Here's the management discussion from Ciena's amended 8-K:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Supplemental Consolidated Financial Data" and the Company's
supplemental consolidated financial statements and notes thereto included
elsewhere in this report on Form 8-K/A. The information in this Form 8-K/A
contains certain forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, risk factors disclosed in
the Company's annual report on Form 10-K for the fiscal year ended October 31,
1998 and risk factors contained in the Company's quarterly reports on Form 10-Q
and current reports on Form 8-K files thereafter. The information presented in
this report is presented as of October 31, 1998 and has not been updated or
changed to reflect any events subsequent to that date, other than the
acquisition of Lightera Networks, Inc.
OVERVIEW
This management discussion and analysis of financial condition and results
of operations has been restated to give retroactive effect to the Company's
March 1999 acquisition of Lightera Networks, Inc., ("Lightera"), a U.S. company
headquartered in Cupertino, California, in a transaction valued at approximately
$463.5 million. Lightera is a developer of carrier class optical core switches.
Under the terms of the agreement, the Company acquired all of the outstanding
shares and stock options of Lightera in exchange for approximately 17.5 million
shares of CIENA common stock and 3.1 million stock options of CIENA. The
transaction constituted a tax-free reorganization and has been accounted for as
a pooling of interest under Accounting Principles Board Opinion No. 16.
Accordingly, all prior period consolidated financial statements presented have
been restated to include the combined results of operations, financial position
and cash flows of Lightera as though it had been a part of CIENA.
CIENA Corporation designs, manufactures and sells open architecture, DWDM
systems for fiberoptic communications networks, including long-distance and
local exchange carriers. CIENA also provides a range of engineering, furnishing
and installation services for telecommunications service providers.
Fiscal 1998 was a year of dramatic events affecting the Company. Soon
after the close of the first fiscal quarter, MCIWorldCom, the Company's largest
customer of fiscal 1997, surprised the Company with an announcement of a major
change in purchasing practices - a change that meant materially reduced revenue
for the Company. This adverse event was followed in the second quarter by the
Company's successful, large scale commercial introduction of the Company's
industry leading 40-channel MultiWave Sentry 4000. The third quarter included
resolution of the Company's longstanding Pirelli SpA ("Pirelli") litigation,
which was followed on June 3, 1998 with the announcement of a planned merger
with Tellabs, Inc. In the fourth quarter, just prior to consummation of the
merger, AT&T advised the Company that it would no longer consider CIENA's long
distance DWDM products for deployment in AT&T's network. The planned merger with
Tellabs was later terminated on September 14, 1998.
The Company's final results for fiscal 1998, its second full year in the
DWDM marketplace, show total revenues in excess of $500 million. The Company
believes this represents a considerable achievement, particularly given the
substantial portion of revenues derived from the sale of its now
third-generation DWDM product, the MultiWave Sentry 4000. Nevertheless, the
termination of the Tellabs merger represented a setback for the Company.
The outlook for fiscal 1999 is challenging. The price discounting offered
by competitors striving to catch up to the Company and acquire market share has
placed pressure on gross margins and operating profitability. But market demand
for high-bandwidth solutions still appears robust, and the Company believes that
its product and service quality, manufacturing experience, and proven track
record of delivery will enable it to endure the gross margin pressure while it
concentrates on efforts to reduce product costs and maximize production
efficiencies. The Company intends to continue this strategy in order to preserve
and enhance market leadership and eventually build on its installed base with
new and additional products. Pursuit of this strategy, in conjunction with
increased investments in selling, marketing, and customer service activities,
will likely limit the Company's operating profitability over at least the first
half of fiscal 1999, and may result in near term operating losses.
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HIGHLIGHTS OF THE FISCAL YEAR 1998
The Company recognizes product revenue in accordance with the shipping
terms specified. For transactions where the Company has yet to obtain customer
acceptance, revenue is deferred until the terms of acceptance are satisfied.
Revenue for installation services is recognized as the services are performed
unless the terms of the supply contract combine product acceptance with
installation, in which case revenues for installation services are recognized
when the terms of acceptance are satisfied and installation is completed.
Revenues from installation service fixed price contracts are recognized on the
percentage of costs incurred to date compared to estimated total costs for each
contract. Amounts received in excess of revenue recognized are recorded as
deferred revenue. For distributor sales where risks of ownership have not
transferred, the Company recognizes revenue when the product is shipped to the
end user.
