10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark one)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2015
OR
o
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: 001-36250
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.)
7035 Ridge Road, Hanover, MD
(Address of Principal Executive Offices)
21076
(Zip Code)

(410) 694-5700
(Registrant’s telephone number, including area code)
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 þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES þ NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
(do not check if smaller reporting company)
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as determined in Rule 12b-2 of the Exchange Act). YES o NO þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Class
 
Outstanding at September 4, 2015
common stock, $0.01 par value
 
134,754,004





CIENA CORPORATION
INDEX
FORM 10-Q
 
PAGE
NUMBER
 
 

2



PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

CIENA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

 
Quarter Ended July 31,
 
Nine Months Ended July 31,
 
2014
 
2015
 
2014
 
2015
Revenue:
 
 
 
 
 
 
 
Products
$
495,889

 
$
493,919

 
$
1,389,651

 
$
1,428,114

Services
107,673

 
109,013

 
307,675

 
325,582

Total revenue
603,562

 
602,932

 
1,697,326

 
1,753,696

Cost of goods sold:
 
 
 
 
 
 
 
Products
275,003

 
273,837

 
777,851

 
797,283

Services
64,586

 
59,226

 
191,960

 
183,838

Total cost of goods sold
339,589

 
333,063

 
969,811

 
981,121

Gross profit
263,973

 
269,869

 
727,515

 
772,575

Operating expenses:
 
 
 
 
 
 
 
Research and development
97,685

 
100,379

 
302,674

 
306,342

Selling and marketing
81,919

 
81,650

 
243,929

 
240,833

General and administrative
36,285

 
29,743

 
98,264

 
89,598

Acquisition and integration costs

 
2,435

 

 
3,455

Amortization of intangible assets
11,019

 
11,019

 
34,951

 
33,057

Restructuring costs
63

 
192

 
178

 
8,260

Total operating expenses
226,971

 
225,418

 
679,996

 
681,545

Income from operations
37,002

 
44,451

 
47,519

 
91,030

Interest and other income (loss), net
(6,328
)
 
(5,491
)
 
(14,231
)
 
(19,273
)
Interest expense
(11,508
)
 
(11,883
)
 
(33,556
)
 
(38,491
)
Income (loss) before income taxes
19,166

 
27,077

 
(268
)
 
33,266

Provision for income taxes
3,006

 
3,452

 
9,666

 
7,767

Net income (loss)
$
16,160

 
$
23,625

 
$
(9,934
)
 
$
25,499

Basic net income (loss) per common share
$
0.15

 
$
0.20

 
$
(0.09
)
 
$
0.23

Diluted net income (loss) per potential common share
$
0.15

 
$
0.19

 
$
(0.09
)
 
$
0.22

Weighted average basic common shares outstanding
106,236

 
118,413

 
105,404

 
113,189

Weighted average dilutive potential common shares outstanding
120,809

 
133,233

 
105,404

 
114,549


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.



3



CIENA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)

 
Quarter Ended July 31,
 
Nine Months Ended July 31,
 
2014
 
2015
 
2014
 
2015
Net income (loss)
$
16,160

 
$
23,625

 
$
(9,934
)
 
$
25,499

Change in unrealized gain on available-for-sale securities, net of tax
(43
)
 
(13
)
 
(12
)
 
(37
)
Change in unrealized loss on foreign currency forward contracts, net of tax
383

 
(154
)
 
34

 
(1,626
)
Change in unrealized loss on forward starting interest rate swap, net of tax

 
(667
)
 

 
(2,885
)
Change in cumulative translation adjustment
(122
)
 
(3,508
)
 
(4,287
)
 
(6,919
)
Other comprehensive income (loss)
218

 
(4,342
)
 
(4,265
)
 
(11,467
)
Total comprehensive income (loss)
$
16,378

 
$
19,283

 
$
(14,199
)
 
$
14,032


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.



4



CIENA CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
 
October 31,
2014
 
July 31,
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
586,720

 
$
697,091

Short-term investments
140,205

 
160,067

Accounts receivable, net
518,981

 
530,261

Inventories
254,660

 
194,017

Prepaid expenses and other
192,624

 
185,140

Total current assets
1,693,190

 
1,766,576

Long-term investments
50,057

 
70,161

Equipment, building, furniture and fixtures, net
126,632

 
159,592

Other intangible assets, net
128,677

 
89,019

Other long-term assets
74,076

 
78,347

      Total assets
$
2,072,632

 
$
2,163,695

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
209,777

 
$
201,774

Accrued liabilities
276,608

 
272,691

Deferred revenue
104,688

 
114,902

Current portion of long-term debt
190,063

 
2,500

Total current liabilities
781,136

 
591,867

Long-term deferred revenue
40,930

 
53,731

Other long-term obligations
45,390

 
63,482

Long-term debt, net
1,274,791

 
1,276,761

Total liabilities
$
2,142,247

 
$
1,985,841

Commitments and contingencies (Note 20)

 

Stockholders’ equity (deficit):
 
 
 
Preferred stock – par value $0.01; 20,000,000 shares authorized; zero shares issued and outstanding

 

Common stock – par value $0.01; 290,000,000 shares authorized; 106,979,960 and 118,725,874 shares issued and outstanding
1,070

 
1,187

Additional paid-in capital
5,954,440

 
6,187,759

Accumulated other comprehensive loss
(14,668
)
 
(26,135
)
Accumulated deficit
(6,010,457
)
 
(5,984,957
)
Total stockholders’ equity (deficit)
(69,615
)
 
177,854

Total liabilities and stockholders’ equity (deficit)
$
2,072,632

 
$
2,163,695


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.


5



CIENA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Nine Months Ended July 31,
 
2014
 
2015
Cash flows provided by operating activities:
 
 
 
Net income (loss)
$
(9,934
)
 
$
25,499

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation of equipment, building, furniture and fixtures, and amortization of leasehold improvements
41,463

 
41,601

Share-based compensation costs
34,204

 
32,402

Amortization of intangible assets
43,931

 
39,659

Provision for inventory excess and obsolescence
22,026

 
18,010

Provision for warranty
18,720

 
12,549

Other
21,254

 
(1,220
)
Changes in assets and liabilities:
 
 
 
Accounts receivable
(55,688
)
 
(12,053
)
Inventories
(66,015
)
 
42,633

Prepaid expenses and other
(26,698
)
 
(5,345
)
Accounts payable, accruals and other obligations
(34,794
)
 
(39,266
)
Deferred revenue
27,498

 
23,015

Net cash provided by operating activities
15,967

 
177,484

Cash flows used in investing activities:
 
 
 
Payments for equipment, furniture, fixtures and intellectual property
(35,974
)
 
(39,729
)
Restricted cash
2,059

 
(42
)
Purchase of available for sale securities
(195,259
)
 
(180,203
)
Proceeds from maturities of available for sale securities
150,000

 
140,000

Settlement of foreign currency forward contracts, net
(10,796
)
 
16,289

Purchase of cost method investment

 
(2,000
)
Net cash used in investing activities
(89,970
)
 
(65,685
)
Cash flows provided by financing activities:
 
 
 
Proceeds from issuance of term loan, net
248,750

 

Payment of long term debt

 
(8,901
)
Payment for debt and equity issuance costs
(3,263
)
 
(420
)
Payment of capital lease obligations
(2,275
)
 
(6,441
)
Proceeds from issuance of common stock
17,518

 
19,622

Net cash provided by financing activities
260,730

 
3,860

Effect of exchange rate changes on cash and cash equivalents
(330
)
 
(5,288
)
Net increase in cash and cash equivalents
186,397

 
110,371

Cash and cash equivalents at beginning of period
346,487

 
586,720

Cash and cash equivalents at end of period
$
532,884

 
$
697,091

Supplemental disclosure of cash flow information
 
 
 
Cash paid during the period for interest
$
23,425

 
$
31,566

Cash paid during the period for income taxes, net
$
9,051

 
$
8,526

Non-cash investing activities
 
 
 
