POS AM 1 v76157a1posam.txt POST-EFFECTIVE AMENDMENT NO. 1 TO FORM S-4 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION VIA EDGAR AS OF OCTOBER 9, 2001 REGISTRATION NO. 333-44536 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ POST-EFFECTIVE AMENDMENT NO. 1 TO FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ MRV COMMUNICATIONS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 3577/3674 06-1340090 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
20415 NORDHOFF STREET CHATSWORTH, CALIFORNIA 91311 (818) 773-9044 (818) 773-0906 (FAX) (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) NOAM LOTAN PRESIDENT AND CHIEF EXECUTIVE OFFICER 20415 NORDHOFF STREET CHATSWORTH, CALIFORNIA 91311 (818) 773-9044 (818) 773-0906 (FAX) (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) COPIES TO: KIRKPATRICK & LOCKHART LLP 10100 SANTA MONICA BLVD. 7TH FLOOR LOS ANGELES, CA 90067- 4104 TELEPHONE: (310) 552-5000 FACSIMILE: (310) 552-5001 ATTENTION: MARK A. KLEIN, ESQ. OR PETER V. HOGAN, ESQ. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 NOTICE OF MERGER OF LUMINENT, INC. WITH AND INTO MRV MERGER SUB CORP. To the former stockholders of Luminent, Inc. Please take notice that, pursuant to Section 253 of the General Corporation Law of the State of Delaware, the previously announced short-form merger of Luminent, Inc., a Delaware corporation, with and into MRV Merger Sub Corp., a Delaware corporation and a wholly-owned subsidiary of MRV Communications, Inc. became effective on , 2001. This short-form merger is referred to in this Notice and the accompanying prospectus supplement of MRV as "the Merger." Under applicable Delaware law, the Merger was approved by the Boards of Directors of MRV and MRV Merger Sub and no action was required by the board of directors or stockholders of Luminent for the Merger to become effective. Upon consummation of the Merger, MRV Merger Sub became the surviving corporation and the corporate existence of Luminent ceased. Each outstanding share of Luminent common stock, $0.001 par value per share (except for shares held by MRV Merger Sub, which were cancelled, and shares held by Luminent stockholders who perfect their statutory appraisal rights under Delaware law), was converted in the Merger. Former Luminent stockholders whose shares were converted are entitled to receive 0.43 of share of MRV common stock, $0.0017 par value, for each share of Luminent common stock owned at the time of the Merger. To receive certificates representing shares of MRV common stock issued in the Merger, former Luminent stockholders must complete and execute the enclosed Letter of Transmittal and deliver their certificates representing Luminent common stock and the Letter of Transmittal to American Stock Transfer and Trust Company, the exchange agent, either in person or by mail at the following addresses: By Mail: By Hand: American Stock Transfer and Trust Company American Stock Transfer and Trust Company 59 Maiden Lane 59 Maiden Lane New York, New York 10038 New York, New York 10038
Section 262 of the General Corporation Law of the State of Delaware provides a procedure by which former holders of record Luminent common stock who do not wish to accept the shares of MRV common stock to which they are entitled under the terms of the Merger may seek a judicial appraisal of the fair value of any or all of their Luminent common stock, exclusive of any element of value arising from the expectation or accomplishment of the Merger. This procedure is summarized in the accompanying prospectus supplement and the full text of Section 262 of the General Corporation Law of the State of Delaware is attached as Annex A to the accompanying prospectus supplement. Sincerely yours, MRV Merger Sub Corp. /s/ NOAM LOTAN Noam Lotan, President 3 THE INFORMATION CONTAINED IN THIS PROSPECTUS SUPPLEMENT IS NOT YET COMPLETE, AND WE MAY SUPPLEMENT OR AMEND IT IN THE FINAL VERSION. WE HAVE FILED A POST- EFFECTIVE AMENDMENT TO OUR REGISTRATION STATEMENT RELATING TO THE SECURITIES DESCRIBED IN THIS PROSPECTUS SUPPLEMENT WITH THE SECURITIES AND EXCHANGE COMMISSION. WE MAY NOT SELL THESE SECURITIES, OR ACCEPT OFFERS TO BUY THEM, UNTIL THE POST-EFFECTIVE AMENDMENT BECOMES EFFECTIVE. THIS PROSPECTUS SUPPLEMENT IS NOT AN OFFER TO SELL THESE SECURITIES, AND WE ARE NOT SOLICITING OFFERS TO BUY THEM, AND THESE SECURITIES WILL NOT BE SOLD IN, ANY STATE WHERE THEIR OFFER OR SALE, OR SOLICITATIONS OF OFFERS TO BUY THEM, WOULD BE UNLAWFUL PRIOR TO THEIR REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. [PRELIMINARY PROSPECTUS NOTE: AS OF THE DATE OF THIS PRELIMINARY PROSPECTUS, THE MERGER HAS NOT YET OCCURRED]. SUBJECT TO COMPLETION -- DATED OCTOBER 9, 2001 MRV COMMUNICATIONS, INC. MRV Communications, Inc. is supplementing its prospectus dated September 6, 2000 for the issuance of 5,160,000 shares of its common stock in connection with the Merger of Luminent, Inc. with and into MRV Merger Sub Corp., MRV's wholly-owned subsidiary. MRV is furnishing this prospectus supplement and the accompanying prospectus to those persons who held common stock, $0.001 par value, of Luminent, Inc., a Delaware corporation, immediately prior to the Merger of Luminent with and into MRV Merger Sub. The Merger was effected on , 2001. Upon consummation of the Merger, MRV Merger Sub became the surviving corporation and the corporate existence of Luminent ceased. Each outstanding share of Luminent common stock, $0.001 par value per share (except for shares held by MRV Merger Sub, which were cancelled, and shares held by Luminent stockholders who perfect their statutory appraisal rights under Delaware law), was converted in the Merger. Former Luminent stockholders whose shares were converted are entitled to receive 0.43 of share of MRV common stock, $0.0017 par value, for each share of Luminent common stock owned at the time of the Merger. In addition, MRV is assuming in the Merger options to purchase Luminent common stock that are outstanding. These Luminent stock options will be converted into options to purchase approximately 5,245,580 shares of MRV common stock containing the same vesting provisions and intrinsic value. Immediately prior to the Merger, MRV Merger Sub held approximately 92% of the outstanding shares of Luminent common stock. The Merger was effected as a short-form merger pursuant to resolutions adopted by the boards of directors of MRV and MRV Merger Sub. No resolutions, vote or authorization from the board of directors of Luminent or the stockholders of Luminent, MRV or MRV Merger Sub was required to consummate the Merger. WE ARE NOT ASKING YOU FOR A PROXY AND YOU ARE REQUESTED NOT TO SEND US A PROXY. Holders of Luminent common stock of record immediately prior to the Merger have certain statutory appraisal rights under Delaware law. Any holder who desires to exercise appraisal rights must file with MRV Merger Sub written demand for appraisal after , 2001 and prior to 2001. For information on how to make this demand, see the section of this prospectus supplement entitled "The Merger -- Surrender of Stock Certificates; Fractional Interests." INVESTMENT IN MRV SHARES INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING AT PAGE 14. MRV's common stock is listed on The Nasdaq National Market under the symbol "MRVC." On September 10, 2001, the last trading day prior to the public announcement of the planned Merger, the closing price of MRV's common stock on The Nasdaq National Market was $3.23 per share. On , 2001, the trading day immediately preceding consummation of the Merger, the closing price of MRV's common stock on The Nasdaq National Market was $ per share. NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THE DATE OF THIS PROSPECTUS SUPPLEMENT IS , 2001. 4 ABOUT THIS PROSPECTUS SUPPLEMENT MRV is providing information to the former stockholders of Luminent about this offering of shares of its common stock in two separate documents: (a) the accompanying prospectus, which provides general information, some of which may not apply to this offering, and (b) this prospectus supplement, which describes the specific details regarding this offering. If information in this prospectus supplement is inconsistent with the prospectus, you should rely on this prospectus supplement. You should read this prospectus supplement and the accompanying prospectus carefully. Both documents contain information you should consider in connection with your receipt of MRV common stock in exchange for your Luminent common stock. WHERE YOU CAN FIND MORE INFORMATION MRV files, and prior to the Merger, Luminent filed, annual, quarterly and special reports, proxy statements and other information with the SEC. This information can be (1) read and copied at the public reference facilities maintained by the SEC at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C., and at the SEC's Chicago Regional Office, 500 West Madison Street, Chicago, Illinois; and (2) accessed via a Web site maintained by the SEC (http://www.sec.gov). Copies of the material can also be obtained from the Public Reference Section of the SEC at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549 at prescribed rates. Please call the SEC at 1-800-SEC-0330 for further information on the public reference rooms, including whether the SEC has made alternative arrangements for public reference facilities since the destruction of its New York Regional Office located at 7 World Trade Center, New York, New York. This prospectus supplement is a part of a registration statement MRV filed with the SEC. This prospectus supplement does not contain all of the information set forth in the registration statement. For more information about MRV and its common stock, you should read the registration statement and its exhibits and schedules. Copies of the registration statement, including its exhibits may be obtained from the SEC's principal office in Washington, D.C. upon payment of the fees prescribed by the SEC, or may be examined without charge at the offices of the SEC. 2 5 TABLE OF CONTENTS ABOUT THIS PROSPECTUS SUPPLEMENT............................ 2 WHERE YOU CAN FIND MORE INFORMATION......................... 2 TABLE OF CONTENTS........................................... 3 QUESTIONS AND ANSWERS ABOUT THE MERGER...................... 4 SELECTED FINANCIAL INFORMATION.............................. 7 Selected MRV Financial Information........................ 7 Selected Luminent Financial Information................... 9 COMPARATIVE PER SHARE DATA.................................. 12 MARKET PRICE INFORMATION.................................... 13 FORWARD-LOOKING STATEMENTS.................................. 14 RISK FACTORS................................................ 14 THE MERGER.................................................. 26 Terms of the Merger....................................... 26 Regulatory Approvals...................................... 26 Background and Reasons for the Merger..................... 26 Federal Securities Consequences........................... 29 Surrender of Stock Certificates; Fractional Interests..... 29 Statutory Appraisal Rights................................ 30 Material United States Federal Income Tax Consequences.... 33 Interests of Certain Persons to the Merger................ 33 Accounting Treatment...................................... 33 Luminent Stock Options.................................... 33 OPINION OF FINANCIAL ADVISOR................................ 35 UNITED STATES FEDERAL INCOME TAX TREATMENT OF THE MERGER.... 42 United States Federal Income Tax Consequences to Luminent Stockholders........................................... 42 United States Federal Income Tax Consequences to MRV Stockholders........................................... 42 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF MRV.......................... 43 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF LUMINENT..................... 54 BUSINESS OF MRV............................................. 68 BUSINESS OF LUMINENT........................................ 82 DESCRIPTION OF LUMINENT CAPITAL STOCK....................... 93 DESCRIPTION OF MRV CAPITAL STOCK............................ 93 COMPARATIVE STOCKHOLDER RIGHTS.............................. 95 MANAGEMENT OF MRV FOLLOWING THE MERGER...................... 96 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 100 PRINCIPAL STOCKHOLDERS...................................... 102 Principal Stockholders of MRV............................. 102 Principal Stockholders of Luminent........................ 103 LEGAL MATTERS............................................... 103 EXPERTS..................................................... 103 INDEX TO FINANCIAL STATEMENTS............................... F-1
3 6 QUESTIONS AND ANSWERS ABOUT THE MERGER Q: Why is MRV effecting the Merger? A: Due to the current slowdown in the telecommunications sectors, the market for optical components is currently suffering from weak demand. Although this could change in the future, MRV believes that the business of Luminent will be better served when integrated into MRV. By applying MRV's system level know-how, a higher level of integration of optical components and optical subsystems is achieved. This is expected to enhance Luminent's optical transmission platforms, thereby better supporting existing customers, while creating new market opportunities. Unifying Luminent with MRV is expected to enhance MRV's and Luminent's competitive position and generate substantial savings in the consolidated results, by removing inefficiencies and duplications. This action is expected to allow Luminent to invest and improve its technology and its bottom line. Q: Is my vote or a stockholders' meeting required to approve the merger? A: No. Immediately prior to the Merger, MRV Merger Sub held approximately 92% of the outstanding shares of Luminent common stock. Because MRV Merger Sub owned at least 90% of Luminent's outstanding shares immediately prior to the Merger, it effected the Merger as a short-form merger under Delaware law pursuant to resolutions adopted by the boards of directors of MRV and MRV Merger Sub. No resolutions, vote or authorization from the board of directors of Luminent or the stockholders of Luminent, MRV or MRV Merger Sub was required to consummate the Merger. Q: Who are the parties to the Merger? A: MRV Communications, Inc. 20415 Nordhoff Street Chatsworth, California 91311 Telephone: (818) 773-0900 MRV creates, acquires, finances and operates companies, and through them, designs, develops, manufactures and markets products, which enable high-speed broadband communications. MRV concentrates on companies and products devoted to optical components and Internet infrastructure systems. MRV leveraged its early experience in fiber optic technology into a number of well-focused operating units specializing in advanced fiber optic components, switching, routing, transaction management and wireless optical transmission systems which it has created, financed or acquired. MRV Merger Sub Corp. c/o MRV Communications, Inc. 20415 Nordhoff Street Chatsworth, California 91311 Telephone: (818) 773-0900 MRV Merger Sub is a wholly-owned subsidiary of MRV. MRV Merger Sub was organized on July 25, 2001. It has been used by MRV solely for the purpose of acquiring the shares of Luminent common stock owned by MRV, which MRV transferred to MRV Merger Sub immediately prior to consummating the Merger. It has not carried on any material activities other than organizational and to receive the Luminent shares transferred to it by MRV. It is the corporation surviving the Merger and immediately prior to it, owned approximately 92% of Luminent's outstanding common stock. 4 7 Luminent, Inc. 20550 Nordhoff Street Chatsworth, California 91311 Telephone (818) 773-9044 Luminent designs, manufactures and sells a comprehensive line of singlemode active and passive fiber optic components for high-capacity data transmission in the metropolitan and access markets. Leading network equipment manufacturers have relied on Luminent to provide technical depth, responsive customer service and volume manufacturing to meet the increasing requirements for transmission capacity and speed between nationwide telecommunications networks and end users. Q: As a stockholder of Luminent, what will I receive in the Merger? A: You will receive 0.43 of a share of MRV common stock for each share of Luminent common stock that you hold. MRV will not issue fractional shares of its common stock. Instead, you will receive cash, without interest, equal to the fraction multiplied by $ , which was the closing price of MRV common stock on the Nasdaq National Market on the trading day immediately prior to the day on which the Merger was consummated. Example: - If you currently own 50 shares of Luminent common stock, you will receive 21 shares of MRV common stock in connection with the Merger and a check for the value of 0.5 of a share of MRV common stock, rounded to the nearest one cent. The value of the shares of MRV common stock that you receive will fluctuate as the price of a share of MRV common stock changes. Q: Was advice obtained as to the fairness from a financial point of view of the merger exchange ratio in the Merger? A. Yes. The board of directors of Luminent retained Duff & Phelps, LLC as its independent financial advisor to make a determination as to the fairness from a financial point view of the merger exchange ratio of 0.43 to the Luminent's minority stockholders. Duff & Phelps rendered its opinion that the merger exchange ratio is fair to the stockholders of Luminent (other than MRV Merger Sub) from a financial point of view. The fairness opinion is reproduced in its entirety in Annex B to this prospectus supplement, and former stockholders of Luminent are urged to read the opinion carefully and in its entirety for a description of the assumptions and qualifications made and other matters considered by Duff & Phelps, in rendering its opinion. See the section entitled "Opinion of Financial Advisor" later in this prospectus supplement. Q: Should I send in my Luminent stock certificates now? A: Yes. To receive certificates representing shares of MRV common stock issued in the Merger, former Luminent stockholders must complete and execute the accompanying Letter of Transmittal and deliver their certificates representing Luminent common stock and the Letter of Transmittal to American Stock Transfer and Trust Company, the exchange agent, at its address stated in the accompanying Notice of Merger of Luminent, Inc. with and into MRV Merger Sub. Q: What are the material United States federal income tax consequences of the Merger? A: The Merger is intended to qualify as a tax-free reorganization for U.S. federal income tax purposes. If the Merger qualifies as a reorganization, Luminent stockholders generally will not recognize gain or loss on the exchange of their stock in the Merger, except for any gain or loss recognized in connection with any cash received instead of a fractional share of MRV stock or cash obtained through perfection of statutory appraisal rights. However, the tax consequences of the Merger to you will depend on the facts of your particular situation. MRV encourages you to contact your tax advisors to determine the tax consequences 5 8 of the Merger to you. To review the tax consequences to MRV and Luminent stockholders in greater detail, see the section entitled "United States Federal Income Tax Treatment of the Merger" later in this prospectus supplement. Q: Whom may I contact with any additional questions? A: You may call Diana Hayden, of MRV's Investor Relations Department at (818) 886-6782 or email her at diana@mrv.com. Q: What will happen to employee stock options held by Luminent employees? A: The outstanding Luminent options will convert into options for MRV common stock at the same 0.43 exchange ratio that applies to Luminent common stock. Thus, for each share of Luminent common stock on which you have an option, you will receive an option to purchase 0.43 of a share of MRV common stock. In addition, the exercise price per share will be adjusted by dividing the current exercise price by 0.43 Example: - An option to purchase 1,000 shares of Luminent common stock at an exercise price of $5.00 per share will convert to an option to purchase 430 shares of MRV common stock (1,000 x 0.43) at an exercise price of $11.63 per share ($5.00 / 0.43) 6 9 SELECTED FINANCIAL INFORMATION SELECTED MRV FINANCIAL INFORMATION The following selected statement of operations data for the three years in the period ended December 31, 2000 and the balance sheet data as of December 31, 1999 and 2000 are derived from MRV's consolidated financial statements and notes thereto, included later in this prospectus supplement, have been audited by Arthur Andersen LLP, independent public accountants, as set forth in their report included later in this prospectus supplement. The selected condensed consolidated statements of operations data for the two years in the period ended December 31, 1997 and the condensed consolidated balance sheet data as of December 31, 1996, 1997 and 1998 were derived from MRV's audited financial statements, which are not included in this prospectus supplement. The selected condensed consolidated statements of operations data for the six months ended June 30, 2000 and 2001, were derived from MRV's unaudited consolidated financial statements, which are included later in this prospectus supplement. In the opinion of MRV's management, all necessary adjustments, consisting only of normal recurring adjustments, have been included to present fairly the financial position and results of operations for each of the periods presented in the unaudited financial statements. Historical results are not necessarily indicative of results that may be expected for any future period. The following data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of 7 10 Operations of MRV" and MRV's Consolidated Financial Statements and the Unaudited Pro Forma Condensed Consolidated Financial Statements of MRV and Luminent, including the related footnotes:
