Summary of Significant Accounting Policies

Foreign Currency

Transactions originally denominated in other currencies are converted into functional currencies in accordance with ASC 830 Foreign Currency Matters. Increases or decreases in the expected amount of cash flows upon settlement of the transaction caused by changes in exchange rates are recorded as foreign currency gains and losses and are included in Other income, net.

For foreign operations with the local currency as the functional currency, assets and liabilities are translated from the local currencies into U.S. dollars at the exchange rate prevailing at the balance sheet date. Revenues, expenses and cash flows are translated at weighted average exchange rates for the period to approximate translation at the exchange rate prevailing at the dates those elements are recognized in the financial statements. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income or loss.

Revenue Recognition

MRV's major revenue-generating products consist of switches and routers, console management, physical layer products, and fiber optic components. MRV generally recognizes product revenue, net of sales discounts, returns and allowances, in accordance with ASC 605 Revenue Recognition, when persuasive evidence of an arrangement exists, delivery has occurred and all significant contractual obligations have been satisfied, the fee is fixed or determinable and collection is considered reasonably assured. Products are generally shipped "FOB shipping point," with no right of return and revenue is recognized upon shipment. If revenue is to be recognized upon delivery, such delivery date is tracked through information provided by the third party shipping company the Company uses to deliver the product to the customer. The Network Integration business units resell third party products. The Company recognizes revenue on these sales on a gross basis, as a principal, because MRV is the primary obligor in the arrangement, MRV is exposed to inventory and credit risk, MRV negotiates the selling prices, and MRV sells the products as part of a solution in which it provides services. Sales of services and system support are deferred and recognized ratably over the contract period in accordance with ASC 605-20 Services. Sales to end customers with contingencies, such as rights of return, rotation rights, conditional acceptance provisions and price protection, are infrequent and insignificant and are deferred until the contingencies have been satisfied or the contingent period has lapsed. For sales to distributors, the Company generally recognizes revenue when product is sold to the distributor rather than when the product is sold by the distributor to the end user. In certain circumstances, distributors have limited rights of return, including stock rotation rights, and/or are entitled to price protection, where a rebate credit may be provided to the customer if MRV lowers its price on products held in the distributor's inventory. MRV estimates and establishes allowances for expected future product returns and credits in accordance with ASC 605. The Company records a reduction in revenue for estimated future product returns and future credits to be issued to the customer in the period in which revenues are recognized, and for future credits to be issued in relation to price protection at the time changes are made to the distributor price book. The Company monitors product returns and potential price adjustments on an ongoing basis and estimates future returns and credits based on historical sales returns, analysis of credit memo data, and other factors known at the time of revenue recognition.

MRV generally warrants its products against defects in materials and workmanship for 90 days to three year periods. The estimated cost of warranty obligations and sales returns and other allowances are recognized at the time of revenue recognition based on contract terms and prior claims experience.

Accounting for Multiple-Element Arrangements entered into prior to January 1, 2011. Arrangements with customers may include multiple deliverables involving combinations of equipment, services and software. In accordance with ASC 605-25 Multiple-Element Arrangements, the entire fee from the arrangement is allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element is met. Fair value for each element is established based on the sales price charged when the same element is sold separately. If multiple element arrangements include software or software-related elements, the Company applies the provisions of ASC 985 Software to the software and software-related elements, or to the entire arrangement if the software is essential to the functionality of the non-software elements.

Accounting for Multiple-Element Arrangements entered into or materially altered after January 1, 2011. In October 2009, the FASB amended ASC 605-25 and ASC 985 and the Company adopted the amendments prospectively effective January 1, 2011. In accordance with the amendments, MRV allocates arrangement consideration at the inception of the arrangement to all deliverables using the relative selling price method. The selling price used for each deliverable is based on (a) vendor-specific objective evidence if available; (b) third-party evidence if vendor-specific objective evidence is not available; or (c) estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. MRV allocates discounts in the arrangement proportionally on the basis of the selling price of each deliverable. In accordance with the amendments, MRV no longer applies the software revenue guidance in ASC Subtopic 985-605 to tangible products containing software components and non-software components that function together to deliver the tangible product's essential functionality.

