Ciena Annual Report 2007

Plain-text annual report

ANNUAL REPORT 2007 focused 1201 Winterson Road, Linthicum, Maryland 21090-2205 (410) 865-8500 (800) 921-1144 www.Ciena.com 002CS-60908 focused on growth focused on growth We’re focused on achieving proﬁ table revenue growth that drives We’re focused on achieving proﬁ table revenue growth that drives sustained shareholder value. By targeting high-growth market segments sustained shareholder value. By targeting high-growth market segments and high-value applications, we’re capturing increasing market share. and high-value applications, we’re capturing increasing market share. And our focus and hard work are paying off, resulting in faster revenue And our focus and hard work are paying off, resulting in faster revenue growth than our overall market sector. growth than our overall market sector. annual revenue up annual revenue up 38% 38% 6 6 1 1 2 2 $ $ 5 5 0 0 2 2 $ $ 4 4 9 9 1 1 $ $ 5 5 6 6 1 1 $ $ 0 0 6 6 1 1 $ $ 2 2 5 5 1 1 1 $ 1 $ 3 3 1 1 $ $ 0 0 2 2 1 1 $ $ 8 8 1 1 1 1 $ $ solid revenue growth solid revenue growth (in millions) (in millions) 5 5 0 0 ’ ’ 4 4 Q Q 6 6 0 0 ’ ’ 1 1 Q Q 6 6 0 0 ’ ’ 2 2 Q Q 6 6 0 0 ’ ’ 3 3 Q Q 6 6 0 0 ’ ’ 4 4 Q Q 7 7 0 0 ’ ’ 1 1 Q Q 7 7 0 0 ’ ’ 2 2 Q Q 7 7 0 0 ’ ’ 3 3 Q Q 7 7 0 0 ’ ’ 4 4 Q Q Ciena Corporation is a global leader in communication network platforms, software and professional services. Our specialty Ciena Corporation is a global leader in communication network platforms, software and professional services. Our specialty is transitioning networks for maximum business value, operational value and end-user value. Integrating expertise in optical, is transitioning networks for maximum business value, operational value and end-user value. Integrating expertise in optical, access and data networking, Ciena enables the delivery of more services faster, transforms the network cost base, and improves access and data networking, Ciena enables the delivery of more services faster, transforms the network cost base, and improves the end-user experience. With industry-leading functionality and performance, Ciena’s offerings form the foundation for the end-user experience. With industry-leading functionality and performance, Ciena’s offerings form the foundation for many of the largest, most reliable and sophisticated telco, cable/MSO, enterprise and government networks across the globe. many of the largest, most reliable and sophisticated telco, cable/MSO, enterprise and government networks across the globe. corporate information corporate information operating executive operating executive ofﬁ cers ofﬁ cers Patrick H. Nettles, Ph.D. Patrick H. Nettles, Ph.D. Executive Chairman of the Executive Chairman of the Board of Directors Board of Directors outside board members outside board members Stephen P. Bradley, Ph.D. Stephen P. Bradley, Ph.D. William Ziegler Professor William Ziegler Professor of Business Administration of Business Administration Harvard Business School Harvard Business School Gary B. Smith Gary B. Smith President, Chief Executive Ofﬁ cer President, Chief Executive Ofﬁ cer and Director and Director Harvey B. Cash Harvey B. Cash General Partner General Partner InterWest Partners InterWest Partners Bruce L. Claﬂ in Bruce L. Claﬂ in Retired, President and CEO Retired, President and CEO 3Com Corporation 3Com Corporation Lawton W. Fitt Lawton W. Fitt Senior Advisor Senior Advisor GSC Group GSC Group Judith M. O’Brien Judith M. O’Brien Executive Vice President Executive Vice President Obopay, Inc. Obopay, Inc. Michael J. Rowny Michael J. Rowny Chairman Chairman Rowny Capital Rowny Capital Gerald H. Taylor Gerald H. Taylor Managing Member Managing Member mortonsgroup, LLC mortonsgroup, LLC Stephen B. Alexander Stephen B. Alexander Senior Vice President, Products Senior Vice President, Products and Technology, and and Technology, and Chief Technology Ofﬁ cer Chief Technology Ofﬁ cer James E. Moylan, Jr. James E. Moylan, Jr. Senior Vice President, Finance, Senior Vice President, Finance, and Chief Financial Ofﬁ cer and Chief Financial Ofﬁ cer Arthur D. Smith, Ph.D. Arthur D. Smith, Ph.D. Senior Vice President and Senior Vice President and Chief Operating Ofﬁ cer Chief Operating Ofﬁ cer Michael G. Aquino Michael G. Aquino Senior Vice President, Senior Vice President, Worldwide Sales Worldwide Sales Russell B. Stevenson, Jr. Russell B. Stevenson, Jr. Senior Vice President, General Senior Vice President, General Counsel and Secretary Counsel and Secretary Andrew C. Petrik Andrew C. Petrik Vice President, Controller Vice President, Controller and Treasurer and Treasurer corporate headquarters corporate headquarters Ciena Corporation Ciena Corporation 1201 Winterson Road 1201 Winterson Road Linthicum, MD 21090-2205 Linthicum, MD 21090-2205 Telephone: (800) 921-1144 Telephone: (800) 921-1144 or (410) 865-8500 or (410) 865-8500 www.Ciena.com www.Ciena.com annual meeting annual meeting Ciena’s annual meeting of share- Ciena’s annual meeting of share- holders will be held at 3:00 pm on holders will be held at 3:00 pm on Wednesday, March 26, 2008 at the Wednesday, March 26, 2008 at the Baltimore Marriott Waterfront Hotel, Baltimore Marriott Waterfront Hotel, 700 Aliceanna Street, Baltimore, MD. 700 Aliceanna Street, Baltimore, MD. independent registered independent registered public accounting ﬁ rm public accounting ﬁ rm PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP McLean, VA McLean, VA general counsel general counsel Hogan & Hartson LLP Hogan & Hartson LLP Baltimore, MD Baltimore, MD transfer agent transfer agent Computershare Trust Company, N.A. Computershare Trust Company, N.A. P.O. Box 43078 P.O. Box 43078 Providence, RI 02940-3078 Providence, RI 02940-3078 Shareholder Inquiries: (781) 575-2879 Shareholder Inquiries: (781) 575-2879 www.Computershare.com www.Computershare.com common stock market data common stock market data Since its initial public offering on Since its initial public offering on February 7, 1997, Ciena’s Common February 7, 1997, Ciena’s Common Stock has traded on the Nasdaq Stock has traded on the Nasdaq Stock Market under the symbol CIEN. Stock Market under the symbol CIEN. investor relations investor relations For additional copies of this report For additional copies of this report or other ﬁ nancial information, contact: or other ﬁ nancial information, contact: Investor Relations Investor Relations Ciena Corporation Ciena Corporation 1201 Winterson Road 1201 Winterson Road Linthicum, MD 21090-2205 Linthicum, MD 21090-2205 IR Hotline: (888) 243-6223 IR Hotline: (888) 243-6223 or (410) 694-5700 or (410) 694-5700 Additional information is available on Additional information is available on Ciena’s website at www.Ciena.com. Ciena’s website at www.Ciena.com. m m o o c c . . e e v v i i t t a a e e r r c c i i c c f f . . w w w w w w D D M M , , a a d d s s e e h h t t e e B B . . c c n n I I s s n n o o i i t t a a c c i i n n u u m m m m o o C C l l a a i i c c n n a a n n i i F F : : n n g g i i s s e e D D n n o o i i t t a a r r o o p p r r o o C C a a n n e e i i C C 8 8 0 0 0 0 2 2 © © Gary B. Smith, President and Chief Executive Officer fellow shareholders, fellow shareholders, 2007 was a momentous year for Ciena. 2007 as we developed and delivered balance and providing an improved By most any measure, we demonstrated innovative solutions to meet our customers’ foundation for future growth. In these concrete, quantifiable success. By remaining evolving needs. Our combined success on times of uncertainty in the credit markets, true to our strategic focus as the specialist all of these fronts enabled us to continue we believe this represents prudent in network transition—and supported to invest in research and development— financial management and provides by the well-timed introduction of our the fuel that enables us to maintain our us a competitive edge. FlexSelectTM Architecture, our practical leadership position—as well as to continue vision to help our customers transition to build a fast and agile operations from current legacy infrastructures to infrastructure to support future growth. 2007 achievements—successful base for future growth next-generation networks—we benefited Our efforts to strike an optimal balance We set out at the beginning of the year from both pure capacity-related network between reinvesting in our business for to leverage our market momentum growth as well as a sweeping trend toward longer-term growth and profitability by pursuing opportunities to further next-generation, Ethernet/IP-based were reflected in solid financial perfor- advance our technology leadership and network infrastructures. mance: GAAP operating profit of more market position. Let me take a few For fiscal 2007 we delivered revenue than 10 percent for fiscal year 2007, moments to summarize our progress. growth well above the average of the compared to 2 percent in 2006, and net industry, gross margin improvement and income of $82.8 million, or $0.87 per customers operating margin expansion, which we diluted share, in fiscal 2007, compared We expanded the breadth and depth successfully leveraged into a substantial to $0.6 million, or $0.01 per diluted share, of our customer base, with significant increase in profitability. For the year ended in fiscal 2006. growth in our international business. October 31, 2007, revenue increased This strong financial performance Sales in North America grew more than 38 percent to $780 million. We improved also included a substantial improvement 30 percent year-over-year, and international gross margin from 45.7 percent in fiscal in cash flow generation, enabling us sales rose 55 percent, with business won year 2006 to 46.5 percent in fiscal year to build on an already significant cash in 10 new countries. Notably, our partner 16% 4 3 $ 14% 8 2 $ 9% 8% 7% 7% 3 1 $ 3 1 $ 2 1 $ 4 1 $ operating profit performance (in millions) as-adjusted operating profit as-adjusted operating margin 0% 2 1 $ - 0 2 $ - -10% -17% 5 0 ’ 4 Q 6 0 ’ 1 Q 6 0 ’ 2 Q 6 0 ’ 3 Q 6 0 ’ 4 Q 7 0 ’ 1 Q 7 0 ’ 2 Q 7 0 ’ 3 Q 7 0 ’ 4 Q sales worldwide increased more than hensive strategy to make Ethernet a carrier- re-engineer our business model and these new and emerging traffic types on the momentum we have established. First, we remain focused on improving 45 percent in fiscal 2007. class, performance-grade convergence globalize our company. Our team is simultaneously with more traditional I’d like to share three concepts on which our operations to ensure we perform as In our traditional customer segment, vehicle from the access network to constantly identifying areas for further voice and data traffic. we will focus in 2008: an agile global enterprise. Second, we the highly competitive telecommunications the network core. With this move, we improvement and efficiency. service provider market, we added 12 new committed to adding new products and Paramount among these activities customers, and we sold new products capabilities to make it possible for flexible, are process and system improvements. into 14 existing accounts. converged Ethernet-based networks We’ve made tremendous progress with a We continue to see opportunities available to deliver any type of service successful upgrade to our Oracle business to apply our expertise in simple and with unparalleled resiliency, service quality system in November. This transition affords highly reliable networks to a wide range and management control. us a solid platform on which to scale and of enterprise applications. In fact, our Supporting this goal, we announced automate the entire business worldwide non-traditional/non-telecommunications our CN 3000TM Ethernet Access Series and going forward. business contributed more than 15 percent CN 5060TM Multiservice Carrier Ethernet We’re also continually streamlining of our overall revenue in fiscal 2007. We Platform, both of which are gaining traction our supply chain for greater efficiency, secured 19 additional customers in the in the market. In fact, we announced in re-engineering front-end processes On the enterprise or business side, customers face expanding compliance needs and increased capacity demands created by new business applications, as well as increased use of video and strains of overall globalization efforts. Wireless carriers—as well as wholesale carriers— are rapidly searching for ways to migrate • Innovation: Our unrelenting efforts to develop leading-edge network technology and translate those ideas into practical solutions will help our customers meet the growing and ever-changing demands of their customers; are committed to pursuing high-growth market opportunities to deliver faster- than-market revenue growth. Third, we will continue to implement our FlexSelect Architecture vision to advance our market, technology and thought leadership in next-generation networks. And, finally, we will leverage the strength of our their backhaul networks to more • Globalization: We must continue business model and resources to scale efficiently support mobile traffic growth, the geographic expansion of our the company for future growth and new data services, and expanded customer base, especially in fast-growing improved financial performance. geographic coverage. economies worldwide, and ensure that Given our strong position heading government and research and education December that BT selected the CN 3000 and improving overall product life cycle We see demand for next-generation we have the business infrastructure to into 2008, I am confident about our arenas, and we demonstrated significant Series for its 21st Century Network (21CN). management. As we strive to grow technologies like ours continuing to grow support efficient global operations and ability to serve existing customers success in serving the enterprise market, The agreement extends our presence in the future, we believe these opera- as our customers—and their customers— take advantage of specialized knowledge with innovative products and win new where we gained 85 new customers. beyond the transmission domain in 21CN tional initiatives will accelerate our look to support more advanced services and cost benefits; and to provide Ethernet access solutions that financial leverage. product portfolio will support the roll-out of new 21CN In 2007, our hard-won reputation as a services and applications. technology leader and “the network These advancements would not have market dynamics Demand drivers for Ciena’s equipment specialist” was enhanced by our anticipa- been possible had we not committed years range from new, consumer-driven tion of, and development of products to ago to a strategy centered on innovation. applications to large, service provider address, the market shift from legacy With initiatives such as the creation of needs for more efficient, more economic networks to the use of high-performance our India design center, we have increased network infrastructures. Ethernet as the technology for the common our R&D capacity by more than 40 percent Applications like on-line gaming, delivery and management of all network since the last year. We are pleased that video-on-demand, high-definition TV services and traffic types. our customers continue to recognize our (HDTV) and the proliferation of new Within our product portfolio, we technological prowess and depth. wireless broadband applications are took steps to advance our leadership in Converged Ethernet Infrastructure. operations contributing not only to increasing network capacity requirements but also Beginning in February, we extended our Our success in 2007 was aided by several to service providers’ demands for a more In 2008 we will work to build on our To summarize, 2008 will be a year Gary B. Smith FlexSelect Architecture with a compre- operational initiatives designed to efficient network architecture to carry accomplishments of 2007 and capitalize of focus and leverage for us. President and Chief Executive Officer and applications. Whether a customer operates a public or private network, we continue to believe that the supplier who best helps these customers practically and profitably transition their existing infrastructure to software-programmable, IP/Ethernet-based networks will be in a position to outpace • Velocity: We must move—in every aspect of what we do—with an increased urgency. Competition is fierce, and network technology is changing fast. We must be continually agile and decisive to maintain and build upon our leadership position. the market. This is why we’ve built Ciena These three concepts are the as the specialist in network transition, pillars of the continued execution of and we’re committed to this unique and our strategy, and key to our goal of valuable role in the marketplace. balancing strategic investments for 2008 vision longer-term revenue growth with maximized short-term profitability. customers and market share. I am equally confident about the commitment and enthusiasm our team members bring to the table each day and how in turn we are committed to providing them a rewarding and stimulating environment. If we are successful in delivering on our goals, then I am equally confident we will be successful in creating enhanced long-term value for our shareholders. Thank you, once again, for your support. 16% 4 3 $ 14% 8 2 $ 9% 8% 7% 7% 3 1 $ 3 1 $ 2 1 $ 4 1 $ operating profi t performance (in millions) as-adjusted operating profi t as-adjusted operating margin 0% 2 1 $ - 0 2 $ - -10% -17% 5 0 ’ 4 Q 6 0 ’ 1 Q 6 0 ’ 2 Q 6 0 ’ 3 Q 6 0 ’ 4 Q 7 0 ’ 1 Q 7 0 ’ 2 Q 7 0 ’ 3 Q 7 0 ’ 4 Q sales worldwide increased more than hensive strategy to make Ethernet a carrier- re-engineer our business model and these new and emerging traffi c types on the momentum we have established. First, we remain focused on improving 45 percent in fi scal 2007. class, performance-grade convergence globalize our company. Our team is simultaneously with more traditional I’d like to share three concepts on which our operations to ensure we perform as In our traditional customer segment, vehicle from the access network to constantly identifying areas for further voice and data traffi c. we will focus in 2008: an agile global enterprise. Second, we the highly competitive telecommunications the network core. With this move, we improvement and effi ciency. service provider market, we added 12 new committed to adding new products and Paramount among these activities customers, and we sold new products capabilities to make it possible for fl exible, are process and system improvements. into 14 existing accounts. converged Ethernet-based networks We’ve made tremendous progress with a We continue to see opportunities available to deliver any type of service successful upgrade to our Oracle business to apply our expertise in simple and with unparalleled resiliency, service quality system in November. This transition affords highly reliable networks to a wide range and management control. us a solid platform on which to scale and of enterprise applications. In fact, our Supporting this goal, we announced automate the entire business worldwide non-traditional/non-telecommunications our CN 3000TM Ethernet Access Series and going forward. business contributed more than 15 percent CN 5060TM Multiservice Carrier Ethernet We’re also continually streamlining of our overall revenue in fi scal 2007. We Platform, both of which are gaining traction our supply chain for greater effi ciency, secured 19 additional customers in the in the market. In fact, we announced in re-engineering front-end processes On the enterprise or business side, customers face expanding compliance needs and increased capacity demands created by new business applications, as well as increased use of video and strains of overall globalization efforts. Wireless carriers—as well as wholesale carriers— are rapidly searching for ways to migrate • Innovation: Our unrelenting efforts to develop leading-edge network technology and translate those ideas into practical solutions will help our customers meet the growing and ever-changing demands of their customers; are committed to pursuing high-growth market opportunities to deliver faster- than-market revenue growth. Third, we will continue to implement our FlexSelect Architecture vision to advance our market, technology and thought leadership in next-generation networks. And, fi nally, we will leverage the strength of our their backhaul networks to more • Globalization: We must continue business model and resources to scale effi ciently support mobile traffi c growth, the geographic expansion of our the company for future growth and new data services, and expanded customer base, especially in fast-growing improved fi nancial performance. geographic coverage. economies worldwide, and ensure that Given our strong position heading government and research and education December that BT selected the CN 3000 and improving overall product life cycle We see demand for next-generation we have the business infrastructure to into 2008, I am confi dent about our arenas, and we demonstrated signifi cant Series for its 21st Century Network (21CN). management. As we strive to grow technologies like ours continuing to grow support effi cient global operations and ability to serve existing customers success in serving the enterprise market, The agreement extends our presence in the future, we believe these opera- as our customers—and their customers— take advantage of specialized knowledge with innovative products and win new where we gained 85 new customers. beyond the transmission domain in 21CN tional initiatives will accelerate our look to support more advanced services and cost benefi ts; and and applications. Whether a customer operates a public or private network, we continue to believe that the supplier who best helps these customers practically and profi tably transition their existing infrastructure to software-programmable, IP/Ethernet-based networks will be in a position to outpace • Velocity: We must move—in every aspect of what we do—with an increased urgency. Competition is fi erce, and network technology is changing fast. We must be continually agile and decisive to maintain and build upon our leadership position. the market. This is why we’ve built Ciena These three concepts are the as the specialist in network transition, pillars of the continued execution of and we’re committed to this unique and our strategy, and key to our goal of valuable role in the marketplace. balancing strategic investments for customers and market share. I am equally confi dent about the commitment and enthusiasm our team members bring to the table each day and how in turn we are committed to providing them a rewarding and stimulating environment. If we are successful in delivering on our goals, then I am equally confi dent we will be successful in creating enhanced long-term value for our shareholders. Thank you, once again, for your support. FlexSelect Architecture with a compre- operational initiatives designed to effi cient network architecture to carry accomplishments of 2007 and capitalize of focus and leverage for us. President and Chief Executive Offi cer 2008 vision In 2008 we will work to build on our longer-term revenue growth with maximized short-term profi tability. To summarize, 2008 will be a year Gary B. Smith product portfolio will support the roll-out of new 21CN In 2007, our hard-won reputation as a services and applications. market dynamics to provide Ethernet access solutions that fi nancial leverage. technology leader and “the network These advancements would not have Demand drivers for Ciena’s equipment specialist” was enhanced by our anticipa- been possible had we not committed years range from new, consumer-driven tion of, and development of products to ago to a strategy centered on innovation. applications to large, service provider address, the market shift from legacy With initiatives such as the creation of needs for more effi cient, more economic networks to the use of high-performance our India design center, we have increased network infrastructures. Ethernet as the technology for the common our R&D capacity by more than 40 percent Applications like on-line gaming, delivery and management of all network since the last year. We are pleased that video-on-demand, high-defi nition TV services and traffi c types. our customers continue to recognize our (HDTV) and the proliferation of new Within our product portfolio, we technological prowess and depth. wireless broadband applications are took steps to advance our leadership in Converged Ethernet Infrastructure. operations contributing not only to increasing network capacity requirements but also Beginning in February, we extended our Our success in 2007 was aided by several to service providers’ demands for a more focused on demand Insatiable bandwidth demand is driving the need for expanding network capacity. Everywhere we look, there is tangible evidence of the explosive growth in bandwidth demand. On the consumer side, all you have to do is look around your home to see the advances driving this growth: highly interactive gaming, HDTV and on-demand video are just a few examples. According to Motorola, as of May 2007 the average U.S. household owned 26 consumer electronic devices, such as mp3 players, digital cameras, smart phones, PCs, HDTVs and DVRs—all of which use and drive bandwidth demands. According to Forrester, an industry analyst fi rm, as of September 2007, 48 percent of U.S. households had a broadband connection to the Internet. And think about how your use of the Internet has changed. Where once it was just a vehicle for checking email, it’s now used as a primary news and entertainment medium where you view recorded and live video and download music, books and movies. In the business world, stringent compliance needs, advanced applications, disaster recovery systems and increasing use of video are all feeding explosive demand. As if that weren’t enough, both consumer and business end users are requiring unlimited mobility and access through wireless devices—from smart phones to laptops and beyond. Ciena, with its reputation as the network specialist, is helping customers, including telecommunications carriers, wireless providers, cable operators and enterprises around the world, not only meet current demand for bandwidth, but also prepare for future growth by transitioning their networks to be more fl exible, more economical and, most importantly, scalable. focused on demand Insatiable bandwidth demand is driving the need for expanding network capacity. Everywhere we look, there is tangible evidence of the explosive growth in bandwidth demand. On the consumer side, all you have to do is look around your home to see the advances driving this growth: highly interactive gaming, HDTV and on-demand video are just a few examples. According to Motorola, as of May 2007 the average U.S. household owned 26 consumer electronic devices, such as mp3 players, digital cameras, smart phones, PCs, HDTVs and DVRs—all of which use and drive bandwidth demands. According to Forrester, an industry analyst fi rm, as of September 2007, 48 percent of U.S. households had a broadband connection to the Internet. And think about how your use of the Internet has changed. Where once it was just a vehicle for checking email, it’s now used as a primary news and entertainment medium where you view recorded and live video and download music, books and movies. In the business world, stringent compliance needs, advanced applications, disaster recovery systems and increasing use of video are all feeding explosive demand. As if that weren’t enough, both consumer and business end users are requiring unlimited mobility and access through wireless devices—from smart phones to laptops and beyond. Ciena, with its reputation as the network specialist, is helping customers, including telecommunications carriers, wireless providers, cable operators and enterprises around the world, not only meet current demand for bandwidth, but also prepare for future growth by transitioning their networks to be more fl exible, more economical and, most importantly, scalable. focused on performance Leveraging our heritage of practical innovation, we deliver maximum performance and economic value. So just how does the laptop in your office or the HDTV in your family room translate into opportunity for Ciena? Ciena’s cus- tomers must provide their customers with high-performance, reliable service that fits the demands of the particular user— whether that’s your son downloading a new movie to his handheld player or a major financial institution backing up the systems they use to execute transactions worldwide. That means our customers’ networks need to be built in a way that enables them to deal with increasing capacity requirements while still being flexible enough to accommodate new traffic types—and all in a way that makes good economic and business sense. Ciena’s customers want one global network as a common delivery vehicle for all services—data, voice, mobile, video and storage. Economically, it just doesn’t make sense for them to try to operate multiple, disparate networks. Ciena’s vision for next-generation networks, our FlexSelect™ Architecture, was designed to enable our customers to achieve that goal, and we are keenly focused on developing and delivering the solutions that make it possible. Ethernet- based networks full mix of voice, video, storage and data applications more bandwidth video on demand data storage streaming audio focused on performance Leveraging our heritage of practical innovation, we deliver maximum performance and economic value. So just how does the laptop in your office or the HDTV in your family room translate into opportunity for Ciena? Ciena’s cus- tomers must provide their customers with high-performance, reliable service that fits the demands of the particular user— whether that’s your son downloading a new movie to his handheld player or a major financial institution backing up the systems they use to execute transactions worldwide. That means our customers’ networks need to be built in a way that enables them to deal with increasing capacity requirements while still being flexible enough to accommodate new traffic types—and all in a way that makes good economic and business sense. Ciena’s customers want one global network as a common delivery vehicle for all services—data, voice, mobile, video and storage. Economically, it just doesn’t make sense for them to try to operate multiple, disparate networks. Ciena’s vision for next-generation networks, our FlexSelect™ Architecture, was designed to enable our customers to achieve that goal, and we are keenly focused on developing and delivering the solutions that make it possible. Ethernet- based networks full mix of voice, video, storage and data applications more bandwidth video on demand data storage streaming audio focused on our purpose Beyond the industry-leading solutions and services Ciena delivers to our customers every day, our purpose as a company is simple. We strive to Create. Communicate. Connect. And we aim to do so with our customers (which we interpret in the broadest sense to mean not only traditional customers, but also our shareholders, partners and vendors—all of whom are customers of sorts); with our communities; and among ourselves as Ciena employees. with our communities create communicate connect with our customers among ourselves focused on our values Our purpose is supported and enabled by three core values that dictate how we operate as a company. integrity. ingenuity. diversity. High ethical standards and character, demonstrated by our actions, our performance Inspired thinking and innovation drive our work Of talent, opinions and needs— all rolling up into one Ciena UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K Annual Report Pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934 (Mark One) [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended October 31, 2007 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 (State or other jurisdiction of incorporation or organization) 23–2725311 (I.R.S. Employer Identification No.) 1201 Winterson road, Linthicum, mD (Address of principal executive offices) 21090–2205 (Zip Code) (410) 865–8500 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Common Stock, $0.01 par value Title of Each Class the naSDaQ Stock market Name of Each Exchange on Which Registered Securities registered pursuant to Section 12(g) of the Act: none Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES [X] NO [ ] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES [ ] NO [X] Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “acceler- ated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [ ] Non-accelerated filer [X] Accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) YES [ ] NO [X] The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant was $2,294,480,968 based on the closing price of the Common Stock on the NASDAQ Global Select Market on April 28, 2007. The number of shares of Registrant’s Common Stock outstanding as of December 14, 2007 was 86,798,914. Documents incorporated by reference Part III of the Form 10-K incorporates by reference certain portions of the Registrant’s definitive proxy statement for its 2008 Annual Meeting of Shareholders to be filed with the Commission not later than 120 days after the end of the fiscal year covered by this report. 10 Ciena Corporation 10-K Table of ConTenTs part i Item 1. Business Item 1A. Risk Factors Item 1B. Unresolved Staff Comments Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders part ii Item 5. Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities Item 6. Selected Consolidated Financial Data Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures about Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information part iii Item 10. Directors, Executive Officers and Corporate Governance Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions, and Director Independence Item 14. Principal Accountant Fees and Services part iV Item 15. Exhibits and Financial Statement Schedules Signatures 12 23 33 33 33 35 36 38 40 61 61 95 95 96 97 97 97 97 97 98 98 11 PaRT I The information in this annual report contains certain forward-looking statements, including statements related to markets for our products and services and trends in our business that involve risks and uncertainties. Our actual results may differ materially from the results discussed in these forward-looking statements. Factors that might cause such a difference include those discussed in “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and elsewhere in this annual report. item 1. BuSineSS overview Ciena Corporation is a supplier of communications networking equipment, software and services that support the transport, switching, aggregation and management of voice, video and data traffic. Our products are used, individu- ally or as part of an integrated solution, in communications network infrastructures operated by telecommunications service providers, cable operators, governments and enterprises around the globe. Our products facilitate the cost- effective delivery of enterprise and consumer-oriented communication services. Through our FlexSelect™ Architecture, we specialize in transitioning 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 ser- vices. By improving network productivity, reducing costs and enabling integrated service offerings, our converged Ethernet infrastructure and broadband access products create business and operational value for our customers. During the past several years, our business has grown as a result of improving market conditions and the execution of our strategy to continue to invest in our product portfolio and target our development toward high-growth segments of the market for communications network equipment. The increasing importance of communications services to consumer and enterprise end users has driven growth in network capacity requirements and the expansion of high- bandwidth applications and services, including IPTV, peer-to-peer connectivity, video on demand and mobile video and storage. The broader mix of high-volume traffic related to these applications is driving a transition from legacy network infrastructures—typically consisting of multiple, disparate networks—to more efficient, simplified, Ethernet- based network architectures. Service providers are seeking network infrastructures better suited to handle higher bandwidth, multiservice traffic with greater efficiency, performance, resiliency, security and reliability, while ensuring a return on their network investment. We believe that our product portfolio and development efforts, focused on Ethernet/IP-related enhancements and the expansion of our FlexSelect Architecture, have enabled us to benefit from both increasing capacity requirements and the transition to more efficient and economical network architectures. financial overview—fiscal 2007 We had revenue of $779.8 million for our fiscal year ended October 31, 2007, an increase of 38.2% from fiscal 2006 revenue of $564.1 million. Income from operations increased from a loss of $31.4 million in fiscal 2006 to income of $48.7 million in fiscal 2007. Net income increased from $0.6 million, or $0.01 per diluted share, in fiscal 2006, to $82.8 million, or $0.87 per diluted share, in fiscal 2007. We generated $108.7 million in cash from operations during fiscal 2007 compared to our use of $79.4 million in cash during fiscal 2006. We manage our business in one operat- ing segment. The matters discussed in this “Business” section should be read in conjunction with the Consolidated Financial Statements found under Item 8 of Part II of this annual report, which includes additional financial informa- tion about our total assets, revenue, measures of profits and loss, and financial information about geographic areas. Corporate Information and access to seC Reports Ciena Corporation was incorporated in Delaware in November 1992, and completed its initial public offering on February 7, 1997. Our principal executive offices are located at 1201 Winterson Road, Linthicum, Maryland 21090. Our telephone number is (410) 865-8500, and our web site address is www.ciena.com. We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those 12 Ciena Corporation 10-K reports, available free of charge on the Investor Relations page of our web site as soon as reasonably practicable after we file these reports with the Securities and Exchange Commission (SEC). Information contained on our web site is not a part of this annual report. industry Background The markets in which we sell our communications networking equipment have been subject to dynamic changes in recent years, including increased competition, growth in communications services and related traffic, and evolving market opportunities. Increased Competition and Consolidation of Communications service Providers Competition among communications service providers to offer a broader mix of revenue-generating services contin- ues to be fierce. Traditional communications service providers face new competitors, new technologies and intense price competition. In addition, the last two years have witnessed significant consolidation among large communica- tions service providers, including a number of our largest customers. SBC acquired AT&T in November 2005 and, in December 2006, the combined company, known as AT&T, acquired BellSouth. In January 2006, Verizon acquired MCI. Similar consolidation has taken place abroad. These mergers are likely to have a major impact in shaping the future of the communications industry. The consolidation and future development of these merged networks likely will present opportunities, as well as significant challenges, for communications network equipment providers. emergence of enterprise and Government Markets As competition among communications service providers has increased, the needs of some of their largest customers have changed. Enterprises require additional bandwidth capacity to satisfy compliance and business continuity requirements, to facilitate global expansion of operations and to support increasing use of video services. Enterprises and government agencies have also become more concerned about network reliability and security. These changing requirements have driven communications service providers to offer a wider range of enterprise-oriented, carrier- managed applications. A number of large enterprises, government agencies and research and education institutions have decided to forego carrier-managed communications services, however, in favor of building their own secure pri- vate networks, some on a global scale. Consumer end Users and broadband applications Consumer adoption of broadband technologies, including peer-to-peer Internet applications, video services, online gaming, and mobile video and data services has increased dramatically in recent years. This has increased the drive for service providers to expand their services offering to include voice, video and data services in a bundled offering; the so-called “triple play.” Meanwhile, increased use of these services to access a growing range of content and applica- tions has accelerated demand for bandwidth. Increased capacity needs and multiservice offerings have caused carriers to transition existing or legacy infrastructures to more efficient, next-generation network infrastructures better suited to handle this traffic. Increased Multiservice Traffic and network Transition Expanding enterprise and consumer reliance upon communications services continues to increase overall traffic on communications networks, particularly in the metro aggregation segment of communications networks. Meanwhile, communications service providers have found traditional sources of revenue from voice and enterprise data services under pressure in the face of increased competition and new technologies. As a result, they are seeking to augment or replace these revenue sources by offering a broader mix of revenue-generating services. Expansion of these ser- vices is driving a transition from multiple, disparate networks based on SONET/SDH to more efficient, converged, multi-purpose Ethernet/IP-based network infrastructures. Consequently, legacy networks primarily designed to sup- port voice and private lines are being converted to packet-oriented networks, which are better able to deliver efficiently video and data alongside traditional voice traffic. The key operational focus of service providers is to make this transition as efficient and cost-effective as possible. 