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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED OCTOBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ................ TO..............
COMMISSION FILE NUMBER 0-21969
CIENA CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 23-2725311
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 WINTERSON ROAD, LINTHICUM, MD 21090
(Address of principal executive offices) (Zip Code)
(410) 865-8500
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the 103,239,704 shares of Common Stock of the
Registrant issued and outstanding as of October 31, 1998, excluding 4,979,049
shares of Common Stock held by affiliates of the Registrant was $1,725,457,102.
This amount is based on the average bid and asked price of the Common Stock on
the Nasdaq Stock Market of $17.56 per share on October 30, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of the Form 10-K incorporates by reference certain portions of the
Registrant's proxy statement for its 1999 annual meeting of stockholders to be
filed with the Commission not later than 120 days after the end of the fiscal
year covered by this report.
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PART I
The information in this Form 10-K contains certain forward-looking
statements, including statements related to markets for the Company's products
and trends in its business that involve risks and uncertainties. The Company's
actual results may differ materially from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Risk Factors" and
"Business" as well as those discussed elsewhere in this Form 10-K.
ITEM 1. BUSINESS
COMPANY
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CIENA Corporation was incorporated in Delaware in November 1992. The
Company completed its initial public offering on February 7, 1997 and a
secondary offering on July 2, 1997.
The Company's principal executive offices are located at 1201 Winterson
Road, Linthicum, Maryland 21090. Its telephone number is (410) 865-8500.
GENERAL
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OVERVIEW
CIENA Corporation (the "Company" or "CIENA") designs, manufactures and
sells open architecture, dense wavelength division multiplexing ("DWDM") systems
for fiberoptic communications networks, including long-distance and local
exchange carriers. CIENA also provides a range of engineering, furnishing and
installation services for telecommunications service providers.
CIENA's long-distance DWDM solutions, the MultiWave(R) 1600 system, the
MultiWave Sentry(TM) 1600 and the MultiWave Sentry 4000 were designed to
alleviate capacity, or bandwidth, constraints in high traffic, long distance
fiber optic routes without requiring the installation of new fiber. The
Company's long-distance MultiWave systems include optical transmission
terminals, optical amplifiers, optical add/drop multiplexers and network
management software. CIENA's short-distance DWDM solution, the MultiWave
Firefly(TM), is designed for point-to-point short-haul applications (distances
of 65km or less). The product contains no optical amplifiers, and allows
simultaneous transmission of up to 24 optical channels per fiber at transmission
speeds of up to 2.5 Gb/s per channel. CIENA's MultiWave systems are designed
with an open architecture that allows them to interoperate with carriers'
existing fiber optic transmission systems having a broad range of transmission
speeds and signal formats.
The Company's research and development efforts are targeted to broadening
the product applications of its DWDM technology as well as integrating the
technology as part of a more comprehensive approach to optical communications
solutions.
On February 19, 1998, the Company acquired ATI Telecom International Ltd.,
("Alta"), a Canadian corporation headquartered near Atlanta, Georgia, in a
transaction valued at approximately $52.5 million. Alta provides a range of
engineering, furnishing and installation services for telecommunications service
providers in the areas of transport, switching and wireless communications. The
historical consolidated financial results of CIENA for prior periods have been
restated to include the financial position and results of operations of Alta.
The Company believes it is a worldwide market leader in field deployment
of open architecture DWDM systems with more than two million optical channel
kilometers installed. For the fiscal year ended October 31, 1998, the Company
recorded revenue from sales of DWDM systems to a total of fourteen customers, a
substantial increase over 1997's customer base of five. Over half of the
Company's total revenue for the year was from sales to Sprint Corporation
("Sprint"). The majority of the Company's fiscal 1998 revenue was derived from
sales of its 40-channel MultiWave Sentry 4000 system which began shipping in
commercial volumes toward the end of the Company's fiscal second quarter. The
Company is actively seeking additional customers among long distance, local and
interoffice fiber optic network operators, as well as Internet service
providers, in the worldwide telecommunications market.
Fiscal 1998 was a year of dramatic events affecting the Company. Soon after
the close of the first fiscal quarter, MCI WorldCom Inc. ("MCIWorldCom" or
"WorldCom"), the Company's largest customer of fiscal 1997, surprised the
Company with an announcement of a major change in purchasing practices - a
change that meant materially
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reduced revenue for the Company. This adverse event was followed in the second
quarter by the Company's successful, large scale commercial introduction of the
Company's industry leading 40-channel MultiWave Sentry 4000. The third quarter
included resolution of the Company's longstanding Pirelli SpA ("Pirelli")
litigation, which was followed on June 3, 1998 with the announcement of a
planned merger with Tellabs, Inc. In the fourth quarter, just prior to
consummation of the merger, AT&T Corporation ("AT&T") advised the Company that
it would no longer consider CIENA's long distance DWDM products for deployment
in AT&T's network. The planned merger with Tellabs was later terminated on
September 14, 1998.
The Company's final results for fiscal 1998, its second full year in the
DWDM marketplace, show total revenues in excess of $500 million. The Company
believes this represents a considerable achievement, particularly given the
substantial portion of revenues derived from the sale of its now
third-generation DWDM product, the MultiWave Sentry 4000. Nevertheless, the
termination of the Tellabs merger represented a setback for the Company.
The outlook for fiscal 1999 is challenging. The price discounting offered
by competitors striving to catch up to the Company and acquire market share has
placed pressure on gross margins and operating profitability. But market demand
for high-bandwidth solutions still appears robust, and the Company believes that
its product and service quality, manufacturing experience, and proven track
record of delivery will enable it to endure the gross margin pressure while it
concentrates on efforts to reduce product costs and maximize production
efficiencies. The Company intends to continue this strategy in order to preserve
and enhance market leadership and eventually build on its installed base with
new and additional products. Pursuit of this strategy, in conjunction with
increased investments in selling, marketing, and customer service activities,
will likely limit the Company's operating profitability over at least the first
half of fiscal 1999, and may result in near term operating losses. See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Risk Factors".
INDUSTRY BACKGROUND
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THE TELECOMMUNICATIONS MARKET
Service providers both domestically and internationally have widely
deployed fiber optic cable forming the backbone of their communication networks.
During the last several years carriers have faced several challenges resulting
from a combination of factors including:
- Unprecedented traffic growth
- Changing traffic demands
- Growing competition
- Increased demand for reliability
Unprecedented Traffic Growth
Recently, service providers have seen dramatic network traffic growth
caused by factors such as:
- the escalating use of the Internet, as well as increased use of
distributed computing, electronic mail, facsimile transmission,
electronic transaction processing, video conferencing, remote access
telecommuting and local and wide area networking;
- growing capacity and processing speed of data communications
equipment such as Asynchronous Transfer Mode (ATM) switches and
Internet Protocol (IP) routers;
- development of high-bandwidth network access technologies, such as
cable modems, hybrid fiber coaxial architectures and digital
subscriber lines, that permit commercial and consumer users to
transmit and receive high volumes of information.
This increased network utilization creates transmission bottlenecks on
heavily used routes that were originally designed for significantly less
traffic. Although exact statistics are not available, the Company believes that
this volume increase has caused some telecommunications carriers to handle
traffic over certain long distance routes at or near the maximum capacity of the
existing installed fiber and electronic-based transmission systems currently in
use.
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Changing Traffic Demands
In addition to more traffic, telecommunication carriers are seeing a shift
in the kind of traffic they are handling. No longer purely telephone or voice
traffic, networks today are carrying an ever increasing volume of data traffic -
traffic generated by computers that process and send information far more
quickly and in much larger quantities than voice-centric networks were designed
for. Carriers and equipment suppliers both have sought more efficient ways to
handle this traffic, adopting cell and packet based protocols such as Frame
Relay, ATM and IP. These protocols more efficiently handle data traffic by
organizing it either in packets, as is the case with Frame Relay and IP, or in
cells for ATM. Each packet or cell contains a header with the destination
information the network needs to efficiently route or switch the packet/cell.
Recently advances by data communications equipment suppliers have made it
possible for ATM switches and IP routers to operate at port speeds of OC-48, or
2.4 gigabits per second. An industry analyst has estimated that the volume of
data-centric traffic traveling in packets or cells will reach 99% of all network
traffic by 2004. Whether or not the estimate is precisely accurate, the Company
believes the trend of increasing cell and packet based traffic is unmistakable
and, as a result, carriers will increasingly look for alternatives to the use of
traditional voice-based or synchronous optical network/synchronous digital
hierarchy (SONET/SDH) telecommunications equipment in their network
architecture. The Company expects that carriers will begin to move toward a
simpler, more cost effective network where data traffic from an ATM switch or an
IP router is directly fed to a DWDM device. The Company believes its ability to
connect directly to ATM switches and IP routers through its DirectConnectTM
feature positions it to benefit from this shift.
Growing Competition
Widespread deregulation of the United States telecommunications industry
has resulted in increased competition among service providers both in the
long-distance and local markets. In addition to heightened price competition,
carriers are increasingly looking for new ways to differentiate their services
from those offered by their competitors. Several new carriers have attempted to
leverage leading edge, high capacity technology as a market differentiator for
their networks. The Company believes this competition is itself a driver for
broader deployment of bandwidth throughout the network and, ultimately, to the
end user.
Increased Demand for Reliability
End-users also are becoming more dependent on around-the-clock network
availability, not only for voice, but also for data traffic. The Company
believes these end-users are becoming less tolerant of service interruptions,
which can be caused by factors such as equipment failure, fiber cuts or high
traffic volume. Consequently, network service providers are faced with a
multi-pronged challenge: more traffic, a different type traffic, and a growing
demand for increased network reliability.
In many cases, this demand for greater reliability has led long distance
carriers to adopt a "ring architecture" in which long distance routes are linked
in a ring configuration so that in the event of a fiber optic cable cut or other
equipment failure between two points of the ring, the signal can be immediately
redirected through the reverse "protection path" of the ring. The service break
associated with a fiber cut or other equipment failure in a network using ring
architecture can be restored in approximately 50 milliseconds, which is
essentially unnoticeable by the consumer. However, many ring architectures now
being deployed demand twice as much fiber capacity (due to the need to maintain
a redundant alternative path to serve as a protection path for each fiber in
use) as non-ring based architectures. Most, if not all of the major carriers
have either already implemented or announced an intention to implement ring
architecture for their networks, which will place greater bandwidth demand on
their existing fiber optic networks.
THE CIENA SOLUTION
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CIENA's MultiWave DWDM systems enhance the transmission capacity of a
single optical fiber, without requiring significant modification or upgrade to
transmission equipment. All MultiWave systems are installed along segments of
fiber optic routes, the beginning and end of which are defined by the presence
of the customers' transmission equipment.
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DESIGN PRINCIPLES
CIENA's MultiWave DWDM systems incorporate the following design
principles:
- OPEN ARCHITECTURE. MultiWave systems are designed with an open
architecture that allows the products to interoperate with carriers'
existing fiber optic transmission systems having a broad range of
transmission speeds and signal formats. This approach is
distinguished from a closed architecture system design pursued by
companies that manufacture other telecommunications equipment and
may seek to preserve the market for their legacy network equipment.
CIENA believes its customers and potential customers perceive value
in the ability to purchase "best of breed" open architecture
equipment as a means by which to preserve their existing network
investment and to maintain an open network evolution path during
this time of dramatic network change.
- SCALABILITY. The MultiWave system design is modular and allows
capacity-specific configurations and the ability to add capacity
through a modular upgrade without interrupting existing MultiWave
traffic. This capability enables a customer to select the number of
channels required on a particular fiber and preserves the customer's
ability to respond quickly to increased demand for capacity without
requiring significant additional equipment purchases and without
costly interruptions to revenue generating services.
- FLEXIBILITY / EFFICIENCY. CIENA's DirectConnect technology allows
for DWDM systems to play an integral role in new network
architectures optimized for cell and packet-based traffic. CIENA's
MultiWave systems can be also tactically implemented on a
route-by-route basis in existing network architectures, providing
relief on capacity-constrained routes without mandating a
network-wide architectural or transmission equipment change. In the
context of new network construction, the Company believes that its
ability to permit increased capacity per fiber, together with the
elimination of multiple regenerators, make deployment of the
MultiWave systems a cost-efficient alternative to more conventional
timedivision multiplexing (TDM) approaches. MultiWave systems
configured with the Company's optical add/drop multiplexer ("OADM")
enable carriers to selectively direct portions of a route's traffic
to various sites along the route without requiring extensive
termination equipment or electronic add/drop multiplexers. The
Company believes the resulting traffic route flexibility at the all
optical layer of the fiber optic network is also potentially
attractive and cost effective to network planners.
- FIBER COMPATIBILITY. CIENA's DWDM systems are compatible with the
various kinds of fiber (dispersion shifted, reduced dispersion and
non-dispersion shifted) deployed world-wide. The products currently
perform optimally on non-dispersion shifted fiber, which comprises
the majority of fiber installed in both North America and Europe.
ENABLING TECHNOLOGIES
CIENA developed its MultiWave DWDM systems based upon the use of several
core enabling technologies that assist in overcoming many of the constraints
that previously limited commercial introduction of DWDM technology:
- ERBUM-DOPED FIBER AMPLIFIERS ("EDFAS") enable the direct
amplification of optical signals without the use of electronic
regenerators;
- IN-FIBER BRAGG GRATINGS produced by the Company, enable precise
filtering of multiple optical signals in a single fiber;
- WAVEWATCHERS NETWORK MANAGEMENT SOFTWARE developed by the Company
makes it possible for a network operator to manage effectively the
status and functions of CIENA MultiWave systems in conjunction with
the network operator's management of other parts of its network. The
Company provides standards compliant network management systems
based upon Simple Network Management Protocol (SNMP), Transmission
Control Protocol/Internet Protocol (TCP/IP) and International
Telecommunications Union (ITU) Telecommunications Management Network
(TMN) standards.
- DIRECTCONNECT provides flexible connectivity directly from CIENA's
DWDM equipment to ATM, IP SONET/SDH equipment enabling customers to
build simpler, more cost-effective data-centric networks.
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"TURNKEY" ASSISTANCE
CIENA has built a portfolio of service capabilities, essentially offering
full turnkey system deployment and maintenance for carriers and emerging
carriers. These services may extend beyond products supplied by CIENA, as
today's carriers often require assistance with facilities build-out, switch
provisioning and integration of the DWDM terminals with existing TDM or
tributary equipment.
CIENA offers its services in formats ranging from "a la carte" to bundled
turnkey deployment and maintenance packages. The Company's goal is to combine
these broad service capabilities with superior products in a way which
facilitates its customers' needs for rapid and smooth development of essential
new capacity.
CIENA'S STRATEGY
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The Company's strategy is to maintain and build upon its market leadership
in the deployment of DWDM systems and to leverage the Company's highbandwidth
technologies in order to provide solutions to both voice and data communications
based network architectures. Important elements of the Company's strategy
include:
- MAINTAIN LEADERSHIP IN DEPLOYMENT OF DWDM IN FIBER OPTIC NETWORKS.
The Company believes that the technological, operational and cost
benefits of the Company's DWDM systems, including the MultiWave
1600, MultiWave Sentry 1600 and MultiWave Sentry 4000, and MultiWave
Firefly, create competitive advantages for telecommunications
carriers worldwide, which are being pressed by their customers to
deliver more bandwidth to address the dramatic growth in Internet
and other data communications traffic. The Company also believes
that achieving early widespread operational deployment of its
systems in a particular carrier's network will provide CIENA
significant competitive advantages with respect to additional DWDM
deployments and channel upgrades within that network and will
enhance its marketing to other carriers as a field proven supplier.
The Company therefore intends to continue aggressively serving its
existing customers while actively pursuing additional DWDM
deployment opportunities among fiber optic carriers in domestic and
foreign long distance, interoffice and local exchange markets.
Additionally, the results of a blind survey conducted on the
Company's behalf by a third party, suggest that among its primary
competitors, it is perceived to be by far the most responsive and
easiest with which to work. The Company intends to emphasize this
service and support excellence as a differentiating factor in its
efforts to maintain and enhance its market position.
- LEVERAGE THE COMPANY'S HIGH BANDWIDTH TECHNOLOGIES AND KNOW-HOW. The
Company believes the overall growth in demand for bandwidth in
telecommunications networks will lead to transmission bottlenecks in
other segments of the networks where the application of DWDM and
other high bandwidth enabling technologies may provide solutions,
either within existing network architectures, or as part of the
design and development of alternative data communications based
network architectures. The Company expects to leverage the core
competencies it has developed in the design, development and
manufacturing of the MultiWave product lines by pursuing new product
development efforts, and strategic alliances or acquisitions, to
address these expected opportunities. The Company intends to move
aggressively to maintain leadership in the design and development of
communications equipment and software which will both respond to
customer needs and help the customers move toward newer, higher
capacity, more cost-efficient network designs for the future.
- CONTINUE TO EMPHASIZE TECHNICAL SUPPORT AND CUSTOMER SERVICE. The
Company markets technically advanced systems to sophisticated
customers. The nature of the Company's systems and market require a
high level of technical support and customer service, including
installation assistance. The Company's efforts to develop
substantial customer service and installation support organization
were significantly enhanced with the acquisition of Alta in February
of 1998. Through the combination of its existing technical support
and customer service operations and Alta, CIENA offers complete
engineering, furnishing and installation services in addition to
full-time customer support from offices in Kansas City, Kansas;
Tulsa, Oklahoma; Atlanta, Georgia; London, United Kingdom; and
Tokyo, Japan and other selected locations where it develops
significant customer relationships.
- CONTINUE TO ENHANCE WORLD CLASS MANUFACTURING CAPABILITY. The
Company's MultiWave systems serve a mission critical role in its
customers' networks. Quality assurance and manufacturing excellence
are necessary for the Company to achieve success. CIENA believes it
has developed a world class manufacturing capability and that this
capability provides the Company with a significant competitive
advantage. The Company achieved ISO 9001 certification in July 1997
in further support of this element of its strategy. The Company
expects to continue to invest in both the capital and the human
resources necessary to maintain and leverage this
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advantage. During 1998, the Company expanded its manufacturing
portfolio from a single product to a total of four products.
- EXPAND SALES AND MARKETING EFFORTS. The nature of the target
customer base for all MultiWave product lines requires a focused
sales effort on a customer-by-customer basis. The Company will
continue to increase its sales and marketing efforts by focusing on
the worldwide market of fiber optic carriers. The Company increased
the number of optical transport customers from five in 1997 to
fourteen during 1998. In addition, CIENA significantly increased its
international presence, particularly in Europe, growing the number
of international customers from three to seven and the percentage of
revenues from international customers from less than 5% of total
revenue in 1997 to approximately 23% of revenue in 1998. In
September of 1998, CIENA announced a realignment of its sales and
marketing organization whereby it established separate sales and
marketing organizations. The Company believes this realignment will
enable it focus more specifically on the independent disciplines of
sales and marketing, thereby strengthening its relationships with
current and potential customers and its competitive positioning. The
Company will continue to strengthen its marketing programs and to
increase its international presence through both direct sales and
international distributor relationships.
CIENA'S OPTICAL TRANSPORT PRODUCTS
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LONG-DISTANCE APPLICATIONS
MULTIWAVE 1600 AND MULTIWAVE SENTRY SYSTEMS
The Company's first DWDM system, the MultiWave 1600, was designed to help
long distance service providers alleviate the bandwidth constraints affecting
their networks. The MultiWave 1600 system is a combination of equipment and
software installed on long distance route segments of up to 600 kilometers (372
miles). For routes in excess of 600 kilometers, a conventional fiber optic
regenerator can be used to reconstruct the optical signals between successive
MultiWave 1600 systems.
The MultiWave 1600 system enables simultaneous transmission of up to 16
optical channels on a single fiber at rates of up to 2.5 Gb/s per channel
without opto-electronic regeneration. A MultiWave 1600 system consists of one
MultiWave terminal on each end of a route segment, one or more MultiWave optical
amplifiers along the route (depending on route length) and CIENA's WaveWatcher
network management software. The CIENA MultiWave optical amplifier is a modular
Erbium-doped fiber amplifier that provides direct composite optical
amplification of the 16 optical channels carried by the MultiWave 1600 and
MultiWave Sentry systems. Within a single MultiWave system, CIENA's MultiWave
optical amplifiers take the place of the service provider's existing
regenerators on routes of up to 600 kilometers (372 miles), and can be spaced as
much as 120 kilometers (74 miles) apart. Unlike a TDM upgrade solution which
involves replacement of all transmission equipment along a fiber route, a
channel upgrade of a CIENA MultiWave system involves no replacement of existing
transmission equipment until all 16 channels are in service. Similarly,
increases in transmission rates up to a maximum of 2.5 Gb/s do not require
replacement of or modification to the optical amplifiers.
CIENA's MultiWave Sentry 1600 and Sentry 4000, the second and third
generation versions of the original MultiWave 1600 system, include enhancements
which significantly expand the ability of the system to interface with data
communications equipment in addition to other types of transmission equipment
and increase the distance which can be spanned between transmission terminals.
In addition, enhancements to the filtering technology used in the MultiWave
Sentry 4000 enable simultaneous transmission of up to 40 optical channels on a
single fiber. Up to eight MultiWave Sentry systems can be concatenated (deployed
end-to-end) together allowing transport of up to 100 Gb/s over total route
lengths of up to 4,800 kilometers (2,900 miles) without the need for
conventional regenerators. The MultiWave Sentry system incorporates DWDM
optimized long-reach receivers and uses standard low-cost short-reach input and
output interfaces to connect to a customer's equipment. MultiWave Sentry also
incorporates built-in performance monitoring capabilities which enable network
operators to identify and measure specified channels and their characteristics.
These added capabilities eliminate the need for conventional long-reach fiber
optic transmission terminals or traditional SONET multiplexers in data-centric
networks, thereby simplifying the construction of cell- and packet-based (IP,
ATM and Frame Relay) networks.
MULTIWAVE OPTICAL ADD/DROP MULTIPLEXER.
