Ciena 10Q 2004 Q2 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark one)

( x ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

For the quarterly period ended April 30, 2004

( ) 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		23-2725311
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

1201 Winterson Road, Linthicum, MD		21090
(Address of Principal Executive Offices)		(Zip Code)

(410) 865-8500
(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 (X) NO ( )

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES (X) NO ( )

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 May 18, 2004

Common stock. $.01 par value		567,680,002

CIENA CORPORATION

INDEX

FORM 10-Q


		PAGE NUMBER
PART I - FINANCIAL INFORMATION

Item 1.	Unaudited Consolidated Financial Statements

	Consolidated Statements of Operations Quarters and six months ended April 30, 2003 and April 30, 2004		3

	Consolidated Balance Sheets October 31, 2003 and April 30, 2004		4

	Consolidated Statements of Cash Flows six months ended April 30, 2003 and April 30, 2004		5

	Notes to Consolidated Financial Statements		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		33

Item 4.	Controls and Procedures		33


PART II - OTHER INFORMATION

Item 1.	Legal Proceedings		34

Item 2.	Changes in Securities and use of Proceeds		35

Item 3.	Defaults Upon Senior Securities		35

Item 4.	Submission of Matters to a Vote of Security Holders		35

Item 5.	Other Information		35

Item 6.	Exhibits and Reports on Form 8-K		35

Signatures			37

Item 1. Financial Statements

CIENA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)
(unaudited)


	Quarter Ended						Six Months Ended
	April 30,			April 30,			April 30,			April 30,
	2003			2004			2003			2004
Revenues:
Products	$	63,399		$	62,422		$	124,620		$	117,096
Services		10,141			12,277			19,394			24,017

Total revenue		73,540			74,699			144,014			141,113
Costs:
Products		40,406			56,289			79,983			90,849
Services		14,919			10,188			29,551			21,489

Total cost of goods sold		55,325			66,477			109,534			112,338

Gross profit		18,215			8,222			34,480			28,775

Operating expenses:
Research and development		52,193			46,479			105,927			93,656
Selling and marketing		25,663			25,075			52,268			50,543
General and administrative		8,066			5,992			22,772			13,083
Deferred stock compensation costs:
Research and development		3,406			1,408			7,204			3,613
Selling and marketing		676			415			1,435			933
General and administrative		346			79			720			200
Amortization of intangible assets		3,421			3,395			6,975			6,791
Restructuring costs		2,724			5,185			2,724			8,578
Recovery of use tax payments		—			(1,931	)		—			(1,931	)
Recovery of doubtful accounts, net		—			(2,794	)		—			(2,794	)

Total operating expenses		96,495			83,303			200,025			172,672

Loss from operations		(78,280	)		(75,081	)		(165,545	)		(143,897	)
Interest and other income, net		11,131			5,614			24,432			13,292
Interest expense		(8,061	)		(6,473	)		(20,264	)		(13,857	)
Gain (loss) on equity investments, net		—			139			(10	)		593
Loss on extinguishment of debt		—			—			(20,606	)		(8,216	)

Loss before income taxes		(75,210	)		(75,801	)		(181,993	)		(152,085	)
Provision for income taxes		251			415			610			839

Net loss	$	(75,461	)	$	(76,216	)	$	(182,603	)	$	(152,924	)

Basic and diluted net loss per common share and dilutive common share	$	(0.17	)	$	(0.16	)	$	(0.42	)	$	(0.32	)

Weighted average basic common and dilutive potential common shares outstanding		433,932			475,189			433,330			474,192

The accompanying notes are an integral part of these consolidated financial statements.

CIENA CORPORATION
CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)
(unaudited)


	October 31,			April 30,
	2003			2004
ASSETS
Current assets:
Cash and cash equivalents	$	309,665		$	218,145
Short-term investments		796,809			824,929
Accounts receivable, net		43,600			38,593
Inventories, net		44,995			34,457
Prepaid expenses and other		34,334			42,388

Total current assets		1,229,403			1,158,512
Long-term investments		519,744			416,199
Equipment, furniture and fixtures, net		114,930			100,123
Goodwill		336,039			335,974
Other intangible assets, net		108,408			99,681
Other long-term assets		69,641			67,346

Total assets	$	2,378,165		$	2,177,835

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	44,402		$	38,532
Accrued liabilities		98,926			89,797
Restructuring liabilities		14,378			12,605
Unfavorable lease commitments		9,380			9,467
Income taxes payable		4,640			5,596
Deferred revenue		14,473			16,373

Total current liabilities		186,199	��		172,370
Long-term deferred revenue		14,547			16,964
Long-term restructuring liabilities		52,164			45,888
Long-term unfavorable lease commitments		61,312			56,362
Other long-term obligations		2,698			2,741
Convertible notes payable		730,428			690,000

Total liabilities		1,047,348			984,325

Commitments and contingencies
Stockholders’ equity:
Preferred stock – par value $0.01; 20,000,000 shares authorized; zero shares issued and outstanding		—			—
Common stock – par value $0.01; 980,000,000 shares authorized; 473,214,856 and 476,940,672 shares issued and outstanding		4,732			4,769
Additional paid-in capital		4,861,182			4,874,950
Deferred stock compensation		(9,664	)		(4,572	)
Notes receivable from stockholders		(448	)		(448	)
Accumulated other comprehensive income (loss)		2,447			(833	)
Accumulated deficit		(3,527,432	)		(3,680,356	)

		1,330,817			1,193,510

Total liabilities and stockholders’ equity	$	2,378,165		$	2,177,835

The accompanying notes are an integral part of these consolidated financial statements.

CIENA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
(unaudited)


	Six Months Ended April 30,
	2003			2004
Cash flows from operating activities:
Net loss	$	(182,603	)	$	(152,924	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Early extinguishment of debt		20,606			8,216
Amortization of premium (discount) on marketable securities		—			15,868
Non-cash impairment from equity transactions		10			(593	)
Non-cash portion of restructuring charges and related asset write-downs		16,040			814
Accretion of notes payable		4,527			599
Effect of accumulated translation adjustment		(2,254	)		(76	)
Depreciation and amortization of leaseholds improvements		43,041			27,639
Amortization of intangibles, deferred stock compensation and debt issuance costs		19,195			15,085
Provision (benefit) for inventory excess and obsolescence		(4,103	)		1,082
Provision for warranty and other contractual obligations		3,405			4,996
Provision for doubtful accounts		—			284
Changes in assets and liabilities:
Accounts receivable		(3,752	)		4,723
Prepaid expenses and other		(2,692	)		(6,615	)
Inventories		19,191			9,456
Accounts payable and accrued liabilities		(51,114	)		(33,009	)
Income taxes payable		5,258			956
Deferred revenue and other obligations		1,853			4,317

Net cash used in operating activities		(113,392	)		(99,182	)

Cash flows from investing activities:
Additions to equipment, furniture and fixtures		(14,195	)		(13,646	)
Maturities of available for sale securities		718,521			389,877
Purchases of available for sale securities		(325,483	)		(333,524	)

Net cash provided by investing activities		378,843			42,707

Cash flows from financing activities:
Net proceeds from (repayment of) other obligations		(914	)		46
Repayment of convertible subordinated notes payable		(139,211	)		(49,243	)
Proceeds from issuance of common stock		5,326			14,152
Repayment of notes receivable from stockholders		1,566			—

Net cash used in financing activities		(133,233	)		(35,045	)

Net increase (decrease) in cash and cash equivalents		132,218			(91,520	)
Cash and cash equivalents at beginning of period		377,189			309,665

Cash and cash equivalents at end of period	$	509,407		$	218,145

The accompanying notes are an integral part of these consolidated financial statements.

CIENA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(1) INTERIM FINANCIAL STATEMENTS

The interim financial statements included herein for CIENA Corporation (the “Company” or “CIENA”) have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, financial statements included in this report reflect all normal recurring adjustments which the Company considers necessary for the fair presentation of the results of operations for the interim periods covered and of the financial position of the Company at the date of the interim balance sheet. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to understand the information presented. 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 the Company’s October 31, 2003 audited consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the fiscal year ended October 31, 2003.

(2) SIGNIFICANT ACCOUNTING POLICIES

Segment Reporting

In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 (“SFAS 131”), “Disclosures about Segments of an Enterprise and Related Information.” SFAS 131 establishes annual and interim reporting standards for operating segments of a company. Effective as of the second quarter of fiscal 2004, CIENA reorganized its operations into multiple operating segments for the purpose of making operating decisions and assessing performance. Those operating segments are the following: Core Networking Group (CNG); Metro and Enterprise Solutions Group (MESG); and Data Networking Group (DNG). The Company’s operating segments have similar economic characteristics and are similar in each of the following areas: the nature of the products and services; the nature of the production processes; the type or class of customer that purchases their products and services; and the nature of the regulatory environment. Accordingly, CIENA has aggregated information related to CNG, MESG and DNG for reporting purposes into one reportable segment and reports only certain enterprise-wide disclosures

Impairment of Goodwill and Other Long-Lived Assets

Effective November 1, 2001, CIENA adopted Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) and ceased to amortize goodwill. As of April 30, 2004, CIENA’s assets include $336.0 million related to goodwill. SFAS 142 requires that we assign goodwill to the Company’s operating segments and to test each segment’s goodwill for impairment on an annual basis, and between annual tests if an event occurs or circumstances change that would, more likely than not, reduce the fair value of the segment below its carrying value. Prior to the reorganization of the Company into operating segments the fair value of CIENA’s goodwill was tested for impairment on an annual basis, and between annual tests if an event occurs or circumstances change that would, more likely than not, reduce the fair value of CIENA on an entity level, rather than a segment level, below its carrying value.

Pro forma stock-based compensation

The Company has elected to continue to account for its stock-based compensation in accordance with the provisions of APB 25 as interpreted by FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25,” (“FIN 44”).

Had compensation cost for the Company’s stock option plans and employee stock purchase plan been determined based on the Black-Scholes valuation method and the fair value at the grant date for awards in the second quarter and first six months of fiscal 2003 and 2004 been determined consistent with the provisions of Statement of Financial Accounting Standard No. 123 (“SFAS 123”), “Accounting for Stock Based Compensation” as amended by Statement of Financial Accounting Standard No. 148 (“SFAS 148”), “Accounting for Stock Based Compensation-Transition and Disclosure,” the Company’s net loss and net loss per share for the second quarter of fiscal 2003 and 2004 would have increased to the pro forma amounts indicated below (in thousands, except per share data):


	Quarter ended April 30,						Six Months Ended April 30,
	2003			2004			2003			2004
Net loss applicable to common stockholders – as reported	$	(75,461	)	$	(76,216	)	$	(182,603	)	$	(152,924	)

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(19,958	)		(13,576	)		(48,752	)		(21,786	)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		4,428			1,902			9,359			4,746

Net loss applicable to common stockholders – pro forma	$	(90,991	)	$	(87,890	)	$	(221,996	)	$	(169,964	)

Basic and diluted net loss per share – as reported	$	(0.17	)	$	(0.16	)	$	(0.42	)	$	(0.32	)

Basic and diluted net loss per share – pro forma	$	(0.21	)	$	(0.18	)	$	(0.51	)	$	(0.36	)

The above pro forma disclosures are not necessarily representative of the effects on reported net income or loss for future years.

