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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

(Mark One)

|  |  |                                                                                                                                      
|- |  | -------------------------------------------------------------------------------------------------------------------------------------
|ý |  | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended March 31, 2002

OR

|  |  |                                                                                                                                                            
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|o |  | Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Transition Period
from ______________ to _______________ .

Commission File Number 000-30633

ONI SYSTEMS CORP.(Exact name of registrant as specified in its charter)

|                                                                                             |  |                                                
|-------------------------------------------------------------------------------------------- |  | -----------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization)                      |  | 77046-9657
(I.R.S. employer
identification no.)
|5965 Silver Creek Valley Road, San Jose, California
(Address of principal executive offices) |  | 95138
(zip code)                               

Registrants telephone number, including area code: (408) 965-2600

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES ý NO o

There were 141,786,963 shares of the Companys common stock, par value $0.0001,
outstanding on March 31, 2002.



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TABLE OF CONTENTS



|                              |                                                                                               |                                                                |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | -------------------------------------------------------------- |  |  |  |  |  | 
|Part I. Financial Information
|                              | Item 1. Condensed Consolidated Financial Statements                                          
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS                         
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS               
|                              |                                                                                               | NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|Part II. Other Information   
|                              | Item 1. Legal Proceedings.                                                                   
|                              | Item 2. Changes in Securities and Use of Proceeds.                                           
|                              | Item 3. Defaults Upon Senior Securities.                                                     
|                              | Item 4. Submission of Matters to a Vote of Security Holders.                                 
|                              | Item 5. Other Information.                                                                   
|                              | Item 6. Exhibits and Reports on Form 8-K.                                                    
|SIGNATURES                   
|EXHIBIT 10.01                



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ONI SYSTEMS CORP.

FORM 10-Q

Quarterly Period Ended March 31, 2002

Table of Contents

|                              |  |                                                                                                    |  |   
|----------------------------- |  | -------------------------------------------------------------------------------------------------- |  | --
|PART I. Financial Information |  | Page                                                                                              
|                              |  |                                                                                                    |  |   
|                             
|Item 1.                       |  | Financial Statements (unaudited)                                                                   |  |   
|                             
|                              |  | Condensed Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001                   |  | 3 
|                             
|                              |  | Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and 2001 |  | 4 
|                             
|                              |  | Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001 |  | 5 
|                             
|                              |  | Notes to Condensed Consolidated Financial Statements                                               |  | 6 
|                             
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations              |  | 12
|                             
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                                         |  | 27
|                             
|PART II. Other Information    |  |                                                                                                   
|                             
|Item 1.                       |  | Legal Proceedings                                                                                  |  | 28
|                             
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                          |  | 29
|                             
|Item 3.                       |  | Defaults Upon Senior Securities                                                                    |  | 29
|                             
|Item 4.                       |  | Submission of Matters to Vote of Security Holders                                                  |  | 29
|                             
|Item 5.                       |  | Other Information                                                                                  |  | 29
|                             
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                   |  | 30
|                             
|Signatures                    |  | 31                                                                                                

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Part I. Financial Information




Item 1. Condensed Consolidated Financial Statements

ONI SYSTEMS CORP.




CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(unaudited)

|                                                |                                              |  |                                            |         |   |           |          |              |   |         |  | 
|----------------------------------------------- | -------------------------------------------- |  | ------------------------------------------ | ------- | - | --------- | -------- | ------------ | - | ------- |  | 
|                                                |                                              |  |                                            |         |   | March 31, |          | December 31,
|                                                |                                              |  |                                            |         |   | 2002      |          | 2001        
|                                                |                                              |  |                                            |         |   |           |          |             
|ASSETS                                          |                                              |  |                                            |         |   |           |          |             
|Current assets:                                 |                                              |  |                                            |         |   |           |          |             
|                                                | Cash and cash equivalents                    |  | $                                          | 339,088 |   |           | $        | 338,511      |  
|                                                | Short-term investments                       |  |                                            | 41,009  |   |           |          | 26,457       |  
|                                                | Accounts receivable, net                     |  |                                            | 24,041  |   |           |          | 43,945       |  
|                                                | Inventory                                    |  |                                            | 50,137  |   |           |          | 53,836       |  
|                                                | Prepaid expenses and other current assets    |  |                                            | 12,772  |   |           |          | 11,114       |  
|                                                |                                              |  |                                            |         |   |           |          |             
|                                                |                                              |  | Total current assets                       |         |   | 467,047   |          |              |   | 473,863 | 
|Property and equipment, net                     |                                              |  | 91,622                                     |         |   |           | 97,286   |             
|Long-term investments                           |                                              |  | 286,716                                    |         |   |           | 313,834  |             
|Other assets                                    |                                              |  | 9,450                                      |         |   |           | 7,907    |             
|Goodwill and intangibles, net                   |                                              |  | 21,993                                     |         |   |           | 23,465   |             
|                                                |                                              |  |                                            |         |   |           |          |             
|                                                |                                              |  | Total assets                               |         | $ | 876,828   |          |              | $ | 916,355 | 
|                                                |                                              |  |                                            |         |   |           |          |             
|LIABILITIES AND STOCKHOLDERS EQUITY            |                                              |  |                                            |         |   |           |          |             
|Current liabilities:                            |                                              |  |                                            |         |   |           |          |             
|                                                | Accounts payable                             |  | $                                          | 11,488  |   |           | $        | 8,953        |  
|                                                | Accrued liabilities                          |  |                                            | 39,222  |   |           |          | 44,076       |  
|                                                | Deferred revenue                             |  |                                            | 4,616   |   |           |          | 5,281        |  
|                                                | Current portion of capital lease obligations |  |                                            | 142     |   |           |          | 217          |  
|                                                |                                              |  |                                            |         |   |           |          |             
|                                                |                                              |  | Total current liabilities                  |         |   | 55,468    |          |              |   | 58,527  | 
|Capital lease obligations, less current portion |                                              |  | 24                                         |         |   |           | 48       |             
|Convertible subordinated notes                  |                                              |  | 300,000                                    |         |   |           | 300,000  |             
|                                                |                                              |  |                                            |         |   |           |          |             
|                                                |                                              |  | Total liabilities                          |         |   | 355,492   |          |              |   | 358,575 | 
|                                                |                                              |  |                                            |         |   |           |          |             
|Capital stock                                   |                                              |  | 943,799                                    |         |   |           | 937,137  |             
|Accumulated other comprehensive income          |                                              |  | 465                                        |         |   |           | 1,419    |             
|Accumulated deficit                             |                                              |  | (422,928                                   | )       |   |           | (380,776 | )           
|                                                |                                              |  |                                            |         |   |           |          |             
|                                                |                                              |  | Total stockholders equity                 |         |   | 521,336   |          |              |   | 557,780 | 
|                                                |                                              |  |                                            |         |   |           |          |             
|                                                |                                              |  | Total liabilities and stockholders equity |         | $ | 876,828   |          |              | $ | 916,355 | 
|                                                |                                              |  |                                            |         |   |           |          |             

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ONI SYSTEMS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)

|                                                                                           |                                                                                   |                          |         |                              |         |      |         |        |         |  
|------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------- | ------------------------ | ------- | ---------------------------- | ------- | ---- | ------- | ------ | ------- | -
|                                                                                           |                                                                                   |                          |         | Three Months Ended March 31,
|                                                                                           |                                                                                   |                          |         |                             
|                                                                                           |                                                                                   |                          |         | 2002                         |         | 2001
|                                                                                           |                                                                                   |                          |         |                              |         |     
|Revenue                                                                                    |                                                                                   | $                        | 20,958  |                              |         | $    | 45,102  |       
|Cost of goods sold, excluding amortization of deferred
stock compensation                  |                                                                                   |                          | 15,582  |                              |         |      | 27,756  |       
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|                                                                                           | Gross profit                                                                      |                          |         | 5,376                        |         |      |         | 17,346 |        
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|Operating expenses:                                                                        |                                                                                   |                          |         |                              |         |      |         |       
|                                                                                           | Research and development, excluding amortization of
deferred stock compensation   |                          |         | 18,666                       |         |      |         | 18,052 |        
|                                                                                           | Sales and marketing, excluding amortization of deferred
stock compensation        |                          |         | 13,595                       |         |      |         | 9,868  |        
|                                                                                           | General and administrative, excluding amortization of
deferred stock compensation |                          |         | 9,698                        |         |      |         | 6,258  |        
|                                                                                           | Amortization of deferred stock compensation*                                      |                          |         | 4,766                        |         |      |         | 12,272 |        
|                                                                                           | Amortization of goodwill and intangibles                                          |                          |         | 1,472                        |         |      |         | 1,325  |        
|                                                                                           | In-process research and development                                               |                          |         |                             |         |      |         | 8,240  |        
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|                                                                                           |                                                                                   | Total operating expenses |         |                              | 48,197  |      |         |        | 56,015  |  
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|                                                                                           |                                                                                   | Operating loss           |         |                              | (42,821 | )    |         |        | (38,669 | )
|Interest income (expense), net                                                             |                                                                                   |                          | 1,206   |                              |         |      | 8,056   |       
|Other income (expense), net                                                                |                                                                                   |                          | (502    | )                            |         |      | (477    | )     
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|Loss before income taxes                                                                   |                                                                                   |                          | (42,117 | )                            |         |      | (31,090 | )     
|Income taxes                                                                               |                                                                                   |                          | 35      |                              |         |      | 1       |       
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|Net loss                                                                                   |                                                                                   | $                        | (42,152 | )                            |         | $    | (31,091 | )     
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|Basic and diluted net loss per share                                                       |                                                                                   | $                        | (0.30   | )                            |         | $    | (0.24   | )     
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|Weighted-average shares outstanding used in computing
basic and diluted net loss per share |                                                                                   |                          | 138,855 |                              |         |      | 129,173 |       
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|                                                                                           |                                                                                   |                          |         |                              |         |      |        
|*Amortization of deferred stock compensation:                                              |                                                                                   |                          |         |                              |         |      |         |       
|                                                                                           | Cost of goods sold                                                                |                          | $       | 545                          |         |      | $       | 5,779  |        
|                                                                                           | Research and development                                                          |                          |         | 1,957                        |         |      |         | 1,433  |        
|                                                                                           | Sales and marketing                                                               |                          |         | 1,656                        |         |      |         | 3,275  |        
|                                                                                           | General and administrative                                                        |                          |         | 608                          |         |      |         | 1,785  |        
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       
|                                                                                           |                                                                                   | $                        | 4,766   |                              |         | $    | 12,272  |       
|                                                                                           |                                                                                   |                          |         |                              |         |      |         |       

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ONI SYSTEMS CORP.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)

