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

FORM 10-K/A
(AMENDMENT NO. 1)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2001

OR

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

For the transition period from ____ to ____

Commission file number: 0-28734

ADVANCED FIBRE COMMUNICATIONS, INC.

A Delaware
Corporation I.R.S. Employer
Identification No.
68-0277743

1465 North McDowell Boulevard
Petaluma, California 94954
Telephone: (707) 794-7700

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: common stock, $0.01 par value

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

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

As of March 11, 2002, there were 82,405,362 shares of Advanced Fibre Communications, Inc. common stock outstanding, and the aggregate market price of shares held by non-affiliates was approximately $1,552,011,000. (Solely for the purpose of calculating the preceding amount, all directors and officers of the registrant are deemed to be affiliates.)

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the Definitive Proxy Statement issued in connection with the 2002 Annual Meeting of Stockholders held on May 29, 2002, are incorporated by reference in Part III of this report.

TABLE OF CONTENTS

PART I.
	Item 1. Business
	Item 2. Properties
PART II.
	Item 6. Selected Consolidated Financial Data
	Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 8. Financial Statements and Supplementary Data
PART III.
	Item 14. Controls and Procedures
PART IV.
	Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
SIGNATURES
10-K/A
Exhibit 23.1

ADVANCED FIBRE COMMUNICATIONS, INC.

Explanatory Note

This Amendment No. 1 to Form 10-K/A (Form 10-K/A) amends Items 1, 2, 6, 7 and 8 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2001, including the consolidated financial statements therein, which was originally filed on March 20, 2002 (the Original Filing). On October 17, 2002, we reported that we had made an adjustment to previously reported financial results for 2001 and the first two quarters of 2002 to correct the previously reported results due to an error in our accounting for an operating lease, and related fixed assets and leasehold improvements upon vacating a leased engineering facility. The adjustment to our 2001 results reflects a $1.7 million after-tax charge ($2.7 million on a pre-tax basis) in the fourth quarter of 2001 for the ongoing shortfall between our sublease income and operating lease obligation, as well as the write-off of related fixed assets and leasehold improvements. Additionally, our adjusted financial results include our previously announced retroactive application of the equity method of accounting for our investment in AccessLan Communications, Inc. (AccessLan), a company we acquired in May of 2002.

Giving effect to these adjustments, net income for 2001 decreased to $165.5 million, or $1.98 earnings per share, from previously reported net income of $167.8 million, or $2.01 earnings per share. Net loss for the fourth quarter of 2001 was adjusted to $7.9 million, or $0.10 loss per share, from a previously reported net loss of $5.8 million, or $0.07 loss per share.

The circumstances pertaining to this adjustment are described in greater detail under Overview in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein, and Note 2 of “Notes to Consolidated Financial Statements.”

Restatement of Financial Statements

The consolidated financial statements and financial statement schedule included in this Form 10-K/A have been restated to give effect to the adjustment discussed under Overview in Item 7 and the previously announced retroactive application of the equity method of accounting for our investment in AccessLan. Except for financial statement information and related disclosures that are specifically related to the restatement, all information contained in this report is stated as of the date of the Original Filing. This amendment does not otherwise update information in the Original Filing to reflect facts or events occurring subsequent to the date of the Original Filing.

ADVANCED FIBRE COMMUNICATIONS, INC.
ANNUAL REPORT ON FORM 10-K/A
(AMENDMENT NO. 1)
FOR THE YEAR ENDED DECEMBER 31, 2001

Table of Contents

		Page
	PART I.
Item 1.	Business	4
Item 2.	Properties	18
	PART II.
Item 6.	Selected Consolidated Financial Data	19
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 8.	Financial Statements and Supplementary Data	33
	PART III.
Item 14.	Controls and Procedures	54
	PART IV.
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	55

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PART I.

Except for the historical financial information contained herein, the following discussion and analysis contains “forward-looking statements.” In some cases, you can identify forward-looking statements by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” or the negative of these terms and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. We discuss many of these risks and uncertainties in greater detail in Part I, Item 1 of this Annual Report on Form 10-K/A under the heading “Risk Factors That Might Affect Future Operating Results and Financial Condition.” These risks and uncertainties may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. These factors are not intended to be an all-encompassing list of risks and uncertainties that may affect the operations, performance, development and results of our business. You should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions as of the date of this report. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.

The following discussion should be read in conjunction with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” financial statements and related notes beginning on page 21 of this Annual Report on Form 10-K/A.

Item 1. Business

Company Background

Advanced Fibre Communications®, Inc., or AFC®, (Nasdaq: AFCI) was incorporated in California in May 1992 and reincorporated in Delaware in September 1995. We completed an initial public offering on October 1, 1996. Our principal executive offices are located at 1465 North McDowell Boulevard, Petaluma, California, 94954 and the telephone number at that address is (707) 794-7700. We can also be reached through our Internet Web site at http://www.afc.com. Information on our Web site is not part of this report. Throughout this document, references to “we” and “our” indicate the same meaning as “AFC” and “AFC’s”, respectively. We develop, manufacture, and support a family of telecommunications access products and services that enable telecommunications companies and other service providers to connect their central office switches to end users for voice and high speed data communications. Our products include integrated multiservice access platforms, integrated access devices, optical network access concentrators, network services, network element management systems, and indoor and environmentally hardened outdoor cabinets and related service and transmission technologies for the portion of the telecommunications network between the service provider’s central office and end user businesses and homes, often referred to as the “local loop,” or “last mile.”

Our OmniMAX™ product family is a multiservice broadband solution for providing voice and data services for the telecommunications industry. We released the AccessMAX™ System 8 in 2001, offering a migration strategy for delivering packet-switched voice and broadband services. The AccessMAX System 8 allows service providers to increase service offerings from legacy time division multiplex, or TDM, services to high speed next-generation broadband services. AccessMAX System 8 also allows more efficient transmission applications such as Voice over Packet, Voice over Digital Subscriber Line, or DSL, and Video over Asymmetric Digital Subscriber Line, or ADSL, while preserving quality of service. The term “broadband” refers to all transmission speeds of T1 and higher. T1 is a digital transmission line or service capable of carrying 24 non-compressed voice calls, or 1.5 megabits per second of data transmissions. “Packet-based” refers to a way voice or data is transmitted over a line. Traditional circuit-based transmission utilizes bandwidth constantly, whether or not voice or data is being transmitted; packet-based transmission occupies bandwidth only when a packet of voice or data is sent, freeing up bandwidth for other users.

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Industry Background

The Telecommunications Act of 1996 opened the telecommunications markets to new entrants and created an environment in which service providers accelerated the offering of expanded voice, data, and video services. Growth in the Internet, electronic commerce, and telecommuting has increased pressure on service providers to supply a broader range of voice and data services over faster networks. Networks are required to transmit increasingly larger volumes of data and video to communicate information, conduct business, and deliver entertainment. Both public and private network customers are requesting the convergence of voice, Internet, data, and video traffic into integrated multimedia services transmitted over one network. These demands have prompted the development and use of broadband networks that are capable of providing the improved reliability and increased speed of transmission generally required for better data and video service over the network. Growth in broadband network applications has resulted in increased infrastructure investment by network operators in order to expand their network capacity and provide new applications and services to meet their customers’ needs.

Expanding Product Portfolio

Our product portfolio is the OmniMAX product family, which consists of products that provide remote broadband access solutions in the telecommunications network. Following are the products and solutions we currently offer:

The OmniMAX Product Family

Our OmniMAX portfolio consists of integrated multiservice access platforms, or IMAPs, integrated access devices, or IADs, optical network access concentrators, network services, network element management systems, environmentally hardened outside plant cabinets, indoor cabinets, and related service and transmission technologies. The OmniMAX product family provides narrowband, wideband, and broadband services to customers. Our OmniMAX products can be deployed quickly and cost-effectively to build domestic and international broadband packet-based networks, and to upgrade legacy access networks for delivering broadband services to subscribers, regardless of their geographic location. Our OmniMAX product family consists of AccessMAX, PremMAX™, TransMAX™, ATLAS™, and Panorama™.

AccessMAX

AccessMAX is our product family of IMAPs and environmentally hardened cabinets and technology for last mile voice, data, and broadband DSL solutions. The AccessMAX group of products includes the UMC1000®, DMAX™, AccessMAX System 8, and our equipment upgrade products EMAX™, and EMAXplus™. In 1996, in anticipation of the predicted growth in demand for high speed Internet access and other broadband services, we engineered a next-generation digital loop carrier, or NGDLC, with a unique three-bus backplane architecture that provides our products the built-in capability to accommodate future advancements in telecommunications technology.

AccessMAX products have a hybrid voice and data architecture enabling them to operate within various types of networks. The systems are scalable to over 2,000 lines and can transition from a narrowband to a broadband access system. Because of this flexibility, AccessMAX products offer cost-effective integrated multiservice access solutions with a wide variety of features and advanced services that can be added or altered as a customer’s network changes and grows.

We have invested substantial engineering resources in the development of custom application specific integrated circuits, or ASICs, such as our Narrowband Gate Array, Wideband Gate Array, and Cell Bus Gate Array. A gate array is a custom design integrated circuit, or chip, that allows systems designers to provide advanced processing functions targeted to the application, typically at a lower cost or with higher functionality than off-the-shelf solutions. Our Cellennia™ is a custom ASIC consisting of over 1.5 million gates, with the ability to multiply the bandwidth capacity of our product tenfold. Cellennia is the key technology that activates our high speed cell bus, providing a fully distributed broadband architecture. This distributed broadband architecture allows us to continue to offer our “pay as you grow” philosophy in the deployment of broadband services.

We have increased the number of DSL circuits on each ADSL card along with a transition to asynchronous transfer mode, or ATM, a technology that involves high speed switching capabilities. These cards, like their

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first generation predecessors, contain plain old telephone service, or POTS, circuitry and splitters to allow service providers the ability to offer POTS and DSL on the same copper pair transport medium.

Different versions of the AccessMAX platform shelves, or channel bank assemblies, are uniquely suited to solve various service delivery needs. The AccessMAX family incorporates both domestic (American National Standards Institute, or ANSI) and international (European Telecommunications Standards Institute, or ETSI) capabilities in a single platform to address the global market for telecommunications equipment.

The UMC1000 is our original narrowband to broadband service delivery platform, and is capable of simultaneously providing traditional narrowband and wideband services such as POTS, integrated services digital network, or ISDN, and T1, along with a variety of DSL services over copper wire, fiber optic cable, or wireless transport media. The UMC1000 product family consists of 48-line and 120-line units, which can be installed in a variety of network configurations. These units can be linked together to form larger line systems of over 2,000 lines. In addition, our DMAX1120 provides the capability and power to accommodate 100% DSL deployment from the UMC1000. This new platform leverages all of the existing capabilities of the UMC1000 while giving service providers more choices as they build out and optimize their networks for the high speed services of the future.

We released the AccessMAX System 8 in 2001, offering a migration strategy for delivering packet-switched voice and broadband services. The AccessMAX System 8 allows service providers to expand access network capacity and service offerings from legacy TDM services to high speed next-generation broadband services to emerging applications such as Voice over Packet, Voice over DSL, and Video over ADSL, while preserving quality of service. The system allows in-service upgrades activating the second ATM cell bus designed into our original backplane architecture in 1996.

EMAX and EMAXplus are our equipment maximization systems that provide rapid and efficient retrofit of in-place third party cabinets. These systems increase the capacity and density of the legacy infrastructure and fit into the space of a typical non-AFC digital loop carrier channel bank, eliminating the need for additional right of way and permits. The added density enables carriers to meet demand for second and third line POTS or ADSL services in areas where standard twisted copper pair phone lines are exhausted. Outside plant labor is minimized by reusing the existing network infrastructure.

Outside Plant Cabinets

For remote applications requiring outdoor housings, we market a variety of cabinets to provide the most cost-effective solution for each application. From 48 to over 2,000 lines, our cabinets incorporate and integrate components to save space and power. All outside cabinets are environmentally hardened to allow operation over an extended range of temperatures.

Indoor Cabinets

Internet service providers, business centers, universities, hospitals, banks, small office and home office customers require traditional telephone service as well as high speed data services such as DSL and ISDN. Service providers can deliver these services from low-cost, secure indoor cabinets that can be installed in stairwells, closets, or basements, occupying minimal floor space. Our indoor cabinets meet these needs with 48 to 480 lines, helping service providers minimize their capital outlay while extending new and existing fiber and copper plant.

ATLAS

ATLAS is our professional service organization made up of teams of professionals, regionally located, who provide consulting and complete end-to-end installation and operations, maintenance, and provisioning services for voice, data, and video networks. ATLAS services include developing and implementing network solutions for service providers, which maximize the use of existing equipment, identify expansion capabilities, and include engineering services, site surveys, implementation recommendations and strategies, project management, and equipment installation for existing and next-generation access networks. In addition, ATLAS offers customized service support agreements, as well as technical training courses, which provide our

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customers with an understanding of technological advancements and hands-on experience to operate and maintain all AFC equipment and software.

Panorama EMS

Our Panorama element management system, or EMS, is a software application product providing a centralized graphic user interface for point and click management of the OmniMAX network. The auto-detection functionality and graphical mapping display allows network administrators to quickly locate and check the status of all AFC equipment within their access network. Panorama’s flexible telecommunications management network architecture, centralized management capabilities, and customized applications integrate with external network management systems to enhance the service provider’s ability to manage OmniMAX networks.

TransMAX

TransMAX is our family of optical network access platforms and includes a multiservice access concentrator allowing voice and data integration over packet-aware optical networks, enhancing data handling efficiencies over traditional non-packet-aware optical networks, saving bandwidth and money. A packet-aware network is one that recognizes that data is being transmitted in packets and ceases transmission once the data has been sent, resulting in more efficient use of bandwidth. A non-packet-aware network can transmit data in packets, but continues to occupy bandwidth by transmitting even after there is no more data to send.

PremMAX

Our PremMAX product line of IADs work with our AccessMAX product line to simplify and lower the cost of delivering total business services to small and medium-sized business customers. The PremMAX IAD aggregates voice and data traffic at the customer premise onto the access loop. The PremMAX product is managed through the Panorama EMS.

Substantial Installed Base

In the U.S., major incumbents such as Sprint Corporation, Verizon Communications Inc., and SBC Communications, Inc., as well as other incumbent local exchange carriers, or ILECs, national local exchange carriers, or NLECs, competitive local exchange carriers, or CLECs, and independent operating companies, or IOCs, deploy the OmniMAX product family. We have also made inroads into the international marketplace as a result of access network modernization in the Caribbean and Latin America, Western Europe, Africa, and the Asia Pacific region. The AccessMAX has received type approval for deployment by major operators in over 23 countries.

The OmniMAX product family is distributed and serviced worldwide through our direct sales force and distributors. Our multiple-channel distribution approach allows customers to select the channel that best addresses their specific needs and provides us with broad coverage of global markets.

Ryan, Hankin, Kent, Inc., or RHK, a telecommunications market research firm, estimates there are between 75 — 80 million POTS lines and 4 — 4.5 million ADSL lines currently deployed industry wide. Of that amount, on a cumulative basis through December 31, 2001, we have shipped or deployed approximately 5.4 million POTS lines and approximately 105,000 ADSL lines.

Markets and Customers

We continue to grow market share in our core NGDLC business, providing products to many carriers including larger ILECs, NLECs, and over 800 IOCs in North America. The key factors that create market demand for NGDLC business are new housing and the replacement of obsolete and high-maintenance outside plant. For carriers, fiber is a cost-effective alternative to building additional copper (twisted pair) infrastructure to reach their customers who live or work beyond three miles from the carrier’s central office. NGDLC remote terminals serve as connectors between the fiber feeder and copper distribution loops providing those customers with both voice and DSL service connections.

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RHK predicts that the DSL market will grow to almost 16 million lines by 2005. Telechoice, publisher of xDSL and DSL industry analysis, estimates that DSL will reach more than 11.5 million subscribers by the end of 2003, most of which will be ADSL. Further, the majority of central office deployment of ADSL has been completed, according to RHK, which could mean the additional deployment of ADSL lines will be in remote terminals such as those offered through our AccessMAX System 8.

We have identified several areas we are targeting for future growth opportunities:

• Central office line termination for soft switching

• Packet aggregation in the central office

• Subscriber management functionality

• Enhanced fiber capabilities

• Enhanced network management and professional services

Service providers are looking to suppliers to support them in the move to a converged packet access network to provide expanded broadband services. Two technical trends mark the broadband rollout: the transition from circuits to packets, and the upgrade of the network infrastructure from copper to fiber. Much of the service providers’ network cores have been upgraded to packets and fiber, but the access network still requires significant investment to be fully converted. Access networks connect end users to the services available at the network core, and provide end user revenue streams to service providers. Conversion of the access network is stimulated by end user demand for broadband services. Our AccessMAX system 8 allows service providers to utilize existing fiber buildout to deploy broadband services and access connections to satisfy end user demand.

There is growth potential through next-generation switching in the access market. Our AccessMAX System 8 addresses the issue of integrated line termination capabilities. Next-generation multiservice packet switches, or soft switches, do not have integrated line termination capabilities, and require packet terminations from the voice side at the central office. AccessMAX System 8 already serves this function at remote terminals with integrated switch interface protocols and full broadband capabilities. As service providers deploy the new soft switches, we plan to continue to develop enhancements to AccessMAX System 8 to continue to support central office line termination systems.

As service providers migrate their network to a converged all packet architecture, efficient packet aggregation in front of high cost switching ports will be a critical step in cost effectively passing traffic between end users and core network elements. The AccessMAX System 8 aggregates voice and data packets at remote terminals, increasing the efficiency of copper and fiber links to the central office. This capability reduces the costs of operating a large packet network. We plan to continue to develop products that will provide central office-based edge switching and aggregation capabilities coupled with service management to assist the migration of service providers to Internet protocol, or IP, networks.

Subscriber management functionality and packet aggregation equipment are necessary to gaining revenue from end user packet terminations. We plan to expand our product family to combine this functionality in a single platform to streamline operations.

Deploying new broadband services into the access network increases the transport needs of the access network. We have integrated fiber transport capabilities into the AccessMAX family of products and we are evaluating technologies that lower the cost of deploying fiber in the access network.

We plan to continue to expand our ATLAS network management and professional services solutions around the AccessMAX product family to help our customers design, install, operate, and manage their complex networks. Our OmniMAX products are sold in the U.S. and international marketplaces to a customer base that includes NLECs, CLECs, IOCs, ILECs, international telecommunications companies, alternative carriers, system integrators and original equipment manufacturers, or OEMs. Historically, the largest revenue-producing markets of our customer base have been the NLECs, IOCs, CLECs, and international telecommunications companies.