(3) RESTRUCTURING COSTS

The Company’s actions were taken to align its workforce, facilities and operating costs with business operations. Prior to the adoption of Statement of Financial Accounting Standard No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities,” for transactions initiated after December 31, 2002, CIENA followed the guidance of Emerging Issues Task Force Issue No. 9413 (“EITF 94-3”), “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” for restructuring charges. However, given the manner in which CIENA undertook such restructuring activities, there have been no significant differences in financial reporting. The Company historically has committed to a plan and incurred the liability concurrently – meeting the criteria of both EITF 94-3 and SFAS 146 consistently. The following table displays the activity and balances of the restructuring reserve account for the period ended April 30, 2004 (in thousands):


							Liabilities recorded
							in connection with
	Workforce			Consolidation of			purchase
	reduction			excess facilities			combination			Total
Balance at October 31, 2002	$	5,199		$	87,845		$	121		$	93,165
Additional reserve recorded		12,240	(a)		19,748	(a)		430	(b)		32,418
Adjustments to previous estimates		(523	) (a)		(310	) (a)		—			(833	)
Non-cash charges		(1,913	)		(28,485	) (d)		—			(30,398	)
Cash payments		(12,154	)		(15,105	)		(551	)		(27,810	)

Balance at October 31, 2003		2,849			63,693			—			66,542
Additional reserve recorded		3,915	(c)		1,337	(c)		—			5,252
Adjustments to previous estimates		154	(c)		3,172	(c)		—			3,326
Cash payments		(5,263	)		(11,364	)		��			(16,627	)

Balance at April 30, 2004		1,655			56,838			—			58,493

Current restructuring liabilities	$	1,655		$	10,950		$	—		$	12,605

Non-current restructuring liabilities	$	—		$	45,888		$	—		$	45,888

(a)		During the second quarter of fiscal 2003, CIENA reduced its workforce by approximately 75 employees. CIENA recorded a restructuring charge of $2.7 million associated with the workforce reduction.

		During the third quarter of fiscal 2003, CIENA recorded a restructuring charge of $15.5 million associated with a workforce reduction of approximately 84 employees, lease terminations, non-cancelable lease costs and the write-down of certain property, equipment and leasehold improvements.

		During the fourth quarter of fiscal 2003, CIENA recorded a restructuring charge of $12.9 million associated with a workforce reduction of approximately 231 employees, lease termination, non-cancelable lease costs and the write-down of certain property, equipment and leasehold improvements.

(b)		During the third quarter of fiscal 2003, CIENA and WaveSmith reduced their combined workforce by 8 employees. Approximately $0.4 million of cost associated with the WaveSmith workforce reduction qualify for treatment under EITF 95-3 “Recognition of Liabilities in Connection with a Purchase Combination” and were recorded as an element of the acquisition.

(c)		During the first quarter of fiscal 2004, CIENA incurred charges of $3.4 million related to the exit of a warehouse, work force reductions of approximately 52 employees and adjustments to previous estimates.

		During the second quarter of fiscal 2004, CIENA recorded a restructuring charge of $5.9 million related to a workforce reduction of approximately 68 employees and an adjustment to an estimate of previously restructured facilities.

(d)		Non-cash charges during fiscal 2003 include the disposal of previously reserved property and equipment.

On April 20, 2004, the Company announced its intention to close its San Jose, California facility by September 30, 2004. The San Jose facility closing, and related actions will affect approximately 425 employees. The Company expects to incur additional restructuring costs and accelerated amortization of leasehold costs of between $75.0 million and $85.0 million associated with this action. The Company expects these costs to include employee severance costs, and asset write-downs. The timing of the restructuring charges will correspond to the specific actions and will likely occur over the next several fiscal quarters.

(4) MARKETABLE DEBT AND EQUITY SECURITIES

Cash, short-term and long-term investments are comprised of the following (in thousands):


	April 30, 2004
			Gross		Gross
			Unrealized		Unrealized		Estimated Fair
	Amortized Cost		Gains		Losses		Value
Corporate bonds	$	479,690	$	198		534	$	479,354
Asset backed obligations		237,185		276		—		237,461
Commercial paper		—		—		—		—
US government obligations		524,665		469		821		524,313
Money market funds		218,145		—		—		218,145

	$	1,459,685	$	943	$	1,355	$	1,459,273

Included in cash and cash equivalents		218,145	$	—		—		218,145
Included in short-term investments		824,015		914		—		824,929
Included in long-term investments		417,525		29		1,355		416,199

	$	1,459,685	$	943	$	1,355	$	1,459,273


	October 31, 2003
			Gross		Gross
			Unrealized		Unrealized		Estimated Fair
	Amortized Cost		Gains		Losses		Value
Corporate bonds	$	617,837	$	787	$	163	$	618,461
Asset-backed obligations		161,474		322		—		161,796
Municipal bonds		5,024		7		—		5,031
Commercial paper		10,487		2		28		10,461
US government obligations		518,609		2,095		229		520,475
Money market funds		309,994		—		—		309,994

	$	1,623,425	$	3,213	$	420	$	1,626,218

Included in cash and cash equivalents		309,665		—		—		309,665
Included in short-term investments		793,807		3,012		10		796,809
Included in long-term investments		519,953		201		410		519,744

	$	1,623,425	$	3,213	$	420	$	1,626,218

The following table summarizes maturities of debt investments (including restricted investments) at April 30, 2004 (in thousands):


			Estimated Fair
	Amortized Cost		Value
Less than one year	$	824,015	$	824,929
Due in 1-2 years		417,525		416,199
Due in 2-5 years		—		—

	$	1,241,540	$	1,241,128

(5) ACCOUNTS RECEIVABLE

As of April 30, 2004, the trade accounts receivable, net of allowance for doubtful accounts, included one customer who accounted for 26.0% of the trade accounts receivable. As of October 31, 2003, the trade accounts receivable, net of allowance for doubtful accounts, included three customers who accounted for 23.6%, 12.5% and 10.1% of the net trade accounts receivable, respectively.

CIENA performs ongoing credit evaluations of its customers and generally has not required collateral or other forms of security from its customers. CIENA maintains an allowance for potential losses on a specific identification basis. During the first six months of fiscal 2004, the Company recovered $3.1 million from a customer, from which payment was previously deemed doubtful due to the customer’s financial condition. The Company also recorded an allowance for doubtful accounts during the first six months of fiscal 2004 of $0.3 million. CIENA’s allowance for doubtful accounts as of April 30, 2004 and October 31, 2003 was $1.7 and $1.5 million, respectively.

(6) INVENTORIES

Inventories are comprised of the following (in thousands):


	October 31,			April 30,
	2003			2004
Raw materials	$	16,121		$	14,646
Work-in-process		5,904			3,413
Finished goods		46,063			36,530

Gross inventories		68,088			54,589
Reserve for excess and obsolescence		(23,093	)		(20,132	)

Net inventories	$	44,995		$	34,457

The Company writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. During the six months ended April 30, 2004, CIENA recorded a provision for inventory reserves of $1.1 million primarily related to excess inventory due to a change in forecasted sales for certain products. The following is a summary of the change in the reserve for excess inventory and obsolete inventory during the six months ended April 30, 2004 (in thousands):


	Inventory Reserve
Reserve balance as of Oct. 31, 2003	$	23,093
Provision for excess inventory, net		1,082
Actual inventory scrapped		(4,043	)

Reserve balance as of April 30, 2004	$	20,132

During the six months ended April 30, 2003, CIENA recorded a benefit for inventory reserves of $4.1 million primarily related to the realization of sales from previously reserved excess inventory. The following is a summary of the change in the reserve for excess inventory and obsolete inventory during the six months ended April 30, 2003 (in thousands):


	Inventory Reserve
Reserve balance as of Oct. 31, 2002	$	48,145
Realization of sales from previously reserved excess inventory, net		(4,103	)
Actual inventory scrapped		(12,550	)

Reserve balance as of April 30, 2003	$	31,492

(7) EQUIPMENT, FURNITURE AND FIXTURES

Equipment, furniture and fixtures are comprised of the following (in thousands):


	October 31,			April 30,
	2003			2004
Equipment, furniture and fixtures	$	332,843		$	329,284
Leasehold improvements		70,145			70,065

		402,988			399,349
Accumulated depreciation and amortization		(288,170	)		(299,253	)
Construction-in-progress		112			27

	$	114,930		$	100,123

During the second quarter of fiscal 2004 the company recorded $1.7 million in accelerated amortization expense of leasehold improvements related to the planned exit of its San Jose, California facility.

(8) OTHER INTANGIBLE ASSETS

Other intangible assets are comprised of the following (in thousands):


	October 31, 2003							April 30, 2004
	Gross		Accumulated			Net		Gross		Accumulated			Net
	Intangible		Amortization			Intangible		Intangible		Amortization			Intangible
Developed technology	$	94,704	$	(22,975	)	$	71,729	$	94,704	$	(28,769	)	$	65,935
Patents and licenses		36,655		(8,984	)		27,671		36,655		(10,919	)		25,736
Covenants not to compete, outstanding purchase orders and contracts		12,700		(3,692	)		9,008		12,700		(4,690	)		8,010

	$	144,059				$	108,408	$	144,059				$	99,681

The aggregate amortization expense of other intangible assets was $4.4 million and $4.4 million for the quarters ended April 30, 2003 and 2004, respectively. The following table represents the expected future amortization of other intangible assets as follows (in thousands):


2004 (remaining six months)	$	8,726
2005		17,453
2006		17,452
2007		17,453
2008		16,107
Thereafter		22,490

	$	99,681

(9) OTHER BALANCE SHEET DETAILS

Other long-term assets (in thousands):


	October 31,		April 30,
	2003		2004
Maintenance spares inventory, net	$	26,206	$	22,125
Deferred debt issuance costs		12,869		11,355
Investments in privately held companies		21,292		21,292
Other		9,274		12,574

	$	69,641	$	67,346

Accrued liabilities (in thousands):


	October 31,		April 30,
	2003		2004
Warranty and other contractual obligations	$	37,380	$	33,951
Accrued compensation, payroll related tax and benefits		33,206		28,753
Accrued excess inventory purchase commitments		1,405		1,009
Accrued interest payable		6,583		6,469
Other		20,352		19,615

	$	98,926	$	89,797

The following table summarizes the activity in the Company’s accrued warranty and other contractual obligations for the six months ended April 30, 2003 and 2004 (in thousands):


	Balance at							Balance at
Six Months ended April 30	beginning of period		Provisions		Settlements			end of period
2003	$	45,498		3,405		(8,131	)	$	40,772
2004	$	37,380		4,996		(8,425	)	$	33,951

Deferred revenue (in thousands):


	October 31,			April 30,
	2003			2004
Products	$	4,772		$	6,709
Services		24,248			26,628

Total deferred revenue		29,020			33,337
Less current portion		(14,473	)		(16,373	)

Long-term deferred revenue	$	14,547		$	16,964

(10) CONVERTIBLE NOTES PAYABLE

On December 19, 2003, CIENA purchased the remaining $48.2 million outstanding ONI Systems Corp. convertible subordinated notes. The Company paid $49.2 million for notes with a cumulative accreted book value of $41.0 million, which resulted in a loss on early extinguishment of debt of $8.2 million.