Purchase of equipment in accounts payable
$
4,334

 
$
16,717

Debt issuance costs in accrued liabilities
$
655

 
$

Equipment acquired under capital lease
$

 
$
464

Building subject to capital lease
$

 
$
14,939

Construction in progress subject to build-to-suit lease
$

 
$
8,770

Non-cash financing activities
 
 
 
Conversion of 4.0% convertible senior notes, due March 15, 2015 into 8,898,387 shares of common stock
$

 
$
180,645


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

6



CIENA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(1)
 INTERIM FINANCIAL STATEMENTS
The interim financial statements included herein for Ciena Corporation and its wholly owned subsidiaries (“Ciena”) have been prepared by Ciena, without audit, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). In the opinion of management, the financial statements included in this report reflect all normal recurring adjustments that Ciena considers necessary for the fair statement of the results of operations for the interim periods covered and of the financial position of Ciena at the date of the interim balance sheets. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to such rules and regulations. The Condensed Consolidated Balance Sheet as of October 31, 2014 was derived from audited financial statements, but does not include all disclosures required by GAAP. However, Ciena believes that the disclosures are adequate to understand the information presented herein. The operating results for interim periods are not necessarily indicative of the operating results for the entire year. These financial statements should be read in conjunction with Ciena’s audited consolidated financial statements and the notes thereto included in Ciena’s annual report on Form 10-K for the fiscal year ended October 31, 2014.
Ciena has a 52 or 53-week fiscal year, which ends on the Saturday nearest to the last day of October of each year. Fiscal 2014 and 2015 are 52-week fiscal years. For purposes of financial statement presentation, each fiscal year is described as having ended on October 31, and the fiscal quarters are described as having ended on January 31, April 30 and July 31 of each fiscal year.

(2)
 SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of the financial statements and related disclosures in conformity with GAAP requires management to make estimates and judgments that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Estimates are used for selling prices for multiple element arrangements, shared-based compensation, convertible notes payable valuations, bad debts, valuation of inventories and investments, recoverability of intangible assets, other long-lived assets, income taxes, warranty obligations, restructuring liabilities, derivatives, incentive compensation, contingencies and litigation. Ciena bases its estimates on historical experience and 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. Any restricted cash collateralizing letters of credit is included in other current assets and other long-term assets depending upon the duration of the restriction.

Investments

Ciena's investments are classified as available-for-sale and are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensive income (loss). Ciena recognizes losses in the income statement when it determines that declines in the fair value of its investments below their cost basis are other-than-temporary. In determining whether a decline in fair value is other-than-temporary, Ciena considers various factors, 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 Ciena's cost basis, and Ciena's 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. Ciena considers all marketable debt securities that it expects to convert to cash within one year or less to be short-term investments, with all others considered to be long-term investments.

Ciena has a minority equity investment in a privately held technology company that is classified in other long-term assets. This investment is carried at cost because Ciena owns less than 20% of the voting equity and does not have the ability to exercise significant influence over the company. Ciena monitors this investment for impairment and makes appropriate reductions to the carrying value when necessary. As of July 31, 2015, the carrying value of this investment was $2.0 million. With respect to this investment, Ciena has not estimated the fair value of this cost method investment because determining the

7



fair value is not practicable. Ciena has not evaluated this investment for impairment as there have not been any events or changes in circumstances that Ciena believes would have had a significant adverse effect on the fair value of this investment.

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 impairment has been identified.

Segment Reporting

Ciena's chief operating decision maker, its chief executive officer, evaluates the company's performance and allocates resources based on multiple factors, including measures of segment profit (loss). Operating segments are defined as components of an enterprise that engage in business activities that may earn revenue and incur expense, for which discrete financial information is available, and for which such information is evaluated regularly by the chief operating decision maker for purposes of allocating resources and assessing performance. Ciena considers the following to be its operating segments for reporting purposes: (i) Converged Packet Optical, (ii) Packet Networking, (iii) Optical Transport, and (iv) Software and Services. See Note 19 below.

Long-lived Assets

Long-lived assets include: equipment, building, furniture and fixtures; intangible assets; and maintenance spares. Ciena tests long-lived assets for impairment whenever triggering events or changes in circumstances indicate that the asset's carrying amount is not recoverable from its undiscounted cash flows. An impairment loss is measured as the amount by which the carrying amount of the asset or asset group exceeds its fair value. Ciena's long-lived assets are assigned to asset groups that represent the lowest level for which cash flows can be identified.

Equipment, Building, Furniture and Fixtures and Internal Use Software

Equipment, furniture and fixtures are recorded at cost. Depreciation and amortization are computed using the straight-line method over useful lives of two to five years for equipment and furniture and fixtures and the shorter of useful life or lease term for leasehold improvements. During the second quarter of fiscal 2015, Ciena gained partial access to an office building in Ottawa, Canada pursuant to a lease arrangement accounted for as a capital lease, which is depreciated over the lease term. The lease building is part of Ciena's new campus facility that will replace the "Lab 10" research and development center on the former Nortel Carling campus. See Note 10 below.

Ciena establishes assets and liabilities for the estimated construction costs incurred under build-to-suit lease arrangements to the extent that Ciena is involved in the construction of structural improvements or takes construction risk prior to commencement of a lease. See Notes 10 and 12 below.

Qualifying internal use software and website development costs incurred during 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 lives of two to five years.

Intangible Assets

Ciena has recorded finite-lived intangible assets as a result of several acquisitions. Finite-lived intangible assets are carried at cost less accumulated amortization. Amortization is computed using the straight-line method over the expected economic lives of the respective assets, up to seven years, which approximates the use of intangible assets.

Maintenance Spares

Maintenance spares are recorded at cost. Spares usage cost is expensed ratably over four years.

Concentrations

Substantially all of Ciena's cash and cash equivalents are maintained at a small number of major U.S. financial institutions. The majority of Ciena's cash equivalents consist of money market funds. Deposits held with banks may exceed the amount of

8



insurance provided on such deposits. Because these deposits generally may be redeemed upon demand, management believes that they bear minimal risk.

Historically, a significant percentage of Ciena's revenue has been concentrated among sales to a small number of large communications service providers. Consolidation among Ciena's customers has increased this concentration. Consequently, Ciena's accounts receivable are concentrated among these customers. See Note 19 below.

Additionally, Ciena's access to certain materials or components is dependent upon sole or limited source suppliers. The inability of any of these suppliers to fulfill Ciena's supply requirements, or significant changes in supply cost, could affect future results. Ciena relies on a small number of contract manufacturers to perform the majority of the manufacturing for its products. If Ciena cannot effectively manage these manufacturers or forecast future demand, or if these manufacturers fail to deliver products or components on time, Ciena's business and results of operations may suffer.

Revenue Recognition

Ciena recognizes revenue 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 customer purchase orders are generally used to determine the existence of an arrangement. Shipping documents and evidence of customer acceptance, when applicable, are used to verify delivery or services rendered. Ciena assesses whether the price is fixed or determinable 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 determined by credit checks and analysis, as well as the customer's payment history. Revenue for maintenance services is deferred and recognized ratably over the period during which the services are performed. Shipping and handling fees billed to customers are included in revenue, with the associated expenses included in product cost of goods sold.

Ciena applies the percentage-of-completion method to long-term arrangements where Ciena is required to undertake significant production, customization or modification engineering, and reasonable and reliable estimates of revenue and cost are available. Utilizing the percentage-of-completion method, Ciena recognizes revenue based on the ratio of actual costs incurred to date to total estimated costs expected to be incurred. In instances that do not meet the percentage-of-completion method criteria, recognition of revenue is deferred until there are no uncertainties regarding customer acceptance. Unbilled percentage-of-completion revenues recognized are included in accounts receivable, net. Billings in excess of revenues recognized on these contracts are recorded within deferred revenue. The percentage of total revenue recognized using the percentage-of-completion method for the nine months ended July 31, 2014 and July 31, 2015 was 4.3% and 1.9%, respectively.

Software 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 criteria of the software are specified by the customer, revenue is deferred until there are no uncertainties regarding customer acceptance.

Ciena limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges.