When deployed as a component of a MultiWave 1600 or MultiWave Sentry
system, the CIENA optical add/drop multiplexer ("OADM") enables carriers
selectively to direct portions of a route's traffic to various sites along the
route without requiring extensive termination equipment or electronic add/drop
multiplexers. A network operator may optically remove (drop) and/or insert (add)
up to four channels from or to the composite 16 channel
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signal at a point along a fiber route where the optical add/drop multiplexer is
installed. The installation of an additional optical add/drop multiplexer at a
different point along that route enables the network operator to reuse those
channels. The optical add/drop multiplexer also provides optical amplification
for up to 16 channels and when used in the MultiWave Sentry systems provides
standard short-reach interfaces to either data communications equipment or
conventional fiber optic transmission terminals. The Company believes the
resulting traffic routing flexibility at the all-optical layer of the fiber
optic network is potentially attractive and cost effective to network planners.
SHORT-DISTANCE APPLICATIONS
MULTIWAVE FIREFLY
CIENA's MultiWave Firefly is targeted toward point-to-point short haul
applications of 65 kilometers (40 miles) or less, which do not require signal
amplification via EDFAs or channel add/drop capability. The product is designed
to handle up to 24 channels at rates of 622 Mb/s and 2.5 Gb/s and is compatible
with the Company's WaveWatcher network management software. As may be required,
MultiWave Firefly systems initially configured for less than the maximum number
of channels can be upgraded to carry up to the maximum at additional cost. CIENA
believes the product is well-suited to applications at RBOCs and CLECs as well
as for certain international applications where route lengths tend to be
shorter.
RING-BASED APPLICATIONS
MULTIWAVE METRO
During 1998 the Company invested considerable engineering and related
resources in developing its MultiWave Metro system. This system targets campus
and interoffice rings and high bandwidth local loop services, using DWDM
technology with as many as 24 different wavelengths. Already in customer trials,
MultiWave Metro is designed to provide high aggregate bandwidth capacity for
multiple applications and data rates. The product also introduces a new level of
service provisioning flexibility for the local loop. MultiWave Metro
simultaneously aggregates multiple traffic types, including SONET/SDH (at both
the SONET levels of 622 Mb/s and 2.5 Gb/s), ATM, gigabit Ethernet, and fast IP
in a ring environment, providing network survivability and the ability to add or
drop traffic at various locations around the ring.
WAVEWATCHER NETWORK MANAGEMENT SYSTEM
WaveWatcher is the MultiWave system's integrated network management
software package. The Company's commitment to providing standards compliant
network management interfaces at all levels, from individual network elements to
the element management system, affords rapid integration into existing
telecommunication management operations.
WaveWatcher operates on a UNIX platform and has been designed to adhere to
both existing and evolving open system network management standards such as
SNMP, TCP/IP and the ITU TMN standards.
WaveWatcher's network element manager uses a separate out-of-band optical
service channel to communicate network management information and provides a
single view of multiple CIENA systems through graphical user interfaces and
supported operating system interfaces. It provides customers with early warnings
of network problems and allows them to manage and monitor network performance.
WaveWatcher provides fault, performance, security and configuration management
of optical networking systems. When used with MultiWave Sentry systems,
WaveWatcher provides additional monitoring capabilities for channel
identification and transmission quality throughout a customer's MultiWave
network.
The Company believes its software development effort is substantially
ahead of competitors' offerings, and provides an important differentiator for
its DWDM systems. The Company expects to begin to market different functionality
levels of its software beginning in 1999.
CIENA'S SERVICES
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On February 19, 1998, the Company acquired Alta, a Canadian corporation
headquartered near Atlanta, Georgia. In addition to providing installation, test
and turn-up services and additional field support for MultiWave products, Alta
provides a range of engineering, furnishing and installation services for
telecommunications service
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providers in the areas of transport, switching and wireless communications.
During 1998, the Company provided services to a total of 52 customers.
PRODUCT DEVELOPMENT
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The Company believes the overall growth in utilization of fiber optic
telecommunications networks will lead to transmission bottlenecks in other
segments of the networks where the application of DWDM technologies may provide
solutions. The Company also believes there may be opportunities for it to
develop products and technologies complementary to DWDM technologies which may
broaden the Company's ability to provide, facilitate and/or interconnect with
high bandwidth solutions offered throughout fiber optic networks. The Company
intends to focus its product development efforts and possibly pursue strategic
alliances or acquisitions to address expected opportunities in these areas.
Summarized below are certain actions taken by the Company during fiscal 1998 in
pursuit of its product development strategy.
ASTRACOM
During December 1997 the Company acquired Astracom, Inc. ("Astracom"), an
early stage telecommunications company located in Atlanta, Georgia. The Company
has used the resources received in the Astracom acquisition to assist in the
development of its MultiWave Metro product.
TERABIT
During April 1998 CIENA acquired Terabit Technology, Inc. ("Terabit"), a
developer of optical components known as photodetectors or optical receivers,
located in Santa Barbara, California. The Company believes the development work
underway at Terabit remains unique and, upon commercial availability, could give
the Company a significant advantage over its competitors. The Company expects to
begin to deploy components using Terabit's technology in its product development
efforts during 1999.
OC-192 CAPABILITY
In September of 1998, CIENA announced and demonstrated an OC-192/STM 64
(10 Gb/s) interface transmission rate capability for its MultiWave Sentry
systems. The enhancement to Sentry's capabilities will enable service providers
to increase the capacity of a single strand of fiber carrying 100 gigabits per
second (Gb/s) today to 480 Gb/s by early 1999 and approaching one terabit by the
year 2000.
While the Company believes the short-term market potential for this
capability is limited, the feature provides carriers with additional flexibility
and assurance that CIENA's products will scale as their networks begin to
migrate to higher transmission speeds. The new capability makes it possible for
a service provider to simultaneously mix or match up to forty-eight 10 Gb/s
(OC-192/OC-192c/STM-64) SONET or SDH channels with 2.5 Gb/s
(OC-48/OC-48c/STM-16) channels, thereby protecting current network investments
while providing increased options for bandwidth and network scalability. The
OC-192 capability is expected to be integrated and commercially available in
MultiWave Sentry systems by the second half of 1999.
BANDWIDTH MANAGEMENT
As service provider networks migrate to higher transmission speeds and DWDM
technology enables carriers to process ever increasing amounts of bandwidth, the
Company believes the next critical evolution in the network will occur in the
devices that allow carriers to efficiently manage this new-found bandwidth. The
Company invested during fiscal 1998 and intends in fiscal 1999 to continue to
invest in the resources and development efforts necessary to develop a product
with bandwidth management capabilities.
CUSTOMERS
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SPRINT RELATIONSHIP
In December 1995, the Company entered into a three-year supply agreement
with Sprint, with the option for Sprint to extend the term of the agreement for
an additional year. The original agreement has been amended and now extends to
December 31, 2001. Prices for all equipment purchased by Sprint under the terms
of the supply agreement are fixed but may not at any time be higher than the
Company's final net price to any "similarly situated customer." The agreement
requires that the Company set up and maintain, at the Company's expense, certain
test facilities for a period of 10 years.
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The Company warrants each deliverable provided by the Company for 60
months from the date of delivery, with Sprint having right to purchase an
unlimited number of one-year extensions of any or all warranties. Certain
upgrades are provided at no cost to Sprint during the warranty or extended
warranty periods. The supply agreement contains penalties for failure to respond
to various types of system failures in a timely manner. The supply agreement
with Sprint also provides Sprint with a perpetual, non-exclusive license to
certain software and a license to use, modify and enhance the Company's source
code under certain conditions. The Company must maintain two years of backwards
compatibility for any enhancements or upgrades to the software. In fiscal 1998
approximately 53% of the Company's revenues were derived from Sprint.
OTHER RELATIONSHIPS
In addition to the Sprint relationship, the Company also has announced
relationships with the following customers:
DOMESTICALLY:
Bell Atlantic ("Bell Atlantic"), Digital Teleport, Inc. ("DTI"),
Enron Communications, Inc. ("Enron"), GST Telecommunications, Inc.
("GST"), MCI WorldCom, Inc.("MCIWorldCom" or "WorldCom")
INTERNATIONALLY:
Cable and Wireless Communications Group ("Cable and Wireless"), UK;
Daini Deuden Inc. ("DDI"), Japan; Hermes Europe Railtel ("Hermes"),
UK; Japan Telecom Co., Ltd. ("Japan Telecom"), Japan; Racal Telecom,
("Racal") UK; Telecom Development ("TD"), France; Teleway Japan
Corporation ("Teleway"), Japan; Telia AB ("Telia") , Sweden
PROSPECTIVE CUSTOMERS BY CATEGORY
REGIONAL BELL OPERATING COMPANIES (RBOCS)
The RBOCs are very active in interoffice and local exchange markets and,
under the Telecommunications Act of 1996, RBOCs are newly eligible to enter the
long distance market once they have met certain requirements for opening their
local markets to competition. The Company anticipates that one or more of the
RBOCs will move aggressively to offer long distance services, although the
timing of that move is uncertain, and the question of how such a move will be
implemented is unclear -- e.g., through the establishment of owned network
facilities, through the purchase of long distance capacity from other long
distance carriers, or through some combination of the two.
Regardless of the timing of any such move, the Company believes there may
be limited opportunities for in-region deployment of the Company's long distance
MultiWave 1600 or Sentry systems in certain RBOCs. Additionally, RBOC mergers
currently under consideration could greatly expand the geographic reach of the
combined companies, such that opportunities for in-region deployment of the
Company's products could be enhanced. The Company announced an agreement with
Bell Atlantic in March of 1998 under which Bell Atlantic is expected to purchase
MultiWave 1600 and MultiWave Firefly systems. During 1998 the Company expanded
its direct and indirect sales efforts to include the interoffice and local
exchange markets traditionally served by the RBOCs and will continue to pursue
opportunities in those markets. In addition to Bell Atlantic, the Company has
signed trial evaluation agreements with certain RBOCs for testing of the
MultiWave 1600, MultiWave Sentry 1600, and MultiWave Firefly systems.
COMPETITIVE LOCAL EXCHANGE CARRIERS (CLECS)
Deregulation also has fueled the growth of competitive local exchange
carriers or CLECs. The Company believes that in the short-term, CLECs could
benefit from the RBOCs hesitancy to open their local markets to competitors and
are likely to move aggressively to capitalize on opportunities in the local
area. CIENA recognized revenue from a sale to its first CLEC customer in 1998
and expects that tactical CLEC applications for its long-haul products, as well
as the MultiWave Firefly and MultiWave Metro short-distance products, will be
well-suited to CLEC network applications.
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INTERNATIONAL COMPETITIVE CARRIERS
New competitive carriers are emerging as a result of deregulation in the
international telecommunications markets as well. CIENA has concentrated its
sales efforts on these emerging carriers as opposed to the traditional carriers
or PTTs. During 1998, CIENA increased its international customer base from two
to seven customers. In many cases, these new competitive carriers do not have
the installed fiber base of the larger carriers and therefore are in need of the
scalable bandwidth CIENA's systems offer. In addition, because of the economies
and flexibility afforded by DWDM, CIENA's equipment is being used on several new
builds where the service provider is physically constructing the network . The
Company expects that in the near-term, the majority of its international revenue
will come from these smaller, more aggressive competitive carriers, and will
continue to concentrate its sales efforts accordingly.
NON-TRADITIONAL TELECOMMUNICATION SERVICE PROVIDERS
The growth of the Internet has produced traffic growth substantial enough
to attract new, non-traditional telecommunication service providers to compete
in this market as well. Both domestically and internationally, companies with
rights-of-way, such as utility companies or railroads are capitalizing on their
"network" ( whether a pipeline, a railroad, or a highway), and in some cases,
are laying optical fiber and constructing telecommunications networks along
those rights-of-way. The bandwidth capabilities of CIENA's equipment enables
these new carriers to provide competitive services while purchasing and laying a
minimal amount of fiber optic cable.
MARKETING AND DISTRIBUTION
- --------------------------------------------------------------------------------
The Company's systems require a relatively large investment, and the
Company's target customers in the fiber optic telecommunications market -- where
network capacity and reliability are critical -- are highly demanding and
technically sophisticated. There are only a small number of such customers in
any country or geographic market. Also, every network operator has unique
configuration requirements which impact the integration of DWDM systems with
existing transmission equipment. The convergence of these factors leads to a
very long sales cycle for MultiWave systems, often more than a year between
initial introduction to the Company and commitment to purchase, and has further
led CIENA to pursue sales efforts on a focused, customer-by-customer basis.
The Company has organized its resources for the separate but coordinated
approach to United States and international customers. In the United States
market, a sales team, comprised of an account manager, systems engineers and
technical support and training personnel, is assigned responsibility for each
customer account, and for the coordination and pursuit of sales contacts. In the
international market, the Company currently pursues prospective customers
through direct sales efforts, as well as through distributors, independent
marketing representatives and independent sales consultants. The Company has
established CIENA Communications, Inc. as a wholly-owned subsidiary in the U.S.
to coordinate sales and marketing and customer service and installation support
functions. CIENA Communications has a branch office, CIENA Japan, to coordinate
sales and marketing efforts in Japan, the Pacific Rim and other Asian areas.
The Company has established CIENA Limited as a wholly-owned subsidiary in the
U.K. to facilitate U.K. and European sales. The Company has distributor or
marketing representative arrangements covering Austria, Germany, Italy and
Switzerland in Europe, and the Republic of Korea and Japan. The Company has
established a direct sales presence in Belgium and has representative support in
Brazil.
In support of its worldwide selling efforts, the Company conducts
marketing communications programs intended to position and promote its products
within the telecommunications industry. Marketing personnel also coordinate the
Company's participation in trade shows and conduct media relations activities
with trade and general business publications.
CISCO RELATIONSHIP
In April of 1998, the Company announced it had formed a working alliance
with Cisco Systems, Inc. ("Cisco"). Under the relationship, the two companies
are currently working together to overlay switching and routing technologies
directly onto optical networks, enabling service providers to build more
scalable and cost-effective architectures for the handling of data services.
Cisco and CIENA have specifically worked to enable service providers to
build high-capacity IP backbones by interfacing the Cisco 12000 Gigabit Switch
Router (GSR) directly to CIENA's long-haul DWDM systems. The Cisco 12000 will
interface with CIENA's DWDM systems via SONET/SDH OC-48c/STM-16 interfaces at
2.5 Gbps, without the need for additional intermediate network elements, such as
SONET terminal multiplexers. Enron
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was the first service provider to announce plans to build a nationwide network
based on an all "IP-over-glass" architecture utilizing Cisco and CIENA
equipment. Future activities between Cisco and CIENA are expected to include
integration of additional platforms and interfaces, including support for ATM,
and the definition of new interfaces between data and optical layers to improve
network flexibility and reduce equipment costs.
Cisco and CIENA also jointly founded the Optical Internetworking Forum
(OIF) to provide a venue in which vendors and users can agree on key
specifications that will complement international standards activities while
accelerating the deployment of optical internetworks.
MANUFACTURING
- --------------------------------------------------------------------------------
The Company conducts all optical assembly, final assembly and final
component, module and system test functions, at its manufacturing facilities in
Maryland. It also manufactures the in-fiber Bragg gratings and Erbium-doped
fiber amplifiers used in all MultiWave product lines. The Company believes its
manufacturing technologies and processes represent a key competitive advantage
and has accordingly invested significantly in automated production capabilities
and manufacturing process improvements and expects to further enhance its
manufacturing process with additional production process control systems.
Certain critical functions, including aspects of fiber splicing, require a
highly skilled work force, and the Company puts significant efforts into
training and maintaining the quality of its manufacturing personnel.
The Company's MultiWave product lines utilize in excess of 1,400 parts,
many of which are customized for the Company. Component suppliers in the
specialized, high technology end of the optical communications industry are
generally not as plentiful or, in some cases, as reliable, as component
suppliers in more mature industries. Some of the component suppliers for the
MultiWave Sentry and MultiWave Firefly systems are new and have not yet had an
opportunity to demonstrate the ability to increase their production to keep pace
with the Company's needs. Certain key optical and electronic components used in
the Company's MultiWave systems are currently available only from sole sources.
The Company has from time to time experienced minor delays in the receipt of
these components, variations in the quality of the components, and a lengthening
the lead times for some components. Any future difficulty in obtaining
sufficient and timely delivery of components could result in delays or
reductions in product shipments which, in turn, could have a material adverse
effect on the Company's business, financial condition and results of operations.
While alternative suppliers have been identified for certain other key optical
and electronic components, those alternative sources have not been qualified.
The time and expense involved in qualifying each additional source are
significant. Accordingly, the Company will for the near term continue to be
dependent on sole and single source suppliers of certain key components. See
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations-Risk Factors."
COMPETITION
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Competition in the telecommunications equipment industry generally is
intense, particularly in that portion of the industry devoted to delivering
higher and more cost effective bandwidth throughout the telecommunications
network. The Company believes that its position as a leading supplier of open
architecture DWDM systems and the field-tested design and performance of its
products give it a current competitive advantage; however, intensifying
competition is a material risk factor facing the Company in fiscal 1999. See
Item 7. "Management's Discussion and Analysis of Financial Conditions and
Results of Operations-Risk Factors."
The competition faced by the Company is dominated by a small number of
very large, usually multinational, vertically integrated companies, each of
which has substantially greater financial, technical and marketing resources,
and greater manufacturing capacity as well as more established customer
relationships with long distance carriers than the Company. Included among the
Company's competitors are Lucent Technologies Inc., formerly part of AT&T
("Lucent"), Northern Telecom Inc. ("Nortel"), Alcatel Alsthom Group ("Alcatel"),
NEC Corporation ("NEC"), Pirelli SpA ("Pirelli"), Siemens AG ("Siemens").
Fujitsu Group ("Fujitsu"), Hitachi Ltd. ("Hitachi") and Telefon AB LM Ericsson
("Ericsson"). Each of the Company's major competitors is believed to be in
various stages of development, introduction or deployment of DWDM products
directly competitive with the Company's MultiWave systems. Pirelli, in
particular, is known to have deployed open architecture WDM equipment. Lucent
has an especially prominent role in the market because of its historical
affiliation with AT&T. Lucent has announced it is supplying closed architecture
DWDM system equipment to AT&T, and has announced an intention to deliver in the
future an 80-channel open architecture DWDM system. Although Lucent's prior
affiliation with AT&T may have inhibited its relationships as a supplier to
other carriers, the spin-off of Lucent into a separate company may make it more
attractive to potential customers as a supplier.
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In addition to DWDM suppliers, traditional TDM-based transmission
equipment suppliers compete with the Company in the market for transmission
capacity. Lucent, Alcatel, Nortel, Fujitsu, Hitachi and NEC are already
providers of a full complement of such equipment. These and other competitors
have introduced or are expected to introduce equipment which will offer 10 Gb/s
transmission capability, and MCIWorldCom has deployed such equipment. The
Company believes the desirability of widescale deployment of 10 Gb/s (OC-192)
TDM based equipment has yet to be demonstrated. Because of the transmission rate
employed, the 10 Gb/s TDM equipment requires digital multiplexing circuits
operating at microwave frequencies, which can lead to instability. This can
complicate reproducibility, which may in turn result in delays in introduction
and higher manufacturing costs. More significantly, at the 10 Gb/s transmission
rate, dispersion distortion effects in the fiber can result in significant
impairments and limitations, particularly in transmission over non-dispersion
shifted fiber, which comprises most of the installed fiber in current long
distance networks in the United States. However, at lower rates, such as 2.5
Gb/s, TDM-based equipment is technically viable and widely available
commercially, and, as an upgrade to existing lower transmission rate
telecommunications links, can represent an alternative incremental approach to
the enhancement of transmission capacity.
While competition in general is broadly based on varying combinations of
price, manufacturing capacity, timely delivery, system reliability, service
commitment and installed customer base, as well as on the comprehensiveness of
the system solution in meeting immediate network needs and foreseeable
scalability requirements, the Company's customers are themselves under
increasing competitive pressure to deliver their services at the lowest possible
cost. This pressure may result in pricing for DWDM systems becoming a more
important factor in customer decisions, which may favor larger competitors which
can spread the effect of price discounts in their DWDM product lines across an
array of products and services, and a customer base, which are larger than the
Company's.
The Company also believes that several new companies, some with
alternative technologies to DWDM, will attempt to break into the market,
particularly the market for applications of the Company's MultiWave Metro
product.
PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS
The Company has licensed certain key enabling technologies with respect to
the production of in-fiber Bragg gratings, utilized publicly available
technology associated with Erbium-doped fiber amplifiers, and applied its
design, engineering and manufacturing skills to develop its MultiWave 1600,
MultiWave Sentry 1600, MultiWave Sentry 4000 and MultiWave Firefly systems.
These licenses expire when the last of the licensed patents expires or is
abandoned. The Company also licenses from third parties certain software
components for its network management software. These software licenses are
perpetual but will generally terminate after an uncured breach of the agreement
by the Company. The Company has applied for trademark registration for MultiWave
Sentry, MultiWave Metro, SMART SPAN, FAIL-SOFT, MODULE SCOPE and has registered
trademarks for WaveWatcher and CIENA OPTICAL COMMUNICATIONS. The Company also
relies on contractual rights, trade secrets and copyrights to establish and
protect its proprietary rights in its products.
The Company intends to enforce vigorously its intellectual property rights
if infringement or misappropriation occurs.
The Company's practice is to require its employees and consultants to
execute non-disclosure and proprietary rights agreements upon commencement of
employment or consulting arrangements with the Company. These agreements
acknowledge the Company's exclusive ownership of all intellectual property
developed by the individual during the course of his work with the Company and
require that all proprietary information disclosed to the individual will remain
confidential. The Company's employees also sign agreements not to compete with
the Company for a period of twelve months following any termination of
employment.
As of October 1998, the Company had received twenty-two United States
patents, and had seventy pending U.S. patent applications. Of the United States
patents that have been issued to the Company, the earliest any will expire is
2012. Pursuant to an agreement between the Company and General Instrument
Corporation dated March 10, 1997, the Company is a co-owner with General
Instrument Corporation of a portfolio of 27 United States and foreign patents
relating to optical communications, primarily for video-on-demand applications.
See Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Risk Factors." The Company has also acquired from Tyco
Submarine Systems, Ltd. (TSSL), U.S. Patent No. 5,173,957 and eight
corresponding foreign patents based thereon as well as a license to a portfolio
of seven U.S. patents owned by TSSL.
