primarily to 100 Mbps Fast Ethernet. We believe that Gigabit Ethernet technology and 10 Gigabit Ethernet technology (which operates at 10,000 Mbps or 10 gigabits per second (“Gbps”)) will become increasingly important in the near future for LAN connectivity. Each Ethernet switch port relies on an optical or copper subsystem to transmit and receive data.
The scalability and migration capacity built into the Ethernet protocol allows original equipment manufacturers (“OEMs”) developing these systems to leverage their experience with this standard to transition to a higher data rate. This next generation of high data rate networking systems will require even higher performance subsystems and components.
Fiber Channel in Storage Area Networks (SANs). Data storage technology is evolving rapidly. Early storage networks used a standard interface protocol known as the Small Computer Systems Interface or SCSI. Current Fiber Channel technology allows devices to communicate with each other at rates up to 4 Gbps over distances of up to 10 kilometers, while maintaining backward compatibility with the installed base of SCSI-based storage systems. Fiber Channel is scalable and the next generation of Fiber Channel, operating at higher data rates, are now coming to market. Fiber Channel-based SANs enable enhanced network applications such as storage backup and better overall storage management achievable through centralized storage resources. Each Fiber Channel switch port relies on a subsystem to transmit and receive data.
Optical and RF Technology in Access, Metropolitan Area, Wide Area and Telecommunication Networks
Access. The past several years have seen rapid growth of broadband services for business and residential customers. In particular, consumer demand for cable modem and DSL services, next generation cellular applications, and the proliferation of wireless access points, is increasing bandwidth capacity requirements from the telecommunication central offices and cable television headends. This bandwidth demand has caused the telecom and cable television (“CATV”) service providers to embark on large network upgrades. These network upgrades require the use of higher bandwidth optical and coaxial technologies to be deployed closer to the end customer. Fiber to the Home (“FTTH”) is an example of this trend. Another example is the deployment of high speed coaxial DS3 signal rates from the central office into the remote terminal and premise wiring portions of the telecom network, extending bandwidth closer to the edge. Each DS3 line is equal to 28 T1 lines.
Metropolitan and Wide Area Networks (“MANs” and “WANs”, respectively). The increased transmission capabilities of optical and RF technologies have allowed for the geographic extension of LANs and SANs through the use of extended networks, such as MANs and WANs. These networks enable enterprises to interconnect network systems throughout a corporate campus or wide geographic area rather than within a single building. Interconnections between network systems are performed by
switches and routers that use optical and RF components and subsystems. These networks enable businesses to use their networks for enhanced applications, such as real-time backup data storage at longer distances for disaster protection. In addition, these networks offer organizations a cost-effective way to address increased bandwidth requirements.
Telecommunication Networks. Optical and RF technology is also used in high data rate telecommunication applications, including the intra-office connection of clusters of telecommunication switches based on the synchronous optical network (“SONET”) and asynchronous transfer mode (“ATM”) protocols. SONET switches and ATM access switches are often used in telecommunication networks to switch regional traffic and route long distance traffic. Newer generation networks are also applying Ethernet protocols to these telecommunication networks. In these core networks, multiple switches are often grouped together within a service provider’s central office network. RF cable assemblies commonly provide the interconnections between many of these systems.
Optical, RF, and Microwave Technology in Military and Aerospace Applications
Modern militaries are becoming increasingly dependent on digital communications and increasingly “smart” weapons, creating a network centric battle “theater”, where the application of high complexity, multiple platform communication technologies is combined with design attributes suitable for the typically harsh environment in which they are deployed. In avionics applications, the high bandwidth and light weight of optical systems serve to increase the performance of aircraft, as well as, use in in-flight entertainment systems. Tactical field communications use both optical and RF technologies to quickly deploy reliable high bandwidth networks in the battlefield. Microwave cable and connector technology is a vital element of phased array radar systems used for threat warning by the military. Militaries often purchase their systems and technologies from large system integrators, often referred to as “prime contractors”. These system integrators typically have strong expertise in system level design and function, with significantly less expertise in components and subsystems. They rely on their suppliers for component and subsystem level expertise, requiring that their suppliers understand both the technology and their particular application environment.
Demands on Suppliers of Optical, RF, and Microwave Subsystems and Components
The ability to send high data rate signals over longer distances depends not only on optical and electronic transceiver technology, but also on the performance of the fiber optic and electronic connections within the network. The demand for increasing bandwidth places continued emphasis on the need for high quality connectivity in critical applications such as in telecommunications, enterprise, military, and video networks, where the transmission of higher data rates over long distances has pushed the limits of signal integrity. Optical and electronic interconnect points within networks can contribute to signal degradation and can substantially reduce the distance over which signals can reliably be sent. The market demands for networks with ever increasing data rates over longer distances have driven the need for high bandwidth subsystems and components that provide the critical interconnections between devices within these high data rate network systems.
Network equipment manufacturers and military system integrators increasingly rely on highly integrated subsystem suppliers to rapidly develop major elements of their systems. These suppliers allow network equipment OEMs and system integrators to better focus on their core competencies in overall product design, specifically differentiating product benefits, marketing and distribution. We expect this trend to continue, with network equipment OEMs and military system integrators outsourcing an increasing percentage of their non-core functions to contract manufacturers and integrated subsystem suppliers.
PRODUCTS
For accounting purposes, our products fall into one industry segment. Within that segment, our products can be broadly split into those with an optical and those with a copper emphasis. Transceivers, for example, are optical products, while the underlying technology of chips, drivers, analytical diagnostics, and related software is primarily electronic, requiring the translation of an electrical pulse into an optical signal at the point of the laser driver or the optical receiver. Almost all of our copper products are coaxial, twinaxial, or triaxial and involve cable with those same characteristics.
Optical Products:
Over the years, we have built standardized and custom broadband network data communication products through our optoelectronic and passive fiber product families. Our legacy optoelectronics products evolved from an early emphasis on a broad range of standardized, multi-source agreement (“MSA”) compliant fiber optic components, including embedded and removable transceivers, multi-channel optical links and custom integrated modules used in telecom, storage, and data networking applications. These products support a wide variety of protocols including Gigabit Ethernet, Fiber Channel and SONET and address a wide range of wavelengths and transmission distances. Today, the Stratos optoelectronics product offerings are offered under the Stratos Optical Technologies brand and consist of (i), specialty optical transceivers, (ii) military and harsh environment optical interconnect components and port-embedded transceivers, (iii) video components and subsystems and (iv) card level and mux/demux (or multiple/demultiflex) solutions, optical flex circuits, and MSA transceivers for telecom/enterprise. Looking ahead, we see significant advantages for our customers as we combine our existing optoelectronics, multiplexing, expanded beam optical connectors, and optical coarse wave division multiplexing (“CWDM”) technology, our advanced miniaturization techniques, and innovative packaging for even more fully integrated media adaptor solutions.
Specialty Transceivers - We manufacture a line of specialty transceivers based upon less commonly manufactured standard and non-standard form factors and protocols. These products leverage our packaging, miniaturization and optoelectronic expertise and offer smaller modules with enhanced performance characteristics that are not available from other suppliers. Stratos has a core competency in extreme miniaturization and has used this to achieve form factors in transceivers and media converters that are half the size of conventional devices.
Military and Harsh Environment Components and Subsystems - Our optoelectronics products for the military market meet the shock and vibration requirements of military and harsh environment applications. We sell specialized transceivers and custom integrated modules designed to meet specific customer requirements, including active bulkheads and connectors, either of which may combine a transceiver media converter and optical interconnect in a single integrated package.
Video Components and Subsystems - We provide optoelectronic solutions specifically designed for the transport of standard definition and high definition video signals. These products include transceivers, media converters, mux/demux products, splitter/combiner products, and subsystems.
CWDM Components and Modules - We manufacture and sell 4, 8 and 16-channel multiplexer and demultiplexer modules, one to four channel optical add/drop modules (“OADM”), integrated modules with pluggable and discrete active components and a dense wave division multiplexing (“DWDM”) interleaver product. These products are typically customized to the specific needs of our telecom and enterprise customers.
MSA Transceivers for Telecom/ Enterprise - Our MSA transceivers offerings include 1x9, gigabit interface converter (“GBIC”), small form factor (“SFF”), small form factor pluggable (“SFP”), and CWDM SFP form factors in multiple laser variations for short, medium and long reach applications.
Optical Flex Circuits and Multifiber Assemblies - We have proprietary, automated and software driven optical flex-circuit manufacturing expertise. Using that expertise, we develop custom circuit cards and backplane solutions for specific customer requirements. The Fiber Optics product line consists of (i) CWDM components and modules, (ii) optical flex circuits and multi-fiber assemblies, (iii) harsh environment connectors, (iv) specialty fiber components and assemblies, and (v) connectors and cable assemblies.
Optical Harsh Environment Connectors - We supply optical expanded beam and physical contact harsh environment connectors to the military and other end markets. Our expanded beam connector technology utilizes optics to expand the beam of light at the end of the fiber, making the connector less susceptible to performance degradation due to dust, debris, moisture, shock and vibration. We also have developed a series of complementary physical contact connectors to address additional applications, including adaptors from physical contact to expanded beam to help bridge these technologies.
Specialty Fiber Components and Assemblies - Our products include custom optical subassemblies for transceiver and device manufacturers in single and multi-fiber applications. We have developed these specialized products for the medical device, military fiber sensor, industrial laser and sensing, and oil and gas markets.
Optical Connectors and Cable Assemblies - We incorporate industry standard optical connectors in support of our optical flex circuit, CWDM, harsh environment connector and specialty products.
Sources and Availability of Raw Materials - Raw materials used in the manufacturing of optical transceivers, connector products and cable assemblies are primarily:
Raw Material
Primary Source
Availability
Electrical
Active
Domestic Dist./ Mfg. Numerous
Passive
Domestic Distributors
Stock
PCB
Domestic Manufacturer
1-8 weeks
Mechanical
Machined
Domestic Manufacturer
2 days-4 weeks
Stamped
Domestic Manufacturer
4-6 weeks
Castings
Domestic Manufacturer
8 weeks
Plastics
Domestic Manufacturer
1-6 weeks
Insulators
Domestic Manufacturer
1-3 weeks
Tubings
Domestic Manufacturer
Stock-2 weeks
Copper Products:
We design, manufacture and market two copper “branded” product lines.
•
Our Trompeter brand product line offers RF connectors, patch jacks, installation tools, adaptors, cable and cable assemblies. Over the past 40 years, Trompeter has carved out a unique position of high customer regard and industry recognition that regularly places it as a leader in independent, third party supplier performance surveys. We emphasize knowledge of customer application design, extraordinary service levels, and high responsiveness to customer needs. We primarily sell our RF interconnect products to the telecom, military/aerospace, and video markets.
•
Our Semflex brand product line includes flexible microwave frequency bulk cable and cable assemblies for the military, aerospace, and test instrumentation markets. Our microwave cable and cable assemblies business, operated under the Semflex brand, designs and manufactures flexible microwave frequency coaxial cable and custom cable assemblies for the military/aerospace, commercial OEM and test instrumentation markets. Additionally, Semflex manufactures custom connectors, adapters, phase trimmers and other components to meet special application requirements, usually associated with the cable assemblies being built.
RF Interconnection Products for Military/ Aerospace - We produce impedance controlled Twinax and Triax RF connectors as well as patch jacks that enable high frequency electrical performance in harsh military and industrial environments. Applications for the military/aerospace RF connector products include MIL-STD-1553 databus couplers, forward battlefield command centers, video control rooms, space based satellite equipment and hermetic interconnects.
RF Interconnection Products for Telecom - Our Trompeter BNC and M-BNC connectors are widely used in telecom applications in central offices as well as emerging deployments of coaxial technology in remote terminal applications. Our product offerings include the 75 ohm Coaxial BNC series, the mini-BNC series, Western Electric Company (“WECo”) and mini-WECo patch plugs and various other interconnect jacks, plugs, and adaptors. Inside a typical telecommunication central office the high speed digital copper line rate is DS3, and utilizes 75 ohm coaxial technology. We are a leading supplier of telco-grade plugs to the newly re-consolidated RBOCs and most CLEC service providers largely due to
our commitment to installer training, best-in-class installation tools, and high quality and service levels for the public switched telephone network.
Within a telecommunications network, a demarcation point is the point where the network responsibility transfers from one network operator to another. Trompeter’s interconnect modules enable a network access point immediately adjacent to a demarcation point, enabling operators to assure a quality handoff, and to avoid service calls for network problems beyond their control. In addition, these products allow customers to access and test network points without disconnecting, avoiding service disruptions.
RF Interconnection Products for Video - We manufacture 75 ohm BNC connectors and patch jacks for video signal applications in both WECo and mini-WECo form factors. Our products are used in cable TV and broadcast station signal management, mobile production vehicles, and post-production editing applications.
RF Cable Assemblies - We manufacture coaxial and twinax cable assemblies, servicing primarily telecom service providers and their central office installers, as well as military communications shelter manufacturers.
Microwave Cable - We manufacture high performance, flexible microwave cable and market these under the Semflex brand. Our production process delivers low attenuation characteristics over length and at microwave frequencies. This capability allows us to produce low-loss tuned cable assemblies where the performance of the cable is matched to the connector design. Applications are primarily high power or low loss or a combination of both.
Microwave Cable Assemblies - Our cable assemblies are typically phase matched microwave frequency custom designs of both the cable and connector for a variety of military, precision test, and wireless applications. We sell both flexible and semi rigid cable assemblies to the military and aerospace industries.
Sources and Availability of Raw Materials - Raw materials used in the manufacturing of RF and Microwave connector and cable products are primarily:
Raw Material
Primary Source
Availability
Brass
Local Distributor
Stock
Stainless Steel
Local Distributor
Stock
BeCu
Local Distributor
Stock
PTFE Rod
Local Distributor
Stock
PTFE Tapes
Domestic Manufacturer
Manufactured from stock
Copper Conductors
Domestic Manufacturer
Manufactured from stock
FEP Jacket Material
Domestic Manufacturer
Manufactured from stock
Polyurethane Jacket Material
Domestic Manufacturer
Manufactured from stock
RF Cable
Domestic Manufacturer
Manufactured from stock
Polyolefin Sleeving
Local Distributor
Stock
Machine parts
Domestic/Offshore/Internal
Stock to 8 weeks
CUSTOMERS
During fiscal 2007 sales to our five largest customers accounted for 20% of consolidated net sales. Sales to our largest single customer, General Dynamics Corporation and its respective contract manufacturers, accounted for 7% of consolidated sales and sales to our second largest customer, EDO, accounted for 7% of consolidated net sales. In fiscal 2006, sales to General Dynamics Corporation and its respective contract manufacturers amounted to 8% of consolidated net sales.
BACKLOG
Backlog consists of written purchase orders for products for which we have assigned shipment dates within the following 12 months. As of April 30, 2007 and 2006, our backlog was approximately $17.5 million and $13.6 million, respectively. Orders in backlog are firm, but are subject to cancellation or rescheduling by the customer.
MANUFACTURING
We provide integrated engineering and manufacturing capabilities at each of our three manufacturing locations, including product design, fabrication, assembly, packaging and testing, and deliver quality assurance through our ISO 9001/2000 certified processes and procedures. We also have proprietary processes such as autocalibration and automated multifiber polishing to ensure that we meet stringent customer requirements. Our integrated engineering/manufacturing business model allows us to reduce development times and respond to customer needs.
Chicago, Illinois: We currently manufacture the majority of our video transport optoelectronic products, CWDM components and modules, optical flex circuits and most multifiber assemblies, and harsh environment assemblies for the domestic market in our 89,000 square foot Chicago facility. Some products are manufactured to our design at offshore contract manufacturing facilities in Asia; some are purchased as Stratos private labeled products, designed and manufactured by other manufacturers in the Far East.
Our optical flex circuit products are assembled by a proprietary, software-driven automated fiber routing and embedding system, along with semi-automated multi-fiber connector polishing machines and processes.
The CWDM operation features micro-optic alignment equipment and processes. We have also developed proprietary test methods to increase throughput of these multi-wavelength modules. The facility also includes extensive test laboratories with Telcordia, Highly Accelerated Life Test and Highly Accelerated Stress Screen capabilities, 3,000 square feet of clean-room capacity and an in-house toolroom.
The Chicago operations are ISO 9001:2000 certified and operate a JD Edwards ERP system.
Mesa, Arizona: Most of the Trompeter and Semflex products are assembled in the Mesa facility. The 50,000 square foot, two building complex includes a full function vertically-integrated manufacturing facility for Semflex’s low loss, tape wrapped, flexible microwave cable line; close coupled with a medium capacity machining facility with significant computer-controlled turning, milling and drilling capability for turn-key production. This operation also produces medium and low volume Swiss screw machine type contacts for the Trompeter RF connector line.