13 These industry trends and market conditions have been significant contributors to the growth of our business. We believe that the capabilities of our product portfolio have positioned us to benefit from both increasing communica- tions network capacity requirements and the transition by carriers to more efficient, converged network architectures. As a result of these market conditions, and the execution of our strategy to continue to invest in our product portfo- lio, we were able to improve our financial performance and grow our revenue from $427.3 million in fiscal 2005, to $564.1 million in fiscal 2006 and to $779.8 million in fiscal 2007. Strategy We believe that growing network capacity requirements, the expansion of communications services and the need to converge multiple, disparate networks to single, Ethernet/IP-based infrastructures will be significant drivers of our cus- tomers’ communications network equipment needs. In response to these needs, we introduced our FlexSelect Architecture, a standards-based, multi-service network architecture that facilitates the transition to next-generation networks while preserving the value of our customers’ investment in existing architectures. Our FlexSelect Architecture combines programmable hardware and integrated control software with service-specific management functionality, automating delivery and management of a broad mix of services including SONET/SDH, IP/Ethernet, storage and video. By creating a software-defined, service-agnostic network and integrating standards-based control planes, our FlexSelect products deliver services over communications networks that offer enhanced flexibility and that are cost- effective to deploy, scale and manage. Since Ethernet is ubiquitous and supports many consumer and enterprise applications, we believe it is well suited as a technology for network consolidation. We believe that our customers will evolve their communications networks toward increasing reliance on Ethernet as an efficient, cost-effective transport and switching protocol. During fiscal 2007, we announced FlexSelect for Ethernet, which seeks to apply the attributes of our FlexSelect Architecture approach—network flexibility, adaptability, manageability and reliability—to carrier Ethernet services. We introduced two new Ethernet-based product platforms during fiscal 2007: the CN 3000™ Ethernet Access Series and the CN 5060™ Multiservice Carrier Ethernet Platform. To implement the network vision underpinning our FlexSelect Architecture, we are pursuing the following strategic initiatives: • Establish technology leadership in the transition from legacy network infrastructures to Ethernet- based infrastructures. We seek to differentiate Ciena from competitors through our network specialist role and our FlexSelect network architecture vision. We are focusing our research and development investments on enabling customers to transition legacy circuit-switched networks to Ethernet/IP-based network infrastructures. We seek to provide customers the cost-effective means by which to support new applications and deliver ser- vices over communications network infrastructures with improved performance, resiliency, security and flexibility. Our current research and development initiatives include: Applying our expertise in carrier networks and mission-critical applications to develop Ethernet-based com- munications networks, improve the reliability of those networks and enable automated service provisioning; Continuing to add advanced Ethernet capabilities and functionality across our product portfolio with the goal of developing a comprehensive performance-grade Ethernet portfolio; Adding software-driven reconfigurability and automation across our portfolio; Enabling broadband and Ethernet access over copper and fiber access lines; and Focusing on cross-product integration and driving a common set of features and network management functionality across our portfolio. • Expand our market opportunity. We are seeking to expand our geographic reach, increase our addressable markets and penetrate new market segments, thereby enabling us to grow and diversify our customer base. Our current sales and marketing initiatives include: Increasing our use of channel partners to expand into select geographic markets and penetrate new market segments, including cable, government and enterprise; Increasing market awareness and acceptance of our Ethernet products and technologies in the core, metro and access portions of the network; 14 Ciena Corporation 10-K Expanding our participation in additional applications for our technology, including carrier-managed ser- vices and wireless backhaul; Leveraging our incumbency to sell our expanded product portfolio to existing customers; and Pursuing strategic technology opportunities, including original equipment manufacturer (OEM) arrange- ments and technology acquisitions, to offer products that complement our existing product portfolio. • Leverage our operating model in the growth of our business. As a result of our efforts in recent years to align our resources with market opportunities and make more efficient use of our resources, we were able to reduce operating expense as a percentage of revenue and increase income from operations during fiscal 2007. We seek to drive further efficiencies and improve our operating model through initiatives that include: Continuing to grow our development facility in India; Streamlining internal business processes to be more efficient; and Improving information systems to drive increased automation and coordination. Customers and markets Our customer base and the markets in which we sell our equipment, software and services have expanded in recent years as new market opportunities have emerged and our product portfolio has grown to include additional products in the metro and access portions of communications networks. The networking equipment needs of our customers vary, depending upon their size, location, the nature of their end users and the applications or services that they sup- port. During fiscal 2007, AT&T and Sprint each represented more than 10% of our total revenue and 38.1% in the aggregate. Revenue from customers within the United States was 71.0% of total revenue in fiscal 2007 and 75.1% in fiscal 2006. Information regarding 10% customers over our last three fiscal years can be found in Note 18 to the Consolidated Financial Statements in Item 8 of Part II of this annual report. We sell our products and services through our direct sales force and third party channel partners in the following markets: Telecommunications service Providers Our telecommunications service provider customers include regional, national and international telecommunications carriers, both wireline and wireless. Telecommunications service providers are our historical customer base and the largest contributor to our revenue. We provide products that enable telecommunications service providers to support consumer demand for video delivery, broadband data and wireless broadband services, while continuing to support legacy voice services. Our products also enable telecommunications carriers to support private networks and applica- tions for enterprise users, including managed services, wide area network consolidation, inter-site connectivity, storage and Ethernet services. Cable operators Our customers include leading cable and multiservice operators in the U.S. and internationally. Our cable and multi- service operator customers rely upon us for carrier-grade, optical Ethernet transport and switching equipment. Our communications networking platforms allow cable operators to integrate voice, video and data applications over a converged infrastructure. Our products support key cable applications including broadcast and digital video, voice over IP, video on demand, broadband data services and services for enterprises. enterprise Our enterprise customers include large, multi-site commercial organizations, including participants in the financial, healthcare, transportation and retail industries. We offer equipment, software and services that facilitate data center connectivity, wide area network consolidation, and storage extension for business continuity and disaster recovery. Our products enable inter-site connectivity between data centers, sales offices, manufacturing plants, retail stores and research and development centers, using an owned or leased private fiber network or a carrier-provided service. Our products facilitate key enterprise applications including data, voice, video, chat, online collaboration, conferencing and other business services. Our products also enable our enterprise customers to prevent unexpected network downtime and ensure the safety, security and availability of their data. 15 Government, Research and education Our government customers include federal and state agencies in the U.S. as well as government entities outside of the U.S. Our customers also include domestic and international research and education institutions seeking to take advantage of technology innovation and facilitate increased collaboration. Our products, software and services enable these customers to improve network performance, security, reliability and flexibility. Our products also enable govern- ment agencies and research and education institutions to build their own secure, private networks. products and Services Our product portfolio includes a range of communications networking equipment and software that is utilized from the core of communications networks, to metropolitan network infrastructures to the network edge, where end users gain access to communications services. We are applying our FlexSelect Architecture vision across our product portfo- lio, which includes transport and switching platforms, packet interworking products and access products. These products are complemented by a comprehensive suite of network and service management tools and consulting, installation and support services. We refer to our transport and switching products and packet interworking products collectively as converged Ethernet infrastructure products. Transport & switching Our transport and switching platforms serve as the foundation for our converged Ethernet infrastructure portfolio and address both the core and metro segments of communications networks. Our principal transport and switching products are our CoreDirector® Multiservice Optical Switch, our CoreStream® Agility Optical Transport System and our CN 4200® FlexSelect Advanced Services Platform family. By increasing capacity and enhancing bandwidth utili- zation, our transport and switching products enable service providers to increase network efficiency, allowing them to support more service types, higher bandwidth applications and higher volumes of traffic. By facilitating the con- vergence of disparate service networks to a multiservice network, these products also enable service providers to reduce capital expenditures and operational costs through equipment reductions, increased automation and net- work simplification. Packet Interworking Our packet interworking products include our multiservice edge switching and aggregation platforms. Our principal packet interworking products are our CN 5000 Packet Services Series and DN 7000™ Series Multiservice Edge Switching and Aggregation Platform. These products adapt and aggregate incoming network traffic and act as a bridge between IP/MPLS devices such as routers and an Ethernet transport and switching structure. These products enable communications service providers to transition their networks to carrier Ethernet and IP/MPLS from legacy technologies, such as ATM and Frame Relay. These platforms more cost-effectively support the aggregation and delivery of multiple application and service types, including mobile wireless backhaul, business data services and residential broadband. By converging traditional and emerging data services in carrier aggregation and service edge networks, these products enable service providers to transition to high-performance, packet-optimized networks while enhancing network reliability, bandwidth efficiency, ease of provisioning and scalability. access Our access portfolio addresses consumer and enterprise broadband services. Our principal access products for con- sumer broadband are our CNX-5™ Broadband DSL System and CNX-5Plus™ Modular Broadband Loop Carrier. These broadband access platforms allow service providers to transition legacy voice networks to support next-generation services such as Internet-based (IP) telephony, video services and DSL, and enable cost-effective migration to higher bandwidth Ethernet network infrastructures. For enterprise broadband services, our CN 3000 Ethernet Access Series platforms enable carriers to extend Ethernet services to all customer sites, regardless of whether they are connected to the carrier’s network by copper or fiber access lines. 16 Ciena Corporation 10-K network and service Management Tools We offer integrated network and service management software across our product portfolio. Designed to simplify network management and operation, our ON-Center® Network & Service Management Suite facilitates rapid and sim- plified provisioning of new services or service modifications and enables efficient allocation of bandwidth for service delivery. ON-Center employs a distributed, scalable architecture capable of managing a series of network elements as a standalone solution or as part of an integrated infrastructure. Our management system can track individual services across multiple product suites, facilitating planned network maintenance, outage detection and identification of cus- tomers or services affected by network troubles. By increasing network automation, minimizing network downtime and monitoring network performance and service metrics, ON-Center® enables customers to improve cost effective- ness, while increasing the performance and functionality of their network operations. Global network services To complement our product portfolio, we offer a broad range of consulting and support services. We provide these professional services through our internal Global Network Services resources as well as through service partners. Our services portfolio includes: • Network analysis, planning and design; • Network optimization and tuning; • Project management, including staging, site preparation and installation activities; • Deployment services, including turnkey installation and turn-up and test services; and, • Maintenance and support services, including helpdesk and technical assistance and training, spares and logistics management, software updates, engineering dispatch, advanced technical support and hardware and software warranty extensions. product Development Our industry is subject to rapid technological developments, evolving standards, and protocols and shifts in customer demand. To remain competitive, we must continue to enhance existing product platforms by adding new features and functionality and introducing new products that extend our FlexSelect Architecture and broaden our reach into exist- ing and new market segments. As the markets in which we sell our products and the technologies that support these products have evolved, our research and development strategy has been to pursue technology and product conver- gence. This convergence allows us to consolidate multiple technologies and functionalities on a single platform, ultimately creating more robust and cost-effective products. Our product development investments are driven by market demand and involve close collaboration among our marketing, sales and product development organizations. We also incorporate feedback from customers in our product development process. We conduct research and development through our internal resources as well as in collaboration with third parties. In some cases, we work with third parties pursuant to technology licenses, OEM arrangements and other strategic technology relationships or investments, to develop new products or modify existing platforms. In addition, we participate in industry and standards organizations where appropriate and incor- porate information from these affiliations throughout the product development process. We regularly review our product offerings and development projects to determine their fit within our portfolio. We assess the market demand, prospective return on investment and growth opportunities, as well as the costs and resources necessary to support these products or development projects. During fiscal 2007, our product development initiatives focused on adding advanced Ethernet capabilities across our product portfolio and expanding our FlexSelect Architecture. We released Ethernet-oriented enhancements to our ON-Center network management software and our CN 4200 FlexSelect Advanced Services Platform and CoreDirector platforms and added wavelength switching capabilities to the CN 4200. We introduced two new Ethernet-based product platforms: the CN 3000 Ethernet Access Series and CN 5060 Multiservice Carrier Ethernet Platform. We also 17 expanded our CN 4200 product from a single product to a product family, which includes platforms with different capacities and form factors. Part of our research and development strategy is to continue to extend Ethernet function- ality across our products, developing a comprehensive performance-grade Ethernet portfolio. Our research and development expense was $137.2 million, $111.1 million and $127.3 million for fiscal 2005, 2006 and 2007, respectively. For more information regarding our research and development expense, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this report. Sales and marketing We sell our communications networking equipment, software and services through our direct sales efforts and channel relationships. In addition to securing new customers, our sales strategy has focused on building long-term relationships with existing customers that allow us to leverage our incumbency by extending existing platforms and selling additional products to support new applications. We maintain a direct sales presence in locations in North America, South America, Europe and Asia. Through these offices we sell and support our product and service offerings into each of our customer markets. In support of our sales efforts, we engage in marketing activities intended to position and promote both our brand and our product, software and service offerings. We also maintain a channel program that works with resellers, systems integrators and service providers to market and sell our products, software and services. Our third party channel sales and other distribution arrangements enable us to leverage our direct sales resources and reach additional geographic regions and customer segments, including government and enterprise customers. We believe this channel strategy affords us expanded market opportunities and reduces the financial risk of entering new markets and pursuing new customer segments. manufacturing We rely on contract manufacturers to perform the majority of the manufacturing for our products. We believe that this allows us to conserve capital, lower costs of product sales, efficiently adjust to changes in market demand and operate without dedicating significant resources to manufacturing-related plant and equipment. We utilize a direct order fulfillment model for certain products. Direct order fulfillment allows us to rely on our contract manufacturers to perform final system integration and test, prior to direct shipment of products from their facilities to our customers. For certain product lines, we continue to perform a portion of the module assembly, final system integration and test- ing. We work closely with our contract manufacturers to manage material, quality, cost and delivery times and we continually evaluate their services to ensure performance on a reliable and cost-effective basis. In recent years we have consolidated our base of suppliers and increasingly utilized a global sourcing strategy. During fiscal 2007, we signifi- cantly reduced supply chain costs through greater sourcing of materials in lower cost regions such as Asia. Our products include some components that are proprietary in nature and only available from one or a small number of suppliers. In some cases, significant time would be required to establish relationships with alternate suppliers or providers of proprietary components. We do not have long-term contracts with any supplier or contract manufacturer that guarantees supply of components or manufacturing services. If component supplies become limited, which has occurred on occasion, or if a supplier is unable to meet our needs, we may encounter manufacturing delays that could adversely affect our business. In an effort to limit our exposure to such delays and to satisfy customer needs for shorter delivery terms, we rely upon a build-to-forecast model across our product portfolio. This inventory purchase model exposes us to the risk that our customers will not order those products for which we have forecast sales, or will purchase less than we have forecast. 18 Ciena Corporation 10-K Backlog Generally, we make sales pursuant to purchase orders issued under master purchase agreements that govern the terms and conditions of the sale of our products and services. These agreements typically do not provide for minimum order quantities. At any given time, we have orders for products that have not been shipped and for services that have not yet been performed. We also have products and services awaiting customer acceptance. Generally, our cus- tomers may cancel or change these orders with limited advance notice, or they may decide not to accept these products and services. As a result, we do not consider these orders to be firm. Competition Competition among providers of communications networking equipment, software and services is intense. The mar- kets for our products, software and services are characterized by rapidly changing and converging technologies. Competition in these markets is based on any one or a combination of the following factors: • product functionality and performance; • price; • • incumbency and existing business relationships; installation and support capability; • manufacturing and lead-time capability; • flexibility and scalability of products; and • the ability of products and services to meet customers’ immediate and future network requirements. Competition for sales of communications networking equipment is dominated by a small number of very large, multi-national companies. Our competitors include Alcatel-Lucent, Cisco, Ericsson, Fujitsu, Huawei, Nokia Siemens Networks, Nortel and Tellabs. These competitors have substantially greater financial, operational and marketing resources than Ciena. Many of them also have well-established relationships with large carriers. In recent years, merg- ers among some of our larger competitors have intensified these advantages. In November 2006, Alcatel completed its acquisition of Lucent. In June 2006, Nokia and Siemens agreed to combine their communications service provider businesses to create a new joint venture, and in January 2006, Ericsson completed its acquisition of certain key assets of Marconi’s telecommunications business. Our industry has also experienced increased competition from low-cost producers in Asia, which can contribute to pricing pressure. We also compete with several smaller, but established, companies that offer one or more products that compete directly or indirectly with our offerings or whose products address specific niches within the markets we address. In addition, there are a variety of earlier-stage companies with products targeted at the communications networking market. These competitors, particularly those that are privately-held, often employ aggressive competitive and busi- ness tactics as they seek to gain entry with certain customers or markets. Due to these practices and the narrower focus of their development efforts, which may allow introduction of products more quickly, these competitors may have offerings that are more attractive to customers. patents, trademarks and other intellectual property rights We rely upon patents, copyrights, trademarks, and trade secret laws to establish and maintain proprietary rights in our technology. We regularly file applications for patents and trademarks and have a significant number of patents and trademarks in the United States and other countries where we do business. We also rely on non-disclosure agree- ments, other contracts, and policies regarding confidentiality, with employees, contractors and customers to establish proprietary rights and protect trade secrets and confidential information. Our practice is to require employees and consultants to execute non-disclosure and proprietary rights agreements upon commencement of employment or consulting arrangements with us. These agreements acknowledge our exclusive ownership of intellectual property developed by the individual during the course of his or her work with us. The agreements also require that these per- sons maintain the confidentiality of all proprietary information disclosed to them. 19 Enforcing proprietary rights, especially patents, can be costly and uncertain. Moreover, monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps that we are taking will detect or prevent unau- thorized use, particularly as we expand our operations, product development and the manufacturing of our products internationally into countries that may not provide the same level of intellectual property protection as the United States. In recent years, we have filed suit to enforce our intellectual property rights and have been subject to several claims related to patent infringement. In some cases, resolution of these claims has resulted in our payment of sub- stantial sums. We believe that the frequency of patent infringement claims is increasing as patent holders, including entities that are not in our industry and who purchase patents as an investment or to monetize such rights by obtain- ing royalties, use such claims as a competitive tactic and source of additional revenue. Third party infringement assertions, even those without merit, could cause us to incur substantial costs. If we are not successful in defending these claims, we could be required to enter into a license requiring ongoing royalty payments, we may be required to redesign our products, or we may be prohibited from selling any infringing technology. Our network and service management software and other products incorporate software and components under licenses from third parties. We may be required to license additional technology from third parties in order to develop new products or product enhancements. There can be no assurance that these licenses will be available on acceptable commercial terms. Failure to obtain such licenses or other rights could affect our development efforts and harm our business, financial condition and operating results. environmental matters Our business and operations are subject to environmental laws in various jurisdictions around the world. We seek to operate our business in compliance with such laws. We are currently subject to laws relating to the materials and con- tent of our products and certain requirements relating to product takeback and recycling. Environmental regulation is increasing, particularly outside of the United States, and we expect that our international operations will be subject to additional environmental compliance requirements, which may expose us to additional costs. To date, our compliance costs relating to environmental regulations have not resulted in a material adverse effect on our business, results of operations or financial condition. employees As of October 31, 2007, we had 1,797 employees. None of our employees is represented by labor unions or covered by a collective bargaining agreement. We have not experienced any work stoppages and we consider the relationships with our employees to be good. 20 Ciena Corporation 10-K Directors and executive officers The table below sets forth certain information concerning our directors and executive officers: name Patrick H. Nettles, Ph.D. Gary B. Smith Stephen B. Alexander Michael G. Aquino Joseph R. Chinnici James E. Moylan, Jr. Andrew C. Petrik Arthur D. Smith, Ph.D. Russell B. Stevenson, Jr. Stephen P. Bradley, Ph.D.(2)(3) Harvey B. Cash(1)(3) Bruce L. Claflin(2) Lawton W. Fitt(2) Judith M. O’Brien(1)(3) Michael J. Rowny(2) Gerald H. Taylor(1) age 64 47 48 51 53 56 44 41 66 66 69 56 54 57 57 66 position Executive Chairman of the Board of Directors President, Chief Executive Officer and Director Senior Vice President, Products & Technology and Chief Technology Officer Senior Vice President, World Wide Sales Senior Vice President, Finance and Chief Financial Officer Senior Vice President, Finance and Chief Financial Officer Designate Vice President, Controller and Treasurer Senior Vice President, Chief Operating Officer Senior Vice President, General Counsel and Secretary Director Director Director Director Director Director Director (1) Member of the Compensation Committee (2) Member of the Audit Committee (3) Member of the Governance and Nominations Committee Ciena’s Directors hold staggered terms of office, expiring as follows: Ms. O’Brien and Messrs. Cash and Smith in 2008; Messrs. Bradley, Claflin and Taylor in 2009; and Ms. Fitt, Dr. Nettles and Mr. Rowny in 2010. Patrick H. Nettles, Ph.D. has served as a Director of Ciena since April 1994 and as Executive Chairman of the Board of Directors since May 2001. From October 2000 to May 2001, Dr. Nettles was Chairman of the Board and Chief Executive Officer of Ciena, and he was President and Chief Executive Officer from April 1994 to October 2000. Dr. Nettles serves as a Trustee for the California Institute of Technology and serves on the board of directors of Axcelis Technologies, Inc. and The Progressive Corporation. Dr. Nettles also serves on the boards of directors of Apptrigger, Inc., a privately held company. Gary B. Smith joined Ciena in 1997 and has served as President and Chief Executive Officer since May 2001. Mr. Smith has also served on Ciena’s Board of Directors since October 2000. Mr. Smith serves on the boards of directors for CommVault Systems, Inc. and the American Electronics Association. Mr. Smith also serves as a member of the Global Information Infrastructure Commission. Stephen B. Alexander joined Ciena in 1994 and has served as Chief Technology Officer since September 1998 and as a Senior Vice President since January 2000. Mr. Alexander currently serves as Senior Vice President of Products & Technology, a position he has held since October 2005. During 2004 and 2005, Mr. Alexander served as General Manager of Products & Technology and General Manager of Transport and Switching and Data Networking. Mr. Alexander serves on the Federal Communications Commission Technology Advisory Council. Michael G. Aquino joined Ciena in June 2002 and has served as Ciena’s Senior Vice President, Worldwide Sales since April 2006. Mr. Aquino previously held positions as Ciena’s Vice President of Americas, with responsibility for sales activities in the region, and Vice President of Government Solutions, where he focused on supporting Ciena’s relation- ships with the U.S. and Canadian government. Joseph R. Chinnici joined Ciena in 1994 and has served as Senior Vice President, Finance and Chief Financial Officer since August 1997. Mr. Chinnici serves on the boards of directors for Sourcefire, Inc. and Optium Corporation. Mr. Chinnici also serves on the board of directors for Brix Networks, Inc. a privately held company. Mr. Chinnici’s resignation as Chief Financial Officer is effective upon the filing of this annual report on Form 10-K. 21 James E. Moylan, Jr. has served as Senior Vice President, Finance since December 2007 and will become Ciena’s Chief Financial Officer effective following the filing of this annual report on Form 10-K. From June 2006 to December 2007, Mr. Moylan served as Executive Vice President and Chief Financial Officer of Swett & Crawford, a wholesale insurance broker. From March 2004 to February 2006, Mr. Moylan served as Executive Vice President and Chief Financial Officer of PRG-Shultz International, Inc., a publicly held recovery audit and business services firm. From June 2002 to April 2003, Mr. Moylan served as Executive Vice President in charge of Composite Panel Distribution and Administration for Georgia- Pacific Corporation’s building products distribution business. From November 1999 to May 2002, Mr. Moylan served as Senior Vice President and Chief Financial Officer of Sonat, Inc., an electronics contract manufacturing company. Andrew C. Petrik joined Ciena in 1996 and has served as Vice President, Controller and Treasurer since August 1997. Arthur D. Smith, Ph.D. joined Ciena in May 1997 and has served as Chief Operating Officer since October 2005. Dr. Smith served as Senior Vice President, Global Operations from September 2003 to October 2005. Previously, Dr. Smith served as Senior Vice President, Worldwide Customer Services and Support from June 2002 to September 2003. Russell B. Stevenson, Jr. has served as Senior Vice President, General Counsel and Secretary since joining Ciena in August 2001. Stephen P. Bradley, Ph.D. has served as a Director of Ciena since April 1998. Professor Bradley is the William Ziegler Professor of Business Administration and teaches Competitive and Corporate Strategy in the Advanced Management Program at the Harvard Business School. A member of the Harvard faculty since 1968, Professor Bradley is also Chairman of Harvard’s Executive Program in Competition and Strategy: Building and Sustaining Competitive Advantage. Professor Bradley serves on the boards of directors of i2 Technologies, Inc. and the Risk Management Foundation of the Harvard Medical Institutions. Harvey B. Cash has served as a Director of Ciena since April 1994. Mr. Cash is a general partner of InterWest Partners, a venture capital firm in Menlo Park, California, that he joined in 1985. Mr. Cash serves on the boards of directors of First Acceptance Corp., i2 Technologies, Inc., Silicon Laboratories, Inc., Argonaut Group, Inc. and Staktek Holdings, Inc. Bruce L. Claflin has served as a Director of Ciena since August 2006. Mr. Claflin served as President and Chief Executive Officer of 3Com Corporation, from January 2001 until his retirement in February 2006. Mr. Claflin joined 3Com as President and Chief Operating Officer in August 1998. Prior to 3Com, Mr. Claflin served as Senior Vice President and General Manager, Sales and Marketing, for Digital Equipment Corporation. Mr. Claflin also worked for 22 years at IBM, where he held various sales, marketing and management positions, including general manager of IBM PC Company’s worldwide research and development, product and brand management, as well as president of IBM PC Company Americas. Mr. Claflin also serves on the board of directors of Advanced Micro Devices (AMD). Lawton W. Fitt has served as a Director of Ciena since November 2000. From October 2002 to March 2005, Ms. Fitt served as Director of the Royal Academy of Arts in London. From 1979 to October 2002, Ms. Fitt was an investment banker with Goldman Sachs & Co., where she was a partner from 1994 to October 2002, and a managing director from 1996 to October 2002. Ms. Fitt is a director of Reuters PLC, Citizens Communications Company and Overture Acquisition Corporation, and a Senior Advisor to GSC Group. Judith M. O’Brien has served as a Director of Ciena since July 2000. Since November 2006, Ms. O’Brien has served as Executive Vice President of Obopay, Inc., a provider of mobile payment services. From February 2001 until October 2006, Ms. O’Brien served as a Managing Director at Incubic Venture Fund, a venture capital firm. From February 1984 until February 2001, Ms. O’Brien was a partner with Wilson Sonsini Goodrich & Rosati, where she specialized in cor- porate finance, mergers and acquisitions and general corporate matters. Ms. O’Brien serves on the board of directors of Grandis Inc., a privately held company. 