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In 2001, we sold our products to a wide variety of customer types, as discussed previously, and we plan to continue to diversify our customer base. During 2001, we derived slightly lower revenues from international markets compared with 2000. We are continuing to expand our presence in international markets and we are focusing our efforts on operators who are making investments in broadband access infrastructures. The migration to broadband and privatization of international incumbent telecommunications companies are prompting service providers to upgrade and expand existing facilities to improve their positions in an increasingly competitive marketplace. Simultaneously, these telecommunications companies are installing technology to enable future advanced services.

For the year 2001, sales to North Supply Company, a subsidiary of Sprint (Sprint), accounted for 10% or more of total revenues. In 2000, Winstar Communications, Inc., (Winstar) and Sprint each accounted for 10% or more of total revenues. Winstar and Sprint each accounted for 10% or more of total revenues in 1999. No other customer accounted for 10% or more of total revenues in any of these periods.

Financial information relating to geographic areas for 1999-2001 is included in Note 12 of “Notes to Consolidated Financial Statements” of this Annual Report on Form 10-K/A.

Backlog

Our backlog primarily consists of purchase orders for services, and products and software to ship within the next year. At December 31, 2001, 2000, and 1999, backlogs were approximately $25.5 million, $40.8 million, and $35.4 million, respectively. Included in the 2000 backlog was $11.9 million of shipments made to Winstar and a value-added reseller, or VAR, that was not recognized in 2001 due to non-collectibility. We consider backlog to be an indicator, but not the sole predictor, of future sales because our customers may cancel or defer orders without penalty. Cancelation or reduction of pending purchase orders could seriously harm our future revenues.

Sales, Marketing, and Customer Support

Our products are marketed worldwide directly to telecommunications companies and indirectly through OEMs, distributors, and sales representatives.

Our U.S. sales, marketing, and customer service groups conduct activities from our corporate headquarters in California, and regional offices in Kansas, Illinois, Connecticut, Florida, Texas, and Virginia. Our U.S. sales personnel are dedicated to specific customer accounts across our U.S. customer base. In addition to direct calls to service providers, sales to customers often involve marketing through consulting engineers who are retained by independent telecommunications companies for engineering, specifications, and installation services.

Our international sales channels include both direct sales to end users and indirect sales through global, regional and country OEMs, integrators, distributors and agents. Our international sales group consists of direct salespeople and technical, engineering, and support personnel located in the U.S., Canada, Mexico, Switzerland, France, and Australia.

The U.S. and international sales organizations receive support from our product marketing organization for product commercialization, advertising, and marketing communications. Our product marketing organization is closely aligned with our customer market base to assess, capture, and deliver technical value propositions, product strategy applications, and technical marketing collateral.

We maintain a customer support organization that provides our customers with high quality technical and administrative product support. We provide warranty service, as well as post-sales technical support, technical and operational training to customers, and technical pre-sales assistance to our sales representatives and distributors. In addition to our field technical service engineers, we also rely on various third party organizations to provide post-sales support to North American customers. We provide international customer support directly or through our authorized distributors. Training courses and materials are made available to customers either through student training or train-the-trainer programs.

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Research and Development

Our research and development efforts are focused on developing local loop products with advanced features for global telecommunications markets. The OmniMAX product family is designed as a modular firmware and hardware platform that can be configured and adapted to particular customer requirements. Development efforts include extensive attention to ease of installation and use by the customer. Research and development personnel work closely with sales and marketing personnel to ensure development efforts are targeted to customer needs. Recent development efforts have focused on enhancements to the OmniMAX product family, such as fiber-to-the-curb capability, DSL service cards, ATM broadband infrastructure, soft switch interfaces and larger line size products. For international markets, efforts have been focused on an international standard for switch interfaces known as V5, ATM broadband infrastructure, and numerous country-specific customizations.

Our industry is characterized by rapidly changing technological and market conditions which may shorten product life cycles. Our future competitive position depends partly on our ability to generate and introduce new technology and features to existing and new products for the OmniMAX product family. We are engaged in developing new features for the OmniMAX product family. During the product development process, we invest substantial resources in products that often require extensive field testing and evaluation before their introduction to the market. We have invested substantial engineering resources in the development of custom ASICs which we believe provide feature and price advantages for our products. These ASICs and the software that manages them create a core capability set that would require considerable effort to replicate.

Research and development costs charged to expense were $64.2 million in 2001, $58.8 million in 2000, and $48.3 million in 1999. As a percentage of total revenues, research and development costs represented 20% in 2001, 14% in 2000, and 16% in 1999. The increase in 2001 research and development costs as a percentage of total revenues was largely the result of the decline in total revenues from 2000 to 2001. We consider our research and development efforts vital to our future success, and we plan to continue to support the development of new products, features and product cost reductions. We have research and development offices in California, Illinois, Florida, and Texas.

Manufacturing

Manufacturing, system integration, and testing operations are performed at our manufacturing facility in Petaluma, California. Manufacturing operations consist primarily of final product assembly and testing. We rely on a number of vendors to manufacture subassemblies to strict specifications for use in our products. Quality is monitored at each stage of the production and supply process, including the selection of component vendors, receiving, assembly, final testing, packaging, and shipping. Functional, environmental, and systems testing and other quality assurance-related activities are performed on the subassemblies incorporated into the OmniMAX product family.

Certain components used in our products are only available from a single source or limited number of vendors. Some of our sole-source vendors are companies which, from time to time, allocate parts to telecommunications equipment manufacturers due to market demand for components and equipment. These vendors supply a number of our competitors as well as us.

Competition

Our competitors range from small companies, both U.S. and international, to large multinational corporations. Principal competitors include: Compagnie Financière Alcatel, Lucent Technologies Inc., and Marconi Communications Inc. Some of these competitors have more extensive financial, marketing, and technical resources than we do and enjoy superior name recognition in the market.

Pursuant to a settlement agreement and related agreements entered into with the Industrial Technology Research Institute, an entity of the Republic of China, certain of its member companies have been granted specific rights to manufacture and sell the ETSI version of the narrowband UMC1000 outside of North America. These companies currently compete with us in international markets, primarily in China. In January 2005, upon termination of certain restrictions set forth in the agreements, these companies will have a worldwide, non-exclusive, royalty-free, irrevocable license to use a certain older version of narrowband UMC1000 technology and will be able to compete with us worldwide.

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We believe rapid technological change, continuing regulatory change, and industry consolidation will continue to cause rapid evolution in the competitive environment of the telecommunications equipment market, the full scope and nature of which is difficult to predict. Moreover, we believe that technological and regulatory change will continue to attract new entrants to the market in which we compete.

Telecommunications and Technology Investments

Over the past several years, we have made investments in several start-up ventures specializing in telecommunications technologies. In 1999, our investment in Cerent Corporation (Cerent) was converted into approximately 10.6 million shares of Cisco Systems, Inc. (Cisco) common stock, adjusted for a 2-for-1 stock split, as a result of Cisco acquiring Cerent. Upon the conversion, we recognized a non-operating gain of approximately $379.3 million. In February and May 2000, we entered into hedging transactions structured as costless collar agreements, or collars, to minimize the impact of potential adverse market risk on the Cisco stock we own. The collars provide us with a floor value of approximately $690.0 million for the shares if held to maturity. We are able to borrow up to the full present value of the floor value of the collars. In 2001, we implemented Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, resulting in the reclassification and recognition of gains in the Cisco shares and the related collars from accumulated other comprehensive income to non-operating income. As a result of the reclassification, we recognized $285.7 million in unrealized gains during 2001. See Note 3 of “Notes to Consolidated Financial Statements” of this Annual Report on Form 10-K/A.

During the fourth quarter of 2001, we recorded a $2.3 million impairment in our investment in a development stage company. Our net investment in this company totaled $4.3 million as of March 11, 2002. We believe macroeconomic conditions and an industry capital spending slowdown adversely affected the valuation of the company and led to the impairment.

In the latter half of 2001, we entered into an OEM agreement with a privately held development stage company, (company) and made an investment in the company. Under the terms of the OEM agreement, we are authorized to use, promote, market and distribute the company’s products in development of end to end solutions utilizing the products. Our investment includes an equity investment in the company’s preferred stock and an option to acquire the company. We carry the investment at cost as we hold less than 20% ownership in the company and do not have the ability to exercise significant influence over the company’s operations. Under the terms of the purchase option agreement, we may, at our sole discretion, elect at any time through April 2, 2002 to acquire for cash or stock, all of the outstanding shares of the company. Our determination as to whether to exercise the option will be based upon our assessment of the company’s product development efforts and business prospects, as well as market conditions and other factors relevant to the company’s business. If we do not exercise the option to acquire the company, and the company has achieved specified engineering and product development milestones, certain shareholders of the company hold a put option giving them the right to require us to purchase from them a specified series of the company’s outstanding preferred stock for approximately $6.0 million. The put option becomes exercisable for 90 days after the expiration of our purchase option.

Compliance with Regulatory and Industry Standards

Our products must comply with a significant number of voice and data regulations and standards which vary between U.S. and international markets, and vary by specific international markets. Standards for new services continue to evolve, and we will need to modify our products or develop new versions to meet these standards. Standards setting and compliance verification in the U.S. are determined by the Federal Communications Commission, or FCC, Underwriters Laboratories, Quality Management Institute, Telcordia Technologies, Inc., other independent third party testing organizations, and by independent telecommunications companies. In international markets, our products must comply with standards and recommendations issued by the Consultative Committee on International Telegraph and Telephony, Industry Canada, and individual regional carriers’ network operating system requirements and specifications. Our products must comply with standards issued by ETSI and implemented and enforced by the telecommunications regulatory authorities of each nation.

In addition to maintaining our ISO 9001 certification since 1997, we have also been certified compliant with TL9000 since 2000. TL 9000 is a set of quality system standards based on best practice and business excellence

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models, specifically created by and for the telecommunications industry. TL 9000 includes all of the elements of the ISO 9001 Quality System Standard, plus a number of other requirements specific to the telecommunications industry. It adds additional focus on customer needs, strategic planning, and accountability. In addition to the TL 9000 Quality System Requirements, there are sets of measurements that TL 9000 registered companies must report. These measurements are based on customer satisfaction, and the quality of the hardware and software developed by the supplier. Included in our certification are products and services in the three classifications of TL 9000: hardware, software, and services.

Environmental Matters

Our operations and manufacturing processes are subject to federal, state, local, and foreign environmental protection laws and regulations. These laws and regulations relate to the use, handling, storage, discharge and disposal of certain hazardous materials and wastes, the pre-treatment and discharge of process waste waters and the control of process air pollutants. We believe that we are in compliance in all material respects with applicable environmental regulations.

Proprietary Rights and Licenses

We attempt to protect our technology through a combination of copyrights, trade secret laws, contractual obligations, and patents. No patents are currently held for the OmniMAX product family, but six patent applications are pending. There can be no assurance that our intellectual property protection measures will be sufficient to prevent misappropriation of our technology. See Part I, Item 1 “Risk Factors That Might Affect Future Operating Results and Financial Condition” as it pertains to this matter in this Annual Report on Form 10-K/A. The laws of many foreign countries do not protect our intellectual property rights to the same extent as the laws of the U.S.

Employees

As of December 31, 2001, we had 843 employees. None of our employees are covered by collective bargaining agreements, and we have never experienced a work stoppage, strike, or labor dispute. We believe relations with our employees are good.

Risk Factors That Might Affect Future Operating Results and Financial Condition

In addition to the other information in this Annual Report on Form 10-K/A, the following are risk factors that should be considered in evaluating AFC and an investment in our common stock. The trading price of our common stock could decline due to any of these risks, and investors in our common stock could lose all or part of their investment.

A number of factors could cause our operating results to fluctuate significantly and cause volatility in our stock price.

Our operations have been, and will continue to be, affected by a wide variety of factors, many of which are outside our control. These factors include, but are not limited to, the level of capital spending and financial strength of our customers, changes in our U.S. and international sales and distribution mix, our product feature component mix and our ability to introduce new technologies and features ahead of our competitors, introductions or announcements of new products by our competitors, the timing and size of the orders we receive, adequacy of supplies for key components and assemblies, our ability to efficiently produce and ship orders promptly on a price-competitive basis, and our ability to integrate and operate acquired businesses and technologies.

We sell our OmniMAX product family primarily to telecommunications companies installing our equipment as part of their access networks. Additions to those networks represent complex and lengthy engineering projects, with our equipment typically representing only a portion of a given project. As a result, the timing of product shipment is often difficult to forecast. A portion of our equipment is usually installed in outdoor locations, so shipments of the system can be subject to the effects of seasonality, with fewer installation projects scheduled for the winter months. Many of our customers spend greater amounts of their calendar-year capital budgets during our fourth quarter and utilize the inventory build-up in the following first quarter. These factors may cause

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revenues in the quarter ended March 31 to be lower than revenues in the preceding quarter ended December 31. Sales in developing countries can be affected by delays and reductions in planned project deployment, currency fluctuations, reductions in capital availability, priority changes in government budgets, delays in receiving government approvals, and the political environment.

Expenditures for research and development, sales and marketing, and general and administrative functions are based in part on future growth projections and are relatively fixed for the near-term. We may be unable to adjust spending in a timely manner in response to any unanticipated failure to meet these growth projections. There can be no assurance that we will not have excess manufacturing capacity or that further utilization of our manufacturing and distribution facility will continue without interruption, which could result in, among other things, higher operating expenses and lower net income.

Fluctuations in our operating results, such as revenues or operating results not meeting the expectations of the investment community, may cause volatility in the price of our common stock. In such event, the market price of our common stock could decline significantly. A significant decline in the market price of our common stock could result in litigation, which could also result in increased costs and diversion of management’s attention and resources from our operations.

We operate in a rapidly changing competitive and economic environment. If we are unable to adapt quickly to these changes, our business and results of operations could be seriously harmed.

The telecommunications equipment market is undergoing rapid competitive and economic changes, the full scope and nature of which are difficult to predict. We believe that technological and regulatory change will continue to attract new entrants to the market in which we compete. Industry consolidation among our competitors may increase their financial resources, enabling them to reduce their prices. This would require that we reduce the prices of our products or risk losing market share. A competitor’s customer may acquire one of our customers and shift all capital spending to our competitor, possibly resulting in material reductions to our revenues and net income.

Many of our competitors are in a better position to withstand reductions in customers’ capital spending. These competitors often have broader product portfolios and market share and may not be as susceptible to downturns in the telecommunications industry. These competitors offer products directly competing with our product portfolio and also provide comprehensive ranges of other access systems. A customer may elect to consolidate its supplier base for the advantages of one-stop shopping solutions for all its product needs. Reductions in our customers’ capital spending could materially reduce our revenues and net income.

Our principal competitors include: Compagnie Financière Alcatel, Lucent Technologies Inc., and Marconi Communications Inc. Some of our competitors have more extensive financial, marketing, and technical resources than we do and enjoy superior name recognition in the market.

Various member companies of the Industrial Technology Research Institute, with whom we currently compete in international markets, primarily in China, have been granted specific rights to manufacture and sell the ETSI version of our narrowband UMC1000 product outside of North America. Upon termination of certain restrictions in January 2005, these member companies will gain a worldwide, non-exclusive, royalty-free, irrevocable license to use an older version of narrowband UMC1000 technology and will be able to compete with us worldwide.

Continued growth in the broadband access market is highly dependent on a vibrant economy, a strong level of capital expenditures for broadband access solutions products, a positive regulatory environment for larger ILEC customers, and the continued funding of emerging local service carriers by large communications equipment providers. The compounding effect of the current economic contraction, current regulatory action or inaction, and high debt levels may result in further reductions in capital expenditures by companies in the telecommunications industry, including some of our customers, and this could seriously harm our revenues and net income.

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We rely on a limited number of customers for a substantial portion of our revenues. If we lose one or more of our significant customers or experience a decrease in the level of sales to any of these customers, our revenues and net income could decline.

Sprint accounted for 10% or more of total revenues in 2001, and Winstar and Sprint each accounted for 10% or more of total revenues in both 2000 and 1999. No other single customer accounted for 10% or more of total revenues in any of these periods. Our five largest customers accounted for 44%, 49%, and 47% of total revenues in 2001, 2000, and 1999, respectively. Although our largest customers have varied from period to period, we anticipate that results of operations in any given period will continue to depend to a significant extent upon sales to a small number of customers. This dependence may increase due to our strategy of focusing on securing several large accounts rather than many small accounts. There can be no assurance that significant existing customers will continue to purchase products from us at current levels, if at all. For example, sales to Winstar decreased in 2001 as a result of their deteriorated financial condition and filing for protection under bankruptcy laws. In the event that a significant existing customer merges with another company, there can be no assurance that such customer will continue to purchase our products. The loss of one or more significant existing customers or a decrease in the level of purchases from these customers could, among other things, result in a decrease in revenues and net income, excess and obsolete inventory, and increase our dependency on our remaining significant customers.

Our revenues depend on the capital spending programs and financial capabilities of our service provider customers and ultimately on the demand for new telecommunications services from end users.

Our customers are concentrated in the public carrier telecommunications industry and, in the U.S., include ILECs, NLECs, IOCs, and CLECs. Our historical markets have been the U.S. and international small to mid-line size markets, and we are attempting to expand into larger-line size markets both in the U.S. and internationally. Our ability to generate future revenues depends upon the capital spending patterns and financial capabilities of our customers, continued demand by our customers for our products and services, and end user demand for advanced telecommunications services. Recent severe financial problems affecting the telecommunications industry in general could continue to cause a slowdown in our sales, and result in slower payments or defaults on account. CLECs in particular have experienced difficulties in raising capital to build out their networks, which, along with the scale and complexity of providing DSL service, has contributed to a substantial slowdown in their capital spending. For example, the financial distress of Winstar and a VAR resulted in our non-recognition of approximately $11.9 million of revenues in the first quarter of 2001, and an increase in our allowance for doubtful accounts of approximately $9.3 million with respect to the VAR. Also, there can be no assurance that telecommunications companies, foreign governments, or other customers will pursue infrastructure upgrades that will necessitate the implementation of advanced products such as ours. Infrastructure improvements may be delayed or prevented by a variety of factors including cost, regulatory obstacles, the lack of consumer demand for advanced telecommunications services and alternative approaches to service delivery.

We may be unable to sell customer-specific inventory which could result in lower gross profit margins and net income.