In addition, the Mesa facility houses an automated nickel plating line, primarily for the Trompeter connector business, as well as an upgraded gold plating line used for all RF and microwave contacts in support of all product lines. Many of the other RF connector product line components are sourced from various low cost suppliers. The facility also houses a multi-shift assembly and test capability for all product lines. Additionally, we own approximately 4.5 acres of land adjacent to the Mesa facility that we can use for future expansion needs.
The Mesa facility is ISO 9001 certified and meets the requirements of MIL-Q-9858A and other military standard requirements. The Mesa facility operates on a DataFlo ERP system.
Haverhill, United Kingdom: Stratos’ Haverhill, United Kingdom facility currently manufactures our harsh environment connectors and cable assemblies and advanced fiber products in 30,000 square feet of leased space. The harsh environment connector components are produced with a seven axis machining center and two micro-turn lathes, featuring 0.1 micron repeatability. Metrology equipment supports production, quality and development and includes ultra high precision gauging (up to 0.1mm accuracy), a precision measuring center, environmental test chambers and a tensile load tester. The specialty fiber components and assembly business is supported by a Class 10,000 clean room, Electro Static Discharge flooring, high vacuum plasma vapor deposition equipment, RF induction heating systems, a high power CO2 laser machining and laser cleaving centers, and a scanning electron microscope. The United Kingdom facility operates on a Pegasus ERP system.
RESEARCH AND DEVELOPMENT
As of April 30, 2007, we had 58 employees engaged in research and development. Our research and development expenses were $8.2 million, $8.3 million and $9.5 million in fiscal 2007, 2006 and 2005, respectively.
We believe continued investment in research and development is critical to our future success. We concentrate our research and development activities on enhancing our existing products and developing new products to meet the evolving needs of our customers. Our interaction with customers throughout the product design process enables us to anticipate emerging technological trends in the networking industry and focus our research and development efforts on addressing these needs.
TECHNOLOGY AND INTELLECTUAL PROPERTY
We have a rich history of product innovation and have been a pioneer in developing several RF and optical devices. These innovations have allowed us to amass a strong IP portfolio, certain segments of which we have crossed-licensed with leading technology companies including Agilent, IBM and Tyco. We collect licensing fees through upfront payments and/or ongoing royalties. As of April 30, 2007, we had in excess of 100 U.S. patents issued and 26 pending patent applications for innovations in the areas of optoelectronics, optical interconnects, RFID products, and RF/microwave products. We protect our other proprietary information such as know-how through trade secrets.
Active Components and Subsystems (Optoelectronics)
We have a number of issued patents in the areas of electromagnetic interference (“EMI”) and radio frequency interference (“RFI”), specifically relating to the electromagnetic energy emissions from the space between the optoelectronic device and the chassis of the host device.
Separate from providing solutions for EMI and RFI problems, we also have patents covering certain aspects of the electrical circuit architecture or electrical circuit operation of optoelectronic devices. These patents cover functions such as a laser feedback system, a laser diode stabilizer, a transceiver module having variable voltage capability, and an optoelectronic transceiver having an adaptable logic level signal detect output.
Active Integrated Modules and Passive Components and Subsystems (Fiber Optics)
We have developed a number of fiber management solutions that organize optical fibers through “flex circuitry” or bonding fibers to flexible substrates, and high capacity/high density solutions that use radio frequency identification (“RFID”) tags that are specifically applied to fiber optic systems. These solutions enable operators to organize and manage their numerous optical fibers interconnecting their host devices. The RFID system enables operators to associate a specific optical fiber with a specific port of a host device. We have twelve issued patents related to the design or manufacturing of flex circuitry, including optical and electrical flex circuitry, and have pending patent applications related to the application of RFID techniques to optical systems. In addition, we have other issued patents that relate to various aspects of optical connectors. We also have patents that cover certain aspects of single fiber ferrules, multifiber ferrules and metallization of an optical fiber.
RF and Microwave Interconnect Products (RF/ Microwave)
Through Trompeter and Semflex, we have an intellectual property portfolio consisting of patents and trade secrets for RF and microwave connectors and various interconnection modules. One innovation includes a visual indicator to ensure a plug-side connector is fully engaged with a jack-side connector so as to form a “failsafe” mated condition. The visual indication allows the operator to notice from a distance that the electrical hardware is properly engaged, which is more cost effective than an operator manually verifying each connection. This function is especially valuable when the electrical hardware is in buildings that are subject to shock and vibration. Another innovation is the M-BNC small form factor bayonet coupling sleeve RF connector which allows miniaturization in the telco space for DS3 connectivity.
SALES AND TECHNICAL SUPPORT
Stratos sells through a network of representatives, distributors, and direct sales professionals primarily across North America, Europe, Asia, and Central America. Our sales teams are organized into three groups, including Stratos Optical Technologies (active and passive optical components and subsystems including optical video and military products), Trompeter (RF interconnects) and Semflex (microwave cable and cable assemblies). Stratos maintains three distinct sales organizations to focus selling efforts on specific customer types and to capture the strong brand identity each has developed in its respective marketplace.
We believe our ability to deliver value-added customer service and technical support is essential to our business. Our sales force and design engineers work closely with our customers through the design and manufacturing process. We also provide extensive technical support to our customers after the design and qualification process is complete. We intend to strengthen our current customer relationships by continuing to deliver a high level of value-added service and technical support and leveraging our reputation for high quality products and service to establish relationships with new customers.
MARKETING
The marketing group is responsible for developing marketing strategies and programs that support the sale of Stratos’ products and enhance its reputation in the industry. These strategies and programs include (i) ongoing interaction with customers for the development of new products and technical support, (ii) advertising and other promotional activities in industry trade journals and publications targeting design engineers, (iii) participation in major trade show events and conferences in the communications network industry to promote Stratos’ broad lines of active and passive optical and RF and microwave components and subsystems, (iv) public relations covering new products and company capabilities, (v) market research to guide R&D investment, (vi) corporate branding to create a consistent and accurate message across the Stratos Optical Technologies, Trompeter and Semflex brands, and (vii) interaction with its customers and peers in industry associations to promote and further enhance related technologies, and to validate Stratos’ emerging role as the technology innovator for solutions in our served markets.
COMPETITION
The market for optical, RF and microwave subsystems and components is highly competitive and subject to rapidly changing technology. We believe the primary competitive factors impacting our business include:
•
Data rate, port density, reliability and other performance features,
•
Ability to rapidly scale production for high volumes,
•
Timeliness of new product introductions,
•
Length of product design cycle,
•
Compatibility with emerging industry standards,
•
Scope and responsiveness of service and technical support,
•
Price and performance characteristics, and
•
Established reputation with key customers.
Within the optoelectronics market, we compete primarily with Agilent Technologies, Inc., Finisar Corporation, JDS Uniphase Corporation and Optical Communications Products, Inc. Within the fiber optic passives market, we compete primarily with Amphenol Corporation, Molex, Inc. and Tyco International, Ltd. and numerous other smaller companies. Within the RF market we compete with ADC Telecommunications, Inc, Amphenol, ITT Cannon (a subsidiary of ITT Industries), Kings Electronics Co., Inc, Radiall, S.A. and numerous other companies globally. In the microwave products business, we compete with Times Microwave, Inc., WL Gore Associates, Inc., Huber+Suhner and a large number of smaller companies. Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing, distribution and other resources than we do, and as a result, may be able to:
•
Respond more quickly to new or emerging technologies or standards and to changes in customer requirements.
•
Devote greater resources to the development, promotion and sale of their products, and
•
Deliver competitive products at a lower price.
In addition, some of our existing and potential customers are also current and potential competitors. These companies may attempt to integrate their operations by producing their own subsystems or components or by acquiring one of our competitors, thereby eliminating the need to purchase our
products. Furthermore, larger companies in other related industries may develop or acquire technologies and apply their significant resources, including their distribution channels and brand name recognition, to capture significant market share.
Some of our critical components used in production of certain of our products are purchased from a key supplier, which has been acquired by a competitor. If this supplier increases prices, reduces quantities available to us or ceases to supply us, our business and results of operations may be significantly harmed. We may not be able to compete successfully against either current or future competitors. 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.
REGULATORY MATTERS
Our properties and business operations are subject to a wide variety of federal, state, local, and foreign environmental, health and safety laws and other legal requirements, including those relating to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous substances used in our manufacturing processes. If we fail to obtain required permits or otherwise fail to operate within these or future legal requirements, we may be required to pay substantial penalties, suspend our operations or make costly changes to our manufacturing processes or facilities. Although we believe that we are in compliance and have complied with all applicable legal requirements, we may be required to incur additional costs to comply with current or future legal requirements.
RoHS (Reduction of Hazardous Substances), lead-free legislation, is being enforced throughout the European Community (EU) commencing July 1, 2006. Full compliance with RoHS (including the use of lead free soldering agents) will be costly and will involve significant engineering investments going forward in product redesign. Stratos is already well into its compliance effort and has achieved a significant set of milestones. Relative to other companies faced with this same regulatory issue, we believe we are matching customer expectations and, in some cases, are well ahead of our competition on this matter.
EMPLOYEES
As of April 30, 2007, we had approximately 524 employees including 14 senior level corporate executives and administrative employees.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information concerning executive officers of Stratos as of July 11, 2007:
Phillip A. Harris (60): President and Chief Executive Officer of Stratos since December 2004 and a director of Stratos since November 2003. Prior to being elected as President and Chief Executive Officer, Mr. Harris served as Chairman of the corporate governance and nominating committee and as a member of the compensation committee. Mr. Harris was a director of Sterling Holding Company from 2002 through the closing of Stratos’ acquisition of Sterling in November 2003. Mr. Harris was Executive Vice President of Sprint North Supply (a telecommunications equipment distributor) from 1994 until his retirement in 2001. From 1978 until 1994, Mr. Harris held a number of senior operating positions with Sprint Corporation (a telecommunications provider).
Barry Hollingsworth (42): Chief Financial Officer of Stratos since February 2005. From 2004 until his appointment as CFO, Mr. Hollingsworth was Vice President of Finance & Administration for Stratos. Prior to joining Stratos, he was Director of Finance at Heidrick & Struggles International from 2000 through 2003, and was employed by Tribune Company from 1994 through 2000, where he served in various capacities including internal audit and investor relations.
Richard C.E. Durrant (46): Executive Vice President of Stratos since November 2004, Executive Vice President Passive Subsystems 2002 through November 2004, and the Managing Director of our UK subsidiary (Stratos Ltd.) since it was acquired by our predecessors in December 1998. Mr. Durrant previously served as the Managing Director of Methode Fiber Optic Europe Ltd. from 1997 through April 2000. From 1989 through 1997 Mr. Durrant served as Sales Director of Mikon Ltd., a Methode subsidiary.
Joe D. Norwood (65): Executive Vice President of Stratos since 2003. Mr. Norwood has served as President and Chief Executive Officer of Sterling since 2001. During 2001, he served as Executive Vice President and Chief Operating Officer of Sterling; from 1997 to 2001, he was President of Sterling’s Trompeter Electronics subsidiary. He served as Vice President of Amphenol Corporation in charge of their RF/Microwave and Fiber Optic Products divisions from 1986 until 1992 and again from 1995 to 1996 as a Vice President of their Time Fiber Communications subsidiary. From 1992 to 1994 he served as a Vice President of ITT Cannon in charge of Military Aerospace and other North American operations. Mr. Norwood holds a BSEE degree from Arizona State University.
Dale Reed (58): Senior Vice President Sales and Marketing since 2006. Mr. Reed was head of sales and marketing at Trompeter from 1996 to 2006. Prior to joining Trompeter in 1996, Mr. Reed spent 6 years as general manager of a microwave frequency circuit board design/fabrication shop, leading that business’ transition from a narrow defense segment to a broader industrial customer base. Mr. Reed graduated with an Economics degree from Trinity College Hartford in 1970 and added post-graduate work from a variety of institutions over the years including Northwestern, Kent State, Bryant, Stanford, and Georgia State (MBA in Marketing in 1979). An active industry influence, he has authored over 40 published articles, is a senior member of IEEE and is President and is on the Board of Directors of IICIT (International Institute of Connectors and Interconnect Technology).
GEOGRAPHIC AREAS
Information concerning our operations in different geographic regions is set forth in Note 19 to our financial statements included in Item 8 of this annual report on Form 10-K.
AVAILABLE INFORMATION
We make available free of charge through our website, www.stratosinternational.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission. These reports may also be obtained free of charge by contacting Investor Relations, Stratos International, Inc, 7444 West Wilson Avenue, Chicago, Illinois 60706; telephone 708-867-9600. Our Internet website and the information contained therein or incorporated therein are not intended to be incorporated into this Annual Report on Form 10-K. You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site at
www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
Item 1A.
Item 1A. Risk Factors
BUSINESS RISK FACTORS:
In the past, we have incurred significant net losses, primarily due to the economic climate in the communications industry.
The economic climate in the communications industry has resulted in reduced capital spending for networking products from peak spending patterns. Spending for networking products appears to have stabilized and may see a rebound, although it is not expected to return to peak levels for the foreseeable future. As a result, many of our customers continue to express uncertainty as to their future requirements. We do not expect substantial growth in the markets we serve. Any decline in demand for our customers’ products or a deterioration of general economic conditions in the communications industry would likely result in reduction in demand for our products and our business, operating results and financial condition would suffer.
Although we have implemented personnel reductions and other cost reduction programs and have recently achieved profitability, many of our costs are fixed in the near term. Consequently, we will need to contain our costs and operating expenses if we are to maintain profitability. If our efforts to contain our costs are not successful, we will continue to incur net losses.
Our success depends on the long-term growth of the communications industry and its use of our technologies. If these events do not occur, our net sales may decline and our business would likely be significantly harmed.
Our subsystems and components are used primarily in military, video broadcast, industrial, enterprise, MANS, WANS and telecommunication networks. These markets are rapidly evolving and it is difficult to predict their potential size or future growth rate. In addition, there is uncertainty as to the extent to which communications technologies will be used throughout these markets. Our success in generating revenue in these markets will depend on the long-term growth of these markets and their use of communications technologies. If these markets do not grow, or if the use of communications technologies in these markets does not expand, our net sales may decline and our business would likely be significantly harmed.
The market for communications equipment is changing rapidly and is dominated by several large manufacturers. Our future growth will depend, in part, upon (1) our ability to develop and introduce new products for this market and (2) the growth of the communications equipment market and (3) our ability to compete successfully in the communications industry. The growth in the market for communications equipment products and services is dependent on a number of factors, including without limitation:
•
The amount of capital expenditures by network providers
•
Regulatory and legal developments
•
Changes to capital expenditure rates by network providers
•
The addition of new customers to the market
•
End-user demand for integrated Internet, data, video, voice and other network services
We cannot predict the growth rate of the market for telecommunications equipment products and services. The economic climate in the communications industry, changes and consolidation in the service provider market and constraints on capital availability have had a material adverse effect on many of our service provider customers, causing some of these customers to go out of business and a number of other customers to substantially reduce their expansion plans and purchases.
We must develop new products and technologies as well as enhancements to existing products and technologies in order to remain competitive. If we fail to do so, our products will no longer be competitive and our net sales will decline.
The market for our products and technologies is characterized by rapid technological change, new and improved product introductions, changes in customer requirements and evolving industry standards. Our future success will depend to a substantial extent on our ability to develop, introduce and support new products and technologies on a successful and timely basis. If we fail to develop and deploy new products and technologies or enhancements of existing products on a successful and timely basis or we experience delays in the development, introduction or enhancement of our products and technologies, our products will no longer be competitive and our net sales will decline. 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 the value of inventories relating to existing products being written down.
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. We may not be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, our new products may be unable to gain market acceptance and we may not 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.
Our products are incorporated into larger systems, which must comply with various domestic and international government regulations. If the performance of our products adversely affects our customers’ ability to comply with these requirements, we may lose these customers and our net sales will decline.
Our products are incorporated into larger systems, which must comply with various regulations and standards established by different countries, which may vary considerably. If the performance of our products adversely affects our customers’ ability to comply with existing or evolving standards established by regulatory authorities or to obtain timely domestic or foreign regulatory approvals, we may lose these customers and our net sales will decline.
If our products fail to comply with evolving industry standards or alternative technologies in our markets, we may be required to make significant expenditures to redesign our products.
Our products comprise only a part of an entire networking system and must comply with evolving industry standards in order to gain market acceptance. In many cases, we introduce a product before an industry standard has become widely accepted and we depend on the companies that provide other components to support industry standards as they evolve. Because industry standards do not exist in some cases at the time we are developing new products, we may develop products that do not comply with the eventual industry standard. If this occurs, we would need to redesign our products to comply with adopted industry standards. In addition, if alternative technologies were adopted as an industry standard within our target markets, we would have to dedicate significant time and resources to redesign
our products to meet this new industry standard. If we are required to redesign our products, we may incur significant expenses and losses due to lack of customer demand, unusable purchased components for these products and the diversion of our engineers from future product development efforts. If we are not successful in redesigning our products or developing new products to meet new standards or any other standard that may emerge, our net sales will decline.