(11) EARNINGS (LOSS) PER SHARE CALCULATION

Basic EPS is computed using the weighted average number of common shares outstanding. Diluted EPS is computed using the weighted average number of common shares outstanding, stock options and warrants using the treasury stock method. Approximately 40.1 million and 34.2 million options and unvested restricted stock were outstanding during the second quarters of fiscal 2003 and 2004 respectively, but were not included in the computation of diluted EPS as the effect would be anti-dilutive.

Approximately 35.9 million and 33.4 million options and unvested restricted stock were outstanding during the first six months of fiscal 2003 and 2004 respectively, but were not included in the computation of diluted EPS as the effect would be anti-dilutive.

(12) COMPREHENSIVE INCOME

The components of comprehensive loss are as follows (in thousands):


	Quarter ended April 30,						Six months ended April 30,
	2003			2004			2003			2004
Net loss	$	(75,461	)	$	(76,216	)	$	(182,603	)	$	(152,924	)
Change in unrealized loss on available-for-sale securities, net of tax		(1,641	)		(3,257	)		(1,331	)		(3,204	)
Change in accumulated translation adjustments		129			(48	)		202			(76	)

Total comprehensive loss	$	(76,973	)	$	(79,521	)	$	(183,732	)	$	(156,204	)

(13) SEGMENT REPORTING

Effective as of the second quarter of fiscal 2004, CIENA reorganized its operations into multiple operating segments for the purpose of making operating decisions and assessing performance. Those operating segments are the following: Core Networking Group (CNG); Metro and Enterprise Solutions Group (MESG); and Data Networking Group (DNG). Each operating group includes products for sale to external customers, the related research and development and product line management. CNG incorporates CIENA’s core transport and core switching product lines. MESG incorporates CIENA’s metropolitan transport, metropolitan switching, storage extension, and LightWorks ON-Center management suite product lines. DNG incorporates CIENA’s multiservice networking product lines and Laurel Networks, Inc. and Luminous Networks, Inc. products that CIENA resells.

On May 3, 2004, CIENA completed the acquisitions of Catena Networks, Inc. and Internet Photonics, Inc. Internet Photonics’ product lines will be incorporated into MESG, and Catena’s product lines will form a new operating segment, the Broadband Access Group (BBG). The CNG, MESG and DNG operating segments have similar economic characteristics and are similar in each of the following areas: the nature of the products and services; the nature of the production processes; the type or class of customer that purchases their products and services; and the nature of the regulatory environment. Accordingly, CIENA has aggregated information related to CNG, MESG and DNG for reporting purposes into one reportable segment and reports only certain enterprise-wide disclosures.

CIENA’s geographic distribution of revenue for the quarter and six months ended April 30, 2003 and 2004 are as follows (in thousands):


	Quarter Ended April 30,								Six Months Ended April 30,
	2003		%		2004		%		2003		%		2004		%
Domestic	$	50,371		68.5	$	58,033		77.7	$	95,073		66.0	$	95,316		67.5
International		23,169		31.5		16,666		22.3		48,941		34.0		45,797		32.5

Total	$	73,540		100.0	$	74,699		100.0	$	144,014		100.0	$	141,113		100.0

CIENA’s revenue derived from products and services for the quarter and six months ended April 30, 2003 and 2004 are as follows (in thousands):


	Quarter Ended April 30,								Six Months Ended April 30,
	2003		%		2004		%		2003		%		2004		%
Products	$	63,399		86.2	$	62,422		83.6	$	124,620		86.5	$	117,096		83.0
Services		10,141		13.8		12,277		16.4		19,394		13.5		24,017		17.0

Total	$	73,540		100.0	$	74,699		100.0	$	144,014		100.0	$	141,113		100.0

During the quarter and six months ended April 30, 2003 and 2004, customers who each accounted for at least 10% of CIENA’s revenue during the respective periods are as follows (in thousands):


	Quarter Ended April 30,								Six Months Ended April 30,
	2003		%**		2004		%**		2003		%**		2004		%**
Company A	$	*		—	$	24,023		32.2	$	*		—	$	27,826		19.7
Company B		*		—		*		—		*		—		14,805		10.5
Company C		12,540		17.1		*		—		26,811		18.6		*		—
Company D		11,001		15.0		*		—		19,346		13.4		*		—
Company E		*		—		*		—		17,948		12.5		*		—
Company F		8,336		11.3		*		—		*		—		*		—

Total	$	31,877		43.4	$	24,023		32.2	$	64,105		44.5	$	42,631		30.2

* – denotes revenue recognized less than 10% of total revenue for the period.

** – denotes % of total revenue

(14) CONTINGENCIES

Litigation

On October 3, 2000, Stanford University and Litton Systems filed a complaint in the United States District Court for the Central District of California alleging that optical fiber amplifiers incorporated into CIENA’s products infringe U.S. Patent No. 4,859,016 (the “`016 Patent”). The complaint seeks injunctive relief, royalties and damages. We believe that we have valid defenses to the lawsuit and intend to defend it vigorously. On October 10, 2003, the court stayed the case pending final resolution of matters before the U.S. Patent and Trademark Office (the “PTO”), including a request for and disposition of a reexamination of the ‘016 Patent. On October 16, 2003, the PTO granted reexamination of the ‘016 Patent, thus resulting in a continuation of the stay of the case.

On July 19, 2000, CIENA and CIENA Properties, Inc., a wholly owned subsidiary of CIENA, filed a complaint in the United States District Court for the District of Delaware requesting damages and injunctive relief against Corvis Corporation (“Corvis”). The suit charged Corvis with infringing four patents relating to CIENA’s optical networking communication systems and technology. A jury trial to determine whether Corvis is infringing these patents commenced on February 10, 2003. On February 24, 2003, the jury decided that Corvis was infringing one of the patents and not infringing two others. The jury was deadlocked with respect to infringement on the fourth patent. This trial was immediately followed by a trial on Corvis’ affirmative defenses based on the validity of two of the patents. On February 28, 2003, the jury in this trial determined that the patents were valid. In April 2003, following a third trial, another jury decided that Corvis had infringed the fourth patent on which the previous jury had deadlocked. Based on these favorable verdicts collectively holding that Corvis is infringing two valid CIENA patents, CIENA has moved for an injunction to prohibit the sale, manufacture, or use by Corvis of the infringing products. The court has not yet ruled on this motion.

As a result of the merger with ONI, we became a defendant in a securities class action lawsuit. Beginning in August 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United States District Court for the Southern District of New York. These complaints name ONI, Hugh C. Martin, ONI’s former chairman, president and chief executive officer; Chris A. Davis, ONI’s former executive vice president, chief financial officer and administrative officer; and certain underwriters of ONI’s initial public offering as defendants. The complaints were consolidated into a single action, and a consolidated amended complaint was filed on April 24, 2002. The amended complaint alleges, among other things, that the underwriter defendants violated the securities laws by failing to disclose alleged compensation arrangements (such as undisclosed commissions or stock stabilization practices) in the initial public offering’s registration statement and by engaging in manipulative practices to artificially inflate the price of ONI’s common stock after the initial public offering. The amended complaint also alleges that ONI and the named former officers violated the securities laws on the basis of an alleged failure to disclose the underwriters’ alleged compensation arrangements and manipulative practices. No specific amount of damages has been claimed. Similar complaints have been filed against more than 300 other issuers that have had initial public offerings since 1998, and all of these actions have been included in a single coordinated proceeding. Mr. Martin and Ms. Davis have been dismissed from the action without prejudice pursuant to a tolling agreement. In July 2002, ONI and other issuers in the consolidated cases filed motions to dismiss the amended complaint for failure to state a claim, which was denied as to ONI on February 19, 2003. CIENA has participated, together with the other issuer defendants in these cases, in mediated settlement negotiations that have led to a preliminary agreement among the plaintiffs, the issuer defendants and their insurers. The settlement, which is subject to court approval, would result in the dismissal of the plaintiffs’ cases against the issuers. CIENA has agreed in principle to the terms of this settlement. Draft settlement documents were circulated for final review in March 2004.

Court of the State of California, County of San Mateo, and is encaptioned K.W. Sams, On Behalf of Himself and All Others Similarly Situated v. ONI Systems Corporation, et al. The second case was brought on March 19, 2002, in the Superior Court of the State of California, County of Santa Clara, and is encaptioned Steven Myeary, On Behalf of Himself and All Others Similarly Situated v. ONI Systems Corporation. On April 14, 2003, the plaintiffs in these cases filed a consolidated amended complaint and named four additional defendants: CIENA Corporation, James F. Jordan, Kleiner Perkins Caufield & Byers and Mohr Davidow Ventures. CIENA and the other defendants subsequently filed a demurrer and served a motion for sanctions on plaintiffs based on factual inaccuracies in the consolidated amended complaint. In response, the plaintiffs filed a corrected consolidated amended complaint, the demurrer to which was sustained by the court in April 2004 with leave to amend. We believe that these lawsuits are without merit and will continue to defend them vigorously.

(15) SUBSEQUENT EVENTS

On May 3, 2004, the Company acquired Catena Networks and Internet Photonics. As a result of these acquisitions the Company expects to record charges for in-process research and development and record intangible assets related existing technology, customer relationships, customer contracts and customer order backlog. The Company expects to complete its tangible and intangible asset and liability assessments, with the help of third party valuation findings, associated with the acquisitions during the third quarter of fiscal 2004.

Under the terms of the agreement to acquire Catena, all the outstanding shares of Catena common stock, preferred stock and outstanding stock options and warrants were exchanged for 75.9 million shares of CIENA common stock. The Company expects to record an aggregate purchase price of approximately $466.1 million for Catena. The purchase price for this acquisition was based on the average closing price of CIENA’s common stock for two trading days prior to, the date of, and the two trading days after the February 19, 2004 announcement.

Under the terms of the agreement to acquire Internet Photonics, all the outstanding shares of Internet Photonics common stock, preferred stock and outstanding stock options and warrants were exchanged for 24.1 million shares of CIENA common stock. The Company expects to record an aggregate purchase price of approximately $148.2 million for Internet Photonics. The purchase price for this acquisition was based on the average closing price of CIENA’s common stock for two trading days prior to, the date of, and the two trading days after the February 19, 2004 announcement.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains, forward-looking statements that involve risks and uncertainties. Under the heading “Risk Factors,” we have described what we believe to be some of the major risks related to these forward-looking statements, as well as the general outlook for our business. Investors should review these risk factors and the rest of this quarterly report in combination with the more detailed description of our business in our annual report on Form 10-K, which we filed with the Securities and Exchange Commission on December 11, 2003, for a more complete understanding of the risks associated with an investment in the Company’s Common Stock.

