Summary of CIENA CORP - Yahoo! Finance

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This section contains statements that discuss future events or expectations, projections of results of operations or financial condition, changes in the markets for our products and services, or other "forward-looking" information. Our "forward-looking" information is based on various factors and was derived using numerous assumptions. In some cases, you can identify these "forward-looking statements" by words like "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of those words and other comparable words. You should be aware that these statements only reflect our current predictions and beliefs. These statements are subject to known and unknown risks, uncertainties and other factors, and actual events or results may differ materially. Important factors that could cause our actual results to be materially different from the forward-looking statements are disclosed throughout this report, particularly under the heading "Risk Factors" in Item 1A of Part I of this annual report. You should review these risk factors for a more complete understanding of the risks associated with an investment in our securities. We undertake no obligation to revise or update any forward-looking statements. The following discussion and analysis should be read in conjunction with our "Selected Consolidated Financial Data" and consolidated financial statements and notes thereto included elsewhere in this annual report.
Overview
We are a provider of communications networking equipment, software and services that support the transport, switching, aggregation and management of voice, video and data traffic. Our optical service delivery and carrier Ethernet service delivery products are used, individually or as part of an integrated solution, in networks operated by communications service providers, cable operators, governments and enterprises around the globe. We are a network specialist targeting the transition of disparate, legacy communications networks to converged, next-generation architectures, better able to handle increased traffic and to deliver more efficiently a broader mix of high-bandwidth communications services. Our products, along with our service-aware operating system and unified service and transport management enable service providers to efficiently and cost-effectively deliver critical enterprise and consumer-oriented communication services. Together with our professional support and consulting services, our product offering seeks to address holistically the business and network needs of our customers. By improving network productivity, reducing operating costs and enabling new and integrated service offerings, we create business and operational value for our customers.
Effect of Recent Market Conditions and Uncertain Macroeconomic Environment on our Business
Through the first nine months of fiscal 2008, our financial performance continued to be strong. We achieved meaningful sequential quarterly revenue growth during this period and revenue was up 28.3% over the first nine months of fiscal 2007. Income from operations increased from $21.5 million in the first nine months of fiscal 2007 to $52.3 million for the first nine months of fiscal 2008. During the second half of 2008, however, our business began to experience the effects of worsening macroeconomic conditions, further exacerbated by customer-specific challenges and significant disruptions in the financial and credit markets globally. We initially experienced order delays, lengthening sales cycles and slowing deployments, principally among our largest service provider customers in North America and Europe. As economic conditions worsened globally, these effects on our business spread across our industry into other customer segments and geographies. Revenue was $179.7 million for the fourth quarter of fiscal 2008, representing a 29.0% sequential decrease from the third quarter and a 16.9% decrease from our results in the fourth quarter of fiscal 2007. We also suffered a $30.5 million loss from operations during the fourth quarter of 2008.
Significant uncertainty around current macroeconomic and industry conditions persists, particularly the effect these conditions and any sustained lack of liquidity in the capital markets may have upon the capital spending of our largest customers. Moreover, we are uncertain of the impact of any near-term change of enterprise and consumer spending and behavior, in response to these market conditions, may have on the spending or financial position of our customers. The level of competition we face during periods of economic weakness can be expected to increase. We can not be certain how long these conditions will continue and the magnitude of their effects on our business and results of operations. Consequently, these conditions have negatively affected visibility of our business and made our forecasting and planning more difficult.
While we expect the near term market conditions to be challenging, we continue to believe in our longer term market opportunities. We believe growing consumer and enterprise use, and increased dependence upon, high-bandwidth applications and services, will require our customers to continue to invest in their networks and transition to more efficient, robust and economical network architectures. As a result, we intend to continue to invest in our business, prioritizing spending related to product development and sales efforts.
During this period of uncertainty, we intend to balance our strategy of continued investment for the long-term and manage our workforce and operating costs carefully to ensure that they are aligned with our business and market opportunities. To

