<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark one)
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 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 Identification No.)
incorporation or organization)
1201 WINTERSON ROAD, LINTHICUM, MD 21090
(Address of Principal Executive Offices) (Zip Code)
(410) 865-8500
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if
changed since last report)
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 the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
CLASS OUTSTANDING AT SEPTEMBER 14, 1998
- -------------------------------- ----------------------------------
Common stock. $.01 par value 102,969,703
Page 1 of 25 pages
<PAGE> 2
CIENA CORPORATION
INDEX
FORM 10-Q
<TABLE>
<CAPTION>
PAGE NUMBER
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations
Quarters and nine months ended July 31, 1997
and July 31, 1998 3
Consolidated Balance Sheets
October 31, 1997 and July 31, 1998 4
Consolidated Statements of Cash Flows
Nine months ended July 31, 1997 and
July 31, 1998 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 11
Item 3. Quantitative and Qualitative Disclosure About
Market Risk - Not applicable
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
</TABLE>
2
<PAGE> 3
ITEM 1. FINANCIAL STATEMENTS
CIENA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
-------------------------------- ----------------------------------
July 31, July 31, July 31, July 31,
1997 1998 1997 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue $121,845 $129,116 $283,121 $416,926
Cost of goods sold 47,569 70,431 116,222 193,326
------------ ------------ ------------ ------------
Gross profit 74,276 58,685 166,899 223,600
------------ ------------ ------------ ------------
Operating expenses:
Research and development 7,245 18,805 14,994 45,656
Selling and marketing 6,722 12,526 14,738 33,538
General and administrative 3,241 3,908 8,041 12,148
Purchased research and development - - - 9,503
Pirelli litigation - 20,579 5,000 30,579
Merger costs - 2,017 - 2,017
------------ ------------ ------------ ------------
Total operating expenses 17,208 57,835 42,773 133,441
------------ ------------ ------------ ------------
Income from operations 57,068 850 124,126 90,159
Interest and other income, net 1,511 2,577 3,893 9,783
Interest expense (85) (58) (319) (223)
------------ ------------ ------------ ------------
Income before income taxes 58,494 3,369 127,700 99,719
Provision for income taxes 22,770 1,280 49,641 42,627
------------ ------------ ------------ ------------
Net income $ 35,724 $ 2,089 $ 78,059 $ 57,092
============ ============ ============ ============
Basic net income per common share $ 0.36 $ 0.02 $ 1.15 $ 0.56
============ ============ ============ ============
Diluted net income per common share and
dilutive potential common share $ 0.34 $ 0.02 $ 0.75 $ 0.53
============ ============ ============ ============
Weighted average basic common shares
outstanding 98,021 102,089 68,010 101,360
============ ============ ============ ============
Weighted average basic common and dilutive
potential common shares outstanding 106,296 108,215 103,705 107,775
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE> 4
CIENA CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
October 31, July 31,
1997 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 268,588 $ 193,486
Marketable debt securities - 28,132
Accounts receivable, net 72,336 108,480
Inventories, net 41,109 76,343
Deferred income taxes 9,139 7,628
Prepaid income taxes - 20,499
Prepaid expenses and other 3,093 10,345
------------ ------------
Total current assets 394,265 444,913
Equipment, furniture and fixtures, net 67,618 125,260
Goodwill and other intangible assets, net - 17,102
Other assets 1,396 3,960
------------ ------------
Total assets $ 463,279 $ 591,235
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 24,760 $ 42,767
Accrued liabilities 32,022 32,571
Income taxes payable 261 943
Deferred revenue 2,591 192
Other current obligations 1,179 893
------------ ------------
Total current liabilities 60,813 77,366
Deferred income taxes 28,167 31,346
Other long-term obligations 1,885 1,592
------------ ------------
Total liabilities 90,865 110,304
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; 360,000,000 shares authorized;
100,287,653 and 102,541,814 shares issued and outstanding 1,003 1,025
Additional paid-in capital 245,219 296,951
Notes receivable from stockholders (64) (333)
Translation adjustment (5) (65)
Retained earnings 126,261 183,353
------------ ------------
Total stockholders' equity 372,414 480,931
------------ ------------
Total liabilities and stockholders' equity $ 463,279 $ 591,235
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE> 5
CIENA CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended July 31,
-------------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 78,059 $ 57,092
Adjustments to reconcile net income to net cash
provided by operating activities:
Non-cash charges from equity transactions 31 31
Amortization of premiums on marketable debt securities - 362
Effect of translation adjustments (4) (60)
Purchased research and development - 9,503
Write down of leasehold improvements 571 -
Depreciation and amortization 5,942 22,850
Provision for doubtful accounts 200 194
Provision for inventory excess and obsolescence 2,409 4,116
Provision for warranty and other contractual obligations 11,587 9,583
Changes in assets and liabilities:
Increase in accounts receivable (40,375) (36,103)
Increase in prepaid expenses and other (207) (7,614)
Increase in inventories (18,284) (39,350)
Increase in prepaid income taxes - (20,499)
(Increase) decrease in deferred income tax asset (4,107) 1,511
Increase in other assets (141) (8,418)
Increase in accounts payable and accruals 29,522 7,957
Increase in income taxes payable 15,801 682
Increase in deferred income tax liability - 3,179
Decrease in deferred revenue and other obligations (570) (2,399)
------------ ------------
Net cash provided by operating activities 80,434 2,617
------------ ------------
Cash flows from investing activities:
Additions to equipment, furniture and fixtures (47,946) (77,572)
Purchases of marketable debt securities - (90,008)
Maturities of marketable debt securities - 61,876
Net cash paid for business combination - (2,103)
------------ ------------
Net cash used in investing activities (47,946) (107,807)
------------ ------------
Cash flows from financing activities:
Repayment of other obligations (1,685) (579)
Net proceeds from issuance of common stock 174,878 5,127
Tax benefit related to exercise of stock options and warrants 17,560 25,481
Repayment of notes receivable from shareholders - 59
------------ ------------
Net cash provided by financing activities 190,753 30,088
------------ ------------
Net increase (decrease) in cash and cash equivalents 223,241 (75,102)
Cash and cash equivalents at beginning of period 24,040 268,588
------------ ------------
Cash and cash equivalents at end of period $ 247,281 $ 193,486
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE> 6
CIENA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Statements
The interim financial statements included herein for CIENA
Corporation (the "Company") have been prepared by the Company, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
In the opinion of management, financial statements included in this report
reflect all normal recurring adjustments which the Company considers necessary
for the fair presentation of the results of operations for the interim periods
covered and of the financial position of the Company at the date of the interim
balance sheet. Certain information and footnote disclosures normally included in
the annual financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. However, the Company believes that the disclosures are adequate to
understand the information presented. The operating results for interim periods
are not necessarily indicative of the operating results for the entire year.
These financial statements should be read in conjunction with the Company's
October 31, 1997 audited consolidated financial statements and notes thereto
included in the Company's Form 10-K annual report for the fiscal year ended
October 31, 1997, as restated in the Company's Form 8-K dated February 19, 1998.
