CIENA CORP

INCOME TAXES

For the periods indicated, the provision (benefit) for income taxes consists of the following (in thousands):



	Year Ended October 31,
	2017				2016			2015
Provision (benefit) for income taxes:
Current:
Federal	$	—			$	—		$	—
State	6,342				5,281			1,435
Foreign	14,563				9,969			10,662
Total current	20,905				15,250			12,097
Deferred:
Federal	(1,047,699		)	⁽¹⁾	—			—
State	(77,429		)	⁽¹⁾	—			—
Foreign	(1,604		)		(1,116		)	—
Total deferred	(1,126,732		)		(1,116		)	—
Provision (benefit) for income taxes	$	(1,105,827	)		$	14,134		$	12,097

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(1) The income tax benefit for 2017 includes the reversal of a significant portion of the valuation allowance on

Ciena’s deferred tax assets in the U.S. See further discussion below.

For the periods indicated, income before provision for income taxes consists of the following (in thousands):



	Year Ended October 31,
	2017		2016		2015
United States	$	114,242	$	58,237	$	(1,029	)
Foreign	41,884		28,481		24,793
Total	$	156,126	$	86,718	$	23,764

Ciena’s foreign income tax as a percentage of foreign income may appear disproportionate compared to the expected tax based on the U.S. federal statutory rate and is dependent upon the mix of earnings and tax rates in our foreign jurisdictions.

For the periods indicated, the tax provision (benefit) reconciles to the amount computed by multiplying income before income taxes by the U.S. federal statutory rate of 35% as follows:



	Year Ended October 31,
	2017		2016		2015
Provision at statutory rate	35.00	%	35.00	%	35.00	%
State taxes	2.29	%	4.00	%	6.04	%
Foreign taxes	(0.35	)%	3.11	%	28.98	%
Research and development credit	(15.38	)%	(22.61	)%	(25.55	)%
Non-deductible compensation and other	10.12	%	4.13	%	30.16	%
Valuation allowance	(739.97	)%	(7.33	)%	(23.73	)%
Effective income tax rate	(708.29	)%	16.30	%	50.90	%

As a result of prospective application of Accounting Standards Update No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, Ciena offset all deferred tax liabilities and assets, as well as any related valuation allowance, and is presenting them as a single non-current amount as of October 31, 2017 and 2016.

The significant components of deferred tax assets and liabilities are as follows (in thousands):



	October 31,
	2017			2016
Deferred tax assets:
Reserves and accrued liabilities	$	56,597		$	59,791
Depreciation and amortization	451,385			298,497
NOL and credit carry forward	803,622			1,109,304
Other	29,398			23,304
Gross deferred tax assets	1,341,002			1,490,896
Valuation allowance	(185,898		)	(1,489,780		)
Deferred tax asset, net of valuation allowance	$	1,155,104		$	1,116

A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows (in thousands):



	Amount
Unrecognized tax benefits at October 31, 2014	$	15,100
Increase related to positions taken in prior period	3,658
Increase related to positions taken in current period	9,138
Reductions related to expiration of statute of limitations	(360		)
Unrecognized tax benefits at October 31, 2015	27,536
Increase related to positions taken in prior period	2,187
Increase related to positions taken in current period	2,654
Reductions related to expiration of statute of limitations	(1,709		)
Unrecognized tax benefits at October 31, 2016	30,668
Increase related to positions taken in prior period	122
Increase related to positions taken in current period	111,412
Reductions related to expiration of statute of limitations	(620		)
Unrecognized tax benefits at October 31, 2017	$	141,582

As of October 31, 2017 and 2016, Ciena had accrued $4.0 million and $4.6 million of interest and penalties, respectively, related to unrecognized tax benefits within other long-term liabilities in the Consolidated Balance Sheets. Interest and penalties of $1.2 million and $0.9 million were recorded to the provision for income taxes during fiscal 2016 and fiscal 2015, respectively. During fiscal 2017, Ciena recorded a net benefit for interest and penalties in its provision for income taxes of $0.6 million, primarily as a result of recognizing a portion of previously unrecognized tax benefits. If recognized, the entire balance of unrecognized tax benefits would impact the effective tax rate. Over the next 12 months, Ciena does not estimate any material changes in unrecognized income tax benefits.

Ciena has not provided for U.S. deferred income taxes on the cumulative unremitted earnings of its non-U.S. affiliates, as it plans to indefinitely reinvest these foreign earnings outside the U.S. As of October 31, 2017, the cumulative amount of such temporary differences for which a deferred tax liability has not been recognized totaled approximately $384 million. If these earnings were distributed to the U.S. in the form of dividends, or otherwise, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, Ciena would be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable. Additionally, there are no other significant temporary differences for which a deferred tax liability has not been recognized.

Since 2002, Ciena has maintained a valuation allowance against its net U.S. deferred tax assets. On a quarterly basis, Ciena evaluates all available positive and negative evidence to determine if a valuation allowance is required. Improved profitability led to Ciena’s U.S. business having cumulative income over a three-year period towards the end of fiscal 2016 for the first time since the valuation allowance was established. However, at that time, Ciena determined that a valuation allowance was still necessary, due to, among other things, the relatively low level of cumulative pre-tax income during this period and Ciena’s history of operating losses. In the fourth quarter of fiscal 2017, based on the sustained and increasing earnings of Ciena’s U.S. business throughout 2017, Ciena’s future projections of profitability and a positive industry outlook, Ciena has concluded that it is more likely than not that Ciena will realize the benefit of most of its U.S. deferred tax assets and accordingly has reversed a majority of the valuation allowance that was recorded against its net U.S. deferred tax assets. This reversal resulted in a one-time, non-cash income tax benefit of $1.125 billion recorded in Ciena’s Consolidated Statement of Operations and a $26.0 million adjustment to Additional Paid-in-Capital in the Consolidated Statement of Changes in Stockholders’ Equity related to certain previously settled call spread options. As of October 31, 2017, Ciena continues to maintain a valuation allowance against net deferred tax assets of $185.9 million primarily related to state and foreign net operating losses and credits that Ciena estimates it will not be able to use. Approximately $38.0 million of the retained valuation allowance relates to deductions for stock compensation which Ciena anticipates will be released through retained earnings in the first quarter of fiscal 2018 upon the adoption of ASU 2016-09.

The following table summarizes the activity in Ciena’s valuation allowance against its gross deferred tax assets (in thousands):



Year ended	Beginning						Ending
October 31,	Balance		Additions		Deductions		Balance
2015	$	1,496,835	$	—	$	1,163	$	1,495,672
2016	$	1,495,672	$	—	$	5,892	$	1,489,780
2017	$	1,489,780	$	—	$	1,303,882	$	185,898

As of October 31, 2017, Ciena had a $1.65 billion net operating loss carry forward and a $0.1 billion income tax credit carry forward which begin to expire in fiscal year 2019 and 2017, respectively. Ciena’s ability to use net operating losses and credit carry forwards is subject to limitations pursuant to the ownership change rules of the Internal Revenue Code Section 382.

Currently, the recognition of windfall tax benefits from stock-based compensation deducted on the tax return is prohibited until realized through a reduction of income tax payable. In fiscal 2018, Ciena will adopt ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. At that time, the cumulative tax benefits totaling approximately $62 million will be recorded in beginning retained earnings effective November 1, 2017.