|                                                       |                                                                             |                                              |                                          |         |                              |        |         |         |        |         |  
|------------------------------------------------------ | --------------------------------------------------------------------------- | -------------------------------------------- | ---------------------------------------- | ------- | ---------------------------- | ------ | ------- | ------- | ------ | ------- | -
|                                                       |                                                                             |                                              |                                          |         | Three Months Ended March 31,
|                                                       |                                                                             |                                              |                                          |         |                             
|                                                       |                                                                             |                                              |                                          |         | 2002                         |        | 2001   
|                                                       |                                                                             |                                              |                                          |         |                              |        |        
|Cash flows from operating activities:                  |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Net loss                                                                    |                                              | $                                        | (42,152 | )                            |        | $       | (31,091 | )     
|                                                       | Adjustments to reconcile net loss to net cash used in operating activities: |                                              |                                          |         |                              |        |         |         |       
|                                                       |                                                                             | Depreciation and amortization                |                                          |         | 12,470                       |        |         |         | 6,044  |        
|                                                       |                                                                             | Provision for doubtful accounts              |                                          |         | 2,355                        |        |         |         |       |        
|                                                       |                                                                             | Amortization of deferred stock compensation  |                                          |         | 4,766                        |        |         |         | 12,272 |        
|                                                       |                                                                             | Amortization of debt financing costs         |                                          |         | 474                          |        |         |         | 474    |        
|                                                       |                                                                             | In-process research and development          |                                          |         |                             |        |         |         | 8,240  |        
|                                                       |                                                                             | Changes in operating assets and liabilities: |                                          |         |                              |        |         |         |        |        
|                                                       |                                                                             |                                              | Accounts receivable                      |         |                              | 17,549 |         |         |        | (23,789 | )
|                                                       |                                                                             |                                              | Inventory                                |         |                              | 3,058  |         |         |        | (5,506  | )
|                                                       |                                                                             |                                              | Prepaid expenses and other assets        |         |                              | (3,675 | )       |         |        | (6,705  | )
|                                                       |                                                                             |                                              | Accounts payable and accrued liabilities |         |                              | (2,319 | )       |         |        | 11,092  |  
|                                                       |                                                                             |                                              | Deferred revenue                         |         |                              | (665   | )       |         |        | (11     | )
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Net cash used in operating activities                                       |                                              |                                          | (8,139  | )                            |        |         | (28,980 | )     
|Cash flows provided by (used in) investing activities: |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Purchase of property and equipment                                          |                                              |                                          | (4,693  | )                            |        |         | (26,816 | )     
|                                                       | Purchase of Finisar technology                                              |                                              |                                          |        |                              |        |         | (5,000  | )     
|                                                       | Purchases of marketable securities                                          |                                              |                                          | (35,318 | )                            |        |         |        |       
|                                                       | Proceeds from sales and maturities of marketable securities                 |                                              |                                          | 46,910  |                              |        |         |        |       
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Net cash provided by (used in) investing activities                         |                                              |                                          | 6,899   |                              |        |         | (31,816 | )     
|Cash flows from financing activities:                  |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Payments under capital lease obligations                                    |                                              |                                          | (99     | )                            |        |         | (44     | )     
|                                                       | Proceeds from repayment of stockholder loans                                |                                              |                                          |        |                              |        |         | 1,880   |       
|                                                       | Proceeds from issuance of common stock, net of issuance costs               |                                              |                                          | 1,896   |                              |        |         | 5,716   |       
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Net cash provided by financing activities                                   |                                              |                                          | 1,797   |                              |        |         | 7,552   |       
|Effect of exchange rate changes                        |                                                                             |                                              | 20                                       |         |                              |        | 12      |        
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Net increase (decrease) in cash and cash equivalents                        |                                              |                                          | 577     |                              |        |         | (53,232 | )     
|Cash and cash equivalents at beginning of period       |                                                                             |                                              | 338,511                                  |         |                              |        | 852,360 |        
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|Cash and cash equivalents at end of period             |                                                                             | $                                            | 339,088                                  |         |                              | $      | 799,128 |        
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|Supplemental disclosures of cash flow information:     |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Taxes paid during period                                                    |                                              | $                                        | 18      |                              |        | $       |        |       
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Interest paid during period                                                 |                                              | $                                        | 2       |                              |        | $       | 7       |       
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|Noncash investing and financing activities:            |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Issuance of restricted common stock and stock options for future services   |                                              | $                                        | 38      |                              |        | $       |        |       
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        
|                                                       | Issuance of common stock in connection with Finisar technology acquisition  |                                              | $                                        |        |                              |        | $       | 21,340  |       
|                                                       |                                                                             |                                              |                                          |         |                              |        |         |        

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ONI SYSTEMS CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)

1. Description of Business

ONI Systems Corp. develops, markets and sells optical communications
equipment to communication service providers in the metropolitan and regional
markets.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission and, therefore, do not include all the
information and footnotes necessary for a complete presentation of ONIs
results of operations, financial position, and cash flows in conformity with
accounting principles generally accepted in the United States of America. The
unaudited financial statements reflect all adjustments (consisting only of
normal recurring adjustments) which are, in the opinion of management,
necessary for a fair presentation of the financial position at March 31, 2002
and the operating results and cash flows for the three months ended March 31,
2002 and 2001. These financial statements and notes should be read in
conjunction with ONIs audited financial statements and related notes for the
year ended December 31, 2001, included in ONIs Annual Report on Form 10-K
filed March 19, 2002 with the Securities and Exchange Commission. The condensed
consolidated balance sheet at December 31, 2001 has been derived from audited
financial statements as of that date.

The results of operations for the three months ended March 31, 2002 are
not necessarily indicative of results that may be expected for any other
interim period or for the full fiscal year ending December 31, 2002.

3. Summary of Restructuring and Impairment Charges and Inventory-Related Charges



| | (a) |  | Restructuring Charges
| | --- |  | ---------------------

In 2001, ONI commenced a restructuring program to re-align business
operations with unfavorable market conditions caused by the downturn in the
communications equipment sector that lowered customer order levels and ONI
shipping volumes. This program included a worldwide reduction in force,
consolidation of facilities and resizing of manufacturing levels. During the
quarter ended September 30, 2001, ONI recorded restructuring and impairment
charges of $17,350, including $16,092 of lease and related expenses associated
with exit and consolidation plans for excess facilities and the impairment of
leasehold improvements and fixed assets at vacated facilities.

A summary of the restructuring and impairment charges is as follows:

|                       |                                                                             |               |   |                    |        |          |   |        |        |           |   |        |        |            |   |       |       | 
|---------------------- | --------------------------------------------------------------------------- | ------------- | - | ------------------ | ------ | -------- | - | ------ | ------ | --------- | - | ------ | ------ | ---------- | - | ----- | ----- | 
|                       |                                                                             |               |   | Charges Recorded   |        |          |   |        |        |           |   |        |        |            |   |      
|                       |                                                                             |               |   | During the Quarter |        |          |   |        |        |           |   |        |        | Accrued at
|                       |                                                                             |               |   | Ended              |        | Non-Cash |   | Cash   |        | March 31,
|                       |                                                                             |               |   | September 30, 2001 |        | Charges  |   | Paid   |        | 2002     
|                       |                                                                             |               |   |                    |        |          |   |        |        |          
|Description of charge: |                                                                             |               |   |                    |        |          |   |        |        |           |   |        |        |            |   |      
|                       | Costs of consolidating facilities                                           |               | $ | 11,431             |        |          | $ |       |        |           | $ | (2,677 | )      |            | $ | 8,754 |      
|                       | Impairment of leasehold improvements
and fixed assets at vacated facilities |               |   | 4,661              |        |          |   | (4,661 | )      |           |   |       |        |            |   |      |      
|                       | Reduction in force                                                          |               |   | 1,258              |        |          |   | (217   | )      |           |   | (1,041 | )      |            |   |      |      
|                       |                                                                             |               |   |                    |        |          |   |        |        |           |   |        |        |            |   |      
|                       |                                                                             | Total charges |   | $                  | 17,350 |          |   | $      | (4,878 | )         |   | $      | (3,718 | )          |   | $     | 8,754 | 
|                       |                                                                             |               |   |                    |        |          |   |        |        |           |   |        |        |            |   |      

Costs of consolidating facilities are comprised primarily of estimated
minimum lease payments and related charges to be made under lease arrangements.
Cash payments associated with the costs of consolidating facilities will be
made through 2006 based on contractual lease commitments.

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| | (b) |  | Inventory-Related Charges
| | --- |  | -------------------------

During the year ended December 31, 2001, ONI recorded a $36,870 write-down
of inventory determined to be excess and obsolete, a charge of $7,425 related
to materials that were required to be purchased from third-party contract
manufacturers and suppliers under purchase commitments, but which are in excess
of required quantities and a reserve of $1,040 associated with impairment of
manufacturing equipment. These provisions were included in cost of goods sold
for the year ended December 31, 2001.

The write-down of inventory on hand and accrual for excess materials
associated with purchase commitments represent inventory that ONI estimates it
will be unable to sell based on current inventory levels and significant
declines in customer capital spending. Through March 31, 2002, ONI has made
cash payments of $3,234 associated with purchases under these purchase
commitments. The remaining accrued purchase commitments of $4,191 is included
in accrued liabilities in the condensed consolidated balance sheet as of March
31, 2002.

4. Business Combination

In February 2001, ONI acquired technology and other assets associated with
Finisar Corporations customer premises equipment business. At closing, ONI
paid $5,000 in cash and issued 488,624 shares of common stock to Finisar
Corporation. At acquisition date, there were additional cash payments of up to
$25,000 that were contingent upon the timely delivery of certain mutually
agreed deliverables. The additional deliverables represent the completion of
various feature sets of one of the purchased products.

During the year ended December 31, 2001, ONI made additional purchase
price payments totaling $12,750 based on delivery and acceptance of the
mutually agreed deliverables specified in the purchase agreement. As of March
31, 2002, the remaining cash payment of up to $6,000 was contingent upon the
timely delivery and acceptance of the final mutually agreed deliverable. In
April 2002, ONI paid $6,000 upon delivery and acceptance of the final mutually
agreed deliverable. This payment was capitalized as additional goodwill in
April 202. Including this final payment, the total actual contingent payments
made were $18,750.

A summary of the allocation of the purchase consideration through March
31, 2002 was as follows:

|                                    |  |   |        | 
|----------------------------------- |  | - | ------ | 
|Property and equipment              |  | $ | 344    | 
|Identifiable intangible assets      |  |   | 17,290 | 
|In-process research and development |  |   | 8,240  | 
|Goodwill                            |  |   | 13,429 | 
|                                    |  |   |        | 
|Total                               |  | $ | 39,303 | 
|                                    |  |   |        | 

5. Revenue Recognition

Revenue is derived from sales of hardware, software and services. Revenue
is accounted for in accordance with Staff Accounting Bulletin (SAB) No. 101,
which summarizes the SEC staffs views in applying generally accepted
accounting principles to revenue recognition in financial statements, Statement
of Position (SOP) 97-2, Software Revenue Recognition and SOP 98-9, Software
Revenue Recognition with Respect to Certain Arrangements. For hardware
transactions where software is not incidental, ONI applies the provisions of
SOP 97-2 and SOP 98-9, and does not segregate the fee between hardware and
software or apply separate accounting guidance to the hardware and software
elements. For hardware transactions where no software is involved, ONI applies
the provisions of SAB 101. The application of the provisions of SAB 101, SOP
97-2 and SOP 98-9 requires significant judgments and estimates by ONI in
connection with the revenue recognized in any accounting period.

ONI recognizes revenue from product sales upon shipment when the following
provisions are met: (a) persuasive evidence of an arrangement exists, generally
based on an executed contract and purchase order; (b) the product has been
delivered, typically to a common carrier; (c) the fee is fixed and
determinable; and (d) collection of the resulting receivable is probable. When
the arrangement with the customer includes future obligations or customer
acceptance requirements, revenue is recognized when those obligations have been
met or customer acceptance has been received. ONI assesses collection based on
a number of factors, including the customers payment patterns, the
credit-worthiness of the customer and the potential effect of market or
economic factors on the customers financial condition. If collection of a fee
is not probable, the fee is deferred and revenue is recognized at the time
collection becomes probable, which is generally upon receipt of cash.

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Services revenue consists primarily of installation services and, to a
lesser extent, of service contracts for maintenance. Revenue from installation
services is recognized upon completion of the installation. Revenue from
service contracts is recognized over the life of the service contract,
generally twelve months.

For arrangements with multiple elements, the fair value of each element is
allocated based on separate sales or renewals to other customers or upon
renewal rates quoted in the contracts. Fair value of services, such as
training, is based upon separate sales of these services to other customers.
For transactions that include hardware, software and installation services
within one arrangement, installation services are not considered essential to
the functionality of the products sold. Installation services do not
significantly change the function of the products sold, have in the past
generally been completed within expected timelines and have at times been
performed by other vendors. Revenue associated with the hardware and software
in these arrangements is generally recognized upon shipment.

Deferred revenue represents amounts billed in excess of revenue
recognized. Deferred revenue includes service contract revenue to be recognized
over future periods, as well as fair value of future obligations under multiple
element arrangements.

6. Net Loss Per Share

Basic and diluted net loss per share have been computed in accordance with
Statement of Financial Accounting Standards (SFAS) No. 128, Earnings per
Share. Basic net loss per share has been computed using the weighted-average
number of common shares outstanding during the period. Diluted net loss per
share is computed using the weighted-average number of common shares and
dilutive potential common shares outstanding during the period, using the
as-if-converted method for convertible preferred shares and the treasury stock
method for options and warrants. All potential common shares have been
excluded from the computation of diluted net loss per share for all periods
presented because the effect would be antidilutive. The following table
presents the calculation of basic and diluted net loss per share:

|                                                                                      |  |                              |         |      |  |   |         |  
|------------------------------------------------------------------------------------- |  | ---------------------------- | ------- | ---- |  | - | ------- | -
|                                                                                      |  | Three Months Ended March 31,
|                                                                                      |  |                             
|                                                                                      |  | 2002                         |         | 2001
|                                                                                      |  |                              |         |     
|Net loss attributable to common stockholders                                          |  | $                            | (42,152 | )    |  | $ | (31,091 | )
|                                                                                      |  |                              |         |      |  |   |         |  
|Basic and diluted:                                                                    |  |                              |         |      |  |   |         |  
|Weighted-average shares of common stock outstanding                                   |  |                              | 141,242 |      |  |   | 134,709 |  
|Less: weighted-average shares subject to repurchase                                   |  |                              | 2,387   |      |  |   | 5,536   |  
|                                                                                      |  |                              |         |      |  |   |         |  
|Weighted-average shares used in computing basic and diluted net loss
per common share |  |                              | 138,855 |      |  |   | 129,173 |  
|                                                                                      |  |                              |         |      |  |   |         |  
|Basic and diluted net loss per common share                                           |  | $                            | (0.30   | )    |  | $ | (0.24   | )
|                                                                                      |  |                              |         |      |  |   |         |  

7. Investments

Short and long-term investments are comprised of marketable securities.
All of the Companys short and long-term investments are classified as
available-for-sale. These investments are carried at fair value and
unrealized gains and losses are included in other comprehensive income (loss)
as a component of stockholders equity. Realized gains or losses upon sale or
maturity of these investments and declines in value determined to be other than
temporary, if any, are included in other income and expense.