Overview

CIENA is a leading global provider of innovative network solutions. Our existing and potential customers include:

•		communications carriers including regional bell operating companies (RBOCs), independent operating companies (IOCs), competitive local exchange carriers (CLECs), long-distance carriers, wireless carriers and wholesale carriers;

•		other communications service providers including cable operators and Internet service providers;

•		enterprises including large businesses, educational and non-profit institutions;

•		federal, state and local governments; and

•		integrators and resellers.

In early 2001, the telecommunications industry began a severe decline, and our dominant customer base, communications carriers, responded by curtailing network build-outs and reducing their overall capital expenses. As a result, the market for our core networking products declined sharply. After several years of significantly lower capital spending, most carriers’ operating costs remain high while their revenue is growing slowly, if at all.

In this environment, we expect that most major carriers will hold their aggregate capital spending flat for the next several years and will not invest substantially in building new core networks or upgrading existing ones. Instead, we believe that carriers, other communications service providers, enterprises and governments will make significant investments in next-generation equipment, particularly equipment that resides at the edge of communications networks and enables the creation and delivery of new high-bandwidth data services. As a result, we have undertaken a number of efforts to expand our addressable market including making acquisitions, establishing partnerships with other equipment suppliers and investing internal resources towards developing, marketing and selling products that address this broader market.

As part of our strategy to increase our addressable market, we completed the acquisitions of Catena Networks and Internet Photonics on May 3, 2004. Catena’s broadband access solutions enable the delivery of traditional “plain old telephone service” (POTS), digital subscriber line service (DSL), and voice-over-IP (VoIP) from a single, integrated platform. Prior to the acquisition, Catena’s customers included RBOCs, major IOCs and CLECs. Internet Photonics has sold its carrier-grade optical Ethernet transport and switching solutions to several large cable providers and carriers who use Internet Photonics’ solutions to deploy Ethernet private-line services. The broadband access markets served by both Catena and Internet Photonics’ products are expected to benefit as service providers shift spending to target the access portions of their networks to enable increased residential access to high-bandwidth services such as DSL, video-on-demand and high definition television (HDTV).

As a result of the Catena and Internet Photonics acquisitions, we expect to incur additional ongoing costs related to product development, selling, and marketing activities. In addition, we expect to incur costs associated with these acquisitions related to amortization of purchased intangible assets, in-process research and development and deferred stock compensation.

Also in pursuit of our strategy, we expect to continue our efforts to reduce our ongoing operating costs in order to better align them with our market opportunities and changing product mix. On April 20, 2004, we announced our intention to close our San Jose, California facility by September 30, 2004. Over the next two fiscal quarters we expect to incur additional restructuring costs and accelerated amortization of leasehold cost of between $75.0 million and $85.0 million associated with this action.

We reported revenue of $74.7 million for the second quarter of fiscal 2004. This was an increase of 12.5% from the first quarter of fiscal 2004 and 1.6% from second quarter of fiscal 2003. We expect revenue for the third quarter of fiscal 2004 will increase by as much as 30 percent from the second quarter of fiscal 2004 primarily as a result of the inclusion of revenue from Catena and Internet Photonics products for the first time.

Our margins can fluctuate substantially from quarter to quarter based on a number of factors, including the mix of products and services we sell and the customers to which we sell them; the volume of products and services we sell; and the amount of provisions or benefits we may incur related to excess inventory costs. Our gross margin for the second quarter of fiscal 2004 was 11% compared to 30.9% for the first quarter of fiscal 2004 and 23.1% for the second quarter of fiscal 2003. The decline in gross margin for the second quarter of fiscal 2004 compared to the first quarter was due primarily to the increased percentage of revenue from core transport systems in the second quarter. The decline in gross margin from the same period a year ago was due to a combination of the increased percentage of revenue from core transport systems and a lower percentage of revenue from core switching systems than in the second quarter of fiscal 2003.Gross margin in the second quarter of fiscal 2004 was also adversely affected by revenues associated with initial deployments of long-haul transport equipment for two significant customers. This equipment, which includes “common equipment” such as chassis and amplifiers, tends to have lower margins than channel cards and other equipment deployed later in the network build. We expect, therefore, that the margins on sales associated with these two projects will improve over time.

As of April 30, 2004, CIENA had 1,702 employees, which was a net reduction of 76 employees from the 1,778 employees on January 31, 2004. We expect to reduce our headcount by approximately 425 employees related to the exiting of the San Jose, California facility. Catena and Internet Photonics will add an aggregate of approximately 380 employees to CIENA in the third quarter of fiscal 2004.

Results of Operations

Three months ended April 30, 2003 compared to three months ended April 30, 2004

Revenue, cost of goods sold and gross profit

The table below (in thousands, except percentage data) sets forth the changes in revenue, cost of goods sold and gross profit from the second quarter of fiscal 2003 to the second quarter of fiscal 2004.


	Second Quarter
									Increase
	2003		%*		2004		%*		(decrease)			%**
Revenue:
Products	$	63,399		86.2	$	62,422		83.6	$	(977	)		(1.5	)
Services		10,141		13.8		12,277		16.4		2,136			21.1

Total Revenue:		73,540		100.0		74,699		100.0		1,159			1.6

Costs:
Products		40,406		54.9		56,289		75.4		15,883			39.3
Services		14,919		20.3		10,188		13.6		(4,731	)		(31.7	)

Total cost of goods sold		55,325		75.2		66,477		89.0		11,152			20.2

Gross Profit	$	18,215		24.8	$	8,222		11.0	$	(9,993	)		54.9

* - Denotes % of total revenue

** - Denotes % change from 2003 to 2004

The table below (in thousands, except percentage data) sets forth the changes in product revenue, product cost of goods sold and product gross profit from the second quarter of fiscal 2003 to the second quarter of fiscal 2004.


	Second Quarter
									Increase
	2003		%*		2004		%*		(decrease)			%**
Product revenue	$	63,399		100.0	$	62,422		100.0	$	(977	)		(1.5	)
Product cost of goods sold		40,406		63.7		56,289		90.2		15,883			39.3

Product gross profit	$	22,993		36.3	$	6,133		9.8	$	(16,860	)		(73.3	)

* - Denotes % of product revenue

** - Denotes % change from 2003 to 2004

The table below (in thousands, except percentage data) sets forth the changes in service revenue, service cost of goods sold and service gross profit (loss) from the second quarter of fiscal 2003 to the second quarter of fiscal 2004.


	Second Quarter
											Increase
	2003			%*			2004		%*		(decrease)			%**
Service revenue	$	10,141			100.0		$	12,277		100.0	$	2,136			21.1
Service cost of goods sold		14,919			147.1			10,188		83.0		(4,731	)		(31.7	)

Service gross profit (loss)	$	(4,778	)		(47.1	)	$	2,089		17.0	$	6,867			143.7

* - Denotes % of service revenue

** - Denotes % change from 2003 to 2004

The table below (in thousands, except percentage data) sets forth the changes in geographic distribution of revenues from the second quarter of fiscal 2003 to the second quarter of fiscal 2004.


	Second Quarter
									Increase
	2003		%*		2004		%*		(decrease)			%**
Domestic	$	50,371		68.5	$	58,033		77.7	$	7,662			15.2
International		23,169		31.5		16,666		22.3		(6,503	)		(28.1	)

Total	$	73,540		100.0	$	74,699		100.0	$	1,159			1.6

* - Denotes % of total revenue

** - Denotes % change from 2003 to 2004

Historically, we have relied on a limited number of customers for a substantial portion of our revenue. During the second quarter of fiscal 2003 and second quarter of fiscal 2004, certain customers each accounted for at least 10% of our revenues during the respective periods as follows (in thousands, except percentage data):


	Second Quarter
	2003		%**		2004		%**
Company A	$	*		—	$	24,023		32.2
Company C		12,540		17.1		*		—
Company D		11,001		15.0		*		—
Company F		8,336		11.3		*		—

Total	$	31,877		43.4	$	24,023		32.2

** - Denotes % of total revenue

* - Denotes revenues recognized less than 10% for the period.

Revenue

•

Product revenuedecreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 primarily due to decreased sales of our metropolitan networking products, partially offset by increased sales from our multiservice networking products, core networking products and LightWorks ON-Center software.

•

Service revenueincreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 due to increased sales of maintenance contracts.

•

Domestic revenueincreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 primarily due to increased sales of our core networking products and multiservice networking products, partially offset by decreased sales from our metropolitan networking products.

•

International revenuedecreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 primarily due to decreased sales of our metropolitan and core networking products, partially offset by increased sales of installation and maintenance revenue.

Gross profit

Cost of goods sold consists of component costs, direct compensation costs, warranty and other contractual obligations, royalties, license fees, direct technical support costs, cost of excess and obsolete inventory and overhead related to manufacturing, technical support and engineering, furnishing and installation (“EF&I”) operations.

•

Gross profit as a percentage of revenuedecreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 largely due to the sale of lower margin product and less benefit from the sale of previously reserved excess and obsolete inventory. This is partially offset by an increase in margin on our services.

•

Gross profit on products as a percentage of product revenue decreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 largely due to a higher percentage of revenue from core transport systems and a lower percentage of revenue from core switching systems combined with less revenue from the sale of previously reserved excess and obsolete inventory.

•

Gross profit on services as a percentage of services revenue increased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 largely due to increased sales of maintenance services and reduced service overhead costs.

Operating expenses

The table below (in thousands, except percentage data) sets forth the changes in operating expenses from the second quarter of fiscal 2003 to the second quarter of fiscal 2004.


	Second Quarter
											Increase
	2003		%*		2004			%*			(decrease)			%**
Research and development	$	52,193		71.0	$	46,479			62.2		$	(5,714	)		(10.9	)
Selling and marketing		25,663		34.9		25,075			33.6			(588	)		(2.3	)
General and administrative		8,066		11.0		5,992			8.0			(2,074	)		(25.7	)
Deferred stock compensation costs:
Research and development		3,406		4.6		1,408			1.9			(1,998	)		(58.7	)
Sales and marketing		676		0.9		415			0.6			(261	)		(38.6	)
General and administrative		346		0.5		79			0.1			(267	)		(77.2	)
Amortization of intangible assets		3,421		4.6		3,395			4.5			(26	)		(0.8	)
Restructuring costs		2,724		3.7		5,185			6.9			2,461			90.3
Recovery of use tax payments		—		—		(1,931	)		(2.6	)		(1,931	)		—
Recovery of doubtful accounts, net		—		—		(2,794	)		(3.7	)		(2,794	)		—

Total operating expenses	$	96,495		131.2	$	83,303			111.5		$	(13,192	)		(13.7	)

* - Denotes % of total revenue

** - Denotes % change from 2003 to 2004

•

Research and developmentexpense decreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 due to reductions in depreciation expense, prototype parts, facility-related costs and employee-related costs partially offset by the $1.7 million accelerated amortization of leasehold improvements related to the planned closing of our San Jose, California facility.

•

Selling and marketingexpense decreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 due to reductions in depreciation expense partially offset by higher costs related to an increase in the number of sales and marketing employees.

•

General and administrativeexpense decreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 primarily due to decreases in legal costs, consulting and outside service expense, and employee-related costs.

