UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark one)
| | |
þ | | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended JulyJanuary 31, 20052006
OR
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o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________ to ________
Commission file number: 0-21969
Ciena Corporation
(Exact name of registrant as specified in its charter)
| | |
Delaware
| | 23-2725311 |
State or other jurisdiction of incorporation or organization) | | 23-2725311 (I.R.S. Employer Identification No.) |
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1201 Winterson Road, Linthicum, MD
| | 21090 |
(Address of Principal Executive Offices) | | 21090 (Zip Code) |
(410) 865-8500
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YESþ NOo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, (as definedor a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act Rule 12b-2)(Check one). YESþ NO
| | | | |
Large accelerated filerþ | | Accelerated filero | | Non-accelerated filero |
Indicate by check mark whether the registrant is a shell company (as defineddetermined in Rule 12b-2 of the Exchange Act). YESo NOþ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
| | |
Class | | Outstanding at August 30, 2005February 28, 2006 |
| | |
Commoncommon stock, $.01 par value | | 577,963,967582,356,152 |
1
CIENA CORPORATION
INDEX
FORM 10-Q
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| | | | NUMBER |
PART I — FINANCIAL INFORMATION
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Item 1. Financial Statements | | | | |
Item 1. | | | | |
ConsolidatedFinancial Statements of Operations for the quarters and nine months ended July 31, 2004 and July 31, 2005 | | | 3 | |
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| | Consolidated Statements of Operations for the three months ended January 31, 2005 and January 31, 2006 | | | 3 | |
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| | Consolidated Balance Sheets at October 31, 20042005 and JulyJanuary 31, 20052006 | | | 4 | |
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| | Consolidated Statements of Cash Flows for the ninethree months ended JulyJanuary 31, 20042005 and JulyJanuary 31, 20052006 | | | 5 | |
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| | Notes to Consolidated Financial Statements | | | 6 | |
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Item 2. | | Management’s Discussion and Analysis of Financial Condition and Results of Operations | | | 1521 | |
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Item 3. | | Quantitative and Qualitative Disclosures About Market Risk | | | 3833 | |
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Item 4. | | Controls and Procedures | | | 3934 | |
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PART II — OTHER INFORMATION
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Item 1. | | Legal Proceedings | | | 3934 | |
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Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities1A. | | Risk Factors | | | 4036 | |
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Item 3. Defaults Upon Senior2. | | Unregistered Sales of Equity Securities and Use of Proceeds | | | 4044 | |
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Item 3. | | Defaults Upon Senior Securities | | | 45 | |
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Item 4. | | Submission of Matters to a Vote of Security Holders | | | 4145 | |
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Item 5. | | Other Information | | | 4145 | |
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Item 6. | | Exhibits | | | 4145 | |
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| | Signatures | | | 4246 | |
2
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
CIENA CORPORATION
CONSOLIDATED STATEMENTSTATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
| | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | Nine Months Ended July 31, | | | Quarter Ended January 31, | |
| | 2004 | | 2005 | | 2004 | | 2005 | | | 2005 | | 2006 | |
Revenues: | | |
Products | | $ | 64,340 | | $ | 97,448 | | $ | 181,436 | | $ | 271,366 | | | $ | 82,300 | | $ | 105,941 | |
Services | | 11,249 | | 13,032 | | 35,266 | | 37,708 | | | 12,448 | | 14,489 | |
| | | | | | | | | | | | | | |
Total revenue | | 75,589 | | 110,480 | | 216,702 | | 309,074 | | | 94,748 | | 120,430 | |
| | | | | | | | | | | | | | |
| | |
Costs: | | |
Products | | 48,069 | | 62,756 | | 138,918 | | 189,447 | | | 60,848 | | 60,399 | |
Services | | 8,723 | | 10,095 | | 30,212 | | 30,601 | | | 9,669 | | 9,576 | |
| | | | | | | | | | | | | | |
Total cost of goods sold | | 56,792 | | 72,851 | | 169,130 | | 220,048 | | | 70,517 | | 69,975 | |
| | | | | | | | | | | | | | |
Gross profit | | 18,797 | | 37,629 | | 47,572 | | 89,026 | | | 24,231 | | 50,455 | |
| | | | | | | | | | | | | | |
Operating expenses: | | |
Research and development | | 57,762 | | 32,619 | | 151,418 | | 101,036 | | | 34,662 | | 29,462 | |
Selling and marketing | | 29,468 | | 29,275 | | 80,011 | | 82,440 | | | 26,840 | | 26,572 | |
General and administrative | | 6,969 | | 9,340 | | 20,052 | | 25,538 | | | 7,656 | | 9,896 | |
Stock compensation costs: | | |
Research and development | | 1,860 | | 2,195 | | 5,473 | | 4,048 | | |
Selling and marketing | | 1,214 | | 934 | | 2,147 | | 4,257 | | |
General and administrative | | 879 | | 153 | | 1,079 | | 505 | | |
Amortization of intangible assets | | 12,667 | | 9,653 | | 19,458 | | 30,268 | | | 10,411 | | 6,295 | |
In-process research and development | | 30,200 | | — | | 30,200 | | — | | |
Restructuring costs | | 13,547 | | 4,355 | | 22,125 | | 15,245 | | | 1,125 | | 2,015 | |
Long-lived asset impairments | | 7,217 | | | (25 | ) | | 7,217 | | 134 | | | 184 | | | (3 | ) |
Recovery of sale, export, use tax liabilities and payments | | | (3,457 | ) | | — | | | (5,388 | ) | | — | | |
Provision for (recovery of) doubtful accounts, net | | — | | 2,604 | | | (2,794 | ) | | 2,604 | | |
Recovery of doubtful accounts, net | | | — | | | (2,604 | ) |
Gain on lease settlement | | | — | | | (6,020 | ) |
| | | | | | | | | | | | | | |
Total operating expenses | | 158,326 | | 91,103 | | 330,998 | | 266,075 | | | 80,878 | | 65,613 | |
| | | | | | | | | | | | | | |
Loss from operations | | | (139,529 | ) | | | (53,474 | ) | | | (283,426 | ) | | | (177,049 | ) | | | (56,647 | ) | | | (15,158 | ) |
Interest and other income, net | | 4,936 | | 6,765 | | 18,228 | | 19,787 | | | 7,433 | | 9,262 | |
Interest expense | | | (6,469 | ) | | | (6,406 | ) | | | (20,326 | ) | | | (19,348 | ) | | | (7,226 | ) | | | (6,053 | ) |
Gain (loss) on equity investments, net | | | (200 | ) | | | (1,708 | ) | | 393 | | | (8,986 | ) | | 22 | | | (733 | ) |
Gain (loss) on extinguishment of debt | | — | | 3,882 | | | (8,216 | ) | | 3,882 | | |
Gain on extinguishment of debt | | | — | | 6,690 | |
| | | | | | | | | | | | | | |
Loss before income taxes | | | (141,262 | ) | | | (50,941 | ) | | | (293,347 | ) | | | (181,714 | ) | | | (56,418 | ) | | | (5,992 | ) |
Provision for income taxes | | 205 | | 86 | | 1,044 | | 1,115 | | | 577 | | 299 | |
| | | | | | | | | | | | | | |
Net loss | | $ | (141,467 | ) | | $ | (51,027 | ) | | $ | (294,391 | ) | | $ | (182,829 | ) | | $ | (56,995 | ) | | $ | (6,291 | ) |
| | | | | | | | | | | | | | |
Basic and diluted loss per common share and dilutive potential common share | | $ | (0.25 | ) | | $ | (0.09 | ) | | $ | (0.58 | ) | | $ | (0.32 | ) | |
| | | | | | | | | | |
Basic and diluted net loss per common share and dilutive potential common share | | | $ | (0.10 | ) | | $ | (0.01 | ) |
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Weighted average basic common and dilutive potential common shares outstanding | | 566,234 | | 576,331 | | 504,812 | | 573,939 | | | 571,573 | | 580,771 | |
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The accompanying notes are an integral part of these consolidated financial statements.
3
CIENA CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
| | | | | | | | | |
| | | | | | | | | | (unaudited) | |
| | October 31, | | July 31, | | | October 31, | | January 31, | |
| | 2004 | | 2005 | | | 2005 | | 2006 | |
ASSETS | | |
| | |
Current assets: | | |
Cash and cash equivalents | | $ | 202,623 | | $ | 313,569 | | | $ | 358,012 | | $ | 298,624 | |
Short-term investments | | 753,251 | | 602,888 | | | 579,531 | | 496,010 | |
Accounts receivable, net | | 45,878 | | 70,622 | | | 72,786 | | 81,136 | |
Inventories, net | | 47,614 | | 51,447 | | | 49,333 | | 64,379 | |
Prepaid expenses and other | | 29,906 | | 30,361 | | | 37,867 | | 34,717 | |
| | | | | | | | | | |
Total current assets | | 1,079,272 | | 1,068,887 | | | 1,097,529 | | 974,866 | |
Long-term investments | | 329,704 | | 200,188 | | | 155,944 | | 166,951 | |
Equipment, furniture and fixtures, net | | 51,252 | | 32,984 | | | 28,090 | | 27,131 | |
Goodwill | | 408,615 | | 408,615 | | | 232,015 | | 232,015 | |
Other intangible assets, net | | 208,015 | | 174,845 | | | 120,324 | | 113,061 | |
Other long-term assets | | 60,196 | | 37,955 | | | 41,327 | | 30,867 | |
| | | | | | | | | | |
Total assets | | $ | 2,137,054 | | $ | 1,923,474 | | | $ | 1,675,229 | | $ | 1,544,891 | |
| | | | | | | | | | |
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LIABILITIES AND STOCKHOLDERS’ EQUITY | | |
| | |
Current liabilities: | | |
Accounts payable | | $ | 31,509 | | $ | 43,025 | | | $ | 43,868 | | $ | 51,995 | |
Accrued liabilities | | 76,045 | | 72,541 | | | 76,491 | | 64,138 | |
Restructuring liabilities | | 16,203 | | 15,201 | | | 15,492 | | 12,687 | |
Unfavorable lease commitments | | 9,902 | | 8,908 | | | 9,011 | | 8,620 | |
Income taxes payable | | 3,354 | | 4,093 | | | 5,785 | | 5,846 | |
Deferred revenue | | 21,566 | | 31,298 | | | 27,817 | | 30,986 | |
| | | | | | | | | | |
Total current liabilities | | 158,579 | | 175,066 | | | 178,464 | | 174,272 | |
Long-term deferred revenue | | 16,010 | | 14,379 | | | 15,701 | | 15,727 | |
Long-term restructuring liabilities | | 65,180 | | 56,722 | | | 54,285 | | 35,939 | |
Long-term unfavorable lease commitments | | 51,341 | | 43,846 | | | 41,364 | | 38,934 | |
Other long-term obligations | | 1,522 | | 1,216 | | | 1,296 | | 1,151 | |
Convertible notes payable | | 690,000 | | 648,752 | | | 648,752 | | 542,262 | |
| | | | | | | | | | |
Total liabilities | | 982,632 | | 939,981 | | | 939,862 | | 808,285 | |
| | | | | | | | | | |
Commitments and contingencies | | |
Stockholders’ equity: | | |
Preferred stock — par value $0.01; 20,000,000 shares authorized; zero shares issued and outstanding | | — | | — | | | — | | — | |
Common stock — par value $0.01; 980,000,000 shares authorized; 571,656,659 and 576,908,483 shares issued and outstanding as of October 31, 2004 and July 31, 2005, respectively | | 5,717 | | 5,769 | | |
Common stock — par value $0.01; 980,000,000 shares authorized; 580,340,947 and 581,581,317 shares issued and outstanding | | | 5,803 | | 5,816 | |
Additional paid-in capital | | 5,482,175 | | 5,485,595 | | | 5,489,613 | | 5,493,614 | |
Deferred stock compensation | | | (13,761 | ) | | | (2,925 | ) | | | (2,286 | ) | | — | |
Notes receivable from stockholders | | | (48 | ) | | — | | |
Changes in unrealized gains on investments, net | | | (2,488 | ) | | | (4,744 | ) | | | (4,673 | ) | | | (3,433 | ) |
Translation adjustment | | | (277 | ) | | | (477 | ) | | | (495 | ) | | | (505 | ) |
Accumulated deficit | | | (4,316,896 | ) | | | (4,499,725 | ) | | | (4,752,595 | ) | | | (4,758,886 | ) |
| | | | | | | | | | |
Total stockholders’ equity | | 1,154,422 | | 983,493 | | | 735,367 | | 736,606 | |
| | | | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 2,137,054 | | $ | 1,923,474 | | | $ | 1,675,229 | | $ | 1,544,891 | |
| | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
4
CIENA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
| | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | Three Months Ended January 31, | |
| | 2004 | | 2005 | | | 2005 | | 2006 | |
Cash flows from operating activities: | | |
Net loss | | $ | (294,391 | ) | | $ | (182,829 | ) | | $ | (56,995 | ) | | $ | (6,291 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | | |
Early extinguishment of debt | | 8,216 | | | (3,882 | ) | | — | | | (6,690 | ) |
Amortization of premium on marketable securities | | 21,893 | | 12,344 | | | 4,913 | | 1,176 | |
Non-cash loss from equity investments | | | — | | 733 | |
Non-cash impairment of long-lived assets | | 7,217 | | 134 | | | 184 | | — | |
Non-cash (gain) loss on equity investments | | | (393 | ) | | 8,986 | | |
Accretion of convertible notes payable | | 599 | | — | | |
In-process research and development | | 30,200 | | — | | |
Depreciation and amortization of leasehold improvements | | 52,325 | | 26,803 | | | 8,383 | | 5,312 | |
Stock compensation | | 8,699 | | 8,810 | | | 2,047 | | 4,183 | |
Amortization of intangibles | | 22,361 | | 33,169 | | | 11,378 | | 7,263 | |
Provision of doubtful accounts | | 284 | | 2,604 | | |
Provision for inventory excess and obsolescence | | 3,026 | | 3,396 | | | 1,115 | | 3,000 | |
Provision for warranty and other contractual obligations | | 7,179 | | 7,546 | | | 3,016 | | 2,470 | |
Other | | 2,270 | | 2,072 | | | 749 | | 608 | |
Changes in assets and liabilities: | | |
Accounts receivable | | | (6,505 | ) | | | (27,348 | ) | | | (6,244 | ) | | | (8,350 | ) |
Inventories | | | (114 | ) | | | (7,229 | ) | | 242 | | | (18,046 | ) |
Prepaid expenses and other | | 13,533 | | 5,194 | | | 4,888 | | 10,151 | |
Accounts payable and accrued liabilities | | | (77,793 | ) | | | (17,789 | ) | | | (13,889 | ) | | | (30,813 | ) |
Income taxes payable | | 969 | | 739 | | | 318 | | 61 | |
Deferred revenue and other obligations | | 3,268 | | 8,101 | | | | (3,436 | ) | | 3,195 | |
| | | | | | | | | | |
Net cash used in operating activities | | | (197,157 | ) | | | (119,179 | ) | | | (43,331 | ) | | | (32,038 | ) |
| | | | | | | | | | |
Cash flows from investing activities: | | |
Additions to equipment, furniture, fixtures and intellectual property | | | (18,828 | ) | | | (8,935 | ) | | | (4,201 | ) | | | (4,375 | ) |
Proceeds from sale of equipment, furniture and fixtures | | 403 | | 266 | | | 177 | | — | |
Restricted cash | | | | (621 | ) | | 1,102 | |
Purchases of available for sale securities | | | (488,832 | ) | | | (490,041 | ) | | | (161,847 | ) | | | (63,641 | ) |
Maturities of available for sale securities | | 686,250 | | 755,320 | | | 200,731 | | 136,219 | |
Acquisition of businesses, net of cash acquired | | 4,864 | | — | | |
Minority equity investments, net | | | (5,500 | ) | | 4,882 | | | | (1,595 | ) | | — | |
| | | | | | | | | | |
Net cash provided by investing activities | | 178,357 | | 261,492 | | | 32,644 | | 69,305 | |
| | | | | | | | | | |
Cash flows from financing activities: | | |
Net proceeds from other obligations | | 72 | | — | | |
Repayment of convertible notes payable | | | (49,243 | ) | | | (36,913 | ) | | — | | | (98,772 | ) |
Proceeds from issuance of common stock | | 13,989 | | 5,498 | | | 347 | | 2,117 | |
Repayment of notes receivable from stockholders | | 47 | | 48 | | | 45 | | — | |
| | | | | | | | | | |
Net cash used in financing activities | | | (35,135 | ) | | | (31,367 | ) | |
Net cash provided by (used in) financing activities | | | 392 | | | (96,655 | ) |
| | | | | | | | | | |
Net (decrease) increase in cash and cash equivalents | | | (53,935 | ) | | 110,946 | | |
Net decrease in cash and cash equivalents | | | | (10,295 | ) | | | (59,388 | ) |
Cash and cash equivalents at beginning of period | | 309,665 | | 202,623 | | | 185,868 | | 358,012 | |
| | | | | | | | | | |
Cash and cash equivalents at end of period | | $ | 255,730 | | $ | 313,569 | | | $ | 175,573 | | $ | 298,624 | |
| | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.statements
5
CIENA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) INTERIM FINANCIAL STATEMENTS
The interim financial statements included herein for Ciena Corporation (“Ciena”) have been prepared by Ciena, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, financial statements included in this report reflect all normal recurring adjustments thatwhich Ciena considers necessary for the fair presentationstatement of the results of operations for the interim periods covered and of the financial position of Ciena at the date of the interim balance sheet. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, Ciena believes that the disclosures are adequate to understand the information presented. The operating results for interim periods are not necessarily indicative of the operating results for the entire year. These financial statements should be read in conjunction with Ciena’s audited consolidated financial statements and notes thereto included in Ciena’s annual report on Form 10-K for the fiscal year ended October 31, 2004.2005.
Ciena has a 52 or 53 week fiscal year, which ends on the Saturday nearest to the last day of October in each year. For purposes of financial statement presentation, each fiscal year is described as having ended on October 31, and each fiscal quarter is described as having ended on January 31, April 30 and July 31 of each fiscal year.
(2) SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
Ciena considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Restricted cash collateralizing letters of credits are included in other current assets and other long-term assets depending upon the duration of the restriction.
Investments
Ciena’s short-term and long-term investments are classified as available-for-sale and are reported at fair value, with unrealized gains and losses, net of tax, recorded in accumulated other comprehensive income. Realized gains or losses and declines in value determined to be other than temporary, if any, on available-for-sale securities, are reported in other income or expense as incurred.
Ciena also has certain other minority equity investments in privately held technology companies. These investments are carried at cost because Ciena owns less than 20% of the voting equity and does not have the ability to exercise significant influence over these companies. These investments are inherently high risk as the market for technologies or products manufactured by these companies are usually early stage at the time of the investment by Ciena and such markets may never be significant. Ciena could lose its entire investment in some or all of these companies. Ciena monitors these investments for impairment and makes appropriate reductions in carrying values when necessary.
Inventories
Inventories are stated at the lower of cost or market, with cost determined on the first-in, first-out basis. Ciena records a provision for excess and obsolete inventory whenever an impairment has been identified.
Equipment, Furniture and Fixtures
Equipment, furniture and fixtures are recorded at cost. Depreciation and amortization are computed using the straight-line method over useful lives of two years to five years for equipment, furniture and fixtures and nine months to ten years for leasehold improvements. Impairments of equipment, furniture and fixtures are determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
Internal use software and web site development costs are capitalized in accordance with Statement of Position (SOP) No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” and
6
Emerging Issues Task Force (EITF) Issue No. 00-02, “Accounting for Web Site Development Costs.” Qualifying costs incurred during the application development stage, which consist primarily of outside services and purchased software license costs, are capitalized and amortized over the estimated useful life of the asset.
Goodwill and Other Intangible Assets
Ciena has recorded goodwill and purchased intangible assets as a result of several acquisitions. Ciena accounts for goodwill in accordance with SFAS 142 “Goodwill and Other Intangible Assets,” which requires Ciena to test each reporting unit’s goodwill for impairment on an annual basis, which Ciena has determined to be the last business day of September each year, and between annual tests if events occur or circumstances change that would, more likely than not, reduce the fair value of the reporting unit below its carrying value. Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed using the straight-line method over the economic lives of the respective assets, generally three to seven years. It is Ciena’s policy to assess periodically the carrying amount of its purchased intangible assets to determine if there has been an impairment to their carrying value. Impairments of other intangibles assets are determined in accordance with SFAS 144.
Concentrations
Substantially all of Ciena’s cash and cash equivalents, short-term and long-term investments, are maintained at two major U.S. financial institutions. The majority of Ciena’s cash equivalents consist of money market funds and overnight repurchase agreements. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and, therefore, bear minimal risk.
Additionally, Ciena’s access to certain raw materials is dependent upon single and sole source suppliers. The inability of any supplier to fulfill supply requirements of Ciena could affect future results. Ciena relies on a small number of contract manufacturers to perform the majority of the manufacturing operations for its products. If Ciena cannot effectively manage these manufacturers and forecast future demand, or if they fail to deliver products or components on time, Ciena’s business may suffer.
Revenue Recognition
Ciena recognizes revenue in accordance with Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition,” which states that revenue is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the price to the buyer is fixed and determinable; and collectibility is reasonably assured. In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met. Services revenue is deferred and recognized ratably over the period during which the services are to be performed.
Some of Ciena’s communications networking equipment is integrated with software that is essential to the functionality of the equipment. Ciena provides unspecified software upgrades and enhancements related to the equipment through maintenance contracts for these products. For transactions involving the sale of software, revenue is recognized in accordance with SOP 97-2, “Software Revenue Recognition,” including deferral of revenue recognition in instances where vendor specific objective evidence for undelivered elements is not determinable.
For arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets, except as otherwise covered by SOP 97-2, the determination as to how the arrangement consideration should be measured and allocated to the separate deliverables of the arrangement is determined in accordance with EITF 00-21, “Revenue Arrangements with Multiple Deliverables.” When a sale involves multiple elements, such as sales of products that include services, the entire fee from the arrangement is allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element are met. Fair value for each element is established based on the sales price charged when the same element is sold separately.
Revenue Related Accruals
Ciena provides for the estimated costs to fulfill customer warranty and other contractual obligations upon the recognition of the related revenue. Such reserves are determined based upon actual warranty cost experience, estimates of component failure rates, and management’s industry experience. Ciena’s sales contracts do not permit the right of return of product by the customer after the product has been accepted.
Accounts Receivable Trade, Net
7
Ciena’s allowance for doubtful accounts is based on its assessment, on a specific identification basis, of the collectibility of customer accounts. Ciena performs ongoing credit evaluations of its customers and generally has not required collateral or other forms of security from its customers. In determining the appropriate balance for Ciena’s allowance for doubtful accounts, management considers each individual customer account receivable in order to determine collectibility. In doing so, management considers creditworthiness, payment history, account activity and communication with such customer. If a customer’s financial condition changes, Ciena may be required to take a charge for an allowance on doubtful accounts. During the first quarter of fiscal 2006, Ciena recorded the recovery of a doubtful account in the amount of $2.6 million as a result of the payment of an amount due from a customer from whom payment was previously deemed doubtful due to the customer’s financial condition.
Research and Development
Ciena charges all research and development costs to expense as incurred.
Advertising Costs
Ciena expenses all advertising costs as incurred.
Share-Based Compensation Expense
On November 1, 2005, Ciena adopted SFAS 123(R), “Share-Based Payment,” which requires the measurement and recognition of compensation expense, based on estimated fair values, for all share-based awards, made to employees and directors, including stock options, restricted stock, restricted stock units and participation in Ciena’s employee stock purchase plan. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 107 relating to SFAS 123(R). Ciena has applied the provisions of SAB 107 in its adoption of SFAS 123(R).
Ciena adopted SFAS 123(R) using the modified prospective application transition method, as of November 1, 2005, the first day of Ciena’s fiscal year 2006. Ciena’s consolidated financial statements as of and for the first quarter of fiscal 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective application transition method, Ciena’s consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized under SFAS 123(R) for the first quarter of fiscal 2006 was $4.2 million, of which $0.4 million was capitalized as part of inventory.
Prior to the adoption of SFAS 123(R), Ciena accounted for share-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” as interpreted by FASB Interpretation (FIN) No. 44, “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25,” as allowed under SFAS 123, “Accounting for Stock-Based Compensation.” Share-based compensation expense of $2.0 million for the first quarter of fiscal 2005 was solely related to share-based awards assumed through acquisitions and restricted stock unit awards that Ciena had been recognizing in its consolidated statement of operations in accordance with the provisions set forth above. Because the exercise price of Ciena’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the grant date, under the intrinsic value method, no share-based compensation expense was otherwise recognized in Ciena’s consolidated statement of operations.
SFAS 123(R) requires companies to estimate the fair value of share-based awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in Ciena’s consolidated statement of operations over the requisite service periods. Share-based compensation expense recognized in Ciena’s consolidated statement of operations for the first quarter of fiscal 2006 includes compensation expense for share-based awards granted (i) prior to, but not yet vested as of October 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123, and (ii) subsequent to October 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), Ciena changed its method of attributing the value of share-based compensation expense from the accelerated multiple-option approach to the straight-line single-option method. Compensation expense for all share-based awards granted on or prior to October 31, 2005 will continue to be recognized using the accelerated multiple-option approach. Compensation expense for all share-based awards subsequent to October 31, 2005 is recognized using the straight-line single-option method. Because share-based compensation expense is based on awards that are ultimately expected to vest, share-based compensation expense has
8
been reduced to account for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In Ciena’s pro forma information required under SFAS 123 for periods prior to fiscal 2006, Ciena accounted for forfeitures as they occurred.
To calculate option-based compensation under SFAS 123(R), Ciena used the Black-Scholes option-pricing model, which it had previously used for valuation of option-based awards for its pro forma information required under SFAS 123 for periods prior to fiscal 2006. For additional information see Note 13. Ciena’s determination of fair value of option-based awards on the date of grant using the Black-Scholes model is affected by Ciena’s stock price as well as assumptions regarding a number of subjective variables. These variables include, but are not limited to Ciena’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.
No tax benefits were attributed to the share-based compensation expense because a valuation allowance was maintained for all net deferred tax assets.
Income Taxes
Ciena accounts for income taxes in accordance with SFAS 109, “Accounting for Income Taxes.” SFAS 109 describes an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective tax bases, and for operating loss and tax credit carry forwards. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than the enactment of changes in tax laws or rates. Valuation allowances are provided, if, based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
Fair Value of Financial Instruments
The carrying amounts of Ciena’s financial instruments, which include short-term and long-term investments, accounts receivable, accounts payable, and other accrued expenses, approximate their fair values due to their short maturities.
As of the last day of the first quarter of fiscal 2006, the fair value of the $542.3 million in aggregate principal amount of convertible notes, due February 1, 2008, was $509.0 million, based on the quoted market price for the notes.
Foreign Currency Translation
Some of Ciena’s foreign branch offices and subsidiaries use the U.S. dollar as their functional currency, because Ciena, as the U.S. parent entity, exclusively funds the operations of these branch offices and subsidiaries with U.S. dollars. For those subsidiaries using the local currency as their functional currency, assets and liabilities are translated at exchange rates in effect at the balance sheet date. Resulting translation adjustments are recorded directly to a separate component of stockholders’ equity. Where the U.S. dollar is the functional currency, translation adjustments are recorded in other income. The net gain (loss) on foreign currency re-measurement and exchange rate changes for the first quarter of fiscal 2005 and the first quarter of fiscal 2006 were immaterial for separate financial statement presentation.
Computation of Basic Net Income (Loss) per Common Share and Diluted Net Income (Loss) per Common and Dilutive Potential Common Share
Ciena calculates earnings per share in accordance with the SFAS 128, “Earnings per Share.” This statement requires dual presentation of basic and diluted EPS on the face of the income statement for entities with a complex capital structure and requires a reconciliation of the numerator and denominator used for the basic and diluted EPS computations.
Software Development Costs
SFAS 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” requires the capitalization of certain software development costs incurred subsequent to the date technological feasibility is established and prior to the date the product is generally available for sale. The capitalized cost is then amortized
9
over the estimated product life. Ciena defines technological feasibility as being attained at the time a working model is completed. To date, the period between achieving technological feasibility and the general availability of such software has been short, and software development costs qualifying for capitalization have been insignificant. Accordingly, Ciena has not capitalized any software development costs.
Segment Reporting
Ciena’s operations are organized into the followingSFAS 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes annual and interim reporting standards for operating segments forof a company. It also requires entity-wide disclosures about the purpose of making operating decisionsproducts and assessing performance:services an entity provides, the material countries in which it holds assets and reports revenue, and its major customers. Ciena organizes its operations into four separate business segments: the Transport and Switching Group (TSG);, the Data Networking Group (DNG);, the Broadband Access Group (BBG); and the Global Network Services Group (GNS).
Goodwill
As of July 31, 2005, Ciena’s assets included $408.6 million related Revenue from sales to goodwill. Because our operations are organized into operating segments, SFAS 142 requires that we assign goodwill to Ciena’s reporting units. Ciena has determined its operating segments and reporting units are the same. In accordance with SFAS 142, Ciena tests each reporting unit’s goodwill for impairment on an annual basis. Ciena annually tests for impairment on the last business day of September each year, and between annual tests if events occur or circumstances change that would, more likely than not, reduce the fair valuecustomers outside of the reporting unit below its carrying value. The following table summarizes the assignment and changesUnited States is reflected as International in the carrying amountCiena’s geographic segment distribution of Ciena’s goodwillrevenue.