Cash and Cash Equivalents

MRV treats highly liquid investments with an original maturity of 90 days or less as cash equivalents. Cash balances and investments are maintained in qualified financial institutions, and at various times, such amounts are in excess of federal insured limits.

Restricted Time Deposits

Restricted time deposits represent investments that are restricted as to withdrawal or use and are primarily in foreign subsidiaries. Restricted time deposits generally secure standby letters of credit, bank lines of credit, or bank loans. When investments in restricted time deposits are directly related to an underlying bank loan and the restricted funds will be used to repay the loans, the investment and the subsequent release of the restricted time deposit are treated as financing activities in the Company's Consolidated Statement of Cash Flows. The other investments in and releases of restricted time deposits are included in investing activities because the funds are invested in certificates of deposit.

Marketable Securities

MRV accounts for its marketable securities, which are available for sale, under the provisions of ASC 320-10 Accounting for Certain Investments in Debt and Equity Securities. There were no marketable securities as of December 31, 2012 and December 31, 2011. Proceeds from sales of marketable securities were $13.5 million and $49.1 million for the years ended December 31, 2011 and 2010, respectively.

Concentration of Credit Risk, Accounts Receivable and Allowance for Doubtful Accounts

Financial instruments that potentially subject the Company to concentrations of credit risk primarily consist of cash and cash equivalents placed with high credit quality institutions and accounts receivable due from customers. MRV evaluates the collectability of accounts receivable based on a combination of factors. If the Company becomes aware of a customer's inability to meet its financial obligations after a sale has occurred, the Company records an allowance to reduce the net receivable to the amount which is reasonably believed to be collected from the customer. For all other customers, the Company records allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment, and historical experience. If the financial conditions of MRV's customers were to deteriorate or if economic conditions worsen, additional allowances may be required in the future.

The following table summarizes the changes in the allowance for doubtful accounts (in thousands):



Year ended:	Balance at beginning of period		Charged to expense	Deductions		Effect of foreign currency exchange rates		Balance at end of period
December 31, 2010	$	3,692	272	(558	)	(64	)	$	3,342
December 31, 2011	$	3,342	210	(1,863	)	(27	)	$	1,662
December 31, 2012	$	1,662	116	(72	)	26		$	1,732

As of December 31, 2012 and 2011, amounts due from Fastweb S.p.A., a Network Integration segment customer, exceeded 10% of gross accounts receivables and as of December 31, 2011 Telecom Italia S.p.A., also a Network Integration segment customer, exceeded 10% of gross accounts receivables.

Inventories

Inventories are stated at the lower of cost or market and consist of material, labor and overhead. Cost is determined by the first in, first out method. If the Company estimates that the net realizable value is less than the cost of the inventory, an adjustment to the cost basis is recorded through a charge to cost of sales to reduce the carrying value to net realizable value. At each balance sheet date, MRV evaluates the ending inventories for excess quantities or obsolescence. This evaluation includes analysis of sales levels and projections of future demand. Based on this evaluation, the Company maintains reserves for excess and obsolete inventory and the inventory balances are reported net of reserves. At the time of recording the reserve, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration of, or increase in, that newly established cost basis. The inventory reserve is not reduced until the underlying inventory is sold or otherwise disposed, which would not result in an increase in net inventory.

Net inventories consisted of the following (in thousands):



December 31:	2012		2011
Raw materials	$	4,348	$	5,401
Work-in process	1,368		1,940
Finished goods	16,728		14,070
Total	$	22,444	$	21,411

Property and Equipment

Property and equipment are stated at cost. Maintenance and repairs are charged to expense as incurred and the costs of additions and betterments that increase the useful lives of the assets are capitalized. When property or equipment are disposed of, the cost and related accumulated depreciation and amortization are removed from the accounts and any gain or loss is included in Other income, net, in the accompanying Consolidated Statements of Operations.