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------- PRO FORMA 1996 1997 1998 1999 2000 2000(1) -------- -------- -------- -------- --------- ----------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Revenues, net.............. $ 88,815 $165,471 $264,075 $288,524 $ 319,394 332,211 Cost of goods sold(2)(3)(5)............ 51,478 94,709 165,385 197,442 203,371 216,203 Research and development(2)(3)........ 8,201 13,093 25,817 35,319 74,078 82,612 Selling, general and administrative(2)(3)..... 13,858 26,993 53,852 67,859 124,700 134,293 Purchased technology in progress(4).............. 17,795 -- 20,633 -- -- -- Restructuring costs(3)..... 6,974 -- 15,671 -- -- -- Amortization of goodwill and other intangibles.... 167 372 2,901 3,898 66,814 99,022 -------- -------- -------- -------- --------- --------- Operating income (loss).... (9,658) 30,304 (20,184) (15,994) (149,569) (199,919) Other income (expense), net(3)(6)................ (4,204) 1,901 4,339 322 (9,578) (9,634) -------- -------- -------- -------- --------- --------- Income (loss) before provision for income taxes, minority interests and extraordinary item... (13,862) 32,205 (15,845) (15,672) (159,147) (209,553) Provision (benefit) for income taxes............. (4,404) 9,474 5,707 (2,153) (5,398) (5,398) Minority interests......... (196) (146) (1,345) 610 796 129 Gain repurchase of convertible notes, net of tax...................... -- -- 2,791 -- -- -- -------- -------- -------- -------- --------- --------- Net income (loss).......... $ (9,654) $ 22,585 $(20,106) $(12,909) $(152,953) (204,026) ======== ======== ======== ======== ========= ========= Net income (loss) per share -- Basic........... $ (0.24) $ 0.48 $ (0.38) $ (0.24) $ (2.33) (2.72) ======== ======== ======== ======== ========= ========= Net income (loss) per share -- Diluted......... $ (0.24) $ 0.44 $ (0.38) $ (0.24) $ (2.33) (2.72) ======== ======== ======== ======== ========= ========= Shares used in per share calculation -- Basic.................... 39,478 47,340 53,064 53,920 65,669 75,007 Diluted.................. 39,478 51,468 53,064 53,920 65,669 75,007 SIX MONTHS ENDED JUNE 30, ----------------------------------------- PRO FORMA 2000 2001 2001(1) ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Revenues, net.............. $139,007 $ 189,634 189,634 Cost of goods sold(2)(3)(5)............ 88,529 155,156 155,156 Research and development(2)(3)........ 26,649 50,787 50,787 Selling, general and administrative(2)(3)..... 41,481 82,123 82,123 Purchased technology in progress(4).............. -- -- -- Restructuring costs(3)..... -- -- -- Amortization of goodwill and other intangibles.... 13,069 57,167 54,390 -------- --------- --------- Operating income (loss).... (30,721) (155,599) (152,822) Other income (expense), net(3)(6)................ (1,678) (2,893) (2,893) -------- --------- --------- Income (loss) before provision for income taxes, minority interests and extraordinary item... (32,399) (158,492) (155,715) Provision (benefit) for income taxes............. 883 (3,622) (3,622) Minority interests......... (332) 6,439 (350) Gain repurchase of convertible notes, net of tax...................... -- -- -- -------- --------- --------- Net income (loss).......... $(33,614) $(148,431) (152,443) ======== ========= ========= Net income (loss) per share -- Basic........... $ (0.56) $ (1.97) (1.90) ======== ========= ========= Net income (loss) per share -- Diluted......... $ (0.56) $ (1.97) (1.90) ======== ========= ========= Shares used in per share calculation -- Basic.................... 59,839 75,245 80,405 Diluted.................. 59,839 75,245 80,405
AT JUNE 30, AT DECEMBER 31, -------------------------- --------------------------------------------------------- PRO FORMA 1996 1997 1998 1999 2000 2001 2001 ------- -------- -------- -------- ---------- ----------- ----------- (IN THOUSANDS) (UNAUDITED) (UNAUDITED) CONDENSED CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents....... $14,641 $ 19,428 $ 20,692 $ 34,330 $ 210,080 $ 174,887 $ 174,887 Working capital................. 56,973 111,559 115,318 106,425 366,752 305,772 305,772 Total assets.................... 96,943 236,236 320,192 314,533 1,096,771 1,023,147 995,373 Total long-term liabilities..... 18,892 2,853 94,317 94,409 154,504 155,182 155,182 Stockholders' equity............ 41,771 189,969 174,429 166,815 781,555 710,305 717,823
------------------------- (1) The unaudited pro forma selected statements of operation data for the year ended December 31, 2000 and for the six months ended June 30, 2001 were derived from the unaudited pro forma financial statements of MRV included later in this prospectus supplement. The December 31, 2000 unaudited pro forma condensed consolidated statement of operations assumes that the Fiber Optic Communications, Optronics, and AstroTerra acquisitions and the purchase of the minority interest in Luminent occurred on January 1, 2000 and consolidates our consolidated statement of operations for the year ended December 31, 2000 with the statements of operations for that year of Fiber Optic 8 11 Communications, Optronics, and Astroterra. The June 30, 2001 unaudited pro forma condensed consolidated statement of operations assumes that the purchase of the minority interest in Luminent occurred on January 1, 2000. See "Unaudited Pro Forma Condensed Consolidated Financial Statements" included later in this prospectus supplement. (2) Includes amounts related to deferred stock compensation of: $8.3 million and $4.8 million in "cost of goods sold"; $13.2 million and $7.6 million in "research and development" expenses; and $38.4 million and $22.1 million in "selling, general and administrative" expenses for the years ended December 31, 2000 and the six months ended June 30, 2001, respectively. (3) Includes one-time charges of $29.3 million, $11.4 million, $501,000 and $16,000 presented in "cost of sales", "selling, general and administrative", "research and development" and "other income, net", respectively, for the six months ended June 30, 2001, to write-down inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other non-recurring items. These charges resulted from the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. (4) Purchased technology in progress and restructuring charges were incurred as a result of acquisitions. Purchased technology in progress for the year ended December 31, 1996, was in conjunction with the acquisition of Fibronics. Restructuring costs during the year ended December 31, 1996, were associated with a plan adopted by MRV on September 30, 1996, calling for the reduction of workforce, closing of certain facilities, retraining of certain employees and elimination of particular product lines. Purchased technology in progress for the year ended December 31, 1998, was in conjunction with the Xyplex acquisition. Restructuring costs during the year ended December 31, 1998, were associated with a plan adopted by MRV in March 1998, calling for the reduction of workforce, closing of certain facilities, elimination of particular product lines, settlement of distribution agreements and other costs. (5) For the years ended December 31, 1998 and 1999, includes amounts relating to the writedown of discontinued products of $3.1 million and $13.8 million, respectively. (6) Interest expenses for the years ended December 31, 1996 and 1997 were in connection with the private placement of $30.0 million principal amount of debentures, the proceeds from which MRV used to finance the cash portion of the Fibronics acquisition. Interest expenses for the year ended December 31, 1998 and 1999, were connected with the private placement of $100.0 million principal amount of 5% Convertible Subordinated Notes. See Note 10 of notes to the consolidated financial statements of MRV included later in this prospectus supplement. SELECTED LUMINENT FINANCIAL INFORMATION The following selected condensed consolidated statements of operations data for the three years ended December 31, 2000, and the condensed consolidated balance sheet data as of December 31, 1999 and 2000, are derived from Luminent's consolidated financial statements and notes thereto included later in this prospectus supplement, which have been audited by Arthur Andersen LLP, independent public accountants, as set forth in their report included with the financial statements appearing in this prospectus supplement. The selected condensed consolidated statements of operations data for the year ended December 31, 1997, and the condensed consolidated balance sheet data at December 31, 1998, were derived from Luminent's audited financial statements, which are not included in this prospectus supplement. The selected condensed consolidated statements of operations data for the year ended December 31, 1996, and the condensed consolidated balance sheet data as of December 31, 1996 and 1997, were derived from Luminent's unaudited financial statements, which are not included in this prospectus supplement. The unaudited pro forma selected statement of operations data for the year ended December 31, 2000, were derived from the unaudited pro forma financial statements of Luminent, which are included later in this prospectus supplement. The selected condensed consolidated statements of operations data for the six months ended June 30, 2000 and 2001, were derived from Luminent's 9 12 unaudited consolidated condensed financial statements, which are included later in this prospectus supplement. In the opinion of Luminent's management, all necessary adjustments, consisting only of normal recurring adjustments, have been included to present fairly the financial position and results of operations for each of the periods presented in Luminent's unaudited financial statements. Historical results are not necessarily indicative of results that may be expected for any future period. The following data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Luminent's Consolidated Financial Statements and the Unaudited Pro Forma Condensed Consolidated Financial Statements of Luminent, including the related footnotes.
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED --------------------------------------------------------------------- JUNE 30, PRO FORMA ------------------- 1996 1997 1998 1999 2000 2000(1) 2000 2001 ----------- -------- -------- -------- -------- ----------- -------- -------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Net sales......................... $ 24,034 $ 35,081 $ 38,596 $ 65,264 $124,193 $ 137,317 $ 43,006 $ 89,344 Cost of sales(2)(3)............... 13,970 21,659 24,289 43,078 84,384 94,754 27,801 90,146 -------- -------- -------- -------- -------- --------- -------- -------- Gross profit.................. 10,064 13,422 14,307 22,186 39,809 42,563 15,205 (802) Operating costs and expenses: Selling, general and administrative(2)(3).......... 1,160 2,102 2,642 5,675 38,768 44,653 8,084 39,528 Research and development(2)(3)............. 2,179 3,520 4,974 8,693 18,204 21,185 6,624 10,030 Parent company allocations...... 787 797 808 885 588 588 -- -- Amortization of goodwill and other intangibles............. -- -- -- -- 47,421 77,744 9,580 38,976 -------- -------- -------- -------- -------- --------- -------- -------- 4,126 6,419 8,424 15,253 104,981 144,170 24,288 88,534 -------- -------- -------- -------- -------- --------- -------- -------- Operating income (loss)....... 5,938 7,003 5,883 6,933 (65,172) (101,607) (9,083) (89,336) Other income (loss), net(3)....... -- -- -- 6 2,246 2,008 192 2,822 -------- -------- -------- -------- -------- --------- -------- -------- Income (loss) before provision for income taxes and minority interests..................... 5,938 7,003 5,883 6,939 (62,926) (99,599) (8,891) (86,514) Provision for income taxes........ 2,297 2,789 2,343 2,764 2,766 2,766 1,469 1,854 Minority interest................. -- -- -- -- (707) (738) 318 (115) -------- -------- -------- -------- -------- --------- -------- -------- Net income (loss)............... $ 3,641 $ 4,214 $ 3,540 $ 4,175 $(64,985) $(101,627) $(10,678) $(88,253) ======== ======== ======== ======== ======== ========= ======== ======== Earnings (loss) per share(4): Basic and diluted income (loss) per share....................... $ 0.03 $ 0.03 $ 0.02 $ 0.03 $ (0.45) $ (0.70) $ (0.07) $ (0.57) Basic and diluted income average shares.......................... 144,000 144,000 144,000 144,000 145,677 145,677 144,000 156,000 ======== ======== ======== ======== ======== ========= ======== ========
AT DECEMBER 31, AT ------------------------------------------------ JUNE 30, 1996 1997 1998 1999 2000 2001 ------- ------- ------- ------- -------- ------------ (UNAUDITED) (UNAUDITED) (IN THOUSANDS) CONDENSED CONSOLIDATED BALANCE SHEET DATA: Cash and short-term investments......................... $ -- $ -- $ -- $ 220 $132,860 $ 93,118 Working capital......................................... 5,387 4,694 7,453 12,561 161,671 123,007 Total assets............................................ 11,779 13,305 14,742 23,127 605,380 541,625 Long-term debt net of current portion................... -- -- -- -- 9,550 8,596
------------------------- (1) The unaudited pro forma selected statement of operation data for the year ended December 31, 2000, were derived from the unaudited pro forma condensed consolidated financial statements of Luminent included later in this prospectus supplement. The unaudited pro forma condensed consolidated statement of operations assumes that the Fiber Optic Communications, Optronics and Quantum acquisitions occurred on January 1, 2000, and consolidates Luminent's consolidated statement of operations for the year ended December 31, 2000, with the statements of operations for that year of Fiber Optic Communications, Optronics and Quantum. See "Unaudited Pro Forma Condensed Consolidated Financial Information of MRV" included later in this prospectus supplement. 10 13 (2) Includes amounts related to deferred stock compensation of: $2.8 million and $1.2 million in "costs of sales"; $21.7 million and $15.7 million in "selling, general and administrative" expenses; and $4.3 and $2.0 million in "research and development" expenses for the year ended December 31, 2000, and the six months ended June 30, 2001, respectively. (3) Includes one-time charges of $29.3 million, $11.4 million, $501,000 and $16,000 presented in "cost of sales", "selling, general and administrative", "research and development" and "other income, net", respectively, for the six months ended June 30, 2001, to write-down inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other non-recurring items. These charges resulted from the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. (4) See note 2 of notes to Luminent's audited consolidated financial statements at December 31, 2000, and for each of the three years in the period then ended and note 1 to Luminent's unaudited consolidated financial statements at June 30, 2001 and for the six months ended June 30, 2000 and 2001, for an explanation of how the number of shares used in calculating this per share data was determined. These financial statements are included later in this prospectus supplement. 11 14 COMPARATIVE PER SHARE DATA The following table reflects (a) the historical net loss and book value per share of MRV common stock and the historical net loss and book value per share of Luminent common stock in comparison with the unaudited pro forma net loss and book value per share after giving effect to the Merger, and (b) the equivalent pro forma net loss and book value per share attributable to 0.43 of a share of a MRV common stock which will be issued for each share of Luminent. For MRV and Luminent, the historical book value per share is computed by dividing their respective stockholders' equity as of December 31, 2000 and June 30, 2001, respectively, by their actual common shares outstanding. The pro forma per share loss from continuing operations is computed by dividing the pro forma loss from continuing operations by the pro forma weighted average number of shares outstanding, assuming MRV had acquired Luminent at the beginning of the earliest period presented. The pro forma combined book value per share is computed by dividing the total pro forma stockholders' equity by the pro forma number of common shares outstanding at December 31, 1999, assuming the Merger had occurred on that date. The Luminent equivalent pro forma combined per share amounts are calculated by multiplying the MRV pro forma combined per share amounts by the exchange ratio of 0.43. The following information should be read in conjunction with the separate selected audited historical consolidated financial statements and related notes of MRV and Luminent, the selected unaudited interim condensed consolidated financial statements of MRV, the unaudited pro forma condensed combined financial information and related notes of MRV, and the selected historical and selected unaudited pro forma financial data included elsewhere in this prospectus supplement. The pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating results or financial position that would have occurred if the Merger had been consummated as of the beginning of the respective periods presented, nor is it necessarily indicative of the future operating results or financial position of the combined companies.
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED 2000 JUNE 30, 2001 ------------ ---------------- (UNAUDITED) HISTORICAL MRV: Net loss from continuing operations per share -- basic and diluted................................................... $(2.33) $(1.97) Book value per share at the end of the period............... $10.67 $ 9.19 HISTORICAL LUMINENT: Net loss from continuing operations per share -- basic and diluted................................................... $(0.45) $(0.57) Book value per share at the end of the period............... $ 3.51 $ 3.05 PRO FORMA COMBINED (UNAUDITED): Pro forma net loss from continuing operations per MRV share -- basic and diluted................................ $(2.17) $(1.93) Pro forma net loss from continuing operations per equivalent Luminent share -- basic and diluted....................... $(0.93) $(0.83) Pro forma book value per MRV share at the end of the period.................................................... $10.22 $ 8.71 Pro forma book value per equivalent Luminent share at the end of the period......................................... $ 4.39 $ 3.74
12 15 MARKET PRICE INFORMATION MRV's common stock is traded in the over-the-counter market and has been included in the Nasdaq National Market since February 28, 1994 under the symbol "MRVC." The following table sets forth the high and low closing sale prices of MRV's common stock for the periods indicated as reported by the Nasdaq National Market. The prices have been adjusted to give retroactive effect to the two-for-one stock split effected on May 11, 2000.
HIGH LOW ------ ------ 1999 First Quarter............................................... $ 4.94 $ 2.97 Second Quarter.............................................. 7.03 2.97 Third Quarter............................................... 12.41 6.31 Fourth Quarter.............................................. 32.81 9.72 2000 First Quarter............................................... $95.25 $25.88 Second Quarter.............................................. 67.25 23.44 Third Quarter............................................... 80.38 45.31 Fourth Quarter.............................................. 49.25 11.06 2001 First Quarter............................................... $21.38 $ 6.22 Second Quarter.............................................. 12.90 5.38 Third Quarter............................................... 8.79 2.43 Fourth Quarter (through October 5, 2001).................... 3.10 2.85
Luminent's common stock has traded on the Nasdaq National Market since November 9, 2000 under the symbol "LMNE." The following table sets forth the high and low closing sale prices of Luminent's common stock for the periods indicated as reported by the Nasdaq National Market
HIGH LOW ------ ----- 2000 Fourth Quarter (from November 9, 2000)...................... $12.25 $4.31 2001 First Quarter............................................... $10.38 $2.31 Second Quarter.............................................. 6.16 2.44 Third Quarter............................................... 3.96 1.20 Fourth Quarter (through October 5, 2001).................... 2.03 1.93
As of September 30, 2001, MRV had 3,426 stockholders of record, as indicated on the records of its transfer agent, and Luminent had 146 stockholders of record, as indicated on the records of its transfer agent, who held, MRV believes, for approximately 6,000 beneficial holders. The table below sets forth the high and low sale prices per share of MRV common stock on the Nasdaq National Market on September 10, 2001, the last completed trading day prior to the public announcement of the proposed Merger, and on , 2001, the effective date of the Merger. Also set forth is the implied equivalent value of one share of Luminent common stock on each respective date, using an exchange ratio of 0.43 of a share of MRV common stock for each share of Luminent common stock.
APPROXIMATE LUMINENT MRV COMMON COMMON STOCK STOCK EQUIVALENT -------------- -------------- HIGH LOW HIGH LOW ----- ----- ----- ----- September 10, 2001.................................. $3.23 $3.02 $1.39 $1.30 , 2001..................................