8. Accounts Receivable

Accounts receivable consists of:

|                                |  |           |        |              |  |   |        | 
|------------------------------- |  | --------- | ------ | ------------ |  | - | ------ | 
|                                |  | March 31, |        | December 31,
|                                |  | 2002      |        | 2001        
|                                |  |           |        |             
|Accounts receivable             |  | $         | 31,482 |              |  | $ | 49,690 | 
|Allowance for doubtful accounts |  |           | 7,441  |              |  |   | 5,745  | 
|                                |  |           |        |              |  |   |        | 
|Accounts receivable, net        |  | $         | 24,041 |              |  | $ | 43,945 | 
|                                |  |           |        |              |  |   |        | 

The allowance for doubtful accounts represents estimated losses resulting
from the inability of customers to make required payments. The allowance is
estimated based on periodic review of customer financial condition and ability
to pay, as well as any deterioration in customer financial condition due to
market, economic or other factors.

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9. Inventory

Inventory consists of:

|                      |  |           |        |              |  |   |        | 
|--------------------- |  | --------- | ------ | ------------ |  | - | ------ | 
|                      |  | March 31, |        | December 31,
|                      |  | 2002      |        | 2001        
|                      |  |           |        |             
|Raw materials         |  | $         | 5,250  |              |  | $ | 7,064  | 
|Work in progress      |  |           | 16,859 |              |  |   | 16,582 | 
|Finished goods        |  |           | 13,501 |              |  |   | 17,969 | 
|Consignment inventory |  |           | 14,527 |              |  |   | 12,221 | 
|                      |  |           |        |              |  |   |        | 
|                      |  | $         | 50,137 |              |  | $ | 53,836 | 
|                      |  |           |        |              |  |   |        | 

10. Accumulated Other Comprehensive Income

The components of other comprehensive income (loss) are as follows:

|                                                 |                                |   |                    |      |  
|------------------------------------------------ | ------------------------------ | - | ------------------ | ---- | -
|                                                 |                                |   | Three Months Ended
|                                                 |                                |   | March 31, 2002    
|                                                 |                                |   |                   
|Net loss                                         |                                | $ | (42,152            | )   
|Unrealized loss on available-for-sale securities |                                |   | (974               | )   
|Foreign currency translation gain                |                                |   | 20                 |     
|                                                 |                                |   |                    |     
|                                                 | Total other comprehensive loss |   |                    | (954 | )
|                                                 |                                |   |                    |     
|Comprehensive loss                               |                                | $ | (43,106            | )   
|                                                 |                                |   |                    |     

There was no other comprehensive income (loss) for the comparable period
ended March 31, 2001. Accumulated other comprehensive income consists of
unrealized gains or losses on available-for-sale securities, which are included
in short and long-term investments in the condensed consolidated balance
sheets, and cumulative translation adjustments.

11. Goodwill and Intangible Assets

Identifiable intangibles are amortized over their estimated useful lives,
not exceeding three years. Beginning in 2002, ONI adopted the provisions of
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets. This Statement requires that goodwill and other
intangibles with an indefinite useful life not be amortized, but be tested for
impairment at least annually. Upon ONIs adoption of SFAS No. 142 beginning
January 1, 2002, goodwill is no longer being amortized. Based on reevaluation
of previously recognized intangible assets, no intangible assets have been
identified as having an indefinite life.

The remaining unamortized goodwill of $10.9 million is currently being
evaluated for the impact of the impairment analysis under SFAS 142 on ONIs
financial statements and related disclosures. The value of goodwill is
reviewed periodically for impairment. Whenever events or changes in
circumstances indicate that the carrying value of the goodwill may not be
recoverable, an impairment charge will be recorded.

The following table presents net loss and loss per share information for
the period ended March 31, 2001, adjusted to exclude the amortization of
goodwill that is no longer being amortized under SFAS No. 142:

|                                   |                          |   |         |         |  
|---------------------------------- | ------------------------ | - | ------- | ------- | -
|Net loss, as reported              |                          | $ | (31,091 | )      
|Add back: amortization of goodwill |                          |   | 466     |        
|                                   |                          |   |         |        
|                                   | Pro forma net loss       |   | $       | (30,625 | )
|                                   |                          |   |         |        
|Loss per share, as reported        |                          | $ | (0.24   | )      
|                                   | Pro forma loss per share |   | $       | (0.24   | )
|                                   |                          |   |         |        

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12. Recent Accounting Pronouncements

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. This Statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. This Statement applies to
legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development or normal use of the
asset. As used in this Statement, a legal obligation results from existing law,
statute, ordinance, written or oral contract, or by legal construction of a
contract under the doctrine of promissory estoppel. SFAS 143 is effective for
fiscal years beginning after June 15, 2002. ONI does not expect the adoption of
SFAS 143 to have a material impact on ONIs financial position or results of
operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. This Statement addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets and supersedes SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the
accounting and reporting provisions of APB No. 30, Reporting the Results of
Operations for a Disposal of a Segment of a Business. SFAS 144 is effective
for fiscal years beginning after December 15, 2001. ONI adopted SFAS 144
beginning in fiscal year 2002. The adoption of SFAS 144 did not have a material
impact on ONIs financial position or results of operations.

13. Segment Reporting

SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information, establishes standards for the manner in which public companies
report information about operating segments in annual and interim financial
statements. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. The method for
determining what information to report is based on the way management organizes
the operating segments within a company for making operating decisions and
assessing financial performances.

ONIs chief executive officer is its chief operating decision-maker. The
financial information that the chief executive officer reviews is identical to
the information presented in the accompanying consolidated statements of
operations. ONI has determined that it operates in a single operating segment:
development and sale of optical networking equipment to communication service
providers in the regional and metropolitan area markets.

ONIs revenue is generally derived from sales of its ONLINE and ONWAVE
products. ONI expects to continue selling these products in the future, and
also to develop other lines of products for sale. ONIs geographic distribution
of revenues for the three months ended March 31, 2002 and 2001, is as follows:

|              |  |                              |    |      |  |  |    |  
|------------- |  | ---------------------------- | -- | ---- |  |  | -- | -
|              |  | Three Months Ended March 31,
|              |  |                             
|              |  | 2002                         |    | 2001
|              |  |                              |    |     
|North America |  |                              | 74 | %    |  |  | 83 | %
|Asia          |  |                              | 22 | %    |  |  | 8  | %
|Europe        |  |                              | 4  | %    |  |  | 9  | %

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14. Contingencies

In March 2000, Nortel Networks filed suit against ONI in the United States
District Court for the Northern District of California. The suit alleged that
ONIs products infringe five patents held by Nortel Networks, and sets forth
allegations of misappropriation of trade secrets, unlawful business practices
and common law unfair competition. Nortel Networks is seeking preliminary and
permanent injunctions and damages against ONI in connection with these claims.
In March 2002, Nortel Networks agreed to dismiss all claims related to four of
the five patents and, on March 22, 2002, the court issued an order dismissing
with prejudice these four patents from the suit. ONI expects to incur
substantial legal and other expenses in connection with the remaining claims in
the Nortel Networks litigation. In the event of an adverse ruling, ONI also
could be required to pay damages to Nortel Networks. The accompanying condensed
consolidated financial statements do not include any liabilities, if any, that
might result from this uncertainty.

Beginning in August 2001, a number of substantially identical class action
complaints alleging violations of the federal securities laws were filed in the
United States District Court for the Southern District of New York. These
complaints name ONI, Hugh C. Martin, ONIs chairman, president and chief
executive officer; Chris A. Davis, ONIs former executive vice president, chief
financial and administrative officer; and certain underwriters of ONIs initial
public offering as defendants. The complaints have since been consolidated into
a single action, and a consolidated amended complaint was filed on April 24,
2002. The amended complaint alleges, among other things, that the underwriter
defendants violated the securities laws by failing to disclose alleged
compensation arrangements (such as undisclosed commissions or stock
stabilization practices) in the initial public offerings registration
statement and by engaging in manipulative practices to artificially inflate the
price of ONIs common stock after the initial public offering. The amended
complaint also alleges that ONI and the named officers violated the securities
laws on the basis of an alleged failure to disclose the underwriters alleged
compensation arrangements and manipulative practices. No specific amount of
damages has been claimed. Similar complaints have been filed against more than
300 other issuers that have had initial public offerings since 1998, and all of
these actions have been included in a single coordinated proceeding. ONI
intends to defend these actions vigorously.

On February 20, 2002, a complaint was filed on behalf of a purported class
of ONI security holders in Superior Court of the State of California, County of
San Mateo, against ONI, Matthew Bross, Kevin Compton, Jonathan Feiber, Gregory
Maffei and Hugh Martin seeking an injunction to prevent the consummation of the
proposed merger with CIENA. The complaint alleges that the defendants, in
connection with the approval of the proposed merger with CIENA, breached their
fiduciary duties, including duties of loyalty and good faith, to ONI
stockholders by, among other things, allegedly failing to obtain the highest
value for ONI stockholders, engaging in self-dealing and unjustly enriching
themselves and other insiders or affiliates of ONI. On March 19, 2002, a
substantially similar complaint which includes similar allegations was filed on
behalf of the same purported class of ONI security holders in Superior Court of
the State of California, County of Santa Clara, against the same defendants
seeking similar relief. ONI believes that these lawsuits are without merit and
intends to defend these actions vigorously.

From time-to-time ONI may be subject to other legal proceedings and claims
in the ordinary course of business. ONI is not aware of any legal proceedings
or claims, including the above matters that ONI believes will have,
individually or in the aggregate, a material adverse effect on ONIs business,
financial condition or results of operations.

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

Some of the statements contained in this discussion constitute
forward-looking statements that involve substantial risks and uncertainties. In
some cases, you can identify these statements by forward-looking words such as
may, will, should, expect, intend, plan, anticipate, believe,
estimate or continue and variations of these words or comparable words. In
addition, any statements which refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking
statements. These statements include discussions of our projections about
levels of future revenue and expenses, potential application of accounting
policies and the proposed merger with CIENA. These forward-looking statements
involve known and unknown risks, uncertainties and situations that may cause
our or our industrys actual results, level of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by these statements.
The risk factors contained in this document, as well as any other cautionary
language in this document, provide examples of risks, uncertainties and events
that may cause our actual results to differ from the expectations described or
implied in our forward-looking statements.

Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. You should not place undue reliance on
these forward-looking statements, which reflect our view only as of the date of
this report. Except as required by law, we do not undertake to update or revise
any forward-looking statement, whether as a result of new information, future
events or otherwise.

In addition, the following information should be read in conjunction with
the financial statements and related notes included in Item 1 of this Quarterly
Report, our Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 19, 2002 and Factors that May Affect Future Results in
this document.

Overview

We develop, market and sell optical communications networking equipment
specifically designed to address the bandwidth and service limitations of
metropolitan and regional networks. Our products include the ONLINE9000, which
is designed for metropolitan markets, the ONLINE7000, which is designed to
provide metropolitan service providers with a more cost-effective solution for
metro access applications and the ONLINE11000, which is designed for regional
markets. We have also released the ONWAVE SONET/SDH Multiplexer and ONWAVE
Data Multiplexer products that allow multiple data signals to be combined
within an individual wavelength channel and eliminate the need for traditional
multiplexing equipment. In 2001, we introduced the ONLINE2500, which is
designed to enable service providers to deliver high bandwidth services to
customers at the optical edge of their metro networks.

We sell our products to telecommunication service providers such as
competitive local exchange carriers, inter-exchange carriers, Internet service
and application service providers, cable operators, utilities and their
affiliates and incumbent local exchange carriers. We have also recently
started selling our ONLINE2500product to enterprise customers for use in their
internal networks.

Revenues for the quarter ended March 31, 2002 were substantially lower
than the already reduced revenue levels in the third and fourth quarters of
2001. Our revenue levels are dependent on the spending levels of our existing
and potential customers. In recent periods, there has been a significant
downturn in the communications equipment market due to substantially reduced
spending levels by communications service providers. In 2001, lower spending by
our customers and potential customers in the communications service provider
market substantially reduced our order levels and revenues. In 2002, we
experienced a further decline in order levels as our existing and potential
customers reduced or delayed anticipated purchases of our products. The
decline in order and revenue levels resulted in substantially lower gross
margins for the quarter ended March 31, 2002.