•

Deferred stock compensationcosts decreased from the second quarter of fiscal 2003 to the second quarter of fiscal 2004 due to the reduced level of unvested stock options and restricted stock, assumed as part of our acquisitions of Cyras Systems, Inc., ONI Systems Corp. and WaveSmith Networks, Inc. As of April 30, 2004, the balance of deferred stock compensation presented as a reduction of stockholder’s equity was $4.6 million.

•

Restructuring costsincurred during the second quarter of 2004 were related to work force reductions of approximately 68 employees and a change in estimated timing of sublease payments from our unused facilities. These actions were taken as part of our efforts to reduce our costs. We expect to incur additional restructuring costs in future periods during fiscal 2004.

•

Recovery of use tax paymentsduring the second quarter of fiscal 2004 was due to the resolution of a use tax audit related to the assets acquired from ONI

•

Recovery of doubtful accounts, netduring the second quarter of fiscal 2004 was related primarily to the payment of an amount due from a customer, from which payment was previously deemed doubtful due to the customer’s financial condition.

Other items

The table below (in thousands, except percentage data) sets forth the changes in other items from the second quarter of fiscal 2003 to the second quarter of fiscal 2004.


	Second Quarter
									Increase
	2003		%*		2004		%*		(decrease)			%**
Interest and other income, net	$	11,131		15.1	$	5,614		7.5	$	(5,517	)		(49.6	)
Interest expense	$	8,061		11.0	$	6,473		8.7	$	(1,588	)		(19.7	)
Gain (loss) on equity investments		—		—	$	139		0.2	$	139			—
Provision for income taxes	$	251		0.3	$	415		0.6	$	164			65.3

* - Denotes % of total revenue

** - Denotes % change from 2003 to 2004

•

Interest and other income, netdecreased from the second quarter of 2003 to the second quarter of 2004 primarily because of the impact of lower average interest rates and lower cash and invested balances.

•

Interest expensedecreased from the second quarter of 2003 to the second quarter of 2004 due to the decrease in our debt obligations between the two periods.

•

Provision for income taxesfor the second quarter of 2003 and the second quarter of 2004 was primarily attributable to foreign tax related to CIENA’s foreign operations. We did not record a tax benefit for CIENA’s domestic losses during either period. CIENA will continue to maintain a valuation allowance against certain deferred tax assets until sufficient evidence exists to support its reversal.

Six months ended April 30, 2003 compared to six months ended April 30, 2004

Revenue, cost of goods sold and gross profit

The table below (in thousands, except percentage data) sets forth the changes in revenue, cost of goods sold and gross profit from the first six months of fiscal 2003 to the first six months of fiscal 2004.


	Six Months Ended April 30,
									Increase
	2003		%*		2004		%*		(decrease)			%**
Revenue:
Products	$	124,620		86.5	$	117,096		83.0	$	(7,524	)		(6.0	)
Services		19,394		13.5		24,017		17.0		4,623			23.8

Total Revenue:		144,014		100.0		141,113		100.0		(2,901	)		(2.0	)

Costs:
Products		79,983		55.6		90,849		64.4		10,866			13.6
Services		29,551		20.5		21,489		15.2		(8,062	)		(27.3	)

Total cost of goods sold		109,534		76.1		112,338		79.6		2,804			2.6

Gross Profit	$	34,480		23.9	$	28,775		20.4	$	(5,705	)		(16.5	)

* - Denotes % of total revenue

** - Denotes % change from 2003 to 2004

The table below (in thousands, except percentage data) sets forth the changes in product revenue, product cost of goods sold and product gross profit from the first six months of fiscal 2003 to the first six months of fiscal 2004.


	Six Months Ended April 30,
									Increase
	2003		%*		2004		%*		(decrease)			%**
Product revenue	$	124,620		100.0	$	117,096		100.0	$	(7,524	)		(6.0	)
Product cost of goods sold		79,983		64.2		90,849		77.6		10,866			13.6

Product gross profit	$	44,637		35.8	$	26,247		22.4	$	(18,390	)		(41.2	)

* - Denotes % of product revenue

** - Denotes % change from 2003 to 2004

The table below (in thousands, except percentage data) sets forth the changes in service revenue, service cost of goods sold and service gross profit (loss) from the first six months of fiscal 2003 to the first six months of fiscal 2004.


	Six Months Ended April 30,
											Increase
	2003			%*			2004		%*		(decrease)			%**
Service revenue	$	19,394			100.0		$	24,017		100.0	$	4,623			23.8
Service cost of goods sold		29,551			152.4			21,489		89.5		(8,062	)		(27.3	)

Service gross profit (loss)	$	(10,157	)		(52.4	)	$	2,528		10.5	$	12,685			124.9

* - Denotes % of service revenue

** - Denotes % change from 2003 to 2004

The table below (in thousands, except percentage data) sets forth the changes in geographic distribution of revenues from the first six months of fiscal 2003 to the first six months of fiscal 2004.


	Six Months Ended April 30,
									Increase
	2003		%*		2004		%*		(decrease)			%**
Domestic	$	95,073		66.0	$	95,316		67.5	$	243			0.3
International		48,941		34.0		45,797		32.5		(3,144	)		(6.4	)

Total	$	144,014		100.0	$	141,113		100.0	$	(2,901	)		(2.0	)

* - Denotes % of total revenue

** - Denotes % change from 2003 to 2004

Historically, we have relied on a limited number of customers for a substantial portion of our revenue. During the first six months of fiscal 2003 and first six months of fiscal 2004, certain customers each accounted for at least 10% of our revenues during the respective periods as follows (in thousands, except percentage data):


	Six Months Ended April 30,
	2003		%**		2004		%**
Company A	$	*		—	$	27,826		19.7
Company B		*		—		14,805		10.5
Company C		26,811		18.6		*		—
Company D		19,346		13.4		*		—
Company E		17,948		12.5		*		—

Total	$	64,105		44.5	$	42,631		30.2

** - Denotes % of total revenue

* - Denotes revenues recognized less than 10% for the period.

Revenue

•

Product revenuedecreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 primarily due to decreased sales of our metropolitan networking products, partially offset by increased sales from our core networking products and multiservice networking products.

•

Service revenueincreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 due to increased sales of maintenance contracts.

•

International revenuedecreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 primarily due to decreased sales of our metropolitan networking products partially offset by increased sales from our core networking products and sales of maintenance contracts.

Gross profit

•

Gross profit as a percentage of revenuedecreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 largely due to the sale of lower margin products and less benefit from the sale of previously reserved excess and obsolete inventory. This was partially offset by an increase in margin on our services.

•

Gross profit on products as a percentage of product revenue decreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 largely due to lower margin product mix and less revenue from the sale of previously reserved excess and obsolete inventory.

•

Gross profit on services as a percentage of services revenue increased from the first six months of fiscal 2003 to the first six months of fiscal 2004 largely due to increased sales of maintenance services and reduced service overhead costs.

Operating expenses

The table below (in thousands, except percentage data) sets forth the changes in operating expenses from the first six months of fiscal 2003 to the first six months of fiscal 2004.


	Six Months Ended April 30,
											Increase
	2003		%*		2004			%*			(decrease)			%**
Research and development	$	105,927		73.6	$	93,656			66.4		$	(12,271	)		(11.6	)
Selling and marketing		52,268		36.3		50,543			35.8			(1,725	)		(3.3	)
General and administrative		22,772		15.8		13,083			9.3			(9,689	)		(42.5	)
Deferred stock compensation costs:
Research and development		7,204		5.0		3,613			2.6			(3,591	)		(49.8	)
Sales and marketing		1,435		1.0		933			0.7			(502	)		(35.0	)
General and administrative		720		0.5		200			0.1			(520	)		(72.2	)
Amortization of intangible assets		6,975		4.8		6,791			4.8			(184	)		(2.6	)
Restructuring costs		2,724		1.9		8,578			6.1			5,854			214.9
Recovery of use tax payments		—		—		(1,931	)		(1.4	)		(1,931	)		—
Recovery of doubtful accounts, net		—		—		(2,794	)		(2.0	)		(2,794	)		—

Total operating expenses	$	200,025		138.9	$	172,672			122.4		$	(27,353	)		(13.7	)

* - Denotes % of total revenue

** - Denotes % change from 2003 to 2004

•

Research and developmentexpense decreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 due to reductions in depreciation expense, facility-related costs and employee-related costs partially offset by increases in outside services, prototype parts and the $1.7 million accelerated amortization of leasehold improvements related to the planned closing of our San Jose, California facility.

•

Selling and marketingexpense decreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 due to reductions in depreciation expense and facility-related costs, partially offset by higher costs related to an increase in the number of sales and marketing employees.

•

General and administrativeexpense decreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 primarily due to decreases in legal costs, consulting and outside service expense, and employee-related costs.

•

Deferred stock compensationcosts decreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 due to the reduced level of unvested stock options and restricted stock, assumed as part of our acquisitions of Cyras Systems, Inc., ONI Systems Corp. and WaveSmith Networks, Inc. As of April 30, 2004, the balance of deferred stock compensation presented as a reduction of stockholder’s equity was $4.6 million.

•

Restructuring costsincreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 related to exiting a warehouse, work force reductions of approximately 121 employees and a change in estimated timing of sublease payments from our unused facilities. These actions were taken as part of our efforts to reduce our costs. We expect to incur additional restructuring costs in future periods during fiscal 2004.

•

Recovery of use tax paymentsduring the first six months of fiscal 2004 was due to the resolution of a use tax audit related to the assets acquired from ONI

•

Recovery of doubtful accounts, netincurred during the first six months of fiscal 2004 was related primarily to the payment of an amount due from a customer, from which payment was previously deemed doubtful due to the customer’s financial condition.

Other items

The table below (in thousands, except percentage data) sets forth the changes in other items from the first six months of fiscal 2003 to the first six months of fiscal 2004.


	Six Months Ended April 30,
											Increase
	2003			%*			2004		%*		(decrease)			%**
Interest and other income, net	$	24,432			17.0		$	13,292		9.4	$	(11,140	)		(45.6	)
Interest expense	$	20,264			14.1		$	13,857		9.8	$	(6,407	)		(31.6	)
Gain (loss) on equity investments	$	(10	)		(0.0	)	$	593		0.4	$	603			6,030.0
Loss on extinguishment of debt	$	20,606			14.3		$	8,216		5.8	$	12,390			(60.1	)
Provision for income taxes	$	610			0.4		$	839		0.6	$	229			37.5

* - Denotes % of total revenue

** - Denotes % change from 2003 to 2004

•

Interest and other income, netdecreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 primarily because of the impact of lower average interest rates and lower cash and invested.

•

Interest expensedecreased from the first six months of fiscal 2003 to the first six months of fiscal 2004 due to the decrease in our debt obligations between the two periods.

•

Gain on equity investments, netincreased during the first six months of fiscal 2003 to the first six months of fiscal 2004 related to a cash payment of $1.6 million received for an investment in a private company that had been previously written down to a value of $1.0 million. The excess of $0.6 million was recorded as a gain on equity investments.