13 16 FORWARD-LOOKING STATEMENTS WE MAKE FORWARD-LOOKING STATEMENTS IN THIS PROSPECTUS SUPPLEMENT THAT MAY NOT PROVE TO BE ACCURATE. This prospectus supplement contains forward-looking statements including statements regarding, among other items, our and Luminent's business strategy, growth strategy and anticipated trends in our business. We may make additional written or oral forward-looking statements from time to time in filings with the Securities and Exchange Commission or otherwise. When we use the words "believe," "expect," "anticipate," "project" and similar expressions, this should alert you that this is a forward-looking statement. These forward-looking statements are largely based on our expectations. They are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond our control. Future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. Statements in this prospectus supplement, including those set forth below in "Risk Factors," describe factors, among others, that could contribute to or cause these differences. In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this prospectus supplement will in fact transpire or prove to be accurate. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this section. RISK FACTORS Investment in shares of MRV common stock involves a high degree of risk. Set forth below and elsewhere in this prospectus supplement are risks and uncertainties that could cause MRV's actual results to differ materially from the results contemplated by the forward-looking statements contained in this prospectus supplement and in public statements and press releases we make from time to time. As used in this Risk Factors section, the pronouns "we," "our" and "us" refers to MRV and its consolidated subsidiaries. WE INCURRED A NET LOSS IN THE YEAR ENDED DECEMBER 31, 2000 AND DURING THE SIX-MONTH PERIOD ENDED JUNE 30, 2001, PRIMARILY AS A RESULT OF THE AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES AND DEFERRED COMPENSATION CHARGES FROM RECENT ACQUISITIONS. WE EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE FORESEEABLE FUTURE. We reported a net loss of $153.0 million for the year ended December 31, 2000 and $148.4 million for the six months ended June 30, 2001. A major contributing factor to the net losses was the amortization of goodwill and other intangibles and deferred stock compensation related to our acquisitions of Fiber Optic Communications, Jolt, Quantum Optech, AstroTerra and Optronics and our employment arrangements with Luminent's former President and Luminent's Chief Financial Officer. We will continue to record amortization of goodwill and other intangibles and deferred stock compensation relating to these acquisitions and the employment arrangements with these executives going forward. Effective January 1, 2002, with the adoption of SFAS 142, we will stop amortization of goodwill, however, we may be required to record an impairment charge (see Recently Issued Accounting Standards). As a consequence of goodwill and other intangibles and deferred stock compensation charges, we do not expect to report net income in the foreseeable future. OUR BUSINESS HAS BEEN ADVERSELY IMPACTED BY THE WORLDWIDE ECONOMIC SLOWDOWN AND RELATED UNCERTAINTIES. Weaker economic conditions worldwide, particularly in the U.S. and Europe, have contributed to the current technology industry slowdown and impacted our business resulting in: - reduced demand for of our products, particularly Luminent's fiber optic components; - increased risk of excess and obsolete inventories; - increased price competition for our products; 14 17 - excess manufacturing capacity under current market conditions; and - higher overhead costs, as a percentage of revenues. These unfavorable economic conditions and reduced capital spending in the telecommunications industry detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States during 2001 to date, and appear to continue to affect these industries in the third quarter of 2001 and may affect them for the balance of 2001 and thereafter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories and we are experiencing these reductions in our business. As a result of these factors, we have recorded in the second quarter of 2001, consolidated one-time charges from our subsidiary, Luminent, which include the write-off of inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other unusual items. The aggregate one-time charges recorded during the second quarter were $41.2 million. These charges are the result of the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. Additionally, these economic conditions are making it very difficult for MRV, Luminent and our other companies, our customers and our vendors to forecast and plan future business activities. This level of uncertainty severely challenges our ability to operate profitably or to grow our businesses. In particular, it is difficult to develop and implement strategy, sustainable business models and efficient operations, and effectively manage manufacturing and supply chain relationships. Many analysts are predicting a further downturn in the U.S. economy in the aftermath of the terrorist attacks on the World Trade Center in New York and the Pentagon in Washington DC in September 2001. As discussed below in the section of these Risk Factors entitled, "We may have difficulty managing our business," we have lost a key member of our management team in the attack on the World Trade Center and that loss has already had and may in the future have adverse consequences on our business. However, we do not know how the consequences of these attacks will additionally affect our business. If the economic or market conditions continue or further deteriorate, or if the economic downturn is exacerbated as a result of political, economic or military conditions associated with current domestic and world events, our businesses, financial condition and results of operations could be further impaired. OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND TO COMPETE EFFECTIVELY, WE MUST CONTINUALLY INTRODUCE NEW PRODUCTS THAT ACHIEVE MARKET ACCEPTANCE. The markets for our products are characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. We expect that new technologies will emerge as competition and the need for higher and more cost effective transmission capacity, or bandwidth, increases. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address these changes as well as current and potential customer requirements. The introduction of new and enhanced products may cause our customers to defer or cancel orders for existing products. We have in the past experienced delays in product development and these delays may occur in the future. Therefore, to the extent customers defer or cancel orders in the expectation of a new product release or there is any delay in development or introduction of our new products or enhancements of our products, our operating results would suffer. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements, or to license these technologies from third parties. Product development delays may result from numerous factors, including: - changing product specifications and customer requirements; - difficulties in hiring and retaining necessary technical personnel; - difficulties in reallocating engineering resources and overcoming resource limitations; - difficulties with contract manufacturers; 15 18 - changing market or competitive product requirements; and - unanticipated engineering complexities. The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. In order to compete, we must be able to deliver products to customers that are highly reliable, operate with its existing equipment, lower the customer's costs of acquisition, installation and maintenance, and provide an overall cost-effective solution. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Any failure to respond to technological changes would significantly harm our business. DEFECTS IN OUR PRODUCTS RESULTING FROM THEIR COMPLEXITY OR OTHERWISE COULD HURT OUR FINANCIAL PERFORMANCE. Complex products, such as those our companies and we offer, may contain undetected software or hardware errors when we first introduce them or when we release new versions. The occurrence of these errors in the future, and our inability to correct these errors quickly or at all, could result in the delay or loss of market acceptance of our products. It could also result in material warranty expense, diversion of engineering and other resources from our product development efforts and the loss of credibility with, and legal actions by, our customers, system integrators and end users. Any of these or other eventualities resulting from defects in our products could cause our sales to decline and have a material adverse effect on our business, operating results and financial condition. OUR GROWTH RATE MAY BE LOWER THAN HISTORICAL LEVELS AND OUR RESULTS COULD FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER. Our revenues may grow at a slower rate in the future than we have experienced in previous periods and, on a quarter-to-quarter basis, our growth in revenue may be significantly lower than our historical quarterly growth rates. Our operating results for a particular quarter are extremely difficult to predict. Our revenue and operating results could fluctuate substantially from quarter to quarter and from year to year. This could result from any one or a combination of factors such as: - the cancellation or postponement of orders; - the timing and amount of significant orders from our largest customers; - our success in developing, introducing and shipping product enhancements and new products; - the mix of products we sell; - adverse effects to our financial statements resulting from, or necessitated by, past and future acquisitions or deferred compensation charges; - new product introductions by our competitors; - pricing actions by our competitors or us; - the timing of delivery and availability of components from suppliers; - changes in material costs; and - general economic conditions. Moreover, the volume and timing of orders we receive during a quarter are difficult to forecast. From time to time, our customers encounter uncertain and changing demand for their products. Customers generally order based on their forecasts. If demand falls below these forecasts or if customers do not 16 19 control inventories effectively, they may cancel or reschedule shipments previously ordered from us. Our expense levels during any particular period are based, in part, on expectations of future sales. If sales in a particular quarter do not meet expectations, our operating results could be materially adversely affected. Our success is dependent, in part, on the overall growth rate of the fiber optic components and networking industry. We can give no assurance that the Internet or the industries that serve it will continue to grow or that we will achieve higher growth rates. Our business, operating results or financial condition may be adversely affected by any decreases in industry growth rates. In addition, we can give no assurance that our results in any particular period will fall within the ranges for growth forecast by market researchers. Because of these and other factors, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance. It is possible that, in future periods, our results of operations may be below the expectations of public market analysts and investors. This failure to meet expectations could cause the trading price of our common stock to decline. Similarly, the failure by our competitors or customers to meet or exceed the results expected by their analysts or investors could have a ripple effect on us and cause our stock price to decline. THE LONG SALES CYCLES FOR OUR PRODUCTS MAY CAUSE REVENUES AND OPERATING RESULTS TO VARY FROM QUARTER TO QUARTER, WHICH COULD CAUSE VOLATILITY IN OUR STOCK PRICE. The timing of our revenue is difficult to predict because of the length and variability of the sales and implementation cycles for our products. We do not recognize revenue until a product has been shipped to a customer, all significant vendor obligations have been performed and collection is considered probable. Customers often view the purchase of our products as a significant and strategic decision. As a result, customers typically expend significant effort in evaluating, testing and qualifying our products and our manufacturing process. This customer evaluation and qualification process frequently results in a lengthy initial sales cycle of, depending on the products, many months or more. In addition, some of our customers require that our products be subjected to lifetime and reliability testing, which also can take months or more. While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing and research and development expenses to customize our products to the customer's needs. We may also expend significant management efforts, increase manufacturing capacity and order long lead-time components or materials prior to receiving an order. Even after this evaluation process, a potential customer may not purchase our products. Even after acceptance of orders, our customers often change the scheduled delivery dates of their orders. Because of the evolving nature of the optical networking and network infrastructure markets, we cannot predict the length of these sales, development or delivery cycles. As a result, these long sales cycles may cause our net sales and operating results to vary significantly and unexpectedly from quarter-to-quarter, which could cause volatility in our stock price. THE PRICES OF OUR SHARES MAY CONTINUE TO BE HIGHLY VOLATILE. Historically, the market price of our shares has been extremely volatile. The market price of our common stock is likely to continue to be highly volatile and could be significantly affected by factors such as: - actual or anticipated fluctuations in our operating results; - announcements of technological innovations or new product introductions by us or our competitors; - changes of estimates of our future operating results by securities analysts; - developments with respect to patents, copyrights or proprietary rights; and - general market conditions and other factors. In addition, the stock market has experienced extreme price and volume fluctuations that have particularly affected the market prices for the common stocks of technology companies in particular, and 17 20 that have been unrelated to the operating performance of these companies. These factors, as well as general economic and political conditions, may materially adversely affect the market price of our common stock in the future. Similarly, the failure by our competitors or customers to meet or exceed the results expected by their analysts or investors could have a ripple effect on us and cause our stock price to decline. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, all of whom have been granted stock options. OUR STOCK PRICE MIGHT SUFFER AS A CONSEQUENCE OF OUR INVESTMENTS IN AFFILIATES. We have created several start-up companies and formed independent business units in the optical technology and Internet infrastructure areas. We account for these investments in affiliates according to the equity or cost methods as required by accounting principles generally accepted in the United States. The market value of these investments may vary materially from the amounts shown as a result of business events specific to these entities or their competitors or market conditions. Actual or perceived changes in the market value of these investments could have a material impact on our share price and in addition could contribute significantly to volatility of our share price. OUR DECISION TO ABANDON THE SPIN-OFF OF LUMINENT TO OUR STOCKHOLDERS AND TO ELIMINATE PUBLIC OWNERSHIP OF LUMINENT'S COMMON STOCK COULD HARM THE MARKET PRICE OF OUR COMMON STOCK. In 2000, we announced our intention to distribute to our stockholders the outstanding common stock of Luminent that we owned assuming certain conditions were met. While we informed our stockholders that we were not obligated to make this distribution and might not if economic, market or other conditions caused our board to decide against it, stockholders and analysts may react negatively to our decision to abandon the distribution or to eliminate public ownership of Luminent's common stock through the Merger. On September 17, 2001, the first trading day following the announcement of our decision to abandon the distribution and effect the Merger the closing price of our stock decreased from $3.23 to $2.43. While September 17, 2001, was the first day of the reopening of the stock market in the United States following the terrorists events of September 11, 2001, the decrease in the market price of our stock could reflect a negative reaction to the news of the Merger and, depending on investors' continuing assessment of the impact of these events on our company, this reaction could be sustained or cause the market price of our shares drop lower. We can give you no assurance that the market price of our shares will not be lower than the market price of the comparable number of Luminent's shares held by former Luminent stockholders prior to the Merger. OUR BUSINESS IS INTENSELY COMPETITIVE AND THE EVIDENT TREND OF CONSOLIDATIONS IN OUR INDUSTRY COULD MAKE IT MORE SO. The markets for fiber optic components and networking products are intensely competitive and subject to frequent product introductions with improved price/performance characteristics, rapid technological change and the continual emergence of new industry standards. We compete and will compete with numerous types of companies including companies that have been established for many years and have considerably greater financial, marketing, technical, human and other resources, as well as greater name recognition and a larger installed customer base, than we do. This may give these competitors certain advantages, including the ability to negotiate lower prices on raw materials and components than those available to us. In addition, many of our large competitors offer customers broader product lines, which provide more comprehensive solutions than our current offerings. We expect that other companies will also enter markets in which we compete. Increased competition could result in significant price competition, reduced profit margins or loss of market share. We can give no assurance that we will be able to compete successfully with existing or future competitors or that the competitive pressures we face will not materially and adversely affect our business, operating results and financial condition. In particular, we expect that prices on many of our products will continue to decrease in the future and that the pace and magnitude of these price decreases may have an adverse impact on our results of operations or financial condition. 18 21 There has been a trend toward industry consolidation for several years. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry. We believe that industry consolidation may provide stronger competitors that are better able to compete. This could have a material adverse effect on our business, operating results and financial condition. WE MAY HAVE DIFFICULTY MANAGING OUR BUSINESSES. We have grown rapidly in recent years, with revenues increasing from $88.8 million for the year ended December 31, 1996, to $319.4 million for the year ended December 31, 2000. Our growth, both internally and through the acquisitions we have made has placed a significant strain on our financial and management personnel and information systems and controls. As a consequence, we must continually implement new and enhance existing financial and management information systems and controls and must add and train personnel to operate these systems effectively. Our delay or failure to implement new and enhance existing systems and controls as needed could have a material adverse effect on our results of operations and financial condition in the future. Our intention to continue to pursue a growth strategy can be expected to place even greater pressure on our existing personnel and to compound the need for increased personnel, expanded information systems, and additional financial and administrative control procedures. We can give no assurance that we will be able to successfully manage operations if they continue to expand. Edmund Glazer, our Vice President of Finance and Administration and Chief Financial Officer was killed on September 11, 2001 in the terrorists' attack on the World Trade Center. His death has created a void in our management team that will exist until a suitable replacement or replacements are found. Until a successor or successors to Mr. Glazer are found and begin performing duties he previously handled and managed, we may face difficulties in compiling, reviewing and releasing financial information and this could result in delays in releasing this information to the public and our meeting deadlines to file the reports required of a public company. These difficulties could adversely affect the marketplace's perception of MRV resulting in decreases in our stock price. WE FACE RISKS FROM OUR INTERNATIONAL OPERATIONS. International sales have become an increasingly important segment of our operations. The following table sets forth the percentage of our total net revenues from sales to customers in foreign countries for the periods indicated below:
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ----------------------- ------------ 1998 1999 2000 2000 2001 ----- ----- ----- ---- ---- Percent of total revenue from foreign sales....... 59% 58% 63% 60% 63%
We have companies and offices in, and conduct a significant portion of our operations in and from, Israel. We are, therefore, directly influenced by the political and economic conditions affecting Israel. Any major hostilities involving Israel, the interruption or curtailment of trade between Israel and its trading partners or a substantial downturn in the economic or financial condition of Israel could have a material adverse effect on our operations. In addition, the recent acquisition of operations in Taiwan and People's Republic of China has increased both the administrative complications we must manage and our exposure to political, economic and other conditions affecting Taiwan and People's Republic of China. Currently there is significant political tension between Taiwan and People's Republic of China, which could lead to hostilities. Risks we face due to international sales and the use of overseas manufacturing include: - greater difficulty in accounts receivable collection and longer collection periods; - the impact of recessions in economies outside the United States; - unexpected changes in regulatory requirements; 19 22 - seasonal reductions in business activities in some parts of the world, such as during the summer months in Europe or in the winter months in Asia when the Chinese New Year is celebrated; - certification requirements; - potentially adverse tax consequences; - unanticipated cost increases; - unavailability or late delivery of equipment; - trade restrictions; - limited protection of intellectual property rights; - unforeseen environmental or engineering problems; and - personnel recruitment delays. The majority of our sales are currently denominated in U.S. dollars and to date our business has not been significantly affected by currency fluctuations or inflation. However, as we conduct business in several different countries, fluctuations in currency exchange rates could cause our products to become relatively more expensive in particular countries, leading to a reduction in sales in that country. In addition, inflation or fluctuations in currency exchange rates in these countries could increase our expenses. The Single European Currency (Euro) was introduced on January 1, 1999 with complete transition to this new currency required by January 2002. We have made and expect to continue to make changes to our internal systems in order to accommodate doing business in the Euro. Any delays in our ability to be Euro- compliant could have an adverse impact on our results of operations or financial condition. Due to numerous uncertainties, we cannot reasonably estimate at this time the effects a common currency will have on pricing within the European Union and the resulting impact, if any, on our financial condition or results of operations. To date, we have not hedged against currency exchange risks. In the future, we may engage in foreign currency denominated sales or pay material amounts of expenses in foreign currencies and, in that event, may experience gains and losses due to currency fluctuations. Our operating results could be adversely affected by currency fluctuations or as a result of inflation in particular countries where material expenses are incurred. WE DEPEND ON THIRD-PARTY CONTRACT MANUFACTURERS FOR NEEDED COMPONENTS AND THEREFORE COULD FACE DELAYS HARMING OUR SALES. We outsource the board-level assembly, test and quality control of material, components, subassemblies and systems relating to our networking products to third-party contract manufacturers. Though there are a large number of contract manufacturers that we can use for outsourcing, we have elected to use a limited number of vendors for a significant portion of our board assembly requirements in order to foster consistency in quality of the products and to achieve economies of scale. These independent third-party manufacturers also provide the same services to other companies. Risks associated with the use of independent manufacturers include unavailability of or delays in obtaining adequate supplies of products and reduced control of manufacturing quality and production costs. If our contract manufacturers failed to deliver needed components timely, we could face difficulty in obtaining adequate supplies of products from other sources in the near term. We can give no assurance that our third party manufacturers will provide us with adequate supplies of quality products on a timely basis, or at all. While we could outsource with other vendors, a change in vendors may require significant lead-time and may result in shipment delays and expenses. Our inability to obtain these products on a timely basis, the loss of a vendor or a change in the terms and conditions of the outsourcing would have a material adverse effect on our business, operating results and financial condition. 20 23 WE MAY LOSE SALES IF SUPPLIERS OF OTHER CRITICAL COMPONENTS FAIL TO MEET OUR NEEDS. Our companies currently purchase several key components used in the manufacture of our products from single or limited sources. We depend on these sources to meet our needs. Moreover, we depend on the quality of the products supplied to us over which we have limited control. We have encountered shortages and delays in obtaining components in the past and expect to encounter shortages and delays in the future. If we cannot supply products due to a lack of components, or are unable to redesign products with other components in a timely manner, our business will be significantly harmed. We have no long-term or short-term contracts for any of our components. As a result, a supplier can discontinue supplying components to us without penalty. If a supplier discontinued supplying a component, our business may be harmed by the resulting product manufacturing and delivery delays. OUR INABILITY TO ACHIEVE ADEQUATE PRODUCTION YIELDS FOR CERTAIN COMPONENTS WE MANUFACTURE INTERNALLY COULD RESULT IN A LOSS OF SALES AND CUSTOMERS. We rely heavily on our own production capability for critical semiconductor lasers and light emitting diodes used in our products. Because we manufacture these and other key components at our own facilities and these components are not readily available from other sources, any interruption of our manufacturing processes could have a material adverse effect on our operations. Furthermore, we have a limited number of employees dedicated to the operation and maintenance of our wafer fabrication equipment, the loss of any of whom could result in our inability to effectively operate and service this equipment. Wafer fabrication is sensitive to many factors, including variations and impurities in the raw materials, the fabrication process, performance of the manufacturing equipment, defects in the masks used to print circuits on the wafer and the level of contaminants in the manufacturing environment. We can give no assurance that we will be able to maintain acceptable production yields and avoid product shipment delays. In the event adequate production yields are not achieved, resulting in product shipment delays, our business, operating results and financial condition could be materially adversely affected. FUTURE HARM COULD RESULT FROM ADDITIONAL ACQUISITIONS. An important element of our strategy is to review acquisition prospects that would complement our existing companies and products, augment our market coverage and distribution ability or enhance our technological capabilities. Future acquisitions could have a material adverse effect on our business, financial condition and results of operations because of the following: - possible charges to operations for purchased technology and restructuring similar to those incurred in connection with our acquisition of Xyplex in 1998; - potentially dilutive issuances of equity securities; - incurrence of debt and contingent liabilities; - incurrence of amortization expenses and impairment charges related to goodwill and other intangible assets and deferred compensation charges similar to those arising with the acquisitions of Fiber Optic Communications, Optronics, Quantum Optech, Jolt and Astroterra in 2000 (see Recently Issued Accounting Standards); - difficulties assimilating the acquired operations, technologies and products; - diversion of management's attention to other business concerns; - risks of entering markets in which we have no or limited prior experience; - potential loss of key employees of acquired organizations; and - difficulties in honoring commitments made to customers by management of the acquired entity prior to the acquisition. 