We believe that the primary reason for the decline in spending levels in
2001 was that access to capital, on which service providers rely to fund the
creation, expansion and improvement of their networks, was significantly
restricted in 2001. In addition to the lack of access to new capital, many
service providers in 2002 have been concerned with managing their deteriorating
financial condition and substantial debt, rather than expanding their networks.

On February 17, 2002, we entered into an Agreement and Plan of Merger with
CIENA Corporation, a Delaware corporation. According to the agreement,
effective on and as of the closing date, which has not yet been determined, we
will merge into CIENA, with CIENA surviving the merger. The proposed
transaction remains subject to a number of contingencies, including approval of
the stockholders of both ONI Systems and CIENA, receipt of regulatory approvals
and other customary closing conditions. The proposed merger will be accounted
for under the purchase method of accounting. Upon consummation of the merger,
CIENA will issue 0.7104 shares of its common stock for each outstanding share
of our common stock and will convert all

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outstanding ONI Systems options and warrants into options and warrants to
purchase shares of CIENA common stock. CIENA will assume our outstanding 5%
convertible subordinated notes due 2005. We have incurred increased general and
administrative expenses, particularly related to legal and accounting fees,
during the quarter ended March 31, 2002, related to this transaction. We
expect to continue to incur general and administrative expenses related to this
transaction.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with generally accepted accounting principles in
the United States. The preparation of these financial statements requires us to
make estimates and judgments in determining the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. We regularly evaluate our estimates, including those related
to customer arrangements, allowances for doubtful accounts, inventories,
valuation of assets, warranty obligations, and contingencies and litigation.
When making estimates, we consider our historical experience, our knowledge of
economic and market factors and various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions.

We believe that the following critical accounting policies represent areas
where significant judgments and estimates have been used in the preparation of
our consolidated financial statements.

Revenue

We derive revenue from sales of hardware, software and services. Revenue
is accounted for in accordance with Staff Accounting Bulletin (SAB) 101,
Revenue Recognition, Statement of Position (SOP) 97-2, Software Revenue
Recognition and SOP 98-9, Software Revenue Recognition with Respect to
Certain Arrangements. For hardware transactions where software is not
incidental, we apply the provisions of SOP 97-2 and SOP 98-9, and we do not
segregate the fee between hardware and software or apply separate accounting
guidance to the hardware and software elements. For hardware transactions where
no software is involved, we apply the provisions of SAB 101. The application of
the provisions of SAB 101, SOP 97-2 and SOP 98-9 require us to make significant
judgments and estimates in connection with the revenue recognized in any
accounting period. Therefore, our estimates and judgments have a direct effect
on the amount and timing of revenue recognized in any period.

We generally recognize hardware and software revenue upon shipment when
the following provisions are met: (a) persuasive evidence of an arrangement
exists, generally based on an executed contract and purchase order; (b) the
product has been delivered, typically to a common carrier; (c) the fee is fixed
and determinable; and (d) collection of the resulting receivable is probable.
When the arrangement with the customer includes future obligations or customer
acceptance requirements, revenue is recognized when those obligations have been
met or customer acceptance has been received. We assess collection based on a
number of factors, including the customers payment patterns, the
credit-worthiness of the customer and the potential effect of market or
economic factors on the customers financial condition. If we determine that
collection of a fee is not probable based on our assessment, we defer the fee
and recognize revenue at the time collection becomes probable, which is
generally upon receipt of cash.

For arrangements with multiple elements we allocate fair value to each
element based on separate sales or renewals to other customers or upon renewal
rates quoted in the contracts. Fair value of services, such as training, is
based upon separate sales by us of these services to other customers. For
transactions that include hardware, software and installation services within
one arrangement, installation services are not considered essential to the
functionality of the products sold. Installation services do not significantly
change the function of the products sold, have in the past generally been
completed within our expected timelines and have at times been performed by
other vendors. Revenue associated with the hardware and software in these
arrangements are generally recognized upon shipment. Revenue from installation
service is recognized upon completion of the installation. Revenue from service
contracts is recognized over the life of the service contract, generally twelve
months.

To the extent customer arrangements contain incentive offerings such as
volume-based pricing, special pricing agreements or other special terms, we may
deem it necessary to record reductions in revenue or to make estimates of
revenue deferrals.

Valuation of assets

We maintain an allowance for doubtful accounts for estimated impairment of
our receivables resulting from the inability of our customers to make required
payments. We estimate the impairment of a receivable based on our judgment of a
customers financial condition and ability to pay, as well as any deterioration
in a customers financial condition due to market, economic or other factors.
We evaluate customers credit worthiness and payment patterns in assessing
their financial condition. Some of our
13Table of Contents

customers have limited operating histories, which can limit the amount of
financial information available to us. We currently sell our products to a
limited number of customers, which results in concentrations of credit risk at
any given point in time. For example, at March 31, 2002, four customers
represented approximately 50% of our total accounts receivable and at December
31, 2001, four customers represented approximately 61% of our total accounts
receivable. Many of our customers require access to significant amounts of
capital to fund or expand their operations. Access to capital has been
significantly restricted recently and lack of sufficient funds can result in
deterioration in the financial condition of our customers or potential
customers or cause them to substantially reduce or cease operations. We have
recorded bad debt expense associated with accounts receivable from customers
who are experiencing liquidity problems, ceasing operations or in bankruptcy
proceedings. If, in future periods, we determine that a customers financial
condition has deteriorated, resulting in an impairment of its ability to make
payments, additional allowances may be required.

We regularly evaluate inventory values for impairment to determine whether
our carrying value exceeds the estimated market value of our inventory. Our
estimates of the market value of our inventory are based on several factors,
including our assumptions about future demand for each of our products,
expected product lives, planned product releases and new product introductions
and overall market conditions. If actual demand is less favorable than we have
projected based on our assumptions of estimated customer order levels, we may
need to record additional write-downs of inventory. The market in which we
operate is characterized by rapid technological changes. If technological
changes occur more rapidly than we expected when we made our estimates of
product lives, planned product releases and new product introductions, we may
have risk of inventory becoming technologically obsolete. Additionally, we
provide requirement forecasts to our contract manufacturers and certain
component vendors up to six months in advance. If actual requirements are less
than forecasts provided to our contract manufacturers or vendors, we may be
required to record additional charges for excess inventory.

The values of our long-lived assets, including property and equipment,
identifiable intangible assets and goodwill, are reviewed for potential
impairment whenever events or changes in circumstances indicate that the
carrying values may not be recoverable. The carrying values of our property and
equipment depend upon our estimates of useful lives over future periods.
Changes in our business or operational strategy or in our manufacturing levels
can result in impairment in the carrying values of our property and equipment.
Our determination of the values of, and any impairment related to, identifiable
intangible assets and goodwill associated with our technology purchase is
affected by our estimates of the expected use of the acquired assets and
changes in our business strategy. If the assumptions we use to determine
valuation of these long-lived assets prove to be wrong, we may be required to
record impairment charges to the carrying values of these assets in future
periods.

Our determination of impairment related to certain equity investments in
privately-held companies is based on recent financing rounds or assumptions
related to projected operating results of the privately-held company and
potential effects of declines in market trends that are determined to be other
than temporary. If the operating results of the privately-held company or the
market in which it operates decline in the future, we may be required to record
impairment charges to reduce the carrying amount in future periods.

The valuation of assets is based on facts known to management at the
balance sheet date. If additional information becomes available at a later
date, current estimates could change.

Warranty Accrual

We record provisions for estimated costs of product warranties at the time
revenue is recognized. Our warranty accrual is based on estimates of product
failure rates, material usage and expected service costs incurred in correcting
any product failure reported under warranty coverage. Our products are
technically advanced and highly complex. The occurrence of defects in complex
hardware and software, and the related costs of correcting any such defects,
are inherently more difficult to estimate. Additionally, we have a limited
operating history and our current products may not have been deployed for an
extended period of time in our customers networks. Therefore, we have limited
historical warranty experience upon which to make our estimates, and future
warranty experience may differ from our historical experience. Should actual
product failure rates, material usage or service costs differ from our
estimates, revisions to the estimated warranty liability would be required.

Results of Operations

During the quarter ended March 31, 2002, we experienced further declines
in revenue levels from the already reduced revenue levels of the third and
fourth quarter of 2001. This decline resulted from further decreases in
capital spending and delays in orders from our customers and anticipated
customers. As a result of the sudden and significant decrease in revenue, we
were unable to maintain the same levels of production efficiencies compared to
prior quarters. Gross margin declined to 25.7% for the quarter ended March 31,
2002 from 38.5% in the comparable quarter of 2001.

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Revenue

Revenue was $21.0 million for the quarter ended March 31, 2002, a decrease
of $24.1 million from the comparable quarter in 2001. During the quarter ended
March 31, 2002, we recognized revenue from 21 customers compared to revenue
from 19 customers for the quarter ended March 31, 2001. The significant
decline in revenue for the quarter ended March 31, 2002, is primarily
attributable to decreased order levels from most customers, a smaller
percentage of repeat customer purchases and, in certain circumstances, the
ceasing of trade credit to customers experiencing liquidity problems.

Our revenues in future periods will continue to depend upon the timing and
level of capital spending by communications service providers, particularly the
regional bell operating companies in the United States and the postal telephone
and telegraph operators in Europe, for purchases of our products. Further, in
the current economic environment, visibility over future order and shipment
levels is limited.

Cost of goods sold, excluding amortization of deferred stock compensation

Cost of goods sold was $15.6 million for the quarter ended March 31, 2002,
a decrease of $12.2 million from the comparable quarter in 2001. The decrease
in cost of goods sold was primarily due to the 53.5% decrease in revenues for
the quarter ended March 31, 2002 from the comparable quarter in 2001. As a
percentage of revenue, cost of goods sold was 74.3% for the quarter ended March
31, 2002, an increase from 61.5% in the comparable period in 2001. The
increase in cost of goods sold as a percentage of revenue was primarily due to
the allocation of fixed production costs over a decreased revenue base.

Gross margin on product sales depends upon several factors, including the
stage and configuration of our customers network deployments, sales volume,
pricing, and our ability to achieve production efficiencies, including cost
reduction initiatives. During the quarter ended March 31, 2002, the
substantial decline in revenue levels resulted in a decline in our gross
margins to 25.7% from 38.5% in the comparable quarter in 2001. The decline in
our gross margins is principally due to loss of production efficiencies. In
addition, we typically realize lower gross margins on initial customer
deployments, which include fewer wavelengths, than on follow-on purchases where
the customer is adding capacity to its network. To date, a large portion of our
revenue has been derived from initial customer deployments. We expect to
continue to add new customers and support initial deployments for our existing
customers such that the mix of initial deployments versus follow-on purchases
may vary on a quarterly basis. In addition, gross margin will be impacted by
revenue levels and our ability to achieve and maintain production efficiencies.

Research and development expense, excluding amortization of deferred stock compensation

Research and development expense was $18.7 million for the quarter ended
March 31, 2002, an increase of $0.6 million from the comparable quarter in 2001.
At March 31, 2002, we had approximately 238 research and development
employees, a slight decrease from 245 at March 31, 2001. Research and
development expenses are comprised primarily of salaries and related personnel
costs, costs related to the design, development, testing and enhancement of our
products and cost of facilities. Research and development expense for the
three months ended March 31, 2002 includes costs of approximately $1.0 million
associated with payments to Telcordia Technologies, Inc. in connection with the
Operation Systems Modification of Intelligent Network Elements, or OSMINE,
certification process. Research and development expense as a percentage of
revenue was 89.1% for the quarter ended March 31, 2002, an increase from 40.0%
in the comparable period in 2001. The increase in research and development as
a percentage of revenue for the quarter ended March 31, 2002, is primarily due
to the substantial decline in revenue levels while research and development
expenditures remained relatively flat from the comparable quarter in 2001.

Research and development is essential to our future success and these
expenses may increase in absolute dollars in future periods.

Sales and marketing expense, excluding amortization of deferred stock compensation

Sales and marketing expense was $13.6 million for the quarter ended March
31, 2002, an increase of $3.7 million from the comparable quarter in 2001.
Sales and marketing expense consists primarily of salaries and commissions,
travel expenses associated with selling activities and customer visits and
costs of advertising and tradeshow activities. The increase in sales and
marketing expenses primarily relates to expansion of our sales force and
customer service and support department on a year-over-year basis, both
domestically and internationally. In 2001, we expanded our international sales
activities and personnel in the United Kingdom and opened sales offices in
Singapore, France, Germany, the Netherlands, Japan and Korea. At March 31,
2002, we had approximately 237 sales, marketing and service employees, an
increase of 59 from 178 at March 31, 2001. Sales and

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marketing expense as a percentage of revenue was 64.9% for the three
months ended March 31, 2002, an increase from 21.9% in the comparable period in
2001.