•

Loss on extinguishment of debtduring the first six months of fiscal 2003 to the first six months of fiscal 2004 is related to the repurchase of ONI 5.00% convertible subordinated notes.

•

Provision for income taxesfor the first six months of fiscal 2003 to the first six months of fiscal 2004 was primarily attributable to foreign tax related to CIENA’s foreign operations. We did not record a tax benefit for CIENA’s domestic losses during either period. CIENA will continue to maintain a valuation allowance against certain deferred tax assets until sufficient evidence exists to support its reversal.

Liquidity and Capital Resources

At April 30, 2004, CIENA’s principal source of liquidity was its cash and cash equivalents, and short-term and long-term investments. We had $218.1 million in cash and cash equivalents, and $1.2 billion in short-term and long-

term investments. Our investment portfolio consists primarily of fixed-income securities, with maturities of two years or less, diversified among industries and individual issuers. Our investments are generally liquid, investment grade securities.

CIENA’s operating activities consumed $113.4 million and $99.2 million net cash during the first six months of fiscal 2003 and 2004, respectively. The primary reason for operating cash consumption was the net losses incurred during the periods.

Our investing activities provided net cash of $378.8 and $42.7 million during the first six months of fiscal 2003 and 2004, respectively. Investment activities included the net redemption of $393.0 and $56.4 million of short and long-term investments during the first quarters of fiscal 2003 and fiscal 2004, respectively. We expect to make additional combined capital equipment and leasehold improvement expenditures of approximately $26.0 million during the remainder of fiscal 2004. These capital expenditures will be used to support selling and marketing, manufacturing and product development activities. We will use our cash and cash equivalents and investments to fund these purchases.

Cash used in financing activities was $133.2 and $35.0 million during the first six months of fiscal 2003 and 2004, respectively. The primary use of cash in financing activities during the first six months of fiscal 2003 was related to the purchase of $154.7 million of the remaining $202.9 million outstanding ONI convertible subordinated notes. We paid $139.2 million for the notes and accrued fees of $1.1 million related to the purchase. Also during the first six months of fiscal 2003, we received $5.3 million from the exercise of stock options and $1.6 million from the repayment of notes receivable from stockholders. During the first six months of fiscal 2004, CIENA purchased the remaining $48.2 million of the outstanding ONI convertible subordinated notes. CIENA paid $49.2 million for notes with a cumulative accreted book value of $41.0 million, which resulted in a loss on early extinguishment of debt of $8.2 million. Also during the first six months of fiscal 2004, we received $14.2 million related to the exercise of employee options.

The following is a summary of our future minimum payments under contractual obligations as of April 30, 2004 (in thousands):


			Less than		One to		Four to five
	Total		one year		three years		years		Thereafter
Convertible notes (1)	$	793,500	$	25,875	$	51,750	$	715,875	$	—
Operating leases		227,945		36,768		67,754		53,384		70,039
Purchase obligations (2)		26,985		26,985		—		—		—

Total	$	1,048,430	$	89,628	$	119,504	$	769,259	$	70,039

(1)

The terms of our convertible notes with a principal value of $690.0 million include interest at 3.75% payable on a semi-annual basis on February 1 and August 1 of each year; the notes are due February 1, 2008.

(2)

Purchase commitments related to amounts we are obligated to pay to our contract manufacturers and component suppliers for inventory.

Some of our commercial commitments, including some of the future minimum payments set forth above, are secured by standby letters of credit. The following is a summary of our commercial commitments secured by standby letters of credit by commitment expiration date as of April 30, 2004 (in thousands):


			Less than		One to		Four to
	Total		one year		three years		five years		Thereafter
Standby letters of credit	$	13,425	$	8,039	$	5,136	$	250	$	—

CIENA does not engage in any off-balance sheet financing arrangements. In particular, we do not have any interest in so-called limited purpose entities, which include special purpose entities (SPEs) and structured finance entities.

Based on past performance and current expectations, we believe that our cash and cash equivalents, short-term investments, and cash generated from operations will satisfy our working capital needs, capital expenditures, investment requirements, commitments, and other liquidity requirements associated with our existing operations through at least the next 12 months.

Critical Accounting Policies and Estimates

The preparation of consolidated financial statements requires CIENA to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Those policies are described in our annual report on Form 10-K. On an on-going basis, we re-evaluate our estimates, including those related to bad debts, inventories, investments, intangible assets, goodwill, income taxes, warranty obligations, restructuring, and contingencies and litigation. CIENA bases its estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Among other things, these estimates form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. During the first six months of fiscal 2004, re-evaluation of certain estimates led to the effects described below.

Reserve for Inventory Obsolescence

CIENA writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based on assumptions about future demand and market conditions. During the first six months of fiscal 2003, we recorded a benefit for inventory reserves of $4.1 million primarily related to the realization of sales from previously reserved excess inventory. During the first six months of fiscal 2004, we recorded a charge of $1.1 million primarily related to excess inventory due to a change in forecasted sales for certain products. If actual market conditions differ from those we have projected, we may be required to take additional inventory write-downs or benefits.

Restructuring

As part of its restructuring costs, CIENA provides for the estimated cost of the net lease expense for facilities that are no longer being used. The provision is equal to the minimum future lease payments offset by estimated sublease payments. Due to the continued excess supply of commercial properties in certain markets where our unused facilities are located we have reduced our estimate of the total future sublease payments we will receive. As a result, we recorded an additional restructuring cost of $3.2 million in the first six months of fiscal 2004. As of the end of the second quarter of fiscal 2004, CIENA’s accrued restructuring liability related to net lease expense and other related charges was $56.8 million. The total minimum lease payments for these restructured facilities are $91.0 million. These lease payments will be made over the lives of our leases, which range from seven months to fifteen years. If actual market conditions are less favorable than those we have projected, we may be required to recognize additional restructuring costs associated with these facilities.

Risk Factors

Investing in our securities involves a high degree of risk. In addition to the other information contained in this quarterly report, including the reports we incorporate by reference, you should consider the following factors before investing in our securities.

Our business could continue to be adversely affected by unfavorable and uncertain conditions in the communications industry

The last three years have seen substantial changes in the communications industry. Most of our customers and potential customers have confronted static or declining revenue. Many have experienced significant financial distress, and some have gone out of business. This has resulted in a significant change in the structure of the equipment industry, with greater concentration of purchasing power in a small number of large services providers, combined with a substantial reduction in overall demand. Together these factors have adversely affected our revenue and operating results. In addition, most of our customers have become more conservative and uncertain about their future purchases which has made managing our business difficult.

We expect the factors described above to continue to affect our business for an indeterminate period, in several significant ways:

•

capital expenditures by many of our customers may be flat or reduced;

•

we will continue to have only limited ability to forecast the volume and product mix of our sales;

•

managing our expenditures will be difficult in light of the uncertainties surrounding our business;

•

increased competition resulting from reduced demand will put substantial downward pressures on the pricing of our products, tending to reduce our profit margins;

•

increased competition will enable customers to insist on more favorable terms and conditions for sales, including extended payment terms or other financing assistance, as a condition of procuring their business; and

•

the bankruptcies or weakened financial condition of some of our customers may require us to write off amounts due to us from prior sales.

The result of any one or a combination of these factors could lead to further reduced revenue and increased operating losses.

We may not be able to achieve the benefits we anticipate from our recently completed mergers with Catena and Internet Photonics

On May 3, 2004, we completed mergers with Catena and Internet Photonics. The process of integrating Catena and Internet Photonics into CIENA will be complex and exposes us to a variety of risks, including the possible loss of key personnel and failure to integrate their product lines. It is possible, therefore, that we will not achieve all of the benefits we anticipate from these mergers.

In addition to these operational risks, the mergers create additional risks that could have a material adverse effect on our business, results of operations and financial condition. For example, the mergers will result in CIENA succeeding to all known and unknown liabilities of Catena and Internet Photonics. These liabilities may include liabilities to stockholders, customers, suppliers or employees, as well as liabilities related to intellectual property disputes.

Our strategy involves pursuing strategic acquisitions and investments that may not be successful

Our business strategy includes acquiring or making strategic investments in other companies to expand our portfolio of products and services and to acquire or accelerate the development of new or improved products. To do so, we may use cash, issue equity that would dilute our current stockholders’ ownership, incur debt or assume indebtedness. In addition, we may incur significant amortization expenses related to intangible assets. Strategic investments and acquisitions involve numerous risks, including:

•

potential large cash expenditures;

•

difficulties in integrating the operations, technologies and products of the acquired companies;

•

diversion of management’s attention;

•

potential difficulties in completing projects of the acquired company;

•

the potential loss of key employees of the acquired company;

•

dependence on unfamiliar or relatively small supply partners; and

•

exposure to unanticipated liabilities.

In addition, acquisitions and strategic investments may involve risks of entering markets in which we have little or no prior experience and competitors have stronger market positions.

We face intense competition that could hurt our sales and profitability

The market for networking solutions is extremely competitive. Competition in this market is based on varying combinations of price, functionality, manufacturing capability, installation, services, scalability and the ability of the system solutions to meet customers’ immediate and future network requirements. A small number of very large companies, including Alcatel, Cisco, Fujitsu, Hitachi, Huawei, Lucent, Marconi, NEC, Nortel, Siemens, and Tellabs have historically dominated the telecommunications equipment industry. They all have greater financial, marketing, manufacturing and intellectual property resources than CIENA. They also often have existing relationships with our customers and potential customers. We also compete with a number of smaller companies that provide significant competition.

Because we sell systems that compete directly with product offerings of these companies, and in some cases displace or replace their equipment, we represent a competitive threat. The decline in the market for communications networking products has resulted in even greater competitive pressures. We expect that the aggressive tactics we have confronted on the part of many of these competitors will continue, and perhaps become more severe. These tactics include:

•

intense price competition in sales of new equipment, resulting in lower profit margins;

•

discounting resulting from sales of used equipment or inventory that a competitor has written down or written off;

•

early announcements of competing products and other marketing efforts;

•

“one-stop shopping” options;

•

customer financing assistance;

•

marketing and advertising assistance; and

•

intellectual property disputes.

Tactics such as those described above can be particularly effective in a concentrated customer base like ours. Our customers are under increasing competitive pressure to deliver their services at the lowest possible cost. This pressure may result in the pricing of communications networking systems becoming a more important factor in customer decisions. This may favor larger competitors that can spread the effect of price discounts across a larger array of products and services and across a larger customer base than ours. If we are unable to offset any reductions in the average sales price for our products by a reduction in the cost of our products, our gross profit margins will be adversely affected. Our inability to compete successfully against our competitors and maintain our gross profit margins would harm our business, financial condition and results of operations.

New competitors continue to emerge to compete with our products. They often base their products on the latest available technology. They may achieve commercial availability of their products more quickly due to the narrower focus of their efforts. Our inability to compete successfully against these companies would harm our business, financial condition and results of operations.

Our future success will depend on our ability to sell our products to our existing incumbent carrier customers and add additional incumbent carriers as new customers

Historically, a large percentage of our sales were made to emerging carriers, many of which no longer exist or have experienced severe financial difficulties and have reduced their equipment purchases. We expect that our sales to emerging carriers will continue to be at a lower level than they were at one time. Consequently, our future success will depend, to a large extent, on our ability to increase our sales to large domestic and international incumbent carriers.