For the fiscal year ended October 31, 1998, the Company recorded $508.1
million in revenue of which $266.9 million was from sales to Sprint. The Company
increased the total number of customers for DWDM systems from five customers in
fiscal 1997 to fourteen customers in fiscal 1998. Revenue from sales to WorldCom
declined from approximately $184.5 million in fiscal 1997 to an amount less than
10% of the Company's total fiscal 1998 revenue. Substantially all of the revenue
recognized from the sales to WorldCom occurred in the Company's first quarter
ended January 31, 1998. In addition to Sprint and WorldCom, during the fiscal
year ended October 31, 1998 the Company recognized revenue from Cable and
Wireless; Hermes; Enron; Racal; Telia of Sweden; TD of France; DTI; GST; and,
through the Company's distributor, NISSHO Electronics Corporation ("NISSHO"),
sales to Teleway, Japan Telecom and to DDI. The Company also recognized an
immaterial amount of revenue from one undisclosed customer.
During December 1997 the Company acquired Astracom, an early stage
telecommunications company located in Atlanta, Georgia. The employees of
Astracom were immediately deployed to assist with the Company's development
efforts from its MultiWave Metro product. The purchase price was approximately
$13.1 million and consisted of the issuance of 169,754 shares of CIENA common
stock, the payment of $2.4 million in cash, and the assumption of certain stock
options. The transaction was recorded using the purchase accounting method with
the purchase price representing approximately $11.4 million in goodwill and
other intangibles, and approximately $1.7 million in net assets assumed. The
amortization period for the intangibles, based on management's estimate of the
useful life of the acquired technology, is five years.
In February 1998 the Company acquired Alta, a Canadian corporation
headquartered near Atlanta, Georgia, in a transaction valued at approximately
$52.5 million. Alta provides a range of engineering, furnishing and installation
services for telecommunications service providers in the areas of transport,
switching and wireless communications. Under the terms of the agreement, the
Company acquired all of the outstanding shares of Alta in exchange for 1,000,000
shares of CIENA common stock. The transaction constituted a tax-free
reorganization and has been accounted for as a pooling of interest under
Accounting Principles Board Opinion No. 16. Accordingly, all prior period
consolidated financial statements presented have been restated to include the
combined results of operations, financial position and cash flows of Alta as
though it had always been a part of CIENA.
In March 1998 the Company announced an agreement to supply Bell Atlantic
with DWDM optical transmission systems. The supply agreement has no minimum
purchase commitments and includes the Company's MultiWave 1600, Sentry and
Firefly systems. Deployment and revenue recognition is expected in the first
half of calendar 1999, subject to successful completion of ongoing testing. The
Bell Atlantic DWDM deployment is expected to mark the first time a RBOC has
committed to deployment of DWDM equipment.
During April 1998 the Company acquired Terabit, a developer of optical
components known as photodetectors or optical receivers. The Company believes
the technology currently under development at Terabit may give it a strategic
advantage over its competitors. Terabit is located in Santa Barbara, California.
The purchase price was approximately $11.5 million and consisted of the issuance
of 134,390 shares of CIENA common stock, the payment of $1.1 million in cash,
and the assumption of certain stock options. The transaction was recorded using
the purchase accounting method with the purchase price representing
approximately $9.5 million in purchased research and development, $1.8 million
in goodwill and other intangibles, and approximately $0.2 million in net assets
assumed. The amortization period for the intangibles, based on management's
estimate of the useful life of the acquired technology, is five years.
From December 1996 until June 1998, the Company was involved in litigation
with Pirelli. On June 1, 1998, the Company announced the resolution of all
pending litigation with Pirelli. The terms of the settlement involved the
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dismissal of Pirelli's three lawsuits against the Company that were pending in
Delaware, dismissal of the Company's legal proceedings against Pirelli in the
United States International Trade Commission, payment to Pirelli of $30.0
million and certain running royalties, a worldwide, non-exclusive cross-license
to each party's patent portfolios, and a 5-year moratorium on future litigation
between the parties. The Company recorded a charge of approximately $30.6
million for the year ended October 31, 1998, relating to legal fees and the
ultimate settlement to Pirelli. The payment of future royalties due to Pirelli
is based upon future revenues derived from the licensed technology. The Company
does not expect the future royalty payments to have a material impact on the
Company's business, financial condition or results of operations.