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EMPLOYEES
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As of October 31, 1998, the Company and its subsidiaries employed 1,382
persons, of whom 252 were primarily engaged in research and development
activities, 648 in manufacturing, 185 in installation services, 170 in sales,
marketing, customer support and related activities and 127 in administration.
None of the Company's employees are currently represented by a labor union. The
Company considers its relations with its employees to be good.
DIRECTORS AND EXECUTIVE OFFICERS
The table below sets forth certain information concerning each of the
directors and executive officers of the Company:
Name Age Position
------------------------------- ------- -----------------------------------------------------------
Patrick H. Nettles, Ph.D.(1) 55 President, Chief Executive Officer and Director
Steve W. Chaddick 47 Senior Vice President, Strategy and Corporate Development
Joseph R. Chinnici 44 Senior Vice President, Finance and Chief Financial Officer
Mark Cummings 47 Senior Vice President, Operations
G. Eric Georgatos 43 Senior Vice President, General Counsel and Secretary
Lawrence P. Huang 47 Senior Vice President, Strategic Account Sales
Jesus Leon 54 Senior Vice President, Products and Technology
Gary B. Smith 38 Senior Vice President, Worldwide Sales
Stephen B. Alexander 39 Vice President, Chief Technology Officer
Rebecca K. Seidman 52 Vice President, Human Resources Development
Andrew C. Petrik 35 Vice President, Controller and Treasurer
Jon W. Bayless, Ph.D.(1)(2)(3) 58 Chairman of the Board of Directors
Harvey B. Cash(1) 60 Director
Clifford H. Higgerson(1)(3) 59 Director
Billy B. Oliver(1)(2) 73 Director
Michael J. Zak(1)(2) 45 Director
Stephen P. Bradley, Ph.D.(1)(3) 57 Director
- ----------
(1) The Company's Directors hold staggered terms of office, expiring as
follows: Messrs Cash and Zak in 1999; Messrs Higgerson, Bradley and
Oliver in 2000; and Messrs Bayless and Nettles in 2001.
(2) Member of the Compensation Committee
(3) Member of the Audit Committee
PATRICK H. NETTLES, PH.D., has served as Chief Executive Officer of the
Company since February 1994, as President and Chief Executive Officer since
April 1994 and as Director since February 1994. From 1992 until 1994, Dr.
Nettles served as Executive Vice President and Chief Operating Officer of Blyth
Holdings Inc., a publicly-held supplier of client/server software. From late
1990 through 1992, Dr. Nettles was President and Chief Executive Officer of
Protocol Engines Inc., a development stage enterprise, formed as an outgrowth of
Silicon Graphics Inc., and targeted toward very large scale integration based
solutions for high-performance computer networking. From 1989 to 1990, Dr.
Nettles was Chief Financial Officer of Optilink, a venture start-up which was
acquired by DSC Communications. Dr. Nettles received his B.S. degree from the
Georgia Institute of Technology and his Ph.D. from the California Institute of
Technology.
STEVE W. CHADDICK has served as Senior Vice President, Strategy and
Corporate Development since September 1998, and from September 1996 to August
1998, served as Senior Vice President, Products and Technologies, and was
previously Vice President of Product Development for the Company since joining
it in 1994. Prior to joining the Company, Mr. Chaddick was Vice President of
Engineering at AT&T Tridom, a company he co-founded in 1983 and which was
acquired by AT&T in 1988. AT&T Tridom focused on the development of very small
aperture satellite terminal systems. Mr. Chaddick was responsible for all
product development at AT&T Tridom, including hardware, embedded systems
software and network management software. Mr. Chaddick received both his B.S.
and M.S. degrees in electrical engineering from the Georgia Institute of
Technology.
JOSEPH R. CHINNICI joined the Company in September 1994 as Controller, and
became Vice President, Finance and Chief Financial Officer in May 1995 and was
promoted to Senior Vice President Finance and Chief Financial Officer in August
1997. From 1993 through 1994, Mr. Chinnici served as a financial consultant for
Halston Borghese Inc. From 1977 to 1993, Mr. Chinnici held a variety of
accounting and finance assignments for Playtex Apparel Inc. (now a division of
Sara Lee Corporation), ending this period as Director of Operations Accounting
and Financial Analysis. Mr. Chinnici currently serves on the board of directors
for Optical Technology
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Group, Inc. Mr. Chinnici holds a B.S. in accounting from Villanova University
and an M.B.A. from Southern Illinois University.
MARK CUMMINGS joined the Company in May 1996 as Vice President,
Manufacturing and was promoted to Senior Vice President, Operations in August
1997. From 1985 to 1996, Mr. Cummings was Vice President, Operations for Cray
Communications, Inc., an international manufacturer of communications equipment.
From 1975 to 1985, Mr. Cummings was Manager of Manufacturing Engineering at
Taylor Instruments, and from 1973 to 1975, an Industrial Engineer at Siemens
Stromberg Carlson Inc. Mr. Cummings holds a B.S. in electronic technology from
the State University of New York at Buffalo, and is currently in the Masters
program in advanced manufacturing systems at the University of Maryland.
G. ERIC GEORGATOS has served as the Company's Senior Vice President,
General Counsel and Secretary since February 1997 and previously served as Vice
President, General Counsel and Secretary since joining it in February 1996. From
1980 to 1995, Mr. Georgatos was an attorney and member of Gray Cary Ware &
Friedenrich, a Professional Corporation, a law firm based in California, where
he served as outside general corporate counsel for a variety of emerging
companies. Mr. Georgatos holds a B.S. degree in business administration from the
University of Southern California and a J.D. from the University of California
Los Angeles.
LAWRENCE P. HUANG has served as Senior Vice President Strategic Account
Sales since September 1998 and Senior Vice President, Sales and Marketing of the
Company from November 1996 to August 1998 and previously served as Vice
President, Sales and Marketing of the Company since joining it in April 1994.
Prior to joining CIENA, Mr. Huang was Vice President/General Manager and Vice
President of Sales and Marketing of AT&T Tridom, which he co-founded with Mr.
Chaddick in 1983. Mr. Huang holds a B.S. in industrial management from the
Georgia Institute of Technology and an M.B.A. from Georgia State University.
JESUS LEON has served as Senior Vice President Products and Technology
since September 1998 and Vice President, Access Products since joining the
Company in November 1996. From December 1995 to October 1996, Mr. Leon served as
Vice President, Engineering, for the Access Systems Division of Alcatel Standard
Electrica, S.A. ("Alcatel Electrica"), a division of Alcatel Alsthom Group.
Alcatel Electrica is a leading global supplier of telecommunications equipment.
Mr. Leon led Alcatel Electrica's product development for all access products
with responsibility for over 1,200 engineers in Europe, Australia and South
Africa. Mr. Leon served in various positions with Alcatel Electrica from
1990-1991. Mr. Leon holds a B.S.E.E. and M.E. from the University of Florida, an
A.B.D. (all but doctoral dissertation) from the Georgia Institute of Technology
and an M.B.A. from Georgia State University.
GARY B. SMITH has served as Senior Vice President Worldwide Sales since
September 1998 and Vice President of International Sales since joining the
Company in November 1997. From June 1995 to October 1997, Mr. Smith served as
Vice President, Sales and Marketing for Intelsat and from August 1991 to May
1995, Mr. Smith served as Vice President of Sales and Marketing for Cray
Communications, Inc. Mr. Smith. received an M.B.A. from Ashridge Management
College, U.K.
STEPHEN B. ALEXANDER has served as Vice President, Chief Technology
Officer since September 1998, and Vice President, Transport Products from
September 1996 to August 1998, and was previously Director of Lightwave Systems
at the Company since joining it in 1994. From 1982 until joining the Company, he
was employed at MIT Lincoln Laboratory, where he last held the position of
Assistant Leader of the Optical Communications Technology Group. Mr. Alexander
is an Associate Editor for the Journal of Lightwave Technology and a General
Chair of the conference on Optical Fiber Communication (OFC) for 1997. He is
author of the tutorial text Optical Communication Receiver Design. Mr. Alexander
received both his B.S. and M.S. degrees in electrical engineering from the
Georgia Institute of Technology.
REBECCA K. SEIDMAN joined the Company in April 1996 as Director of Human
Resources Development, and was promoted to Vice President, Human Resources
Development in June 1996. From 1984 until joining the Company, Ms. Seidman
served consecutively as Director of Marketing, Vice President, Administration,
and Principal of Walpert, Smullian & Blumenthal, P.A., a regional accounting and
consulting firm. Ms. Seidman is a Phi Beta Kappa graduate of Goucher College and
co-author of Total Quality Distribution, a book discussing practical
applications of Total Quality in the wholesale distribution industry.
ANDREW C. PETRIK joined the Company in July 1996 as Controller, and became
Treasurer in December 1996 and was promoted to Vice President in August 1997.
From 1989 to 1996, Mr. Petrik was employed by Microdyne Corporation where he was
the Assistant Controller from 1989 to 1994 and Assistant Vice President of
Marketing
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and Product Planning from 1994 to 1996. Mr. Petrik holds a B.S. in Accounting
from the University of Maryland and is a Certified Public Accountant.
JON W. BAYLESS, PH.D. has been a Director of the Company since April 1994
and has served as Chairman of the Board of Directors since November 1996. Dr.
Bayless is a general partner of various venture capital funds associated with
Sevin Rosen Funds where, since 1981, he has focused on developing business
opportunities in the fields of telecommunications and computers. Dr. Bayless is
also the controlling stockholder and sole director of Jon W. Bayless, Inc., the
general partner of Atlantic Partners L.P., which is the general partner of Citi
Growth Fund L.P., a venture capital investment firm. Dr. Bayless currently
serves as a director of 3DX Technologies Inc. and of several private companies.
Dr. Bayless is also Chairman of the Board of Directors of Shared Resource
Exchange, Inc. Shared Resource Exchange, Inc. filed for reorganization under
Chapter 11 of the Federal Bankruptcy Code in August 1996. A plan under Chapter
11 has been approved. Dr. Bayless has held faculty positions at Southern
Methodist University, Virginia Polytechnic Institute, and the Catholic
University of America. He holds patents in the field of digital
telecommunications, and is a senior member of the Institute of Electronic
Engineers. Dr. Bayless earned his B.S. degree in electrical engineering at the
University of Oklahoma. He earned his M.S. degree in electrical engineering at
the University of Alabama, and his Ph.D. in electrical engineering at Arizona
State University.
HARVEY B. CASH has been a Director of the Company since April 1994. Mr.
Cash is a general partner of InterWest Partners, a venture capital firm in Menlo
Park, California which he joined in 1985. Mr. Cash serves on the board of
directors of Benchmarq Microelectronics, Liberte, Inc., AMX Corporation, i2
Technologies Inc. and Aurora Electronics, Inc. He is also an advisor to Austin
Ventures. Mr. Cash received a B.S. in electrical engineering from Texas A&M
University and an M.B.A. from Western Michigan University.
CLIFFORD H. HIGGERSON has been a Director of the Company since April 1994.
Mr. Higgerson has since 1991 been a general partner of Vanguard Venture
Partners, a venture capital firm specializing in high technology start-ups,
located in Palo Alto, California. Mr. Higgerson is also the managing partner of
Communications Ventures, Inc. Mr. Higgerson is a director of Advanced Fibre
Communications and Digital Microwave Corp. Mr. Higgerson earned his B.S. in
electrical engineering from the University of Illinois and an M.B.A. in finance
from the University of California at Berkeley.
BILLY B. OLIVER has been a Director of the Company since June 1996. Since
his retirement in 1985 after nearly 40 years of services at AT&T, Mr. Oliver has
worked as a self-employed communications consultant. During his last 15 years
with AT&T, he held the position of Vice President, Engineering Planning and
Design, where he was directly involved in and had significant responsibility for
the evolution of AT&T's long distance network during that period. He was a
co-recipient of the Alexander Graham Bell Medal for the conception and
implementation of Nonhierarchical Routing in AT&T's network. Mr. Oliver is also
a director of Digital Microwave Corp., Communications Network Enhancement Inc.
and Enterprise Network Services Inc. Mr. Oliver earned his B.S.E.E. degree from
North Carolina State University.
MICHAEL J. ZAK has been a Director of the Company since December 1994. He
has been employed by Charles River Ventures of Waltham, Massachusetts since 1991
and has been a general partner of the general partner of Charles River
Partnership VII and its related entities since 1993. From 1986 through 1991, he
was a founder and corporate officer of Concord Communications, Inc., a developer
of network management software. He is a director of three other private
companies. Mr. Zak has a B.S. degree in engineering from Cornell University and
an M.B.A. from Harvard Business School.
STEPHEN P. BRADLEY, PH.D. became a Director of the Company in April 1998.
Professor Bradley is a William Ziegler Professor of Business Administration and
the Chairman of the Program for Management Development at the Harvard Business
School. A member of the Harvard faculty since 1968, Professor Bradley is also
Chairman of Harvard's Executive Program in Competition and Strategy and teaches
in Harvard's Delivering Information Services program. Professor Bradley has
written extensively on the telecommunications industry and the impact of
technology on competitive strategy. Professor Bradley received his B.E. in
Electrical Engineering from Yale University in 1963 and his M.S. and Ph.D. in
Operations Research from the University of California, Berkeley, in 1965 and
1968 respectively.
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ITEM 2. PROPERTIES
All of the Company's properties are leased. The Company's principal
executive offices, sales and marketing functions are located in Linthicum,
Maryland in a 68,000 square foot facility. The Company's product development
functions are located in a 96,000 square foot facility in Linthicum, Maryland, a
27,500 square foot facility in the Atlanta, Georgia area and a 8,700 square foot
facility in Santa Barbara, California. Manufacturing facilities are located in
both Savage and Linthicum, Maryland and consist of four facilities with a total
of approximately 210,000 square feet that are used for such functions as
manufacturing production, systems integration and test, pilot production and
customer service and support. The Company's primary engineering, furnishment and
installation facility is located in a 26,000 square foot facility located in the
Atlanta, Georgia area. The Company has sales, marketing and customer support
offices in located in Overland Park, Kansas; Richardson, Texas; Tulsa, Oklahoma;
Chicago, Illinois; Middletown, New Jersey; Denver, Colorado; Birmingham,
Alabama; Edmonton, Canada; London, England; Tokyo, Japan; Beijing, China; Paris,
France; Brussels, Belgium and Manila, Philippines.
ITEM 3. LEGAL PROCEEDINGS
KIMBERLIN LITIGATION
On September 9, 1998 the U.S. District Court for the Southern District of
New York granted summary judgment with respect to federal securities law claims
brought against the Company and certain of its individual directors by investor
Kevin Kimberlin and related parties, finding "no violations" of federal
securities laws in the Company's or directors' conduct. The Court also dismissed
all related state law claims without prejudice, declining to exercise
jurisdiction over these claims. The remaining state law claims, as well as the
Company's counterclaim against the Kimberlin-related parties, were fully and
finally resolved in October 1998 by agreement of the parties.
CLASS ACTION LITIGATION
A class action complaint was filed on August 26, 1998 in U.S. District
Court for the District of Maryland entitled Witkin et.al v. CIENA Corporation
et. al (Case No. Y-98-2946). Several other complaints, substantially similar in
content, have been filed. These cases were consolidated by court order on
November 30, 1998. The complaints allege that CIENA and certain officers and
directors violated certain provisions of the federal securities laws, including
Section 10(b) and Rule 10b-5 under the Securities Exchange Act of 1934, by
making false statements, failing to disclose material information and taking
other actions intending to artificially inflate and maintain the market price of
CIENA's common stock during the Class Period of May 21, 1998 to September 14,
1998, inclusive. The plaintiffs seek designation of the suit as a class action
on behalf of all persons who purchased shares of CIENA's common stock during the
Class Period and the awarding of compensatory damages in an amount to be
determined at trial and attorneys' fees. The proceedings are at an early stage.
No discovery has been taken, and no prediction can be made as to its outcome.
The Company believes the suit is without merit and intends to defend itself
vigorously.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been traded on the Nasdaq National Market
since the Company's initial public offering on February 7, 1997 under the Nasdaq
symbol CIEN. The following table sets forth for the fiscal periods indicated the
high and low sales prices of the Common Stock, as reported on the Nasdaq
National Market.
Price Range of Common Stock
---------------------------
High Low
---- ---
Fiscal Year 1997
Period of February 7, 1997 to April 30, 1997...................... $44.00 $22.25
Third Quarter ended July 31, 1997................................. $57.25 $28.50
Fourth Quarter ended October 31, 1997............................. $63.62 $43.00
Fiscal Year 1998
First Quarter ended January 31, 1998 ................................... $63.56 $47.44
Second Quarter ended April 30, 1998 .................................... $58.25 $37.25
Third Quarter ended July 31, 1998 ................................ $92.38 $46.88
Fourth Quarter ended October 31, 1998............................. $75.88 $ 8.13
The closing sale price for the Common Stock on October 30, 1998 was
$17.56.
The market price of the Company's Common Stock has fluctuated
significantly and may be subject to significant fluctuations in the future. Much
of the fluctuations during the third and fourth quarters of fiscal 1998 was
related to the Company's planned and then terminated merger with Tellabs, Inc.
See Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Overview and Risk Factors."
As of October 31, 1998, there were approximately 784 holders of record of
the Company's Common Stock and 103,239,704 shares of Common Stock outstanding.
The Company has never paid cash dividends on its capital stock. The
Company currently intends to retain earnings for use in its business and does
not anticipate paying any cash dividends in the foreseeable future.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and the notes thereto included in Item 8. "Financial Statements and
Supplementary Data".
YEAR ENDED OCTOBER 31,(1)
1994 1995 1996 1997 1998
------------ --------------- --------------- ---------------- ---------------
(in thousands except share and per share data)
STATEMENT OF OPERATIONS DATA:
Revenue ................................... $ 20,890 $ 21,691 $ 88,463 $ 413,215 $ 508,087
Cost of goods sold......................... 15,638 16,185 47,315 166,472 256,014
------------ --------------- --------------- -------------- -------------
Gross profit ............................ 5,252 5,506 41,148 246,743 252,073
Operating expenses:
Research and development............... 1,287 6,361 8,922 23,308 64,536
Selling and marketing................... 1,339 1,907 5,641 22,627 45,945
General and administrative............... 2,352 3,034 6,422 11,823 17,825
Purchased research and development... - - - - 9,503
Pirelli litigation....................... - - - 7,500 30,579
Costs of proposed merger................. - - - - 2,548
------------ --------------- --------------- -------------- -------------
Total operating expenses.................. 4,978 11,302 20,985 65,258 170,936
------------ --------------- --------------- -------------- -------------
Income (loss) from operations............ 274 (5,796) 20,163 181,485 81,137
Other income (expense), net............... (180) 172 7,185 12,292
653
------------ --------------- --------------- -------------- -------------
Income (loss) before income taxes........ 94 (5,624) 20,816 188,670 93,429
Provision for income taxes............... 942 824 3,553 72,703 40,235
============ --------------- --------------- -------------- -------------
Net income (loss).......................... $ (848) $ (6,448) $ 17,263 $ 115,967 $ 53,194
============ =============== =============== ============== =============
Basic net income (loss) per common share $ (0.12) $ (0.51) $ 1.25 $ 1.53 $ 0.52
============ =============== =============== ============== =============
Diluted net income (loss) per common
and dilutive potential common share... $ (0.12) $ (0.51) $ 0.19 $ 1.11 $ 0.49
============ =============== =============== ============== =============
Weighted average basic common shares
outstanding.......................... 7,317 12,717 13,817 75,802 101,751
============ =============== =============== ============== =============
Weighted average basic common and
dilutive potential common shares
Outstanding............................ 7,317 12,717 92,407 104,664 107,895
============ =============== =============== ============== =============
OCTOBER 31, (1)
1994 1995 1996 1997 1998
------------ ---------------- ---------------- --------------- --------------
BALANCE SHEET DATA: (in thousands)
Cash and cash equivalents.................. $ 4,440 $ 8,261 $ 24,040 $ 268,588 $ 227,397
Working capital............................ 5,485 7,221 42,240 333,452 366,108
Total assets............................... 12,076 17,706 79,676 463,279 572,424
Long-term obligations, excluding
current portion.......................... 1,901 2,074 3,465 1,414
1,885
Mandatorily redeemable preferred stock 3,492 14,454 40,404 -
-
Stockholders' equity (deficit)............. (300) (6,662) 10,783 372,414 474,949
(1) The Company 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. Fiscal 1994, 1995, 1997,` and 1998 comprised 52 weeks and
fiscal 1996 comprised 53 weeks.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and the Company's consolidated financial
statements and notes thereto included elsewhere in this report on Form 10-K.
OVERVIEW
CIENA Corporation designs, manufactures and sells open architecture, DWDM
systems for fiberoptic communications networks, including long-distance and
local exchange carriers. CIENA also provides a range of engineering, furnishing
and installation services for telecommunications service providers.
Fiscal 1998 was a year of dramatic events affecting the Company. Soon
after the close of the first fiscal quarter, MCIWorldCom, the Company's largest
customer of fiscal 1997, surprised the Company with an announcement of a major
change in purchasing practices - a change that meant materially reduced revenue
for the Company. This adverse event was followed in the second quarter by the
Company's successful, large scale commercial introduction of the Company's
industry leading 40-channel MultiWave Sentry 4000. The third quarter included
resolution of the Company's longstanding Pirelli SpA ("Pirelli") litigation,
which was followed on June 3, 1998 with the announcement of a planned merger
with Tellabs, Inc. In the fourth quarter, just prior to consummation of the
merger, AT&T advised the Company that it would no longer consider CIENA's long
distance DWDM products for deployment in AT&T's network. The planned merger with
Tellabs was later terminated on September 14, 1998.
The Company's final results for fiscal 1998, its second full year in the
DWDM marketplace, show total revenues in excess of $500 million. The Company
believes this represents a considerable achievement, particularly given the
substantial portion of revenues derived from the sale of its now
third-generation DWDM product, the MultiWave Sentry 4000. Nevertheless, the
termination of the Tellabs merger represented a setback for the Company.