Reclassification
Certain prior year amounts have been reclassified to its reporting units as of July 31, 2005 (in thousands):
| | | | | | | | | | | | | | | | |
| | TSG | | | DNG | | | BBG | | | Total | |
Balance as of October 31, 2004 | | $ | 147,000 | | | $ | 85,015 | | | $ | 176,600 | | | $ | 408,615 | |
Goodwill acquired | | | — | | | | — | | | | — | | | | — | |
Purchase adjustments | | | — | | | | — | | | | — | | | | — | |
Impairment losses | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | |
Balance as of July 31, 2005 | | $ | 147,000 | | | $ | 85,015 | | | $ | 176,600 | | | $ | 408,615 | |
| | | | | | | | | | | | |
Impairment or Disposal of Long-lived Assets
Ciena accounts for the impairment or disposal of long-lived assets such as equipment, furniture, fixtures, and other intangible assets in accordance with the provisions of SFAS 144, “Accounting for the Impairment or Disposal of Long-lived Assets.” During the first nine months of fiscal 2005, Ciena recorded impairment losses of $0.1 million primarily relatedconform to excess research and development test equipment classified as held for sale.
Investments
Ciena’s short-term and long-term investments are classified as available-for-sale and are reported at fair value, with unrealized gains and losses, net of tax, recorded in accumulated other comprehensive income. Realized gains or losses and declines in value determined to be other than temporary, if any, on available-for-sale securities, are reported in other income or expense as incurred.
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Ciena also has certain other minority equity investments in privately held technology companies. These investments are generally carried at cost because Ciena owns less than 20% of the voting equity and does not have the ability to exercise significant influence over any of these companies. These investments are inherently high risk as the market for technologies or products manufactured by these companies are usually early stage at the time of the investment by Ciena and such markets may never materialize or become significant. Ciena could lose its entire investment in some or all of these companies. Ciena monitors these investments for impairment and makes appropriate reductions in carrying values when necessary. During the nine months ended July 31, 2005, Ciena recorded a charge of $9.0 million from a decline in the fair value of certain equity investments that was determined to be other than temporary.
Pro Forma Stock-Based Compensation
In December 2004, the FASB issued its final standard on accounting for share-based payments, SFAS 123R, “Share-Based Payment,” which addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. Thecurrent year consolidated financial statement eliminates the ability to account for share-based compensation transactions using Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees,” and requires instead that such transactions be accounted for using a fair-value-based method. SFAS 123R becomes effective in the first quarter of fiscal 2006 for Ciena. SFAS 123R permits early adoption for interim or annual periods for which financial statements or interim reports have not been issued. We expect the adoption of SFAS 123R will have a material effect on our financial position and results of operations but will not affect our net cash flows.
Ciena has elected to continue to account for its stock-based compensation in accordance with the provisions of APB 25 as interpreted by FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation (an Interpretation of APB Opinion No. 25)” and will implement SFAS 123R beginning the first quarter of fiscal 2006.
Had (i) compensation cost for Ciena’s stock option plans and employee stock purchase plan been determined based on the Black-Scholes valuation method; and (ii) the fair value at the grant date for awards in the second quarter and first six months of fiscal 2004 and 2005 been determined consistent with the provisions of SFAS 123, “Accounting for Stock Based Compensation” as amended by SFAS 148, “Accounting for Stock Based Compensation-Transition and Disclosure,” Ciena’s net loss and net loss per share for the third quarters and the nine months ended July 31, 2004 and 2005 would have changed by the pro forma amounts indicated below (in thousands, except per share data):
| | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | Nine Months Ended July 31, | |
| | 2004 | | | 2005 | | | 2004 | | | 2005 | |
Net loss — as reported | | $ | (141,467 | ) | | $ | (51,027 | ) | | $ | (294,391 | ) | | $ | (182,829 | ) |
| | | | | | | | | | | | |
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | | | 7,220 | | | | 7,616 | | | | 29,006 | | | | 31,648 | |
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects | | | 3,953 | | | | 3,282 | | | | 8,699 | | | | 8,810 | |
| | | | | | | | | | | | |
Net loss — pro forma | | $ | (144,734 | ) | | $ | (55,361 | ) | | $ | (314,698 | ) | | $ | (205,667 | ) |
| | | | | | | | | | | | |
Basic and diluted net loss per share — as reported | | $ | (0.25 | ) | | $ | (0.09 | ) | | $ | (0.58 | ) | | $ | (0.32 | ) |
| | | | | | | | | | | | |
Basic and diluted net loss per share — pro forma | | $ | (0.26 | ) | | $ | (0.10 | ) | | $ | (0.62 | ) | | $ | (0.36 | ) |
| | | | | | | | | | | | |
The above pro forma disclosures are not necessarily representative of the effects on reported net income or loss for future years.presentation.
(3) RESTRUCTURING COSTS
Ciena has previously taken actions to align its workforce, facilities and operating costs with business opportunities. Prior to the adoption of SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” applicable to transactions initiated after December 31, 2002, Ciena followed the guidance of Emerging Issues Task Force Issue No. 94-3 (“EITF 94-3”), “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” for restructuring charges. However, given the manner in which Ciena undertook such restructuring activities, there have been no significant
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differences in financial reporting. Ciena historically has committed to a restructuring plan and has incurred the associated liability concurrently in accordance with the provisions of SFAS 146. The following table displays the activity and balances of the restructuring reserve account for the first ninethree months of fiscal 2005ending January 31, 2006 (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Workforce | | Consolidation of | | | | | Workforce | | Consolidation of | | | |
| | reduction | | excess facilities | | Total | | | reduction | | excess facilities | | Total | |
Balance at October 31, 2004 | | $ | 1,446 | | $ | 79,937 | | $ | 81,383 | | |
Balance at October 31, 2005 | | | $ | 270 | | $ | 69,507 | | $ | 69,777 | |
Additional reserve recorded | | | 5,350 | (a) | | | 447 | (b) | | 5,797 | | | | 1,469 | (a) | | | 742 | (a) | | 2,211 | |
Adjustments to previous estimates | | — | | | 9,448 | (c) | | 9,448 | | | — | | | (196 | ) (b) | | | (196 | ) |
Lease settlement | | | — | | | (6,020 | ) (c) | | | (6,020 | ) |
Cash payments | | | (6,451 | ) | | | (18,254 | ) | | | (24,705 | ) | | | (1,011 | ) | | | (16,135 | ) | | | (17,146 | ) |
| | | | | | | | | | | | | | |
Balance at July 31, 2005 | | $ | 345 | | $ | 71,578 | | $ | 71,923 | | |
Balance at January 31, 2006 | | | $ | 728 | | $ | 47,898 | | $ | 48,626 | |
| | | | | | | | | | | | | | |
Current restructuring liabilities | | $ | 345 | | $ | 14,856 | | $ | 15,201 | | | $ | 728 | | $ | 11,959 | | $ | 12,687 | |
| | | | | | | | | | | | | | |
Non-current restructuring liabilities | | $ | — | | $ | 56,722 | | $ | 56,722 | | | $ | — | | $ | 35,939 | | $ | 35,939 | |
| | | | | | | | | | | | | | |
| | |
(a) | | During the first quarter of fiscal 2005,2006, Ciena recorded a charge of approximately $1.0$0.7 million related to the closure of one of its facilities located in Kanata, Ontario and a charge of $1.5 million related to a workforce reduction of approximately 21 employees. During the second quarter of fiscal 2005, Ciena recorded a charge of approximately $2.1 million related to a workforce reduction of approximately 53 employees. During the third quarter of fiscal 2005, Ciena recorded a charge of approximately $2.3 million related to a workforce reduction of approximately 9662 employees. |
|
(b) | | During the first and second quarter of fiscal 2005, Ciena incurred a charge of approximately $0.3 million related to certain other costs associated with the closure of its San Jose, CA facility on September 30, 2004. During the third quarter of fiscal 2005,2006, Ciena recorded a chargean adjustment of approximately $0.1$0.2 million related to the closure of one of its Kanata, Canadacosts associated with previously restructured facilities. |
|
(c) | | During the first quarter of fiscal 2005,2006, Ciena reversedrecorded a chargegain of $0.1$6.0 million related to an adjustment to vacatedthe buy-out of the lease of its former Fremont, CA facility, cost estimates. During the second quarter of fiscal 2005,which Ciena recorded a charge of approximately $7.6 million related to a decrease in estimated future sublease payments forhad previously restructured facilities. During the third quarter of fiscal 2005, Ciena recorded a charge of approximately $1.9 million related to a decrease in estimated future sublease payments for previously restructured facilities. These adjustments to previously restructured facilities are due to the continued excess supply of commercial property.restructured. |
(4) MARKETABLE DEBT AND EQUITY SECURITIES
Cash, short-term and long-term investments, exclusive of restricted cash, are comprised of the following (in thousands):
810
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | July 31, 2005 | | | January 31, 2006 | |
| | Gross Unrealized | | Gross Unrealized | | Estimated Fair | | | Gross Unrealized | | Gross Unrealized | | Estimated Fair | |
| | Amortized Cost | | Gains | | Losses | | Value | | | Amortized Cost | | Gains | | Losses | | Value | |
Corporate bonds | | $ | 320,379 | | $ | — | | $ | 1,737 | | $ | 318,642 | | | $ | 258,524 | | $ | — | | $ | 1,463 | | $ | 257,061 | |
Asset-backed obligations | | 206,215 | | — | | 698 | | 205,517 | | | 170,619 | | — | | 651 | | 169,968 | |
U.S. government obligations | | 281,219 | | — | | 2,302 | | 278,917 | | | 237,252 | | — | | 1,320 | | 235,932 | |
Money market funds | | 313,576 | | — | | 7 | | 313,569 | | | 298,623 | | 1 | | — | | 298,624 | |
| | | | | | | | | | | | | | | | | | |
| | $ | 1,121,389 | | $ | — | | $ | 4,744 | | $ | 1,116,645 | | | $ | 965,018 | | $ | 1 | | $ | 3,434 | | $ | 961,585 | |
| | | | | | | | | | | | | | | | | | |
Included in cash and cash equivalents | | 313,576 | | — | | 7 | | 313,569 | | | 298,623 | | 1 | | — | | 298,624 | |
Included in short-term investments | | 606,241 | | — | | 3,353 | | 602,888 | | | 498,361 | | — | | 2,351 | | 496,010 | |
Included in long-term investments | | 201,572 | | — | | 1,384 | | 200,188 | | | 168,034 | | — | | 1,083 | | 166,951 | |
| | | | | | | | | | | | | | | | | | |
| | $ | 1,121,389 | | $ | — | | $ | 4,744 | | $ | 1,116,645 | | | $ | 965,018 | | $ | 1 | | $ | 3,434 | | $ | 961,585 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | October 31, 2004 | | | October 31, 2005 | |
| | Gross Unrealized | | Gross Unrealized | | Estimated Fair | | | Gross Unrealized | | Gross Unrealized | | Estimated Fair | |
| | Amortized Cost | | Gains | | Losses | | Value | | | Amortized Cost | | Gains | | Losses | | Value | |
Corporate bonds | | $ | 403,178 | | $ | — | | $ | 1,059 | | $ | 402,119 | | | $ | 291,044 | | $ | — | | $ | 1,888 | | $ | 289,156 | |
Asset-backed obligations | | 215,811 | | — | | 165 | | 215,646 | | |
Asset backed obligations | | | 195,471 | | — | | 844 | | 194,627 | |
Commercial paper | | 17,999 | | — | | 4 | | 17,995 | | | — | | — | | — | | — | |
U.S. government obligations | | 448,455 | | — | | 1,260 | | 447,195 | | | 253,633 | | — | | 1,941 | | 251,692 | |
Money market funds | | 202,623 | | — | | — | | 202,623 | | | 358,012 | | — | | — | | 358,012 | |
| | | | | | | | | | | | | | | | | | |
| | $ | 1,288,066 | | $ | — | | $ | 2,488 | | $ | 1,285,578 | | | $ | 1,098,160 | | $ | — | | $ | 4,673 | | $ | 1,093,487 | |
| | | | | | | | | | | | | | | | | | |
Included in cash and cash equivalents | | 202,623 | | — | | — | | 202,623 | | | 358,012 | | — | | — | | 358,012 | |
Included in short-term investments | | 754,813 | | — | | 1,562 | | 753,251 | | | 582,947 | | — | | 3,416 | | 579,531 | |
Included in long-term investments | | 330,630 | | — | | 926 | | 329,704 | | | 157,201 | | — | | 1,257 | | 155,944 | |
| | | | | | | | | | | | | | | | | | |
| | $ | 1,288,066 | | $ | — | | $ | 2,488 | | $ | 1,285,578 | | | $ | 1,098,160 | | $ | — | | $ | 4,673 | | $ | 1,093,487 | |
| | | | | | | | | | | | | | | | | | |
The following table summarizes maturities of debt investments (including restricted investments) at JulyJanuary 31, 20052006 (in thousands):
| | | | | | | | | | | | | | | | |
| | Amortized Cost | | Estimated Fair Value | | | Amortized Cost | | Estimated Fair Value | |
Less than one year | | $ | 606,241 | | $ | 602,888 | | | $ | 498,361 | | $ | 496,010 | |
Due in 1-2 years | | 201,572 | | 200,188 | | | 168,034 | | 166,951 | |
Due in 2-5 years | | — | | — | | | — | | — | |
| | | | | | | | | | |
| | $ | 807,813 | | $ | 803,076 | | | $ | 666,395 | | $ | 662,961 | |
| | | | | | | | | | |
(5) ACCOUNTS RECEIVABLE
As of JulyJanuary 31, 2005,2006, trade accounts receivable, net of allowance for doubtful accounts, included four customers who accounted for 15.3%10.0%, 10.9%12.4%, 10.4%12.8%, and 10.4%15.0% of net trade accounts receivable, respectively. As of October 31, 2004,2005, trade accounts receivable, net of allowance for doubtful accounts, included three customers who accounted for 24.0%12.1%, 12.3%13.1% and 11.2%13.8% of net trade accounts receivable, respectively.
Ciena performs ongoing credit evaluations of its customers and generally has not required collateral or other forms of security from its customers. Ciena maintains an allowance for potential losses associated with accounts that it deems doubtful on a specific identification basis. DuringIn determining the third quarter of fiscal 2005, Ciena recorded a provisionappropriate balance for Ciena’s allowance for doubtful accounts, of $2.6 million relatingmanagement considers each individual customer account receivable in order to onedetermine collectibility. In doing so, management considers creditworthiness, payment history, account activity and communication with such customer. If a customer’s financial condition changes, Ciena may be required to take a charge for an allowance on doubtful accounts. Ciena’s allowance for doubtful accounts as of October 31, 20042005 and JulyJanuary 31, 20052006 was $1.0 and $3.3 million and $0.7 million, respectively. During the first quarter of fiscal 2006, Ciena recorded the recovery of a doubtful account in the amount of $2.6 million.
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(6) INVENTORIES
Inventories are comprised of the following (in thousands):
11
| | | | | | | | | |
| | | | | | | | | | October 31, | | January 31, | |
| | October 31, 2004 | | July 31, 2005 | | | 2005 | | 2006 | |
Raw materials | | $ | 19,591 | | $ | 21,542 | | | $ | 21,177 | | $ | 24,251 | |
Work-in-process | | 3,833 | | 3,293 | | | 3,136 | | 3,528 | |
Finished goods | | 46,123 | | 48,644 | | | 47,615 | | 58,812 | |
| | | | | | | | | | |
| | 69,547 | | 73,479 | | | 71,928 | | 86,591 | |
Reserve for excess and obsolescence | | | (21,933 | ) | | | (22,032 | ) | |
Provision for excess and obsolescence | | | | (22,595 | ) | | | (22,212 | ) |
| | | | | | | | | | |
| | $ | 47,614 | | $ | 51,447 | | | $ | 49,333 | | $ | 64,379 | |
| | | | | | | | | | |
Ciena writes down its inventory for estimated obsolescence or unmarketable inventory by the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. During the ninethree months ended JulyJanuary 31, 2005,2006, Ciena recorded a provision for excess inventory reserves of $3.4$3.0 million, primarily related to excess inventory due to a change in forecasted sales for certain products. The following is a summary of the change in the reserve for excess inventory and obsolete inventory during the ninethree months ended JulyJanuary 31, 20052006 (in thousands):
| | | | | | | | |
| | Inventory Reserve | | | Inventory Reserve | |
Reserve balance as of October 31, 2004 | | $ | 21,933 | | |
Reserve balance as of October 31, 2005 | | | $ | 22,595 | |
Provision for excess inventory, net | | 3,396 | | | 3,000 | |
Actual inventory scrapped | | | (3,297 | ) | | | (3,383 | ) |
| | | | | | | | |
Reserve balance as of July 31, 2005 | | $ | 22,032 | | |
Reserve balance as of January 31, 2006 | | | $ | 22,212 | |
| | | | | | | | |
During the ninethree months ended JulyJanuary 31, 2004,2005, Ciena recorded a provision for excess inventory of $3.0$1.1 million, primarily related to excess inventory due to a change in forecasted sales for certain products. The following is a summary of the change in the reserve for excess and obsolete inventory during the ninethree months ended JulyJanuary 31, 20042005 (in thousands):
| | | | | | | | |
| | Inventory Reserve | | | Inventory Reserve | |
Reserve balance as of October 31, 2003 | | $ | 23,093 | | |
Reserve balance as of October 31, 2004 | | | $ | 21,933 | |
Provision for excess inventory, net | | 3,026 | | | 1,115 | |
Actual inventory scrapped | | | (4,825 | ) | | | (493 | ) |
| | | | | | | | |
Reserve balance as of July 31, 2004 | | $ | 21,294 | | |
Reserve balance as of January 31, 2005 | | | $ | 22,555 | |
| | | | | | | | |
(7) PREPAID EXPENSES AND OTHER
Prepaid expenses and other are comprised of the following (in thousands):
| | | | | | | | |
| | October 31, | | | January 31, | |
| | 2005 | | | 2006 | |
Interest receivable | | $ | 7,743 | | | $ | 7,133 | |
Prepaid VAT and other taxes | | | 4,848 | | | | 4,725 | |
Prepaid expenses | | | 9,103 | | | | 9,032 | |
Restricted cash | | | 10,376 | | | | 9,863 | |
Other non-trade receivables | | | 5,797 | | | | 3,964 | |
| | | | | | |
| | $ | 37,867 | | | $ | 34,717 | |
| | | | | | |
(8) EQUIPMENT, FURNITURE AND FIXTURES
Equipment, furniture and fixtures are comprised of the following (in thousands):
| | | | | | | | |
| | October 31, | | | July 31, | |
| | 2004 | | | 2005 | |
Equipment, furniture and fixtures | | $ | 259,809 | | | $ | 178,008 | |
Leasehold improvements | | | 38,064 | | | | 33,733 | |
| | | | | | |
| | | 297,873 | | | | 211,741 | |
Accumulated depreciation and amortization | | | (247,336 | ) | | | (179,259 | ) |
Construction-in-progress | | | 715 | | | | 502 | |
| | | | | | |
| | $ | 51,252 | | | $ | 32,984 | |
| | | | | | |
During fiscal 2005, Ciena abandoned or disposed of certain idle assets that it determined to have no future value. These assets had an aggregate original cost of $94.1 million and a carrying value of $3.8 million. These assets were abandoned before the end of their estimated useful life, and accordingly, Ciena recorded $3.8 million in accelerated depreciation expense during the third quarter of 2005.
Ciena also recorded an impairment of $0.1 million, primarily related to research and development equipment classified as held for sale in the first nine months of fiscal 2005. The residual carrying value of these assets is insignificant.
1012
| | | | | | | | |
| | October 31, | | | January 31, | |
| | 2005 | | | 2006 | |
Equipment, furniture and fixtures | | $ | 249,282 | | | $ | 249,761 | |
Leasehold improvements | | | 32,875 | | | | 32,925 | |
| | | | | | |
| | | 282,157 | | | | 282,686 | |
Accumulated depreciation and amortization | | | (254,458 | ) | | | (256,713 | ) |
Construction-in-progress | | | 391 | | | | 1,158 | |
| | | | | | |
| | $ | 28,090 | | | $ | 27,131 | |
| | | | | | |
(8)(9) OTHER INTANGIBLE ASSETS
Other intangible assets are comprised of the following (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | October 31, 2004 | | | July 31, 2005 | |
| | Gross | | | Accumulated | | | Net | | | Gross | | | Accumulated | | | Net | |
| | Intangible | | | Amortization | | | Intangible | | | Intangible | | | Amortization | | | Intangible | |
Existing technology | | $ | 177,704 | | | $ | (43,076 | ) | | $ | 134,628 | | | $ | 177,704 | | | $ | (64,389 | ) | | $ | 113,315 | |
Patents and licenses | | | 46,670 | | | | (13,208 | ) | | | 33,462 | | | | 46,670 | | | | (17,716 | ) | | | 28,954 | |
Covenants not to compete, outstanding purchase orders and contracts | | | 54,000 | | | | (14,075 | ) | | | 39,925 | | | | 54,000 | | | | (21,424 | ) | | | 32,576 | |
| | | | | | | | | | | | | | | | | | |
| | $ | 278,374 | | | $ | (70,359 | ) | | $ | 208,015 | | | $ | 278,374 | | | $ | (103,529 | ) | | $ | 174,845 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | October 31, 2005 | | | January 31, 2006 | |
| | Gross | | | Accumulated | | | Net | | | Gross | | | Accumulated | | | Net | |
| | Intangible | | | Amortization | | | Intangible | | | Intangible | | | Amortization | | | Intangible | |
Developed technology | | $ | 139,983 | | | $ | (70,502 | ) | | $ | 69,481 | | | $ | 139,983 | | | $ | (74,771 | ) | | $ | 65,212 | |
Patents and licenses | | | 47,370 | | | | (19,219 | ) | | | 28,151 | | | | 47,370 | | | | (20,780 | ) | | $ | 26,590 | |
Customer relationships, covenants not to compete, outstanding purchase orders and contracts | | | 45,981 | | | | (23,289 | ) | | | 22,692 | | | | 45,981 | | | | (24,722 | ) | | $ | 21,259 | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 233,334 | | | | | | | $ | 120,324 | | | $ | 233,334 | | | | | | | $ | 113,061 | |
| | | | | | | | | | | | | | | | | | | | |
The aggregate amortization expense of other intangible assets was $22.4$11.4 million and $33.2$7.3 million for the nine monthsquarter ended JulyJanuary 31, 20042005 and 2005,2006, respectively. The following table represents the expected future amortization of other intangible assets as follows (in thousands):
| | | | | | | | |
2005 (remaining three months) | | $ | 10,621 | | |
2006 | | 42,483 | | |
2006 (remaining nine months) | | | $ | 21,787 | |
2007 | | 42,483 | | | 29,050 | |
2008 | | 41,273 | | | 27,840 | |
2009 | | 21,054 | | | 19,254 | |
2010 | | | 14,500 | |
Thereafter | | 16,931 | | | 630 | |
| | | | | | |
| | $ | 174,845 | | | $ | 113,061 | |
| | | | | | |
(9)(10) OTHER BALANCE SHEET DETAILS
Other long-term assets (in thousands):
| | | | | | | | | | | | | | | | |
| | October 31, | | July 31, | | | October 31, | | January 31, | |
| | 2004 | | 2005 | | | 2005 | | 2006 | |
Maintenance spares inventory, net | | $ | 18,959 | | $ | 12,304 | | | $ | 12,513 | | $ | 12,606 | |
Deferred debt issuance costs | | 9,841 | | 7,117 | | | 6,406 | | 4,759 | |
Investments in privately held companies | | 21,592 | | 7,722 | | | 7,223 | | 6,489 | |
Restricted cash | | | 4,393 | | 3,804 | |
Other | | 9,804 | | 10,812 | | | 10,792 | | 3,209 | |
| | | | | | | | | | |
| | $ | 60,196 | | $ | 37,955 | | | $ | 41,327 | | $ | 30,867 | |
| | | | | | | | | | |
Accrued liabilities (in thousands):
13
| | | | | | | | | | | | | | | | |
| | October 31, | | July 31, | | | October 31, | | January 31, | |
| | 2004 | | 2005 | | | 2005 | | 2006 | |
Warranty | | $ | 30,189 | | $ | 27,215 | | | $ | 27,044 | | $ | 26,752 | |
Accrued compensation, payroll related tax and benefits | | 23,531 | | 28,689 | | | 26,164 | | 22,252 | |
Accrued interest payable | | 6,469 | | — | | | 6,082 | | — | |
Other | | 15,856 | | 16,637 | | | 17,201 | | 15,134 | |
| | | | | | | | | | |
| | $ | 76,045 | | $ | 72,541 | | | $ | 76,491 | | $ | 64,138 | |
| | | | | | | | | | |
The following table summarizes the activity in Ciena’s accrued warranty for the ninethree months ended JulyJanuary 31, 20042005 and 20052006 (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | Beginning | | | | | | | | | | | | | | | Balance at end | |
Nine Months Ended July 31, | | Balance | | | Provisions | | | Acquisitions | | | Settlements | | | of period | |
2004 | | $ | 36,189 | | | | 7,179 | | | | 1,000 | | | | (12,212 | ) | | $ | 32,156 | |
2005 | | $ | 30,189 | | | | 7,546 | | | | — | | | | (10,520 | ) | | $ | 27,215 | |
| | | | | | | | | | | | | | | | | | |
Three months ended | | | Beginning | | | | | | | | | | | Balance at end | |
January 31, | | | Balance | | | Provisions | | | Settlements | | | of period | |
2005 | | | | $ | 30,189 | | | | 3,016 | | | | (4,268 | ) | | $ | 28,937 | |
2006 | | | | $ | 27,044 | | | | 2,470 | | | | (2,762 | ) | | $ | 26,752 | |
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Deferred revenue (in thousands):
| | | | | | | | | | | | | | | | |
| | October 31, | | July 31, | | | October 31, | | January 31, | |
| | 2004 | | 2005 | | | 2005 | | 2006 | |
Products | | $ | 8,578 | | $ | 18,694 | | | $ | 14,534 | | $ | 18,023 | |
Services | | 28,998 | | 26,983 | | | 28,984 | | 28,690 | |
| | | | | | | | | | |
Total deferred revenue | | 37,576 | | 45,677 | | | 43,518 | | 46,713 | |
Less current portion | | | (21,566 | ) | | | (31,298 | ) | | | (27,817 | ) | | | (30,986 | ) |
| | | | | | | | | | |
Long-term deferred revenue | | $ | 16,010 | | $ | 14,379 | | | $ | 15,701 | | $ | 15,727 | |
| | | | | | | | | | |
(10)(11) CONVERTIBLE NOTES PAYABLE
Ciena 3.75% Convertible Notes, due February 1, 2008
On February 9, 2001, Ciena completed a public offering of 3.75% convertible notes, due February 1, 2008, in an aggregate principal amount of $690 million, due February 1, 2008.$690.0 million. Interest is payable on February 1st and August 1st of each year. TheAt the election of the holder, the notes may be converted into shares of Ciena’s common stock at any time before their maturity or their prior redemption or repurchase by Ciena. The conversion rate is 9.5808 shares per each $1,000 principal amount of notes, subject to adjustment in certain circumstances.
During the third quarter of fiscal 2005, Ciena purchased $41.2 million of the outstanding 3.75% convertible notes for $36.9 million in open market transactions. Ciena recorded a gain on the extinguishment of debt in the amount of $3.9 million, which consists of the $4.3 million gain from the repurchase of the notes less a write-off of $0.4 million of associated debt issuance costs. Ciena has the option to redeem all or a portion of the notes that have not been previously converted at the following redemption prices (expressed as percentage of principleprincipal amount):
| | | | |
| | Redemption | |
Period | | Price | |
|
Beginning on February 1, 2005 and ending on January 31, 2006 | | | 101.607 | % |
Beginning on February 1, 2006 and ending on January 31, 2007 | | | 101.071 | % |
Beginning on February 1, 2007 and ending on January 31, 2008 | | | 100.536 | % |
On July 31, 2005,During the first quarter of fiscal 2006, Ciena repurchased $106.5 million of the outstanding 3.75% convertible notes for $98.8 million in open market transactions. Ciena recorded a gain on the extinguishment of debt in the amount of $6.7 million, which consists of the $7.7 million gain from the repurchase of the notes, less $1.0 million of associated debt issuance costs.
As of the last day of the first quarter of fiscal 2006, the fair market value of the remaining $648.8$542.3 million in aggregate principal amount of 3.75% convertible notes outstanding was $578.2 million. The fair value is$509.0 million, based on athe quoted market price for the notes.
On December 19, 2003, Ciena purchased the remaining $48.2 million of the outstanding ONI Systems Corp. 5.0% convertible subordinated notes. Ciena paid $49.2 million for notes with a cumulative accreted book value of $41.0 million, which resulted in a loss on early extinguishment of debt of $8.2 million.
(11)(12) LOSS PER SHARE CALCULATION
Basic and diluted EPS isare computed using the weighted average number of common shares outstanding (excluding restricted stock subject to repurchase). DilutedBecause of the anti-dilutive effect, diluted EPS is computed by combiningand the weighted average number of common shares outstanding for purposes of basic EPS withdo not include shares underlyingunderlying: stock options, warrants, restricted stock, restricted stock units, and Ciena’s 3.75% convertible notes determined using the treasury stock method.
