2013.01.31 - 10Q
Table of Contents

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 January 31, 2013
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: 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.)
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 March 8, 2013
common stock, $0.01 par value
 
101,527,083


Table of Contents

CIENA CORPORATION
INDEX
FORM 10-Q
 
PAGE
NUMBER
 
 

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

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

 
Quarter Ended January 31,
 
2012
 
2013
Revenue:
 
 
 
Products
$
333,673

 
$
353,057

Services
83,012

 
100,036

Total revenue
416,685

 
453,093

Cost of goods sold:
 
 
 
Products
197,752

 
196,521

Services
51,177

 
60,777

Total cost of goods sold
248,929

 
257,298

Gross profit
167,756

 
195,795

Operating expenses:
 
 
 
Research and development
89,664

 
89,125

Selling and marketing
64,411

 
66,588

General and administrative
29,664

 
28,208

Amortization of intangible assets
13,471

 
12,453

Restructuring costs
1,722

 
5,030

Total operating expenses
198,932

 
201,404

Loss from operations
(31,176
)
 
(5,609
)
Interest and other income (loss), net
(4,887
)
 
(137
)
Interest expense
(9,570
)
 
(10,732
)
Loss on extinguishment of debt
—

 
(28,630
)
Loss before income taxes
(45,633
)
 
(45,108
)
Provision for income taxes
2,020

 
2,216

Net loss
$
(47,653
)
 
$
(47,324
)
Basic net loss per common share
$
(0.49
)
 
$
(0.47
)
Diluted net loss per potential common share
$
(0.49
)
 
$
(0.47
)
Weighted average basic common shares outstanding
98,066

 
101,204

Weighted average dilutive potential common shares outstanding
98,066

 
101,204


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



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

 
Quarter Ended January 31,
 
2012
 
2013
Net loss
$
(47,653
)
 
$
(47,324
)
Change in unrealized loss on available-for-sale securities, net of tax
(24
)
 
(44
)
Change in unrealized gain on foreign currency forward contracts, net of tax
364

 
77

Change in accumulated translation adjustments
(2,222
)
 
960

Total comprehensive loss
$
(49,535
)
 
$
(46,331
)

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



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CIENA CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
 
October 31,
2012
 
January 31,
2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
642,444

 
$
552,267

Short-term investments
50,057

 
84,918

Accounts receivable, net
345,496

 
394,785

Inventories
260,098

 
266,901

Prepaid expenses and other
117,595

 
136,002

Total current assets
1,415,690

 
1,434,873

Equipment, furniture and fixtures, net
123,580

 
122,207

Other intangible assets, net
257,137

 
239,300

Other long-term assets
84,736

 
88,792

Total assets
$
1,881,143

 
$
1,885,172

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
179,704

 
$
182,671

Accrued liabilities
209,540

 
214,918

Deferred revenue
79,516

 
79,916

Convertible notes payable
216,210

 
216,210

Total current liabilities
684,970

 
693,715

Long-term deferred revenue
27,560

 
28,562

Other long-term obligations
31,779

 
32,785

Long-term convertible notes payable
1,225,806

 
1,208,745

Total liabilities
1,970,115

 
1,963,807

Commitments and contingencies

 

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; 100,601,792 and 101,518,915 shares issued and outstanding
1,006

 
1,015

Additional paid-in capital
5,797,765

 
5,854,424

Accumulated other comprehensive income (loss)
(3,354
)
 
(2,361
)
Accumulated deficit
(5,884,389
)
 
(5,931,713
)
Total stockholders’ equity (deficit)
(88,972
)
 
(78,635
)
Total liabilities and stockholders’ equity (deficit)
$
1,881,143

 
$
1,885,172


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


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CIENA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

 
Three Months Ended January 31,
 
2012
 
2013
Cash flows from operating activities:
 
 
 
Net loss
$
(47,653
)
 
$
(47,324
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Loss on extinguishment of debt
—

 
28,630

Change in fair value of embedded redemption feature
980

 
(310
)
Depreciation of equipment, furniture and fixtures, and amortization of leasehold improvements
14,721

 
14,745

Share-based compensation costs
8,888

 
8,320

Amortization of intangible assets
19,415

 
17,838

Provision for inventory excess and obsolescence
8,224

 
3,580

Provision for warranty
7,706

 
4,029

Other
2,605

 
2,951

Changes in assets and liabilities:
 
 
 
Accounts receivable
17,078

 
(49,540
)
Inventories
(26,799
)
 
(10,383
)
Prepaid expenses and other
14,500

 
(25,785
)
Accounts payable, accruals and other obligations
15,850

 
6,121

Deferred revenue
(22,634
)
 
1,402

Net cash provided by (used in) operating activities
12,881

 
(45,726
)
Cash flows used in investing activities:
 
 
 
Payments for equipment, furniture, fixtures and intellectual property
(7,898
)
 
(12,243
)
Restricted cash
(866
)
 
627

Purchase of available for sale securities
—

 
(84,918
)
Proceeds from maturities of available for sale securities
—

 
50,000

Proceeds from sale of cost method investment
524

 
—

Net cash used in investing activities
(8,240
)
 
(46,534
)
Cash flows from financing activities:
 
 
 
Payment for debt and equity issuance costs
—

 
(3,237
)
Repayment of capital lease obligations
—

 
(676
)
Proceeds from issuance of common stock
5,669

 
5,820

Net cash provided by financing activities
5,669

 
1,907

Effect of exchange rate changes on cash and cash equivalents
(1,745
)
 
176

Net increase (decrease) in cash and cash equivalents
10,310

 
(90,353
)
Cash and cash equivalents at beginning of period
541,896

 
642,444

Cash and cash equivalents at end of period
$
550,461

 
$
552,267

Supplemental disclosure of cash flow information
 
 
 
Cash paid during the period for interest
$
2,458

 
$
4,739

Cash paid during the period for income taxes, net
$
2,823

 
$
3,259

Non-cash investing and financing activities
 
 
 
Purchase of equipment in accounts payable
$
7,409

 
$
4,215

Debt issuance costs in accrued liabilities
$
—

 
$
219

Fixed assets acquired under capital leases
$
3,078

 
$
646


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

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CIENA CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(1)
 INTERIM FINANCIAL STATEMENTS
The interim financial statements included herein for Ciena Corporation (“Ciena”) have been prepared by Ciena, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). In the opinion of management, 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 generally accepted accounting principles ("GAAP") have been condensed or omitted pursuant to such rules and regulations. The October 31, 2012 Condensed Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. 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, 2012.
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 2013 is a 52-week fiscal year. Fiscal 2012 was a 53-week fiscal year with the additional week occurring in the fourth quarter. For purposes of financial statement presentation, each fiscal year is described as having ended on October 31, and each fiscal quarter is 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 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 convertible notes payable valuations, purchase accounting, 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. 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. Ciena recognizes losses 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 its 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. All others are considered long-term investments.

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

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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. See Note 17 below.

Long-lived Assets

Long-lived assets include: equipment, 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 assets' 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 which represent the lowest level for which cash flows can be identified.

Equipment, 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, furniture and fixtures and the shorter of useful life or lease term for leasehold improvements.

Qualifying internal use software and website development costs incurred during the application development stage that 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 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 17 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 their 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 and forecast future demand, or if they 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

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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 generally deferred and recognized ratably over the period during which the services are to be performed.

Ciena applies the percentage of completion method to long-term arrangements where it is required to undertake significant production, customizations 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.

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 is 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.

VSOE is established based on Ciena's standard pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, which exists across certain of Ciena's service offerings, 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.

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 its customers. 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, which would 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

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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 18 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 based 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 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 its 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. Ciena uses the straight-line method to record expense for grants with only service-based vesting. See Note 16 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 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 2007 and 2008, in Mexico for 2007 and in the United Kingdom for 2009. Management does not expect the outcome of these audits to have a material adverse effect on the Company'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 (2009), United Kingdom (2006), Canada (2005) and India (2007). However, 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. All of the uncertain tax positions, if recognized, would decrease the effective income tax rate.

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 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 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 tax law “with-and-without” method. Under the with-and-without method, the windfall is considered realized and

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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, see Note 13 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

•
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 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. GAAP requires that a liability for the cost associated with an exit or disposal activity be recognized in the period in which the liability is incurred, except for one-time employee termination benefits related to a service period of more than 60 days, which are accrued over the service period. See Note 3 below.

Foreign Currency

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. 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 other income. The net gain (loss) on foreign currency re-measurement and exchange rate changes is immaterial for separate financial statement presentation.

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Derivatives

Ciena's 4.0% convertible senior notes due March 15, 2015 (the "2015 Notes") include a redemption feature that is accounted for as a separate embedded derivative. The embedded redemption feature is recorded at fair value on a recurring basis, and these changes are included in interest and other income, net on the Condensed Consolidated Statement of Operations.

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 twelve months or less and are designated as cash flow hedges. At the inception of the cash flow hedge, and on an ongoing basis, Ciena assesses whether the forward contract 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 the occurrence of the forecasted transaction, is subsequently reclassified to the line item in the 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, net. From time to time Ciena may also use foreign currency forwards to hedge certain balance sheet exposures. These forwards 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, net. See Note 12 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 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 15 below.