Some of our customers have order specifications requiring us to design, purchase parts, and build systems that are unique to a customer. In many cases, we forecast and purchase components in advance and allocate resources to design and manufacture the systems. If our customers’ requirements change, or we experience delays or cancelation of orders, we may be unable to cost-effectively rework the system configurations and return the parts to inventory as available for sale. In the fourth quarter of 2001, we recorded an $18.0 million write-down to cost of revenues for excess and obsolete inventory, much of which was customer-specific inventory. We also recognized a $12.0 million accrual to cost of revenues in the fourth quarter of 2001 for long-term purchase agreements with contract manufacturers, much of which was incurred for specific customers. In the first quarter of 2001, we increased our inventory reserves by approximately $2.2 million for inventories designed in accordance with the specifications of Winstar and Tellabs. Write-downs and accruals for unrealizable inventory negatively impacts our gross profit margins and net income.

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We must attract, retain, and motivate key technical and management personnel in a competitive market in order to sustain or grow our business.

Our success depends to a significant extent upon key technical and management employees. Competition for highly qualified employees is intense and the process of locating key technical and management personnel with the required combination of skills and attributes is often lengthy and expensive. This competition is particularly intense in Northern California, where there is a concentration of established and emerging technology companies. In general, we do not have employment agreements with our employees, or carry key person life insurance. There can be no assurance that we will be successful in retaining our existing key personnel or in attracting and retaining the additional employees we may require. We must continue to recruit, train, assimilate, motivate, and retain qualified managers and employees to manage our operations effectively. Otherwise, we may be unable to execute our business plan effectively and our results of operations could be significantly adversely affected.

Recent and future acquisitions may compromise our operations and financial results.

As part of our efforts to enhance our existing products, introduce new products, and fulfill changing customer requirements, we may pursue acquisitions of complementary companies, products, and technologies. Acquisitions could adversely affect our operating results in the short term as a result of dilutive issuances of equity securities and the incurrence of additional debt costs. The purchase price for an acquired company may exceed its book value, creating goodwill, possibly resulting in significant impairment write-downs charged to our operating results in one or more periods. We have limited experience in acquiring and integrating outside companies. In the process of making an acquisition, we may suffer disruption to our business, become exposed to unknown liabilities of acquired companies, or fail to successfully integrate another company, its products and technologies, or its personnel. The effects of these events could harm our business, financial condition, and results of operations.

We are subject to numerous and changing regulations and industry standards. If our products do not meet these regulations or are not compatible with these standards, our ability to sell our products could be seriously harmed.

Our products must comply with a significant number of voice and data regulations and standards, which vary between U.S. and international markets, and may vary within specific international markets. Standards for new services continue to evolve, and we will need to modify our products or develop new versions to meet these standards. Standards setting and compliance verification in the U.S. are determined by the FCC, Underwriters Laboratories, Quality Management Institute, Telcordia Technologies, Inc., other independent third party testing organizations, and by independent telecommunications companies. In international markets, our products must comply with recommendations issued by the Consultative Committee on International Telegraph and Telephony, Industry Canada, and individual regional carriers’ network operating system requirements and specifications. Our products must also comply with standards issued by the ETSI and implemented and enforced by the telecommunications regulatory authorities of each nation.

We need to continue to ensure that our products are easily integrated with various telecommunications systems. Telcordia testing on our products is often required to ensure interoperability with various standards of operations, administration, maintenance, and provisioning systems. Telcordia testing also requires significant investments in time and money to achieve compliance. If our systems fail to comply with evolving standards in U.S. and international markets on a timely basis, or if we fail to obtain compliance on new features, our ability to sell our products would be impaired, and we could experience, among other things, delayed or lost customer orders, decreased revenues, and lower net income.

We have maintained compliance with ISO 9001 since we were first certified in 1997. The ISO standard consists of all elements defining a quality system, aimed primarily at achieving customer satisfaction by preventing non-conformity at all stages, from design through servicing. We have maintained compliance with TL9000 since we were first certified for hardware, software and services in 2000. TL9000 certification is a quality standard designed specifically for the telecommunications industry. There can be no assurance that we will maintain these certifications. The failure to maintain any such certification or to maintain interoperability with other companies may negatively affect our ability to compete with other telecommunications equipment vendors and may preclude selling certain of our products in certain markets.

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In 1996, the U.S. Congress passed regulations that affect telecommunications services, including changes to pricing, access by competitive vendors and many other broad changes to the data and telecommunications networks and services. These changes have had a major impact on the pricing of existing services, and may affect the deployment of future services. These changes have caused greater consolidation in the telecommunications industry, which in turn could disrupt existing customer relationships, and could result in, among other things, delays or loss of customer orders, decreased revenues, and lower net income. Regulatory issues stemming from the 1996 Telecommunications Act include conflicting state and federal regulations for DSL deployment, and it is unclear when resolution will take place. There can be no assurance that any future legislative and regulatory changes will not have a material adverse effect on the demand for our products. Uncertainty regarding future legislation and governmental policies combined with emerging new competition may also affect the demand for our products.

We face risks associated with international markets and distribution channels.

International sales constituted 14% of our total revenues in 2001, 11% in 2000 and 11% in 1999. International sales have fluctuated in absolute dollars and as a percentage of revenues and are expected to continue to fluctuate in future periods.

We have had limited success in entering new international markets. Many international telecommunications companies are owned or strictly regulated by local authorities. Access to international markets is often difficult to achieve due to trade barriers and established relationships between government-owned or controlled telecommunications companies and traditional local equipment vendors. Successful expansion of international operations and sales in some of these markets may depend on our ability to establish and maintain productive strategic relationships with established telecommunications companies, local equipment vendors, or entities successful at penetrating international markets. In the fourth quarter of 2001, we closed our sales and representative offices in Hong Kong, Shanghai, and London. We rely on a number of third party distributors and sales representatives to market and sell our products outside of the U.S., and there can be no assurance that such distributors or sales representatives will provide the support and effort necessary to service international markets effectively. In addition, in the past our gross profit margins, in some cases, have been lower for products sold through some of our third party and indirect distribution channels than for products sold through our direct sales efforts. Increased sales through our third party and indirect distribution channels may reduce our overall gross profit margins and net income.

Sales activities in foreign countries may subject us to taxation in those countries. Although we have attempted to minimize our exposure to taxation in foreign countries, any income or other taxes imposed may increase our overall effective tax rate and adversely impact our competitiveness in those countries. In addition, we currently intend that the earnings of our foreign subsidiaries remain permanently invested in these entities in order to facilitate the potential expansion of our business. To the extent that these earnings are actually or deemed repatriated, U.S. federal and state income taxes would be imposed, and this could adversely impact our cash flows.

We must comply with various country-specific standards and regulations to compete in certain markets. Some international network standards vary from those of the U.S., and our product family may be incompatible with the legacy infrastructure. This could hamper our ability to sell our product family into certain countries. If our existing international customers adopt non-U.S.-compliant network standards, we could experience a loss of revenues and lowered net income. Any inability to obtain or maintain local regulatory approval could delay or prevent entrance into certain markets, which could result in, among other things, delays or loss of customer orders, decreased revenues, and lower net income.

We may be unable to secure necessary components and support because we depend upon a limited number of third party manufacturers and support organizations, and in some cases we rely upon sole source suppliers.

Certain components used in our products, including our proprietary ASICs, codec components, certain surface mount technology components, and other components, are only available from a single source or limited number of vendors. A limited number of vendors manufacture the subassemblies to our specifications for use in our systems. We purchase most components on a purchase order basis, and we do not have guaranteed supply arrangements with many of our key suppliers. Some of the sole source and limited source vendors are

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companies who, from time to time, allocate parts to telecommunications equipment manufacturers due to market demand for components and equipment. During the worldwide telecommunications market expansion in the late 1990’s, many component suppliers placed critical components on worldwide allocation. During 2000 we experienced shortages of certain optical components, laser diodes, which are used in our products. Many of our competitors are much larger and may be able to obtain priority allocations from these shared vendors, thereby limiting or making unreliable our sources of supply for these components. If we are unable to obtain sufficient supply from alternative sources, reduced supplies and higher prices of components could significantly limit our ability to meet scheduled product deliveries to our customers and increase our expenses, which would seriously harm our business and results of operations.

Our failure to develop and introduce new products that meet changing customer requirements and address technological advances would limit our future revenues.

New product development often requires long-term forecasting of market trends, and development and implementation of new technologies. If we fail or are late to respond to new technological developments, or if we experience delays in product development, market acceptance of our products may be significantly reduced or delayed. The telecommunications equipment market is characterized by rapidly changing technology, evolving industry standards, changes in end user requirements, and frequent new product introductions and enhancements. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable.

Our success will depend upon our ability to enhance the OmniMAX product family through the development of new technology and to develop and introduce, on a timely basis, new products or new product feature enhancements. From time to time, we or our competitors may announce new products or product enhancements, services, or technologies that have the potential to replace or shorten the life cycle of the OmniMAX product family causing customers to defer purchases of our equipment. If we fail to respond on a cost-effective and timely basis to technological advances in the telecommunications industry, we may experience diminished market acceptance and reduced sales of our products, and our business would be seriously harmed.

Our products are complex and may contain undetected errors which could result in significant unexpected expense.

Our products contain a significant amount of complex hardware, firmware, and software that may contain undetected errors that may become apparent as product features are introduced, or as new versions are released. It is possible that, despite significant testing, hardware, firmware, or software errors will be found in our products after commencement of shipments resulting in delays or cancelation of customer orders, payment of contract penalties to customers, warranty costs or the loss of market acceptance and revenues.

Our product line is concentrated in a single family of products and a decline in demand for these products would result in decreased revenues and net income.

Substantially all of our revenues are derived from the OmniMAX product family, and we expect this concentration will continue in the foreseeable future. Any decrease in prices or sales levels could result in decreased revenues and lower net income. Factors potentially affecting sales prices and demand for our products include price competition, new product introductions or announcements by competitors, or product obsolescence, among others.

Failure or inability to protect our intellectual property will adversely affect our ability to compete, which could result in decreased revenues.

We attempt to protect our technology through a combination of copyrights, trade secret laws, contractual obligations, and patents. We do not presently hold any patents for the OmniMAX product family, and although six patent applications are pending, they may not result in any issued patents. These intellectual property protection measures may not be sufficient to prevent wrongful misappropriation of our technology nor will they prevent competitors from independently developing technologies that are substantially equivalent or superior to our technology. The laws of many foreign countries do not protect our intellectual property rights to the same

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extent as the laws of the U.S. Failure or inability to protect proprietary information could result in loss of our competitive advantage, loss of customer orders and decreased revenues. Furthermore, policing the unauthorized use of our products is difficult. Litigation may be necessary in the future to enforce our intellectual property rights. This litigation could result in substantial costs and diversion of resources and may not ultimately be successful.

We may be subject to intellectual property infringement claims that are costly to defend and could limit our ability to use some technologies in the future.

Like other participants in our industry, we expect that we will continue to be subject to infringement claims and other intellectual property disputes as competition in our market continues to intensify. We have been subject to several intellectual property disputes in the past. In the future, we may be subject to additional litigation and may be required to defend against claimed infringements of the rights of others or to determine the scope and validity of the proprietary rights of others. Any such litigation could be costly and divert management’s attention from our operations. Adverse determinations in such litigation could result in the loss of our proprietary rights, subject us to significant liabilities, require us to seek licenses from third parties, or prevent us from manufacturing or selling our products. Furthermore, there can be no assurance that any necessary licenses will be available on reasonable terms. Any one of these results could seriously harm our business and results of operations.

Item 2. Properties

We lease five buildings in Petaluma, California. Two of these buildings are subleased; the other three, a total of approximately 374,000 square feet, house the principal executive offices, as well as administrative, sales, marketing, product development, manufacturing, and distribution functions. In addition to our Petaluma facilities, we lease domestic properties in Miramar, Florida (research and development), Richardson, Texas (sales, and research and development), Buffalo Grove, Illinois (research and development, and technical assistance), Largo, Florida, and several other locations for sales and technical assistance. As of December 1, 2001, we have subleased the Largo facility. Internationally, we occupy leased offices for sales and sales support functions in: Paris, France; Fribourg, Switzerland; Mexico City, Mexico; and Sydney, Australia.

We utilized approximately 68% of our total available space as of March 11, 2002. We believe that the facilities used in our operations are suitable for their respective uses and adequate to meet our level of operations anticipated in 2002. In addition, we believe that appropriate additional facilities will be available to accommodate growth as needed.

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PART II.

Item 6. Selected Consolidated Financial Data

FIVE-YEAR SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA

			Years Ended December 31,
			2001(1)			2000(2)		1999(3) (4)		1998(4)		1997
			(restated)
			(in thousands, except per share data)
Consolidated Statements of Income Data:
Revenues			$	327,569		$	416,850	$	296,611	$	316,409	$	267,858
Cost of revenues				215,956			215,303		157,911		171,843		145,933
	Gross profit			111,613			201,547		138,700		144,566		121,925
Operating expenses:
	Research and development			64,169			58,828		48,343		41,687		25,726
	Sales and marketing			49,385			47,463		34,425		35,992		21,854
	General and administrative			37,323			29,172		33,947		30,437		20,799
		Total operating expenses		150,877			135,463		116,715		108,116		68,379
Operating income (loss)				(39,264	)		66,084		21,985		36,450		53,546
Other income, net				306,238			51,444		385,444		4,051		4,866
Income before income taxes				266,974			117,528		407,429		40,501		58,412
Income taxes				101,450			39,960		158,359		14,648		21,612
Net income			$	165,524		$	77,568	$	249,070	$	25,853	$	36,800
Basic net income per share (5)			$	2.03		$	0.97	$	3.20	$	0.34	$	0.52
Shares used in basic per share computations				81,381			80,201		77,723		75,273		70,131
Diluted net income per share (5)			$	1.98		$	0.91	$	3.05	$	0.32	$	0.48
Shares used in diluted per share computations				83,638			84,800		81,657		79,825		77,469
				As of December 31,
				2001			2000		1999		1998		1997
Consolidated Balance Sheets Data:
Cash, cash equivalents, and marketable securities			$	955,742		$	875,153	$	732,122	$	110,866	$	105,196
Working capital				774,297			744,723		583,357		208,604		193,640
Total assets(6) (7)				1,147,410			1,135,175		900,787		309,114		273,983
Stockholders’ equity				838,605			819,665		645,064		267,839		223,720
Book value per share				10.21			10.15		8.16		3.52		3.08
Number of employees				843			959		722		815		660

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(1)	2001 includes an unrealized gain of $285.7 million resulting from our application of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, and related net gains on our Cisco Systems, Inc. (Cisco) common stock holdings during the year. See Note 3 of “Notes to Consolidated Financial Statements” for further information. Pro forma net income for 2001, which excludes the unrealized Cisco gains, and certain other income statement credits and charges, was $16.1 million. See Management’s Discussion and Analysis under the heading, “Pro Forma Results” for additional information.
(2)	2000 includes $42.9 million from Marconi Communications Inc. as settlement of outstanding litigation and a subsequent distribution payment. Without this non-operating income, and excluding $1.1 million in acquisition related costs, net income would have been $50.0 million.
(3)	1999 includes a $379.3 million gain recognized upon conversion of an investment into Cisco common stock. Without this gain, and related tax effects, our net income for the year ended December 31, 1999 would have been $19.6 million.
(4)	Amounts have been restated to reflect the acquisition of GVN Technologies, Inc. in May 2000 accounted for as a pooling of interests; number of employees has not been restated.
(5)	See Note 1 of “Notes to Consolidated Financial Statements” for an explanation of the determination of the number of shares used in computing basic and diluted net income per share.
(6)	Total assets for 2001, 2000, and 1999 include the market value of our Cisco holdings and related collars of $670.5 million, $659.0 million, and $551.4 million, respectively.
(7)	Certain prior year amounts included in total assets have been reclassified to conform with current year presentation.

AFC’s long-term debt is not significant. No cash dividends per share were paid for any of the five years presented.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This report contains “forward-looking statements.” In some cases, you can identify forward-looking statements by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” or the negative of these terms and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. We discuss many of these risks and uncertainties in greater detail in Part I, Item 1 of this Annual Report on Form 10-K/A under the heading “Risk Factors That Might Affect Future Operating Results and Financial Condition” as filed with the Securities and Exchange Commission. These risks and uncertainties may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. These factors are not intended to be an all-encompassing list of risks and uncertainties that may affect the operations, performance, development and results of our business. You should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions as of the date of this report. We are under no duty to update any of the forward-looking statements after the date of this report to conform such statements to actual results or to changes in our expectations.

The following discussion should be read in conjunction with our financial statements and related notes included elsewhere in this report.

A certification with respect to this Annual Report on Form 10-K/A by our Chief Executive Officer and Chief Financial Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002, has been submitted to the SEC as additional correspondence accompanying this report.

Overview

On October 17, 2002, we announced that we had made an adjustment to previously reported results for the year ended December 31, 2001. The adjustment is the result of a $1.7 million after-tax charge ($2.7 million on a pre-tax basis) that should have been taken in the fourth quarter of 2001. During the fourth quarter of 2001, we vacated an engineering facility in Largo, Florida, and entered into a sublease agreement for the entire space. Upon a recent review of our facilities, we realized that, in accordance with generally accepted accounting principles, we should have recognized an impairment charge in the fourth quarter of 2001 for the ongoing shortfall between our sublease income and our operating lease obligation. The net book value of the related leasehold improvements, furniture, fixtures, and telephone equipment also should have been written off. Additionally, our adjusted financial results include our previously announced retroactive application of the equity method of accounting for our investment in AccessLan Communications, Inc. (AccessLan). Our equity in AccessLan’s losses was $0.6 million after tax ($0.9 million on a pre-tax basis.) Accordingly, the discussion below has been modified to reflect the adjustments to our 2001 financial statements.

We design, manufacture, and provide a family of products and services that offer broadband, wideband, and narrowband solutions for the portion of the telecommunications network between the service provider’s central office and end user businesses and homes. Our OmniMAX™ product family is a multiservice broadband solution for providing voice and data services for the telecommunications industry. We released the AccessMAX™ System 8 in 2001, offering a migration strategy for delivering packet-switched voice and broadband services. The AccessMAX System 8 allows service providers to expand network access capacity and service offerings from legacy time division multiplex services to high speed next-generation broadband services to emerging applications such as Voice over Packet, Voice over Digital Subscriber Line, or DSL, and Video over Asymmetric Digital Subscriber Line, while preserving quality of service. We market our product family through our direct sales force, distributors, and value-added resellers. We sell our products primarily to service providers who install our equipment as part of their access networks. Our customers generally include national local exchange carriers, or NLECs, independent operating companies, or IOCs, large incumbent local exchange carriers, or ILECs, competitive local exchange carriers, or CLECs, and international carriers.