Revenue for multiple element arrangements is allocated to each unit of accounting based on the relative selling price of each delivered element, with revenue recognized for each delivered element when the revenue recognition criteria are met. Ciena determines the selling price for each deliverable based upon the selling price hierarchy for multiple-deliverable arrangements. Under this hierarchy, Ciena uses vendor-specific objective evidence ("VSOE") of selling price, if it exists, or third party evidence ("TPE") of selling price if VSOE does not exist. If neither VSOE nor TPE of selling price exists for a deliverable, Ciena uses its best estimate of selling price ("BESP") for that deliverable. For multiple element software arrangements where VSOE of undelivered maintenance does not exist, revenue for the entire arrangement is recognized over the maintenance term.

VSOE, when determinable, is established based on Ciena's pricing and discounting practices for the specific product or service when sold separately. In determining whether VSOE exists, Ciena requires that a substantial majority of the selling prices for a product or service fall within a reasonably narrow pricing range. Ciena has been unable to establish TPE of selling price because its go-to-market strategy differs from that of others in its markets, and the extent of customization and differentiated features and functions varies among comparable products or services from its peers. Ciena determines BESP based upon management-approved pricing guidelines, which consider multiple factors including the type of product or service, gross margin objectives, competitive and market conditions, and the go-to-market strategy, all of which can affect pricing practices.

9




Warranty Accruals

Ciena provides for the estimated costs to fulfill customer warranty obligations upon recognition of the related revenue. Estimated warranty costs include estimates for material costs, technical support labor costs and associated overhead. Warranty is included in cost of goods sold and is 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 the product by the customer after the product has been accepted.

Accounts Receivable, Net

Ciena's allowance for doubtful accounts 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 them. In determining the appropriate balance for Ciena's allowance for doubtful accounts, management considers each individual customer account receivable in order to determine collectibility. In doing so, management considers creditworthiness, payment history, account activity and communication with the customer. If a customer's financial condition changes, Ciena may be required to record an allowance for doubtful accounts for that customer, which could negatively affect its results of operations.

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, cost of prototype equipment, consulting and third party services, depreciation, facility costs and information technology.

Government Grants

Ciena accounts for proceeds from government grants as a reduction of operating expense when there is reasonable assurance that Ciena has complied with the conditions attached to the grant and that the grant proceeds will be received. Grant benefits are recorded to the line item in the Condensed Consolidated Statement of Operations to which the grant activity relates. See Note 20 below.

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

Ciena measures and recognizes compensation expense for share-based awards based on estimated fair values on the date of grant. 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 variables, including expected stock price volatility over the expected term of the award and projected employee stock option exercise behaviors. Ciena estimates the fair value of each restricted stock unit award based on the fair value of the underlying common stock on the date of grant. In each case, Ciena only recognizes expense in its Condensed Consolidated Statement of Operations for those stock options or restricted stock units that are expected ultimately to vest. Ciena recognizes the estimated fair value of performance-based awards, net of estimated forfeitures, as share-based expense over the performance period, using graded vesting, which considers each performance period or tranche separately, 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 targets and the performance period required to meet those targets and the expense is adjusted accordingly. Ciena uses the straight-line method to record expense for share-based awards with only service-based vesting. See Note 18 below.

Income Taxes

Ciena accounts for income taxes using an asset and liability approach that recognizes deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the carrying amounts of assets and liabilities for

10



financial reporting purposes and their respective tax bases, and for operating loss and tax credit carryforwards. In estimating future tax consequences, Ciena 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.

In the ordinary course of business, transactions occur for which the ultimate outcome may be uncertain. In addition, tax authorities periodically audit Ciena's income tax returns. These audits examine significant tax filing positions, including the timing and amounts of deductions and the allocation of income tax expenses among tax jurisdictions. Ciena is currently under audit in India for 2008 through 2013 and in Canada for 2010 through 2012. Management does not expect the outcome of these audits to have a material adverse effect on Ciena's consolidated financial position, results of operations or cash flows. Ciena's major tax jurisdictions and the earliest open tax years are as follows: United States (2012), United Kingdom (2012), Canada (2010) and India (2008). Limited adjustments can be made to Federal U.S. tax returns in earlier years in order to reduce net operating loss carryforwards. Ciena classifies interest and penalties related to uncertain tax positions as a component of income tax expense.

Ciena has not provided for U.S. deferred income taxes on the cumulative unremitted earnings of its non-U.S. affiliates, as it plans to indefinitely 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 expansion requirements.

Ciena recognizes windfall tax benefits associated with the exercise of stock options or release of restricted stock units directly to stockholders' equity only when realized. A windfall tax benefit occurs when the actual tax benefit realized by Ciena upon an employee's disposition of a share-based award exceeds the deferred tax asset, if any, associated with the award that Ciena had recorded. When assessing whether a tax benefit relating to share-based compensation has been realized, Ciena follows the “with-and-without” method. Under the with-and-without method, the windfall is considered realized and recognized for financial statement purposes only when an incremental benefit is provided after considering all other tax benefits including Ciena's net operating losses. The with-and-without method results in the windfall from share-based compensation awards always being effectively the last tax benefit to be considered. Consequently, the windfall attributable to share-based compensation will not be considered realized in instances where Ciena's net operating loss carryover (that is unrelated to windfalls) is sufficient to offset the current year's taxable income before considering the effects of current-year windfalls.

Loss Contingencies

Ciena is subject to the possibility of various losses arising in the ordinary course of business. These may relate to disputes, 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 contingency 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 in order to determine whether any accruals should be adjusted and whether new accruals are required.

Fair Value of Financial Instruments

The carrying value of Ciena's cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximates fair market value due to the relatively short period of time to maturity. For information related to the fair value of Ciena's convertible notes and Term Loan, see Note 15 below.

Fair value for the measurement of financial assets and liabilities is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. Ciena utilizes a valuation hierarchy for disclosure of the inputs for fair value measurement. This hierarchy prioritizes the inputs into three broad levels as follows:

Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities;

Level 2 inputs are quoted prices for identical or similar assets or liabilities in less active markets or model-derived valuations in which significant inputs are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument; and


11



Level 3 inputs are unobservable inputs based on Ciena's assumptions used to measure assets and liabilities at fair value.

By distinguishing between inputs that are observable in the marketplace, and therefore more objective, and those that are unobservable and therefore more subjective, the hierarchy is designed to indicate the relative reliability of the fair value measurements. A financial asset's or liability's classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

Restructuring

From time to time, Ciena takes actions to better align its workforce, facilities and operating costs with perceived market opportunities, business strategies and changes in market and business conditions. Ciena recognizes a liability for the cost associated with an exit or disposal activity in the period in which the liability is incurred, except for one-time employee termination benefits related to a service period, typically of more than 60 days, which are accrued over the service period. See Note 3 below.

Foreign Currency

Certain of Ciena's foreign branch offices and subsidiaries use the U.S. dollar as their functional currency because Ciena Corporation, as the U.S. parent entity, exclusively funds the operations of these branch offices and subsidiaries. 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 monetary assets and liabilities are transacted in a currency other than the entity's functional currency, re-measurement adjustments are recorded in interest and other income (loss), net on the Condensed Consolidated Statement of Operations. See Note 4 below.

Derivatives

Ciena's 4.0% convertible senior notes due March 15, 2015 (the "2015 Notes") matured during the second quarter of fiscal 2015. The 2015 Notes included a redemption feature accounted for as a separate embedded derivative which expired when the 2015 notes matured. Until maturity of the 2015 Notes, the embedded redemption feature was recorded at fair value on a recurring basis, and these changes were included in interest and other income (loss), net on the Condensed Consolidated Statement of Operations. See Note 4 below.

From time to time, Ciena uses foreign currency forward contracts to reduce variability in certain forecasted non-U.S. dollar denominated cash flows. Generally, these derivatives have maturities of 15 months or less. During fiscal 2014, Ciena also entered into interest rate hedge arrangements to reduce variability in certain forecasted interest expense associated with its Term Loan. All of these derivatives are designated as cash flow hedges. At the inception of the cash flow hedge, and on an ongoing basis, Ciena assesses whether the derivative has been effective in offsetting changes in cash flows attributable to the hedged risk during the hedging period. The effective portion of the derivative's net gain or loss is initially reported as a component of accumulated other comprehensive income (loss), and, upon occurrence of the forecasted transaction, is subsequently reclassified to the line item in the Condensed Consolidated Statement of Operations to which the hedged transaction relates. Any net gain or loss associated with the ineffectiveness of the hedging instrument is reported in interest and other income (loss), net. To date, no ineffectiveness has occurred.