Software Development Costs

Ciena develops software for sale to its customers. Generally accepted accounting principles require 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

In May 2011, the Financial Accounting Standards Board ("FASB") issued an accounting standards update that amends current fair value measurement and disclosure guidance to converge with International Financial Reporting Standards (IFRS). This update provides improved comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRS. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011. Ciena adopted this guidance in the first quarter of fiscal 2013.

In June 2011, the Financial Accounting Standards Board issued an accounting standards update that requires an entity to present total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. This guidance is effective for fiscal years and interim periods beginning after December 15, 2011. Ciena adopted this guidance in the first quarter of fiscal 2013.

In February 2013, the Financial Accounting Standards Board issued an accounting standard update to require reclassification adjustments from other comprehensive income to be presented either in the financial statements or in the notes to the financial statements. This accounting standard update will be effective for Ciena beginning in the first quarter of fiscal 2014, at which time Ciena will include the required disclosures.

(3)
RESTRUCTURING COSTS

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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 three months ended January 31, 2013 (in thousands):

 
Workforce
reduction
 
Consolidation
of excess
facilities
 
Total
Balance at October 31, 2012
$
1,449

 
$
3,600

 
$
5,049

Additional liability recorded
3,905

 
1,087

 
4,992

Non-cash disposal
—

 
(619
)
 
(619
)
Cash payments
(3,190
)
 
(1,437
)
 
(4,627
)
Balance at January 31, 2013
$
2,164

 
$
2,631

 
$
4,795

Current restructuring liabilities
$
2,164

 
$
1,817

 
$
3,981

Non-current restructuring liabilities
$
—

 
$
814

 
$
814


The following table sets forth the restructuring activity and balance of the restructuring liability accounts for the three months ended January 31, 2012 (in thousands):

 
Workforce
reduction
 
Consolidation
of excess
facilities
 
Total
Balance at October 31, 2011
$
160

 
$
3,293

 
$
3,453

Additional liability recorded
1,722

 
—

 
1,722

Cash payments
(242
)
 
(463
)
 
(705
)
Balance at January 31, 2012
$
1,640

 
$
2,830

 
$
4,470

Current restructuring liabilities
$
1,640

 
$
439

 
$
2,079

Non-current restructuring liabilities
$
—

 
$
2,391

 
$
2,391



(4)
MARKETABLE SECURITIES

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

 
January 31, 2013
 
Amortized Cost
 
Gross Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated Fair
Value
U.S. government obligations
$
84,918

 
$
—

 
$
—

 
$
84,918

Included in short-term investments
$
84,918

 
$
—

 
$
—

 
$
84,918


 
October 31, 2012
 
Amortized Cost
 
Gross Unrealized
Gains
 
Gross Unrealized
Losses
 
Estimated Fair
Value
U.S. government obligations
$
49,987

 
$
70

 
$
—

 
$
50,057

Included in short-term investments
$
49,987

 
$
70

 
$
—

 
$
50,057



The following table summarizes final legal maturities of debt investments at January 31, 2013 (in thousands):


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Amortized
Cost
 
Estimated
Fair Value
Less than one year
$
84,918

 
$
84,918

Due in 1-2 years
—

 
—

 
$
84,918

 
$
84,918


(5)
FAIR VALUE MEASUREMENTS

As of the date indicated, the following table summarizes the fair value of assets and liabilities that are recorded at fair value on a recurring basis (in thousands):

 
January 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
U.S. government obligations
$
84,918

 
$
—

 
$
—

 
$
84,918

Foreign currency forward contracts
—

 
200

 
—

 
200

Embedded redemption feature
—

 
—

 
100

 
100

Total assets measured at fair value
$
84,918

 
$
200

 
$
100

 
$
85,218

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
—

 
$
159

 
$
—

 
$
159

Total liabilities measured at fair value
$
—

—

$
159

 
$
—

 
$
159


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

 
January 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Short-term investments
$
84,918

 
$
—

 
$
—

 
$
84,918

Prepaid expenses and other
—

 
200

 
—

 
200

Other long-term assets
—

 
—

 
100

 
100

Total assets measured at fair value
$
84,918

 
$
200

 
$
100

 
$
85,218

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Accrued liabilities
$
—

 
$
159

 
$
—

 
$
159

Total liabilities measured at fair value
$
—


$
159

 
$
—

 
$
159


Ciena’s Level 3 assets included in other long-term assets reflect an embedded redemption feature contained within Ciena's 2015 Notes. See Note 13 below. The embedded redemption feature is bifurcated from Ciena’s 2015 Notes using the “with-and-without” approach. As such, the total value of the embedded redemption feature is calculated as the difference between the value of the 2015 Notes (the “Hybrid Instrument”) and the value of an identical instrument without the embedded redemption feature (the “Host Instrument”). Both the Host Instrument and the Hybrid Instrument are valued using a modified binomial model. The modified binomial model utilizes a risk free interest rate, an implied volatility of Ciena’s stock, the recovery rates of bonds and the implied default intensity of the 2015 Notes.
As of the dates indicated, the following table sets forth, in thousands, the reconciliation of changes in fair value measurements of Level 3 assets:


14
Table of Contents

 
Level 3
Balance at October 31, 2012
$
420

Issuances
—

Settlements
(630
)
Changes in unrealized gain (loss)
310

Transfers into Level 3
—

Transfers out of Level 3
—

Balance at January 31, 2013
$
100


(6)
 ACCOUNTS RECEIVABLE

As of January 31, 2013, one customer accounted for 10% of accounts receivable. Allowance for doubtful accounts was $1.5 million and $1.6 million as of October 31, 2012 and January 31, 2013, respectively. Ciena has not historically experienced a significant amount of bad debt expense.

(7)
INVENTORIES
As of the dates indicated, inventories are comprised of the following (in thousands):
 
October 31,
2012
 
January 31,
2013
Raw materials
$
39,678

 
$
46,230

Work-in-process
10,736

 
7,079

Finished goods
178,210

 
178,815

Deferred cost of goods sold
71,484

 
77,146

 
300,108

 
309,270

Provision for excess and obsolescence
(40,010
)
 
(42,369
)
 
$
260,098

 
$
266,901


Ciena writes down its inventory for estimated obsolescence or unmarketable inventory 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 three months of fiscal 2013, Ciena recorded a provision for excess and obsolescence of $3.6 million, primarily related to engineering design changes and the discontinuance of certain parts and components used in the manufacture of our Optical Transport and Converged Packet Optical products. Deductions from the provision for excess and obsolete inventory relate to disposal activities.

(8)
PREPAID EXPENSES AND OTHER
As of the dates indicated, prepaid expenses and other are comprised of the following (in thousands):

 
October 31,
2012
 
January 31,
2013
Prepaid VAT and other taxes
$
37,806

 
$
55,562

Deferred deployment expense
19,449

 
18,580

Product demonstration equipment, net
33,144

 
33,058

Prepaid expenses
16,477

 
16,129

Restricted cash
2,030

 
1,336

Other non-trade receivables
8,689

 
11,337

 
$
117,595

 
$
136,002


Depreciation of product demonstration equipment was $2.4 million and $1.8 million for the first three months of fiscal 2012 and 2013, respectively.

(9)
EQUIPMENT, FURNITURE AND FIXTURES

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As of the dates indicated, equipment, furniture and fixtures are comprised of the following (in thousands):

 
October 31,
2012
 
January 31,
2013
Equipment, furniture and fixtures
$
422,118

 
$
381,693

Leasehold improvements
61,493

 
62,663

 
483,611

 
444,356

Accumulated depreciation and amortization
(360,031
)
 
(322,149
)
 
$
123,580

 
$
122,207


Depreciation of equipment, furniture and fixtures, and amortization of leasehold improvements was $12.3 million and $13.0 million for the first three months of fiscal 2012 and 2013, respectively. During the first three months of fiscal 2013, in connection with the restructuring activities described above, Ciena disposed of equipment, furniture and fixtures with an original cost of $51.9 million and the related accumulated depreciation of $51.3 million.

(10)
 OTHER INTANGIBLE ASSETS
As of the dates indicated, other intangible assets are comprised of the following (in thousands):
 
October 31, 2012
 
January 31, 2013
 
Gross
Intangible
 
Accumulated
Amortization
 
Net
Intangible
 
Gross
Intangible
 
Accumulated
Amortization
 
Net
Intangible
Developed technology
$
417,833

 
$
(279,195
)
 
$
138,638

 
$
417,833

 
$
(289,808
)
 
$
128,025

Patents and licenses
46,538

 
(45,566
)
 
972

 
46,538

 
(45,620
)
 
918

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

 
(206,046
)
 
117,527

 
323,573

 
(213,216
)
 
110,357

Total other intangible assets
$
787,944

 
$
(530,807
)
 
$
257,137

 
$
787,944

 
$
(548,644
)
 
$
239,300


The amortization of finite-lived other intangible assets was $19.4 million and $17.8 million for the first three months of fiscal 2012 and 2013, respectively. Expected future amortization of finite-lived other intangible assets for the fiscal years indicated is as follows (in thousands):

Period ended October 31,
 
2013 (remaining nine months)
$
53,471

2014
57,152

2015
52,879

2016
52,879

2017
22,783

Thereafter
136

 
$
239,300


(11)
OTHER BALANCE SHEET DETAILS
As of the dates indicated, other long-term assets are comprised of the following (in thousands):