Property and equipment consisted of the following (in thousands):



December 31:	2012			2011
Property and equipment, at cost:
Machinery and equipment	$	8,196		$	7,827
Computer hardware and software	7,204			6,562
Leasehold improvements	2,528			2,648
Furniture and fixtures	2,065			2,009
Construction in progress	393			492
Total property and equipment, at cost	20,386			19,538
Less — accumulated depreciation and amortization	(16,651		)	(15,778		)
Total	$	3,735		$	3,760

Depreciation is computed using the straight line method over the estimated useful lives of the related assets, as follows:



	Life (years)
Asset category	From	To
Machinery and equipment	2	5
Computer hardware and software	3	6
Leasehold improvements	1	10
Furniture and fixtures	3	15

Depreciation expense for the years ended December 31, 2012, 2011 and 2010 was $1.4 million, $1.3 million and $1.2 million, respectively.

Goodwill and Other Intangibles

In accordance with ASC 350 Intangibles — Goodwill and Other, goodwill and intangible assets with indefinite lives are not amortized, but instead are measured for impairment at least annually, or when events indicate that impairment exists. MRV's annual impairment review date is October 1. Reviews for impairment are performed at each of MRV's reporting units. Intangible assets that are determined to have definite lives are amortized over their useful lives. See Note 4 "Goodwill and Other Intangibles" for further information.

Investments

MRV accounts for investments in unconsolidated entities in accordance with ASC 323 Investments — Equity Method and Joint Ventures. Unconsolidated investments, for which the Company does not have the ability to exercise significant influence over operating and financial policies, are accounted for under the cost method. The Company accounts for investments for which MRV has the ability to exercise significant influence in terms of operating and financial policies, under the equity method. All unconsolidated investments in which the Company owns greater than 20% of the voting stock are accounted for under the equity method. The Company did not hold investments as of December 31, 2012.

Under the cost and equity method, a loss in value of an investment, which is deemed to be other than a temporary decline, is recognized. Evidence of a loss in value might include absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity, which would justify the carrying amount of the investment. There were no cost or equity method investments held as of December 31, 2012 and December 31, 2011.

Impairment of Long-Lived Assets

MRV evaluates its long-term tangible assets, such as property and equipment and other long-term assets, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may be impaired. The Company takes into consideration events or changes such as product discontinuance, plant closures, product dispositions and history of operating losses or other changes in circumstances to indicate that the carrying amount may not be recoverable. The carrying value of an asset is considered impaired when the anticipated undiscounted cash flow from such asset is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value. Fair market value is determined using the anticipated cash flows discounted at a rate based on our weighted average cost of capital, which represents the blended after-tax costs of debt and equity. There was no impairment loss on tangible assets of continuing operations during the three years ended December 31, 2012.

Fair Value of Financial Instruments

MRV's financial instruments, including cash and cash equivalents, restricted time deposits, short-term and long-term marketable securities, accounts receivable, accounts payable, accrued liabilities and short-term debt obligations are carried at cost, which approximates their fair market value.

ASC 820-10 Fair Value Measurements defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820-10 establishes a three-level hierarchy that prioritizes the use of observable inputs. The fair value hierarchy is divided into three levels based on the source of inputs as follows: Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access; Level 2 - Valuations for which all significant inputs are observable, either directly or indirectly, other than level 1 inputs; Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

All of MRV's assets and a majority of its liabilities that are measured at fair value are measured using the unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date. Under this standard, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

During 2012 the Company recorded a liability for the estimated fair value of 250,000 warrants that may be awarded to plaintiffs in a litigation matter, see Note 9, Commitments and Contingencies. In calculating the fair value the Company used Black Scholes with level 2 inputs including a volatility of 55% based on the Company's historical quoted prices and peer company data, the risk free interest rate of 0.8% and the 5 years expected term of the warrants. The resulting fair value was $4.30 per warrant.

Other Assets

Other assets include prepaid expenses that will be consumed within a twelve month period. Prepaid expenses included in other assets were $1.8 million and $1.0 million for 2012 and 2011, respectively.

Liability for Severance Pay

Under the laws of certain foreign jurisdictions, MRV is obligated to make severance payments to employees in those foreign jurisdictions on the basis of factors such as each employee's current salary and length of employment. The liability for severance pay is calculated as the amount that the Company would be required to pay if every employee were to separate as of the end of the period, and is recorded as part of other long-term liabilities.