that end, during the fourth quarter of fiscal 2008, we effected a targeted headcount reduction of 56 employees. This headcount reduction resulted in a restructuring charge of approximately $1.1 million, principally associated with severance costs.
Acquisition of World Wide Packets
On March 3, 2008, we completed our acquisition of World Wide Packets, Inc. ("WWP"), a provider of communications network equipment that enables the cost-effective delivery of a variety of carrier Ethernet-based services, including business Ethernet services, Internet access, video conferencing and VoIP. WWP's service delivery and aggregation switches support the access and aggregation tiers of communications networks and are typically deployed in metro and access networks. Through our acquisition of WWP, we expanded our Ethernet offering beyond infrastructure to include service delivery capability and enhanced our embedded and management software suites. We believe that this transaction will improve our time to market with carrier Ethernet products and allow us to reach new customers and market segments, while strengthening and diversifying our position within existing customer networks. We also believe that the service delivery switching and aggregation technology acquired through this acquisition will enable us to penetrate additional application segments, including Ethernet business services, mobile backhaul for 4G wireless networks, and Ethernet infrastructure for high-bandwidth services such as IPTV and triple play.
As a result of this acquisition, we recorded $223.7 million in goodwill and $64.7 million in other intangible assets. We are amortizing the other intangible assets over their useful lives. See "Critical Accounting Policies and Estimates
- Goodwill" and "-Long-lived Assets (excluding goodwill)" below for information relating to these items and our test for impairment. Under purchase accounting rules, we revalued the acquired WWP finished goods inventory to fair value at the time of the acquisition. This revaluation increased the marketable inventory carrying value by approximately $5.3 million above WWP's original cost, of which we recognized $1.1 million in the second quarter of fiscal 2008 and $4.2 million in the third quarter of fiscal 2008, as an increase in cost of goods sold. See Note 2 to the Consolidated Financial Statements included in Item 8 of Part II of this report for additional information related to this acquisition. Financial Results for Fiscal 2008 and Financial Position We generated revenue of $902.4 million, representing a 15.7% increase from fiscal 2007 revenue of $779.8 million. Results for fiscal 2008 include revenue from our acquisition of WWP, which closed during the second quarter. Optical service delivery product sales increased $86.1 million, reflecting a $67.9 million increase in sales of CN 4200™ FlexSelect™ Advanced Service Platform and a $52.6 million increase in sales of our core switching products. Fiscal 2008 revenue growth also benefited from an increase in service revenue. Our percentage of international revenue increased from $226.2 million, or 29.0% of total revenue in fiscal 2007, to $311.6 million, or 34.5% of total revenue in fiscal 2008.
For fiscal 2008, two customers each accounted for greater than 10% of our revenue and 37.8% in the aggregate. AT&T represented 25.2% and BT represented 12.6% of total revenue. A small number of service providers continues to represent a large portion of our revenue. Our concentration of revenue has been affected in recent years by consolidation among communications service providers, including several of our largest customers. While we believe this illustrates our success in leveraging our incumbent position within service provider networks, the resulting concentration of revenue increases our risk of quarterly fluctuations in revenue and operating results. Our concentration in revenue can exacerbate our exposure to reductions in spending or changes in network strategy involving one or more of our significant customers.
Gross margin for fiscal 2008 was 50.0%, up from 46.5% in fiscal 2007. Product gross margin was 53.1% in fiscal 2008, up from 51.4% in fiscal 2007. Gross margin improvement during fiscal 2008 reflects the effect of favorable product and customer mix, including increased sales of our core switching products, and a significant improvement in our services gross margin. Gross margin benefited from significant product cost reductions and improved manufacturing efficiencies as a result of supply chain consolidation efforts and our increased use of lower cost contract manufacturers and suppliers in Asia. Gross margin continues to be susceptible to quarterly fluctuation due to a number of factors, including product and customer mix during the period, our ability to drive product cost reductions, the level of pricing pressure we encounter, the effect of our services gross margin, the introduction of new products or entry into new markets, charges for excess and obsolete inventory and changes in warranty costs. Part of our strategy is to maintain the product gross margin improvements made in recent years by focusing our development and sale efforts on Ethernet-based, software-intensive products that enable the flexible, cost-effective delivery of higher value communications services.
Operating expense increased from $313.6 in fiscal 2007 to $429.1 million in fiscal 2008, and increased as a percentage of revenue from 40.2% to 47.5%, respectively. Increased operating expense reflects the addition of the WWP operations