On June 3, 1998 the Company announced an agreement to merge with Tellabs,
Inc. ("Tellabs"), a Delaware corporation headquartered in Lisle, Illinois.
Tellabs designs, manufactures, markets and services voice and data transport
network access systems. Under the terms of the original agreement, all
outstanding shares of CIENA stock were to have been exchanged at the ratio of
one share of Tellabs common stock for each share of CIENA common stock. On
August 21, 1998 the Company was informed by AT&T that AT&T had decided not to
pursue further evaluation of CIENA's DWDM systems. Following the impact of the
AT&T announcement on the market prices of the common stock of the respective
companies, the Company and Tellabs management renegotiated the terms of the
merger agreement, and on August 28, 1998 announced an amendment to the original
merger agreement which was approved by the respective companys' boards of
directors. Under the terms of the agreement as amended, all outstanding shares
of CIENA stock were to have been exchanged at the ratio of 0.8 share of Tellabs
common stock for each share of CIENA common stock. Subsequent to August 28,
1998, further adverse investor reaction raised serious questions about the
ultimate ability to obtain shareholder approval for the merger. An agreement to
terminate the merger was announced on September 14, 1998.
In June 1998 at the SUPERCOMM trade show in Atlanta, Georgia, the Company
demonstrated its MultiWave Metro(TM) ("Metro") DWDM system for metropolitan and
local access applications. Metro enables carriers to offer 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.
The Company had previously announced that AT&T was evaluating a customized
version of its MultiWave 1600 Sentry system. In July 1998 AT&T indicated to the
Company that capacity requirements of its network had grown to such extent that
the delays in final certification and approval for deployment of the Company's
customized 16 channel system would make actual deployment of that system
inadvisable, and that AT&T would accordingly shift to an accelerated evaluation
of commercially available, higher channel count systems. The Company believed
AT&T would evaluate the Company's MultiWave(R) 4000 system positively in this
context, particularly because the Company believes it is the only manufacturer
in the world with operational 40 channel systems ready for prompt delivery on an
"off-the -shelf" basis in substantial manufacturing volumes. However, on August
21, 1998 the Company was informed by AT&T that AT&T had decided not to pursue
further evaluation of CIENA's DWDM systems.
During the first quarter of 1998 the Company continued its effort to
expand its manufacturing capabilities by leasing an additional facility of
approximately 35,000 square feet located in the Linthicum, Maryland area. This
facility is used for manufacturing and customer service activities. In April
1998 the Company leased an additional manufacturing facility in the Linthicum
area of approximately 57,000 square feet. With the addition of this new facility
the Company has a total of four facilities with approximately 210,000 square
feet that can be used for manufacturing operations. In April 1998 the Company
completed the transfer of its principal executive, sales, and marketing
functions located in Linthicum in a portion of its 96,000 square foot facility
to an approximately 68,000 square foot facility also located in Linthicum.
During the third quarter of 1998, the Company completed the process of
renovating the vacated portions of the 96,000 square foot facility for the
purpose of accommodating expanding research and development functions.
As of October 31, 1998 the Company and its subsidiaries employed
approximately 1,432 persons, which was an increase of 591 persons over the
approximate 841 employed on October 31, 1997.
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RESULTS OF OPERATIONS
FISCAL YEARS ENDED 1996, 1997 AND 1998
REVENUE. The Company recognized $508.1 million, $413.2 million and $88.5
million in revenue for the years ended October 31, 1998, 1997 and 1996,
respectively. Sales to Sprint accounted for $266.9 million (52.5%), $179.4
million (43.4%) and $54.8 million (62.0%), of the Company's revenue during
fiscal 1998, 1997 and 1996, respectively. While WorldCom accounted for $184.5
million (44.7%) of the Company's revenue during fiscal 1997, it was not a
significant contributor to fiscal 1998 revenues. There were no other customers
who accounted for 10% or more of the Company's revenues during fiscal 1998, 1997
and 1996. Revenue derived from foreign sales accounted for approximately 23.0%,
2.8%. and 4.0% of the Company's revenues during fiscal 1998, 1997 and 1996,
respectively.
The Company expects Sprint's purchases in fiscal 1999 to be focused
primarily on filling out installed systems with additional channel cards and
therefore substantially below the purchasing volume in either of the last two
years. The Company also expects the percentage of fiscal 1999 revenue derived
from foreign sales to increase relative to fiscal 1998. Based on overall new bid
activity as well as expected deployment plans of existing customers, the Company
believes revenue growth in fiscal 1999 over fiscal 1998 is possible, but will be
highly dependent on winning new bids for shipments from new and existing
customers during the year. Competition of new bids is intense, and there is no
assurance the Company will be successful in winning enough new bids and new
customers to achieve year over year sequential growth.