Weighted average number of common sharesnotes. Shares underlying stock options, warrants, restricted stock, restricted stock units, and Ciena’s 3.75% convertible notesthese securities totaled (i) approximately 57.5 million and 63.6 million during the third quarter of fiscal 2004 and 2005, respectively, and (ii) approximately 42.3 million and 65.7 million during the first nine months of fiscal 2004 and 2005, respectively. These shares were not included in the computation of diluted EPS as the effect would be anti-dilutive.
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62.5 million and 63.6 million for the first quarter of fiscal 2005 and the first quarter of fiscal 2006, respectively.
(12)(13) SHARE-BASED COMPENSATION EXPENSE
During fiscal 2005, the Board of Directors determined that all future grants of stock options, restricted stock units, or other forms of equity-based compensation will solely be issued under the Ciena Corporation 2000 Equity Incentive Plan (the “2000 Plan”) and the 2003 Employee Stock Purchase Plan (the “ESPP”).
Ciena Corporation 2000 Equity Incentive Plan
The 2000 Plan, which is a shareholder approved plan, was assumed by Ciena as a result of its merger with ONI. It authorizes the issuance of stock options, restricted stock, restricted stock units and stock bonuses to employees, officers, directors, consultants, independent contractors and advisors. The Board of Directors or its Compensation Committee has broad discretion to establish the terms and conditions for grants, including number of shares, vesting and required service or other performance criteria. The maximum term of any award under the 2000 Plan is ten years. The exercise price of options may not be less than 85% of the fair market value of the stock at the date of grant, or 100% of the fair market value for qualified options.
Under the terms of the 2000 Plan, the number of shares authorized for issuance will increase by 5.0% of the number of issued and outstanding shares of Ciena each January 1st, unless the Compensation Committee reduces the amount of the increase in any year. By action of the Compensation Committee, the plan increased by (i) zero shares on January 1, 2006, (ii) zero shares on January 1, 2005, and (iii) 9.5 million shares, or 2.0% of the then issued and outstanding shares of Ciena, on January 1, 2004. In addition, any shares subject to outstanding options or other awards under the ONI 1997 Stock Plan, ONI 1998 Equity Incentive Plan, or ONI 1999 Equity Incentive Plan that are forfeited upon cancellation of the award are available for grant and issuance under the 2000 Plan. As of January 31, 2006, there were 38.9 million shares authorized and available to grant under the 2000 Plan.
Stock Options
The following table is a summary of Ciena’s stock option activity (shares in thousands):
| | | | | | | | |
| | | | | | Weighted |
| | | | | | Average |
| | Options | | Exercise |
| | Outstanding | | Price |
Balance as of October 31, 2005 | | | 60,591 | | | $ | 6.40 | |
Granted | | | 2,570 | | | | 2.42 | |
Exercised | | | (1,136 | ) | | | 2.08 | |
Canceled | | | (1,341 | ) | | | 5.68 | |
| | | | | | | | |
Balance as of January 31, 2006 | | | 60,684 | | | $ | 4.79 | |
| | | | | | | | |
The total intrinsic value of options exercised in the first quarter of fiscal 2006 was $1.5 million.
The following table summarizes information with respect to stock options outstanding at January 31, 2006 (shares and intrinsic value in thousands):
15
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | Options Outstanding at January 31, 2006 | | | Vested Options at January 31, 2006 | |
| | | | | | | | | | | | | | | | Weighted | | | | | | | | | | | | | | | Weighted | | | | | | | |
| | | | | | | | | | | | | | | | Average | | | | | | | | | | | | | | | Average | | | | | | | |
| | | | | | | | | | | | | | | | Remaining | | | Weighted | | | | | | | | | | | Remaining | | | Weighted | | | | |
Range of | | | | | | | Contractual | | | Average | | | Aggregate | | | | | | | Contractual | | | Average | | | Aggregate | |
Exercise | | | | | | | Life | | | Exercise | | | Intrinsic | | | | | | | Life | | | Exercise | | | Intrinsic | |
Price | | | Number | | | (Years) | | | Price | | | Value | | | Number | | | (Years) | | | Price | | | Value | |
$ | 0.01 | | | | — | | | $ | 2.36 | | | | 10,120 | | | | 7.19 | | | $ | 1.83 | | | $ | 21,987 | | | | 3,336 | | | | 2.71 | | | $ | 1.00 | | | $ | 10,016 | |
$ | 2.37 | | | | — | | | $ | 2.49 | | | | 8,781 | | | | 8.97 | | | | 2.45 | | | | 13,644 | | | | 2,187 | | | | 7.85 | | | | 2.41 | | | | 3,480 | |
$ | 2.50 | | | | — | | | $ | 3.29 | | | | 10,058 | | | | 8.49 | | | | 3.07 | | | | 9,394 | | | | 8,619 | | | | 8.41 | | | | 3.10 | | | | 7,738 | |
$ | 3.30 | | | | — | | | $ | 4.48 | | | | 5,350 | | | | 8.01 | | | | 3.93 | | | | 959 | | | | 5,294 | | | | 7.99 | | | | 3.94 | | | | 927 | |
$ | 4.49 | | | | — | | | $ | 4.53 | | | | 7,377 | | | | 6.81 | | | | 4.53 | | | | — | | | | 7,377 | | | | 6.81 | | | | 4.53 | | | | — | |
$ | 4.54 | | | | — | | | $ | 6.71 | | | | 5,125 | | | | 6.93 | | | | 5.91 | | | | — | | | | 5,125 | | | | 6.93 | | | | 5.91 | | | | — | |
$ | 6.72 | | | | — | | | $ | 11.88 | | | | 6,028 | | | | 6.26 | | | | 8.50 | | | | — | | | | 6,028 | | | | 6.26 | | | | 8.50 | | | | — | |
$ | 11.89 | | | | — | | | $ | 149.50 | | | | 7,845 | | | | 4.98 | | | | 10.66 | | | | — | | | | 7,845 | | | | 4.98 | | | | 10.66 | | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
$ | 0.01 | | | | — | | | $ | 149.50 | | | | 60,684 | | | | 7.29 | | | $ | 4.79 | | | $ | 45,984 | | | | 45,811 | | | | 6.63 | | | $ | 5.56 | | | $ | 22,161 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
As of January 31, 2006, total unrecognized compensation expense related to unvested stock options was $17.7 million. This expense is expected to be recognized over a weighted-average period of 1.6 years.
On October 26, 2005, Ciena’s Board of Directors accelerated the vesting of approximately 14.1 million unvested, “out-of-the-money” stock options previously awarded to employees, officers and directors under Ciena’s stock option plans. Certain performance-based options held by executives were not subject to this acceleration. For purposes of the acceleration, options with an exercise price greater than $2.49 per share were deemed “out-of-the-money.” The accelerated options, which were considered fully vested as of October 26, 2005, had exercise prices ranging from $2.50 to $46.99 per share and a weighted average exercise price of $4.39 per share. Ciena did not accelerate the vesting of options that had an exercise price per share of $2.49 or less. The primary purpose of the accelerated vesting was to enable Ciena to avoid recognizing future compensation expense associated with these out-of-the-money stock options upon adoption of SFAS 123(R) for fiscal 2006.
Restricted Stock Units
A restricted stock unit is a right to receive a share of Ciena common stock when the unit vests. Ciena calculates the fair value of each restricted stock unit using the intrinsic value method and recognizes the expense straight-line over the requisite period. The following table is a summary of Ciena’s restricted stock unit activity (shares and intrinsic value in thousands):
| | | | | | | | | | | | |
| | | | | | Weighted | | Intrinsic |
| | Restricted | | Average | | Value at |
| | Stock Units | | Grant Date | | Jan. 31, |
| | Outstanding | | Fair Value | | 2006 |
Balance as of October 31, 2005 | | | 127 | | | $ | 6.76 | | | | | |
Granted | | | 1,457 | | | | 2.37 | | | | | |
Converted | | | (43 | ) | | | 6.76 | | | | | |
Canceled | | | — | | | | — | | | | | |
| | | | | | | | | | | | |
Balance as of January 31, 2006 | | | 1,541 | | | $ | 2.61 | | | $ | 6,164 | |
| | | | | | | | | | | | |
The total intrinsic value of restricted stock units converted into shares in the first quarter of fiscal 2006 was $0.1 million.
As of January 31, 2006, total unrecognized compensation expense related to restricted stock units was $4.0 million. This expense is expected to be recognized over a weighted-average period of 1.5 years.
2003 Employee Stock Purchase Plan
In March 2003, Ciena shareholders approved the ESPP which authorized the issuance of 20.0 million shares. Under the ESPP, eligible employees may enroll in a 24-month offer period during certain open enrollment periods.
16
New offer periods begin March 16 and September 16 of each year. Each offer period consists of four, six-month purchase periods during which employee payroll deductions are accumulated. These deduction amounts, which are subject to certain limitations, are accumulated, and, at the end of each purchase period, are used to purchase shares of common stock. The purchase price of the shares is 15% less than the fair market value on either the first day of an offer period or the last day of a purchase period, whichever is lower. If the fair market value on the purchase date is less than the fair market value on the first day of an offer period, then participants automatically commence a new 24-month offer period. The ESPP has a ten-year term.
At the 2005 annual meeting, Ciena shareholders approved an amendment to the ESPP pursuant to which 11.8 million shares were added to the ESPP on March 16, 2005, increasing the number of shares available under the ESPP to 25.0 million. The amendment to the ESPP also provided for an “evergreen” provision, pursuant to which, beginning on December 31, 2005, the number of shares available for issuance under the ESPP annually increases by up to four million shares, provided that the total number of shares available for issuance at any time under the ESPP shall not exceed 25.0 million. Pursuant to the evergreen provision, the maximum number of shares that may be added to the ESPP during the remainder of its ten-year term is 28.0 million. On December 31, 2005, the evergreen provision automatically added an additional 2.1 million shares to the ESPP, increasing the total number of shares available to 25.0 million.
As of January 31, 2006, unrecognized compensation expense related to the ESPP was $0.8 million. This expense is expected to be recognized over a weighted-average period of 1.2 years.
Share-Based Compensation under SFAS 123(R) for Fiscal 2006 and APB 25 for Fiscal 2005
On November 1, 2005, Ciena adopted SFAS 123(R), which requires the measurement and recognition of compensation expense, based on estimated fair values, for all share-based payments awards made to Ciena’s employees and directors including stock options, restricted stock, restricted stock unit awards and stock purchased under Ciena’s ESPP.
Prior to the adoption of SFAS 123(R), Ciena accounted for share-based awards to employees and directors using the intrinsic value method in accordance with APB 25, as interpreted by FASB Interpretation (FIN) No. 44, “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25,” as allowed under SFAS 123, “Accounting for Stock-Based Compensation.” Share-based compensation expense of $2.0 million for the first quarter of fiscal 2005 was solely related to share-based awards assumed through acquisitions and restricted stock unit awards that Ciena had been recognizing in its consolidated statement of operations in accordance with the provisions set forth above. Because the exercise price of Ciena’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the grant date, under the intrinsic value method, no share-based compensation expense was otherwise recognized in Ciena’s consolidated statement of operations.
The following table summarizes share-based compensation expense under SFAS 123(R) for the three months ended January 31, 2006 and under APB 25, as interpreted by FIN 44, for the three months ended January 31, 2005, which was allocated as follows (in thousands):
| | | | | | | | |
| | Quarter Ended January 31, | |
| | 2005 | | | 2006 | |
Product costs | | $ | — | | | $ | 135 | |
Service costs | | | — | | | | 188 | |
| | | | | | |
Stock-based compensation expense included in cost of sales | | | — | | | | 323 | |
| | | | | | |
| | | | | | | | |
Research and development | | | 1,011 | | | | 1,637 | |
Sales and marketing | | | 876 | | | | 1,046 | |
General and administrative | | | 160 | | | | 821 | |
| | | | | | |
Stock-based compensation expense included in operating expense | | | 2,047 | | | | 3,504 | |
| | | | | | |
|
| | | | | | |
Stock-based compensation expense capitalized in inventory | | | — | | | | 356 | |
| | | | | | |
| | | | | | | | |
Total stock-based compensation | | $ | 2,047 | | | $ | 4,183 | |
| | | | | | |
Pro Forma Share-Based Compensation under SFAS 123 for Fiscal 2005
17
Had (i) compensation expense for Ciena’s stock option plans and employee stock purchase plan been determined based on the Black-Scholes valuation method; and (ii) the fair value at the grant date for awards in the first quarter of fiscal 2005 been determined consistent with the provisions of SFAS 123, “Accounting for Stock Based Compensation” as amended by SFAS 148, “Accounting for Stock Based Compensation-Transition and Disclosure,” Ciena’s net loss and net loss per share for the first quarter of fiscal 2005 would have changed by the pro forma amounts indicated below (in thousands, except per share data):
| | | | |
| | Quarter Ended | |
| | January 31, 2005 | |
Net loss applicable to common stockholders — as reported | | $ | (56,995 | ) |
| | | |
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | | | 11,799 | |
| | | | |
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects | | | 2,047 | |
| | | |
Net loss applicable to common stockholders — pro forma | | $ | (66,747 | ) |
| | | |
Basic and diluted net loss per share — as reported | | $ | (0.10 | ) |
| | | |
Basic and diluted net loss per share — pro forma | | $ | (0.12 | ) |
| | | |
Fair Value and Assumptions Used to Calculate Fair Value under SFAS 123(R) and SFAS 123
The weighted average fair value of each restricted stock unit granted under Ciena’s stock option plans for the first quarter of fiscal 2006 was $2.37, and there were no restricted stock units issued in the first quarter of fiscal 2005. The fair value of each restricted stock unit award is estimated on the date of grant using the intrinsic value method. The weighted average fair value of each option granted for the first quarter of fiscal 2005 and the first quarter of fiscal 2006 was $1.62 and $1.47, respectively.
The fair value of each option award is estimated on the date of grant using the Black-Scholes Option Pricing Model, with the following weighted average assumptions for the first quarter of fiscal 2005 and the first quarter of fiscal 2006:
| | | | | | | | |
| | Quarter Ended January 31, | |
| | 2005 | | | 2006 | |
Expected volatility | | | 66 | % | | | 62 | % |
Risk-free interest rate | | | 3.65 | % | | | 4.3% - 4.5 | % |
Expected life (years) | | | 4.5 | | | | 6.0 - 6.1 | |
Expected dividend yield | | | 0.0 | % | | | 0.0 | % |
Assumptions for Option-Based Awards under SFAS 123(R)
Consistent with SFAS 123(R) and SAB 107, Ciena considered the implied volatility and historical volatility of its stock price in determining its expected volatility, and, finding both to be equally reliable, determined that a combination of both would result in the best estimate of expected volatility.
The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of Ciena’s employee stock options.
The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding. Because Ciena considers its options to be “plain vanilla,” it calculated the expected term using the simplified method as prescribed in SAB 107. Under SAB 107, options are considered to be “plain vanilla” if they have the following basic characteristics: granted “at-the-money”; exerciseability is conditioned upon service through the vesting date; termination of service prior to vesting results in forfeiture; limited exercise period following termination of service; options are non-transferable and non-hedgeable.
The dividend yield assumption is based on Ciena’s history and expectation of dividend payouts.
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As share-based compensation expense recognized in the consolidated statement of operations for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures were estimated based on Ciena’s historical experience.
Assumptions for option-based awards under SFAS 123
Prior to the first quarter of fiscal 2006, Ciena considered the implied volatility and historical volatility of its stock price in determining its expected volatility. The risk-free interest rate was based upon assumption of interest rates appropriate for the term of Ciena’s employee stock options. The dividend yield assumption was based on Ciena’s history and expectation of dividend payouts. Forfeitures prior to the first quarter of fiscal 2006 were accounted for as they occurred.
(14) COMPREHENSIVE LOSS
The components of comprehensive loss for the quarters and nine months ended July 31, 2004 and 2005 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | Nine Months Ended July 31, | | | Quarter ended January 31, | |
| | 2004 | | 2005 | | 2004 | | 2005 | | | 2005 | | 2006 | |
Net loss | | $ | (141,467 | ) | | $ | (51,027 | ) | | $ | (294,391 | ) | | $ | (182,829 | ) | | $ | (56,995 | ) | | $ | (6,291 | ) |
Change in unrealized loss on available- for-sale securities, net of tax | | | (2,702 | ) | | 196 | | | (5,906 | ) | | | (2,256 | ) | |
Change in unrealized loss on available-for-sale securities, net of tax | | | | (2,444 | ) | | 1,240 | |
Change in accumulated translation adjustments | | | (26 | ) | | | (196 | ) | | | (102 | ) | | | (200 | ) | | | (8 | ) | | | (10 | ) |
| | | | | | | | | | | | | | |
Total comprehensive loss | | $ | (144,195 | ) | | $ | (51,027 | ) | | $ | (300,399 | ) | | $ | (185,285 | ) | | $ | (59,447 | ) | | $ | (5,061 | ) |
| | | | | | | | | | | | | | |
(13)(15) SEGMENT REPORTING
Revenue from sales to customers outside of the United States is reflected as International in the geographic distribution of revenue below. Ciena’s geographic distribution of revenue for the quartersfirst quarter of fiscal 2005 and nine months ended July 31, 2004 and 2005 werefiscal 2006 was as follows (in thousands, except percentage data):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | Nine Months Ended July 31, | | | Quarter Ended January 31, | |
| | 2004 | | %* | | 2005 | | %* | | 2004 | | %* | | 2005 | | %* | | | 2005 | | %* | | 2006 | | %* | |
Domestic | | $ | 61,231 | | 81.0 | | $ | 89,357 | | 80.9 | | $ | 156,547 | | 72.2 | | $ | 248,216 | | 80.3 | | |
United States | | | $ | 78,686 | | 83.0 | | $ | 102,670 | | 85.3 | |
International | | 14,358 | | 19.0 | | 21,123 | | 19.1 | | 60,155 | | 27.8 | | 60,858 | | 19.7 | | | 16,062 | | 17.0 | | 17,760 | | 14.7 | |
| | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 75,589 | | 100.0 | | $ | 110,480 | | 100.0 | | $ | 216,702 | | 100.0 | | $ | 309,074 | | 100.0 | | | $ | 94,748 | | 100.0 | | $ | 120,430 | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of total revenue |
During the quartersfirst quarter of fiscal 2005 and nine months ended July 31, 2004 and 2005,fiscal 2006, customers who each accounted for at least 10% of Ciena’s revenue during the respective periods were as follows (in thousands, except percentage data):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | Nine Months Ended July 31, | |
| | 2004 | | | %* | | | 2005 | | | %* | | | 2004 | | | %* | | | 2005 | | | %* | |
Customer A | | $ | 12,458 | | | | 16.5 | | | $ | 13,780 | | | | 12.5 | | | $ | 40,284 | | | | 18.6 | | | $ | 37,882 | | | | 12.3 | |
Customer B | | | 7,933 | | | | 10.5 | | | | N/A | | | | — | | | | N/A | | | | — | | | | 34,395 | | | | 11.1 | |
Customer C | | | N/A | | | | — | | | | 14,802 | | | | 13.4 | | | | N/A | | | | — | | | | 34,739 | | | | 11.2 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 20,391 | | | | 27.0 | | | $ | 28,582 | | | | 25.9 | | | $ | 40,284 | | | | 18.6 | | | $ | 107,016 | | | | 34.6 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | Quarter Ended January 31, | |
| | 2005 | | | %* | | | 2006 | | | %* | |
Company A | | | n/a | | | | — | | | $ | 13,990 | | | | 11.6 | |
Company B | | | 17,643 | | | | 18.6 | | | | 23,494 | | | | 19.5 | |
Company C | | | 12,420 | | | | 13.1 | | | | n/a | | | | — | |
Company D | | | n/a | | | | — | | | | 17,073 | | | | 14.2 | |
| | | | | | | | | | | | |
Total | | $ | 30,063 | | | | 31.7 | | | $ | 54,556 | | | | 45.3 | |
| | | | | | | | | | | | |
| | |
N/A n/a | | Denotes revenue recognized less than 10% of total revenue for the period |
|
* | | Denotes % of total revenue |
The table below (in thousands, except percentage data) sets forth ourCiena’s operating segment revenues for the quartersfirst quarter of fiscal 2005 and nine months ended July 31, 2004 and 2005.fiscal 2006.
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | Nine Months Ended July 31, | | | Quarter Ended January 31, | |
| | 2004 | | %* | | 2005 | | %* | | 2004 | | %* | | 2005 | | %* | | | 2005 | | %* | | 2006 | | %* | |
Revenues: | | |
TSG | | $ | 42,240 | | 55.9 | | $ | 64,641 | | 58.5 | | $ | 152,635 | | 70.4 | | $ | 182,638 | | 59.0 | | | $ | 50,440 | | 53.3 | | $ | 74,901 | | 62.3 | |
DNG | | 7,138 | | 9.4 | | 6,757 | | 6.1 | | 13,839 | | 6.4 | | 28,302 | | 9.2 | | | 16,579 | | 17.5 | | 6,057 | | 5.0 | |
BBG | | 14,962 | | 19.8 | | 26,050 | | 23.6 | | 14,962 | | 6.9 | | 60,426 | | 19.6 | | | 15,281 | | 16.1 | | 24,983 | | 20.7 | |
GNS | | 11,249 | | 14.9 | | 13,032 | | 11.8 | | 35,266 | | 16.3 | | 37,708 | | 12.2 | | | 12,448 | | 13.1 | | 14,489 | | 12.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Consolidated revenue | | $ | 75,589 | | 100.0 | | $ | 110,480 | | 100.0 | | $ | 216,702 | | 100.0 | | $ | 309,074 | | 100.0 | | | $ | 94,748 | | 100.0 | | $ | 120,430 | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of total revenue |
Segment profit (loss) is determined based on internal performance measures used by the Chief Executive Officer to assess the performance of each operating segment in a given period. In connection with that assessment, the Chief Executive Officer excludes the following other non-performance items: corporate selling and marketing;marketing, corporate general and administrative costs; stock compensation;costs, amortization of intangibles;intangibles, in-process research and development;development, restructuring costs;costs, long-lived asset impairment;impairment, recovery of sale, export and use taxes;taxes, provisions or recovery of doubtful accounts;accounts, accelerated amortization of leaseholds;leaseholds, interest income, interest expense, equity investment gains or losses, gains or losses on extinguishment of debt, and provisions for income taxes.
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The table below (in thousands) sets forth ourCiena’s operating segment profit (loss) and the reconciliation to consolidated net loss for the quartersfirst quarter of fiscal 2005 and nine months ended July 31, 2004 and 2005.the first quarter of fiscal 2006.
| | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | Nine Months Ended July 31, | | | Quarter Ended January 31, | |
| | 2004 | | 2005 | | 2004 | | 2005 | | | 2005 | | 2006 | |
Segment profit (loss): | | |
TSG | | $ | (29,923 | ) | | $ | (2,050 | ) | | $ | (94,027 | ) | | $ | (28,343 | ) | | $ | (16,902 | ) | | $ | 9,937 | |
DNG | | | (2,197 | ) | | | (2,103 | ) | | | (9,490 | ) | | 429 | | | 4,857 | | | (1,408 | ) |
BBG | | | (141 | ) | | 3,221 | | | (374 | ) | | | (820 | ) | | | (3,442 | ) | | 5,298 | |
GNS | | 1,709 | | 2,264 | | 3,589 | | 5,179 | | | 2,238 | | 4,775 | |
| | | | | | | | | | | | | | |
Total segment profit (loss) | | $ | (30,552 | ) | | $ | 1,332 | | $ | (100,302 | ) | | $ | (23,555 | ) | | $ | (13,249 | ) | | $ | 18,602 | |
| | |
Other non-performance items: | | |
Non-performance items: | | |
Corporate selling and marketing | | | (25,377 | ) | | | (25,597 | ) | | | (69,402 | ) | | | (70,895 | ) | | | (22,135 | ) | | | (24,181 | ) |
Corporate general and administrative | | | (6,969 | ) | | | (9,340 | ) | | | (20,052 | ) | | | (25,538 | ) | | | (7,496 | ) | | | (9,896 | ) |
Stock compensation costs: | | |
Research and development | | | (1,860 | ) | | | (2,195 | ) | | | (5,473 | ) | | | (4,048 | ) | | | (1,011 | ) | | — | |
Selling and marketing | | | (1,214 | ) | | | (934 | ) | | | (2,147 | ) | | | (4,257 | ) | | | (876 | ) | | — | |
General and administrative | | | (879 | ) | | | (153 | ) | | | (1,079 | ) | | | (505 | ) | | | (160 | ) | | — | |
Amortization of intangible assets | | | (12,667 | ) | | | (9,653 | ) | | | (19,458 | ) | | | (30,268 | ) | | | (10,411 | ) | | | (6,295 | ) |
In-process research and development | | | (30,200 | ) | | — | | | (30,200 | ) | | — | | |
Restructuring costs | | | (13,547 | ) | | | (4,355 | ) | | | (22,125 | ) | | | (15,245 | ) | | | (1,125 | ) | | | (2,015 | ) |
Long-lived asset impairments | | | (7,217 | ) | | 25 | | | (7,217 | ) | | | (134 | ) | | | (184 | ) | | 3 | |
Recovery of sale, export, use tax liability and payments | | 3,457 | | — | | 5,388 | | — | | |
(Provision) benefit for doubtful accounts, net | | — | | | (2,604 | ) | | 2,794 | | | (2,604 | ) | |
Accelerated amortization of leasehold | | | (12,504 | ) | | — | | | (14,153 | ) | | — | | |
Recovery of doubtful accounts, net | | | — | | 2,604 | |
Gain on lease settlement | | | — | | 6,020 | |
Interest and other financial charges, net | | | (1,733 | ) | | 2,533 | | | (9,921 | ) | | | (4,665 | ) | | 229 | | 9,166 | |
Provision for income taxes | | | (205 | ) | | | (86 | ) | | | (1,044 | ) | | | (1,115 | ) | | | (577 | ) | | | (299 | ) |
| | | | | | | | | | | | | | |
Consolidated net loss | | $ | (141,467 | ) | | $ | (51,027 | ) | | $ | (294,391 | ) | | $ | (182,829 | ) | | $ | (56,995 | ) | | $ | (6,291 | ) |
| | | | | | | | | | | | | | |
(14)(16) CONTINGENCIES
Litigation
On October 3, 2000, Stanford University and Litton Systems filed a complaint in the United States District Court for the Central District of California against Ciena and several other defendants, alleging that optical fiber amplifiers incorporated into Ciena’scertain of those parties’ products infringe U.S. Patent No. 4,859,016 (the “‘016 Patent”). The complaint seeks injunctive relief, royalties and damages. On October 10, 2003, the court stayed the case pending final resolution of matters before the U.S. Patent and Trademark Office (the “PTO”), including a request for and disposition of a reexamination of the ‘016 Patent. On October 16, 2003 and November 2, 2004, the PTO granted reexaminations of the ‘016 Patent, resulting in a continuation of the stay of the case. On July 11, 2005, the PTO
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issued a Notice of Intent to Issue a Reexamination Certificate and a Statement of Reasons for Patentability/Confirmation, stating its intent to confirm all claims of ‘016 Patent. As a result, on October 10, 2005, Litton Systems filed a motion with the district court for an order lifting the stay of the case, and defendant Pirelli S.p.A. filed with the PTO a new request for ex parte reexamination of the ‘016 Patent. On December 15, 2005, the PTO denied Pirelli’s request for reexamination. On December 19, 2005, the district court denied Litton Systems’ motion to lift the stay. The PTO has not yet issued a Reexamination Certificate. Ciena believes that it has valid defenses to the lawsuit and intends to defend it vigorously in the event the stay of the case is lifted.
As a result of ourits merger with ONI Systems Corp. in June 2002, weCiena became a defendant in a securities class action lawsuit. Beginning in August 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United States District Court for the Southern District of New York. These complaints name ONI, Hugh C. Martin, ONI’s former chairman, president and chief executive officer; Chris A. Davis, ONI’s former executive vice president, chief financial officer and administrative officer; and certain underwriters of ONI’s initial public offering as defendants. The complaints were consolidated into a single action, and a consolidated amended complaint was filed on April 24, 2002. The amended complaint alleges, among other things, that the underwriter defendants violated the securities laws by failing to disclose alleged compensation arrangements (such as undisclosed commissions or stock stabilization practices) in the initial public offering’s registration statement and by engaging in manipulative practices to artificially inflate the price of ONI’s common stock after the initial public offering. The amended complaint also alleges that ONI and the named former officers violated the securities laws on the basis of an alleged failure to disclose the underwriters’ alleged compensation arrangements and manipulative practices. No specific amount of damages has been claimed. Similar complaints have been filed against more than 300 other issuers that have had initial public offerings since 1998, and all of these
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actions have been included in a single coordinated proceeding. Mr. Martin and Ms. Davis have been dismissed from the action without prejudice pursuant to a tolling agreement. In July 2004, following mediated settlement negotiations, the plaintiffs, the issuer defendants (including Ciena), and their insurers entered into a settlement agreement, whereby the plaintiffs’ cases against the issuers are to be dismissed. The plaintiffs and issuer defendants subsequently moved the court for preliminary approval of the settlement agreement, which motion was opposed by the underwriter defendants. On February 15, 2005, the district court granted the motion for preliminary approval of the settlement agreement, subject to certain modifications to the proposed bar order, and directed the parties to submit a revised settlement agreement reflecting its opinion. IfOn August 31, 2005, the parties are able to agree upondistrict court issued a preliminary order approving the required modifications,stipulated settlement agreement, approving and such modifications are acceptable tosetting dates for notice of the court, notice will be givensettlement to all class members, ofand scheduling the settlement, a “fairness”fairness hearing will be held and,for April 2006. After the fairness hearing, if the court determines that the settlement is fair to the class members, the settlement will be approved. The settlement agreement does not require Ciena to pay any amount toward the settlement or to make any other payments.