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October 31,
2012
 
January 31,
2013
Maintenance spares inventory, net
$
57,548

 
$
62,369

Deferred debt issuance costs, net
20,575

 
19,276

Embedded redemption feature
420

 
100

Restricted cash
2,413

 
2,479

Other
3,780

 
4,568

 
$
84,736

 
$
88,792


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. Amortization of debt issuance costs related to our convertible notes payable and the Credit Facility, which is included in interest expense, was $1.3 million and $1.5 million during the first three months of fiscal 2012 and fiscal 2013, respectively.
As of the dates indicated, accrued liabilities are comprised of the following (in thousands):
 
October 31,
2012
 
January 31,
2013
Warranty
$
55,132

 
$
53,490

Compensation, payroll related tax and benefits
48,885

 
56,965

Vacation
29,581

 
29,247

Current restructuring liabilities
3,516

 
3,981

Interest payable
4,404

 
8,355

Other
68,022

 
62,880

 
$
209,540

 
$
214,918


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

 
 
 
 
 
 
 
Balance at
Three months ended
Beginning
 
 
 
 
 
end of
January 31,
Balance
 
Provisions
 
Settlements
 
period
2012
$
47,282

 
7,706

 
(5,944
)
 
$
49,044

2013
$
55,132

 
4,029

 
(5,671
)
 
$
53,490


As of the dates indicated, deferred revenue is comprised of the following (in thousands):

 
October 31,
2012
 
January 31,
2013
Products
$
29,279

 
$
34,766

Services
77,797

 
73,712

 
107,076

 
108,478

Less current portion
(79,516
)
 
(79,916
)
Long-term deferred revenue
$
27,560

 
$
28,562


(12)
 FOREIGN CURRENCY FORWARD CONTRACTS

As of January 31, 2013, Ciena had forward contracts to reduce the variability in its Canadian Dollar denominated expense, which principally relate to research and development activities. These derivative contracts have been designated as cash flow hedges. During the first quarter of fiscal 2013, in order to hedge certain balance sheet exposures, Ciena entered into a three-month forward contract to sell Brazilian Real and buy equivalent US Dollars. This derivative contract has not been designated as a hedge. Ciena's foreign currency forward contracts are immaterial for separate financial statement presentation.


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(13)
 CONVERTIBLE NOTES PAYABLE

Private Exchange Offer Transactions

On December 27, 2012, Ciena issued $187.5 million in aggregate principal amount of 4.0% Convertible Senior Notes due 2020 (the “2020 Notes”) in separate private offerings in exchange for $187.5 million in aggregate principal amount of 2015 Notes (the “Exchange Transactions”). The Exchange Transactions resulted in the retirement of outstanding 2015 Notes with a carrying value of $187.9 million, the write-off of unamortized debt issuance costs of $2.3 million, and settlement of $0.6 million relating to the redemption feature on the 2015 Notes accounted for as a separate embedded derivative. The 2020 Notes offered in the Exchange Transactions had a fair value of $213.6 million, which resulted in a loss on extinguishment of debt of $28.6 million in the first quarter of fiscal 2013. Ciena does not expect the Exchange Transactions to affect its taxes from continuing operations, as the company continues to provide a valuation allowance against its deferred tax assets.

The 2020 Notes are senior unsecured obligations and rank equally with all of Ciena's other existing and future senior unsecured debt. The 2020 Notes pay interest from the date of issuance at a rate of 4.0% per year with respect to each $1,000 original principal amount. The interest is payable semi-annually on June 15 and December 15, commencing on June 15, 2013. The principal amount of the 2020 Notes will also accrete at a rate of 1.85% per year commencing December 27, 2012, compounding on a semi-annual basis. The accreted portion of the principal payable at maturity does not bear interest and is not convertible into shares of Ciena's common stock. The 2020 Notes will mature on December 15, 2020.

The 2020 Notes may be converted prior to maturity, at the option of the holder, into shares of Ciena's common stock at an initial conversion rate of 49.0557 shares of common stock per $1,000 in original principal amount, which is equal to an initial conversion price of $20.385 per share. In addition, Ciena may elect to convert the 2020 Notes in whole or in part at any time on or prior to December 15, 2020, if the daily volume weighted average price of the common stock equals or exceeds 130% of the conversion price then in effect for at least 20 trading days in any 30 consecutive trading day period. If Ciena elects to convert the 2020 Notes on or before maturity, the conversion rate will be adjusted to include an amount of additional shares, determined by reference to a make-whole table, payable in Ciena common stock, or its cash equivalent, at Ciena's election. An aggregate of 9,197,944 shares of Ciena common stock issuable upon conversion of the 2020 Notes have been reserved for issuance.

Upon certain fundamental changes, holders of the 2020 Notes have the option to require Ciena to purchase the 2020 Notes at a price equal to the accreted principal amount of the notes delivered for repurchase plus any accrued and unpaid interest on the original principal amount. Upon a holder's election to convert the 2020 Notes in connection with certain fundamental changes, the conversion rate will be adjusted to include an amount of additional shares, determined by reference to a make-whole table, payable in Ciena common stock, or its cash equivalent, at the election of the Company.

Accounting guidance issued by the FASB requires the issuer of convertible debt instruments with cash settlement features, including partial cash settlement, to account separately for the liability and equity components of the instrument. Under this guidance, the debt is recognized at the present value of its cash flows discounted using the issuer's nonconvertible debt borrowing rate at the time of issuance and the equity component is recognized as the difference between the proceeds from the issuance of the note and the fair value of the liability. The reduced carrying value on the convertible debt results in a debt discount that is accreted back to the convertible debt's principal amount through the recognition of non-cash interest expense over the expected life of the debt, which results in recognizing the interest expense on these borrowings at effective rates approximating what Ciena would have incurred had nonconvertible debt with otherwise similar terms been issued.

Because the additional make-whole shares can be settled in cash or common stock at Ciena's option, the debt and equity components were accounted for separately. Ciena measured the fair value of the debt component of the 2020 Notes using an effective interest rate of 7.0%. As a result, Ciena attributed $170.4 million of the fair value of the 2020 Notes to the debt component, which is netted against the face value of the 2020 Notes as a debt discount. The debt discount will be accreted over the period from the date of issuance to the contractual maturity date, resulting in the recognition of non-cash interest expense. In addition, Ciena recorded $43.1 million within additional paid-in capital representing the equity component of the 2020 Notes.

The 2020 Notes were issued pursuant to an Indenture entered into as of December 27, 2012 (the “Indenture”) with The Bank of New York Mellon Trust Company, N.A., as trustee. The Indenture provides for customary events of default which include (subject in certain cases to customary grace and cure periods), among others, the following: nonpayment of principal (including accreted portion) or interest; breach of covenants or other agreements in the Indenture; defaults in failure to pay certain other indebtedness; and certain events of bankruptcy or insolvency. Generally, if an event of default occurs and is

18
Table of Contents

continuing under the Indenture, the trustee or the holders of at least 25% in aggregate original principal amount of the 2020 Notes then outstanding may declare the principal (including accreted portion) of, premium, if any, and accrued interest on all the 2020 Notes immediately due and payable.

The principal balance, unamortized discount and net carrying amount of the liability and equity components of our 2020 Notes were as follows as of January 31, 2013:
 
Liability Component
 
Equity Component
 
Principal Balance
 
Unamortized Discount
 
Net Carrying Amount
 
Net Carrying Amount
4.0% Convertible Senior Notes due December 15, 2020
$
187,852

 
$
16,968

 
$
170,884

 
$
43,100


The following table sets forth, in thousands, the carrying value and the estimated fair value of Ciena’s outstanding convertible notes:
 
January 31, 2013
Description
Carrying Value
 
Fair Value(2)
0.25% Convertible Senior Notes due May 1, 2013
216,210

 
215,669

4.0% Convertible Senior Notes, due March 15, 2015 (1)
187,861

 
210,703

0.875% Convertible Senior Notes due June 15, 2017
500,000

 
450,000

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

 
399,875

4.0% Convertible Senior Notes due December 15, 2020 (3)
170,884

 
222,422

 
$
1,424,955

 
$
1,498,669

(1)
Includes unamortized bond premium related to embedded redemption feature
(2)
The fair value reported above is based on the quoted prices for the notes on the date above.
(3)
Includes unamortized discount and accretion of principal.