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 and network access systems. On August 28, 1998 the Company announced
that the Company and Tellabs had agreed to amend the agreement to reflect, among
other things, a change in the stock exchange ratios. Under the terms of the
amended merger agreement, all outstanding shares of CIENA stock were to have
been exchanged at the ratio of 0.8 shares of Tellabs common stock for each share
of CIENA common stock. An agreement to terminate the merger was reached on
September 13, 1998. See Item 2. "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
As more fully described in Note 5, the Company acquired ATI Telecom
International Ltd., ("Alta") in February 1998. The acquisition was accounted for
as a pooling of interests, and the historical consolidated financial statements
of the Company for all periods prior to this acquisition have been restated to
include the financial position, results of operations and cash flows of Alta.
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-completion method, measured by the percentage of
costs incurred to date compared to estimated total costs for each contract.
Amounts received in excess of revenue recognized are included as deferred
revenue in the accompanying balance sheets. For distributor sales where risks of
ownership have not transferred, the Company recognizes revenue when the product
is shipped through to the end user.
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. As of July 31, 1998 all of the
marketable debt securities are corporate debt securities with contractual
maturities of six months or less.
6
<PAGE> 7
Goodwill and Other Intangibles
The Company's goodwill and other intangibles are the result of
external purchases of technology and goodwill and are recorded at the lower of
their cost or the fair market value disbursed in conjunction with the purchase.
The goodwill and other intangibles are amortized over the useful life of the
assets, determined by management to be between five and fourteen years, on a
straight-line basis. For the nine months ended July 31, 1998, the Company
recorded goodwill amortization of approximately $1,308,000, resulting in
accumulated amortization of $2,255,000 as of July 31, 1998.
Computation of Basic Net Income per Common Share and Diluted Net Income per
Common and Dilutive Potential Common Share
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)
<TABLE>
<CAPTION>
For the Quarter Ended July 31, 1998
---------------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------------------- -------------------- -----------------
<S> <C> <C> <C>
BASIC EPS
Income available to common stockholders $ 2,089 102,089 $ 0.02
=================
EFFECT OF DILUTIVE SECURITIES
Stock options - 6,126
----------------------- --------------------
DILUTED EPS
Income available to common stockholders +
assumed conversions $ 2,089 108,215 $ 0.02
======================= ==================== =================
<CAPTION>
For the Quarter Ended July 31, 1997
---------------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------------------- -------------------- -----------------
<S> <C> <C> <C>
BASIC EPS
Income available to
common stockholders $ 35,724 98,021 $ 0.36
=================
EFFECT OF DILUTIVE SECURITIES
Stock options and warrants - 8,275
----------------------- --------------------
DILUTED EPS
Income available to common
stockholders + assumed conversions $ 35,724 106,296 $ 0.34
======================= ==================== =================
</TABLE>
7
<PAGE> 8
<TABLE>
<CAPTION>
For Nine Months Ended July 31, 1998
------------------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-------------------- ---------------------- --------------------
<S> <C> <C> <C>
BASIC EPS
Income available to
common stockholders $ 57,092 101,360 $ 0.56
====================
EFFECT OF DILUTIVE SECURITIES
Stock options and warrants - 6,415
-------------------- ----------------------
DILUTED EPS
Income available to common
stockholders + assumed conversions $ 57,092 107,775 $ 0.53
==================== ====================== ====================
<CAPTION>
For Nine Months Ended July 31, 1997
------------------------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
-------------------- ---------------------- --------------------
<S> <C> <C> <C>
BASIC EPS
Income available to
common stockholders $ 78,059 68,010 $ 1.15
====================
EFFECT OF DILUTIVE SECURITIES
Stock options and warrants - 9,112
Conversion of Preferred Stock - 26,583
-------------------- ----------------------
DILUTED EPS
Income available to common
stockholders + assumed conversions $ 78,059 103,705 $ 0.75
==================== ====================== ====================
</TABLE>
Stock options to purchase 92,850 and 440,450 shares of common stock
were outstanding during the quarter ended and nine months ended July 31, 1998,
respectively, but were not included in the computation of diluted EPS because
the options' exercise price was greater than the average market price of the
common shares.
8
<PAGE> 9
(2) INVENTORIES
Inventories are comprised of the following (in thousands):
<TABLE>
<CAPTION>
October 31, July 31,
1997 1998
------------------ -----------------
<S> <C> <C>
Raw materials $ 27,716 $ 44,608
Work-in-process 5,679 6,290
Finished goods 15,180 34,599
------------------ -----------------
48,575 85,497
Less reserve for excess and obsolescence (7,466) (9,154)
------------------ -----------------
$ 41,109 $ 76,343
================== =================
</TABLE>
(3) EQUIPMENT, FURNITURE AND FIXTURES
Equipment, furniture and fixtures are comprised of the following
(in thousands):
<TABLE>
<CAPTION>
October 31, July 31,
1997 1998
------------------ -----------------
<S> <C> <C>
Equipment, furniture and fixtures $ 65,444 $ 134,851
Leasehold improvements 13,953 22,542
------------------ -----------------
79,397 157,393
Accumulated depreciation and amortization (12,279) (33,383)
Construction-in-progress 500 1,250
------------------ -----------------
$ 67,618 $ 125,260
================== =================
</TABLE>
(4) ACCRUED LIABILITIES - COMMITMENTS AND CONTINGENCIES
Litigation
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 due to Pirelli, a worldwide, non-exclusive
cross-license to each party's patent portfolios, and a 5-year moratorium on
future litigation between the parties. 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 and or results of operations. See
Part II, Item 1, "Legal Proceedings".
Accrued Liabilities
Accrued liabilities are comprised of the following (in thousands):
<TABLE>
<CAPTION>
October 31, July 31,
1997 1998
----------------- -----------------
<S> <C> <C>
Warranty and other contractual obligations $ 12,205 $ 15,363
Accrued compensation 8,284 11,105
Legal and related costs 4,577 409
Consulting and outside services 3,219 2,006
Unbilled construction-in-process and leasehold improvements 1,427 911
Other 2,310 2,777
----------------- -----------------
$ 32,022 $ 32,571
================= =================
</TABLE>
9
<PAGE> 10
(5) ACQUISITIONS
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.
ATI Telecom
On February 19, 1998, the Company acquired ATI Telecom International
Ltd., ("Alta"), a Canadian corporation headquartered in Norcross, 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 was accounted for as a pooling of interests. 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 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)
<TABLE>
<CAPTION>
Quarter
Ended
Year Ended October 31, January 31,
1995 1996 1997 1998
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues:
CIENA $ - $ 54,838 $ 373,827 $ 134,267
Alta 21,691 33,625 39,531 11,349
Intercompany eliminations - - (143) (524)
--------------- -------------- --------------- -----------------
Consolidated total, as restated $ 21,691 $ 88,463 $ 413,215 $ 145,092
=============== ============== =============== =================
Net Income (loss):
CIENA $ (7,629) $ 14,718 $ 112,945 $ 39,768
Alta 1,181 2,545 3,022 (70)
--------------- -------------- --------------- -----------------
Consolidated total, as restated $ (6,448) $ 17,263 $ 115,967 $ 39,698
=============== ============== =============== =================
</TABLE>
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 photodetector 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.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains certain forward-looking statements that involve
risks and uncertainties. The Company has set forth in Form 10-K Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Risk Factors," as filed with the Securities and Exchange Commission
on December 10, 1997, and in a Form 8-K filed on December 29, 1997, a detailed
statement of risks and uncertainties relating to the Company's business. In
addition, set forth below under the heading "Risk Factors" is a further
discussion of certain of those risks as they relate to the period covered by
this report, the Company's near term outlook with respect thereto, and the
forward-looking statements set forth herein; however, the absence in this
quarterly report of a complete recitation of or update to all risk factors
identified in the Form 8-K or Form 10-K should not be interpreted as modifying
or superseding any such risk factor, except to the extent set forth below.