On January 18, 2005, Ciena filed a complaint in the United States District Court, Eastern District of Texas, Marshall Division against Nortel Networks, Inc., Nortel Networks Corporation and Nortel Networks Limited (collectively, “Nortel”), which complaint was subsequently amended. Ciena’s amended complaint charges Nortel with infringement of nine patents related to Ciena’s communications networking systems and technology. Ciena seeks to enjoin Nortel’s infringing activities and recover damages caused by such infringement. On March 14, 2005, Nortel filed an answer to Ciena’s complaint and a counterclaim against Ciena, each of which have subsequently been amended. Nortel’s amended counterclaim charges Ciena with infringement of 13 patents related to Nortel’s communications networking systems and technology, including certain of Nortel’s SONET, ATM and VLAN systems and technology. Nortel’s counterclaim seeks injunctive relief and damages. This matterTrial on 13 of the 22 total patents in suit (six for Ciena and seven for Nortel) is currently scheduled for trial in June 2006.
In addition to the matters described above, we areCiena is subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we doCiena does not expect that the ultimate costs to resolve these matters will have a material effect on ourthe company’s results of operations, financial position or cash flows.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Some of the statements contained, or incorporated by reference, in this quarterly report discuss future events or expectations, contain projections of results of operations or financial condition, changes in the markets for our products and services, or state other “forward-looking” information. These statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. Ciena’s “forward-looking” information is based on various factors and was derived using numerous assumptions. In some cases, you can identify these “forward-looking statements” by words like “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of those words and other comparable words. You should be aware that these statements only reflect our current predictions and beliefs. ActualThese
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statements are subject to known and unknown risks, uncertainties and other factors, and actual events or results may differ materially. Important factors that could cause our actual results to be materially different from the forward-looking statements are disclosed throughout this report, particularly under the heading “Risk Factors” in Item 1A of Part II of this report below. InvestorsYou should review these risk factors and the rest of this quarterly report in combination with the more detailed description of our business in our annual report on Form 10-K, which we filed with the Securities and Exchange Commission on December 9, 2004,January 12, 2006, for a more complete understanding of the risks associated with an investment in Ciena’s common stock.securities. Ciena undertakes no obligation to revise or update any forward-looking statements.
Overview
Ciena Corporation supplies application-focused communications networking equipment, software and services to communicationstelecommunications service providers, cable operators, governments and enterprises. Ciena isOur product and service offerings enable customers to converge, transition and connect communications networks that deliver voice, video and data services. We are a network specialist, focused on optimizing access and edge networks for broadband communication, enhancing enterprise data services and evolving network infrastructureinfrastructures to support new, services through automationhigh-bandwidth applications and network convergence. Ciena leverages its core competencies in optical networking, data networkingOur equipment, software and broadband access to develop and deliver solutions that address its customers’ most important networking problems. Our solutionsservices enable customers to gain a competitive advantage by increasing the functionality of their networks and reducing their costs of transporting data, voice, video and video.data.
In responseOur revenue increased to dramatic$120.4 million in the first quarter of fiscal 2006, representing a 27.1% increase from $94.7 million in the first quarter of fiscal 2005 and a 1.9% increase from $118.2 million in the fourth quarter of fiscal 2005. We have started to witness indications of increased demand for our equipment, software and services as customers appear to be investing in their core and metro network infrastructures to satisfy increasing capacity needs. We are also seeing increased investment at the edge of the network as a result of increased sales of broadband services by communications service providers. Finally, some large carriers are considering, or have taken steps towards developing, next-generation, converged networks in order to increase the efficiency of their networks and expand their service offerings. One example is BT’s 21st Century Network, or 21CN, for which we were selected as a preferred supplier for the optical transmission portion. Our revenues for the first quarter do not include any revenue from the 21CN project.
We expect further revenue growth and improvement in our financial results during fiscal 2006. Some of this expected revenue growth will come from orders related to larger network builds, which occur in phases. The timing and size of these orders, our ability to deliver products against them, and the timing of satisfaction of acceptance criteria will all contribute to fluctuations in our revenues from quarter to quarter. We also expect the cash required to finance inventory and accounts receivable to fluctuate, but generally to increase during fiscal 2006.
Our revenues, margins, and cash requirements are significantly dependent upon, among other things, the availability of component supplies and manufacturing capacity sufficient to meet demand, particularly as it relates to larger network builds. Recently, we have experienced component supply shortages affecting our operations. Supply shortages can be exacerbated by difficulties in forecasting and aligning our supply needs with customer demand, which is often difficult to predict. If shortages persist or worsen, they could constrain our future growth and revenue opportunities and adversely affect our financial performance.
Gross margin increased to 41.9% in the first quarter of 2006, up from 25.6% in the first quarter of fiscal 2005 and 39.9% for the fourth quarter of fiscal 2005. Gross margin improvement reflects both changes in the market for communications networking equipment over the last several years,product mix and significant gains resulting from our focus on cost reductions. To continue to drive cost improvements we have soughtare employing a global approach to expandsourcing components and manufacturing our addressable market, diversify our customer baseproducts, and broaden our networking solutions portfolio. Our strategy has beenare increasingly utilizing overseas suppliers in lower cost regions, particularly in Asia. We believe that these steps will be important to maintain and build upon our historical expertisegross margin improvement in core networkingrecent quarters.
Operating expense decreased to $65.6 million in the first quarter of fiscal 2006, from $80.9 million in the first quarter of fiscal 2005. This decrease was due in large part to reducing headcount and positionclosing facilities in the United States and Canada in prior periods. In the first quarter of 2006, we also recognized gains of $6.0 million from the buy-out of the lease on our former Fremont, CA facility, and $2.6 million due to the recovery of a doubtful account.
In early November 2005, we effected a headcount reduction of 62 employees and closed one of our facilities in Kanata, Ontario. This resulted in a restructuring charge of $2.2 million in the first quarter of fiscal 2006. We expect to take additional steps to reduce our operating expense and will incur additional restructuring costs during future periods. As of January 31, 2006, headcount was 1,442, down from 1,497 at the end of fiscal 2005.
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Ciena to take advantage of new market opportunities arising as communications service providers, cable operators, governments and enterprises invest in next-generation equipment. We have sought to achieve these goals through a combination of internal development and acquisitions, and by creating new strategic relationships and distribution arrangements to reach enterprise and government customers. Simultaneous with these efforts, we have sought to align our workforce, facilities and operating expenses with the market opportunities available to us, balancing our research and development investment with cost controls and prudent cash management.
Our financial results, product development announcements and cost reduction activities during the third The first quarter of fiscal 2005 reflect2006 represents our first fiscal period following adoption of Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” which requires that we recognize compensation expense on our consolidated statement of operations for all share-based awards made to employees and directors based on estimated fair values. We have adopted SFAS 123(R) using the effectsmodified prospective application transition method, and accordingly have not restated financial statements for prior periods to include the impact of this strategy. Revenue increasedSFAS 123(R). To determine the valuation of share-based awards under SFAS 123(R), we continue to $110.5use the Black-Scholes option pricing model that we utilized to determine our pro forma share-based compensation in prior periods. Share-based compensation was $4.2 million representing a 6.4% increase fromduring the secondfirst quarter of fiscal 2005 and a 46.2% increase from2006, of which $0.4 million was capitalized as part of inventory. Additional information regarding our adoption of SFAS 123(R) during the thirdfirst quarter of fiscal 2004. Third quarter sequential revenue growth was driven primarily by increased sales of our broadband access products and metro transport and switching products. Third quarter broadband access product revenue primarily consisted of sales of our CNX-5™ Broadband DSL System, which offers communications service providers a simple line card replacement to deploy DSL services from their existing legacy network infrastructure without reducing plain old telephone service (POTS) port density. Our CNX-5 sales are significantly dependent upon the level of customer demand for DSL service offerings from regional bell operating companies (RBOCs) in North America and are affected by changes in DSL promotion and pricing. The mix of products that have driven our revenue growth for the past several quarters has varied and we expect this mix of products to continue to fluctuate on a quarterly basis.
Our third quarter financial results also reflect our second consecutive quarter of progress2006 is set forth in the area of gross margin. Our product gross margin increased sequentiallynotes to 35.6% from 28.1%the financial statements above and in “Critical Accounting Policies and Estimates” below.
During the secondfirst quarter of fiscal 2005. The increase was primarily due to favorable product mix during the quarter, but margins also benefited from product-related cost reductions. We continue to focus on aggressive cost reductions across all product lines.
During the third quarter, we continued to take steps to reduce our ongoing operating expense. In May, we effected a headcount reduction of 96 employees, most employed in our Kanata, Ontario facility. We also made progress toward establishing a development operation in India, through which we intend to further reduce operating costs and leverage offshore resources. We intend to continue to pursue alternatives to reduce our general and administrative, sales and marketing and research and development costs.
During the third quarter,2006, we repurchased approximately $41.2an additional $106.5 million in principal amount of our outstanding 3.75% convertible notes, due February 1, 2008, in open market transactions. At July 31, 2005, an aggregate principal amount ofThese additional repurchases used approximately $648.8$98.8 million remained outstanding. We used $36.9 million of ourin cash to effect these repurchases during the quarter, whichand resulted in a savings of approximately $4.3 million in outstanding principalgain on the notes.extinguishment of debt in the amount of $6.7 million, which consists of the $7.7 million gain from the repurchase of the notes less $1.0 million of associated debt issuance costs. At January 31, 2006, the remaining principal balance on our outstanding convertible notes was $542.3 million. We intend to continue to evaluate and pursue alternatives that enable usopportunities to exercise prudent cash management and achieve cost savings relating to the repayment of our outstanding convertible notes.notes when it is prudent to do so.
Ciena believes network adaptability is emerging as a key concern for enterprises, and as a competitive differentiator for service providers, as both look to evolve their networks to support and deliver new service offerings. During the third quarter, we announced our FlexSelect™ Architecture, a standards-based, service oriented network architecture that facilitates flexible and adaptable management of network services. We also introduced two new products based on this network vision: the CN 4200™ Advanced Services Platform and CoreStream® Regional. The CN 4200 is a multi-service transport and aggregation platform that provides “any service on any port at any time” via software programmable hardware that operates down to the port level. It enables cost-effective transition from time division multiplexing (TDM) to service-selectable packet networks. CoreStream Regional is an extension of our CoreStream Agility Optical Transmission System and provides customers with a cost-effective option to provide wavelength division multiplexing (DWDM) to metro and regional core networks with moderate capacity and distance requirements. Both products illustrate our flexible, adaptable, service oriented approach to the development of next generation products as well as our commitment to prudent development efforts that enable us to achieve gross margin improvement and compete more effectively in the global marketplace.
Fiscal 2005 has witnessed a considerable increase in consolidation activity among U.S. communications service providers. This activity includes proposed mergers between Verizon and MCI, and between SBC and AT&T, all of which have been significant customers during prior periods. Mergers of large carriers will have a major impact in shaping the future of the telecommunications industry, our historical customer base for our products. These mergers also have the effect of further reducing the number of potential communications service provider customers seeking to purchase networking equipment from vendors and continuing to concentrate customer purchasing power. It is too soon to determine the near-term and long-term effects, if any, that these proposed consolidations will have on our business.
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As of July 31, 2005, Ciena had 1,497 employees, a net reduction of 154 employees from the 1,651 employees on October 31, 2004 and a net reduction of 246 employees from the 1,743 employees on July 31, 2004.
Results of Operations
Three months ended JulyJanuary 31, 20042005 compared to three months ended JulyJanuary 31, 20052006
Revenue, cost of goods sold and gross profit
Cost of goods sold consists of component costs, direct compensation costs, warranty and other contractual obligations, royalties, license fees, direct technical support costs, cost of excess and obsolete inventory and overhead related to manufacturing, technical support and engineering, furnishing and installation (“EF&I”) operations.
The table below (in thousands, except percentage data) sets forth the changes in revenue, cost of goods sold and gross profit from the thirdfirst quarter of fiscal 20042005 to the thirdfirst quarter of fiscal 2005.2006.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Increase | | | | | Quarter Ended January 31, | | Increase | | | |
| | 2004 | | %* | | 2005 | | %* | | (decrease) | | %** | | | 2005 | | %* | | 2006 | | %* | | (decrease) | | %** | |
Revenue: | | |
Products | | $ | 64,340 | | 85.1 | | $ | 97,448 | | 88.2 | | $ | 33,108 | | 51.5 | | | $ | 82,300 | | 86.9 | | $ | 105,941 | | 88.0 | | $ | 23,641 | | 28.7 | |
Services | | 11,249 | | 14.9 | | 13,032 | | 11.8 | | 1,783 | | 15.9 | | | 12,448 | | 13.1 | | 14,489 | | 12.0 | | 2,041 | | 16.4 | |
| | | | | | | | | | | | | | | | | | | | |
Total revenue | | $ | 75,589 | | 100.0 | | $ | 110,480 | | 100.0 | | $ | 34,891 | | 46.2 | | | 94,748 | | 100.0 | | 120,430 | | 100.0 | | 25,682 | | 27.1 | |
| | | | | | | | | | | | | | | | | | | | |
Costs: | | |
Products | | 48,069 | | 63.6 | | 62,756 | | 56.8 | | 14,687 | | 30.6 | | | 60,848 | | 64.2 | | 60,399 | | 50.1 | | | (449 | ) | | (0.7 | ) |
Services | | 8,723 | | 11.5 | | 10,095 | | 9.1 | | 1,372 | | 15.7 | | | 9,669 | | 10.2 | | 9,576 | | 8.0 | | | (93 | ) | | | (1.0 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total cost of goods sold | | 56,792 | | 75.1 | | 72,851 | | 65.9 | | 16,059 | | 28.3 | | | 70,517 | | 74.4 | | 69,975 | | 58.1 | | | (542 | ) | | (0.8 | ) |
| | | | | | | | | | | | | | | | | | | | |
Gross profit | | $ | 18,797 | | 24.9 | | $ | 37,629 | | 34.1 | | $ | 18,832 | | 100.2 | | | $ | 24,231 | | 25.6 | | $ | 50,455 | | 41.9 | | $ | 26,224 | | 108.2 | |
| | | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of total revenue |
|
** | | Denotes % change from 20042005 to 20052006 |
The table below (in thousands, except percentage data) sets forth the changes in product revenue, product cost of goods sold and product gross profit from the thirdfirst quarter of fiscal 20042005 to the thirdfirst quarter of fiscal 2005.2006.
23
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Increase | | | | | Quarter Ended January 31, | | Increase | | | |
| | 2004 | | %* | | 2005 | | %* | | (decrease) | | %** | | | 2005 | | %* | | 2006 | | %* | | (decrease) | | %** | |
Product revenue | | $ | 64,340 | | 100.0 | | $ | 97,488 | | 100.0 | | $ | 33,148 | | 51.5 | | | $ | 82,300 | | 100.0 | | $ | 105,941 | | 100.0 | | $ | 23,641 | | 28.7 | |
Product cost of goods sold | | 48,069 | | 74.7 | | 62,756 | | 64.4 | | 14,687 | | 30.6 | | | 60,848 | | 73.9 | | 60,399 | | 57.0 | | | (449 | ) | | | (0.7 | ) |
| | | | | | | | | | | | | | | | | | | | |
Product gross profit | | $ | 16,271 | | 25.3 | | $ | 34,732 | | 35.6 | | $ | 18,461 | | 113.5 | | | $ | 21,452 | | 26.1 | | $ | 45,542 | | 43.0 | | $ | 24,090 | | 112.3 | |
| | | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of product revenue |
|
** | | Denotes % change from 20042005 to 20052006 |
The table below (in thousands, except percentage data) sets forth the changes in service revenue, service cost of goods sold and service gross profit (loss) from the thirdfirst quarter of fiscal 20042005 to the thirdfirst quarter of fiscal 2005.2006.
17
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Increase | | | | | Quarter Ended January 31, | | Increase | | | |
| | 2004 | | %* | | 2005 | | %* | | (decrease) | | %** | | | 2005 | | %* | | 2006 | | %* | | (decrease) | | %** | |
Service revenue | | $ | 11,249 | | 100.0 | | $ | 13,032 | | 100.0 | | $ | 1,783 | | 15.9 | | | $ | 12,448 | | 100.0 | | $ | 14,489 | | 100.0 | | $ | 2,041 | | 16.4 | |
Service cost of goods sold | | 8,723 | | 77.5 | | 10,095 | | 77.5 | | 1,372 | | 15.7 | | | 9,669 | | 77.7 | | 9,576 | | 66.1 | | | (93 | ) | | | (1.0 | ) |
| | | | | | | | | | | | | | | | | | | | |
Service gross profit | | $ | 2,526 | | 22.5 | | $ | 2,937 | | 22.5 | | $ | 411 | | 16.3 | | | $ | 2,779 | | 22.3 | | $ | 4,913 | | 33.9 | | $ | 2,134 | | 76.8 | |
| | | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of service revenue |
|
** | | Denotes % change from 20042005 to 20052006 |
Revenue from sales to customers outside of the United States is reflected as International in the geographic distribution of revenue below. The table below (in thousands, except percentage data) sets forth the changes in geographic distribution of revenues from the thirdfirst quarter of fiscal 20042005 to the thirdfirst quarter of fiscal 2005.2006.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | | | | Quarter Ended January 31, | | Increase | | | |
| | Increase | | | | 2005 | | %* | | 2006 | | %* | | (decrease) | | %** | |
| | 2004 | | %* | | 2005 | | %* | | (decrease) | | %** | |
Domestic | | $ | 61,231 | | | | 81.0 | | | $ | 89,357 | | | | 80.9 | | | $ | 28,126 | | | | 45.9 | | |
United States | | | $ | 78,686 | | 83.0 | | $ | 102,670 | | 85.3 | | $ | 23,984 | | 30.5 | |
International | | | 14,358 | | | | 19.0 | | | | 21,123 | | | | 19.1 | | | | 6,765 | | | | 47.1 | | | 16,062 | | 17.0 | | 17,760 | | 14.7 | | 1,698 | | 10.6 | |
| | | | | | | | | | | | | | | | | | | | |
Total | | $ | 75,589 | | | | 100.0 | | | $ | 110,480 | | | | 100.0 | | | $ | 34,891 | | | | 46.2 | | | $ | 94,748 | | 100.0 | | $ | 120,430 | | 100.0 | | $ | 25,682 | | 27.1 | |
| | | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of total revenue |
|
** | | Denotes % change from 20042005 to 20052006 |
During the thirdfirst quarter of fiscal 20042005 and thirdfirst quarter of fiscal 2005,2006, certain customers each accounted for at least 10% of our revenues during the respective periods as follows (in thousands, except percentage data):
| | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | |
| | 2004 | | | %* | | | 2005 | | | %* | |
Customer A | | $ | 12,458 | | | | 16.5 | | | $ | 13,780 | | | | 12.5 | |
Customer B | | | 7,933 | | | | 10.5 | | | | N/A | | | | — | |
Customer C | | | N/A | | | | — | | | | 14,802 | | | | 13.4 | |
| | | | | | | | | | | | |
Total | | $ | 20,391 | | | | 27.0 | | | $ | 28,582 | | | | 25.9 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | Quarter Ended January 31, | |
| | 2005 | | | %* | | | 2006 | | | %* | |
Company A | | | n/a | | | | — | | | $ | 13,990 | | | | 11.6 | |
Company B | | | 17,643 | | | | 18.6 | | | | 23,494 | | | | 19.5 | |
Company C | | | 12,420 | | | | 13.1 | | | | n/a | | | | — | |
Company D | | | n/a | | | | — | | | | 17,073 | | | | 14.2 | |
| | | | | | | | | | | | |
Total | | $ | 30,063 | | | | 31.7 | | | $ | 54,556 | | | | 45.3 | |
| | | | | | | | | | | | |
| | |
N/A Denotes revenue recognized less than 10% of total revenue for the period |
|
* | | Denotes % of total revenue |
Revenue
| • | | Product revenueincreased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 due to increased sales of our transport and switching products and broadband access systems. |
|
| • | | Domestic revenueincreased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 primarily due to increased domestic sales of our transport and switching products and broadband access systems. |
|
| • | | International revenuedecreased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 primarily due to decreased international sales of our transport and switching products. |
Gross profit
Gross profit as n/a percentage of total revenue and gross profit on products as a percentage of product revenueboth increased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 largely due to favorable product mix during the quarter and cost reductions across multiple product lines.
Operating expenses
The table below (in thousands, except percentage data) sets forth the changes in operating expenses from the third quarter of fiscal 2004 to the third quarter of fiscal 2005.
18
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | | | | | |
| | | | | | | | | | | | | | | | | | Increase | | | | |
| | 2004 | | | %* | | | 2005 | | | %* | | | (decrease) | | | %** | |
Research and development | | $ | 57,762 | | | | 76.4 | | | $ | 32,619 | | | | 29.5 | | | $ | (25,143 | ) | | | (43.5 | ) |
Selling and marketing | | | 29,468 | | | | 39.0 | | | | 29,275 | | | | 26.5 | | | | (193 | ) | | | (0.7 | ) |
General and administrative | | | 6,969 | | | | 9.2 | | | | 9,340 | | | | 8.5 | | | | 2,371 | | | | 34.0 | |
Stock compensation costs: | | | | | | | | | | | | | | | | | | | | | | | | |
Research and development | | | 1,860 | | | | 2.5 | | | | 2,195 | | | | 2.0 | | | | 335 | | | | 18.0 | |
Selling and marketing | | | 1,214 | | | | 1.6 | | | | 934 | | | | 0.8 | | | | (280 | ) | | | (23.1 | ) |
General and administrative | | | 879 | | | | 1.2 | | | | 153 | | | | 0.1 | | | | (726 | ) | | | (82.6 | ) |
Amortization of intangible assets | | | 12,667 | | | | 16.8 | | | | 9,653 | | | | 8.7 | | | | (3,014 | ) | | | (23.8 | ) |
In-process research and development | | | 30,200 | | | | 40.0 | | | | — | | | | — | | | | (30,200 | ) | | | (100.0 | ) |
Restructuring costs | | | 13,547 | | | | 17.9 | | | | 4,355 | | | | 3.9 | | | | (9,192 | ) | | | (67.9 | ) |
Long-lived asset impairments | | | 7,217 | | | | 9.5 | | | | (25 | ) | | | — | | | | (7,242 | ) | | | (100.3 | ) |
Recovery of sale, export, use tax liabilities and payments | | | (3,457 | ) | | | (4.6 | ) | | | — | | | | — | | | | 3,457 | | | | (100.0 | ) |
Provision for doubtful accounts, net | | | — | | | | — | | | | 2,604 | | | | 2.4 | | | | 2,604 | | | | 100.0 | |
| | | | | | | | | | | | | | | | | | |
Total operating expenses | | $ | 158,326 | | | | 209.5 | | | $ | 91,103 | | | | 82.4 | | | $ | (67,223 | ) | | | (42.5 | ) |
| | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of total revenue |
|
** | | Denotes % change from 2004 to 2005 |
| • | | Research and development expensedecreased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 due to reductions in accelerated leasehold amortization, employee-related costs, consulting fees, depreciation expense and facility-related costs. Research and development expense during the third quarter of fiscal 2004 includes $12.5 million of accelerated leasehold amortization due to the closing of our San Jose, CA facility in September 2004. Research and development expense during the third quarter of 2005 includes $1.5 million of accelerated depreciation related to our decision to abandon or dispose of certain idle assets determined to have no future value. |
|
| • | | Selling and marketing expensedecreased slightly from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 due to reductions in employee-related costs offset by increases in depreciation expense and tradeshow and marketing activities. Selling and marketing expense during the third quarter of 2005 includes $2.0 million of accelerated depreciation related to our decision to abandon or dispose of certain idle assets determined to have no future value. |
|
| • | | General and administrative expenseincreased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 primarily due to increases in consulting expense related to Sarbanes-Oxley compliance, expenses related to legal services, and information system costs partially offset by a decrease in employee-related costs. |
|
| • | | Stock compensation costsdecreased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 due to a reduction in staffing levels, which resulted in a lower level of unvested stock options and restricted stock. As of July 31, 2005, the balance of deferred stock compensation, presented as a reduction of stockholders’ equity, was $2.9 million. With the adoption of SFAS 123R, we expect our reported stock compensation cost will materially increase beginning in the first quarter of fiscal 2006. |
|
| • | | Amortization of intangible assets costsdecreased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 primarily because of intangible assets, such as non-compete agreements and purchase commitments, were fully amortized in previous periods. |
|
| • | | In-process research and development (IPR&D) costs represents the estimated value of purchased in-process technology that had not reached technological feasibility and had no alternative future use at the time of the acquisition. In the third quarter of fiscal 2004 we recorded $25.0 million and $5.2 million of IPR&D from our Catena and Internet Photonics acquisitions, respectively. |
|
| • | | Restructuring costsincurred during the third quarter of 2005 were related to work force reductions of 96 employees and adjustments to previously restructured facilities due to the continued excess supply of commercial property. These workforce reductions were taken as part of our efforts to reduce our costs. We expect to incur additional restructuring costs in future periods. |
19
| • | | Long-lived assets impairmentsfor the third quarter of fiscal 2004 were primarily related to the impairment of research and development equipment, which was classified as held for sale. During the third quarter of 2005, we recorded a credit because we sold some of this equipment for an amount in excess of its carrying value. |
|
| • | | Recovery of sales, export, use tax liabilities and paymentsduring the first nine months of fiscal 2004 was due to the resolution of a use tax audit related to assets acquired from ONI. |
|
| • | | Provision for doubtful accounts, netduring the third quarter of fiscal 2005 was $2.6 million. We maintain an allowance for potential losses on a specific identification basis. During the third quarter of fiscal 2005, we recorded a provision for doubtful accounts of $2.6 million relating to one customer. |
Other items
The table below (in thousands, except percentage data) sets forth the changes in other items from the third quarter of fiscal 2004 to the third quarter of fiscal 2005:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | | | | | |
| | | | | | | | | | | | | | | | | | Increase | | | | |
| | 2004 | | | %* | | | 2005 | | | %* | | | (decrease) | | | %** | |
Interest and other income, net | | $ | 4,936 | | | | 6.5 | | | $ | 6,765 | | | | 6.1 | | | $ | 1,829 | | | | 37.1 | |
Interest expense | | $ | 6,469 | | | | 8.6 | | | $ | 6,406 | | | | 5.8 | | | $ | (63 | ) | | | (1.0 | ) |
Loss on equity investments, net | | $ | 200 | | | | 0.3 | | | $ | 1,708 | | | | 1.5 | | | $ | 1,508 | | | | 754.0 | |
Gain on extinguishment of debt | | $ | — | | | | 0.0 | | | $ | 3,882 | | | | 3.5 | | | $ | 3,882 | | | | 100.0 | |
Provision for income taxes | | $ | 205 | | | | 0.3 | | | $ | 86 | | | | 0.1 | | | $ | (119 | ) | | | (58.0 | ) |
| | |
* | | Denotes % of total revenue |
|
** | | Denotes % change from 2004 to 2005 |
| • | | Interest and other income, netincreased from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 primarily due to higher rates of return on our investments partially offset by the impact of lower cash and investment balances. |
|
| • | | Interest expensedecreased slightly from the third quarter of fiscal 2004 to the third quarter of fiscal 2005 due to the decrease in our debt obligations between the two periods resulting from our purchase of $41.2 million of the Ciena 3.75% convertible notes during the third quarter of fiscal 2005. |
|
| • | | Loss on equity investments, netreflects losses due to declines in the value of our investments in privately held technology companies that were determined to be other than temporary in the third quarters of fiscal 2004 and 2005. |
|
| • | | Gain on extinguishment of debtreflects the purchase of $41.2 million of our outstanding 3.75% convertible notes for $36.9 million. We recorded a gain in the amount of $3.9, which consists of the $4.3 million gain from the repurchase of the notes less a write-off of $0.4 million of associated debt issuance costs. |
|
| • | | Provision for income taxesfor the third quarter of fiscal 2004 and the third quarter of fiscal 2005 was primarily attributable to foreign tax related to our foreign operations. We did not record a tax benefit for Ciena’s domestic losses during either period. We will continue to maintain a valuation allowance against certain deferred tax assets until sufficient evidence exists to support its reversal. |
Nine months ended July 31, 2004 compared to nine months ended July 31, 2005
Revenue, cost of goods sold and gross profit
The table below (in thousands, except percentage data) sets forth the changes in revenue, cost of goods sold and gross profit for the nine months ended July 31, 2004 and 2005:
20
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | | | | | |
| | | | | | | | | | | | | | | | | | Increase | | | | |
| | 2004 | | | %* | | | 2005 | | | %* | | | (decrease) | | | %** | |
Revenue: | | | | | | | | | | | | | | | | | | | | | | | | |
Products | | $ | 181,436 | | | | 83.7 | | | $ | 271,366 | | | | 87.8 | | | $ | 89,930 | | | | 49.6 | |
Services | | | 35,266 | | | | 16.3 | | | | 37,708 | | | | 12.2 | | | | 2,442 | | | | 6.9 | |
| | | | | | | | | | | | | | | | | | | |
Total Revenue | | $ | 216,702 | | | | 100.0 | | | $ | 309,074 | | | | 100.0 | | | $ | 92,372 | | | | 42.6 | |
| | | | | | | | | | | | | | | | | | | |
Costs: | | | | | | | | | | | | | | | | | | | | | | | | |
Products | | | 138,918 | | | | 64.1 | | | | 189,447 | | | | 61.3 | | | | 50,529 | | | | 36.4 | |
Services | | | 30,212 | | | | 13.9 | | | | 30,601 | | | | 9.9 | | | | 389 | | | | 1.3 | |
| | | | | | | | | | | | | | | | | | | |
Total cost of goods sold | | | 169,130 | | | | 78.0 | | | | 220,048 | | | | 71.2 | | | | 50,918 | | | | 30.1 | |
| | | | | | | | | | | | | | | | | | | |
Gross profit | | $ | 47,572 | | | | 22.0 | | | $ | 89,026 | | | | 28.8 | | | $ | 41,454 | | | | 87.1 | |
| | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of total revenue |
|
** | | Denotes % change from 2004 to 2005 |
The table below (in thousands, except percentage data) sets forth the changes in product revenue, product cost of goods sold and product gross profit for the nine months ended July 31, 2004 and 2005:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | | | | | |
| | 2004 | | | %* | | | 2005 | | | %* | | | Increase (decrease) | | | %** | |
Product revenue | | $ | 181,436 | | | | 100.0 | | | $ | 271,366 | | | | 100.0 | | | $ | 89,930 | | | | 49.6 | |
Product cost of goods sold | | | 138,918 | | | | 76.6 | | | | 189,447 | | | | 69.8 | | | | 50,529 | | | | 36.4 | |
| | | | | | | | | | | | | | | | | | | |
Product gross profit | | $ | 42,518 | | | | 23.4 | | | $ | 81,919 | | | | 30.2 | | | $ | 39,401 | | | | 92.7 | |
| | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of product revenue |
|
** | | Denotes % change from 2004 to 2005 |
The table below (in thousands, except percentage data) sets forth the changes in service revenue, service cost of goods sold and service gross profit for the nine months ended July 31, 2004 and 2005:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | | | | | |
| | | | | | | | | | | | | | | | | | Increase | | | | |
| | 2004 | | | %* | | | 2005 | | | %* | | | (decrease) | | | %** | |
Service revenue | | $ | 35,266 | | | | 100.0 | | | $ | 37,708 | | | | 100.0 | | | $ | 2,442 | | | | 6.9 | |
Service cost of goods sold | | | 30,212 | | | | 85.7 | | | | 30,601 | | | | 81.2 | | | | 389 | | | | 1.3 | |
| | | | | | | | | | | | | | | | | | | |
Service gross profit | | $ | 5,054 | | | | 14.3 | | | $ | 7,107 | | | | 18.8 | | | $ | 2,053 | | | | 40.6 | |
| | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of service revenue |
|
** | | Denotes % change from 2004 to 2005 |
The table below (in thousands, except percentage data) sets forth the changes in geographic distribution of revenues for the nine months ended July 31, 2004 and 2005:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | | | | | |
| | | | | | | | | | | | | | | | | | Increase | | | | |
| | 2004 | | | %* | | | 2005 | | | %* | | | (decrease) | | | %** | |
Domestic | | $ | 156,547 | | | | 72.2 | | | $ | 248,216 | | | | 80.3 | | | $ | 91,669 | | | | 58.6 | |
International | | | 60,155 | | | | 27.8 | | | | 60,858 | | | | 19.7 | | | | 703 | | | | 1.2 | |
| | | | | | | | | | | | | | | | | | | |
Total | | $ | 216,702 | | | | 100.0 | | | $ | 309,074 | | | | 100.0 | | | $ | 92,372 | | | | 42.6 | |
| | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of total revenue |
|
** | | Denotes % change from 2004 to 2005 |
21
During for the nine months ended July 31, 2004 and 2005, certain customers each accounted for at least 10% of our revenues during the respective periods as follows (in thousands, except percentage data):
| | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | |
| | 2004 | | | %* | | | 2005 | | | %* | |
Customer A | | $ | 40,284 | | | | 18.6 | | | $ | 37,882 | | | | 12.3 | |
Customer B | | | N/A | | | | — | | | | 34,395 | | | | 11.1 | |
Customer C | | | N/A | | | | — | | | | 34,739 | | | | 11.2 | |
| | | | | | | | | | | | |
Total | | $ | 40,284 | | | | 18.6 | | | $ | 107,016 | | | | 34.6 | |
| | | | | | | | | | | | |
| | |
N/A | | Denotes revenue recognized less than 10% of total revenue for the period |
|
* | | Denotes % of total revenue |
Revenue
| • | | Product revenueincreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006, primarily due to increased sales of broadband access systems obtained from our May 2004 acquisition of Catena Networks,transport and switching products and increased sales of our data networking products and transport and switching products. Asbroadband access systems, partially offset by a result of the timingdecrease in sales of our acquisition of Catena and IPI, product revenue for 2004 reflects only one quarter of revenue from these acquireddata networking products. |
|
| • | | Service revenueincreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006, primarily due to an increaseincreases in the sale ofdeployment services, maintenance and support services and product training and managed services. |
|
24
| • | | DomesticUnited States revenueincreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006, primarily due to increased sales of our transport and switching products and increased sales of our broadband access systems, obtained from our May 2004 acquisition of Catena Networks, and increased domesticpartially offset by a decrease in sales of our data networking products and transport and switching products. |
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| • | | International revenuedecreasedincreased slightly from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006, primarily due to decreased internationalincreased sales of our core optical switches.transport and switching products and maintenance and support services. |
Gross profit
| • | | Gross profit as a percentage of revenueincreased from the first quarter of fiscal 2005 to the first quarter of fiscal 2006 largely due to increased sales volume, sales of higher margin products and grosscost improvements resulting from our efforts to employ a global approach to sourcing components and manufacturing our products. |
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| • | | Gross profit on products as a percentage of product revenueboth increased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 2005 largely2006, primarily due to favorablecost reductions and higher margin product mix and product cost reductions.mix. |
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| • | | Gross profit on services as a percentage of services revenueincreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006 largely due to increased sales of product training services and reduced service overhead and deployment costs. Service gross profit during the first quarter of fiscal 2006 benefited from an unusually favorable mix of deployment service engagements with higher than normal margins, as well as higher margin product training revenue. |
Operating expenses
The table below (in thousands, except percentage data) sets forth the changes in operating expenses forfrom the nine months ended July 31, 2004first quarter of fiscal 2005 to the nine months ended July 31, 2005.first quarter of fiscal 2006.