From time to time, Ciena uses foreign currency forward contracts to hedge certain balance sheet exposures. These forward contracts are not designated as hedges for accounting purposes, and any net gain or loss associated with these derivatives is reported in interest and other income (loss), net on the Condensed Consolidated Statement of Operations.

Ciena records derivative instruments in the Condensed Consolidated Statements of Cash Flows within operating, investing, or financing activities consistent with the cash flows of the hedged items.

See Notes 6 and 13 below.

Computation of Net Income (Loss) per Share

Ciena calculates basic earnings per share ("EPS") by dividing earnings attributable to common stock by the weighted average number of common shares outstanding for the period. Diluted EPS includes other potential dilutive shares that would be outstanding if securities or other contracts to issue common stock were exercised or converted into common stock. Ciena

12



uses a dual presentation of basic and diluted EPS on the face of its income statement. A reconciliation of the numerator and denominator used for the basic and diluted EPS computations is set forth in Note 17 below.

Software Development Costs

Ciena develops software for sale to its customers. GAAP requires the capitalization of certain software development costs that are 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 life of the product. Ciena defines technological feasibility as being attained at the time a working model is completed. To date, the period between Ciena achieving technological feasibility and the general availability 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.

Newly Issued Accounting Standards - Not Yet Effective

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which provides guidance for revenue recognition. This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets. This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts.  In August 2015, the FASB issued an amendment to defer the effective date by one year and allow entities to early adopt no earlier than the original effective date. Based on this amendment, the standard will be effective for Ciena beginning in the first quarter of fiscal 2019. Ciena is currently evaluating the impact of the adoption of this ASU on its Consolidated Financial Statements and disclosures.

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern. ASU 2014-15 requires management to evaluate and provide related disclosures, at each annual or interim reporting period, whether there are conditions or events that exist that raise substantial doubt about an entity's ability to continue as a going concern within one year after the date the financial statements are issued. The standard will be effective for Ciena beginning in the first quarter of fiscal 2018. The adoption of this accounting standard update is not expected to have a material effect on Ciena's Consolidated Financial Statements and disclosures.

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying value of that debt liability, consistent with debt discounts. The guidance is effective retrospectively for fiscal years, and interim periods within those years, and will be effective for Ciena beginning in the first quarter of fiscal 2017. Early adoption is permitted for financial statements that have not been previously issued. Ciena does not expect the impact of adopting this guidance will be material to the its consolidated financial statements and related disclosures.


(3)
RESTRUCTURING COSTS
Ciena has undertaken a number of restructuring activities intended to reduce expense and better align its workforce and costs with market opportunities, product development and business strategies. The following table sets forth the restructuring activity and balance of the restructuring liability accounts for the nine months ended July 31, 2015 (in thousands):

 
Workforce
reduction
 
Consolidation
of excess
facilities
 
Total
Balance at October 31, 2014
$
181

 
$
1,134

 
$
1,315

Additional liability recorded
8,260

(a)

 
8,260

Cash payments
(7,748
)
 
(370
)
 
(8,118
)
Balance at July 31, 2015
$
693

 
$
764

 
$
1,457

Current restructuring liabilities
$
693

 
$
396

 
$
1,089

Non-current restructuring liabilities
$

 
$
368

 
$
368


(a) During the fiscal quarter ended January 31, 2015, Ciena recorded a charge of $8.1 million of severance and other employee-related costs associated with a global workforce reduction of approximately 125 employees.

13




The following table sets forth the restructuring activity and balance of the restructuring liability accounts for the nine months ended July 31, 2014 (in thousands):

 
Workforce
reduction
 
Consolidation
of excess
facilities
 
Total
Balance at October 31, 2013
$
80

 
$
1,936

 
$
2,016

Additional liability recorded
169

 
9

 
178

Cash payments
(208
)
 
(269
)
 
(477
)
Balance at July 31, 2014
$
41

 
$
1,676

 
$
1,717

Current restructuring liabilities
$
41

 
$
612

 
$
653

Non-current restructuring liabilities
$

 
$
1,064

 
$
1,064



(4) INTEREST AND OTHER INCOME (LOSS), NET
The components of interest and other income (loss), net, are as follows (in thousands):
 
Quarter Ended July 31,
 
Nine Months Ended July 31,
 
2014
 
2015
 
2014
 
2015
Interest income
$
88

 
$
323

 
$
235

 
$
788

Change in fair value of embedded derivative
(190
)
 

 
(2,740
)
 

Gain (loss) on non-hedge designated foreign currency forward contracts
(1,484
)
 
4,924

 
(11,677
)
 
14,925

Foreign currency exchange gain (loss)
(4,341
)
 
(10,424
)
 
993

 
(32,910
)
Other
(401
)
 
(314
)
 
(1,042
)
 
(2,076
)
Interest and other income (loss), net
$
(6,328
)
 
$
(5,491
)
 
$
(14,231
)
 
$
(19,273
)


(5)
SHORT-TERM AND LONG-TERM INVESTMENTS

As of the dates indicated, investments are comprised of the following (in thousands):

 
July 31, 2015
 
Amortized Cost
 
Gross Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated Fair
Value
U.S. government obligations:
 
 
 
 
 
 
 
Included in short-term investments
$
105,041

 
$
44

 

 
$
105,085

Included in long-term investments
70,149

 
12

 

 
70,161

 
$
175,190

 
$
56

 
$

 
$
175,246

 
 
 
 
 
 
 
 
Commercial paper:
 
 
 
 
 
 
 
Included in short-term investments
54,982

 

 

 
54,982

 
$
54,982

 
$

 
$

 
$
54,982



14



 
October 31, 2014
 
Amortized Cost
 
Gross Unrealized
Gains
 
Gross Unrealized
Losses
 
Estimated Fair
Value
U.S. government obligations:
 
 
 
 
 
 
 
Included in short-term investments
$
110,182

 
$
29

 
$

 
$
110,211

Included in long-term investments
50,016

 
41

 

 
50,057

 
$
160,198

 
$
70

 
$

 
$
160,268

 
 
 
 
 
 
 
 
Commercial paper:
 
 
 
 
 
 
 
Included in short-term investments
29,994

 

 

 
29,994

 
$
29,994

 
$

 
$

 
$
29,994



The following table summarizes the final legal maturities of debt investments at July 31, 2015 (in thousands):

 
Amortized
Cost
 
Estimated
Fair Value
Less than one year
$
160,023

 
$
160,067

Due in 1-2 years
70,149

 
70,161

 
$
230,172

 
$
230,228


(6)
FAIR VALUE MEASUREMENTS

As of the date indicated, the following table summarizes the assets and liabilities that are recorded at fair value on a recurring basis (in thousands):
 
July 31, 2015
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds
$
538,895

 
$

 
$

 
$
538,895

U.S. government obligations

 
175,246

 

 
175,246

Commercial paper

 
99,980

 

 
99,980

Foreign currency forward contracts

 
5,837

 

 
5,837

Total assets measured at fair value
$
538,895

 
$
281,063

 
$

 
$
819,958

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Foreign currency forward contracts
$

 
$
1,941

 
$

 
$
1,941

Forward starting interest rate swap

 
4,968

 

 
4,968

Total liabilities measured at fair value
$


$
6,909

 
$

 
$
6,909



15



 
October 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds
$
440,013

 
$

 
$

 
$
440,013

U.S. government obligations

 
160,268

 

 
160,268

Commercial paper

 
89,989

 

 
89,989

Foreign currency forward contracts

 
1,561

 

 
1,561

Total assets measured at fair value
$
440,013

 
$
251,818

 
$

 
$
691,831

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Foreign currency forward contracts
$

 
$
200

 
$

 
$
200

Forward starting interest rate swap

 
2,083

 