We expect sales and marketing expense in future quarters to be remain
relatively flat to the extent current economic and market conditions continue.

General and administrative expense, excluding amortization of deferred stock compensation

General and administrative expense was $9.7 million for the quarter ended
March 31, 2002, an increase of $3.4 million from the comparable quarter in
2001. General and administrative expense for the quarter ended March 31, 2002,
included a $2.4 million increase in the provision for doubtful accounts for
trade accounts receivable considered to be uncollectible. Excluding the
provision for doubtful accounts, the increase in general and administrative
expense is primarily due to the increased legal, accounting and administrative
expenses associated with our proposed merger with CIENA and, to a lesser
extent, to additional facilities and related costs associated with our larger
corporate facilities. These increases were partially offset by decreased
salaries and related personnel costs due to the decrease in headcount. At
March 31, 2002, we had approximately 87 general and administrative employees, a
decrease of 10 from 97 at March 31, 2001. General and administrative expense
was 46.3% as a percentage of revenue for the three months ended March 31, 2002,
an increase from 13.9% in the comparable period in 2001.

The increased allowance for doubtful accounts in the three months ended
March 31, 2002, relates to the expected loss from two customers whose financial
condition suggests that they may not be able to make required payments to ONI.
During the three months ended March 31, 2002, one customer filed for bankruptcy
protection and a second customers financial condition has deteriorated to an
extent that it is probable they will not meet all of their payment obligations
to us. Therefore, an additional reserve was recorded to provide for the
increased risk of not collecting the outstanding receivable balances from these
customers.

We expect to incur additional general and administrative expense
associated with our proposed merger with CIENA, particularly for legal and
accounting fees. Excluding merger related expenses and the additional
provision for doubtful accounts, we expect general and administrative expense
to be flat to lower in future quarters if current economic and market
conditions continue.

Amortization of deferred stock compensation

Amortization of deferred stock compensation was $4.8 million for the
quarter ended March 31, 2002, a decrease of $7.5 million from the comparable
quarter in 2001. Deferred stock compensation is being amortized on an
accelerated basis over the vesting period, generally four years, consistent
with the method described in FASB Interpretation No. 28, Accounting for Stock
Appreciation Rights and Other Variable Stock Options or Award Plans.
Accordingly, we expect the amortization of deferred stock compensation to
continue to decline in future quarters. From inception through March 31, 2002,
we have amortized a total of $113.0 million of deferred stock compensation. As
of March 31, 2002, we have a deferred stock compensation balance of $12.8
million to be amortized over future periods through 2004.

Amortization of goodwill and intangibles

In accordance with SFAS No. 142, goodwill is no longer amortized
subsequent to December 31, 2001. We will evaluate the carrying value of the
goodwill on an annual basis for impairment. To the extent required under the
provisions of SFAS No. 142, and if the carrying value of goodwill exceeds the
fair value, we will adjust the carrying value to fair value and record the
impairment in the period. Amortization of intangibles was $1.5 million for the
quarter ended March 31, 2002, compared with amortization of goodwill and
intangibles of $1.3 million for the quarter ended March 31, 2001.

As of March 31, 2002, we had goodwill of $13.4 million and related
accumulated amortization of $2.5 million, leaving an unamortized goodwill
balance of $10.9 million. At March 31, 2002, we had one remaining payment
related to the acquisition of assets and technology from Finisar Corporation.
This payment was contingent upon the completion of the final mutually agreed
deliverable. In April 2002, upon the completion of the final mutually agreed
deliverable, we made a final payment of $6.0 million. This payment was
capitalized as additional goodwill in April 2002.

In-process research and development

In association with the purchase of certain technology from Finisar, we
recorded $8.2 million of in-process research and development in the quarter
ended March 31, 2001. The amount allocated to purchased in-process research and
development was

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determined through established valuation techniques in the high-technology
communications industry, and was expensed upon acquisition because
technological feasibility had not been established and no future alternative
uses existed.

Interest and other income (expense), net

Interest and other income (expense), net was $0.7 million for the quarter
ended March 31, 2002, a decrease of $6.9 million from the comparable quarter in
2001. Interest and other income (expense), net includes interest income earned
from cash, cash equivalents and marketable securities balances and interest
expense on our 5% subordinated convertible notes. The decrease is primarily a
result of decreased interest earned due to lower average cash balances and
lower interest rates. As of March 31, 2002, our cash is invested in money
market funds and short to intermediate term marketable securities that
currently earn an average rate of return of approximately 2.9%. Further
interest rate reductions by the Federal Reserve would negatively impact the
level of interest income earned on these investments.

Liquidity and Capital Resources

At March 31, 2002, our principal source of liquidity was our cash, cash
equivalents and short-term investments of $380.1 million. At March 31, 2002, we
also had $286.7 million of investments in marketable securities that have been
classified as long-term investments on our balance sheet based on scheduled
maturities of greater than 12 months from the balance sheet date. At December
31, 2001, we had cash, cash equivalents and short-term investments of $365.0
million and investments in marketable securities classified as long-term on our
balance sheet of $313.8 million.

We used $8.1 million of cash in operating activities in the quarter ended
March 31, 2002, a decrease of $20.8 million from the $29.0 million used in the
comparable quarter in 2001. The decrease resulted from a net loss of $42.2
million, an increase in prepaid expenses and other assets of $3.7 million and
decrease in accounts payable and accrued liabilities of $2.3 million and a
decrease in deferred revenue of $0.7 million, offset by total non-cash charges
of $20.1 million, a decrease in accounts receivable of $17.5 million and a
decrease in inventory of $3.1 million. Non-cash charges for the quarter ended
March 31, 2001 consisted of $12.5 million of depreciation and amortization,
$4.8 million of amortization of deferred stock compensation, $2.4 million
related to a provision for doubtful accounts and $0.5 million related to
amortization of debt financing costs. Cash used in operations for the quarter
ended March 31, 2001 consisted of a net loss of $31.1 million, an increase of
$23.8 million in accounts receivable, an increase in inventory of $5.5 million
and an increase in prepaid expenses and other assets of $6.7 million, offset
primarily by non-cash charges of $6.0 million for depreciation and
amortization, $12.3 million related to amortization of deferred stock
compensation and $8.2 million related to in-process research and development,
and an increase in accounts payable and accrued liabilities of $11.1 million.

As part of our cash management strategy, we invested some of our cash and
cash equivalents in short to long-term marketable securities. Net cash
provided by investing activities of $6.9 million in the quarter ended March 31,
2002, consisted primarily of $46.9 million of proceeds from sales and
maturities of marketable securities, partially offset by $35.3 million of
purchases of marketable securities and $4.7 million of purchases of property
and equipment. Net cash used in investing activities of $31.8 million for the
quarter ended March 31, 2001 consisted of $26.8 million of purchases of
property and equipment and $5.0 million related to the purchase of Finisar
technology.

We generated $1.8 million in cash from financing activities for the
quarter ended March 31, 2002, consisting of proceeds of $1.9 million from
exercises of stock options and purchases under employee stock purchase plans,
net of $0.1 million used for payments under capital lease obligations. We
generated $7.6 million in cash from financing activities for the quarter ended
March 31, 2001, consisting primarily of proceeds of $5.7 million from exercises
of stock options and purchases under employee stock purchase plans and $1.9
million of proceeds from repayments on stockholder loans.

In February 2001, we acquired technology and other assets associated with
Finisar Corporations customer premises equipment business. At closing, we paid
$5.0 million in cash and issued 488,624 shares of common stock to Finisar.
During 2001, we made additional cash payments related to this acquisition
totaling $12.8 million. These payments related to the delivery and acceptance of
mutually agreed deliverables in accordance with the terms of the acquisition
agreement. These payments also included $0.3 million related to the purchase of
fixed assets and $0.2 million of acquisition costs incurred. At March 31, 2002,
we had one remaining cash payment of up to $6.0 million, contingent upon the
timely delivery and acceptance of the final mutually agreed upon deliverable.
This final payment totaled $6.0 million and was made in April 2002.

We have an equipment financing facility that allows us to draw funds of up
to $1.5 million to finance the purchase of equipment at an annual interest
charge of 7.51%. This facility does not require us to maintain any financial
covenants and will expire in December 2002. As of March 31, 2002, there was
approximately $0.2 million payable under this facility.

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In October 2000, we sold $300.0 million of 5% convertible subordinated
notes due October 15, 2005. We make interest payments on these notes on a
semi-annual basis in April and October. In April 2002, we paid our semi-annual
interest payment of $7.5 million on these notes. These notes do not require us
to maintain any financial covenants.

As part of our restructuring program, which commenced in the third quarter
of 2001, we implemented a worldwide reduction in workforce that decreased our
worldwide head count by approximately 16%, consolidated facilities and reduced
manufacturing levels and capital expenditures. We expect that these plans will
allow us to preserve cash flows in certain business operations while continuing
to devote capital resources to continue our research and development
activities, to develop our sales, marketing and customer service and support
organizations, to support our information systems requirements and for other
general corporate activities. The level of our capital requirements depend on
numerous factors, including:



| |  |  | the resources we devote to developing, manufacturing, marketing, selling and supporting our products;
| | - |  | -----------------------------------------------------------------------------------------------------
|
| |  |  | market acceptance of our products and the timing and extent of sales of our products; and            
|
| |  |  | the timing and extent of capital expenditures required to establish our international operations.    

We fund our operations partially through cash generated from operations
and partially through use of proceeds from our public offerings of common
stock. Our cash generated from operations are dependent upon several factors,
including the timing and volume of customer orders and timing of cash
collections from customers. We believe that our current cash balances will be
sufficient to fund our operations for at least the next 12 months.

The following is a summary of our future minimum payments under
contractual obligations as of March 31, 2002 (in thousands):

|                                             |       |   |                        |        |      |   |        |        |      |   |        |        |            |   |         |         |  |   |        |        |  |   |        |        |  |   |         |         | 
|-------------------------------------------- | ----- | - | ---------------------- | ------ | ---- | - | ------ | ------ | ---- | - | ------ | ------ | ---------- | - | ------- | ------- |  | - | ------ | ------ |  | - | ------ | ------ |  | - | ------- | ------- | 
|                                             |       |   | Payments due by period
|                                             |       |   |                       
|                                             |       |   | 2002*                  |        | 2003 |   | 2004   |        | 2005 |   | 2006   |        | Thereafter |   | Total  
|                                             |       |   |                        |        |      |   |        |        |      |   |        |        |            |   |        
|Convertible subordinated notes(1)            |       | $ | 15,000                 |        |      | $ | 15,000 |        |      | $ | 15,000 |        |            | $ | 311,875 |         |  | $ |       |        |  | $ |       |        |  | $ | 356,875 |        
|Capital lease obligations                    |       |   | 115                    |        |      |   | 51     |        |      |   |       |        |            |   |        |         |  |   |       |        |  |   |       |        |  |   | 166     |        
|Purchase commitments(2)                      |       |   | 4,191                  |        |      |   |       |        |      |   |       |        |            |   |        |         |  |   |       |        |  |   |       |        |  |   | 4,191   |        
|Operating leases                             |       |   | 8,285                  |        |      |   | 12,401 |        |      |   | 14,044 |        |            |   | 14,597  |         |  |   | 14,437 |        |  |   | 61,777 |        |  |   | 125,541 |        
|Contingent payment related to acquisition(3) |       |   | 6,000                  |        |      |   |       |        |      |   |       |        |            |   |        |         |  |   |       |        |  |   |        |        |  |   | 6,000   |        
|                                             |       |   |                        |        |      |   |        |        |      |   |        |        |            |   |         |         |  |   |        |        |  |   |        |        |  |   |         |        
|                                             | Total |   | $                      | 33,591 |      |   | $      | 27,452 |      |   | $      | 29,044 |            |   | $       | 326,472 |  |   | $      | 14,437 |  |   | $      | 61,777 |  |   | $       | 492,773 | 
|                                             |       |   |                        |        |      |   |        |        |      |   |        |        |            |   |         |         |  |   |        |        |  |   |        |        |  |   |         |        



---

|*   |  | From April 1, 2002 through December 31, 2002                                                                                                                                                                                                                                                      
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(1) |  | The terms of our $300.0 million convertible subordinated notes include
interest at 5%, payable on a semi-annual basis on April 15 and October 15
of each year. The note is due on October 15, 2005, at which time we would
be required to repay the principal if the notes are not converted.     
|   
|   
|   
|   
|(2) |  | Purchase commitments relate to amounts we are obligated to pay to our
contract manufacturers and component suppliers for inventory.                                                                                                                                                               
|   
|   
|   
|   
|(3) |  | As of March 31, 2002, we had one remaining payment based on completion
and acceptance of a deliverable specified in the acquisition agreement
related to the purchase of Finisar Corporations customer premises
equipment business. This payment totaled $6.0 million and was paid in
April 2002.