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| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Increase | | | | | Quarter Ended January 31, | | Increase | | | |
| | 2004 | | %* | | 2005 | | %* | | (decrease) | | %** | | | 2005 | | %* | | 2006 | | %* | | (decrease) | | %** | |
Research and development | | $ | 151,418 | | 69.9 | | $ | 101,036 | | 32.7 | | $ | (50,382 | ) | | | (33.3 | ) | | $ | 34,662 | | 36.6 | | $ | 29,462 | | 24.5 | | $ | (5,200 | ) | | | (15.0 | ) |
Selling and marketing | | 80,011 | | 36.9 | | 82,440 | | 26.7 | | 2,429 | | 3.0 | | | 26,840 | | 28.3 | | 26,572 | | 22.1 | | | (268 | ) | | | (1.0 | ) |
General and administrative | | 20,052 | | 9.3 | | 25,538 | | 8.3 | | 5,486 | | 27.4 | | | 7,656 | | 8.1 | | 9,896 | | 8.2 | | 2,240 | | 29.3 | |
Stock compensation costs: | | |
Research and development | | 5,473 | | 2.5 | | 4,048 | | 1.3 | | | (1,425 | ) | | | (26.0 | ) | |
Selling and marketing | | 2,147 | | 1.0 | | 4,257 | | 1.4 | | 2,110 | | 98.3 | | |
General and administrative | | 1,079 | | 0.5 | | 505 | | 0.2 | | | (574 | ) | | | (53.2 | ) | |
Amortization of intangible assets | | 19,458 | | 9.0 | | 30,268 | | 9.8 | | 10,810 | | 55.6 | | | 10,411 | | 11.0 | | 6,295 | | 5.2 | | | (4,116 | ) | | | (39.5 | ) |
In-process research and development | | 30,200 | | 13.9 | | — | | — | | | (30,200 | ) | | | (100.0 | ) | |
Restructuring costs | | 22,125 | | 10.2 | | 15,245 | | 4.9 | | | (6,880 | ) | | | (31.1 | ) | | 1,125 | | 1.2 | | 2,015 | | 1.7 | | 890 | | 79.1 | |
Long-lived asset impairments | | 7,217 | | 3.3 | | 134 | | — | | | (7,083 | ) | | | (98.1 | ) | |
Recovery of sales, export, use tax liabilities and payments | | | (5,388 | ) | | | (2.5 | ) | | — | | — | | 5,388 | | | (100.0 | ) | |
Provision for (recovery of) doubtful accounts, net | | | (2,794 | ) | | | (1.3 | ) | | 2,604 | | 0.8 | | 5,398 | | | (193.2 | ) | |
Long-lived asset impairment | | | 184 | | 0.2 | | | (3 | ) | | | (0.0 | ) | | | (187 | ) | | | (101.6 | ) |
Recovery of doubtful accounts, net | | | — | | 0.0 | | | (2,604 | ) | | | (2.2 | ) | | | (2,604 | ) | | n/a | |
Gain on lease settlement | | | — | | 0.0 | | | (6,020 | ) | | | (5.0 | ) | | | (6,020 | ) | | n/a | |
| | | | | | | | | | | | | | | | | | | | | | |
Total operating expenses | | $ | 330,998 | | 152.7 | | $ | 266,075 | | 86.1 | | $ | (64,923 | ) | | | (19.6 | ) | | $ | 80,878 | | 85.4 | | 65,613 | | 54.5 | | $ | (15,265 | ) | | | (18.9 | ) |
| | | | | | | | | | | | | | | | | | | | | | |
| | |
* | | Denotes % of total revenue |
|
** | | Denotes % change from 20042005 to 20052006 |
| • | | Research and development expensedecreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006, primarily due to reductions of $3.3 million in accelerated leasehold amortization,employee compensation and $1.5 million in depreciation expense, employee-related costs, consulting expense, facility related costs and prototype material expense. For the nine months ended July 31, 2004, research and development expenses includes $14.2The reduction in employee compensation was driven by headcount reductions, partially offset by an increase of $0.6 million of accelerated leasehold amortization due to the closing of our San Jose, CA facility in September 2004.share-based compensation expense. |
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| • | | Selling and marketing expenseincreased slightly decreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006 due to higherreductions of $1.3 million in depreciation costs related to tradeshow and marketing activities and increased travel expenditures, partially$0.5 million in temporary import costs, offset by reductionsincreases of $0.8 million in depreciationemployee compensation and $0.7 million in demonstration equipment costs. The increase in employee compensation was primarily driven by an increase of $0.6 million in salaries and commissions and $0.2 million in share-based compensation expense. |
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| • | | General and administrative expenseincreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006 primarily due to increases of $1.4 million in consulting expense related to Sarbanes-Oxley compliance, expenses related to legal services,employee compensation and $0.8 million in audit fees, slightly offset by a decrease of $0.3 million in information system costs. |
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| • | | Stock The increase in employee compensation costsdecreased from the first nine months of fiscal 2004 to the first nine months of fiscal 2005 due to the reductionincluded $0.7 million in staffing levels, which resulted in a lower level of unvested stock options and restricted stock. As of July 31, 2005, the balance of deferred stockshare-based compensation presented as a reduction of stockholders’ equity, was $2.9 million. With the adoption of SFAS 123R, we expect our reported stock compensation cost will materially increase beginning in our first quarter of fiscal 2006.expense. |
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| • | | Amortization of intangible assets costsincreaseddecreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of |
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| | | fiscal 20052006 due to higher amountsthe write off of purchased intangible assets such as developed technology and customer relationships resulting from our acquisitions of Catena Networks and Internet Photonicsrecorded in May 2004. |
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| • | | In-process research and development (IPR&D) costsrepresents the estimated value of purchased in-process technology that had not reached technological feasibility and had no alternative future use at the time of the acquisition. In the thirdfourth quarter of fiscal 2004 we recorded $25.0 million and $5.2 million of IPR&D from our Catena and Internet Photonics acquisitions, respectively.2005. |
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| • | | Restructuring costsincurred during the first nine monthsquarter of fiscal 20052006 were related to a work force reductionsreduction of approximately 17062 employees and an adjustment to previously restructured facilities due to the continued excess supplyclosure of commercial property.a facility located in Kanata, Ontario. These workforce reductionsactions were taken as part of our continuing efforts to reduce our costs.expense. We expect to incur additional restructuring costs during future periods. |
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| • | | Long-lived assets impairment chargesfor the first nine months of fiscal 2005 were primarily related to the impairment of research and development equipment, which was classified as held for sale.2006. |
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| • | | Recovery of sales, export, use tax liabilities and paymentsdoubtful accounts, netduringfor the first nine monthsquarter of fiscal 20042006 was related to the payment of an amount due from a customer from whom payment was previously deemed doubtful due to the resolutioncustomer’s financial condition. |
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| • | | Gain on lease settlementfor the first quarter of a use tax auditfiscal 2006 was related to assets acquired from ONI.the termination of our obligations under the lease for our former Fremont, CA facility. |
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Provision for (recovery of) doubtful accounts, netduring the first nine months of fiscal 2004 was related primarily to the payment of an amount due from a customer, from which payment was previously deemed doubtful due to the customer’s financial condition. Ciena maintains an allowance for potential losses on a specific identification basis. During the third quarter of fiscal 2005, Ciena recorded a provision for doubtful accounts of $2.6 million relating to one customer.
Other items
The table below (in thousands, except percentage data) sets forth the changes in other items forfrom the nine months ended July 31, 2004first quarter of fiscal 2005 to the nine months ended July 31, 2005.first quarter of fiscal 2006.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Increase | | | | Quarter Ended January 31, | | Increase | | |
| | 2004 | | %* | | 2005 | | %* | | (decrease) | | %** | | 2005 | | %* | | 2006 | | %* | | (decrease) | | %** |
Interest and other income, net | | $ | 18,228 | | 8.4 | | $ | 19,787 | | 6.4 | | $ | 1,559 | | 8.6 | | | $ | 7,433 | | 7.8 | | $ | 9,262 | | 7.7 | | $ | 1,829 | | 24.6 | |
Interest expense | | $ | 20,326 | | 9.4 | | $ | 19,348 | | 6.3 | | $ | (978 | ) | | | (4.8 | ) | | $ | 7,226 | | 7.6 | | $ | 6,053 | | 5.0 | | $ | (1,173 | ) | | | (16.2 | ) |
Gain (loss) on equity investments, net | | $ | 393 | | 0.2 | | $ | (8,986 | ) | | | (2.9 | ) | | $ | (9,379 | ) | | | (2,386.5 | ) | |
Gain (loss) on extinguishment of debt | | $ | (8,216 | ) | | | (3.8 | ) | | $ | 3,882 | | 1.3 | | $ | 12,098 | | | (147.2 | ) | |
Gain (loss) on equity investments | | | $ | 22 | | 0.0 | | $ | (733 | ) | | | (0.6 | ) | | $ | (755 | ) | | | (3,431.8 | ) |
Gain on extinguishment of debt | | | $ | — | | — | | $ | 6,690 | | 5.6 | | $ | 6,690 | | n/a | |
Provision for income taxes | | $ | 1,044 | | 0.5 | | $ | 1,115 | | 0.4 | | $ | 71 | | 6.8 | | | $ | 577 | | 0.6 | | $ | 299 | | 0.2 | | $ | (278 | ) | | | (48.2 | ) |
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* | | Denotes % of total revenue |
|
** | | Denotes % change from 20042005 to 20052006 |
| • | | Interest and other income, netincreased slightly from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006 primarily becausedue to the impact of higher rates of return on investments.interest rates. |
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| • | | Interest expensedecreased from the first nine monthsquarter of fiscal 20042005 to the first nine monthsquarter of fiscal 20052006 due to the decrease in our debt obligations between the two periods resulting from ourthe repurchase of the remaining outstanding ONI 5.0% convertible subordinated notes during fiscal 2004 and $41.2 million in principal amountsome of our 3.75% convertible notes during the third quarter of fiscal 2005.2005 and fiscal 2006. |
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| • | | Gain (loss)Loss on equity investments, netduringincreased from the first nine months of fiscal 2004 includes a cash payment of $1.6 million received for an investment in a private company that had been previously written down to a value of $1.0 million partially offset by a $0.2 million write-down of an investment. The resulting $0.4 million was recorded as a gain on equity investments. During the first nine monthsquarter of fiscal 2005 we recorded a $9.0 million lossto the first quarter of fiscal 2006 due to a decline in the value of our investments in privately held technology companies that was determined to be other than temporary. |
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| • | | Gain (loss) on extinguishment of debtduringfor the first nine monthsquarter of fiscal 20042006 resulted from our repurchase of the ONI 5.0% convertible subordinated notes. During the third quarter of fiscal 2005, we purchased $41.2$106.5 million of our outstanding 3.75% outstanding convertible notes, due February 1, 2008, in open market transactions for $36.9$98.8 million. We recorded a gain on the extinguishment of debt in the amount of $3.9$6.7 million, which consists of the $4.3$7.7 million gain from the repurchase of the notes, less a write-off of $0.4$1.0 million of associated debt issuance costs. |
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| • | | Provision for income taxesfor the first nine monthsquarter of fiscal 20042005 and the first nine monthsquarter of fiscal 20052006 was primarily attributable to foreign tax related to ourCiena’s foreign operations. We did not record a tax benefit for our domestic losses during either period. We will continue to maintain a valuation allowance against certain deferred tax assets until sufficient evidence exists to support its reversal. |
Summary of Operating Segments
Three months ended July 31, 2004 compared to three months ended July 31, 2005
The table below (in thousands, except percentage data) sets forth the changes in our operating segment revenues from the thirdfirst quarter of fiscal 20042005 to the thirdfirst quarter of fiscal 20052006 for our four operating segments: Transport and Switching Group (TSG); Data Networking Group (DNG); Broadband Access Group (BBG); and the Global Networking Services Group (GNS).
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| | | | | | | | | | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Increase | | | | | Quarter Ended January 31, | | Increase | | | |
| | 2004 | | %* | | 2005 | | %* | | (decrease) | | %** | | | 2005 | | %* | | 2006 | | %* | | (decrease) | | %** | |
Revenues: | | |
TSG | | $ | 42,240 | | 55.9 | | $ | 64,641 | | 58.5 | | $ | 22,401 | | 53.0 | | | $ | 50,440 | | 53.3 | | $ | 74,901 | | 62.3 | | $ | 24,461 | | 48.5 | |
DNG | | 7,138 | | 9.4 | | 6,757 | | 6.1 | | | (381 | ) | | | (5.3 | ) | | 16,579 | | 17.5 | | 6,057 | | 5.0 | | | (10,522 | ) | | | (63.5 | ) |
BBG | | 14,962 | | 19.8 | | 26,050 | | 23.6 | | 11,088 | | 74.1 | | | 15,281 | | 16.1 | | 24,983 | | 20.7 | | 9,702 | | 63.5 | |
GNS | | 11,249 | | 14.9 | | 13,032 | | 11.8 | | 1,783 | | 15.9 | | | 12,448 | | 13.1 | | 14,489 | | 12.0 | | 2,041 | | 16.4 | |
| | | | | | | | | | | | | | | | | | |
Consolidated revenue | | $ | 75,589 | | 100.0 | | $ | 110,480 | | 100.0 | | $ | 34,891 | | 46.2 | | | $ | 94,748 | | 100.0 | | $ | 120,430 | | 100.0 | | $ | 25,682 | | 27.1 | |
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| | |
* | | Denotes % of total revenue |
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** | | Denotes % change from 20042005 to 20052006 |
| • | | TSG revenueincreased from the thirdfirst quarter of fiscal 20042005 to the thirdfirst quarter of fiscal 20052006 primarily due to increased sales of core optical switchestransport and our long-haul transportswitching products. |
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| • | | DNG revenuedecreased from the first quarter of fiscal 2005 to the first quarter of fiscal 2006 due to decreased sales of multiservice edge switching products. DNG revenue for the first quarter of fiscal 2005 reflected $14.3 million of revenue recognized upon initial acceptance by Verizon of multiservice edge switching products, some of which was shipped in prior quarters. |
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| • | | BBG revenueincreased from the third quarter of fiscal 2004 to the thirdfirst quarter of fiscal 2005 primarilyto the first quarter of fiscal 2006 due to increased sales of our CNX-5™CNX-5 Broadband DSL System. |
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| • | | GNS revenueincreased from the thirdfirst quarter of 2004fiscal 2005 to the thirdfirst quarter of 2005 primarilyfiscal 2006 due to increased sales ofincreases in deployment services, maintenance and support services, and product training and managed services. |
Segment profit (loss) is determined based on internal performance measures used by the Chief Executive Officer to assess the performance of each operating segment in a given period. In connection withmaking that assessment, the Chief Executive Officer excludes the following other non-performance items: corporate selling and marketing;marketing, corporate general and administrative costs; stock compensation;costs, amortization of intangibles;intangibles, in-process research and development;development, restructuring costs;costs, long-lived asset impairment;impairment, recovery of sale, export and use taxes;taxes, provisions or recovery of doubtful accounts;accounts, accelerated amortization of leaseholds;leaseholds, interest income, interest expense, equity investment gains or losses, gains or losses on extinguishment of debt, and provisions for income taxes.
The table below (in thousands, except percentage data) sets forth the changes in our segment profit (loss) and the reconciliation to consolidated net loss for the thirdfirst quarter of fiscal 20042005 to the thirdfirst quarter of fiscal 2005.2006.
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| | | | | | | | | | | | | | | | | |
| | Quarter Ended July 31, | | | | | | | | | | | | | | | | | | | | | |
| | Increase | | | | | Quarter Ended January 31, | | Increase | | | |
| | 2004 | | 2005 | | (decrease) | | %** | | | 2005 | | 2006 | | (decrease) | | %** | |
Segment profit (loss): | | |
TSG | | $ | (29,923 | ) | | $ | (2,050 | ) | | $ | 27,873 | | | (93.1 | ) | | $ | (16,902 | ) | | $ | 9,937 | | $ | 26,839 | | | (158.8 | ) |
DNG | | | (2,197 | ) | | | (2,103 | ) | | 94 | | | (4.3 | ) | | 4,857 | | | (1,408 | ) | | | (6,265 | ) | | | (129.0 | ) |
BBG | | | (141 | ) | | 3,221 | | 3,362 | | | (2,384.4 | ) | | | (3,442 | ) | | 5,298 | | 8,740 | | | (253.9 | ) |
GNS | | 1,709 | | 2,264 | | 555 | | 32.5 | | | 2,238 | | 4,775 | | 2,537 | | 113.4 | |
| | | | | | | | | | | | | | |
Total segment profit (loss) | | $ | (30,552 | ) | | $ | 1,332 | | $ | 31,884 | | | (104.4 | ) | | $ | (13,249 | ) | | $ | 18,602 | | $ | 31,851 | | | (240.4 | ) |
| | |
Other non-performance items: | | |
Non-performance items: | | |
Corporate selling and marketing | | | (25,377 | ) | | | (25,597 | ) | | | (220 | ) | | 0.9 | | | | (22,135 | ) | | | (24,181 | ) | | | (2,046 | ) | | 9.2 | |
Corporate general and administrative | | | (6,969 | ) | | | (9,340 | ) | | | (2,371 | ) | | 34.0 | | | | (7,496 | ) | | | (9,896 | ) | | | (2,400 | ) | | 32.0 | |
Stock compensation costs: | | |
Research and development | | | (1,860 | ) | | | (2,195 | ) | | | (335 | ) | | 18.0 | | | | (1,011 | ) | | — | | 1,011 | | | (100.0 | ) |
Selling and marketing | | | (1,214 | ) | | | (934 | ) | | 280 | | | (23.1 | ) | | | (876 | ) | | — | | 876 | | | (100.0 | ) |
General and administrative | | | (879 | ) | | | (153 | ) | | 726 | | | (82.6 | ) | | | (160 | ) | | — | | 160 | | | (100.0 | ) |
Amortization of intangible assets | | | (12,667 | ) | | | (9,653 | ) | | 3,014 | | | (23.8 | ) | | | (10,411 | ) | | | (6,295 | ) | | 4,116 | | | (39.5 | ) |
In-process research and development | | | (30,200 | ) | | — | | 30,200 | | | (100.0 | ) | |
Restructuring costs | | | (13,547 | ) | | | (4,355 | ) | | 9,192 | | | (67.9 | ) | | | (1,125 | ) | | | (2,015 | ) | | | (890 | ) | | 79.1 | |
Long-lived asset impairments | | | (7,217 | ) | | 25 | | 7,242 | | | (100.3 | ) | | | (184 | ) | | 3 | | 187 | | | (101.6 | ) |
Recovery of sale, export, use tax liability and payments | | 3,457 | | — | | | (3,457 | ) | | | (100.0 | ) | |
Provision for doubtful accounts, net | | — | | | (2,604 | ) | | | (2,604 | ) | | | (100.0 | ) | |
Accelerated amortization of leasehold | | | (12,504 | ) | | — | | 12,504 | | | (100.0 | ) | |
Recovery of doubtful accounts, net | | | — | | 2,604 | | 2,604 | | n/a | |
Gain on lease settlement | | | — | | 6,020 | | 6,020 | | n/a | |
Interest and other financial charges, net | | | (1,733 | ) | | 2,533 | | 4,266 | | | (246.2 | ) | | 229 | | 9,166 | | 8,937 | | 3,902.6 | |
Provision for income taxes | | | (205 | ) | | | (86 | ) | | 119 | | | (58.0 | ) | | | (577 | ) | | | (299 | ) | | 278 | | | (48.2 | ) |
| | | | | | | | | | | | | | |
Consolidated net loss | | $ | (141,467 | ) | | $ | (51,027 | ) | | $ | 90,440 | | | (63.9 | ) | | $ | (56,995 | ) | | $ | (6,291 | ) | | $ | 50,704 | | | (89.0 | ) |
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| | |
** | | Denotes % change from 20042005 to 20052006 |
| • | | TSG segment lossTSG:decreasedThe performance improvement from the third quarter of fiscal 2004 to the thirdfirst quarter of fiscal 2005 to the first quarter of fiscal 2006 is primarily dueattributable to increased revenue,$25.2 million in increased gross profit and lowera $1.5 million reduction in research and development costs. |
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| • | | BBG segment profitDNG: increasedThe decline in performance from the third quarter of fiscal 2004 to the thirdfirst quarter of fiscal 2005 due to increasedthe first quarter of fiscal 2006 is primarily attributable to decreased revenues. DNG revenue and lower research and development costs.in the first quarter of fiscal 2005 reflected $14.3 million of revenue recognized upon initial acceptance by Verizon of multiservice edge switching equipment, some of which was shipped in prior quarters. |
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| • | | GNS segment profitBBG:increasedThe performance improvement from the third quarter of fiscal 2004 to the thirdfirst quarter of fiscal 2005 due to increased revenue. |
Nine months ended July 31, 2004 compared to nine months ended July 31, 2005
The table below (in thousands, except percentage data) sets forth the changes in our operating segment revenues for the nine months ended July 31, 2004 to the nine months ended July 31, 2005 for our four operating segments
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | | | | | |
| | | | | | | | | | | | | | | | | | Increase | | | | |
| | 2004 | | | %* | | | 2005 | | | %* | | | (decrease) | | | %** | |
Revenues: | | | | | | | | | | | | | | | | | | | | | | | | |
TSG | | $ | 152,635 | | | | 70.4 | | | $ | 182,638 | | | | 59.0 | | | $ | 30,003 | | | | 19.7 | |
DNG | | | 13,839 | | | | 6.4 | | | | 28,302 | | | | 9.2 | | | | 14,463 | | | | 104.5 | |
BBG | | | 14,962 | | | | 6.9 | | | | 60,426 | | | | 19.6 | | | | 45,464 | | | | 303.9 | |
GNS | | | 35,266 | | | | 16.3 | | | | 37,708 | | | | 12.2 | | | | 2,442 | | | | 6.9 | |
| | | | | | | | | | | | | | | | | | | |
Consolidated revenue | | $ | 216,702 | | | | 100.0 | | | $ | 309,074 | | | | 100.0 | | | $ | 92,372 | | | | 42.6 | |
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| | |
* | | Denotes % of total revenue |
|
** | | Denotes % change from 2004 to 2005 |
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| • | | TSG revenueincreased from the first nine months of fiscal 2004 to the first nine monthsquarter of fiscal 20052006 is primarily attributable to increased revenue and a $3.3 million reduction in research and development costs, partially offset by a $2.2 million charge related to excess inventory due to increaseda change in forecasted sales of long haul transport products and sales of our optical Ethernet transport products obtained from our May 2004 acquisition of Internet Photonics. As a result of the timing of this acquisition, nine month segment revenue for 2004 only reflects one quarter of revenue from these acquiredcertain products. |
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| • | | DNG revenueGNS:increasedThe performance improvement from the first nine monthsquarter of 2004fiscal 2005 to the first nine monthsquarter of fiscal 2005 due2006 is primarily attributable to increased sales of multiservice edge switching products, primarilydeployment services, maintenance and support services, and product training services without a corresponding increase in support of new service aggregation and broadband deployments at Verizonexpenses. GNS gross profit during the first fiscal quarter of 2005. |
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| • | | BBG revenueincreased for the first nine monthsfiscal 2006 benefited from an unusually favorable mix of 2004 to the first nine months of fiscal 2005 due to increased sales of CNX-5™ Broadband DSL Systems from our May 2004 acquisition of Catena Networks. As a result of the timing of this acquisition, nine month segment revenue for 2004 only reflects one quarter of revenue from these acquired products. |
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| • | | GNS revenueincreased from the first nine months of fiscal 2004 to the first nine months of fiscal 2005 due to an increase in sales ofdeployment service engagements with higher than normal margins, as well as higher margin product training and managed services. |
The table below (in thousands, except percentage data) sets forth the changes in our segment profit (loss) and the reconciliation to consolidated net loss for the nine months ended July 31, 2004 to nine months ended July 31, 2005.