21 24 We can give no assurance as to whether we can successfully integrate the companies, products, technologies or personnel of any business that we might acquire in the future. WE CANNOT PREDICT THE IMPACT OF POTENTIAL ACTIONS BY THE SEC WITH RESPECT TO OUR VALUATION METHODOLOGY FOR IN-PROCESS RESEARCH AND DEVELOPMENT RELATED TO BUSINESS COMBINATIONS. Actions and comments from the SEC have indicated it has been reviewing the valuation methodology of in-process research and development related to business combinations. We believe we are in compliance with all of the existing rules and related guidance as applicable to our business operations. However, the SEC may change these rules or issue new guidance applicable to our business in the future. There can be no assurance that the SEC will not seek to reduce the amount of in-process research and development previously expensed by us. This would result in the restatement of our previously filed financial statements and could have a material adverse effect on our operating results and financial condition for periods subsequent to the acquisitions. IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, WE MAY NOT BE ABLE TO COMPETE. We rely on a combination of trade secret laws and restrictions on disclosure and patents, copyrights and trademarks to protect our intellectual property rights. We cannot assure you that our pending patent applications will be approved, that any patents that may be issued will protect our intellectual property or that third parties will not challenge any issued patents. Other parties may independently develop similar or competing technology or design around any patents that may be issued to us. We cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Any of this kind of litigation, regardless of outcome, could be expensive and time consuming, and adverse determinations in any of this kind of litigation could seriously harm our business. WE COULD BECOME SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS, WHICH COULD BE COSTLY AND SUBJECT US TO SIGNIFICANT LIABILITY. From time to time, third parties, including our competitors, may assert patent, copyright and other intellectual property rights to technologies that are important to us. We expect we will increasingly be subject to license offers and infringement claims as the number of products and competitors in our market grows and the functioning of products overlaps. In this regard, in March 1999, we received a written notice from Lemelson Foundation Partnership in which Lemelson claimed to have patent rights in our vision and automatic identification operations, which are widely used in the manufacture of electronic assemblies. In April 1999, we received a written notice from Rockwell International Corporation in which Rockwell claimed to have patent rights in certain technology related to our metal organic chemical vapor deposition, or MOCVD, processes. In October 1999, we received written notice from Lucent Technologies, Inc. in which Lucent claimed we have violated certain of Lucent's patents falling into the general category of communications technology, with a focus on networking functionality. In October 1999, we received a written notice from Ortel Corporation, which has since been acquired by Lucent, in which Ortel claimed to have patent rights in certain technology related to our photodiode module products. In January 2001, we were advised that Lucent had assigned certain of its rights and claims to Agere Systems, Inc., including the claim made on the Ortel patent. To date, we have not been contacted by Agere regarding this patent claim. In July 2000, we received written notice from Nortel Networks, which claimed we violated Nortel's patent relating to technology associated with local area networks. In May 2001, we received written notice from IBM, which claims that several of our optical components and Internet infrastructure products make use of inventions covered by certain patents claimed by IBM. We are evaluating the patents noted in the letters. Others' patents, including Lemelson's, Rockwell's, Lucent's, Agere's, Nortel's and IBM's, may be determined to be valid, or some of our products may ultimately be determined to infringe the Lemelson, Rockwell, Lucent, Agere, Nortel or IBM patents, or those of other companies. Lemelson, Rockwell, Lucent, Agere, Nortel or IBM, or other companies may pursue litigation with respect to these or other claims. The results of any litigation are inherently uncertain. In the event of an 22 25 adverse result in any litigation with respect to intellectual property rights relevant to our products that could arise in the future, we could be required to obtain licenses to the infringing technology, to pay substantial damages under applicable law, to cease the manufacture, use and sale of infringing products or to expend significant resources to develop non-infringing technology. Licenses may not be available from third parties, including Lemelson, Rockwell, Lucent, Ortel, Nortel or IBM, either on commercially reasonable terms or at all. In addition, litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail. Accordingly, any infringement claim or litigation against us could significantly harm our business, operating results and financial condition. IN THE FUTURE, WE MAY INITIATE CLAIMS OR LITIGATION AGAINST THIRD PARTIES FOR INFRINGEMENT OF OUR PROPRIETARY RIGHTS TO PROTECT THESE RIGHTS OR TO DETERMINE THE SCOPE AND VALIDITY OF OUR PROPRIETARY RIGHTS OR THE PROPRIETARY RIGHTS OF COMPETITORS. THESE CLAIMS COULD RESULT IN COSTLY LITIGATION AND THE DIVERSION OF OUR TECHNICAL AND MANAGEMENT PERSONNEL. Necessary licenses of third-party technology may not be available to us or may be very expensive, which could adversely affect our ability to manufacture and sell our products. From time to time we may be required to license technology from third parties to develop new products or product enhancements. We cannot assure you that third-party licenses will be available to us on commercially reasonable terms, if at all. The inability to obtain any third-party license required to develop new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost, either of which could seriously harm our ability to manufacture and sell our products. WE ARE DEPENDENT ON CERTAIN MEMBERS OF OUR SENIOR MANAGEMENT. We are substantially dependent upon Dr. Shlomo Margalit, our Chairman of the Board of Directors and Chief Technical Officer, and Mr. Noam Lotan, our President and Chief Executive Officer. The loss of the services of either of these officers could have a material adverse effect on us. We have entered into employment agreements with Dr. Margalit and Mr. Lotan and are the beneficiary of key man life insurance policies in the amounts of $1.0 million each on their lives. However, we can give no assurance that the proceeds from these policies will be sufficient to compensate us in the event of the death of either of these individuals, and the policies are not applicable in the event that either of them becomes disabled or is otherwise unable to render services to us. OUR BUSINESS REQUIRES US TO ATTRACT AND RETAIN QUALIFIED PERSONNEL. Our ability to develop, manufacture and market our products, run our companies and our ability to compete with our current and future competitors depends, and will depend, in large part, on our ability to attract and retain qualified personnel. Competition for executives and qualified personnel in the networking and fiber optics industries is intense, and we will be required to compete for that personnel with companies having substantially greater financial and other resources than we do. To attract executives, we have had to enter into compensation arrangements, that have resulted in substantial deferred compensation charges and adversely affected our results of operations. We may enter into similar arrangements in the future to attract qualified executives, including a new executive or executives to assume the duties previously handled and managed by Edmund Glazer, our recently deceased Vice President of Finance and Administration and Chief Financial Officer. If we should be unable to attract and retain qualified personnel, our business could be materially adversely affected. We can give no assurance that we will be able to attract and retain qualified personnel. ENVIRONMENTAL REGULATIONS APPLICABLE TO OUR MANUFACTURING OPERATIONS COULD LIMIT OUR ABILITY TO EXPAND OR SUBJECT US TO SUBSTANTIAL COSTS. We are subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during our manufacturing processes. Further, we are subject to other safety, labeling and training regulations as required by local, state and federal law. Any failure by us to 23 26 comply with present and future regulations could subject us to future liabilities or the suspension of production. In addition, these kinds of regulations could restrict our ability to expand our facilities or could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. We cannot assure you that these legal requirements will not impose on us the need for additional capital expenditures or other requirements. If we fail to obtain required permits or otherwise fail to operate within these or future legal requirements, we may be required to pay substantial penalties, suspend our operations or make costly changes to our manufacturing processes or facilities. IF WE FAIL TO ACCURATELY FORECAST COMPONENT AND MATERIAL REQUIREMENTS FOR OUR MANUFACTURING FACILITIES, WE COULD INCUR ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS. We use rolling forecasts based on anticipated product orders to determine our component requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials. Lead times for components and materials that we order vary significantly and depend on factors such as specific supplier requirements, the size of the order, contract terms and current market demand for the components. For substantial increases in production levels, some suppliers may need six months or more lead time. If we overestimate our component and material requirements, we may have excess inventory, which would increase our costs. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively impact our net sales. Current softness in demand and pricing in the communications market have necessitated a review of our inventory, facilities and headcount. As a result, we and Luminent recorded in the second quarter of 2001, a one-time charge, to write-down inventory to realizable value and inventory purchase commitments of approximately $28.5 million. WE ARE AT RISK OF SECURITIES CLASS ACTION OR OTHER LITIGATION THAT COULD RESULT IN SUBSTANTIAL COSTS AND DIVERT MANAGEMENT'S ATTENTION AND RESOURCES. In the past, securities class action litigation has been brought against a company following periods of volatility in the market price of its securities. Due to the volatility and potential volatility of our stock price or the volatility of Luminent's stock price following its initial public offering, we may be the target of securities litigation in the future. Additionally, while Luminent and we informed investors that we were under no obligation to, and might not, make the distribution to our stockholders of our Luminent common stock and that we could and might eliminate public ownership of Luminent through a short-form merger with us, our decisions to abandon our distribution of Luminent's common stock to our stockholders or to eliminate public ownership of Luminent's common stock through the Merger may result in securities or other litigation. Securities or other litigation could result in substantial costs and divert management's attention and resources. WE MAY INCUR SIGNIFICANT COSTS TO AVOID INVESTMENT COMPANY STATUS AND MAY SUFFER ADVERSE CONSEQUENCES IF DEEMED TO BE AN INVESTMENT COMPANY. We may incur significant costs to avoid investment company status and may suffer other adverse consequences if deemed to be an investment company under the Investment Company Act of 1940. The Investment Company Act of 1940 requires registration for companies that are engaged primarily in the business of investing, reinvesting, owning, holding or trading in securities. A company may be deemed to be an investment company if it owns "investment securities" with a value exceeding 40% of the value of its total assets (excluding government securities and cash items) on an unconsolidated basis, unless an exemption or safe harbor applies. Securities issued by companies other than majority-owned subsidiaries are generally counted as investment securities for purposes of the Investment Company Act. Investment companies are subject to registration under, and compliance with, the Investment Company Act unless a particular exclusion or safe harbor provision applies. If we were to be deemed an investment company, we would become subject to the requirements of the Investment Company Act. As a consequence, we would 24 27 be prohibited from engaging in business or issuing our securities as we have in the past and might be subject to civil and criminal penalties for noncompliance. In addition, certain of our contracts might be voidable. Registration as an investment company would subject us to restrictions that are inconsistent with our fundamental business strategy of equity growth through creating, acquiring, building and operating optical components and network infrastructure companies. Although our investment securities currently comprise substantially less than 40% of our total assets, fluctuations in the value of these securities or of our other assets, or the sale of one or more of companies in exchange for the securities of the purchaser, may cause this limit to be exceeded. In that case, unless an exclusion or safe harbor was available to us, we would have to attempt to reduce our investment securities as a percentage of our total assets. This reduction can be attempted in a number of ways, including the disposition of investment securities and the acquisition of non-investment security assets. If we were required to sell investment securities, we may sell them sooner than we otherwise would. These sales may be at depressed prices and we may never realize anticipated benefits from, or may incur losses on, these investments. We may be unable to sell some investments due to contractual or legal restrictions or the inability to locate a suitable buyer. Moreover, we may incur tax liabilities when we sell assets. We may also be unable to purchase additional investment securities that may be important to our operating strategy. If we decide to acquire non-investment security assets, we may not be able to identify and acquire suitable assets and businesses or the terms on which we are able to acquire these assets may be unfavorable. DELAWARE LAW AND OUR ABILITY TO ISSUE PREFERRED STOCK MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE IN CONTROL, WHICH MAY CAUSE OUR STOCK PRICE TO DECLINE. We are authorized to issue up to 1,000,000 shares of preferred stock. This preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the board of directors without further action by stockholders. The terms of any series of preferred stock may include voting rights (including the right to vote as a series on particular matters), preferences as to dividend, liquidation, conversion and redemption rights and sinking fund provisions. No preferred stock is currently outstanding. The issuance of any preferred stock could materially adversely affect the rights of the holders of our common stock, and therefore, reduce the value of our common stock. In particular, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell our assets to, a third party and thereby preserve control by the present management. Certain provisions of Delaware law also may discourage, delay or prevent someone from acquiring or merging with us, which may cause the market price of our common stock to decline. 25 28 THE MERGER TERMS OF THE MERGER On , 2001, which was the effective date of the Merger, Luminent merged with and into MRV Merger Sub, the surviving corporation. On the effective date of the Merger, Luminent ceased to exist, and MRV Merger Sub assumed all of the assets and liabilities of Luminent. Each outstanding share of Luminent common stock (except for shares owned by MRV Merger Sub, which were cancelled, and shares owned by stockholders who perfect their statutory appraisal rights under Delaware law) was converted in the Merger. Former Luminent stockholders whose shares were converted are entitled to receive 0.43 of a share of MRV common stock for each share of Luminent common stock owned on the effective date of the Merger. Included with this prospectus supplement is a Letter of Transmittal for use in exchanging certificates which formerly represented Luminent common stock for certificates representing MRV common stock and cash, if any, to be paid in lieu of fractional shares. See the section of this prospectus supplement entitled "The Merger -- Surrender of Stock Certificates; Fractional Interests". The Merger was a short form merger pursuant to Section 253 of the Delaware General Corporation Law and was therefore effected pursuant to resolutions of the boards of directors of MRV and MRV Merger Sub without any vote, approval or authorization from the stockholders of Luminent or MRV or the board of directors of Luminent. Luminent stockholders have certain statutory appraisal rights under Delaware law. See the section below entitled "The Merger -- Statutory Appraisal Rights". MRV's board of directors resolved to effect a short-form merger with Luminent, subject to the satisfaction of certain conditions, including that the Merger would be subject to effectiveness of the Post-Effective Amendment to the Registration Statement of which this prospectus supplement is a part and to the receipt of a legal opinion with respect to the validity of the shares to be issued in the Merger to be filed as an exhibit to the Registration Statement. REGULATORY APPROVALS No federal or state regulatory approval was required in connection with the Merger. BACKGROUND AND REASONS FOR THE MERGER BACKGROUND Luminent designs, manufactures and sells a comprehensive line of fiber optic components that enable communications equipment manufacturers to provide optical networking equipment for the metropolitan and access segments of the communications network. Directly and through its subsidiaries, MRV designs, manufactures and sells data networking products, including networking and Internet infrastructure products such as switching and router management systems, and through Luminent, MRV is engaged in the fiber optics components business. Luminent's fiber optic components business was the original business of MRV when MRV began operations in July 1988. In March 2000, Luminent was incorporated in Delaware as a wholly-owned subsidiary of MRV. In April 2000, Luminent began doing business under the Luminent trade name. From inception in 1988 until September 2000, when MRV completed the contribution and transfer to Luminent of its business, Luminent operated as a division of MRV. In November 2000, Luminent completed an initial public offering, or IPO, of 12,000,000 shares of its common stock. From the completion of the IPO until immediately prior to the Merger, MRV continued to own 144,000,000 shares, or approximately 92%, of Luminent's outstanding common stock. MRV had planned to distribute its remaining Luminent shares to MRV's stockholders following Luminent's IPO, although Luminent and MRV made clear to stockholders in their various public filings that MRV was not obligated to do so. Among the conditions recited for making the distribution were: - the receipt of a private letter ruling from the Internal Revenue Service that MRV's distribution of its shares of Luminent common stock to the holders of MRV common stock will be tax-free to MRV and its stockholders for United States federal income tax purposes; 26 29 - MRV's redemption or repayment of its outstanding convertible subordinated notes; and - nothing must have happened in the intervening time between the time of Luminent's IPO and the distribution, including changes in market or economic conditions or in Luminent's or MRV's business and financial condition or in the relative market prices of Luminent's common stock and MRV's common stock, that would cause MRV's board of directors to conclude that the distribution was not in MRV's best interest or the best interest of MRV's stockholders. MRV received a private letter from the Internal Revenue Service stating that MRV's distribution of its shares of Luminent common stock to the holders of MRV common stock would be tax-free to MRV and its stockholders for United States federal income tax purposes, provided the distribution occurred by November 8, 2001. However, due to the deterioration of market conditions in the telecommunications industry since Luminent's IPO, the market for optical components is currently suffering from both reduced demand, as well as ample supply, resulting from the abundance of new competitors that have recently entered the market. Industry analysts have estimated that in 2001 and in 2002 the optical component sector will decline substantially, compared with 2000. This is a result of weak demand and excess component inventory already in the hands of telecommunication equipment vendors, including Luminent's customers. Specifically, the sector continues to suffer severely from weak system demand and from a $4.3 billion component inventory overhang. Luminent has been impacted by a significant deterioration in the outlook of two of its largest customers, Cisco Systems and Marconi. Furthermore, near term visibility is poor, reflecting both uncertainty about the global economy, consumer confidence as well uncertainty about the future of the telecommunications industry. According to industry analysts, visibility into the recovery remains "nonexistent". The health of the emerging carriers continues to deteriorate and so is demand for data services. Carrier's capital spending is expected to decline at a greater rate in 2002 than in 2001. Accordingly, industry sources anticipate that demand for optical components will remain depressed for several quarters. In addition, it is expected that even when the economy in general and the telecommunications sector eventually recovers, a robust recovery for optical components will occur only after the carriers and equipment vendors recover. The decline of MRV's stock price following Luminent's IPO paralleled the decline in Luminent's stock price during the same period and reflected the overall decline in the telecommunications industry generally and the optical components sector particularly. The principal amount of MRV's outstanding convertible subordinated notes is approximately $89.6 million. These notes are convertible, at the option of the holders, into MRV common stock at a conversion price of approximately $13.52 per share. By their terms, these notes became redeemable on or after June 15, 2001, at 102% of their face amount, or approximately $91.4 million, if redeemed before June 15, 2002 and at 101% of their face amount, or approximately $90.5 million, if redeemed on or after June 15, 2002 and prior to maturity, in either case plus accrued interest to the date of redemption. MRV had planned to redeem the Notes prior to the distribution but wanted holders to convert them into common stock rather than accept payment of the redemption price. However, from and after June 15, 2001, when MRV could redeem its notes, MRV's share price was, and thereafter remained well below the conversion price of the notes rendering nil any expectation that redemption would result in conversion. Accordingly, MRV's board concluded that the use of over $90 million in cash, even if available, to effect the redemption and thereafter complete the distribution would not be in the best interests of MRV's stockholders. MRV's board also considered proceeding with the distribution without redeeming MRV's outstanding notes. However, this would result in an adjustment to the number of MRV shares into which the notes would be convertible. MRV's board concluded that the effect of that adjustment, namely substantial dilution to existing MRV stockholders, would also not be in their best interests. 