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Factors That May Affect Future Results

We have a history of losses, expect to continue to incur additional losses, and may never achieve profitability.

Through March 31, 2002, we incurred cumulative losses of $422.9 million,
and we expect to continue to incur losses in the future. If we do not become
profitable, the value of our stock will decrease. We have large fixed expenses
associated with sales and marketing, research and development, manufacturing,
and general and administrative activities. In February 2000, we began to ship
our first product, and our revenue to date has been limited. In order for us to
become profitable, we will need to generate and sustain higher revenue while
maintaining reasonable cost and expense levels. A delay in generating or
recognizing revenue could cause significant variations in our operating results
from quarter to quarter and annually and could result in substantial operating
losses.

Our limited operating history, together with current economic uncertainty,
makes forecasting our future revenue and operating results difficult, which may
adversely affect our stock price and our ability to manage our business.

We commenced business as an independent company in December 1997. We
announced general availability and commenced sales of our first products in
2000. Consequently, we have a limited history upon which we can rely in
planning and making the critical decisions that will affect our future
operating results. In addition, current economic uncertainty adds to the
difficulty of making decisions in the immediate future regarding resource
allocations for research and development and marketing and sales over the next
several quarters. If our predictions about the best use of our resources turn
out to be inaccurate, we may not make the best use of our resources and we may
forego better opportunities.

Since our quarterly revenue and operating results are difficult to predict
and may fluctuate significantly from quarter to quarter, it is likely that in
some future quarters, our operating results may be below the expectations of
market analysts and investors. This could cause the trading price of our common
stock to decline.

Current unfavorable economic and market conditions could cause our existing and
potential customers to delay or forgo purchases of our products.

As a result of current unfavorable economic and market conditions, many
service providers, including our existing and potential customers, have reduced
their capital spending on communications equipment, including optical
networking equipment. If these economic and market conditions persist for an
extended period or worsen, our customers and potential customers may decide to
delay or to forgo the purchase of our products. These decisions could harm our
revenue, results of operations and financial condition.

If the proposed merger with CIENA is not completed, our business and stock
price may be adversely affected.

On February 17, 2002, we entered into an Agreement and Plan of Merger with
CIENA Corporation. The merger is subject to a number of contingencies,
including approval by a majority vote of the stockholders of both companies,
receipt of regulatory approvals and other customary closing conditions. In
addition, two class action lawsuits have been filed against ONI Systems and our
directors that seek injunctions to prevent the consummation of the proposed
merger. See Part II Item 1  Legal Proceedings. Therefore, there is a risk
that the merger will not be completed or that it will not be completed in the
expected time period. If the merger is not completed or the completion is
substantially delayed, we could be subject to a number of risks that may
adversely affect our business and stock price, including:



| |  |  | we would not realize the benefits, including a potentially enhanced
financial and competitive position, that we expect from being part of a
combined company;                         
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the diversion of management attention and the unavoidable disruption
to our relationships with customers and vendors may detract from our
ability to grow revenues and minimize costs;
|
| |  |  | we could lose important personnel as a result of the departure of
employees who decide to pursue other opportunities in light of the
proposed merger;                                 
|
| |  |  | we have and will continue to incur significant expenses related to
the merger prior to its closing that may not be recovered;                                                         
|
| |  |  | depending on the circumstances, we may be obligated to pay CIENA a $36.7 million termination fee; and                                                                                 

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| |  |  | we may be unable to respond effectively to competitive pressures, industry developments and future opportunities.
| | - |  | -----------------------------------------------------------------------------------------------------------------

In connection with the proposed merger, CIENA has filed a joint proxy
statement/prospectus with the SEC. When the joint proxy statement/prospectus
has been declared effective by the SEC, it will be mailed to all holders of ONI
Systems common stock and will contain important information about ONI Systems,
CIENA, and the proposed merger, risks relating to the merger and the combined
company and related matters. ONI Systems urges all of its stockholders to read
the definitive joint proxy statement/prospectus when it becomes available.

We may not be able to achieve the benefits we anticipate from the merger with
CIENA, which could harm the business of the combined company.

If the merger closes, it may not be successful because we may not achieve
the benefits we envision from the merger. If the anticipated benefits are not
realized, the business of the combined company could suffer, which could cause
the value of the CIENA stock to be received by our stockholders to decline in
value after the closing of the merger. Among the risks associated with the
success of the merger, there are:



| |  |  | the risk that the current significant industry wide downturn will
continue to depress demand for CIENAs and ONI Systems products;                
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the risk that CIENA and ONI Systems will not be able to integrate
their respective products, technology and geographically dispersed
organizations;
|
| |  |  | the risk that the merger could adversely affect CIENAs or ONI
Systems relationships with current and potential customers; and                    
|
| |  |  | the possibility of management and employee disruption and departures
associated with the merger and integrating the operations of the
companies.   

The value of consideration to be received by ONI Systems stockholders will not
be determined until the closing of the proposed merger.

Since the exchange ratio is fixed and will not be adjusted for changes in
the market prices of either CIENA common stock or ONI Systems common stock, the
per share value of the consideration to be received by ONI Systems stockholders
might be less than the price per share implied by the exchange ratio
immediately prior to the announcement of the merger or at any other time prior
to the closing of the transaction. As a result, our stockholders will not know
the value of consideration at the time of our special stockholders meeting when
our stockholders will have the opportunity to vote on the proposed merger.

The uncertainty created by the proposed merger could have an adverse effect on
our revenue and results of operations.

Prior to the closing of the proposed merger or the termination of the
Agreement and Plan of Merger, the proposed merger creates uncertainty about ONI
Systems future. As a result of this uncertainty, customers may decide to
delay, defer, or cancel purchases of our products pending resolution of the
proposed merger. If these decisions represent a significant portion of our
anticipated revenue, our results of operations and quarterly revenues could be
substantially below the expectations of market analysts. This could cause a
reduction in the price of our common stock.

We have a limited number of currently available products and, if they are not
commercially successful, our revenue will not grow and we may not achieve
profitability.

If our customers and potential customers do not adopt, purchase and
successfully deploy our products in large numbers, our revenue may not grow and
our business, financial condition and results of operations will be seriously
harmed. Since the market for our products is relatively new, future demand for
our products is uncertain and will depend on the speed of adoption of optical
networking, in general, and optical equipment in metro networks, in particular.
Communication service providers may not choose to purchase and deploy our
equipment. Even if service providers do deploy our products in their networks,
they may not operate as expected, which could delay or prevent their adoption.

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Our new products and product enhancements may not achieve widespread market
acceptance.

Any failure of our future products to achieve market acceptance could harm
our business and financial results. The market in which we compete is
characterized by more rapid technological change than most, because it is newly
emerging. As a result, we expect there will be frequent new product
introductions, changes in customer requirements and evolving industry
standards. Therefore, we are currently developing new products and features for
existing products and have devoted and expect to continue to devote significant
engineering and financial resources to the development and marketing of these
new products and features. Unexpected technical challenges could prevent us
from successfully developing new products and features in a timely manner or at
all. In addition, new products and features could be more costly to develop and
test than we anticipate. Even if we are able to develop and introduce new
products and features, they may not achieve market acceptance if they do not
offer performance desired by customers or if competitors develop products that
customers prefer.

We expect that substantially all of our revenue will be generated from a small
number of customers, and our revenue will not grow if we do not sell products
to them in large numbers and if we do not add customers.

We expect that substantially all of our revenue will depend on sales of
our products to a small number of customers and that our revenue will only grow
if these customers purchase substantial quantities of our products. As of March
31, 2002, we had 33 customers. Most of these customers are not contractually
committed to purchase any minimum quantities of our products. If these
customers or future customers do not purchase substantial quantities of our
products for any reason, our ability to succeed would be harmed. The decision
to purchase substantial quantities of our products will depend, in part, on our
customers and potential customers desire and ability to introduce or expand
commercial services. We cannot be sure that any customer will introduce or
expand commercial services utilizing our products on a timely basis, if at all.
Any delay in introducing, or failure to introduce, these services would
seriously harm our revenue, results of operations and financial condition.

In addition, if we fail to attract new customers, our growth will be
limited. Specifically, we believe that our long-term success depends
significantly on decisions by the regional bell operating companies in the
United States and the postal telephone and telegraph operators in Europe to
purchase substantial quantities of our products.

Our success depends on the success of the businesses of our customers and
potential customers, which we have no ability to foresee or control.

If our customers and potential customers are not successful in building
their communications systems, promoting their products, including new
revenue-generating data services, receiving requisite approvals and
accomplishing the many other requirements for the success of their businesses,
our growth will be limited. Many factors in addition to the effectiveness of
our products influence the ultimate success of our customers, and we have no
control over these factors. Many of our customers and potential customers
require substantial capital for the expansion of their networks. The inability
of customers or potential customers to obtain sufficient financing on
attractive terms, or any downturn in their business, could impair our ability
to make future sales.

Specifically, many of our customers and potential customers are
competitive local exchange carriers or other emerging service providers which
are attempting to build new next generation networks. Building these networks
requires substantial capital and, recently, access to capital for these service
providers has been significantly restricted. As a result, some emerging service
providers are scaling back their plans to expand their networks, filing for
bankruptcy to reorganize their businesses or going out of business. For
example, four of our customers have gone out of business or filed for
bankruptcy, and we believe that there is a risk that additional customers and
potential customers may go out of business or file for bankruptcy in 2002. If
any of our significant customers go out of business or file for bankruptcy,
they may delay purchases of or no longer purchase our equipment, which could
harm our revenue, results of operations and financial condition. In addition, a
bankruptcy court may allow for the resale of ONI Systems equipment by our
customers and, as a result, our existing or potential customers may purchase
ONI Systems equipment from our bankrupt customers rather than from us. Resale
of substantial amounts of equipment in this manner could harm our revenue,
results of operations and financial condition.

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We face intense competition that could prevent us from growing and becoming
profitable.

The market for communications equipment is rapidly evolving and is marked
by intense competition and technical innovations. We expect the pace of change
to accelerate in the future. We also expect many new competitors to emerge as
the market for optical networking equipment expands and evolves in response to
technical innovations and increasing demand for new broadband and
wavelength-based services. We currently compete with both public and private
companies providing solutions for network and bandwidth management in the
metropolitan and regional markets. Many of these companies have existing
relationships with communication service providers, making it more difficult
for us to sell our products to these potential customers.

Some of our current and potential competitors are large public companies
that have longer operating histories, significantly greater financial,
technical and marketing resources, wider customer relationships and a broader
product line than we do. Consequently, these competitors are able to devote
greater resources to the development, promotion, sale and support of their
products. These large public companies are better positioned than we are to
acquire companies and new technologies that may displace our products or make
them obsolete. Any of these acquisitions could give the acquiring competitor a
strategic advantage. In addition, a number of start-up companies are rapidly
developing competing technologies in an attempt to market products to
communication service providers.

We expect the average selling prices of our products to decline, which may
reduce gross margins and revenue.

Our industry has experienced rapid erosion of average product selling
prices. We anticipate that the average selling prices of our products will
decline in response to competitive pressures, increased sales discounts, new
product introductions by our competitors or other factors. If we are unable to
achieve sufficient cost reductions and increases in sales volumes, this decline
in average selling prices will reduce our gross margins and revenue.

We face risks associated with our international operations that could limit our
sales and add to our cost of operations.

We market and sell our products in the United States and internationally.
We intend to expand our international operations and to enter new international
markets. This expansion will require significant management attention and
financial resources. We may not be able to maintain or increase international
market demand for our products.

We have limited experience in marketing and distributing our products
internationally. International operations are subject to inherent risks,
including:



| |  |  | lower margin sales, especially in Asia, resulting from customers
making purchasing decisions based primarily on price rather than
functionality;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | longer accounts receivable payment cycles and increased efforts related to collecting accounts receivable;                                      
|
| |  |  | difficulties and costs of staffing and managing foreign operations; and                                                                         
|
| |  |  | certification requirements with which we may be unfamiliar.                                                                                     

We depend on sole or limited source suppliers for key components of our
products, and if we are unable to buy these components on a timely basis, we
will not be able to deliver products to our customers.