22 Ciena Corporation 10-K Michael J. Rowny has served as a Director of Ciena since August 2004. Mr. Rowny has been Chairman of Rowny Capital, a private equity firm, since 1999. From 1994 to 1999, and previously from 1983 to 1986, Mr. Rowny was with MCI Communications in positions including President and Chief Executive Officer of MCI’s International Ventures, Alliances and Correspondent group, acting Chief Financial Officer, Senior Vice President of Finance, and Treasurer. Mr. Rowny serves on the board of directors of Neustar, Inc. Gerald H. Taylor has served as a Director of Ciena since January 2000. Mr. Taylor has served as a Managing Member of mortonsgroup, LLC, a venture partnership specializing in telecommunications and information technology, since January 2000. From 1996 to 1998, Mr. Taylor was Chief Executive Officer of MCI Communications Corporation. item 1a. riSK FaCtorS Investing in our securities involves a high degree of risk. In addition to the other information contained in this report, you should consider the following risk factors before investing in our securities. our ability to grow our business and increase revenue depends upon continued growth of communica- tions network traffic and the adoption of communications services and applications by enterprise and consumer end users. We have experienced considerable annual revenue growth over the past two fiscal years, in part, due to growing demand and improved conditions in our markets. The growth of our business and revenue is dependent upon a num- ber of market factors, including the continued growth of communications network traffic and increased reliance by consumers and businesses upon high-capacity communications services. We believe our business has benefitted from increases in the amount of data transmitted over communications networks and the desire among service providers to address capacity needs and offer additional consumer and enterprise services over more efficient, economical network architectures. There is no assurance these improved market conditions or our success in competing in these markets will continue. If growth in demand for bandwidth, or the adoption of new communications services, does not con- tinue, or slows, the growth of our business and our revenues would be negatively impacted. a small number of communications service provider customers account for a significant portion of our revenue and the loss of any of these customers, or a significant reduction in their spending, would have a material adverse effect on our business, financial condition and results of operations. Our revenue has become increasingly concentrated among a relatively small number of customers. AT&T accounted for 25.3%, and Sprint for 12.8% of our fiscal 2007 revenue. The loss of, or significant reductions in spending by, one or more of our large customers would have a material adverse effect on our business, financial condition and results of operations. Our increased concentration in revenue has been affected, in part, by consolidations among a number of our largest customers. These consolidations have resulted in increased concentration of customer purchasing power, which in turn may lead to constraints on pricing, fluctuations in revenue, increases in costs to meet demands of large customers and pressure to accept onerous contract terms. Consolidation may result in fewer opportunities to participate in larger network builds and could increase our exposure to changes in customer network strategy and reductions in customer capital expenditures. In addition, because a significant part of our revenue remains concen- trated among telecommunications service providers, our business could be exposed to risks associated with a market-wide change in business prospects, competitive pressures or other conditions affecting our carrier customers. We face intense competition that could hurt our sales and profitability. The markets in which we compete for sales of networking equipment, software and services are extremely competi- tive, particularly the market for sales to communications service providers. Competition in these markets is based on any one or a combination of the following factors: price, product features and functionality, manufacturing capability and lead-times, incumbency and existing business relationships, scalability and the ability of products to meet the immediate and future network requirements of customers. A small number of very large companies has historically dominated our industry. These competitors have substantially greater financial, technical and marketing resources, greater manufacturing capacity and better established relationships with telecommunications carriers and other 23 potential customers than we do. Recent consolidation activity among large networking equipment providers has caused some of our competitors to grow even larger, which may increase their strategic advantages. In 2006, Alcatel acquired Lucent, Nokia and Siemens combined their communications service provider businesses to create a new joint venture, and Ericsson acquired certain telecommunications business assets of Marconi. These transactions may adversely affect our competitive position. We also compete with a number of smaller companies that provide significant competition for a specific product, application, customer segment or geographic market. These competitors often base their products on the latest avail- able technologies. Due to the narrower focus of their efforts, these competitors may achieve commercial availability of their products more quickly and may be more attractive to customers. Increased competition in our markets has resulted in aggressive business tactics, including: • “one-stop shopping” options; • significant price competition, particularly from competitors in Asia; • customer financing assistance; • early announcements of competing products and extensive marketing efforts; • competitors offering equity ownership positions to customers; • competitors offering to repurchase our equipment from existing customers; • marketing and advertising assistance; and • intellectual property assertions and disputes. The tactics described above can be particularly effective in an increasingly concentrated base of potential customers such as telecommunications service providers. If we fail to compete successfully in our markets, our sales and profitability would suffer. our revenue and operating results can fluctuate unpredictably from quarter to quarter. Our revenue can fluctuate unpredictably from quarter to quarter. Fluctuations in our revenue can lead to even greater fluctuations in our operating results. Our budgeted expense levels depend in part on our expectations of future revenue. Any substantial adjustment to expenses in order to account for lower levels of revenue is difficult and takes time. Consequently, if our revenue declines, our levels of inventory, operating expense and general overhead would be high relative to revenue, and this could result in operating losses. Other factors contribute to fluctuations in our revenue and operating results, including: • the level of demand for our products and the timing and size of customer orders, particularly from large tele- communications carrier customers; • satisfaction of contractual acceptance criteria and related revenue recognition requirements; • delays, changes to or cancellation of orders from customers; • the effects of consolidation of our customers, including increased exposure to any changes in network strategy and reductions in customer capital expenditures; • the availability of an adequate supply of components and sufficient manufacturing capacity; • the introduction of new products by us or our competitors; • readiness of customer sites for installation; and • changes in general economic conditions as well as those specific to our market segments. Many of these factors are beyond our control, particularly in the case of large carrier orders and multi-vendor or multi- technology network infrastructure builds where the achievement of certain performance thresholds for acceptance is subject to the readiness and performance of the customer or other providers, and changes in customer requirements or installation plans. As a consequence, our revenue and operating results for a particular quarter may be difficult to predict and our prior results are not necessarily indicative of results likely in future periods. Any one or a combination of the factors above may cause our revenue and operating results to fluctuate from quarter to quarter. 24 Ciena Corporation 10-K our gross margin may fluctuate from quarter to quarter which may adversely affect our level of profitability. Our gross margin fluctuates from quarter to quarter and may be adversely affected by numerous factors, including: • customer, product and service mix in any period; • • • the effect of our services gross margin, which is generally lower than our product gross margin; sales volume during the period; increased price competition; • charges for excess or obsolete inventory; • changes in the price or availability of components for our products; • our ability to continue to reduce product manufacturing costs; • introduction of new products, with initial sales at relatively small volumes with resulting higher production costs; and • increased warranty or repair costs. The factors that contribute to fluctuations in revenue and operating results can also significantly affect our gross mar- gin. Fluctuations in gross margin may affect our level of profitability in any period. As a consequence, our gross margin for a particular quarter may be difficult to predict, and our prior results are not necessarily indicative of results likely in future periods. network equipment sales to large communications service providers often involve lengthy sales cycles and protracted contract negotiations and may require us to assume terms or conditions that negatively affect our pricing, payment terms and the timing of revenue recognition. Our future success will depend in large part on our ability to maintain and expand our sales to large communications service providers. These sales typically involve lengthy sales cycles, protracted or difficult contract negotiations, and extensive product testing and network certification. We are sometimes required to assume contract terms or condi- tions that negatively affect pricing, payment terms and the timing of revenue recognition in order to consummate a sale. These terms may, in turn, negatively affect our revenue and results of operations and increase our susceptibility to quarterly fluctuations in our results. Communications service providers may ultimately insist upon terms and condi- tions that we deem too onerous or not in our best interest. Moreover, our purchase agreements generally do not require that a customer guarantee any minimum purchase level and customers often have the right to modify, delay, reduce or cancel previous orders. As a result, we may incur substantial expense and devote time and resources to potential relationships that never materialize or result in lower than anticipated sales. investment of research and development resources in technologies for which there is not a matching mar- ket opportunity, or failure to sufficiently or timely invest in technologies for which there is market demand, would adversely affect our revenue and profitability. The market for communications networking equipment is characterized by rapidly evolving technologies and changes in market demand. To succeed in this market, we are continually investing research and development resources into the enhancement of our existing products, the creation of new products and the development or acquisition of new technologies. There is often a lengthy period between commencing these development initiatives and bringing the new or revised product to market, and, during this time, technology or the market may move in directions we had not anticipated. There is a significant possibility, therefore, that at least some of our development decisions will not turn out as anticipated, and that our investment in a project will be unprofitable. There is also a possibility that we may miss a market opportunity because we fail to invest, or invest too late, in a new product or an enhancement of an existing product that could have been highly profitable. Changes in the market may also cause us to discontinue pre- viously planned investments in products, which can have a disruptive effect on relationships with customers that were anticipating the availability of a new product or feature. If we fail to make the right investments and to make them at the right time, our competitive position may suffer and our revenue and profitability could be harmed. 25 We may be exposed to unanticipated risks and additional obligations in connection with our resale of complementary products or technology of other companies. We have entered into agreements with strategic partners that permit us to distribute their products or technology. We rely upon these relationships to add complementary products or technologies or to fulfill an element of our product portfolio. As part of our strategy to diversify our product portfolio and customer base, we may enter into additional original equipment manufacturer (OEM) or resale agreements in the future. We may incur unanticipated costs or dif- ficulties relating to our resale of third party products. Our third party relationships could expose us to risks associated with delays in their development, manufacturing or delivery of products or technology. We may also be required by customers to assume warranty, service and other commercial obligations greater than the commitments, if any, made to us by these technology partners. Some of our strategic partners are relatively small companies with limited financial resources. If they are unable to satisfy their obligations to us or our customers, we may have to expend our own resources to satisfy these obligations. Exposure to the risks above could harm our reputation with key customers and negatively affect our business and our results of operations. product performance problems could damage our business reputation and negatively affect our results of operations. The development and production of equipment that addresses rapidly growing, multi-service communications net- work traffic is complicated. Due to their complexity, some of our products can be fully tested only when deployed in communications networks or with other equipment. As a result, new products or product enhancements can contain undetected hardware or software errors at the time of release. We have introduced new or upgraded products recently and expect to continue to enhance and extend our product portfolio. Product performance problems are often more acute for initial deployments of new products and product enhancements. Unanticipated problems can relate to the design, manufacturing, installation or integration of our products. If we experience significant perfor- mance, reliability or quality problems with our products, or our customers suffer significant network restoration delays relating to these problems, a number of negative effects on our business could result, including: • increased costs to address software or hardware defects; • payment of liquidated damages or claims for damages for performance failures or delays; • increased inventory obsolescence and warranty expense; • delays in collecting accounts receivable; • cancellation or reduction in orders from customers; and • damage to our reputation or legal actions by customers or end users. Product performance problems could damage our business reputation and negatively affect our business and results of operations. We may be required to write off significant amounts of inventory as a result of our inventory purchase practices, the convergence of our product lines and our supplier transitions. To avoid delays and meet customer demand for shorter delivery terms, we place orders with our contract manufactur- ers and suppliers to manufacture components and complete assemblies based on forecasts of customer demand. As a result, our inventory purchases expose us to the risk that our customers either will not order those products for which we have forecasted sales or will purchase fewer than the number of products we have forecasted. Our purchase agreements generally do not require that a customer guarantee any minimum purchase level, and customers often have the right to modify, reduce or cancel purchase quantities. As a result, we may purchase inventory based on fore- casted sales and in anticipation of purchases that never come to fruition. Historically, our inventory write-offs have resulted from the circumstances above. As features and functionalities converge across our product lines, however, we face an increased risk that customers may elect to forego purchases of one product we have inventoried in favor of purchasing another product with similar functionality or application. We may be exposed to write-offs due to signifi- cant inventory purchases that we deem necessary as we transition from one supplier to another, or resulting from a supplier’s decision to discontinue the manufacture of certain components. We may also be required to write off 26 Ciena Corporation 10-K inventory as a result of the effect of evolving domestic and international environmental regulations. If we are required to write off or write down a significant amount of inventory due to the factors above or otherwise, our results of operations for the period would be materially adversely affected. Shortages in component supply or manufacturing capacity could increase our costs, adversely affect our results of operations and constrain our ability to grow our business. As we have expanded our use of contract manufacturers, broadened our product portfolio and increased sales volume in recent years, manufacturing capacity and supply constraints have become increasingly significant issues for us. We have encountered component shortages that have affected our operations and ability to deliver products in a timely manner. Growth in customer demand for the communications networking products supplied by us, our competitors and other third parties, has resulted in supply constraints among providers of some components used in our products. In addition, environmental regulations, such as RoHS, have resulted in, and may continue to give rise to, increased demand for compliant components. As a result, we may experience delays or difficulty obtaining compliant compo- nents from suppliers. Component shortages and manufacturing capacity constraints may also arise, or be exacerbated by difficulties with our suppliers or contract manufacturers, or our failure to adequately forecast our component or manufacturing needs. If shortages or delays occur or persist, the price of required components may increase, or the components may not be available at all. If we are unable to secure the components or subsystems that we require at reasonable prices, or are unable to secure adequate manufacturing capacity, we may experience delivery delays and may be unable to satisfy our contractual obligations to customers. These delays may cause us to incur liquidated dam- ages to customers and negatively affect our revenue and gross margin. Shortages in component supply or manufacturing capacity could also limit our opportunities to pursue additional growth or revenue opportunities and could harm our business reputation and customer relationships. We may not be successful in selling our products into new markets and developing and managing new sales channels. We continue to take steps to sell our expanded product portfolio into new geographic markets and to a broader cus- tomer base, including enterprises, cable operators, wireless operators and federal, state and local governments. We have less experience in these markets and believe, in order to succeed in these markets, we must develop and man- age new sales channels and distribution arrangements. We expect these relationships to be an increasingly important part of the growth of our business and our efforts to increase revenue. We may not be successful in reaching addi- tional customer segments or expanding into new geographic regions and may be exposed to increased expense and business and financial risks associated with entering new markets and pursuing new customer segments. We may expend time, money and other resources on channel relationships that are ultimately unsuccessful. In addition, sales to federal, state and local governments require compliance with complex procurement regulations with which we have little experience. We may be unable to increase our sales to government contractors if we determine that we cannot comply with applicable regulations. Our failure to comply with regulations for existing contracts could result in civil, criminal or administrative proceedings involving fines and suspension, or exclusion from participation in federal government contracts. Failure to manage additional sales channels effectively would limit our ability to succeed in these new markets and could adversely affect our ability to grow our customer base and revenue. We may experience delays in the development and enhancement of our products that may negatively affect our competitive position and business. To remain competitive, we must continue to enhance existing product platforms by adding new features and func- tionality and introduce new products. Because our products are based on complex technology, we can experience unanticipated delays in developing, improving, manufacturing or deploying them. Each step in the development life cycle of our products presents serious risks of failure, rework or delay, any one of which could decrease the timing and cost-effective development of such products and could affect customer acceptance of such products. Unexpected intellectual property disputes, failure of critical design elements, and other execution risks may delay or even prevent the introduction of these products. Our development efforts may also be affected, particularly in the near term, by the transfer of some of our research and development activity to our facility in India. Modification of research and 27 development strategies and changes in allocation of resources could also be disruptive to our development efforts. If we do not develop and successfully introduce products in a timely manner, our competitive position may suffer and our business, financial condition and results of operations would be harmed. We must manage our relationships with contract manufacturers effectively to ensure that our manufactur- ing and production requirements are met. We rely on contract manufacturers to perform the majority of the manufacturing operations for our products and components and we are increasingly utilizing overseas suppliers, particularly in Asia. The qualification of our contract manufacturers is a costly and time-consuming process, and these manufacturers build products for other companies, including our competitors. We are constantly reviewing our manufacturing capability, including the work of our con- tract manufacturers, to ensure that our production requirements are met in terms of cost, capacity, quality and reliability. From time to time, we may decide to transfer the manufacturing of a product from one contract manufac- turer to another, to better meet our production needs. Efforts to transfer to a new contract manufacturer or consolidate our use of suppliers may result in temporary increases in inventory volumes purchased in order to ensure continued supply. We may not effectively manage these contract manufacturer transitions, and our new contract manufacturers may not perform as well as expected. Our reliance upon contract manufacturers could also expose us to risks that could harm our business related to difficulties with lead times, on-time delivery, quality assurance and product changes required to meet evolving environmental standards and regulations. These risks can result in strategic harm to our business, including delays affecting our time to market for new or enhanced products. In addition, we do not have contracts in place with some of these providers and do not have guaranteed supply of components or man- ufacturing capacity. Our inability to effectively manage our relationships with our contract manufacturers, particularly overseas, could negatively affect our business and results of operations. We depend on sole and limited source suppliers for some of our product components and the loss of a source, or a lack of availability of key components, could increase our costs and harm our customer relationships. We depend on a limited number of suppliers for our product components and subsystems, as well as for equipment used to manufacture and test our products. Our products include several components for which reliable, high-volume suppliers are particularly limited. Some key optical and electronic components we use in our products are currently available only from sole or limited sources. As a result of this concentration in our supply chain, particularly for optical components, our business would be negatively affected if our suppliers were to experience any significant disruption in their operations affecting the price, quality, availability or timely delivery of components. Concentration in our sup- ply chain can exacerbate our exposure to risks associated with vendors’ discontinuing the manufacture of certain components for our products. The loss of a source of supply, or lack of sufficient availability of key components, could require us to redesign products that use those components, which would increase our costs and negatively affect our product gross margin. The partial or complete loss of a sole or limited source supplier could result in lost revenue, added costs and deployment delays that could harm our business and customer relationships. our failure to manage our relationships with service delivery partners effectively could adversely impact our financial results and relationship with customers. We rely on a number of service delivery partners, both domestic and international, to complement our global service and support resources. We rely upon third party service delivery partners for the installation of our equipment in some large network builds. These projects often include onerous customization, installation, testing and acceptance terms. In order to ensure the timely installation of our products and satisfaction of obligations to our customers, we must identify, train and certify our partners. The certification of these partners can be costly and time-consuming, and these partners provide similar services for other companies, including our competitors. We may not be able to effectively manage our relationships with our partners and cannot be certain that they will be able to deliver services in the man- ner or time required. If our service partners are unsuccessful in delivering services: • we may suffer delays in recognizing revenue; • our services revenue and gross margin may be adversely affected; and • our relationship with customers could suffer. 28 Ciena Corporation 10-K Difficulties with service delivery partners could cause us to transition a larger share of deployment and other services from third parties to internal resources, thereby increasing our service overhead costs and negatively affecting our ser- vices gross margin and results of operations. We may incur significant costs and our competitive position may suffer as a result of our efforts to protect and enforce our intellectual property rights or respond to claims of infringement from others. Our business is dependent upon the successful protection of our proprietary technology and intellectual property. We are subject to the risk that unauthorized parties may attempt to access, copy or otherwise obtain and use our propri- etary technology, particularly as we expand our product development into India and increase our reliance upon contract manufacturers in Asia. These and other international operations could expose us to a lower level of intellec- tual property protection than in the United States. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps that we are taking will prevent or minimize the risks of unauthorized use. If competi- tors are able to use our technology, our ability to compete effectively could be harmed. In recent years, we have filed suit to enforce our intellectual property rights. From time to time we have also been subject to litigation and other third party intellectual property claims, including as a result of our indemnification obli- gations to customers or resellers that purchase our products. The frequency of these assertions is increasing as patent holders, including entities that are not in our industry and that purchase patents as an investment or to monetize such rights by obtaining royalties, use infringement assertions as a competitive tactic and a source of additional revenue. Intellectual property claims can significantly divert the time and attention of our personnel and result in costly litiga- tion. Intellectual property infringement claims can also require us to pay substantial damages or royalties, enter into costly license agreements or develop non-infringing technology. Accordingly, the costs associated with third party intellectual property claims could adversely affect our business, results of operations and financial condition. our international operations could expose us to additional risks and result in increased operating expense. We market, sell and service our products globally. We have established offices around the world, including in North America, Europe, Latin America and the Asia Pacific region. We have also established a major development center in India and are increasingly relying upon overseas suppliers, particularly in Asia, for sourcing of components and con- tract manufacturing of our products. We expect that our international activities will be dynamic in the near term, and we may enter new markets and withdraw from or reduce operations in others. These changes to our international operations may require significant management attention and result in additional expense. In some countries, our suc- cess will depend in part on our ability to form relationships with local partners. Our inability to identify appropriate partners or reach mutually satisfactory arrangements for international sales of our products could impact our ability to maintain or increase international market demand for our products. International operations are subject to inherent risks, including: • effects of changes in currency exchange rates; • greater difficulty in collecting accounts receivable and longer collection periods; • difficulties and costs of staffing and managing foreign operations; • the impact of economic changes in countries outside the United States; • less protection for intellectual property rights in some countries; • adverse tax and customs consequences, particularly as related to transfer-pricing issues; • social, political and economic instability; • trade protection measures, export compliance, qualification to transact business and other regulatory require- ments; and • natural disasters and epidemics. These and other factors related to our international operations may result in increased risk to our business and could give rise to unanticipated expense or other effects that could adversely affect our financial results. 29 our use and reliance upon development resources in india may expose us to unanticipated costs or liabilities. We have established a development center in India and expect to continue to increase hiring of personnel for this facility. There is no assurance that our reliance upon development resources in India will enable us to achieve mean- ingful cost reductions or greater resource efficiency. Further, our development efforts and other operations in India involve significant risks, including: • difficulty hiring and retaining appropriate engineering resources due to intense competition for such resources and resulting wage inflation; • the knowledge transfer related to our technology and exposure to misappropriation of intellectual property or confidential information, including information that is proprietary to us, our customers and other third parties; • heightened exposure to changes in the economic, security and political conditions of India; • fluctuation in currency exchange rates and tax risks associated with international operations; and • development efforts that do not meet our requirements because of language, cultural or other differences asso- ciated with international operations, resulting in errors or delays. Difficulties resulting from the factors above and other risks related to our operations in India could expose us to increased expense, impair our development efforts, harm our competitive position and damage our reputation. our exposure to the credit risks of our customers and resellers may make it difficult to collect receivables and could adversely affect our operating results and financial condition. In the course of our sales to customers, we may have difficulty collecting receivables and could be exposed to risks associated with uncollectible accounts. We may be exposed to similar risks relating to third party resellers and other sales channel partners. While we monitor these situations carefully and attempt to take appropriate measures to pro- tect ourselves, it is possible that we may have to write down or write off doubtful accounts. Such write-downs or write-offs could negatively affect our operating results for the period in which they occur, and, if large, could have a material adverse effect on our operating results and financial condition. efforts to restructure our operations and align our resources with market opportunities could disrupt our business and affect our results of operations. Over the last several years, we have taken steps, including reductions in force, office closures, and internal reorganiza- tions to reduce the size and cost of our operations and to better match our resources with our market opportunities. We may take similar steps in the future to improve efficiency and match our resources with market opportunities. Any such changes could be disruptive to our business and may result in the recording of accounting charges. These include inventory and technology-related write-offs, workforce reduction costs and charges relating to consolidation of excess facilities. If we are required to take a substantial charge related to any future restructuring activities, our results of operations would be adversely affected in the period in which we take such a charge. if we are unable to attract and retain qualified personnel, we may be unable to manage our business effectively. Competition to attract and retain highly skilled technical and other personnel with experience in our industry is increasing in intensity, and our employees have been the subject of targeted hiring by our competitors. We may experience difficulty retaining and motivating existing employees and attracting qualified personnel to fill key positions. It may be difficult to replace members of our management team or other key personnel, and the loss of such individuals could be disruptive to our business. Because we generally do not have employment contracts with our employees, we must rely upon providing competitive compensation packages and a high-quality work environment in order to retain and motivate employees. If we are unable to attract and retain qualified personnel, we may be unable to manage our business effectively. We may be adversely affected by fluctuations in currency exchange rates. To date, we have not significantly hedged against foreign currency fluctuations. Historically, our primary exposure to currency exchange rates has been related to non-U.S. dollar denominated operating expense in Europe, Asia and Canada where we sell primarily in U.S. dollars. With the growth of our international headcount, we have witnessed increases in operating expense resulting from the weakening of the U.S. dollar. We expect these risks to continue as we further increase headcount in India. 30 Ciena Corporation 10-K As we increase our international sales and utilization of international suppliers, we may transact additional business in currencies other than the U.S. dollar. As a result, we will be subject to the possibility of greater effects of foreign exchange translation on our financial statements. For those countries outside the United States where we have signifi- cant sales, a devaluation in the local currency would make our products more expensive for customers to purchase or increase our operating costs, thereby adversely affecting our competitiveness. There can be no assurance that exchange rate fluctuations in the future will not have a material adverse effect on our revenue from international sales and, consequently, our business, operating results and financial condition. Strategic acquisitions and investments may expose us to increased costs and unexpected liabilities. We may acquire or make strategic investments in other companies to expand the markets we address and diversify our customer base. We may also engage in these transactions to acquire or accelerate the development of technology or products. To do so, we may use cash, issue equity that would dilute our current shareholders’ ownership, incur debt or assume indebtedness. These transactions involve numerous risks, including: • difficulty integrating the operations, technologies and products of the acquired companies; • diversion of management’s attention; • difficulty completing projects of the acquired company and costs related to in-process projects; • the loss of key employees of the acquired company; • amortization expenses related to intangible assets and charges associated with impairment of goodwill; • ineffective internal controls over financial reporting; • dependence on unfamiliar supply partners; and • exposure to unanticipated liabilities, including intellectual property infringement claims. As a result of these and other risks, any acquisitions or strategic investments may not reap the intended benefits and may ultimately have a negative impact on our business, results of operation and financial condition. Changes in government regulation could lead our customers to reduce investment in their communications networks which would reduce the size of our market and could adversely affect our business. The Federal Communications Commission, or FCC, has jurisdiction over the U.S. communications industry and similar agencies have jurisdiction over the communication industries in other countries. Many of our most important custom- ers are subject to the rules and regulations of these agencies. Changes in regulatory requirements in the United States or other countries could inhibit service providers from investing in their communications network infrastructures and thus could adversely affect the sale of our products. Changes in regulatory tariff requirements or other regulations relating to pricing or terms of carriage on communications networks could slow the expansion of network infrastruc- tures and adversely affect our business, operating results, and financial condition. the investment of our substantial cash balance and our investments in marketable debt securities are sub- ject to risks which may cause losses and affect the liquidity of these investments. At October 31, 2007, we had $892.1 million in cash and cash equivalents and $856.1 million in investments in mar- ketable debt securities. We have historically invested these amounts in corporate bonds, asset-backed obligations, commercial paper, securities issued by the United States, certificates of deposit and money market funds meeting cer- tain criteria. These investments are subject to general credit, liquidity, market and interest rate risks, which may be exacerbated by U.S. sub-prime mortgage defaults that have affected various sectors of the financial markets and caused credit and liquidity issues. During the fourth quarter of fiscal 2007, we determined that declines in the fair value of certain of our investments in commercial paper issued by two structured investment vehicles (SIVs) were oth- er-than-temporary. Each of these SIVs entered receivership during our fourth quarter of fiscal 2007 and subsequently failed to make payment at maturity. As of October 31, 2007, we recognized realized losses of $13.0 million related to these investments and estimated the fair value of these investments at $33.9 million. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Investments” in Item 7 of Part II of this report for more information about this loss and our determination of the fair value of these investments at October 31, 2007. We may recognize further realized losses in the fair value of these investments or a complete 31 loss of these investments. Additional losses would have a negative effect on our net income. Information and the markets relating to investments that hold mortgage-related assets as collateral remain dynamic. There may be further declines in the value of these investments and the value of the collateral held by these entities. As a result, we may experience a reduction in value or loss of liquidity of other investments. In addition, should our other investments cease paying or reduce the amount of interest paid to us, our interest income would suffer. These market risks associ- ated with our investment portfolio may have a negative adverse effect on our results of operations, liquidity and financial condition. We may be required to take further write-downs of goodwill and other intangible assets. As of October 31, 2007, we had $232.0 million of goodwill on our balance sheet. This amount primarily represents the remaining excess of the total purchase price of our acquisitions over the fair value of the net assets acquired. At October 31, 2007, we had $67.1 million of other intangible assets on our balance sheet. The amount primarily reflects purchased technology from our acquisitions. At October 31, 2007, goodwill and other intangible assets represented approximately 12.4% of our total assets. During the fourth quarter of 2005, we incurred a goodwill impairment charge of approximately $176.6 million and an impairment of other intangibles of $45.7 million. If we are required to record additional impairment charges related to goodwill and other intangible assets, such charges would have the effect of decreasing our earnings or increasing our losses in such period. If we are required to take a substantial impairment charge, our operating results could be materially adversely affected in such period. Failure to maintain effective internal controls over financial reporting could have a material adverse effect on our business, operating results and stock price. Section 404 of the Sarbanes-Oxley Act of 2002 requires that we include in our annual report a report containing man- agement’s assessment of the effectiveness of our internal controls over financial reporting as of the end of our fiscal year and a statement as to whether or not such internal controls are effective. Compliance with these requirements has resulted in, and is likely to continue to result in, significant costs and the commitment of time and operational resources. Growth of our business, including our broader product portfolio and increased transaction volume, will necessitate ongoing changes to our internal control systems, processes and information systems. Our increasingly global operations, including our development facility in India and offices abroad, will pose additional challenges to our internal control systems as their operations become more significant. We cannot be certain that our current design for internal control over financial reporting will be sufficient to enable management or our independent registered public accounting firm to determine that our internal controls are effective for any period, or on an ongoing basis. If we or our independent registered public accounting firms are unable to assert that our internal controls over financial reporting are effective our business may be harmed. Market perception of our financial condition and the trading price of our stock may be adversely affected, and customer perception of our business may suffer. obligations associated with our outstanding indebtedness on our convertible notes may adversely affect our business. At October 31, 2007, indebtedness on our outstanding convertible notes totaled $1.3 billion in aggregate principal, of which $542.3 million in aggregate principal amount on our 3.75% convertible notes becomes due and payable on February 1, 2008. Our indebtedness and repayment obligations could have important negative consequences, including: • • • • increasing our vulnerability to general adverse economic and industry conditions; limiting our ability to obtain additional financing; reducing the availability of cash resources for other purposes, including capital expenditures; limiting our flexibility in planning for, or reacting to, changes in our business and the markets in which we com- pete; and • placing us at a possible competitive disadvantage to competitors that have better access to capital resources. We may also add additional indebtedness such as equipment loans, working capital lines of credit and other long term debt. 32 Ciena Corporation 10-K our business is dependent upon the proper functioning of our information systems and upgrading these systems may result in disruption to our business, operating processes and internal controls. The efficient operation of our business is dependent on the successful operation of our information systems. In par- ticular, we rely on our information systems to process financial information, manage inventory and administer our sales transactions. In an effort to improve the efficiency of our operations, achieve greater automation and support the growth of our business, we are in the process of upgrading certain information systems and have recently imple- mented a new version of our Oracle management information system. We anticipate that we will have to modify a number of operational processes and internal control procedures as a result of this upgrade. Any material disruption, malfunction or similar problems with our information systems could have a negative effect on our business and results of operations in the period affected. In addition, in recent years, we have experienced a considerable growth in trans- action volume, headcount and reliance upon international resources in our operations. Our information systems need to be sufficiently scalable to support the continued growth of our operations and the efficient management of our business. If our information system resources are inadequate, we may be required to undertake costly upgrades and the growth of our business could be harmed. our stock price is volatile. Our common stock price has experienced substantial volatility in the past and may remain volatile in the future. Volatility can arise as a result of a number of the factors discussed in this “Risk Factors” section, as well as divergence between our actual or anticipated financial results and published expectations of analysts, and announcements that we, our competitors, or our customers may make. item 1B. unreSoLVeD StaFF CommentS Not applicable. item 2. propertieS As of October 31, 2007, all of our properties are leased. Our principal executive offices are located in Linthicum, Maryland. We lease thirty-eight facilities related to our ongoing operations. These include five buildings located at various sites near Linthicum, Maryland, including an engineering facility, three manufacturing facilities, and one administrative and sales facility. We have engineering and/or service facilities located in Alpharetta, Georgia; Acton, Massachusetts; and Kanata, Canada. We also maintain a sales and service facility in London, England. During fiscal 2006, we commenced operations of our development facility in Gurgaon, India, and our manufacturing support office in Shenzhen, China. We also lease various small offices in the United States and abroad to support our sales and services. We believe the facilities we are now using are adequate and suitable for our business requirements. We lease a number of properties that we no longer occupy. As part of our restructuring costs, we provide for the esti- mated cost of the net lease expense for these facilities. The cost is based on the fair value of future minimum lease payments under contractual obligations offset by the fair value of the estimated future sublease payments that we may receive. As of October 31, 2007, our accrued restructuring liability related to these properties was $4.7 million. If actual market conditions relating to the use of these facilities are less favorable than those projected by management, additional restructuring costs associated with these facilities may be required. For additional information regarding our lease obligations, see Note 17 to the financial statements included in Item 8 of Part II of this report. item 3. LegaL proCeeDingS On October 3, 2000, Stanford University and Litton Systems filed a complaint in the United States District Court for the Central District of California against Ciena and several other defendants, alleging that optical fiber amplifiers incorporated into certain of those parties’ products infringe U.S. Patent No. 4,859,016 (the “‘016 Patent”). The com- plaint seeks injunctive relief, royalties and damages. On October 10, 2003, the court stayed the case pending final resolution of matters before the U.S. Patent and Trademark Office (the “PTO”), including a request for and disposition 33 of a reexamination of the ‘016 Patent. On October 16, 2003, and November 2, 2004, the PTO granted reexamina- tions of the ‘016 Patent, resulting in a continuation of the stay of the case. On September 11, 2006, the PTO issued a Notice of Intent to Issue a Reexamination Certificate and Statement of Reasons for Patentability/Confirmation, stating its intent to confirm certain claims of the ‘016 Patent. On June 22, 2007, the district court issued an order lifting the stay of the case. The parties are currently engaged in discovery. Separately, on July 2, 2007, defendant JDS Uniphase filed with the PTO a request for ex parte reexamination of the ‘016 Patent and a request that the district court rein- state the stay of the case on the basis of its reexamination request. On November 20, 2007, the PTO granted the request for reexamination in part, including only claim 12 of the ‘016 Patent in the scope of its reexamination. On November 28, 2007, based on the PTO’s rationale in granting reexamination, defendant JDS Uniphase filed with the PTO another request for ex parte reexamination of claim 11 of the ‘016 Patent. The court has not ruled on the motion to reinstate the stay. On December 11, 2007, the district court continued the final pretrial conference to June 16, 2008. The case has not yet been scheduled for trial. We are not able to predict the ultimate outcome of this matter at this time or to reasonably estimate the amount or range of the potential loss, if any, that might result from an adverse resolution of this matter. We believe that we have valid defenses to the lawsuit and intend to defend it vigorously. As a result of our merger with ONI Systems Corp. in June 2002, Ciena became a defendant in a securities class action lawsuit. Beginning in August 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United States District Court for the Southern District of New York. These com- plaints name ONI, Hugh C. Martin, ONI’s former chairman, president and chief executive officer; Chris A. Davis, ONI’s former executive vice president, chief financial officer and administrative officer; and certain underwriters of ONI’s initial public offering as defendants. The complaints were consolidated into a single action, and a consolidated amended com- plaint was filed on April 24, 2002. The amended complaint alleges, among other things, that the underwriter defendants violated the securities laws by failing to disclose alleged compensation arrangements (such as undisclosed commissions or stock stabilization practices) in the initial public offering’s registration statement and by engaging in manipulative prac- tices to artificially inflate the price of ONI’s common stock after the initial public offering. The amended complaint also alleges that ONI and the named former officers violated the securities laws on the basis of an alleged failure to disclose the underwriters’ alleged compensation arrangements and manipulative practices. No specific amount of damages has been claimed. Similar complaints have been filed against more than 300 other issuers that have had initial public offer- ings since 1998, and all of these actions have been included in a single coordinated proceeding. Mr. Martin and Ms. Davis have been dismissed from the action without prejudice pursuant to a tolling agreement. In July 2004, following mediated settlement negotiations, the plaintiffs, the issuer defendants (including Ciena), and their insurers entered into a settle- ment agreement, whereby the plaintiffs’ cases against the issuers would be dismissed, the insurers would agree to guarantee a recovery by the plaintiffs from the underwriter defendants of at least $1 billion, and the issuer defendants would agree to assign or surrender to the plaintiffs certain claims the issuers may have against the underwriters. The set- tlement agreement did not require Ciena to pay any amount toward the settlement or to make any other payments. In October 2004, the district court certified a class with respect to the Section 10(b) claims in six “focus cases” selected out of all of the consolidated cases, which cases did not include Ciena, and which decision was appealed by the underwriter defendants to the U.S. Court of Appeals for the Second Circuit. On February 15, 2005, the district court granted the motion filed by the plaintiffs and issuer defendants for preliminary approval of the settlement agreement, subject to cer- tain modifications to the proposed bar order, and on August 31, 2005, the district court issued a preliminary order approving the revised stipulated settlement agreement. On December 5, 2006, the U.S. Court of Appeals for the Second Circuit vacated the district court’s grant of class certification in the six focus cases. On April 6, 2007, the Second Circuit denied plaintiffs’ petition for rehearing. In light of the Second Circuit’s decision, the parties agreed that the settlement could not be approved. On June 25, 2007, the district court approved a stipulation filed by the plaintiffs and the issuer defendants terminating the proposed settlement. On August 14, 2007, the plaintiffs filed second amended complaints against the defendants in the six focus cases, as well as a set of amended master allegations against the other issuer defendants, including changes to the definition of the purported class of investors. On September 27, 2007, the plaintiffs filed a motion for class certification based on their amended complaints and allegations. On November 12, 2007, the defendants in the six focus cases moved to dismiss the second amended complaints. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the matter at this time. 34 Ciena Corporation 10-K In addition to the matters described above, we are subject to various legal proceedings, claims and litigation arising in the ordinary course of business. We do not expect that the ultimate costs to resolve these matters will have a material effect on our results of operations, financial position or cash flows. item 4. SuBmiSSion oF matterS to a Vote oF SeCurity HoLDerS No matters were submitted to a vote of security holders in the fourth quarter of fiscal 2007. 35 PaRT II item 5. marKet For regiStrant’S Common StoCK, reLateD StoCKHoLDer matterS anD iSSuer purCHaSeS oF eQuity SeCuritieS (a) Ciena’s common stock is traded on the NASDAQ Global Select Market under the symbol “CIEN.” The following table sets forth the high and low sales prices of Ciena common stock, as reported on the NASDAQ Global Select Market, for the fiscal periods indicated. The sales prices below have been adjusted to reflect the one-for-seven reverse stock split of Ciena’s authorized and outstanding common stock effected on September 22, 2006. price range of Common Stock High Low Fiscal Year 2006 First Quarter ended January 31 Second Quarter ended April 30 Third Quarter ended July 31 Fourth Quarter ended October 31 Fiscal Year 2007 First Quarter ended January 31 Second Quarter ended April 30 Third Quarter ended July 31 Fourth Quarter ended October 31 $28.77 $39.34 $33.67 $30.87 $30.56 $32.80 $41.13 $49.55 $16.31 $26.04 $23.38 $23.08 $24.39 $24.75 $28.22 $32.75 As of December 14, 2007, there were approximately 1,670 holders of record of Ciena’s common stock and 86,798,914 shares of common stock outstanding. Ciena has never paid cash dividends on its capital stock. We intend to retain earn- ings for use in our business and we do not anticipate paying any cash dividends in the foreseeable future. 36 Ciena Corporation 10-K The following graph shows a comparison of cumulative total returns for an investment in the common stock of Ciena, the NASDAQ Telecommunications Index and the S&P 500 Index from October 31, 2002 to October 31, 2007. The NASDAQ Telecommunications Index contains securities of NASDAQ-listed companies classified according to the Industry Classification Benchmark as Telecommunications and Telecommunications Equipment. They include providers of fixed- line and mobile telephone services, and makers and distributors of high-technology communication products. This graph is not deemed to be “filed” with the SEC or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, and the graph shall not be deemed to be incorporated by reference into any prior or subsequent filing by Ciena under the Securities Act of 1933 or the Exchange Act. 300 250 200 150 100 50 0 s r a l l o D . S . u oct 02 apr 03 oct 03 apr 04 oct 04 apr 05 oct 05 apr 06 oct 06 apr 07 oct 07 Ciena S&p 500 index naSDaQ telecommunications index Assumes $100 invested in Ciena Corporation, the NASDAQ Telecommunications Index and the S&P 500 Index on October 31, 2002 with all dividends reinvested at month-end. (b) Not applicable. (c) Not applicable. 37 item 6. SeLeCteD ConSoLiDateD FinanCiaL Data The following selected consolidated financial data should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the notes thereto included in Item 8, “Financial Statements and Supplementary Data.” Ciena has a 52 or 53 week fiscal year, which ends on the Saturday nearest to the last day of October in each year. For purposes of financial statement presentation, each fiscal year is described as having ended on October 31. Fiscal 2003, 2004, 2005 and 2006 consisted of 52 weeks and fiscal 2007 consisted of 53 weeks. Balance Sheet Data: (in thousands) Cash and cash equivalents Short-term investments Long-term investments Total assets Short-term convertible notes payable Long-term convertible notes payable Total liabilities Stockholders’ equity 2003 $ 294,914 796,809 519,744 2,378,165 — 730,428 1,047,348 1,330,817 as of october 31, 2004 $ 185,868 753,251 329,704 2,137,054 — 690,000 982,632 1,154,422 2005 $ 358,012 579,531 155,944 1,675,229 — 648,752 939,862 735,367 2006 $ 220,164 628,393 351,407 1,839,713 — 842,262 1,086,087 753,626 2007 $ 892,061 822,185 33,946 2,416,273 542,262 800,000 1,566,119 850,154 38 Ciena Corporation 10-K Statement of operations Data: (in thousands, except per share data) Revenue Cost of goods sold Gross profit Operating expenses: Research and development Selling and marketing General and administrative Amortization of intangible assets In-process research and development Restructuring costs Goodwill impairment Long-lived asset impairment Gain on lease settlement Recovery of sale, export, use tax liabilities and payments Provision (benefit) for doubtful accounts Total operating expenses Income (loss) from operations Interest and other income, net Interest expense Gain (loss) on equity investments, net Loss, other-than-temporary, on marketable debt investments Gain (loss) on extinguishment of debt Income (loss) before income taxes Provision for income taxes Net income (loss) Basic net income (loss) per common share Diluted net income (loss) per dilutive potential common share Weighted average basic common shares Weighted average dilutive potential common shares year ended october 31, 2003 $ 283,136 210,091 73,045 2004 $ 298,707 226,954 71,753 2005 $ 427,257 291,067 136,190 2006 $564,056 306,275 257,781 2007 $779,769 417,500 362,269 212,523 105,921 39,703 17,870 2,800 13,575 — 47,176 — — — 439,568 (366,523) 45,987 (39,359) (4,760) — (20,606) (385,261) 1,256 $(386,517) (6.06) $ 205,364 112,310 28,592 30,839 30,200 57,107 371,712 15,926 — (5,388) (2,794) 843,868 (772,115) 25,936 (29,841) (4,107) — (8,216) (788,343) 1,121 $(789,464) (10.60) $ 137,245 115,022 33,715 38,782 — 18,018 176,600 45,862 — — 2,602 567,846 (431,656) 31,294 (28,413) (9,486) — 3,882 (434,379) 1,320 $(435,699) (5.30) $ $ (6.06) 63,814 $ (10.60) 74,493 $ (5.30) 82,170 111,069 104,434 47,476 25,181 — 15,671 — — (11,648) — (3,031) 289,152 (31,371) 50,245 (24,165) 215 127,296 118,015 50,262 25,350 — (2,435) — — (4,871) — (14) 313,603 48,666 76,483 (26,996) 592 — 7,052 1,976 1,381 595 0.01 (13,013) — 85,732 2,944 $ 82,788 0.97 $ 0.01 83,840 $ 0.87 85,525 $ $ $ 63,814 74,493 82,170 85,011 99,604 39 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 asso- ciated 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 Ciena Corporation is a supplier of communications networking equipment, software and services that support the transport, switching, aggregation and management of voice, video and data traffic. Our products are used, individu- ally or as part of an integrated solution, in communications network infrastructures operated by telecommunications service providers, cable operators, governments and enterprises around the globe. Our products facilitate the cost- effective delivery of enterprise and consumer-oriented communication services. Through our FlexSelect™ Architecture, we specialize in transitioning 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 ser- vices. By improving network productivity, reducing costs and enabling integrated service offerings, our converged Ethernet infrastructure and broadband access products create business and operational value for our customers. Over the past fiscal year, market conditions and the execution of our network specialist strategy enabled us to gener- ate revenue of $779.8 million, representing a 38.2% increase from fiscal 2006 revenue of $564.1 million. Growth in consumer and enterprise reliance upon communications services continues to drive increases in network capacity requirements and new high-bandwidth applications and services. The resulting broader mix of high-volume traffic is driving a transition from legacy network infrastructures to more efficient, simplified, Ethernet-based network architec- tures. We believe that our FlexSelect Architecture and Ethernet/IP-related enhancements to our product portfolio have enabled us to benefit from both increasing capacity requirements and the convergence of networks to more efficient and economical architectures. We believe that these conditions that have allowed us to achieve significant revenue growth over the past two fiscal years will enable continued growth of our business during fiscal 2008, although we currently expect a somewhat lower annual growth rate than we achieved in fiscal 2007. Consolidation within the telecommunications industry and among several of our largest customers continues to affect our concentration of revenue. For fiscal 2007, two customers each accounted for greater than 10% of our fiscal 2007 revenue, and 38.1% in the aggregate. AT&T represented 25.3% and Sprint represented 12.8%. We believe that our fiscal 2007 results illustrate our success in leveraging our incumbent position within large carriers. However, this con- centration of our revenue exposes us to additional risks, including greater pricing pressure and increased susceptibility to changes in customers’ network strategy or reductions in their capital expenditures. Our percentage of international revenue increased from $140.4 million, or 24.9% of total revenue, in fiscal 2006 to $226.2 million, or 29.0% of total revenue in fiscal 2007. We expect our international sales to continue to increase as a percentage of revenue in fiscal 2008. 40 Ciena Corporation 10-K Revenue was $216.2 million for the fourth quarter of fiscal 2007, representing a 5.5% sequential quarterly increase. While we believe that we will be able to grow annual revenue from the level achieved for fiscal 2007, the nature of our business continues to expose us to the likelihood of quarterly fluctuation in revenue during fiscal 2008. A sizable portion of our revenue comes from sales to a small number of telecommunications service providers for large com- munication 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. 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 fluctua- tions in our revenue on a quarterly basis. Improving and stabilizing gross margin was an area of significant focus for us during fiscal 2007. Gross margin for fiscal 2007 was 46.5%, up from 45.7% in fiscal 2006, and product gross margin was 51.4%, up from 47.5%. Gross margin for the fourth quarter of fiscal 2007 was 50.5%. Gross margin improvement during fiscal 2007 reflects the effect of favorable product and customer mix and the negative effect of a reduced services gross margin. Our increased gross margin for fiscal 2007 also reflects significant product cost reductions and improved manufacturing efficiencies, as we increasingly utilize lower cost suppliers in Asia. Part of our strategy is to maintain the product gross margin improvements made during fiscal 2007 by focusing on the development and sale of Ethernet-based, software-intensive products that enable the flexible, cost-effective delivery of higher value communications services. Our gross margin, however, continues to be susceptible to quarterly fluctuation due to a number of factors, includ- ing: product and customer mix during the period, our ability to drive further product cost reductions, the level of pricing pressure we encounter, the effect of changes in 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. Operating expense increased from $289.2 million in fiscal 2006 to $313.6 million in fiscal 2007, but decreased as a percentage of revenue from 51.3% to 40.2%. Operating expense for the fourth quarter of fiscal 2007 was $82.0 mil- lion, a slight increase from $81.6 million in the third quarter of fiscal 2007. We expect operating expense to increase in absolute dollars during fiscal 2008 to support growth of the business, research and development projects, and increased headcount for our India development site and sales resources. The results above drove significant improvements in income from operations and net income during fiscal 2007. Income from operations increased from a loss of $31.4 million in fiscal 2006 to income of $48.7 million in fiscal 2007. Net income increased from $0.6 million, or $0.01 per diluted share, in fiscal 2006 to $82.8 million, or $0.87 per diluted share, in fiscal 2007. Net income for the fourth quarter of fiscal 2007 was $30.4 million, or $0.30 per diluted share. This compares with net income of $28.3 million, or $0.29 per diluted share, for the third quarter of fiscal 2007. We continue to work to gain additional leverage from our operating model to drive operating margin improvements. We expect interest income, which was a significant component of our net income in fiscal 2007, to decrease as a result of our repayment of the remaining principal balance of $542.3 million on our 3.75% convertible notes during the first quarter of fiscal 2008, and lower interest rates on investment balances. We generated $108.7 million in cash from operations during fiscal 2007 as compared to our use of $79.4 million during fiscal 2006. 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. We generated $11.3 million in cash from operations during the fourth quarter of fiscal 2007, consisting of $61.4 mil- lion in cash from net income (adjusted for non-cash charges) and a $50.1 million net use of cash resulting from changes in working capital. This compares with $64.1 million in cash generated from operations during the third quarter of fiscal 2007, consisting of $44.1 million in cash from net income (adjusted for non-cash charges) and a $20.0 million net increase in cash resulting from changes in working capital. On June 11, 2007, we completed a $500.0 million public offering of 0.875% Convertible Senior Notes due June 15, 2017. This offering resulted in net proceeds of approximately $445.8 million, after deducting underwriting discounts, expenses and $42.5 million we used to purchase a call spread option on our common stock. The call spread option is intended to mitigate our exposure to potential dilution from the conversion of the notes. We expect to use the net 41 proceeds of the offering for general corporate purposes, which may include the repurchase, or repayment at maturity, of our outstanding 3.75% convertible notes. The remaining principal balance on our outstanding 3.75% convertible notes of $542.3 million becomes due and payable on February 1, 2008. See “Liquidity and Capital Resources” and Notes 11 and 13 to our financial statements in Item 8 of Part II of this report for a discussion of our convertible notes and call spread options. We had $892.1 million in cash and cash equivalents and $856.1 million in short-term and long-term investments in marketable debt securities at October 31, 2007. Our investments in marketable debt securities at October 31, 2007 reflect a $13.0 million realized loss recognized during the fourth quarter of 2007 related to our investments in com- mercial paper issued by two structured investment vehicles that entered receivership during the fourth quarter of fiscal 2007 and failed to make payment at maturity. Due to the mortgage-related assets that they hold, each of these enti- ties has been exposed to adverse market conditions that have affected the value of their collateral and their ability to access short-term funding. At the time of our investment in the third quarter of fiscal 2007, each investment had a rating of A1+ by Standard and Poor’s and P-1 by Moody’s, their highest ratings respectively. Giving effect to these losses, our investment portfolio at October 31, 2007 included an estimated fair value of $33.9 million in commercial paper issued by these two SIVs. Information and the markets relating to these investments remain dynamic and there may be further declines in the value of these investments, the value of the collateral held by these entities and the liquidity of our investments. To the extent we determine that a further decline in fair value is other-than-temporary, we may recognize additional realized losses in future periods, up to the aggregate amount of these investments, which would have a negative effect on our net income. See “Critical Accounting Policies and Estimates—Investments” below for additional information regarding this loss and our determination of the fair value of these investments at October 31, 2007. As of October 31, 2007, headcount was 1,797, an increase from 1,485 at October 31, 2006 and an increase from 1,770 at July 31, 2007. results of operations In this report we discuss our revenue in three major groupings as follows: 1. Converged Ethernet Infrastructure. This group incorporates our transport and switching products and packet interworking products and related software previously reported in our optical networking and data net- working product groups. 2. Ethernet Access. This group includes our CNX-5™ Broadband DSL System and CNX-5Plus™ Modular Broadband Loop Carrier and related software previously reported in our broadband access product group. For the periods covered in this report, this group does not include CN 3000 Ethernet Access Series, as we have yet to recognize revenue related to this recently announced product. 3. Global Network Services. This group continues to include revenue associated with our service, support and training activities. Cost of goods sold consists of component costs, direct compensation costs, warranty and other contractual obliga- tions, royalties, license fees, direct technical support costs, cost of excess and obsolete inventory and overhead related to manufacturing, technical support, and engineering, furnishing and installation (“EF&I”) operations. 42 Ciena Corporation 10-K fiscal 2006 Compared to fiscal 2007 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: Revenue: Products Services Total revenue Costs: Products Services Total cost of goods sold Gross profit 2006 %* 2007 %* Fiscal year $502,427 61,629 564,056 263,667 42,608 306,275 $257,781 89.1 10.9 100.0 46.7 7.6 54.3 45.7 $695,289 84,480 779,769 337,866 79,634 417,500 $362,269 89.2 10.8 100.0 43.3 10.2 53.5 46.5 increase (decrease) $192,862 22,851 215,713 74,199 37,026 111,225 $104,488 %** 38.4 37.1 38.2 28.1 86.9 36.3 40.5 * Denotes % of total revenue ** Denotes % change from 2006 to 2007 The table below (in thousands, except percentage data) sets forth the changes in product revenue, product cost of goods sold and product gross profit for the periods indicated: Product revenue Product cost of goods sold Product gross profit 2006 $502,427 263,667 $238,760 * Denotes % of product revenue ** Denotes % change from 2006 to 2007 Fiscal year %* 100.0 52.5 47.5 2007 $695,289 337,866 $357,423 %* 100.0 48.6 51.4 increase (decrease) $192,862 74,199 $118,663 %** 38.4 28.1 49.7 The table below (in thousands, except percentage data) sets forth the changes in service revenue, service cost of goods sold and service gross profit (loss) for the periods indicated: Service revenue Service cost of goods sold Service gross profit 2006 $61,629 42,608 $19,021 * Denotes % of service revenue ** Denotes % change from 2006 to 2007 Fiscal year %* 100.0 69.1 30.9 2007 $84,480 79,634 $ 4,846 %* 100.0 94.3 5.7 increase (decrease) $ 22,851 37,026 $(14,175) %** 37.1 86.9 (74.5) The table below (in thousands, except percentage data) sets forth the changes in distribution of revenue for the peri- ods indicated: Converged Ethernet infrastructure Ethernet access Global network services Total 2006 %* 2007 %* Fiscal year $420,567 81,860 61,629 $564,056 74.6 14.5 10.9 100.0 $645,159 50,129 84,481 $779,769 82.8 6.4 10.8 100.0 increase (decrease) $224,592 (31,731) 22,852 $215,713 %** 53.4 (38.8) 37.1 38.2 * Denotes % of total revenue ** Denotes % change from 2006 to 2007 43 Revenue from sales to customers outside of the United States is reflected as International in the geographic distribu- tion of revenue below. The table below (in thousands, except percentage data) sets forth the changes in geographic distribution of revenue for the periods indicated: United States International Total 2006 $423,687 140,369 $564,056 Fiscal year %* 75.1 24.9 100.0 2007 $553,582 226,187 $779,769 %* 71.0 29.0 100.0 increase (decrease) $129,895 85,818 $215,713 %** 30.7 61.1 38.2 * Denotes % of total revenue ** Denotes % change from 2006 to 2007 Certain customers each accounted for at least 10% of our revenue for the periods indicated (in thousands, except percentage data) as follows: Verizon Sprint AT&T Total 2006 $ 70,225 89,793 66,926 $226,944 Fiscal year %* 12.4 15.9 11.9 40.2 2007 N/A — 100,122 196,924 $297,046 %* 12.8 25.3 38.1 N/A Denotes revenue representing less than 10% of total revenue for the period * Denotes % of total revenue Revenue • Product revenue increased due to a $224.6 million increase in sales of our converged Ethernet infrastructure products. We believe that our converged Ethernet infrastructure revenue has benefitted from both increasing network capacity requirements and the transition to more efficient and economical network architectures. Increased product revenue for fiscal 2007 primarily reflects a $140.2 million increase in sales of core switching products, a $60.5 million increase in core transport and a $59.4 million increase of our CN 4200™ FlexSelect™ Advanced Service Platform. The decrease in Ethernet access product revenue reflects a $36.8 million reduction in sales of our CNX-5™ Broadband DSL System, which was negatively affected by customer consolidation activity. • Service revenue increased primarily due to increases of $17.1 million in deployment service sales and $4.4 mil- lion in maintenance and support services, reflecting increased sales volume and increased installation activity. • United States revenue increased due to a $152.6 million increase in sales of our converged Ethernet infra- structure products. This primarily reflects a $133.2 million increase in sales of core switching products, and a $40.0 million increase in core transport. United States revenue was also affected by a $31.9 million decrease of revenue from Ethernet access products. • International revenue increased due to a $72.0 million increase in sales of our converged Ethernet infrastruc- ture products. This primarily reflects a $53.3 million increase in sales of our CN 4200™ FlexSelect™ Advanced Service Platform and a $20.5 million increase in sales of core transport products. International revenue also reflects an increase of $13.7 million in service revenue, primarily related to deployment. Gross profit • Gross profit as a percentage of revenue increased primarily due to product gross margin improvement off- set by a significant reduction in services gross margin. • Gross profit on products as a percentage of product revenue increased primarily due to favorable prod- uct and customer mix, significant product cost reductions, improved manufacturing efficiencies, and lower warranty expense. • Gross profit on services as a percentage of services revenue decreased significantly as a result of increased deployment overhead costs associated with the expansion of our internal resources related to deploy- ment activities for international network infrastructure projects. 44 Ciena Corporation 10-K Operating expense The table below (in thousands, except percentage data) sets forth the changes in operating expense for the periods indicated: Research and development Selling and marketing General and administrative Amortization of intangible assets Restructuring costs Recovery of doubtful accounts, net Gain on lease settlement Total operating expenses 2006 $111,069 104,434 47,476 25,181 15,671 (3,031) (11,648) $289,152 * Denotes % of total revenue ** Denotes % change from 2006 to 2007 Fiscal year %* 19.7 18.5 8.4 4.5 2.8 (0.5) (2.1) 51.3 2007 $127,296 118,015 50,262 25,350 (2,435) (14) (4,871) $313,603 %* 16.3 15.1 6.4 3.3 (0.3) — (0.6) 40.2 increase (decrease) $ 16,227 13,581 2,786 %** 14.6 13.0 5.9 169 (18,106) 0.7 (115.5) 3,017 6,777 $ 24,451 (99.5) (58.2) 8.5 • Research and development expense increased due to higher employee compensation cost of $10.9 million, primarily due to growth in headcount at our India development center. Other increases included $4.8 million in prototype expense, $1.2 million in facilities and information systems costs and $0.6 million in travel-related expenditures. This was partially offset by a decrease in consulting expense of $1.8 million. • Selling and marketing expense increased primarily due a $9.4 million increase in employee compensation, which primarily reflects increased headcount in fiscal 2007. Other increases included $1.7 million in travel expense, $1.1 million in consulting, and $0.8 million in tradeshow activities. • General and administrative expense increased due to an $8.6 million increase in employee compensation, which reflects a $3.2 million increase in stock compensation cost and increased headcount. This increase was partially offset by a $7.1 million reduction in legal expense. Legal expense for fiscal 2007 and fiscal 2006 included $2.3 million and $5.7 million, respectively, in costs associated with the settlement of patent litigation. • Amortization of intangible assets costs increased slightly due to the purchase of certain developed technol- ogy during the fourth quarter of fiscal 2007. • Restructuring costs during fiscal 2007 primarily reflect adjustments related to the return to use of previously restructured facilities. Restructuring costs during fiscal 2006 were primarily related to an adjustment of $10.0 mil- lion due to changes in market conditions related to our former facilities in San Jose, CA. During fiscal 2006, we also recorded charges totaling $6.3 million related to the closure of our facilities in Kanata, Ontario, Shrewsbury, NJ and Beijing, China. • Recovery of doubtful accounts, net during fiscal 2007 and fiscal 2006 was related to our receipt of pay- ment of amounts due from customers from whom payment was previously deemed doubtful due to their financial condition. • Gain on lease settlement for fiscal 2007 was related to the termination of lease obligations for our former San Jose, CA facilities. During the fourth quarter of fiscal 2007, we paid $53.0 million in connection with the settlement of this lease obligation. This transaction resulted in a gain on lease settlement of approximately $4.9 million by eliminating the remaining unfavorable lease commitment balance of $34.9 million and reduc- ing our restructuring liabilities by $23.5 million, offset by approximately $0.5 million of other expenses. The gain during fiscal 2006 was related to the termination of the lease obligations for our former Freemont, CA and Cupertino, CA facilities. 45 Other items The table below (in thousands, except percentage data) sets forth the changes in other items for the periods indicated: Interest and other income, net Interest expense Loss, other-than-temporary, on marketable debt securities Gain on equity 2006 $50,245 $24,165 $ — investments, net $ 215 Gain on extinguishment of debt Provision for income taxes $ 7,052 $ 1,381 * Denotes % of total revenue ** Denotes % change from 2006 to 2007 Fiscal year %* 8.9 4.3 — — 1.3 0.2 2007 $76,483 $26,996 $13,013 $ 592 $ — $ 2,944 %* 9.8 3.5 1.7 0.1 — 0.4 increase (decrease) $26,238 $ 2,831 %** 52.2 11.7 $13,013 100.0 $ 377 175.3 $ (7,052) $ 1,563 (100.0) 113.2 • • Interest and other income, net increased in part due to higher average cash and investment balances result- ing from the proceeds of our April 10, 2006 issuance of 0.25% convertible senior notes and our June 11, 2007 issuance of 0.875% convertible senior notes, in part due to higher interest rates. We expect interest income to decrease as a result of our repayment of the remaining principal balance of $542.3 million on our 3.75% con- vertible notes, which becomes due on February 1, 2008, and lower interest rates on investment balances. Interest expense increased primarily due to interest associated with our April 10, 2006 issuance of 0.25% convertible senior notes and June 11, 2007 issuance of 0.875% convertible senior notes. We expect interest expense to decrease as a result of our repayment of the remaining principal balance of $542.3 million on our 3.75% convertible notes, which becomes due on February 1, 2008. • Loss, other-than-temporary for fiscal 2007 was the result of a realized loss of $13.0 million related to our marketable debt securities. During the fourth quarter of fiscal 2007, we determined that declines in the fair value of our investments in certain commercial paper were other-than-temporary. This commercial paper was issued by SIV Portfolio plc (formerly known as Cheyne Finance plc) and Rhinebridge LLC, two structured invest- ment vehicles (SIVs) that entered into receivership during the fourth quarter of fiscal 2007 and failed to make payment at maturity. Due to the mortgage-related assets that they hold, each of these entities has been exposed to adverse market conditions that have affected the value of their collateral and their ability to access short-term funding. See “Critical Accounting Policies and Estimates—Investments” below for additional infor- mation regarding this loss and our determination of the fair value of these investments at October 31, 2007. • Gain on extinguishment of debt for fiscal 2006 resulted from our repurchase of $106.5 million of our out- standing 3.75% convertible notes in open market transactions for $98.4 million. We recorded a gain on the extinguishment of debt in the amount of $7.1 million, which consists of the $8.1 million gain from the repur- chase of the notes, less $1.0 million of associated debt issuance costs. • Provision for income taxes was primarily attributable to foreign tax related to our foreign operations. We will continue to maintain a valuation allowance against all net deferred tax assets until sufficient evidence exists to support its reversal. See “Critical Accounting Policies and Estimates—Deferred Tax Valuation Allowance” below for information relating to this valuation allowance and the conditions required for our release of the valuation allowance. 