(14)
CREDIT FACILITY
During fiscal 2012, Ciena entered into a $150.0 million senior secured asset-based revolving credit facility (the “Credit Facility”). Ciena principally expects to use the 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 January 31, 2013, letters of credit totaling $51.8 million were collateralized by the Credit Facility. There were no borrowings outstanding under the Credit Facility as of January 31, 2013. Ciena satisfied the financial criteria such that the Credit Facility did not mature early on January 31, 2013.
(15)
 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 (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 January 31,
Numerator
2012
 
2013
Net loss
$
(47,653
)
 
$
(47,324
)

 
Quarter Ended January 31,
Denominator
2012
 
2013
Basic weighted average shares outstanding
98,066

 
101,204

Dilutive weighted average shares outstanding
98,066

 
101,204


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Table of Contents


 
Quarter Ended January 31,
EPS
2012
 
2013
Basic EPS
$
(0.49
)
 
$
(0.47
)
Diluted EPS
$
(0.49
)
 
$
(0.47
)

The following table summarizes the weighted average 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):

 
Quarter Ended January 31,
 
2012
 
2013
Shares underlying stock options, restricted stock units and warrants
7,098

 
5,223

0.25% Convertible Senior Notes due May 1, 2013
5,470

 
5,470

4.0% Convertible Senior Notes due March 15, 2015
18,396

 
14,615

0.875% Convertible Senior Notes due June 15, 2017
13,108

 
13,108

3.75% Convertible Senior Notes due October 15, 2018
17,355

 
17,355

4.0% Convertible Senior Notes due December 15, 2020
—

 
3,781

Total excluded due to anti-dilutive effect
61,427


59,552


(16)
SHARE-BASED COMPENSATION EXPENSE
Ciena maintains two active equity compensation plans, the 2008 Omnibus Incentive Plan (“2008 Plan”) and the Amended and Restated Employee Stock Purchase Plan (“ESPP”). These plans were approved by stockholders and are described in Ciena’s annual report on Form 10-K. In March 2012, Ciena stockholders approved the addition of 5.5 million additional shares of common stock for issuance under the 2008 Plan. As a result, the total number of shares authorized for issuance under the 2008 Plan is 18.5 million shares. As of January 31, 2013, approximately 5.3 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 restrictions and vest incrementally over a four-year period. 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, 2012
3,207

 
$
27.58

Granted
—

 
—

Exercised
(19
)
 
7.51

Canceled
(626
)
 
31.46

Balance at January 31, 2013
2,562

 
$
26.79


The total intrinsic value of options exercised during the first three months of fiscal 2012 and fiscal 2013 was $0.1 million and $0.2 million, respectively. There were no stock options granted by Ciena during the first three months of fiscal 2012 and fiscal 2013.
The following table summarizes information with respect to stock options outstanding at January 31, 2013, based on Ciena’s closing stock price on the last trading day of Ciena’s first fiscal quarter of 2013 (shares and intrinsic value in thousands):


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Table of Contents

 
 
 
 
 
 
Options Outstanding at
 
Vested Options at
 
 
 
 
 
 
January 31, 2013
 
January 31, 2013
 
 
 
 
 
 
Number
 
Weighted
Average
Remaining
 
Weighted
 
 
 
Number
 
Weighted
Average
Remaining
 
Weighted
 
 
Range of
 
of
 
Contractual
 
Average
 
Aggregate
 
of
 
Contractual
 
Average
 
Aggregate
Exercise
 
Underlying
 
Life
 
Exercise
 
Intrinsic
 
Underlying
 
Life
 
Exercise
 
Intrinsic
Price
 
Shares
 
(Years)
 
Price
 
Value
 
Shares
 
(Years)
 
Price
 
Value
$
0.94

 
—

 
$
16.31

 
293

 
4.67

 
$
8.44

 
$
2,177

 
275

 
4.55

 
$
8.23

 
$
2,104

$
16.52

 
—

 
$
17.29

 
383

 
2.29

 
16.68

 
—

 
383

 
2.29

 
16.68

 
—

$
17.43

 
—

 
$
24.50

 
513

 
2.15

 
20.50

 
—

 
513

 
2.15

 
20.50

 
—

$
24.69

 
—

 
$
28.28

 
369

 
3.69

 
26.94

 
—

 
369

 
3.69

 
26.94

 
—

$
28.61

 
—

 
$
31.43

 
174

 
3.28

 
29.62

 
—

 
173

 
3.28

 
29.62

 
—

$
31.71

 
—

 
$
32.55

 
26

 
4.02

 
31.92

 
—

 
26

 
4.02

 
31.92

 
—

$
33.00

 
—

 
$
37.10

 
302

 
4.13

 
35.19

 
—

 
302

 
4.13

 
35.19

 
—

$
37.31

 
—

 
$
47.32

 
477

 
1.65

 
44.88

 
—

 
477

 
1.65

 
44.88

 
—

$
47.53

 
—

 
$
55.79

 
25

 
0.70

 
48.94

 
—

 
25

 
0.7

 
48.94

 
—

$
0.94

 
—

 
$
267.52

 
2,562

 
2.90

 
$
26.79

 
$
2,177

 
2,543

 
2.88

 
$
26.89

 
$
2,104


     Assumptions for Option-Based Awards
Ciena recognizes the fair value of service-based options as share-based compensation expense on a straight-line basis over the requisite service period. Ciena did not grant any option-based awards during the first three months of fiscal 2012 or fiscal 2013.
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. Ciena relies 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.
     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 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, 2012
4,403

 
$
14.16

 
$
56,267

Granted
2,000

 
 
 
 
Vested
(473
)
 
 
 
 
Canceled or forfeited
(486
)
 
 
 
 
Balance at January 31, 2013
5,444

 
$
14.84

 
$
86,402



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The total fair value of restricted stock units that vested and were converted into common stock during the first three months of fiscal 2012 and fiscal 2013 was $7.3 million and $7.5 million, respectively. The weighted average fair value of each restricted stock unit granted by Ciena during the first three months of fiscal 2012 and fiscal 2013 was $10.69 and $15.64 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 cost is reversed.

Amended and Restated Employee Stock Purchase Plan
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 the Company 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. In March 2012, Ciena stockholders approved an amendment and restatement of the ESPP, extending the term to January 24, 2023 and increasing by 5.0 million the number of shares authorized for issuance thereunder. 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 0.6 million shares, provided that the total number of shares available at that time shall not exceed 8.2 million.
During the first three months of fiscal 2013, Ciena issued 0.4 million shares under the ESPP. At January 31, 2013, 7.7 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 January 31,
 
2012
 
2013
Product costs
$
485

 
$
561

Service costs
437

 
427

Share-based compensation expense included in cost of sales
922

 
988

Research and development
2,134

 
2,033

Sales and marketing
3,101

 
2,743

General and administrative
2,797

 
2,556

Acquisition and integration costs
6

 
—

Share-based compensation expense included in operating expense
8,038

 
7,332

Share-based compensation expense capitalized in inventory, net
(72
)
 
—

Total share-based compensation
$
8,888

 
$
8,320


As of January 31, 2013, total unrecognized share-based compensation expense was $72.2 million: (i) $0.1 million related to unvested stock options and expected to be recognized over a weighted-average period of 0.4 year, and (ii) $72.1 million related to unvested restricted stock units and expected to be recognized over a weighted-average period of 1.6 years.

(17)
 SEGMENTS AND ENTITY WIDE DISCLOSURES


22
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Segment Reporting
During the first quarter of fiscal 2013, Ciena reorganized its internal organizational structure and the management of its business into the following new operating segments: (i) Converged Packet Optical; (ii) Packet Networking; (iii) Optical Transport; and (iv) Software and Services. 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's segment revenue and segment profit (loss) for fiscal 2012 have been restated to reflect the new operating segments adopted in fiscal 2013. The following describes each of the newly reorganized operating segments:

•
Converged Packet Optical — includes networking solutions optimized for the convergence of coherent optical transport, OTN switching and packet switching. These platforms enable automated packet-optical infrastructures that create and efficiently allocate high-capacity bandwidth for the delivery of a wide variety of enterprise and consumer-oriented network services. Products in this segment include the 6500 Packet-Optical Platform featuring Ciena's WaveLogic coherent optical processors. Products also include Ciena's family of CoreDirector® Multiservice Optical Switches, its 5430 Reconfigurable Switching System and its OTN configuration for the 5410 Reconfigurable Switching System. These products include multiservice, multi-protocol switching systems that consolidate the functionality of an add/drop multiplexer, digital cross-connect and packet switch into a single, high-capacity intelligent switching system. These products address both the core and metro segments of communications networks and support key managed services, Ethernet/TDM Private Line, Triple Play and IP services. 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.

•
Packet Networking — principally includes Ciena's 3000 family of service delivery switches and service aggregation switches, the 5000 series of service aggregation switches, and its Ethernet packet configuration for the 5410 Service Aggregation Switch. These products support the access and aggregation tiers of communications networks and have principally been deployed to support wireless backhaul infrastructures and business data services. Employing sophisticated, carrier-grade Ethernet switching technology, these products deliver quality of service capabilities, virtual local area networking and switching functions, and carrier-grade operations, administration, and maintenance features. This segment includes legacy broadband products that transition voice networks to support Internet-based (IP) telephony, video services and DSL. 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 optical transport solutions that add capacity to core, regional and metro networks and enable cost-effective and efficient transport of voice, video and data traffic at high transmission speeds. Ciena's principal products in this segment include 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 the Ciena One software suite, including OneControl, the integrated network and service management software designed to automate and simplify network management, operation and service delivery. These software solutions can track individual services across multiple product suites, facilitating planned network maintenance, outage detection and identification of customers or services affected by network performance. In addition to Ciena One, this segment includes the ON-Center® Network & Service Management Suite, Ethernet Services Manger, and the OMEA and Preside platforms from the MEN Business. This segment also includes a broad range of consulting and support services, including installation and deployment, maintenance support, consulting, network design 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.

Reportable segment asset information is not disclosed because it is not reviewed by the chief operating decision maker for purposes of evaluating performance and allocating resources.