If we are unable to buy components on a timely basis, we will not be able
to deliver our products to customers, which would harm our sales and revenue.
We currently purchase key components, including optical filters, amplifiers,
transmitters, receivers and switches and electronic microprocessors, from
limited sources. In addition, we rely on a sole supplier for some optical
components. Optical components are complex, and we may not be able to develop
multiple or alternate sources of supply in a timely manner, which could hurt
our ability to deliver our products to customers. Sole or limited source
suppliers may be vulnerable to pressure from large purchasers of their
products, who may be competitors of ours, not to sell their products to us.

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We rely on contract manufacturers to produce our products, and our business
would be harmed if they were to stop meeting our manufacturing requirements.

We rely on contract manufacturers to complete most of the manufacturing of
optical assemblies for our products. If for any reason these manufacturers were
to stop satisfying our needs without providing us with sufficient warning to
procure an alternate source, our ability to sell our products would be harmed.

The process of qualifying a new contract manufacturer for complex products
such as our optical assemblies is lengthy and would consume a substantial
amount of the time of our technical personnel and management. If we sought to
change manufacturers in a short period of time, our business would be
disrupted. In addition, we may be unsuccessful in identifying a new
manufacturer capable of and willing to meet our needs on terms that we would
find acceptable.

If we fail to predict our manufacturing and component requirements accurately,
we could incur additional costs or experience manufacturing delays.

We provide forecasts of our demand to our contract manufacturers and
component vendors up to six months prior to scheduled delivery of products to
our customers. If we overestimate our requirements, we may have excess
inventory, which could increase our costs, result in cancellation penalties and
harm our relationships with our contract manufacturers and component vendors
due to reduced future orders. If we underestimate our requirements, we may have
an inadequate inventory of components and optical assemblies. Inadequate
inventory could interrupt manufacturing of our products and result in delays in
shipments. In addition, lead times for materials and components that we order
are long and depend on factors such as the procedures of, or contract terms
with, a specific supplier and demand for each component at a given time. In the
case of some optical components in short supply, component suppliers have
imposed strict allocations that limit the number of these components they will
supply to a given customer in a specified time period. These suppliers may
choose to increase allocations to larger, more established companies, which
could reduce our allocations and harm our ability to manufacture our products.

Due to the long sales cycle for our products, the timing of revenue is
difficult to predict and may cause our operating results to fluctuate
unexpectedly.

The sales cycle for our products is lengthy; it may extend for six months
or more. The length of our sales cycle may cause our revenue and operating
results to vary unexpectedly from quarter to quarter. A customers decision to
purchase our products involves a significant commitment of its resources and a
lengthy evaluation and product qualification process. Consequently, we may
incur substantial expenses and devote senior management attention to potential
relationships that never materialize, in which event our investments will
largely be lost and we may miss other opportunities. In addition, our lengthy
sales cycle makes it difficult to predict the quarter in which we may recognize
revenue from any sale.

If we cannot rapidly expand our customer service and support organization to
support large deployments by incumbent local exchange carriers, we may not be
able to sell our products to these important customers.

In the event that we receive large orders for our products from incumbent
local exchange carriers in the United States and Europe, which we believe is
crucial for our long term success, we will have to quickly increase our
customer service and support organization. Our products are complex and require
highly-trained customer service and support personnel. Hiring and training
customer service and support personnel can be difficult in our industry due to
the limited number of people available with the necessary technical skills. If
we are unable to expand our customer service and support organization to meet
the needs of incumbent local exchange carriers, we may not be able to sell our
products to these customers.

If we lose key personnel, we may be unable to manage our business.

Our future success depends upon the continued services of our executive
officers and other key engineering, sales, marketing and support personnel,
including Hugh C. Martin, our president, chief executive officer and chairman
of our board of directors. None of our officers or key employees is bound by an
employment agreement for any specific term, and we do not have key person
life insurance policies covering any of our employees.

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If our products do not operate properly with other equipment in our customers
networks, we may suffer product installations delays, order cancellations or
increased costs under warranty obligations, and our reputation could be harmed.

Our products are designed to interoperate with our customers existing
networks, each of which has its own specifications, is based on various
industry standards and contains multiple generations of products from many
vendors. If interoperability problems occur, they may cause us to incur
warranty, support and repair costs, divert the attention of our engineering
personnel from our product development efforts and suffer customer relations
problems whether or not these problems are due to our products.

In order to sell our products to regional bell operating companies, which
we believe is crucial for our long term success, Telcordia Technologies, Inc.
must certify that each of our products have successfully completed the OSMINE
process. This process ensures interoperability of network solutions and
operations support systems for these carriers. If our products are not
certified as having successfully completed the OSMINE process or if
certification is delayed, we will not be able to sell our products to these
carriers.

Our products may have defects that we find only after full deployment in
complex networks, which could seriously harm our business.

Our products are technically advanced and highly complex, and it is common
for complex hardware and software to have defects, which are difficult to
detect. Our current and any future products or releases can only be fully
tested when deployed for an extended period of time as part of networks that
include equipment from other vendors. Consequently, our customers may discover
defects in our hardware or software after deployment. This could lead to
dissatisfied customers or diversion of resources to repair these defects.

Our products may become obsolete if we do not quickly meet industry standards
that may emerge.

Our success depends in part on both the adoption of industry standards for
new technologies in our market and our products compliance with industry
standards. To date, no industry standard for our products has been adopted. The
absence of an industry standard may prevent market acceptance of our products
if potential customers delay purchases of new equipment until standards are
adopted. In addition, if our products cannot support an industry standard,
potential customers may not choose our products. As a result, we may incur
significant losses due to lack of customer demand, excess inventory and
diversion of our engineers from product development efforts.

If we are unable to protect and enforce our intellectual property rights, we
may be unable to compete effectively.

We regard substantial elements of our products and services as proprietary
and attempt to protect them by relying on patent, trademark, service mark,
copyright and trade secret laws. We also rely on confidentiality procedures and
contractual provisions with our employees, consultants and corporate partners.
Any steps we take to protect our intellectual property may be inadequate, time
consuming and expensive. Furthermore, despite our efforts, we may be unable to
prevent third parties from infringing upon or misappropriating our intellectual
property, which could harm our business.

Necessary licenses for third-party technology may not be available to us or may
be very expensive.

In the future, we may be required to license from third parties technology
that is used in our products or is required to develop new products or product
enhancements. While we have been able to license third-party technology to
date, in the future third-party licenses may not be available to us on
commercially reasonable terms or at all. Third parties who hold exclusive
rights to technology that we seek to license may include our competitors. If we
are unable to obtain any necessary third-party licenses, we would be required
to redesign our product or obtain substitute technology, which may perform less
well, be of lower quality or be more costly.

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We are involved in an intellectual property dispute and in the future we may
become involved in similar disputes, which could subject us to significant
liability, divert the time and attention of our management and prevent us from
selling our products.

In March 2000, Nortel Networks filed suit against us in the United States
District Court for the Northern District of California. The suit alleges that
our products infringe five patents held by Nortel Networks, and sets forth
allegations of misappropriation of trade secrets, unlawful business practices
and common law unfair competition. In March 2002, Nortel Networks agreed to
dismiss all claims related to four of the five patents. We continue to
investigate the remaining allegations. Nortel Networks is seeking preliminary
and permanent injunctions and damages against us in connection with these
remaining claims. If Nortel Networks is able to obtain an injunction preventing
us from selling our products, we would suffer a substantial reduction in our
revenues and incur losses over an extended period of time. We have incurred and
expect to incur substantial legal and other expenses as well as diversion of
management and technical time and attention in connection with this litigation.
The expenses and diversion of resources associated with this litigation could
seriously harm our business and financial condition and could affect our
ability to raise capital in the future. In the event of an adverse ruling, we
may be unable to sell our products or be required to pay substantial damages to
Nortel Networks, and if this litigation is resolved by settlement, we might
need to make substantial payments to Nortel Networks.

In the future, we may be a party to litigation to protect our intellectual
property or as a result of other alleged infringements of intellectual
property. These claims and any resulting lawsuit, if successful, could subject
us to significant liability for damages and invalidate our proprietary rights.
These lawsuits, regardless of their success, would be time- consuming and
expensive to resolve and would divert management time and attention. Any
potential intellectual property litigation also could force us to do one or
more of the following:



| |  |  | stop selling, incorporating or using our products that use the
challenged intellectual property;                                                                                          
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on reasonable terms, or at all; or
|
| |  |  | redesign those products that use the challenged technology.                                                                                                                               

If we are forced to take any of these actions, our business may be harmed.
Although we carry general liability insurance, our insurance may not cover
potential claims of this type or may not be adequate to indemnify us for all
liability that may be imposed.

We may not be able to obtain additional financing to satisfy our future capital
needs.

In the future, we may need to raise additional capital in order to develop
new services or products, or to acquire complementary services, businesses or
technologies. Product development and acquisition activities are particularly
capital-intensive in our industry. Additional financing may not be available on
terms favorable to us, or at all. If we issue additional equity securities,
stockholders may experience dilution or the new equity securities may have
rights, preferences or privileges senior to those of the then-existing holders
of common stock.

Acquisitions could disrupt our business and harm our financial condition.

We may acquire or invest in complementary businesses, products and
technologies. We may not successfully integrate any businesses, products,
technologies or personnel that we might acquire and, as a result, our operating
results could suffer. Any acquisitions or investments could lead to:



| |  |  | stock issuances that would reduce our current stockholders
percentage ownership;                                                
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | debt that will give rise to interest charges and may impose material
restrictions on the manner in which we operate our business;
|
| |  |  | responsibility for unanticipated liabilities;                                                                                    
|
| |  |  | amortization expenses related to intangible assets;                                                                              
|
| |  |  | large and immediate write-offs;                                                                                                  

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| |  |  | problems combining the purchased operations, technologies or products with ours;     
| | - |  | -------------------------------------------------------------------------------------
|
| |  |  | unanticipated costs;                                                                 
|
| |  |  | diversion of managements attention from our core business;                          
|
| |  |  | adverse effects on existing relationships with suppliers and customers;              
|
| |  |  | risks associated with entering markets in which we have limited prior experience; and
|
| |  |  | potential loss of key employees, particularly those of the acquired organizations.   

Our ability to conduct business could be impacted by a variety of factors such
as earthquakes, fires, terrorist activities and other unpredictable events.

Unpredictable events that are beyond our control could impact our ability
to conduct our business operations. For example, the aftermath of the September
11, 2001 terrorist attacks may affect our business opportunities and our
ability to conduct our business. A decrease in business and consumer confidence
in the economy and the stability of financial markets, resulting directly or
indirectly from these attacks or domestic and foreign responses to these
attacks, could lead to delays or reductions in capital expenditures by our
customers and potential customers. In addition, further disruptions of the air
transport system in the United States and abroad may negatively impact our
ability to deliver products to customers, visit potential customers, provide
support and service to our existing customers and obtain components in a timely
fashion.

Insiders may be able to delay or prevent a change in corporate control, which
could prevent you from realizing a premium over the market price of our common
stock.

As of March 31, 2002, our executive officers, directors and entities
affiliated with them beneficially owned approximately 12.0% of our outstanding
common stock, including shares of common stock that are subject to
options exercisable within 60 days of March 31, 2002. These stockholders, if acting together, may be able to influence
matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combination
transactions.

This ability to exercise influence over all matters requiring stockholder
approval could prevent or significantly delay another company or person from
acquiring or merging with us. As a result, offers to acquire ONI Systems that
represent a premium over the available market price of our common stock may be
withdrawn or otherwise fail to be realized.

In connection with our merger agreement with CIENA, our executive officers
and directors entered into voting agreements under which they agreed to vote
their shares of our common stock, constituting approximately 11.5% of our
outstanding common stock as of March 31, 2002, in favor of the merger with
CIENA and against potential alternative transactions.

The continuing control of ONI Systems by insiders could permit insiders to
engage in transactions to the detriment of stockholder value.

We have engaged in transactions with related parties, including loans to
executive officers. The ability of executive officers, directors and their
affiliated entities to exercise influence over all matters requiring
stockholder approval could enable insiders to approve transactions involving
each other that might otherwise not be approved and which could reduce the
market price of our common stock.

We have experienced and expect to continue to experience volatility in our
stock price which makes an investment in our stock more risky and litigation
more likely.

The market price of our common stock has fluctuated significantly in the
past and may fluctuate significantly in the future in response to a number of
factors, some of which are beyond our control, including:



| |  |  | changes in financial estimates by securities analysts;                                       
| | - |  | ---------------------------------------------------------------------------------------------
|
| |  |  | changes in market valuations of communications and Internet infrastructure-related companies;

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| |  |  | announcements, by us or our competitors, of new products or of
significant acquisitions, strategic partnerships or joint ventures;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | volume fluctuations, which are particularly common among highly
volatile securities of Internet-related companies; and            
|
| |  |  | volatility of stock markets, particularly the Nasdaq National Market
on which our common stock is listed.                         