46 Ciena Corporation 10-K fiscal 2005 Compared to fiscal 2006 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: Revenue: Products Services Total revenue Costs: Products Services Total cost of goods sold Gross profit 2005 %* 2006 %* Fiscal year $374,275 52,982 427,257 248,931 42,136 291,067 $136,190 87.6 12.4 100.0 58.2 9.9 68.1 31.9 $502,427 61,629 564,056 263,667 42,608 306,275 $257,781 89.1 10.9 100.0 46.7 7.6 54.3 45.7 increase (decrease) $128,152 8,647 136,799 14,736 472 15,208 $121,591 %** 34.2 16.3 32.0 5.9 1.1 5.2 89.3 * Denotes % of total revenue ** Denotes % change from 2005 to 2006 The table below (in thousands, except percentage data) sets forth the changes in product revenue, product cost of goods sold and product gross profit for the periods indicated: Product revenue Product cost of goods sold Product gross profit 2005 $374,275 248,931 $125,344 * Denotes % of product revenue ** Denotes % change from 2005 to 2006 Fiscal year %* 100.0 66.5 33.5 2006 $502,427 263,667 $238,760 %* 100.0 52.5 47.5 increase (decrease) $128,152 14,736 $113,416 The table below (in thousands, except percentage data) sets forth the changes in service revenue, service cost of goods sold and service gross profit for the periods indicated: Service revenue Service cost of goods sold Service gross profit 2005 $52,982 42,136 $10,846 * Denotes % of service revenue ** Denotes % change from 2005 to 2006 Fiscal year %* 100.0 79.5 20.5 2006 $61,629 42,608 $19,021 %* 100.0 69.1 30.9 increase (decrease) $8,647 472 $8,175 %** 34.2 5.9 90.5 %** 16.3 1.1 75.4 The table below (in thousands, except percentage data) sets forth the changes in distribution of revenue for the peri- ods indicated: Converged Ethernet infrastructure Ethernet access Global network services Total 2005 %* 2006 %* Fiscal year $291,549 82,726 52,982 $427,257 68.2 19.4 12.4 100.0 $420,567 81,860 61,629 $564,056 74.6 14.5 10.9 100.0 increase (decrease) $129,018 (866) 8,647 $136,799 %** 44.3 (1.0) 16.3 32.0 * Denotes % of total revenue ** Denotes % change from 2005 to 2006 47 Revenue from sales to customers outside of the United States is reflected as International in the geographic distribu- tion of revenue below. The table below (in thousands, except percentage data) sets forth the changes in geographic distribution of revenue for the periods indicated: United States International Total 2005 $340,774 86,483 $427,257 Fiscal year %* 79.8 20.2 100.0 2006 $423,687 140,369 $564,056 %* 75.1 24.9 100.0 increase (decrease) $ 82,913 53,886 $136,799 %** 24.3 62.3 32.0 * Denotes % of total revenue ** Denotes % change from 2005 to 2006 Certain customers each accounted for at least 10% of our revenue for the periods indicated (in thousands, except percentage data) as follows: Verizon BellSouth SAIC Sprint AT&T Total 2005 $ 43,673 43,946 46,058 N/A N/A $133,677 Fiscal year %* 10.2 10.3 10.8 — — 31.3 2006 $ 70,225 N/A — N/A — 89,793 66,926 $226,944 %* 12.4 15.9 11.9 40.2 N/A Denotes revenue representing less than 10% of total revenue for the period * Denotes % of total revenue Revenue • Product revenue increased due to a $129.0 million increase in sales of our converged Ethernet infrastructure products. This primarily reflects a $48.3 million increase in sales from our CN 4200™ FlexSelect™ Advanced Services Platform introduced in the third quarter of fiscal 2005, a $43.7 million increase in sales from our core transport products and a $35.0 million increase in sales from our core switching products. • Service revenue increased primarily due to a $4.6 million increase in sales of maintenance and support ser- vices, a $2.2 million increase in sales of deployment services, and a $1.2 million increase in sales of product training services. • United States revenue increased due to a $79.3 million increase in sales of our converged Ethernet infrastruc- ture products. This increase primarily reflects a $38.1 million increase in sales from our core transport products, a $30.7 million increase in sales from our core switching products, and a $15.9 million increase from sales of our CN 4200™ FlexSelect™ Advanced Services Platform. • International revenue increased due to a $49.7 million increase in sales of our converged Ethernet infrastruc- ture products. This increase primarily reflects a $32.4 million increase in sales from our CN 4200™ FlexSelect™ Advanced Services Platform and a $17.3 million increase in sales from other transport and switching products. Gross profit • Gross profit as a percentage of revenue increased largely due to increased sales volume, sales of higher margin products and cost improvements resulting from our efforts to employ a global approach to sourcing components and manufacturing our products. • Gross profit on products as a percentage of product revenue increased primarily due to cost reductions and higher margin product mix. • Gross profit on services as a percentage of services revenue increased primarily due to service rate stabil- ity in connection with our deployment services and reduced service overhead and deployment costs. 48 Ciena Corporation 10-K Operating expenses The table below (in thousands, except percentage data) sets forth the changes in operating expense for the periods indicated: Research and development Selling and marketing General and administrative Amortization of intangible assets Restructuring costs Goodwill impairment Long-lived asset impairment Provision for (recovery of) doubtful accounts, net Gain on lease settlement Total operating expenses 2005 $137,245 115,022 33,715 38,782 18,018 176,600 45,862 2,602 — $567,846 * Denotes % of total revenue ** Denotes % change from 2005 to 2006 Fiscal year %* 32.1 26.9 7.9 9.1 4.2 41.3 10.7 0.6 — 132.8 2006 $111,069 104,434 47,476 25,181 15,671 — — (3,031) (11,648) $289,152 %* 19.7 18.5 8.4 4.5 2.8 — — (0.5) (2.1) 51.3 increase (decrease) $ (26,176) (10,588) 13,761 (13,601) (2,347) (176,600) (45,862) (5,633) (11,648) $(278,694) %** (19.1) (9.2) 40.8 (35.1) (13.0) (100.0) (100.0) (216.5) N/A (49.1) • Research and development expense decreased primarily due to reductions of $12.3 million in employee compensation, $6.9 million in prototype expense and $6.3 million in depreciation expense. The reduction in employee compensation was driven by headcount reductions. • Selling and marketing expense decreased due to reductions of $7.3 million in depreciation costs, $2.2 mil- lion in product introduction and marketing activities, $2.0 million in facility and information systems expense, $1.7 million in temporary import costs and $0.8 million in travel. These reductions were slightly offset by increases of $2.3 million in employee compensation. Salaries, bonuses and commissions increased by $3.3 mil- lion during fiscal 2006, offset by a reduction of $1.1 million in share-based compensation expense. • General and administrative expense increased due to an increase of $6.5 million in legal expense, primarily related to our patent litigation with Nortel Networks, $5.9 million in employee compensation and $1.5 million in audit fees partially offset by a decrease of $0.5 million in directors and officers insurance expense. Included in the legal expenses were $5.7 million in contingent fees paid to outside counsel and advisors connected with the settlement of the Nortel litigation. The increase in employee compensation included an increase of $2.7 million in share-based compensation expense. • Amortization of intangible assets decreased due to the write-off of intangible assets recorded in the fourth quarter of fiscal 2005. • Restructuring costs incurred during fiscal 2006 were primarily related to a $10.0 million charge associated with previously restructured unused facilities located in San Jose, CA, and $6.3 million in charges related to workforce reductions of approximately 155 employees and costs associated with the closure of facilities located in Kanata, Canada; Shrewsbury, NJ and Beijing, China. • Provision for (recovery of) doubtful accounts, net for fiscal 2006 was related to the receipt of amounts due from customers from whom payment was previously deemed doubtful due to the customers’ financial condition. • Gain on lease settlement for fiscal 2006 was related to the termination of our obligations under the leases for our former Fremont, CA and Cupertino, CA facilities. 49 Other items The table below (in thousands, except percentage data) sets forth the changes in other items for the periods indicated: Interest and other income, net Interest expense Gain (loss) on equity investments, net Gain on extinguishment of debt Provision for income taxes 2005 $31,294 $28,413 Fiscal year %* 7.3 6.7 2006 $50,245 $24,165 $ (9,486) (2.2) $ 215 $ 3,882 $ 1,320 0.9 0.3 $ 7,052 $ 1,381 %* 8.9 4.3 — 1.3 0.2 increase (decrease) $18,951 $ (4,248) %** 60.6 (15.0) $ 9,701 (102.3) $ 3,170 61 $ 81.7 4.6 * Denotes % of total revenue ** Denotes % change from 2005 to 2006 • • Interest and other income, net increased primarily due to higher interest rates. Interest expense decreased due to the repurchase of a portion of our outstanding 3.75% convertible notes during fiscal 2005 and fiscal 2006. • Loss on equity investments, net in fiscal 2005 was due to a decline in the value of our investments in pri- vately held technology companies that was determined to be other-than-temporary. • Gain (loss) on extinguishment of debt for fiscal 2006 resulted from our repurchase of $106.5 million of our outstanding 3.75% convertible notes in open market transactions for $98.4 million. We recorded a gain on the extinguishment of debt in the amount of $7.1 million, which consists of the $8.1 million gain from the repur- chase of the notes, less a write-off of $1.0 million of associated debt issuance costs. • Provision for income taxes for fiscal 2005 and fiscal 2006 was primarily attributable to foreign tax related to Ciena’s foreign operations. We did not record a tax benefit for domestic losses during fiscal 2005 or fiscal 2006. We will continue to maintain a valuation allowance against certain deferred tax assets until sufficient evidence exists to support its reversal. See “Critical Accounting Policies and Estimates—Deferred Tax Valuation Allowance” below. Liquidity and Capital resources At October 31, 2007, our principal sources of liquidity were cash and cash equivalents, short-term investments in mar- ketable debt securities and cash from operations. The following table summarizes our cash and cash equivalents and investments in marketable debt securities (in thousands): Cash and cash equivalents Short-term investments in marketable debt securities Long-term investments in marketable debt securities Total cash and cash equivalents and investments in marketable debt securities october 31, 2006 $ 220,164 2007 $ 892,061 increase (decrease) $ 671,897 628,393 822,185 193,792 351,407 33,946 (317,461) $1,199,964 $1,748,192 $ 548,228 The increase in total cash and cash equivalents and investments in marketable debt securities at October 31, 2007 was primarily related to the net proceeds of approximately $445.8 million from our June 11, 2007 issuance of 0.875% convertible senior notes, our net income during fiscal 2007 and the effect of non-cash items described in “Operating Activities” below. Based on past performance and current expectations, we believe that our cash and cash 50 Ciena Corporation 10-K equivalents, investments in marketable debt securities and cash generated from operations will satisfy our working capital needs, capital expenditures and other liquidity requirements associated with our existing operations through at least the next 12 months. In anticipation of paying off the $542.3 million principal of our outstanding 3.75% convert- ible notes at maturity on February 1, 2008, we have reallocated investments to increase our position in cash and cash equivalents and short-term investments in marketable debt securities. Included in long-term investments in marketable debt securities at October 31, 2007 is approximately $33.9 million in investments in commercial paper issued by two SIVs that entered into receivership during the fourth quarter of fiscal 2007 and failed to make payment at maturity. We realized a $13.0 million other-than-temporary loss related to this commercial paper in the fourth quarter of fiscal 2007. Due to the mortgage-related assets that they hold, each of these entities has been exposed to adverse market conditions that have affected the value of their collateral and their ability to access short-term funding. These investments are no longer trading and have no readily determinable market value. Information and the markets relating to these investments remain dynamic, and there may be further declines in the value of these investments, the value of the collateral held by these entities and the liquidity of our investment. As a result, we may realize further reductions in the fair value of these investments, additional losses or a complete loss of these investments. See “Critical Accounting Policies and Estimates—Investments” below for additional infor- mation regarding this loss and our determination of the fair value of these investments at October 31, 2007. The following sections review the significant activities that had an impact on our cash during fiscal 2007. operating activities The following tables set forth (in thousands) significant components of our $108.7 million of cash generated by oper- ating activities for fiscal 2007: Net income Net income year ended october 31, 2007 $82,788 Our net income for fiscal 2007 included the significant non-cash items summarized in the following table (in thousands): Non-cash loss on equity investments and marketable securities Depreciation of equipment, furniture and fixtures; and amortization of leasehold improvements Share-based compensation costs Amortization of intangible assets Provision for inventory excess and obsolescence Provision for warranty Total significant non-cash charges year ended october 31, 2007 $13,013 12,833 19,572 29,220 12,180 12,743 $99,561 Accounts Receivable, Net Cash provided by accounts receivable, net decreased by $3.1 million from the end of fiscal 2006 to the end of fiscal 2007. Our accounts receivable balance decreased due to a proportionately higher volume of shipments made early in the fourth quarter of fiscal 2007 and higher sales to customers with shorter payment terms, primarily associated with our domestic revenue. Our days sales outstanding (“DSO”) decreased from 68 days for fiscal 2006 to 48 days for fis- cal 2007. 51 The following table sets forth (in thousands) changes to our accounts receivable, net of allowance for doubtful accounts receivable, from the end of fiscal 2006 through the end of fiscal 2007: Accounts receivable, net october 31, 2006 $107,172 2007 $104,078 increase (decrease) $(3,094) Inventory Excluding the non-cash effect of a $12.2 million provision for excess and obsolescence, cash consumed by inventory for fiscal 2007 was $8.7 million. Ciena’s inventory turns increased from 2.5 for fiscal 2006 to 3.3 for fiscal 2007. The following table sets forth (in thousands) changes to the components of our inventory from the end of fiscal 2006 through the end of fiscal 2007: Raw materials Work-in-process Finished goods Gross inventory Provision for inventory excess and obsolescence Inventory october 31, 2006 $ 29,627 9,156 89,628 128,411 2007 $ 28,611 4,123 96,054 128,788 (22,326) $106,085 (26,170) $102,618 increase (decrease) $(1,016) (5,033) 6,426 377 (3,844) $(3,467) Accounts payable During fiscal 2007, we modified our standard vendor payment terms and payment practices from net 30 days to net 45 days. This change contributed to an increase in our accounts payable balance of $16.1 million. The following table sets forth (in thousands) changes in our accounts payable from the end of fiscal 2006 through end of fiscal 2007: Accounts payable october 31, 2006 $39,277 2007 $55,389 increase (decrease) $16,112 Restructuring and unfavorable lease commitments During fiscal 2007, we paid $24.0 million on leases related to restructured facilities and $5.6 million on leases associ- ated with unfavorable lease commitments. Also, during the fourth quarter of fiscal 2007, we paid $53.0 million in connection with the settlement of our lease obligation related to previously restructured facilities in San Jose, CA. This transaction resulted in a gain on lease settlement of $4.9 million by eliminating our remaining unfavorable lease com- mitment balance of $34.9 million and reducing our restructuring liabilities by $23.5 million, offset by approximately $0.5 million of other expenses. The following table reflects (in thousands) the balance of liabilities for our restructured facilities and unfavorable lease commitments and the change in these balances from the end of fiscal 2006 through the end of fiscal 2007: Restructuring liabilities Unfavorable lease commitments Long-term restructuring liabilities Long-term unfavorable lease commitments Total restructuring liabilities and unfavorable lease commitments october 31, 2006 $ 8,914 8,512 26,720 2007 $1,026 — 3,662 increase (decrease) $ (7,888) (8,512) (23,058) 32,785 — (32,785) $76,931 $4,688 $(72,243) 52 Ciena Corporation 10-K Interest payable on Ciena’s convertible notes Interest on Ciena’s outstanding 3.75% convertible notes, due February 1, 2008, is payable on February 1 and August 1 of each year. Ciena paid $20.3 million in interest on the 3.75% convertible notes during fiscal 2007. Interest on Ciena’s outstanding 0.25% convertible senior notes, due May 1, 2013, is payable on May 1 and November 1 of each year, commencing on November 1, 2006. Ciena paid $1.2 million in interest on the 0.25% convertible notes during fiscal 2007. Interest on Ciena’s outstanding 0.875% convertible senior notes, due June 15, 2017, is payable on June 15 and December 15 of each year, commencing on December 15, 2007. The indentures governing our outstanding convertible notes do not contain any financial covenants. The indentures provide for customary events of default, including payment defaults, breaches of covenants, failure to pay certain judgments and certain events of bankruptcy, insolvency and reorganization. If an event of default occurs and is con- tinuing, the principal amount of the notes, plus accrued and unpaid interest, if any, may be declared immediately due and payable. These amounts automatically become due and payable if an event of default relating to certain events of bankruptcy, insolvency or reorganization occurs. For additional information about our convertible notes, see Note 11 to our financial statements included in Item 8 of Part II of this report. The following table reflects (in thousands) the balance of interest payable and the change in this balance from the end of fiscal 2006 through the end of fiscal 2007. Accrued interest payable october 31, 2006 $5,502 2007 $6,998 increase (decrease) $1,496 Deferred revenue During fiscal 2007, deferred revenue increased by $23.0 million. The increase in product deferred revenue was primar- ily due to an increase in payments received in advance of shipment, and also reflects payments received in advance of our ability to recognize revenue. The increase in service deferred revenue is related to payment for service contracts that will be recognized over the contract term. The following table reflects (in thousands) the balance of deferred rev- enue and the change in this balance from the end of fiscal 2006 through the end of fiscal 2007: Products Services Total deferred revenue october 31, 2006 $ 4,276 36,400 $40,676 2007 $13,208 50,432 $63,640 increase (decrease) $ 8,932 14,032 $22,964 financing activities On June 11, 2007, we completed a $500.0 million public offering of 0.875% Convertible Senior Notes due June 15, 2017. This offering resulted in net proceeds of approximately $445.8 million, after deducting underwriting discounts, expenses and $42.5 million we used to purchase a call spread option on our common stock. The call spread option is intended to mitigate our exposure to potential dilution from the conversion of the notes. We expect to use the net proceeds of the offering for general corporate purposes, which may include the repurchase or repayment at maturity of our outstanding 3.75% convertible notes. The remaining principal balance on our outstanding 3.75% convertible notes of $542.3 million becomes due and payable on February 1, 2008. Cash provided by financing activities during fiscal 2007 also includes $36.8 million related to the exercise of employee stock options and participation in our employee stock purchase plan. 53 Contractual obligations The following is a summary of our future minimum payments under contractual obligations as of October 31, 2007 (in thousands): Convertible notes(1) Operating leases(2) Purchase obligations(3) Total total $1,400,389 71,590 135,794 $1,607,773 Less than one year $557,639 13,744 135,794 $707,177 one to three years $10,250 21,338 — $31,588 three to five years $10,250 15,634 — $25,884 thereafter $822,250 20,874 — $843,124 (1) $542.3 million in outstanding principal balance on our 3.75% convertible notes becomes due and payable on February 1, 2008. (2) The amount for operating leases above does not include insurance, taxes, maintenance and other costs required by the applicable operating lease. These costs are variable and are not expected to have a material impact. (3) Purchase obligations relate to purchase order commitments to our contract manufacturers and component suppliers for inventory. In certain instances, we are permitted to cancel, reschedule or adjust these orders. Consequently, only a portion of the amount reported above relates to firm, non-cancelable and unconditional obligations. Some of our commercial commitments, including some of the future minimum payments set forth above, are secured by standby letters of credit. The following is a summary of our commercial commitments secured by standby letters of credit by commitment expiration date as of October 31, 2007 (in thousands): Standby letters of credit total $21,916 Less than one year $3,392 one to three years $18,359 three to five years $165 thereafter $— off-Balance Sheet arrangements Ciena does not engage in any off-balance sheet financing arrangements. In particular, we do not have any equity inter- ests in so-called limited purpose entities, which include special purpose entities (SPEs) and structured finance entities. Critical accounting policies and estimates The preparation of our consolidated financial statements requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expense, and related disclosure of contingent assets and liabili- ties. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. On an ongoing basis, we reevaluate our estimates, including those related to bad debts, inventories, investments, intangible assets, goodwill, income taxes, warranty obligations, restructuring, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Among other things, these estimates form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. To the extent that there are material differences between our estimates and actual results, our consolidated financial statements will be affected. We believe that the following critical accounting policies reflect those areas where significant judgments and esti- mates are used in the preparation of our consolidated financial statements. Revenue Recognition We recognize revenue in accordance with Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition,” (SAB 104) which states that revenue is realized or realizable and earned when all of the following criteria are met: persuasive evi- dence of an arrangement exists; delivery has occurred or services have been rendered; the price to the buyer is fixed or determinable; and collectibility is reasonably assured. Customer purchase agreements and customer purchase orders are generally used to determine the existence of an arrangement. Shipping documents and customer accep- tance, when applicable, are used to verify delivery. We assess whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We 54 Ciena Corporation 10-K assess collectibility based primarily on the creditworthiness of the customer as determined by credit checks and analy- sis, as well as the customer’s payment history. In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met. Revenue for maintenance services is generally deferred and recognized ratably over the period during which the services are to be performed. Some of our communications networking equipment is integrated with software that is essential to the functionality of the equipment. Accordingly, we account for revenue in accordance with Statement of Position No. 97-2, “Software Revenue Recognition,” (SOP 97-2) and all related interpretations. SOP 97-2 incorporates additional guidance unique to software arrangements incorporated with general accounting guidance, such as, revenue is recognized when per- suasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable. In instances where final acceptance of the product is specified by the customer, revenue is deferred until all acceptance criteria have been met. Arrangements with customers may include multiple deliverables, including any combination of equipment, services and software. If multiple element arrangements include software or software related elements, we apply the provi- sions of SOP 97-2 to determine the amount of the arrangement fee to be allocated to those separate units of accounting. Multiple element arrangements that include software are separated into more than one unit of account- ing if the functionality of the delivered element(s) is not dependent on the undelivered element(s), there is vendor-specific objective evidence of the fair value of the undelivered element(s), and general revenue recognition cri- teria related to the delivered element(s) have been met. The amount of product and service revenue recognized is affected by our judgments as to whether an arrangement includes multiple elements and, if so, whether vendor- specific objective evidence of fair value exists. Changes to the elements in an arrangement and our ability to establish vendor-specific objective evidence for those elements could affect the timing of revenue recognition. For all other deliverables, we apply the provisions of Emerging Issues Task Force (EITF) No. 00-21, “Revenue Arrangements with Multiple Deliverables,” (EITF 00-21). EITF 00-21 allows for separation of elements into more than one unit of account- ing if the delivered element(s) have value to the customer on a stand-alone basis, objective and reliable evidence of fair value exists for the undelivered element(s), and delivery of the undelivered element(s) is probable and substantially within our control. Revenue is allocated to each unit of accounting based on the relative fair value of each accounting unit or using the residual method if objective evidence of fair value does not exist for the delivered element(s). The revenue recognition criteria described above is applied to each separate unit of accounting. If these criteria are not met, revenue is deferred until the criteria are met or the last element has been delivered. Our total deferred revenue for products was $4.3 million and $13.2 million as of October 31, 2006 and 2007, respec- tively. Our service revenue is deferred and recognized ratably over the period during which the services are to be performed. Our total deferred revenue for services was $36.4 million and $50.4 million as of October 31, 2006 and 2007, respectively. share-based Compensation On November 1, 2005, we adopted SFAS 123(R), “Share-Based Payments,” as interpreted by SAB 107, which requires the measurement and recognition of compensation expense for share-based awards based on estimated fair values. SFAS 123(R) requires companies to estimate the fair value of share-based awards on the date of grant. Share-based compensation expense recognized in our consolidated statement of operations includes compensation expense for share-based awards granted (i) prior to, but not yet vested as of October 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123, and (ii) subsequent to October 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R), as interpreted by SAB 107. We estimate the fair value of each option-based award on the date of grant using the Black-Scholes option-pricing model. This option pricing model requires that we make several estimates, including the option’s expected life and the price volatility of the underlying stock. The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding. Because we consider our options to be “plain vanilla,” we calculate the expected life using the simplified method as prescribed in SAB 107. Under SAB 107, options are considered 55 to be “plain vanilla” if they have the following basic characteristics: granted “at-the-money”; exerciseability is condi- tioned upon service through the vesting date; termination of service prior to vesting results in forfeiture; limited exercise period following termination of service; and options are non-transferable and non-hedgeable. We consider the implied volatility and historical volatility of our stock price in determining our expected volatility, and, finding both to be equally reliable, have determined that a combination of both measures would result in the best estimate of expected volatility. The estimated fair value of option-based awards, net of estimated forfeitures, is recognized as stock-based compensa- tion expense on a straight-line basis over the requisite service period. We estimate the fair value of our restricted stock unit awards based on the fair value of our common stock on the date of grant. Our outstanding restricted stock unit awards are subject to service-based vesting conditions and/or performance-based vesting conditions. The estimated fair value of service-based awards, net of estimated forfei- tures, is recognized as share-based expense ratably over the vesting period on a straight-line basis. Awards with performance-based vesting conditions require the achievement of certain company-based, financial or other perfor- mance criteria or targets as a condition to the vesting, or acceleration of vesting, of such awards. The estimated fair value of performance-based awards, net of estimated forfeitures, is recognized as share-based expense over the per- formance period, using graded vesting, which considers each performance period or tranche separately, and based upon our determination of whether it is probable that the performance targets will be achieved. At each reporting period, we reassess the probability of achieving the performance targets and the performance period required to meet those targets. Determining whether the performance targets will be achieved involves judgment, and the esti- mate of expense may be revised periodically based on the probability of achieving the performance targets. Revisions are reflected in the period in which the estimate is changed. If any performance goals are not met, no compensation cost is ultimately recognized and, to the extent previously recognized, compensation cost is reversed. No tax benefits were attributed to the share-based compensation expense because a full valuation allowance was maintained for all net deferred tax assets. Because share-based compensation expense is based on awards that are ultimately expected to vest, the amount of expense takes into account estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Changes in these esti- mates and assumptions can materially affect the measure of estimated fair value of our share-based compensation. See Note 15 to our financial statements in Item 8 of Part II of this report for information regarding our treatment of share-based compensation. Reserve for Inventory obsolescence We make estimates about future customer demand for our products when establishing the appropriate reserve for excess and obsolete inventory. We write down inventory that has become obsolete or unmarketable by an amount equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. Inventory write downs are a component of our product cost of goods sold. Upon recognition of the write down, a new lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. We recorded charges for excess and obsolete inventory of $12.2 million, $9.0 million, and $5.2 million in fiscal 2007, 2006 and 2005 respectively. These charges were primarily related to excess inventory due to a change in forecasted sales for certain of our products. In an effort to limit our exposure to delivery delays and to satisfy customer needs we purchase inventory based on forecasted sales across our product lines. In addition, part of our research and develop- ment strategy is to promote the convergence of similar features and functionalities across our product lines. Each of these practices exposes us to an increased risk that our customers will not order those products for which we have forecasted sales, or will purchase less than we have forecasted. Historically, we have experienced write downs due to changes in strategic direction, discontinuance of a product and declines in market conditions. If actual market condi- tions differ from those we have assumed, if there is a sudden and significant decrease in demand for our products, or if there is a higher incidence of inventory obsolescence due to a rapid change in technology, we may be required to take additional inventory write-downs and our gross margin could be adversely affected. 56 Ciena Corporation 10-K Restructuring As part of our restructuring costs, we provide for the estimated cost of the net lease expense for facilities that are no longer being used. The provision is equal to the fair value of the minimum future lease payments under our con- tracted lease obligations, offset by the fair value of the estimated sublease payments that we may receive. As of October 31, 2007, our accrued restructuring liability related to net lease expense and other related charges was $4.7 million. The total minimum lease payments for these restructured facilities are $21.8 million. These lease pay- ments will be made over the remaining lives of our leases, which range from three months to eleven years. If actual market conditions are different than those we have projected, we are required to recognize additional restructuring costs or benefits associated with these facilities. During fiscal 2006, we recognized net adjustments resulting in restructuring costs of $9.2 million, which included a $10.0 million adjustment during the third quarter of fiscal 2006 relating to our unused San Jose, CA facilities. During the fourth quarter of fiscal 2007, we paid $53 million in con- nection with the settlement of our lease obligation related to previously restructured facilities in San Jose, CA. This transaction resulted in a gain on lease settlement of $4.9 million by eliminating our remaining unfavorable lease commitment balance of $34.9 million and reducing our restructuring liabilities by $23.5 million, offset by approxi- mately $0.5 million of other expenses. allowance for Doubtful accounts Our allowance for doubtful accounts receivable is based on management’s assessment, on a specific identification basis, of the collectibility of customer accounts. We perform ongoing credit evaluations of our customers and gener- ally have not required collateral or other forms of security from customers. In determining the appropriate balance for our allowance for doubtful accounts receivable, management considers each individual customer account receivable in order to determine collectability. In doing so, management considers creditworthiness, payment history, account activity and communication with such customer. If a customer’s financial condition changes, or if actual defaults are higher than our historical experience, we may be required to take a charge for an allowance for doubtful accounts receivable which could have an adverse impact on our results of operations. Goodwill As of October 31, 2007, our consolidated balance sheet included $232.0 million in goodwill. This amount primarily represents the remaining excess of the total purchase price of our acquisitions over the fair value of the net assets acquired. In accordance with SFAS 142, we test our goodwill for impairment on an annual basis, which we have determined to be the last business day of fiscal September each year, and between annual tests if an event occurs or circumstances change that would, more likely than not, reduce the fair value of the reporting unit below its carrying value. There was no impairment of goodwill in fiscal 2007 or 2006. During the fourth quarter of 2005, we incurred a goodwill impairment charge of approximately $176.6 million. If actual industry or market conditions change or our forecasts change at the time of our annual assessment or in periods prior to our annual assessment, we may be required to record additional goodwill impairment charges. Such charges would have the effect of decreasing our earnings or increasing our losses in such period. Intangible assets As of October 31, 2007, our consolidated balance sheet included $67.1 million in other intangible assets, net. We account for the impairment or disposal of long-lived assets such as equipment, furniture, fixtures, and other intan- gible assets in accordance with the provisions of SFAS 144. In accordance with SFAS 144, we test each intangible asset for impairment whenever events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable. Valuation of our intangible assets requires us to make assumptions about future sales prices and sales volumes for our products that involve new technologies and uncertainties around customer acceptance of new products. If actual market conditions differ or our forecasts change, we may be required to record additional impair- ment charges in future periods. Such charges would have the effect of decreasing our earnings or increasing our losses in such period. 57 Investments We have an investment portfolio comprised of marketable debt securities including short-term commercial paper, cer- tificates of deposit, corporate bonds, asset-backed obligations and U.S. government obligations. The value of these securities is subject to market volatility for the period we hold these investments and until their sale or maturity. We recognize realized losses when declines in the fair value of our investments, below their cost basis, are judged to be other-than-temporary. In determining whether a decline in fair value is other-than-temporary, we consider various fac- tors including market price (when available), investment ratings, the financial condition and near-term prospects of the investee, the length of time and the extent to which the fair value has been less than our cost basis, and our intent and ability to hold the investment until maturity or for a period of time sufficient to allow for any anticipated recovery in market value. We make significant judgments in considering these factors. If it is judged that a decline in fair value is other-than-temporary, the investment is valued at the current fair value and a realized loss equal to the decline is reflected in net income, which could materially adversely affect our operating results. During the fourth quarter of fiscal 2007, we determined that declines in the estimated fair value of our investments in certain commercial paper were other-than-temporary. This commercial paper was issued by SIV Portfolio plc (formerly known as Cheyne Finance plc) and Rhinebridge LLC, two structured investment vehicles (SIVs) that entered into receiv- ership during the fourth quarter of fiscal 2007 and failed to make payment at maturity. Due to the mortgage-related assets that they hold, each of these entities has been exposed to adverse market conditions that have affected the value of their collateral and their ability to access short-term funding. We purchased these investments in the third quarter of fiscal 2007 and, at the time of purchase, each investment had a rating of A1+ by Standard and Poor’s and P-1 by Moody’s, their highest ratings respectively. These investments are no longer trading and have no readily deter- minable market value. We have reviewed current investment ratings, valuation estimates of the underlying collateral, company specific news and events, and general economic conditions in considering the fair value of these investments. In estimating fair value, we used a valuation approach based on a liquidation of assets held by each SIV and their sub- sequent distribution of cash. We utilized assessments of the underlying collateral from multiple indicators of value, which were then discounted to reflect the expected timing of disposition and market risks. Based on this assessment of fair value, as of October 31, 2007, we recognized realized losses of $13.0 million related to these investments. Giving effect to these losses, our investment portfolio at October 31, 2007 included an estimated fair value of $33.9 million in commercial paper issued by these entities. See Note 4 to the financial statements included as Item 8 of Part II of this report. Information and the markets relating to these investments remain dynamic and there may be further declines in the value of these investments, the value of the collateral held by these entities and the liquidity of our investments. To the extent we determine that a further decline in fair value is other-than-temporary, we may recognize additional real- ized losses in future periods up to the aggregate amount of these investments. We are not aware of any other of our marketable debt securities that have experienced a similar decline in fair value. Our investments are subject to general credit, liquidity, market and interest rate risks, which may be exacerbated by U.S. sub-prime mortgage defaults that have affected various sectors of the financial markets and caused credit and liquidity issues. As of October 31, 2007 our marketable debt investments had unrealized losses of $0.1 million. These gross unrealized losses were primarily due to changes in interest rates. Management has determined that the gross unrealized losses on our marketable debt investments at October 31, 2007, are temporary in nature because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity. As of October 31, 2007, our minority investments in privately held technology companies, reported in other assets, were $6.7 million. These investments are generally carried at cost because we own less than 20% of the voting equity and do not have the ability to exercise significant influence over any of these companies. These investments are inher- ently high risk. The markets for technologies or products manufactured by these companies are usually early stage at the time of our investment and such markets may never materialize or become significant. We could lose our entire investment in some or all of these companies. We monitor these investments for impairment and make appropriate reductions in carrying values when necessary. If market conditions, the expected financial performance, or the com- petitive position of the companies in which we invest deteriorate, we may be required to record a charge in future periods due to impairment in their value. 