Investors should review this quarterly report in combination with the Form 8-K
and Form 10-K in order to have a more complete understanding of the principal
risks associated with an investment in the Company's Common Stock.
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 Corporation ("AT&T") that AT&T
had decided not to pursue further evaluation of CIENA's dense wavelength
division multiplexing ("DWDM") systems. Following the impact of the AT&T
decision on the market prices 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 company's 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 to events of the last several weeks raised serious questions about the
ultimate ablity to obtain shareholder approval for the merger, which made it
difficult to move forward with the kind of momentum needed to realize
shareholder value. An agreement to terminate the merger was reached on
September 13, 1998.
OVERVIEW AND OUTLOOK
CIENA Corporation is a leading supplier of DWDM systems for
fiberoptic communications networks. CIENA's DWDM systems alleviate capacity
constraints and enable flexible provisioning of additional bandwidth on
high-traffic routes in carriers' networks.
In the face of the stock market's reaction to the Company's August
14, 1998 announcement of preliminary results for the third fiscal quarter of
1998, and to better assess for itself the appropriate reaction to these results
in relation to the Company's business plan and business prospects, for
approximately two weeks after the August 14 announcement, certain senior
management officials traveled to meet in person with certain of the Company's
key customers and potential customers. The Company believes it appropriate to
share those observations and impressions with investors in this report. While
these observations contain forward-looking statements that must be understood in
light of the Company's detailed discussion of the risks facing it (see the
discussion of "Risk Factors" appearing later in this report), the Company
believes these statements and observations will be helpful to investors in
gaining a clearer picture of the Company's position and prospects.
1. The basic market driver for the Company's business is demand for bandwidth
in fiberoptic communications networks. Based on the level of new carrier
activity, and new proposals and ongoing customer discussions worldwide, the
Company believes the basic market driver remains very strong.
2. The carriers' needs to deliver more bandwidth to end users--whether through
evolution of voice-centric network architectures or through revolutionary
shifts to new data-centric architectures--favor the utilization of optical
communications technologies, such as those for which the Company is known.
3. Through the first three quarters of fiscal 1998, the Company achieved in
excess of 45% revenue growth over the same period of fiscal 1997. This
revenue growth has been achieved almost entirely from sales of its products
for long distance applications; has occurred despite minimal or no
purchases from the three (soon to be two) long distance networks which by
industry estimates hold in excess of 80% of the U.S. long distance market
(AT&T, MCI and WorldCom); and represents shipments to eleven customers, as
compared to only four in fiscal 1997. The Company believes these facts are
indicators of (1) strong demand for bandwidth, (2) the level of seriousness
with which new carrier entrants are pursuing network buildouts and
expansion in the U.S. and worldwide.
11
<PAGE> 12
4. The Company comfortably estimates that it has over one million channel
miles of its long distance DWDM systems operating in live traffic
deployments in seven different networks, and with what it believes is an
outstanding record of reliability. The Company is not aware of any
competing DWDM supplier which has even a 16 channel system fully
operational and carrying live traffic; and is not aware of any competitor
which can currently equal the Company's DWDM manufacturing capacity and
volume delivery capability.
5. The gross margin pressure evident in the Company's third quarter in part
reflects the building of the Company's manufacturing capacity to
accommodate production requirements higher than were experienced in this
quarter. However, this capacity gives the Company the competitive advantage
of responsive, near term, high volume delivery capability. The Company
desires to preserve that advantage. The Company believes the recent gross
margin pressure is also a reflection of the aggressive pricing approaches
and other actions the long entrenched telecom equipment suppliers are
willing to take in order to obtain market share in the DWDM market. The
Company believes use of these aggressive tactics and other actions targeted
at CIENA is itself evidence that (1) the DWDM market is large and important
to network equipment vendors, and (2) CIENA is a recognized market
leader.
The Company believes it is positioned well in a strategically important
technology and product sector for the future of fiberoptic communications
networks. But this sector--if understood as being defined by communications
systems and products which increase capacity not incrementally but by orders of
magnitude by comparison to existing solutions--appears very much to be still in
its nascent stages, although it has the full attention of the long entrenched
telecom equipment vendors. Additionally, the potential customer base for such
systems and products is currently transforming from four dominant long distance
carriers (when the Company got started), to many new entrants (including for
this purpose new competitive thrusts by established carriers such as the RBOCs)
targeting some or all of a network's traditional segments--long distance, local
exchange, access, and, ultimately, the enterprise/user itself.
The Company believes these key observations of major change: an
important business sector in its nascent stages; a sector in which the
entrenched telecom equipment vendors must participate effectively for their
continued growth; and a customer environment characterized by considerable
activity by new entrants--further underscore that the Company's results will
likely continue to show significant quarter to quarter fluctuation on the top
and bottom lines. They also present what management believes is a business
opportunity geared well to an entrepreneurial, fast-moving, customer-responsive
culture. The Company believes it has the culture to capitalize on this
opportunity, but doing so is not without significant risks. See "Risk Factors".
Should the Company's near term results reflect further flatness or
declines in revenue and net income, both of which are very possible given the
current market environment and the continuing risks of the business, the
Company's stock price could face further volatility and downward pressure. At
the present time, the Company expects materially lower revenue and operating
results for the fourth fiscal quarter of 1998. See "Risk Factors". The Company
believes, however, that the right course over the next several quarters is to
stay the course in terms of maintaining the production capacity and delivery
capability which give the Company a key competitive advantage in this nascent
but high-growth-potential industry. The Company also believes that until timely
delivery of high volume equipment requirements and high quality customer service
and support are demonstrated by its competitors, the Company intends a measured
and gradual response to the pricing pressure created by competitors seeking to
acquire market share. The Company therefore intends to stay with this course,
even if near term operating performance, as measured by fluctuating revenues,
gross margins and earnings per share, suffers relative to analysts expectations.
HIGHLIGHTS OF THE QUARTER AND NINE MONTHS ENDED JULY 31, 1998
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 due to Pirelli, 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 $20.6 million and $30.6 million for the quarter and nine months
ended July 31, 1998, respectively, 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 and or results of operations See Part II, Item 1
"Legal Proceedings".
In February 1998 the Company completed its acquisition of Alta, a
provider of telecommunications engineering, furnishing and installation
services, located in Norcross, Georgia. The addition of Alta provides the
Company with the installation experience and extensive field support capability
required to assist customers with equipment deployment. See Note 5 of Notes to
Consolidated Financial Statements.
Revenues for the nine months ended July 31, 1998 of $416.9 million
were largely the result of MultiWave Sentry(TM)("Sentry"), Multiwave 4000
("4000"), and Multiwave 1600 ("1600") systems sales to Sprint Corporation
("Sprint").