| | | | | | | | | | | | | | | | |
| | Nine Months Ended July 31, | | | | | | | |
| | | | | | | | | | Increase | | | | |
| | 2004 | | | 2005 | | | (decrease) | | | %** | |
Segment profit (loss): | | | | | | | | | | | | | | | | |
TSG | | $ | (94,027 | ) | | $ | (28,343 | ) | | $ | 65,684 | | | | (69.9 | ) |
DNG | | | (9,490 | ) | | | 429 | | | | 9,919 | | | | (104.5 | ) |
BBG | | | (374 | ) | | | (820 | ) | | | (446 | ) | | | 119.3 | |
GNS | | | 3,589 | | | | 5,179 | | | | 1,590 | | | | 44.3 | |
| | | | | | | | | | | | | |
Total segment loss | | $ | (100,302 | ) | | $ | (23,555 | ) | | $ | 76,747 | | | | (76.5 | ) |
| | | | | | | | | | | | | | | | |
Other non-performance items: | | | | | | | | | | | | | | | | |
Corporate selling and marketing | | | (69,402 | ) | | | (70,895 | ) | | | (1,493 | ) | | | 2.2 | |
Corporate general and administrative | | | (20,052 | ) | | | (25,538 | ) | | | (5,486 | ) | | | 27.4 | |
Stock compensation costs: | | | | | | | | | | | | | | | | |
Research and development | | | (5,473 | ) | | | (4,048 | ) | | | 1,425 | | | | (26.0 | ) |
Selling and marketing | | | (2,147 | ) | | | (4,257 | ) | | | (2,110 | ) | | | 98.3 | |
General and administrative | | | (1,079 | ) | | | (505 | ) | | | 574 | | �� | | (53.2 | ) |
Amortization of intangible assets | | | (19,458 | ) | | | (30,268 | ) | | | (10,810 | ) | | | 55.6 | |
In-process research and development | | | (30,200 | ) | | | — | | | | 30,200 | | | | (100.0 | ) |
Restructuring costs | | | (22,125 | ) | | | (15,245 | ) | | | 6,880 | | | | (31.1 | ) |
Long-lived asset impairments | | | (7,217 | ) | | | (134 | ) | | | 7,083 | | | | (98.1 | ) |
Recovery of sale, export, use tax liability and payments | | | 5,388 | | | | — | | | | (5,388 | ) | | | (100.0 | ) |
(Provision for) benefit for doubtful accounts, net | | | 2,794 | | | | (2,604 | ) | | | (5,398 | ) | | | (193.2 | ) |
Accelerated amortization of leasehold | | | (14,153 | ) | | | — | | | | 14,153 | | | | (100.0 | ) |
Interest and other financial charges, net | | | (9,921 | ) | | | (4,665 | ) | | | 5,256 | | | | (53.0 | ) |
Provision for income taxes | | | (1,044 | ) | | | (1,115 | ) | | | (71 | ) | | | 6.8 | |
| | | | | | | | | | | | | |
Consolidated net loss | | $ | (294,391 | ) | | $ | (182,829 | ) | | $ | 111,562 | | | | (37.9 | ) |
| | | | | | | | | | | | | |
| | |
** | | Denotes % change from 2004 to 2005 |
| • | | TSG segment lossdecreased from the first nine months of fiscal 2004 to the first nine months of fiscal 2005 primarily due to increased revenue, increased gross profit and lower research and development costs. |
|
| • | | DNG segment profitincreased from the first nine months of fiscal 2004 to the first nine months of fiscal 2005 due to increased in revenue, increased gross profit and lower research and development costs. |
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| • | | BBG segment lossincreased from the first nine months of fiscal 2004 to the first nine months of fiscal 2005 due to the increased research and development cost partially offset by increased sales of CNX-5™ Broadband DSL Systems. BBG activity consists of the acquired operations of Catena Networks, which was |
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| | | acquired in May 2004. As a result of the timing of this acquisition, nine month segment loss for 2004 primarily reflects one quarter of segment operating activities. |
|
| • | | GNS segment profitincreased from the first nine months of fiscal 2004 to the first nine months of fiscal 2005 due to reduced service overhead costs.revenue. |
Liquidity and Capital Resources
Ciena’sAt January 31, 2006, our principal source of liquidity is itswas cash and cash equivalents, short-term investments and long-term investments. The following table summarizes our cash and cash equivalents, short-term investments and long-term investments (in thousands):
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| | | | | | | | | | | | |
| | October 31, | | | January 31, | | | Increase | |
| | 2005 | | | 2006 | | | (decrease) | |
Cash and cash equivalents | | $ | 358,012 | | | $ | 298,624 | | | $ | (59,388 | ) |
Short-term investments | | | 579,531 | | | | 496,010 | | | | (83,521 | ) |
Long-term investments | | | 155,944 | | | | 166,951 | | | | 11,007 | |
| | | | | | | | | |
Total cash, cash equivalents, short-term and long-term investment | | $ | 1,093,487 | | | $ | 961,585 | | | $ | (131,902 | ) |
| | | | | | | | | |
The decrease in total cash, cash equivalents and short-term and long-term investments. At July 31, 2005, we had $313.6 million in cash and cash equivalents, and $803.1 million in short-term and long-term investments. Our investment portfolio consists primarily of fixed-income securities, with maturities of two years or less, diversified among industries and individual issuers. Our investments are generally liquid, investment grade securities.
Ciena’s operating activities consumed $197.2 million and $119.2 million net cash during the first nine months of fiscal 2004 and 2005, respectively. The primary reason for operating cash consumption was the net loss incurred during the periods.
Our investing activities provided net cash of $178.4 million and $261.5 million during the first nine months of fiscal 2004 and 2005, respectively. Investment activities included the net redemption of $197.4 million and $265.3 million of short and long-term investments during the first nine monthsquarter of fiscal 2004 and fiscal 2005, respectively.
Cash used in financing activities2006 was $35.1primarily related to $32.0 million and $31.4 million during the first nine months of fiscal 2004 and 2005 respectively. The primary use of cash consumed in financingoperating activities during the first nine monthsand $98.8 million of fiscal 2004 was related to the purchase of the remaining $48.2 million in outstanding ONI 5.0% convertible subordinated notes. We paid $49.2 millioncash used for the notes and fees related to the purchase. During the first nine months of fiscal 2004, we received $14.0 million from the exercise of employee options and the sale of stock pursuant to the employee stock purchase plan. The primary use of cash in financing activities during the first nine months of fiscal 2005 was related to our open market purchase of $41.2 million in principal amountrepurchase of our outstanding 3.75% convertible notes, due February 1, 2008, for $36.9 million in cash. At July 31, 2005, an aggregate principal amount of approximately $648.8 million remained outstanding. We intend to continue to evaluate and pursue alternatives that enable us to exercise prudent cash management and achieve cost savings relating to the repayment of our outstanding convertible notes. During the first nine months of fiscal 2005, we received $5.5 million from the exercise of employee options and the sale of stock pursuant to the employee stock purchase plan.
Based on past performance and current expectations, we believe that our cash and cash equivalents, short-term investments, and cash generated from operations will satisfy our working capital needs, capital expenditures investment requirements, commitments, and other liquidity requirements associated with our existing operations through at least the next 12 months.
The following sections review the significant activities that had an impact on our cash during the first quarter of fiscal 2006.
Operating Activities
The following tables set forth (in thousands) significant components of our $32.0 million of cash used in operating activities for the first quarter of fiscal 2006.
Net loss
| | | |
| | Quarter Ended |
| | January 31, |
| | 2006 |
Net loss | | $ (6,291) |
| | |
Our first quarter of fiscal 2006 net loss included the significant non-cash items summarized in the following table (in thousands):
| | | | |
Gain on early extinguishment of debt | | $ | (6,690 | ) |
Amortization of intangibles | | | 7,263 | |
Share-based compensation costs | | | 4,183 | |
Depreciation and amortization of leasehold improvements | | | 5,312 | |
| | | |
Total significant non-cash charges | | $ | 10,068 | |
| | | |
Accounts Receivable, Net
Cash consumed by accounts receivable, net increased from the first quarter of fiscal 2005 to the first quarter of fiscal 2006, primarily due to increased sales, and higher days sales outstanding (“DSO”). Ciena’s DSO for periods ending January 31, 2005 and January 31, 2006 were 49.5 days and 60.4 days, respectively. Increased DSOs were primarily affected by large shipments of product during the last month of our fiscal quarter rather than extended payment terms. We expect that our accounts receivable, net and DSOs may fluctuate from quarter to quarter in fiscal 2006, but generally will increase during fiscal 2006, due to the size and timing of orders, the timing of satisfaction of contractual acceptance criteria, and extended payment terms.
The following table sets forth (in thousands) changes to our accounts receivable, net of allowance for doubtful accounts balance from the end of fiscal 2005 through the first quarter of fiscal 2006.
| | | | | | | | | | | | |
| | October 31, | | | January 31, | | | Increase | |
| | 2005 | | | 2006 | | | (decrease) | |
Accounts receivable, net | | $ | 72,786 | | | $ | 81,136 | | | $ | 8,350 | |
| | | | | | | | | |
Inventory, Net
Cash consumed by inventory, net increased from first quarter of fiscal 2005 to the first quarter of fiscal 2006 primarily due to increased demand, and a decrease in inventory turns. Ciena’s inventory turns for the periods ending
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January 31, 2005 and January 31, 2006 were 5.3 turns per year and 3.8 turns per year, respectively. The decrease was primarily related to increases in finished goods inventory purchased by Ciena based on customer forecasts in advance of orders and finished goods inventory located at customer facilities awaiting contractual acceptance. We expect cash consumed by inventory will fluctuate from quarter to quarter in fiscal 2006, but generally will increase during fiscal 2006, due to increases in finished goods inventory located at customer facilities awaiting contractual acceptance.
The following table sets forth (in thousands) changes to the components of our inventory from the end of fiscal 2005 through the first quarter of fiscal 2006.
| | | | | | | | | | | | |
| | October 31, | | | January 31, | | | Increase | |
| | 2005 | | | 2006 | | | (decrease) | |
Raw materials | | $ | 21,177 | | | $ | 24,251 | | | $ | 3,074 | |
Work-in-process | | | 3,136 | | | | 3,528 | | | | 392 | |
Finished goods | | | 47,615 | | | | 58,812 | | | | 11,197 | |
| | | | | | | | | |
Gross inventory | | | 71,928 | | | | 86,591 | | | | 14,663 | |
Reserve for excess and obsolescence | | | (22,595 | ) | | | (22,212 | ) | | | 383 | |
| | | | | | | | | |
Net inventory | | $ | 49,333 | | | $ | 64,379 | | | $ | 15,046 | |
| | | | | | | | | |
Restructuring and unfavorable lease commitments
In the first quarter of fiscal 2006, we paid $12.8 million in connection with a termination of our obligations under a lease for our former Fremont, CA facility. Ciena paid an additional $3.4 million on leases related to restructured facilities and $2.5 million on leases associated with unfavorable lease commitments. The following table reflects (in thousands) the balances of liabilities for our restructured facilities and unfavorable lease commitments and the change in these balances from the fourth quarter of fiscal 2005 to the first quarter of fiscal 2006.
| | | | | | | | | | | | |
| | October 31, | | | January 31, | | | Increase | |
| | 2005 | | | 2006 | | | (decrease) | |
Restructuring liabilities | | $ | 15,492 | | | $ | 12,687 | | | $ | (2,805 | ) |
Unfavorable lease commitments | | | 9,011 | | | | 8,620 | | | | (391 | ) |
Long-term restructuring liabilities | | | 54,285 | | | | 35,939 | | | | (18,346 | ) |
Long-term unfavorable lease commitments | | | 41,364 | | | | 38,934 | | | | (2,430 | ) |
| | | | | | | | | |
Total restructuring liabilities and unfavorable lease commitments | | $ | 120,152 | | | $ | 96,180 | | | $ | (23,972 | ) |
| | | | | | | | | |
Interest Payable on Ciena’s 3.75% Convertible Notes
Interest on Ciena’s 3.75% convertible notes is payable on February 1st and August 1st of each year. During the first quarter of fiscal 2006, Ciena paid $11.5 million in interest on the convertible notes. To the extent that Ciena makes its interest payment on the convertible notes prior to the end the first and third quarter or each fiscal year, the accrued interest payable balance as of the end of these quarters will be zero. The following table reflects (in thousands) the balances of interest payable and the change in this balance from the fourth quarter of fiscal 2005 to the first quarter of fiscal 2006.
| | | | | | | | | | | | |
| | October 31, | | | January 31, | | | Increase | |
| | 2005 | | | 2006 | | | (decrease) | |
Accrued interest payable | | $ | 6,082 | | | $ | — | | | $ | (6,082 | ) |
Financing Activities
Cash used in financing activities during the first quarter of fiscal 2006 was primarily related to the repurchase of $106.5 million of our outstanding 3.75% convertible notes, due February 1, 2008, in open market transactions for $98.8 million. We recorded a gain on the extinguishment of debt in the amount of $6.7 million, which consists of the $7.7 million gain from the repurchase of the notes less $1.0 million of associated debt issuance costs.
Contractual Obligations
The following is a summary of our future minimum payments under contractual obligations as of JulyJanuary 31, 20052006 (in thousands):
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less than one | | One to three | | Three to five | | | | | Less than one | | One to three | | Three to five | | | |
| | Total | | year | | years | | years | | Thereafter | | | Total | | year | | years | | years | | Thereafter | |
Convertible notes (1) | | $ | 709,572 | | $ | 24,328 | | $ | 24,328 | | $ | 660,916 | | $ | — | | | $ | 582,932 | | $ | 20,335 | | $ | 562,597 | | $ | — | | $ | — | |
Operating leases | | 188,502 | | 36,512 | | 60,587 | | 49,615 | | 41,788 | | | 153,506 | | 25,554 | | 55,867 | | 43,085 | | 29,000 | |
Purchase obligations (2) | | 68,559 | | 68,559 | | — | | — | | — | | | 95,710 | | 95,710 | | — | | — | | — | |
| | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 966,633 | | $ | 129,399 | | $ | 84,915 | | $ | 710,531 | | $ | 41,788 | | | $ | 832,148 | | $ | 141,599 | | $ | 618,464 | | $ | 43,085 | | $ | 29,000 | |
| | | | | | | | | | | | | | | | | | | | | | |
| | |
(1) | | Our 3.75% convertible notes have an aggregate principal amount of $648.8$542.3 million, due February 1, 2008. Interest is payable on February 1st and August 1st of each year. |
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(2) | | Purchase commitments relatedrelate to amounts we are obligated to pay to our contract manufacturers and component suppliers for inventory. |
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Some of our commercial commitments, including some of the future minimum payments set forth above, are secured by standby letters of credit. The following is a summary of our commercial commitments secured by standby letters of credit by commitment expiration date as of JulyJanuary 31, 20052006 (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | | | | | Less than one | | | One to | | | Three to | | | | |
| | Total | | | year | | | three years | | | five years | | | Thereafter | |
Standby letters of credit | | $ | 13,298 | | | $ | 13,048 | | | $ | 250 | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | Less than one | | | One to | | | Three to | | | | |
| | Total | | | year | | | three years | | | five years | | | Thereafter | |
Standby letters of credit | | $ | 11,536 | | | $ | 10,786 | | | $ | 750 | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | |
Off-Balance Sheet Arrangements
Ciena does not engage in any off-balance sheet financing arrangements. In particular, we do not have any interest in so-called limited purpose entities, which include special purpose entities (SPEs) and structured finance entities.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements requires Ciena to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we reevaluate our estimates, including those related to bad debts, inventories, investments, intangible assets, goodwill, income taxes, warranty obligations, restructuring, and contingencies and litigation. We base ourCiena bases its estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Among other things, these estimates form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. During the third quarter of fiscal 2005,2006, reevaluation of certain estimates led to the effects described below.
Revenue Recognition
Ciena’s productsSome of our communications networking equipment is integrated with software that is essential to the functionality of the equipment. We provide unspecified software upgrades and services include hardware, software,enhancements related to the equipment through our maintenance contracts for these products. Accordingly, we account for revenue in accordance with Statement of Position No. 97-2, “Software Revenue Recognition,” and professional services. We recognize revenueall related interpretations. Revenue is recognized when there is persuasive evidence of an arrangement withexists, delivery has occurred, the customer, we have fulfilled our obligations under the arrangement, the pricefee is fixed or determinable, and collectibility is reasonably assured. In instances where final acceptance of the product is specified by the customer, revenue is deferred until all acceptance criteria have been met. Customer purchase agreements and customer purchase orders are generally used to determine the existence of an arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history. When a sale involves multiple elements, such as sales of products that include services, the entire fee from the arrangement is allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element are met. The thirdamount of product and fourth criteria may require usservice revenue recognized is affected by our judgments as to make significant judgments orwhether an arrangement includes multiple elements and, if so, whether vendor-specific objective evidence of fair value exists. Changes to the elements in an
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arrangement and our ability to establish vendor-specific objective evidence for those elements could affect the timing of revenue recognition. Our total deferred revenue for products was $14.5 million and $18.0 million as of October 31, 2005 and January 31, 2006, respectively. Our service revenue is deferred and recognized ratably over the period during which the services are to be performed. Our total deferred revenue for services was $29.0 million and $28.7 million as of October 31, 2005 and January 31, 2006, respectively.
Share-Based Compensation
On November 1, 2005, Ciena adopted SFAS 123(R), “Shared-Based Payment,” which requires the measurement and recognition of compensation expense, based on estimated fair values, for all share-based awards, made to employees and directors, including stock options, restricted stock, restricted stock units and participation in Ciena’s employee stock purchase plan. Share-based compensation expense recognized in Ciena’s consolidated statement of operations for the first quarter of fiscal 2006 includes compensation expense for share-based awards granted (i) prior to, but not yet vested as of October 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123, and (ii) subsequent to October 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R).
We estimate the fair value of stock options granted using the Black-Scholes option pricing method. This option pricing model requires the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding. Because Ciena considers its options to be “plain vanilla” we calculate the expected term using the simplified method as prescribed in SAB 107. Under SAB 107, options are considered to be “plain vanilla” if they have the following basic characteristics: granted “at-the-money”; exerciseability is conditioned upon service through the vesting date; termination of service prior to vesting results in forfeiture; limited exercise period following termination of service; options are non-transferable and non-hedgeable. The expected stock price volatility was determined using a combination of historical and implied volatility of Ciena’s common stock. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Because share-based compensation expense is based on awards that are ultimately expected to vest, it has been reduced to account for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In Ciena’s pro forma information required under SFAS 123 for the periods prior to fiscal 2006, Ciena accounted for forfeitures as they occurred. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation.
Reserve for Inventory Obsolescence
Ciena writes down inventory that has become obsolete or unmarketable by an amount equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. During the first nine monthsquarter of fiscal 2005,2006, we recorded a charge of $3.4$3.0 million primarily related to excess inventory due to a change in forecasted sales for certain products. In an effort to limit our exposure to delivery delays and to satisfy customer needs for shorter delivery terms, we are currently transitioning our manufacturing operations from the build-to-order model we have used in recent years, to a build-to-forecast model for some of our product lines, including core transport and switching and metro transport. This change in our inventory purchases exposes us to the risk that our customers will not order those products for which we have forecasted sales, or will purchase less than we have forecasted. If actual market conditions differ from those we have assumed, we may be required to take additional inventory write-downs or benefits.
Restructuring
As part of its restructuring costs, Ciena provides for the estimated cost of the net lease expense for facilities that are no longer being used. The provision is equal to the fair value of the minimum future lease payments under our contracted lease obligations, offset by the fair value of the estimated sublease payments. Due to the continued excess supply of commercial properties in certain markets where our unused facilities are located,payments that we have reduced our estimate of the total future sublease payments we willmay receive. As a result, we recorded an additional restructuring cost of $15.2 million in the first nine months of fiscal 2005. As of JulyJanuary 31, 2005,2006, Ciena’s accrued restructuring liability related to net lease expense and other related charges was $71.6$47.9 million. The total minimum lease payments for these restructured facilities are $95.3$67.9 million. These lease payments will be made over the remaining lives of our leases, which range from one month to twelvethirteen years. If actual market conditions are less favorable than those we have projected, we may be required to recognize additional restructuring costs associated with these facilities.
Accounts Receivable Trade, Net
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Ciena’s allowance for doubtful accounts is based on our assessment, on a specific identification basis, of the collectibility of customer accounts. Ciena performs ongoing credit evaluations of its customers and generally has not required collateral or other forms of security from its customers. In determining the appropriate balance for Ciena’s allowance for doubtful accounts, management considers each individual customer account receivable in order to determine collectibility. In doing so, management considers creditworthiness, payment history, account activity and communication with such customer. If a customer’s financial condition changes, Ciena may be required to take a charge for an allowance on doubtful accounts. During the first quarter of fiscal 2006, Ciena recorded the recovery of a doubtful account in the amount of $2.6 million as a result of the payment of an amount due from a customer from whom payment was previously deemed doubtful due to the customer’s financial condition.
Goodwill
At JulyJanuary 31, 2005,2006, Ciena’s consolidated balance sheet included $408.6$232.0 million in goodwill. Due to Ciena’s reorganization into operating segments, SFAS 142 requires that we assign goodwill to Ciena’s reporting units. Ciena has determined its operating segments and reporting units are the same. In accordance with SFAS 142, Ciena tests each reporting unit’s goodwill for impairment on an annual basis, and between annual tests if an event occurs or circumstances change that would, more likely than not, reduce the fair value of the reporting unit below its carrying value. Based on the operating results, forecasts, and business factors with the segments, Ciena recorded an impairment loss of $371.7 million in the fourth quarter of fiscal 2004. If actual market conditions differ or forecasts change at the time of our annual assessment in fiscal 20052006 or in periods prior to our annual assessment, we may be required to record additional goodwill impairment charges.
Intangible Assets
As of JulyJanuary 31, 2005,2006, Ciena’s consolidated balance sheet included $174.8$113.1 million in other intangible assets, net. We account for the impairment or disposal of long-lived assets such as equipment, furniture, fixtures, and other intangible assets in accordance with the provisions of SFAS 144. In accordance with SFAS 144, Ciena tests each intangible asset for impairment whenever events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable. Management does not believe that events or changes in circumstances have occurred during the first nine months of fiscal 2005 that would indicate that our intangible asset carrying amounts may not be recoverable. If actual market conditions differ or forecasts change, we may be required to record additional impairment charges in future periods.
Investments
As of JulyJanuary 31, 20052006, Ciena’s minority investments in privately held technology companies was $7.7were $6.5 million. These investments are generally carried at cost asbecause Ciena owns less than 20% of the voting equity and does not have the ability to exercise significant influence over any of these companies. These investments are inherently high risk as the market for technologies or products manufactured by these companies are usually early stage at the time of the investment by Ciena and such markets may never materialize or become significant. Ciena could lose its entire investment in some or all of these companies. Ciena monitors these investments for impairment and makes appropriate reductions in carrying values when necessary. Ciena recorded a net charge of $9.0$0.7 million during the first nine monthsquarter of fiscal 2005,2006, from a decline in the fair valuesvalue of certain equity investments that werewas determined to be other than temporary. If actual market conditions, differ,expected financial performance or the competitive position of the companies in which we invest deteriorate, Ciena may be required to record an additional charge in future periods.
Deferred Tax Valuation Allowance
As of JulyJanuary 31, 2005,2006, Ciena has recorded a valuation allowance of $1.1$1.2 billion against our gross deferred tax assets of $1.1$1.2 billion. We calculated the valuation allowance in accordance with the provisions of SFAS 109, “Accounting for Income Taxes,” which requires an assessment of both positive and negative evidence when measuring the need for a valuation allowance. Positive evidence,Evidence such as operating results during the most recent three-year period is given more weight because,than forecasted results, due to our current lack of visibility there is a greaterand the degree of uncertainty that we will achieve the level of future profitability needed to record the deferred assets. Our results over the most recent three-year period were heavily affected by our recent business restructuring activities. Our cumulative loss in the most recent three-year period represents sufficient negative evidence to require a valuation allowance under the provisions of SFAS 109. We intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal.
Risk Factors
Investing in our securities involves a high degree of risk. In addition to the other information contained in this report, you should consider the following risk factors before investing in our securities.
Our business and results of operations could continue to be adversely affected by conditions in the communications industry.
The last few years have seen substantial changes in the communications industry. Many of our customers and potential customers, including communications service providers that have historically provided a significant portion of our sales, have confronted static or declining revenue. Many existing or potential customers have experienced significant financial distress or withdrawn from segments of the business, and some have gone out of business. These factors have adversely affected our revenue and operating results.
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This year, several large communications service providers have announced merger transactions. These include proposed mergers between Verizon and MCI, and between SBC and AT&T, all of which have been significant customers during prior periods. These mergers will have a major impact on the future of the telecommunications industry. They will increase concentration of purchasing power among a few large service providers and may result in delays in, or the curtailment of, investments in communications networks, as a result of changes in strategy, network overlap or cost reduction efforts.
The impact of the market factors above may continue to affect our business and results of operations, in several meaningful ways:
| • | | capital expenditures by many of our customers may be flat or reduced; |
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| • | | we will continue to have only limited ability to forecast the volume and product mix of our sales; and |
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| • | | managing our expenditures and inventory will be difficult in light of the uncertainties surrounding our business. |
Any one or a combination of these factors could have a material adverse impact on our business, financial condition and results of operations.
We face intense competition that could hurt our sales and profitability.
The markets in which we compete for sales of networking equipment, software and services are extremely competitive, particularly the market for sales to communications service providers. Competition in these markets is based on price, functionality, manufacturing capability, installation, services, scalability and the ability of products and services to meet customers’ network requirements. A small number of very large companies have historically dominated the communications networking equipment industry. Our industry has also increasingly experienced competition from low-cost producers in Asia. Many of our competitors have substantially greater financial, technical and marketing resources, greater manufacturing capacity and better established relationships with incumbent carriers and other potential customers than Ciena. As a result of increased merger activity among communication service providers, there has been speculation of consolidation among networking equipment providers, which, if it occurred, could cause some competitors to grow even larger and more powerful.
We also compete with a number of smaller companies that provide significant competition for a specific product or market. These competitors often base their products on the latest available technologies. Due to the narrower focus of their efforts, these competitors may achieve commercial availability of their products more quickly and may be more attractive to customers.
Increased competition in our markets has resulted in aggressive business tactics, including:
| • | | intense price competition; |
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| • | | discounting resulting from sales of used equipment or inventory that a competitor has written down or written off; |
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| • | | early announcements of competing products and extensive marketing efforts; |
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| • | | “one-stop shopping” options; |
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| • | | competitors offering to repurchase Ciena equipment from existing customers; |
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| • | | customer financing assistance; |
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| • | | marketing and advertising assistance; and |
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| • | | intellectual property assertions and disputes. |
The tactics described above can be particularly effective in an increasingly concentrated base of potential customers such as communications service providers. Our inability to compete successfully in our markets would harm our business, financial condition and results of operations.
We expect gross margin to fluctuate, and our product gross margins may be adversely affected by a number of factors.
Our gross margin fluctuates from period to period and our product gross margins may continue to be adversely affected by numerous factors, including:
| • | | increased price competition, including competition from low-cost producers in Asia; |
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| • | | the mix in any period of higher and lower margin products and services; |
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| • | | charges for excess or obsolete inventory; |
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| • | | changes in the price or availability of components for our products; |
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| • | | our ability to reduce product manufacturing costs; |
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| • | | introduction of new products, with initial sales at relatively small volumes with resulting higher production costs; and |
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| • | | increased service, installation, warranty or repair costs. |
We expect product gross margin to continue to fluctuate on a quarterly basis. Fluctuations in product gross margin may make it difficult to manage our business and attain profitability.
Our revenue and operating results can fluctuate unpredictably from quarter to quarter.