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Segment Revenue

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

 
Quarter Ended January 31,
 
2012
 
2013
Revenue:
 
 
 
Converged Packet Optical
$
202,044

 
$
239,960

Packet Networking
21,501

 
45,837

Optical Transport
107,656

 
57,597

Software and Services
85,484

 
109,699

Consolidated revenue
$
416,685

 
$
453,093


Segment Profit (Loss)
Segment profit (loss) 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 (net); interest expense; loss on extinguishment of debt and provisions (benefit) for income taxes.
The table below (in thousands) sets forth Ciena’s segment profit (loss) and the reconciliation to consolidated net income (loss) during the respective periods:
 
Quarter Ended January 31,
 
2012
 
2013
Segment profit (loss):
 
 
 
Converged Packet Optical
$
30,288

 
$
47,118

Packet Networking
(4,288
)
 
5,083

Optical Transport
34,031

 
20,587

Software and Services
18,061

 
33,882

Total segment profit
78,092

 
106,670

Less: non-performance operating expenses
 
 
 
  Selling and marketing
64,411

 
66,588

  General and administrative
29,664

 
28,208

  Amortization of intangible assets
13,471

 
12,453

  Restructuring costs
1,722

 
5,030

Add: other non-performance financial items
 
 
 
  Interest expense and other income (loss), net
(14,457
)
 
(10,869
)
  Loss on extinguishment of debt
—

 
(28,630
)
Less: Provision for income taxes
2,020

 
2,216

Consolidated net loss
$
(47,653
)
 
$
(47,324
)

Entity Wide Reporting
The following table reflects Ciena’s geographic distribution of revenue based on the location of the purchaser, with any country accounting for a significant percentage of total revenue in the period specifically identified. Revenue attributable to geographic regions outside of the United States and Canada is reflected as “Other International” revenue. For the periods below, Ciena’s geographic distribution of revenue was as follows (in thousands):


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Quarter Ended January 31,
 
2012
 
2013
United States
$
233,078

 
$
264,235

Canada
42,652

 
n/a

International
140,955

 
188,858

Total
$
416,685

 
$
453,093


n/a
Denotes revenue representing less than 10% of total revenue for the period

The following table reflects Ciena's geographic distribution of equipment, furniture and fixtures, net, with any country accounting for a significant percentage of total equipment, furniture and fixtures, net, specifically identified. Equipment, furniture and fixtures, net, attributable to geographic regions outside of the United States and Canada are reflected as “Other International.” For the periods below, Ciena's geographic distribution of equipment, furniture and fixtures was as follows (in thousands):

 
October 31,
2012
 
January 31,
2013
United States
$
64,653

 
$
64,145

Canada
48,376

 
47,634

Other International
10,551

 
10,428

Total
$
123,580

 
$
122,207


For the periods below, customers accounting for at least 10% of Ciena’s revenue were as follows (in thousands):

 
Quarter Ended January 31,
 
2012
 
2013
Company A
$
80,586

 
$
71,679

Company B
n/a

 
48,063

Total
$
80,586

 
$
119,742

________________________________
n/a
Denotes revenue representing less than 10% of total revenue for the period

The customers identified above purchased products and services from each of Ciena's operating segments.
    
(18)
 COMMITMENTS AND CONTINGENCIES
Ontario Grant
Ciena was awarded a conditional grant from the Province of Ontario in June 2011. Under this strategic jobs investment fund grant, Ciena can receive up to an aggregate of C$25.0 million in funding for eligible costs relating to certain next-generation, coherent optical transport development initiatives over the period from November 1, 2010 to October 31, 2015. Ciena anticipates receiving disbursements, approximating C$5.0 million per fiscal year, over the period above. Amounts received under the grant are subject to recoupment in the event that Ciena fails to achieve certain minimum investment, employment and project milestones. As of January 31, 2013, Ciena has recorded a C$12.2 million benefit to date as a reduction in research and development expenses, of which C$1.3 million was recorded in the first three months of fiscal 2013. As of January 31, 2013, amounts receivable from this grant were C$4.1 million.

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

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assessments. As of October 31, 2012 and January 31, 2013, Ciena had accrued liabilities of $1.7 million and $1.8 million, respectively, related to these contingencies, which are reported as a component of other current accrued liabilities. As of January 31, 2013, Ciena estimates that it could be exposed to possible losses of up to $5.9 million, for which it has not accrued liabilities. Ciena has not accrued the additional income tax liabilities because it does not believe that such losses are probable. Ciena has not accrued the additional import taxes and duties because it does not believe the incurrence of such losses are probable. Ciena continues 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 estimable and more likely than not (for income taxes) or probable (for non-income taxes).

In addition to the matters described above, Ciena is subject to various tax liabilities arising in the ordinary course of business. Ciena does not expect that the ultimate settlement of these liabilities will have a material effect on its results of operations, financial position or cash flows.

Litigation

On July 29, 2011, Cheetah Omni LLC filed a complaint in the United States District Court for the Eastern District of Texas against Ciena and several other defendants, alleging, among other things, that certain of the parties' products infringe upon multiple U.S. patents relating to certain reconfigurable optical add-drop multiplexer (ROADM) technologies. The complaint seeks injunctive relief and damages. On November 8, 2011, Ciena filed an answer and counterclaims to Cheetah Omni's amended complaint. The parties are currently engaged in discovery. Ciena believes that it has valid defenses to the lawsuit and intends to defend it vigorously.

On May 29, 2008, Graywire, LLC filed a complaint in the United States District Court for the Northern District of Georgia against Ciena and four other defendants, alleging, among other things, that certain of the parties' products infringe U.S. Patent 6,542,673 (the “'673 Patent”), relating to an identifier system and components for optical assemblies. The complaint seeks injunctive relief and damages. In July 2009, upon request of Ciena and certain other defendants, the U.S. Patent and Trademark Office (“PTO”) granted the defendants' inter partes application for reexamination with respect to certain claims of the '673 Patent, and the district court granted the defendants' motion to stay the case pending reexamination of all of the patents-in-suit. In December 2010, the PTO confirmed the validity of some claims and rejected the validity of other claims of the '673 Patent, to which Ciena and other defendants filed an appeal. On March 16, 2012, the PTO on appeal rejected multiple claims of the '673 Patent, including the two claims on which Ciena is alleged to infringe. Subsequently, the plaintiff requested a reopening of the prosecution of the '673 Patent, to which Ciena and the other defendants filed an opposition. The case currently remains stayed, and there can be no assurance as to whether or when the stay will be lifted.
 
 In addition to the matters described above, Ciena is subject to various legal proceedings and claims arising in the ordinary course of business, including claims against third parties that may involve contractual indemnification obligations on the part of Ciena. 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.


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Some of the statements contained, or incorporated by reference, in this quarterly report discuss future events or expectations, contain projections of results of operations or financial condition, changes in the markets for our products and services, or state other “forward-looking” information. Ciena’s “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 in Item 1A “Risk Factors” of Part II of this report below. You should review these risk factors and the rest of this quarterly report in combination with the more detailed description of our business and management’s discussion and analysis of financial condition in our annual report on Form 10-K, which we filed with the Securities and Exchange Commission on December 21, 2012, for a more complete understanding of the risks associated with an investment in Ciena’s securities. Ciena undertakes no obligation to revise or update any forward-looking statements.

Overview
 

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We are a provider of equipment, software and services that support the transport, switching, aggregation, service delivery and management of voice, video and data traffic on communications networks.

We are a network specialist focused on networking solutions that enable converged, next-generation architectures, optimized to handle a broader mix of high-bandwidth communications services. Our Converged Packet Optical, Packet Networking, Optical Transport and Software products are used, individually or as part of an integrated solution, in communications networks operated by service providers, cable operators, governments, enterprises, research and education institutions and other network operators across the globe. Our products allow network operators to scale capacity and increase transmission speeds, efficiently allocate network traffic, and deliver services to business and consumer end users. Our network solutions also include our integrated Ciena One software suite, which provides network management capabilities that unify our product portfolio and provide automation and management features that enable efficient service delivery. To complement our hardware and software portfolio, we offer a broad range of consulting and support services that help our customers design, optimize, deploy, manage and maintain their networks. We believe that the close, collaborative engagement with customers enabled by our services offerings is an important component of our network specialist approach and a significant differentiator for us with customers.

Network operators face a challenging and rapidly changing environment that requires their networks to be robust enough to address increasing capacity needs and flexible enough to adapt quickly to emerging applications and evolving consumer and business use of communications services. At the same time, network operators are competing to distinguish their service offerings and add revenue-generating services, while managing the cost to implement and maintain their networks. To address these business, infrastructure and service delivery challenges, we offer a comprehensive, solutions-oriented portfolio that builds upon the principles of our OPn Architecture for next-generation networks. Our OPn Architecture, which underpins our solutions offering and guides our research and development strategy, is described more fully in "Market Opportunity and Strategy" below. Through this network approach, we seek to enable high-capacity, configurable infrastructures that can be managed and adapted by network-level applications, and to provide flexible interfaces for the integration of computing, storage and network resources. By increasing network flexibility for service delivery, reducing required network elements and enabling increased scale at reduced cost, our communications networking solutions create business and operational value for our customers.

Our quarterly reports on Form 10-Q, annual reports on Form 10-K and current reports on Form 8-K filed with the SEC are available through the SEC's website at www.sec.gov or free of charge on our website as soon as reasonably practicable after we file these documents. We routinely post the reports above, recent news and announcements, financial results and other important information about Ciena on the "Investors" page of our website at www.ciena.com.
 