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The Company also recognized revenues from 1600 sales to LDDS WorldCom
("WorldCom"). Substantially all of the revenue recognized from the sales to
WorldCom occurred in the Company's first quarter ended January 31, 1998. During
the nine months ended July 31, 1998 the Company received initial product
acceptance and revenue recognition for Sentry systems supplied to Cable and
Wireless Communications Group ("Cable and Wireless"). Additionally, during the
nine months ended July 31, 1998 the Company signed a one-year exclusive contract
with Hermes Europe Railtel ("Hermes") to supply the 4000 system. Deployment and
revenue recognition for the Hermes sales occurred in the Company's third quarter
ended July 31, 1998 with additional deployments expected during the fourth
quarter of fiscal 1998. Also during the nine months ended July 31, 1998 the
Company recognized revenue from sales of 4000 systems to Digital Teleport, Inc.
("DTI"), GST Telecommunications, Inc. ("GST") and through the Company's
distributor, NISSHO Electronics Corporation ("NISSHO"), sales of Sentry and 4000
systems to Teleway Japan Corporation ("Teleway"), Japan Telecom Co., Ltd ("Japan
Telecom") and to Daini Deuden Inc. of Japan ("DDI"). Revenue recognition for
certain of the Cable and Wireless, Hermes, Teleway and Japan Telecom shipments
had been previously deferred until completion of initial field testing and
product acceptance. Revenues for the nine months ended July 31, 1998 also
included the Company's initial product acceptance and revenue recognition from
1600 systems sales to GST. Revenues received from GST represent the Company's
first sales in the competitive local exchange carrier ("CLEC") market.
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 1600, Sentry and Firefly
systems. Deployment and revenue recognition is expected in the second half of
calendar 1998, subject to successful completion of ongoing testing. The Bell
Atlantic DWDM deployment is expected to mark the first time a regional Bell
operating company ("RBOC") has committed to deployment of DWDM equipment. See
"Risk Factors".
In June 1998 the Company announced an agreement to supply Sentry and
Firefly DWDM systems to Racal Telecom, one of Europe's leading providers of
managed network services. Deployment began in June 1998 with revenue recognition
expected in the second half of calendar 1998, subject to successful completion
of field testing. In June 1998 the Company also announced that it had signed,
jointly with CS telecom France, a five year contract with Telecom Development
("TD") of France to supply Sentry and Firefly DWDM systems for immediate
deployment. Deployment began in June 1998 for the first route supporting TD's
Paris to Lyon link with revenue recognition expected in the second half of
calendar 1998, subject to successful completion of installation and field
testing. See "Risk Factors".
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
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".
In August 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 192,500 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 67,000 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 July 31, 1998 the Company employed 1,366 persons, which
includes 222 persons as a result of the Company's acquisition of Alta. This was
an increase of 525 persons over the 841 persons employed on October 31, 1997.
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RESULTS OF OPERATIONS
THREE MONTHS ENDED JULY 31, 1997 COMPARED TO THREE MONTHS ENDED JULY 31,
1998
REVENUE. The Company recognized $121.8 million and $129.1 million in
revenue for the third quarters ended July 31, 1997 and 1998, respectively.
The approximate $7.3 million or 6.0% increase in revenues in the third
quarter 1998 compared to the third quarter 1997 was the result of increased
sales to Sprint and sales to new customers, offset by a substantial decline
in sales to WorldCom. The Company recognized DWDM systems revenue from two
and eleven customers, respectively, during quarters ended July 31, 1997 and
1998. A majority of the revenues in the Company's third quarter 1998 was
attributed to sales of the Company's 4000 system, the Company's 40 channel
version of the Sentry product, which was not available for sale in the
third quarter of 1997. The Company also believes the anticipated change to
calendar quarter reporting in connection with the planned merger with
Tellabs resulted in some shifting of orders out of the fiscal third
quarter.
GROSS PROFIT. Gross profits were $74.3 million and $58.7 million for
the third quarters ended July 31, 1997 and 1998, respectively. Gross margin
as a percentage of revenues was 61.0% and 45.5% for the third quarters 1997
and 1998, respectively. The approximate $15.6 million or 21% decrease in
gross profit in the third quarter 1998 compared to the third quarter 1997,
was generally the result of lower system selling prices and under absorbed
higher manufacturing costs in the third quarter 1998 compared to third
quarter 1997, but was also impacted specifically by price concessions
offered to a large customer in return for volume commitments. The customer
mix in a given quarter can significantly impact gross margins.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
were $7.2 million and $18.8 million for the third quarters ended July 31,
1997 and 1998, respectively. During the third quarters 1997 and 1998,
research and development expenses were 6.0% and 14.6% of revenue,
respectively. The approximate $11.6 million or 160% increase in research
and development expenses in the third quarter 1998 compared to the third
quarter 1997 was the result of increases in staffing levels, consumption of
prototype materials, write-off certain prototype parts, utilization of
outside consultants for certain development efforts and higher costs of
test equipment used to develop and test new products and features. The
Company expenses research and development costs as incurred.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses were
$6.7 million and $12.5 million for the third quarters ended July 31, 1997
and 1998, respectively. During the third quarters 1997 and 1998, selling
and marketing expenses were 5.5% and 9.7% of revenue, respectively. The
approximate $5.8 million or 86% increase in selling and marketing expenses
in the third quarter 1998 compared to the third quarter 1997 was primarily
the result of increased staffing levels in the areas of sales, technical
assistance and field support, and increases in trade show participation,
promotional costs, travel expenditures and rent expense.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses were $3.2 million and $3.9 million for the third quarters ended
July 31, 1997 and 1998, respectively. During the third quarters 1997 and
1998, general and administrative expenses were 2.7% and 3.0% of revenue,
respectively. The approximate $0.7 million or 21% increase in general and
administrative expenses from the third quarter 1997 compared to the third
quarter 1998 was primarily due to increased staffing levels and outside
consulting services.
PIRELLI LITIGATION. The Pirelli litigation charge of $20.6 million in
the third quarter 1998 was attributable to a $30.0 million payment made to
Pirelli during third quarter 1998 and to additional other legal and related
costs incurred in connection with the settlement of this litigation. These
charges were partially offset by accrued legal and related cost associated
with this litigation. See Note 4 of Notes to Consolidated Financial
Statements. See Part II, Item 1 "Legal Proceedings".
MERGER COSTS. The merger costs for the third quarter ended July 31,
1998 of $2.0 million were costs related to the contemplated merger between
the Company and Tellabs. These costs include approximately $1.2 million in
Securities and Exchange Commission filing fees and approximately $0.8
million in legal, accounting, and other related expenses.
OPERATING MARGINS. The Company's operating margins were $57.1 million
and $23.4 million for the third quarters ended July 31, 1997 and 1998,
respectively, exclusive of the effect of the one-time charges related to
the settlement of the Pirelli litigation and the costs associated with the
contemplated merger between the Company and Tellabs. During the third
quarters 1997 and 1998, operating margins were 46.8% and 18.2% of revenue,
respectively, exclusive of the effect of the one-time charges related to
the settlement of the Pirelli litigation and the costs associated with the
contemplated merger between the Company and Tellabs. The results of
operations for the third quarter 1998 are not necessarily indicative of
results to be expected in future periods. See "Risk Factors."