Current market conditions cause our revenue to fluctuate and make it difficult to make reliable estimates of future revenue. Fluctuations in our revenue can lead to even greater fluctuations in our operating results. Our budgeted expense levels depend in part on our expectations of long-term future revenue. Any substantial adjustment to expenses to account for lower levels of revenue is difficult and takes time. Consequently, if our revenue declines, our levels of inventory, operating expense and general overhead would be high relative to revenue, resulting in additional operating losses.
Other factors contribute to fluctuations in our revenue and operating results, including:
| • | | fluctuations in demand for our products and the timing and size of customer orders; |
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| • | | changes in customers’ requirements, including changes or cancellations to orders from customers; |
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| • | | satisfaction of contractual customer acceptance criteria and related revenue recognition issues; |
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| • | | the introduction of new products by us or our competitors; |
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| • | | readiness of customer sites for installation; |
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| • | | manufacturing and shipment delays and deferrals; |
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| • | | actual events, outcomes and amounts that differ from our assumptions and estimates used in our determination of the value of certain assets (including goodwill and other intangible assets), liabilities and other items reflected in our financial statements; |
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| • | | changes in accounting rules, including recording expenses associated with equity based compensation awards; and |
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| • | | changes in general economic conditions as well as those specific to our market segments. |
Failure to establish and maintain effective internal controls over financial reporting could have a material adverse effect on our business, operating results and stock price.
Beginning with our annual report for our fiscal year ended October 31, 2005, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to include a report by our management on our internal controls over financial reporting. Such report must contain an assessment by management of the effectiveness of our internal controls over financial reporting as of the end of our fiscal year and a statement as to whether or not such internal controls are effective. Such report must also contain a statement that our independent registered public accounting firm has issued an attestation report on management’s assessment of such internal controls.
In order to achieve timely compliance with Section 404, in fiscal 2004 we began a process to document and evaluate our internal controls over financial reporting. Our efforts to comply with Section 404 have resulted in, and are likely to continue to result in, significant costs, the commitment of time and operational resources and the diversion of management’s attention. If our management identifies one or more material weaknesses in our internal controls over financial reporting, we will be unable to assert that these controls are effective. If we are unable to assert that our internal controls over financial reporting are effective as of October 31, 2005 (or if our independent registered public accounting firm is unable to attest that our management’s report is fairly stated or they are unable to express an opinion on our management’s assessment of the effectiveness of internal controls over financial reporting or on the effectiveness of our internal controls over financial reporting), our business may be harmed. Market perception of our financial condition and the trading price of our stock may be adversely affected and customer perception of our business may suffer.
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Our business and results of operations are affected by the competitive pressures faced by our existing and potential communications service provider customers.
Traditional communications service providers are under increasing competitive pressure from providers within their industry and other participants that offer, or seek to offer, overlapping or similar services. These pressures are likely to continue to cause communications service providers to seek to minimize the costs of the equipment that they buy. These competitive pressures may result in pricing becoming a more important factor in customer purchasing decisions. Increased focus on pricing may favor low-cost communications equipment vendors in Asia and larger competitors that can spread the effect of price discounts across a broader offering of products and services and across a larger customer base. These pressures may harm our competitive position and adversely affect our business and results of operations.
We may not be successful in selling our products into new markets and developing and managing new sales channels.
As we have expanded our product portfolio, we have entered and begun to sell our products in new markets and to a broader customer base, including enterprises, cable operators, and federal, state and local governments. To succeed in these new markets, we believe we must develop and manage new sales channels and distribution arrangements. Because we have only limited experience in developing and managing such channels, it is uncertain to what extent we will be successful. In addition, sales to federal, state and local governments require compliance with complex procurement regulations with which we have little experience. We may be unable to increase our sales to government contractors if we determine that we cannot comply with applicable regulations. Our failure to comply with regulations for existing contracts could result in civil, criminal or administrative proceedings involving fines and suspension or debarment from federal government contracts. Failure to succeed in these new markets will adversely affect our ability to grow our customer base and revenues.
If we do not maintain and expand our sales with large communications service providers, our revenues and results of operations will suffer.
Our future success will depend on our ability to maintain and expand our sales to existing and new communications service provider customers, particularly overseas. Many of our competitors have long-standing relationships with such customers, which can pose significant obstacles to our sales efforts. In addition, sales to large communications service providers typically involve lengthy sales cycles, protracted or difficult contract negotiations and extensive product testing and network certification. Communications service providers may insist upon terms and conditions, including terms that negatively affect pricing, payment and the timing of revenue recognition, that we deem too onerous or not in Ciena’s best interest. As a result of the obstacles above, we may incur substantial expenses and devote time and resources to potential relationships that never materialize or meet our expectations. Our revenues and results of operations will suffer if we are unable to expand our business with and sales to large communications service providers.
Product performance problems could damage our business reputation and limit our sales prospects.
The development and production of new products with high technology content is complicated and often involves problems with software, components and manufacturing methods. Modifying our products to enable customers to integrate them into a new type of network architecture entails similar risks. If significant reliability, quality, or network monitoring problems develop as a result of our product development, manufacturing or integration, a number of negative effects on our business could result, including:
| • | | increased costs associated with fixing software or hardware defects, including service and warranty expenses; |
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| • | | payment of liquidated damages for performance failures; |
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| • | | high inventory obsolescence expense; |
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| • | | delays in collecting accounts receivable; |
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| • | | reduced orders from existing or potential customers; and |
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| • | | damage to our reputation. |
Because we outsource the manufacturing of many of our products to electronic manufacturing service or “EMS” providers and expect to increasingly rely upon direct order fulfillment, through which our manufacturers will test our products on our behalf and deliver them directly to customers, we may be subject to product performance problems as a result of the acts or omissions of these third parties.
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We must continue to make substantial investments in product development in order to keep pace with technological advances and succeed in existing and new markets for our products.
In order to be successful, we must balance our initiatives to reduce our operating costs against the need to keep pace with technological advances. The market for communications networking equipment, software and services is characterized by rapid technological change, frequent introductions of new products, and recurring changes in customer requirements. To succeed, we must continue to develop new products and new features for existing products that meet customer requirements and market demand. In addition, we must be able to identify and gain access to new technologies as our market segments evolve. Because our market segments are constantly evolving, we may allocate development resources toward products or technologies for which market demand is lower than anticipated. Managing our efforts to keep pace with new technologies and reduce operating expense is difficult and there is no assurance that we will be successful.
We may be required to take further write-downs of goodwill.
As of July 31, 2005, we had $408.6 million of goodwill on our balance sheet. This amount primarily represents the remaining excess of the total purchase price of our acquisitions over the fair value of the net assets acquired. At July 31, 2005, goodwill represented approximately 21.2% of our total assets. During the fourth quarter of 2004, we incurred a goodwill impairment charge of approximately $371.7 million. If we are required to record additional impairment charges related to goodwill and other intangible assets, such charges would have the effect of decreasing our earnings or increasing our losses in such period. If we are required to take a substantial impairment charge, our earnings per share or net loss per share would be materially adversely affected in such period.
We may not be successful in enhancing and upgrading our products.
Because our products are based on complex technology, we can experience unanticipated delays in developing, improving, manufacturing or deploying them. At any given time, various enhancements to our products are in the development phase and are not yet ready for commercial manufacturing or deployment. The maturing process from laboratory prototype to customer trials, and subsequently to general availability, involves a number of steps, including:
| • | | completion of product development; |
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| • | | the qualification and sourcing of critical components; |
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| • | | validation of manufacturing methods and processes; |
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| • | | extensive quality assurance and reliability testing, and staffing of testing infrastructure; |
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| • | | validation of software; and |
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| • | | establishment of systems integration and systems test validation requirements. |
Each of these steps, in turn, presents serious risks of failure, rework or delay, any one of which could decrease the speed and scope of product introduction and marketplace acceptance of the product. Specialized application specific integrated circuits (“ASICs”) and intensive software testing and validation are key to the timely introduction of enhancements to several of our products, and schedule delays are common in the final validation phase, as well as in the manufacture of specialized ASICs. In addition, unexpected intellectual property disputes, failure of critical design elements, and a host of other execution risks may delay or even prevent the introduction of these products. If we do not develop and successfully introduce products in a timely manner, our business, financial condition and results of operations would be harmed.
We may incur significant costs and our competitive position may suffer as a result of our efforts to protect and enforce our intellectual property rights or respond to claims of infringement from others.
Despite efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. This is likely to become an increasingly important issue as we expand our operations and product development into countries that provide a lower level of intellectual property protection. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps that we are taking will prevent unauthorized use of our technology. If competitors are able to use our technology, our ability to compete effectively could be harmed.
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In recent years, we have filed suit to enforce our intellectual property rights and have been subject to several claims of patent infringement, including our pending patent litigation with Nortel Networks. We may become involved in additional disputes in the future. Such lawsuits can be costly, may significantly divert the time and attention of our personnel and may result in counterclaims of infringement. In some cases, we have been required us to pay the patent holders substantial sums or enter into license agreements requiring ongoing royalty payments in order to resolve these matters. The frequency of assertions of patent infringement is increasing as patent holders use such actions as a competitive tactic as well as to seek alternative sources of revenue. If we are sued for infringement and are unsuccessful in defending the suit, we could be subject to significant damages, and our business and results of operations could be adversely affected.
We may be required to write off significant amounts of inventory.
Historically, we have placed the majority of our orders to manufacture components or complete assemblies for many of our products only when we have firm orders from our customers. Because this practice can result in delays in the delivery of products to customers, we are increasingly ordering equipment and components from our suppliers based on forecasts of customer demand across all of our products. We believe this change is necessary in response to increased customer insistence upon shortened delivery terms. This change in our inventory purchases exposes us to the risk that our customers will not order those products for which we have forecasted sales, or will purchase fewer than the number of products we have forecasted. In such event, we may be required to write off, or write down inventory, potentially resulting in an accounting charge that could materially affect our results of operations for the quarter in which such charge occurs.
We must manage our relationships with electronic manufacturing service (EMS) providers in order to ensure that our product requirements are met timely and effectively.
We rely on EMS providers to perform the majority of the manufacturing operations for our products and components, and are increasingly utilizing overseas suppliers, particularly in Asia. The qualification of these providers is an expensive and time-consuming process, and these manufacturers build product for other companies, including our competitors. In addition, we do not have contracts in place with some of these providers. We may not be able to effectively manage our relationships with our EMS providers, particularly overseas. We cannot be certain that our EMS providers will be able to fill our orders in a timely manner. If we underestimate our future product requirements, the EMS providers may not have enough product to meet our customer requirements, and this could result in delays in the shipment of our products which could harm our business. If we overestimate product requirements, we may have to write off excess inventory. In addition, because EMS providers are subject to many of the same risks as equipment vendors serving the communications industry, many EMS providers have experienced their own financial difficulties, which may affect their ability to obtain components and to timely deliver products to Ciena or to end users through direct order fulfillment.
We are constantly reviewing our manufacturing capability, including the work of our EMS providers, to ensure that our production requirements are met in terms of cost, capacity, quality and reliability. From time to time, we may decide to transfer the manufacturing of a product from one EMS provider to another, to better meet our production needs. It is possible that we may not effectively manage this transition or the new contract manufacturer may not perform as well as expected and, as a result, we may not be able to fill orders in a timely manner, which could harm our business.
Our failure to manage our service delivery partners effectively could adversely impact our financial results and relationship with customers.
We rely on a number of service delivery partners, both domestic and international, to complement our global service and support resources. The certification of these partners incurs costs and is time-consuming, and these partners service products for other companies, including our competitors. We may not be able to effectively manage our relationships with our partners and we cannot be certain that they will be able to deliver our services in the manner or time required. If our service partners are unsuccessful in delivering services:
| • | | our services revenue may be adversely affected; |
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| • | | our relationship with customers could suffer; and |
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| • | | we may suffer delays in recognizing revenues in cases where revenue recognition is dependent upon product installation, testing and acceptance. |
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We depend on a limited number of suppliers, and for some items we do not have a substitute supplier.
We depend on a limited number of suppliers for components of our products, as well as for equipment used to manufacture and test our products. Our products include several high-performance components for which reliable, high-volume suppliers are particularly limited. Some key optical and electronic components we use in our products are currently available only from sole or limited sources, and in some cases, that source also is a competitor. The loss of a source of key components could require us to re-engineer products that use those components, which would increase our costs. Delays in component availability or delivery, or component performance problems, could result in delayed deployment of our products and our inability to recognize revenue. These delays could also harm our business reputation, customer relationships and our results of operations.
Our international operations could expose us to additional risk and result in increased operating expense.
We market, sell and service our products globally. We have established offices around the world, including in North America, Europe, Latin America and the Asia Pacific region. In addition, we are increasingly relying upon overseas suppliers, particularly in Asia, to manufacture our products and components. We expect that our international activities will be dynamic over the foreseeable future as we enter some new markets and withdraw from or reduce operations in others in order to match our resources with revenue opportunities. These changes to our international operations will require significant management attention and financial resources. In some countries, our success will depend in part on our ability to form relationships with local partners. Our inability to identify appropriate partners or reach mutually satisfactory arrangements for international sales of our products could impact our ability to maintain or increase international market demand for our products.
International operations are subject to inherent risks, and our future results could be adversely affected by a number of factors, including:
| • | | greater difficulty in collecting accounts receivable and longer collection periods; |
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| • | | difficulties and costs of staffing and managing foreign operations; |
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| • | | the impact of recessions in economies outside the United States; |
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| • | | unexpected changes in regulatory requirements; |
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| • | | certification requirements; |
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| • | | reduced protection for intellectual property rights in some countries; |
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| • | | potentially adverse tax consequences; |
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| • | | political and economic instability; |
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| • | | trade protection measures and other regulatory requirements; |
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| • | | effects of changes in currency exchange rates; |
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| • | | service provider and government spending patterns; and |
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| • | | natural disasters and epidemics. |
Our efforts to offshore certain resources and operations to India may not be successful and may expose us to unanticipated costs or liabilities.
In order to reduce ongoing operating expenses and maximize our resources, we have begun to execute our plan to establish a development operation in India. We have limited experience in offshoring our business functions and there is no assurance that our plan will enable us to achieve meaningful cost reductions or greater resource efficiency. Further, offshoring to India involves significant risks, including:
| • | | misappropriation of intellectual property or confidential information, including information that is proprietary to Ciena, its customers and other third parties; |
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| • | | heightened exposure to changes in the economic, security and political conditions of India; |
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| • | | currency exchange and tax risks associated with offshore operations; and |
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| • | | development efforts that do not meet our requirements because of language, cultural or other differences associated with international operations, resulting in errors or delays. |
Difficulties resulting from the factors above and other risks associated with offshoring could impair our development efforts, harm our competitive position and damage our reputation with existing and potential customers. These factors could be disruptive to our business and may cause us to incur substantial unanticipated costs or expose us to unforeseen liabilities.
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The steps that we are taking to restructure and reduce the size of our operations could disrupt our business.
We regularly review our operations to ensure that our business resources are aligned with market opportunities. We have taken several steps, including reductions in force, dispositions of assets and office closures, and internal reorganization of our sales and engineering functions to reduce the size and cost of our operations and to better match our resources with our market opportunities. During the next six to twelve months we expect to take additional steps to reduce our operating expenses. These efforts could be disruptive to our business. Reductions to headcount and other cost cutting measures may result in the loss of technical expertise that could adversely affect our research and development efforts and ability to meet product development schedules. These decisions often result in the recording of accounting charges, such as inventory and technology-related write-offs, workforce reduction costs, charges relating to consolidation of excess facilities, or claims from resellers or users of discontinued products. If we are required to take a substantial charge, our earnings per share or net loss per share would be adversely affected in such period. If we cannot manage our cost reduction and restructuring efforts effectively, our business, results of operations and financial condition could be harmed.
We may be required to assume warranty, service and other unexpected obligations in connection with our resale of complementary products of other companies.
We have entered into agreements with strategic partners that permit us to distribute the products of other companies. As part of our strategy to diversify our product portfolio and customer base, we may enter into additional resale agreements in the future. To the extent we succeed in reselling the products of these companies, we may be required by customers to assume certain warranty and service obligations. While our suppliers often agree to support us with respect to these obligations, we may be required to extend greater protection in order to effect a sale. Moreover, our suppliers are relatively small companies with limited financial resources. If they are unable to provide the required support, we may have to expend our own resources to do so. This risk is amplified because the equipment that we are selling has been designed and manufactured by other third parties and may be subject to warranty claims, the magnitude of which we are unable to evaluate fully.
Our exposure to the credit risks of our customers may make it difficult to collect receivables and could adversely affect our operating results and financial condition.
Industry and economic conditions have weakened the financial position of some of our customers. To sell to some of these customers, we may be required to take risks of uncollectible accounts. While we monitor these situations carefully and attempt to take appropriate measures to protect ourselves, it is possible that we may have to write down or write off doubtful accounts. Such write-downs or write-offs would negatively affect our operating results for the period in which they occur, and, if large, could have a material adverse effect on our operating results and financial condition.
If we are unable to attract and retain qualified personnel, we may be unable to manage our business effectively.
If we are unable to retain and motivate our existing employees and attract qualified personnel to fill key positions, we may be unable to effectively develop our existing products, increase sales and effect our strategic repositioning. Because we generally do not have employment contracts with our employees, we must rely upon providing competitive compensation packages and a dynamic work environment to retain and motivate employees. In response to the decline in our revenue and weakness in the communications networking equipment market, we have paid our employees significantly reduced or no bonuses since the end of fiscal 2001. Because our compensation packages include equity-based incentives, pressure on our stock price could affect our ability to continue to offer competitive compensation packages to our employees. In addition to these compensation issues, we must continue to motivate employees to execute our strategies and achieve our goals, which may be difficult due to morale challenges posed by the workforce reductions and uncertainty in our industry.
If we lose members of our management team or other key personnel, it may be difficult to replace them. It may also be difficult to effectively execute our strategy of positioning Ciena to benefit from opportunities in new markets. Competition for highly skilled technical and other personnel with experience in our industry can be intense. As a result, we may not be successful in identifying, recruiting and hiring qualified engineers and other key personnel.
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Our strategy of pursuing strategic acquisitions and investments may expose us to increased costs and unexpected liabilities.
Our business strategy includes acquiring or making strategic investments in other companies to increase our portfolio of products and services, expand the markets we address, diversify our customer base and acquire or accelerate the development of new or improved products. To do so, we may use cash, issue equity that would dilute our current stockholders’ ownership, incur debt or assume indebtedness. Strategic investments and acquisitions involve numerous risks, including:
| • | | difficulties in integrating the operations, technologies and products of the acquired companies; |
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| • | | diversion of management’s attention; |
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| • | | potential difficulties in completing projects of the acquired company and costs related to in-process research and development; |
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| • | | the potential loss of key employees of the acquired company; |
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| • | | subsequent amortization expenses related to intangible assets and charges associated with impairment of goodwill; |
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| • | | dependence on unfamiliar or relatively small supply partners; and |
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| • | | exposure to unanticipated liabilities, including intellectual property infringement claims. |
As a result of these and other risks, any acquisitions or strategic investments may not reap the intended benefits and may ultimately have a negative impact on our business, results of operation and financial condition.
We may be adversely affected by fluctuations in currency exchange rates.
Historically, our primary exposure to currency exchange rates has been related to non-dollar denominated operating expenses in Europe, Asia and Canada where we sell primarily in U.S. dollars. As we increase our international sales and utilization of international suppliers, we may decide to transact business in currencies other than the U.S. dollar. As a result, we would be subject to the impact of foreign exchange translation on our financial statements. For those countries outside the United States where we have significant sales, a devaluation in the local currency would result in reduced revenue and operating profit and reduce the value of our local inventory presented in our financial statements. In addition, fluctuations in foreign currency exchange rates may make our products more expensive for customers to purchase or increase our operating costs, thereby adversely affecting our competitiveness. To date, we have not significantly hedged against foreign currency fluctuations; however, we may pursue hedging alternatives in the future. Although exposure to currency fluctuations to date has not had an adverse effect on our business, there can be no assurance that exchange rate fluctuations in the future will not have a material adverse effect on our revenue from international sales and, consequently, our business, operating results and financial condition.
Our stock price is volatile.
Our common stock price has experienced substantial volatility in the past, and is likely to remain volatile in the future. Volatility can arise as a result of a number of the factors discussed in this “Risk Factors” section, as well as divergence between our actual or anticipated financial results and published expectations of analysts, and announcements that we, our competitors, or our customers may make.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The following discussion about Ciena’s market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. Ciena is exposed to market risk related to changes in interest rates and foreign currency exchange rates. Ciena does not use derivative financial instruments for speculative or trading purposes.
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Interest Rate Sensitivity.Ciena maintains a short-term and long-term investment portfolio. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels at JulyJanuary 31, 2005,2006, the fair value of the portfolio would decline by approximately $53.4$36.1 million.
Foreign Currency Exchange Risk.As a global concern, Ciena faces exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and if our exposure
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increases, adverse movement in foreign currency exchange rates could have a material adverse impact on Ciena’s financial results. Historically Ciena’s primary exposures have been related to non-dollar denominated operating expenses in Canada, Europe and Asia where Ciena sells primarily in U.S. dollars. Ciena is prepared to hedge against fluctuations in foreign currency if this exposure becomes material. As of JulyJanuary 31, 2005,2006, the assets and liabilities of Ciena related to non-dollar denominated currencies were not material. Therefore, we do not expect an increase or decrease of 10% in the foreign exchange rate would have a material impact on Ciena’s financial position.
Item 4. Controls and Procedures
Ciena’s management,Disclosure Controls and Procedures
As of the end of the period covered by this report, Ciena carried out an evaluation under the supervision and with the participation of Ciena’s management, including Ciena’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of ourCiena’s disclosure controls and procedures (as defined in Rules 13a-15(e) and have15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon this evaluation, Ciena’s Chief Executive Officer and Chief Financial Officer concluded that Ciena’s disclosure controls and procedures were effective as of the end of the period covered by this report, they were effective.report.
Changes in Internal Control over Financial Reporting
There was no change in Ciena’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during Ciena’s lastthe most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, Ciena’s internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
On October 3, 2000, Stanford University and Litton Systems filed a complaint in the United States District Court for the Central District of California against Ciena and several other defendants, alleging that optical fiber amplifiers incorporated into Ciena’scertain of those parties’ products infringe U.S. Patent No. 4,859,016 (the “‘016 Patent”). The complaint seeks injunctive relief, royalties and damages. On October 10, 2003, the court stayed the case pending final resolution of matters before the U.S. Patent and Trademark Office (the “PTO”), including a request for and disposition of a reexamination of the ‘016 Patent. On October 16, 2003 and November 2, 2004, the PTO granted reexaminations of the ‘016 Patent, resulting in a continuation of the stay of the case. Ciena believesOn July 11, 2005, the PTO issued a Notice of Intent to Issue a Reexamination Certificate and a Statement of Reasons for Patentability/Confirmation, stating its intent to confirm all claims of ‘016 Patent. As a result, on October 10, 2005, Litton Systems filed a motion with the district court for an order lifting the stay of the case, and defendant Pirelli S.p.A. filed with the PTO a new request for ex parte reexamination of the ‘016 Patent. On December 15, 2005, the PTO denied Pirelli’s request for reexamination. On December 19, 2005, the district court denied Litton Systems’ motion to lift the stay. The PTO has not yet issued a Reexamination Certificate. We believe that it haswe have valid defenses to the lawsuit and intendsintend to defend it vigorously in the event the stay of the case is lifted.
As a result of our merger with ONI Systems Corp. in June 2002, we became a defendant in a securities class action lawsuit. Beginning in August 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United States District Court for the Southern District of New York. These complaints name ONI, Hugh C. Martin, ONI’s former chairman, president and chief executive officer; Chris A. Davis, ONI’s former executive vice president, chief financial officer and administrative officer; and certain underwriters of ONI’s initial public offering as defendants. The complaints were consolidated into a single action, and a consolidated amended complaint was filed on April 24, 2002. The amended complaint alleges, among other things, that the underwriter defendants violated the securities laws by failing to disclose alleged compensation arrangements (such as undisclosed commissions or stock stabilization practices) in the initial public offering’s
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registration statement and by engaging in manipulative practices to artificially inflate the price of ONI’s common stock after the initial public offering. The amended complaint also alleges that ONI and the named former officers violated the securities laws on the basis of an alleged failure to disclose the underwriters’ alleged compensation arrangements and manipulative practices. No specific amount of damages has been claimed. Similar complaints have been filed against more than 300 other issuers that have had initial public offerings since 1998, and all of these actions have been included in a single coordinated proceeding. Mr. Martin and Ms. Davis have been dismissed from the action without prejudice pursuant to a tolling agreement. In July 2004, following mediated settlement negotiations, the plaintiffs, the issuer defendants (including Ciena), and their insurers entered into a settlement agreement, whereby the plaintiffs’ cases against the issuers are to be dismissed. The plaintiffs and issuer defendants subsequently moved the court for preliminary approval of the settlement agreement, which motion was opposed by the underwriter defendants. On February 15, 2005, the district court granted the motion for preliminary approval of the settlement agreement, subject to certain modifications to the proposed bar order, and directed the parties to submit a revised settlement agreement reflecting its opinion. IfOn August 31, 2005, the parties are able to agree upondistrict court issued a preliminary order approving the required modifications,stipulated settlement agreement, approving and such modifications are acceptable tosetting dates for notice of the court, notice will be givensettlement to all class members, ofand scheduling the settlement, a “fairness”fairness hearing will be held and,for April 2006. After the fairness hearing, if the court determines that the settlement is fair to the class members, the settlement will be approved. The settlement agreement does not require Ciena to pay any amount toward the settlement or to make any other payments.
On January 18, 2005, Ciena filed a complaint in the United States District Court, Eastern District of Texas, Marshall Division against Nortel Networks, Inc., Nortel Networks Corporation and Nortel Networks Limited (collectively, “Nortel”), which complaint was subsequently amended. Ciena’s amended complaint charges Nortel with infringement of nine patents related to Ciena’s communications networking systems and technology. Ciena seeks to enjoin Nortel’s infringing activities and recover damages caused by such infringement. On March 14, 2005, Nortel filed an answer to Ciena’s complaint and a counterclaim against Ciena, each of which have subsequently been
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amended. Nortel’s amended counterclaim charges Ciena with infringement of 13 patents related to Nortel’s communications networking systems and technology, including certain of Nortel’s SONET, ATM and VLAN systems and technology. Nortel’s counterclaim seeks injunctive relief and damages. This matterTrial on 13 of the 22 total patents in suit (six for Ciena and seven for Nortel) is currently scheduled for trial in June 2006.
In addition to the matters described above, we are subject to various legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material effect on our results of operations, financial position or cash flows.
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Item 1A. Risk Factors
Investing in our securities involves a high degree of risk. In addition to the other information contained in this report, you should consider the following risk factors before investing in our securities.
We face intense competition that could hurt our sales and our ability to achieve and maintain profitability.
The markets in which we compete for sales of networking equipment, software and services are extremely competitive, particularly the market for sales to telecommunications service providers. Competition in these markets is based on any one or a combination of the following factors: price, functionality, manufacturing capability, installation, services, existing business and customer relationships, scalability and the ability of products and services to meet customers’ immediate and future network requirements. A small number of very large companies have historically dominated the communications networking equipment industry. Our industry has also increasingly experienced competition from low-cost producers in Asia. Many of our competitors have substantially greater financial, technical and marketing resources, greater manufacturing capacity and better established relationships with incumbent carriers and other potential customers than us. As a result of increased merger activity among communication service providers, there has been speculation of consolidation among networking equipment providers, which, if it occurred, could cause some competitors to grow even larger and more powerful. We also compete with a number of smaller companies that provide significant competition for a specific product or market. These competitors often base their products on the latest available technologies. Due to the narrower focus of their efforts, these competitors may achieve commercial availability of their products more quickly and may be more attractive to customers. As we seek to expand our channel sales strategy, we also may face competition from resellers and distributors of some of our products, who may be competitors in other customer markets or with respect to complementary technologies.
Increased competition in our markets has resulted in aggressive business tactics, including:
| • | | intense price competition; |
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| • | | discounting resulting from sales of used equipment or inventory that a competitor has written down or written off; |
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| • | | early announcements of competing products and extensive marketing efforts; |
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| • | | “one-stop shopping” options; |
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| • | | competitors offering to repurchase our equipment from existing customers; |
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| • | | customer financing assistance; |
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| • | | marketing and advertising assistance; and |
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| • | | intellectual property assertions and disputes. |
The tactics described above can be particularly effective in an increasingly concentrated base of potential customers such as communications service providers. Our inability to compete successfully in our markets would harm our sales and our ability to achieve and maintain profitability.
Our revenue and operating results can fluctuate unpredictably from quarter to quarter.
Our revenue can fluctuate unpredictably from quarter to quarter. Fluctuations in our revenue can lead to even greater fluctuations in our operating results. Our budgeted expense levels depend in part on our expectations of future revenue. Any substantial adjustment to expenses to account for lower levels of revenue is difficult and takes time. Consequently, if our revenue declines, our levels of inventory, operating expense and general overhead would be high relative to revenue, resulting in additional operating losses.