We are also dependent on sales to the military/aerospace industry, including U.S. and foreign government entities.
Approximately 36% of our sales for the fiscal year 2007 came from direct and indirect sales to the military/aerospace industry, which is heavily dependent on sales to U.S. and foreign government entities, either directly through contracts with such entities or indirectly through distributors and to prime contractors or subcontractors who are building systems or subsystems for them. A significant decline in U.S. and foreign government expenditures could have a material adverse effect on our sales.
Our sales cycle runs from our customers’ initial design to production for commercial sale. This cycle is long and unpredictable and may cause our net sales to decline or our operating expenses to increase.
Because of the length of our sales cycles, our ability to accurately predict the timing of our sales is limited. As a result, if sales forecasts from specific customers are not realized, we may be unable to compensate for the sales shortfall and our net sales may decline. The period of time between our initial contact with a customer and the receipt of a purchase order may span over a year or more, and varies by product and customer. During this time, customers may perform, or require us to perform extensive evaluation and qualification testing of our products. Generally, they consider a wide range of issues before committing to purchase our products, including ability to interoperate with other subsystems and components, product performance and reliability. We may incur substantial sales and marketing expenses and expend significant management effort while our potential customers are qualifying our products. Even after incurring these costs, we ultimately may not sell any or may only sell small amounts of our products to these potential customers. Consequently, if new sales do not result from our efforts to qualify our products, our operating expenses will increase.
Our customers may cease purchasing our products at any time and may cancel or defer purchases on short notice, which may cause our net sales to decline or increase our operating expenses.
We generally do not have long-term contracts with our customers. Sales are typically made pursuant to individual purchase orders, often with short lead times, that may be canceled or deferred by customers on short notice without significant penalty. Our customers base their orders for our products on the forecasted sales and manufacturing schedules for their own products. Our customers have in the past significantly accelerated, canceled or delayed orders for our products in response to unanticipated changes in the manufacturing schedules for their own products, and will likely do so again in the future.
If we do not decrease our manufacturing costs or increase sales of higher margin products as the average unit price of our existing products decreases, our gross margins will decline.
The average unit prices of our products frequently decrease as the products mature in response to increased competition, the introduction of new products and increased unit volumes. Most of our products are designed and manufactured in our own facilities. Accordingly, a significant portion of our cost of sales is fixed over the near term. In order to remain competitive, we must continually reduce our manufacturing costs through design and engineering changes and increases in manufacturing efficiencies. We must also continue to develop and introduce on a timely basis new products that incorporate features that can be sold at higher average selling prices. Our inability to reduce
manufacturing costs or introduce new products with higher average selling prices will cause our gross margins to decline, which would significantly harm our operating results.
The market for our products is highly competitive, which may result in lost sales or lower gross margins.
The market for our products is highly competitive. For optoelectronics, we compete primarily with Agilent Technologies, Inc., Finisar Corporation, JDS Uniphase Corporation and Optical Communications Products, Inc. For fiber optics, we compete primarily with Amphenol Corporation, Molex, Inc. and Tyco International, Ltd. and numerous other smaller companies. For RF products we compete with ADC Telecommunications, Inc, Amphenol, ITT Cannon (a subsidiary of ITT Industries), Kings Electronics Co., Inc, Radiall, S.A. and numerous other companies globally. In the microwave products business, we compete with Times Microwave, Inc., WL Gore Associates, Inc., Huber+Suhner, and a large number of smaller companies.
Many of these companies have substantially greater financial, technical, marketing and distribution resources and brand name recognition than we have. As a result, these competitors are able to devote greater resources than we can to the development, promotion, sale and support of their products. In addition, several of our competitors have large market capitalizations or cash reserves and are much better positioned than we are to acquire other companies in order to gain new technologies or products. Many of our competitors have much greater name recognition, more extensive customer bases, better-developed distribution channels and broader product offerings than we do. These companies may leverage their customer bases and broader product offerings and adopt aggressive pricing policies to gain market share. In addition, companies with diversified product offerings can better sustain an economic downturn.
We expect that more companies, including some of our customers, will enter the markets for our products. We may not be able to compete successfully against either current or future competitors. Competitive pressures, combined with weakening demand, may result in further price reductions, lower margins and loss of market share. In addition, some of our current and potential customers are attempting to integrate their operations by producing their own subsystems or components or acquiring one or more of our competitors, which may eliminate the need to purchase our products. Furthermore, larger companies in other related industries are developing and acquiring technologies and applying their significant resources, including their distribution channels and brand name recognition, in an effort to capture significant market share. While this trend has not historically impacted our competitive position, it may result in future decreases in our net sales.
Further, we manufacture many of our products in the United States and the United Kingdom. Our manufacturing costs are higher than the manufacturing costs of some of our competitors, particularly those located in foreign countries that benefit from lower-priced labor and government subsidies. If our current or potential future customers decide to purchase products from these lower-cost competitors, we could suffer a significant decline in our sales, which could have a material adverse effect on our business, operating results and financial condition.
We depend on suppliers for several key components. If we underestimate or overestimate our requirements for these components, our business could be significantly harmed.
We purchase several key components that are incorporated into our products from a limited number of suppliers. We have experienced shortages and delays in obtaining key components in the past and expect to experience shortages and delays in the future. These shortages and delays have typically
occurred when demand within the industry has increased rapidly and exceeded the capacity of suppliers of key components in the short term. Delays and shortages also often occur in the early stages of a product’s life cycle. The length of shortages and delays in the past has varied from several days to a month. We are unable to predict the length of any future shortages or delays.
Some of our critical components used in production of certain of our products are purchased from a key supplier, which has been acquired by one of our competitors. If this supplier increases prices, reduces quantities available to us or ceases to supply us, our business and results of operations may be significantly harmed.
The inability to obtain sufficient quantities of these components that meet our quality requirements may interrupt and delay the manufacturing of our products or result in the cancellation of orders for our products. In addition, our suppliers could discontinue the manufacture or supply of these components at any time. We may not be able to identify and integrate alternative sources of supply in a timely fashion, or at all. Any transition to alternative suppliers may result in delays in shipment and increased expenses and may limit our ability to deliver products to our customers. Furthermore, if we are unable to identify an alternative source of supply, we may have to redesign or modify our products, which may cause delays in shipments, increased design and manufacturing costs and increased prices for our products.
We make forecasts for our component requirements based on anticipated product orders. Although from time to time we enter into long-term agreements for the purchase of key components, our purchases of key components are generally made on a purchase order basis. We may also maintain an inventory of limited source components to limit the potential impact of a component shortage. We may not accurately predict the demand for our products and the lead-time required to obtain key components. If we overestimate our requirements, we may have excess inventory, which may become obsolete and would increase our costs. If we underestimate our requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Either of these occurrences would significantly harm our business.
Our success depends on our ability to hire and retain qualified personnel, and if we are unable to do so, our product development efforts and customer relations will suffer.
Our products require sophisticated manufacturing, research and development, marketing and sales, and technical support. Our success depends on our ability to attract, train and retain qualified technical personnel in each of these areas. Competition for personnel in all of these areas is intense and we may not be able to hire or retain sufficient personnel to achieve our goals or support the anticipated growth in our business. The market for the highly-trained personnel we require is very competitive, due to the limited number of people available with the necessary technical skills and understanding of our products and technology. If we fail to hire and retain qualified personnel, our product development efforts and customer relations will suffer.
Our products may contain defects, which 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 may contain defects, particularly when first introduced or as new versions are released. Our customers integrate our subsystems and components into systems and products that they develop themselves or acquire from other vendors. As a result, when problems occur in equipment or systems into which our products have been incorporated, it may be difficult to identify the source of the problem. We may be subject to liability claims for damages related to product defects or experience manufacturing delays as a result of these defects in the future, any or all of which could be substantial.
The length of any future manufacturing delays in connection with a product defect will depend on the nature of the defect, and whether we or one of our component suppliers was the source of the defect. Moreover, the occurrence of defects, whether caused by our products or technology or the products of another vendor, may result in significant customer relations problems and injury to our reputation and may impair the market acceptance of our products and technologies.
We are subject to environmental laws and other legal requirements that have the potential to subject us to substantial liability and increase our costs of doing business.
Our properties and business operations are subject to a wide variety of environmental, health and safety laws and other legal requirements, including those relating to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous substances used in our manufacturing processes. These legal requirements may impose on us the need for additional capital expenditures or other requirements. If we fail to obtain required permits or otherwise fail to operate within these or future legal requirements, we may be required to pay substantial penalties, suspend our operations or make costly changes to our manufacturing processes or facilities. Although we believe that we are in compliance and have complied with all applicable legal requirements, we may also be required to incur additional costs to comply with current or future legal requirements.
Economic, political and regulatory risks associated with international operations may limit our sales and increase our costs of doing business abroad.
A significant portion of our sales is generated from customers located outside the United States, principally in Europe. Sales to customers located outside of the United States were approximately 31.0% of our net sales during fiscal year 2007 and approximately 29% of our net sales during fiscal year 2006. We also operate a manufacturing facility in the United Kingdom. Our international operations are subject to a number of risks and uncertainties, including:
•
Difficulties in managing operations in different locations
•
Changes in foreign currency rates
•
Longer accounts receivable collection cycles
•
Difficulties associated with enforcing agreements through foreign legal systems
•
Trade protection measures and import and export licensing requirements
•
Changes in a specific country’s or region’s political or economic conditions
•
Potentially adverse tax consequences
•
The potential difficulty in enforcing intellectual property rights in some foreign countries
•
Acts of terrorism directed against the United States or U.S. affiliated targets
These, and other factors could adversely impact our international sales or increase our costs of doing business abroad or impair our ability to expand into international markets, and therefore could significantly harm our business.
We may pursue additional acquisitions. If we are unable to successfully integrate any businesses or technologies that we acquire in the future or are unable to realize the intended benefits of any future acquisitions, our business will be harmed.
As part of our strategy, we may pursue opportunities to buy other businesses or technologies that would complement our current products, expand our markets or enhance our technical capabilities, or that may otherwise offer growth opportunities. Our experience in acquiring other businesses and technologies is limited. Acquisitions could result in a number of financial consequences, including:
•
Use of significant amounts of cash
•
The incurrence of debt and contingent liabilities
•
Potentially dilutive issuances of equity securities
•
Large one-time write-offs
•
Amortization expenses related to intangible assets
Acquisitions also involve numerous operational risks, including:
•
Difficulties in integrating operations, products, technologies and personnel
•
Unanticipated costs or write-offs associated with the acquisition
•
Diversion of management’s attention from other business concerns
•
Diversion of capital and other resources from our existing businesses
•
Potential loss of key employees of purchased organizations
If we are unable to successfully integrate other businesses or technologies that we may acquire in the future or are unable to realize the intended benefits of any future acquisitions, our business will be harmed.
Our inability to protect our intellectual property rights would significantly impair their value and our competitive position.
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. Although we have numerous issued patents and pending patent applications, we cannot be sure that any patents will be issued as a result of our pending patent applications or, if issued, that any patent claim allowed will be sufficiently broad to protect our technology. In addition, we cannot be sure that any existing or future patents will not be challenged, invalidated or circumvented, or that any right granted thereunder would provide us with meaningful protection of our technology. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. We may be unable to detect the unauthorized use of our intellectual property or to take appropriate steps to enforce our intellectual property rights. Policing unauthorized use of our products and technology is difficult. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States. Further, enforcing our intellectual property rights could result in the expenditure of significant financial and managerial resources and the success of these efforts cannot be predicted with certainty. Litigation has been necessary and may continue to be necessary in the future to enforce our intellectual property rights. Such litigation could be costly and its outcome cannot be predicted with certainty. Our inability to adequately protect against unauthorized use of our intellectual property would significantly impair its value and our competitive position.
Various litigation matters, in which we are defendants, could result in significant monetary damages and expenses or restrictions on our ability to sell our products.
We are involved in various litigation matters that arise from time to time in the ordinary course of business. Our Annual Reports on Form 10-K and quarterly reports on Form 10-Q describe certain litigation matters. See discussion under Part I, Item 3: “Legal Proceedings” below and the footnotes to our financial statements.
In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. From time to time, third parties may assert patent, copyright and other
intellectual property rights to technologies used in our business. In addition, our rights to use our name or other trademarks are subject to challenge by others. Any claims, with or without merit, could be time-consuming, result in costly litigation, and divert the efforts of our technical and management personnel. If we are unsuccessful in defending ourselves against such claims, we could be subject to significant monetary damages and may be required to do one or more of the following: (1) stop using the challenged technology or selling our products that use or incorporate such technology, (2) attempt to obtain a license to sell or use the relevant technology, which license may not be available on reasonable terms or at all, (3) attempt to license a substitute technology on reasonable terms or (4) redesign the applicable products to avoid infringement.
In the event a claim against us were 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.
RISKS RELATING TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK:
The market prices for securities of technology related companies have been volatile in recent years and our stock price could fluctuate significantly.
Our common stock has been publicly traded only since June 27, 2000. The market price of our common stock has been subject to significant fluctuations since the date of our initial public offering. These fluctuations could continue. Factors that could affect our stock price include:
•
Strategic moves by us or our competitors, such as acquisitions (including our announced merger with Emerson Electric Co.)
•
Economic and stock market conditions generally and specifically as they may impact participants in the communications industry
•
Earnings and other announcements by, and changes in market evaluations of, participants in the communications industry
•
Changes in financial estimates and recommendations by securities analysts following our stock
•
Announcements or implementation by us or our competitors of technical innovations or new products, and
In addition, the securities of many companies have experienced extreme price and volume fluctuations in recent years, often unrelated to the companies’ operating performance. Specifically, market prices for securities of technology related companies have frequently reached elevated levels, often following their initial public offerings. These levels may not be sustainable and may not bear any relationship to these companies’ operating performances.
Provisions in our charter documents and Delaware law and our shareholder rights plan may delay or prevent an acquisition of our company, which could decrease the value of the shares of our common stock.
Our restated certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us without the consent of our Board of Directors. These provisions include the authority of our Board of Directors has the right to issue preferred stock without shareholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. Delaware law also imposes some restrictions on mergers and business combinations between us and any holder of 15% or more of our outstanding common stock. These provisions apply even if the
offer may be considered beneficial by some shareholders. In addition, we have adopted a stockholder rights plan designed to protect Stratos and its shareholders from unfair or coercive takeover tactics, which is similar to stockholder rights plans adopted by many other companies.
Item 1B.
Item 1B. Unresolved Staff Comments
Not Applicable.
Item 2.
Item 2. Properties
We own and lease office, administrative and manufacturing facilities. We are actively marketing limited use facilities, which we do not need at the current level of our business. We have recorded a reserve through the end of the lease term in 2007 for future rental obligations for our Mountain View, California leased facility, which we have been unable to sub-lease in light of current rental conditions in the area.
Item 3.
Item 3. Legal Proceedings
From time to time, Stratos becomes involved in various lawsuits and legal proceedings that arise in the normal course of business. We believe that the resolution of these lawsuits and legal proceedings will not have a significant effect on our business, financial condition or results of operations.
Stratos and certain of our former directors and executive officers have been named as defendants in purported class action lawsuits filed in the United States District Court, Southern District of New York. The first of these lawsuits, filed on July 25, 2001, is captioned Kucera v. Stratos Lightwave, Inc. et al. No. 01 CV 6821. The complaints are substantially identical to numerous other complaints filed against other companies that went public during the time of Stratos’ IPO. Three other similar lawsuits have also been filed against Stratos and certain of our former directors and executive officers. The complaints also name as defendants the underwriters for Stratos’ initial public offering. The complaints generally allege, among other things, that the registration statement and prospectus from our June 26, 2000 initial public offering failed to disclose certain alleged actions by the underwriters for the offering. The complaints charge Stratos and several of our former directors and executive officers with violations of Sections 11 and 15 of the Securities Act of 1933, as amended, and/or Section 10(b) and Section 20(a) to the Security Exchange Act of 1934, as amended. The complaints also allege claims solely against the underwriting defendants under Section 12(a)(2) of the Securities Act of 1933, as amended.
In 2003, we agreed to a Memorandum and Understanding, which reflects a settlement of these class actions as between the purported class action plaintiffs, Stratos and the former officers and directors, and our liability insurers. Under the terms of the Memorandum of Understanding, our liability insurers will pay certain sums to the plaintiffs, with the amount dependent upon the plaintiffs’ recovery from the underwriters in the IPO class actions as a whole. The plaintiffs will dismiss with prejudice their claims against Stratos and our former officers and directors, and Stratos will assign to the plaintiffs certain claims that it may have against the underwriters. The plaintiffs filed with the Court a motion for preliminary approval of the settlement, which, when granted, would lead to the mailing of class-wide notices of the settlement and a hearing date for approval of the settlement. The issuers, including Stratos, filed a statement joining in the plaintiffs’ motion for preliminary approval of the settlement. The underwriter defendants opposed the motion. On February 15, 2005, the Court issued its ruling granting the plaintiffs’ motion for preliminary approval of the settlement with the issuers, subject to certain changes to the bar order to be included as part of the settlement and to the notice to the class, and the Court recently approved the revisions made to the settlement and the notice pursuant to its prior order. The settlement still remains subject to final approval by the Court after notice of the settlement is sent to the class. A final fairness hearing on the settlement was held on April 24, 2006, at which time the Court took final approval of the settlement under advisement.