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INTEREST AND OTHER INCOME, NET. Interest income and other income
(expense), net were $1.5 million and $2.6 million for the third quarters
ended July 31, 1997 and 1998, respectively. The approximate $1.1 million
increase in interest income and other income (expense), net was
attributable to higher invested cash balances.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes
were $22.8 million and $1.3 million for the third quarters ended July 31,
1997 and 1998, respectively. During the third quarters 1997 and 1998, the
provision for income taxes were 38.9% and 38.0% of income before income
taxes, respectively. The decline in the income tax rate in third quarter
1998 compared to third quarter 1997 was the result of a lower combined
effective state income tax expenses, a larger benefit from the Company's
Foreign Sales Corporation and an increase in tax credits derived from
research and development activities.
NINE MONTHS ENDED JULY 31, 1997 COMPARED TO NINE MONTHS ENDED JULY 31, 1998
REVENUE. The Company recognized $283.1 million and $416.9 million in
revenue for the nine months ended July 31, 1997 and 1998, respectively. The
approximate $133.8 million or 47% increase in revenues in the nine months
ended July 31, 1998 compared to the nine months ended July 31, 1997 was
largely the result of increased sales to Sprint, Cable and Wireless,
Hermes, DTI, Teleway, and Japan Telecom offset by a decline in sales to
WorldCom. The Company had no sales for Cable and Wireless, Hermes, DTI, and
Japan Telecom in the first nine months of 1997. The Company recognized
DWDM systems revenue from three and eleven customers during the nine months
ended July 31, 1997 and 1998, respectively. A significant portion of the
increase in the Company's nine month 1998 revenues compared to nine month
1997 revenues was attributed to sales of the Company's Sentry and 4000
systems, which were not available for sale in the first nine months of
1997.
GROSS PROFIT. Gross profits were $166.9 million and $223.6 million
for the nine months ended July 31, 1997 and 1998, respectively. Gross
margin as a percentage of revenues was 58.9% and 53.6% for the nine months
ended July 31, 1997 and 1998, respectively. The approximate $56.7 million
or 34% increase in gross profit in the first nine months of 1998 compared
to the first nine months of 1997 was the result of increased revenues for
those periods. The decline in gross margin percentage for the comparable
periods was the result of a combination of factors including: a reduction
in selling price due to the Company's market penetration efforts and
increased competitive pressures, partially offset by reductions in
component costs and by reductions in the percentage of significantly lower
margin installation service revenue to total revenues for the periods.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
were $15.0 million and $45.7 million for the nine months ended July 31,
1997 and 1998, respectively. During the first nine months of 1997 and 1998,
research and development expenses were 5.3% and 11.0% of revenue,
respectively. The approximate $30.7 million or 205% increase in research
and development expenses in the first nine months of 1998 compared to the
first nine months of 1997 was the result of increases in staffing levels,
consumption of prototype materials, utilization of outside consultants for
certain development efforts and higher costs of test equipment used to
develop and test new products and features. The Company expenses research
and development costs as incurred.
SELLING AND MARKETING EXPENSES. Selling and marketing expenses were
$14.7 million and $33.5 million for the nine months ended July 31, 1997 and
1998, respectively. During the first nine months of 1997 and 1998, selling
and marketing expenses were 5.2% and 8.0% of revenue, respectively. The
approximate $18.8 million or 128% increase in selling and marketing
expenses in the first nine months of 1998 compared to the first nine months
of 1997 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, promotional costs, travel
expenditures and rent expense.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses were $8.0 million and $12.1 million for the nine months ended July
31, 1997 and 1998, respectively. During the first nine months of 1997 and
1998, general and administrative expenses were 2.8% and 2.9% of revenue,
respectively. The approximate $4.1 million or 51% increase in general and
administrative expenses in the first nine months of 1998 compared to the
first nine months of 1997 was primarily increased staffing levels and
outside consulting services.
PURCHASED RESEARCH AND DEVELOPMENT. Purchased research and
development costs were $9.5 million for the nine months ended July 31,
1998. These costs were for the purchase of technology and related assets
associated with the acquisition of Terabit during the second quarter 1998.
See Note 5 of Notes to Consolidated Financial Statements.
PIRELLI LITIGATION. The Pirelli litigation costs of $30.6 million in
for the nine months ended July 31, 1998 was attributable to a $30.0 million
payment made to Pirelli during third quarter 1998 and to additional other
legal and related costs incurred in connection with the settlement of this
litigation. See Note 4 of Notes to Consolidated Financial Statements. See
Part II, Item 1 "Legal Proceedings".
MERGER COSTS. The merger costs for the nine months ended July 31,
1998 were costs related to the contemplated merger between the Company and
Tellabs. These costs include approximately $1.2 million in Securities
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and Exchange Commission filing fees and approximately $0.8 million in
legal, accounting, and other related expenses.
OPERATING MARGINS. The Company's operating margins were $129.1
million and $132.3 million for the nine months ended July 31,1997 and 1998,
respectively, exclusive of one time charges related to purchased research
and development, Pirelli litigation and costs associated with the
contemplated merger between the Company and Tellabs. During the first nine
months of 1997 and 1998, operating margins were 45.6% and 31.7% of revenue,
respectively, exclusive of exclusive of one time charges related to
purchased research and development, Pirelli litigation and costs associated
with the contemplated merger between the Company and Tellabs. The results
of operations for the nine months ended July 31, 1998 are not necessarily
indicative of results to be expected in future periods. See "Risk Factors."
INTEREST AND OTHER INCOME, NET. Interest income and other income
(expense), net were $3.9 million and $9.8 million for the nine months ended
July 31, 1997 and 1998, respectively. The approximate $5.9 million increase
in interest income and other income (expense), net was attributable to
higher invested cash balances.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes
were $49.6 million and $42.6 million for the nine months ended July 31,
1997 and 1998, respectively. During the first nine months of 1997 and 1998,
the provision for income taxes were 38.9% and 38.5% of income before income
taxes, respectively, exclusive of the effect of one-time charges for
purchased research and development expenses recorded in the second quarter
of 1998 and an adjustment to the estimated state income tax liability
associated with the Alta operations recorded in Alta's first quarter of
1998. Purchased research and development charges are not deductible for tax
purposes. The decrease in the income tax rate, exclusive of one-time
charges, for the first nine months of 1998 compared to first nine months of
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 tax credits derived from research and development.
LIQUIDITY AND CAPITAL RESOURCES
At July 31, 1998, the Company's principal source of liquidity was its
cash and cash equivalents of $193.5 million and its marketable debt
securities of $28.1 million. The Company's marketable debt securities have
maturities no longer than six months.
Cash generated from operations was $2.6 million for the nine months
ended July 31, 1998. This amount was principally attributable to net
income, the non-cash charges of depreciation, amortization, provisions for
inventory obsolescence and warranty, purchased research and development,
increases in accounts payable, and accrued expenses; offset by increases in
prepaid income taxes, accounts receivable and inventory due to increased
revenue and to the general increase in business activity.
Investment activities in the nine months ended July 31, 1998 included
the net purchase of $28.1 million worth of corporate debt securities, $77.6
million invested in capital expenditures and $2.1 million used in the
acquisition of Astracom and Terabit. Of the amount invested in capital
expenditures, $68.3 million was used for additions to capital equipment and
furniture and the remaining $9.3 million was invested in leasehold
improvements.
The Company made a payment of $30.0 million during June 1998 in
connection with the settlement of the Pirelli litigation. See Note 4 of
Notes to Consolidated Financial Statements. See Part II, Item 1 "Legal
Proceedings".
The Company believes that its existing cash balance and cash flows
from future operations will be sufficient to meet the Company's capital
requirement for at least the next 18 to 24 months.