 
2,083

Total liabilities measured at fair value
$

 
$
2,283

 
$

 
$
2,283


As of the date indicated, the assets and liabilities above are presented on Ciena’s Condensed Consolidated Balance Sheet as follows (in thousands):

 
July 31, 2015
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
538,895

 
$
44,998

 
$

 
$
583,893

Short-term investments

 
160,067

 

 
160,067

Prepaid expenses and other

 
5,837

 

 
5,837

Long-term investments

 
70,161

 

 
70,161

Total assets measured at fair value
$
538,895

 
$
281,063

 
$

 
$
819,958

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Accrued liabilities
$

 
$
1,941

 
$

 
$
1,941

Other long-term obligations

 
4,968

 

 
4,968

Total liabilities measured at fair value
$


$
6,909

 
$

 
$
6,909


 
October 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Cash equivalents
$
440,013

 
$
59,995

 
$

 
$
500,008

Short-term investments

 
140,205

 

 
140,205

Prepaid expenses and other

 
1,561

 

 
1,561

Long-term investments

 
50,057

 

 
50,057

Total assets measured at fair value
$
440,013

 
$
251,818

 
$

 
$
691,831

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Accrued liabilities
$

 
$
200

 
$

 
$
200

Other long-term obligations

 
2,083

 

 
2,083

Total liabilities measured at fair value
$

 
$
2,283

 
$

 
$
2,283



(7)
 ACCOUNTS RECEIVABLE

16




As of October 31, 2014 and July 31, 2015, there were no individual customers that accounted for greater than 10% of net accounts receivable. Ciena has not historically experienced a significant amount of bad debt expense. Allowance for doubtful accounts was $2.1 million and $2.3 million as of October 31, 2014 and July 31, 2015, respectively.

(8)
INVENTORIES
As of the dates indicated, inventories are comprised of the following (in thousands):
 
October 31,
2014
 
July 31,
2015
Raw materials
$
64,853

 
$
54,112

Work-in-process
8,371

 
8,924

Finished goods
165,799

 
119,635

Deferred cost of goods sold
75,763

 
59,606

 
314,786

 
242,277

Provision for excess and obsolescence
(60,126
)
 
(48,260
)
 
$
254,660

 
$
194,017


Ciena writes down its inventory for estimated obsolescence or unmarketable inventory by an amount equal to the difference between the cost of inventory and the estimated net realizable value based on assumptions about future demand and market conditions. During the first nine months of fiscal 2015, Ciena recorded a provision for excess and obsolescence of $18.0 million, primarily related to the discontinuance of certain parts and components used in the manufacture of its Converged Packet Optical products and a decrease in the forecasted demand for both its legacy, stand-alone WDM and SONET/SDH-based transport platforms and its 5410 Service Aggregation Switch. Deductions from the provision for excess and obsolete inventory relate primarily to disposal activities.

(9)
PREPAID EXPENSES AND OTHER
As of the dates indicated, prepaid expenses and other are comprised of the following (in thousands):

 
October 31,
2014
 
July 31,
2015
Prepaid VAT and other taxes
$
86,464

 
$
86,113

Product demonstration equipment, net
42,385

 
42,469

Deferred deployment expense
27,991

 
24,238

Prepaid expenses
23,539

 
23,095

Other non-trade receivables
10,683

 
3,388

Derivative assets
1,562

 
5,837

 
$
192,624

 
$
185,140


Depreciation of product demonstration equipment was $6.7 million and $7.3 million for the first nine months of fiscal 2014 and 2015, respectively.

(10)
EQUIPMENT, BUILDING, FURNITURE AND FIXTURES
As of the dates indicated, equipment, building, furniture and fixtures are comprised of the following (in thousands):


17



 
October 31,
2014
 
July 31,
2015
Equipment, furniture and fixtures
$
383,059

 
$
382,850

Building subject to capital lease

 
13,939

Construction in progress subject to build-to-suit lease

 
8,770

Leasehold improvements
46,354

 
47,020

 
429,413

 
452,579

Accumulated depreciation and amortization
(302,781
)
 
(292,987
)
 
$
126,632

 
$
159,592

On October 23, 2014, Ciena entered into a lease agreement to lease an office building located in Ottawa, Canada. During the second quarter of fiscal 2015, Ciena gained access to a portion of the building and recorded a capital lease asset and liability.
Ciena capitalizes construction in progress and record a corresponding long-term liability for build-to-suit lease agreements where Ciena is considered the owner, for accounting purposes, during the construction period. On April 15, 2015, Ciena entered into a build-to-suit lease arrangement pursuant to which the landlord will construct, and Ciena will subsequently lease two new office buildings at its new Ottawa, Canada campus. The landlord will construct the buildings and contribute up to a maximum of CAD$290.00 per rentable square foot in total construction costs plus certain allowances for tenant improvements, and Ciena will be responsible for any additional construction costs. As of July 31, 2015, there were $8.8 million in costs incurred under this build-to-suit lease arrangement. Upon occupancy of the facilities, Ciena expects this arrangement to qualify as a capital lease. As a result, the facilities will be depreciated over the shorter of their useful life or the lease term.
  
The total of depreciation of equipment, furniture and fixtures, and amortization of leasehold improvements, was $34.8 million and $34.3 million for the first nine months of fiscal 2014 and 2015, respectively.

(11)
 OTHER INTANGIBLE ASSETS
As of the dates indicated, other intangible assets are comprised of the following (in thousands):
 
October 31, 2014
 
July 31, 2015
 
Gross
Intangible
 
Accumulated
Amortization
 
Net
Intangible
 
Gross
Intangible
 
Accumulated
Amortization
 
Net
Intangible
Developed technology
$
417,833

 
$
(351,929
)
 
$
65,904

 
$
417,833

 
$
(372,178
)
 
$
45,655

Patents and licenses
46,538

 
(45,908
)
 
630

 
46,538

 
(46,031
)
 
507

Customer relationships, covenants not to compete, outstanding purchase orders and contracts
323,573

 
(261,430
)
 
62,143

 
323,573

 
(280,716
)
 
42,857

Total other intangible assets
$
787,944

 
$
(659,267
)
 
$
128,677

 
$
787,944

 
$
(698,925
)
 
$
89,019


The amortization of finite-lived other intangible assets was $43.9 million and $39.7 million for the first nine months of fiscal 2014 and 2015, respectively. Expected future amortization of finite-lived other intangible assets for the fiscal years indicated is as follows (in thousands):

Period ended October 31,
 
2015 (remaining three months)
$
13,220

2016
52,879

2017
22,783

2018
137

 
$
89,019


(12)
OTHER BALANCE SHEET DETAILS
As of the dates indicated, other long-term assets are comprised of the following (in thousands):


18



 
October 31,
2014
 
July 31,
2015
Maintenance spares, net
$
54,101

 
$
58,959

Deferred debt issuance costs, net
15,160

 
11,889

Other
4,815

 
7,499

 
$
74,076

 
$
78,347


Deferred debt issuance costs relate to Ciena's convertible notes payable (described in Note 15 below), Term Loan (described in Note 15 below) and our ABL Credit Facility (described in Note 16 below). Deferred debt issuance costs are amortized using the straight-line method, which approximates the effect of the effective interest rate method, through the maturity of the related debt. The amortization of deferred debt issuance costs is included in interest expense, and was $3.6 million and $3.6 million during the first nine months of fiscal 2014 and fiscal 2015, respectively.
As of the dates indicated, accrued liabilities and other short-term obligations are comprised of the following (in thousands):
 
October 31,
2014
 
July 31,
2015
Compensation, payroll related tax and benefits
82,207

 
79,794

Warranty
55,997

 
53,834

Vacation
35,126

 
31,990

Capital lease obligations
7,788

 
6,319

Interest payable
6,409

 
5,817

Other
89,081

 
94,937

 
$
276,608

 
$
272,691


The following table summarizes the activity in Ciena’s accrued warranty for the fiscal periods indicated (in thousands):

Nine months ended
Beginning
 
 
 
 
 
Ending
July 31,
Balance
 
Provisions
 
Settlements
 
Balance
2014
$
56,303

 
18,720

 
(17,581
)
 
$
57,442

2015
$
55,997

 
12,549

 
(14,712
)
 
$
53,834

The decrease in the first nine months of fiscal 2015 warranty provision compared to the first nine months of fiscal 2014 was due to lower failure rates and reduced component and labor repair costs.
As of the dates indicated, deferred revenue is comprised of the following (in thousands):

 
October 31,
2014
 
July 31,
2015
Products
$
50,457

 
$
56,355

Services
95,161

 
112,278

 
145,618

 
168,633

Less current portion
(104,688
)
 
(114,902
)
Long-term deferred revenue
$
40,930

 
$
53,731


As of the dates indicated, other long-term obligations are comprised of the following (in thousands):


19



 
October 31, 2014
 
July 31,
2015
Income tax liability
$
14,342

 
$
13,810

Deferred tenant allowance
10,839

 
10,057

Straight-line rent
5,174

 
5,801

Capital lease obligations
4,589

 
13,977

Construction liability

 
8,770

Forward starting interest rate swap
2,083

 
4,968

Other
8,363

 
6,099

 
$
45,390

 
$
63,482

 
Ciena capitalizes construction in progress and records a corresponding long-term liability for build-to-suit lease agreements where Ciena is considered the owner during the construction period for accounting purposes. 