The outlook for fiscal 1999 is challenging. The price discounting offered
by competitors striving to catch up to the Company and acquire market share has
placed pressure on gross margins and operating profitability. But market demand
for high-bandwidth solutions still appears robust, and the Company believes that
its product and service quality, manufacturing experience, and proven track
record of delivery will enable it to endure the gross margin pressure while it
concentrates on efforts to reduce product costs and maximize production
efficiencies. The Company intends to continue this strategy in order to preserve
and enhance market leadership and eventually build on its installed base with
new and additional products. Pursuit of this strategy, in conjunction with
increased investments in selling, marketing, and customer service activities,
will likely limit the Company's operating profitability over at least the first
half of fiscal 1999, and may result in near term operating losses.
HIGHLIGHTS OF THE FISCAL YEAR 1998
The Company recognizes product revenue in accordance with the shipping
terms specified. For transactions where the Company has yet to obtain customer
acceptance, revenue is deferred until the terms of acceptance are satisfied.
Revenue for installation services is recognized as the services are performed
unless the terms of the supply contract combine product acceptance with
installation, in which case revenues for installation services are recognized
when the terms of acceptance are satisfied and installation is completed.
Revenues from installation service fixed price contracts are recognized on the
percentage of costs incurred to date compared to estimated total costs for each
contract. Amounts received in excess of revenue recognized are recorded as
deferred revenue. For distributor sales where risks of ownership have not
transferred, the Company recognizes revenue when the product is shipped to the
end user.
For the fiscal year ended October 31, 1998, the Company recorded $508.1
million in revenue of which $266.9 million was from sales to Sprint. The Company
increased the total number of customers for DWDM systems from five customers in
fiscal 1997 to fourteen customers in fiscal 1998. Revenue from sales to WorldCom
declined from approximately $184.5 million in fiscal 1997 to an amount less than
10% of the Company's total fiscal 1998 revenue. Substantially all of the revenue
recognized from the sales to WorldCom occurred in the Company's first quarter
ended January 31, 1998. In addition to Sprint and WorldCom, during the fiscal
year ended October 31, 1998 the Company recognized revenue from Cable and
Wireless; Hermes; Enron; Racal; Telia of Sweden; TD of France; DTI; GST; and,
through the Company's distributor, NISSHO Electronics Corporation ("NISSHO"),
sales to Teleway, Japan Telecom and to DDI. The Company also recognized an
immaterial amount of revenue from one undisclosed customer.
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During December 1997 the Company acquired Astracom, an early stage
telecommunications company located in Atlanta, Georgia. The employees of
Astracom were immediately deployed to assist with the Company's development
efforts from its MultiWave Metro product. The purchase price was approximately
$13.1 million and consisted of the issuance of 169,754 shares of CIENA common
stock, the payment of $2.4 million in cash, and the assumption of certain stock
options. The transaction was recorded using the purchase accounting method with
the purchase price representing approximately $11.4 million in goodwill and
other intangibles, and approximately $1.7 million in net assets assumed. The
amortization period for the intangibles, based on management's estimate of the
useful life of the acquired technology, is five years.
In February 1998 the Company acquired Alta, a Canadian corporation
headquartered near Atlanta, Georgia, in a transaction valued at approximately
$52.5 million. Alta provides a range of engineering, furnishing and installation
services for telecommunications service providers in the areas of transport,
switching and wireless communications. Under the terms of the agreement, the
Company acquired all of the outstanding shares of Alta in exchange for 1,000,000
shares of CIENA common stock. The transaction constituted a tax-free
reorganization and has been accounted for as a pooling of interest under
Accounting Principles Board Opinion No. 16. Accordingly, all prior period
consolidated financial statements presented have been restated to include the
combined results of operations, financial position and cash flows of Alta as
though it had always been a part of CIENA.
In March 1998 the Company announced an agreement to supply Bell Atlantic
with DWDM optical transmission systems. The supply agreement has no minimum
purchase commitments and includes the Company's MultiWave 1600, Sentry and
Firefly systems. Deployment and revenue recognition is expected in the first
half of calendar 1999, subject to successful completion of ongoing testing. The
Bell Atlantic DWDM deployment is expected to mark the first time a RBOC has
committed to deployment of DWDM equipment.
During April 1998 the Company acquired Terabit, a developer of optical
components known as photodetectors or optical receivers. The Company believes
the technology currently under development at Terabit may give it a strategic
advantage over its competitors. Terabit is located in Santa Barbara, California.
The purchase price was approximately $11.5 million and consisted of the issuance
of 134,390 shares of CIENA common stock, the payment of $1.1 million in cash,
and the assumption of certain stock options. The transaction was recorded using
the purchase accounting method with the purchase price representing
approximately $9.5 million in purchased research and development, $1.8 million
in goodwill and other intangibles, and approximately $0.2 million in net assets
assumed. The amortization period for the intangibles, based on management's
estimate of the useful life of the acquired technology, is five years.
From December 1996 until June 1998, the Company was involved in litigation
with Pirelli. On June 1, 1998, the Company announced the resolution of all
pending litigation with Pirelli. The terms of the settlement involved the
dismissal of Pirelli's three lawsuits against the Company that were pending in
Delaware, dismissal of the Company's legal proceedings against Pirelli in the
United States International Trade Commission, payment to Pirelli of $30.0
million and certain running royalties, a worldwide, non-exclusive cross-license
to each party's patent portfolios, and a 5-year moratorium on future litigation
between the parties. The Company recorded a charge of approximately $30.6
million for the year ended October 31, 1998, relating to legal fees and the
ultimate settlement to Pirelli. The payment of future royalties due to Pirelli
is based upon future revenues derived from the licensed technology. The Company
does not expect the future royalty payments to have a material impact on the
Company's business, financial condition or results of operations.
On June 3, 1998 the Company announced an agreement to merge with
Tellabs, Inc. ("Tellabs"), a Delaware corporation headquartered in Lisle,
Illinois. Tellabs designs, manufactures, markets and services voice and data
transport network access systems. Under the terms of the original agreement,
all outstanding shares of CIENA stock were to have been exchanged at the ratio
of one share of Tellabs common stock for each share of CIENA common stock. On
August 21, 1998 the Company was informed by AT&T that AT&T had decided not to
pursue further evaluation of CIENA's DWDM systems. Following the impact of the
AT&T announcement on the market prices of the common stock of the respective
companies, the Company and Tellabs management renegotiated the terms of the
merger agreement, and on August 28, 1998 announced an amendment to the original
merger agreement which was approved by the respective companys' boards of
directors. Under the terms of the agreement as amended, all outstanding shares
of CIENA stock were to have been exchanged at the ratio of 0.8 share of Tellabs
common stock for each share of CIENA common stock. Subsequent to August 28,
1998, further adverse investor reaction raised serious questions about the
ultimate ability to obtain shareholder approval for the merger. An agreement to
terminate the merger was announced on September 14, 1998.
In June 1998 at the SUPERCOMM trade show in Atlanta, Georgia, the Company
demonstrated its MultiWave Metro(TM) ("Metro") DWDM system for metropolitan and
local access applications. Metro enables carriers to offer
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multi-protocol high-bandwidth services economically using their existing network
infrastructure. The Metro product is expected to be commercially available by
the first quarter of calendar 1999. The Company also demonstrated at the
SUPERCOM trade show a 96 channel DWDM system. The 96 channel DWDM system is
expected to be commercially available during the first half of calendar 1999.
See "Risk Factors".
The Company had previously announced that AT&T was evaluating a customized
version of its MultiWave 1600 Sentry system. In July 1998 AT&T indicated to the
Company that capacity requirements of its network had grown to such extent that
the delays in final certification and approval for deployment of the Company's
customized 16 channel system would make actual deployment of that system
inadvisable, and that AT&T would accordingly shift to an accelerated evaluation
of commercially available, higher channel count systems. The Company believed
AT&T would evaluate the Company's MultiWave(R) 4000 system positively in this
context, particularly because the Company believes it is the only manufacturer
in the world with operational 40 channel systems ready for prompt delivery on an
"off-the-shelf" basis in substantial manufacturing volumes. However, on August
21, 1998 the Company was informed by AT&T that AT&T had decided not to pursue
further evaluation of CIENA's DWDM systems.
During the first quarter of 1998 the Company continued its effort to
expand its manufacturing capabilities by leasing an additional facility of
approximately 35,000 square feet located in the Linthicum, Maryland area. This
facility is used for manufacturing and customer service activities. In April
1998 the Company leased an additional manufacturing facility in the Linthicum
area of approximately 57,000 square feet. With the addition of this new facility
the Company has a total of four facilities with approximately 210,000 square
feet that can be used for manufacturing operations. In April 1998 the Company
completed the transfer of its principal executive, sales, and marketing
functions located in Linthicum in a portion of its 96,000 square foot facility
to an approximately 68,000 square foot facility also located in Linthicum.
During the third quarter of 1998, the Company completed the process of
renovating the vacated portions of the 96,000 square foot facility for the
purpose of accommodating expanding research and development functions.
As of October 31, 1998 the Company and its subsidiaries employed
approximately 1,382 persons, which was an increase of 541 persons over the
approximate 841 employed on October 31, 1997.
RESULTS OF OPERATIONS
FISCAL YEARS ENDED 1996, 1997 AND 1998
REVENUE. The Company recognized $508.1 million, $413.2 million and $88.5
million in revenue for the years ended October 31, 1998, 1997 and 1996,
respectively. Sales to Sprint accounted for $266.9 million (52.5%), $179.4
million (43.4%) and $54.8 million (62.0%), of the Company's revenue during
fiscal 1998, 1997 and 1996, respectively. While WorldCom accounted for $184.5
million (44.7%) of the Company's revenue during fiscal 1997, it was not a
significant contributor to fiscal 1998 revenues. There were no other customers
who accounted for 10% or more of the Company's revenues during fiscal 1998, 1997
and 1996. Revenue derived from foreign sales accounted for approximately 23.0%,
2.8%. and 4.0% of the Company's revenues during fiscal 1998, 1997 and 1996,
respectively.
The Company expects Sprint's purchases in fiscal 1999 to be focused
primarily on filling out installed systems with additional channel cards and
therefore substantially below the purchasing volume in either of the last two
years. The Company also expects the percentage of fiscal 1999 revenue derived
from foreign sales to increase relative to fiscal 1998. Based on overall new bid
activity as well as expected deployment plans of existing customers, the Company
believes revenue growth in fiscal 1999 over fiscal 1998 is possible, but will be
highly dependent on winning new bids for shipments from new and existing
customers during the year. Competition of new bids is intense, and there is
no assurance the Company will be successful in winning enough new bids and new
customers to achieve year over year sequential growth. See "Risk Factors".
The Company began shipping MultiWave 1600 systems for field testing in May
1996 with customer acceptance by Sprint occurring in July 1996. For fiscal years
1996 and 1997 all of the Company's DWDM system revenues were derived form the
MultiWave 1600 product. During fiscal 1998 the Company began shipments of and
recognized revenues from sales of MultiWave Sentry 1600, MultiWave Firefly, and
MultiWave Sentry 4000 systems. The amount of revenue recognized from MultiWave
1600 sales declined in fiscal 1998 as compared to fiscal 1997. This decline in
MultiWave 1600 sales in fiscal 1998 was offset by revenue recognized from sales
of MultiWave Sentry 1600, MultiWave Firefly, and MultiWave Sentry 4000 systems.
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GROSS PROFIT. Cost of goods sold consists of component costs, direct
compensation costs, warranty and other contractual obligations, royalties,
license fees, inventory obsolescence costs and overhead related to the Company's
manufacturing and engineering, furnishing and installation operations. Gross
profit was $252.1 million, $246.7 million and $41.1 million for fiscal years
1998, 1997, and 1996, respectively. Gross margin was 49.6%, 59.7%, and 46.5% for
fiscal 1998, 1997, and 1996, respectively. The increase in gross profit from
fiscal 1997 to fiscal 1998 was attributable to increased revenues. The decrease
in gross margin percentage from fiscal 1997 to fiscal 1998 was largely
attributable to lower selling prices. The increase in gross margin percentage
from fiscal 1996 to fiscal 1997 was primarily the result of a change in product
mix from revenues largely derived from lower margin engineering, furnishing and
installation sales to higher margin MultiWave product sales. This year to year
increase was also attributable to fixed overhead costs being allocated over a
larger revenue base, an improvement in manufacturing efficiencies, and
reductions in component costs.
The Company's gross margins may be affected by a number of factors,
including continued competitive market pricing, lower manufacturing volumes and
efficiencies and fluctuations in component costs. During fiscal 1999, the
Company expects to face continued pressure on gross margins, primarily as a
result of substantial price discounting by competitors seeking to acquire market
share.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$64.5 million, $23.3 million, and $8.9 million for fiscal 1998, 1997, and 1996,
respectively. The approximate $41.2 million or 177% increase from fiscal 1997 to
1998 and the approximate $14.4 million or 161% increase from fiscal 1996 to
fiscal 1997 in research and development expenses related to increased staffing
levels, purchases of materials used in development of new or enhanced product
prototypes, and outside consulting services in support of certain developments
and design efforts. During fiscal 1998, 1997, and 1996 research and development
expenses were 12.7%, 5.6%, and 10.1% of revenue, respectively. The Company
expects that its research and development expenditures will continue to increase
moderately in absolute dollars and perhaps as a percentage of revenue during
fiscal 1999 to support the continued development of the various DWDM products,
the exploration of new or complementary technologies, and the pursuit of various
cost reduction strategies. The Company has expensed research and development
costs as incurred.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses were $45.9
million, $22.6 million, and $5.6 million for fiscal 1998, 1997, and 1996,
respectively. The approximate $23.3 million or 103% increase from fiscal 1997 to
1998 and the approximate $17.0 million or 301% increase from fiscal 1996 to
fiscal 1997 in selling and marketing expenses was primarily the result of
increased staffing levels in the areas of sales, technical assistance and field
support, and increases in commissions earned, trade show participation and
promotional costs. During fiscal 1998, 1997, and 1996 selling and marketing
expenses were 9.0%, 5.5%, and 6.4% of revenue, respectively. The Company
anticipates that its selling and marketing expenses may increase in absolute
dollars and perhaps as a percentage of revenue during fiscal 1999 as additional
personnel are hired and additional offices are opened to allow the Company to
pursue new customers and market opportunities. The Company also expects the
portion of selling and marketing expenses attributable to technical assistance
and field support, specifically in Europe and Asia, will increase as the
Company's installed base of operational MultiWave systems increases.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $17.8 million, $11.8 million, and $6.4 million for fiscal 1998, 1997, and
1996, respectively. The approximate $6.0 million or 50.8% increase from fiscal
1997 to 1998 and the approximate $5.4 million or 84.1% increase from fiscal 1996
to fiscal 1997 in general and administrative expenses was primarily the result
of increased staffing levels and outside consulting services. During fiscal
1998, 1997 and 1996, general and administrative expenses were 3.5%, 2.9%, and
7.3% of revenue, respectively. The Company believes that its general and
administrative expenses will moderately increase in absolute dollars and perhaps
as a percentage of revenue during fiscal 1999 as a result of the expansion of
the Company's administrative staff required to support its expanding operations.
PURCHASED RESEARCH AND DEVELOPMENT. Purchased research and development
costs were $9.5 million for the fiscal year 1998. These costs were for the
purchase of technology and related assets associated with the acquisition of
Terabit during the second quarter of fiscal 1998.
PIRELLI LITIGATION. The Pirelli litigation costs of $30.6 million in
fiscal 1998 were attributable to a $30.0 million payment made to Pirelli during
the third quarter of 1998 and to additional other legal and related costs
incurred in connection with the settlement of this litigation. The Pirelli
litigation expense in fiscal 1997 was primarily the result of a $7.5 million
charge for actual and estimated legal and related costs associated with the
litigation.
COSTS OF PROPOSED MERGER. The costs of the proposed merger for fiscal 1998
were costs related to the contemplated merger between the Company and Tellabs.
These costs include approximately $1.2 million in
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Securities and Exchange Commission filing fees and approximately $1.3 million in
legal, accounting, and other related expenses.
OPERATING PROFIT. The Company's operating profit for fiscal 1998, 1997 and
1996 was $81.1 million or 16.0% of revenue, $181.5 million or 43.9% and $20.2
million or 22.8%, respectively. Excluding charges for purchased research and
development, Pirelli litigation and costs from the proposed Tellabs merger
fiscal 1998 operating profit was $123.8 million or 24.4% of revenue and
excluding Pirelli litigation costs in fiscal 1997 operating profit was $189.0
million or 45.7%. The decrease in operating profit and operating margin from
fiscal 1997 to fiscal 1998 was due to increased competitive pricing pressures
causing a reduction in gross profit margin and increased operating expenses from
investments in operating infrastructure. The year to year increases in operating
profits from fiscal 1996 to fiscal 1997 was primarily due to the comparable
increases in revenues and gross profits derived from the Company's MultiWave
systems. If the Company is unable to convert fiscal 1998 investments in
operating infrastructure into significant revenue generating relationships, the
Company's business, financial condition and results of operations could be
materially and adversely affected. See "Risk Factors".
OTHER INCOME (EXPENSE), NET. Other income (expense), net, consists of
interest income earned on the Company's cash, cash equivalents and marketable
debt securities, net of interest expense associated with the Company's debt
obligations. Other income (expense), net, was $12.3 million, $7.2 million, and
$0.7 million for fiscal 1998, 1997, and 1996, respectively. The year to year
increase in other income (expense), net, was primarily the result of the
investment of the net proceeds of the Company's stock offerings and net
earnings.
PROVISION FOR INCOME TAXES. During fiscal 1996, the Company received
product acceptance from its initial customer and commenced profitable
operations, at which time the Company reversed its previously established
deferred tax valuation allowance. The provision for income taxes for fiscal 1996
of $3.6 million is net of a tax benefit of approximately $4.6 million related to
the reversal of the deferred tax valuation allowance. The Company's provision
for income taxes was 38.5% of pre-tax earnings, or $72.7 million for fiscal 1997
and was 43.1% of pre-tax earnings, or $40.2 million for fiscal 1998. The
increase in the tax rate from fiscal 1997 to fiscal 1998 was primarily the
result of charges for purchased research and development expenses recorded in
fiscal 1998 and an adjustment to the estimated prior year state income tax
liability associated with Alta operations. Purchase research and development
charges are not deductible for tax purposes. Exclusive of the effect of these
charges, the Company's provision for income taxes was 38.4% of income before
income taxes in fiscal 1998. The decrease in tax rate, exclusive of the above
charges, for fiscal 1998 compared to fiscal 1997 was the result of a lower
combined effective state income tax expense, a larger benefit from the Company's
Foreign Sales Corporation and an increase in expected credits derived from
research and development activities offset by an increase in non-deductible
goodwill amortization expense.
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QUARTERLY RESULTS OF OPERATIONS
The tables below set forth the operating results and percentage of revenue
represented by certain items in the Company's statements of operations for each
of the eight quarters in the period ended October 31, 1998. This information is
unaudited, but in the opinion of the Company reflects all adjustments
(consisting only of normal recurring adjustments) that the Company considers
necessary for a fair presentation of such information in accordance with
generally accepted accounting principles. The results for any quarter are not
necessarily indicative of results for any future period.
Jan. 31, April 30, Jul. 31, Oct. 31,
1997 1997 1997 1997
-------------- ------------- -------------- -------------
Revenue................................. $ 63,673 $ 97,603 $121,845 $130,094
Cost of goods sold...................... 28,253 40,400 47,569 50,250
-------------- ------------- -------------- -------------
Gross profit...................... 35,420 57,203 74,276 79,844
-------------- ------------- -------------- -------------
Operating expenses:
Research and development............ 3,050 4,699 7,245 8,314
Selling and marketing............... 3,070 4,946 6,722 7,889
General and administrative.......... 2,003 2,797 3,241 3,782
Purchased research & development.... - - - -
Pirelli litigation.................. 5,000 - - 2,500
Cost of proposed merger............. - - - -
-------------- ------------- -------------- -------------
Total operating expenses................ 13,123 12,442 17,208 22,485
-------------- ------------- -------------- -------------
Income (loss) from operations........... 22,297 44,761 57,068 57,359
Other income (expense), net............. 302 1,846 1,426 3,611
-------------- ------------- -------------- -------------
Income (loss) before income taxes....... 22,599 46,607 58,494 60,970
Provision (benefit) for income taxes.... 8,744 18,127 22,770 23,062
-------------- ------------- -------------- -------------
Net income (loss)....................... $ 13,855 $ 28,480 $ 35,724 $ 37,908
============== ============= ============== =============
Basic net income (loss) per common share $ 0.97 $ 0.31 $ 0.36 $ 0.38
============== ============= ============== =============
Diluted net income (loss) per common
share and dilutive potential
common share.......................... $ 0.14 $ 0.27 $ 0.34 $ 0.35
============== ============= ============== =============
Weighted average basic common share (1) 14,216 92,644 98,021 99,786
============== ============= ============== =============
Weighted average basic common and
dilutive potential common share (1)... 100,425 105,456 106,296 107,308
============== ============= ============== =============
Jan. 31, April 30, Jul. 31, Oct. 31,
1998 1998 1998 1998
-------------- ------------- -------------- ----------------
Revenue................................. $ 145,092 $142,718 $129,116 $ 91,161
Cost of goods sold...................... 58,980 63,915 70,431 62,688
-------------- ------------- -------------- ----------------
Gross profit...................... 86,112 78,803 58,685 28,473
-------------- ------------- -------------- ----------------
Operating expenses:
Research and development............ 10,203 16,648 18,805 18,880
Selling and marketing............... 9,968 11,044 12,526 12,407
General and administrative.......... 3,792 4,448 3,908 5,677
Purchased research & development.... - 9,503 - -
Pirelli litigation.................. - 10,000 20,579 -
Cost of proposed merger............. - - 2,017 531
-------------- ------------- -------------- ----------------
Total operating expenses................ 23,963 51,643 57,835 37,495
-------------- ------------- -------------- ----------------
Income (loss) from operations........... 62,149 27,160 850 (9,022)
Other income (expense), net............. 3,691 3,350 2,519 2,732
-------------- ------------- -------------- ----------------
Income (loss) before income taxes....... 65,840 30,510 3,369 (6,290)
Provision (benefit) for income taxes.... 26,142 15,205 1,280 (2,392)
-------------- ------------- -------------- ----------------
Net income (loss)....................... $ 39,698 $ 15,305 $ 2,089 $ (3,898)
============== ============= ============== ================
Basic net income (loss) per common share $ 0.39 $ 0.15 $ 0.02 $ (0.04)
============== ============= ============== ================
Diluted net income (loss) per common
share and dilutive potential
common share.......................... $ 0.37 $ 0.14 $ 0.02 $ (0.04)
============== ============= ============== ================
Weighted average basic common share (1) 100,641 101,350 102,089 102,914
============== ============= ============== ================
Weighted average basic common and
dilutive potential common share (1)... 107,552 107,560 108,215 102,914
============== ============= ============== ================
Jan. 31, Apr. 30, Jul. 31, Oct. 31,
1997 1997 1997 1997
------------ -------------- ------------- -----------
Revenue................................. 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold...................... 44.4 41.4 39.0 38.6
------------ -------------- ------------- -----------
Gross profit...................... 55.6 58.6 61.0 61.4
Operating expenses:
Research and development.......... 4.8 4.8 5.9 6.4
Selling and marketing............. 4.8 5.1 5.5 6.1
General and administrative........ 3.1 2.9 2.7 2.9
Purchased research & development. - - - -
Pirelli litigation .............. 7.9 - - 1.9
Cost of proposed merger........... - - - -
------------ -------------- ------------- -----------
Total operating expenses................ 20.6 12.8 14.1 17.3
------------ -------------- ------------- -----------
Income (loss) from operations........... 35.0 45.8 46.9 44.1
Other income (expense), net............. 0.5 1.9 1.2 2.8
------------ -------------- ------------- -----------
Income (loss) before income taxes....... 35.5 47.7 48.1 46.9
Provision (benefit) for income taxes.... 13.7 18.6 18.7 17.7
------------ -------------- ------------- -----------
Net income (loss)....................... 21.8 % 29.1 % 29.4 % 29.2 %
============ ============== ============= ===========
Jan. 31, Apr. 30, Jul. 31, Oct. 31,
1998 1998 1998 1998
------------- ------------- ------------ -----------
Revenue................................. 100.0 % 100.0 % 100.0 % 100.0 %
Cost of goods sold...................... 40.7 44.8 54.5 68.8
------------- ------------- ------------ -----------
Gross profit...................... 59.3 55.2 45.5 31.2
Operating expenses:
Research and development.......... 7.0 11.7 14.6 20.7
Selling and marketing............. 6.9 7.7 9.7 13.6
General and administrative........ 2.6 3.1 3.0 6.2
Purchased research & development. - 6.7 - -
Pirelli litigation .............. - 7.0 15.9 -
Cost of proposed merger........... - - 1.6 0.6
------------- ------------- ------------ -----------
Total operating expenses................ 16.5 36.2 44.8 41.1
------------- ------------- ------------ -----------
Income (loss) from operations........... 42.8 19.0 0.7 (9.9)
Other income (expense), net............. 2.6 2.4 1.9 3.0
------------- ------------- ------------ -----------
Income (loss) before income taxes....... 45.4 21.4 2.6 (6.9)
Provision (benefit) for income taxes.... 18.0 10.7 1.0 (2.6)
------------- ------------- ------------ -----------
Net income (loss)....................... 27.4 % 10.7 % 1.6 % (4.3) %
============= ============= ============ ===========
(1) The sum of the quarterly earnings per share for fiscal 1997 does not equal
the reported annual earnings per share for fiscal 1997 due to the effect
of the Company's stock issuances during the year.