YEAR 2000 READINESS
The Company has taken actions to understand the nature and extent of
the work required to make its systems, products and infrastructure Year
2000 compliant. The Company began work this year to change its main
financial, manufacturing and information system to a company-wide Year 2000
compliant enterprise resource planning ("ERP") computer-based system and
expects to have the ERP system fully installed in the fourth quarter of
1998. The Company believes, based on available information, that it will be
able to manage its Year 2000 transition without any material adverse effect
on the Company's business, financial condition and results of operations.
The Company estimates that it has spent approximately $4.0 million on its
ERP implementation and estimates that it well likely spend $25,000 to
$50,000 to address remaining identified Year 2000 issues. The Company
expects that it will use cash from operations for Year 2000 readiness
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 and independent verification and validation
processes to assure the reliability of its risk and cost estimates
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RISK FACTORS
ORGANIZATIONAL FOCUS. The Company has been subjected to an avalanche
of negative media coverage in recent weeks. An oddly timed communication
from AT&T on August 21, 1998, arriving less than an hour before the
shareholder votes of both Tellabs and CIENA to approve the merger, and
indicating its decision to remove CIENA from further consideration as a
DWDM vendor, added to the media blitz. A shareholder class action lawsuit
has been filed against the Company and certain members of its management
team. Within a week of the AT&T August 21 announcement, the exchange ratio
in the proposed merger with Tellabs was renegotiated from one share of
Tellabs Common Stock for each share of CIENA Common Stock, to .8 shares of
Tellabs Common Stock for each share of CIENA Common Stock. On September 9,
1998, the Company received a copy of a press release indicating that
Digital Teleport, Inc. ("DTI"), a customer based in St. Louis, Missouri,
had committed 80% of its planned purchases of DWDM equipment to Pirelli
Cables and Systems, as part of an apparent package which included Pirelli's
supply of fiber optic cable needed by DTI to build out its planned national
network. On September 13, 1998, Tellabs and the Company agreed to
terminate the merger agreement. The cumulative impact of these events and
their attendant publicity has caused and may continue to cause a
significant distraction of management time and energy from the more direct
needs of operating and growing the business. The impact of the distraction
of recent weeks is difficult to project, and could result in adverse
effects on the near term operating condition and performance of the
Company. Additionally, the Company believes certain of the media coverage
was substantially influenced by orchestrated activities of one or more
short sellers, and of a competitor of the Company. Based on the
precipitous decline of the Company's stock price in recent weeks, the
activities of the short seller are believed to have been concluded; there
is no assurance, however, that the tactics used by the competition to
foster adverse publicity regarding the Company will cease. See
"Competition".
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. The Company further
believes its MultiWave 1600 is the only commercially deployed and
operational full 16-channel open architecture DWDM system anywhere in the
world, and further believes the demonstrated commercial manufacturability
and delivery record of its MultiWave 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 and more extensive and
established customer relationships with network operators than the
Company. Each of Lucent, Alcatel, Nortel, NEC, Pirelli, Siemens and
Ericsson are moving very aggressively to capture market share in the DWDM
market. The Company expects and has experienced aggressive competitive
moves from industry participants, which have to date included early
announcement of competing or alternative products, substantial and
increasing price discounting, and other tactics designed specifically to
target CIENA and its products. Such early announcements of competing
products can 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 1997 a
proposed high-capacity DWDM system which it claims will handle 400 Gb/s of
capacity per fiber, and which it further claims will be commercially
available worldwide in the fourth quarter. There can be no assurance that
announcements like those of Lucent or others in the industry will not
cause confusion and delay in customer purchasing decisions. Further, if
new products such as that announced by Lucent are in fact developed,
perform as advertised, and are manufacturable in volume quantities by the
fourth quarter of this year, the likelihood of significant orders for the
Company's 16-channel MultiWave Sentry and 40-channel MultiWave 4000
systems may diminish. The timing of shipments by the Company and
corresponding revenue, if delayed by reason of deferred deployment of
MultiWave Sentry or MultiWave 4000 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.
In addition, Lucent, Alcatel, Nortel, NEC and Siemens are already
providers of a full complement of switches, fiberoptic transmission
terminals and fiberoptic signal regenerators and thereby can position
themselves as vertically integrated, "one-stop shopping" solution providers
to potential customers.
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 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. For example, on
September 9, 1998, the Company received a copy of a press release
indicating that DTI, a customer based in St. Louis, Missouri, had committed
80% of its planned purchases of DWDM equipment to Pirelli Cables and
Systems, as part of an apparent package which included Pirelli's supply of
fiber optic cable needed by DTI to build out its planned national network.
While the Company has supplied its DWDM equipment to DTI, believes DTI is
satisfied with the operation of the equipment, and is expected to continue
to be a second source vendor of DWDM equipment to DTI, the Company is not
able to offer fiber optic cable or other products over which it could
spread the effects of price discounts on DWDM equipment. The
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Company's ability to obtain orders from DTI in the near term may
therefore be limited absent substantial price discounting.
The Company's customers generally prefer to have at least two sources
for key network equipment such as DWDM systems, but the Company 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. The DTI/Pirelli announcement of
September 9 is an example of this. Sprint has for several quarters
indicated it intends to establish a second vendor for DWDM equipment. 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 decisions which are not under the control of the Company, and 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.
The Company has also been accumulating evidence that a competitor may
have engaged in targeted and legally questionable activities in order to
undermine the Company's market position as well as the proposed merger with
Tellabs. The Company has not yet reached any conclusions regarding this
evidence, and is continuing to investigate. But the mere fact that one or
more competitors are apparently willing to resort to such tactics suggests
how intense the competition is and, from the Company's point of view, how
far ahead of the competition the Company's products apparently are. The
Company believes the short-term impact of such tactics can be significant;
in fact, the Company believes at least some of the adversity it has
recently encountered is a direct result of such tactics. There is no
assurance that use of such tactics will cease.
There can be no assurance that the Company will be able to compete
successfully with its competitors or that aggressive competitive moves
faced by the Company will not result in 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.
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
WorldCom, and will in the near term continue to be highly dependent on
those two customers, and on the development of new customers, as well as
obtaining additional business from existing customers. While the scope of
commercial applications of the Company's MultiWave Metro product (scheduled
for general availability by the end of 1998) and MultiWave Firefly 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
WorldCom. AT&T was a potential source for significant additional revenue,
but on August 21, 1998, less than an hour before the shareholder votes of
both Tellabs and CIENA to approve their merger, AT&T informed CIENA of its
decision to remove CIENA from further consideration as a DWDM vendor. The
loss of AT&T as a potential customer heightens the risks to CIENA inherent
in having a relatively small number of customers. The number of potential
major customers may also decrease if and as customers merge with or acquire
one another. In November 1997, WorldCom and MCI announced an agreement to
merge; 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 Company believes WorldCom is very satisfied with the Company's
products, and intends to continue significant purchases; however, WorldCom
informed the Company in February 1998 that its DWDM system requirements for
1998 will be substantially reduced, based on a change in WorldCom's capital
equipment acquisition policies. According to information shared with the
Company in February 1998, WorldCom purchased equipment during 1997, based
on a policy designed to meet an estimated two years worth of anticipated
network capacity requirements. The new policy calls for purchasing activity
and bandwidth deployment to more closely coincide with just in time
inventory management, which, according to WorldCom, means significant
purchasing from CIENA may not resume until the latter part of calendar
1998. Consistent with WorldCom's announced change in purchasing practices,
WorldCom's purchases in the Company's third quarter were not material. The
extent to which the recent adverse publicity concerning the Company will
impact WorldCom's decisions as to whether or when to resume purchasing
cannot be predicted; it is clear, however, that the Company will have to
continue to demonstrate to WorldCom and its other customers that the
Company's existing products and products in development represent
attractive value in comparison to the alternatives available in the market.