We have limited experience in selling to incumbent carriers relative to many of our larger competitors. Many of them have long-standing relationships with incumbent carriers, which present additional challenges to the sales process. The sales cycle for these larger customers is often substantially longer than for sales to smaller customers; and they often require extensive testing of products before deciding to purchase them. In addition, even after a product has been selected for an incumbent carrier’s network and a contract has been signed, we are typically unable to recognize revenue until final network certification tests are completed satisfactorily, a process that is often lengthy and difficult. Complying with these certification requirements may involve unanticipated delays that could adversely affect our ability to sell to larger carriers or the timing of recognition of revenue. If we do not succeed in increasing our sales to our existing incumbent carrier customers and adding additional incumbent carriers as customers, our business will suffer.

We may not be successful in selling our products into new markets and developing and managing new sales channels.

We believe that, in order to succeed, we must enter new markets and build a larger and more diverse customer base. Therefore, we are beginning to sell some of our products to large enterprises, cable operators, independent operating companies and federal, state and local governments. To succeed in these markets, we believe we must develop and manage new sales channels through resellers, distributors and systems integrators. Since we have only limited experience in developing and managing such channels, it is uncertain to what extent we will be successful.

Sales to federal, state and local governments often require compliance with complex procurement rules and regulations with which we have little experience. We may be unable to increase our sales to government contractors if we determine that we cannot comply with applicable rules and regulations. In addition, failure to comply with rules and regulations for existing contracts could result in civil, criminal or administrative proceedings involving fines and suspension or debarment from federal government contracts.

Failure to succeed in these new markets or developing and managing new sales channels will adversely affect our ability to achieve our planned levels of revenue, which would adversely affect our profitability.

Product performance problems could limit our sales prospects

The development and production of new products with high technology content often involves problems with software, components and manufacturing methods. If significant reliability, quality or network monitoring problems develop, including those due to defects in software or faulty components, a number of negative effects on our business could result, including:

•

costs associated with fixing software or hardware defects;

•

high service and warranty expenses;

•

payment of liquidated damages for performance failures;

•

high inventory obsolescence expense;

•

high levels of product returns;

•

delays in collecting accounts receivable;

•

reduced orders from existing customers; and

•

declining interest from potential customers.

Although we maintain accruals for product warranties, actual costs could exceed these amounts. From time to time, there will be interruptions or delays in the activation of our products at a customer’s site. These interruptions or delays may result from product performance problems or from issues with installation and activation, some of which are outside our control. If we experience significant interruptions or delays that we cannot promptly resolve, confidence in our products could be undermined, which could cause us to lose customers or otherwise harm our business.

The steps that we are taking to restructure and reduce the size of our operations could disrupt our business.

Since November 2001, we have taken several steps, including reductions in force and dispositions of assets to reduce the size of our operations to better match the reduced sales of our products and services. During the next six to twelve months we expect to take steps to reduce our operating expenses even further.

This could cause additional disruption in our business, could result in lost revenue and will require us to incur expenses. For example we have restructured our sales force and other customer facing operations. If we do not manage this program effectively, our relationships with our customers could be harmed. In addition, on April 20, 2004, we announced our intention to close our San Jose, California facility by September 30, 2004. As a result, we will be required to transfer ongoing development work for certain CIENA product lines to other CIENA facilities. If we cannot manage this transition effectively, our development efforts could be disrupted, which could harm our business.

We must continue to make substantial investments in new technology that may not produce anticipated results.

In order to be successful, we must balance our initiatives to reduce our operating costs against the need to keep pace with technological advances. The market for communications networking solutions is characterized by rapid technological change, frequent introductions of new products, and recurring changes in customer requirements. To succeed in this market, we must continue to develop new products and new features for existing products. Doing so is difficult and costly, and there is no assurance that we will be successful. In addition, we must be able to identify and gain access to promising new technologies.

We are investing substantial resources in developing and delivering products that reside toward the edge of large communications networks. As a result, we have undertaken a number of efforts to expand our addressable market and the range of solutions we are able to offer both current and potential customers. We are implementing this strategy through a combination of internal development, acquisitions of smaller companies, and strategic alliances with other vendors. We are continuing to make the necessary investments to maintain our technology leadership in our core networking products. If we do not execute this strategy effectively, we could lose our existing market share for core networking products to our competitors, and fail to succeed in the new markets that we are entering, which would likely have an adverse effect on our financial condition.

Selling our products requires substantial investments of our resources that may not produce anticipated benefits

�� In order to sell our products to both potential and existing customers, we must invest in financial, engineering, manufacturing and logistics support resources, even though we are unsure of the volume, duration or timing of customer purchases. Our customers are generally technically sophisticated and demanding. Consequently, we may incur substantial expenses and devote resources to potential relationships that never materialize or fulfill our expectations, in which event our investment may largely be lost.

Our results can fluctuate unpredictably

Purchases by many of our potential and existing customers can be unpredictable, sporadic and subject to unanticipated changes. Our results, in turn, can fluctuate unpredictably. A decision to purchase our products requires a significant investment and commitment of resources by our customers. As a result, the sales cycles for many of our products are long, often as much as a year or two between initial contact with a potential customer and the recognition of revenue from sales to the customer. Further, purchases by our existing customers tend to be large and sporadic, depending upon their need to build a customer base, their plans for expanding their networks, the availability of financing, and the effects of regulatory and business conditions in the countries in which they operate. Current economic and market conditions have made it even more difficult to make reliable estimates of future revenue.

Fluctuations in our revenue can lead to even greater fluctuations in our operating results. Our budgeted expense levels depend in part on our expectations of long-term future revenue. Any substantial adjustment to expenses to account for lower levels of revenue is difficult and takes time. Consequently, if our revenue does decline, our levels of inventory, operating expenses and general overhead would be high relative to our revenue, resulting in additional operating losses.

Other factors can also contribute to fluctuations in our revenue and operating results, including:

•

variations and the mix between higher and lower margin products and services;

•

fluctuations in demand for our products;

•

changes in our pricing policies or the pricing policies of our competitors;

•

the timing and size of orders from customers;

•

changes in customers’ requirements, including changes or cancellations to orders from customers;

•

the introduction of new products by us or our competitors;

•

changes in the price or availability of components for our products;

•

readiness of customer sites for installation;

•

satisfaction of contractual customer acceptance criteria and related revenue recognition issues;

•

manufacturing and shipment delays and deferrals;

•

increased service, installation, warranty or repair costs;

•

financial effects of future restructurings;

•

the timing and amount of employer payroll tax to be paid on employee gains on stock options exercised; and

•

changes in general economic conditions as well as those specific to the telecommunications industry.

We may not be successful in enhancing and upgrading our products

Since our products are based on complex technology, we can experience unanticipated delays in developing, improving, manufacturing or deploying them. Modifying our products to enable customers to integrate them into a new type of network architecture entails similar development risks.

Certain enhancements to our products are in the development phase and are not yet ready for commercial manufacturing or deployment. The maturing process from laboratory prototype to customer trials, and subsequently to general availability, involves a number of steps, including:

•

completion of product development;

•

the qualification and multiple sourcing of critical components;

•

validation of manufacturing methods and processes;

•

extensive quality assurance and reliability testing, and staffing of testing infrastructure;

•

validation of software; and

•

establishment of systems integration and systems test validation requirements.

Each of these steps, in turn, presents serious risks of failure, rework or delay, any one of which could decrease the speed and scope of product introduction and marketplace acceptance of the product. Specialized application specific integrated circuits (“ASICs”) and intensive software testing and validation are key to the timely introduction of enhancements to several of our products, and schedule delays are common in the final validation phase, as well as in the manufacture of specialized ASICs. In addition, unexpected intellectual property disputes, failure of critical design elements, and a host of other execution risks may delay or even prevent the introduction of these products. If we do not develop and successfully introduce products in a timely manner, our business, financial condition and results of operations would be harmed.

We depend on a limited number of suppliers, and for some items we do not have a substitute supplier

We depend on a limited number of suppliers for components of our products, as well as for equipment used to manufacture and test our products. Our products include several high-performance components for which reliable, high-volume suppliers are particularly limited. Furthermore, some key optical and electronic components we use in our products are currently available only from sole or limited sources, and in some cases, that source also is a competitor. Any delay in component availability for any of our products could result in delays in deployment of these products and in our ability to recognize revenue. These delays could also harm our customer relationships and our results of operations.

Furthermore, the market for optical components has recently been consolidated resulting in reduced competition, which could lead to higher prices. In addition, the loss of a source of supply of key components could require us to re-engineer products that use those components, which would increase our costs.

On occasion, we have experienced delays in receipt of components and have received components that do not perform according to their specifications. Any future difficulty in obtaining sufficient and timely delivery of components could result in delays or reductions in product shipments, which, in turn, could harm our business.

Any delays in component availability for any of our products or test equipment could result in delays in deployment of these products and in our ability to recognize revenue from them. These delays could also harm our customer relationships and our results of operations.

We rely on contract manufacturers for our products

We rely on a small number of contract manufacturers to perform the majority of the manufacturing operations for our products. The qualification of these manufacturers is an expensive and time-consuming process, and these contract manufacturers build modules for other companies, including our competitors. In addition, we do not have contracts in place with some of these manufacturers. We may not be able to effectively manage our relationships with our manufacturers and we cannot be certain that they will be able to fill our orders in a timely manner. If we underestimate our future product requirements, the contract manufacturers may not have enough product to meet our customer requirements, and this could result in delays in the shipment of our products which could harm our business. If we overestimate product requirements, we may have to write off excess inventory.

We are constantly reviewing our contract manufacturing capability to ensure that our production requirements are met in terms of cost, capacity and quality. Periodically, we may decide to transfer the manufacturing of a product from one contract manufacturer to another, to better meet our production needs. It is possible that we may not effectively manage this transition or the new contract manufacturer may not perform as well as expected and, as a result, we may not be able to fill orders in a timely manner which could harm our business.

We rely on service delivery partners

We rely on a number of service delivery partners, both domestic and international, to complement CIENA’s global service and support resources. The certification of these partners incurs costs and is time-consuming, and these partners service products for other companies, including our competitors. We may not be able to effectively manage our relationships with our partners and we cannot be certain that they will be able to deliver our services in the manner or time required. If our service partners are unsuccessful in delivering services:

•

we may compromise the relevant services revenue; and

•

we may suffer delays in recognizing product revenues in cases where revenue recognition is dependent upon product installation, testing and acceptance.

Our ability to compete could be harmed if we are unable to protect and enforce our intellectual property rights or if we infringe on intellectual property rights of others

We share our proprietary information and intellectual property, including our source code, with other parties as necessary to meet the needs of our business. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We enter into non-disclosure and proprietary rights agreements with our employees and consultants, license agreements with our corporate partners, and we control access to and distribution of our products, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. This is likely to become an increasing issue as we expand our operations and sales into countries that provide a lower level of protection for intellectual property.

Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology. If competitors are able to use our technology, our ability to compete effectively could be harmed. We have filed a patent infringement lawsuit to enforce our intellectual property right, and may become involved with additional disputes in the future. Such lawsuits can be costly and may significantly divert the time and attention of our personnel.

We have been subject to several claims of patent infringement, which in some cases have required us to pay the patent holders substantial sums or enter into license agreements requiring ongoing royalty payments. The frequency of assertions of patent infringement in the field of telecommunications networking solutions is increasing as patent holders seek alternative sources of revenue. There is a possibility that we may again find ourselves required to take patent licenses or to redesign or stop selling products that allegedly infringe patents belonging to others. If we are sued for infringement and are unsuccessful in defending the suit, we could be subject to significant damages, and our business and customer relationships could be adversely affected.

We face risks associated with our international operations

We market, sell and service our products globally. We have established offices around the world, including in North America, Europe, Latin America and the Asia Pacific region. We will continue to expand our international operations and enter new international markets. This expansion will require significant management attention and financial resources to develop successfully direct and indirect international sales and support channels. In some countries, our success will depend in part on our ability to form relationships with local partners. We cannot be sure that we will be able to identify appropriate partners or reach mutually satisfactory arrangements with them for sales of our products. There is a risk that we may sometimes choose the wrong partner. For these reasons, we may not be able to maintain or increase international market demand for our products.

International operations are subject to inherent risks, and our future results could be adversely affected by a variety of uncontrollable and changing factors. These include:

•

greater difficulty in collecting accounts receivable and longer collection periods;

•

difficulties and costs of staffing and managing foreign operations;

•

the impact of recessions in economies outside the United States;

•

unexpected changes in regulatory requirements;

•

certification requirements;

•

reduced protection for intellectual property rights in some countries;

•

potentially adverse tax consequences;

•

political and economic instability;

•

trade protection measures and other regulatory requirements;

•

effects of changes in currency exchange rates;

•

service provider and government spending patterns; and

•

natural disasters and epidemics.

Such factors could have a material adverse impact on our operating results and financial condition.

We face risks in reselling the products of other companies

We have recently entered into agreements that permit us to distribute the products of other companies and may enter into other agreements in the future. To the extent we succeed in reselling the products of these companies, we may be required by customers to assume warranty and service obligations. While these suppliers have agreed to support us with respect to those obligations, they are relatively small companies with limited financial resources. If they should be unable, for any reason, to provide the required support, we may have to expend our own resources on doing so. This risk is amplified by the fact that the equipment has been designed and manufactured by others, and is thus subject to warranty claims whose magnitude we are currently unable to evaluate fully.

If we are unable to retain and attract qualified personnel, we may be unable to effectively manage our business

If we are unable to retain and motivate our existing employees and attract qualified personnel to fill key positions, we may be unable to effectively develop our existing products, make timely product introductions and increase sales. Since we generally do not have employment contracts with our employees, we must rely upon providing competitive compensation packages and a dynamic work environment to retain and motivate employees. In response to the decline in our revenue and weakness in the telecommunications equipment market, we have not increased salaries for most of our employees since the end of fiscal 2001. In addition, we have paid our employees significantly reduced or no bonuses under our bonus program since the end of fiscal 2001. Since our compensation packages include equity-based incentives, pressure on our stock price could affect our ability to continue to offer competitive compensation packages to our employees. In addition to these compensation issues, we must continue to motivate employees to execute our strategies and achieve our goals, which may be difficult due to morale challenges posed by the workforce reductions and uncertainty in our industry.

If we lose members of our management team or other key personnel, it may be difficult to replace them. Competition for highly skilled technical and other personnel can be intense. As a result, we may not be successful in identifying, recruiting and hiring qualified engineers and other key personnel.

We are exposed to the credit risk of our customers

Industry and economic conditions have weakened the financial position of some of our customers. To sell to some of these customers, we may be required to take risks of uncollectible accounts. While we monitor these situations carefully and attempt to take appropriate measures to protect ourselves, it is possible that we may have to write down or write off doubtful accounts. Such write-downs or write-offs, if large, could have a material adverse effect on our operating results and financial condition.

Our stock price is volatile

Our common stock price has experienced substantial volatility in the past, and is likely to remain volatile in the future. Volatility can arise as a result of divergence between our actual or anticipated financial results and published expectations of analysts, and announcements that we, our competitors, or our customers may make.

Divergence between our actual results and our anticipated results, analyst estimates and public announcements by us, our competitors, or by customers will occur from time to time in the future, with resulting stock price volatility, irrespective of our overall year-to-year performance or long-term prospects. As long as we continue to depend on a limited customer base, and particularly when a substantial majority of their purchases consist of newly introduced products, there is substantial chance that our quarterly results will vary widely.

Forward-looking statements

Some of the statements contained, or incorporated by reference, in this quarterly report discuss future expectations, contain projections of results of operations or financial condition or state other “forward-looking” information. Those statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. The “forward-looking” information is based on various factors and was derived using numerous assumptions. In some cases, you can identify these so-called “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 those statements only reflect our predictions. Actual events or results may differ substantially. Important factors that could cause our actual results to be materially different from the forward-looking statements are disclosed throughout this report, particularly under the heading “Risk Factors” above. We do not undertake a duty to update any of our forward-looking statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following discussion about the Company’s market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company is exposed to market risk related to changes in interest rates and foreign currency exchange rates. The Company does not use derivative financial instruments for speculative or trading purposes.

Interest Rate Sensitivity.CIENA maintains a short-term and long-term investment portfolio. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels at April 30, 2004, the fair value of the portfolio would decline by approximately $89.1 million.

Foreign Currency Exchange Risk.As a global concern, CIENA faces exposure to adverse movements in foreign currency exchange rates. These exposures may change over time as business practices evolve and if our exposure increases, adverse movement in foreign currency exchange rates could have a material adverse impact on CIENA’s financial results. Historically CIENA’s primary exposures have been related to non-dollar denominated operating expenses in Europe and Asia where CIENA sells primarily in U.S. dollars. CIENA is prepared to hedge against fluctuations in foreign currency if this exposure becomes material. As of April 30, 2004, the assets and liabilities of CIENA related to non-dollar denominated currencies were not material. Therefore, we do not expect an increase or decrease of 10% in the foreign exchange rate would have a material impact on CIENA’s financial position.

Item 4. Controls and Procedures

The Chief Executive Officer and Chief Financial Officer of CIENA have evaluated the effectiveness of our disclosure controls and procedures and have concluded that, as of the end of the period covered by this report, they were effective.

There was no change in CIENA’s internal control over financial reporting during CIENA’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, CIENA’s internal control over financial reporting.

PART II. - OTHER INFORMATION

Item 1. Legal Proceedings

On July 19, 2000, CIENA and CIENA Properties, Inc., a wholly owned subsidiary of CIENA, filed a complaint in the United States District Court for the District of Delaware requesting damages and injunctive relief against Corvis Corporation (“Corvis”). The suit charged Corvis with infringing four patents relating to CIENA’s optical networking communication systems and technology. A jury trial to determine whether Corvis is infringing these patents commenced on February 10, 2003. On February 24, 2003, the jury decided that Corvis was infringing one of the patents and not infringing two others. The jury was deadlocked with respect to infringement on the fourth patent. This trial was immediately followed by a trial on Corvis’ affirmative defenses based on the validity of two of the patents. On February 28, 2003, the jury in this trial determined that the patents were valid. In April 2003, following a third trial, another jury decided that Corvis had infringed the fourth patent on which the previous jury had deadlocked. Based on these favorable verdicts collectively holding that Corvis is infringing two valid CIENA patents, CIENA has moved for an injunction to prohibit the sale, manufacture or use by Corvis of the infringing products. The court has not yet ruled on this motion.

As a result of the merger with ONI, we also became a defendant in two substantially identical purported class actions on behalf of ONI security holders originally brought against ONI and members of its board of directors. The complaints allege that the director defendants breached their fiduciary duties to ONI in approving the merger with CIENA and seek declaratory, injunctive and other relief permitted by equity. The plaintiffs failed to obtain an injunction against completion of the merger. The first of these cases was filed on February 20, 2002, in the Superior Court of the State of California, County of San Mateo, and is encaptioned K.W. Sams, On Behalf of Himself and All Others Similarly Situated v. ONI Systems Corporation, et al. The second case was brought on March 19, 2002, in the Superior Court of the State of California, County of Santa Clara, and is encaptioned Steven Myeary, On Behalf of Himself and All Others Similarly Situated v. ONI Systems Corporation. On April 14, 2003, the plaintiffs in these cases filed a consolidated amended complaint and named four additional defendants: CIENA Corporation, James F. Jordan, Kleiner Perkins Caufield & Byers and Mohr Davidow Ventures. CIENA and the other defendants subsequently filed a

demurrer and served a motion for sanctions on plaintiffs based on factual inaccuracies in the consolidated amended complaint. In response, the plaintiffs filed a corrected consolidated amended complaint, the demurrer to which was sustained by the court in April 2004 with leave to amend. We believe that these lawsuits are without merit and will continue to defend them vigorously.

Item 2. Changes in Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of matters to a Vote of Security Holders

The annual meeting of our stockholders was held on March 10, 2004. At the annual meeting, our stockholders voted on the following matters:


	Votes		Votes
	For		Withheld
Election of three Class I Directors
Patrick H. Nettles, Ph.D.		413,930,763		7,673,935
John R. Dillon		403,777,764		17,826,934
Lawton W. Fitt		406,552,937		15,051,761

In addition, the following directors continue to hold office after that meeting: Stephen P. Bradley, Ph.D., Harvey B. Cash, Don H. Davis, Jr., Judith M. O’Brien, Gerald H. Taylor and Gary B. Smith.

Item 5. Other Information

Nicholas S. Jeffrey has resigned from his position as Senior Vice President, World Wide Sales effective June 11, 2004 and is being replaced by James F. Collier.

Item 6. Exhibits and Reports on Form 8-K


(a)	Exhibit		Description
		10.38	Catena Networks, Inc. 1998 Equity Incentive Plan

		10.39	Internet Photonics, Inc. Amended and Restated 2000 Corporate Stock Option Plan (including Addendums thereto)

		31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

		31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

		32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

		32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)

Reports on Form 8-K:

•

Form 8-K (Item 5 and Item 7 reported) filed April 20, 2004

•

Form 8-K (Item 5 and Item 7 reported) filed May 3, 2004

•

Form 8-K (Item 2 and Item 7 reported) filed May 12, 2004

•

Form 8-K (Item 12 reported) filed May 20, 2004*

* Information furnished in this Form 8-K is not deemed to be filed herewith or incorporated by reference into any filing.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		CIENA CORPORATION

Date:May 20, 2004	By:	/s/ Gary B. Smith
		Gary B. Smith
		President, Chief Executive Officer
		and Director
		(Duly Authorized Officer)

Date:May 20, 2004	By:	/s/ Joseph R. Chinnici
		Joseph R. Chinnici
		Senior Vice President, Finance and
		Chief Financial Officer
		(Principal Financial Officer)

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Ciena (CIEN) 10-Q2004 Q2 Quarterly report

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