27 30 REASONS FOR THE MERGER Reflecting the overall deterioration in the industry, Luminent, like others engaged in the fiber optics components business, has also suffered a substantial decline in its business. For example, Luminent's revenue has decreased by more than 50%, from approximately $48.2 million during the quarter ended March 2001 to an estimated $20 to $21 million during the quarter ended September 30, 2001. Management believes that current prospects point to further deterioration of economic conditions in the telecommunications industry and Luminent's business in 2002. This is based on announcements by industry participants, the substantial reduction in sales during 2001, the excess component inventories held by Marconi and Cisco, Luminent's largest customers, decreases in the average selling prices for some of Luminent's products, and management's experience that as products in the optical networking market have become a commodity, the average selling price of these products have and will continue to decrease in response to competitive pricing pressures and new product introductions by industry participants. Management believes that failure to unite MRV and Luminent can be detrimental to both MRV and Luminent. In MRV's case, MRV's cash position is constantly being eroded by its funding of several development stage companies, which consume rather than generate cash. Because of current market conditions, MRV's ability to raise cash through traditional capital markets or through the sale of one or more of its portfolio companies is considered remote. Even when the capital markets recover, MRV does not expect to be able to raise capital on as favorable of terms if Luminent is kept as separate publicly traded company since virtually all of MRV's value is reflected solely by its holdings in Luminent and without regard to its other businesses. Management believes that when the capital markets recover, the unification of Luminent with MRV will facilitate MRV's ability to raise capital at values more fully reflective of its other businesses in addition to Luminent. In Luminent's case, given the perceived dim prospects for a quick recovery, management believes that a different strategy and a new direction are needed for Luminent. Luminent needs to develop and introduce new products, broaden its product line toward a new direction, relying less on products such as fiber optic transceivers. These products have become commodities in the industry for which the economies of scale and manufacturing advantages of Luminent's larger competitors make it difficult for Luminent to compete against. Management believes that a new product direction, which will emphasize a higher level of integration of optical components, such as transceivers and integrated circuits, is needed. Management further believes that forward-integration of optical and electronic technologies will provide added value and product differentiation, which will result in a more competitive and potentially higher-margin product offerings. MRV offers vast system level expertise and know-how in data communication systems and the substantial experience and ability in the development of application specific integrated circuits and software, which, management believes, will facilitate and foster a higher and more rapid level integration of optical components and electronic subsystems than Luminent can achieve on its own. This is expected to result in new optical transmission platforms with system level capabilities, able to perform complex networking functions such as network management and protocol level agility. The resulting products are expected to achieve not only higher reliability and performance, but also to reduce production costs. MRV's board of directors considered the expected facilitation of MRV's access to the capital markets and Luminent's ability to produce new products more rapidly and with higher levels of integration of optical components and electronic subsystems in determining that the Merger was in the best interests of MRV's stockholders. In addition, MRV's board of directors took into account, among other things, that: - the Merger would result in cost savings by eliminating expenses associated with maintaining Luminent as a public company and by providing Luminent with from various economies of scale including shared global administrative functions, facilities and volume purchase discounts not available to Luminent as a stand-alone entity; - the Merger would eliminate actual and potential conflicts of interest between MRV and Luminent; 28 31 - alternatives to the Merger, such as pursuing a sale of its Luminent shares to, or a business combination involving Luminent and, a third party was expected to yield less benefits and more disadvantages to MRV than the proposed Merger; - the Merger would generally be tax free to Luminent's stockholders; - Luminent's stockholders would receive MRV common stock with greater market liquidity than Luminent common stock; - Luminent stockholders would receive an equity interest in a much larger and more diversified business entity; - Luminent stockholders, through their ownership of MRV common stock, would have a continuing interest in the business and assets previously owned by Luminent; and - based on the advice of Duff & Phelps LLC, Luminent's financial advisor, the exchange ratio was fair to Luminent's stockholders from a financial point of view. In view of the number and wide variety of factors considered in connection with its evaluation of the Merger and the complexity of these matters, MRV's board of directors did not find it practicable to, nor did it attempt to, quantify, rank or otherwise assign relative weights to the specific factors that it considered. In addition, the board of directors did not undertake to make any specific determination as to whether any particular factor was favorable or unfavorable to the board of directors' ultimate determination or assign any particular weight to any factor, but conducted an overall analysis of the factors described above, including discussions with and questioning of MRV's management and management's analysis of the proposed Merger. In considering the factors described above, individual members of MRV's board of directors may have given different weight to different factors. MRV's board of directors considered all these factors together and, on the whole, considered them to be favorable to, and to support, its determination. FEDERAL SECURITIES CONSEQUENCES This prospectus supplement and the prospectus do not cover any resales of MRV common stock to be received by Luminent's stockholders upon completion of the Merger. No person is authorized to make any use of this document in connection with a resale of that type. All shares of MRV common stock that Luminent stockholders receive in the Merger will be freely transferable. However, shares of MRV common stock received by persons who are deemed to be "affiliates" of Luminent under the Securities Act and the related SEC rules and regulations at the time of Merger will be restricted securities. These affiliates may resell their shares of MRV common stock only in transactions permitted by Rule 145 or other provisions under the Securities Act. Persons who may be deemed to be affiliates of Luminent for these purposes generally include individuals or entities that control, are controlled by, or are under common control with Luminent and may include officers, directors and principal stockholders of Luminent. The shares of MRV common stock issued in the Merger are listed on the Nasdaq National Market. SURRENDER OF STOCK CERTIFICATES; FRACTIONAL INTERESTS Enclosed with this prospectus supplement is a Letter of Transmittal to be used by former Luminent stockholders in surrendering to American Stock Transfer and Trust Company, the Exchange Agent certificates that represented shares of Luminent common stock prior to the Merger. The Letter of Transmittal contains instructions concerning the surrender of certificates. The Letter of Transmittal should be completed by each former Luminent stockholder (other than stockholders who choose to perfect their statutory appraisal rights) and returned to the Exchange Agent, along with all stock certificates that represented shares of Luminent common stock. Each former Luminent stockholder (other than stockholders who choose to perfect their statutory appraisal rights) is entitled to receive, upon surrender, a certificate registered in the former Luminent stockholder's name representing the number of whole shares 29 32 of MRV common stock to which the holder of the surrendered certificates is entitled pursuant to the Merger. If the MRV common stock is to be issued to a person other than the person in whose name a surrendered certificate is registered, the certificate so surrendered must be endorsed and otherwise be in proper form for transfer, and the person requesting a transfer must pay to MRV any required transfer taxes or must prove to the satisfaction of MRV that transfer taxes have either been paid or are not payable. The Exchange Agent will issue the MRV common stock attributable to any certificate that has been lost or destroyed only upon receipt of satisfactory evidence of ownership of the shares of Luminent common stock formerly represented thereby and after appropriate indemnification. To avoid the application of backup federal income tax withholding provisions to payments of cash in lieu of fractional shares of MRV common stock issued pursuant to the Merger, each Luminent stockholder must provide the Exchange Agent with his or her correct taxpayer identification number in accordance with the instructions in the Letter of Transmittal. Holders of certificates that represented Luminent common stock (except for shares of Luminent common stock owned by MRV Merger Sub, which were cancelled, and shares owned by stockholders who perfect their statutory appraisal rights under Delaware law) no longer have any rights with respect to the shares of Luminent common stock except the right to receive the MRV common stock issued in the Merger (and cash in lieu of fractional shares). See section of this prospectus supplement entitled "The Merger -- Statutory Appraisal Rights" below. In addition, former Luminent stockholders will not be entitled to vote the shares of MRV common stock to which they are entitled or to receive any dividends payable to holders of record of MRV common stock until the certificates are surrendered to the Exchange Agent accompanied by a properly executed Letter of Transmittal. After surrender of the certificates, those holders will succeed to their rights as holders of MRV common stock. No fractional shares of MRV common stock will be issued. In lieu of any fractional shares, and upon surrender of the holders' certificates evidencing Luminent common stock accompanied by a properly executed Letter of Transmittal, each holder of Luminent common stock entitled to receive a fractional share of MRV common stock will receive instead an amount in cash, without interest, equal to the value of that fractional share based on the closing sales price of MRV common stock on the effective date of the Merger, which was $ per share. STATUTORY APPRAISAL RIGHTS The following discussion of the provisions of Section 262 of the General Corporation Law of the State of Delaware is not intended to be a complete statement of these provisions and is qualified in its entirety by reference to the text of Section 262, which is reproduced in full as Annex A to this prospectus supplement. Former stockholders who held Luminent common stock on the effective date of the Merger and who follow the procedures specified in Section 262 will be entitled to have their shares of Luminent common stock appraised by the Delaware Court of Chancery and to receive payment of the fair value of these shares, exclusive of any element of value arising from the accomplishment or expectations of the Merger, as determined by the Delaware Court of Chancery. The procedures set forth in Section 262 should be strictly complied with. Failure to follow any of those procedures may result in a termination or waiver of appraisal rights under Section 262. Any stockholder entitled to appraisal rights may, after , 2001 and prior to , 2001, demand from MRV Merger Sub the appraisal of any or all of his or her shares of Luminent common stock by delivering a written demand for an appraisal to Noam Lotan at MRV Merger Sub c/o MRV Communications, Inc., 20415 Nordhoff Street, Chatsworth, California 91311. Failure to deliver that written demand will constitute a waiver of the stockholder's appraisal rights. This demand will be sufficient if it reasonably informs MRV Merger Sub of the identity of the stockholder and that the 30 33 stockholder intends by the notice to demand the appraisal of his, her or its shares. Demand is necessary if the stockholder is to perfect his, her or its appraisal rights. The written demand for appraisal must be made by or for the holder of record of Luminent common stock registered in his, her or its name. Accordingly, the demand should be executed by or for the stockholder of record, fully and correctly, as that stockholder's name appears on his, her or its stock certificates. If the applicable shares of Luminent common stock were owned of record in a fiduciary capacity, such as by a trustee, guardian or custodian, execution of the demand should be made in that capacity, and if the applicable shares of Luminent common stock were owned of record by more than one person, as in a joint tenancy or tenancy in common, the demand should be executed by or for all joint owners. An authorized agent, including one of two or more joint owners, may execute the demand for appraisal for a stockholder of record. However, the agent must identify the record owner(s) and expressly disclose the fact that, in executing the demand, he or she is acting as agent for the record owner(s). If a stockholder held shares of Luminent common stock through a broker who in turn held the shares through a central securities depository nominee such as Cede & Co., a demand for appraisal of the shares must be made by or on behalf of the depository nominee and must identify the depository nominee as the holder of record A record owner may exercise appraisal rights with respect to all or less than all of the shares held of record. If the record owner desires to exercise appraisal rights as to a portion of his, her or its shares, the written demand should set forth the number of shares covered by it. Where no number of shares is expressly mentioned, the demand will be presumed to cover all shares of Luminent common stock standing in the name of the record owner. Within 120 days after the effective date of the Merger, i.e., by , 2002, MRV Merger Sub or any stockholder of Luminent who has complied with the demand requirements and who is otherwise entitled to appraisal rights, may file a petition in the Delaware Court of Chancery demanding a determination of the value of the Luminent common stock of all former stockholders of Luminent who have complied with the demand requirements and who are otherwise entitled to appraisal rights. Notwithstanding the foregoing, at any time within 60 days after the effective date of the Merger, i.e., by , 2001, any stockholder has the right to withdraw his, her or its demand for appraisal and to accept the terms offered in the Merger. If no petition demanding a determination of value is filed, appraisal rights will be lost for all stockholders who had previously demanded appraisal of their Luminent common stock. Holders of Luminent common stock seeking to exercise appraisal rights should not assume that MRV Merger Sub will file a petition with respect to the appraisal of the value of their Luminent common stock or that MRV Merger Sub will initiate any negotiations with respect to the fair value of their Luminent common stock. Accordingly, stockholders should regard it as their obligation to take all steps necessary to perfect their appraisal rights in the manner prescribed in Section 262. Within 120 days after the effective date of the Merger, i.e., by , 2002, any stockholder who is entitled to and has perfected his, her or its appraisal rights will be entitled to receive upon written request from MRV Merger Sub a statement setting forth the aggregate number of shares with respect to which demands for appraisal have been received and the aggregate number of holders of those shares. This written statement must be mailed to the requesting stockholder within 10 days after his, her or its written request for the statement is received by MRV Merger Sub as the surviving corporation, or within 10 days after the expiration of the period for delivery of demands for appraisals, whichever is later. Upon the filing of a petition by a stockholder, service of a copy of that petition must be made upon MRV Merger Sub as the surviving corporation. Within 20 days after that service, MRV Merger Sub must file in the Office of the Register in Chancery in which the petition was filed a duly verified list containing the names and addresses of all stockholders who have demanded payment for their shares and with whom agreements as to the value of their shares have not been reached by MRV Merger Sub. If the petition is originally filed by MRV Merger Sub, it must be accompanied by that duly verified list. After the filing of a petition for appraisal, the Register in Chancery, if ordered by the Delaware Court of Chancery, must give notice of the time and place fixed for hearing by registered or certified mail to both MRV Merger 31 34 Sub and to the stockholders shown on the list at the addresses stated on the list. This notice must also be given by one or more publications at least one week before the day of the hearing in a newspaper of general circulation published in the City of Wilmington, Delaware or those publications as the Delaware Court of Chancery deems advisable. The forms of the notices by mail and by publication must be approved by the Delaware Court of Chancery, and the costs of mailing and publication will be borne by MRV Merger Sub. At the hearing on the petition, the Delaware Court of Chancery will determine the stockholders who have complied with Section 262 of the Delaware General Corporation Law and who have thus become entitled to appraisal rights. The Delaware Court of Chancery may require the stockholders who have demanded an appraisal for their shares to submit to the Register in Chancery their certificates that formerly represented Luminent common stock for notation thereon of the pendency of the appraisal proceedings. If any stockholder fails to comply with that direction, the Delaware Court of Chancery may dismiss the proceedings as to the stockholder. If a petition for an appraisal is timely filed, after a hearing on the petition the Delaware Court of Chancery will determine the stockholders entitled to appraisal rights and will appraise the value of the Luminent common stock owned by those stockholders, determining the fair value the stock exclusive of any element of value arising from the accomplishment or expectation of the Merger. The Delaware Court of Chancery will direct payment of the fair value of the shares of Luminent common stock with a fair rate of interest, if any, on the fair value to stockholders entitled thereto upon surrender to MRV Merger Sub of stock certificates. Upon application of a stockholder, the Delaware Court of Chancery may, in its discretion, order that all or a portion of the expenses incurred by any stockholder in connection with an appraisal proceeding, including without limitation, reasonable attorneys' fees and the fees and expenses of experts, be charged pro rata against the value of all the shares of Luminent common stock entitled to appraisal. No representation is made as to the outcome of the appraisal of fair value as determined by the Delaware Court of Chancery, and stockholders should recognize that an appraisal could result in a determination of a value higher or lower than, or the same as, the value of the shares of MRV common stock issued in the Merger. Moreover, MRV Merger Sub reserves the right to assert, in any appraisal proceeding, that, for purposes of Section 262, the fair value of a share of Luminent common stock is less than the value of the 0.43 of a share of MRV common stock issued in the Merger. In determining the fair value of the shares of Luminent common stock, the Delaware Court of Chancery is required to take into account all relevant factors. Therefore, the determination could be based upon a number of considerations, including the market value of shares of Luminent common stock and the asset value and earning capacity of Luminent. In Weinberger v. UOP, Inc., et al (decided February 1, 1983), the Delaware Supreme Court stated, among other things, that "proof of value by any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court", should be considered in an appraisal proceeding. Section 262 provides that "fair value" is to be "exclusive of any element of value arising from the accomplishment or expectation of the Merger". In Weinberger, the Delaware Supreme Court held that "elements of future value, including the nature of the enterprise, which are known or susceptible of proof as of the date of the Merger and not the product of speculation, may be considered". In Glassman v. Unocal Exploration Corp. (decided July 25, 2001) the Delaware Supreme Court reaffirmed Weinberger in the context of a short form merger undertaken pursuant to Section 253 of the Delaware General Corporation Law. From and after the effective date of the Merger, no stockholder who has demanded his, her or its appraisal rights will be entitled to vote the MRV common stock to which the stockholder would have been entitled had he, she or it chosen not to exercise appraisal rights, nor will he, she or it be entitled to payments of dividends, if any, or other distributions on the stock (except dividends, if any, or other distributions payable to Luminent stockholders of record on a date that is prior to the effective date of the Merger); provided, however, that if no petition for an appraisal has been filed within the time provided by Delaware law, or if the stockholder delivers to MRV Merger Sub a written withdrawal of his, her or its 32 35 demand for an appraisal and an acceptance of the Merger, either within 60 days after the effective date of the Merger or thereafter with written approval of MRV Merger Sub (which MRV Merger Sub reserves the right to give or withhold in its discretion), then the right of the stockholder to an appraisal will cease, and (upon surrender of certificates formerly representing Luminent common stock together with a properly completed Letter of Transmittal) the stockholder will receive the shares of MRV common stock into which the shares of Luminent common stock were converted in the Merger. Notwithstanding the foregoing, no appraisal proceeding in the Delaware Court of Chancery will be dismissed as to any stockholder without the approval of the Delaware Court of Chancery, and the approval may be conditioned upon whatever terms the Delaware Court of Chancery deems just. MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES The Merger is intended to qualify as a tax-free reorganization for U.S. federal income tax purposes. If the Merger so qualifies, stockholders of Luminent common stock will generally not recognize any gain or loss on the exchange of their Luminent stock for MRV common stock in the Merger, except for any gain or loss recognized in connection with any cash received instead of a fractional share of MRV stock or pursuant a Luminent stockholder's statutory appraisal rights. The companies themselves, as well as current stockholders of MRV common stock, will not recognize gain or loss as a result of the Merger. To review the tax consequences to MRV and Luminent stockholders in more detail, see the section entitled "United States Federal Income Tax Treatment of the Merger" later in this prospectus supplement. THE UNITED STATES FEDERAL INCOME TAX CONSEQUENCES DESCRIBED ABOVE MAY NOT APPLY TO ALL HOLDERS OF LUMINENT COMMON STOCK. YOUR TAX CONSEQUENCES WILL DEPEND ON YOUR OWN SITUATION. YOU SHOULD CONSULT YOUR TAX ADVISOR FOR A FULL UNDERSTANDING OF THE TAX CONSEQUENCES OF THE MERGER TO YOU. INTERESTS OF CERTAIN PERSONS TO THE MERGER Immediately, prior to the Merger, MRV Merger Sub, a wholly owned subsidiary of MRV, owned an aggregate of 144,000,000 shares of Luminent common stock. Luminent's board of directors consisted of members of the boards of directors of MRV and MRV Merger Sub and a director independent of MRV, MRV Merger Sub and Luminent. MRV Merger Sub succeeded to all of the assets and liabilities of Luminent upon consummation of the Merger. Executive officers and directors of MRV Merger Sub, MRV and their affiliates with management responsibilities for Luminent and MRV who owned Luminent common stock would receive the same benefits from the Merger as were received by other Luminent stockholders. As of effective date of the Merger, none of these persons owned any outstanding Luminent common stock nor had any rights to purchase or acquire Luminent common stock. These persons collectively owned less than 6.5 percent of the outstanding MRV common stock immediately prior to the effective date of the Merger. ACCOUNTING TREATMENT The exchange of MRV common stock for publicly held Luminent common stock in the Merger will be accounted for as a purchase for financial reporting purposes. LUMINENT STOCK OPTIONS At the effective time of the Merger, each outstanding Luminent stock option shall be deemed to constitute an option to acquire, on the same terms and conditions as were applicable under the option, the same number of shares of MRV common stock as the holder of the option or warrant would have been entitled to receive pursuant to the Merger agreement, had the holder exercised the Luminent option in full immediately prior to the effective time of the Merger, rounded to the nearest whole number, unless rounding down is necessary to preserve the status of incentive stock options as described below. The exercise price per share shall equal: the aggregate exercise price for the Luminent shares otherwise 33 36 purchasable pursuant to the option, divided by the aggregate number of whole MRV shares purchasable pursuant to the Luminent option in accordance with the foregoing. In the case of any stock option that qualifies as an incentive stock option under the Internal Revenue Code, the option price, number of shares purchasable pursuant to the option and the terms and conditions of the exercise of the option shall be determined in order to comply with Section 424(a) of the Internal Revenue Code. 34 37 OPINION OF FINANCIAL ADVISOR On September 24, 2001, Luminent's Board of Directors engaged Duff & Phelps, as its independent financial advisor, to make a determination as to whether the Merger Exchange Ratio of .43 shares of MRV common stock for each share of Luminent stock not held by MRV (the "Merger Exchange Ratio") is fair to the minority common stockholders of Luminent from a financial point of view. Duff & Phelps rendered a written opinion (the "Opinion") to the Board of Directors of Luminent that, as of October 4, 2001, the Merger Exchange Ratio is fair to the minority stockholders of Luminent from a financial point of view. Duff & Phelps' opinion is attached as Annex B and is incorporated herein by reference. LUMINENT STOCKHOLDERS ARE ENCOURAGED TO READ THIS OPINION IN ITS ENTIRETY. Duff & Phelps is a nationally recognized investment banking firm that is regularly engaged to render financial opinions in connection with mergers and acquisitions, tax matters, corporate planning, and other purposes. Previously, Duff & Phelps has not provided financial advisory services to Luminent, MRV or its subsidiary companies. In connection with its Opinion, Duff & Phelps made such reviews, analyses and inquiries as it deemed necessary and appropriate under the circumstances. Among other things, Duff & Phelps (a) met with certain members of senior management of Luminent to discuss the history, financial condition, future prospects and projected performance of Luminent and toured their facilities in Chatsworth, California; (b) met with certain members of senior management of MRV to discuss the history, financial condition, future prospects and projected performance of MRV and its divisions and subsidiaries and toured the MRV's facilities in Chatsworth, California; (c) met with certain members of senior management of MRV's subsidiaries, Nbase-Xyplex, Inc. and Optical Access, Inc., at MRV's headquarters, to discuss the history, financial condition, future prospects and projected performance of these subsidiaries; (d) met with certain members of senior management of Broadband Highway, Inc. to discuss the history, financial condition, future prospects and projected performance of Broadband Highway, Inc. and toured their facilities in Woodland Hills, California; (e) met with certain members of senior management of Zuma Networks, Inc. to discuss the history, financial condition, future prospects and projected performance of Zuma Networks, Inc. and toured their facilities in West Hills, California; (f) met with representatives from Arthur Andersen LLP, auditor for both Luminent and MRV, to discuss the historical financial statements and consolidating statements for both Luminent and MRV; (g) reviewed Luminent's financial statements and SEC filings, including the annual report on Form 10-K for the year ended December 31, 2000, and quarterly report on Form 10-Q the six-month period ended June 30, 2001; (h) reviewed MRV's financial statements and SEC filings, including the annual report on Form 10-K for the year ended December 31, 2000, and quarterly report on Form 10-Q for the six-month period ended June 30, 2001; (i) reviewed MRV's internally generated consolidating financial statements for the fiscal year ended December 31, 2000, and six-month period ended June 30, 2001; (j) reviewed revenue estimates for third quarter 2001 provided by Luminent and MRV management; (k) reviewed the historical trading price and trading volume of Luminent and MRV common stock; (l) reviewed certain articles and press releases regarding Luminent and MRV; (m) reviewed other operating and financial information provided by management of Luminent and MRV; and (n) reviewed economic and industry information and conducted such studies, analyses and investigations as Duff & Phelps deemed appropriate. Duff & Phelps' Opinion is based upon an analysis of the foregoing in light of its assessment of the general, economic and financial market conditions, as they can be evaluated by Duff & Phelps, as of October 4, 2001. Events occurring after October 4, 2001 could materially affect the assumptions used in preparing its Opinion. In connection with its Opinion, with Luminent's permission and without any independent verification, Duff & Phelps assumed that all information reviewed by it with respect to Luminent, MRV and the Merger, whether supplied by Luminent, MRV or its advisors, or obtained by Duff & Phelps from publicly available sources, is true, correct and complete in all material respects and does not contain any untrue statements of material fact or omit to state a material fact necessary to make the information supplied to 35 38 Duff & Phelps not misleading. Duff & Phelps did not make an independent valuation or appraisal of the assets or liabilities of Luminent or MRV and was not furnished with such valuation or appraisal. Any inaccuracies in or omissions from the information on which Duff & Phelps relied could materially affect its Opinion. Set forth below is a summary of the analyses performed by Duff & Phelps in reaching its Opinion as of October 4, 2001. Current Status of Luminent's Business. Duff & Phelps considered Luminent's historical and projected revenues and cash flows, historical stock price performance, current cash position and future prospects for the optical component industry, among other factors, to determine the fairness of the Merger Exchange Ratio. Luminent's revenues grew steadily from 1996 through 2000, increasing from $24.0 million to $124.2 million. Furthermore, Luminent's revenues for the six months ended June 30, 2001 were $89.3 million, relative to $43.0 million for the same period in 2000. However, on September 26, 2001, due to a drop in demand for its products, Luminent management reduced its revenue estimates for the third- quarter 2001 to $20 million to $21 million. In addition, Luminent's largest clients, Marconi Communications and Cisco Systems, are facing weaker orders. As a result, Duff & Phelps has projected Luminent's revenues in the near and medium term future to be considerably lower than their historical levels. During the fiscal years 1996 through 2000, after adjusting for non-cash charges including depreciation and amortization expenses, Luminent had positive pro-forma net income. Furthermore, for the six month period ended June 30, 2001, after adjusting for approximately $59 million in non-cash charges, such as depreciation, amortization and deferred compensation, and adding back $41.2 million of one-time charges related to the write-down of inventory, restructuring costs and other non-recurring items, Luminent had positive pro-forma net income. Future profitability from operations will be more difficult to achieve due to lower revenue levels. Luminent sold 12 million shares in an IPO for $12 per share on November 9, 2000, raising a net $132.3 million. As of October 4, 2001, the cash and equivalents account for Luminent was approximately $90 million. Luminent's stock price declined significantly after its IPO. By the end of November 2000, it had dropped by 50% to $6 per share. Since then, Luminent's stock price has fluctuated from approximately $10 per share, to a low of $1.20 per share. As of September 10, 2001, the last trading day prior to the announcement of the proposed the Merger, Luminent's stock priced closed at $1.35 per share. There are significant business issues facing Luminent. Over the past six months there has been significant turnover in Luminent's senior management team, including the departure of its president, William R. Spivey. Marconi Communications, which represented 40% of Luminent's fiscal 1999 sales and 18% of fiscal 2000 sales, appears to be having significant financial difficulties. Marconi PLC's stock price closed on October 1, 2001 at $.44 per share, down from a high of $28.19 on October 20, 2000. Marconi's financial difficulties could result in the cancellation or postponement of its orders to Luminent and could potentially create difficulty in collecting on current Marconi accounts receivables. The telecommunications components market is currently flooded with competitors. Furthermore, there is a surplus of inventory throughout the industry. These factors are impacting sales volume, pricing and profitability for all companies operating in this sector. Current Status of MRV's Business. Duff & Phelps considered MRV's historical and projected revenues and cash flows, current cash position, the current market for development stage companies in the telecommunications sector, and the historical trading price of MRV, among other factors, to determine the fairness of the Merger Exchange Ratio. 