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The Company also believes Sprint is very satisfied with the Company's
products, and intends to continue significant purchases; however, Sprint
has for several quarters indicated it intends to establish a second vendor
for DWDM equipment. 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 decisions which are not under the
control of the Company, and 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.
The reduction, delay or cancellation of orders for, or a delay in
shipment of the Company's products to Sprint, or a failure by WorldCom to
resume purchasing at significant levels in the latter part of calendar
1998, or the inability to develop additional customers in the
telecommunications market would have a material adverse affect on the
Company's business, financial condition and results of operations. The
extent to which the recent negative publicity relating to the Company and
its renegotiated 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, and if the negative
publicity has the effect of causing customer to delay or reduce purchases
from the Company, the adverse effect could be material. See "Organizational
Focus."
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. Due to
the size and complexity of the AT&T network, and the uniqueness of AT&T's
requirements for the MultiWave Sentry, the Company invested considerable
financial, engineering, manufacturing and logistics support resources in
positioning the commercial relationship to be successful. The Company's
acquisition of Alta, an installation services company, is another example
of this risk. This acquisition, closed in the second fiscal quarter of
1998, has brought approximately 160 installation personnel to the Company,
and was undertaken in large part to position the Company to be able to
service the installation requirements associated with any AT&T deployment,
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's near term earnings may moderate or even decline, even if
revenues were to increase, which is not likely in the near term. The
Company presently expects fiscal fourth quarter 1998 revenues and operating
results will be materially below those reported for the third fiscal
quarter 1998. If the Company is unable to convert these investments into
significant revenue generating relationships over the next two or three
quarters, the Company's business, financial condition and results of
operations for the year could be materially and adversely affected.
IMPACTS OF CHANGES IN CUSTOMER MIX. With the loss of AT&T as a
potential customer, and with WorldCom yet to resume significant purchasing,
the Company's sales efforts must focus 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 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 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. For example, in the fiscal third quarter being reported
hereby, an unanticipated delay in a $25 million order from a new carrier
customer was the principal cause of a shortfall of revenue relative to
investor expectations and, in turn, significant stock price volatility.
Although this customer, DTI, was believed to have a clear need for DWDM
equipment, and was expected to place a substantial order with the Company
in the near term, the impact of the delay in the third fiscal quarter was
significant and adverse to the Company's results of operations, and
investor reaction was particularly adverse. A similar scenario could occur
in the next few quarters, as much of the Company's anticipated revenue over
this period is comprised of less than $25 million orders from each of
several customers. See "Stock Price Volatility". Then, on September 9,
1998, the Company the Company received a copy of a press release indicating
that DTI had committed 80% of its planned purchases of DWDM equipment to
Pirelli Cables and Systems, as part of an apparent package which included
Pirelli's supply of fiber optic cable needed by DTI to build out its
planned national network. While the Company is expected to continue to be a
second source vendor of DWDM equipment to DTI, the Company is not able to
offer fiber optic cable or
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other products over which it could spread the effects of price
discounts on DWDM equipment. The Company's ability to obtain any orders
from DTI in the near term may therefore be limited absent substantial price
discounting.
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 1600 system. 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 the
MultiWave 1600 system. 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 not experienced to date any general
decline in reliability among these vendors, but the intensifying
competition described above makes this risk factor increasingly important.
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, may cause material
fluctuations in revenue. As an example, the unexpected delay of an
anticipated $25 million order from DTI during the third fiscal quarter
materially impacted the Company's results of operations. This order now
appears likely to be further delayed, reduced or possibly withheld
completely as the result of certain commitments made by the DTI with
Pirelli. 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 or introduces other DWDM products, such as the
MultiWave Sentry, MultiWave 4000, MultiWave Firefly and the 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, may also lead to
delay or deferral of purchasing decisions. 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. See "Impacts of Changes in Customer Mix".
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 are expected to reflect
substantially increased investment in financial, engineering, manufacturing
and logistics support resources in positioning 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 the 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 earnings may moderate or decline, even if
revenues were to increase, which is not likely in the near term. The
Company presently expects fiscal fourth quarter 1998 revenues and operating
results will be materially below those reported for the third fiscal
quarter 1998. In general, quarter-to-quarter sequential revenue in the
first two or three years of operations are likely to vary widely 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. Competition for such personnel is intense and there can be no
assurance that the Company will be successful in retaining its existing key
personnel and in attracting and retaining the personnel it requires.
Competition for such personnel often intensifies when a company becomes
party to a merger, as various recruiters look for key personnel interested
in leaving. The pending and now terminated merger with Tellabs, and the
attendant publicity and media speculation regarding its outcome, have
introduced uncertainty among personnel relating to the future direction of
the Company. See "Organizational Focus" Additionally, the stock price
volatility and eventual decline attendant to events of the past few weeks
have left many key contributors to the Company without meaningful equity
incentives--their incentive stock options are now significantly "out of
the money". The Company believes its management team and other key
contributors were and are committed to remain intact, with or without the
merger with Tellabs, but there can be no assurance of that, and the loss
of equity incentives may adversely effect the Company's ability to retain
them. Failure to retain the Company's key personnel, and attract new
personnel likely would have a material adverse effect on the Company's
business, financial condition and results of operations.
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LEGAL PROCEEDINGS. See Part II, "Legal Proceedings" for disclosure
concerning a recent shareholder class action lawsuit filed against the
Company and certain of its officers and directors. Because the matter is at
an early stage, it is not possible to predict its 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.
ANTICIPATING DEMAND FOR BANDWIDTH. The Company's systems enable high
capacity transmission over long distance, and with the introduction of
MultiWave Firefly, 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 carriers' 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 have
believed the deployment of large-scale capacity quickly will be a
competitive advantage--i.e., they have assumed the accelerating demand for
bandwidth will continue and the 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 last year's purchases of $184.5 million. WorldCom
indicated to the Company that last year it purchased DWDM systems from the
Company at a level that contemplated two years' of capacity requirements,
and that this year's purchases would be substantially reduced because
limited to one year's estimate of capacity requirements. 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, the Company has shipped equipment
during fiscal 1998 to several new customers attempting to build out new
networks--under circumstances where the Company had not even identified
these customer opportunities within a year of 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.
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. Additionally, a typical year end wind-down of customers' annual
capital equipment procurement cycles, or a seasonal slow down in
purchasing, neither of which was experienced by the Company in its first
year of product shipments, may be experienced in this and future years.
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 this 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. Unless and until WorldCom resumes
purchases at a level comparable to the prior fiscal year, the Company will
continue to need material purchases from one or more other customers in
order to offset the reduction from WorldCom. There can be no assurance of
the Company's ability to offset reductions, and in particular, Sprint is
unlikely to continue purchasing at the rate experienced in the two quarters
just completed.