In December 2006, the Second Circuit Court of Appeals reversed the district judge’s order certifying a class in six focus cases, finding that the purported class of plaintiffs cannot be certified as a matter of law. The plaintiffs filed a petition for rehearing, which the Second Circuit denied on April 6, 2007. In a hearing before the district court on May 30, 2007, the plaintiffs acknowledged that they need to revise their class definition and said that they will file a revised motion to certify the IPO Securities Litigation cases as class actions in late September 2007. On June 22, 2007, the issuers filed a joint stipulation terminating the proposed settlement with the plaintiffs. The Court has allowed the plaintiffs to conduct additional discovery relating to class certification issues from the underwriters and the issuers.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to our stockholders during the fourth quarter of fiscal 2007.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the NASDAQ Global Market under the symbol “STLW.” The following table sets forth the range of high and low closing sales prices of our common stock for the periods indicated:
The closing price of our common stock on July 11, 2007 was $7.99. The approximate number of stockholders of record on July 11, 2007 was 650, excluding shares held in street name.
We have never declared or paid dividends on our common stock and currently do not intend to pay dividends in the foreseeable future so that we may reinvest our earnings in the development of our business. Any payment of dividends in the future will be at the discretion of our Board of Directors.
Item 6.
Item 6. Selected Financial Data.
You should read the following selected consolidated financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this annual report on Form 10-K.
The consolidated statement of operations data set forth below for the fiscal years ended April 30, 2007, 2006, and 2005 and the consolidated balance sheet data as of April 30, 2007 and 2006 are derived from, and are qualified by reference to, our audited consolidated financial statements included elsewhere in this annual report on Form 10-K, and are reported in thousands, except par value and per share amounts. The consolidated statement of operations data set forth below for the fiscal year ended April 30, 2004 and 2003 and the consolidated balance sheet data as of April 30, 2005, 2004 and 2003 are derived from consolidated audited financial statements previously filed with the SEC.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ substantially from those anticipated in these forward-looking statements as a result of several factors including, the cautionary statements set forth under “Business Risk Factors”.
ORGANIZATION OF INFORMATION
Our Management’s discussion and analysis is comprised of three major sections: Overview, Critical Accounting Policies, and Results of Operations. These sections include the following information:
•
Overview is a general discussion of our business.
•
Critical Accounting Policies are the policies we believe are important to understanding certain of the material judgments and assumptions incorporated in our reported financial results.
•
Results of Operations include an overview of our consolidated 2007 results compared to 2006, and 2006 results compared to 2005. This section also includes a discussion of key actions and events that impacted our results.
OVERVIEW
Stratos is an innovative international supplier of shielded electronic and optical interconnects, plus the transceiver components that are used to connect these two transmission line mediums. We design and manufacture interconnect components and subsystems used in telecom communications, datacom, military and video markets for signal networking.
On November 6, 2003, Stratos acquired Sterling Holding Company, a privately-held company based in Mesa, Arizona that designs and manufactures RF and microwave interconnect products via its two operating units, Trompeter Electronics, Inc. and Semflex, Inc. The 6,082,000 Stratos common shares issued in this transaction were valued at $5.09 a share, which was the closing price on July 2, 2003, the day the merger was announced. Stratos also issued 50,000 shares of Series B redeemable preferred stock with a face value of $5.0 million and a contingent value of up to an additional $6.25 million based on certain events, including the future performance of Stratos’ share price. The total purchase consideration was $38.8 million, consisting of common and preferred shares of Stratos stock valued at $36.0 million and $2.8 million of acquisition related costs. Our financial statements since November 6, 2003 reflect the acquisition of Sterling.
We are a leading designer, developer and manufacturer of RF and microwave components, active and passive optical, optoelectronic, subsystems and interconnect products used in telecom, enterprise, military and video markets.
We have a rich history of optical and mechanical packaging expertise and have been a pioneer in developing several optical devices using innovative form factors for telecom, datacom, video, military, and harsh environment applications. We have a broad range of products and are a market leader in several niches including specialty optical products such as RJ and low rider transceivers, Media Interface Adapters, flex circuits, as well as high performance RF and microwave coax and triax interconnect products. We currently serve more than 1,300 active customers in telecom, military and video markets.
The average unit prices of many of our products generally decrease as the products mature in response to factors such as increased competition, the introduction of new products and increased unit volumes. We anticipate that average selling prices of many of our products will continue to decline in future periods, although the timing and degree of the declines cannot be predicted with any certainty. 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. There can be no assurance that we will be able to introduce new products to offset the anticipated decrease in the average selling prices of our products.
License fees and royalties represent payments received from licensees of our patented technology, which is also used by us in our optical subsystems. These license agreements generally provide for up-front payments and/or future fixed payments or ongoing royalty payments based on a percentage of sales of the licensed products. The timing and amounts of these payments is beyond our control. Accordingly, the amount received in any given period is expected to vary significantly. We will consider entering into similar agreements in the future, however, we are not able to predict whether we will enter into any additional licenses in the future and, if so, the amount of any license fees or royalties.
Our cost of revenues consists of materials, salaries and related expenses for manufacturing personnel and manufacturing overhead. We purchase several key components used in the manufacture of our products from a limited number of suppliers. We have periodically experienced shortages and delivery delays for these materials. In some circumstances, we maintain an inventory of limited source components to decrease the risk of shortage. If we overestimate our requirements, we may have excess inventory of these components.
The majority of our products are designed and manufactured in our own facilities. In the future we may expand the volume of products manufactured by third parties. In order to remain competitive, we must continually reduce our manufacturing costs through design and engineering innovations and increases in manufacturing efficiencies. There can be no assurance that we will be able to reduce our manufacturing costs.
Research and development expenses consist primarily of salaries and related expenses for design engineers, scientists and other technical personnel, depreciation of test and prototyping equipment, and tooling. Research and development expenses also consist of materials and operating expenses related to major product development projects. We charge all research and development expenses to operations as incurred.
Stratos sells through a network of representatives, distributors, and direct sales professionals primarily across North America, Europe, Asia, and Central America. Stratos’ sales teams are organized into three groups including Stratos Optical Technologies (active and passive optical components and subsystems), Trompeter (RF Interconnects) and Semflex (Microwave Innovations). Stratos maintains three distinct
sales organizations to focus selling efforts on specific customer types and to capture the strong brand identity each has developed in its respective marketplace.
The marketing group is responsible for developing marketing strategies and programs that support the sale of Stratos’ products and enhance its reputation in the industry. These strategies and programs include (i) ongoing interaction with customers for the development of new products and technical support, (ii) advertising and other promotional activities in industry trade journals and publications targeting design engineers, (iii) participation in major trade show events and conferences in the communications network industry to promote our broad lines of active and passive optical and RF and microwave components and subsystems, (iv) public relations covering new products and company capabilities, (v) market research to guide R&D investment, (vi) corporate branding to create a consistent and accurate message across the Stratos Optical Technologies, Trompeter and Semflex brands, and (vii) interaction with its customers and peers in industry associations to promote and further enhance related technologies, and to validate Stratos’ role as the technology innovator for solutions in our served markets.
Sales and marketing expenses consist primarily of personnel costs, including sales commissions, travel costs, outside consulting services, and product marketing and promotion costs. We expect to continue to make significant expenditures for sales and marketing services.
General and administrative expenses consist primarily of personnel costs for our administrative and financial groups, as well as legal, accounting, information technology and other professional fees. We expect to continue to make significant expenditures for general and administrative services.
Critical Accounting Policies
Accounts Receivable
We sell products primarily to various OEMs and distributors. Sales to these customers have varying degrees of collection risk associated with them. Management periodically assesses collection risk and the related allowance for doubtful accounts based on the aging of accounts, historical experience and the customer’s financial condition. If an account becomes uncollectible, it is charged against the allowance for doubtful accounts.
Inventory Reserves
It is our policy to reserve 100% of the value of inventory we specifically identify and consider obsolete or excessive given our future sales estimates. We define obsolete inventory as inventory that will no longer be used in the manufacturing process or items that have potential quality problems. Excess inventory is defined as inventory in excess of one to two years projected usage depending upon the product. Excess inventory is determined using our best estimate of future demand at the time, based upon information then available to us. In general, our policy is to scrap inventory determined to be obsolete shortly after the determination is made and to keep excess inventory for a reasonable amount of time before it is discarded. Occasionally, changed circumstances in the marketplace present us with an opportunity to sell inventory that was previously determined to be excessive or obsolete. If this occurs, we vigorously pursue such opportunities.
Impairment of Long-Lived Assets
We review the carrying value of our long-lived assets if the facts and circumstances, such as significant declines in sales, earnings or cash flows or material adverse changes in the business climate suggest that they may be impaired. If this review indicates that long-lived assets will not be recoverable, as determined based on the estimated undiscounted cash flows of the long-lived asset, impairment is measured by comparing the carrying value of the long-lived asset to fair value. Fair value is determined based on quoted market values, discounted cash flows or appraisals. If an asset is considered held for sale, we adjust the carrying value of the underlying assets to fair value, as determined based on the estimated net realizable proceeds of the assets.
Revenue Recognition
Revenue from product sales, net of trade discounts, is recognized when title passes, which generally occurs upon shipment. We handle returns by replacing, repairing or issuing credit for defective products when returned. SEC Staff Accounting Bulletin No. 104 (“SAB 104”) provides guidance on the recognition, presentation and disclosure of revenue in financial statements. SAB 104 establishes the SEC’s view that it is not appropriate to recognize revenue until all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the seller’s price to the buyer is fixed or determinable, and (4) collectability is reasonably assured. Further, SAB 104 requires that both title and the risks and rewards of ownership be transferred to the buyer before revenue can be recognized.
Customer Returns
It is our policy to establish a reserve for customer returns based on any known returns and anticipated returns based on past experience and accordingly adjust revenue, accounts receivable and inventories.
Customer demand is a changing dynamic. Occasionally, we have and will receive requests from customers to accept the return of merchandise for which they had previously accepted delivery. Although we have no obligation to do so, each such request is evaluated in light of contemplated future business from that customer. We will continue to consider these requests in the future, however, we are not able to predict the amount of any such returns. The sales of our products do not allow the customer the right of return.
Recent Accounting Pronouncements: In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157 “Fair Value Measurements”. The statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The statement applies under other accounting pronouncements that require or permit fair value measurements. The statement does not require any new fair value measurements and we do not expect the application of this standard to change our current practice. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007.
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 “Accounting for Income Taxes.” The interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB 109 “Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 31, 2006, with early adoption permitted. The adoption of FIN 48 does not have a material effect on our consolidated financial position, results of operations or cash flow.
In December 2004, the FASB issued SFAS No. 123(R), a revision to SFAS No. 123, “Accounting for Stock-Based Compensation”. This standard requires us to measure the cost of employee services received in exchange for equity awards based on the grant date fair value of the awards. The cost will be recognized as compensation expense over the vesting period of the awards. Stratos was required to adopt SFAS No. 123(R) at the beginning of fiscal 2007 and adopted the prospective method of transition under the statement. Under this method, we will begin recognizing compensation cost for equity based compensation for all new or modified grants after the date of adoption. In addition, we will recognize the unvested portion of the grant date fair value of awards issued prior to adoption based on the fair values previously calculated for disclosure purposes. Because, virtually all of Stratos’ outstanding options are vested, we have determined that the effect of the adoption of the statement on our consolidated financial statements is immaterial.
Results of Operations
Fiscal years ended April 30, 2007 and 2006
Net Sales: Net sales increased to $91.7 million in fiscal 2007 from $79.0 million in fiscal 2006. The increase is primarily attributed to sales to new customers and increased sales to existing customers. This $12.6 million increase includes a $4.6 million increase in sales into the military/government end market, $4.3 million increase into other end markets, $2.1 million increase in the net sales into the telecom/metro end market, $1.3 million increase of net sales into the data networking end market and a $0.3 million increase into the storage/enterprise end market. Our total sales order backlog increased to $17.5 million as of April 30, 2007 from $13.6 million as of April 30, 2006.
License Fees and Royalties: License fees and royalties increased to $1.1 million in fiscal 2007 from $0.5 million in fiscal 2006. The increase of $0.6 million was attributed to renegotiating existing agreements. License fees consist of payments contingent on sales volume of licensed products.
Cost of Revenues and Gross Margins: Cost of revenues increased to $58.0 million in fiscal 2007 from $50.1 million in fiscal 2006. Gross profit as a percentage of total revenues, or gross margin increased to 37.4% in fiscal 2007 from 37.1% in fiscal 2006. The increase in gross margins is attributed to more profitable sales mix and a reduction in manufacturing costs as a percentage of sales.
Cost of revenues was charged approximately $0.9 million in fiscal 2007 and $1.4 million in fiscal 2006 to increase the reserve for obsolete and excess inventory.
Research and Development: Research and development expenses decreased to $8.2 million in fiscal 2007 from $8.3 million in fiscal 2006. The $0.1 million decrease consisted of a $0.2 million decrease in operating expenses, $0.2 million decrease in material used for research and development offset in part by an increase of $0.3 million in personnel costs dedicated to research and development.
Sales and Marketing: Sales and marketing expenses increased to $11.1 million in fiscal 2007 from $10.2 million in fiscal 2006, an increase of $0.9 million. This increase was directly related to increased sales. Sales commissions increased $0.9 million in fiscal 2007. Salaries and benefits increased $0.2 million in fiscal 2007 offset by a decrease of $0.2 million of operating expenses in fiscal 2007 as compared to the prior year.
General and Administrative: General and administrative expenses increased to $16.7 million in fiscal 2007 from $15.8 million in fiscal 2006, an increase of $0.9 million. The increase included incentive pay of $0.9 million earned in fiscal 2007 and increased professional fees $0.6 million for Sarbanes-Oxley compliance in fiscal 2007. The increase was partially offset by decreased operating expenses $0.6 million in fiscal 2007 as compared to the prior year.
Restructuring and Other Charges: During fiscal years 2006 we recorded restructuring and other charges related to the consolidation and elimination of various operating activities. Such charges included personnel severance expenses, lease expenses for limited-use facilities, and write-down of the values of certain assets related to the restructuring of operations. Restructuring and other charges were $1.0 million in fiscal 2006, of which, $0.8 million related to the closing of a leased facility in Westlake Village, California, and $0.2 million related to other personnel severance expenses.
Litigation Settlements, Net: Stratos recorded $1.1 million of net litigation settlement income in fiscal year 2006, of which $0.7 million related to a settlement from our insurance company for reimbursement of previous litigation expenses, and $0.4 million related to patent infringement settlements.
Investment Income, Net: Investment income, net of investment expense, increased to $1.8 million in fiscal 2007 from $1.2 million in fiscal 2006. Investment income consists of earnings on the short-term investment of excess cash balances. The increase is attributed to increases in interest rates earned throughout fiscal 2007.
Other Income: Other income was $1.1 million in fiscal 2007 and was comprised primarily of unrealized foreign exchange gains on intercompany loans recorded in our operations in the United Kingdom. Other income in fiscal 2006 was $0.8 million and was due primarily to $0.8 million of gains related relating to the resolution and reversal of prior period accruals, and $0.3 million of various other items, partially offset by $0.3 million of unrealized foreign exchange losses on intercompany loans recorded in our operations in the United Kingdom.
Income Taxes: Through April 30, 2007 we had recorded a valuation allowance of $80.0 million against deferred income tax assets primarily associated with tax loss carry forwards. This allowance is necessary because our significant operating losses experienced in recent years establishes a presumption that realization of these income tax benefits does not meet a “more likely than not” standard.
As of April 30, 2007 we have net operating loss carry forwards of approximately $183.7 million. We believe that our acquisition of Sterling Holding Company in November 2003 triggered Internal Revenue Code Section 382 limitations on the net operating loss that existed prior to the acquisition, which was approximately $132.5 million. Of that amount, we believe the available utilization of the net operating loss is limited to approximately $2 million on an annual basis. Our net operating loss carry forwards will expire between 2022 and 2026.
Fiscal years ended April 30, 2006 and 2005
Net Sales: Net sales decreased to $79.0 million in fiscal 2006 from $79.9 million in fiscal 2005. This $0.9 million decrease includes a $2.3 million decrease in the net sales into the telecom/metro end market, $1.7 million decrease into the storage/enterprise end market and a $1.3 million decrease into other end markets. These decreases were offset in part by a $4.4 million increase of net sales into the data networking end market. Sales into the military/government end market were unchanged year over year. Our total sales order backlog increased to $13.6 million as of April 30, 2006 from $11.5 million as of April 30, 2005.