36 39 For purposes of Duff & Phelps' analysis, MRV was broken down into three separate components: (1) MRV's 92.3% interest in Luminent; (2) the start-up, development stage businesses; and (3) the other MRV divisions, which includes Optical Access, Inc; iTouch Communications, Inc.; Nbase-Xyplex, Inc.; Cescomm, Inc.; Appointech, Inc. and the European subsidiaries (the "MRV Divisions"). The start-up, development stage companies of MRV do not generate revenue and require ongoing cash infusions. A number of these companies, such as Charlotte's Networks, Inc. and Zuma Networks, Inc. have technologies that warrant significant valuations, even in today's soft market. It is, however, difficult to find buyers for development stage companies and realize these valuations. The MRV Divisions have stable and growing revenues. While certain of the companies within the MRV Divisions are profitable, analyzed as a group, the MRV Divisions generate losses and are cash flow negative. Therefore, the MRV Divisions require ongoing cash infusions. Certain companies within the MRV Divisions, such as Optical Access, Inc., warrant significant valuations even in today's soft market. It is difficult, however, find buyers for companies in the telecommunications sector today. MRV's revenues grew steadily from 1996 through 2000, increasing from $88.8 million to $319.4 million. MRV's revenues, excluding Luminent, were approximately $64.8 million in fiscal 1996 and $195.2 million in fiscal 2000. MRV's revenues for the six months ended June 30, 2001 were $189.6 million, relative to $139 million for the same period in 2000. Excluding Luminent, MRV's revenues for the six-month period ended June 30, 2001 were $104.9 million. MRV's non-Luminent business is projected to generate revenues during the last two quarters of fiscal 2001 that are relatively similar to the first two quarters. Furthermore, due to the fact that MRV's businesses are not as affected by the economic recession as Luminent's business, revenues are projected to grow into the future. MRV has been unprofitable every year since 1998, both including and excluding Luminent. For the six-month period ended June 30, 2001, after adjusting for noncash charges including depreciation and amortization, MRV's operations, excluding Luminent, had an operating loss of 4.1 million. Due to the development stage businesses in MRV's portfolio, MRV's non-Luminent businesses are projected to be unprofitable into the near-term future. As of October 4, 2001, MRV, excluding Luminent, had a relatively weak cash position, with an estimated $62 million in cash and equivalents plus an additional $52 million in restricted cash. Furthermore, MRV had $50 million in long-term debt and $89.6 million in convertible debentures. Due to the fact that MRV's non-Luminent businesses, in aggregate, are cash flow negative, they will most likely require continued cash infusions in the near to medium term future. Over the past twelve month period, MRV's common stock price ranged from a high of $49.25 as of October 5, 2000, to a low of $2.43 as of September 17, 2001. The deterioration of MRV's stock price reflects the depressed state of the telecommunications sector. As of September 10, 2001, the last trading day prior to the announcement of the proposed Merger, MRV's stock priced closed at $3.23 per share. On September 11, 2001, MRV's Chief Financial Officer, Edmund Glazer, died on Flight 11 from Boston to Los Angeles. There is a significant void in MRV's management team without Mr. Glazer. FUNDAMENTAL VALUATION OF ANALYSIS OF LUMINENT'S COMMON STOCK To determine the fair market value of Luminent's common stock, Duff & Phelps utilized a comparable public company analysis and a discounted cash flow analysis, as follows: Comparable Public Company Analysis. Duff & Phelps compared selected financial and other operating ratios for Luminent to the corresponding ratios of certain publicly traded fiber-optic component companies. These comparable public companies were as follows: Agere Systems, Inc.; Avanex Corporation; Bookham Technology PLC; Finisar Corporation; JDS Uniphase Corporation; New Focus, Inc.; Oplink Communications, Inc.; Optical Communication Products; and Stratos Lightwave, Inc. The ratios analyzed included enterprise value-to-sales and enterprise value-to-cash. For purposes of Duff & Phelps' analysis, enterprise value is defined as market value of equity plus book value of interest bearing debt. The statistics 37 40 were generally based on financial and operating data at or for the twelve months ended June 30, 2001, and market prices as of October 1, 2001. Other commonly used valuation multiples, such as enterprise value-to-cash flow and equity value-to-net income, were not applicable since the large majority of the comparable public companies had negative cash flow and negative earnings. Furthermore, price-to-book value multiples were not applicable due to the fact that many of the comparable public companies have a significant portion of their asset value in goodwill. Since the time the goodwill was booked, there has most likely been significant goodwill impairment. Due to the fact that the goodwill has not been written down to reflect its current fair market value, this approach is not meaningful. Enterprise value as a multiple of latest twelve months' revenues for the comparable companies ranged from 0.8x to 3.8x with a median of 1.8x. Based on a risk analysis of Luminent relative to the comparable public companies, Duff & Phelps determined that a reasonable multiple to apply to Luminent's latest twelve months revenues was 1.5x, resulting in an enterprise value indication for Luminent of $256 million. Enterprise value as a multiple of cash and equivalents for the comparable companies ranged from 0.4x to 6.2x with a median of 1.8x. Based on a risk analysis of Luminent relative to the comparable public companies, Duff & Phelps determined that a reasonable multiple to apply to Luminent's $90 million in cash was 1.8x, resulting in an enterprise value indication for Luminent of $162 million. Discounted Cash Flow Analysis. Duff & Phelps performed a discounted cash flow analysis of Luminent based on projections developed by Duff & Phelps, relying on industry reports regarding the outlook for optical components companies in the telecommunications industry and information provided by Luminent's management during Duff & Phelps' due diligence investigation. The terminal value of Luminent was estimated by capitalizing projected 2005 revenue. The projected cash flows and terminal value were discounted to the present value using a discount rate of 20%, which represents Duff & Phelps' estimate of Luminent's weighted average cost of capital (WACC). The resulting indication of Luminent's enterprise value was $120 million. Determination of Luminent's Equity Value. Duff & Phelps weighted each of the three valuation indications of Luminent's enterprise value equally, resulting in a concluded value of $180 million. As of June 30, 2001, Luminent had approximately $23.6 million in interest bearing debt. Deducting the debt from the concluded enterprise valuation results in a valuation of Luminent's equity, on a marketable minority interest basis, of $156.4 million. Luminent has approximately 12.2 million stock options issued and outstanding, with exercise prices ranging from $2.63 to $12.00 per share. Based on the Black-Scholes option pricing model, the aggregate fair market value of the options is $2.37 million. Deducting the aggregate value of the options from the concluded equity value results in the fair market value of the common equity of $154 million. Based on 156 million shares of Luminent common stock issued and outstanding, the fair market value of Luminent's common stock, on a marketable minority interest basis, is approximately $1.00 per share. Premium for Control. Duff & Phelps analyzed control transactions that have closed since December 31, 1999, for (1) companies in the telecommunications equipment and components industry; (2) other communications related companies; and (3) electronics companies. The median control premium paid for companies in the telecommunications equipment and components industry was 89.9%. The median control premium paid for companies in the other communications related businesses was 52.9%. The average control premium paid for companies in the electronics industry was 70.3%. Based on these control premiums, Duff & Phelps concluded that an appropriate control premium to apply to the concluded marketable minority interest value of Luminent's common stock was 80%. Applying the 80% control premium to the $1.00 minority interest value conclusion for Luminent results in the fair market value of Luminent, on a controlling interest basis, of $1.80 per share. 38 41 FUNDAMENTAL VALUATION ANALYSIS OF MRV'S COMMON STOCK Start-up Company Valuations. MRV has numerous investments in development stage, start-up companies. To determine the fair market value of each of these companies, Duff & Phelps analyzed MRV's historical investment in each company, and held discussions with MRV management regarding (1) the technologies at each company, (2) the historical private placement valuations for certain of these companies, (3) management's ongoing discussions with potential buyers of certain of these companies, and (4) management's estimate of the current fair market value of each of the start-up companies. To the estimates of value for the minority-owned positions held by MRV, Duff & Phelps applied discounts for minority interest ranging from 20% to 25%. For all but one of the majority-owned and minority-owned companies, to reflect the relative illiquidity of these types of companies in today's market, Duff & Phelps applied a discount for lack of marketability of 40%. Due to the fact that Charlotte's Network, Inc. holds sufficient cash within the company to fund its cash needs for approximately two years, the discount for lack of marketability was reduced to 25%. After applying these discounts, the aggregate fair market value of the MRV majority-owned and minority-owned start-up company investments was $142.3 million. Valuation of other MRV Divisions. The other MRV Divisions include Optical Access, Inc.; iTouch Communications, Inc.; Nbase-Xyplex, Inc.; Cescomm, Inc.; Appointech, Inc. and the European subsidiaries. The MRV Divisions were valued using a comparable public company analysis and a discounted cash flow analysis. Comparable Public Company Analysis. Duff & Phelps compared selected financial and other operating ratios for the MRV Divisions to the corresponding ratios of certain publicly traded companies in the telecommunications industry. These comparable public companies were as follows: Avici Systems, Inc.; Corvis Corporation; Enterasys Networks Inc.; Extreme Networks, Inc.; Foundry Networks, Inc.; ONI Systems Corporation; Redback Networks, Inc.; Riverstone Networks, Inc.; and Sycamore Networks, Inc. The ratios analyzed were the enterprise value-to-sales multiples. The statistics were generally based on financial and operating data for the twelve months ended June 30, 2001, and market prices as of October 1, 2001. Other commonly used valuation multiples, such as enterprise value-to-cash flow and equity value-to-net income, were not applicable since the large majority of the comparable public companies had negative cash flow and negative earnings. Furthermore, price-to-book value multiples were not applicable due to the fact that many of the comparable public companies have a significant portion of their asset value in goodwill. Since this goodwill was booked, there has likely been significant goodwill impairment. Due to the fact that the goodwill has most likely not been written down to reflect its current fair market value, this approach is not meaningful. Furthermore, the enterprise value-to-cash multiples were not analyzed, as the MRV Divisions had insufficient cash to produce a meaningful valuation indication. Enterprise value as a multiple of latest twelve months' revenues for the comparable companies ranged from 1.2x to 5.3x with a median of 2.0x. Based on a risk analysis of the MRV Divisions relative to the comparable public companies, and given the MRV Division's relatively low level of cash, Duff & Phelps determined that a reasonable multiple to apply to MRV's Division's latest twelve months revenues of $199.5 million was 1.0x, which is below the bottom of the range of multiples. This results in an enterprise value indication for the MRV Divisions of $200 million. Discounted Cash Flow Analysis. Duff & Phelps performed a discounted cash flow analysis of the MRV Divisions based on projections developed by Duff & Phelps, relying on industry reports regarding the outlook for companies in the telecommunications industry and information provided by MRV's management during Duff & Phelps' due diligence investigation. The terminal value of the MRV Divisions was estimated by capitalizing projected 2005 revenue. The projected cash flows and terminal value were discounted to the present value using a discount rate of 30%, which represents Duff & Phelps' estimate of MRV's weighted average cost of capital (WACC). The resulting indication of enterprise value using the discounted cash flow approach for the MRV Divisions was $200 million. 39 42 Determination of MRV Division's Equity Value. Duff & Phelps weighted the two valuation indications of the MRV Divisions equally, resulting in a concluded value of $200 million. As of June 30, 2001, the MRV Divisions had approximately $2.8 million in interest bearing debt. Deducting the debt from the concluded enterprise valuation results in a valuation of the MRV Divisions' equity, on a marketable minority interest basis, of $197.2 million. MRV's 92.3% Interest in Luminent. MRV owns approximately 92.3% of Luminent. Based on Duff & Phelps' analysis of the fair market value of Luminent, on a marketable minority interest basis, of $154 million (or $1.00 per share), and applying MRV's 92.3% ownership position, results in the fair market value of MRV's interest in Luminent of $142.1 million. Determination of MRV's Equity Value. To determine the fair market value of MRV's total enterprise, Duff & Phelps aggregated the fair market value of (1) the start-up companies of $142.3 million; (2) the MRV Divisions of $197.2 million; and (3) MRV's 92.3% interest in Luminent of $142.1 million, resulting in a total enterprise valuation for MRV of $481.6 million. To determine the fair market value of MRV's equity, the face value of the interest bearing debt of $140 million was deducted. This results in the fair market value of MRV's equity of $342 million. MRV has approximately 16.8 million stock options and warrants issued and outstanding, with exercise prices ranging from $2.54 to $33.00 per share. Based on the Black-Scholes option pricing model, the aggregate fair market value of the options and warrants is $33.4 million. Deducting the aggregate value of the options from the concluded equity value results in the fair market value of the common equity of $308.5 million. Based on 72.5 million shares of MRV common stock issued and outstanding, the fair market value of MRV's common stock, on a marketable minority interest basis, is $4.26 per share. MERGER EXCHANGE RATIO ANALYSIS Duff & Phelps tested the reasonableness of the Merger Exchange Ratio of .43 shares of MRV stock for every share of Luminent stock not held by MRV based on (1) a fundamental valuation analyses of the common stock of Luminent and MRV, (2) the relative stock prices for MRV and Luminent prior to the announcement of the proposed Merger, and (3) the historical relative stock prices of Luminent and MRV prior to the announcement date of the Merger. Fundamental Valuation Analysis. Duff & Phelps' fundamental valuation of Luminent's common stock of $1.80 per share, on a controlling interest basis, and its fundamental valuation of MRV's common stock of $4.26 per share, on a marketable minority interest basis, implies a merger exchange ratio of 42%. The Merger Exchange Ratio of 43% appears reasonable in light of the Duff & Phelps' fundamental valuation analysis. Relative Pre-announcement Prices. On September 10, 2001, Luminent's closing stock price was $1.35 per share, and MRV's closing stock price was $3.23 per share, implying a merger exchange ratio of 42%. The Merger Exchange Ratio of 43% appears reasonable in light of the relative pre-announcement prices for Luminent common stock and MRV common stock. Relative Historical Prices. From November 9, 2000 (Luminent's IPO date) to September 10, 2001 (the last trading date prior to the Merger announcement), the merger exchange ratios implied from Luminent's and MRV's stock prices tended to range from 40% to 50%, with a low of 34% and a high of 60%. The Merger Exchange Ratio of 43% appears reasonable in light of the historical relative stock trading prices of Luminent and MRV. Based on the foregoing analysis, Duff & Phelps concluded that the Merger Exchange Ratio of .43 shares of MRV common stock for every share of Luminent common stock not held by MRV is fair to the minority stockholders of Luminent from a financial point of view as of the date of its Opinion. No company or transaction used in the above analyses is identical to Luminent, MRV or the Merger. Accordingly, an analysis of the results of the foregoing is not mathematical; rather, it involves complex considerations and judgments concerning differences in financial and operating characteristics of the 40 43 companies and other facts that could affect the public trading value of the companies to which they are being compared. The material analyses performed by Duff & Phelps have been summarized above. Nonetheless, the summary set forth above does not purport to be a complete description of the analyses performed by Duff & Phelps. The preparation of a fairness opinion involves various determinations as to the most appropriate and relevant methods of financial analysis and the application of these methods to the particular circumstances. Therefore, such an opinion is not readily susceptible to a summary description. Duff & Phelps did not form a conclusion as to whether any individual analysis, considered in isolation, supported or failed to support an opinion as to fairness. Rather, in reaching its conclusion, Duff & Phelps considered the results of the analyses in light of each other and ultimately reached its opinion based on the results of all analyses taken as a whole. Duff & Phelps did not place a particular reliance or weight on any particular analysis, but instead concluded that its analyses, taken as whole, supported its determination. In performing its analyses, Duff & Phelps made numerous assumptions with respect to Luminent's and MRV's performance, general business and economic conditions and other matters. The analyses performed by Duff & Phelps are not necessarily indicative of future actual values or future results, which may be significantly more or less favorable than suggested by such analyses. The analyses do not purport to be appraisals or to reflect prices at which a company might actually be sold or the prices at which any securities may trade at the present time or at any time in the future. Duff & Phelps developed projections of future performance for Luminent and MRV based on discussions with management of Luminent and MRV and industry research. The projections were based on numerous variables and assumptions which are inherently unpredictable and must be considered not certain of occurrence as projected. Accordingly, actual results could vary significantly from those assumed in the projections and any related analyses. Duff & Phelps' opinion does not address the relative merits of the Merger as compared to any alternative business strategies that might exist for Luminent or the effect of any other business combination in which Luminent might engage. Pursuant to the terms of the engagement of Duff & Phelps, Luminent has agreed to pay Duff & Phelps a fee of $125,000 for financial advisory services in connection with the Merger, including the rendering of its opinion. Luminent has also agreed to reimburse Duff & Phelps for reasonable out-of-pocket expenses and to indemnify Duff & Phelps against certain expenses and liabilities, including liabilities under the Federal securities law, incurred in connection with the performance of its duties under the engagement. Duff & Phelps' opinion to the Board of Directors of Luminent was one of many factors taken into consideration by the Board of Directors of Luminent in making its determination to approve the Merger. 41 44 UNITED STATES FEDERAL INCOME TAX TREATMENT OF THE MERGER The Merger will be treated for U.S. federal income tax purposes as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code. MRV, MRV Merger Sub and Luminent will each be a party to that reorganization within the meaning of Section 368(b) of the Internal Revenue Code. None of MRV, MRV Merger Sub or Luminent will recognize any gain or loss for U.S. federal income tax purposes as a result of the Merger. UNITED STATES FEDERAL INCOME TAX CONSEQUENCES TO LUMINENT STOCKHOLDERS For U.S. federal income tax purposes: - A holder of Luminent common stock will not recognize any gain or loss upon its exchange in the Merger of its shares of Luminent common stock for shares of MRV common stock; - If a holder of Luminent common stock receives cash instead of a fractional share of MRV common stock, the holder will be required to recognize a gain or loss, measured by the difference between (1) the amount of cash received instead of that fractional share, and (2) the portion of the tax basis of that holder's shares of Luminent common stock allocable to that fractional share. This gain or loss will be a capital gain or loss and will be a long-term capital gain or loss if the share of Luminent common stock exchanged for that fractional share of MRV common stock was held for more than one year at the effective time of the Merger and short-term capital gain or loss if the share of Luminent common stock exchanged for that fractional share of MRV common stock was held for one year or less at the effective time of the Merger; - A holder of Luminent common stock will have a tax basis in the MRV common stock received in the Merger equal to (1) the tax basis of the Luminent common stock surrendered by that holder in the Merger, less (2) any tax basis of the Luminent common stock surrendered that is allocable to any fractional share of MRV common stock for which cash is received by that holder; and - The holding period for shares of MRV common stock received in exchange for shares of Luminent common stock in the Merger will include the holding period for the shares of Luminent common stock surrendered in the Merger. A holder of Luminent common stock who exercises appraisal rights with respect to a share of Luminent common stock and who receives payment for the stock in cash will generally recognize capital gain or loss, measured by the difference between (1) the stockholder's tax basis in that share, and (2) the amount of cash received. UNITED STATES FEDERAL INCOME TAX CONSEQUENCES TO MRV STOCKHOLDERS For U.S. federal income tax purposes, holders of MRV common stock will not recognize a gain or loss as a result of the Merger. This discussion of material U.S. federal income tax consequences is intended to provide only a general summary and is not a complete analysis or description of all potential U.S. federal income tax consequences of the Merger. This discussion does not address tax consequences that may vary with, or are contingent on, individual circumstances. In addition, it does not address any non-income tax or any foreign, state or local tax consequences of the Merger. ACCORDINGLY, MRV STRONGLY ENCOURAGES EACH LUMINENT STOCKHOLDER TO CONSULT HIS OR HER OWN TAX ADVISOR TO DETERMINE THE PARTICULAR UNITED STATES FEDERAL, STATE, LOCAL OR FOREIGN INCOME OR OTHER TAX CONSEQUENCES TO THE STOCKHOLDER AS A RESULT OF THE MERGER. 42 45 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF MRV OVERVIEW MRV creates, acquires, finances and operates companies, and through them, designs, develops, manufactures and markets products, which enable high-speed broadband communications. MRV concentrates on companies and products devoted to optical components and network infrastructure systems. MRV has leveraged its early experience in fiber optic technology into a number of well-focused operating units specializing in advanced fiber optic components, switching, routing, transaction management and wireless optical transmission systems which MRV has created, financed or acquired. During 2000, MRV completed several strategic acquisitions. These acquisitions were made to expand MRV's product offerings, enhance its technological expertise and expand its manufacturing capabilities. The table below summarizes the more notable acquisitions.