Cost of Sales

Cost of sales includes material, depreciation on fixed assets used in the manufacturing process, shipping costs, direct labor and overhead. The portion of cost of sales related to service revenue was $33.6 million and $29.1 million for the years ended December 31, 2012 and 2011, respectively.

Product Development and Engineering

Product development and engineering costs are charged to expense as incurred.

Software Development Costs

In accordance with ASC 985-20 Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, development costs related to software products are expensed as incurred until the technological feasibility of the product has been established. Technological feasibility occurs when a working model is completed. After technological feasibility is established, additional costs are capitalized.

MRV believes its process for developing software is essentially completed concurrent with the establishment of technological feasibility, and, accordingly, no software development costs have been capitalized to date.

Sales and Marketing

Sales and marketing costs are charged to expense as incurred. For the years ended December 31, 2012, 2011 and 2010, advertising and trade show costs were $1.2 million, $1.3 million and $1.4 million, respectively.

Income Taxes

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes.

The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheet.

Net Income (Loss) Per Share

Basic net income (loss) per share is computed using the weighted average number of shares of Common Stock outstanding, including restricted shares which, although they are legally outstanding and have voting rights, are subject to vesting and are treated as common stock equivalents in calculating diluted income (loss) per share. Diluted net income (loss) per share is computed using the weighted average number of shares of Common Stock outstanding and dilutive potential shares of Common Stock from stock options outstanding during the period. Diluted shares outstanding also include the dilutive effect of in-the-money options, which is calculated based on the average share price for each period using the treasury stock method.

ASC 260-10 Earnings per Share, requires that employee equity share options, nonvested shares and similar equity instruments granted by MRV, be treated as potential shares of Common Stock outstanding in computing diluted net income per share. Diluted shares outstanding include the dilutive effect of in-the-money options, calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service not yet recognized, and the amount of income tax benefits that would be realized and recorded in additional paid-in capital if the deduction for the award would reduce income taxes payable are assumed to be used to repurchase shares.

Outstanding stock options to purchase 416.3 thousand shares were excluded from the computation of dilutive shares for the year ended December 31, 2012 because of the net loss. Outstanding stock options to purchase 404.8 thousand shares were excluded from the computation of dilutive shares for the year ended December 31, 2011. Outstanding stock options to purchase 400.1 thousand shares were excluded from the computation of dilutive shares for the year ended December 31, 2010. In addition, for the year ended December 31, 2012, 2011 and 2010 respectively, 4.4 thousand, 37.8 thousand and 42.7 thousand potentially dilutive shares were excluded from the calculation of diluted net income (loss) per share because they were anti-dilutive. Treasury shares are excluded from the number of shares outstanding.

On December 3, 2012, the Company announced that the Board of Directors approved a repurchase of shares of Common Stock of the Company in an amount up to $10.0 million under a stock repurchase program. The program expires on December 31, 2013. Under this program the Company purchased 40 thousand shares at a total cost of $0.4 million during the year ended December 31, 2012.

Share-Based Compensation

As discussed in Note 12 "Share-Based Compensation," the fair value of stock options and warrants are determined using the Black-Scholes valuation model. The assumptions used in calculating the fair value of share-based payment awards represent MRV's best estimates. Those estimates may be impacted by certain variables including stock price volatility, employee stock option exercise behaviors, additional stock option grants, estimates of forfeitures, and the related income tax impact. See Note 12, Share-Based Compensation, for a further discussion on share-based compensation and assumptions used.

Recently Issued Accounting Standards

In July 2012 the FASB issued ASU 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”). The amendments in ASU 2012-02 are intended to reduce cost and complexity by providing an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments in ASU 2012-02 also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset's fair value when testing an indefinite-lived intangible asset for impairment, which is equivalent to the impairment testing requirements for other long-lived assets. In accordance with the amendments in ASU 2012-02, an entity will have an option not to calculate annually the fair value of an indefinite-lived intangible asset if the entity determines that it is not more-likely-than-not that the asset is impaired. The amendments in ASU 2012-02 are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity's financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The adoption of ASU 2012-02 is not expected to have a material impact on the Company's consolidated financial statements and the Company is not electing early adoption of implementation of the regulation amendment.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.