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The Company's quarterly operating results have varied and are expected to
vary significantly in the future. The Company's detailed discussion of risk
factors addresses the many factors that have caused such variation in the past,
and may cause similar variations in the future. See "Risk Factors". In addition
to those factors, in fiscal 1998, the distraction attendant to the aborted
Tellabs merger had a significant, though difficult to quantify impact on the
Company's operations in the third and fourth quarter. But apart from the
distraction factor, the Company believes the single most significant trend
affecting the Company's financial performance is the material effect of very
aggressive price discounting by competitors seeking to acquire market share in
the increasingly important market for high-capacity solutions. The Company chose
in the face of this pressure to continue to build market share in fiscal 1998 at
the cost of declining margins. The Company intends to continue this strategy in
order to preserve and enhance its market leadership and eventually build on its
installed base with new and additional products. Pursuit of this strategy, in
conjunction with increased investments in selling, marketing, and customer
service activities, will likely limit the Company's operating profitability over
at least the first half of fiscal 1999, and may result in near term operating
losses.
LIQUIDITY AND CAPITAL RESOURCES
The Company financed its operations and capital expenditures from
inception through fiscal 1996 principally through the sale of Convertible
Preferred Stock for proceeds totaling $40.6 million and capital lease financing
totaling $4.1 million. The Company completed its initial public offering of
Common Stock in February 1997 and realized net proceeds of approximately $121.8
million with an additional $0.6 million received from the exercise of certain
outstanding warrants. In July 1997, the Company completed a public offering of
Common Stock and realized net proceeds of approximately $52.2 million. During
fiscal 1997 and fiscal 1998 the Company also realized approximately $53.1
million and $22.6 million in tax benefits from the exercise of stock options and
certain stock warrants, respectively. As of October 31, 1998, the Company had
$227.4 million in cash and cash equivalents and $16.0 million in corporate debt
securities with contractual maturities of six months or less.
The Company's operating activities used cash of $1.2 million in fiscal
1996, and provided cash of $85.0 million and $35.5 million for fiscal 1997 and
1998, respectively. The cash used in operations in fiscal 1996 was accounted for
primarily by the Company's research and development activities relating to its
early development of the MultiWave system. Cash provided by operations in fiscal
1997 and 1998 was principally attributable to net income adjusted for the
non-cash charges of depreciation, amortization, provisions for inventory
obsolescence and warranty, increases in accounts payable, accrued expenses and
income tax payable; offset by increases in accounts receivable and inventories
due to increased revenue and to the general increase in business activity.
Cash used in investing activities in fiscal 1996, 1997 and 1998 was $11.6
million, $66.8 million and $104.5 million, respectively. Included in investment
activities were capital equipment expenditures in fiscal 1996, 1997 and 1998 of
$9.9 million, $51.9 million and $75.4 million, respectively. These capital
equipment expenditures were primarily for test, manufacturing and computer
equipment. The Company expects additional capital equipment expenditures of
approximately $50.0 million to be made during fiscal 1999 to support selling and
marketing, manufacturing and product development activities. In addition, since
its inception the Company's investing activities have included the use of $28.3
million for the construction of leasehold improvements and the Company expects
to use an additional $3.0 million of capital during fiscal 1999 in the
construction of leasehold improvements for its facilities.
The Company believes that its existing cash balance and cash flows
expected from future operations will be sufficient to meet the Company's capital
requirements for at least the next 18 to 24 months.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS No. 130), "Comprehensive Income".
SFAS No. 130 becomes effective for the Company's fiscal year 1999 and requires
reclassification of earlier financial statements for comparative purposes. SFAS
No. 130 requires that changes in the amounts of certain items, including foreign
currency translation adjustments and gains and losses on certain securities be
shown in the financial statements. SFAS No. 130 does not require a specific
format for the financial statement in which comprehensive income is reported,
but does require that an amount representing total comprehensive income be
reported in that statement. The Company believes the adoption of SFAS No. 130
will not have a material effect on the consolidated financial statements.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures about
Segments of an Enterprise and Related Information". This Statement will change
the way public companies report information about segments of their business in
annual financial
25
27
statements and requires them to report selected segment information in their
quarterly reports issued to stockholders. It also requires entity-wide
disclosures about the products and services an entity provides, the material
countries in which it holds assets and reports revenues, and its major
customers. The Statement is effective for the Company's fiscal year 1999. The
Company believes the adoption of SFAS No. 131 will not have a material effect on
the consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS No. 133), "Accounting for
Derivative Instruments and Hedging Activities". This Statement requires
companies to record derivatives on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes in the values of
those derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedge accounting. SFAS No. 133 will be effective
for the Company's fiscal year ending October 31, 2000. The Company believes the
adoption of SFAS No. 133 will not have a material effect on the consolidated
financial statements.
YEAR 2000 READINESS
Many computer systems were not designed to handle any dates beyond the
year 1999; accordingly, affected hardware and software will need to be modified
prior to the year 2000 in order to remain functional. The Company's operations
make use of a variety of computer equipment and software. If the computer
equipment and software used in the operation of the Company do not correctly
recognize data information when the year changes to 2000, there could be an
adverse impact on the Company's operations.
The Company has taken actions to understand the nature and extent of work
required, if any, to make its systems, products and infrastructure Year 2000
compliant. Based on internal testing performed to date and completed by the
Company, the Company currently believes and warrants to its customers that its
products are Year 2000 compliant. However, since all customer situations cannot
be anticipated, particularly those involving interaction of the Company's
products with third party products, the Company may see an increase in warranty
and other claims as a result of the Year 2000 transition. The impact of customer
claims, if broader than anticipated, could have a material adverse impact on the
Company's results of operations or financial condition.
The Company is currently in the process of conducting a comprehensive
inventory and evaluation of both information technology ("IT") or software
systems and non-IT systems used to run its systems. Non-IT systems typically
include embedded technology such as microcontrollers. Examples of the Company's
Non-IT systems include certain equipment used for production, research, testing
and measurement processes and calibration. As of December 1998 the Company had
assessed approximately 80% of the IT and non-IT systems used in its operations
with an insignificant amount of those systems having been identified as Year
2000 non-compliant. The Company has begun the process of upgrading or replacing
those identified non-compliant systems with completion expected during fiscal
1999. For the Year 2000 non-compliance systems identified to date, the cost of
remediation is not considered to be material to the Company's financial
condition or operating results. However, if implementation of replacement
systems is delayed, or if significant new noncompliance issues are identified,
the Company's results of operations or financial condition may be materially
adversely affected.
The Company changed its main financial, manufacturing and information
system to a company-wide Year 2000 compliant enterprise resource planning
("ERP") computer-based system during the fourth quarter of fiscal 1998. The
Company estimates that it has spent approximately $4.0 million on its ERP
implementation and estimates that it will likely spend $50,000 to $100,000 to
address identified Year 2000 issues. The Company expects that it will use cash
from operations for Year 2000 remediation and replacement costs. Approximately
less than 2% of the information technology budget is expected to be used for
remediation. No other information technology projects have been deferred due to
the Year 2000 efforts. To date, the Company has not yet employed an independent
verification and validation process to assure the reliability of its risk and
cost estimates.
The Company is also in the process of contacting its critical suppliers to
determine that suppliers' operations and the products and services they provide
are Year 2000 compliant. To date, the Company's optical suppliers have
represented that they are year 2000 compliant or are in the process of becoming
compliant by December 31, 1999. If these suppliers fail to adequately address
the Year 2000 issue for the products they provide to the Company, this could
have a material adverse impact on the Company's operations and financial
results.
Contingency plans will be developed if it appears the Company or its key
suppliers will not be Year 2000 compliant, and such noncompliance is expected to
have a material adverse impact on the Company's operations.
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28
RISK FACTORS
COMPETITION. The Company believes the rapid pace at which the need for
higher and more cost-effective bandwidth has developed was not widely
anticipated in the global telecommunications industry--a factor which enabled
the Company to achieve early product and market leadership in the DWDM field.
More than two years after its initial shipments in 1996, the Company continues
to believe its MultiWave 1600 and MultiWave Sentry 1600 and 4000 systems are the
only widely deployed and operational full 16-channel and 40-channel open
architecture DWDM systems anywhere in the world, and further believes the
demonstrated commercial manufacturability of its MultiWave Sentry 4000 system
gives the Company's high-capacity product offerings a level of credibility not
possessed by its competitors.
However, competition in the global telecommunications industry
historically has been dominated by a small number of very large companies, each
of which have greater financial, technical and marketing resources, greater
manufacturing capacity, broader product lines and more extensive and established
customer relationships with network operators than the Company. Lucent, Alcatel,
Nortel, NEC, Pirelli, Siemens, Ericsson, Fujitsu, and Hitachi most of which
provide a full complement of switches, fiberoptic transmission terminals and
fiberoptic signal regenerators in addition to DWDM equipment, are examples of
this type of company. Many of them have substantial economic interests in
continuing sales of the legacy equipment which has dominated the historical
network architecture designed for voice traffic; those interests are best served
by containing the pace at which paradigm-shifting new technologies are adopted,
such as DWDM over new voice/data architectures. At the same time, these
companies must participate in new technology markets or face potentially
significant loss of account control and market share in the overall
telecommunications equipment marketplace. New market entrants like CIENA, which
appear to be achieving rapid and widespread market acceptance of new equipment,
can represent a specific threat to these established companies. As a result, the
Company expects and has observed aggressive competitive moves from many of these
industry participants, which have to date included early announcement of
competing or alternative products, substantial and increasing price discounting,
customer financing assistance, packaged, "one-stop-shopping" deals combining
DWDM equipment with other network equipment and supplies, and other tactics.
Early announcements of competing products can and does cause confusion and delay
in customer purchasing decisions, particularly if the announcements are viewed
as credible in terms of both the performance of the announced product, and the
time within which it will be available. For example, Lucent announced in January
1998 a proposed high-capacity DWDM system which it claimed would handle 400 Gb/s
of capacity per fiber, and which it further claimed would be commercially
available worldwide in the fourth quarter of 1998. The Company believed at the
time of the announcement that the Lucent system would not be commercially
available worldwide in the fourth quarter of 1998 and continues to believe so;
however, the Company did compete during 1998 against the promise of this
product.
There can be no assurance that competitors will not make similar
announcements of competing products in the future, with adverse impacts on
customer purchasing decisions. Further, if new competing products are in fact
developed, perform as advertised, and are manufacturable in volume quantities in
the near future, the likelihood of significant orders for the Company's
MultiWave systems may diminish. The timing of shipments by the Company and
corresponding revenue, if delayed by reason of deferred deployment of MultiWave
systems pending evaluation of a competitor's product, could and likely would
cause substantial swings, and potentially material and adverse effects, on the
Company's quarterly financial condition and results of operations.
While competition in general is broadly based on varying combinations of
price, manufacturing capacity, timely delivery, system reliability, service
commitment and installed customer base, as well as on the comprehensiveness of
the system solution in meeting immediate network needs and foreseeable
scaleability requirements, the Company's customers are themselves under
increasing competitive pressure to deliver bandwidth to their customers at the
lowest possible cost. This pressure may result in pricing for DWDM systems
becoming a more important factor in customer decisions, which may favor larger
competitors which can spread the effect of price discounts in their DWDM product
lines across an array of products and services, and a customer base, which are
larger than the Company's.
The Company's customers generally prefer to have at least two sources for
key network equipment such as DWDM systems, but the Company believes it has
until recently been the only supplier of 16 channel, or greater than 16 channel,
open architecture DWDM systems. As competitors catch up with manufacturable DWDM
systems which are realistic alternatives to those supplied by the Company, the
Company's customers may reduce the portion of their DWDM purchases allocated to
the Company. Sprint has for several quarters indicated it intends to establish a
second vendor for DWDM equipment. Although the Company recently negotiated a
contract with Sprint which conferred "preferred vendor" status on the Company
through 1999, the timing of Sprint's selection of a second vendor, and the
impact a selection might have on relative purchasing from the Company and the
second vendor, are
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29
decisions which are not under the control of the Company. There can be no
assurance that these decisions will not result in a reduction in future
purchasing from the Company, which could in turn have a material adverse effect
on the Company's financial condition and results of operations.
Intellectual property disputes may also be asserted as part of a
competitive effort to reduce the Company's leadership position and limit its
ability to achieve greater market share, even if the merits of specific disputes
are doubtful. Some of the Company's competitors are also key suppliers of
components for the Company's systems, and could harm the Company through delay,
interruption or other failures to supply the Company with appropriate quality
items. See "Competitors as Suppliers".
While the Company will consider all appropriate means to position itself
to compete successfully, including taking legal action where the tactics of
competitors are believed to be unlawful, there can be no assurance that the
Company will be able to compete successfully with its larger competitors or that
aggressive competitive moves faced by the Company will not result in lost sales,
significantly lower prices for the Company's products, additional decreases in
gross profit margins, and otherwise have a material adverse effect on its
business, financial condition and results of operations.
The Company has also observed an increase in the funding of new companies
intending to develop new products for the rapidly evolving telecom industry.
The business and product plans for these companies are not always publicly
known, but they may provide additional competition as to the Company's existing
product lines as well as potential future products.
CONCENTRATION OF POTENTIAL CUSTOMERS; DEPENDENCE ON MAJOR CUSTOMERS. The
Company's business, and particularly the size of its revenue growth potential,
has historically been dependent on two customers, Sprint and MCIWorldCom. While
the scope of commercial applications of the Company's MultiWave Firefly and
MultiWave Metro product (scheduled for general commercial availability in the
first calendar quarter of 1999) and is expected to expand the number of
potential customers for the Company, in the near term, additional potential
customers, consisting almost exclusively of long distance and other
telecommunications carriers using fiberoptic networks, are relatively few in
number, and of those, a very small number have revenue potential comparable to
that of Sprint and MCI WorldCom. The absence of AT&T as a potential customer
heightens the risks to CIENA inherent in having a relatively small number of
customers; additionally, the Company expects Sprint's purchases in fiscal 1999
to be focused primarily on filling out installed systems with additional channel
cards, and therefore substantially below the purchasing volume in either of the
last two fiscal years. The Company's visibility into MCIWorldcom's purchasing
plans for 1999 is at present very limited. The number of potential major
customers may also decrease if and as customers merge with or acquire one
another. In May 1998, SBC and Ameritech announced an agreement to merge; in July
1998, Bell Atlantic and GTE announced an agreement to merge. The distraction
and/or reorganization sometimes attendant to such mergers could delay, limit or
otherwise adversely affect the capital equipment purchasing patterns of the
parties to them, with a corresponding adverse effect on the Company's sales,
even if the customer is otherwise satisfied with or interested in the Company's
products.
The extent to which the negative publicity relating to the Company and its
terminated merger agreement with Tellabs will impact the Company's ability to
develop additional customers, or obtain additional orders from existing
customers, in the near term is difficult to predict; there can be no assurance
that there will be no adverse effect. If the negative publicity has the effect
of causing customers to delay or reduce purchases from the Company, the adverse
effect could be material.
Additionally, the size and complexity of the Company's potential
customers, and the typically long and unpredictable sales cycles associated with
them, require the Company to make considerable early investments in account
management personnel, product customization efforts in both engineering and
manufacturing, and in some cases, facilities in proximity to the customer's
locations, without assurance of future revenues. The Company invested
considerable financial, engineering, manufacturing and logistics support
resources in positioning the AT&T relationship to be successful, even though the
Company had no assurance as to the volume, duration or timing of any purchases
which might ensue from AT&T. The ongoing leveraging of these resources into
other customer opportunities will need to be completed promptly and efficiently
in order to minimize their impact on near term results of operations, and there
is no assurance the Company will successfully do so. The Company also intends to
invest in developing significant customer relationships with Bell Atlantic and
other RBOCs and CLECs, as well as internationally. Over the near term, this
investment of resources has been evident in increased operating expenses and in
a rise in the Company's manufacturing and general overhead structure, with the
result that the Company may experience operating losses, even if revenues were
to increase. If the Company is unable to convert these investments into
significant revenue generating relationships, the Company's business, financial
condition and results of operations could be materially and adversely affected.
IMPACTS OF CHANGES IN CUSTOMER MIX. With the Company's equipment now
widely deployed in the Sprint network, with MCIWorldCom beginning to resume
purchasing but at modest levels, and without AT&T as a potential customer, the
Company's sales efforts are focused on a greater number of smaller
opportunities. The Company believes the pace of bandwidth demand is strong
enough to create a number of smaller opportunities
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30
sufficient to support revenue growth over the long-term. However, the smaller
opportunities often represent new carriers working aggressively to establish
saleable new capacity. These new carriers face a number of problems which the
established carriers do not; specifically, they must attempt to balance the need
to build their own customer base, acquire all necessary rights of way and
interconnections necessary for saleable network service, and build out new
capacity sufficient to meet anticipated needs, all while working within capital
budget constraints. These aspects of newer carriers tend to make them even less
predictable as to either timing or volume of purchasing than the established
carriers; in turn, this tends to exacerbate the problem of limited visibility
which the Company has regularly struggled with in conducting sales forecasting,
materials and manufacturing planning, and in providing guidance to analysts as
part of investor relations activities. See "Stock Price Volatility". Unless and
until the Company's customer base broadens over the next several quarters, the
likelihood of unanticipated changes in customer purchasing plans which could
adversely impact the Company's results relative to investor expectations is
higher than it has been in the past. Most of the Company's anticipated revenue
over the next several quarters is comprised of less than $25 million orders from
each of several customers. Slips in timing of purchases, or changes in the
amount of purchases at any one or more of these customers could have a material
adverse effect on the Company's results of operations and relative to investor
expectations. See "Stock Price Volatility".
ANTICIPATING DEMAND FOR BANDWIDTH. The Company's systems enable high
capacity transmission over long distance, and with the introduction of MultiWave
Firefly and MultiWave Metro, certain short-haul portions of, optical
communications networks; however, the Company's customers and target customers
determine how much capacity is required, when it will be deployed, and what
equipment configurations will be used, if any. The Company has encountered a
wide variety of customer views of how much capacity will be needed over what
periods of time, as well as how to convert such capacity into revenue. Those
views reflect the customers' differing competitive strategies and financial and
marketing resources, and result in widely varying patterns and timing of
evaluation, purchase and deployment of the Company's systems, other DWDM systems
or other capacity solutions. Certain carriers believe the deployment of
large-scale capacity quickly is a competitive advantage--i.e., they believe the
accelerating demand for bandwidth will continue and the added capacity will be
utilized quickly. This viewpoint leads to prompt and widespread deployment of
high-channel count DWDM systems. Other carriers have adopted more of a
wait-and-see approach, which dictates a more gradual channel by channel
deployment of higher capacity systems. New carrier entrants sometimes try to
combine these viewpoints, favoring rapid and widespread installation of the
foundational elements of high capacity systems, while opting for pricing and
other supply agreement features which allow for deferral of channel purchases
until the need is demonstrated. These views are further influenced by the pace
at which the higher bandwidth available over long distance routes is distributed
or distributable over "the last mile" of the networks, as well as the
willingness of carriers to aggressively lower their charges for services as a
means of accelerating consumption of the higher bandwidth. All of these views
are also subject to abrupt change, as competition and the evolving marketplace
may demand. As an example, WorldCom informed the Company in February 1998 that
its DWDM system requirements for 1998 would be substantially below the previous
year's purchases of $184.5 million. WorldCom indicated to the Company that in
1997 it had purchased DWDM systems from the Company at a level that contemplated
two years' of capacity requirements, and that 1998's purchases would be
substantially reduced. WorldCom's information in February 1998 demonstrated that
there can be surprises as network operators and their purchasing groups grapple
with unprecedented changes and challenges to network planning. As a further
example of the impact of the evolving marketplace, during fiscal 1998 the
Company shipped equipment to and recognized revenue from several new customers
attempting to build out new networks--under circumstances where the Company had
not even identified these customer opportunities as of a year prior to shipment.