DATE OF TOTAL FORM OF CONSIDERATION ACQUIRED COMPANY ACQUISITION CONSIDERATION AND OTHER NOTES TO ACQUISITION ---------------- -------------- -------------- ------------------------------ Fiber Optic Communications, April 24, 2000 $310.4 million $48.6 million in cash and 5.4 Inc. million shares of common stock and options issued; approximately 97% of capital stock assumed; goodwill and other intangibles recorded of $261.6 million; deferred stock compensation recorded of $14.1 million Jolt Limited May 1, 2000 $57.7 million 1.9 million shares of common stock and options issued; 100% of capital stock assumed; goodwill and other intangibles recorded of $33.7 million; deferred stock compensation recorded of $25.0 million Quantum Optech Inc. July 12, 2000 $36.2 million 1.2 million shares of common stock and options issued; 100% of capital stock assumed; goodwill and other intangibles recorded of $27.9 million; deferred stock compensation recorded of $2.7 million
43 46
DATE OF TOTAL FORM OF CONSIDERATION ACQUIRED COMPANY ACQUISITION CONSIDERATION AND OTHER NOTES TO ACQUISITION ---------------- -------------- -------------- ------------------------------ AstroTerra Corporation July 12, 2000 $160.3 million 2.4 million shares of common stock and options issued; 100% of capital stock assumed; goodwill and other intangibles recorded of $108.3 million; deferred stock compensation recorded of $50.0 million Optronics International Corp. July 21, 2000 $124.3 million 4.2 million shares of common stock and options issued; approximately 99% of capital stock assumed; goodwill and other intangibles recorded of $99.5 million; deferred stock compensation recorded of $13.4 million
Each of these acquisitions was accounted for using the purchase method and therefore, the results of operations of the acquired businesses have been included in MRV's consolidated financial statements from the respective dates of acquisition. Goodwill and other intangibles from these acquisitions totaled $463.9 million. Goodwill and other intangibles from these acquisitions totaled $346.1 million as of June 30, 2001. For the year ended December 31, 2000, MRV recorded amortization of goodwill and other intangibles from these acquisitions of $60.6 million and for the six months ended June 30, 2001, MRV recorded amortization of goodwill and other intangibles from these acquisitions of $57.2 million. MRV expects to record amortization charges of goodwill and other intangibles for these acquisitions of approximately $29.0 million per quarter until December 31, 2001. At January 1, 2002, MRV intends to implement SFAS No. 142, "Goodwill and Other Intangible Assets" (see Recently Issued Accounting Standards, below). In connection with these acquisitions, a portion of the purchase prices paid represented deferred stock compensation relating to options to purchase MRV's common stock. The fair values of these options were $105.2 million and have been recorded as deferred stock compensation. Deferred stock compensation amortization expense for the year ended December 31, 2000, relating to these stock options was approximately $42.7 million. Deferred stock compensation amortization expenses for the six months ended June 30, 2001, relating to these stock options was approximately $33.8 million, compared with $7.3 million for the six months ended June 30, 2000. MRV expects to incur approximately $78.8 million of total deferred stock compensation, which will be fully amortized by 2004. Deferred stock compensation is being amortized using the graded method using an estimated employment period of four years. In July 2000, MRV and Luminent, entered into employment agreements with Luminent's former President and Chief Executive Officer and its Vice President of Finance and Chief Financial Officer. The agreements provide for annual salaries, performance bonuses and combinations of stock options to purchase shares of MRV's common stock and Luminent's common stock. The stock options were granted to Luminent's executives at exercise prices below market value, resulting in deferred stock compensation. Deferred stock compensation from these stock option grants reported for the year ended December 31, 2000, was $54.2 million. Deferred stock compensation from these stock option grants reported for the six months ended June 30, 2001, was $13.0 million, and MRV will incur additional deferred stock compensation of approximately $25.0 million through 2004. Luminent's President and Chief Executive Officer resigned in September 2001. Dr. Spivey's resignation was considered by the parties to be a termination other than for cause under his employment agreement entitling him to the severance benefits of his employment agreement, including payment over a one year period of an amount equal to two times the sum of his annual salary plus bonus and the vesting of all of his unvested Luminent options. Dr. Spivey's MRV and Luminent stock options are now exercisable through September 11, 2003. During 44 47 the quarter ended September 30, 2001, the Company will record a charge of $1.0 million to reflect severance expense and an immediate write-down of deferred stock compensation expense of $18.9 million. Fiber Optic Communications, Quantum Optech and Optronics International were acquired and contributed to Luminent as part of MRV'S original plan to complete an initial public offering of its fiber optics components business and eventually spin-off this business to MRV's stockholders. This plan was terminated in September 2001 when MRV decided not to complete the spin-off of Luminent and to merge Luminent with MRV Merger Sub, MRV's wholly-owned subsidiary, thereby eliminating public ownership of Luminent. Fiber Optic Communications develops and manufactures passive fiber optic components for wavelength division multiplexing. Quantum Optech specializes in developing and manufacturing optical thin film coating and filters for dense wavelength division multiplexing. Optronics focuses on developing and manufacturing high temperature semiconductor lasers, transceivers and detectors for optical networks. These acquisitions also provided additional manufacturing capabilities for future growth. AstroTerra and Jolt were acquired and contributed to MRV's subsidiary, Optical Access, which focuses on optical wireless products that deliver high-speed communications traffic to the so-called last mile portion of the communications network and eventually spin-off this business to MRV's stockholders. AstroTerra develops and manufactures free-space optical wireless communication systems to connect data and telecommunications networks. Jolt develops and manufactures multi-port wireless optics communications equipment. These acquisitions provided strategic components and technology for Optical Access' wireless optical solution. On October 6, 2000, MRV's wholly-owned subsidiary, Optical Access, filed a registration statement with the Securities and Exchange Commission for the initial public offering of its common stock. Because of the time lapse since the initial filing, MRV expensed in the quarter ended June 30, 2001, all costs ($1.0 million) of this offering. Optical Access designs, manufactures and markets an optical wireless solution that delivers high-speed communications traffic to the portion of the communications network commonly know as the last mile, which extends from the end user to the service provider's central office. MRV reported a net loss of $153.0 million for the year ended December 31, 2000, and $148.4 million for the six months ended June 30, 2001. A significant portion of the net loss was due to the amortization of goodwill and other intangibles and deferred stock compensation related to MRV's recent acquisitions and its employment arrangements with Luminent's former President and its Chief Financial Officer. MRV will continue to record amortization of goodwill and other intangibles through 2005, and deferred stock compensation through 2004, relating to these acquisitions and Luminent's employment arrangements with its executives. Effective January 1, 2002, the adoption of SFAS 142 will stop amortization of goodwill, however, it may require the Company to record an impairment charge (see Recently Issued Accounting Standards). As a consequence of these charges, MRV does not expect to report net income in the foreseeable future. See discussion of the impact on the amortization of goodwill and other intangibles due to the adoption of SFAS 142 as of January 1, 2002 (see Recently Issued Accounting Standards). On November 10, 2000, Luminent completed the initial public offering of its common stock, selling 12.0 million shares at $12.00 per share for net proceeds of approximately $132.3 million. Luminent designs, manufactures and sells a comprehensive line of fiber optic components that enable communications equipment manufacturers to provide optical networking equipment for the rapidly growing metropolitan and access segments of the communications networks. While MRV had planned to distribute all of its shares of Luminent common stock to its stockholders, unfavorable business and economic conditions in the fiber optic, data networking and telecommunications industries and the resulting adverse effects on the market prices of the common stock of MRV and Luminent, has caused MRV to determine to abandon the distribution and merge Luminent into MRV Merger Sub, MRV's wholly-owned subsidiary, thereby eliminating public ownership of Luminent. See the section entitled "The Merger -- Reasons for the Merger" earlier in this prospectus supplement. 45 48 MARKET CONDITIONS AND CURRENT OUTLOOK Macroeconomic factors, such as an economic slowdown in the U.S. and abroad, have detrimentally impacted demand for optical components. The unfavorable economic conditions and reduced capital spending has detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States during 2001 to date, and may continue to affect them for the remainder of 2001 and thereafter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories. As a result of the current slowdown in the communications industry, MRV recorded in its consolidated results for the six months ended June 30, 2001, charges relating to Luminent's write-down of inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other non-recurring items. These charges, totaling $41.2 million, resulted from the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. Luminent's restructuring activities primarily involved employee severance costs, abandonment and non-utilization of assets and other similar actions. Costs for restructuring activities were limited to either incremental costs that directly result from the restructuring activities and provide no future benefit or costs incurred under contractual obligations that existed before the restructuring plan and will continue with either no future benefit or become a penalty incurred for termination of the obligation. Restructuring costs totaling $14.5 million consisting of severance and outplacement of terminated employees and exit costs are included in the results of operations. The restructuring activities as described above, resulted in 150 layoffs during the six months ended June 30, 2001, and will result in additional layoffs of approximately 450 personnel, bringing Luminent's total workforce to approximately 1,200 employees. Affected employees will come from all divisions and areas of Luminent. The majority of affected employees will be in the manufacturing group. A summary of the restructuring costs as of June 30, 2001, consists of the following (in thousands):
REMAINING PROVISION UTILIZED BALANCE --------- ----------- --------- (UNAUDITED) Exit Costs Asset impairment................................. $ 8,904 $8,904 $ -- Closed and abandoned facilities.................. 1,108 -- 1,108 Other commitments................................ 2,402 -- 2,402 Other............................................ 991 -- 991 ------- ------ ------ 13,405 8,904 4,501 Employee severance costs........................... 1,072 196 876 ------- ------ ------ $14,477 $9,100 $5,377 ======= ====== ======
In addition to the costs associated with the restructuring plan, Luminent also recorded a one-time $26.1 million charge to write-down inventory to realizable value and an additional $598,000 charge to bad debt. 46 49 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, MRV's statements of operations data expressed as a percentage of revenues.
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30, ---------------------------------- ----------------------------------------- PRO FORMA PRO FORMA 1998 1999 2000 2000(1) 2000 2001 2001 ---- ---- ---- ----------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Revenues, net.............. 100% 100% 100% 100% 100% 100% 100% Cost of goods sold......... 63 68 64 65 64 82 82 Research and development... 10 12 23 25 19 27 27 Selling, general and administrative........... 20 24 39 40 30 43 43 Purchased technology in progress................. 8 -- -- -- -- -- -- Restructuring costs........ 6 -- -- -- -- -- -- Amortization of goodwill and other intangibles.... 1 1 21 30 9 30 29 --- --- --- --- --- --- --- Operating loss............. (8) (6) (47) (60) (22) (82) (81) Other income (expense), net...................... 2 -- (3) (3) (1) (2) (2) --- --- --- --- --- --- --- Loss before provision for income taxes, minority interests and extraordinary items...... (6) (5) (50) (63) (23) (84) (82) Provision (benefit) for income taxes............. 2 (1) (2) (2) 1 (2) (2) Minority interests......... 1 -- -- -- -- (3) -- Gain on extraordinary items, net of tax........ 1 -- -- -- -- -- -- --- --- --- --- --- --- --- Net income (loss).......... (8)% (4)% (48)% (61)% (24)% (78)% 80% === === === === === === ===
SIX MONTHS ENDED JUNE 30, 2001 AND 2000 Net Sales. MRV generally recognizes revenue upon shipment of its products, at which time, customer acceptance of the products has been attained and collection is considered probable. MRV defers revenue recognition on shipment of products where return privileges exist until the products are sold to end-users. Net sales for the six months ended June 30, 2001, were $189.6 million, compared to net sales of $139.0 million for the six months ended June 30, 2000. The change represented an increase of $50.6 million or 36.4% for the six months ended June 30, 2001 over the six month period ended June 30, 2000. This increase was due in part to an increase in its fiber optic components business, specifically relating to existing business and growth through recent acquisitions. Gross Profit. Gross profit is equal to MRV's net sales less its cost of sales. MRV's cost of sales includes materials, direct labor and overhead. Cost of inventory is determined by the first-in, first-out method. Gross profit for the six months ended June 30, 2001 was $34.5 million, compared to gross profit of $50.5 million during the six months ended June 30, 2000. The changes represented a decrease of $16.0 million or approximately 31.7% for the six months ended June 30, 2001 over the six months ended June 30, 2000. 47 50 MRV's gross margins (defined as gross profit as a percentage of net sales) are generally affected by price changes over the life of the products and the overall mix of products sold. Higher gross margins are generally expected from new products and improved production efficiencies as a result of increased utilization. Conversely, prices for existing products generally will continue to decrease over their respective life cycles. MRV's gross margin decreased to 18.2% for the six months ended June 30, 2001 compared to gross margins of 36.3% in the six months periods ended June 30, 2000. The decrease in gross margin was partially attributed to a write-off of inventory and other market-related one-time charges of $29.3 million taken by Luminent during the six months ended June 30, 2001. The decrease was also partially attributable to increased deferred compensation amortization expense. Prior to Luminent's one-time charges and deferred stock compensation expenses, gross margin would have been 35.8%, for the six months ended June 30, 2001, compared to 36.3% for the six months ended June 30, 2000. Research and Development (R&D). R&D expenses increased 90.6% to $50.8 million for six months ended June 30, 2001, over the same six month period in 2000. R&D expenses of consolidated development stage enterprises reflects the costs incurred by consolidated development stage enterprises. These expenses were $18.7 million or 9.9% of revenues for the six months ended June 30, 2001, as compared to $13.3 million or 9.6% of revenues for the six months ended June 30, 2000. This represents an increase of $5.4 million or 40.6% for the six month period ended June 30, 2001 compared to the same period in 2000. Prior to deferred stock compensation expenses, R&D expenses would have increased 28.2% to $17.1 million during the six month period ended June 30, 2001. The increase in R&D expenses of consolidated development stage enterprises is due to the acceleration in the growth of those enterprises consistent with their objectives of bringing new products to market. Selling, General and Administrative (SG&A). SG&A expenses increased 98.0% to $82.1 million for the six months ended June 30, 2001, over the same six month period in 2000. SG&A expenses were 43.3% of net sales for the six months ended June 30, 2001. Prior to deferred stock compensation expenses, SG&A would have increased 31.9% to $45.0 million for the six months ended June 30, 2001. As a percentage of sales, SG&A prior to deferred stock compensation expenses would have been 23.8% in the six months ended June 30, 2001, compared to 24.6% of net sales in the six months ended June 30, 2000. This decrease principally resulted from MRV's recent acquisitions. Amortization of Goodwill and Other Intangibles From Acquisitions. Amortization of goodwill and other intangibles increased to $57.2 million for the six months ended June 30, 2001, from $13.1 million in the corresponding period ending June 30, 2000. The increase in these costs was affected by MRV's recent acquisitions. MRV expects to incur additional amortization of goodwill and other intangibles resulting from these acquisitions totaling approximately $29.0 million each quarter until December 1, 2001. At January 1, 2002, MRV intends to implement SFAS No. 142, "Goodwill and Other Intangibles Assets" (see Recently Issued Accounting Standards). Furthermore, as MRV continues to engage in strategic acquisitions, additional goodwill and other intangibles may be recorded. Other Expense, Net. In June 1998, MRV issued $100.0 million principal amount of 5% convertible subordinated notes due in 2003 (the "Notes"). The Notes were offered in a 144A private placement to qualified institutional investors at the stated amount, less a selling discount of 3%. In late 1998, MRV repurchased $10.0 million principal amount of the Notes at a discount from the stated amount. MRV incurred $2.3 million in interest expense relating to the Notes during the six months ended June 30, 2001 and June 30, 2000. The increase in other expenses, net, is primarily attributed to the costs of MRV's unconsolidated development stage enterprises of $3.0 million for the six months ended June 30, 2001, as compared to $1.0 million in the comparable period in 2000. The remaining components of other expense, net, are primarily interest income recognized from short-term and long-term investments. Provision (Benefit) for Income Taxes. The benefit for income taxes for the six months ended June 30, 2001 were $3.6 million, compared to a tax provision of $883,000 for the six months ended June 30, 2000. The decrease in the provision for income taxes in 2001 over 2000 was primarily attributable 48 51 to a larger loss for tax purposes in 2001. MRV's income tax expense fluctuates primarily due to the tax jurisdictions where it currently has operating facilities and varying tax rates in those jurisdictions. YEARS ENDED DECEMBER 31, 2000 AND 1999 Revenues. Revenues for the year ended December 31, 2000 increased $30.9 million, or 11%, to $319.4 million from $288.5 million for the year ended December 31, 1999. MRV's revenues were favorably impacted by growth in its fiber optic components business, which offset MRV's decision in February 2000 to discontinue the production and sale of its LAN switches for enterprise networks. Further revenue growth was realized due to the greater acceptance of its Internet infrastructure products, such as MRV's In-Reach(TM) product line, and products acquired through MRV's recent acquisitions, such as passive fiber optic components and products designed for wireless networks. None of the companies MRV acquired during 2000 contributed 10% or more to its total revenues from the date of their acquisition through December 31, 2000. Gross Profit. Gross profit is equal to MRV's revenues less its cost of goods sold. MRV's cost of goods sold includes materials, direct labor and overhead. Cost of inventory is determined by the first-in, first-out method. Gross profit for the year ended December 31, 2000 increased $24.9 million, or 27%, to $116.0 million from $91.1 million for the year ended December 31, 1999. MRV's gross margins (defined as gross profit as a percentage of revenues) increased to 36% for the year ended December 31, 2000, from 32% for the year ended December 31, 1999. Prior to deferred stock compensation expenses, MRV's gross margin would have increased to 39% for the year ended December 31, 2000. MRV's margins increased due to a favorable shift in product mix toward higher margin product lines, such as those for 3G wireless networks and other Internet infrastructure products. Research and Development (R&D). R&D expenses increased $38.8 million or 110%, to $74.1 million for the year ended December 31, 2000 from $35.3 million for the year ended December 31, 1999. R&D expenses of consolidated development stage enterprises represented a 108% increase to $41.5 million from $20.0 million for the year ended December 31, 1999. Prior to deferred stock compensation expenses, R&D would have increased $25.5 million, or 73%, to $60.8 million for the year ended December 31, 2000. MRV's increased spending in R&D illustrates its commitment to continued product development and technological expansion. Additionally, R&D from MRV's consolidated development stage enterprises continued to increase as those enterprises strive towards bringing new products to market. Selling, General and Administrative (SG&A). SG&A expenses increased $56.8 million, or 84%, to $124.7 million from $67.9 for the year ended December 31, 1999. SG&A expenses were 39% of revenue, during the year ended December 31, 2000 compared to 24% of revenue for the year ended December 31, 1999. Prior to deferred stock compensation expenses, SG&A would have increased 27%, to $86.3 million for the year ended December 31, 2000. SG&A would have been 27% of net sales for the year ended December 31, 2000. The increase in SG&A expenses is primarily a result of MRV's recent acquisitions. MRV has also increased personnel and related costs in its operating entities in response to MRV's growth in business. Amortization of Goodwill and Other Intangibles. Amortization of goodwill and other intangibles increased $62.9 million to $66.8 million from $3.9 million for the year ended December 31, 2000. Furthermore, as MRV continues to engage in strategic acquisitions, additional goodwill and other intangibles will be recorded. Interest and Other Income and Expense. MRV incurred $4.5 million in interest expense relating to the Notes for each year ended December 31, 2000 and 1999, respectively. The increase in other income (expense), is primarily attributed to MRV's share of losses from its unconsolidated development stage enterprises of $7.3 million for the year ended December 31, 2000. For the year ended December 31, 1999, these entities were included in MRV's consolidated statements of operations based on its ownership in those enterprises. The remaining components of other income (expense), principally represent interest income recognized from short-term and long-term investments. 49 52 Provision (Benefit) for Income Taxes. The benefit for income taxes for the year ended December 31, 2000 was $5.4 million, compared to $2.2 million for the year ended December 31, 1999. MRV's income tax expense fluctuates primarily due to the tax jurisdictions where MRV currently has operating facilities and the varying tax rates in those jurisdictions. YEARS ENDED DECEMBER 31, 1999 AND 1998 Revenues. Revenues for the year ended December 31, 1999 increased 9%, to $288.5 million from $264.1 million for 1998. Revenues from sales of networking products and optical transmission products were 77% and 23%, respectively, of total revenues during the year ended December 31, 1999 as compared to 82% and 19%, respectively, of total revenues during the year ended December 31, 1998. Revenues increased as a result of greater marketing efforts and greater market acceptance of MRV's products, both domestically and internationally. International sales accounted for approximately 58% of revenues for the year ended December 31, 1999, as compared to 59% of revenues for the year ended December 31, 1998. Gross Profit. Gross profit for the year ended December 31, 1999 decreased $7.6 million, or 8%, to $91.1 million from $98.7 million for 1998. MRV's gross margin decreased from 37% during the year ended December 31, 1998 to 32% for the year ended December 31, 1999 as a result of its decision to exit the LAN switching business. During the last two years, MRV endured intense price competition from its larger competitors. MRV had planned to compensate for this price competition by introducing new lower cost products during 1998. MRV began shipping these products in the last quarter of 1998, however, the commoditization of these products and the economy of scales and manufacturing advantages of its larger competitors were too difficult for MRV to overcome. Therefore MRV decided to exit the LAN switching business and in connection with this decision recorded a charge of $13.8 million primarily to write-off inventory. Research and Development (R&D). R&D expenses increased $9.5 million, or 37%, to $35.3 million from $25.8 million for the year ended December 31, 1999. R&D expenses as a percentage of revenues increased from 10% of revenues during year ended December 31, 1998, to 12% of revenues for year ended December 31, 1999. This increase was primarily caused by additional development projects commenced during the year and associated personnel costs as well as increased expenses resulting from personnel added to existing projects. MRV intends to continue to invest in the research and development of new products. MRV believes that its ability to develop and commercialize new products is its key competitive factor. Selling, General and Administrative (SG&A). SG&A expenses increased $14.0 million, or 26%, to $67.9 million from $53.9 million for 1998. SG&A expenses were 24% of revenues for the year ended December 31, 1999, compared to 20% of revenue for the year ended December 31, 1998. The increases in SG&A expense, both in absolute dollars and as a percentage of revenue were due primarily to substantially increased marketing efforts as well as the addition of personnel and overhead costs in additional and expanded locations. Purchased Technology in Progress and Restructuring Costs. Purchased technology in progress for the year ended December 31, 1998 was $20.6 million. The purchased technology in 1998 was related to R&D projects of Xyplex in progress at the time MRV acquired Xyplex on January 30, 1998, which had not yet reached technological feasibility and for which MRV had no alternative future use. Restructuring costs during the year ended December 31, 1998 were $15.7 million. The restructuring costs in 1998 were associated with MRV's plan adopted in March 1998 calling for the reduction of workforce, closing of certain facilities, elimination of particular product lines, settlement of distribution agreements and other costs. The restructuring costs incurred in first quarter of 1998 were offset by a restructuring credit of $7.5 million booked during the last quarter of 1998 in connection with MRV's decision to consolidate the Xyplex and NBase organizations. This credit principally resulted from the renegotiation of Xyplex' lease in Littletown, Massachusetts and a reevaluation reducing the anticipated cost of discontinuing some of Xyplex' legacy products. MRV did not incur these charges or receive a similar credit in 1999. 50 53 Interest. In November 1998, MRV repurchased $10.0 million face amount of the Notes at a discount from par resulting in a gain of $2.8 million recorded in the fourth quarter of 1998. The outstanding Notes resulted in interest expense of $2.5 million for the year ended December 31, 1998 and $4.5 million for the year ended December 31, 1999. QUARTERLY RESULTS OF OPERATIONS The following tables set forth MRV's unaudited condensed consolidated statements of operations data for each of the ten quarters ended June 30, 2001. These statements should be read in conjunction with MRV's consolidated financial statements and related notes appearing elsewhere in this prospectus. MRV has prepared this unaudited consolidated information on a basis consistent with its audited consolidated financial statements, and in the opinion of its management, it reflects all normal recurring adjustments that MRV considers necessary for a fair presentation of its financial position and operating results for the quarters presented. You should not draw any conclusions about MRV's future results from the operating results for any quarter.