The Company began shipping MultiWave 1600 systems for field testing in May
1996 with customer acceptance by Sprint occurring in July 1996. For fiscal years
1996 and 1997 all of the Company's DWDM system revenues were derived form the
MultiWave 1600 product. During fiscal 1998 the Company began shipments of and
recognized revenues from sales of MultiWave Sentry 1600, MultiWave Firefly, and
MultiWave Sentry 4000 systems. The amount of revenue recognized from MultiWave
1600 sales declined in fiscal 1998 as compared to fiscal 1997. This decline in
MultiWave 1600 sales in fiscal 1998 was offset by revenue recognized from sales
of MultiWave Sentry 1600, MultiWave Firefly, and MultiWave Sentry 4000 systems.
GROSS PROFIT. Cost of goods sold consists of component costs, direct
compensation costs, warranty and other contractual obligations, royalties,
license fees, inventory obsolescence costs and overhead related to the Company's
manufacturing and engineering, furnishing and installation operations. Gross
profit was $252.1 million, $246.7 million and $41.1 million for fiscal years
1998, 1997, and 1996, respectively. Gross margin was 49.6%, 59.7%, and 46.5% for
fiscal 1998, 1997, and 1996, respectively. The increase in gross profit from
fiscal 1997 to fiscal 1998 was attributable to increased revenues. The decrease
in gross margin percentage from fiscal 1997 to fiscal 1998 was largely
attributable to lower selling prices. The increase in gross margin percentage
from fiscal 1996 to fiscal 1997 was primarily the result of a change in product
mix from revenues largely derived from lower margin engineering, furnishing and
installation sales to higher margin MultiWave product sales. This year to year
increase was also attributable to fixed overhead costs being allocated over a
larger revenue base, an improvement in manufacturing efficiencies, and
reductions in component costs.
The Company's gross margins may be affected by a number of factors,
including continued competitive market pricing, lower manufacturing volumes and
efficiencies and fluctuations in component costs. During fiscal 1999, the
Company expects to face continued pressure on gross margins, primarily as a
result of substantial price discounting by competitors seeking to acquire market
share.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$67.1 million, $23.3 million, and $8.9 million for fiscal 1998, 1997, and 1996,
respectively. The approximate $43.8 million or 188% increase from fiscal 1997 to
1998 and the approximate $14.4 million or 161% increase from fiscal 1996 to
fiscal 1997 in research and development expenses related to increased staffing
levels, purchases of materials used in development of new or enhanced product
prototypes, and outside consulting services in support of certain developments
and design efforts. During fiscal 1998, 1997, and 1996 research and development
expenses were 13.2%, 5.6%, and 10.1% of revenue, respectively. The Company
expects that its research and development expenditures will continue to increase
moderately in absolute dollars and perhaps as a percentage of revenue during
fiscal 1999 to support the continued development of the various DWDM products,
the exploration of new or complementary technologies, and the pursuit of various
cost reduction strategies. The Company has expensed research and development
costs as incurred.
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SELLING AND MARKETING EXPENSES. Selling and marketing expenses were $46.2
million, $22.6 million, and $5.6 million for fiscal 1998, 1997, and 1996,
respectively. The approximate $23.6 million or 104% increase from fiscal 1997 to
1998 and the approximate $17.0 million or 301% increase from fiscal 1996 to
fiscal 1997 in selling and marketing expenses was primarily the result of
increased staffing levels in the areas of sales, technical assistance and field
support, and increases in commissions earned, trade show participation and
promotional costs. During fiscal 1998, 1997, and 1996 selling and marketing
expenses were 9.1%, 5.5%, and 6.4% of revenue, respectively. The Company
anticipates that its selling and marketing expenses may increase in absolute
dollars and perhaps as a percentage of revenue during fiscal 1999 as additional
personnel are hired and additional offices are opened to allow the Company to
pursue new customers and market opportunities. The Company also expects the
portion of selling and marketing expenses attributable to technical assistance
and field support, specifically in Europe and Asia, will increase as the
Company's installed base of operational MultiWave systems increases.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $18.5 million, $11.8 million, and $6.4 million for fiscal 1998, 1997, and
1996, respectively. The approximate $6.7 million or 56.6% increase from fiscal
1997 to 1998 and the approximate $5.4 million or 84.1% increase from fiscal 1996
to fiscal 1997 in general and administrative expenses was primarily the result
of increased staffing levels and outside consulting services. During fiscal
1998, 1997 and 1996, general and administrative expenses were 3.6%, 2.9%, and
7.3% of revenue, respectively. The Company believes that its general and
administrative expenses will moderately increase in absolute dollars and perhaps
as a percentage of revenue during fiscal 1999 as a result of the expansion of
the Company's administrative staff required to support its expanding operations.