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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 Company's business, financial condition and results of operations. For
example, an expected $25 million order for the third fiscal quarter was
unexpectedly delayed by the customer late in the quarter just completed,
leading in substantial part to a shortfall in revenue and net income
relative to investor expectations. This delayed order now appears likely to
be further delayed, reduced or possibly withheld completely as the result
of new commitments by the customer to purchase DWDM equipment from a
competitor. See discussion of DTI under "Competition" and "Impacts of
Changes in Customer Mix".
Further, as is the case with most manufacturing companies, the
Company has manufactured, and from time to time in the future likely will
manufacture 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. Long distance carriers 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 or deferral 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.
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. 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 Firefly. The failure to
deliver new and improved products, or appropriately customized products, in
a timely fashion relative to customer expectations (which expectations 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 delivery of MultiWave Sentry, MultiWave 4000 and
MultiWave Firefly at various times during this fiscal year. 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 telecom 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 continued purchasing by its
customers.
RECENT PRODUCT INTRODUCTION. The MultiWave 1600 has been operational
and carrying live traffic for approximately two years; the MultiWave Sentry
and MultiWave 4000 for less than a year; and the MultiWave Firefly is just
now being introduced into the field. 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.
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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 quarter 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 declining level 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 this quarter, as a $25 million
order from a customer was unexpectedly delayed late in the quarter. This
delayed order now appears likely to be further delayed, reduced or possibly
withheld completely as the result of new commitments by the customer to
purchase DWDM equipment from a competitor. See discussion of DTI under
"Competition" and "Impacts of Changes in Customer Mix".
The WorldCom example, and the example of this 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. 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 current fiscal year, when
substantial majority of purchases by these customers are likely to be
focused on products, such as MultiWave Sentry, MultiWave 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".
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
PIRELLI LITIGATION
On June 1, 1998 the Company announced resolution of the long-standing
litigation with Pirelli S.p.A. The terms of the settlement involve
dismissal of Pirelli's three lawsuits against CIENA now 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, and certain undisclosed financial
terms. As a result of the settlement, CIENA recorded a one-time charge for
the nine months ended July 31, 1998, of $30.6 million relating to the
Pirelli settlement and associated legal fees.
KIMBERLIN LITIGATION
Kevin Kimberlin and parties controlled by him (the "Kimberlin
Parties") are owners of Common Stock of the Company, the substantial
majority of which has been derived from the conversion at the time of the
Company's IPO of Series A, Series B and Series C Preferred Stock then owned
by them. On November 20, 1996, the Kimberlin Parties filed suit in U.S.
District Court for the Southern District of New York against the Company,
and certain directors of the Company, alleging that the Kimberlin Parties
were entitled to purchase additional shares of Series C Preferred Stock at
the time of the closing of the Series C Preferred Stock financing, but were
denied that opportunity by the defendants. The lawsuit alleges that certain
rights of first refusal existing under the Series B Preferred Stock
Purchase Agreement entitled the Kimberlin Parties to purchase more shares
of Series C Preferred Stock than were in fact purchased by them at the time
of the closing of the Series C Preferred Stock financing in December 1995.
The lawsuit claims breach of contract, breach of fiduciary duty and
violation of Securities and Exchange Commission Rule 10b-5 by the
defendants. On January 6, 1997, the Company filed its answer to the
Kimberlin Parties complaint, and filed a counterclaim for rescission of the
sale of the shares of Series C Preferred Stock purchased by the Kimberlin
Parties in the Series C Preferred Stock financing. The Kimberlin Parties
amended their complaint in May 1997,
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alleging that the same facts and conduct with respect to the private
placement of Series C Preferred Stock represent a violation of federal
insider trading laws.
The number of shares to be purchased by each party to the Series C
Preferred Stock financing was communicated in writing to the Kimberlin
Parties in December 1995 prior to the Series C closing. Further, as
permitted under the Series B Preferred Stock Purchase Agreement, the Series
C Preferred Stock Purchase Agreement expressly stated that all rights of
first refusal referred to in the lawsuit were waived. The required number
of Series B investors, including the Kimberlin Parties, signed the Series C
Preferred Stock Purchase Agreement containing that waiver. In July 1996,
the Kimberlin Parties reaffirmed to the Company in writing that their
beneficial ownership of shares did not include any shares which they have
subsequently claimed in the lawsuit they were entitled to purchase. The
Kimberlin Parties allege that they were misled into waiving their right of
first refusal, and did not discover that they had been misled until October
1996.
The Company believes that the Kimberlin Parties' claims, brought as
the Company's IPO was being prepared, and the amended claims, are without
merit and intends to defend itself vigorously. The Company has moved for
summary judgment on the entire matter, including the Company's counterclaim
for rescission. The Kimberlin Parties have also moved for summary judgment
on a portion of the dispute. The Company believes its motion for summary
judgment should be granted, but there is no assurance of that outcome. If
the motion is not granted the Company intends to proceed to trial.
If the Company's motion for summary judgment is denied, the Company
intends to take the matter to trial; if the plaintiff's motion is granted,
the Company intends to appeal. There can be no assurance of the outcome of
the pending motions.
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). The complaint alleges that CIENA
and certain officers and directors violated certain provisions of the
federal securities laws, including 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 August 21, 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. While this proceeding is at a very early stage, the
Company believes the suit is without merit and intends to defend itself
vigorously.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Description
------- -----------
11.0 Statement of Computation of Per Share Earnings -
see Note 1 of Notes to Consolidated Financial
Statements
27.0 Financial Data Schedule (filed only electronically
with the SEC)
(b) Reports on Form 8-K: Form 8-K filed June 3, 1998, June 23, 1998,
August 14, 1998, August 24, 1998 and August 27, 1998
24
<PAGE> 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CIENA CORPORATION
Date: September 14, 1998 By: /s/ Patrick H. Nettles
------------------- ----------------------
Patrick H. Nettles
President, Chief
Executive Officer
and Director
(Duly Authorized Officer)
Date: September 14, 1998 By: /s/ Joseph R. Chinnici
------------------- ----------------------
Joseph R. Chinnici
Senior Vice President,
Finance and
Chief Financial Officer
(Principal Financial Officer)
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains Summary Financial Information extracted from The
Balance Sheet, Statement of Operation and Statement of Cash Flows included
in the Company's Form 10-Q for the period ending July 31, 1998, and is qualified
in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> MAY-01-1998
<PERIOD-END> JUL-31-1998
<CASH> 193,486
<SECURITIES> 28,132
<RECEIVABLES> 109,210
<ALLOWANCES> 730
<INVENTORY> 76,343
<CURRENT-ASSETS> 444,913
<PP&E> 158,643
<DEPRECIATION> 33,383
<TOTAL-ASSETS> 591,235
<CURRENT-LIABILITIES> 77,366
<BONDS> 0
0
0
<COMMON> 1,025
<OTHER-SE> 479,906
<TOTAL-LIABILITY-AND-EQUITY> 591,235
<SALES> 129,116
<TOTAL-REVENUES> 129,116
<CGS> 70,431
<TOTAL-COSTS> 70,431
<OTHER-EXPENSES> 57,835
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 58
<INCOME-PRETAX> 3,369
<INCOME-TAX> 1,280
<INCOME-CONTINUING> 2,089
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,089
<EPS-PRIMARY> 0.02
<EPS-DILUTED> 0.02
</TABLE>