58 Ciena Corporation 10-K Deferred Tax Valuation allowance As of October 31, 2007, we have recorded a valuation allowance fully offsetting gross deferred tax assets of $1.2 bil- lion. We calculated the valuation allowance in accordance with the provisions of SFAS 109, “Accounting for Income Taxes,” which requires an assessment of both positive and negative evidence regarding the realizability of these deferred tax assets, when measuring the need for a valuation allowance. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. In determining net deferred tax assets and valuation allowances, management is required to make judgments and estimates related to projections of profitability, the timing and extent of the utilization of net operating loss carryforwards, applicable tax rates, transfer pricing methodologies and tax planning strategies. The valuation allowance is reviewed quarterly and is maintained until sufficient positive evidence exists to support the reversal. Because evidence such as our operating results during the most recent three-year period is afforded more weight than forecasted results for future periods, our cumulative loss during this three-year period represents sufficient negative evidence regarding the need for a full valuation allow- ance under SFAS 109. We will release this valuation allowance when management determines that it is more likely than not that our deferred tax assets will be realized. If we are able to sustain a meaningful level of profitability in future periods, and forecast sufficient earnings for periods thereafter, we may be required to release a significant por- tion of the valuation allowance. Any future release of valuation allowance will be recorded as a tax benefit increasing net income, an adjustment to acquisition intangibles, or an adjustment to paid-in capital. Because we expect our recorded tax rate to increase in subsequent periods following a release of the valuation allowance, our net income would be affected in periods following the release. Any valuation allowance release will not affect the amount of cash paid for income taxes Warranty Our liability for product warranties, included in other accrued liabilities, was $33.6 million as of October 31, 2007. Our products are generally covered by a warranty for periods ranging from one to five years. We accrue for warranty costs as part of our cost of goods sold based on associated material costs, technical support labor costs, and associ- ated overhead. Material cost is estimated based primarily upon historical trends in the volume of product returns within the warranty period and the cost to repair or replace the equipment. Technical support labor cost is estimated based primarily upon historical trends and the cost to support the customer cases within the warranty period. The provision for product warranties was $12.7 million, $14.5 million, and $9.7 million in fiscal 2007, 2006 and 2005 respectively. The provision for warranty claims may fluctuate on a quarterly basis depending upon the mix of products and customers in that period. If actual product failure rates, material replacement costs, service or labor costs differ from our estimates, revisions to the estimated warranty provision would be required. An increase in warranty claims or the related costs associated with satisfying these warranty obligations could increase our cost of sales and negatively affect our gross margin. loss Contingencies We are subject to the possibility of various losses arising in the ordinary course of business. These may relate to dis- putes, litigation and other legal actions. We consider the likelihood of loss or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. A loss is accrued when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether any accruals should be adjusted and whether new accruals are required. effects of recent accounting pronouncements See Note 1 to our financial statements included in Item 8 of Part II of this report for information relating to our discus- sion of the effects of recent accounting pronouncements. 59 unaudited Quarterly results of operations The tables below (in thousands, except per share data) set forth the operating results represented by certain items in our statements of operations for each of the eight quarters in the period ended October 31, 2007. This information is unaudited, but in our opinion reflects all adjustments (consisting only of normal recurring adjustments) that we con- sider necessary for a fair statement of such information in accordance with generally accepted accounting principles. The results for any quarter are not necessarily indicative of results for any future period. Jan. 31, 2006 apr. 30, 2006 Jul. 31, 2006 oct. 31, 2006 Jan. 31, 2007 apr. 30, 2007 Jul. 31, 2007 oct. 31, 2007 Revenue: Products Services Total Revenue Costs: Products Services Total cost of goods sold Gross profit Operating expenses: Research and development Selling and marketing General and administrative Amortization of intangible assets Restructuring costs Long lived asset impairment Gain on lease settlement Recovery of (provision for) doubtful accounts, net Total operating expenses Income (loss) from operations Interest and other income, net Interest expense Gain (loss) on equity investments, net Loss, other than temporary, on marketable debt investments Gain on extinguishment of debt Income (loss) before income taxes Provision for income tax Net income (loss) Basic net income (loss) per common share Diluted net income (loss) per dilutive potential common share Weighted average basic common shares Weighted average dilutive potential common shares 60 Ciena Corporation 10-K $105,941 $117,208 $137,809 $141,469 $146,282 $173,212 $182,143 $193,652 22,538 216,190 20,315 193,527 22,808 204,951 18,483 159,952 18,819 165,101 14,489 120,430 14,690 152,499 13,967 131,175 60,399 9,576 69,975 50,455 58,957 9,312 68,269 62,906 70,356 10,479 80,835 71,664 73,955 13,241 87,196 72,756 74,979 16,494 91,473 73,628 91,319 20,378 111,697 81,830 84,383 22,903 107,286 97,665 87,185 19,859 107,044 109,146 29,462 26,572 28,856 26,657 26,190 24,903 26,561 26,302 29,853 24,875 31,642 30,182 31,671 30,303 34,130 32,655 9,896 11,246 16,217 10,117 10,301 11,707 14,564 13,690 6,295 2,015 6,295 3,014 6,295 11,008 6,296 (366) 6,295 (466) 6,295 (734) 6,295 (1,196) 6,465 (39) (3) (3) (6,020) (5,628) — — 6 — — — — — — — — (4,871) (2,604) 65,613 (247) 70,190 (139) 84,474 (41) 68,875 (10) 70,848 — 79,092 — 81,637 (4) 82,026 (15,158) (7,284) (12,810) 3,881 2,780 2,738 16,028 27,120 9,262 (6,053) 11,197 (5,815) 14,045 (6,148) 15,741 (6,149) 14,845 (6,148) 16,897 (6,148) 19,464 (6,931) 25,277 (7,769) (733) — 948 — — — 592 — — 6,690 — 362 — — — — — — — — — (13,013) — — (5,992) 299 31,615 1,205 $ (6,291) $ (1,910) $ (4,285) $ 13,081 $ 11,056 $ 13,010 $ 28,312 $ 30,410 13,473 392 29,153 841 13,487 477 (1,540) 370 (3,965) 320 11,477 421 $ (0.08) $ (0.02) $ (0.05) $ 0.15 $ 0.13 $ 0.15 $ 0.33 $ 0.35 $ (0.08) $ (0.02) $ (0.05) $ 0.14 $ 0.12 $ 0.14 $ 0.29 $ 0.30 82,967 83,518 84,197 84,657 84,953 85,198 85,651 86,241 82,967 83,518 84,197 93,146 93,259 93,737 101,568 108,812 item 7a. QuantitatiVe anD QuaLitatiVe DiSCLoSureS aBout marKet riSK The following discussion about our market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for spec- ulative or trading purposes. Interest Rate Sensitivity. We maintain a short-term and long-term investment portfolio. See Note 4 to the financial statements in Item 8 of Part II of this report for information relating to the fair value of these investments. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels at October 31, 2007, the fair value of the portfolio would decline by approximately $24.1 million. Foreign Currency Exchange Risk. As a global concern, we face exposure to adverse movements in foreign currency exchange rates. Because our sales are primarily denominated in U.S. dollars, the impact of foreign currency fluctua- tions on sales has not been material. Our primary exposures are related to non-U.S. dollar denominated operating expense in Canada, Europe, India and China. During fiscal 2007, approximately 77% of our operating expense was U.S. dollar denominated. As of October 31, 2007, our assets and liabilities related to non-dollar denominated curren- cies were primarily related to intercompany payables and receivables. We do not expect an increase or decrease of 10% in the foreign exchange rate would have a material impact on our financial position. To date, we have not sig- nificantly hedged against foreign currency fluctuations. Should exposure to fluctuations in foreign currency become more significant, however, we may pursue hedging alternatives. item 8. FinanCiaL StatementS anD SuppLementary Data The following is an index to the consolidated financial statements: Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Changes in Stockholders’ Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements page number 62 63 64 65 66 67 61 report oF inDepenDent regiStereD puBLiC aCCounting Firm To the Board of Directors and Shareholders of Ciena Corporation: In our opinion, the accompanying consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Ciena Corporation and its subsidiaries at October 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effective- ness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accor- dance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the cir- cumstances. We believe that our audits provide a reasonable basis for our opinions. As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation in fiscal year 2006. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transac- tions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding preven- tion or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstate- ments. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP McLean, Virginia December 27, 2007 62 Ciena Corporation 10-K ConSoLiDateD BaLanCe SHeetS (in thousands, except share data) ASSETS Current assets: Cash and cash equivalents Short-term investments Accounts receivable, net Inventories Prepaid expenses and other Total current assets Long-term investments Equipment, furniture and fixtures, net Goodwill Other intangible assets, net Other long-term assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable Accrued liabilities Restructuring liabilities Unfavorable lease commitments Income taxes payable Deferred revenue Convertible notes payable Total current liabilities Long-term deferred revenue Long-term restructuring liabilities Long-term unfavorable lease commitments Other long-term obligations Convertible notes payable Total liabilities Commitments and contingencies Stockholders’ equity: october 31, 2006 2007 $ 220,164 628,393 107,172 106,085 36,372 1,098,186 351,407 29,427 232,015 91,274 37,404 $ 1,839,713 $ 39,277 79,282 8,914 8,512 5,981 19,637 — 161,603 21,039 26,720 32,785 1,678 842,262 1,086,087 $ 892,061 822,185 104,078 102,618 47,817 1,968,759 33,946 46,671 232,015 67,144 67,738 $ 2,416,273 $ 55,389 90,922 1,026 — 7,768 33,025 542,262 730,392 30,615 3,662 — 1,450 800,000 1,566,119 Preferred stock—par value $0.01; 20,000,000 shares authorized; zero shares issued and outstanding Common stock—par value $0.01; 140,000,000 shares authorized; 84,891,656 and 86,752,069 shares issued and outstanding Additional paid-in capital Changes in unrealized gains on investments, net Translation adjustment Accumulated deficit Total stockholders’ equity Total liabilities and stockholders’ equity The accompanying notes are an integral part of these consolidated financial statements. — — 849 5,505,853 (496) (580) (4,752,000) 753,626 $ 1,839,713 868 5,519,741 350 (1,593) (4,669,212) 850,154 $ 2,416,273 63 ConSoLiDateD StatementS oF operationS (in thousands, except per share data) Revenue: Products Services Total revenue Costs: Products Services Total cost of goods sold Gross profit Operating expenses: Research and development Selling and marketing General and administrative Amortization of intangible assets Restructuring costs Goodwill impairment Long-lived asset impairment Gain on lease settlement Provision for (recovery of) doubtful accounts Total operating expenses Income (loss) from operations Interest and other income (expense), net Interest expense Loss, other than temporary, on marketable debt investments Gain on extinguishment of debt Gain (loss) on equity investments, net Income (loss) before income taxes Provision for income taxes Net income (loss) Basic net income (loss) per common share Diluted net income (loss) per dilutive potential common share Weighted average basic common shares Weighted average dilutive potential common shares The accompanying notes are an integral part of these consolidated financial statements. year ended october 31, 2005 2006 2007 $ 374,275 52,982 427,257 248,931 42,136 291,067 136,190 137,245 115,022 33,715 38,782 18,018 176,600 45,862 — 2,602 567,846 (431,656) 31,294 (28,413) — 3,882 (9,486) (434,379) 1,320 $(435,699) (5.30) $ (5.30) $ 82,170 82,170 $502,427 61,629 564,056 263,667 42,608 306,275 257,781 111,069 104,434 47,476 25,181 15,671 — — (11,648) (3,031) 289,152 (31,371) 50,245 (24,165) — 7,052 215 1,976 1,381 595 0.01 0.01 83,840 85,011 $ $ $ $695,289 84,480 779,769 337,866 79,634 417,500 362,269 127,296 118,015 50,262 25,350 (2,435) — — (4,871) (14) 313,603 48,666 76,483 (26,996) (13,013) — 592 85,732 2,944 $ 82,788 0.97 $ 0.87 $ 85,525 99,604 64 Ciena Corporation 10-K ConSoLiDateD StatementS oF CHangeS in StoCKHoLDerS’ eQuity Common Stock Shares additional paid-in Capital par Value — — — — — — — (2,044) — 829 — — — — 12 — — 5,494,587 — — — — 9,546 10 (in thousands, except share data) Balance at October 31, 2004 81,665,237 $817 $5,487,075 Net loss — Changes in unrealized gains on investments, net Translation adjustment Comprehensive loss Exercise of stock options, net Unearned stock compensation Deferred stock compensation costs Forfeiture of unearned stock compensation Reduction of receivables from stockholders — — — 1,240,612 — — — — 1,985,807 — — Balance at October 31, 2005 82,905,849 — Net income Changes in unrealized gains on investments, net Translation adjustment Comprehensive income Exercise of stock options, net Stock compensation expense Removal of opening deferred stock compensation balance upon adoption — of SFAS 123(R) Purchase of call spread option — Balance at October 31, 2006 84,891,656 Net income — Changes in unrealized gains on investments, net — Translation adjustment — Comprehensive income — Exercise of stock options, net 36,816 Stock compensation expense 19,572 Exercise of warrant — (42,500) Purchase of call spread option Balance at October 31, 2007 86,752,069 $868 $5,519,741 — — — 1,847,455 — 12,958 — (2,286) (28,457) 5,505,853 — — — — 27,967 14,042 — — — 19 — — — — — 849 — — — — 20 — accumu- receivable lated Deferred notes other Stock from Compre- Compen- Stock- hensive sation holders income accumu- lated Deficit total Stock- holders’ equity $(13,761) $(48) $(2,765) $(4,316,896) $1,154,422 (435,699) — — (435,699) — — — — — — — — — (10) — (2,185) (218) — — — 9,441 — 2,044 — — — — — — — — — — (2,185) (218) (438,102) 9,558 — 9,441 — — 48 (2,286) — — — — (5,168) — — (4,752,595) 595 48 735,367 595 — — — — — — — — — — 4,177 (85) — — — — — — — — 4,177 (85) 4,687 27,987 14,042 2,286 — — — — — — — — — (1,076) — — — (4,752,000) 82,788 — (28,457) 753,626 82,788 — — 846 — — (1,013) — — 82,621 — — 36,835 — — 19,572 — — — (42,500) — — — $ — $(1,243) $(4,669,212) $ 850,154 846 (1,013) — — — — — — — — — — — — $ The accompanying notes are an integral part of these consolidated financial statements. 65 ConSoLiDateD StatementS oF CaSH FLoWS (in thousands) Cash flows from operating activities: Net income (loss Adjustments to reconcile net income (loss) to net cash provided by used in operating activities: Early extinguishment of debt Amortization of premium (discount) on marketable securities Non-cash loss from equity investments and marketable securities Non-cash impairment of long-lived assets Depreciation and amortization of leasehold improvements Goodwill impairment Stock compensation Amortization of intangibles Provision for doubtful accounts Provision for inventory excess and obsolescence Provision for warranty and other contractual obligations Other Changes in assets and liabilities: Accounts receivable Inventories Prepaid expenses and other Accounts payable and accruals Income taxes payable Deferred revenue and other obligations Net cash provided by (used in) operating activities Cash flows from investing activities: Payments for equipment, furniture, fixtures and intellectual property Proceeds from sale of equipment, furniture and fixtures Restricted cash Purchase of available for sale securities Proceeds from maturities of available for sale securities Minority equity investments, net Net cash provided by (used in) investing activities Cash flows from financing activities: Proceeds from issuance of convertible notes payable Repurchase of 3.75% convertible notes payable Debt issuance costs Purchase of call spread option Proceeds from issuance of common stock and warrants Repayment of notes receivable from stockholders Net cash provided by (used in) financing activities Effect of exchange rate changes on cost and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Supplemental disclosure of cash flow information Cash paid during the period for: Interest expense Income taxes non-cash investing and financing activities Purchase of equipment in accounts payable The accompanying notes are an integral part of these consolidated financial statements. year ended october 31, 2005 2006 2007 $(435,699) $ 595 $ 82,788 (3,882) 13,636 9,486 45,862 33,377 176,600 9,441 42,651 2,602 5,232 9,738 3,218 (29,510) (6,951) 7,420 (19,633) 2,431 5,942 (128,039) (11,315) 278 1,986 (578,846) 910,505 4,882 327,490 — (36,913) — — 9,558 48 (27,307) — 172,144 185,868 $ 358,012 (7,052) (823) 733 — 16,401 — 14,042 29,050 — 9,012 14,522 2,028 (34,386) (65,764) 4,056 (59,161) 196 (2,842) (79,393) (17,760) — 4,552 (1,090,409) 851,084 948 (251,585) 300,000 (98,410) (7,990) (28,457) 27,987 — 193,130 — (137,848) 358,012 $ 220,164 — (14,191) 13,013 — 12,833 — 19,572 29,220 — 12,180 12,743 2,544 3,094 (8,713) (20,568) (60,524) 1,787 22,964 108,742 (32,105) — (13,277) (864,012) 989,705 (181) 80,130 500,000 — (11,750) (42,500) 36,835 — 482,585 440 671,897 220,164 $ 892,061 $ 25,817 977 $ $ $ 21,685 969 $ 21,504 1,157 $ $ — $ — $ 3,062 66 Ciena Corporation 10-K noteS to ConSoLiDateD FinanCiaL StatementS (1) Ciena Corporation and Significant accounting policies and estimates Description of business Ciena Corporation is a supplier of communications networking equipment, software and services that support the trans- port, switching, aggregation and management of voice, video and data traffic. Ciena’s products are used, individually or as part of an integrated solution, in communications network infrastructures operated by telecommunications service providers, cable operators, governments and enterprises around the globe. Ciena’s products facilitate the cost-effective delivery of enterprise and consumer-oriented communication services. Through its FlexSelect™ Architecture, Ciena spe- cializes in transitioning 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. Ciena was incorporated in Delaware in November 1992, and completed its initial public offering on February 7, 1997. Ciena’s principal executive offices are located at 1201 Winterson Road, Linthicum, Maryland 21090. Principles of Consolidation Ciena has 12 wholly owned U.S. and international subsidiaries, which have been consolidated in the accompanying financial statements. The accompanying consolidated financial statements include the accounts of Ciena and its wholly owned subsidiaries. All material inter-company accounts and transactions have been eliminated in consolidation. fiscal Year Ciena has a 52 or 53 week fiscal year, which ends on the Saturday nearest to the last day of October in each year (October 29, 2005, October 28, 2006 and November 3, 2007 for the periods reported). For purposes of financial statement presentation, each fiscal year is described as having ended on October 31. Fiscal 2005 and fiscal 2006 con- sisted of 52 weeks and fiscal 2007 consisted of 53 weeks. During fiscal 2007, Ciena identified certain immaterial adjustments and recorded expenses of $0.7 million related to its provision for warranty and $0.3 million related to service costs, each of which related to fiscal 2006. Also, during fiscal 2007, Ciena identified immaterial operating expense totaling $0.5 million incurred in fiscal 2007 that was inad- vertently recorded in fiscal 2006. Ciena’s revenue for the fiscal 2007 is understated by $0.8 million due to an equivalent overstatement of revenue during fiscal 2006. Ciena believes that these adjustments are not material to its results for fiscal 2006 or fiscal 2007, or any interim period therein. Use of estimates The preparation of the financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Estimates are used for bad debts, valua- tion of inventories and investments, recoverability of intangible assets and goodwill, income taxes, warranty obligations, restructuring liabilities and contingencies and litigation. Ciena bases its estimates on historical experience and also on assumptions that it believes are reasonable. Actual results may differ materially from management’s estimates. Cash and Cash equivalents Ciena considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Restricted cash collateralizing letters of credits are included in other current assets and other long-term assets depending upon the duration of the restriction. 67 Investments Ciena’s investments represent investments in marketable debt securities that are classified as available-for-sale and are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensive income. Realized gains or losses and declines in value determined to be other-than-temporary, if any, on available-for-sale securities, are reported in other income or expense as incurred. Inventories Inventories are stated at the lower of cost or market, with cost computed using standard cost, which approximates actual cost on a first-in, first-out basis. Ciena records a provision for excess and obsolete inventory when an impair- ment has been identified. equipment, furniture and fixtures Equipment, furniture and fixtures are recorded at cost. Depreciation and amortization are computed using the straight-line method over useful lives of two years to five years for equipment, furniture and fixtures and the shorter of useful life or lease term for leasehold improvements. Impairments of equipment, furniture and fixtures are deter- mined in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Internal use software and web site development costs are capitalized in accordance with Statement of Position (SOP) No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” and Emerging Issues Task Force (EITF) Issue No. 00-2, “Accounting for Web Site Development Costs.” Qualifying costs incurred dur- ing the application development stage, which consist primarily of outside services and purchased software license costs, are capitalized and amortized straight-line over the estimated useful life of the asset. Goodwill and other Intangible assets Ciena has recorded goodwill and purchased intangible assets as a result of several acquisitions. Ciena accounts for goodwill in accordance with SFAS 142 “Goodwill and Other Intangible Assets,” which requires Ciena to test each reporting unit’s goodwill for impairment on an annual basis, which Ciena has determined to be the last business day of fiscal September each year. Ciena operates its business and tests its goodwill for impairment as a single reporting unit. Testing is required between annual tests if events occur or circumstances change that would, more likely than not, reduce the fair value of the reporting unit below its carrying value. Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed using the straight-line method over the economic lives of the respective assets, generally three to seven years. Impairments of other intangible assets are determined in accordance SFAS 144. Minority equity Investments Ciena has certain minority equity investments in privately held technology companies that are classified as other assets. These investments are carried at cost because Ciena owns less than 20% of the voting equity and does not have the ability to exercise significant influence over these companies. These investments are inherently high risk as the markets for technologies or products manufactured by these companies are usually early stage at the time of the investment by Ciena and such markets may never be significant. Ciena could lose its entire investment in some or all of these companies. Ciena monitors these investments for impairment and makes appropriate reductions in carrying values when necessary. Unfavorable lease Commitments Ciena has recorded unfavorable lease commitments as a result of several acquisitions. Ciena accounts for unfavor- able lease commitments in accordance with SFAS 141 “Business Combinations.” The value of the unfavorable lease commitments are based upon the present value of the assumed lease obligations based upon rental rates and 68 Ciena Corporation 10-K interest rates at the time of the acquisition. During the fourth quarter of fiscal 2007, Ciena settled a lease obliga- tion relating to previously restructured facilities in San Jose, CA, thereby eliminating its remaining unfavorable lease commitment balance. Concentrations Substantially all of Ciena’s cash and cash equivalents, short-term and long-term investments in marketable debt secu- rities, are maintained at two major U.S. financial institutions. The majority of Ciena’s cash equivalents consist of money market funds and overnight repurchase agreements. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and, therefore, man- agement believes that they bear minimal risk. Historically, a large percentage of Ciena’s revenue has been the result of sales to a small number of communications service providers. Consolidation among Ciena’s customers has increased this concentration. Consequently, Ciena’s accounts receivable can be concentrated among these customers. See Notes 5 and 18 below. Additionally, Ciena’s access to certain raw materials is dependent upon sole and limited source suppliers. The inability of any supplier to fulfill Ciena’s supply requirements could affect future results. Ciena relies on a small number of con- tract manufacturers to perform the majority of the manufacturing for its products. If Ciena cannot effectively manage these manufacturers and forecast future demand, or if they fail to deliver products or components on time, Ciena’s business may suffer. Revenue Recognition Ciena recognizes revenue in accordance with Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition,” (SAB 104) which states that revenue is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the price to the buyer is fixed or determinable; and collectibility is reasonably assured. Customer purchase agreements and cus- tomer purchase orders are generally used to determine the existence of an arrangement. Shipping documents and customer acceptance, when applicable, are used to verify delivery. Ciena assesses whether the fee is fixed or deter- minable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. Ciena assesses collectibility based primarily on the creditworthiness of the customer as deter- mined by credit checks and analysis, as well as the customer’s payment history. In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met. Revenue for maintenance services is generally deferred and recognized ratably over the period during which the services are to be performed. Some of Ciena’s communications networking equipment is integrated with software that is essential to the functional- ity of the equipment. Accordingly, Ciena accounts for revenue in accordance with Statement of Position No. 97-2, “Software Revenue Recognition,” (SOP 97-2) and all related interpretations. SOP 97-2 incorporates additional guid- ance unique to software arrangements incorporated with general revenue recognition criteria, such as, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable. In instances where final acceptance of the product is specified by the customer, revenue is deferred until all acceptance criteria have been met. Arrangements with customers may include multiple deliverables, including any combination of equipment, services and software. If multiple element arrangements include software or software related elements, Ciena applies the provisions of SOP 97-2 to determine the amount of the arrangement fee to be allocated to those separate units of accounting. Multiple element arrangements that include software are separated into more than one unit of accounting if the func- tionality of the delivered element(s) is not dependent on the undelivered element(s), there is vendor-specific objective evidence of the fair value of the undelivered element(s), and general revenue recognition criteria related to the deliv- ered element(s) have been met. The amount of product and service revenue recognized is affected by our judgments as to whether an arrangement includes multiple elements and, if so, whether vendor-specific objective evidence of fair 69 value exists. Changes to the elements in an arrangement and our ability to establish vendor-specific objective evidence for those elements could affect the timing of revenue recognition. For all other deliverables, Ciena applies the provi- sions of Emerging Issues Task Force (EITF) No. 00-21, “Revenue Arrangements with Multiple Deliverables,” (EITF 00-21). EITF 00-21 allows for separation of elements into more than one unit of accounting if the delivered element(s) have value to the customer on a stand-alone basis, objective and reliable evidence of fair value exists for the undelivered element(s), and delivery of the undelivered element(s) is probable and substantially in Ciena’s control. Revenue is allo- cated to each unit of accounting based on the relative fair value of each accounting unit or using the residual method if objective evidence of fair value does not exist for the delivered element(s). The revenue recognition criteria described above is applied to each separate unit of accounting. If these criteria are not met, revenue is deferred until the criteria are met or the last element has been delivered. Ciena’s total deferred revenue for products was $4.3 million and $13.2 million as of October 31, 2006 and 2007, respectively. Our service revenue is deferred and recognized ratably over the period during which the services are to be performed. Our total deferred revenue for services was $36.4 million and $50.4 million as of October 31, 2006 and 2007, respectively. Warranty accruals Ciena provides for the estimated costs to fulfill customer warranty upon the recognition of the related revenue. Estimated warranty costs include material costs, technical support labor costs and associated overhead. The warranty liability is included in costs of goods sold and determined based upon actual warranty cost experience, estimates of component failure rates and management’s industry experience. Ciena’s sales contracts do not permit the right of return of product by the customer after the product has been accepted. accounts Receivable Trade, net Ciena’s allowance for doubtful accounts receivable is based on its assessment, on a specific identification basis, of the collectibility of customer accounts. Ciena performs ongoing credit evaluations of its customers and generally has not required collateral or other forms of security from its customers. In determining the appropriate balance for Ciena’s allowance for doubtful accounts receivable, management considers each individual customer account receivable in order to determine collectability. In doing so, management considers creditworthiness, payment history, account activ- ity and communication with such customer. If a customer’s financial condition changes, Ciena may be required to take a charge for an allowance for doubtful accounts receivable. Research and Development Ciena charges all research and development costs to expense as incurred. Types of expense incurred in research and development include employee compensation, prototype, consulting, depreciation, facility costs and informa- tion technologies. advertising Costs Ciena expenses all advertising costs as incurred. legal Costs Ciena expenses legal costs associated with litigation defense as incurred. share-based Compensation expense On November 1, 2005, Ciena adopted SFAS 123(R), as interpreted by SAB 107, which requires the measurement and recognition of compensation expense for share-based awards based on estimated fair values. SFAS 123(R) requires companies to estimate the fair value of share-based awards on the date of grant. 70 Ciena Corporation 10-K Ciena estimates the fair value of each option-based award on the date of grant using the Black-Scholes option- pricing model. This model is affected by Ciena’s stock price as well as estimates regarding a number of subjective variables. These subjective variables include, but are not limited to Ciena’s expected stock price volatility over the term of the awards, and projected employee stock option exercise behaviors. Ciena estimates the fair value of each share-based award on the fair value of the underlying common stock on the date of grant. In each case, Ciena only recognizes expense to its consolidated statement of operations for those options or shares that are expected ulti- mately to vest. Ciena uses two attribution methods to record expense, the straight-line method for grants with only service-based vesting or the graded-vesting method, which considers each performance period or tranche separately, for all other awards. No tax benefits were attributed to the share-based compensation expense because a full valuation allowance was maintained for all net deferred tax assets. Income Taxes Ciena accounts for income taxes in accordance with SFAS 109, “Accounting for Income Taxes.” SFAS 109 describes an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective tax bases, and for operating loss and tax credit carry forwards. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than the enactment of changes in tax laws or rates. Valuation allowances are provided, if, based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Ciena has not provided U.S. deferred income taxes on the cumulative unremitted earnings of its non-U.S. affiliates as it plans to permanently reinvest cumulative unremitted foreign earnings outside the U.S. and it is not practicable to determine the unrecognized deferred income taxes. These cumulative unremitted foreign earnings relate to ongoing operations in foreign jurisdictions and are required to fund foreign operations, capital expenditures, and any expan- sion requirements. loss Contingencies Ciena is subject to the possibility of various losses arising in the ordinary course of business. These may relate to dis- putes, litigation and other legal actions. Ciena considers the likelihood of loss or the incurrence of a liability, as well as Ciena’s ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss con- tingency is accrued when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Ciena regularly evaluates current information available to it to determine whether any accruals should be adjusted and whether new accruals are required. fair Value of financial Instruments The carrying amounts of Ciena’s financial instruments, which include short-term and long-term investments in market- able debt securities, accounts receivable, accounts payable, and other accrued expenses, approximate their fair values due to their short maturities. foreign Currency Translation Some of Ciena’s foreign branch offices and subsidiaries use the U.S. dollar as their functional currency, because Ciena, as the U.S. parent entity, exclusively funds the operations of these branch offices and subsidiaries with U.S. dollars. For those subsidiaries using the local currency as their functional currency, assets and liabilities are translated at exchange rates in effect at the balance sheet date, and the statement of operations is translated at a monthly average rate. Resulting translation adjustments are recorded directly to a separate component of stockholders’ equity. Where the U.S. dollar is the functional currency, re-measurement adjustments are recorded in other income. The net gain (loss) on foreign currency re-measurement and exchange rate changes is immaterial for separate finan- cial statement presentation. 71 Computation of basic net Income (loss) per Common share and Diluted net Income (loss) per Dilutive Potential Common share Ciena calculates earnings per share (EPS) in accordance with the SFAS 128, “Earnings per Share.” This statement requires dual presentation of basic and diluted EPS on the face of the income statement for entities with a complex capital struc- ture and requires a reconciliation of the numerator and denominator used for the basic and diluted EPS computations. software Development Costs SFAS 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” requires the capitalization of certain software development costs incurred subsequent to the date technological feasibility is established and prior to the date the product is generally available for sale. The capitalized cost is then amortized straight-line over the estimated product life. Ciena defines technological feasibility as being attained at the time a working model is completed. To date, the period between achieving technological feasibility and the general avail- ability of such software has been short, and software development costs qualifying for capitalization have been insignificant. Accordingly, Ciena has not capitalized any software development costs. segment Reporting SFAS 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes annual and interim reporting standards for operating segments of a company. It also requires entity-wide disclosures about the products and services an entity provides, the material countries in which it holds assets and reports revenue, and its major cus- tomers. Ciena reports its financial results as a single business segment. newly Issued accounting standards In September 2006, the SEC issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 provides interpretative guidance on the process of quantifying financial statement misstatements and is effective for fiscal years ending after November 15, 2006. The adoption of this statement in fiscal 2007 did not have a material impact on Ciena’s financial condition, results of operations or cash flows. In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments” which amends SFAS 133, “Accounting for Derivative Instruments and Hedging Activities” and SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. The adoption of this statement in fiscal 2007 did not have a material impact on Ciena’s financial condition, results of operations or cash flows. In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections” which supersedes APB Opinion No. 20, “Accounting Changes” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS 154 also carries forward, without change, the guidance contained in APB 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. SFAS 154 requires retrospective applica- tion to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The correction of an error in previously issued financial statements is not a change in accounting principle. However, the reporting of an error correction involves adjustments to previously issued financial statements similar to those generally applicable to reporting an accounting change retroactively. Therefore, the reporting of a correction of an error by restating previously issued financial state- ments is also addressed by SFAS 154. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of this statement in fiscal 2007 did not have a material impact on Ciena’s financial condition, results of operations or cash flows. 72 Ciena Corporation 10-K In September 2006, the FASB issued SFAS 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2008, and interim peri- ods within those fiscal years. Ciena is currently evaluating the impact the adoption of this statement could have on its financial condition, results of operations and cash flows. In July 2006, the FASB issued FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes, an inter- pretation of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes.” FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classifica- tion, interest and penalties, accounting in interim periods, disclosure and transition. The interpretation applies to all tax positions related to income taxes subject to SFAS 109. FIN 48 is effective for fiscal years beginning after December 15, 2006. Differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption should be accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. Ciena is currently evaluating the impact of the adoption of FIN 48 on its consolidated financial statements, and anticipates any adjustment to retained earnings will not be material. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities— Including an Amendment of FASB Statement No. 115.” SFAS No. 159 permits an entity to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Ciena is currently evaluating the impact the adoption of this statement could have on its financial condition, results of operations and cash flows. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51.” SFAS No. 160 requires all entities to report noncontrolling (minority) interests in subsid- iaries as equity in the consolidated financial statements. Its intention is to eliminate the diversity in practice regarding the accounting for transactions between an entity and noncontrolling interests. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is pro- hibited. Ciena is currently evaluating the impact the adoption of this statement could have on its financial condition, results of operations and cash flows. In December 2007, the FASB issued SFAS No. 141(R), a revised version of SFAS No. 141, “Business Combinations.” The revision is intended to simplify existing guidance and converge rulemaking under U.S. generally accepted accounting principles (GAAP) with international accounting rules. This statement applies prospectively to business combinations where the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, and may affect the release of our valuation allowance against prior acquisition intangibles. An entity may not apply it before that date. The new standard also converges financial reporting under U.S. GAAP with international accounting rules. Ciena is currently evaluating the impact the adoption of this state- ment could have on its financial condition, results of operations and cash flows. 73 (2) restructuring Costs Ciena has previously taken actions to align its workforce, facilities and operating costs with perceived market and business opportunities. Ciena historically has committed to a restructuring plan and has incurred the associated liabil- ity concurrently in accordance with the provisions of SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The following table displays the activity and balances of the restructuring liability accounts for the fiscal years indicated (in thousands): Balance at October 31, 2004 Additional liability recorded Adjustment to previous estimates Cash payments Balance at October 31, 2005 Additional liability recorded Adjustment to previous estimates Lease settlements Cash payments Balance at October 31, 2006 Additional liability recorded Adjustment to previous estimates Lease settlements Cash payments Balance at October 31, 2007 Current restructuring liabilities Non-current restructuring liabilities Workforce reduction $ 1,446 5,770(a) — (6,946) 270 4,652(b) — (4,922) — 72(c) 1 — — (72) — — — $ $ $ Consolidation of excess Facilities $ 79,937 884(a) 11,364(a) (22,678) 69,507 1,782(b) 9,237(b) (11,648)(b) (33,244) 35,634 (c) (2,508)(c) (4,871)(c) (23,568) $ 4,688 $ 1,026 $ 3,662 total $ 81,383 6,654 11,364 (29,624) 69,777 6,434 9,237 (11,648) (38,166) 35,634 73 (2,508) (4,871) (23,640) $ 4,688 $ 1,026 $ 3,662 (a) During the first quarter of fiscal 2005, Ciena recorded a restructuring charge of approximately $1.0 million related to a workforce reduction of 21 employees and a charge of approximately $0.3 million related to certain other costs associated with the closure of its San Jose, CA facility on September 30, 2004. This restructuring charge also reflects a reversed charge of $0.1 million related to an adjustment to estimates associated with costs for previously restructured facilities. During the second quarter of fiscal 2005, Ciena recorded a restructuring charge of approximately $2.1 million related to a workforce reduction of 53 employees and a charge of approximately $7.6 million related to an adjustment to estimates associated with costs for previously restructured facilities. During the third quarter of fiscal 2005, Ciena recorded a restructuring charge of approximately $2.3 million related to a workforce reduction of 96 employees and recorded a charge of approximately $0.1 million related to the closure of one of its Kanata, Canada facilities. This restructuring charge also reflects approximately $1.9 million related to an adjustment to estimates associated with costs for previously restructured facilities. During the fourth quarter of fiscal 2005, Ciena recorded a restructuring charge of approximately $0.4 million related to a workforce reduction of 7 employees and recorded a charge of approximately $0.4 million related to the closure of Ciena’s Durham, NC facilities. This restructuring charge also reflects approximately $2.0 million related to an adjustment to estimates associated with costs for previously restructured facilities. (b) During the first quarter of fiscal 2006, Ciena recorded a charge of $0.7 million related to the closure of one of its facilities located in Kanata, Canada and a charge of $1.5 million related to a workforce reduction of 62 employees. During the first quarter of fiscal 2006, Ciena recorded a credit adjustment of $0.2 million related to costs associated with previously restructured facilities. During the first quarter of fiscal 2006, Ciena recorded a gain of $6.0 million related to the buy-out of the lease of its former Fremont, CA facility, which Ciena had previously restructured. During the second quarter of fiscal 2006, Ciena recorded a charge of $0.7 million related to the closure of its Shrewsbury, NJ facility and a charge of $2.5 million related to a workforce reduction of 86 employees. During the second quarter of fiscal 2006, Ciena recorded a credit adjustment of $0.2 million related to costs associated with previously restructured facilities. During the second quarter of fiscal 2006, Ciena recorded a gain of $5.6 million related to the buy-out of the lease of its former Cupertino, CA facility, which Ciena had previously restructured. During the third quarter of fiscal 2006, Ciena recorded a charge of $0.5 million related to a workforce reduction of 7 employees and additional employee costs related to the closure of its Shrewsbury, NJ facility in the second quarter of fiscal 2006. During the third quarter of fiscal 2006, pri- marily due to changes in market conditions, Ciena recorded an adjustment of $10.1 million related to costs associated with previously restructured facilities, $10.0 million of which was related to its former facilities located in San Jose, CA. Ciena also recorded a charge of $0.4 million related to the closure of its facility located in Beijing, China during the third quarter of fiscal 2006. During the fourth quarter of fiscal 2006, Ciena recorded a charge of $0.1 million related to other costs associated with a previous workforce reduc- tion and a credit of $0.5 million related to the settlement of a previously recorded facility liability. (c) During the first quarter of fiscal 2007, Ciena recorded a charge of $0.1 million related to other costs associated with a previous workforce reduction and an adjustment of $0.5 million related to costs associated with previously restructured facilities. During the second quarter of fiscal 2007, Ciena recorded an adjustment of $0.8 million related to its return to use of a facility that had been previ- ously restructured. During the third quarter of fiscal 2007, Ciena recorded an adjustment of $1.2 million primarily related to its return to use of a facility that had been previously restructured. During the fourth quarter of fiscal 2007, Ciena recorded a gain on lease settlement of $4.9 million related to the termination of lease obligations for our former San Jose, CA facilities. We paid $53.0 million in connection with the settlement of this lease obligation. This transaction eliminated Ciena’s remaining unfavorable lease commitment balance of $34.9 million and reduced Ciena’s restructuring liabilities by $23.5 million, offset by approximately $0.5 million of other expenses. 74 Ciena Corporation 10-K (3) goodwill and Long-Lived asset impairments Goodwill Impairment SFAS 142 “Goodwill and Other Intangible Assets,” requires Ciena to test each reporting unit’s goodwill for impair- ment on an annual basis, which Ciena has determined to be the last business day of fiscal September each year. Testing is required between annual tests if events occur or circumstances change that would, more likely than not, reduce the fair value of the reporting unit below its carrying value. For fiscal 2007, fiscal 2006 and fiscal 2005, Ciena determined that its operating segments and reporting units were the same. For fiscal 2005, the fair value of Ciena’s goodwill was tested for impairment on a segment level. For fiscal 2006 and fiscal 2007, the fair value of Ciena’s good- will was tested for impairment on an enterprise level due to the elimination of Ciena’s former business units in the third quarter of fiscal 2006. The table below sets forth changes in carrying amount of goodwill during the fiscal years indicated (in thousands): Balance as of October 31, 2004 Goodwill acquired Impairment losses Balance as of October 31, 2005 Goodwill acquired Impairment losses Balance as of October 31, 2006 Goodwill acquired Impairment losses Balance as of October 31, 2007 total $ 408,615 — (176,600) 232,015 — — 232,015 — — $ 232,015 Goodwill assessment—fiscal 2005 Ciena performed an assessment of the fair value of its reporting units and its intangible assets as of September 24, 2005. Ciena compared the fair value of each of its reporting units at that time to each reporting unit’s carrying value including goodwill. In conjunction with Ciena’s assessment, it became apparent that developments in the market for broadband loop carrier products, particularly outside of the United States, would require Ciena to make a substantial commitment of research and development resources in order to compete successfully in this market with Ciena’s CN 1000™ Next-Generation Broadband Access platform. Given the uncertainties associated with this international mar- ket and the magnitude of the investment required, Ciena determined it would not be cost-effective to make such investment and suspended research and development for this product. This decision significantly reduced Ciena’s fore- casted long-term revenue for its former Broadband Access Group (BBG) reporting unit. As a result, the carrying value of BBG, including goodwill, exceeded the fair value of BBG as of September 24, 2005. The fair value of the BBG reporting unit was determined using the average of the valuations calculated using market multiples and discounted cash flows. Because of the forecasted decline in long-term revenue for BBG, no control premium was added to the valuation results for the BBG reporting unit. Because BBG’s carrying value, including goodwill, exceeded the fair value of the reporting unit as a whole, Ciena assessed the fair value of BBG’s individual assets, including identified intangible assets and liabilities, in order to derive an implied fair value for BBG’s goodwill. Ciena determined the estimated fair value of the identifiable intangible assets of the unit using discounted cash flows. Ciena used cash flow periods ranging from one to ten years, depending on the nature of the asset, and assumed that revenue for the BBG reporting unit would decline to zero over ten years. Ciena used discount rates of 10% to 14%, based on the specific risks and circumstances associated with the identi- fied intangible assets and Ciena’s weighted average cost of capital. The assumptions supporting the estimated discounted cash flows for identified intangible assets, including the cash flow periods, discount rates and forecasted future revenue, reflect management’s estimates. Ciena determined that the implied fair value of goodwill assigned to BBG was zero. Because the carrying amount of the goodwill assigned to BBG was greater than the implied fair value, Ciena recorded an impairment loss of $176.6 million in fiscal 2005. 75 Goodwill assessment—fiscal 2006 and fiscal 2007 Ciena performed an assessment of the fair value of its single reporting unit and its intangible assets as of September 23, 2006 and September 29, 2007. Ciena compared its fair value on each assessment date to its carrying value, including goodwill, and determined that the carrying value, including goodwill, did not exceed fair value. Because the carrying amount was less than its fair value, no impairment loss was recorded. The fair value of Ciena was determined using the average market price of Ciena’s common stock over a 10-day period before and after each assessment date, with a con- trol premium added to the valuation results. long-lived asset Impairment—equipment, furniture and fixtures During fiscal 2005, Ciena recorded impairment losses of $0.2 million related to excess equipment, furniture and fixtures that were classified as held for sale as a result of Ciena’s restructuring activities. Ciena did not record an impairment of equipment, furniture and fixtures during fiscal 2006 or fiscal 2007. long-lived asset Impairment—other Intangible assets Ciena performs assessments of the carrying value of its other intangible assets pursuant to SFAS 144. SFAS 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and requires compa- nies to test each intangible asset for impairment, whenever events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable. During fiscal 2005, Ciena recorded a charge of $45.7 million related to the impairment of BBG developed technology and customer relationships acquired from Catena Networks in May 2004. This charge was based on the amount by which the carrying amount of the intangible assets exceeded their estimated fair value. Fair value was determined based on discounted estimated future cash flows derived from the intangible assets. Ciena used a cash flow period of five years and assumed that revenue related to these intangible assets would decline to zero over five years. The dis- count rate used was 15%. The assumptions supporting the estimated future cash flows, including the discount rate reflect management’s best estimates. The discount rate was based upon Ciena’s weighted average cost of capital as adjusted for the risks associated with its operations. Ciena did not record an impairment of intangible assets during fiscal 2006 or fiscal 2007. (4) marketable Debt Securities As of the dates indicated, short-term and long-term investments in marketable debt securities are comprised of the following (in thousands): Corporate bonds Asset backed obligations Commercial paper US government obligations Certificate of deposit Included in short-term investments Included in long-term investments amortized Cost $258,904 121,274 198,407 31,186 246,003 $855,774 821,828 33,946 $855,774 october 31, 2007 gross unrealized gains $252 136 — 55 — $443 443 — $443 gross unrealized Losses $42 44 — — — $86 86 — $86 estimated Fair Value $259,114 121,366 198,407 31,241 246,003 $856,131 822,185 33,946 $856,131 76 Ciena Corporation 10-K Corporate bonds Asset backed obligations Commercial paper US government obligations Included in short-term investments Included in long-term investments amortized Cost $468,152 195,728 152,768 163,643 $980,291 629,269 351,022 $980,291 october 31, 2006 gross unrealized gains $437 142 — 84 $663 66 597 $663 gross unrealized Losses $ 525 305 — 324 $1,154 942 212 $1,154 estimated Fair Value $468,064 195,565 152,768 163,403 $979,800 628,393 351,407 $979,800 Estimated fair value of commercial paper at October 31, 2007 includes investments in SIV Portfolio plc (formerly known as Cheyne Finance plc) and Rhinebridge LLC, two structured investment vehicles (SIVs) that entered into receiv- ership during the fourth quarter of fiscal 2007 and failed to make payment at maturity. Due to the mortgage-related assets that they hold, each of these entities has been exposed to adverse market conditions that have affected their collateral and their ability to access short-term funding. Ciena purchased these investments in the third quarter of fis- cal 2007 and, at the time of purchase, each investment had a rating of A1+ by Standard and Poor’s and P-1 by Moody’s, their highest ratings respectively. These investments are no longer trading and have no readily determinable market value. Ciena reviewed current investment ratings, valuation estimates of the underlying collateral, company specific news and events, and general economic conditions in considering the fair value of these investments. In esti- mating fair value, Ciena used a valuation approach based on a liquidation of assets held by each SIV and their subsequent distribution of cash. Ciena utilized assessments of the underlying collateral from multiple indicators of value which were then discounted to reflect the expected timing of disposition and market risks. Based on this assess- ment of fair value, as of October 31, 2007, Ciena recognized realized losses of $13.0 million related to these investments. Giving effect to these losses, our investment portfolio at October 31, 2007 included an estimated fair value of $33.9 million in commercial paper issued by these entities. Information and the markets relating to these investments remain dynamic, and there may be further declines in the value of these investments, the value of the col- lateral held by these entities and the liquidity of our investments. To the extent Ciena determines that a further decline in fair value is other-than-temporary, Ciena may recognize additional realized losses in future periods up to the aggre- gate amount of these investments. Gross unrealized losses related to marketable debt investments were primarily due to changes in interest rates. Ciena’s management has determined that the gross unrealized losses at October 31, 2007 are temporary in nature because Ciena has the ability and intent to hold these investments until a recovery of fair value, which may be maturity. As of the dates indicated, gross unrealized losses were as follows (in thousands): unrealized Losses Less than 12 months gross unrealized Losses $41 7 $48 Fair Value $50,152 6,140 $56,292 october 31, 2007 unrealized Losses 12 months or greater gross unrealized Losses $ 1 37 $38 Fair Value $ 2,999 22,923 $25,922 total gross unrealized Losses $42 44 $86 Fair Value $53,151 29,063 $82,214 Corporate bonds Asset backed obligations 77 unrealized Losses Less than 12 months gross unrealized Losses $400 153 — 112 $665 Fair Value $196,947 92,869 — 38,692 $328,508 october 31, 2006 unrealized Losses 12 months or greater gross unrealized Losses $125 152 — 212 $489 Fair Value $ 26,687 34,828 — 40,839 $102,354 total gross unrealized Losses $ 525 305 — 324 $1,154 Fair Value $223,634 127,697 — 79,531 $430,862 Corporate bonds Asset backed obligations Commercial paper US government obligations The following table summarizes maturities of debt investments at October 31, 2007 (in thousands): Less than one year Due in 1–2 years Due in 2–5 years amortized Cost $701,322 99,754 54,698 $855,774 estimated Fair Value $701,588 99,789 54,754 $856,131 (5) accounts receivable As of October 31, 2007, one customer accounted for 40.1% of net trade accounts receivable. As of October 31, 2006, two customers accounted for 25.4% and 21.8% of net trade accounts receivable, respectively. Ciena’s allow- ance for doubtful accounts as of each of October 31, 2007 and October 31, 2006 was $0.1 million. During fiscal 2006, Ciena recorded a recovery of doubtful accounts in the amount of $3.0 million as a result of the receipt of amounts due from customers from whom payment was previously deemed doubtful due to their financial condition. In addition, during fiscal 2006, $0.1 million of uncollectible accounts were written off against the allowance. During fiscal 2005, Ciena recorded a provision for doubtful accounts of $2.6 million relating to one customer from which payment was doubtful due to a change in its financial condition. The following table summarizes the activity in Ciena’s allowance for doubtful accounts for the fiscal years indicated (in thousands): year ended october 31, 2005 2006 2007 Balance at Beginning of period $ 961 $3,291 $ 146 net provisions (recovery) $ 2,602 $(3,031) (14) $ Deductions $272 $114 $ — Balance at end of period $3,291 $ 146 $ 132 (6) inventories As of the dates indicated, inventories are comprised of the following (in thousands): Raw materials Work-in-process Finished goods Provision for excess and obsolescence october 31, 2006 $ 29,627 9,156 89,628 128,411 (22,326) $106,085 2007 $ 28,611 4,123 96,054 128,788 (26,170) $102,618 78 Ciena Corporation 10-K Ciena writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. During fiscal 2005, fiscal 2006 and fiscal 2007, Ciena recorded provisions for inventory reserves of $5.2 million, $9.0 million and $12.2 million, respectively, primarily related to increases in excess inventory due to changes in forecasted sales for certain products. Deductions from the reserve for excess and obsolete inventory gen- erally relate to disposal activities. The following table summarizes the activity in Ciena’s reserve for excess and obsolete inventory for the fiscal years indicated (in thousands): year ended october 31, 2005 2006 2007 Balance at Beginning of period $21,933 $22,595 $22,326 provisions $ 5,232 $ 9,012 $12,180 Deductions $4,570 $9,281 $8,336 Balance at end of period $22,595 $22,326 $26,170 (7) prepaid expenses and other As of the dates indicated, prepaid expenses and other are comprised of the following (in thousands): Interest receivable Prepaid VAT and other taxes Deferred deployment expense Prepaid expenses Restricted cash Other non-trade receivables october 31, 2006 $ 8,547 9,467 1,948 6,497 6,990 2,923 $36,372 2007 $ 4,981 18,092 6,237 10,724 3,994 3,789 $47,817 (8) equipment, Furniture and Fixtures As of the dates indicated, equipment, furniture and fixtures are comprised of the following (in thousands): Equipment, furniture and fixtures Leasehold improvements Accumulated depreciation and amortization october 31, 2006 $ 253,953 36,203 290,156 2007 $ 269,534 37,249 306,783 (260,729) $ 29,427 (260,112) $ 46,671 (9) other intangible assets As of the dates indicated, other intangible assets are comprised of the following (in thousands): october 31, 2006 2007 Developed technology Patents and licenses Customer relationships, covenants not to compete, outstanding purchase orders and contracts gross accumulated intangible amortization $139,983 47,370 $(87,577) (25,463) net intangible $52,406 21,907 gross accumulated intangible amortization $145,073 47,370 $(104,822) (31,708) net intangible $40,251 15,662 45,981 $233,334 (29,020) 16,961 $91,274 45,981 $238,424 (34,750) 11,231 $67,144 79 During the fourth quarter of fiscal 2007, Ciena purchased certain developed technology of $5.1 million. The aggregate amortization expense of other intangible assets in fiscal 2007, fiscal 2006 and fiscal 2005 was $29.2 million, $29.1 million, and $42.7 million, respectively. Expected future amortization of other intangible assets for the fiscal years indicated is as follows (in thousands): year ended october 31, 2008 2009 2010 2011 2012 $28,858 20,272 15,518 1,648 848 $67,144 (10) other Balance Sheet Details As of the dates indicated, other long-term assets are comprised of the following (in thousands): Maintenance spares inventory, net Deferred debt issuance costs Investments in privately held companies Restricted cash Other october 31, 2006 $14,724 10,306 6,489 3,227 2,658 $37,404 2007 $20,816 18,059 6,671 19,499 2,693 $67,738 Deferred debt issuance costs are amortized using the straight line method which approximates the effect of the effective interest rate method on the maturity of the related debt. Amortization of debt issuance cost, which is included in interest expense, was $4.0 million, $3.1 million, and $3.0 million for fiscal 2007, fiscal 2006 and fiscal 2005, respectively. As of the dates indicated, accrued liabilities are comprised of the following (in thousands): Warranty Accrued compensation, payroll related tax and benefits Accrued interest payable Other october 31, 2006 $31,751 24,102 5,502 17,927 $79,282 2007 $33,580 32,053 6,998 18,291 $90,922 The following table summarizes the activity in Ciena’s accrued warranty for the fiscal years indicated (in thousands): year ended october 31, 2005 2006 2007 Balance at Beginning of period $30,189 $27,044 $31,751 provisions $ 9,738 $14,522 $12,743 Settlements $(12,883) $ (9,815) $(10,914) Balance at end of period $27,044 $31,751 $33,580 80 Ciena Corporation 10-K As of the dates indicated, deferred revenue are comprised of the following (in thousands): Products Services Less current portion Long-term deferred revenue october 31, 2006 $ 4,276 36,400 40,676 (19,637) $ 21,039 2007 $ 13,208 50,432 63,640 (33,025) $ 30,615 (11) Convertible notes payable Ciena 3.75% Convertible notes, Due february 1, 2008 On February 9, 2001, Ciena completed a public offering of 3.75% Convertible Notes, due February 1, 2008, in an aggregate principal amount of $690.0 million. Interest is payable on February 1 and August 1 of each year. The notes may be converted into shares of Ciena’s common stock at any time before their maturity or their prior redemption or repurchase by Ciena. The conversion rate is 1.3687 shares per each $1,000 principal amount of notes, subject to adjustment in certain circumstances. Prior to maturity, Ciena has the option to redeem all or a portion of the notes that have not been previously converted at 100.536% of the principal amount. During fiscal 2006, Ciena repurchased $106.5 million of the outstanding 3.75% convertible notes for $98.4 million in open market transactions. Ciena recorded a gain on the extinguishment of debt in the amount of $7.1 million, which consists of the $8.1 million gain from the repurchase of the notes, less a write-off of $1.0 million of associated debt issuance costs. During fiscal 2005, Ciena repurchased $41.2 million of the outstanding 3.75% convertible notes for $36.9 million in open market transactions. Ciena recorded a gain on the extinguishment of debt in the amount of $3.9 million, which consists of the $4.3 million gain from the repurchase of the notes, less a write-off of $0.4 million of associated debt issuance costs. As of the end of fiscal 2007 and fiscal 2006, the fair value of the outstanding $542.3 million in aggregate principal amount of 3.75% convertible notes was $534.2 million and $525.3 million, respectively. Fair value is based on the quoted market price for the notes on the dates above. 0.25% Convertible senior notes, Due May 1, 2013 On April 10, 2006, Ciena completed a public offering of 0.25% Convertible Senior Notes due May 1, 2013, in aggregate principal amount of $300.0 million. Interest is payable on May 1 and November 1 of each year. The notes are senior unsecured obligations of Ciena and rank equally with all of Ciena’s other existing and future senior unsecured debt. At the election of the holder, notes may be converted prior to maturity into shares of Ciena common stock at the ini- tial conversion rate of 25.3001 shares per $1,000 in principal amount, which is equivalent to an initial conversion price of $39.5255 per share. The notes may not be redeemed by Ciena prior to May 5, 2009. At any time on or after May 5, 2009, if the closing sale price of Ciena’s common stock for at least 20 trading days in any 30 consecutive trading day period ending on the date one day prior to the date of the notice of redemption exceeds 130% of the conversion price, Ciena may redeem the notes in whole or in part, at a redemption price in cash equal to the princi- pal amount to be redeemed, plus accrued and unpaid interest. If Ciena undergoes a “fundamental change” (as that term is defined in the indenture governing the notes to include certain change in control transactions), holders of notes will have the right, subject to certain exemptions, to require Ciena to purchase for cash any or all of their notes at a price equal to the principal amount, plus accrued and unpaid interest. If the holder elects to convert his or her notes in connection with a specified fundamental change, in certain circumstances, Ciena will be required to increase the applicable conversion rate, depending on the price paid per share for Ciena common stock and the effective date of the fundamental change transaction. 81 Ciena used approximately $28.5 million of the net proceeds of this offering to purchase a call spread option on its common stock that is intended to limit exposure to potential dilution from the conversion of the notes. See Note 13 below for a description of this call spread option. As of the end of fiscal 2007 and fiscal 2006, the fair value of the $300.0 million in aggregate principal amount of 0.25% convertible senior notes outstanding was $387.5 million and $251.3 million, respectively. Fair value is based on the quoted market price for the notes on the dates above. 0.875% Convertible senior notes, Due June 15, 2017 On June 11, 2007, Ciena completed a public offering of 0.875% Convertible Senior Notes due June 15, 2017, in aggregate principal amount of $500.0 million. Interest is payable on June 15 and December 15 of each year, begin- ning on December 15, 2007. The notes are senior unsecured obligations of Ciena and rank equally with all of Ciena’s other existing and future senior unsecured debt. At the election of the holder, notes may be converted prior to maturity into shares of Ciena common stock at the ini- tial conversion rate of 26.2154 shares per $1,000 in principal amount, which is equivalent to an initial conversion price of approximately $38.15 per share. The notes are not redeemable by Ciena prior to maturity. If Ciena undergoes a “fundamental change” (as that term is defined in the indenture governing the notes to include certain change in control transactions), holders of notes will have the right, subject to certain exemptions, to require Ciena to purchase for cash any or all of their notes at a price equal to the principal amount, plus accrued and unpaid interest. If the holder elects to convert his or her notes in connection with a specified fundamental change, in certain circumstances, Ciena will be required to increase the applicable conversion rate, depending on the price paid per share for Ciena common stock and the effective date of the fundamental change transaction. Ciena used approximately $42.5 million of the net proceeds of this offering to purchase a call spread option on its common stock that is intended to limit exposure to potential dilution from conversion of the notes. See Note 13 below for a description of this call spread option. As of the end of fiscal 2007, the fair value of the outstanding $500.0 million in aggregate principal amount of 0.875% convertible senior notes was $675.9 million, based on the quoted market price for the notes. 82 Ciena Corporation 10-K (12) earning (Loss) per Share Calculation The following table (in thousands except per share amounts) is a reconciliation of the numerator and denominator of the basic net income (loss) per common share (“Basic EPS”) and the diluted net income (loss) per dilutive potential common share (“Diluted EPS”). Basic EPS is computed using the weighted average number of common shares out- standing. Diluted EPS is computed using the weighted average number of (i) common shares outstanding, (ii) shares issuable upon vesting of restricted stock units, (iii) shares issuable upon exercise of outstanding stock options, employee stock purchase plan options and warrants using the treasury stock method; and (iv) shares underlying the 0.25% and 0.875% convertible senior notes. Diluted EPS for fiscal 2007 reflects only a portion of the shares underly- ing the 0.875% convertible notes because they were issued on June 11, 2007. numerator Net income (loss) Add: Interest expense for 0.25% convertible senior notes Add: Interest expense for 0.875% convertible senior notes Net income (loss) used to calculate Diluted EPS 2005 $(435,699) — — $(435,699) 2006 $595 — — $595 year ended october 31, Denominator Basic weighted average shares outstanding Add: Shares underlying outstanding stock options, employees stock purchase plan options, warrants and restricted stock units Add: Shares underlying 0.25% convertible senior notes Add: Shares underlying 0.875% convertible senior notes Dilutive weighted average shares outstanding epS Basic EPS Diluted EPS 2005 82,170 — — — 82,170 2005 $(5.30) $(5.30) year ended october 31, 2006 83,840 1,171 — — 85,011 year ended october 31, 2006 $0.01 $0.01 2007 $82,788 1,882 2,261 $86,931 2007 85,525 1,352 7,590 5,137 99,604 2007 $0.97 $0.87 explanation of shares excluded Due to anti-Dilutive effect For fiscal 2005, the weighted average number of shares underlying stock options, restricted stock units, warrants and Ciena’s 3.75% convertible notes are considered anti-dilutive because Ciena incurred net losses. For fiscal 2006, the weighted average number of shares underlying outstanding stock options, employee stock pur- chase plan options, restricted stock units and warrants in the table below are considered anti-dilutive because the exercise price of these awards is greater than the average per share closing price on the NASDAQ Stock Market during this period. In addition, the weighted average number of shares issuable upon conversion of Ciena’s 0.25% convert- ible senior notes and 3.75% convertible notes are considered anti-dilutive pursuant to SFAS 128 because the related interest expense on a per common share “if converted” basis exceeds Basic EPS for the period. For fiscal 2007, the weighted average number of shares underlying outstanding stock options, employee stock pur- chase plan options, restricted stock units, and warrants in the table below are considered anti-dilutive because the exercise price of these equity awards is greater than the average per share closing price on the NASDAQ Stock Market during this period. In addition, the weighted average number of shares issuable upon conversion of Ciena’s 3.75% convertible notes, are considered anti-dilutive pursuant to SFAS 128 because the related interest expense on a per common share “if converted” basis exceeds Basic EPS for the period. 83 The following table summarizes the shares excluded from the calculation of the denominator for Basic and Diluted EPS due to their anti-dilutive effect for the fiscal years indicated (in thousands): Shares excluded from epS year ended october 31, Denominator Due to anti-dilutive effect Shares underlying stock options, restricted stock units and warrants 0.25% Convertible senior notes 3.75% Convertible notes Total excluded due to anti-dilutive effect 2005 8,374 — 928 9,302 2006 4,178 4,203 756 9,137 2007 3,041 — 742 3,783 (13) Stockholders’ equity Call spread option Ciena holds two call spread options on its common stock relating to the shares issuable upon conversion of two issues of its convertible notes. These call spread options are designed to mitigate exposure to potential dilution from the conversion of the notes. Ciena purchased a call spread option relating to the 0.25% Convertible Senior Notes due May 1, 2013 for $28.5 million during the second quarter of fiscal 2006. Ciena purchased a call spread option relating to the 0.875% Convertible Senior Notes due June 15, 2017 for $42.5 million during the third quarter of fiscal 2007. In each case, the call spread options were purchased at the time of the notes offering from an affiliate of the under- writer. The cost of each call spread option was recorded as a reduction in paid in capital. Each call spread option is exercisable, upon maturity of the relevant issue of convertible notes, for such number of shares of Ciena common stock issuable upon conversion of that series of notes in full. Each call spread option has a “lower strike price” equal to the conversion price for the notes and a “higher strike price” that serves to cap the amount of dilution protection provided. At its election, Ciena can exercise the call spread options on a net cash basis or a net share basis. The value of the consideration of a net share settlement will be equal to the value upon a net cash settlement and can range from $0, if the market price per share of Ciena common stock upon exercise is equal to or below the lower strike price, to approximately $45.7 million (in the case of the April 2006 call spread option) or approximately $76.1 million (in the case of the June 2007 call spread), if the market price per share of Ciena common stock upon exercise is at or above the higher strike price. If the market price on the date of exercise is between the lower strike price and the higher strike price, in lieu of a net settlement, Ciena may elect to receive the full number of shares underlying the call spread option by paying the aggregate option exercise price, which is equal to the original principal outstanding on that series of notes. Should there be an early unwind of the call spread option, the amount of cash or shares to be received by Ciena will depend upon the existing overall market conditions, and on Ciena’s stock price, the volatility of Ciena’s stock and the remaining term of the call spread option. The number of shares sub- ject to the call spread options and the lower and higher strike prices are subject to customary adjustments. 