Under these circumstances, for so long as the Company remains dependent on
few customers, the Company will be vulnerable to significant quarterly
fluctuations, and to difficulty in predicting the direction or magnitude of
future demand for the Company's systems.
The Company believes growth in data communications and in commercial and
consumer use of the Internet remains solid as a market driver of demand for
bandwidth, which in turn fuels demand for DWDM systems and other high-bandwidth
solutions. The Company also is confident that its products are well targeted
toward the visible emerging chokepoints in the networks. The Company is less
certain whether it will be able to accurately anticipate changes in direction or
magnitude of near term demand. Unanticipated reductions in demand would
adversely affect the Company's profitability and, depending on the size of the
gap between actual, reduced demand, and investor expectation of such demand,
could result in further stock price volatility irrespective of the Company's
overall competitive position and long term prospects.
CUSTOMER CAPITAL EQUIPMENT SPENDING AND THE ECONOMY. In addition to the
risks associated with assessing the core demand for bandwidth and its impact on
individual customer purchasing decisions, broader concerns about the condition
of the world and U.S. economy can have a generic dampening effect on the kind of
large scale
29
31
commitments to capital equipment acquisition on which the Company's business
depends. Established carriers may delay or reduce capital equipment acquisition
during times of economic uncertainty. New competitive carriers may be less
likely to delay or reduce capital equipment acquisition because their ability to
generate revenue depends on the prompt deployment of service-providing
equipment. But if the new competitive carrier is not adequately financed,
economic uncertainty can limit its access to new financing sources and cause a
delay in capital equipment purchasing. If current economic conditions
deteriorate sufficiently to negatively impact the purchasing decisions of
established or new carriers, or both, the Company's business will be adversely
affected. Deteriorating economic conditions may also result in demands for
vendor-supplied financing, particularly among less well-financed new carriers.
The Company's larger competitors may be able to provide more attractive
financing than can the Company, which may give them a competitive advantage over
the Company in this segment of the market. Additionally, the pricing and gross
margin pressures experienced by the Company as a result of competition could be
magnified if deflationary expectations become broadly embedded in the world
economy.
NEW PRODUCT DEVELOPMENT DELAYS. The Company's ability to anticipate
changes in technology, industry standards, customer requirements and product
offerings and to develop and introduce new and enhanced products in a timely
fashion relative to customer expectations of increasingly short product
development cycles, will be significant factors in the Company's ability to
remain a market leader in the deployment of DWDM systems and in the optical
communications market generally. The complexity of the technology involved in
product development efforts in the DWDM field, including product customization
efforts for individual customers, can result in unanticipated delays. The
qualification and ramping up of new suppliers for new or customized products
requires extensive planning and can result in unanticipated delays which affect
the Company's ability to deliver such products in a timely fashion. The software
certification process for new telecom equipment used in RBOC networks--a process
traditionally conducted by Bellcore on behalf of the RBOCs--can also result in
unanticipated delays, and has resulted in some delay in the commercial
introduction of MultiWave Sentry and Firefly for the RBOC market. The failure to
deliver new and improved products, or appropriately customized products, in a
timely fashion relative to customer expectations (which can be influenced by
competitors' announcements of competing products), would have a material adverse
effect on the Company's competitive position and financial condition. See
"Competition". The Company has made a general commitment to the commercial
availability of MultiWave Metro within the next several months. The Company's
performance on this commitment relative to customer expectations will likely
have a material impact on the Company's ability to further solidify its position
in the communications industry as a credible, long-term supplier of multiple
products and successive next-generation solutions. The Company believes it will
be successful in this effort, but there is no assurance of that, and there will
likely be few objective "leading indicators" of the Company's success or
failure, other than purchasing by its customers.
RECENT PRODUCT INTRODUCTION. The MultiWave 1600 has been operational and
carrying live traffic for approximately two years; the MultiWave Sentry 1600 and
MultiWave Sentry 4000 for less than a year; and the MultiWave Firefly is just
now being introduced into the field. The in-service reliability of the Company's
equipment has to date substantially exceeded statistical standards predicted for
equipment of this kind. However, the introduction of new fiberoptic systems with
high technology content is likely to involve occasional problems as the
technology and manufacturing methods mature, and the Company's experience has
been consistent with this expectation. Further, the Company's history of
installation activity indicates that the newness and high precision nature of
DWDM equipment may require enhanced customer training and installation support
from the Company. The Company is aware of instances domestically and
internationally in which installation and activation of certain MultiWave
systems have been delayed due to faulty components found in certain portions of
these systems. The Company is aware of few performance issues once the systems
are installed and operational. However, if recurring or material reliability,
quality or network monitoring problems should develop, a number of material and
adverse effects could result, including manufacturing rework costs, high service
and warranty expense, high levels of product returns, delays in collecting
accounts receivable, reduced orders from existing customers and declining level
of interest from potential customers. Although the Company maintains accruals
for product warranties, there can be no assurance that actual costs will not
exceed these amounts. The pace at which the customer requires upgrades from 16
to 40 to higher channel count systems occurs (which in some cases can involve
replacement of portions of the existing equipment) can further complicate the
assessment of appropriate product warranty reserves. The Company expects there
will be interruptions or delays from time to time in the activation of the
systems and the addition of channels, particularly because the Company does not
control all aspects of the installation and activation activities. The Company
believes its record to date of problem identification, diagnosis and resolution
has been good, but if significant interruptions or delays occur, or if their
cause is not promptly identified, diagnosed and resolved, confidence in the
MultiWave systems could be undermined. An undermining of confidence in the
MultiWave systems would have a material adverse effect on the Company's customer
relationships, business, financial condition and results of operations.
30
32
FLUCTUATION IN QUARTERLY AND ANNUAL RESULTS. The Company's revenue and
operating results have varied and are likely to continue to vary significantly
from quarter to quarter and from year to year as a result of a number of
factors, including the size and timing of orders, product mix and shipments of
systems. The timing of order placement, size of orders, satisfaction of
contractual customer acceptance criteria, as well as order delays or deferrals
and shipment delays and deferrals, have caused and may continue to cause
material fluctuations in revenue. See "Competition" and "Impacts of Changes in
Customer Mix". Delays or deferrals in purchasing decisions may increase as
competitors introduce new competing products, customers change purchasing
practices, and as the Company develops and introduces new DWDM products or moves
to next-generation versions of existing products, such as the MultiWave Sentry
1600, MultiWave Sentry 4000, MultiWave Firefly and MultiWave Metro.
Consolidation among the Company's customers and target customers, such as that
involved in the WorldCom/MCI merger, and the distraction and/or reorganization
attendant to such consolidation - which may continue well after consummation -
may also lead to delay or deferral of purchasing decisions. The Company believes
its present limited visibility into MCIWorldcom's purchasing plan is in part a
reflection of this phenomenon. See "Concentration of Potential Customers;
Dependence on Major Customers". Changes in customers' approaches to bandwidth
deployment can also materially impact purchasing decisions. See "Anticipating
Demand for Bandwidth." The ongoing shift in the Company's customer mix also
affects the likelihood of fluctuating results, as do general economic
conditions. See "Impacts of Changes in Customer Mix"; "Customer Capital
Equipment Spending and the Economy".
The Company's dependence on a small number of existing and potential
customers increases the revenue impact of each customer's actions relative to
these factors. The Company's expense levels in the future will be partially
based on its expectations of long term future revenue and as a result net income
for any quarterly period in which material orders are shipped or delayed or not
forthcoming could vary significantly. The Company's expense levels for the next
two quarters to some extent reflect the substantial investment in financial,
engineering, manufacturing and logistics support resources already incurred in
order to position the AT&T, RBOC, international and other potential commercial
relationships to be successful, even though AT&T has now removed CIENA from
further consideration as a DWDM vendor, and there is no assurance as to the
volume, duration or timing of any purchases which might ensue from others. See
"Concentration of Potential Customers; Dependence on Major Customers". Over the
near term, this investment of resources has been evident in increased inventory
levels and operating expenses, and in a rise in the Company's manufacturing and
general overhead and expense structure, with the result that the Company's near
term results of operations may be only modestly profitable or may involve
operating losses, even if revenues sequentially increase. In general,
quarter-to-quarter sequential revenue and operating results over the next 12
months are likely to fluctuate and therefore may not be reliable indicators of
annual performance.
DEPENDENCE ON KEY PERSONNEL. The Company's success has always depended in
large part upon its ability to attract and retain highly-skilled technical,
managerial, sales and marketing personnel, particularly those skilled and
experienced with optical communications equipment. The Company believes its
heritage as an entrepreneurial startup has been an important factor in its
success to date in attracting and retaining key personnel. However, competition
for such personnel is intense and often increases when a company becomes party
to a merger, as various recruiters look for key personnel interested in leaving.
The terminated merger with Tellabs, and the attendant publicity and media
speculation regarding its outcome and impact on the Company, have intensified
competitors' efforts to entice employees to leave the Company. There can be no
assurance that the Company will be able to retain all of its key contributors or
attract new personnel to add to or replace them. Failure to retain the Company's
key personnel, and to attract new personnel likely would have a material adverse
effect on the Company's business, financial condition and results of operations.
LEGAL PROCEEDINGS. See Part II, "Legal Proceedings" for disclosure
concerning recent shareholder class action lawsuits filed against the Company
and certain of its officers and directors. The Company believes the lawsuits are
without merit and is defending itself vigorously. However, because the lawsuits
are at an early stage, it is not possible to predict the outcome at this time,
and there is no assurance that the outcome would not have a material adverse
effect on the Company's financial condition and results of operations.
COMPETITORS AS SUPPLIERS. Certain of the Company's component suppliers are
both primary sources for such components and major competitors in the market for
system equipment. For example, the Company buys certain key components from
Lucent, Alcatel, Nortel, NEC and Siemens, each of which offers optical
communications systems and equipment which are competitive with the Company's
MultiWave systems. Lucent is the sole source of two integrated circuits and is
one of two suppliers of Erbium-doped fiber. Alcatel and Nortel are suppliers of
lasers used in MultiWave systems. NEC is a supplier of certain testing
equipment. The Company's business, financial condition and results of operations
could be materially and adversely affected if these supply relationships were to
decline in reliability or otherwise change in any manner adverse to the Company.
The Company to date has
31
33
not experienced to date any general decline in reliability among these vendors,
but the intensifying competition described above makes this risk factor
increasingly important.
LONG AND UNPREDICTABLE SALES CYCLES. The purchase of network equipment
such as DWDM equipment is typically carried out by network operators pursuant to
multiyear purchasing programs which may increase or decrease annually as the
operators adjust their capital equipment budgets and purchasing priorities. The
Company's customers do not typically share detailed information on the duration
or magnitude of planned purchasing programs, nor do they consistently provide to
the Company advance notice of contemplated changes in their capital equipment
budgets and purchasing priorities. Such changes may occur due to factors unique
to the individual customer or in response to general economic conditions. See
"Customer Capital Equipment Spending and the Economy". Additionally, to the
extent that the Company's customers follow budgeting cycles which generally
correspond to the calendar year, the Company may experience a slow down in
demand toward the calendar year end. Further, the Company is experiencing a
shift in its customer mix which may add to the length and unpredictable nature
of the sales cycle. See "Impacts of Changes in Customer Mix". These
uncertainties substantially complicate the Company's manufacturing planning, and
may lead to substantial and unanticipated fluctuations in the timing of orders
and revenue. The Company has in fact experienced such unanticipated fluctuations
in prior quarters, but until the third fiscal quarter of 1998, any unanticipated
reduction in orders from one customer had been offset in part or in whole by
unanticipated increases in orders for other routes with the same customer or in
orders from another customer. There can be no assurance of the Company's ability
to offset such reductions in the future.
Any curtailment or termination of customer purchasing programs, decreases
in customer capital budgets or reduction in the purchasing priority assigned to
equipment such as DWDM equipment, particularly if significant and unanticipated
by the Company and not offset by increased purchasing from other customers,
could have a material adverse effect on the predictability of the Company's
business, and on its financial condition and results of operations.
Further, as is the case with most manufacturing companies, the Company has
manufactured, and likely will continue to manufacture a portion of its finished
products on the basis of non-binding customer forecasts rather than actual
purchase orders. However, in contrast to most manufacturing companies, given the
Company's dependence on very few customers, and the relatively high cost of the
Company's DWDM systems, the financial consequences of mismatches between what is
built and what is actually ordered can be magnified. Customers may also
encounter delays in their build out of new routes or in their installation of
new equipment in existing routes, with the result that orders for the MultiWave
systems may be delayed or deferred. Any such delay with any major customer, as
well as any other delay, deferral or unanticipated change in the configuration
of orders for MultiWave systems, could result in material fluctuations in the
timing of orders and revenue, and could have a material adverse effect on the
Company's business, financial condition and results of operations.
STOCK PRICE VOLATILITY. The Company's Common Stock price has experienced
substantial price volatility, and is likely to continue to do so. Such
volatility can arise as a result of the activities of short sellers and risk
arbitrageurs, and may have little relationship to the Company's financial
results or prospects. Volatility can also arise as a result of any divergence
between the Company's actual or anticipated financial results and published
expectations of analysts and as a result of announcements by the Company, as
occurred in the fiscal year just ended. The Company attempts to address this
possible divergence through its public announcements and reports; however, the
degree of specificity the Company can offer in such announcements, and the
likelihood that any forward-looking statements made by the Company will prove
correct in actual results, can and will vary, due primarily to the uncertainties
associated with the Company's dependence on a small number of existing and
potential customers, the impacts of changes in the customer mix, the actions of
competitors, long and unpredictable sales cycles and customer purchasing
programs, the absence of unconditional minimum purchase commitments from any
customer, a lack of visibility into its customers' deployment plans over the
course of the capital equipment procurement year, and the lack of reliable data
on which to anticipate core demand for high bandwidth transmission capacity. An
example of this uncertainty is evidenced in the February 1998 communication from
WorldCom that its DWDM system requirements for 1998 would be substantially
reduced relative to last year's purchases, due to a change in its purchasing
policies. See "Concentration of Potential Customers; Dependence on Major
Customers". A further example of this uncertainty occurred the third fiscal
quarter, as an order expected to be $25 million or more from a customer was
unexpectedly delayed late in the quarter. This delayed order now appears likely
to be withheld as the result of new commitments by the customer to purchase DWDM
equipment from a competitor. See "Competition" and "Impacts of Changes in
Customer Mix".
The WorldCom example in fiscal 1998, and the example of the third fiscal
quarter indicate that divergence between the Company's actual or anticipated
financial results and published expectations of stock analysts can occur
notwithstanding the Company's efforts to address those expectations through
public announcements and reports.
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34
Such divergence will likely occur from time to time in the future, with
resulting stock price volatility, irrespective of the Company's overall year to
year performance or long term prospects. For so long as the Company remains
highly dependent on few customers, and particularly in years, like the just
completed fiscal year, when substantial majority of purchases by these customers
are likely to be focused on products, such as MultiWave Sentry 1600 and 4000,
and MultiWave Firefly, being introduced for the first time, there is substantial
risk of widely varying quarterly results, including the so-called "missed
quarter" relative to investor expectations which do not account for these
issues, with attendant risk of higher volatility in the Company's stock price.
See "Concentration of Potential Customers; Dependence on Major Customers"; and
"Anticipating Demand for Bandwidth".
TECHNOLOGICAL CHANGE AND NEW PRODUCTS. The Company expects that new
technologies will emerge, and existing technologies will rapidly evolve, as
competition in the telecommunications industry increases and the need for higher
and more cost efficient bandwidth expands. The Company's ability to anticipate
changes in technology, industry standards, customer requirements and product
offerings and to develop and introduce new and enhanced products will be
significant factors in the Company's ability to remain the leader in the
deployment of open architecture DWDM systems and other high-capacity solutions.
There is no assurance of the Company's ability to successfully do so. The market
for telecommunications equipment is characterized by substantial capital
investment and diverse and competing technologies such as fiberoptic, cable,
wireless and satellite technologies. The accelerating pace of deregulation in
the telecommunications industry will likely intensify the competition for
improved technology. Many of the Company's competitors have substantially
greater financial, technical and marketing resources and manufacturing capacity
with which to develop or acquire new technologies and generally to compete for
market acceptance of their products. The introduction of new products embodying
new technologies or the emergence of new industry standards could render the
Company's existing products uncompetitive from a pricing standpoint, obsolete or
unmarketable. Any of these outcomes would have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE ON SUPPLIERS. Suppliers in the specialized, high technology
sector of the optical communications industry are generally not as plentiful or,
in some case, as reliable, as suppliers in more mature industries. The Company
is dependent on a limited number of suppliers for key components of its
MultiWave systems as well as equipment used to manufacture the MultiWave
systems. MultiWave systems collectively utilize approximately 1,400 components,
and certain key optical and electronic components are currently available only
from a sole source. While alternative suppliers have been identified for certain
key optical and electronic components, not all of those alternative sources have
been qualified by the Company. The Company has to date conducted most of its
business with suppliers through the issuance of conventional purchase orders
against the Company's forecasted requirements. The Company also pursues
long-term supply agreements with some key suppliers, but a large majority of its
business with vendors continues to be done without such agreements. The Company
has from time to time experienced minor delays in the receipt of key components,
and any future difficulty in obtaining sufficient and timely delivery of them
could result in delays or reductions in product shipments which, in turn, could
have a material adverse effect on the company's business, financial condition
and results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about the Company's market risk disclosures
involves forward-looking statements. Actual results could differ materially from
those projected in the forward-looking statements. The Company is exposed to
market risk related to changes in interest rates and foreign currency exchange
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.
INTEREST RATE SENSITIVITY. The Company maintains a short-term investment
portfolio consisting mainly of corporate debt securities and U.S. government
agency discount notes with an average maturity of less than six months. These
held-to-maturity 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 percent from levels at October 31,
1998, the fair value of the portfolio would decline by an immaterial amount. The
Company has the ability to hold its fixed income investments until maturity, and
therefore the Company would not expect its operating results or cash flows to be
affected to any significant degree by the effect of a sudden change in market
interest rates on its securities portfolio.
FOREIGN CURRENCY EXCHANGE RISK. As a global concern, the Company faces
exposure to adverse movements in foreign currency exchange rates. These
exposures may change over time as business practices evolve and could have a
material adverse impact on the Company's financial results. Historically the
Company's primary exposures have been related to nondollar-denominated operating
expenses in Canada, Europe and Asia where the Company sells primarily in U.S.
dollars. The introduction of the Euro as a common currency for members of the
European Monetary Union is scheduled to take place in the Company's fiscal year
1999. The Company has not determined
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35
what impact, if any, the Euro will have on foreign exchange exposure. The
Company is prepared to hedge against fluctuations in the Euro if this exposure
becomes material. As of October 31, 1998 the assets and liabilities of the
Company related to nondollar-denominated currencies was not material.
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36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following is an index to the consolidated financial statements and
supplementary data :
PAGE
NUMBER
------
Report of Independent Accountants....................................... 36
Consolidated Balance Sheets............................................. 37
Consolidated Statements of Operations................................... 38
Consolidated Statements of Changes in Stockholders' Equity (Deficit).... 39
Consolidated Statements of Cash Flows................................... 40
Notes to Consolidated Financial Statements.............................. 41
35
37
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of CIENA Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of cash flows and of changes in
stockholders' equity (deficit) present fairly, in all material respects, the
financial position of CIENA Corporation and subsidiaries at October 31, 1998 and
1997, and the results of their operations and their cash flows for each of the
three years in the period ended October 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
McLean, VA
November 25, 1998
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38
CIENA CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
October 31,
---------------------------------------
1997 1998
------------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 268,588 $ 227,397
Marketable debt securities.................................................. - 15,993
Accounts receivable (net of allowance of $722 and $1,528)................... 72,336 85,472
Inventories, net............................................................ 41,109 70,908
Deferred income taxes....................................................... 9,139 15,301
Prepaid income taxes........................................................ - 8,558
Prepaid expenses and other.................................................. 3,093 4,415
------------------- -----------------
Total current assets...................................................... 394,265 428,044
Equipment, furniture and fixtures, net.......................................... 67,618 123,405
Goodwill and other intangible assets, net....................................... 5 16,270
Other assets.................................................................... 1,391 4,705
------------------- -----------------
Total assets................................................................ $ 463,279 $ 572,424
=================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................ $ 24,760 $ 25,686
Accrued liabilities......................................................... 32,022 34,328
Income taxes payable........................................................ 261 -
Deferred revenue............................................................ 2,591 1,084
Other current obligations................................................... 1,179 838
------------------- -----------------
Total current liabilities................................................. 60,813 61,936
Deferred income taxes....................................................... 28,167 34,125
Other long-term obligations................................................. 1,885 1,414
------------------- -----------------
Total liabilities......................................................... 90,865 97,475
Commitments and contingencies................................................... - -
------------------- -----------------
Stockholders' equity:
Preferred stock - par value $.01; 20,000,000 shares authorized; zero shares
issued and outstanding.................................................... - -
Common stock - par value $.01; 180,000,000 shares authorized;
100,287,653 and 103,239,704 shares issued and outstanding................. 1,003 1,032
Additional paid-in capital.................................................. 245,219 294,926
Notes receivable from stockholders.......................................... (64) (357)
Cumulative translation adjustment........................................... (5) (107)
Retained earnings........................................................... 126,261 179,455
------------------- -----------------
Total stockholders' equity................................................ 372,414 474,949
=================== =================
Total liabilities and stockholders' equity.................................. $ 463,279 $ 572,424
=================== =================
The accompanying notes are an integral part of these consolidated
financial statements.