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Our customers normally install a portion of the OmniMAX system in outdoor locations, and shipments are subject to the effects of seasonality with fewer installation projects scheduled for the winter months. Historically, we have also experienced a weaker demand for our products during the beginning of the year as compared with the shipment levels in the preceding fourth quarter. This fluctuation is a result of customers maximizing their calendar-year capital budgets in the fourth quarter and utilizing the inventory build-up during the following first quarter. As a result of these factors, we believe that over time, revenues for the quarter ended March 31 will be lower than revenues in the preceding quarter ended December 31.

Our results of operations have been adversely affected by the recent downturn in the telecommunications industry and worldwide economies. We experienced lower than forecasted shipments during 2001. We believe current economic conditions may continue to cause customers to reduce and defer capital spending. We also believe the current regulatory environment is causing delays in some of our customers’ investments in broadband services. Some of our larger customers are delaying deployment of DSL until clarification occurs on regulatory issues stemming from the Telecommunications Act of 1996. In the current environment, there exists conflicting state and federal regulations for DSL deployment, and it is unclear when resolution will take place.

Beginning in late 2000 and continuing through mid-2001, we focused on building our organization and procuring inventory to support forecasted business growth. As the general slowdown in our customers’ capital spending and the effect that had on our results of operations became apparent, we implemented a reduction in force in October 2001. Related to this reduction, we recorded $2.7 million for an engineering facility lease impairment and fixed asset write-off, and $1.6 million in severance costs in 2001. We also reduced staff in certain foreign sales offices in December 2001 and incurred $0.6 million for closure and severance costs. As part of our original forecasted growth in early 2001, we entered into long-term purchase agreements with vendors. In the fourth quarter of 2001, after receiving additional customer input, we updated our business plan for 2002 and determined an inventory adjustment was needed. We wrote-down inventory by $18.1 million and recognized a $12.0 million accrual for inventory purchase agreements.

We completed an inventory of certain fixed assets in the fourth quarter of 2001 and recorded a $1.4 million loss on the disposal of idle and obsolete equipment. We determined that our investment in a privately-held company was impaired and recorded a $2.3 million write-down in the fourth quarter of 2001 to reflect the company’s lowered market valuation.

In the fourth quarter of 2001, we recorded a $13.6 million distribution payment due from Marconi Communications Inc. (Marconi), as non-operating income. As a result of our implementation of Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, in the first quarter of 2001, we recognized $285.7 million in non-operating income in 2001 for the net unrealized gain on our shares of Cisco Systems, Inc. (Cisco) and the related collar agreements.

During the first quarter of 2001, we did not recognize revenues of approximately $11.9 million on shipments made to Winstar Communications, Inc. (Winstar) and a value-added reseller, or VAR, due to the likelihood of non-collectibility. Winstar and the VAR filed for protection under bankruptcy laws in the second and fourth quarters of 2001, respectively. We also increased our allowance for doubtful accounts by approximately $9.3 million for the VAR receivable. In addition, we increased inventory reserves by approximately $2.2 million for inventories designed in accordance with the specifications of Winstar and Tellabs, Inc. (Tellabs), because we did not anticipate further business with either of these customers.

We attempted to balance our operating expenses with our decreased revenues and results of operations. We have focused on cost controls while we continued to invest in research and development activities that would keep us in a strong position to take advantage of sales opportunities when economic conditions improve and demand recovers.

Our discussion and analysis of our financial conditions and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of revenues, expenses, assets, and liabilities, and related disclosure of contingent assets and liabilities. As the complexity and subjectivity of estimates and judgments increase, the inherent level of precision in the financial statements can decrease. Applying GAAP requires our judgment in

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determining the relative appropriateness of acceptable accounting principles and methods of application in diverse and complex economic activities. We evaluate our estimates and judgments on an on-going basis, including those related to our product warranty, product returns, assessment of recoverability of capitalized software development costs, excess and obsolete inventory, and allowance for doubtful accounts. We base our estimates on historical experience and other assumptions we believe are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities, which may not be readily apparent from other sources.

We believe the application of our accounting policies accurately reflects our financial condition and results of operations in the consolidated financial statements, and provides comparability between periods. We believe our accounting policies are reasonable and appropriate for our business. The following critical accounting policies affect the more significant estimates and judgments used in the preparation of our consolidated financial statements.

Critical Accounting Policies and Estimates

Some business transactions are subject to uncertainty and are recorded using estimates and our best judgment at any given time, within the parameters of GAAP. An explanation of the sensitivity of financial statements to the methods, assumptions and estimates underlying their preparation and the interplay of specific uncertainties with accounting measurements follows.

Revenue Recognition, Allowances and Product Warranty. In compliance with the Securities and Exchange Commission (SEC) Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, and SFAS No. 48, Revenue Recognition When Right of Return Exists, we recognize revenue when the earnings process is complete. The earnings process is considered complete when persuasive evidence of an arrangement between a customer and AFC exists, when delivery and acceptance has occurred or services have been rendered, when pricing is fixed or determinable, when any right of return lapses or is reasonably estimable, and when collectibility is reasonably assured. We follow these same revenue recognition standards for sales made to our authorized distributors and sales representatives. AICPA Statements of Position 97-2, Software Revenue Recognition, and 98-9, Modification of SOP 97-2, Software Recognition, With Respect to Certain Transactions, generally require revenues earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. Revenues allocated to maintenance are recognized ratably over the maintenance term. Revenues from service activities are generally recognized ratably over the service period. Allowances for returns are established based on experience. A provision for estimated warranty costs is established at the time of sale and adjusted periodically based on experience. We consider differing market conditions when recognizing revenues, such as the recent decline in capital spending in our industry, and the relative financial condition of our customers. These conditions do not impact the method by which we recognize revenues or the methodology for computing the provision for warranty; however, such conditions could impact the allowance for returns.

Research and Development and Software Development Costs. We follow SFAS No. 2, Accounting For Research and Development Costs, and charge all research and development costs to expense as incurred. We follow SFAS No. 86, Accounting For the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. Costs incurred for the development of computer software and enhancements to existing software products that will be sold, leased, or otherwise marketed are capitalized when technological feasibility has been established. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated future revenues and changes in technologies. Costs that are capitalized include direct labor and related overhead. Amortization of capitalized software development costs begins when the product is available for general release. Amortization is based on the straight-line method. Unamortized capitalized software development costs determined to be in excess of net realizable value of the product are expensed immediately. Under different circumstances, we believe there would be no change in the way we expense research and development costs and, accordingly, there would be no change to our results of operations, financial position, or changes in cash flows. If we changed the estimates used in the assessment of recoverability for computer software-related capitalized costs, such as the anticipated future revenues or changes in technologies, these could result in a lower net realizable value. This in turn would increase our reported operating expenses, and lower our net income, but would have no effect on our cash flows.

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Allowance for Doubtful Accounts. We have an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make payments to our accounts receivable. We base our allowance on periodic assessment of our customers’ liquidity and financial condition through credit rating agencies, financial statement review, and historical collection trends. Additional allowances may be required if the liquidity or financial condition of our customers were to deteriorate, resulting in an impairment in their ability to make payments. We consider differing market conditions when recording our allowance, such as the recent downturn in the telecommunications industry and worldwide economies, and the relative financial condition of our customers. These conditions do not impact the methodology we use to compute our allowance.

Inventories and Reserve for Excess and Obsolete Inventories. Inventories include material, labor and overhead and are valued at the lower of cost (first-in, first-out basis) or market. A reserve for excess and obsolete product and an accrual for purchase commitments have been established; the balances are assessed continuously, and adjusted on a quarterly basis. Under different market conditions, such as an environment of decreasing vendor and material costs, we could change our methodology to last-in, first-out basis, resulting in short-term effects such as lower costs of revenues, higher gross profit margin, and higher net income. However, this alternative methodology could lead to higher reserves for excess and obsolete product as the potential for higher-priced inventory on hand increases, and could result in additional short-term effects such as higher cost of revenues, lower gross profit margin, and lower net income.

We provide additional clarification and analysis about non-financial information in Part I, Item 1 of this Annual Report on Form 10-K/A under the heading “Risk Factors That Might Affect Future Operating Results and Financial Condition”.

Results of Operations

The following table sets forth, for the periods indicated, the percentage of revenues represented by certain items reflected in our consolidated statements of income:

			Years Ended December 31,
			2001			2000			1999
			(restated)
Revenues				100	%		100	%		100	%
Cost of revenues				66			52			53
	Gross profit			34			48			47
Operating expenses:
	Research and development			20			14			16
	Sales and marketing			15			11			12
	General and administrative			11			7			11
		Total operating expenses		46			32			39
Operating income (loss)				(12	)		16			7
Other income, net				93			12			130
Income before income taxes				82			28			137
Income taxes				31			10			53
Net income				51	%		19	%		84	%

2001 Compared with 2000

Revenues. In 2001, revenues, including service revenues and royalties, decreased by 21% from 2000 to $327.6 million. U.S. sales declined 24% to $282.0 million in 2001 and represented 86% of total revenues compared with 89% in 2000. The decline in U.S. revenues in both amount and as a percentage of total revenues, reflected the significant decline in sales to Tellabs, Winstar, and other CLECs in 2001. International revenues declined 5% to $45.6 million in 2001 and represented 14% of total revenues compared with 11% in 2000. The decline in international revenues was mainly a result of reduced sales into South Africa, partially offset by overall increased sales into Latin America and Canada. The higher ratio of international to total revenues in 2001, was largely a function of the decline in sales to U.S. customers from 2000 to 2001.

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For the year 2001, sales to North Supply Company, a subsidiary of Sprint (Sprint) accounted for 10% or more of total revenues. In 2000, Winstar and Sprint each accounted for 10% or more of total revenues. No other customer accounted for 10% or more of total revenues in either period. Although our largest customers have varied over time, we anticipate that results of operations in any given period will continue to depend to a great extent on sales to a small number of large accounts. Our five largest customers accounted for 44% of total revenues in 2001 and 49% in 2000. A number of these accounts have signed multiyear agreements with us which provide a potential revenue stream for 2002 and beyond. However, these contracts permit customers to cancel or reduce the size of their commitments upon notice. Accordingly, there can be no assurance that ongoing sales to these customers will continue, or continue at increasing volumes.

Gross Profit. In 2001, gross profit decreased by 45% to $111.6 million. Gross profit represented 34% of total revenues in 2001 compared with 48% in 2000.

In the fourth quarter of 2001, we recorded $18.0 million in charges to cost of revenues for excess and obsolete inventory and recognized a $12.0 million accrual against cost of revenues for inventory purchase agreements. We experienced a delay in DSL rollouts and changes in some of our larger customers’ DSL build-out plans. This, along with a shift from our first generation DSL products to our second generation DSL products, accounted for a large portion of the excess and obsolete inventory write-down. We had inventory built to CLEC specifications that, upon the rapid decline of our CLEC customers’ capital spending, we could not cost-effectively re-work for other customers. Some of the other products in our product family have been superseded by newer generation technology, resulting in obsolete inventory. We refocused our international efforts towards newer generation broadband products, resulting in a write-down of obsolete inventory. Component inventories were built up in accordance with our original business plan, resulting in write-downs for amounts in excess of our revised business plan requirements.

To a lesser extent, gross profit in 2001 declined from 2000 due to negotiated discounts and product mix for some of our larger volume customers. Materials purchases were lower in 2001 compared with 2000, while overhead costs remained relatively unchanged, resulting in costs being spread over a lower volume of products. The resulting higher burden rate decreased our gross profits in 2001. Gross profit in 2001 was also impacted by the recognition of cost of sales for shipments to Winstar and a VAR for which approximately $11.9 million in revenues were not recorded. We also recorded a $2.2 million reserve for specific inventories deemed to be unsellable as a result of Winstar’s financial distress and our expectation that we would not have further sales to Tellabs for the remainder of 2001.

Our gross profits are affected by a number of factors including, but not limited to, excess custom inventory, obsolete inventory, long-term purchase agreements with vendors, customer mix, product mix, volume discounts, cost reduction programs, and volume of third party distributor sales. Customers have the ability to cancel purchases, resulting in excess customized inventory that we may be unable to re-work and sell cost-effectively.

Research and Development. In 2001, research and development expenses increased by 9% to $64.2 million, and represented 20% of total revenues compared with 14% in 2000.

The increase in expenses from 2000 to 2001 was primarily the result of compensation and benefits, fixed asset disposals, a facility lease impairment, depreciation and amortization, software costs, and rent and facility costs. Compensation and benefits were higher primarily because the average number of personnel during 2001, particularly during the first half of the year, was greater than during 2000. Compensation also included severance costs related to our October 2001 reduction in force. As of December 31, 2001 our research and development headcount decreased 9% from 2000 due to consolidation of our Florida offices, the reduction in force, and concerted efforts to make the engineering organization more efficient using existing employee resources and skills. During the fourth quarter of 2001, after completing an inventory of our engineering-related fixed assets, we disposed of obsolete equipment and recorded a loss on the disposals. In the fourth quarter of 2001, we vacated our Largo, Florida facility and entered into a sublease agreement. We recorded an impairment charge for the ongoing shortfall between our remaining lease obligation and the sublease income, and wrote down the related fixed assets and leasehold improvements, totaling $2.7 million. Depreciation and amortization increased as a result of additional capital purchases to support development and testing of new products and features.

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These increases reflect our efforts to invest in key product development areas in order to retain our market share and be positioned to take advantage of future market opportunities. During 2000, we achieved technological feasibility of our Panorama EMS software and we capitalized costs associated with it. We completed and released the software during 2001, and accordingly began recording post-release costs to research and development expenses. Rent and related facility costs increased for some of our satellite engineering offices. Partially offsetting these increases were savings in outside services, performance-based compensation, direct materials, temporary help, and travel and entertainment. Various engineering projects involving outside services were completed by the end of 2000, and our utilization of outside services decreased in 2001, accordingly. Performance-based compensation was lower as a result of not meeting certain financial targets, primarily because of the general slowdown in our customers’ capital spending and the effect that had on our results of operations in 2001. In 2000, more direct materials were utilized for development and completion of our AccessMAX System 8, and 7.1A and 8.0 cards by the end of 2000. Direct material usage was lower in 2001 as new projects were in different development stages than in 2000 and required lower expenditure levels. In an effort to reduce our operating expenses in 2001, we eliminated virtually all of the temporary help positions that had been filled during 2000. Travel and entertainment expenses were lower due to cost containment efforts in 2001, reflecting our efforts to align our organization with current results of operations.

We believe rapidly evolving technology and competition in our industry necessitates the continued commitment of our resources to research and development to remain competitive. We plan to continue to support the development of new products and features, while seeking to carefully manage the rate of increase in associated costs through expense controls.

Sales and Marketing. In 2001, sales and marketing expenses increased by 4% to $49.4 million, and represented 15% of total revenues compared with 11% in 2000.

The increase in sales and marketing expenses from 2000 to 2001 was primarily the result of higher compensation and benefits, fixed asset disposals, distributor commissions, and depreciation. As part of our efforts to build support teams for our larger customers, we experienced a higher average number of sales and marketing employees during the first half of 2001 as compared with 2000. As the general slowdown in our customers’ capital spending and the effect that had on our results of operations became apparent, we implemented a reduction in force, resulting in an 11% decrease in sales and marketing headcount from December 31, 2000 to December 31, 2001. A higher average number of sales and marketing employees during the first half of 2001 over the levels in 2000 resulted in higher compensation and benefit costs. Included in compensation were severance costs arising from our October 2001 reduction in force.

During 2001, we reviewed some of our sales and marketing-related trade show, demo equipment, and demo inventory and disposed of idle and obsolete material. We experienced sales growth in certain international countries in which we utilize distributors, causing an increase in distributor commissions. We also incurred higher levels of depreciation as a result of purchasing additional software and technical equipment used by our sales, marketing, and customer service departments in supporting sales and marketing efforts and product releases. Cost containment efforts in 2001 reflected our efforts to align our organization with current results of operations. These efforts, along with the effects of the September 11 tragedies, caused a significant reduction in our travel and related expenses. As part of our efforts to balance our organization with our results of operations, we reduced our rate of employee hiring, which lowered hiring and relocation costs. The effect of our customers’ reduced capital spending in 2001 negatively impacted our results of operations and accordingly, we did not pay performance-based compensation due to our failure to meet certain financial targets. As a result of current economic pressures and our revised business plan, we reduced our participation in trade shows and decreased our advertising.

We believe we have aligned sales and marketing expenses with current results of operations. We plan to monitor and align future sales and marketing expenses with future operating results.

General and Administrative. In 2001, general and administrative expenses increased 28% to $37.3 million and represented 11% of total revenues as compared to 7% in 2000.

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The increase from 2000 to 2001 was mainly caused by an increase in provision for doubtful accounts in the first quarter of 2001 for a VAR. During the last quarter of 2001, we inventoried some of our general and administrative-related fixed assets and disposed of obsolete equipment, recording a loss on the disposals. Depreciation increased in 2001 from 2000 because leasehold improvements associated with buildings we moved into in mid-year 2000 were occupied for the entire year in 2001. Primarily as a result of a general slowdown in our customers’ capital spending patterns and the effect that had on our results of operations in 2001, we did not meet our internal financial targets and did not pay associated performance-based compensation. We made significant donations to education and housing programs in 2000, and although we have continued to make donations to various causes in 2001, we adjusted our expenditure levels to reflect our overall reduction in operating expenses. We also reduced the number of general and administrative employees by 13% from December 31, 2000 to December 31, 2001.

We believe we have aligned general and administrative expenses with current results of operations. We plan to monitor and align future general and administrative expenses with future operating results.

Other Income. In 2001, other income increased 497% to $307.2 million. Our application of SFAS No. 133 in 2001 resulted in the recognition of $285.7 million in unrealized gains on our Cisco investment and the related collars. In 2000, prior to adoption of SFAS No. 133, the unrealized gains and losses on the Cisco investment and related collars were netted and reflected in the carrying value of the investment, deferred tax liabilities, and accumulated other comprehensive income on our balance sheet. In 2000, we recorded $32.8 million from Marconi as settlement of outstanding litigation, and $10.1 million as a subsequent distribution payment. In 2001, we recognized $13.6 million as a distribution payment due from Marconi which was subsequently received in January 2002. The settlement of outstanding litigation calls for Marconi to meet specified distribution revenue goals in 2002; failure to do so makes them liable to us for a distribution payment for 2002. If this occurs, we will recognize the distribution payment in 2002 as non-operating income. In the fourth quarter of 2001, we recorded a $2.3 million impairment in our equity investment in a privately-held company as a result of the lowered valuation of the company. Macroeconomic conditions and an industry-wide capital spending slowdown have affected the availability of venture capital funding for, and valuations of, development stage companies.