The following is a schedule by fiscal years of future minimum lease payments under capital leases and the present value of minimum lease payments as of July 31, 2015 (in thousands):

Period ended October 31,
 
2015 (remaining three months)
$
1,934

2016
6,055

2017
1,628

2018
1,290

2019
1,290

Thereafter
19,808

Net minimum capital lease payments
32,005

Less: Amount representing interest
(11,709
)
Present value of minimum lease payments
20,296

Less: Current portion of present value of minimum lease payments
(6,319
)
Long-term portion of present value of minimum lease payments
$
13,977



(13)
DERIVATIVE INSTRUMENTS

Foreign Currency Derivatives       

As of July 31, 2015 and October 31, 2014, Ciena had forward contracts in place to reduce the variability in its Canadian Dollar and Indian Rupee denominated expense, which principally related to its research and development activities. The notional amount of these contracts was approximately $31.8 million and $51.5 million as of July 31, 2015 and October 31, 2014, respectively. These foreign exchange contracts have maturities of 15 months or less and have been designated as cash flow hedges.

During the first nine months of fiscal 2015 and fiscal 2014, in order to hedge certain balance sheet exposures, Ciena entered into forward contracts to sell Brazilian Real and buy an equivalent U.S. Dollar amount. During the first nine months of fiscal 2015 and fiscal 2014, in order to hedge certain balance sheet exposures, Ciena entered into forward contracts to sell U.S. Dollars and buy an equivalent amount of Canadian Dollars. The notional amount of these contracts was approximately $182.6 million and $194.5 million as of July 31, 2015 and October 31, 2014, respectively. These foreign exchange contracts have maturities of 12 months or less and have not been designated as hedges for accounting purposes.

Interest Rate Derivatives

During fiscal 2014, Ciena entered into interest rate cap arrangements to limit interest paid under the Term Loan to a maximum of 0.75% plus a spread of 300 basis points through July 2015. The total notional amount of interest rate caps

20



outstanding as of October 31, 2014 was $249.4 million. The interest rate caps expired in July 2015. Also in fiscal 2014, Ciena entered into floating interest rate to fixed interest rate swap arrangements ("interest rate swap") that fix the interest rate under the Term Loan at 5.004% for the period commencing on July 20, 2015 through July 19, 2018. The total notional amount of these derivatives as of July 31, 2015 and October 31, 2014 was $247.5 million.

Ciena expects the variable rate payments to be received under the terms of the interest rate swap to exactly offset the forecasted variable rate payments on the equivalent notional amounts of the Term Loan. These derivative contracts have been designated as cash flow hedges.

Other information regarding Ciena's derivatives is immaterial for separate financial statement presentation. See Note 4 and Note 6 above.

(14) ACCUMULATED OTHER COMPREHENSIVE INCOME

The following table summarizes the changes in accumulated balances of other comprehensive income (loss) for the nine months ending July 31, 2015:
 
Unrealized
 
Unrealized
 
Unrealized
 
Cumulative
 
 
 
Gain/(Loss) on
 
Gain/(Loss) on
 
Gain/(Loss) on Forward
 
Foreign Currency
 
 
 
Marketable Securities
 
Foreign Currency Contracts
 
Starting Interest Rate Swap
 
Translation Adjustment
 
Total
Balance at October 31, 2014
$
71

 
$
(173
)
 
$
(2,083
)
 
$
(12,483
)
 
$
(14,668
)
Other comprehensive income (loss) before reclassifications
(37
)
 
(5,451
)
 
(2,885
)
 
(6,919
)
 
(15,292
)
Amounts reclassified from AOCI

 
3,825

 

 

 
3,825

Balance at July 31, 2015
$
34

 
$
(1,799
)
 
$
(4,968
)
 
$
(19,402
)
 
$
(26,135
)

The following table summarizes the changes in accumulated balances of other comprehensive income (loss) for the nine months ending July 31, 2014:

 
Unrealized
 
Unrealized
 
Cumulative
 
 
 
Gain/(Loss)
on
 
Gain/(Loss)
on
 
Foreign Currency
 
 
 
Marketable Securities
 
Derivative Instruments
 
Translation Adjustment
 
Total
Balance at October 31, 2013
$
30

 
$
(261
)
 
$
(7,543
)
 
$
(7,774
)
Other comprehensive income (loss) before reclassifications
(12
)
 
(862
)
 
(4,287
)
 
(5,161
)
Amounts reclassified from AOCI

 
896

 

 
896

Balance at July 31, 2014
$
18

 
$
(227
)
 
$
(11,830
)
 
$
(12,039
)

All amounts reclassified from accumulated other comprehensive income were related to settlement (gains)/losses on foreign currency forward contracts designated as cash flow hedges. These reclassifications impacted "research and development" on the Condensed Consolidated Statements of Operations.


(15)
 SHORT-TERM AND LONG-TERM DEBT

Term Loan

On July 15, 2014, Ciena entered into a Credit Agreement providing for senior secured term loans in an aggregate principal amount of $250 million (the “Term Loan”) with a maturity date of July 15, 2019. The Term Loan requires Ciena to make installment payments of approximately $0.6 million on a quarterly basis. The principal balance, unamortized discount and net carrying amount of the Term Loan were as follows as of July 31, 2015 (in thousands):

21



 
 
Principal Balance
 
Unamortized Discount
 
Net Carrying Amount
Term Loan Payable due July 15, 2019
 
$
247,500

 
$
1,149

 
$
246,351


The following table sets forth, in thousands, the carrying value and the estimated fair value of the Term Loan:
 
 
July 31, 2015
 
 
Carrying Value
 
Fair Value(2)
Term Loan Payable due July 15, 2019(1)
 
$
246,351

 
$
248,428


(1)
Includes unamortized bond discount.
(2)
The Term Loan is categorized as Level 2 in the fair value hierarchy. Ciena estimated the fair value of its Term Loan using a market approach based upon observable inputs, such as current market transactions involving comparable securities.

Maturity of 2015 Convertible Notes

On March 15, 2015, Ciena's outstanding 4.0% Convertible Senior Notes due 2015 (the “2015 Notes”) matured. As a result of conversion elections made by holders of a substantial majority of the outstanding 2015 Notes under the terms of the indenture, together with certain private exchange transactions conducted by Ciena prior to maturity, approximately $180.6 million in aggregate principal amount of 2015 Notes, representing 96.3% of the outstanding aggregate principal amount of 2015 Notes, was settled through the issuance of Ciena common stock at or prior to maturity. In total, Ciena issued approximately 8.9 million shares of Ciena common stock as a result of the conversion elections and private exchange transactions in respect of the 2015 Notes. Ciena repaid in cash approximately $6.9 million in aggregate principal amount of 2015 Notes at maturity.