Market Opportunity and Strategy

We believe that a number of underlying drivers in the market represent significant, long-term opportunities for our business. We believe that market trends, including the proliferation of smartphones, tablets and similar devices running mobile web applications, the prevalence of video applications, and the shift of enterprise and consumer applications to cloud-based or virtualized network environments, are indicative of increasing use and dependence by consumers and enterprises upon a growing variety of broadband applications and services. We expect that these services will continue to add significant multiservice network traffic, requiring network operators to invest in next-generation, high-capacity network infrastructures that are more efficient, robust and programmable.
Our corporate strategy to capitalize on these market dynamics, promote operational efficiency and drive profitable growth of our business includes the following initiatives:
Promote our OPn Architecture for Next-Generation Networks. The services and applications running on communications networks require that more of the traffic on these networks be packet-oriented. The traditional approach to this problem has been to add IP routing capability at various points in the network. As capacity needs grow, this approach becomes unnecessarily complex and costly. We reduce the cost and complexity of growing networks with a programmable infrastructure that brings together the reliability and capacity of optical networking with the flexibility and economics of packet networking technologies. Combining these attributes with network level applications creates an approach we call our OPn Architecture. Our OPn Architecture leverages the convergence of optical and packet networking to enable network scale, applies advanced control plane software for network programmability, and enables network-level applications to integrate and optimize network, computing and storage resources in a virtualized environment. We intend to promote the scalability, programmability, flexibility and cost effectiveness advantages of our OPn Architecture, and we see opportunities in offering a portfolio of carrier-class solutions that facilitates the transition to converged, next-generation networks.


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Table of Contents

Alignment of Research and Development Investment with Growth Opportunities. We seek to ensure that our product development initiatives and investments are closely aligned with market growth opportunities and reflect the changing dynamics faced by network operators. We are investing in our OPn Architecture with current development efforts focused on expanding packet capabilities on our Packet Networking and and Converged Packet Optical products for metro and service aggregation applications, optimizing our core network solutions for application in metro networks, and investing in new vectors for growth. Our research and development efforts seek to extend our WaveLogic coherent optical processor for 40G and 100G optical transport across our portfolio and to introduce 400G transmission products. We are also focused on enhancing our software applications, extending our OneConnect control plane across the 5400 and 6500 platform families, and developing network level applications that automate network functions and support new service introduction.

Evolve Go-to-Market Model. We seek to evolve our go-to-market sales model, both from a coverage and an engagement perspective.

Coverage. Our coverage model is focused on penetrating high-growth geographic markets, selling into key customer segments and addressing additional network applications with our solutions. We seek to enhance our brand internationally, expand our geographic reach and capture market share in international markets, including Brazil, the Middle East, Russia, Japan and India. We intend to pursue opportunities to diversify our customer base beyond our traditional customer base. We are expanding our sales efforts to: capture opportunities arising from enterprise migration to, and increased reliance upon, cloud-based services; build upon our reputation as a trusted network equipment supplier with government agencies and research and educational institutions; and target Internet content providers and other network operators emerging as a result of network modernization drivers and the adoption of new communication services. We seek to expand the application of our solutions, including in metro aggregation, submarine networks, and in support of cloud-based services, business Ethernet services and mobile backhaul. We intend to pursue selling initiatives and strategic channel opportunities, including relationships with key resellers, and carrier-managed sales to end users through our service provider customers, in order to complement our direct sales force and penetrate more deeply our targeted geographic markets and customer segments.

Engagement. Our strategy is to leverage our close relationship with customers in the design, development, implementation and support of their networks and to promote a close alignment of our solutions with customer network priorities. This engagement model is a key differentiator for our business and provides us with unique insight into the business and network needs of our customers. We seek to expand our Network Transformation Solutions offering to address the network modernization and service delivery demands of our customers, as well as their desire to drive additional value from their network infrastructure. We believe this services-oriented solutions offering shifts our value proposition beyond the sale of our next-generation communications networking products and allows us to play a key role in the design and evolution of our customers' networks to support their strategic business objectives. By understanding and addressing their network infrastructure needs and the evolving markets in which our customers compete, we believe this engagement approach creates additional business and operational value for our customers, enabling them to better compete in a challenging environment.

Business optimization to yield operating leverage. We seek to improve the operational efficiencies in our business and gain additional operating leverage. We are focused on the transformation and redesign of certain business processes, systems, and resources. These initiatives include additional investments, re-engineering and automation of certain key business processes, including the engagement of strategic partners or resources to assist with select business functions. In addition, we are focused on optimizing our supply chain structure in order to increase efficiency, reduce overhead and cost-reduce our product solutions. These initiatives include the rationalization and consolidation of third party manufacturers, distribution facilities and logistics providers, direct order fulfillment of additional products, and the consideration of select vertical integration within our supply chain. We seek to leverage these opportunities to promote the profitable growth of our business.

Global Market Conditions and Competitive Landscape

We believe that the market opportunity described above, together with multiservice traffic growth, is driving a shift in network priorities and spending toward high-capacity, next-generation network architectures. However, during fiscal 2012 our market experienced a challenging environment, including declining growth rates in spending in the markets addressed by our packet-optical networking solutions. We believe that this reflects the macroeconomic conditions and competitive landscape encountered in our market during the year. In particular, the sustained period of macroeconomic uncertainty and volatility in the global economy and in capital markets has resulted in a high degree of uncertainty and cautious customer behavior in our industry and markets. These dynamics, most notably in Europe, have resulted and may continue to result in lower levels of capital expenditure on communications network infrastructure. Broad macroeconomic weakness has previously resulted in periods of decreased demand for our products and services that have adversely affected our results of operations. We remain

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uncertain as to how long current macroeconomic and industry conditions will persist and the magnitude of the effect of these conditions on the growth of our markets and business, as well as our results of operations.

We continue to encounter a highly competitive marketplace, particularly for our coherent optical transport products, as we and our competitors have introduced new, high-capacity, high-speed network solutions and have aggressively sought to capture market share. In this competitive environment, securing new opportunities, particularly in international markets, often requires that we agree to less favorable initial pricing, commercial terms that can elongate the revenue recognition cycle, startup costs to operationalize our solutions in customer networks, financial commitments or performance bonds that place cash resources at risk, and other onerous contractual commitments that place a disproportionate allocation of risk upon the vendor. These terms can adversely affect our results of operations and contribute to fluctuations in our results. We expect the competitive landscape to remain challenging and dynamic as we and our competitors introduce new, competing platforms, as networking technologies or features converge, and as competitors seek customer adoption of their network architectural approaches. Although we are beginning to see network operators adopt converged network architectures that align well with our OPn architecture and solutions offering, particularly in North America, competition in our sector remains significant. We expect this level of competition to continue, as Chinese equipment vendors and other multinational competitors seek to obtain new business or retain incumbent positions with large customers around the world, and to potentially increase, as network technologies and features converge and our business thereby begins to overlap more directly with certain of our traditional networking supplier competitors as well as with information technology and software vendors.

Operational Reorganization

To address the market and technological dynamics described above, including the growing need to transport, aggregate and manage multiple types of services, network operators are increasingly demanding and adopting solutions that enable the convergence of both network functions and network layers, particularly the integration of transport, OTN switching and packet switching capabilities. Our OPn Architecture, which underpins our solutions offering and guides our research and development strategy, and our continued development and addition of features to our solutions portfolio, are intended to address these market and networking design dynamics. Specifically, we continue to converge OTN switching functionality into our coherent optical transport solutions. At the same time, we are integrating more transport functionality and packet switching into our switching platforms. To address these changes in our markets and the convergence of certain solutions portfolios, during the first quarter of fiscal 2013, we reorganized our organizational structure and the management of our business into the following new operating segments: (i) Converged Packet Optical; (ii) Packet Networking; (iii) Optical Transport; and (iv) Software and Services. Notably, our new Converged Packet Optical segment consists of our former Packet-Optical Switching segment with the addition of our 6500 Packet-Optical Platform. We have restated segment revenue and segment profit (loss) for fiscal 2012 presented in this Form 10-Q to reflect the new operating segments. See "Results of Operations — Operating Segments" below for additional details regarding our new operating segments effective for fiscal 2013 and the product families and platforms that make up these segments.

Restructuring

In an effort to manage operating expense and execute on our strategy to drive additional operating leverage from our business, we have undertaken a number of restructuring activities intended to better align our workforce and operating costs with market opportunities and product development strategies. During the first quarter of fiscal 2013, we announced an initiative to achieve greater research and engineering efficiencies by consolidating and reallocating certain engineering resources to ensure alignment with development priorities. These activities resulted in a headcount reduction affecting approximately 85 employees, principally in our global products group in North America. We believe these actions will facilitate synergies across our engineering teams and further clarify the mandate of each our remaining research and development centers. In addition, we implemented a headcount reduction of a small number of sales and services resources in EMEA in order to free up investment capacity and reallocate global resources to better support our evolving go-to-market sales coverage model described above. During the first quarter of fiscal 2013, we incurred approximately $5.0 million in restructuring costs, including expense related to the actions above. As we look to manage operating expense and drive further efficiency and leverage from our operations, we will continue to assess allocation of headcount, facilities and other resources to ensure that they are optimized toward key growth opportunities.