Income Taxes. In 2001 and 2000, we recorded income taxes at an effective tax rate of 38% and 34%, respectively. The higher rate in 2001 was due to the effect of recognizing an investment gain related to our implementation of SFAS No. 133.

2000 Compared with 1999

Revenues. In 2000, revenues, including service revenues and royalties, increased by 41% over 1999 to $416.8 million. U.S. revenues comprised 86% of this increase with sales growth distributed across a broad range of customers and markets.

U.S. revenues grew 39% to $368.9 million in 2000, and represented 89% of total revenues compared with 89% in 1999. The increase in revenues from the U.S. was primarily the result of our increase in market share in a growing industry.

International revenues increased 52% to $47.9 million in 2000, and represented 11% of total revenues compared with 11% in 1999. The increase in international revenues was primarily due to growth in sales to South African, Caribbean, and Canadian customers.

For the year 2000, sales to Winstar and Sprint each accounted for 10% or more of total revenues. In 1999, Winstar and Sprint each accounted for 10% or more of total revenues. No other customer accounted for 10% or more of total revenues in either of these periods.

Gross Profit. In 2000, gross profit increased by 45% to $201.5 million. As a percentage of total revenues, gross profit margin represented 48% in 2000, compared with 47% in 1999. The increase in gross profit margin was primarily due to favorable customer mix, product mix, and cost reductions. Successful cost reduction initiatives in our manufacturing operations contributed to lower costs as a percentage of total revenues compared with 1999. In

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addition, the comparatively higher margin on sales of our Panorama EMS software product contributed to the increase in gross profit margin in 2000 compared with 1999.

Research and Development. In 2000, research and development expenses increased by 22% to $58.8 million, and represented 14% of total revenues compared with 16% in 1999.

The increase in spending was primarily due to increases in hiring, compensation and benefits expenses, and continued investment in new product development. As a result of the acquisition of GVN in May 2000, the number of employees in research and development increased by 27 employees.

The decrease in the ratio of expenses to total revenues compared with 1999 was primarily due to capitalizing Panorama EMS software development costs out of expenses into other assets in the fourth quarter of 2000. The amount represents development costs for the full year. These costs are being amortized over the life of the current software release which is estimated to be one year. In addition, we implemented a new product development methodology that significantly improved our ability to make priority decisions regarding new projects. The process involves cross-functional teams working together to evaluate viability of projects before development begins. As a result, we have experienced improved project management, more efficient use of resources, and product cost reductions.

Sales and Marketing. In 2000, sales and marketing expenses increased by 38% to $47.5 million, and represented 11% of total revenues compared with 12% in 1999.

The increase in sales and marketing expenses was mainly due to hiring, compensation and benefits expenses, primarily attributable to a growth in employee headcount, and to increased travel and entertainment expenses. These increases were partially offset by a decrease in distributor commissions as a smaller portion of our sales in 2000 were made through distributors.

General and Administrative. In 2000, general and administrative expenses decreased 14% to $29.2 million and represented 7% of total revenues compared with 11% in 1999.

This decrease in absolute dollars and as a percentage of total revenues was primarily attributable to a decrease in litigation expenses. In 1999, litigation expenses were primarily associated with the Marconi lawsuit which was settled in February 2000. This decrease was partially offset by increases in compensation and benefits due to an increase in headcount, and to corporate donations to educational institutions and other non-profit community organizations.

Other Income. In 2000, other income decreased $334.0 million or 87%. In 1999, other income included a $379.3 million gain for the step-up in basis of our investment in Cerent Corporation (Cerent) upon conversion to Cisco common stock. In 2000, other income included $32.8 million from Marconi as settlement of outstanding litigation, and $10.1 million as a subsequent distribution payment.

Income Taxes. In 2000 and 1999, we recorded income taxes at an effective rate of approximately 34% and 39%, respectively. The effective tax rate decreased primarily due to the gain arising from the conversion of our investment in Cerent into Cisco common stock in 1999.

Pro Forma Results

The following table provides a reconciliation of GAAP net income to pro forma net income. This information is provided to help clarify our ongoing, or core, business performance and highlight infrequent transactions (in thousands, except per share data):

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				Years Ended
				December 31,
				2001			2000			1999
				(restated)
GAAP net income				$	165,524		$	77,568		$	249,070
	Pro forma exclusions:
		Operating:
		Cost of sales for revenues not recognized			4,300			—			—
		Excess and obsolete inventory			18,850			—			—
		Purchase commitments			13,412			—			—
		Provision for doubtful accounts			9,251			—			—
		Severance and closure costs for reduction in force			4,935			—			—
		Loss on fixed asset disposals			1,412			—			—
		Acquisition-related costs			—			1,062			—
	Non-operating:
		Litigation settlement and distribution payments			(13,600	)		(42,886	)		—
		Conversion of investment into Cisco stock			—			—			(379,290	)
		Unrealized gain on Cisco investment			(285,729	)		—			—
		Investment impairment			2,275			—			—
			Total exclusions		(244,894	)		(41,824	)		(379,290	)
		Income tax effect			95,468			14,221			149,785
			Exclusions, net of tax		(149,426	)		(27,603	)		(229,505	)
Pro forma net income				$	16,098		$	49,965		$	19,565

Pro forma net income, a non-GAAP measure, is provided to help clarify our ongoing business performance. For pro forma purposes, the following amounts have been excluded:

2001

• A $4.3 million charge to cost of revenues is excluded from 2001 as these costs related to sales we did not recognize in the first quarter of 2001.

• An $18.9 million charge for excess and obsolete inventory, consisting of $18.8 million to cost of revenues, and $0.1 million to sales and marketing expenses, is excluded from 2001 to take into account the abrupt decline in customers’ spending, customer bankruptcy, changes in DSL rollout, and the resulting impact these had on custom inventory and obsolete inventory levels.

• A $13.4 million accrual for purchase agreements is excluded from 2001 cost of revenues to reflect the abrupt decline in customers’ capital spending and the impact this had on our forecasted needs and long-term agreements with vendors.

• A $9.3 million charge to provision for doubtful accounts is excluded from 2001 operating expenses to take into account the abrupt decline in a customer’s financial condition.

• A $4.9 million charge for facility lease impairment, fixed assets write-down, severance costs, and foreign sales office closures is excluded from 2001 operating expenses. Macroeconomic conditions and an industry capital spending slowdown forced us to take a 9% reduction in force in October, consolidate offices, and reduce sales and sales support to certain international locations to re-align our focus on our core customers, markets, and products.

• A $1.4 million charge for loss on disposal of information technology fixed assets is excluded from 2001 operating expenses as a result of an extensive fixed asset inventory.

• $13.6 million distribution payment from Marconi is excluded from 2001 non-operating income to omit the effect of non-core business income.

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• $285.7 million in unrealized gains on our Cisco investment are excluded from 2001 non-operating income to omit the effect of non-core business income.

• A $2.3 million charge for impairment on investment is excluded from 2001 non-operating income as a result of the investee company’s equity round financing and related valuation.

• The $95.5 million tax effect related to the amounts listed above is excluded from 2001 income taxes.

2000

• A $1.1 million charge related to acquisition of GVN is excluded from 2000 operating expenses to reflect the infrequent nature of this event.

• A $32.8 million Marconi litigation settlement gain is excluded from 2000 non-operating income to reflect the infrequent nature of this event.

• A $10.1 million distribution payment from Marconi is excluded from 2000 non-operating income to omit the effect of non-core business income.

• The $14.2 million tax effect related to the amounts listed above is excluded from 2000 income taxes.

1999

• $379.3 million unrealized gain related to the conversion of our investment in Cerent into Cisco common stock is excluded to reflect the infrequent nature of this event.

• The $149.8 million tax effect related to the unrealized gain is excluded from 1999 income taxes.

Liquidity and Capital Resources

Capital resources and liquidity, our ability to generate adequate amounts of cash to meet our needs as of December 31, 2001 and 2000 consisted of the following (in thousands):

	December 31,
	2001		2000
Cash and cash equivalents	$	39,528	$	8,368
Cisco marketable securities and related collars		670,489		658,961
Other marketable securities		245,725		207,824
Working capital, excluding cash and cash equivalents, marketable securities and related collars, and associated deferred tax assets and liabilities		72,941		124,249

As of December 31, 2001, cash, cash equivalents, and marketable securities totaled $955.7 million compared with $875.2 million as of December 31, 2000. At December 31, 2001, we recorded a value of $670.5 million in Cisco common stock and the related collars on our balance sheet. The value of our Cisco investment at December 31, 2001 consisted of $195.8 million in share value, and $474.7 million in collar value, as compared with a share value of $403.9 million and a collar value of $255.1 million as of December 31, 2000.

We currently own approximately 10.6 million shares of Cisco common stock. We protected the value of approximately 10.0 million of these shares in February 2000 using a costless collar with a three-year term. In May 2000, we also entered a similar three-year collar arrangement for the remaining shares of Cisco common stock. We pledged all of our Cisco stock to secure our obligations under the collar agreements. We have the ability to borrow up to the full present value of the $690.0 million floor value of the collars; we currently do not have any borrowings outstanding against the collars.

At maturity of these collars in February 2003 and May 2003, we may have a significant taxable gain depending on the market value of Cisco common stock at that time. The floor value of the collars at maturity is $690.0 million. We have recognized the accumulated gains on the share value and the collar value of our investment in non-operating income, and have recorded the related deferred tax liability. We will adjust the deferred tax liability for the potential additional taxable gain through maturity of the collars, and accordingly, there will be no income statement impact at maturity. The cash flow impact will depend on a number of factors including the market value of the Cisco shares at the time of maturity. We believe we have sufficient cash resources to meet any tax obligation, which could be as much as $265.0 million. We are currently evaluating various tax-efficient business opportunities for this investment.

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Operating activities in 2001 generated net cash of $79.4 million. This was primarily the result of net income, and adjustments for non-cash activities including: the unrealized gains resulting from SFAS No. 133 implementation and related tax expenses, increases in our accounts receivable collections, increase in inventory charges, and higher depreciation and amortization amounts. Days sales outstanding, or DSO, were 64 days at the end of 2001, compared with 77 days at the end of 2000. The decrease in DSO was primarily due to the write-off of the VAR receivable, increased shipping linearity, and improved domestic collections. Net cash of $62.5 million was used in investing activities in 2001, primarily for marketable securities purchases.

During the last half of 2001, we made a $6.5 million investment in a development stage company (company) and paid $6.0 million for an option to acquire the company. Under the terms of the purchase option agreement, we may, at our sole discretion, elect at any time through April 2, 2002 to acquire for cash or stock, all of the outstanding shares of the company. Our determination as to whether to exercise the option will be based upon our assessment of the company’s product development efforts and business prospects, as well as market conditions and other factors relevant to the company’s business. If we do not exercise the option to acquire the company, and the company has achieved specified engineering and product development milestones, certain shareholders of the company hold a put option giving them the right to require us to purchase from them a specified series of the company’s outstanding preferred stock for approximately $6.0 million. The put option becomes exercisable for 90 days after the expiration of our purchase option. If the put option is exercised, it may qualify as a triggering event for an impairment review of our investment in the company, and may result in a write-down and charge to our current results of operations.

We maintain an uncommitted bank facility for the issuance of commercial and standby letters of credit. As of December 31, 2001 we had approximately $2.7 million in letters of credit outstanding under this facility, including $1.0 million issued as a five-year deposit on one of our leased facilities.

We also maintain bank agreements with two banks under which we may enter into foreign exchange contracts up to $40.0 million. There are no borrowing provisions or financial covenants associated with these facilities. At December 31, 2001, there were approximately $1.2 million nominal amount foreign exchange contracts outstanding.

We entered into collar agreements on our Cisco shares. If we hold the stock until maturity of the agreements, we will receive a minimum of $690.0 million. At maturity, the other party to the agreements bears the risk of gains and losses on the Cisco shares. During the term of the agreement, collar inefficiencies and the remaining time until maturity can result in net gains or losses from marking the shares and the collars to market in any one quarter.

We seek to minimize our foreign currency risk by using forward contracts to hedge material accounts receivable and accounts payable. These contracts are marked to market and the gains and losses are reflected in our results of operations.

The following table sets forth, for the periods indicated, the commitments to make future minimum payments under contractual obligations (in thousands):

		Facility
		Operating
		Leases
2002		$	8,523
2003			8,247
2004			8,328
2005			8,215
2006			7,769
Thereafter			30,054
	Total	$	71,136

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We sublease three of our facilities; total future minimum lease payments have not been reduced by approximately $8.4 million of future minimum sublease payments to be received under non-cancelable subleases. We accrued $1.5 million to short term and long term liabilities for our Largo, Florida facility operating lease. The amount represents the present value of the loss we expect to incur for the ongoing shortfall between our sublease income and operating lease obligation. If the sublessee does not renew its lease agreement with us, and we are unable to enter into another agreement through the term of the lease obligation (March 31, 2007), the amount of the ultimate loss based on the lease could increase by up to $1.0 million before tax.

We believe our existing cash and marketable securities, available credit facilities and cash flows from operating and financing activities are adequate to support our financial resource needs, including working capital and capital expenditure requirements, and operating lease obligations, for the next twelve months.

SFAS No. 133 Implementation in 2001

On January 1, 2001, we adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities. SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The statement requires that we recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Additional discussion on the effect of SFAS No. 133 on our financial position and results of operations is included in Notes 1 and 3 of “Notes to Consolidated Financial Statements.”

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Item 8. Financial Statements and Supplementary Data

ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)

			Years Ended December 31,
			2001			2000		1999
			(restated)
Revenues			$	327,569		$	416,850	$	296,611
Cost of revenues				215,956			215,303		157,911
		Gross profit		111,613			201,547		138,700
Operating expenses:
	Research and development			64,169			58,828		48,343
	Sales and marketing			49,385			47,463		34,425
	General and administrative			37,323			29,172		33,947
		Total operating expenses		150,877			135,463		116,715
Operating income (loss)				(39,264	)		66,084		21,985
Other income (expense):
	Unrealized gains on Cisco investment			285,729			—		379,290
	Interest income			9,829			9,880		6,007
	Equity in losses of investee			(930	)		—		—
	Other			11,610			41,564		147
		Total other income, net		306,238			51,444		385,444
Income before income taxes				266,974			117,528		407,429
Income taxes				101,450			39,960		158,359
Net income			$	165,524		$	77,568	$	249,070
Basic net income per share			$	2.03		$	0.97	$	3.20
Shares used in basic per share computations				81,381			80,201		77,723
Diluted net income per share			$	1.98		$	0.91	$	3.05
Shares used in diluted per share computations				83,638			84,800		81,657

See accompanying notes to consolidated financial statements.

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ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

					December 31,
					2001			2000
					(restated)
ASSETS
	Current assets:
		Cash and cash equivalents			$	39,528		$	8,368
		Cisco marketable securities and related collars				670,489			658,961
		Other marketable securities				245,725			207,824
		Accounts receivable, less allowances of $952 and $1,948 in 2001 and 2000, respectively				58,528			99,099
		Inventories				29,711			59,356
		Other current assets				34,967			24,059
				Total current assets		1,078,948			1,057,667
	Property and equipment, net					55,406			66,699
	Other assets					13,056			10,809
				Total assets	$	1,147,410		$	1,135,175
LIABILITIES AND STOCKHOLDERS’ EQUITY
	Current liabilities:
			Accounts payable		$	9,969		$	19,920
			Accrued liabilities			73,550			48,349
			Deferred tax liabilities			221,132			244,675
				Total current liabilities		304,651			312,944
	Long-term liabilities					4,154			2,566
	Commitments and contingencies
	Stockholders’ equity:
			Preferred stock, $0.01 par value; 5,000,000 shares authorized; no shares issued and outstanding			—			—
			Common stock, $0.01 par value; 200,000,000 shares authorized; 82,113,830 and 80,729,972 shares issued and outstanding in 2001 and 2000, respectively			821			807
			Additional paid-in capital			287,937			268,003
			Notes receivable from stockholders			(56	)		(56	)
			Accumulated other comprehensive income			1,242			167,774
			Retained earnings			548,661			383,137
				Total stockholders’ equity		838,605			819,665
				Total liabilities and stockholders’ equity	$	1,147,410		$	1,135,175

See accompanying notes to consolidated financial statements

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ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
Years Ended December 31, 2001, 2000, and 1999
(in thousands, except share data)

													Notes			Accumulated					Total
		Common Stock					Deferred			Additional			Receivable			Other Com-					Stock-			Com-
							Stock			Paid-In			Stock-			prehensive			Retained		holders'			prehensive
		Shares			Amount		Compensation			Capital			holders			Income			Earnings		Equity			Income
Balances as of December 31, 1998			76,191,353		$	762	$	(84	)	$	211,392		$	(730	)	$	—		$	56,499	$	267,839		$	25,853
Exercise of common stock options and warrants			2,346,136			23		—			8,613			—			—			—		8,636
Issuance of common stock			16,276			—		—			3			—			—			—		3
Employee stock purchase plan purchases			219,318			2		—			2,245			—			—			—		2,247
Inclusion of GVN earnings for the period July 1 to December 31, 1998			—			—		—			881			—			—			—		881
Conversion of preferred stock into common stock in pooling			239,959			2		—			1,998			—			—			—		2,000
Conversion of debt and accrued interest into common stock			106,637			1		—			1,817			—			—			—		1,818
Cancelation of notes receivable from stockholder			—			—		—			—			489			—			—		489
Granting of stock options below intrinsic value			—			—		(395	)		395			—			—			—		—
Vesting of stock options below intrinsic value			—			—		308			513			—			—			—		821
Forfeiture of stock options			—			—		75			(75	)		—			—			—		—
Repurchase of common stock			(42,287	)		—		—			(11	)		—			—			—		(11	)
Tax benefit from option exercises			—			—		—			10,303			—			—			—		10,303
Net Income			—			—		—			—			—			—			249,070		249,070		$	249,070
Other comprehensive income:
	Net unrealized gain on available-for-sale securities(1)		—			—		—			—			—			100,968			—		100,968			100,968
Balances as of December 31, 1999			79,077,392			790		(96	)		238,074			(241	)		100,968			305,569		645,064		$	350,038
Exercise of common stock options and warrants			1,388,094			14		—			8,747			—			—			—		8,761
Employee stock purchase plan purchases			213,129			2		—			2,456			—			—			—		2,458
Conversion of preferred stock into common stock in pooling			56,240			1		—			1,248			—			—			—		1,249
Forfeiture of stock options			—			—		96			(96	)		—			—			—		—
Repurchase of common stock			(4,044	)		—		—			(1	)		—						—		(1	)
Payments of notes receivable from stockholders			—			—		—			—			102			—			—		102
Cancelation of notes receivable from stockholder			—			—		—			—			83			—			—		83
Cancelation of common stock			(839	)		—		—			—			—			—			—		—
Tax benefit from option exercises			—			—		—			17,575			—			—			—		17,575
Net Income			—			—		—			—			—			—			77,568		77,568		$	77,568
Other comprehensive income:
	Foreign exchange rate translation		—			—		—			—			—			(12	)		—		(12	)		(12	)
	Net unrealized gain on available- for-sale securities(1)		—			—		—			—			—			66,818			—		66,818			66,818
Balances as of December 31, 2000			80,729,972			807		—			268,003			(56	)		167,774			383,137		819,665		$	144,374
Exercise of common stock options			1,125,894			11		—			9,931			—			—			—		9,942
Employee stock purchase plan purchases			265,582			3		—			4,249			—			—			—		4,252
Cancelation of common stock			(7,618	)		—		—			—			—			—			—		—
Tax benefit from option exercises			—			—		—			5,754			—			—			—		5,754
Net income (restated)			—			—		—			—			—			—			165,524		165,524		$	165,524
Other comprehensive income:
	Foreign exchange rate translation		—			—		—			—			—			(4	)		—		(4	)		(4	)
	Reclassification of unrealized gain on trading securities		—			—		—			—			—			(166,528	)		—		(166,528	)		(166,528	)
Balances as of December 31, 2001 (restated)			82,113,830		$	821	$	—		$	287,937		$	(56	)	$	1,242		$	548,661	$	838,605		$	(1,008	)

		2000		1999
(1) Net unrealized gain on available-for-sale marketable securities		$	108,600	$	166,178
	Less: deferred income taxes related to the net unrealized gain		41,782		65,210
	Net unrealized gain on available-for-sale securities	$	66,818	$	100,968

See accompanying notes to consolidated financial statements.