Outstanding Convertible Notes Payable

The principal balance, unamortized discount and net carrying amount of the liability and equity components of Ciena's 4.0% convertible senior notes due December 15, 2020 are as follows as of July 31, 2015:
 
Liability Component
 
Equity Component
 
Principal Balance
 
Unamortized Discount
 
Net Carrying Amount
 
Net Carrying Amount
4.0% Convertible Senior Notes due December 15, 2020
$
196,679

 
$
13,769

 
$
182,910

 
$
43,131


The following table sets forth, in thousands, the carrying value and the estimated fair value of Ciena’s outstanding convertible notes:
 
 
July 31, 2015
 
 
Carrying Value
 
Fair Value(1)
0.875% Convertible Senior Notes due June 15, 2017
 
500,000

 
507,813

3.75% Convertible Senior Notes due October 15, 2018
 
350,000

 
498,750

4.0% Convertible Senior Notes due December 15, 2020 (2)
 
182,910

 
274,116

 
 
$
1,032,910

 
$
1,280,679



(1)
The convertible notes are categorized as Level 2 in the fair value hierarchy. Ciena estimated the fair value of its outstanding convertible notes using a market approach based upon observable inputs, such as current market transactions involving comparable securities.
(2)
Includes unamortized discount and accretion of principal.


(16)
ABL CREDIT FACILITY

22



Ciena Corporation and certain of its subsidiaries are parties to a senior secured asset-based revolving credit facility (the “ABL Credit Facility”) providing for a total commitment of $200 million with a maturity date of December 31, 2016. Ciena principally uses the ABL Credit Facility to support the issuance of letters of credit that arise in the ordinary course of its business and thereby to reduce its use of cash required to collateralize these instruments. As of July 31, 2015, letters of credit totaling $54.3 million were collateralized by the ABL Credit Facility. There were no borrowings outstanding under the ABL Credit Facility as of July 31, 2015.
(17)
 EARNINGS (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 potential common share (“Diluted EPS”). Basic EPS is computed using the weighted average number of common shares outstanding. Diluted EPS is computed using the weighted average number of the following, in each case, to the extent the effect is not anti-dilutive: (i) common shares outstanding, (ii) shares issuable upon vesting of restricted stock units, (iii) shares issuable under Ciena’s employee stock purchase plan and upon exercise of outstanding stock options, using the treasury stock method, and (iv) shares underlying Ciena’s outstanding convertible notes.

 
Quarter Ended July 31,
 
Nine Months Ended July 31,
Numerator
2014
 
2015
 
2014
 
2015
Net income (loss)
$
16,160

 
$
23,625

 
$
(9,934
)
 
$
25,499

Add: Interest expense associated with 0.875% convertible senior notes due 2017
1,384

 
1,384

 
$

 

Net income (loss) used to calculate Diluted EPS
$
17,544

 
$
25,009

 
$
(9,934
)
 
$
25,499


 
Quarter Ended July 31,
 
Nine Months Ended July 31,
Denominator
2014
 
2015
 
2014
 
2015
Basic weighted average shares outstanding
106,236

 
118,413

 
105,404

 
113,189

Add: Shares underlying outstanding stock options, employee stock purchase plan and restricted stock units
1,465

 
1,712

 

 
1,360

Add: Shares underlying 0.875% convertible senior notes due 2017
13,108

 
13,108

 

 

Dilutive weighted average shares outstanding
120,809

 
133,233

 
105,404

 
114,549


 
Quarter Ended July 31,
 
Nine Months Ended July 31,
EPS
2014
 
2015
 
2014
 
2015
Basic EPS
$
0.15

 
$
0.20

 
$
(0.09
)
 
$
0.23

Diluted EPS
$
0.15

 
$
0.19

 
$
(0.09
)
 
$
0.22


The following table summarizes the weighted average shares excluded from the calculation of the denominator for Diluted EPS due to their anti-dilutive effect for the periods indicated (in thousands):
 
Quarter Ended July 31,
 
Nine Months Ended July 31,
 
2014
 
2015
 
2014
 
2015
Shares underlying stock options and restricted stock units
1,123

 
755

 
3,205

 
1,534

4.0% Convertible Senior Notes due March 15, 2015
9,198

 

 
9,198

 
4,515

0.875% Convertible Senior Notes due June 15, 2017

 

 
13,108

 
13,108

3.75% Convertible Senior Notes due October 15, 2018
17,356

 
17,356

 
17,356

 
17,356

4.0% Convertible Senior Notes due December 15, 2020
9,198

 
9,198

 
9,198

 
9,198

Total shares excluded due to anti-dilutive effect
36,875


27,309

 
52,065

 
45,711


(18)
SHARE-BASED COMPENSATION EXPENSE

23



Ciena grants equity awards under its 2008 Omnibus Incentive Plan (the "2008 Plan") and makes shares of its common stock available for purchase under its Amended and Restated Employee Stock Purchase Plan (the “ESPP”). These plans were approved by stockholders and are described in Ciena’s Annual Report on Form 10-K for the fiscal year ended October 31, 2014.
2008 Omnibus Incentive Plan
The 2008 Plan authorizes the issuance of awards including stock options, restricted stock units (RSUs), restricted stock, unrestricted stock, stock appreciation rights (SARs) and other equity and/or cash performance incentive awards to employees, directors and consultants of Ciena. Subject to certain restrictions, the Compensation Committee of the Board of Directors has broad discretion to establish the terms and conditions for awards under the 2008 Plan, including the number of shares, vesting conditions, and the required service or performance criteria. Options and SARs have a maximum term of ten years, and their exercise price may not be less than 100% of fair market value on the date of grant. Repricing of stock options and SARs is prohibited without stockholder approval. Certain change in control transactions may cause awards granted under the 2008 Plan to vest, unless the awards are continued or substituted for in connection with the transaction. The total number of shares authorized for issuance under the 2008 Plan is 25.1 million shares. As of July 31, 2015, approximately 6.1 million shares remained available for issuance under the 2008 Plan.
     Stock Options
Outstanding stock option awards to employees are generally subject to service-based vesting conditions and vest incrementally over a four-year period. As of July 31, 2015, all outstanding options have completed their service-based vesting conditions and are fully vested. The following table is a summary of Ciena’s stock option activity for the period indicated (shares in thousands):

 
Shares Underlying
Options
Outstanding
 
Weighted
Average
Exercise Price
Balance at October 31, 2014
1,288

 
$
25.43

Exercised
(255
)
 
15.27

Canceled
(104
)
 
25.66

Balance at July 31, 2015
929

 
$
28.19


The total intrinsic value of options exercised during the first nine months of fiscal 2014 and fiscal 2015 was $1.0 million and $1.8 million, respectively. Ciena did not grant any stock options during the first nine months of fiscal 2014 or fiscal 2015.
The following table summarizes information with respect to stock options outstanding at July 31, 2015, based on Ciena’s closing stock price on the last trading day of Ciena’s third fiscal quarter of 2015 (shares and intrinsic value in thousands):

 
 
 
 
 
 
Options Outstanding and Vested at
 
 
 
 
 
 
July 31, 2015
 
 
 
 
 
 
Number
 
Weighted
Average
Remaining
 
Weighted
 
 
Range of
 
of
 
Contractual
 
Average
 
Aggregate
Exercise
 
Underlying
 
Life
 
Exercise
 
Intrinsic
Price
 
Shares
 
(Years)
 
Price
 
Value
$
0.94

 

 
$
16.31

 
93

 
2.99
 
$
6.96

 
$
1,713

$
16.52

 

 
$
17.29

 
47

 
0.62
 
16.61

 
419

$
17.43

 

 
$
24.50

 
81

 
1.15
 
19.07

 
520

$
24.69

 

 
$
28.28

 
267

 
1.63
 
27.38

 
15

$
28.61

 

 
$
32.55

 
97

 
2.07
 
29.99

 

$
33.00

 

 
$
37.10

 
244

 
2.31
 
35.25

 

$
37.31

 

 
$
47.32

 
100

 
1.96
 
44.07

 

$
0.94

 