License Fees and Royalties: License fees and royalties were $0.5 million in fiscal 2006 and in fiscal 2005. License fees consist of payments contingent on sales volume of licensed products.
Cost of Revenues and Gross Margins: Cost of revenues decreased to $50.1 million in fiscal 2006 from $52.6 million in fiscal 2005. Gross profit as a percentage of total revenues, or gross margin increased to 37.1% in fiscal 2006 from 34.6% in fiscal 2005. The increase in gross margins is attributed to more profitable sales mix and a reduction in manufacturing costs.
Cost of sales was charged approximately $1.4 million and $1.0 million in fiscal 2006 and 2005, to increase the reserve for obsolete and excess inventory.
Research and Development: Research and development expenses decreased to $8.3 million in fiscal 2006 from $9.5 million in fiscal 2005. The $1.2 million decrease was the result of a $1.2 million decrease in personnel costs dedicated to research and development.
Sales and Marketing: Sales and marketing expenses decreased to $10.2 million in fiscal 2006 from $10.5 million in fiscal 2005. This decrease was due to lower sales and marketing salaries, fringe benefits, bonuses and commissions.
General and Administrative: General and administrative expenses decreased to $15.8 million in fiscal 2006 from $21.9 million in fiscal 2005. This $6.1 million decrease was due to a $3.5 million decrease in legal and professional fees related to litigation that has since been settled, a $1.5 million decrease in general operating expenses, and a $1.1 million decrease in salaries and bonus expense.
Restructuring and Other Charges: During fiscal years 2006 and 2005, we recorded restructuring and other charges related to the consolidation and elimination of various operating activities. Such charges included personnel severance expenses, lease expenses for limited-use facilities, and write-down of the values of certain assets related to the restructuring of operations. Restructuring and other charges were $1.0 million in fiscal 2006, of which, $0.8 million related to the closing of a leased facility in Westlake Village, California, and $0.2 million related to other personnel severance expenses. Restructuring charges in fiscal 2005 were $4.7 million, of which $2.7 million related to personnel and severance costs and $2.0 million related to the lease obligation for a limited use facility that we have been unable to sub-lease through the end of its lease term in 2007.
Litigation Settlements, Net: Stratos recorded $1.1 million of net litigation settlement income in fiscal year 2006, of which $0.7 million related to a settlement from our insurance company for reimbursement of previous litigation expenses, and $0.4 million related to patent infringement settlements. In fiscal 2005, Stratos recorded $2.6 million of net litigation settlement income, of which $4.4 million related to net settlements of several patent infringement cases, and was partially offset by $1.8 million in settlements paid by Stratos related to outstanding litigation.
Investment Income, Net: Investment income, net of investment expense, increased to $1.2 million in fiscal 2006 from $0.6 million in fiscal 2005. Investment income consists of earnings on the short-term investment of excess cash balances. The increase is attributed to increases in interest rates earned throughout fiscal 2006.
Other Income: Other income in fiscal 2006 was $0.8 million and was due primarily to $0.8 million of gains related relating to the resolution and reversal of prior period accruals, and $0.3 million of various other items, partially offset by $0.3 million of unrealized foreign exchange losses on intercompany loans recorded in our operations in the United Kingdom. Other income in fiscal 2005 was $0.5 million and was comprised primarily of unrealized foreign exchange losses on intercompany loans recorded in our operations in the United Kingdom.
Income Taxes: Through April 30, 2006 we had recorded a valuation allowance of $79.9 million against deferred income tax assets primarily associated with tax loss carry forwards. This allowance is necessary because our significant operating losses experienced in recent years establishes a presumption that realization of these income tax benefits does not meet a “more likely than not” standard.
As of April 30, 2006 we have net operating loss carry forwards of approximately $178.3 million at April 30, 2006. We believe that our acquisition of Sterling Holding Company in November 2003 triggered Internal Revenue Code Section 382 limitations on the net operating loss that existed prior to the acquisition, which was approximately $132.5 million. Of that amount, we believe the available utilization of the net operating loss is limited to approximately $2 million on an annual basis. Our net operating loss carry forwards will expire between 2022 and 2026.
LIQUIDITY AND CAPITAL RESOURCES:
Net cash provided (used) in operating activities totaled $6.7 million, $6.0 million and ($3.8) million for fiscal years 2007, 2006 and 2005 respectively. Cash provided from operating activities for fiscal 2007 resulted primarily from net income after adding back non-cash items including depreciation and amortization. Cash was also provided from decreases in refundable income tax receivables, prepaid expenses and increases in accounts payable offset in part by increases in inventories and trade receivables. Cash provided from operating activities for fiscal 2006 resulted primarily from net income after adding back non-cash items including depreciation and amortization. Cash was also provided from decreases in inventories, prepaid expenses and increases in accounts payable offset in part by increases in trade receivables.
Day’s sales outstanding in accounts receivable was 57 days at April 30, 2007 compared to 60 days at April 30, 2006.
Net cash (used) provided by investing activities was ($1.5) million, ($1.3) million and $11.2 million in fiscal 2007, 2006 and 2005, respectively. These amounts reflect the net proceeds from the sale of short-term investments, the proceeds from the sale of assets, offset in part by the purchases of equipment and facilities in all fiscal years.
Net cash (used) by financing activities was ($3.0) million, ($6.3) million and ($2.0) million in fiscal 2007, 2006 and 2005, respectively. Net cash used in financing activities for fiscal 2007 represents $1.9 million for the purchase of treasury shares, $1.0 million for the redemption of preferred shares, $0.3 million of dividends on preferred stock offset in part by $0.2 million of proceeds from the exercise of stock options. Net cash used in financing activities for fiscal 2006 represents $3.0 million for the redemption of preferred shares, $1.6 million for the purchase of treasury shares, $1.1 million of dividends on preferred stock, $0.8 million of repayment of long term debt, offset in part by $0.3 million of proceeds from the exercise of stock options. Net cash used in financing activities from fiscal 2005 represents $2.2 million of repayments of long-term borrowings, and $0.4 million of dividends on preferred stock, offset in part by $0.6 million of proceeds from the exercise of stock options.
As of April 30, 2007, our principal source of liquidity was approximately $33.6 million in cash, cash equivalents and short-term investments.
Since many of our costs are fixed in the near term, we expect to continue to incur significant manufacturing, research and development, sales and marketing and administrative expenses.
We continue to examine and pursue opportunities for improving gross margins and cash flows. The merger with Sterling combined two companies with brands that are well respected by segments of the
telecommunications, military, video and broadcast customer base, and that seek solutions to difficult problems at the electrical side of the high- performance, high-bandwidth interfaces. We believe that these products, when combined with superior customer service, provide the potential for improving gross margins and cash flows.
Our future capital requirements will depend on a number of factors, including our ability to generate increased sales and our ability to manage operating expenses. The continued diversification of our end markets and expansion of our product offerings through internal and, possibly, external growth could materially change our level of cash and cash equivalents. This diversification may require us to seek equity or debt financing. Our cash commitments are the payment of cumulative cash dividends on the Series B Preferred Stock on terms specified in the Certificate of Designation for such stock, in the amount of approximately $0.1 million annually. Also, we are obligated to redeem all shares of Series B Preferred Stock in accordance with the terms of the Certificate of Designation for such stock no later than 60 days following the occurrence of certain events relating to the achievement of $250 million in annual revenue or $500 million in market capitalization. In addition, in the event of a change of control, the outstanding Series B Preferred Stock becomes redeemable for an aggregate of $1.0 million, subject to upward adjustment under certain circumstances relating to market price of our Common Stock.
We believe that our current cash balances will be sufficient to meet our cash needs for working capital, capital expenditures, the Series B Preferred Stock dividend and repayments of borrowings for the next 12 months.
CONTRACTUAL OBLIGATIONS:
Stratos’ contractual obligations as of April 30, 2007 are as follows:
OFF-BALANCE SHEET ARRANGEMENTS:
We are not party to any transactions, arrangements and other relationships with unconsolidated entities or other persons that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, or capital resources. We have no exposures to off-balance sheet arrangements; no special purpose entities; and no activities that include non-exchange-traded contracts accounted for at fair value.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are subject to certain market risks, including foreign currency fluctuations and interest rates applicable to our investments. Although our Stratos U.K. subsidiary enters into transactions in currencies other than its functional currency, the Pound Sterling, foreign currency exposures arising from these transactions are not material to us. The primary foreign currency exposure arises from the translation of our net equity investment in our foreign subsidiary to U.S. Dollars. We view our investment in our foreign subsidiary as long-term. The primary currencies to which we are exposed are the Pound Sterling and Euro.
We do not have exposure to interest rate risk because we do not have any debt. Our market risks include lower income from our short-term investments if interest rates decline.
Item 8.
Item 8. Financial Statements and Supplementary Data
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets at April 30, 2007 and 2006
Consolidated Statements of Operations For the fiscal years ended April 30, 2007, 2006, and 2005
Consolidated Statements of Shareholders’ Equity For the fiscal years ended April 30, 2007, 2006, and 2005
Consolidated Statements of Cash Flows For the fiscal years ended April 30, 2007, 2006, and 2005
Consolidated Statements of Comprehensive Income (Loss) For the fiscal years ended April 30, 2007, 2006, and 2005
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Stratos International, Inc.
We have audited the accompanying consolidated balance sheets of Stratos International, Inc. and subsidiaries as of April 28, 2007 and April 29, 2006 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements 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, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Stratos International, Inc. at April 28, 2007 and April 29, 2006, and the results of its operations and its cash flows for each of the two years then ended, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, effective April 30, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”, using the modified prospective transition method.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Stratos International, Inc.’s internal control over financial reporting as of April 28, 2007 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated July 11, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
/s/ BDO Seidman, LLP
Chicago, Illinois
July 11, 2007
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Stratos International, Inc.
We have audited the consolidated balance sheet of Stratos International, Inc. and subsidiaries as of April 30, 2005, and the related consolidated statements of operations, shareholders’ equity, cash flows, and comprehensive loss for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides 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 Stratos International, Inc. and subsidiaries as of April 30, 2005 and the consolidated results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
June 16, 2005
Stratos International, Inc.
Consolidated Balance Sheets
At April 30, 2007 and 2006
(In thousands, except par value and share amounts)
See notes to consolidated financial statements
Stratos International, Inc
Consolidated Statements of Operations
For the fiscal years ended April 30, 2007, 2006 and 2005
(In thousands, except per share amounts)
See notes to consolidated financial statements
Stratos International, Inc
Consolidated Statements of Shareholders’ Equity
For the fiscal years ended April 30, 2007, 2006 and 2005
(In thousands, except share amounts)
See notes to consolidated financial statements
Stratos International, Inc
Consolidated Statements of Cash Flows
For the fiscal years ended April 30, 2007, 2006 and 2005
(In thousands)
See notes to consolidated financial statements
Stratos International, Inc
Consolidated Statements of Comprehensive Income (Loss)
For the fiscal years ended April 30, 2007, 2006 and 2005
(In thousands)
See notes to consolidated financial statements
Stratos International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(all amounts in thousands, except share and per share data)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company: Stratos International is a leading supplier of shielded electronic and optical interconnects, plus the transceiver conversion and multiplexing components that are used to combine optical and copper signal transmission lines. We design and manufacture interconnect components and subsystems used in telecommunications, datacom, military/aerospace and video markets for signal networking. We provide integrated engineering and manufacturing capabilities at each of our three manufacturing locations, including product design, fabrication, assembly, packaging and testing, and deliver quality assurance through our ISO 9001/2000 certified processes and procedures. Our manufacturing plants are located in Chicago Illinois, Mesa Arizona and Haverhill UK. We also have a research and development facility in Melbourne Florida.
Principles of consolidation: The consolidated financial statements include the accounts of the parent company and all subsidiaries, after elimination of intercompany accounts and transactions.
Stratos’ fiscal reporting period ends on the closest Saturday to April 30th. For simplicity purposes Stratos refers to its fiscal year end as April 30.
Foreign currency translation: The functional currency of our foreign subsidiary is the local currency in the United Kingdom (the Pound Sterling). Accordingly, its results of operations are translated into U.S. Dollars using average exchange rates during the year, while the assets and liabilities are translated using period end exchange rates. Adjustments as a result of the translation process are included in accumulated other comprehensive income (loss).
Use of estimates: We prepare our financial statements in conformity with U. S. generally accepted accounting principles, which requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Revenue recognition: Revenue from product sales, net of trade discounts, is recognized when title passes, which generally occurs upon shipment. We handle returns by replacing, repairing or issuing credit for defective products when returned. We establish a reserve for returns based on any known and anticipated returns and accordingly adjust revenue, accounts receivable and inventories.
Revenue from license fees and royalties represents payments received from licensees of patented technologies, which we also use in our own product offerings. These license agreements generally provide for fixed up-front and/or future payments or ongoing royalty payments based on sales volumes of licensed products that are recognized as revenue over the respective licensing periods. The timing and amounts of these payments is beyond our control and may vary significantly between periods. We will consider entering into similar agreements in the future; however, we cannot predict the timing and resulting amounts of license fees and royalties, if any.
Shipping and handling fees and costs: We include shipping and handling fees billed to customers in “net sales,” and related costs in “sales and marketing” expenses. Shipping and handling fees in fiscal 2007, 2006 and 2005 were $0.3 million, $0.3 million, and $0.3 million, respectively. Product freight out costs in fiscal 2007, 2006, and 2005 were $0.6 million, $0.6 million, and $0.3 million, respectively.
Research and development costs: Costs associated with the development of new products are charged to expense when incurred.
Advertising: We expense all advertising costs as incurred. Advertising expenses in fiscal 2007, 2006, and 2005 were $0.4 million, $0.3 million, and $0.3 million, respectively.
Stock-based compensation: In December 2004, the FASB issued SFAS No. 123(R), a revision to SFAS No. 123, Accounting for Stock-Based Compensation. This standard requires us to measure the cost of employee services received in exchange for equity awards based on the grant date fair value of the awards. The cost is recognized as compensation expense over the vesting period of the awards. Stratos adopted SFAS No. 123(R) at the beginning of fiscal 2007. We adopted the prospective method of transition under the statement. Under this method, we began recognizing compensation cost for equity based compensation for all new or modified grants after the date of adoption. In addition, we recognize the unvested portion of the grant date fair value of awards issued prior to adoption based on the fair values previously calculated for disclosure purposes. SFAS No. 123(R) did not have a material effect on our financial statements for the period ended April 30, 2007.
No stock options have been issued during the twelve months ended April 30, 2007, and 2006. Unearned compensation was reclassified to additional paid-in capital for the period ended April 30, 2007 in accordance with SFAS 123(R).
Income taxes: We file consolidated U.S. Federal and state income tax returns as required. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and their reported amounts, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We assess on an ongoing basis the need for valuation reserves against net deferred tax assets.
Cash and cash equivalents: Cash equivalents consist of time deposits and certificates of deposit with original maturities of three months or less and are carried at their approximate fair values.
Short-term investments: Short-term investments represent short-term corporate debt that is available for sale to meet working capital needs. Cost approximated estimated fair value at the balance sheet date, and gross unrealized gains or losses were not significant. Interest earned relating to these securities is reported as a component of investment income.
Financial instruments: Our financial instruments include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, accrued expenses and long-term debt. The fair values of these financial instruments approximate their net carrying values at April 30, 2007 and 2006.
Accounts receivable: Accounts receivable represents amounts due from customers for products shipped or services performed. We make judgments as to the collectibility of accounts receivable based on historical trends and future expectations and estimate an allowance for doubtful accounts. These allowances adjust gross trade accounts receivable down to net realizable value. Accounts receivable
balances are determined to be delinquent when the amount is past due based on payment terms with the customer.
Inventories: Inventories are stated at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs.
Property, plant and equipment: Properties are stated on the basis of cost. Depreciation and amortization are provided on a straight-line basis over the estimated useful lives of the assets. Accelerated methods are generally used for income tax purposes.
Assets held for sale: Assets held for sale represent property and equipment that is no longer in use and is actively marketed for sale. When we reclassify an asset to assets held for sale, we adjust the carrying value of the underlying asset to its fair value based on the estimated net realizable proceeds.
Intangible assets: Purchased intangible assets are recorded at fair value. We use discounted cash flow models to value intangible assets, and employ the help of independent appraisers for the valuation of significant intangible assets upon acquisition. The discounted cash flow models require assumptions about the timing and amount of future net cash inflows, risk, the cost of capital and terminal values.
Goodwill: We review goodwill for impairment on an annual basis, or if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, we further evaluate the amount of impairment loss.
Long-lived assets: We review long-lived assets for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. We consider market conditions, legal factors and expected cash flows, among other factors, to reach a conclusion about the recoverability of long-lived asset values. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. We measure an impairment loss as the amount by which the carrying amount of a long-lived asset exceeds its fair value.