Convertible Debt Exchange Offer Transactions

On December 27, 2012, we issued $187.5 million in aggregate principal amount of new 4.0% Convertible Senior Notes due 2020 (the “2020 Notes”) in separate, private transactions with holders in exchange for $187.5 million in aggregate principal amount of our outstanding 4.0% Convertible Senior Notes due 2015 (the “2015 Notes”). Certain terms of the new

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2020 Notes are the same as the 2015 Notes that they replaced, including the 4.0% annual cash interest rate and the conversion rate of 49.0557 shares of Ciena common stock per $1,000 in original principal amount, which is equal to an initial conversion price of $20.385 per share. Unlike the 2015 Notes, however, the principal amount of the 2020 Notes will accrete at a rate of 1.85% per year commencing December 27, 2012, compounding on a semi-annual basis. The accreted portion of the principal is payable in cash upon maturity but does not bear cash interest and is not convertible into Ciena common stock. Accretion of principal is reflected as a non-cash component of interest expense during the term of the 2020 Notes. The 2020 Notes also provide us with the option, at our election, to convert the 2020 Notes in whole or in part, prior to maturity, into the underlying common stock, provided the trading price of our common stock exceeds $26.50 (or 130% of the then applicable conversion price) for the required measurement period. If we elect to convert the 2020 Notes on or before maturity, holders would receive a make-whole premium payable in Ciena common stock, or its cash equivalent, at our election. The 2020 Notes will mature on December 15, 2020. Following these private exchange offer transactions, $187.5 million in aggregate principal amount of the 2015 Notes remained outstanding with terms unchanged. We believe that the extension of maturity enabled by these exchange transactions has strengthened our balance sheet and provided enhanced financial flexibility. See Note 13 to our Condensed Consolidated Financial Statements included in Item 1 of Part I of this report for a summary of the 2020 Notes, and an explanation of the $28.6 million loss on the extinguishment of a portion of the 2015 Notes and the separate accounting for the debt and equity components of the 2020 Notes.

Financial Results

Revenue for the first quarter of fiscal 2013 was $453.1 million, representing a sequential decrease of 2.7% from $465.5 million in the fourth quarter of fiscal 2012. Due to the timing of our first fiscal quarter during the calendar year, we typically experience some seasonality that can result in lower order volume and revenue as the procurement cycles of some of our customers slow and network deployment activity at service providers is curtailed. Revenue-related details reflecting sequential changes from the fourth quarter of fiscal 2012 include:

•
Product revenue for the first quarter of fiscal 2013 decreased by $10.1 million, primarily due to a decrease of $14.2 million in Optical Transport, slightly offset by an increase of $3.7 million in software sales.
•
Service revenue for the first quarter of fiscal 2013 decreased by $2.3 million.
•
Revenue from the United States for the first quarter of fiscal 2013 was $264.2 million, an increase from $249.5 million in the fourth quarter of fiscal 2012.
•
International revenue for the first quarter of fiscal 2013 was $188.9 million, a decrease from $216.0 million in the fourth quarter of fiscal 2012.
•
As a percentage of revenue, international revenue was 41.7% during the first quarter of fiscal 2013, a decrease from 46.4% during the fourth quarter of fiscal 2012.
•
For the first quarter of fiscal 2013, two customers each accounted for greater than 10% of revenue and represented 26.4% of total revenue. This compares to one customer that accounted for greater than 10% of revenue and represented 11.3% of total revenue in the fourth quarter of fiscal 2012.

Gross margin for the first quarter of fiscal 2013 was 43.2%, an increase from 41.3% in the fourth quarter of fiscal 2012. Increased gross margin reflects improved mix of higher-margin packet platforms and software content, including within our Packet Networking and Converged Packet Optical segments, lower warranty costs and greater leverage from efforts to streamline and optimize our supply chain activities. We expect gross margin to fluctuate during fiscal 2013 and do not expect to attain the level of gross margin achieved during the first fiscal quarter on a sustained basis during the remainder of fiscal 2013.

Operating expense was $201.4 million for the first quarter of fiscal 2013, a decrease from $214.1 million in the fourth quarter of fiscal 2012. See Note 1 to our Condensed Consolidated Financial Statements in Item 1 of Part I of this report which describes our 53-week fiscal year for fiscal 2012, with the additional week included during our fiscal fourth quarter. First quarter fiscal 2013 operating expense reflects a decrease of $7.4 million in selling and marketing expense, primarily due to lower variable compensation, a $6.7 million decrease in research and development expense, and $1.6 million decrease in general and administrative expense. A meaningful portion of the research and development-related expense reduction during the first fiscal quarter reflects delays in certain activities for which we expect to incur expense in subsequent quarters during fiscal 2013. In spite of the lower level of operating expense achieved in the first quarter of fiscal 2013, we expect operating expense for fiscal 2013 to increase from fiscal 2012 to support the global go-to-market coverage model and the need to maintain competitive compensation for our employees.

Reflecting the margin improvement and operating expense reductions above, our loss from operations for the first quarter of fiscal 2013 improved to $5.6 million, compared to a $21.9 million loss from operations during the fourth quarter of fiscal

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2012. Our net loss for the first quarter of fiscal 2013 was $47.3 million, or $0.47 per share. This compares to a net loss of $38.8 million or $0.39 per share, for the fourth quarter of fiscal 2012.

Due in part to the seasonal impacts noted above, including a larger portion of sales occurring later in the first fiscal quarter of 2013 and the timing of related collections activity, we used $45.7 million in cash from operations during the first quarter of fiscal 2013, consisting of $32.5 million in cash provided by net losses adjusted for non-cash charges and $78.2 million used in working capital. This compares with cash generated of $10.6 million in cash from operations during the fourth quarter of fiscal 2012, consisting of $23.7 million in cash provided by net losses adjusted for non-cash charges and $13.1 million used in working capital.

As of January 31, 2013, we had $552.3 million in cash and cash equivalents and $84.9 million of short-term investments in U.S. treasury securities. This compares to $550.5 million in cash and cash equivalents and $50.2 million of short-term investments in U.S. treasury securities at January 31, 2012 and $642.4 million in cash and cash equivalents and $50.1 million of short-term investments in U.S. treasury securities at October 31, 2012. Our 0.25% convertible senior notes will mature on May 1, 2013 and we expect to repay the remaining $216.2 million in aggregate principal outstanding during the second quarter of fiscal 2013.
As of January 31, 2013, we had 4,448 employees, a decrease from 4,481 at October 31, 2012 and an increase from 4,386 at January 31, 2012.

Consolidated Results of Operations

Operating Segments

For the reasons described in "Overview" above, during the first quarter of fiscal 2013, Ciena reorganized its internal organizational structure and the management of its business into the following new operating segments:

•
Converged Packet Optical — includes networking solutions optimized for the convergence of coherent optical transport, OTN switching and packet switching. These platforms enable automated packet-optical infrastructures that create and efficiently allocate high-capacity bandwidth for the delivery of a wide variety of enterprise and consumer-oriented network services. Products in this segment include the 6500 Packet-Optical Platform featuring Ciena's WaveLogic coherent optical processors. Products also include Ciena's family of CoreDirector® Multiservice Optical Switches, its 5430 Reconfigurable Switching System and its OTN configuration for the 5410 Reconfigurable Switching System. These products include multiservice, multi-protocol switching systems that consolidate the functionality of an add/drop multiplexer, digital cross-connect and packet switch into a single, high-capacity intelligent switching system. These products address both the core and metro segments of communications networks and support key managed services, Ethernet/TDM Private Line, Triple Play and IP services. 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.

•
Packet Networking — principally includes Ciena's 3000 family of service delivery switches and service aggregation switches, the 5000 series of service aggregation switches, and its Ethernet packet configuration for the 5410 Service Aggregation Switch. These products support the access and aggregation tiers of communications networks and have principally been deployed to support wireless backhaul infrastructures and business data services. Employing sophisticated, carrier-grade Ethernet switching technology, these products deliver quality of service capabilities, virtual local area networking and switching functions, and carrier-grade operations, administration, and maintenance features. This segment also includes legacy broadband products that transition voice networks to support Internet-based (IP) telephony, video services and DSL. 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 optical transport solutions that add capacity to core, regional and metro networks and enable cost-effective and efficient transport of voice, video and data traffic at high transmission speeds. Ciena's principal products in this segment include 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

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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 the Ciena One software suite, including OneControl, the integrated network and service management software designed to automate and simplify network management, operation and service delivery. These software solutions can track individual services across multiple product suites, facilitating planned network maintenance, outage detection and identification of customers or services affected by network performance. In addition to Ciena One, this segment includes the ON-Center® Network & Service Management Suite, Ethernet Services Manger, and the OMEA and Preside platforms from the MEN Business. This segment also includes a broad range of consulting and support services, including installation and deployment, maintenance support, consulting, network design 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.