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39
CIENA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Year Ended October 31,
---------------------------------------------------------------------
1996 1997 1998
--------------------- -------------------- ------------------
Revenue.................................................... $ 88,463 $ 413,215 $ 508,087
Cost of goods sold......................................... 47,315 166,472 256,014
--------------------- -------------------- ------------------
Gross profit........................................ 41,148 246,743 252,073
--------------------- -------------------- ------------------
Operating expenses:
Research and development............................ 8,922 23,308 64,536
Selling and marketing............................... 5,641 22,627 45,945
General and administrative.......................... 6,422 11,823 17,825
Purchased research and development.................. - - 9,503
Pirelli litigation ................................. - 7,500 30,579
Cost of proposed merger............................. - - 2,548
--------------------- -------------------- ------------------
Total operating expenses..................... 20,985 65,258 170,936
--------------------- -------------------- ------------------
Income from operations..................................... 20,163 181,485 81,137
Interest and other income (expense), net................... 1,096 7,593 12,551
Interest expense........................................... (443) (408) (259)
--------------------- -------------------- ------------------
Income before income taxes................................. 20,816 188,670 93,429
Provision for income taxes................................. 3,553 72,703 40,235
--------------------- -------------------- ------------------
Net income ................................................ $ 17,263 $ 115,967 $ 53,194
===================== ==================== ==================
Basic net income per common share.......................... $ 1.25 $ 1.53 $ 0.52
===================== ==================== ==================
Diluted net income per common share and
dilutive potential common share..................... $ 0.19 $ 1.11 $ 0.49
===================== ==================== ==================
Weighted average basic common shares outstanding........... 13,817 75,802 101,751
===================== ==================== ==================
Weighted average basic common and dilutive
potential common shares outstanding................. 92,407 104,664 107,895
===================== ==================== ==================
The accompanying notes are an integral part of these consolidated
financial statements.
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40
CIENA CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS)
NOTES TOTAL
COMMON STOCK ADDITIONAL RECEIVABLE CUMULATIVE RETAINED STOCKHOLDERS'
----------------------------- PAID-IN- FROM TRANSLATION EARNINGS EQUITY
SHARES AMOUNT CAPITAL STOCKHOLDERS ADJUSTMENT (DEFICIT) (DEFICIT)
-------------- ------------- ----------- --------------- ----------- ---------- ------------
BALANCE AT OCTOBER 31, 1995..... 12,935,415 129 178 - - (6,969) (6,662)
Exercise of warrants............ 676,425 7 - - - 7
Exercise of stock options....... 579,745 6 71 (60) - - 17
Compensation cost of stock
options....................... - - 2 - - - 2
Issuance of warrant for
settlement of certain equity
rights........................ - - 156 - - - 156
Net income...................... - - - - - 17,263 17,263
-------------- ------------- ----------- --------------- ----------- ---------- ------------
BALANCE OF OCTOBER 31, 1996..... 14,191,585 142 407 (60) - 10,294 10,783
Issuance of common stock,
net of issuance costs......... 7,002,060 70 173,947 - - - 174,017
Conversion of Preferred
Stock......................... 74,815,740 748 40,256 - - - 41,004
Exercise of warrants............ 666,086 7 - - - - 7
Exercise of stock options....... 3,612,182 36 859 (73) - - 822
Tax benefit from the exercise of
stock options................. - - 29,709 - - - 29,709
Repayment of receivables
from stockholders............. - - - 69 - - 69
Translation adjustment.......... - - - - (5) - (5)
Compensation cost of stock
options....................... - - 41 - - - 41
Net income...................... - - - - - 115,967 115,967
-------------- ------------- ----------- --------------- ----------- ---------- ------------
BALANCE AT OCTOBER 31, 1997..... 100,287,653 1,003 245,219 (64) (5) 126,261 372,414
Purchase acquisitions, net of
transaction costs............. 304,144 3 20,817 - - - 20,820
Exercise of stock options....... 2,647,907 26 6,215 (392) - - 5,849
Tax benefit from the exercise of
stock options................. - - 22,634 - - - 22,634
Repayment of receivables from
stockholders.................. - - - 99 - - 99
Translation adjustment.......... - - - - (102) - (102)
Compensation cost of stock
options....................... - - 41 - - - 41
Net income...................... - - - - - 53,194 53,194
-------------- ------------- ----------- --------------- ----------- ---------- ------------
BALANCE AT OCTOBER 31, 1998..... 103,239,704 $ 1,032 $ 294,926 $ (357) $ (107) $ 179,455 $ 474,949
============== ============= =========== =============== =========== ========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
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41
CIENA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED OCTOBER 31,
-----------------------------------------------------
1996 1997 1998
--------------- ---------------- ---------------
Cash flows from operating activities:
Net income .............................................................. $ 17,263 $ 115,967 $ 53,194
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Non-cash charges from equity transactions............................. 158 41 41
Amortization of premiums on marketable debt securities - - 464
Effect of translation adjustment - (5) (102)
Purchased research and development - - 9,503
Write down of leasehold improvements and equipment.................... 883 923 1,605
Depreciation and amortization......................................... 1,082 10,251 33,266
Provision for doubtful accounts....................................... 76 489 806
Provision for inventory excess and obsolescence....................... 1,937 7,585 9,617
Provision for warranty and other contractual obligations.............. 1,584 11,866 10,523
Changes in assets and liabilities:
Increase in accounts receivable.................................... (20,601) (46,309) (13,707)
Increase in inventories............................................ (15,165) (35,466) (39,416)
Increase in deferred income tax assets............................. (1,834) (7,305) (6,162)
Increase in prepaid income taxes - - (8,558)
Increase in prepaid expenses and other assets...................... (1,009) (2,403) (11,456)
Increase (decrease) in accounts payable and accrued expenses....... 7,259 30,311 (8,307)
Increase (decrease) in income taxes payable........................ 3,801 (3,701) (261)
Increase in deferred income tax liabilities........................ - 4,793 5,958
Increase (decrease) in deferred revenue and other obligations 3,386 (2,007) (1,507)
-------------- --------------- --------------
Net cash (used in) provided by operating activities.................... (1,180) 85,030 35,501
-------------- --------------- --------------
Cash flows from investing activities:
Additions to equipment, furniture and fixtures......................... (11,558) (66,820) (86,399)
Purchase of marketable debt securities................................. - - (93,869)
Maturities of marketable debt securities .............................. - - 77,876
Net cash paid for business combinations................................ - - (2,070)
-------------- --------------- --------------
Net cash used in investing activities.............................. (11,558) (66,820) (104,462)
-------------- --------------- --------------
Cash flows from financing activities:
Net proceeds from (repayment of) other obligations..................... 2,543 (2,260) (812)
Net proceeds from issuance of or subscription to
mandatorily redeemable preferred stock............................. 25,950 - -
Net proceeds from issuance of common stock ............................ 24 175,446 5,849
Tax benefit related to exercise of stock options and warrants.......... - 53,083 22,634
Repayment of notes receivable from stockholders........................ - 69 99
-------------- --------------- --------------
Net cash provided by financing activities.......................... 28,517 226,338 27,770
-------------- --------------- --------------
Net increase (decrease) in cash and cash equivalents............... 15,779 244,548 (41,191)
Cash and cash equivalents at beginning of period........................... 8,261 24,040 268,588
-------------- --------------- --------------
Cash and cash equivalents at end of period................................. $ 24,040 $ 268,588 $ 227,397
============== =============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest............................................................ $ 419 $ 405 $ 249
============== =============== ==============
Income taxes........................................................ $ 1,830 $ 26,999 $ 30,203
============== =============== ==============
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Issuance of common stock for notes receivable from stockholders........ $ 60 $ 73 $ 392
============== =============== ==============
The accompanying notes are an integral part of these consolidated
financial statements.
40
42
CIENA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
Description of Business
CIENA Corporation (the "Company" or "CIENA") designs, manufactures and
sells open architecture, dense wavelength division multiplexing ("DWDM") systems
for fiberoptic communications networks, including long-distance and local
exchange carriers. CIENA also provides a range of engineering, furnishing and
installation services for telecommunications service providers.
Principles of Consolidation
The Company has ten wholly owned U.S. and international subsidiaries which
have been consolidated in the accompanying financial statements. During the
fiscal year ended October 31, 1998, the Company completed a merger with ATI
Telecom International Ltd., ("Alta"). The merger constituted a tax-free
reorganization and has been accounted for as a pooling of interests under
Accounting Principles Board Opinion No. 16. Accordingly, all prior period
consolidated financial statements presented have been restated to include the
combined results of operations, financial position and cash flows of Alta as
though it had been a part of CIENA. The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries. All material intercompany accounts and transactions have been
eliminated in consolidation. See Note 2.
Fiscal Year
The Company has a 52 or 53 week fiscal year which ends on the Saturday
nearest to the last day of October in each year (October 31, 1998; November 1,
1997; and November 2, 1996). For purposes of financial statement presentation,
each fiscal year is described as having ended on October 31. Fiscal 1998 and
1997 comprised 52 weeks and fiscal 1996 comprised 53 weeks.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates,
judgements and assumptions that affect the reported amounts of assets,
liabilities, revenue and expenses, together with amounts disclosed in the
related notes to the financial statements. Actual results could differ from the
recorded estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
Marketable Debt Securities
The Company has classified its investments in marketable debt securities
as held-to-maturity securities as defined by Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". Such investments are recorded at their amortized cost in the
accompanying consolidated balance sheets. All of the marketable debt securities
are corporate debt securities with contractual maturities of six months or less
and have $60,000 and $9,000 of unrealized gain and unrealized loss,
respectively, as of October 31, 1998.
Inventories
Inventories are stated at the lower of cost or market, with cost determined
on the first-in, first-out basis. The Company records a provision for excess and
obsolete inventory whenever such an impairment has been identified.
41
43
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
2-5 years for equipment, furniture and fixtures and of 6-10 years for leasehold
improvements.
Goodwill
The Company has recorded goodwill from two purchase transactions. See Note
2. It is the Company's policy to continually assess the carrying amount of its
goodwill to determine if there has been an impairment to its carrying value. The
Company would record any such impairment when identified.
Concentrations
Substantially all of the Company's cash and cash equivalents are custodied
at four major U.S. financial institutions. The majority of the Company's cash
equivalents include U.S. Government Federal Agency Securities, short term
marketable securities, 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.
Historically, the Company has relied on a limited number of customers for a
substantial portion of its revenue. In terms of total revenue, the Company's
largest two customers have been Sprint and WorldCom. While there were no
revenues derived from WorldCom in fiscal 1996, Sprint accounted for 62% of the
Company's fiscal 1996 revenues and both Sprint and WorldCom combined accounted
for greater than 88% of the Company's 1997 fiscal revenues. WorldCom accounted
for less than 10% and Sprint accounted for approximately 53% of the Company's
fiscal 1998 revenues. The Company expects that a significant portion of its
future revenue will continue to be generated by a limited number of customers.
The loss of any one of these customers or any substantial reduction in orders by
any one of these customers could materially adversely affect the Company's
financial condition or operating results. Additionally, the Company's access to
certain raw materials is dependent upon single and sole source suppliers. The
inability of any supplier to fulfill supply requirements of the Company could
impact future results.
The Company performs ongoing credit evaluations of its customers and
generally does not require collateral from its customers. The Company maintains
an allowance for potential losses when identified and has not incurred any
significant losses to date. As of October 31, 1997, Sprint and WorldCom
accounted for 84% of the trade accounts receivable. Sprint and three other
customers comprise of 10%, 11%, 25% and 26% of the trade accounts receivable
respectively as of October 31, 1998.
Revenue Recognition
The Company recognizes product revenue in accordance with the shipping
terms specified. For transactions where the Company has yet to obtain customer
acceptance, revenue is deferred until the terms of acceptance are satisfied.
Revenue for installation services is recognized as the services are performed
unless the terms of the supply contract combine product acceptance with
installation, in which case revenues for installation services are recognized
when the terms of acceptance are satisfied and installation is completed.
Revenues from installation service fixed price contracts are recognized on the
percentage of costs incurred to date compared to estimated total costs for each
contract. Amounts received in excess of revenue recognized are recorded as
deferred revenue. For distributor sales where risks of ownership have not
transferred, the Company recognizes revenue when the product is shipped through
to the end user.
Revenue-Related Accruals
The Company 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. The
Company's contractual sales arrangements generally do not permit the right of
return of product by the customer after the product has been accepted.
Research and Development
The Company charges all research and development costs to expense as
incurred.
42
44
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 (SFAS No. 109), "Accounting for Income
Taxes". SFAS No. 109 is 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 carryforwards. In estimating future tax
consequences, SFAS No. 109 generally considers all expected future events other
than the enactment of changes in tax laws or rates. Tax savings resulting from
deductions associated with stock options and certain stock warrants are credited
directly to additional paid in capital when realization of such benefit is fully
assured and to deferred tax liabilities prior to such point. See Note 8.
Foreign Currency Translation
The majority of the Company's foreign branches and subsidiaries use the
U.S. dollar as their functional currency as the U.S. parent exclusively funds
the branches and subsidiaries' operations 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 shareholders' equity. Where the U.S. dollar is the functional
currency, translation adjustments are recorded in other income. The net gain
(loss) on foreign currency remeasurement and exchange rate changes for fiscal
1996, 1997, and 1998 was immaterial for separate financial statement
presentation .
Computation of Basic Net Income per Common Share and Diluted Net Income per
Common and Dilutive Potential Common Share
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128).
SFAS No. 128 simplifies the earnings per share (EPS) computation and replaces
the presentation of primary EPS with a presentation of basic EPS. This statement
also 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. The Company has implemented SFAS No. 128 in fiscal 1998, as
required. Accordingly, all prior period EPS data has been restated. See Note 6.
Software Development Costs
Statement of Financial Accounting Standards No. 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
over the estimated product life. The Company 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, the Company has not
capitalized any software development costs.
Accounting for Stock Options
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for
Stock-Based Compensation", which is effective for the Company's consolidated
financial statements for fiscal years 1996, 1997, and 1998. SFAS No. 123 allows
companies to either account for stock-based compensation under the new
provisions of SFAS No. 123 or using the intrinsic value method provided by
Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for Stock
Issued to Employees", but requires pro forma disclosure in the footnotes to the
financial statements as if the measurement provisions of SFAS No. 123 had been
adopted. The Company has elected to continue to account for its stock based
compensation in accordance with the provisions of APB No. 25 and present the pro
forma disclosures required by SFAS No. 123. See Note 7.
Newly Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS No. 130), "Comprehensive Income".
SFAS No. 130 becomes effective for the Company's fiscal
43
45
year 1999 and requires reclassification of earlier financial statements for
comparative purposes. SFAS No. 130 requires that changes in the amounts of
certain items, including foreign currency translation adjustments and gains and
losses on certain securities be shown in the financial statements. SFAS No. 130
does not require a specific format for the financial statement in which
comprehensive income is reported, but does require that an amount representing
total comprehensive income be reported in that statement. The Company believes
the adoption of SFAS No. 130 will not have a material effect on the consolidated
financial statements.
Also in June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131 (SFAS No. 131), "Disclosures
about Segments of an Enterprise and Related Information". This Statement will
change the way public companies report information about segments of their
business in annual financial statements and requires them to report selected
segment information in their quarterly reports issued to stockholders. It also
requires entity-wide disclosures about the products and services an entity
provides, the material countries in which it holds assets and reports revenues,
and its major customers. The Statement is effective for the Company's fiscal
year 1999. The Company believes the adoption of SFAS No. 131 will not have a
material effect on the consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS No. 133), "Accounting for
Derivative Instruments and Hedging Activities". This Statement requires
companies to record derivatives on the balance sheet as assets or liabilities,
measured at fair value. Gains or losses resulting from changes in the values of
those derivatives would be accounted for depending on the use of the derivative
and whether it qualifies for hedge accounting. SFAS 133 will be effective for
the Company's fiscal year ending October 31, 2000. The Company believes the
adoption of SFAS No. 133 will not have a material effect on the consolidated
financial statements.
Reclassification
Certain prior year amounts have been reclassified to conform to current
year consolidated financial statement presentation.
(2) BUSINESS COMBINATIONS
Astracom
During December 1997 the Company completed an Agreement and Plan of Merger
with Astracom, Inc. ("Astracom"), an early stage telecommunications company
located in Atlanta, Georgia. The purchase price was approximately $13.1 million
and consisted of the issuance of 169,754 shares of CIENA common stock, the
payment of $2.4 million in cash, and the assumption of certain stock options.
The transaction was recorded using the purchase accounting method with the
purchase price representing approximately $11.4 million in goodwill and other
intangibles, and approximately $1.7 million in net assets assumed. The
amortization period for the intangibles, based on management's estimate of the
useful life of the acquired technology, is five years. The operations of
Astracom are not material to the consolidated financial statements of the
Company and, accordingly, separate pro forma financial information has not been
presented.
Alta
On February 19, 1998 the Company completed a merger with ATI Telecom
International Ltd., ("Alta"), a Canadian corporation headquartered near Atlanta,
Georgia, in a transaction valued at approximately $52.5 million. Alta provides a
range of engineering, furnishing and installation services for
telecommunications service providers in the areas of transport, switching and
wireless communications. Under the terms of the agreement the Company exchanged
1,000,000 shares of its common stock for all the common stock of Alta. The
merger constituted a tax-free reorganization and has been accounted for as a
pooling of interests under Accounting Principles Board Opinion No. 16.
Accordingly, all prior period consolidated financial statements presented have
been restated to include the combined results of operations, financial position
and cash flows of Alta as though it had been a part of CIENA.
Prior to the merger, Alta's year ended on December 31. In recording the
business combination, Alta's prior period financial statements have been
restated to conform to CIENA's fiscal year end.
All intercompany transactions between CIENA and Alta have been eliminated
in consolidation. Certain reclassifications were made to Alta financial
statements to conform to CIENA's presentation. No material adjustments were made
to conform to CIENA's accounting policies.
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46
The following table shows the separate historical results of CIENA and Alta
for the periods prior to the consummation of the merger of the two entities:
(in thousands)
Year Ended October 31,
-------------------------------------------
1996 1997
------------------- ----------------------
Revenues:
CIENA $ 54,838 $ 373,827
Alta 33,625 39,531
Intercompany eliminations - (143)
------------------- ----------------------
Consolidated revenues $ 88,463 $ 413,215
=================== ======================
Net Income (loss):
CIENA $ 14,718 $ 112,945
Alta 2,545 3,022
------------------- ----------------------
Consolidated net income $ 17,263 $ 115,967
=================== ======================
Terabit
During April 1998 the Company completed an Agreement and Plan of
Reorganization with Terabit Technology, Inc. ("Terabit"), a developer of optical
components known as photodetectors or optical receivers. Terabit is located in
Santa Barbara, California. The purchase price was approximately $11.5 million
and consisted of the issuance of 134,390 shares of CIENA common stock, the
payment of $1.1 million in cash, and the assumption of certain stock options.
The transaction was recorded using the purchase accounting method with the
purchase price representing approximately $9.5 million in purchased research and
development, $1.8 million in goodwill and other intangibles, and approximately
$0.2 million in net assets assumed. The amortization period for the intangibles,
based on management's estimate of the useful life of the acquired technology, is
five years. The operations of Terabit are not material to the consolidated
financial statements of the Company and, accordingly, separate pro forma
financial information has not been presented.
In connection with the Terabit acquisition, the Company recorded a $9.5
million charge in the year ended October 31, 1998 for purchased research and
development. This generally represents the estimated value of purchased
in-process technology related to Terabit's avalanche photodiodes (APD) that have
not yet reached technological feasibility and have no alternative future use.
The amount of purchase price allocated to in-process research and
development was determined using the discounted cash flow method. This method
consisted of estimating future net cash flows attributable in-process APD
technology for a discrete projection period and discounting the net cash flows
back to their present value. The discount rate includes a factor that takes into
account the uncertainty surrounding the successful development of the purchased
in-process technology. The estimated revenue associated with the APD technology
future net cash flows assumed a five year compound annual growth rate of between
5% to 43%. The revenue growth rates were developed considering, among other
things, the current and expected industry trends and acceptance of the
technologies in historical growth rates for similar industry products.
Management's estimates or projections were based upon an estimated period of ten
years with revenues reaching a peak in 2002 and declining through 2008. The
estimated net cash flows were discounted to present value at a rate of return
which considers the relative risk of achieving the net cash flows and the time
value of money. A 30% was used to effect the risk associated with Terabits APD
technology. This rate is higher than the Company's normal discount rate due to
inherent uncertainties surrounding the successful development of purchase
in-process technology, the useful life of the technology, and the profitability
levels of such technology.
The resulting net cash flows from the APD project was based on
management's estimates of revenues, cost of sales, research and development
costs, selling general and administrative costs, and income taxes associated
with the project.
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(3) INVENTORIES
Inventories are comprised of the following (in thousands):
October 31,
----------------------------------------------
1997 1998
--------------------- --------------------
Raw materials....................................... $ 27,716 $ 43,268
Work-in-process..................................... 5,679 8,592
Finished goods...................................... 15,180 30,202
--------------------- --------------------
48,575 82,062
Reserve for excess and obsolescence................. (7,466) (11,154)
--------------------- --------------------
$ 41,109 $ 70,908
===================== ====================
The following is a table depicting the activity in the Company's reserve for
excess and obsolescence (in thousands):
October 31,
-----------------------------------------------
1997 1998
---------------------- --------------------
Beginning balance.................................... $ 1,937 $ 7,466
Provision charged to operations...................... 7,585 9,617
Amounts written off to reserve....................... (2,056) (5,929)
---------------------- --------------------
Ending balance....................................... $ 7,466 $ 11,154
====================== ====================
(4) EQUIPMENT, FURNITURE AND FIXTURES
Equipment, furniture and fixtures are comprised of the following (in thousands):
October 31,
------------------------------------------------
1997 1998
---------------------- ---------------------
Equipment, furniture and fixtures..................... $ 65,444 $ 139,142
Leasehold improvements................................ 13,953 24,055
---------------------- ---------------------
79,397 163,197
Accumulated depreciation and amortization............. (12,279) (41,144)
Construction-in-progress.............................. 500 1,352
---------------------- ---------------------
$ 67,618 $ 123,405
====================== =====================
(5) ACCRUED LIABILITIES
Accrued liabilities are comprised of the following (in thousands):
October 31,
---------------------------------------------
1997 1998
-------------------- --------------------
Warranty and other contractual obligations............... $ 12,205 $ 17,256
Accrued compensation..................................... 8,284 9,128
Legal and related costs.................................. 4,577 534
Consulting and outside services.......................... 3,219 2,837
Unbilled construction-in-process and leasehold
improvements........................................... 1,427 -
Other.................................................... 2,310 4,573
-------------------- --------------------
$ 32,022 $ 34,328
==================== ====================
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(6) EARNINGS PER SHARE CALCULATION
The following is a reconciliation of the numerators and denominators of the
basic net income per common share ("basic EPS") and diluted net income per
common and dilutive potential common share ("diluted EPS"). Basic EPS is
computed using the weighted average number of common shares outstanding. Diluted
EPS is computed using the weighted average number of common shares outstanding,
stock options and warrants using the treasury stock method and shares issued
upon conversion of all outstanding shares of Mandatorily Redeemable Preferred
Stock (in thousands except per share amounts).