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ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

					Years Ended December 31,
					2001			2000			1999
					(restated)
Cash flows from operating activities:
	Net income				$	165,524		$	77,568		$	249,070
	Adjustments to reconcile net income to net cash provided by operating activities:
			Unrealized gains on Cisco investment			(285,729	)		—			(379,290	)
			Tax related to SFAS No. 133 reclass of Cisco investment			106,776			—			—
			Reserve for inventory write-down and accrued purchase commitments			31,519			1,800			—
			Deferred income taxes			(23,488	)		(649	)		144,853
			Depreciation and amortization			19,422			15,544			13,187
			Allowances for uncollectible accounts and returns			10,261			600			(1,586	)
			Tax benefit from option exercises			5,754			17,575			10,303
			Other non-cash adjustments to operating income			4,906			83			489
			Write-down of impaired investment			2,275			—			—
			Stock based compensation			—			—			821
			Equity in losses of investee, net of tax			577			—			—
			Changes in operating assets and liabilities:
				Accounts receivable		30,310			(37,688	)		14,306
				Inventories		11,538			(23,585	)		12,914
				Other current assets		(5,366	)		(18,777	)		(1,451	)
				Long-term assets		1,368			927			(5,180	)
				Accrued and other liabilities		13,730			17,335			1,459
				Accounts payable		(9,951	)		52			7,186
				Net cash provided by operating activities		79,426			50,785			67,081
Cash flows from investing activities:
		Purchases of marketable securities				(627,140	)		(405,243	)		(491,534	)
		Sales of marketable securities				306,406			152,086			124,268
		Maturities of marketable securities				283,668			195,177			308,002
		Purchase of property and equipment				(12,921	)		(23,743	)		(15,865	)
		Other long term investments				(12,473	)		(4,635	)		3,063
				Net cash used in investing activities		(62,460	)		(86,358	)		(72,066	)
Cash flows from financing activities:
		Proceeds from exercise of common stock options and warrants, net				14,194			6,578			15,575
				Net cash provided by financing activities		14,194			6,578			15,575
Effect of adjustment to conform fiscal year ends in pooling transaction						—			5,991			—
Increase (decrease) in cash and cash equivalents						31,160			(23,004	)		10,590
Cash and cash equivalents, beginning of year						8,368			31,372			20,782
Cash and cash equivalents, end of year					$	39,528		$	8,368		$	31,372
Cash paid:
		Income taxes			$	4,784		$	19,093		$	2,399

See accompanying notes to consolidated financial statements.

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Advanced Fibre Communications, Inc.
Notes to Consolidated Financial Statements

Note 1. Description of Business and Summary of Significant Accounting Policies

Advanced Fibre Communications, Inc. (AFC) designs, manufactures, and provides a family of products and services that offer broadband, wideband, and narrowband solutions for the portion of the telecommunications network between the service provider’s central office and users’ businesses and homes, often referred to as the “local loop,” or “last mile.” Our OmniMAX™ product family is a multiservice broadband solution providing voice and data services for the telecommunications industry. Our product line consists of integrated multiservice access platforms, integrated access devices, optical network access concentrators, network services, network element management systems, environmentally hardened outdoor plant cabinets, indoor cabinets, and related service and transmission technologies. We sell our products primarily to telecommunications companies who install our equipment as part of their access networks. Our customers are national local exchange carriers, independent operating companies, large incumbent local exchange carriers, competitive local exchange carriers, and international carriers.

Fiscal Year

We operate on a 13-week fiscal quarter. In the year 2000, we operated on a 53-week fiscal year, with 14 weeks in the third quarter. We believe the effect of the additional week was not material to year-to-year comparisons of results of operations or cash flows.

Basis of Consolidation

The consolidated financial statements include the accounts of AFC and our subsidiaries. All significant intercompany balances and transactions have been eliminated.

Critical Accounting Policies and Estimates

Revenue Recognition, Allowances and Product Warranty. In compliance with the Securities and Exchange Commission (SEC) Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, and Statement of Financial Accounting Standards (SFAS) No. 48, Revenue Recognition When Right of Return Exists, we recognize revenue when the earnings process is complete. The earnings process is considered complete when persuasive evidence of an arrangement between a customer and AFC exists, when delivery and acceptance has occurred or services have been rendered, when pricing is fixed or determinable, when any right of return lapses or is reasonably estimable, and when collectibility is reasonably assured. We follow these same revenue recognition standards for sales made to our authorized distributors and sales representatives. AICPA Statements of Position 97-2, Software Revenue Recognition, and 98-9, Modification of SOP 97-2, Software Recognition, With Respect to Certain Transactions, generally require revenues earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. Revenues allocated to maintenance are recognized ratably over the maintenance term. Revenues from service activities are generally recognized ratably over the service period. Allowances for returns are established based on experience. A provision for estimated warranty costs is established at the time of sale and adjusted periodically based on experience.

Research and Development and Software Development Costs. We follow SFAS No. 2, Accounting For Research and Development Costs, and charge all research and development costs to expense as incurred. We follow SFAS No. 86, Accounting For the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. Costs incurred for the development of computer software and enhancements to existing software products that will be sold, leased, or otherwise marketed are capitalized when technological feasibility has been established. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated future revenues and changes in technologies. Costs that are capitalized include direct labor and

37

related overhead. Amortization of capitalized software development costs begins when the product is available for general release. Amortization is based on the straight-line method. Unamortized capitalized software development costs determined to be in excess of net realizable value of the product are expensed immediately.

Allowance for Doubtful Accounts. We have an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make payments to our accounts receivable. We base our allowance on periodic assessment of our customers’ liquidity and financial condition through credit rating agencies, financial statement review, and historical collection trends. Additional allowances may be required if the liquidity or financial condition of our customers were to deteriorate, resulting in an impairment in their ability to make payments.

Inventories and Reserve for Excess and Obsolete Inventories. Inventories include material, labor and overhead and are valued at the lower of cost (first-in, first-out basis) or market. A reserve for excess and obsolete product and an accrual for purchase commitments have been established; the balances are assessed continuously, and adjusted on a quarterly basis.

Other Significant Accounting Policies

Cash and Cash Equivalents. We consider all highly liquid investments in debt instruments with original maturities of three months or less to be cash equivalents. Cash and cash equivalents are generally invested in money market funds.

Marketable Securities and Investments. Our marketable securities are reported at fair value, and are classified as trading or available-for-sale. At December 31, 2000, all marketable securities were classified as available-for-sale. On January 1, 2001, we reclassified our investment in stock of Cisco Systems, Inc. (Cisco) to trading, and thereafter periodic changes in its fair value are included in non-operating income or expense.

We have equity investments in non-publicly traded development-stage companies accounted for under the cost method. Our ownership in each of these companies is less than 20%. We hold one seat on the board of directors of one of these companies. However, we do not have significant influence over the operating or financial policies of that company.

Property and Equipment. Property and equipment are recorded at cost. We compute depreciation using the straight-line method over the estimated useful lives, generally three years for computers and internal use software, and seven years for office and engineering equipment, furniture, and fixtures.

Long-Lived Assets. We evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the potential future income expected to be generated by the asset. If an asset is considered to be impaired, it is written down to its market value, which is assessed based on factors specific to the type of asset.

Income Taxes. We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

Equity-Based Compensation Plans. We follow Accounting Principles Board (APB) opinion No. 25, Accounting for Stock Issued to Employees, and we account for equity-based compensation plans with employees and non-employees of the board of directors using the intrinsic value method.

Derivative Instruments and Hedging Activities

In 2001, we adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, which require that we recognize all derivatives as either assets or liabilities in the balance sheet and that we measure those instruments at fair value. We also use foreign exchange contracts to offset gains and losses on exchange rate fluctuations against gains and losses on assets or liabilities hedged.

38

Net Income Per Share

Basic net income per share is computed using the weighted average number of shares of common stock outstanding. Diluted net income per share is computed using the weighted average number of shares of common stock, and common equivalent shares from options to purchase common stock and contributions to the Employee Stock Purchase Plan using the treasury stock method, when dilutive.

Foreign Currency Translation

Operations conducted in our foreign offices are transacted in local currencies. Assets and liabilities are translated into U.S. dollars using the translation rate at the balance sheet date, and income and expense amounts are translated at weighted average exchange rates during the year. Translation adjustments are recorded to other comprehensive income in the equity section of the balance sheet.

Certain Risks and Concentrations

Cash equivalents and trade accounts receivable are the primary financial instruments exposing us to credit risk. To reduce credit risk, we perform ongoing credit evaluations of our customers’ financial condition. In some cases, we may require customer prepayment, bank guarantees, or letters of credit and, if necessary, we put customers on credit limits. We maintain adequate allowances for potential credit losses. Our customers are concentrated in the public carrier telecommunications industry. Our five largest customers accounted for 43% and 30% of our gross accounts receivable at December 31, 2001 and 2000, respectively. Although our largest customers have varied from period to period, we anticipate that receivables in any given period will continue to be concentrated to a significant extent among a small number of customers. Recent severe financial problems affecting the telecommunications industry in general may continue to result in slower payments or defaults on accounts receivable. To reduce the currency risk with respect to foreign receivables, we use foreign exchange hedging contracts in those situations where it is deemed warranted.

Our products are concentrated in the telecommunications equipment market, which is highly competitive and subject to rapid change. Significant technological changes in the industry could adversely affect our operating results. Our inventories include components that may be specialized in nature, and subject to rapid technological obsolescence. We actively manage our inventory levels, and we consider technological obsolescence and potential changes in product demand based on macroeconomic conditions when estimating required allowances to reduce recorded inventory amounts to market value. Such estimates could change in the future.

Reclassifications and Restatements

Certain prior year amounts have been reclassified to conform with the current year’s presentation. In addition, as discussed in Note 2 of this Annual Report on Form 10-K/A, the results for the year ended December 31, 2001 have been restated.

All historical financial information was restated to reflect the acquisition of GVN Technologies, Inc. (GVN) in the second quarter of fiscal 2000, which was accounted for as a pooling of interests. See Note 11 for additional information on our acquisition of GVN.

SFAS No. 133 Implementation in 2001

On January 1, 2001 we implemented SFAS No. 133, as amended. There was no transition adjustment upon implementation. Prior to our implementation of SFAS No. 133, we classified our Cisco investment as available-for-sale, and recorded unrealized gains and losses on the investment, the costless collar agreements related to the investment, and the associated tax effects, in accumulated other comprehensive income on the balance sheet. Upon implementation of SFAS No. 133, we reclassified these securities from available-for-sale to trading securities, and recognized the accumulated gains on the share value and the collar value in non-operating income. The related tax effects were recorded as a component of income tax expenses.

39

The ongoing effects of SFAS No. 133 on the financial statements will depend on future market conditions. Changes in value of our investment and the costless collars are, and will continue to be, reported in current period earnings.

Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, and specifies criteria for recognizing intangible assets acquired in a business combination. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. Intangible assets with finite useful lives will continue to be amortized over their respective estimated useful lives. SFAS No. 142 became effective for us in January 2002. Our implementation of these statements will not have a material impact on our results of operations or financial position.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 143, Accounting for Asset Retirement Obligations, and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 143 requires that the fair value of an asset retirement obligation be recorded as a liability in the period in which a legal obligation is incurred. SFAS No. 143 is effective January 1, 2003. SFAS No. 144 establishes one accounting model to be used for long-lived assets to be disposed of by sale, and broadens the presentation of discounted operations to include more disposal transactions. SFAS No. 144 supercedes both 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 Opinion No. 30, Reporting the Results of Operations. SFAS No. 144 became effective for us in January 2002. We do not expect the implementation of these statements to have a material impact on our results of operations and financial position.

Note 2. Adjustment to Prior Period Results

Correction. We restated our financials statements for the year ended December 31, 2001 due to an error in our accounting for an operating lease and related fixed assets upon vacating an engineering facility. The adjustment to operating results for the year ended December 31, 2001 was a $1.7 million after-tax charge ($2.7 million on a pre-tax basis) that should have been taken in the fourth quarter of 2001. During the fourth quarter of 2001, we vacated an engineering facility in Largo, Florida, and entered into a sublease agreement for the entire space. Upon a subsequent review of our facilities, we realized that, in accordance with generally accepted accounting principles, we should have recognized a $1.5 million pre-tax impairment charge in the fourth quarter of 2001 for the ongoing shortfall between our sublease income and our operating lease obligation. In addition, we should have written off the $1.2 million pre-tax net book value of the related leasehold improvements, furniture, fixtures, and telephone equipment.

The adjustment had no impact on revenues or cash flows for the restated period.

Retroactive equity method of accounting for our investment in AccessLan Communications, Inc. (AccessLan). In the latter half of 2001, we invested $12.5 million in AccessLan, which we accounted for using the cost method of accounting. Effective April 1, 2002, upon exercise of our option to purchase the remaining interests in AccessLan, we changed our method of accounting from the cost method to the equity method. We retroactively applied the equity method for our ownership interest in AccessLan from the date of our initial investment as required under Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. This resulted in reductions to net income and retained earnings of $0.6 million for the year ended December 31, 2001.

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The consolidated financial statements have been restated to reflect the following adjustments for the year ended December 31, 2001:

• A $2.7 million increase to research and development expenses for the lease impairment and the related write-off of leasehold improvements and fixed assets

• A $0.9 million increase in non-operating expenses to record our equity in AccessLan’s losses for the period during which we held an investment in AccessLan

• Tax benefit of $1.4 million associated with the above items

At December 31, 2001, retained earnings decreased by approximately $2.3 million as a result of these adjustments. Other balance sheet lines that were impacted were:

• Other current assets for the reduction in our investment in AccessLan

• Property and equipment for the write-off of the Largo facility leasehold improvements and fixed assets

• Accrued liabilities for the effect on current taxes payable and the current portion of the lease impairment charge

• Long term liabilities for the long term portion of the lease impairment charge

• Deferred tax liabilities for the tax impact of the Largo facility impairment charge and write-off

The consolidated financial statements as of, and for the year ended, December 31, 2001, have been restated to include the effects of the adjustments, as follows:

Consolidated Statement of Income:

		Year ended
		December 31, 2001
					as previously
		restated			reported
		(in thousands, except per share data)
Research and development			64,169			61,435
	Operating expenses		150,877			148,143
Equity in losses of investee			(930	)		—
	Other income, net		306,238			307,168
Income before income taxes			266,974			270,638
Income taxes			101,450			102,842
Net income		$	165,524		$	167,796
Basic earnings per share		$	2.03		$	2.06
Diluted earnings per share		$	1.98		$	2.01

Consolidated Balance Sheet:

		December 31, 2001
				as previously
		restated		reported
		(in thousands)
Other current assets		$	34,967	$	35,897
	Total current assets		1,078,948		1,079,878
Property and equipment, net			55,406		56,608
	Total assets		1,147,410		1,149,542
Accrued liabilities			73,550		73,624
Deferred tax liabilities			221,132		222,176
	Total current liabilities		304,651		305,769
Long term liabilities			4,154		2,896
Retained earnings			548,661		550,933
	Total stockholders’ equity		838,605		840,877
	Total liabilities and stockholders’ equity		1,147,410		1,149,542

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Note 3. Marketable Securities

Marketable securities are valued at fair market value, and are comprised of the following (in thousands):

		December 31,
		2001		2000
Corporate equity securities		$	670,489	$	658,961
Municipal debt securities			241,725		202,334
Corporate debt securities			4,000		5,490
	Total marketable securities	$	916,214	$	866,785

Corporate Equity Securities

On November 1, 1999, we acquired approximately 10.6 million shares of Cisco common stock (adjusted for a 2-for-1 stock split) as a result of the completion of Cisco’s acquisition of Cerent Corporation (Cerent) and resulting exchange of our Cerent stock for Cisco’s common stock. We recorded a gain for the step-up in basis of $379.3 million before taxes at the acquisition date.

In February and May 2000, we entered into hedging transactions structured as costless collar agreements, with terms of approximately three years, to minimize the potential market risk on the Cisco stock we own. The collars provide us with a floor value of approximately $690.0 million for the shares if held to maturity. We are able to borrow up to the full present value of the floor value of the collars; we currently do not have any borrowings outstanding against them. Gains and losses on our investment in Cisco stock will be partially offset by gains and losses in the costless collar agreements to the extent that the Cisco stock trades below $65 per share or above $99 per share.

For the years ended December 31, 2000 and 1999, we deferred unrealized gains on our Cisco investment of $107.6 million and $166.6 million, respectively, and reported them in stockholders’ equity in accumulated other comprehensive income, net of deferred income taxes. Upon implementation of SFAS No. 133 in January 2001, we reclassified these securities from available-for-sale to trading securities, and recognized the accumulated gains of $19.1 million share value and $255.1 million collar value in non-operating income. The related tax effects of $106.8 million were recorded as a component of income tax expenses. This reclassification resulted in a decrease of accumulated other comprehensive income of $167.4 million, net of taxes.