during the second quarter of fiscal 2008 and higher employee costs associated with headcount growth. Increased operating expense also reflects the expansion and acceleration of research and development initiatives that add features and functionality to our optical service delivery products and extend our portfolio of carrier Ethernet service delivery products to increase our addressable market.
Income from operations decreased from $48.7 million in fiscal 2007 to $21.9 million in fiscal 2008, primarily due to increased operating expense as a percentage of revenue. Net income decreased from $82.8 million, or $0.87 per diluted share, in fiscal 2007, to $38.9 million, or $0.42 per diluted share, in fiscal 2008. The decrease in net income for fiscal 2008 reflects the reduction in operating income as well as a $39.7 million decrease in interest and other income, net, which was a significant component of our net income in fiscal 2007. Interest income decreased significantly during fiscal 2008 as a result of our repayment at maturity of the remaining principal balance of $542.3 million on our 3.75% convertible notes during the first quarter of fiscal 2008 and our payment, during the second quarter, of approximately $210.0 million in cash consideration for our acquisition of WWP. Lower cash balances resulting from these payments, together with lower interest rates, were the principal cause of our net income reduction. This decline was partially offset by a $14.1 million decrease in interest expense over this same period.
We generated $117.6 million in cash from operations during fiscal 2008 as compared to $108.7 million during fiscal 2007. Cash from operations during fiscal 2008 consisted of $168.7 million in cash from net income (adjusted for non-cash charges) and a $51.1 million net decrease in cash resulting from changes in working capital. Cash from operations during fiscal 2007 consisted of $170.7 million in cash from net income (adjusted for non-cash charges) and a $62.0 million net decrease in cash resulting from changes in working capital.
At October 31, 2008, we had $550.7 million in cash and cash equivalents and $522.5 million of short-term and long-term investments in marketable debt securities. During fiscal 2007 and 2008, we recognized a $13.0 million and $5.1 million loss, respectively, relating to our commercial paper investments in Rhinebridge LLC and SIV Portfolio plc (formerly known as Cheyne Finance plc). See "Critical Accounting Policies and Estimates - Investments" below for information relating to our losses associated with our investment in commercial paper issued by these two structured investment vehicles (SIVs). During fiscal 2008, we received final payment in connection with the completion of restructuring activities related to these SIVs and we no longer hold these investments.
As of October 31, 2008, headcount was 2,203, an increase from 1,797 at October 31, 2007 and 1,485 at October 31, 2006. Results of Operations
Our results of operations for the fiscal 2008 include the operations of World Wide Packets beginning on March 3, 2008, the effective date of the acquisition. Revenue
We derive revenue from sales of our products and services, which we discuss in the following three major groupings:
1. Optical Service Delivery. Included in product revenue, this revenue grouping reflects sales of our transport and switching products and legacy data networking products and related software. This revenue grouping was previously referred to as our converged Ethernet infrastructure products.

2. Carrier Ethernet Service Delivery. Included in product revenue, this revenue grouping reflects sales of our service delivery and aggregation switches acquired from WWP, Ethernet access products, broadband access products, and the related software.

3. Global Network Services. Included in Global Network Services revenue are sales of services, including installation, deployment, maintenance support and training activities.

A sizable portion of our revenue comes from sales to a small number of service providers for large communication network builds. These projects are generally characterized by large and sporadic equipment orders and contract terms that can result in the recognition or deferral of significant amounts of revenue in a given quarter. As a result, the nature of our business exposes us to the likelihood of quarterly fluctuation in revenue. The level of demand for our products, the timing and size of equipment orders, our ability to deliver products to fulfill those orders, and the timing of product acceptance for revenue recognition all contribute to and can cause significant fluctuations in our revenue and operating results on a quarterly basis.

Cost of Goods Sold
Product cost of goods sold consists primarily of amounts paid to third-party contract manufacturers, component costs, direct compensation costs and overhead associated with manufacturing-related operations, warranty and other contractual obligations, royalties, license fees, amortization of intangible assets and cost of excess and obsolete inventory.
Services cost of goods sold consists primarily of direct and third-party costs associated with provision of services including installation, deployment, maintenance support and training activities. Operating Expense
Research and development expense primarily consists of salaries and related employee expense, including share-based compensation expense, prototype costs relating to design, development, testing of our products and third-party consulting costs.
Sales and marketing expense primarily consists of salaries, commissions and related employee expense, including share-based compensation expense, and sales and marketing support expense including travel, demonstration units, trade show expense and third-party consulting costs.
General and administrative expense primarily consists of salaries and related employee expense, including share-based compensation expense, and costs for third-party consulting and other services.
Amortization of intangible assets primarily reflects purchased technology and customer relationships, from our acquisitions. Fiscal 2007 compared to Fiscal 2008
Revenue, cost of goods sold and gross profit The table below (in thousands, except percentage data) sets forth the changes in revenue, cost of goods sold and gross profit for the periods indicated:

                                                    Fiscal Year                                 Increase
                                2007             %*             2008             %*            (decrease)          %**
Revenue:
Products                      $ 695,289           89.2        $ 791,415           87.7        $     96,126          13.8
Services                         84,480           10.8          111,033           12.3              26,553          31.4

Total revenue                   779,769          100.0          902,448          100.0             122,679          15.7

Costs:
Products                        337,866           43.3          371,238           41.1              33,372           9.9
Services                         79,634           10.2           80,283            8.9                 649           0.8

Total cost of goods sold        417,500           53.5          451,521           50.0              34,021           8.1

Gross profit                  $ 362,269           46.5        $ 450,927           50.0        $     88,658          24.5

* Denotes % of total revenue