Impairment of Long-Lived Assets: We review the carrying value of our long-lived assets if the facts and circumstances, such as significant declines in sales, earnings or cash flows or material adverse changes in the business climate suggest that they may be impaired. If this review indicates that long-lived assets will not be recoverable, as determined based on the estimated undiscounted cash flows of the long-lived asset, impairment is measured by comparing the carrying value of the long-lived asset to fair value. Fair value is determined based on quoted market values, discounted cash flows or appraisals. If an asset is considered held for sale, we adjust the carrying value of the underlying assets to fair value, as determined based on the estimated net realizable proceeds of the assets.
Recent Accounting Pronouncements: In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157 “Fair Value Measurements”. The statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The statement applies under other accounting pronouncements that require or permit fair value measurements. The statement does not require any new fair value measurements and we do not
expect the application of this standard to change our current practice. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007.
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 “Accounting for Income Taxes.” The interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB 109 “Accounting for Income Taxes.” The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 31, 2006, with early adoption permitted. The adoption of FIN 48 will not have a material effect on our consolidated financial position, results of operations or cash flow.
In December 2004, the FASB issued SFAS No. 123(R), a revision to SFAS No. 123, “Accounting for Stock-Based Compensation”. This standard requires us to measure the cost of employee services received in exchange for equity awards based on the grant date fair value of the awards. The cost will be recognized as compensation expense over the vesting period of the awards. Stratos was required to adopt SFAS No. 123(R) at the beginning of fiscal 2007 and adopted the prospective method of transition under the statement. Under this method, we will begin recognizing compensation cost for equity based compensation for all new or modified grants after the date of adoption. In addition, we will recognize the unvested portion of the grant date fair value of awards issued prior to adoption based on the fair values previously calculated for disclosure purposes. Because, virtually all of Stratos’ outstanding options are vested, we have determined that the effect of the adoption of the statement on our consolidated financial statements is immaterial.
of production. Because actual future production levels are subject to many factors, including demand for our products, we cannot presently determine if the adoption of SFAS No. 151 will have a material impact on future results of operations.
NOTE 2. ACCOUNTS RECEIVABLE
We reduce our accounts receivable balance to account for an allowance for doubtful accounts. The table below shows the activity in the allowance for doubtful accounts during each of the fiscal years ended April 30:
NOTE 3. INVENTORIES
We define obsolete inventory as items no longer useful in our manufacturing process or items that have potential quality problems, and record a reserve of 100% of their values. We determine excess inventory using estimates for future demand. Details of our inventories and related reserves for the fiscal years ended April 30, are as follows:
The write-off of obsolete inventory reserves represents the disposal of related inventory or usage of product previously reserved for.
NOTE 4. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets at April 30, 2007 and 2006 consist primarily of cash payments for insurance policies and maintenance agreements applicable for a period up to one year.
NOTE 5. PROPERTY, PLANT AND EQUIPMENT
Details of property, plant and equipment at April 30, 2007 and 2006, were as follows:
NOTE 6. INTANGIBLE ASSETS
Amortizable intangible assets were comprised of the following:
The following table shows the estimated future amortization expense for intangible assets:
NOTE 7. GOODWILL
We performed our annual goodwill impairment review in accordance with SFAS No. 142 during the fourth quarters of fiscal years 2007, 2006, and 2005. Our goodwill impairment tests resulted in no additional impairment charges.
Goodwill was adjusted to $3.0 million from $3.4 million at April 30, 2006 as the result of releasing a portion of our deferred income tax valuation allowance. Other indefinite lived assets and trade names were $2.7 million. Goodwill and other indefinite-lived assets at April 30, 2005 are comprised of goodwill of $3.4 million and trade names of $2.7 million, each related to the Sterling acquisition.
NOTE 8. IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we evaluate our long-lived assets for impairment. This process requires us to consider whether any indicators of impairment are present and, if so, whether the sum of the estimated undiscounted future cash flows attributable to those assets is less than their carrying values. We recognize an impairment loss based on the excess of the carrying amounts of long-lived assets over their respective fair values, if any. There was no impairment of assets for the years ended April 30, 2007, 2006 and 2005.
NOTE 9. RESTRUCTURING AND OTHER CHARGES
We recorded restructuring and other charges related to the consolidation and elimination of various operating activities in each of our fiscal years 2006 and 2005. The charges included the write-down of the values of certain assets, personnel severance expenses, lease expenses for limited-use facilities and legal costs related to the restructuring of operations. The restructurings allowed us to compete more effectively in our markets and created a cost structure more in line with the current level of our business.
In September 2005 we began moving administrative functions from our Westlake Village, California location to our facilities in Mesa, Arizona. We incurred charges of $0.8 million for employee costs, legal and other costs. The moves were completed by December 15, 2005. We also incurred $0.2 million of severance expenses at other locations in fiscal 2006.
We recorded $4.7 million in restructuring and other charges in fiscal year 2005, of which, $2.7 million related to personnel and severance costs for the elimination of 45 primarily administrative positions and $2.0 million related to the lease obligation for a limited use facility. We completed the workforce reduction during our third quarter of fiscal 2005.
Charges relating to the restructuring, subsequent activities and the remaining balances are summarized as follows:
Expenses for asset write-downs are non-cash charges, and are offset against the carrying values of the respective assets. The limited-use facility rental expense will be paid in monthly installments through the end of the lease term in 2007.
NOTE 10. ACCRUED EXPENSES
Accrued expenses are detailed as follows:
NOTE 11. LONG-TERM DEBT
During the year ended April 30, 2006 the remaining principal balance of our long term debt of $.8 million was paid in full. The debt consisted of a note payable for the purchase of computer software and hardware in connection with the implementation of a new information technology system in fiscal year 2002. The note was supported by a letter of credit in the amount of $2.7 million that expired on August 1, 2005.
Cash payments in fiscal years 2006 and 2005 for interest on debt amounted to $0.0 million, $0.1 million respectively.
NOTE 12. REDEEMABLE SERIES B PREFERRED STOCK
The number of authorized shares of preferred stock is 1,000,000 of which 50,000 shares are designated as Series B preferred stock. The Series B preferred stock has a par value of $0.01 per share and a stated value and a liquidation preference of $100.00 per share, plus accrued and unpaid dividends. With respect to dividend rights and rights on liquidation, dissolution and winding up, the Series B Preferred Stock ranks senior to all classes of our stock, except those classes of preferred stock, which may be expressly designated as ranking senior or on parity with the Series B Preferred Stock. As of April 30, 2007 and 2006 we had 9,820 and 19,790 shares of Series B Preferred Stock issued and outstanding, respectively.
During the year ended April 30, 2007 we purchased 9,970 shares at $127 per share plus accrued dividends for $1.3 million. During the year ended April 30, 2006 we purchased 30,210 shares at $127 per share plus accrued dividends for $3.9 million.
The holders of Series B Preferred Stock are entitled to receive cumulative cash dividends, when and as declared by the Board of Directors of Stratos out of funds legally available until the dividend termination date. The cash dividend per share is equal to (1) seven percent per annum, or an increased rate in the case of Stratos failure to pay dividends in accordance with the provisions of the certificate of designation relating to the Series B Preferred Stock, multiplied by (2) $100 per share, subject to adjustment, plus the amount of accrued but unpaid dividends with respect to each share of Series B Preferred. Dividends, to the extent declared by the Board of Directors of Stratos, will be payable quarterly. In addition, Stratos may, at any time following the fifth anniversary of the issuance of the Series B Preferred, declare an optional special dividend of $100 on each issued and outstanding share of Series B Preferred, plus the amount of all accrued but unpaid dividends with respect to each such share, in which case no further cash dividends are required to be paid. Stratos may not pay or declare dividends on any securities ranking junior to the Series B Preferred, unless (i) the holders of 75% of the outstanding shares of Series B Preferred consent to such payment or (ii) all accrued and unpaid dividends on the shares of Series B Preferred have been paid or set aside for payment.
No later than 60 days following the occurrence of certain events relating to Stratos’ achievement of $250 million in annual revenue or $500 million in market capitalization, Stratos must redeem all shares of Series B Preferred Stock at a redemption price initially equal to $100 per share, plus an amount equal to all accrued and unpaid dividends thereon to and including the date of redemption. The initial redemption price is subject to adjustment as follows. If, on the last day immediately preceding the redemption event, the “market price” (as defined in the certificate of designation relating to the Series B Preferred Stock) of Stratos’ common stock is (1) $7.00 or less per share, there will be no adjustment to the initial redemption price; (2) greater than $7.00 and less than $12.00 per share, the initial redemption price will be increased by $25 per share for every whole dollar by which the market price exceeds $7.00 per share and (3) $12.00 or more per share, the initial redemption price will be increased by $125 per share. If, however, the optional special dividend has been declared, the redemption price for each share of the Series B Preferred Stock will be reduced by $100 per share after taking into account the above adjustments.
In addition, at any time following the fifth anniversary of the issuance of the Series B Preferred Stock, Stratos, at its option, is entitled to redeem any or all shares of Series B Preferred Stock, at a redemption price of $125 per share, plus an amount equal to all unaccrued and unpaid dividends thereon to and including the date of redemption, minus $100 per share if the optional special dividend has been declared prior to such redemption.
Each holder of Series B Preferred Stock is entitled to one vote for each share held on the record date for determining the shareholders entitled to vote with respect to all matters presented to Stratos’ shareholders for their action and, except as otherwise provided, the holders of Series B Preferred Stock and any other outstanding series of stock will vote together with the holders of shares of common stock as a single class.
In general, the vote of at least 75% of the outstanding Series B Preferred Stock, voting separately as a class, is required to (1) amend any terms of the Series B Preferred or (2) approve any merger, reorganization, consolidation or similar transaction or any reclassification of outstanding securities that would have a material adverse effect on the dividend, liquidation or redemption rights of the Series B Preferred. However, the vote of at least 90% of the outstanding Series B Preferred is required to amend any terms of the Series B Preferred that govern dividends or payments to be made upon a liquidation, dissolution or winding-up of Stratos. Furthermore, no separate vote is required if any of the foregoing is in connection with a “change in ownership” of Stratos. For purposes of the certificate of designation relating to the Series B Preferred Stock, change in ownership means (1) any sale or transfer of all or substantially all of Stratos’ assets in any transaction or series of transactions, and (2) any merger, reorganization or consolidation to which Stratos is a party, unless after giving effect to such merger, reorganization or consolidation the holders of Stratos’ outstanding capital stock immediately prior to such merger, reorganization or consolidation will continue to own Stratos’ outstanding capital stock possessing the voting power to elect a majority of Stratos’ Board of Directors.
Upon any voluntary or involuntary liquidation, dissolution or winding-up of Stratos, the holders of Series B Preferred Stock will be entitled to receive liquidating distributions in the amount of $100 per share plus all accrued and unpaid dividends thereon to the date fixed for distribution, before any distribution or payment is made to the holders of Stratos’ common stock or on any other class of Stratos’ stock ranking junior to the Series B Preferred Stock. If a change in ownership (as defined above) of Stratos occurs, the holders of the Series B Preferred Stock will be entitled to receive liquidating distributions of $100 per share, subject to adjustment based on the market price of Stratos common stock, as described more fully above.
The Series B Preferred will not be convertible into Stratos’ common stock and will not be entitled to the benefit of a sinking fund.
NOTE 13. CAPITAL STOCK
Common and preferred stock
On March 22, 2001, our Board of Directors declared a dividend of one preferred share purchase right (“Right”) for each outstanding share of Common Stock, par value $0.01 per share outstanding on April 3, 2001 to stockholders of record on that date. Each Right entitles the registered holder to purchase from Stratos one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $0.01 per share, at a price of $800.00, subject to adjustment. The description and terms of the Rights are set forth in a Rights Agreement, dated as of March 23, 2001, as amended, between Stratos and Mellon Investor Services LLC, as Rights Agent. Pursuant to an Agreement and Plan of Merger, dated as of July 2, 2003 was entered into between Stratos, Sleeping Bear Merger Corp. and Sterling, we agreed to amend the Rights Agreement in light of our issuance of shares in the merger. We also agreed to amend the Rights Agreement in connection with our merger agreement with Emerson Electric Co. signed on May 14, 2007. The terms of the Rights may be amended by our Board of Directors without the consent of the Rights holders, except that from and after such time as any person becomes an Acquiring Person no such amendment may adversely affect the interests of the Rights holders (other than the Acquiring Person and its Affiliates and Associates). Until a Right is exercised, the Rights holder, as such, will have no rights as a stockholder of Sterling, including, without limitation, the right to vote or to receive dividends.
For a detailed discussion on shareholder rights, please refer to the exhibits to this report.
Stock options
In fiscal 2002, we adopted the Stratos Lightwave, Inc. 2002 Stock Plan for Acquired Companies (the “2002 Plan”). The 2002 Plan permitted us to award stock options, restricted stock and stock appreciation rights to present and future directors, officers and employees. Stock options granted to date generally vest over a period of 12 to 48 months after the date of grant and have a 10-year term. Shareholder approval was not solicited for this plan. Under the terms of the acquisition agreements, we assumed all outstanding options held by the employees of Tsunami Optics, Inc. and Paracer, Inc. at the date of acquisition. These options were converted into options to purchase shares of Stratos’ common stock. The number of shares and the exercise price of the Tsunami and Paracer options that converted into Stratos options were adjusted using a conversion formula set per the purchase agreement. The resulting Stratos options have maintained the original vesting provisions and option period. The Tsunami and Paracer options converted into 110,498 options under the 2002 Plan to purchase shares of Stratos’ common stock at a weighted average price of $0.50 per share. These amounts take into consideration the 1 for 10 reverse split effected October 21, 2002.
In fiscal 2004, we adopted the Stratos Lightwave, Inc. 2003 Stock Plan (“2003 Plan”). The 2003 Plan permits us to award stock, options, stock appreciation rights and restricted stock awards to present and future directors, officers, employees and others performing services for Stratos or any of our subsidiaries or affiliates. Pursuant to the 2003 Plan, as amended in 2005, the maximum number of shares for which awards may be issued is 2,700,000. Following shareholder approval of the 2003 Plan on November 6, 2003, no additional awards may be granted under the 2002 Plan. The approval of the 2003 Plan, however, has not affected and will not affect any awards granted under the 2002 Plan prior to November 6, 2003.
During fiscal 2007, we granted 108,000 shares of restricted stock to the directors with a weighted average fair market value of $6.21 per share. During fiscal 2006, we granted 278,900 shares of restricted stock to directors, officers and key employees, with a weighted average fair market value of $7.25 per share. During fiscal 2005, we granted 383,834 shares of restricted stock with a weighted average fair market value of $4.33 per share. The restricted shares vest over a period of three to five years from date of grant based on annual performance criteria. Aside from the annual performance requirements the awards vest 100% on the last anniversary of date of grant.
To date we have not issued any options to others performing services for Stratos or our subsidiaries.
The following table illustrates options outstanding under all plans as of April 30, 2007:
The following table illustrates activities in our option plans:
In computing the fair value of stock options granted, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. Stratos did not grant any options in 2007, 2006 or 2005.
We have authorized for issuance 1,507,714 shares of common stock under the 2003 Plan. Following shareholder approval of the 2003 Plan on November 6, 2003, no additional awards may be granted under the 2000 Plan or the 2002 Plan. The approval of the 2003 Plan, however, has not affected and will not affect any awards granted under the 2000 Plan or the 2002 Plan prior to November 6, 2003. No options were granted under the 2003 Plan during fiscal 2007 or 2006.
NOTE 14. EMPLOYEE 401(K) SAVINGS PLAN
Stratos sponsors 401(k) Savings Plans (the “Plans”) that cover substantially all of its employees. The Plans are salary reduction plans that allow employees to defer a percentage of wages subject to Internal Revenue Service limits. The Plans also allow for discretionary contributions by Stratos equal up to 4.5% of eligible compensation. Stratos made discretionary contributions to the Plans totaling approximately $0.6 million, $0.6 million and $0.7 million in 2007, 2006 and 2005, respectively.
NOTE 15. LEASES
We lease various facilities and equipment under operating leases that expire through 2013. Rental expense was $1.0 million in fiscal 2007, $1.0 million in fiscal 2006 and $1.3 million in fiscal 2005.
Future minimum rental expense under all non cancelable operating leases with terms greater than one year are as follows:
NOTE 16. NET INCOME (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted loss per share:
Options to purchase 239,325, 290,526 and 368,703 shares of common stock at a weighted average option price of $16.22, $15.94 and $15.43 were outstanding during fiscal 2007, 2006 and 2005 respectively, but were not included in the computation of diluted loss per share in 2006 and 2005 because of the net loss in those years and therefore, the effect would have been antidilutive.
NOTE 17. INCOME TAXES
Through April 30, 2007, we recorded a valuation allowance of $80.0 million against deferred income tax assets primarily associated with tax loss carry forwards. Our significant operating losses experienced in recent years establishes a presumption that realization of these income tax benefits does not meet a “more likely than not” standard.