 
$
47.32

 
929

 
1.93
 
$
28.19

 
$
2,667


     Assumptions for Option-Based Awards

24



Ciena recognizes the fair value of service-based options as share-based compensation expense on a straight-line basis over the requisite service period.
     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 three or four-year period. Awards with performance-based vesting conditions require the achievement of certain operational, financial or other performance criteria or targets as a condition of vesting, or the acceleration of vesting, of such awards. Ciena recognizes the estimated fair value of performance-based awards, net of estimated forfeitures, as share-based compensation expense over the performance period, using graded vesting, which considers each performance period or tranche separately, 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 targets and the performance period required to meet those targets.
The following table is a summary of Ciena's restricted stock unit activity for the period indicated, with the aggregate fair value of the balance outstanding at the end of each period, based on Ciena's closing stock price on the last trading day of the relevant period (shares and aggregate fair value in thousands):


 
Restricted
Stock Units
Outstanding
 
Weighted
Average Grant
Date Fair Value
Per Share
 
Aggregate
Fair Value
Balance at October 31, 2014
4,012

 
$
18.02

 
$
67,241

Granted
2,509

 
 
 
 
Vested
(1,572
)
 
 
 
 
Canceled or forfeited
(219
)
 
 
 
 
Balance at July 31, 2015
4,730

 
$
18.88

 
$
120,374


The total fair value of restricted stock units that vested and were converted into common stock during the first nine months of fiscal 2014 and fiscal 2015 was $40.4 million and $33.5 million, respectively. The weighted average fair value of each restricted stock unit granted by Ciena during the first nine months of fiscal 2014 and fiscal 2015 was $21.96 and $19.15 respectively.

     Assumptions for Restricted Stock Unit Awards

The fair value of each restricted stock unit award 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 targets 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 performance goals are not met, no compensation cost is ultimately recognized against that goal and, to the extent previously recognized, compensation expense is reversed.
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. Ciena estimates forfeitures at the time of grant and revises those estimates in subsequent periods based upon new or changed information.

Amended and Restated Employee Stock Purchase Plan (ESPP)
Under the ESPP, eligible employees may enroll in a twelve-month offer period that begins in December and June of each year. Each offer period includes two six-month purchase periods. Employees may purchase a limited number of shares of Ciena common stock at 85% of the fair market value on either the day immediately preceding the offer date or the purchase date, whichever is lower. The ESPP is considered compensatory for purposes of share-based compensation expense. Pursuant to the ESPP's “evergreen” provision, on December 31 of each year, the number of shares available under the ESPP increases by up to

25



0.6 million shares, provided that the total number of shares available at that time shall not exceed 8.2 million. Unless earlier terminated, the ESPP will terminate on January 24, 2023.
During the first nine months of fiscal 2015, Ciena issued 1.0 million shares under the ESPP. At July 31, 2015, 6.4 million shares remained available for issuance under the ESPP.

Share-Based Compensation Expense for Periods Reported

The following table summarizes share-based compensation expense for the periods indicated (in thousands):

 
Quarter Ended July 31,
 
Nine Months Ended July 31,
 
2014
 
2015
 
2014
 
2015
Product costs
$
737

 
$
671

 
$
1,984

 
$
1,811

Service costs
572

 
490

 
1,720

 
1,583

Share-based compensation expense included in cost of sales
1,309

 
1,161

 
3,704

 
3,394

Research and development
2,368

 
2,114

 
7,722

 
6,815

Sales and marketing
3,890

 
3,571

 
12,199

 
11,071

General and administrative
3,376

 
3,516

 
10,543

 
11,158

Share-based compensation expense included in operating expense
9,634

 
9,201

 
30,464

 
29,044

Share-based compensation expense capitalized in inventory, net
(182
)
 
(96
)
 
36

 
(36
)
Total share-based compensation
$
10,761

 
$
10,266

 
$
34,204

 
$
32,402


As of July 31, 2015, total unrecognized share-based compensation expense related to unvested restricted stock units was approximately $72.8 million, and this expense is expected to be recognized over a weighted-average period of 1.5 years.


26



(19)
 SEGMENTS AND ENTITY WIDE DISCLOSURES
Segment Reporting

Ciena’s internal organizational structure and the management of its business are grouped into the following operating segments:

Converged Packet Optical — includes the 6500 Packet-Optical Platform and the 5430 Reconfigurable Switching System, which feature Ciena's WaveLogic coherent optical processors. Products also include Ciena's family of CoreDirector® Multiservice Optical Switches and the OTN configuration for the 5410 Reconfigurable Switching System. This segment also includes sales of operating system software and enhanced software features embedded in each of these products. Revenue from this segment is included in product revenue on the Condensed Consolidated Statement of Operations. In May 2015, Ciena launched its new Waveserver™ product. Revenue from sales of Waveserver are included in our Converged Packet Optical segment.

Packet Networking — includes Ciena's 3000 family of service delivery switches and service aggregation switches and the 5000 family of service aggregation switches. This segment also includes Ciena’s 8700 Packetwave Platform and Ciena's Ethernet packet configuration for the 5410 Service Aggregation Switch. This segment also includes sales of operating system software and enhanced software features embedded in each of these products. Revenue from this segment is included in product revenue on the Condensed Consolidated Statement of Operations.

Optical Transport — includes the 4200 Advanced Services Platform, Corestream® Agility Optical Transport System, 5100/5200 Advanced Services Platform, Common Photonic Layer (CPL) and 6100 Multiservice Optical Platform. This segment includes sales from SONET/SDH, transport and data networking products, as well as certain enterprise-oriented transport solutions that support storage and LAN extension, interconnection of data centers, and virtual private networks. This segment also includes operating system software and enhanced software features embedded in each of these products. Revenue from this segment is included in product revenue on the Condensed Consolidated Statement of Operations.

Software and Services — includes Ciena's Agility software portfolio, which includes a SDN multilayer WAN controller, NFV platform, and network level software applications for enabling on-demand, high-bandwidth WAN services delivered in an open network ecosystem. This segment also includes the OneControl Unified Management System, ON-Center® Network & Service Management Suite, Ethernet Services Manager and Optical Suite Release. This segment includes a broad range of services for consulting and network design, installation and deployment, maintenance support and training activities. Except for revenue from the software portion of this segment, which is included in product revenue, revenue from this segment is included in services revenue on the Condensed Consolidated Statement of Operations.
    
Ciena's long-lived assets, including equipment, building, furniture and fixtures, finite-lived intangible assets and maintenance spares, are not reviewed by the chief operating decision maker for purposes of evaluating performance and allocating resources. As of July 31, 2015, equipment, building, furniture and fixtures totaling $159.6 million primarily support asset groups within Ciena's Converged Packet Optical, Packet Networking, and Software and Services segments and support Ciena's unallocated selling and general and administrative activities. As of July 31, 2015, all of Ciena's finite-lived intangible assets, totaling $89.0 million, were assigned to asset groups within Ciena's Converged Packet Optical segment. As of July 31, 2015, all of the maintenance spares, totaling $59.0 million, were assigned to asset groups within Ciena's Software and Services segment.

Segment Revenue

The table below (in thousands) sets forth Ciena’s segment revenue for the respective periods:


27



 
Quarter Ended July 31,
 
Nine Months Ended July 31,
 
2014
 
2015
 
2014
 
2015
Revenue:
 
 
 
 
 
 
 
Converged Packet Optical
$
382,031

 
$
407,970

 
$
1,072,272

 
$
1,177,441

Packet Networking
69,464

 
57,209

 
187,699

 
165,480

Optical Transport
31,016

 
17,482

 
100,729

 
56,275

Software and Services
121,051

 
120,271

 
336,626

 
354,500

Consolidated revenue
$
603,562

 
$
602,932

 
$
1,697,326

 
$
1,753,696


Segment Profit
Segment profit is determined based on internal performance measures used by the chief executive officer to assess the performance of each operating segment in a given period. In connection with that assessment, the chief executive officer excludes the following items: selling and marketing costs; general and administrative costs; acquisition and integration costs; amortization of intangible assets; restructuring costs; interest and other income (loss), net; interest expense; and provisions for income taxes.
The table below (in thousands) sets forth Ciena’s segment profit and the reconciliation to consolidated net income (loss) during the respective periods indicated:
 
Quarter Ended July 31,
 
Nine Months Ended July 31,
 
2014
 
2015
 
2014
 
2015
Segment profit:
 
 
 
 
 
 
 
Converged Packet Optical
$
104,020

&