Other factors contribute to fluctuations in our revenue and operating results, including:
| • | | the level of demand for our products and the timing and size of customer orders, particularly from telecommunications service provider customers; |
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| • | | satisfaction of contractual customer acceptance criteria and related revenue recognition requirements; |
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| • | | availability of an adequate supply of components and sufficient manufacturing capacity; |
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| • | | changes in customers’ requirements, including delay, changes or cancellations of orders from customers; |
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| • | | the introduction of new products by us or our competitors; |
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| • | | readiness of customer sites for installation; |
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| • | | any significant payment by us associated with the resolution of pending legal proceedings; |
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| • | | changes in accounting rules; and |
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| • | | changes in general economic conditions as well as those specific to our market segments. |
Many of these factors are beyond our control, particularly in the case of large carrier orders and multi-vendor or multi-technology network builds where the achievement of certain performance thresholds for acceptance is subject to the readiness and performance of the customer or other providers, changes in customer requirements or installation plans, and the availability of an adequate supply of components and manufacturing capacity. Any one or a combination of the factors above may cause our revenue and operating results to fluctuate from quarter to quarter. These fluctuations may make it difficult to manage our business and achieve or maintain profitability. As a consequence, our revenues and operating results for a particular quarter may be difficult to predict and our prior results are not necessarily indicative of results likely in future periods.
Our gross margin may fluctuate from quarter to quarter and our product gross margins may be adversely affected by a number of factors, some of which are beyond our control.
Our gross margin fluctuates from period to period and our product gross margins may be adversely affected by numerous factors, including:
| • | | increased price competition, including competition from low-cost producers in Asia; |
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| • | | the mix in any period of higher and lower margin products and services; |
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| • | | sales volume during the period; |
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| • | | charges for excess or obsolete inventory; |
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| • | | changes in the price or availability of components for our products; |
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| • | | our ability to continue to reduce product manufacturing costs; |
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| • | | introduction of new products, with initial sales at relatively small volumes with resulting higher production costs; and |
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| • | | increased warranty or repair costs. |
The factors discussed above regarding fluctuations in revenue and operating results can also affect margins. We expect product gross margin to continue to fluctuate from quarter to quarter. Fluctuations in product gross margin may make it difficult to manage our business and achieve or maintain profitability. As a consequence, our gross margin for a particular quarter may be difficult to predict and our prior results are not necessarily indicative of results likely in future periods.
Our business and results of operations are significantly affected by conditions in the communications industry, including increases in consolidation activity.
The last few years have seen substantial changes in the communications industry. Many of our customers and potential customers, including telecommunications service providers that have historically provided a significant portion of our sales, have confronted static or declining revenue for their traditional voice services. Traditional communications service providers are under increasing competitive pressure from providers within their industry and other participants that offer, or seek to offer, overlapping or similar services. These pressures are likely to continue to cause communications service providers to seek to minimize the costs of the equipment that they buy and may cause static or reduced capital expenditures by customers or potential customers. These competitive pressures may also result in pricing becoming a more important factor in customer purchasing decisions. Increased focus on pricing may favor low-cost communications equipment vendors in Asia and larger competitors that can spread the effect of price discounts across a broader offering of products and services and across a larger customer base.
In 2005, several large communications service providers announced merger transactions. These included the mergers of Verizon and MCI, and SBC and AT&T, all of which have been significant customers during prior periods. These mergers will have a major impact on the future of the telecommunications industry. They will further increase concentration of purchasing power among a few large service providers and may result in delays in, or the curtailment of, investments in communications networks, as a result of changes in strategy, network overlap, cost reduction efforts or other considerations. These industry conditions may negatively affect our business, financial condition and results of operation.
We may not be successful in selling our products into new markets and developing and managing new sales
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channels.
We continue to take steps to sell our expanded product portfolio into new markets and to a broader customer base, including communication service providers, enterprises, cable operators, and federal, state and local governments. To succeed in these markets, we believe we must develop and manage new sales channels and distribution arrangements. We expect these relationships to be an increasing part of our business as we seek to grow. Because we have only limited experience in developing and managing such channels, we may not be successful in reaching additional customer segments, expanding into new geographic regions, or reducing the financial risks of entering new markets and pursuing new customer segments. In addition, sales to federal, state and local governments require compliance with complex procurement regulations with which we have little experience. We may be unable to increase our sales to government contractors if we determine that we cannot comply with applicable regulations. Our failure to comply with regulations for existing contracts could result in civil, criminal or administrative proceedings involving fines and suspension or debarment from federal government contracts. Failure to manage additional sales channels effectively would limit our ability to succeed in these new markets and could adversely affect our ability to grow our customer base and revenues.
Network equipment sales to large communications service providers often involve, lengthy sales cycles and protracted contract negotiations and may require us to assume terms or conditions that negatively affect our pricing, payment and timing of revenue recognition.
In recent years we have sought to add large, incumbent communication service providers as customers for our products, software and services. Our future success will depend on our ability to maintain and expand our sales to these existing communications service provider customers and add new customers. Many of our competitors have long-standing relationships with communications service providers, which can pose significant obstacles to our sales efforts. Sales to large communications service providers typically involve lengthy sales cycles, protracted or difficult contract negotiations, and extensive product testing and network certification. We are sometimes required to assume terms or conditions that negatively affect pricing, payment and the timing of revenue recognition in order to consummate a sale. This may negatively affect the timing of revenue recognition, which would, in turn, negatively affect our gross margin and results of operations. Communications service providers may ultimately insist upon terms and conditions, that we deem too onerous or not in our best interest. As a result, we may incur substantial expenses and devote time and resources to potential relationships that never materialize.
Continued shortages in component supply or manufacturing capacity could increase our costs, adversely affect our results of operations and constrain our ability to grow our business.
As we have expanded our product portfolio, increased our use of contract manufacturers and increased our product sales in recent years, manufacturing capacity and supply constraints related to components and subsystems have become increasingly significant issues for us. We have encountered and continue to experience component shortages that have affected our operations and ability to deliver products timely to customers. Growth in customer demand for the communications networking products supplied by us, our competitors and other third parties, has resulted in supply constraints among providers of some components used in our products. Component shortages and manufacturing capacity constraints may also arise, or be exacerbated by difficulties with our suppliers or contract manufacturers, or our failure to adequately forecast our component or manufacturing needs. If shortages or delays persist or worsen, the price of required components may increase, or the components may not be available at all. If we are unable to secure the components or subsystems that we require at reasonable prices, or are unable to secure manufacturing capacity adequate to meet our needs, we may not be able to satisfy our contractual obligations to customers and our revenue and gross margins could be materially affected. We may also be subject to payment of liquidated damages for delays under customer contracts, and our customer relationships and business reputation may be harmed.
Product performance problems could damage our business reputation and limit our sales prospects.
The development and production of new products with high technology content is complicated and often involves problems with software, components and manufacturing methods. Modifying our products to enable customers to integrate them into a new type of network architecture entails similar risks. If significant reliability, quality, or network monitoring problems develop as a result of our product development, manufacturing or integration, a number of negative effects on our business could result, including:
increased costs associated with fixing software or hardware defects, including service and warranty expenses;
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| • | | payment of liquidated damages for performance failures; |
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| • | | high inventory obsolescence expense; |
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| • | | delays in collecting accounts receivable; |
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| • | | reduced orders from existing or potential customers; and |
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| • | | damage to our reputation. |
Because we outsource manufacturing and use a direct order fulfillment model for certain of our products, we may be subject to product performance problems as a result of the acts or omissions of these third parties. These product performance problems could damage our business reputation and negatively affect our sales.
We must continue to make substantial and prudent investments in product development in order to keep pace with technological advances and succeed in existing and new markets for our products.
In order to be successful, we must balance our initiatives to reduce our operating costs against the need to keep pace with technological advances. The market for communications networking equipment, software and services is characterized by rapid technological change, frequent introductions of new products, and recurring changes in customer requirements. To succeed, we must continue to develop new products and new features for existing products that meet customer requirements and market demand. In addition, we must be able to identify and gain access, including any applicable third party licenses, to new technologies as our market segments evolve. Because our market segments are constantly evolving, we may allocate development resources toward products or technologies for which market demand is lower than anticipated. We may ultimately decide that such lower than expected demand no longer warrants continued investment in a product or technology. These decisions are difficult and may be disruptive to our business and our relationship with customers. Managing our efforts to keep pace with new technologies and reduce operating expense is difficult and there is no assurance that we will be successful.
We may be required to take further write-downs of goodwill and other intangible assets.
As of January 31, 2006, we had $232.0 million of goodwill on our balance sheet. This amount primarily represents the remaining excess of the total purchase price of our acquisitions over the fair value of the net assets acquired. At January 31, 2006, we had $113.1 million of other intangible assets on our balance sheet. The amount primarily reflects purchased technology from our acquisitions. At January 31, 2006, goodwill and other intangible assets represented approximately 22.3% of our total assets. During the fourth quarter of 2005, we incurred a goodwill impairment charge of approximately $176.6 million and an impairment of other intangibles of $45.7 million. If we are required to record additional impairment charges related to goodwill and other intangible assets, such charges would have the effect of decreasing our earnings or increasing our losses in such period. If we are required to take a substantial impairment charge, our earnings per share or net loss per share could be materially adversely affected in such period.
We may experience unanticipated delays in the development and enhancement of our products that may negatively affect our competitive position and business.
Because our products are based on complex technology, we can experience unanticipated delays in developing, improving, manufacturing or deploying them. Each step in the development life cycle of our products presents serious risks of failure, rework or delay, any one of which could decrease the timing and cost effective development of such product and could affect customer acceptance of the product. Specialized application specific integrated circuits (“ASICs”) and intensive software testing and validation are key to the timely introduction of enhancements to several of our products, and schedule delays are common in the final validation phase, as well as in the manufacture of specialized ASICs. In addition, unexpected intellectual property disputes, failure of critical design elements, and a host of other execution risks may delay or even prevent the introduction of these products. If we do not develop and successfully introduce products in a timely manner, our competitive position may suffer and our business, financial condition and results of operations would be harmed.
We may incur significant costs and our competitive position may suffer as a result of our efforts to protect and enforce our intellectual property rights or respond to claims of infringement from others.
Despite efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. This is likely to become an increasingly important issue as we expand our operations and product development into countries that provide a lower level of intellectual property protection. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps that we are taking
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will prevent unauthorized use of our technology. If competitors are able to use our technology, our ability to compete effectively could be harmed.
In recent years, we have filed suit to enforce our intellectual property rights and, from time to time, have been subject to litigation and other third party intellectual property claims, including as a result of our indemnification obligations to customers or resellers that purchase our products. The frequency of these assertions is increasing as patent holders, including entities that are not in our industry and that purchase patents as an investment or to monetize such rights by obtaining royalties, use such actions as a competitive tactic and a source of additional revenue. Intellectual property claims can significantly divert the time and attention of our personnel and result in costly litigation. Our pending patent infringement litigation with Nortel Networks, described elsewhere in this report, has resulted in, and is likely to continue to result in, significant costs. If we are unsuccessful in this litigation, we may be required to pay significant damages, and could be enjoined from marketing or selling certain products. Intellectual property infringement claims can also require us to pay substantial royalties, enter into license agreements and/or develop nor-infringing technology. Accordingly, the costs associated with third party intellectual property claims could adversely affect our business, results of operations and financial condition.
We may be required to write off significant amounts of inventory.
In recent years, we have placed the majority of our orders to manufacture components or complete assemblies for many of our products only when we have firm orders from our customers. Because this practice can result in delays in the delivery of products to customers, we are increasingly ordering equipment and components from our suppliers based on forecasts of customer demand across all of our products. We believe this change is necessary in response to increased customer insistence upon shortened delivery terms. This change in our inventory purchases exposes us to the risk that our customers will not order those products for which we have forecasted sales, or will purchase fewer than the number of products we have forecasted. In such event, we may be required to write off, or write down inventory, potentially resulting in an accounting charge that could materially affect our results of operations for the quarter in which such charge occurs.
We must manage our relationships with electronic manufacturing service (EMS) providers in order to ensure that our product requirements are met timely and effectively.
We rely on EMS providers to perform the majority of the manufacturing operations for our products and components, and are increasingly utilizing overseas suppliers, particularly in Asia. Because EMS providers are subject to many of the same risks as equipment vendors serving the communications industry, many EMS providers have experienced their own financial difficulties in recent years. The qualification of our EMS providers is a costly and time-consuming process, and these manufacturers build product for other companies, including our competitors. We are constantly reviewing our manufacturing capability, including the work of our EMS providers, to ensure that our production requirements are met in terms of cost, capacity, quality and reliability. From time to time, we may decide to transfer the manufacturing of a product from one EMS provider to another, to better meet our production needs. It is possible that we may not effectively manage this transition or the new contract manufacturer may not perform as well as expected. As a result, we may not be able to fill orders in a timely manner, which could harm our business. In addition, we do not have contracts in place with some of these providers. Our inability to effectively manage our relationships with our EMS providers, particularly overseas, could negatively affect our business and results of operations.
We depend on a limited number of suppliers, and for some items we do not have a substitute supplier.
We depend on a limited number of suppliers for our product components and subsystems, as well as for equipment used to manufacture and test our products. Our products include several components for which reliable, high-volume suppliers are particularly limited. Some key optical and electronic components we use in our products are currently available only from sole or limited sources, and in some cases, that source also is a competitor. The loss of a source of key components could require us to re-engineer products that use those components, which would increase our costs. Increases in demand for components by us, our competitors or other third parties from sole or limited sources would result in additional supply constraints. Delays in component availability or delivery, or component performance problems, could result in delayed deployment of our products, and inability to recognize revenue, which would negatively affect our results of operations. These delays could also limit our opportunity to pursue additional growth or revenue opportunities and harm our business reputation and customer relationships.
Our international operations could expose us to additional risk and result in increased operating expense.
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We market, sell and service our products globally. We have established offices around the world, including in North America, Europe, Latin America and the Asia Pacific region. In addition, we are increasingly relying upon overseas suppliers, particularly in Asia, to manufacture our products and components. In 2005, we established a development operation in India to pursue offshore development resources. We expect that our international activities will be dynamic over the foreseeable future as we enter some new markets and withdraw from or reduce operations in others in order to match our resources with revenue opportunities. These changes to our international operations will require significant management attention and financial resources. In some countries, our success will depend in part on our ability to form relationships with local partners. Our inability to identify appropriate partners or reach mutually satisfactory arrangements for international sales of our products could impact our ability to maintain or increase international market demand for our products.
International operations are subject to inherent risks, and our future results could be adversely affected by a number of factors, including:
| • | | greater difficulty in collecting accounts receivable and longer collection periods; |
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| • | | difficulties and costs of staffing and managing foreign operations; |
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| • | | the impact of recessions in economies outside the United States; |
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| • | | reduced protection for intellectual property rights in some countries; |
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| • | | adverse tax consequences; |
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| • | | political and economic instability; |
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| • | | trade protection measures, export compliance, qualification do transact business and other regulatory requirements; |
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| • | | effects of changes in currency exchange rates; and |
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| • | | natural disasters and epidemics. |
Our efforts to offshore certain resources and operations to India may not be successful and may expose us to unanticipated costs or liabilities.
We have established a development operation in India and expect to increase hiring of personnel for this facility during the remainder of fiscal 2006. We have limited experience in offshoring our business functions, particularly development operations, and there is no assurance that our plan will enable us to achieve meaningful cost reductions or greater resource efficiency. Further, offshoring to India involves significant risks, including:
| • | | the hiring and retention of appropriate engineering resources, particularly in view of the rapid increase in similar activity in India by other companies that are competing to hire engineers with the skills that we require; |
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| • | | the knowledge transfer related to our technology and exposure to misappropriation of intellectual property or confidential information, including information that is proprietary to us, our customers and other third parties; |
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| • | | heightened exposure to changes in the economic, security and political conditions of India; |
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| • | | currency exchange and tax risks associated with offshore operations; and |
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| • | | development efforts that do not meet our requirements because of language, cultural or other differences associated with international operations, resulting in errors or delays. |
Difficulties resulting from the factors above and other risks associated with offshoring could impair our development efforts, harm our competitive position and damage our reputation with existing and potential customers. These factors could be disruptive to our business and may cause us to incur substantial unanticipated costs or expose us to unforeseen liabilities.
The steps that we are taking to restructure our operations and align our resources with market opportunities could disrupt our business.
We have taken several steps, including reductions in force, dispositions of assets and office closures, and internal reorganizations to reduce the size and cost of our operations and to better match our resources with our market opportunities. During the next twelve months we expect to take additional steps to reduce our operating expenses. These efforts could be disruptive to our business. Reductions to headcount and other cost cutting measures
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may result in the loss of technical expertise that could adversely affect our research and development efforts and ability to meet product development schedules. Efforts to reduce operating expense often result in the recording of accounting charges, such as inventory and technology-related write-offs, workforce reduction costs, charges relating to consolidation of excess facilities, or claims from users of discontinued products. If we are required to take a substantial charge, our earnings per share or net loss per share would be adversely affected in such period. If we cannot manage our cost reduction and restructuring efforts effectively, our business, results of operations and financial condition could be harmed.
Our exposure to the credit risks of our customers and resellers may make it difficult to collect receivables and could adversely affect our operating results and financial condition.
Industry and economic conditions have weakened the financial position of some of our customers. To sell to some of these customers, we may be required to take risks of uncollectible accounts. We may be exposed to similar risks relating to third party resellers and other sales channel partners, as we intend to increasingly utilize such parties as we enter into new geographic regions, particularly in Europe. While we monitor these situations carefully and attempt to take appropriate measures to protect ourselves, it is possible that we may have to write down or write off doubtful accounts. Such write-downs or write-offs would negatively affect our operating results for the period in which they occur, and, if large, could have a material adverse effect on our operating results and financial condition.
If we are unable to attract and retain qualified personnel, we may be unable to manage our business effectively.
If we are unable to retain and motivate our existing employees and attract qualified personnel to fill key positions, we may be unable to manage our business effectively, including the development of existing and new products. If we lose members of our management team or other key personnel, it may be difficult to replace them. Competition for highly skilled technical and other personnel with experience in our industry can be intense. Because we generally do not have employment contracts with our employees, we must rely upon providing competitive compensation packages and a high-quality work environment in order to retain and motivate employees. We have paid our employees significantly reduced or no bonuses for several years. In addition, we have informed employees that we will not be issuing stock options at the same level as historical grants. In addition to these compensation issues, we must continue to motivate and retain employees, which may be difficult due to morale challenges posed by our continuing workforce reductions and offshoring of certain operations.
Our failure to identify additional service delivery partners and manage our relationships with these partners effectively could adversely impact our financial results and relationship with customers.
We rely on a number of service delivery partners, both domestic and international, to complement our global service and support resources. We expect to increasingly rely upon third party service delivery partners for the installation of our equipment in larger network builds, which often include more onerous installation, testing and acceptance terms. In order to ensure that we timely install our products and satisfy obligations to our customers, we must identify, train and certify additional appropriate partners. The certification of these partners can be costly and time-consuming, and these partners service products for other companies, including our competitors. There can be no assurance that we will be able to identify an adequate number of qualified service delivery partners. We may not be able to effectively manage our relationships with our partners and we cannot be certain that they will be able to deliver our services in the manner or time required. If our service partners are unsuccessful in delivering services:
| • | | we may suffer delays in recognizing revenues in cases where revenue recognition is dependent upon product installation, testing and acceptance; |
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| • | | our services revenue may be adversely affected; and |
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| • | | our relationship with customers could suffer. |
We may be required to assume warranty, service and other unexpected obligations in connection with our resale of complementary products of other companies.
We have entered into agreements with strategic partners that permit us to distribute the products of other companies. As part of our strategy to diversify our product portfolio and customer base, we may enter into additional resale agreements in the future. To the extent we succeed in reselling the products of these companies, we may be required by customers to assume certain warranty and service obligations. While our suppliers often agree to support us with respect to these obligations, we may be required to extend greater protection in order to effect a sale.
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Moreover, our suppliers are relatively small companies with limited financial resources. If they are unable to provide the required support, we may have to expend our own resources to do so. This risk is amplified because the equipment that we are selling has been designed and manufactured by other third parties and may be subject to warranty claims, the magnitude of which we are unable to evaluate fully. We may be required to assume warranty, service and other unexpected obligations in connection with our resale of complementary products of other companies.
Our strategy of pursuing strategic acquisitions and investments may expose us to increased costs and unexpected liabilities.
Our business strategy includes acquiring or making strategic investments in other companies to increase our portfolio of products and services, expand the markets we address, diversify our customer base and acquire or accelerate the development of new or improved products. To do so, we may use cash, issue equity that would dilute our current shareholders’ ownership, incur debt or assume indebtedness. Strategic investments and acquisitions involve numerous risks, including:
| • | | difficulties in integrating the operations, technologies and products of the acquired companies; |
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| • | | diversion of management’s attention; |
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| • | | potential difficulties in completing projects of the acquired company and costs related to in-process research and development; |
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| • | | the potential loss of key employees of the acquired company; |
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| • | | subsequent amortization expenses related to intangible assets and charges associated with impairment of goodwill; |
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| • | | ineffective internal controls over financial reporting for purposes of Section 404 of the Sarbanes-Oxley Act; |
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| • | | dependence on unfamiliar supply partners; and |
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| • | | exposure to unanticipated liabilities, including intellectual property infringement claims. |
As a result of these and other risks, any acquisitions or strategic investments may not reap the intended benefits and may ultimately have a negative impact on our business, results of operation and financial condition.
We may be adversely affected by fluctuations in currency exchange rates.
Historically, our primary exposure to currency exchange rates has been related to non-U.S. dollar denominated operating expenses in Europe, Asia and Canada where we sell primarily in U.S. dollars. As we increase our international sales and utilization of international suppliers, we may decide to transact additional business in currencies other than the U.S. dollar. As a result, we would be subject to the impact of foreign exchange translation on our financial statements. For those countries outside the United States where we have significant sales, a devaluation in the local currency would result in reduced revenue and operating profit and reduce the value of our local inventory presented in our financial statements. In addition, fluctuations in foreign currency exchange rates may make our products more expensive for customers to purchase or increase our operating costs, thereby adversely affecting our competitiveness. To date, we have not significantly hedged against foreign currency fluctuations; however, we may pursue hedging alternatives in the future. Although exposure to currency fluctuations to date has not had an adverse effect on our business, there can be no assurance that exchange rate fluctuations in the future will not have a material adverse effect on our revenue from international sales and, consequently, our business, operating results and financial condition.
Failure to maintain effective internal controls over financial reporting could have a material adverse effect on our business, operating results and stock price.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that we include in our annual report on Form 10-K, a report containing management’s assessment of the effectiveness of our internal controls over financial reporting as of the end of our fiscal year and a statement as to whether or not such internal controls are effective. Such report must also contain a statement that our independent registered public accounting firm has issued an attestation report on management’s assessment of such internal controls.
We initially became subject to these requirements for our fiscal year ended October 31, 2005. Compliance with these requirements has resulted in, and is likely to continue to result in, significant costs, the commitment of time and operational resources and the diversion of management’s attention. Growth of our business, including our broader
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product portfolio and increased transaction volume, will necessitate ongoing changes to our internal control systems, processes and infrastructure, including our information systems. Our increasingly global operations, including our development facility in India and offices abroad, will pose additional challenges to our internal control systems as their operations become more significant. We cannot be certain that our current design for internal control over financial reporting, and any modifications necessary to reflect changes in our business, will be sufficient to enable management or our independent registered public accounting firm to determine that our internal controls are effective as of the end of fiscal 2006 or on an ongoing basis. If we are unable to assert that our internal controls over financial reporting are effective (or if our independent registered public accounting firm is unable to attest that our management’s report is fairly stated or they are unable to express an opinion on our management’s assessment of the effectiveness of internal controls over financial reporting or on the effectiveness of our internal controls over financial reporting), our business may be harmed. Market perception of our financial condition and the trading price of our stock may be adversely affected and customer perception of our business may suffer.
Our stock price is volatile.
Our common stock price has experienced substantial volatility in the past, and may remain volatile in the future. Volatility can arise as a result of a number of the factors discussed in this “Risk Factors” section, as well as divergence between our actual or anticipated financial results and published expectations of analysts, and announcements that we, our competitors, or our customers may make.
Item 2. Changes inUnregistered Sales of Equity Securities and Use of Proceeds and Issuer Purchases of Equity Securities
(a)–(d) (b) Not applicableapplicable.
(e)(c) The following table provides information with respect to any purchase made by or on behalf of Ciena, or any “affiliated purchaser” as defined in 17 C.F.R. § 240.10b-18(a)(3), of shares of any class of equity securities registered by Ciena pursuant to Section 12 of the Securities Exchange Act of 1934, as amended:
| | | | | | | | | | | | | | | | |
| | (a) | | | (b) | | | (c) | | | (d) | |
| | | | | | | | | | | | | | Maximum | |
| | | | | | | | | | | | | number (or | |
| | | | | | | | | | Total number of | | | appropriate | |
| | | | | | | | | | shares purchased | | | dollar value) of | |
| | | | | | | | | | as part of | | | shares that may | |
| | | | | | | | | publicly | | | yet be purchased | |
| | Total number of | | | Average price | | | announced plans | | | under the plans | |
Period | | shares purchased | | | paid per share | | | or programs (1) | | | or programs | |
May 1, 2005 through May 28, 2005 | | | 11,605 | | | $ | 0.02 | | | | 11,605 | | | | * | |
May 29, 2005 through June 25, 2005 | | | — | | | | — | | | | — | | | | * | |
June 26, 2005 through July 30, 2005 | | | 7,165 | | | $ | 0.00 | | | | 7,165 | | | | * | |
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| | | | | | | | | | | | |
Total | | | 18,770 | | | $ | 0.01 | | | | 18,770 | | | | * | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | (a) | | | (b) | | | (c) | | | (d) | |
| | | | | | | | | | | | | | Maximum number | |
| | | | | | | | | | | | | | (or appropriate | |
| | | | | | | | | | Total number of | | | dollar value) of | |
| | | | | | | | | | shares purchased | | | shares that may | |
| | | | | | | | | | as part of publicly | | | yet be purchased | |
| | Total number of | | | Average price | | | announced plans | | | under the plans or | |
Period | | shares purchased | | | paid per share | | | or programs (1) | | | programs (1) | |
October 30, 2005 through November 26, 2005 | | | 2,419 | | | $ | 0.00 | | | | 2,419 | | | | * | |
November 27, 2005 through December 24, 2005 | | | — | | | | — | | | | — | | | | * | |
December 25, 2005 through January 28, 2006 | | | 601 | | | $ | 0.00 | | | | 601 | | | | * | |
| | | | | | | | | | | | |
|
Total | | | 3,020 | | | $ | 0.00 | | | | 3,020 | | | | * | |
| | | | | | | | | | | | |
| | |
| | | * | | Not applicable. See description of repurchase activity below. |
| (1) | | As initially disclosed in our Form 10-Q for the first quarter of fiscal 2005, Ciena does not repurchase its shares in open market transactions. The repurchase activity in the table above consists solely of Ciena’s repurchase of outstanding shares in private transactions with certain former employees. Pursuant to the terms of equity compensation plans and certain award agreements that Ciena assumed in connection with its acquisitions of WaveSmith Networks, Inc. and Catena Networks Inc., employees may exercise certain stock options or restricted stock prior to vesting. Under these plans, upon the employee’s termination of employment, Ciena is granted the right to repurchase the shares issued, to the extent that the option or restricted stock has not vested, at the grantee’s exercise price. If Ciena does not exercise this repurchase right, the shares vest and remain owned by the grantee. | | | | | Ciena believes it is in the best interest of its stockholders,shareholders, and it is Ciena’s corporate practice, to repurchase shares subject to these award agreements if the closing price of such shares on the Nasdaq Stock NASDAQ National |
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| | | Market during the 30 day period following the grantee’s termination of employment is greater than the grantee’s exercise price during the 30 day period following separation or termination of employment.price. At the end of our thirdfirst quarter of fiscal 2005, 121,2682006, 44,949 outstanding shares remained subject to repurchase pursuant to the terms above. This number of shares subject to Ciena repurchase will (i) increase, to the extent that holders of equity awards under these plans exercise any options or restricted stock that have not yet vested, and (ii) decrease, as such awards vest pursuant to their terms and Ciena’s repurchase rights lapse. Ciena expects that all awards assumed through acquisition that permit early exercise by the grantee and repurchase by Ciena will be fully vested on May 1, 2006, at which time Ciena’s repurchase rights will lapse. |
Item 3. Defaults Upon Senior Securities Not applicable. 40
Item 4. Submission of mattersMatters to a Vote of Security Holders Not applicable. Item 5. Other Information Not applicable. Item 6. Exhibits | | | Exhibit | | Description | | 10.1 | | Form of Revised Indemnification Agreement between Ciena Corporation and Directors and Executive Officers** | | 10.2 | | Third Amended and Restated 1994 Stock Option Plan (Incorporated by reference from Ciena’s Form S-8 filed October 30, 2001). | | 31.1 | | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | | | | 31.2 | | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | | | | 32.1 | | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | | | | 32.2 | | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| | | | ** | | Represents management contract or compensatory plan or arrangement |
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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. | | | | | | CIENA CORPORATION | | Date: September 1, 2005 March 3, 2006 | By: | /s/ Gary B. Smith | | | | Gary B. Smith | | | | President, Chief Executive Officer and Director (Duly (Duly Authorized Officer) | | |
| | | | | | | | Date: September 1, 2005 March 3, 2006 | By: | /s/ Joseph R. Chinnici | | | | Joseph R. Chinnici | | | | Senior Vice President, Finance and Chief Financial Officer (Principal Finance Officer) | | |
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