84 Ciena Corporation 10-K (14) income taxes The provision for income taxes consists of the following (in thousands): Provision for income taxes: Current: Federal State Foreign Total current Deferred: Federal State Foreign Total deferred Provision for income taxes 2005 $ — — 1,320 1,320 — — — — $1,320 october 31, 2006 $ — 23 1,358 1,381 — — — — $1,381 Income (loss) before provision for income taxes consists of the following (in thousands): United States International Total 2005 $(438,956) 4,577 $(434,379) october 31, 2006 $(2,549) 4,525 $ 1,976 2007 $ — 309 2,635 2,944 — — — — $2,944 2007 $77,150 8,582 $85,732 The tax provision reconciles to the amount computed by multiplying income or loss before income taxes by the U.S. federal statutory rate of 35% as follows: Provision at statutory rate State taxes Foreign taxes Research and development credit Non-deductible goodwill and other Valuation allowance 2005 35.00% — 0.06% 0.65% (15.04%) (20.97%) (0.30%) october 31, 2006 35.00% 1.14% 14.04% (55.94%) 16.15% 59.48% 69.87% 2007 35.00% 0.36% 0.11% (2.47%) 0.99% (30.55%) 3.44% The significant components of deferred tax assets and liabilities were as follows (in thousands): october 31, 2006 2007 Deferred tax assets: Reserves and accrued liabilities Depreciation and amortization NOL and credit carry forward Other Gross deferred tax assets Valuation allowance Net deferred tax asset $ 50,088 118,122 994,906 26,406 1,189,522 (1,189,522) — $ $ 22,815 156,918 959,704 40,686 1,180,123 (1,180,123) — $ 85 During fiscal 2002, Ciena established a valuation allowance against its deferred tax assets. Ciena intends to maintain a valuation allowance until sufficient positive evidence exists to support its reversal. The following table summarizes the activity in Ciena’s valuation allowance against its gross deferred tax assets (in thousands): year ended october 31, 2005 2006 2007 Balance at Beginning of period $1,077,906 $1,173,266 $1,189,522 additions $95,360 $16,256 — $ Deductions — $ $ — $9,399 Balance at end of period $1,173,266 $1,189,522 $1,180,123 As of October 31, 2007, Ciena had a $2.39 billion net operating loss carry forward and an $84.0 million income tax credit carry forward which begin to expire in fiscal year 2018 and 2012, respectively. Ciena’s ability to use net operat- ing losses and credit carry forwards are subject to limitations pursuant to the ownership change rules of the Internal Revenue Code Section 382. The income tax provision does not reflect the tax savings resulting from deductions associated with Ciena’s equity compensation and convertible debt. The tax benefit of approximately $74.7 million will be credited to additional paid-in capital when realized. For deductions associated with Ciena’s equity compensation, credits to paid-in capital will be recorded when those tax benefits are used to reduce taxes payable. Approximately $48.4 million of the valuation allowance as of October 31, 2007 was attributable to deferred tax assets associated with the acquisitions of ONI, WaveSmith, Akara, Catena and IPI. (15) Share-Based Compensation expense On November 1, 2005, Ciena adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for share-based awards based on estimated fair values. Prior to the adoption of SFAS 123(R), Ciena accounted for share-based awards to employees and directors using the intrinsic value method in accordance with APB 25, as inter- preted by FIN 44, “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25,” as allowed under SFAS 123, “Accounting for Stock-Based Compensation.” For fiscal 2005 the disclosure below includes the pro forma effect of share-based compensation expense on net loss and net loss per share in accordance with SFAS 123. During fiscal 2005, the Board of Directors determined that all future grants of stock options, restricted stock units, or other forms of equity-based compensation will solely be issued under the Ciena Corporation 2000 Equity Incentive Plan (the “2000 Plan”) and the 2003 Employee Stock Purchase Plan (the “ESPP”). Ciena Corporation 2000 equity Incentive Plan The 2000 Plan is a shareholder-approved plan that was assumed by Ciena as a result of its merger with ONI. It autho- rizes the issuance of stock options, restricted stock, restricted stock units and stock bonuses to employees, officers, directors, consultants, independent contractors and advisors. The Compensation Committee of the Board of Directors has broad discretion to establish the terms and conditions for equity awards, including number of shares, vesting con- ditions and any required service or other performance criteria. The maximum term of any award under the 2000 Plan is ten years. The exercise price of options may not be less than 85% of the fair market value of the stock at the date of grant, or 100% of the fair market value for qualified options. Under the terms of the 2000 Plan, the number of shares authorized for issuance will increase by 5.0% of the number of Ciena shares issued and outstanding on January 1 of each year, unless the Compensation Committee reduces the amount of the increase in any year. No additional shares were added to the Plan as a result of this provision in 2005, 2006 or 2007. In addition to the evergreen provision, any shares subject to outstanding awards under the ONI 1997 Stock Plan, ONI 1998 Equity Incentive Plan, or ONI 1999 Equity Incentive Plan that are forfeited or cancelled shall become available for issuance under the 2000 Plan. As of October 31, 2007, there were 3.9 million shares authorized and available for issuance under the 2000 Plan. 86 Ciena Corporation 10-K stock options Outstanding stock option awards to employees are generally subject to service-based vesting restrictions and vest incre- mentally over a four-year period, with awards subject to 12 months of accelerated vesting upon a change in control. The following table is a summary of Ciena’s stock option activity for the fiscal years indicated (shares in thousands): Balance as of October 31, 2004 Granted Exercised Canceled Balance as of October 31, 2005 Granted Exercised Canceled Balance as of October 31, 2006 Granted Exercised Canceled Balance as of October 31, 2007 options outstanding 9,079 2,041 (599) (1,871) 8,650 579 (1,304) (815) 7,110 695 (1,507) (427) 5,871 Weighted average exercise price $48.23 17.78 15.75 45.15 44.80 21.95 16.71 41.18 48.52 32.47 23.04 41.52 $53.67 The total intrinsic value of options exercised during fiscal 2007 and fiscal 2006 was $21.6 million and $18.2 million, respectively. The weighted average fair value of each stock option granted by Ciena in fiscal 2007 and 2006 was $32.47 and $21.95, respectively. The following table summarizes information with respect to stock options outstanding at October 31, 2007, based on Ciena’s closing stock price of $46.88 per share on November 2, 2007 (shares and intrinsic value in thousands): options outstanding at october 31, 2007 Vested options at october 31, 2007 Weighted average remaining Weighted Contractual average exercise price $ 14.65 17.21 21.86 27.78 31.70 41.52 60.58 155.25 $ 53.67 Life (years) 7.29 7.56 6.77 8.01 5.15 6.83 4.41 3.23 5.97 number of Shares 643 605 488 822 708 818 762 1,025 5,871 Weighted average remaining Weighted number Contractual average exercise Life price (years) $ 12.84 6.77 17.13 7.38 21.90 6.65 27.60 6.65 31.71 5.06 41.19 5.60 60.58 4.41 155.25 3.23 $ 62.68 5.16 of Shares 302 281 457 374 689 577 762 1,025 4,467 aggregate intrinsic Value $20,730 17,954 12,208 15,701 10,737 4,385 — — $81,715 aggregate intrinsic Value $10,279 8,369 11,404 7,205 10,451 3,286 — — $50,994 range of exercise price 16.52 $ 0.01–$ 17.43 $16.53–$ 22.96 $17.44–$ 31.36 $22.97–$ 31.71 $31.37–$ 46.97 $31.72–$ $46.98–$ 83.13 $83.14–$1,046.50 $ 0.01–$1,046.50 87 assumptions for option-based awards under sfas 123(R) The fair value of service-based options is recognized as stock-based compensation expense on a straight-line basis over the requisite service period. The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted average assumptions: Expected volatility Risk-free interest rate Expected life (years) Expected dividend yield year ended october 31, 2006 2007 61.5% 4.3%–5.1% 5.5–6.1 55.8% 4.2%–5.1% 6.0–6.4 0.0% 0.0% Consistent with SFAS 123(R) and SAB 107, Ciena considered the implied volatility and historical volatility of its stock price in determining its expected volatility, and, finding both to be equally reliable, determined that a combination of both would result in the best estimate of expected volatility. The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of Ciena’s employee stock options. The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding. Because Ciena considers its options to be “plain vanilla,” it calculated the expected term using the simplified method as prescribed in SAB 107. Under SAB 107, options are considered to be “plain vanilla” if they have the following basic characteristics: granted “at-the-money”; exercisability is conditioned upon service through the vesting date; termination of service prior to vesting results in forfeiture; limited exercise period following termina- tion of service; options are non-transferable and non-hedgeable. The dividend yield assumption is based on Ciena’s history and expectation of dividend payouts. Because share-based compensation expense is recognized only for those awards that are ultimately expected to vest, the amount of share-based compensation expense recognized reflects a reduction for estimated forfeitures. We estimate for- feitures at the time of grant and revise those estimates in subsequent periods based upon new or changed information. We rely upon historical experience in establishing forfeiture rates. If actual forfeitures differ from current estimates, total unrecognized share-based compensation expense will be adjusted for future changes in estimated forfeitures. assumptions for option-based awards under sfas 123 The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted average assumptions: Expected volatility Risk-free interest rate Expected life (years) Expected dividend yield year ended october 31, 2005 58%–67% 3.65%–4.26% 3.9–5.5 0.0% Ciena considered the implied volatility and historical volatility of its stock price in determining its expected volatility. The risk-free interest rate was based upon assumption of interest rates appropriate for the term of Ciena’s employee stock options. The dividend yield assumption was based on Ciena’s history and expectation of dividend payouts. Forfeitures were accounted for as they occurred. 88 Ciena Corporation 10-K Restricted stock Units A restricted stock unit is a stock award that entitles the holder to receive shares of Ciena common stock as the unit vests. Ciena’s outstanding restricted stock unit awards are subject to service-based vesting conditions and/or performance-based vesting conditions. Awards subject to service-based conditions typically vest in increments over a four-year period. Awards with performance-based vesting conditions require the achievement of certain company- based, financial or other performance criteria or targets as a condition to the vesting, or acceleration of vesting, of such awards. The aggregate intrinsic value of Ciena’s restricted stock units is based on Ciena’s closing stock price on the last trading day of each fiscal year. For fiscal 2007, Ciena’s closing stock price at year end was $46.88 per share. The following table is a summary of Ciena’s restricted stock unit activity for the fiscal years indicated (shares and fair value in thousands): Balance as of October 31, 2004 Granted Vested Canceled or forfeited Balance as of October 31, 2005 Granted Vested Canceled or forfeited Balance as of October 31, 2006 Granted Vested Canceled or forfeited Balance as of October 31, 2007 restricted Stock units outstanding 22 — — (4) 18 261 (64) (53) 162 1,216 (176) (67) 1,135 Weighted average grant Date Fair Value per Share $45.85 aggregate intrinsic Value $ 373 $47.32 $ 301 $22.99 $ 3,829 $27.94 $53,236 The total fair value of restricted stock units that vested and were converted into common stock during fiscal 2007, fis- cal 2006 and fiscal 2005 was $6.5 million, $2.6 million and $0.0 million, respectively. The weighted average fair value of each restricted stock unit granted by Ciena in fiscal 2007 and 2006 was $28.36 and $19.47, respectively. assumptions for Restricted stock Unit awards under sfas 123(R) and sfas 123 The fair value of each restricted stock unit award is estimated using the intrinsic value method which is based on the closing price on the date of grant. Share-based expense for service-based restricted stock unit awards is recognized, net of estimated forfeitures, ratably over the vesting period on a straight-line basis. Share-based expense for performance-based restricted stock unit awards, net of estimated forfeitures, is recognized ratably over the performance period based upon Ciena’s determination of whether it is probable that the performance targets will be achieved. At each reporting period, Ciena reassesses the probability of achieving the performance tar- gets and the performance period required to meet those targets. The estimation of whether the performance targets will be achieved involves judgment, and the estimate of expense is revised periodically based on the probability of achieving the performance targets. Revisions are reflected in the period in which the estimate is changed. If any per- formance goals are not met, no compensation cost is ultimately recognized and, to the extent previously recognized, compensation cost is reversed. The weighted average fair value of each restricted stock unit granted during fiscal 2007 and fiscal 2006 was $28.36 and $19.47, respectively. No restricted stock unit awards were made during fiscal 2005. 89 2003 employee stock Purchase Plan In March 2003, Ciena shareholders approved the ESPP, which has a ten-year term and originally authorized the issu- ance of 2.9 million shares. At the 2005 annual meeting, Ciena shareholders approved an amendment increasing the number of shares available to 3.6 million and adopting an “evergreen” provision that on December 31 of each year provides for an increase in the number of shares available by up to 0.6 million shares, provided that the total number of shares available shall not exceed 3.6 million. Pursuant to the evergreen provision, the maximum number of shares that may be added to the ESPP during the remainder of its ten-year term is 3.4 million. Under the ESPP, eligible employees may enroll in an offer period during certain open enrollment periods. New offer periods begin March 16 and September 16 of each year. Prior to the offer period commencing September 15, 2006, (i) each offer period consisted of four six-month purchase periods during which employee payroll deductions were accumulated and used to purchase shares of common stock; and (ii) the purchase price of the shares was 15% less than the fair market value on either the first day of an offer period or the last day of a purchase period, whichever was lower. In addition, if the fair market value on the purchase date was less than the fair market value on the first day of an offer period, then participants automatically com- menced a new offer period. On May 30, 2006, the Compensation Committee amended the ESPP, effective September 15, 2006, to shorten the offer period under the ESPP to six months. As a result of this change, the offer period and any purchase period will be the same six-month period. Under the amended ESPP, the applicable purchase price equals 95% of the fair market value of Ciena common stock on the last day of each purchase period. Employees enrolled with offer periods com- menced prior to September 15, 2006, will be permitted to complete the remaining purchase periods in their current offer period. These amendments were intended to enable the ESPP to be considered a non-compensatory plan under FAS 123(R) for future offering periods. The following table is a summary of ESPP activity for the fiscal years indicated (shares and fair value in thousands): Balance as of October 31, 2004 Issued March 15, 2005 Plan Amendment Issued September 15, 2005 Balance as of October 31, 2005 Evergreen provision Issued March 15, 2006 Issued September 15, 2006 Balance as of October 31, 2006 Evergreen provision Issued March 15, 2007 Issued September 14, 2007 Balance as of October 31, 2007 eSpp Shares available for issuance 2,252 intrinisic Value at exercise Date (366) 1,685 (307) 3,264 307 (335) (260) 2,976 571 (119) (45) 3,383 $ 741 1,072 8,662 4,610 1,137 $ 581 The amendments to the ESPP for offer periods on or after September 15, 2006 were intended to enable the ESPP to be considered a non-compensatory plan under FAS 123(R) for future offering periods. For offer periods that com- menced prior to September 15, 2006, however, fair value is determined as of the grant date, using the graded vesting approach. Under the graded vesting approach, the 24-month ESPP offer period, which consists of four six-month pur- chase periods, is treated for valuation purpose as four separate option tranches with individual lives of six, 12, 18 and 24 months, each commencing on the initial grant date. Each tranche is expensed straight-line over its individual life. 90 Ciena Corporation 10-K share-based Compensation Recognized under aPb 25 for fiscal 2005 and sfas 123(R) for fiscal 2006 and fiscal 2007 The following table summarizes share-based compensation expense for the fiscal years indicated (in thousands): Product costs Service costs Stock-based compensation expense included in cost of sales Research and development Sales and marketing General and administrative Stock-based compensation expense included in operating expense Stock-based compensation expense capitalized in inventory, net Total stock-based compensation $ 2005 — — — 4,404 4,404 633 9,441 — $9,441 year ended october 31, 2006 $ 1,075 810 1,885 5,057 3,415 3,385 11,857 299 $14,041 2007 $ 1,257 920 2,177 3,649 6,724 6,440 16,813 582 $19,572 As of October 31, 2007, total unrecognized compensation expense was: (i) $15.3 million, which relates to unvested stock options and is expected to be recognized over a weighted-average period of 1.7 years; (ii) $23.6 million, which relates to restricted stock units and is expected to be recognized over a weighted-average period of 1.8 years; and (iii) $0.1 million, which relates to the ESPP and is expected to be recognized over a weighted-average period of 0.4 years. Pro forma share-based Compensation under sfas 123 for fiscal 2005 For fiscal 2005, recognizing share-based compensation expense in accordance with SFAS 123 would have affected Ciena’s net loss and net loss per share by the pro forma amounts indicated below (in thousands, except per share data): Net loss applicable to common stockholders—as reported Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects Add: Stock-based employee compensation expense included in reported net income, net of related tax effects Net loss applicable to common stockholders—pro forma Basic and diluted net loss per share—as reported Basic and diluted net loss per share—pro forma (16) other employee Benefit plans year ended october 31, 2005 $(435,699) 61,623 9,441 $(487,881) (5.30) $ (5.94) $ employee 401(k) Plan Ciena has a 401(k) defined contribution profit sharing plan. The plan covers all U.S. based employees who are not part of an excluded group. Participants may contribute up to 60% of pre-tax compensation, subject to certain limita- tions. Effective January 1, 2007, the plan includes an employer matching contribution equal to 50% of the first 6% an employee contributes each pay period. For fiscal 2006 and fiscal 2005, the employer matching contribution was equal to 50% of the first 3% an employee contributed each pay period. Ciena may also make discretionary annual profit sharing contributions up to the IRS regulated limit. Ciena has made no profit sharing contributions to date. During fiscal 2007, fiscal 2006, and fiscal 2005, Ciena made matching contributions of approximately $2.3 million, $1.2 million and $1.3 million, respectively. 91 (17) Commitments and Contingencies foreign Tax Contingencies Ciena has received assessment notices from the Mexican tax authorities asserting deficiencies in payments between 2001 and 2005 related primarily to income taxes and import taxes and duties. Ciena has filed judicial petitions appealing these assessments. As of October 31, 2007 and October 31, 2006, Ciena had accrued liabilities of $0.9 million and $0.7 mil- lion, respectively, related to these contingencies, which are reported as a component of other current accrued liabilities. As of October 31, 2007, Ciena estimates that it could be exposed to possible losses of up to $5.8 million for which it has not accrued liabilities. Ciena has not accrued these liabilities because it does not deem such losses probable. Ciena con- tinues to evaluate the likelihood of probable and reasonably possible losses, if any, related to these assessments. As a result, future increases or decreases to accrued liabilities may be necessary and will be recorded in the period when such amounts are probable and estimable. operating lease Commitments Ciena has certain minimum obligations under non-cancelable operating leases expiring on various dates through 2019 for equipment and facilities. Future annual minimum rental commitments under non-cancelable operating leases at October 31, 2007 are as follows (in thousands): year ended october 31, 2008 2009 2010 2011 2012 Thereafter Total $13,744 11,564 9,774 8,692 6,942 20,874 $71,590 Rental expense for fiscal 2007, fiscal 2006, and fiscal 2005 was approximately $10.6 million, $9.2 million and $11.6 mil- lion, respectively. In addition, Ciena paid approximately $29.9 million, $45.3 million and $33.0 million during fiscal 2007, fiscal 2006 and fiscal 2005, respectively, related to rent costs for restructured facilities and unfavorable lease commit- ments, which were offset against Ciena’s restructuring liabilities and unfavorable lease obligations. The amount for operating lease commitments above does not include insurance, taxes, maintenance and other costs required by the applicable operating lease. These costs are variable and are not expected to have a material impact. Purchase Commitments with Contract Manufacturers and suppliers As of October 31, 2007, Ciena has purchase commitments of $135.8 million. Purchase commitments relate to pur- chase order obligations to our contract manufacturers and component suppliers for inventory. In certain instances, we are permitted to cancel, reschedule or adjust these orders. Consequently, only a portion of the amount reported as purchase commitments relates to firm, non-cancelable and unconditional obligations. litigation On October 3, 2000, Stanford University and Litton Systems filed a complaint in the United States District Court for the Central District of California against Ciena and several other defendants, alleging that optical fiber amplifiers incorpo- rated into certain of those parties’ products infringe U.S. Patent No. 4,859,016 (the “‘016 Patent”). The complaint seeks injunctive relief, royalties and damages. On October 10, 2003, the court stayed the case pending final resolution of matters before the U.S. Patent and Trademark Office (the “PTO”), including a request for and disposition of a reex- amination of the ‘016 Patent. On October 16, 2003, and November 2, 2004, the PTO granted reexaminations of the ‘016 Patent, resulting in a continuation of the stay of the case. On September 11, 2006, the PTO issued a Notice of Intent to Issue a Reexamination Certificate and Statement of Reasons for Patentability/Confirmation, stating its intent to confirm certain claims of the ‘016 Patent. On June 22, 2007, the district court issued an order lifting the stay of the 92 Ciena Corporation 10-K case. The parties are currently engaged in discovery. Separately, on July 2, 2007, defendant JDS Uniphase filed with the PTO a request for ex parte reexamination of the ‘016 Patent and a request that the district court reinstate the stay of the case on the basis of its reexamination request. On November 20, 2007, the PTO granted the request for reexamina- tion in part, including only claim 12 of the ‘016 Patent in the scope of its reexamination. On November 28, 2007, based on the PTO’s rationale in granting reexamination, defendant JDS Uniphase filed with the PTO another request for ex parte reexamination of claim 11 of the ‘016 Patent. The court has not ruled on the motion to reinstate the stay. On December 11, 2007, the district court continued the final pretrial conference to June 16, 2008. The case has not yet been scheduled for trial. Ciena is not able to predict the ultimate outcome of this matter at this time or to reasonably estimate the amount or range of the potential loss, if any, that might result from an adverse resolution of this matter. Ciena believes that it has valid defenses to the lawsuit and intends to defend it vigorously. As a result of our merger with ONI Systems Corp. in June 2002, Ciena became a defendant in a securities class action lawsuit. Beginning in August 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United States District Court for the Southern District of New York. These complaints name ONI, Hugh C. Martin, ONI’s former chairman, president and chief executive officer; Chris A. Davis, ONI’s former executive vice president, chief financial officer and administrative officer; and certain underwriters of ONI’s initial public offering as defendants. The complaints were consolidated into a single action, and a consolidated amended complaint was filed on April 24, 2002. The amended complaint alleges, among other things, that the underwriter defendants violated the securities laws by failing to disclose alleged compensation arrangements (such as undisclosed commissions or stock stabilization practices) in the initial public offering’s registration statement and by engaging in manipulative practices to artificially inflate the price of ONI’s common stock after the initial public offer- ing. The amended complaint also alleges that ONI and the named former officers violated the securities laws on the basis of an alleged failure to disclose the underwriters’ alleged compensation arrangements and manipulative prac- tices. No specific amount of damages has been claimed. Similar complaints have been filed against more than 300 other issuers that have had initial public offerings since 1998, and all of these actions have been included in a single coordinated proceeding. Mr. Martin and Ms. Davis have been dismissed from the action without prejudice pursuant to a tolling agreement. In July 2004, following mediated settlement negotiations, the plaintiffs, the issuer defendants (including Ciena), and their insurers entered into a settlement agreement, whereby the plaintiffs’ cases against the issuers would be dismissed, the insurers would agree to guarantee a recovery by the plaintiffs from the underwriter defendants of at least $1 billion, and the issuer defendants would agree to assign or surrender to the plaintiffs certain claims the issuers may have against the underwriters. The settlement agreement did not require Ciena to pay any amount toward the settlement or to make any other payments. In October 2004, the district court certified a class with respect to the Section 10(b) claims in six “focus cases” selected out of all of the consolidated cases, which cases did not include Ciena, and which decision was appealed by the underwriter defendants to the U.S. Court of Appeals for the Second Circuit. On February 15, 2005, the district court granted the motion filed by the plaintiffs and issuer defendants for preliminary approval of the settlement agreement, subject to certain modifications to the proposed bar order, and on August 31, 2005, the district court issued a preliminary order approving the revised stipulated settle- ment agreement. On December 5, 2006, the U.S. Court of Appeals for the Second Circuit vacated the district court’s grant of class certification in the six focus cases. On April 6, 2007, the Second Circuit denied plaintiffs’ petition for rehearing. In light of the Second Circuit’s decision, the parties agreed that the settlement could not be approved. On June 25, 2007, the district court approved a stipulation filed by the plaintiffs and the issuer defendants terminating the proposed settlement. On August 14, 2007, the plaintiffs filed second amended complaints against the defendants in the six focus cases, as well as a set of amended master allegations against the other issuer defendants, including changes to the definition of the purported class of investors. On September 27, 2007, the plaintiffs filed a motion for class certification based on their amended complaints and allegations. On November 12, 2007, the defendants in the six focus cases moved to dismiss the second amended complaints. Due to the inherent uncertainties of litigation, Ciena cannot accurately predict the ultimate outcome of the matter at this time. In addition to the matters described above, Ciena is subject to various legal proceedings, claims and litigation arising in the ordinary course of its business. Ciena does not expect that the ultimate costs to resolve these matters will have a material effect on its results of operations, financial position or cash flows. 93 (18) entity Wide Disclosures The following table reflects Ciena’s geographic distribution of revenue based on the location of the purchaser. Revenue attributable to geographic regions outside of the United States is reflected as International revenue, with any country accounting for greater than 10% of total revenue in the period specifically identified. For the periods below, Ciena’s geographic distribution of revenue was as follows (in thousands, except percentage data): United States United Kingdom International Total 2005 $340,774 N/A 86,483 $427,257 %* 79.8 — 20.2 100.0 2006 $423,687 N/A 140,369 $564,056 %* 75.1 — 24.9 100.0 2007 $553,582 100,681 125,506 $779,769 %* 71.0 12.9 16.1 100.0 Fiscal year * Denotes % of total revenue N/A Denotes less than 10% for period The following table reflects Ciena’s geographic distribution of equipment, furniture and fixtures. Equipment, furniture and fixtures attributable to geographic regions outside of the United States are reflected as International, with any country attributable for greater than 10% of total equipment, furniture and fixtures specifically identified. For the periods below, Ciena’s geographic distribution of equipment, furniture and fixtures was as follows (in thousands, except percentage data): United States International Total 2006 $21,934 7,493 $29,427 %* 74.5 25.5 100.0 2007 $38,391 8,280 $46,671 %* 82.3 17.7 100.0 * Denotes % of total equipment, furniture and fixtures For the periods below, Ciena’s distribution of revenue was as follows (in thousands, except percentage data): 2005 %* 2006 %* 2007 %* Fiscal year $291,549 82,726 52,982 $427,257 68.2 19.4 12.4 100.0 $420,567 81,860 61,629 $564,056 74.6 14.5 10.9 100.0 $645,159 50,129 84,481 $779,769 82.8 6.4 10.8 100.0 Converged Ethernet infrastructure Ethernet access Global network services Total * Denotes % of total revenue For the periods below, customers accounting for at least 10% of Ciena’s revenue were as follows (in thousands, except per- centage data): Verizon Sprint AT&T BellSouth SAIC Total Fiscal year 2005 $ 43,673 N/A N/A 43,946 46,058 $133,677 %* 10.2 — — 10.3 10.8 31.3 2006 $ 70,225 89,793 66,926 N/A N/A $226,944 %* 12.4 15.9 11.9 — — 40.2 %* — 12.8 25.3 2007 N/A 100,122 196,924 N/A — N/A — $297,046 38.1 N/A Denotes revenue representing less than 10% of total revenue for the period * Denotes % of total revenue 94 Ciena Corporation 10-K item 9. CHangeS in anD DiSagreementS WitH aCCountantS on aCCounting anD FinanCiaL DiSCLoSure None. item 9a. ControLS anD proCeDureS Disclosure Controls and procedures As of the end of the period covered by this report, Ciena carried out an evaluation under the supervision and with the participation of Ciena’s management, including Ciena’s Chief Executive Officer and Chief Financial Officer, of Ciena’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon this evaluation, Ciena’s Chief Executive Officer and Chief Financial Officer concluded that Ciena’s disclosure controls and procedures were effective as of the end of the period covered by this report. Changes in internal Control over Financial reporting There was no change in Ciena’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, Ciena’s internal control over financial reporting. 95 report of management on internal Control over Financial reporting The management of Ciena Corporation is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934). The internal control over financial reporting at Ciena Corporation was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those policies and procedures that: • pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of Ciena Corporation; • provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America; • provide reasonable assurance that receipts and expenditures of Ciena Corporation are being made only in accordance with authorization of management and directors of Ciena Corporation; and • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or dis- position of assets that could have a material effect on the consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management of Ciena Corporation assessed the effectiveness of the company’s internal control over financial reporting as of October 31, 2007. Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management determined that, as of October 31, 2007, Ciena Corporation maintained effective internal control over financial reporting. Management reviewed the results of its assess- ment with the Audit Committee of our Board of Directors. PricewaterhouseCoopers LLP, independent registered public accounting firm, who audited and reported on the con- solidated financial statements of Ciena Corporation included in this annual report, has also audited the effectiveness of Ciena Corporation’s internal control over financial reporting as of October 31, 2007, as stated in its report appear- ing under Item 8 of part II of this annual report. /s/ Gary B. Smith Gary B. Smith /s/ Joseph R. Chinnici Joseph R. Chinnici President and Chief Executive Officer Senior Vice President and Chief Financial Officer December 27, 2007 December 27, 2007 item 9B. otHer inFormation None. 96 Ciena Corporation 10-K PaRT III item 10. DireCtorS, eXeCutiVe oFFiCerS anD Corporate goVernanCe Pursuant to General Instruction G(3) of Form 10-K, information relating to Ciena’s directors and executive officers is set forth in Part I of this annual report under the caption Item 1. “Business—Directors and Executive Officers.” Additional information concerning our Audit Committee and regarding compliance with Section 16(a) of the Exchange Act responsive to this item is incorporated herein by reference to Ciena’s definitive proxy statement with respect to our 2008 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K. As part of our system of corporate governance, our board of directors has adopted a code of ethics that is specifically applicable to our chief executive officer and senior financial officers. This Code of Ethics for Senior Financial Officers, as well as our Code of Business Conduct and Ethics, applicable to all directors, officers and employees, are available on the corporate governance page of our web site at http://www.ciena.com. We intend to satisfy any disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of the Code of Ethics for Senior Financial Officers, by posting such information on our web site at the address above. item 11. eXeCutiVe CompenSation Information responsive to this item is incorporated herein by reference to Ciena’s definitive proxy statement with respect to our 2008 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K. item 12. SeCurity oWnerSHip oF Certain BeneFiCiaL oWnerS anD management anD reLateD StoCKHoLDer matterS Information responsive to this item is incorporated herein by reference to Ciena’s definitive proxy statement with respect to our 2008 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K. item 13. Certain reLationSHipS anD reLateD tranSaCtionS, anD DireCtor inDepenDenCe Information responsive to this item is incorporated herein by reference to Ciena’s definitive proxy statement with respect to our 2008 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K. item 14. prinCipaL aCCountant FeeS anD SerViCeS Information responsive to this item is incorporated herein by reference to Ciena’s definitive proxy statement with respect to our 2008 Annual Meeting of Shareholders to be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K. 97 PaRT IV item 15. eXHiBitS anD FinanCiaL Statement SCHeDuLeS (a) 1. The information required by this item is included in Item 8 of Part II of this annual report. 2. The information required by this item is included in Item 8 of Part II of this annual report. 3. Exhibits: See Index to Exhibits. The Exhibits listed in the accompanying Index to Exhibits are filed or incorpo- rated by reference as part of this annual report. (b) Exhibits. See Index to Exhibits. The Exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this annual report. (c) Not applicable. SignatureS Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Linthicum, County of Anne Arundel, State of Maryland, on the 27th day of December 2007. Ciena Corporation By: /s/ Gary B. Smith Gary B. Smith President, Chief Executive Officer and Director Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the fol- lowing persons on behalf of the Registrant and in the capacities and on the date indicated. Signatures title Date /s/ Patrick H. Nettles, Ph.D. Patrick H. Nettles, Ph.D. /s/ Gary B. Smith Gary B. Smith (Principal Executive Officer) /s/ Joseph R. Chinnici Joseph R. Chinnici (Principal Financial Officer) /s/ Andrew C. Petrik Andrew C. Petrik (Principal Accounting Officer) /s/ Stephen P. Bradley, Ph.D. Stephen P. Bradley, Ph.D. /s/ Harvey B. Cash Harvey B. Cash /s/ Bruce L. Claflin Bruce L. Claflin /s/ Lawton W. Fitt Lawton W. Fitt /s/ Judith M. O’Brien Judith M. O’Brien /s/ Michael J. Rowny Michael J. Rowny /s/ Gerald H. Taylor Gerald H. Taylor Executive Chairman of the Board of Directors December 27, 2007 President, Chief Executive Officer and Director December 27, 2007 Sr. Vice President, Finance and Chief Financial Officer December 27, 2007 Vice President, Controller and Treasurer December 27, 2007 Director Director Director Director Director Director Director December 27, 2007 December 27, 2007 December 27, 2007 December 27, 2007 December 27, 2007 December 27, 2007 December 27, 2007 98 Ciena Corporation 10-K focused on growth focused on growth We’re focused on achieving proﬁ table revenue growth that drives We’re focused on achieving proﬁ table revenue growth that drives sustained shareholder value. By targeting high-growth market segments sustained shareholder value. By targeting high-growth market segments and high-value applications, we’re capturing increasing market share. and high-value applications, we’re capturing increasing market share. And our focus and hard work are paying off, resulting in faster revenue And our focus and hard work are paying off, resulting in faster revenue growth than our overall market sector. growth than our overall market sector. annual revenue up annual revenue up 38% 38% 6 6 1 1 2 2 $ $ 5 5 0 0 2 2 $ $ 4 4 9 9 1 1 $ $ 5 5 6 6 1 1 $ $ 0 0 6 6 1 1 $ $ 2 2 5 5 1 1 1 $ 1 $ 3 3 1 1 $ $ 0 0 2 2 1 1 $ $ 8 8 1 1 1 1 $ $ solid revenue growth solid revenue growth (in millions) (in millions) 5 5 0 0 ’ ’ 4 4 Q Q 6 6 0 0 ’ ’ 1 1 Q Q 6 6 0 0 ’ ’ 2 2 Q Q 6 6 0 0 ’ ’ 3 3 Q Q 6 6 0 0 ’ ’ 4 4 Q Q 7 7 0 0 ’ ’ 1 1 Q Q 7 7 0 0 ’ ’ 2 2 Q Q 7 7 0 0 ’ ’ 3 3 Q Q 7 7 0 0 ’ ’ 4 4 Q Q Ciena Corporation is a global leader in communication network platforms, software and professional services. Our specialty Ciena Corporation is a global leader in communication network platforms, software and professional services. Our specialty is transitioning networks for maximum business value, operational value and end-user value. Integrating expertise in optical, is transitioning networks for maximum business value, operational value and end-user value. Integrating expertise in optical, access and data networking, Ciena enables the delivery of more services faster, transforms the network cost base, and improves access and data networking, Ciena enables the delivery of more services faster, transforms the network cost base, and improves the end-user experience. With industry-leading functionality and performance, Ciena’s offerings form the foundation for the end-user experience. With industry-leading functionality and performance, Ciena’s offerings form the foundation for many of the largest, most reliable and sophisticated telco, cable/MSO, enterprise and government networks across the globe. many of the largest, most reliable and sophisticated telco, cable/MSO, enterprise and government networks across the globe. corporate information corporate information operating executive operating executive ofﬁ cers ofﬁ cers Patrick H. Nettles, Ph.D. Patrick H. Nettles, Ph.D. Executive Chairman of the Executive Chairman of the Board of Directors Board of Directors outside board members outside board members Stephen P. Bradley, Ph.D. Stephen P. Bradley, Ph.D. William Ziegler Professor William Ziegler Professor of Business Administration of Business Administration Harvard Business School Harvard Business School Gary B. Smith Gary B. Smith President, Chief Executive Ofﬁ cer President, Chief Executive Ofﬁ cer and Director and Director Harvey B. Cash Harvey B. Cash General Partner General Partner InterWest Partners InterWest Partners Bruce L. Claﬂ in Bruce L. Claﬂ in Retired, President and CEO Retired, President and CEO 3Com Corporation 3Com Corporation Lawton W. Fitt Lawton W. Fitt Senior Advisor Senior Advisor GSC Group GSC Group Judith M. O’Brien Judith M. O’Brien Executive Vice President Executive Vice President Obopay, Inc. Obopay, Inc. Michael J. Rowny Michael J. Rowny Chairman Chairman Rowny Capital Rowny Capital Gerald H. Taylor Gerald H. Taylor Managing Member Managing Member mortonsgroup, LLC mortonsgroup, LLC Stephen B. Alexander Stephen B. Alexander Senior Vice President, Products Senior Vice President, Products and Technology, and and Technology, and Chief Technology Ofﬁ cer Chief Technology Ofﬁ cer James E. Moylan, Jr. James E. Moylan, Jr. Senior Vice President, Finance, Senior Vice President, Finance, and Chief Financial Ofﬁ cer and Chief Financial Ofﬁ cer Arthur D. Smith, Ph.D. Arthur D. Smith, Ph.D. Senior Vice President and Senior Vice President and Chief Operating Ofﬁ cer Chief Operating Ofﬁ cer Michael G. Aquino Michael G. Aquino Senior Vice President, Senior Vice President, Worldwide Sales Worldwide Sales Russell B. Stevenson, Jr. Russell B. Stevenson, Jr. Senior Vice President, General Senior Vice President, General Counsel and Secretary Counsel and Secretary Andrew C. Petrik Andrew C. Petrik Vice President, Controller Vice President, Controller and Treasurer and Treasurer corporate headquarters corporate headquarters Ciena Corporation Ciena Corporation 1201 Winterson Road 1201 Winterson Road Linthicum, MD 21090-2205 Linthicum, MD 21090-2205 Telephone: (800) 921-1144 Telephone: (800) 921-1144 or (410) 865-8500 or (410) 865-8500 www.Ciena.com www.Ciena.com annual meeting annual meeting Ciena’s annual meeting of share- Ciena’s annual meeting of share- holders will be held at 3:00 pm on holders will be held at 3:00 pm on Wednesday, March 26, 2008 at the Wednesday, March 26, 2008 at the Baltimore Marriott Waterfront Hotel, Baltimore Marriott Waterfront Hotel, 700 Aliceanna Street, Baltimore, MD. 700 Aliceanna Street, Baltimore, MD. independent registered independent registered public accounting ﬁ rm public accounting ﬁ rm PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP McLean, VA McLean, VA general counsel general counsel Hogan & Hartson LLP Hogan & Hartson LLP Baltimore, MD Baltimore, MD transfer agent transfer agent Computershare Trust Company, N.A. Computershare Trust Company, N.A. P.O. Box 43078 P.O. Box 43078 Providence, RI 02940-3078 Providence, RI 02940-3078 Shareholder Inquiries: (781) 575-2879 Shareholder Inquiries: (781) 575-2879 www.Computershare.com www.Computershare.com common stock market data common stock market data Since its initial public offering on Since its initial public offering on February 7, 1997, Ciena’s Common February 7, 1997, Ciena’s Common Stock has traded on the Nasdaq Stock has traded on the Nasdaq Stock Market under the symbol CIEN. Stock Market under the symbol CIEN. investor relations investor relations For additional copies of this report For additional copies of this report or other ﬁ nancial information, contact: or other ﬁ nancial information, contact: Investor Relations Investor Relations Ciena Corporation Ciena Corporation 1201 Winterson Road 1201 Winterson Road Linthicum, MD 21090-2205 Linthicum, MD 21090-2205 IR Hotline: (888) 243-6223 IR Hotline: (888) 243-6223 or (410) 694-5700 or (410) 694-5700 Additional information is available on Additional information is available on Ciena’s website at www.Ciena.com. Ciena’s website at www.Ciena.com. m m o o c c . . e e v v i i t t a a e e r r c c i i c c f f . . w w w w w w D D M M , , a a d d s s e e h h t t e e B B . . c c n n I I s s n n o o i i t t a a c c i i n n u u m m m m o o C C l l a a i i c c n n a a n n i i F F : : n n g g i i s s e e D D n n o o i i t t a a r r o o p p r r o o C C a a n n e e i i C C 8 8 0 0 0 0 2 2 © © ANNUAL REPORT 2007 focused 1201 Winterson Road, Linthicum, Maryland 21090-2205 (410) 865-8500 (800) 921-1144 www.Ciena.com 002CS-60908

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