October 31,
-------------------------------------------------------------------
1996 1997 1998
------------------- ------------------- -------------------
Net Income.................................. $ 17,263 $ 115,967 $ 53,194
=================== =================== ===================
Weighted average shares-basic............... 13,817 75,802 101,751
------------------- ------------------- -------------------
Effect of dilutive securities:
Employee stock options and warrants. 8,533 8,774 6,144
Conversion of preferred stock.......... 70,057 20,088 -
------------------- ------------------- -------------------
Weighted average shares-diluted............. 92,407 104,664 107,895
=================== =================== ===================
Basic EPS................................... $ 1.25 $ 1.53 $ 0.52
=================== =================== ===================
Diluted EPS................................. $ 0.19 $ 1.11 $ 0.49
=================== =================== ===================
(7) STOCKHOLDERS' EQUITY
Stockholder Rights Plan
In December 1997, the Company's Board of Directors adopted a Stockholder
Rights Plan. This plan is designed to deter any potential coercive or unfair
takeover tactics in the event of an unsolicited takeover attempt. It is not
intended to prevent a takeover of the Company on terms that are favorable and
fair to all shareholders and will not interfere with a merger approved by the
Board of Directors. Each right entitles shareholders to buy a "unit" equal to
one one-thousandth of a share of Preferred Stock of the Company. The rights will
be exercisable only if a person or a group acquires or announces a tender or
exchange offer to acquire 15% or more of the Company's common stock or if the
Company enters into certain other business combination transactions not approved
by the Board of Directors.
In the event the rights become exercisable, the rights plan allows for CIENA
shareholders to acquire stock of the surviving corporation, whether or not CIENA
is the surviving corporation, having a value twice that of the exercise price of
the Rights. The Rights were distributed to shareholders of record in January
1998. The Rights will expire December 2007 and are redeemable for $.001 per
right at the approval of the Company's Board of Directors.
Public Offerings
In February 1997, the Company successfully completed its initial public
offering of Common Stock. The Company sold 5,750,000 shares, inclusive of
750,000 shares from the exercise of the underwriters over-allotment option, at a
price of $23 per share. Net proceeds from the offering were approximately
$121,800,000 with an additional $600,000 received from the exercise of 300,000
shares of outstanding Convertible Preferred Stock warrants.
In July 1997 the Company completed a public offering of 10,477,216 shares of
Common Stock of which 1,252,060 shares were sold by the Company inclusive of
252,060 shares from the exercise of the underwriters over-allotment option, at a
price of $44 per share. Net proceeds to the Company from the public offering
were approximately $52,200,000.
Stock Incentive Plans
The Company has an Amended and Restated 1994 Stock Option Plan (the "1994
Plan"). Under the 1994 Plan, 20,050,000 shares of the Company's authorized but
unissued Common Stock are reserved for options issuable to
47
49
employees. Certain of these options are immediately exercisable upon grant, and
both the options and the shares issuable upon exercise of the options generally
vest to the employee over a four year period. The Company has the right to
repurchase any exercised and non-vested shares at the original purchase price
from the employees upon termination of employment. In June 1996 the Company
approved the 1996 Outside Directors Stock Option Plan (the "1996 Plan"). Under
the 1996 Plan, 750,000 shares of the Company's authorized but unissued Common
Stock are reserved for options issuable to outside members of the Company's
Board of Directors. These options vest to the director over periods from one to
three years, depending on the type of option granted, and are exercisable once
vested. Under the 1994 Plan and the 1996 Plan, options may be incentive stock
options or non-qualified options, and the exercise price for each option shall
be established by the Board of Directors provided, however, that the exercise
price per share shall not be not less than the fair market value for incentive
stock options and not less than 85% of fair market value for non-qualified stock
options.
Following is a summary of the Company's stock option activity:
Shares Weighted Average
(in thousands) Exercise Price
-------------------------------------------------------
Balance at October 31, 1995.......................... 6,941 $ 0.03
Granted.............................................. 5,901 1.85
Exercised............................................ (579) 0.14
Canceled............................................. (1,180) 0.18
--------------------
Balance at October 31, 1996.......................... 11,083 0.97
Granted.............................................. 1,737 32.81
Exercised............................................ (3,612) 0.27
Canceled............................................. (98) 0.52
--------------------
Balance at October 31, 1997.......................... 9,110 7.33
Granted.............................................. 4,654 26.12
Exercised............................................ (2,648) 2.40
Canceled............................................. (3,280) 40.85
--------------------
Balance at October 31, 1998.......................... 7,836 5.83
====================
During September 1998, the Company cancelled and re-issued outstanding
employee stock options with exercise prices in excess of the fair market value,
except those options held by outside directors and officers of the Company. A
total of 2,905,116 options with an average exercise price of $42.87 were
cancelled and reissued at $12.38 per share. At October 31, 1998 approximately
292,000 shares of Common Stock subject to repurchase by the Company had been
issued upon the exercise of options and approximately 2.2 million of the total
outstanding options were vested and not subject to repurchase by the Company
upon exercise.
The following table summarizes information with respect to stock options
outstanding at October 31, 1998:
Options Not Subject to
Options Outstanding Repurchase Upon Exercise
----------------------------------------------------------- ----------------------------------
Weighted
Average
Number Remaining Weighted Weighted
Range of Outstanding Contractual Average Number Average
Exercise at Oct. 31, Life Exercise at Oct. 31, Exercise
Price 1998 (Years) Price 1998 Price
- ------------------------------ ----------------- ------------------- ------------------- ---------------- ----------------
$ 0.02 - $ 0.03 1,048,678 6.23 $ 0.03 878,524 $ 0.03
$ 0.06 - $ 1.66 1,102,096 7.41 $ 0.80 363,080 $ 0.80
$ 2.25 - $ 4.34 2,648,482 7.66 $ 2.48 450,455 $ 2.54
$ 4.40 - $ 11.56 189,216 8.56 $ 6.55 47,818 $ 6.15
$ 12.38 - $ 12.38 2,761,977 8.93 $ 12.38 419,150 $ 12.36
$ 12.56 - $ 43.25 85,675 9.57 $ 32.40 - $ -
----------------- ----------------
$ 0.02 - $ 43.25 7,836,124 7.92 $ 5.83 2,159,027 $ 3.21
================= ================
Pro forma Stock-Based Compensation
The Company has elected to continue to follow the provisions of APB No. 25
for financial reporting purposes and has adopted the disclosure-only provisions
of SFAS No. 123. Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant date for awards in fiscal years
1996, 1997, and 1998 consistent with the provisions of SFAS No. 123, the
Company's net income and net income per share for fiscal
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50
years 1996, 1997, and 1998 would have been decreased to the pro forma amounts
indicated below (in thousands, except per share amounts):
October 31,
------------------------------------------------------------
1996 1997 1998
----------------- --------------- -----------------
Net income applicable to common stockholders -
as reported.................................... $ 17,263 $ 115,967 $ 53,194
================= =============== =================
Net income applicable to common stockholders -
pro forma...................................... $ 16,770 $ 110,404 $ 28,327
================= =============== =================
Basic net income per share - as reported............ $ 1.25 $ 1.53 $ 0.52
================= =============== =================
Basic net income per share - pro forma.............. $ 1.21 $ 1.46 $ 0.28
================= =============== =================
Diluted net income per share - as reported.......... $ 0.19 $ 1.11 $ 0.49
================= =============== =================
Diluted net income per share - pro forma............ $ 0.18 $ 1.05 $ 0.26
================= =============== =================
The above pro forma disclosures are not necessarily representative of the
effects on reported net income or loss for future years.
The aggregate fair value and weighted average fair value of each option
granted in fiscal years 1996, 1997 and 1998 were approximately $6.7 million,
$33.6 million, $73.0 million and $1.14, $19.33, and $20.90 respectively. The
fair value of each option grant is estimated on the date of grant using the
Black-Scholes Option Pricing Model with the following weighted average
assumptions for fiscal years 1996, 1997, and 1998:
October 31,
---------------------------------------------------------
1996 1997 1998
-------------------- -------------------- ------------
Expected volatility 60% 60% 109%
Risk-free interest rate 6.1% 5.8% 4.4%
Expected life 3 yrs. 3 yrs. 3yrs.
Expected dividend yield 0% 0% 0%
(8) INCOME TAXES
Income before income taxes and the provision for income taxes consists of the
following (in thousands):
October 31,
-------------------------------------------------------------
1996 1997 1998
------------------- ------------------ -----------------
Income before income taxes......................... $ 20,816 $ 188,670 93,429
=================== ================== =================
Provision for income taxes:
Current:
Federal............................................. $ 4,483 $ 67,744 39,780
State............................................... 694 7,373 4,444
Foreign............................................. 210 98 40
------------------- ------------------ -----------------
Total current................................ 5,387 75,215 44,264
------------------- ------------------ -----------------
Deferred:
Federal............................................. (1,690) (2,015) (3,376)
State............................................... (144) (497) (653)
Foreign............................................. - - -
------------------- ------------------ -----------------
Total deferred............................... (1,834) (2,512) (4,029)
------------------- ------------------ -----------------
Provision for income taxes.......................... $ 3,553 $ 72,703 40,235
=================== ================== =================
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The tax provision reconciles to the amount computed by multiplying income before
income taxes by the U.S. federal statutory rate of 35% as follows:
October 31,
----------------------------------------------------------------
1996 1997 1998
----------------- ----------------- ------------------
Provision at statutory rate............................ 35.0 % 35.0 % 35.0 %
Reversal of valuation allowance........................ (20.0) - -
Non-deductible purchased research and development - - 3.8
State taxes, net of federal benefit.................... 2.7 2.6 3.8
Research and development credit........................ - - (3.6)
Other.................................................. (0.6) 0.9 4.1
----------------- ----------------- ------------------
17.1 % 38.5 % 43.1 %
================= ================= ==================
The significant components of deferred tax assets and liabilities were as
follows (in thousands):
October 31,
--------------------------------------------------
1997 1998
------------------------ --------------------
Deferred tax assets:
Reserves and accrued liabilities................... $ 9,281 $ 14,611
Other.............................................. - 690
Net operating loss and credit carry forward........ 1,555 1,562
------------------------ --------------------
Gross deferred tax assets......................... 10,836 16,863
Valuation allowance............................... (1,697) (1,562)
------------------------ --------------------
Net current deferred tax asset................. $ 9,139 $ 15,301
======================== ====================
Deferred tax liabilities:
Equipment leases................................... $ 3,985 $ 7,978
Services........................................... 19,389 21,594
Depreciation and other............................. 4,793 4,553
------------------------ --------------------
Deferred long term tax liabilities............. $ 28,167 $ 34,125
======================== ====================
As of October 31, 1997 the Company assumed net operating loss carry forwards
of approximately $4.5 million through its acquisition of Alta. The net operating
loss carry forwards begin expiring in fiscal 2002.
The income tax provisions do not reflect the tax savings resulting from
deductions associated with the Company's stock option plans or the exercise of
certain stock warrants. Tax benefits of approximately $29.7 million and $23.4
million in fiscal 1997, and $22.6 million and $3.6 million in fiscal 1998, from
exercises of stock options and certain stock warrants were credited directly to
additional paid-in-capital and to long-term deferred income taxes, respectively.
(9) EMPLOYEE BENEFIT PLANS
Employee 401(k) Plan
In January 1995, the Company adopted a 401(k) defined contribution profit
sharing plan. The plan covers all full-time employees who are at least 21 years
of age, have completed three months of service and are not covered by a
collective bargaining agreement where retirement benefits are subject to good
faith bargaining. Participants may contribute up to 15% of pre-tax compensation,
subject to certain limitations. The Company may make discretionary annual profit
sharing contributions of up to the lesser of $30,000 or 25% of each
participant's compensation. In fiscal 1997 the Company revised the plan to
include an employer matching contribution equal to 100% of the first 3% of
participating employee contributions, with a five year vesting plan applicable
to the Company's contribution. The Company has made no profit sharing
contributions to date. During fiscal 1997 and 1998 the Company made matching
contributions of approximately $0.3 million and $1.1 million, respectively.
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Employee Stock Purchase Plan
In March 1998, the shareholders approved the Corporation's 1998 Stock
Purchase Plan ("the Purchase Plan") under which 2.5 million shares of common
stock have been reserved for issuance. Eligible employees may purchase a limited
number of shares of the Company's stock at 85% of the market value at certain
plan-defined dates, the first of which occurs in March 1999. As of October 31,
1998 no shares had been issued from the Purchase Plan.
(10) COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments
The Company has certain minimum obligations under noncancelable operating
leases expiring on various dates through 2006 for equipment and facilities.
Future annual minimum rental commitments under noncancelable operating leases at
October 31, 1998 are as follows (in thousands):
Fiscal year ending October 31,
- ------------------------------
1999...................................................... $ 5,729
2000...................................................... 5,510
2001...................................................... 5,070
2002...................................................... 4,282
2003...................................................... 3,050
Thereafter................................................ 10,358
--------------------
$ 33,999
====================
Rental expense for fiscal 1996, 1997 and 1998 was approximately $717,000,
$2,652,000 and $5,616,000, respectively.
Litigation
Class Action Litigation. A class action complaint was filed on August 26,
1998 in U.S. District Court for the District of Maryland entitled Witkin et.al
v. CIENA Corporation et. al (Case No. Y-98-2946). Several other complaints,
substantially similar in content, have been filed. These cases were consolidated
by court order on November 30, 1998. The complaint alleges that CIENA and
certain officers and directors violated certain provisions of the federal
securities laws, including Section 10(b) and Rule 10b-5 under the Securities
Exchange Act of 1934, by making false statements, failing to disclose material
information and taking other actions intending to artificially inflate and
maintain the market price of CIENA's common stock during the Class Period of May
21, 1998 to September 14, 1998, inclusive. The plaintiffs seek designation of
the suit as a class action on behalf of all persons who purchased shares of
CIENA's common stock during the Class Period and the awarding of compensatory
damages in an amount to be determined at trial and attorneys' fees. The
proceedings are at an early stage. No discovery has been taken, and no
prediction can be made as to its outcome. The Company believes the suit is
without merit and intends to defend itself vigorously.
Kimberlin Litigation. On September 9, 1998 the U.S. District Court for the
Southern District of New York granted summary judgment with respect to federal
securities law claims brought against the Company and certain of its individual
directors by investor Kevin Kimberlin and related parties, finding "no
violations" of federal securities laws in the Company's or directors' conduct.
The Court also dismissed all related state law claims without prejudice,
declining to exercise jurisdiction over these claims. The remaining state law
claims, as well as the Company's counterclaim against the Kimberlin-related
parties, were fully and finally resolved in October 1998 by agreement of the
parties.
Pirelli Litigation. On June 1, 1998 the Company resolved the long-standing
litigation with Pirelli S.p.A. The terms of the settlement involve dismissal of
Pirelli's three lawsuits against CIENA previously pending in Delaware, dismissal
of CIENA's legal proceedings against Pirelli in the United States International
Trade Commission, a worldwide, non-exclusive cross-license to each party's
patent portfolios, a five-year moratorium on future litigation between the
parties. As a result of the settlement, CIENA recorded a charge for the fiscal
year ended October 31, 1998 of $30.6 million relating to the Pirelli settlement
and associated legal fees.
51
53
(11) FOREIGN SALES
The Company has sales and marketing operations outside the United States in
Canada, The United Kingdom, Belgium, France, Japan, China and the Philippines.
The Company has distributor or marketing representative arrangements covering
Austria, Germany, Italy and Switzerland in Europe, and the Republic of Korea and
Japan in Asia. The Company also has representatives in Mexico and Brazil.
Included in revenues are export sales of approximately $3.5 million, $11.7
million, and $117.1 million in fiscal years 1996, 1997 and 1998, respectively.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
52
54
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to the directors and executive officers of the Company
is set forth in Part I of this report under the caption Item 1. Business-
"Directors, and Executive Officers" and is incorporated by reference herein.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Rebecca K. Seidman and Jon W. Bayless each filed one late Form 4, each
reporting a single transaction.
ITEM 11. EXECUTIVE COMPENSATION
The information is incorporated herein by reference to the Company's
definitive 1999 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information is incorporated herein by reference to the Company's
definitive 1999 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information is incorporated herein by reference to the Company's
definitive 1999 Proxy Statement.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Form:
1. Financial Statement Schedules:
All schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements
or notes thereto.
2. Exhibits: See Index to Exhibits on page 55. The Exhibits listed in
the accompanying Index to Exhibits are filed or incorporated by
reference as part of this report.
(b) Reports on Form 8-K
Date of Report Description
-------------- -----------
August 14, 1998 Announcement of preliminary fiscal 1998 third quarter results.
August 21, 1998 Announcements regarding AT&T decision not to pursue further
evaluation of CIENA's DWDM system. CIENA Corporation and
Tellabs agree to adjourn their respective shareholder meetings until
September 9, 1998.
August 27, 1998 CIENA and Tellabs entered into a First Amendment to their Merger
Agreement dated June 2, 1998.
September 13, 1998 CIENA and Tellabs announced on September 14, 1998 that they had
agreed to terminate the Plan of Merger dated June 2, 1998.
September 14, 1998 Announcement of merger termination, introduction of OC-192
capability, bolstering of its strategy, marketing and sales functions,
statement from CIENA's Patrick Nettles, granting of CIENA's motion
for summary judgement in the Kimberlin litigation.
October 14, 1998 Amendment of CIENA's Shareholder Rights Agreement
53
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Linthicum, County of Anne Arundel, State of Maryland, on the 10 day of December
1998.
CIENA CORPORATION
By: /s/ Patrick H. Nettles
-----------------------
Patrick H. Nettles
President, Chief Executive Officer
and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
date indicated.
Signatures Title Date
/s/ Patrick H. Nettles President, Chief Executive Officer December 10, 1998
--------------------------- and Director
Patrick H. Nettles (Principal Executive Officer)
/s/ Joseph R. Chinnici Sr. Vice President, Finance and December 10, 1998
-------------------------- Chief Financial Officer
Joseph R. Chinnici (Principal Financial Officer)
/s/ Andrew C. Petrik Vice President, Controller December 10, 1998
-------------------------- and Treasurer
Andrew C. Petrik (Principal Accounting Officer)
/s/ Jon W. Bayless Director December 10, 1998
--------------------------
Jon W. Bayless
/s/ Harvey B. Cash Director December 10, 1998
--------------------------
Harvey B. Cash
/s/Clifford H. Higgerson Director December 10, 1998
--------------------------
Clifford H. Higgerson
/s/ Billy B. Oliver Director December 10, 1998
--------------------------
Billy B. Oliver
/s/ Michael J. Zak Director December 10, 1998
--------------------------
Michael J. Zak
/s/ Stephen P. Bradley Director December 10, 1998
--------------------------
Stephen P. Bradley
54
56
INDEX TO EXHIBITS
Exhibit
Number Description
------- -----------
3.1* Certificate of Amendment to Third Restated Certificate of Incorporation
3.2* Third Restated Certificate of Incorporation
3.3* Amended and Restated Bylaws
4.1* Specimen Stock Certificate
4.2*** Rights Agreement dated December 29, 1997
4.3**** Amendment to Rights Agreement
10.1* Form of Indemnification Agreement for Directors and Officers
10.2* Amended and Restated 1994 Stock Option Plan
10.3* Form of Employee Stock Option Agreements
10.4* 1996 Outside Directors Stock Option Plan
10.5* Forms of 1996 Outside Directors Stock Option Agreement
10.7* Lease Agreement dated October 5, 1995 between the
Company and CS Corridor-32 Limited Partnership
10.6* Series C Preferred Stock Purchase Agreement dated December 20, 1995
10.8+* Purchase Agreement Between Sprint/United Management Company and the Company dated
December 14, 1995
10.9+* Basic Purchase Agreement between WorldCom Network Services, Inc. and the Company
dated September 19, 1996
10.10* Settlement Agreement and Mutual Release, between the Company and William K.
Woodruff & Company, dated August 26, 1996
10.13* Employment Agreement dated April 9, 1994 between the Company and Patrick Nettles
10.14* Lease Agreement dated November 1, 1996 by and between the Company and Aetna Life
Insurance Company
10.15* Revolving Note and Business Loan Agreement dated November 25, 1996 between the
Company and Mercantile-Safe Deposit & Trust Company
10.16+* First Addendum to Procurement Agreement
between the Registrant and Sprint/United
Management Company dated December 19, 1996
10.17++ Third Addendum to Procurement Agreement between the Registrant and Sprint/United
Management Company
10.18 Form of Transfer of Control/Severance Agreement
21** Subsidiaries of registrant
23.1 Consent of Independent Accountants
27 Financial Data Schedule
* Incorporated by reference from the Company's Registration Statement on
Form S-1 (333-17729).
** Incorporated by reference from the Company's Registration Statement on
Form S-1 (333-28525).
*** Incorporated by reference from the Company's Form 8-K dated December 29,
1997.
**** Incorporated by reference from the Company's Form 8-K dated October 14,
1998.
+ Confidential treatment has been granted by the Securities and Exchange
Commission with respect to certain portions of these exhibits.
++ Confidential treatment has been requested with respect to certain portions
of this exhibit.
The confidential portions have been filed separately with the Securities
and Exchange Commission.
55