We have net operating loss carry forwards of approximately $183.7 million. We believe that our acquisition of Sterling Holding Company in November 2003 triggered Internal Revenue Code Section 382 limitations on the net operating loss that existed prior to the acquisition, which was approximately $132.5 million. Of that amount, we believe the available utilization of the net operating loss is limited to approximately $2 million on an annual basis. Our net operating loss carry forwards will expire between 2022 and 2026.
Significant components of our deferred tax assets and liabilities at the balance sheet dates were as follows:
Income tax provisions during our fiscal years consisted of the following:
NOTE 18. SEGMENT AND GEOGRAPHIC INFORMATION
We operate in one industry segment, the development, manufacture and sale of optical, RF, and microwave components and subsystems for various applications and multiple end markets. These subsystems are designed for use in storage, data networking, metro and wide area telecom networks, military, aerospace, video, government security, oil and gas, and other industrial markets and applications.
Our products can be broadly segmented into those with an optical and those with a copper emphasis. Transceivers, for example, are optical products, while the underlying technology of chips, drivers, analytical diagnostics, and related software is primarily electronic, requiring the translation of an electrical pulse into an optical signal at the point of the laser driver or the optical receiver. Almost all of our copper products are coaxial, twinaxial, or triaxial and involve cable with those same characteristics.
Information about our results of operations in different geographic regions is as follows:
NOTE 19. MATERIAL CUSTOMERS and CONCENTRATION of CREDIT RISK
During fiscal 2007, sales to General Dynamics UK, Ltd. and its’ respective contract manufacturers amounted to 7% of consolidated sales and sales to EDO Corp. amounted to 7% of consolidated sales.
During fiscal 2006, sales to General Dynamics UK, Ltd. and its respective contract manufacturres amounted to 8% of consolidated net sales.
During fiscal 2005, sales to General Dynamics UK Ltd. and Tellabs, Inc. and their respective contract manufacturers amounted to 8% and 4%, respectively, of consolidated net sales.
Accounts receivable are generally due within 30 to 60 days. Credit losses relating to all customers consistently have been within management’s expectations.
NOTE 20. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited results of operations for the two fiscal years ended April 30, 2007:
We use the traditional quarter end on a 4-5-4 reporting period, whereas the first month of the quarter ends on the Saturday of the fourth week, the second month of the quarter ends on the Saturday of the fifth week, and the third month ends on the Saturday of the fourth week.
The unaudited quarterly results of operations for the quarter ended October 31, 2005 includes $0.5 million of restructuring charges. The unaudited quarterly results of operations for the quarter ended January 31, 2006 includes $0.7 million of income from litigation settlements and $0.4 million of restructuring charges. The unaudited quarterly results of operations for the quarter ended April 30, 2006 include $0.4 million of income from litigation settlements and $0.2 million of restructuring charges.
The unaudited quarterly results of operations for the quarter ended January 31, 2005, includes $2.8 million of personnel and severance costs related to restructuring of operations and $1.9 million of lease obligations for limited use facilities. In addition, the unaudited quarterly result of operations for the quarter ended April 30, 2005, includes charges of $1.8 million for the settlement of litigation.
NOTE 21. LITIGATION
From time to time, Stratos becomes involved in various lawsuits and legal proceedings that arise in the normal course of business. We believe that the resolution of these lawsuits and legal proceedings will not have a significant effect on our business, financial condition or results of operations.
Stratos and certain of our former directors and executive officers have been named as defendants in purported class action lawsuits filed in the United States District Court, Southern District of New York. The first of these lawsuits, filed on July 25, 2001, is captioned Kucera v. Stratos Lightwave, Inc. et al. No. 01 CV 6821. The complaints are substantially identical to numerous other complaints filed against other companies that went public during the time of Stratos’ IPO. Three other similar lawsuits have also been filed against Stratos and certain of our former directors and executive officers. The complaints also name as defendants the underwriters for Stratos’ initial public offering. The complaints generally allege, among other things, that the registration statement and prospectus from our June 26, 2000 initial public offering failed to disclose certain alleged actions by the underwriters for the offering. The complaints charge Stratos and several of our former directors and executive officers with violations of Sections 11 and 15 of the Securities Act of 1933, as amended, and/or Section 10(b) and Section 20(a) to the Security Exchange Act of 1934, as amended. The complaints also allege claims solely against the underwriting defendants under Section 12(a)(2) of the Securities Act of 1933, as amended.
In 2003, we agreed to a Memorandum and Understanding, which reflects a settlement of these class actions as between the purported class action plaintiffs, Stratos and the former officers and directors, and our liability insurers. Under the terms of the Memorandum of Understanding, our liability insurers will pay certain sums to the plaintiffs, with the amount dependent upon the plaintiffs’ recovery from the underwriters in the IPO class actions as a whole. The plaintiffs will dismiss with prejudice their claims against Stratos and our former officers and directors, and Stratos will assign to the plaintiffs certain claims that it may have against the underwriters. The plaintiffs filed with the Court a motion for preliminary approval of the settlement, which, when granted, would lead to the mailing of class-wide notices of the settlement and a hearing date for approval of the settlement. The issuers, including Stratos, filed a statement joining in the plaintiffs’ motion for preliminary approval of the settlement. The underwriter defendants opposed the motion. On February 15, 2005, the Court issued its ruling granting the plaintiffs’ motion for preliminary approval of the settlement with the issuers, subject to certain changes to the bar order to be included as part of the settlement and to the notice to the class, and the Court recently approved the revisions made to the settlement and the notice pursuant to its prior order. The settlement still remains subject to final approval by the Court after notice of the settlement is sent to the class. A final fairness hearing on the settlement was held on April 24, 2006, at which time the Court took final approval of the settlement under advisement.
In December 2006, the Second Circuit Court of Appeals reversed the district judge’s order certifying a class in six focus cases, finding that the purported class of plaintiffs cannot be certified as a matter of law. The plaintiffs filed a petition for rehearing, which the Second Circuit denied on April 6, 2007. In a hearing before the district court on May 30, 2007, the plaintiffs acknowledged that they need to revise their class definition and said that they will file a revised motion to certify the IPO Securities Litigation cases as class actions in late September 2007. On June 22, 2007, the issuers filed a joint stipulation terminating the proposed settlement with the plaintiffs. The Court has allowed the plaintiffs to conduct additional discovery relating to class certification issues from the underwriters and the issuers.
In February 2002, we acquired Tsunami Optics, Inc. The acquisition agreement contemplated a potential earn-out payment of up to $18 million in common stock if certain financial targets were achieved following the acquisition. In June 2002, Catherine Lego, as representative of the former Tsunami shareholders, filed a lawsuit against Stratos in the United States District Court, Northern District of California alleging, among other things, that Stratos breached the acquisition agreement by refusing to allow Tsunami to operate as a separate subsidiary and firing the Tsunami executives that were necessary to operate the business thereby making it impossible for Tsunami to achieve the targets
required to receive any earn-out payments. The complaint also alleged fraud and violations of federal securities laws in connection with the acquisition of Tsunami. Plaintiffs sought $38 million in damages or the rescission of the acquisition agreement. Stratos filed a counterclaim against Ms. Lego and several other shareholders and officers of Tsunami which alleged fraud, breach of contract and violations of federal securities laws. The counterclaim sought compensatory and punitive damages.
In April 2004, the Court entered an order in favor of Stratos to dismiss with prejudice 11 of 13 counts of the plaintiffs’ complaint. A trial on the plaintiffs’ two remaining claims (breach of contract and rescission) was held in December 2004. On February 16, 2005, the Court entered judgment in Stratos’ favor on both of plaintiffs’ two remaining claims. The Court entered judgment against Stratos on its counterclaim against the plaintiffs. The plaintiffs appealed the trial court’s judgments. Stratos did not appeal the trial court’s judgment in plaintiffs’ favor on Stratos’ counterclaims. In August 2005, the plaintiffs agreed to dismiss their appeal, and the appeal was dismissed with prejudice on September 7, 2005.
In August 2002, James Campbell, the former CEO of Tsunami, filed a lawsuit against Stratos in California state court alleging wrongful termination in breach of his employment contract, fraud and age discrimination. Campbell’s claims were subsequently amended to include intentional infliction of emotional distress. Campbell sought unspecified damages, punitive damages and attorney’s fees. During the first quarter of fiscal year 2006 we settled this litigation.
In August 2004, Federal Insurance Company, issuer of Stratos’ directors’ and officers’ insurance policy, filed a complaint for declaratory judgment in the United States District Court, Northern District of Illinois to deny coverage to Stratos for the Lego and Campbell lawsuits described above. The suit was filed in response to Stratos’ submission of a claim for insurance coverage for the Lego and Campbell lawsuits and reimbursement of defense costs. Federal did not seek damages from Stratos and Stratos disputed denial of the coverage. In June 2005 the court determined that Federal was not responsible for the claim for insurance coverage or the reimbursement of the defense costs. We filed an appeal of the ruling. In November 2005, the lawsuit was settled.
During the first quarter of fiscal 2006, Stratos settled two patent infringement suits with Picolight, Inc. The cases were filed in the U.S. District Court for the District of Delaware and were dismissed with prejudice in connection with the settlement on June 10, 2005.
During the first quarter of fiscal 2006, Stratos received a lump sum of $5.5 million from the settlement of litigation in fiscal 2003. The present value of this amount was recorded as litigation settlements in the fiscal 2003 Consolidated Statement of Operations. In addition, Stratos paid $1.8 million in the first quarter of fiscal 2006 in settlement of two cases. This amount was recorded as litigation settlements in the fiscal 2005 Consolidated Statement of Operations.
NOTE 22. OPERATING CONSIDERATIONS AND MANAGEMENT PLANS
The accompanying consolidated financial statements have been prepared assuming Stratos will continue as a going concern. As shown in the consolidated financial statements, we incurred significant net losses in prior years as a result of operating in markets that have experienced a severe economic downturn since late in fiscal 2001. These conditions remained in effect through fiscal 2006.
In response to these conditions, we proactively addressed our operational issues in an effort to improve profitability and cash flows. We implemented programs to control other manufacturing, research and development, sales and marketing, and general and administrative costs. We reduced our overhead cost structure, improved our efficiency in the use of raw materials and scrap, and we are working with suppliers to further reduce the cost of raw materials used in the manufacture of our products. Since April 2001, we have also reduced production, technical, sales, and administrative staff levels, exited several small unprofitable businesses and consolidated our remaining operations into three primary locations. We sold our facility in Palm Bay, Florida in May 2004 and we are actively working to sell or sublease several other limited use facilities.
We are also examining and pursuing opportunities for improving gross margins and cash flows. The merger with Sterling combined two companies with brands that are well-respected by segments of the telecommunications, military, video and broadcast customer base that seek solutions to difficult problems at the electrical side of the high-performance, high-bandwidth interface which are solved by our product offerings. We believe that these products, when combined with superior customer service, provide the potential for improving gross margins and cash flows.
We are examining the requirements of our customers and the broader potential customer base where our core competencies could provide value to customers in an enduring and profitable way. We are also focused on improving customer service through better execution of delivery, support and cycle time, particularly for specialty products to those customers who value and will pay for this service. We are seeking to create a customer-responsive organization that executes on demand and stands behind our customers’ strategy. We expect that these efforts will contribute to sales growth and increase the market potential for our products.
NOTE 23. SUBSEQUENT EVENTS
Stratos International, Inc. reported on May 7, 2007 that it received a notice from Nasdaq indicating that, because Stratos failed to hold its’ 2006 annual meeting of shareholders prior to April 30, 2007, (the end of Stratos’ fiscal year), Nasdaq was initiating the process to delist Stratos’ securities from trading on The Nasdaq Global Market. Stratos appealed the delisting determination and requested a hearing, which was held on June 7, 2007.
The Nasdaq Listing Qualification Panel determined to continue the listing of Stratos subject to the completion of the merger with Emerson Electric Co. on or before July 13, 2007 as discussed below.
Stratos International, Inc. announced on May 14, 2007 that it has agreed to be acquired by Emerson Electric Co. (NYSE: EMR). Under the terms of the agreement, the holders of Stratos common stock will receive $8.00 per share in cash for their shares, for a total consideration of approximately $118.0 million, or an aggregate consideration of approximately $85.0 million, net of acquired cash. The proposed transaction is subject to customary regulatory approvals, approval by Stratos stockholders and satisfaction of other customary conditions.
A special meeting of the stockholders of Stratos will be held at 10:00 am, local time on July 12, 2007 at the corporate offices located at 7444 W. Wilson Avenue, Chicago, Illinois. The stockholders will be asked to approve and adopt the Agreement and Plan of Merger, dated May 14, 2007 among Stratos International, Inc., Emerson Network Power Connectivity Solutions, Inc. and it’s direct wholly-owned subsidiary Emersub C, Inc. If the merger is completed, Stratos will become a wholly-owned subsidiary of Emerson.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
On August 1, 2005, the Audit Committee of Stratos International, Inc. engaged BDO Seidman, LLP to serve as the independent registered public accounting firm of Stratos for the fiscal year ending April 30,
2006. BDO replaced the firm of Ernst & Young, LLP, which served as the independent registered public accounting firm of Stratos for the fiscal year ended April 30, 2005 and was dismissed effective August 1, 2005. For additional information, see Stratos’ Current Report on Form 8-K dated August 1, 2005.
In connection with audits of Stratos for the two most recent fiscal years preceding the change in accountants and through August 1, 2005, no “disagreements” within the meaning of Item 304(a)(1)(iv) of Regulation S-K, or any events of the type listed in Item 304(a)(1)(v)(A) through (D) of Regulation S-K, occurred within the two most recent fiscal years and the interim period prior to August 1, 2005. Thus, during the 2006 fiscal year, there have not been any transactions or events involving any such disagreements or events.
Item 9A.
Item 9A. Controls and procedures
As of the end of the period covered by this report on Form 10-K, our management, including our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet, and management believes that they meet, reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, subject to the limitations noted above, our disclosure controls and procedures are effective in timely alerting them to material information required to be disclosed in our filings with the SEC.
Managements Report on Internal Controls Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal accounting and financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment under the framework in Internal Control - Integrated Framework (COSO), our management concluded that our internal control over financial reporting was effective as of April 30, 2007. Our management’s assessment of the effectiveness of our internal control over financial reporting as of April 30, 2007, has been audited by BDO Seidman LLP, an independent registered public accounting firm, as stated in their report which is included herein.
July 11, 2007
/s/ Phillip A. Harris
Phillip A. Harris
President and Chief Executive Officer
/s/ Barry Hollingsworth
Barry Hollingsworth
Chief Financial Officer
Report of Independent Registered Public Accounting Firm on
Internal Control over Financial Reporting
Board of Directors and Stockholders
Stratos International, Inc
We have audited management’s assessment, included in the accompanying “Management’s Report on Internal Control over Financial Reporting” that Stratos International, Inc. maintained effective internal control over financial reporting as of April 28, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Stratos International, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Stratos International, Inc. maintained effective internal control over financial reporting as of April 28, 2007, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, Stratos International, Inc. maintained, in all material respects, effective internal control over financial reporting as of April 28, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Standards Board (United States), the consolidated balance sheets of Stratos International, Inc. as of April 28, 2007 and April 29, 2006 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years then ended and our report dated July 11, 2007 expressed an unqualified opinion on those consolidated Financial Statements.
/s/ BDO Seidman, LLP
Chicago, Illinois
July 11, 2007
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) that occurred during the fiscal quarter ended April 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
Not applicable
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The name, age, and positions held by each of our executive officers are provided in Part I, Item 1 “Business” above.
Director
Age
Principal Occupation
Reginald W. Barrett
Mr. Barrett has served as a Director of Stratos since November 2003. Mr. Barrett is Chairman of the Stratos Board of Directors. He serves as member of Stratos’ Compensation Committee and Chairman of its Strategic Development Committee and Governance Committee. Mr. Barrett is President and Chief Executive Officer of Clements National Company (a manufacturer of electrical and hot air products). Mr. Barrett was a director of Sterling from 1991 through the closing of Stratos’ acquisition of Sterling in November 2003. From 1982 until his retirement in 1990, Mr. Barrett served as President of Pyle National, which became part of Brintec Corporation (a connector manufacturer).
Kenne P. Bristol
Mr. Bristol serves as Chairman of Stratos’ Compensation Committee and is a member of its Strategic Development Committee and Governance Committee. He served as Chairman of the Alliance Bancorp Division of Charter One Financial, Inc., a Nasdaq-listed banking company, from July 2001 to September 2004. Mr. Bristol also served as President, Chief Executive Officer and a Director of Alliance Bancorp, Inc., and its primary subsidiary Liberty Federal Bank, from July 1992 until it was acquired by Charter One Financial, Inc. in July 2001. Prior to its acquisition, Alliance Bancorp, Inc., was a Nasdaq-listed public company. Mr Bristol chairs the Compensation Committee and has been a director of Stratos since 2005.