In addition, as a consequence of the announcement of our proposed merger
with CIENA, we anticipate that changes in the price of our common stock will be
substantially influenced by changes in the price of CIENAs common stock.

Following periods of volatility in the market price of a companys
securities, securities class action litigation has often been instituted
against that company. We are currently named in securities class action and
derivative lawsuits. The complaints in these lawsuits allege that the some of
the underwriters who participated in our initial public offering received
undisclosed fees or benefits and entered into undisclosed arrangements to
inflate the market price of our common stock. See Part II Item 1  Legal
Proceedings. The current lawsuits and any future litigation, if instituted,
could result in substantial costs and a diversion of managements attention.

Leverage and debt service obligations may adversely affect our cash flow.

We have a substantial amount of outstanding indebtedness. There is the
possibility that we may be unable to generate cash sufficient to pay the
principal of, interest on and other amounts payable in respect of the notes
when due.

Provisions of Delaware law, our certificate of incorporation and our bylaws
could delay or prevent a takeover of us, which could prevent you from realizing
a premium over the market price of our common stock.

Provisions of Delaware law, our certificate of incorporation and bylaws
could have the effect of delaying or preventing a third party from acquiring
us, even if a change in control would be beneficial to our stockholders. These
provisions include:



| |  |  | authorizing the issuance of preferred stock without stockholder approval;      
| | - |  | -------------------------------------------------------------------------------
|
| |  |  | providing for a classified board of directors with staggered, three-year terms;
|
| |  |  | prohibiting cumulative voting in the election of directors;                    
|
| |  |  | prohibiting stockholders from calling stockholders meetings; and               
|
| |  |  | prohibiting stockholder actions by written consent.                            

These provisions and other provisions of Delaware law could make it more
difficult for a third party to acquire us, even if doing so would benefit our
stockholders. As a result, offers to acquire ONI Systems that represent a
premium over the available market price of our common stock may be withdrawn or
otherwise fail to be realized.




Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest rate sensitivity

We do not currently use derivative financial instruments for speculative
trading or hedging purposes. We maintain our cash equivalents in money market
funds.

Short and long-term investments

As of March 31, 2002, we hold our cash, cash equivalents and short and
long-term investments with three major financial institutions and our exposure
to market risk for changes in interest rates relate primarily to our investment
portfolio. We do not use derivative financial instruments in our investment
portfolio. The primary objective of our investment activities is to preserve
principal while maximizing yields without significantly increasing risk. This
is accomplished by investing in widely diversified investments, consisting only
of investment grade securities. We do hold investments in both fixed rate and
floating rate interest earning instruments, which carry a degree of interest
rate risk. Fixed rate securities may have their fair market value adversely
impacted due to a rise in interest rates, while floating rate securities may
produce less income than expected if interest rates fall.

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Other investments

Other assets include equity investments in two privately-held companies.
These investments were accounted for using the cost method. We periodically
review our equity investments for potential impairment. During the year ended
December 31, 2001, we determined that one of these investments had incurred a
decline in value that was other-than-temporary, and we recorded an impairment
charge of $4.0 million to reduce this equity investment to an estimated
recoverable value of approximately $1.0 million.

Subordinated convertible notes

Our subordinated convertible notes were issued at a fixed interest rate
and with fixed conversion rates and therefore do not expose us to the risk of
earnings or cash flow loss due to changes in market interest rates.

Exchange rate sensitivity

Currently, the majority of our sales and expenses are denominated in
United States dollars. The expenses related to international subsidiaries whose
functional currency is the local currency have not been significant. Therefore,
we have had no material exposure to foreign currency rate fluctuation and have
not engaged in any foreign exchange hedging activities to date. We currently
have an insignificant level of transactions denominated in other than the
United States dollar. We expect to conduct a more significant number of
transactions in foreign currencies in the future, so we may engage in foreign
exchange hedging activities at that time. We develop products in the United
States and market our products in the United States, Europe and Asia Pacific.
As a result, our financial results could be affected by factors such as changes
in foreign currency exchange rates or weak economic conditions in foreign
markets. Since the majority of our sales are currently made in U.S. dollars, a
strengthening of the dollar could make our products less competitive in foreign
markets.




Part II. Other Information




Item 1. Legal Proceedings.

On March 10, 2000, Nortel Networks filed suit against us in the United
States District Court for the Northern District of California. The suit
involved allegations that our products infringe five patents held by Nortel
Networks, and sets forth allegations of misappropriation of trade secrets,
unlawful business practices and common law unfair competition. Nortel Networks
seeks preliminary and permanent injunctions and damages against us in
connection with these claims. In March 2002, Nortel Networks agreed to dismiss
all claims related to four of the five patents, and, on March 22, 2002, the
court issued an order dismissing with prejudice these four patents from the
suit. We continue to investigate and conduct discovery concerning the
remaining claims asserted by Nortel Networks. We believe that we have
meritorious defenses against Nortel Networks allegations, and we intend to
defend the Nortel Networks litigation vigorously. Based on our investigation to
date, we believe that our products do not infringe the Nortel Networks patents
and that we have not engaged in misappropriation of trade secrets, unlawful
business practices or common law unfair competition. This suit is further
described on page 13 of our Annual Report on Form 10-K for the fiscal year
ended December 31, 2001.

Beginning in August 2001, a number of substantially identical class action
complaints alleging violations of the federal securities laws were filed in the
United States District Court for the Southern District of New York. These
complaints name ONI Systems, Hugh C. Martin, our chairman, president and chief
executive officer; Chris A. Davis, our former executive vice president, chief
financial and administrative officer; and certain underwriters of our initial
public offering as defendants. The complaints have since been consolidated into
a single action, and a consolidated amended complaint was filed on April 24,
2002. The amended complaint alleges, among other things, that the underwriter
defendants violated the securities laws by failing to disclose alleged
compensation arrangements (such as undisclosed commissions or stock
stabilization practices) in the initial public offerings registration
statement and by engaging in manipulative practices to artificially inflate the
price of our common stock after the initial public offering. The amended
complaint also alleges that ONI Systems and the named officers violated the
securities laws on the basis of an alleged failure to disclose the underwriters
alleged compensation arrangements and manipulative practices. No specific
amount of damages has been claimed. Similar complaints have been filed against
more than 300 other issuers that have had initial public offerings since 1998,
and all of these actions have been included in a single coordinated proceeding.
We intend to defend these actions vigorously. However, due to the inherent
uncertainties of litigation, we cannot accurately predict the ultimate outcome
of the litigation. Any unfavorable outcome of this litigation could have a
negative impact on our business, financial condition and results of operations.

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On May 3, 2002, a shareholder derivative complaint alleging violations of
California state laws was filed in the Superior Court of the State of
California, County of Santa Clara. The complaint names Hugh Martin; the other
members of our board of directors; Terrence J. Schmid, our former chief
financial officer and vice president, finance and administration; and certain
underwriters of the our initial public offering as defendants. The complaint
alleges that the defendants breached their fiduciary duties, acted negligently
and were unjustly enriched in determining the offering price of ONI Systems
common stock in our initial public offering. No specific amount of damages has
been claimed. The complaint is encaptioned Sabrina J. Kurzman and Michael J.
Kurzman, Derivatively on Behalf of ONI Systems Corp. v. Hugh C. Martin, et al,
Case No. CV 807562. These allegations arise from the same circumstances as and
are related to the allegations raised in the securities class actions filed in
federal court which are described above. Due to the inherent uncertainties of
litigation, we cannot accurately predict the ultimate outcome of this
litigation.

On February 20, 2002, a complaint was filed on behalf of a purported class
of ONI Systems security holders in the Superior Court of the State of
California, County of San Mateo, against ONI Systems, Matthew Bross, Kevin
Compton, Jonathan Feiber, Gregory Maffei and Hugh Martin seeking an injunction
to prevent the consummation of the proposed merger with CIENA. The complaint
is encaptioned K.W. Sams, On Behalf of Himself and All Others Similarly
Situated v. ONI Systems Corporation, et al, Case No. CIV-420819. The complaint
alleges that the defendants, in connection with the approval of the proposed
merger with CIENA, breached their fiduciary duties, including duties of loyalty
and good faith, to ONI Systems stockholders by, among other things, allegedly
failing to obtain the highest value for ONI Systems stockholders, engaging in
self-dealing and unjustly enriching themselves and other insiders or affiliates
of ONI Systems.

On March 19, 2002, a substantially similar complaint which includes
similar allegations was filed on behalf of the same purported class of ONI
Systems security holders in Superior Court of the State of California, County
of Santa Clara, against the same defendants seeking similar relief. The
complaint is encaptioned Steven Myeary, On Behalf of Himself and All Others
Similarly Situated v. ONI Systems Corporation, et al, Case No. CV-806192. We
believe that both of these lawsuits are without merit and intend to defend them
vigorously.




Item 2. Changes in Securities and Use of Proceeds.



| | (a) |  | Changes in Securities
| | --- |  | ---------------------

On January 25, 2002, we issued 24,897 shares of ONI Systems common stock
to FMR Corp. upon exercise of a previously issued warrant to purchase an
aggregate of 223,000 shares of common stock at an exercise price of $0.91 per
share. Following this partial exercise, there are 186,953 shares of our common
stock remaining subject to the warrant. Our issuance of the shares upon the
exercise of this warrant was exempt from registration pursuant to Rule 506
promulgated under the Securities Act of 1933 and Section 4(2) of the Securities
Act.




Item 3. Defaults Upon Senior Securities.

None.




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

None




Item 5. Other Information.

On February 17, 2002, we entered into a definitive Agreement and Plan of
Merger with CIENA Corporation, a Delaware corporation. According to the
Agreement and Plan of Merger, effective on and as of the closing date, which
has not yet been determined, we will merge with and into CIENA, with CIENA
surviving the merger. The terms of the proposed merger are described on page 3
of our Annual Report on Form 10-K for the fiscal year ended December 31, 2001
and reports on Form 8-K filed February 19, 2002 and February 25, 2002.

In October 2001, we filed a Tender Offer Statement on Schedule TO with the
Securities and Exchange Commission. Under the terms of the exchange offer
included in this Tender Offer Statement, we offered some of our employees the
right to exchange their options for our commitment to issue new options with a
new exercise price at least six months and a day from the cancellation date.
The terms of this exchange offer are described on page 16 of our Annual Report
on Form 10-K for the fiscal year ended December 31, 2001.

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Item 6. Exhibits and Reports on Form 8-K.



| | (a) |  | Exhibits. The following exhibits are filed as part of this Form
10-Q:
| | --- |  | ---------------------------------------------------------------------

| |  |                                                                                                                 |  |  |  | 
| |  | --------------------------------------------------------------------------------------------------------------- |  |  |  | 
| |  | 10.01  First Amendment to Services Agreement, dated April 9,
2002, by and between ONI Systems and George Reyes.



| | (b) |  | Reports on Form 8-K                                                                                                                                                                                                                                                                                                                             
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | On February 8, 2002, we filed a report on Form 8-K dated
February 7, 2002, to report under Item 5 that Ken Burckhardt,
Vice President, Finance and Interim Chief Financial Officer, was
leaving ONI Systems and that George Reyes had been hired to
serve as Interim Chief Financial Officer until a permanent Chief
Financial Officer is hired.
|
| |     |  | On February 19, 2002, we filed a report on Form 8-K dated
February 18, 2002, to report under Item 5 that ONI Systems had
signed a definitive Agreement and Plan of Merger with CIENA
Corporation.                                                                                                                                               
|
| |     |  | On February 25, 2002, we filed a report on Form 8-K, under Items
5 and 7, attaching the Agreement and Plan of Merger, dated as of
February 17, 2002, by and between CIENA Corporation and ONI
Systems as an exhibit.                                                                                                                            

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SIGNATURES

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

Date: May 15, 2002

| |  |                   |  |                                                                                         
| |  | ----------------- |  | ----------------------------------------------------------------------------------------
| |  | ONI SYSTEMS CORP.
| |  | By:               |  | /s/ Hugh C. Martin                                                                      
| |  |                   |  |                                                                                         
| |  |                   |  | Hugh C. Martin
President, Chief Executive Officer
and Chairman of the Board of Directors
| |  | By:               |  | /s/ George Reyes                                                                        
| |  |                   |  |                                                                                         
| |  |                   |  | George Reyes
Interim Chief Financial Officer                                            

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EXHIBIT INDEX

10.01  First Amendment to Services Agreement, dated April 9,
2002, by and between ONI Systems and George Reyes.