PURCHASED RESEARCH AND DEVELOPMENT. Purchased research and development
costs were $9.5 million for the fiscal year 1998. These costs were for the
purchase of technology and related assets associated with the acquisition of
Terabit during the second quarter of fiscal 1998.
PIRELLI LITIGATION. The Pirelli litigation costs of $30.6 million in
fiscal 1998 were attributable to a $30.0 million payment made to Pirelli during
the third quarter of 1998 and to additional other legal and related costs
incurred in connection with the settlement of this litigation. The Pirelli
litigation expense in fiscal 1997 was primarily the result of a $7.5 million
charge for actual and estimated legal and related costs associated with the
litigation.
COSTS OF PROPOSED MERGER. The costs of the proposed merger for fiscal 1998
were costs related to the contemplated merger between the Company and Tellabs.
These costs include approximately $1.2 million in Securities and Exchange
Commission filing fees and approximately $1.3 million in legal, accounting, and
other related expenses.
OPERATING PROFIT. The Company's operating profit for fiscal 1998, 1997 and
1996 was $77.6 million or 15.3% of revenue, $181.5 million or 43.9% and $20.2
million or 22.8%, respectively. Excluding charges for purchased research and
development, Pirelli litigation and costs from the proposed Tellabs merger
fiscal 1998 operating profit was $120.2 million or 23.7% of revenue and
excluding Pirelli litigation costs in fiscal 1997 operating profit was $189.0
million or 45.7%. The decrease in operating profit and operating margin from
fiscal 1997 to fiscal 1998 was due to increased competitive pricing pressures
causing a reduction in gross profit margin and increased operating expenses from
investments in operating infrastructure. The year to year increases in operating
profits from fiscal 1996 to fiscal 1997 was primarily due to the comparable
increases in revenues and gross profits derived from the Company's MultiWave
systems. If the Company is unable to convert fiscal 1998 investments in
operating infrastructure into significant revenue generating relationships, the
Company's business, financial condition and results of operations could be
materially and adversely affected.
OTHER INCOME (EXPENSE), NET. Other income (expense), net, consists of
interest income earned on the Company's cash, cash equivalents and marketable
debt securities, net of interest expense associated with the Company's debt
obligations. Other income (expense), net, was $12.6 million, $7.2 million, and
$0.7 million for fiscal 1998, 1997, and 1996, respectively. The year to year
increase in other income (expense), net, was primarily the result of the
investment of the net proceeds of the Company's stock offerings and net
earnings.
PROVISION FOR INCOME TAXES. During fiscal 1996, the Company received
product acceptance from its initial customer and commenced profitable
operations, at which time the Company reversed its previously established
deferred tax valuation allowance. The provision for income taxes for fiscal 1996
of $3.6 million is net of a tax benefit of approximately $4.6 million related to
the reversal of the deferred tax valuation allowance. The Company's provision
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for income taxes was 38.5% of pre-tax earnings, or $72.7 million for fiscal 1997
and was 43.4% of pre-tax earnings, or $39.1 million for fiscal 1998. The
increase in the tax rate from fiscal 1997 to fiscal 1998 was primarily the
result of charges for purchased research and development expenses recorded in
fiscal 1998 and an adjustment to the estimated prior year state income tax
liability associated with Alta operations. Purchase research and development
charges are not deductible for tax purposes. Exclusive of the effect of these
charges, the Company's provision for income taxes was 38.4% of income before
income taxes in fiscal 1998. The decrease in tax rate, exclusive of the above
charges, for fiscal 1998 compared to fiscal 1997 was the result of a lower
combined effective state income tax expense, a larger benefit from the Company's
Foreign Sales Corporation and an increase in expected credits derived from
research and development activities offset by an increase in non-deductible
goodwill amortization expense.
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