Quarter ended January 31, 2012 compared to the quarter ended January 31, 2013
Revenue
The table below (in thousands, except percentage data) sets forth the changes in our operating segment revenue for the periods indicated:

 
Quarter Ended January 31,
 
Increase
 
 
 
2012
 
%*
 
2013
 
%*
 
(decrease)
 
%**
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Converged Packet Optical
$
202,044

 
48.5
 
$
239,960

 
53.0
 
$
37,916

 
18.8

Packet Networking
21,501

 
5.2
 
45,837

 
10.1
 
24,336

 
113.2

Optical Transport
107,656

 
25.8
 
57,597

 
12.7
 
(50,059
)
 
(46.5
)
Software and Services
85,484

 
20.5
 
109,699

 
24.2
 
24,215

 
28.3

Consolidated revenue
$
416,685

 
100.0
 
$
453,093

 
100.0
 
$
36,408

 
8.7

_____________________________
*    Denotes % of total revenue
**    Denotes % change from 2012 to 2013

•
Converged Packet Optical revenue increased reflecting a $47.0 million increase in sales of our 6500 Packet-Optical Platform, largely driven by service provider demand for high-capacity, optical transport for coherent 40G and 100G network infrastructures. In addition, sales of our 5430 reconfigurable switching system and the OTN configuration for the 5410 Reconfigurable Switching System increased by $5.5 million and $5.2 million respectively. These increases were partially offset by a $20.1 million decrease in sales of our CoreDirector® Multiservice Optical Switches. The strong performance of this segment, particularly as compared to the expected annual revenue declines in Optical Transport segment revenue, reflects the preference of network operators to adopt next-generation architectures that enable the convergence of high-capacity, coherent optical transport with integrated OTN switching and control plane functionality.
•
Packet Networking revenue increased reflecting increases of $18.0 million in sales of our 3000 and 5000 families of service delivery and aggregation switches and a $6.3 million increase in sales of our 5410 Service Aggregation Switch to support wireless backhaul, Ethernet business services and residential broadband applications. Segment revenue benefited from the expansion of Ethernet business services by our North American service provider customers and sales of service delivery and aggregation products in support of this effort.
•
Optical Transport revenue decreased reflecting sales decreases of $17.7 million in our 4200 Advanced Services Platform, $12.5 million of 5100/5200 Advanced Services Platform, $12.0 million in legacy transport products, $4.8 million of CPL and $3.0 million in our 6100 Multiservice Optical Platform. Revenue for our Optical Transport segment, which currently consists principally of stand-alone WDM and SONET/SDH-based transport platforms, has experienced meaningful declines in annual revenue in recent years, reflecting network operators' transition toward next-generation network architectures as described above.

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•
Software and Services revenue increased reflecting increases of $10.5 million in installation and deployment, $7.2 million in software sales, $4.6 million in network transformation consulting and $2.0 million in maintenance and support services revenue.

Revenue from sales to customers outside of the United States is reflected as International in the geographic distribution of revenue below. The table below (in thousands, except percentage data) sets forth the changes in geographic distribution of revenue for the periods indicated:

 
Quarter Ended January 31,
 
Increase
 
 
 
2012
 
%*
 
2013
 
%*
 
(decrease)
 
%**
United States
$
233,078

 
55.9
 
$
264,235

 
58.3
 
$
31,157

 
13.4
International
183,607

 
44.1
 
188,858

 
41.7
 
5,251

 
2.9
Total
$
416,685

 
100.0
 
$
453,093

 
100.0
 
$
36,408

 
8.7
_____________________________________
*    Denotes % of total revenue
**    Denotes % change from 2012 to 2013
•
United States revenue reflects increases of $22.6 million in Packet Networking sales, $11.6 million in Software and Services revenue and $9.8 million in Converged Packet Optical sales. These increases were partially offset by a decrease of $12.8 million in Optical Transport sales.
•
International revenue reflects increases of $28.1 million in Converged Packet Optical sales, $12.6 million in Software and Services revenue and $1.8 million in Packet Networking sales. These increases were offset by a decrease of $37.3 million in Optical Transport sales.

A sizable portion of our revenue continues to come from sales to a small number of service providers. As a result, our financial results are significantly affected by and can fluctuate depending upon spending levels and the business opportunities and challenges encountered by our service provider customers. Some of our customers have indicated a procurement strategy to reduce the number of vendors from which they purchase equipment, which could further affect our concentration of revenue where we participate in these efforts. For the first quarter of fiscal 2013, two customers accounted for greater than 10% of revenue and represented 26.4% of total revenue. This compares to one customer that accounted for 19.3% of total revenue in the first quarter of fiscal 2012.

Cost of Goods Sold and Gross Profit

Product cost of goods sold consists primarily of amounts paid to third-party contract manufacturers, component costs, employee-related costs and overhead, shipping and logistics costs associated with manufacturing-related operations, warranty and other contractual obligations, royalties, license fees, amortization of intangible assets, cost of excess and obsolete inventory and, when applicable, estimated losses on committed customer contracts.

Services cost of goods sold consists primarily of direct and third-party costs, including employee-related costs, associated with our provision of services including installation, deployment, maintenance support, consulting and training activities and when applicable, estimated losses on committed customer contracts.

Our gross profit as a percentage of revenue, or “gross margin,” is susceptible to fluctuations due to a number of factors. In any given period, gross margin can vary significantly depending upon the mix and concentration of revenue by segment, product line within a particular segment, geography, and customers. Gross margin can also be affected by our concentration of lower margin "commons" equipment sales and higher margin channel cards, the mix of lower margin installation services within our service revenue, our introduction of new products, and changes in expense for excess and obsolete inventory and warranty obligations. We expect that gross margins will be subject to fluctuation based on our level of success in driving product cost reductions, rationalizing our supply chain and consolidating third party contract manufacturers and distribution sites as part of our effort to optimize our operations. Gross margin can also be adversely affected by the level of pricing pressure and competition that we encounter in the market. In an effort to retain or secure customers, enter new markets or capture market share, we may agree to pricing or other unfavorable commercial terms that result in lower or negative gross margins on a particular order or group of orders. These market dynamics and factors may adversely affect our gross margins and results of operations in certain periods.

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Service gross margin can be affected by the mix of customers and services, particularly the mix between deployment and maintenance services, geographic mix and the timing and extent of any investments in internal resources to support this business.
The tables below (in thousands, except percentage data) set forth the changes in revenue, cost of goods sold and gross profit for the periods indicated:

 
Quarter Ended January 31,
 
Increase
 
 
 
2012
 
%*
 
2013
 
%*
 
(decrease)
 
%**
Total revenue
$
416,685

 
100.0
 
$
453,093

 
100.0
 
$
36,408

 
8.7
Total cost of goods sold
248,929

 
59.7
 
257,298

 
56.8
 
8,369

 
3.4
Gross profit
$
167,756

 
40.3
 
$
195,795

 
43.2
 
$
28,039

 
16.7
_____________________________________
*    Denotes % of total revenue
**    Denotes % change from 2012 to 2013

 
Quarter Ended January 31,
 
Increase
 
 
 
2012
 
%*
 
2013
 
%*
 
(decrease)
 
%**
Product revenue
$
333,673

 
100.0
 
$
353,057

 
100.0
 
$
19,384

 
5.8

Product cost of goods sold
197,752

 
59.3
 
196,521

 
55.7
 
(1,231
)
 
(0.6
)
Product gross profit
$
135,921

 
40.7
 
$
156,536

 
44.3
 
$
20,615

 
15.2

_____________________________________
*    Denotes % of product revenue
**    Denotes % change from 2012 to 2013

 
Quarter Ended January 31,
 
Increase
 
 
 
2012
 
%*
 
2013
 
%*
 
(decrease)
 
%**
Service revenue
$
83,012

 
100.0
 
$
100,036

 
100.0
 
$
17,024

 
20.5
Service cost of goods sold
51,177

 
61.7
 
60,777

 
60.8
 
9,600

 
18.8
Service gross profit
$
31,835

 
38.3
 
$
39,259

 
39.2
 
$
7,424

 
23.3
_____________________________________
*    Denotes % of services revenue
**    Denotes % change from 2012 to 2013

•
Gross profit as a percentage of revenue increased as a result of the factors described below.
•
Gross profit on products as a percentage of product revenue increased primarily due to improved mix of higher-margin packet platforms with software content, including within our Packet Networking and Converged Packet Optical segments, higher sales of integrated network service management software, lower warranty costs, lower excess and obsolete inventory charges and greater leverage from efforts to streamline and optimize our supply chain activities.
•
Gross profit on services as a percentage of services revenue increased primarily due to improved margins on installation and deployment services and increased consulting service revenue, including our Network Transformation Solutions offering. These margin improvements are due to operational efficiencies.
Operating Expense

Operating expense consists of the component elements described below.


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Research and development expense primarily consists of salaries and related employee expense (including share-based compensation expense), prototype costs relating to design, development, and testing of our products, depreciation expense and third-party consulting costs.

Sales and marketing expense primarily consists of salaries, commissions and related employee expense (including share-based compensation expense), and sales and marketing support expense, including travel, demonstration units, trade show expense and third-party consulting costs.

General and administrative expense primarily consists of salaries and related employee expense (including share-based compensation expense), and costs for third-party consulting and other services.

Amortization of intangible assets primarily reflects purchased technology and customer relationships from our acquisitions.

Restructuring costs primarily reflect actions Ciena has taken to better align its workforce, facilities and operating costs with perceived market opportunities, business strategies and changes in market and business conditions.

The table below (in thousands, except percentage data) sets forth the changes in operating expense for the periods indicated:

 
Quarter Ended January 31,
 
Increase
 
 
 
2012
 
%*
 
2013
 
%*
 
(decrease)
 
%**
Research and development
$
89,664

 
21.5
 
$
89,125

 
19.7
 
$
(539
)
 
(0.6
)
Selling and marketing
64,411

 
15.5
 
66,588

 
14.7
 
2,177

 
3.4

General and administrative
29,664

 
7.1
 
28,208

 
6.2
 
(1,456
)
 
(4.9
)
Amortization of intangible assets
13,471

 
3.2
 
12,453

 
2.7
 
(1,018
)
 
(7.6
)
Restructuring costs
1,722

 
0.4
 
5,030

 
1.1
 
3,308

 
192.1

Total operating expenses
$
198,932

 
47.7
 
$