Director
Age
Principal Occupation
Edward J. O’Connell
Mr. O’Connell has served as a director of Stratos since June 2000 and is Chairman of the Audit Committee. He is also a member of Stratos Governance Committee. Mr. O’Connell has been Chief Financial Officer at Hinshaw & Culbertson, LLP, a provider of professional legal services, since May 2005. Prior to that, he served as Chief Financial Officer of Gardner, Carton & Douglas, a provider of professional legal services, since 2000. From 1999 to 2000, Mr. O’Connell served as Chief Financial Officer of Hey Company, LLC, a company involved with e-commerce. From 1998 to 1999, Mr. O’Connell served as the Senior Vice President of Finance and Administration, Chief Financial Officer and Secretary of ebix.com, a software, consulting services and e-commerce company. From 1995 to 1998, Mr. O’Connell served as Chief Operating Officer and Chief Financial Officer for Keck, Mahin & Cate, a provider of legal professional services.
Newell V. Starks
Mr. Starks has served as Vice Chairman of the Board of Stratos since November 2003. From November 2003 through September 2005, Mr. Starks served as Chief Strategy Officer of Stratos. He was Chairman of Sterling’s board of directors during 2003 and a director of Sterling from its organization in 1989 through the closing of Stratos’ acquisition of Sterling in November 2003. From 1984 until 1991, Mr. Starks was employed by CVC, most recently as Vice President, where he was in charge of CVC’s initial investment in Sterling. Since leaving CVC, Mr. Starks has served as a private consultant to technology companies, including Sterling, on strategic matters and also has been a private investor.
Brian J. Stark
Brian J Stark has been a director since June 2006. Mr. Stark is former President of the Controls Group for Johnson Controls, where he was responsible for systems, products and services worldwide, and facility management covering a broad range of operations, maintenance and consulting programs. Mr. Stark serves on the Board of Directors for the Milwaukee School of Engineering and Children’s Hospital of Wisconsin. He holds a Bachelor of Science Degree in Electrical Engineering from Milwaukee School of Engineering. Mr. Stark is a member of the Audit Committee.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our directors, executive officers and holders of more than 10% of our common stock to file with the SEC reports regarding their ownership and changes in ownership of our securities. Based upon a review of filings with the SEC and written representations that no other reports were required, we believe that all of our directors, executive officers and 10% shareholders complied during fiscal 2007 with the reporting requirements of Section 16(a), Other than (i) filings for Messrs. Harris, Hollingsworth and Norwood with respect to shares granted in April 2006 under our incentive plan were filed late, and (ii) filings for Messrs. Barrett, Harris, Howe, Norwood and Starks with respect to repurchases by Stratos of our Series B Preferred Stock were filed late.
No family relationships exist among any of the executive officers, directors or director nominees.
Stratos has a standing corporate governance and nominating committee which is responsible for nominating directors, among other functions. The members of the committee currently are Messrs. Barrett (Chairman), Bristol and O’Connell. The committee has a written charter, a copy of which is available at Stratos’ website, www.stratosinternational.com. The committee will consider nominees for director submitted by stockholders. Stockholders wishing to submit nominees should submit written information to the committee with respect to such nominees; such information should include all full biographical information and other information required to be included in proxy statements under the SEC rules. Nominees should possess certain minimal qualifications, including, among other criteria, senior management experience in business, government and/ or other relevant organizations. Nominees recommended by stockholders in accordance with these procedures will receive the same consideration received by nominees identified to the committee through other means
The members of the audit committee currently are Messrs. O’Connell (Chairman), Howe, Nelsen and Stark. The audit committee recommends the appointment of our independent registered public accounting firm, reviews our internal accounting procedures and financial statements and consults with and reviews the services provided by our independent registered public accounting firm, including the results and scope of their audit. Our board of directors has determined that each member of the audit committee is independent, as independence for audit committee members is defined in the listing standards of the NASDAQ Global Market and in applicable SEC rules. Our board of directors has also determined that Mr. O’Connell, the audit committee’s Chairman, is an audit committee financial expert, as such term is defined by the rules of the SEC, based on Mr. O’Connell’s many years of experience as a chief financial officer of various entities. The audit committee has a written charter, a copy of which is available at Stratos’ website, www.stratosinternational.com.
We have adopted a code of ethics that applies to all of our directors, officers, and employees, including our principal executive officer, principal financial officer and principal accounting officer or controller or persons performing similar functions. A copy of our code of ethics is filed as Exhibit 14 to this annual report on Form 10-K. The code of ethics is also published at our website at www.stratosinternational.com. We intend to satisfy disclosure requirements under Item 10 of Form 8-K regarding record any amendment to, or waiver from, our code of ethics, applicable to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, by posting on our website notification of such amendment or waiver.
Item 11.
Item 11. Executive Compensation
Compensation Discussion and Analysis
Overview of Compensation Program
The Compensation Committee (the “Committee”) of the Board has responsibility for (i) carrying out the Board’s responsibilities relating to compensation of Stratos’ executives, (ii) reviewing and recommending to the Board compensation plans, policies and programs intended to attract, retain and appropriately reward coworkers in order to motivate their performance in the achievement of Stratos’ business objectives and align their interests with the long-term interests of Stratos’ shareholders, (iii) overseeing, designing and implementing the overall compensation strategy of Stratos and making such changes to the strategy as it may deem to be appropriate and (iv) administering Stratos’ stock option, incentive-compensation and equity-based plans.
Compensation Philosophy and Objectives
The Committee believes that the most effective executive compensation program is one that is designed to reward the achievement of specific annual, long-term and strategic goals by Stratos, and which aligns executives’ interests with those of the stockholders by rewarding performance above established goals, with the ultimate objective of improving stockholder value. The Committee evaluates both performance and compensation to ensure that Stratos maintains its ability to attract and retain superior employees in key positions and that compensation provided to key employees remains competitive relative to the compensation paid to similarly situated executives of our peer companies. To that end, the Committee believes executive compensation packages provided by Stratos to its executives, including the named executive officers, should include both cash and stock-based compensation that reward performance as measured against established goals.
Role of Executive Officers in Compensation Decisions
The Committee makes all compensation decisions for the executive officers and approves recommendations regarding equity awards to all employees of Stratos. The Chief Executive Officer annually reviews the performance of each executive officer. The conclusions reached and recommendations based on this review, including with respect to salary adjustments and annual award amounts, are presented to the Committee. The Committee can exercise its discretion in modifying any recommended adjustments or awards to executives.
Setting Executive Compensation
Based on the foregoing objectives, the Committee has structured Stratos’ annual and long-term incentive-based cash and non-cash executive compensation to motivate executives to achieve the business goals set by Stratos and reward the executives for achieving such goals.
2007 Executive Compensation Components
For the fiscal year ended April 30, 2007, the principal components of compensation for executive officers were:
•
base salary;
•
performance-based incentive compensation;
•
long-term equity incentive compensation;
•
retirement and other benefits; and
•
perquisites and other personal benefits.
Base Salary
Stratos provides executive officers and other employees with base salary to compensate them for services rendered during the fiscal year. Base salary ranges for named executive officers are determined for each executive based on his or her position and responsibility by using market data. Base salary ranges are designed so that salary opportunities for a given position will be between 80% and 125% of the midpoint of the base salary established for each range.
During its review of base salaries for executives, the Committee primarily considers:
•
market data from outside sources;
•
internal review of the executive’s compensation, both individually and relative to other officers; and
•
individual performance of the executive.
Salary levels are typically considered annually as part of Stratos’ performance review process as well as upon a promotion or other change in job responsibility. Merit based increases to salaries of officers are based on the Committee’s assessment of the individual’s performance.
Compensation Committee Report
The Compensation Committee of Stratos has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this annual report.
The Compensation Committee
Kenne P. Bristol, Chair
Reginald W. Barrett
David Y. Howe
Summary Compensation Table
The following table sets forth compensation information for the fiscal year ended April 30, 2007 for the individuals serving as Stratos’ Chief Executive Officer and four other executive officers (the “Named Officers”) as of April 30, 2007.
Grants of Plan-Based Awards
There were no grants of plan-based awards to Company officers in 2007.
Outstanding Equity Awards at Fiscal Year-End
The following table summarizes outstanding equity awards held by Company executives at April 30, 2007.
Option Exercises and Stock Vested Table
The following table summarizes vesting of stock awards during fiscal year 2007. There were no exercises of options by Stratos officers during 2007.
Pension Benefits
There were no plans providing for payments or other benefits at, or following, or in connection with retirement for Stratos officers in 2007.
Nonqualified Deferred Compensation
There were no plans providing for deferral of compensation that is not tax-qualified for Stratos officers in 2007.
Director Compensation
The following table summarizes fees earned and stock awards granted to directors of Stratos in 2007.
Severance and Change in Control Arrangements
Stratos announced on May 14, 2007 that it has agreed to be acquired by Emerson Electric Co. (NYSE: EMR). Under the terms of the agreement, the holders of Stratos International common stock will receive $8.00 per share in cash for their shares, for a total consideration of approximately $118.0 million, or an aggregate consideration of approximately $85.0 million, net of acquired cash. The proposed transaction is subject to customary regulatory approvals, approval by Stratos’ International’s stockholders and satisfaction of other customary conditions. A special meeting of the stockholders of Stratos International, Inc will be held at 10:00 am, local time on July 12, 2007 at the corporate offices located at 7444 W. Wilson Avenue, Chicago, Illinois. The stockholders will be asked to approve and adopt the Agreement and Plan of Merger, dated May 14, 2007 among Stratos International, Inc., Emerson Network Power Connectivity Solutions, Inc. and it’s direct wholly-owned subsidiary Emersub C, Inc. If the merger is completed, Stratos will become a wholly-owned subsidiary of Emerson.
Each of the management retention agreements with our executive officers provides for the payment of certain severance benefits to the executive officers following termination of their employment after a change of control of Stratos, as described more fully below:
•
Phillip A. Harris, our president and chief executive officer, is entitled to certain severance benefits under his management retention agreement if his employment is terminated voluntarily for any reason following a “change of control” (as defined in such agreement); and
•
Barry Hollingsworth, our chief financial officer, Joe Norwood, our executive vice president, and Dale Reed, our senior vice president-sales and marketing, are each entitled to certain severance benefits under their respective management retention agreements if their employment is terminated by us other than for “cause” or they resign for “good reason” within two years following a “change of control” (as such terms are defined in such agreements).
In addition, Richard C.E. Durrant, our executive vice president, is entitled to certain severance benefits under his management retention agreement if he is terminated by us on prior to August 3, 2007 other than for “cause” (as defined therein) or if he voluntarily resigns for any reason, regardless of whether or not a change of control occurs. Mr. Durrant’s severance benefits will not increase as a result of the merger.
The following table sets forth an estimate of the potential cash severance payments that could be payable in a lump sum payment in the event such executive officers become entitled to such severance amount pursuant to each of their management retention agreements (described above) following the merger with Emerson (assuming current compensation amounts without regard to additional payments resulting from potential base pay increases in 2007):
At the effective time of the merger, all restricted shares under Stratos’ equity plans will be vested in full immediately prior to the effective time and will be converted into the right to receive the applicable merger consideration in cash, without interest. Each option to purchase common stock that is outstanding immediately prior to the effective time of the merger, whether or not then exercisable, will be cancelled and the option holder will be entitled to receive a cash payment, without interest, equal to the product of (i) the number of shares of common stock subject to such option and (ii) the excess, if any, of the applicable per share merger consideration over the exercise price per share of common stock, less applicable withholding taxes. Our directors and executive officers will be able to receive the same cash consideration for their shares of common stock (including restricted shares) and options as all of our other stockholders and holders of options, as applicable.
The following table sets forth for each of our executive officers:
•
the number of shares of our common stock, including restricted shares, held by such person as of April 30, 2007;
•
the amount of cash that will be paid in respect of such shares upon consummation of the merger;
•
the number of shares subject to outstanding options held by such person that have an exercise price per share that is less than $8.00;
•
the amount of cash that will be paid in respect of such options upon consummation of the merger; and
•
the total amount of cash that will be received by such person in respect of such shares and options upon consummation of the merger.
All dollar amounts are gross amounts and do not reflect deductions for income taxes and other withholding and do not reflect the impact of any applicable excise tax. With respect to options, the payment is calculated by multiplying the number of shares subject to such option by the amount by which $8.00 exceeds the per share exercise price of the option. Any options that have an exercise price per share equal to or greater than the applicable per share merger consideration will be cancelled and extinguished without any payment.
Information regarding equity compensation plans is set forth in Note 14 to our financial statements included in Item 8 of this annual report on Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters
Beneficial Ownership
The following beneficial ownership tables set forth information as of June 11, 2007 regarding ownership of shares of Stratos common stock by the following persons:
•
each person who is known to Stratos to own beneficially more than 5% of the outstanding shares of Stratos common stock, based upon Stratos’ records or the records of the SEC;
•
each director and Named Executive Officer; and
•
all directors and executive officers of Stratos as a group.
Unless otherwise indicated, to Stratos’ knowledge, all persons listed on the beneficial ownership tables below have sole voting and investment power with respect to their shares of Stratos common stock. Shares of Stratos common stock subject to options exercisable within 60 days of June 11, 2007 are considered outstanding for the purpose of computing the percentage ownership of the person holding such options.
On May 14, 2007, we announced a merger agreement, subject to approval by our stockholders and certain other conditions, pursuant to which all of our outstanding stock would be acquired by Emerson Electric Co.
Equity Compensation Plan Information
The following table provides information about shares of our common stock that may be issued upon exercise of stock options under all of our existing equity compensation plans as of April 30, 2007.
Stratos’ only equity compensation plan not approved by security holders is the Stratos Lightwave, Inc. 2002 Stock Plan for Acquired Companies (the “2002 Plan”). Following shareholder approval of the Stratos Lightwave, Inc. 2003 Stock Plan (the “2003 Plan”) on November 6, 2003 no additional awards may be granted under any prior plans, including the 2002 Plan. The approval of the 2003 Plan, however, has not affected and will not affect any awards granted under prior plans before November 6, 2003.
Item 13.
Item 13. Certain Relationships and Related Transactions
There were no transactions with related persons during Stratos’ 2007 fiscal year required by applicable SEC rules and regulations to be disclosed hereunder.
Item 14.
Item 14. Principal Accountant Fees and Services
The following table presents fees for professional services rendered by BDO Seidman, LLP with respect to fiscal 2007 and 2006. Other fees include Sarbanes-Oxley and our 401k plan.
“Audit fees” are fees Stratos paid for professional services relating to the annual audit of Stratos’ consolidated financial statements included in Stratos’ annual report on Form 10-K, review of the financial statements included in Stratos’ quarterly reports on Form 10-Q and the filing of registration statements with the SEC. “Tax fees” relate primarily to fees paid in connection with consultations on various tax planning and compliance matters. “All other fees” are fees for any products and services that are not included in other categories, and include fees related to our audit of internal controls under the Sarbanes-Oxley Act and our 401k plan.
All audit-related services, tax services and other services are pre-approved by the audit committee prior to performance. In some cases, pre-approval is provided by the full audit committee for up to a year, and relates to a particular defined task or scope of work and is subject to a specific budget. In other cases, the Chairman of the audit committee has the delegated authority from the audit committee to pre-approve additional services, and such pre-approvals are then communicated to the full audit committee. In its pre-approval and review of non-audit service fees, the audit committee considers, among other factors, the possible effect of the performance of such services on the auditors’ independence.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
1. Financial Statements: See “Index to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.
2. Financial Statement Schedules: See Notes 2 and 3 to Consolidated Financial Statements, “Allowance for Doubtful Accounts” and “Inventories”, respectively in Part II, Item 8 of this Form 10-K.
3. Exhibits: The exhibits listed in the accompanying index to exhibits are filed or incorporated by reference as part of this Form 10-K.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized.
STRATOS INTERNATIONAL, INC.
July 11, 2007
By: /s/ Phillip A. Harris
Phillip A. Harris
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Phillip A. Harris and Barry Hollingsworth, and each of them, such person’s true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, in any and all capacities, to sign one or more Annual Reports for Stratos’ fiscal year ended April 30, 2007 on Form 10-K under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or such other form as any such attorney-in-fact may deem necessary or desirable, any amendments thereto, and all additional amendments thereto, each in such form as they or either of them may approve, and to file the same with all exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done so that such Annual Report shall comply with the Exchange Act and the applicable rules and regulations adopted or issued pursuant thereto, as fully and to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them or their substitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and the dates indicated.
STRATOS INTERNATIONAL, INC.
EXHIBIT INDEX
*
Filed herewith.
**
Management contract or compensatory plan or arrangement required to be filed as an exhibit to this annual report on Form 10-K.

Furnished as exhibit to this annual report on Form 10-K.