Debt Securities

At December 31, 2001, our debt securities portfolio contained a $1.4 million unrealized gain, compared with a $0.6 million unrealized loss at December 31, 2000. The fair value of securities maturing in one year or less and those maturing between one year and five years was $145.0 million and $100.7 million, respectively, as of December 31, 2001.

Note 4. Inventories

The major components of inventories are as follows (in thousands):

		December 31,
		2001		2000
Raw materials		$	12,909	$	23,741
Work-in-progress			993		1,746
Finished goods			15,809		33,869
	Total inventories	$	29,711	$	59,356

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Note 5. Property and Equipment

A summary of property and equipment follows (in thousands):

		December 31,
		2001		2000
		(restated)
Furniture and fixtures		$	15,273	$	13,560
Computer, software, and office equipment			33,031		36,071
Engineering equipment			50,221		53,777
			98,525		103,408
Less: accumulated depreciation			43,119		36,709
	Property and equipment, net	$	55,406	$	66,699

At December 31, 2001 engineering equipment included $2.0 million of inventory that was transferred to fixed assets used to build test equipment for our operations. The restatement of the December 31, 2001 financial statements included a write-off of the net book value of property and equipment housed in our Largo, Florida engineering facility which we subleased for a three-year term in December 2001. The amount of the write-off was $1.2 million.

Note 6. Accrued Liabilities

A summary of accrued liabilities follows (in thousands):

		December 31,
		2001		2000
		(restated)
Income and sales taxes		$	24,052	$	11,866
Accrual for purchase commitments			14,026		1,800
Warranty			12,639		11,597
Salaries and benefits			10,201		11,055
Other accruals			8,690		12,014
Deferred revenues			3,942		17
	Total accrued liabilities	$	73,550	$	48,349

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Note 7. Income Taxes

A summary of the components of income taxes (benefit) follows (in thousands):

							Charge in
							Lieu of
							Income
		Current		Deferred(1)			Taxes(2)		Total
Year ended December 31, 2001 (restated):
	Federal	$	7,215	$	78,318		$	5,204	$	90,737
	State		5,203		4,960			550		10,713
Income taxes		$	12,418	$	83,278		$	5,754	$	101,450
Year ended December 31, 2000:
	Federal	$	16,080	$	1,334		$	15,494	$	32,908
	State		6,954		(1,983	)		2,081		7,052
Income taxes (benefit)		$	23,034	$	(649	)	$	17,575	$	39,960
Year ended December 31, 1999:
	Federal	$	2,986	$	121,787		$	9,175	$	133,948
	State		217		23,066			1,128		24,411
Income taxes		$	3,203	$	144,853		$	10,303	$	158,359

(1)

Deferred tax expenses exclude deferred taxes on the unrealized gains and losses on available-for-sale marketable securities that is included in equity in accumulated other comprehensive income. For 2001, the deferred portion of the tax provision includes $106.8 million that was reclassed from accumulated other comprehensive income to tax expenses upon our implementation of SFAS No. 133 in January 2001. Excluding this amount, the deferred portion of the tax provision would be a benefit, or decrease, of $23.5 million.

(2)

The charge in lieu of income taxes results from the tax benefit of stock option exercises.

Income taxes differ from the amounts computed by applying the U.S. federal statutory tax rate of 35% in each of the years ended December 31, 2001, 2000, and 1999 to income before income taxes as follows (in thousands):

		Years Ended December 31,
		2001			2000			1999
		(restated)
Income taxes at statutory rate		$	93,441		$	41,135		$	142,600
State taxes, net of federal benefit			6,963			4,583			16,050
Current losses and temporary differences for which no benefit was recognized			1,390			1,038			774
Foreign sales corporation benefit			—			(184	)		(114	)
Utilization of tax credits			(1,632	)		(2,250	)		(1,450	)
Tax exempt interest			(2,044	)		(2,761	)		(1,400	)
Change in valuation allowance			—			—			(1,668	)
Other			3,332			(1,601	)		3,567
	Income taxes	$	101,450		$	39,960		$	158,359

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'

The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows (in thousands):

		December 31,
		2001			2000
		(restated)
Deferred tax assets:
	Allowances and accruals	$	29,213		$	15,675
	Research tax credit carry-forwards		4,913			1,513
	Net operating loss carry-forwards		5,367			—
	Unrealized loss on marketable securities		595			239
	Gross deferred tax assets		40,088			17,427
Deferred tax liabilities:
	Recognized gain on marketable securities		(254,217	)		(147,687	)
	Unrealized gain on marketable securities		(765	)		(107,230	)
	Net book value over net tax basis		(6,238	)		(7,185	)
	Gross deferred tax liabilities		(261,220	)		(262,102	)
	Net deferred tax liabilities	$	(221,132	)	$	(244,675	)

As of December 31, 2001, we had research credit carry-forwards for federal income tax purposes of approximately $1.6 million, and for California income tax return purposes of approximately $5.0 million. These research tax credits are available to reduce future income subject to income taxes, and will carry forward indefinitely until utilized. For the year 2001 we had federal net operating loss carry-forwards in the amount of approximately $14.0 million. This net operating loss may be utilized to offset future income tax expenses, and will expire in 2021.

Note 8. Bank Borrowings

We maintain an uncommitted bank facility for the issuance of commercial and standby letters of credit. As of December 31, 2001 we had approximately $2.7 million in letters of credit outstanding under this facility, including $1.0 million issued as a five-year deposit on one of our leased facilities.

We also maintain bank agreements with two banks under which we may enter into foreign exchange contracts for up to $40.0 million. There are no borrowing provisions or financial covenants associated with these facilities. At December 31, 2001, there were approximately $1.2 million nominal amount foreign exchange contracts outstanding.

In February and May 2000, we entered into hedging transactions structured as costless collar agreements to minimize the impact of potential adverse market risk on the Cisco shares we own. We are able to borrow up to the full present value of the floor value of the collars; we currently do not have any borrowings outstanding against them.

Note 9. Stockholders’ Equity

Common Stock Options

Our 1996 Stock Incentive Plan (the 1996 Plan) is the successor equity incentive program to our 1993 Stock Option/Stock Issuance Plan (the Predecessor Plan). The share reserve automatically increases on the first trading day of each calendar year by an amount equal to 3% of the number of shares of common stock outstanding on the last trading day of the immediately preceding calendar year. As of December 31, 2001, 26,178,848 shares of common stock were authorized for issuance under the 1996 Plan. There are no remaining shares authorized for issuance under the Predecessor Plan as of December 31, 2001.

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• Options issued prior to 1997 generally vest 20% on the first anniversary of the grant date and ratably over the following 48 months

• Options issued after 1997 to new employees generally vest 25% on the first anniversary of the grant date and ratably over the following 36 months

• Options issued in 1997 through 1999 to employees with at least one year of service generally vest ratably over 48 months from the date of grant

• Options issued after 1999 to employees with at least one year of service generally vest ratably over 36 months from the date of grant

• Options issued to non-employee directors of AFC’s board generally vest 33% on the first anniversary of the grant date and ratably over the following 24 months

• Options expire ten years from the date of grant and are normally canceled three months after termination of employment

A summary of the stock option plan activity is presented below:

	Years Ended December 31,
	2001					2000					1999
				Weighted					Weighted					Weighted
				Average					Average					Average
				Exercise					Exercise					Exercise
Options	Shares			Price		Shares			Price		Shares			Price
Outstanding at beginning of year		10,629,510		$	23.16		9,187,496		$	14.53		8,171,547		$	6.62
Granted		5,920,899			17.91		4,150,386			36.72		5,148,606			21.11
Exercised		(1,125,894	)		8.89		(1,332,154	)		6.51		(1,727,436	)		4.96
Canceled		(1,162,936	)		27.57		(1,376,218	)		22.57		(2,405,221	)		8.48
Outstanding at end of year		14,261,579		$	21.75		10,629,510		$	23.16		9,187,496		$	14.53
Exercisable at end of year		6,100,525		$	20.58		3,219,604		$	15.11		2,145,102		$	6.64
Available for grant		1,452,320					3,788,384					6,558,508
Weighted average fair value of options granted during the year				$	11.61				$	25.20				$	13.27

The following table summarizes information about stock options outstanding as of December 31, 2001:

		Options Outstanding						Options Exercisable
				Weighted
				Average		Weighted				Weighted
				Remaining		Average				Average
Range of Option				Contractual		Exercise				Exercise
Exercise Prices		Shares		Life (Years)		Price		Shares		Price
	$0.01 - $7.88		2,086,435		5.9	$	6.71		1,646,006	$	6.48
	8.03 - 9.56		693,566		7.0		8.63		486,909		8.66
	9.69 - 16.31		1,550,651		8.1		15.11		1,046,940		15.75
	16.50 - 16.63		2,404,855		9.3		16.63		528,951		16.62
	16.81 - 19.67		2,084,396		9.8		19.32		88,525		18.09
	19.69 - 22.15		925,532		8.9		20.74		305,635		21.15
	22.44 - 28.63		1,838,726		8.8		24.52		645,251		24.81
	29.13 - 39.75		619,722		8.3		35.40		294,665		35.36
	40.31 - 44.38		933,212		8.1		43.90		581,199		44.01
	45.13 - 81.31		1,124,484		8.4		52.73		476,444		53.15
	$0.01 - $81.31		14,261,579		8.4	$	21.75		6,100,525	$	20.58

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Employee Stock Purchase Plan

Under the 1996 Employee Stock Purchase Plan (the Purchase Plan) we are authorized to issue up to three million shares of common stock to eligible employees of AFC and participating subsidiaries. The Purchase Plan has been implemented in a series of successive offering periods, each with a maximum duration of 24 months. Eligible employees can enter on the start date of any offering period or on any subsequent semi-annual entry date. Effective February 1, 2001 the maximum contribution rate allowed under the Purchase Plan was increased from 10% to 15%. The purchase price of the stock is the lower of 85% of 1) the fair market value of the common stock on the participant’s entry date (strike price), or 2) the fair market value on the semi-annual purchase date. Purchase dates are January 31 and July 31 of each year, or the closest business day preceding those dates when the purchase date falls on a non-business day. If the fair market value on any purchase date during the existing offering period is less than the strike price established at the beginning of the offering period, a new offering period will commence. The current offering period commenced on February 1, 2002 and is scheduled to continue through January 31, 2004.

A total of 265,582 shares of common stock with a weighted average fair value of $16.01 per share were purchased in 2001. At December 31, 2001, 1,976,552 shares remained available for issuance. A total of 133,940 shares with a weighted average fair value of $14.75 was purchased on January 31, 2002 using contributions withheld during the period from August 1, 2001 to January 31, 2002.

Pro Forma Fair Value Information

We apply the intrinsic value method of accounting prescribed by APB Opinion No. 25 for our stock-based compensation plans. If compensation cost for our stock-based compensation plans had been determined in accordance with the fair value approach set forth in SFAS No. 123, Accounting for Stock-Based Compensation, our net income and earnings per share would have been reduced to the pro forma amounts as follows (in thousands, except per share data):

		2001		2000		1999
		(restated)
Net income:
	As reported	$	165,524	$	77,568	$	249,070
	Pro forma		106,156		31,349		223,576
Basic net income per share:
	As reported	$	2.03	$	0.97	$	3.20
	Pro forma		1.30		0.39		2.88
Diluted net income per share:
	As reported	$	1.98	$	0.91	$	3.05
	Pro forma		1.27		0.37		2.74

The fair value of option grants in 2001, 2000, and 1999 were estimated on the date of grant using the Black-Scholes option-pricing model, assuming no dividend yield, with the following weighted average assumptions:

				Risk-free			Expected Life
	Volatility			Interest Rate			(Years)
2001		100	%		4.31	%		3
2000		100			5.89			3
1999		90			5.81			4

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Pro forma compensation costs related to the Purchase Plan were recognized for the fair value of the employees’ purchase rights, as of the date of purchase using the Black-Scholes option-pricing model. The following weighted average assumptions were used, assuming no dividend yield:

Semi-Annual				Risk-free			Expected Life
Purchase Dates	Volatility			Interest Rate			(Months)
January 2002		100	%		4.8	%		13
July 2001		100			4.8			13
January 2001		97			4.9			17
July 2000		97			4.9			17
January 2000		85			4.9			8
July 1999		85			4.9			8
January 1999		75			5.8			14

Stockholders’ Rights Plan

In May 1998, our board of directors adopted a Stockholders’ Rights Plan. This plan is designed to deter any potential coercive or unfair takeover tactics in the event of an unsolicited takeover attempt. In accordance with the plan, purchase rights were distributed as a dividend in May 1998 at the rate of one right for each share of common stock of AFC. Each right entitles stockholders to buy a unit equal to one one-thousandth of a share of our Series A Junior Participating Preferred Stock for $225.00 per unit, subject to anti-dilution adjustments. The rights will be exercisable only if a person or a group acquires, or announces a tender or exchange offer to acquire, 15% or more of our common stock.

In the event the rights become exercisable, the rights plan allows for AFC stockholders to acquire stock of the surviving corporation, whether or not AFC is the surviving corporation, having a value twice that of the exercise price of the rights. The rights will expire in May 2008 and are redeemable for $0.001 per right at the approval of our board of directors.

Net Income Per Share

The computation of shares and net income amounts used in the calculation of basic and diluted net income per share are as follows (in thousands, except per share data):

	Years Ended December 31,
	2001		2000		1999
	(restated)
Net income	$	165,524	$	77,568	$	249,070
Shares used in basic per share calculations - weighted average common shares outstanding for the period		81,381		80,201		77,723
Weighted average number of shares of dilutive options and warrants		2,257		4,599		3,934
Shares used in diluted per share calculations		83,638		84,800		81,657
Basic net income per share	$	2.03	$	0.97	$	3.20
Diluted net income per share	$	1.98	$	0.91	$	3.05

Options to purchase 5,504,953, 842,653, and 773,219 shares of common stock which were outstanding at December 31, 2001, 2000, and 1999, respectively, were excluded from the computation of diluted net income per share because the exercise prices for the options were greater than the respective average market price of the common shares, and their inclusion would be antidilutive.

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Note 10. Commitments and Contingencies

Leases

Office space and certain equipment are leased under operating leases. Future minimum payments under operating leases with an initial term of more than one year as of December 31, 2001 are summarized as follows (in thousands):

2002	$	8,523
2003		8,247
2004		8,328
2005		8,215
2006		7,769
Thereafter		30,054
Total minimum lease payments	$	71,136

We sublease three of our facilities. Total future minimum lease payments have not been reduced by approximately $8.4 million of future sublease payments to be received under non-cancelable subleases. We accrued $1.5 million to short term and long term liabilities for our Largo, Florida facility operating lease. The amount represents the present value of the loss we expect to incur for the ongoing shortfall between our sublease income and operating lease obligation. If the sublessee does not renew its lease agreement with us, and we are unable to enter into another sublease agreement through the term of the lease obligation (March 31, 2007), the amount of the ultimate loss based on the lease could increase by up to $1.0 million before tax. Total sublease payments received in 2001 and 2000 were $1.5 million and $0.6 million, respectively. We did not have sublease income in 1999. Total rent expenses for all operating leases were $8.6 million, $7.9 million, and $6.6 million for the years ended December 31, 2001, 2000, and 1999, respectively.

Employee Benefit Plan

We have a 401(k) plan (the Plan) under which employees may contribute a portion of their compensation on a tax-deferred basis to the Plan. We contributed to the Plan on a matching basis up to a maximum of $5,250 per employee during 2001. Participants in the Plan are neither required, nor solicited by us, to elect a stock fund that contains AFC common stock. We act as the Plan administrator. During 2001, 2000, and 1999, we contributed $2.6 million, $2.1 million, and $1.8 million respectively, to the Plan.

Purchase Agreements with Contract Manufacturers

We have long-term purchase agreements with certain contract manufacturers, or CMs, which allow us to negotiate volume discounts, and help assure us of a steady supply of components that fully comply with all applicable specifications for such components that we need. The agreements require the CMs to purchase component parts to be used in the manufacture of product to our specifications, and authorize the CMs to purchase such parts in accordance with agreed upon lead times. While the agreements do not obligate us to purchase any specified minimum volume, we provide CMs with forecasts of our expected needs, and we issue purchase orders covering a certain period of time for specific quantities. In the event we terminate the manufacturing agreement with a CM, cancel a purchase order previously issued to and accepted by a CM, or no longer have need for components which a CM has purchased on our behalf, we agree to compensate the respective CM as follows:

• for any materials it has purchased for use in the manufacture of our products bought within standard lead times, or otherwise, if we granted approval of the purchase

• for work in process, and

• for all finished products manufactured for us that are in the CM’s possession.

49

Under such agreements, our maximum liability as of December 31, 2001 was approximately $26.0 million, of which $14.0 million was accrued on the balance sheet.

Litigation

Securities Litigation: Various class action lawsuits were filed in the U.S. District Court for the Northern District of California against AFC and certain of our current and former officers and directors between July 2, 1998 and August 17, 1998. On November 2, 1998, these lawsuits were consolidated by the court, and a Consolidated Amended Class Action Complaint (CAC) was served on January 27, 1999. In addition, on November 2, 1998, this consolidated class action was coordinated with two individual actions filed by the State Board of Administration of Florida, and by an individual, John Earnest. These three complaints allege various federal and state securities law violations for the period March 25, 1997 through and including June 30, 1998, and seek an unspecified amount of damages.

Defendants filed motions to dismiss the CAC and the two individual complaints. On March 24, 2000, the court granted defendants’ motions to dismiss with leave to amend. On June 2, 2000, plaintiffs in the consolidated class action served their Second Amended Class Action Complaint (SAC). On June 14, 2000, the individual plaintiffs each respectively filed second amended complaints. On June 30, 2000, defendants moved to dismiss the SAC. By stipulated order, the filing of motions was stayed in the two individual cases pending resolution of the defendants’ motion to dismiss. On February 15, 2001, the court granted the motion to dismiss the SAC with leave to amend. On March 19, 2001, plaintiffs in the consolidated class action served their Third Amended Class Action Complaint (TAC). Defendants moved to dismiss the TAC, and, on May 29, 2001, the court granted in part and denied in part this motion with leave to amend. On July 2, 2001, plaintiffs in the consolidated class action served their Fourth Amended Class Action Complaint (FAC). In addition, on July 12, 2001, the individual plaintiffs each respectively served third amended complaints. Defendants moved to dismiss the FAC, and, on August 21, 2001, the court granted in part and denied in part this motion. On September 13, 2001, defendants filed an answer to the remaining allegations in the FAC. On October 15, 2001, defendants filed motions to dismiss the individual third amended complaints, and, on December 19, 2001, the court granted defendants’ motions to dismiss with leave to amend. On or about January 17, 2002, the individual plaintiffs each respectively filed and served fourth amended complaints. On February 15, 2002, defendants filed motions to dismiss these fourth amended complaints. Limited discovery has occurred.

Based on current information, we believe the lawsuits are without merit and that we have meritorious defenses to the actions. Accordingly, we are vigorously defending the litigation. Depending on the amount and timing, an unfavorable resolution of this matter could materially affect our future results of operations or cash flows in a particular period. In addition, although it is reasonably possible we may incur a loss upon the conclusion of this claim, an estimate of any loss or range of loss cannot be made. No provision for any liability that may result upon adjudication has been made in the consolidated financial statements. In connection with these legal proceedings, we expect to incur substantial legal and other expenses. Stockholder suits of this kind are highly complex and can extend for a protracted period of time, which can substantially increase the cost of such litigation and divert the attention of management from the operations of AFC.

Statements regarding the potential impact of pending litigation are forward-looking. They reflect our current view with respect to future events, and involve risks and uncertainties which may cause actual results to be materially different from any future result that may be suggested, expressed or implied.

Note 11. Acquisition of GVN Technologies, Inc.

On May 16, 2000, we completed the acquisition of GVN of Largo, Florida, a developer of integrated access device equipment for the service provider market. In the acquisition, the former stockholders of GVN received .088 shares of our common stock in exchange for each share of GVN common stock and preferred stock. The acquisition was accounted for as a pooling of interests. An aggregate of 894,306 shares of our common stock was issued pursuant to the acquisition, and we converted an aggregate of 209,794 options to purchase GVN common stock into options to purchase AFC common stock.

50

The following information presents certain statement of income data of the separate companies for 1999, the year preceding the merger (in thousands):

Year ended December 31, 1999:		Net revenues		Net income (loss)
AFC		$	296,571	$	250,297
GVN			40		(1,227	)
	Total	$	296,611	$	249,070

There were no material transactions between AFC and GVN prior to the merger. The effects of conforming GVN’s accounting policies to those of AFC were not material.

Note 12. Segment Information

We develop, manufacture, and support a family of telecommunications access products and services that enable telecommunications companies and other service providers to connect their central office switches to end users for voice and high speed data communications. We derive all of our revenues from sales of the OmniMAX product family. The chief operating decision makers evaluate performance, make operating decisions, and allocate resources based on consolidated financial data. Accordingly, we consider AFC to be in a single industry segment. We do not prepare reports for our individual products, and accordingly, we do not present revenues, or any other related financial information by individual product.

We evaluate performance in each geographic region based on revenues only. We do not assess our performance in geographic regions on other measures of income or expense, such as depreciation and amortization, operating income, or net income. Therefore, geographic information is presented only for revenues and long-lived assets.

The following geographic information is presented for the years ending December 31, 2001, 2000, and 1999 (in thousands):

			Years ended December 31,
			2001			2000			1999
			(restated)
Revenues:
	Domestic		$	282,004		$	368,904		$	265,135
	International			45,565			47,946			31,476
		Total revenues	$	327,569		$	416,850		$	296,611
Long-lived assets:
	Domestic		$	68,325		$	76,786		$	63,145
	International			137			722			1,058
		Total long-lived assets	$	68,462		$	77,508		$	64,203
Total assets			$	1,147,410		$	1,135,175		$	900,787
Major customers, percentage of revenues:
	Customer A			17	%		14	%		12	%
	Customer B			—			16	%		16	%

51

INDEPENDENT AUDITORS’ REPORT

The Board of Directors and Stockholders
Advanced Fibre Communications, Inc.:

We have audited the accompanying consolidated balance sheets of Advanced Fibre Communications, Inc. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Advanced Fibre Communications, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Notes 1 and 3 to the consolidated financial statements, in 2001 the Company changed its method of accounting for derivative financial instruments upon implementation of Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities.

As discussed in Note 2 to the consolidated financial statements, the accompanying consolidated balance sheet as of December 31, 2001, and the related consolidated statement of income, shareholders’ equity and comprehensive income, and cash flows for the year then ended have been restated.

KPMG LLP

San Francisco, California
January 29, 2002, except for Note 2,
which is as of November 8, 2002

52

Advanced Fibre Communications, Inc.
Quarterly Results of Operations
Selected quarterly financial data is summarized below (unaudited) (in thousands)

			Quarters ended
			Dec. 31,			Sept. 30,		June 30,		Mar. 31,			Dec. 31,		Sept. 30,		June 30,		Mar. 31,
			2001(1)			2001		2001		2001(2)			2000(3)		2000		2000		2000(4)
			(restated)
Revenues			$	82,102		$	84,647	$	78,609	$	82,211		$	116,099	$	114,100	$	101,232	$	85,419
Cost of revenues				76,281			47,050		43,977		48,648			55,039		60,355		54,005		45,904
Gross profit				5,821			37,597		34,632		33,563			61,060		53,745		47,227		39,515
Operating expenses:
	Research and development			18,306			15,100		14,797		15,966			13,523		16,189		14,444		14,672
	Sales and marketing			11,857			12,459		12,238		12,831			12,791		12,795		12,298		9,579
	General and administrative			7,801			6,655		6,499		16,368			6,269		7,268		8,408		7,227
		Total operating expenses		37,964			34,214		33,534		45,165			32,583		36,252		35,150		31,478
Operating income (loss)				(32,143	)		3,383		1,098		(11,602	)		28,477		17,493		12,077		8,037
Other income, net				21,276			20,648		10,856		253,458			12,291		2,169		2,034		34,950
Income (loss) before taxes				(10,867	)		24,031		11,954		241,856			40,768		19,662		14,111		42,987
Income taxes (benefit)				(3,000	)		8,455		4,090		91,905			13,861		6,685		4,798		14,616
Net income (loss)			$	(7,867	)	$	15,576	$	7,864	$	149,951		$	26,907	$	12,977	$	9,313	$	28,371
Basic net income (loss) per share			$	(0.10	)	$	0.19	$	0.10	$	1.85		$	0.33	$	0.16	$	0.12	$	0.36
Shares used in basic per share computations				82,034			81,699		81,176		80,963			80,688		80,431		80,043		79,624
Diluted net income (loss) per share			$	(0.10	)	$	0.18	$	0.09	$	1.80		$	0.32	$	0.15	$	0.11	$	0.33
Shares used in diluted per share computations				82,034			84,371		83,277		83,101			83,999		84,658		85,043		84,968

(1)	In the fourth quarter ending December 31, 2001, gross profit was lower than preceding quarters as a result of a write-off of $18.0 million for excess and obsolete inventories, and an accrual of $12.0 million for purchase commitments. These charges contributed to the $32.1 million operating loss for the quarter.
(2)	In the first quarter ending March 31, 2001, general and administrative expenses included $9.3 million provision for doubtful accounts related to receivables from a value-added reseller , or VAR, deemed to be uncollectible. This expense, along with non-recognition of $11.9 million in revenues for shipments made to Winstar and the VAR, for which product costs were recognized, and an increase of $2.2 million in reserve for excess and obsolete inventories, contributed to the operating loss of $11.6 million for the quarter. In addition, other income and income taxes for the quarter included the effects of our implementation of SFAS No. 133 on January 1, 2001. The deferred gains on our Cisco investment and related collars of $274.2 million, and the associated deferred taxes of $106.8 million were reclassified from accumulated other comprehensive income to non-operating income and tax expenses, respectively.
(3)	In the fourth quarter ending December 31, 2000, gross profit was higher than preceding quarters as a result of recognition of revenues on the first release of our software product, Panorama™ element management system, which generated higher margins.
(4)	In the first quarter ending March 31, 2000, other income included $32.8 million from Marconi Communications Inc., as a settlement of outstanding litigation.

See accompanying notes to consolidated financial statements.

53

PART III.

Item 14. Controls and Procedures

Within 90 days prior to the date of this report, an evaluation was carried out under the supervision and with the participation of AFC’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of AFC’s disclosure controls and procedures as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that AFC’s disclosure controls and procedures are effective to ensure that information required to be disclosed by AFC in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of that evaluation, there were no significant changes to AFC’s internal controls or in other factors that could significantly affect these controls, including any corrective actions with regard to significant deficiencies or material weaknesses.

54

PART IV.

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

The following is a list of the consolidated financial statements and the financial statement schedules which are included in this Annual Report on Form 10-K/A:

1.	Financial Statements:
	As of December 31, 2001 and 2000:

• Consolidated Balance Sheets

For the Years Ended December 31, 2001, 2000, and 1999:

• Consolidated Statements of Income

• Consolidated Statements of Stockholders’ Equity and Comprehensive Income

• Consolidated Statements of Cash Flows

	Notes to Consolidated Financial Statements
	Independent Auditors’ Report
	Quarterly Results of Operations (Unaudited)
2.	Financial Statement Schedule:

• Schedule II — Valuation and Qualifying Accounts

All other financial statements and financial statement schedules have been omitted because they are not applicable, or the required information is included in the consolidated financial statements or notes thereto.

3(a). Exhibits:

Exhibit
Number	Document Description
3.3.1	Fifth Amended and Restated Certificate of Incorporation of the Registrant. (2)
3.3.2	Certificate of Designation of Series A Junior Participating Preferred Stock. (4)
3.5	Amended and Restated Bylaws of the Registrant. (9)
4.1	Specimen Certificate of Common Stock. (1)
4.3	Certificate of Incorporation of the Registrant (included in Exhibit 3.3.1).
4.4	Rights Agreement dated as of May 13, 1998 between the Registrant and BankBoston, N.A. (4)
4.5	Amendment to Rights Agreement dated as of October 19, 1998 between the Registrant and BankBoston, N.A. (5)
10.10	Compensation Agreement, dated March 23, 1999 between the Registrant and John A. Schofield. (6)
10.11	Hangzhou Aftek Communication Registrant Ltd. Contract, dated June 18, 1994 between Advanced Fibre Technology Communication (Hong Kong) Limited and Hangzhou Communication Equipment Factory of the MPT., HuaTong Branch. (1) †
10.15	Redwood Business Park Net Lease, dated June 3, 1996 between the Registrant and G & W/Redwood Associates Joint Venture, for the premises located at Buildings 1 & 9 of Willow Brook Court. (1)
10.17	Form of Indemnification Agreement for Executive Officers and Directors of the Registrant. (1)
10.18	The Registrant’s 1993 Stock Option/Stock Issuance Plan, as amended (1993 Plan). (1)
10.19	Form of Stock Option Agreement pertaining to the 1993 Plan. (1)
10.20	Form of Notice of Grant of Stock Option pertaining to the 1993 Plan. (1)
10.21	Form of Stock Purchase Agreement pertaining to the 1993 Plan. (1)
10.22	The Registrant’s 1996 Stock Incentive Plan (1996 Plan). (1)

55

Exhibit
Number	Document Description
10.23	Form of Stock Option Agreement pertaining to the 1996 Plan. (1)
10.23.1	Form of Automatic Stock Option Agreement pertaining to the 1996 Plan. (1)
10.24	Form of Notice of Grant of Stock Option pertaining to the 1996 Plan. (1)
10.24.1	Form of Notice of Grant of Non-Employee Director Automatic Stock Option pertaining to the 1996 Plan. (1)
10.25	Form of Stock Issuance Agreement pertaining to the 1996 Plan. (1)
10.26	The Registrant’s Employee Stock Purchase Plan. (1)
10.31	Cypress Center Net Lease, dated October 9, 1997 between the Registrant and RNM Lakeville L.P., for the premises located at 2210 South McDowell Boulevard. (3)
10.33	Redwood Business Park Net Lease, dated September 22, 1999 between the Registrant and 99 AF Petaluma, L.L.C., for the premises located at 1465 McDowell Boulevard North. (7)
10.35	Master Stock Purchase Agreement and Pledge Agreement Specialized Term Appreciation Retention Sale (STARS) dated February 9, 2000 between the Registrant and Bank of America, N.A. (8)
21.1	Subsidiaries of the Registrant. (1)
23.1	Report on Schedule and Consent of KPMG LLP.
24.1	Power of Attorney. (9)

(1)	Incorporated by reference from the Registrant’s Registration Statement on Form S-1 (File No. 333-8921) filed with the Securities and Exchange Commission on July 26, 1996, as amended, and declared effective September 30, 1996.
(2)	Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1997, filed with the Securities and Exchange Commission on November 7, 1997.
(3)	Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1997, filed with the Securities and Exchange Commission on March 23, 1998.
(4)	Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 19, 1998.
(5)	Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 29, 1998.
(6)	Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999, filed with the Securities and Exchange Commission on May 7, 1999.
(7)	Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 31, 1999, filed with the Securities and Exchange Commission on November 8, 1999.
(8)	Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1999, filed with the Securities and Exchange Commission on March 21, 2000.
(9)	Previously filed on March 21, 2002 as an exhibit to this Form 10-K.
†	Portions of this Exhibit have been granted Confidential Treatment.

3(b). Reports on Form 8-K:

None.

56

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

	ADVANCED FIBRE COMMUNICATIONS, INC. (Registrant)
Date: November 12, 2002	By:	/s/ John A. Schofield
		John A. Schofield President and Chief Executive Officer

          Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature and Title	Date
/s/ John A. Schofield	November 12, 2002
John A. Schofield Chairman of the Board
/s/ Ruann F. Ernst	November 12, 2002
Ruann F. Ernst Director
/s/ Clifford H. Higgerson	November 12, 2002
Clifford H. Higgerson Director

57

Signature and Title	Date
/s/ William L. Keever	November 12, 2002
William L. Keever Director
/s/ Martin R. Klitten	November 12, 2002
Martin R. Klitten Director
/s/ Dan Rasdal	November 12, 2002
Dan Rasdal Director
/s/ Alex Sozonoff	November 12, 2002
Alex Sozonoff Director
/s/ Keith E. Pratt	November 12, 2002
Keith E. Pratt Senior Vice President, Chief Financial Officer, and Assistant Secretary (Duly Authorized Signatory and Principal Financial Officer)
/s/ R. Leon Blackburn	November 12, 2002
R. Leon Blackburn Vice President, Corporate Controller (Duly Authorized Signatory and Principal Accounting Officer)

58

ADVANCED FIBRE COMMUNICATIONS, INC.
SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
(in thousands)

			ADDITIONS
	Balance at		Charged to		Charged		Deductions			Balance at
Allowance for	beginning		costs and		to other		from			end of
doubtful accounts	of period		expenses		accounts		allowance			period
Year ending December 31, 1999	$	1,136		1,050		—		(304	)	$	1,882
Year ending December 31, 2000		1,882		600		—		(534	)		1,948
Year ending December 31, 2001		1,948		10,261		58		(11,315	)		952

			ADDITIONS
Reserve for	Balance
inventories and	at		Charged to		Charged			Deductions			Balance at
purchase	beginning		costs and		to other			from			end of
commitments	of period		expenses		accounts			reserve			period
Year ending December 31, 1999	$	4,951		7,221		(113	)		(4,051	)	$	8,008
Year ending December 31, 2000		8,008		10,150		635			(2,905	)		15,888
Year ending December 31, 2001		15,888		38,906		(329	)		(4,616	)		49,849

			ADDITIONS
	Balance
	at		Charged to			Charged		Deductions		Balance at
Allowance for	beginning		costs and			to other		from		end of
customer returns	of period		expenses			accounts		reserve		period
Year ending December 31, 1999	$	1,953		(1,176	)		—		—	$	777
Year ending December 31, 2000		777		945			—		—		1,722
Year ending December 31, 2001		1,722		(1,171	)		—		—		551

			ADDITIONS
	Balance
	at		Charged to		Charged			Deductions			Balance at
	beginning		costs and		to other			from			end of
Warranty reserve	of period		expenses		accounts			reserve			period
Year ending December 31, 1999	$	6,563		8,910		—			(6,575	)	$	8,898
Year ending December 31, 2000		8,898		10,100		(1,111	)		(6,290	)		11,597
Year ending December 31, 2001		11,597		9,307		—			(8,265	)		12,639

59

SIGNATURE

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

	ADVANCED FIBRE COMMUNICATIONS, INC.
Date: November 12, 2002	By:	/s/Keith E. Pratt
		Name: Keith E. Pratt Title: Senior Vice President, Chief Financial Officer, and Assistant Secretary (Duly Authorized Signatory and Principal Financial Officer)

60

CERTIFICATIONS

I, John A. Schofield, Chairman of the Board, President and Chief Executive Officer of Advanced Fibre Communications, Inc., or AFC, certify that:

          1. I have reviewed this annual report on Form 10-K/A of AFC;

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

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

          4. AFC’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for AFC and we have:

(a) designed such disclosure controls and procedures to ensure that material information relating to AFC, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

(b) evaluated the effectiveness of AFC’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

(c) presented in this annual report our conclusion about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

          5. AFC’s other certifying officer and I have disclosed, based on our most recent evaluation, to AFC’s auditors and the audit committee of AFC’s board of directors (or persons performing the equivalent function):

(a) all significant deficiencies in the design or operation of internal controls which could adversely affect AFC’s ability to record, process, summarize and report financial data and have identified for AFC’s auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in AFC’s internal controls; and

          6. AFC’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 12, 2002	By:	/s/John A. Schofield
	Name:	John A. Schofield
	Title:	Chairman of the Board,
		President and Chief Executive Officer
		(Duly Authorized Signatory and Chief Executive Officer)

61

I, Keith E. Pratt, Senior Vice President, Chief Financial Officer, and Assistant Secretary of Advanced Fibre Communications, Inc., or AFC, certify that:

          1. I have reviewed this annual report on Form 10-K/A of AFC;

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

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

          4. AFC’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for AFC and we have:

(a) designed such disclosure controls and procedures to ensure that material information relating to AFC, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

(b) evaluated the effectiveness of AFC’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

(c) presented in this annual report our conclusion about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

          5. AFC’s other certifying officer and I have disclosed, based on our most recent evaluation, to AFC’s auditors and the audit committee of AFC’s board of directors (or persons performing the equivalent function):

(a) all significant deficiencies in the design or operation of internal controls which could adversely affect AFC’s ability to record, process, summarize and report financial data and have identified for AFC’s auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in AFC’s internal controls; and

          6. AFC’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 12, 2002	By:	/s/ Keith E. Pratt
	Name:	Keith E. Pratt
	Title:	Senior Vice President, Chief Financial Officer, and Assistant Secretary
		(Duly Authorized Signatory and Principal Financial Officer)

62

ADVANCED FIBRE COMMUNICATIONS, INC.

Index to exhibits filed with this Annual Report on Form 10-K/A:

Exhibit
Number	Document Description
23.1	Report on Schedule and Consent of KPMG LLP.

63