FOR THE THREE MONTHS ENDED -------------------------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, 1999 1999 1999 1999 2000 2000 --------- -------- ------------- ------------ --------- -------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Revenues, net............ $70,116 $73,251 $71,254 $ 73,903 $65,072 $ 73,935 Costs and Expenses: Cost of goods sold..... 46,366 47,595 44,653 58,828 42,736 45,793 Research and development.......... 9,592 8,572 8,476 9,806 11,891 14,758 Selling, general and administrative....... 14,718 14,750 15,581 22,474 16,028 26,467 Amortization of goodwill and other intangibles.......... -- 1,142 951 1,014 -- 12,055 ------- ------- ------- -------- ------- -------- 70,676 72,059 69,661 92,122 70,655 99,073 Operating income (loss)............. (560) 1,192 1,593 (18,219) (5,583) (25,138) Other income (expense), net.................... 278 132 165 (253) (488) (1,190) ------- ------- ------- -------- ------- -------- Income before (provision) benefit for income taxes and minority interest........... (282) 1,324 1,758 (18,472) (6,071) (26,328) (Provision) benefit for income taxes........... (627) (782) (1,169) 4,731 494 (1,377) Minority interest........ -- (17) (22) 649 (287) (45) ------- ------- ------- -------- ------- -------- Net income (loss).... $ (909) $ 525 $ 567 $(13,092) $(5,864) $(27,750) ======= ======= ======= ======== ======= ======== Basic and diluted income (loss) per share....... $ (0.02) $ 0.01 $ 0.01 $ (0.24) $ (0.10) $ (0.44) Basic weighted average shares................. 53,300 53,472 53,868 55,082 56,850 62,764 ======= ======= ======= ======== ======= ======== Diluted weighted average shares................. 53,300 57,621 60,154 55,082 56,850 62,754 ======= ======= ======= ======== ======= ======== FOR THE THREE MONTHS ENDED ---------------------------------------------------- SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, 2000 2000 2001 2001 ------------- ------------ --------- --------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) (UNAUDITED) Revenues, net............ $ 82,720 $ 97,667 $100,104 $ 89,530 Costs and Expenses: Cost of goods sold..... 47,910 66,932 66,391 88,765 Research and development.......... 21,803 25,626 25,005 25,782 Selling, general and administrative....... 52,699 29,506 38,412 43,711 Amortization of goodwill and other intangibles.......... 27,348 27,411 28,139 29,028 -------- -------- -------- --------- 149,760 149,475 157,947 187,286 Operating income (loss)............. (67,040) (51,808) (57,843) (97,756) Other income (expense), net.................... (5,764) (2,136) (520) (2,373) -------- -------- -------- --------- Income before (provision) benefit for income taxes and minority interest........... (72,804) (53,944) (58,363) (100,129) (Provision) benefit for income taxes........... (1,005) 7,286 2,683 939 Minority interest........ (570) 1,698 1,388 5,051 -------- -------- -------- --------- Net income (loss).... $(74,379) $(44,960) $(54,292) $ (94,139) ======== ======== ======== ========= Basic and diluted income (loss) per share....... $ (1.06) $ (0.62) $ (0.73) $ (1.24) Basic weighted average shares................. 70,122 72,768 74,370 76,111 ======== ======== ======== ========= Diluted weighted average shares................. 70,122 72,768 74,370 76,111 ======== ======== ======== =========
51 54 LIQUIDITY AND CAPITAL RESOURCES On November 10, 2000, Luminent completed the initial public offering of its common stock, selling 12.0 million shares at $12.00 per share and raising net proceeds of approximately $132.3 million. Cash and cash equivalents were $174.9 million at June 30, 2001, compared to $210.1 million at December 31, 2000. As of June 30, 2001, MRV had working capital of $305.8 million, compared with $366.8 million as of December 31, 2000. The ratio of current assets to current liabilities at June 30, 2001 was 3.6 to 1, compared to 4.3 to 1 at December 31, 2000. These decreases are primarily attributable to operating losses and capital expenditures. Cash and cash equivalents were $210.1 million at December 31, 2000, compared to $34.3 million at December 31, 1999. As of December 31, 2000, MRV had working capital of $366.8 million, compared with $106.4 million as of December 31, 1999. The ratio of current assets to current liabilities at December 31, 2000 was 4.3 to 1, compared to 3.1 to 1 at December 31, 1999. This is primarily due to the consolidation of MRV's recent acquisitions, cash utilized for acquisitions and the cash Luminent received from its initial public offering. Cash used in operating activities was $43.5 million for the six months ended June 30, 2001, compared to cash used in operating activities of $5.0 million for the six months ended June 30, 2000. Cash used in operating activities was primarily impacted by MRV's net loss, partially offset by the amortization of goodwill and amortization of deferred stock compensation. Cash used in operating activities was $29.8 million for the year ended December 31, 2000, compared to cash provided by operating activities of $2.0 million for the year ended December 31, 1999. Cash used in operating activities was primarily impacted by MRV's net loss, partially offset by the amortization of goodwill and other intangibles and amortization of deferred stock compensation. The increase in cash used in operating activities was also a result of an overall increase in MRV's current assets. Cash used in investing activities was $15.0 million for the six months ended June 30, 2001, compared to cash used in investing activities of $55.6 million for the six months ended June 30, 2000. MRV spent approximately $26.6 million on the purchase of property and equipment for business expansion and increased manufacturing capacity. It received cash of $71.2 million from the sale or maturity of investments. Cash provided by investing activities was $9.2 million for year ended December 31, 2000, compared to cash provided by investing activities of $6.2 million for the year ended December 31, 1999. MRV spent approximately $24.0 million on the purchase of property and equipment for business expansion and increased manufacturing capacity. MRV purchased approximately $21.6 million in investments primarily in partner companies. MRV also received cash of $97.7 million from the sale of investments, which was offset by net cash used in its recent acquisitions and equity purchases of $44.5 million. Cash provided by financing activities was primarily generated through the issuance of common stock and through short-term borrowings during the six months ended June 30, 2001 and from proceeds from line of credit as well as through short-term borrowings during the six months ended June 30, 2000. In June 1998, MRV issued $100.0 million principal amount of 5% convertible subordinated notes due 2003 (the Notes) in a private placement raising net proceeds of $96.4 million. The Notes are convertible into MRV's common stock at a conversion price of $13.52 per share (equivalent to a conversion rate of approximately 73.94 shares per $1,000 principal amount of notes), representing an initial conversion premium of 24%, for a total of approximately 7.4 million shares of MRV's common stock. The Notes bear interest at 5% per annum, which is payable semi-annually on June 15 and December 15 of each year. The Notes have a five-year term and are callable by MRV on or after June 15, 2001. The premiums payable to call the Notes are 102% of the outstanding principal amount during the 12 months ending June 14, 2002 and 101% during the 12 months ending June 14, 2003, plus accrued interest through the date of redemption. MRV believes that its cash flows from operations will be sufficient to satisfy its working capital, capital expenditure and research and development requirements for at least the next 12 months. However, MRV may require or choose to obtain additional debt or equity financing in order to finance acquisitions or other investments in its business. MRV will continue to devote resources for expansion and other business requirements. Its future capital requirements will depend on many factors, including acquisitions, its rate of revenue growth, the timing and extent of spending to support development of new products and 52 55 expansion of sales and marketing, the timing of new product introductions and enhancements to existing products and market acceptance of its products. EFFECTS OF INFLATION MRV believes that the relatively moderate rate of inflation in the United States over the past few years has not had a significant impact on its sales or operating results or on the prices of raw materials. However, in view of its recent expansion of operations in Taiwan, Israel and other countries, which have experienced substantial inflation, there can be no assurance that inflation will not have a materially adverse effect on its operating results in the future. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS MRV operates on an international basis. A majority of its revenues and expenses are incurred in U.S. dollars, however, a significant portion of its revenues and expenses are incurred in other currencies. Fluctuations in the value of the currencies in which MRV conducts its business relative to the U.S. dollar will cause U.S. dollar translation of these currencies to vary from one period to another. MRV cannot predict the effect of exchange rate fluctuations upon future operating results. However, because MRV has expenses as well as revenues in each of the principal functional currencies, the exposure to its financial results to currency fluctuations is reduced. MRV has not historically attempted to reduce its currency risks through hedging instruments, however, MRV may do so in the future. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998 and June 1999, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Investments and Hedging Activities," and SFAS No. 137, which delayed the effective date of SFAS No. 133. In June 2000, the FASB issued SFAS No. 138, which provides additional guidance for the application of SFAS No. 133 for certain transactions. MRV will adopt the statement in January 2001 and does not expect the adoption of this statement to have a material impact on its financial position or results of operations. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements," and related interpretations. SAB 101 summarized certain of the Securities and Exchange Commission's views in applying accounting principles generally accepted in the United States to revenue recognition in financial statements. MRV has applied the provisions of SAB 101 in the consolidated financial statements. The adoption of SAB 101 did not have a material impact on its financial condition or results of operations. In March 2000, the FASB issued interpretation No. 44 (FIN 44), "Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25." FIN 44 clarifies the application of APB No. 25 for certain issues, including the definition of an employee, the treatment of the acceleration of stock options and the accounting treatment for options assumed in business combinations. FIN 44 became effective on July 1, 2000, but is applicable for certain transactions dating back to December 1998. The adoption of FIN 44 did not have a significant impact on its financial position or results of operations. The FASB recently approved two pronouncements: SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", which provide guidance on the accounting for business combinations to be accounted for using the purchase method. Under the new rules, goodwill will no longer be subject to amortization over its useful life. Rather, goodwill will be subject to at least an annual impairment assessment. This assessment is a fundamentally different two-step approach and is based on a comparison between a reporting unit's fair value and its carrying value. Intangible assets have newly defined criteria and will be accounted for separately from goodwill and will continue to be amortized over their useful lives. MRV plans to adopt these pronouncements on January 1, 2002. MRV is currently reviewing these standards to determine the impact on its results of operations and its financial position. The most significant anticipated effect on MRV's financial statements at adoption would be the discontinuing of the amortization of goodwill and the possible impairment loss measured as of the date of adoption. 53 56 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF LUMINENT MARKET CONDITIONS AND CURRENT OUTLOOK Macroeconomic factors, such as an economic slowdown in the U.S. and abroad, have detrimentally impacted demand for communications products, thereby resulting in reduced demand for optical components in general. The unfavorable economic conditions and reduced capital spending detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States during 2001 to date, and may continue to affect them for the remainder of 2001 and thereafter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories. Luminent's two largest customers, Cisco and Marconi, recently announced that they expect declining revenues and profitability in the near term due to softening demand for telecommunications and networking equipment. This has resulted in reductions and rescheduling by Cisco and Marconi in purchases from their suppliers such as Luminent as they seek to reduce their existing inventories and adjusts to reduced demand in the market. This will likely result in lower sales to Cisco and Marconi, and could result in lower revenues overall. Luminent's sales may decline significantly with resulting fluctuations or harm to its operating results and financial condition if either Cisco or Marconi cancels, reduces or delays purchases of Luminent's products or unduly delays qualifying them. During the six months ended June 30, 2001, Luminent recorded restructuring and other one-time charges totaling $41.2 million, resulting from the lower demand for its products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. These charges include the write-down of inventory of $26.1 million, asset impairment charges of $8.9 million, and other restructuring and unusual items related to the recent market conditions of $6.2 million. Additionally, Luminent began to reduce its workforce, which it expects will result in layoffs of approximately 600 people, bringing its total workforce to approximately 1,200 employees. Furthermore, Luminent is undertaking a formal review of the goodwill generated in its acquisitions based on the adoption of SFAS 142. Luminent plans to adopt this statement effective January 1, 2002, (see Recently Issued Accounting Standards). OVERVIEW Luminent designs, manufactures and sells a comprehensive line of fiber optic components that enable communications equipment manufacturers to provide optical networking equipment for the rapidly growing metropolitan and access segments of the communications network. Luminent's fiber optic components business was the original business of MRV when MRV began operations in July 1988. From inception in 1988 until Luminent's separation on September 8, 2000, when MRV completed the contribution and transfer to Luminent of Luminent's business, Luminent operated as a division of MRV and conducted business using MRV's trade name. In March 2000, Luminent was incorporated in Delaware as a wholly owned subsidiary of MRV. In April 2000, Luminent began operating under the Luminent trade name. With MRV's decision to abandon its planned distribution of Luminent's common stock to MRV's stockholders and the completion of the Merger, Luminent will operate as a wholly-owned subsidiary of MRV. On April 24, 2000, MRV acquired approximately 97% of the outstanding capital stock of Fiber Optic Communications, a Taiwanese manufacturer of passive fiber optic components with facilities in both Taiwan and the People's Republic of China. The purchase price paid was approximately $310.4 million in cash, common stock and options to purchase common stock of MRV, including amounts recorded as deferred stock compensation. On July 12, 2000, MRV acquired all of the outstanding capital stock of Quantum, a Taiwanese manufacturer of active and passive fiber optic components. The purchase price paid was approximately $36.2 million in common stock and options to purchase common stock of MRV, 54 57 including amounts recorded as deferred stock compensation. On July 21, 2000, MRV acquired approximately 99% of the outstanding capital stock of Optronics, a Taiwanese manufacturer of active fiber optic components. The purchase price paid was approximately $124.3 million in common stock and options to purchase common stock of MRV, including amounts recorded as deferred stock compensation. The acquisitions were made to expand Luminent's product offerings, enhance its technology experience and expand its manufacturing capabilities. These acquisitions were accounted for using the purchase method and the outstanding capital stock purchased by MRV in each of the acquisitions has been contributed to Luminent as of the dates of acquisition. Therefore, the results of operations of Fiber Optic Communications, Optronics and Quantum have been included in Luminent's consolidated financial statements from April 25, 2000, July 13, 2000 and July 22, 2000, respectively. In connection with the acquisitions of Fiber Optic Communications, Optronics and Quantum, a portion of the purchase prices paid represented deferred stock compensation relating to options to purchase the common stock of MRV. These options had fair values of approximately $14.1 million, $13.4 million and $2.7 million for Fiber Optic Communications, Optronics and Quantum, respectively. Deferred stock compensation amortization expense for the year ended December 31, 2000 and the six months ended June 30, 2001 relating to these stock options were approximately $12.5 million and $5.9 million, respectively. In connection with these acquisitions, Luminent expects to incur an additional $11.7 million of deferred stock compensation until fully amortized in 2004. Deferred stock compensation is amortized using the graded method over a four-year period. Goodwill resulting from the Fiber Optic Communications, Optronics and Quantum acquisitions totaled $261.6 million, $99.5 million and $27.9 million, respectively. For the year ended December 31, 2000, Luminent recorded amortization of goodwill of $35.9 million relating to the acquisition of Fiber Optic Communications, $8.9 million relating to the acquisition of Optronics and $2.6 million relating to the acquisition of Quantum. For the six months ended June 30, 2001, Luminent recorded total amortization of goodwill of approximately $39.0 million, relating to these acquisitions. Luminent expects to record amortization of goodwill for Fiber Optic Communications, Optronics and Quantum of approximately $19.5 million per quarter until December 31, 2001. At January 1, 2002, Luminent intends to implement SFAS No. 142 (see Recent Accounting Pronouncements, below). Fiber Optic Communications produces margins similar to us; however, it has not experienced the growth in net sales or operating income that Luminent has experienced during the last three fiscal years. Luminent is not aware of any unusual trends specific to the businesses of its acquired companies, except that they are experiencing the same softness in demand and pricing that Luminent and the rest of Luminent's industry are experiencing. In July 2000, MRV and Luminent entered into four-year employment agreements with Luminent's former President and Chief Executive Officer and its Vice President of Finance and Chief Financial Officer. The agreements provided for annual salaries, performance bonuses and combinations of stock options to purchase shares of MRV's common stock and Luminent's common stock. These options to Luminent's executives were granted at exercise prices below market value, resulting in deferred stock compensation. Deferred stock compensation related to these individuals reported for the year ended December 31, 2000 was $16.3 million. Deferred stock compensation reported for the six months ended June 30, 2001 was $13.0 million, and Luminent will incur additional deferred stock compensation of approximately $25.0 million through 2004. Luminent's President and Chief Executive Officer resigned in September 2001. Dr. Spivey's resignation was considered by the parties to be a termination other than for cause under his employment agreement entitling him to the severance benefits of his employment agreement, including payment over a one year period of an amount equal to two times the sum of his annual salary plus bonus and the vesting of all of his unvested Luminent options. Dr. Spivey's MRV and Luminent options are now exercisable through September 11, 2003. During the quarter ended September 30, 2001, the Company will record $1.0 million in severance expense and an immediate write-down of deferred stock compensation expense of $18.9 million. 55 58 Although Luminent reported net income of $3.5 million and $4.2 million for the years ended December 31, 1998 and 1999, respectively, it reported net losses of $65.0 million for the year ended December 31, 2000 and $88.3 million for the six months ended June 30, 2001. The net losses were primarily due to Luminent's amortization of goodwill and other intangibles and deferred stock compensation related to the acquisitions of Fiber Optic Communications, Optronics and Quantum for the year ended December 31, 2000 and for the six months ended June 30, 2001, Luminent's employment arrangements with its former President and Chief Executive Officer and its Vice President of Finance and Chief Financial Officer for the year ended December 31, 2000 and for the six months ended June 30, 2001 and recording restructuring and other one-time charges totaling $41.2 million resulting from the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular for the six months ended June 30, 2001. These one-time charges include the write-down of inventory of $26.1 million, asset impairment of $8.9 million, and other restructuring and non-recurring items related to the recent market conditions of $6.2 million (see Results of Operations, below). In addition, Luminent will record amortization of goodwill and other intangible assets and deferred stock compensation relating to the Fiber Optic Communications, Optronics and Quantum acquisitions and its employment arrangements going forward. As a consequence of these amortization charges, Luminent does not expect to report net income in the foreseeable future. Prior to Luminent's separation from MRV, Luminent entered into various agreements related to interim and ongoing relationships with MRV. These agreements provide for transitional services and support in the areas of data processing and telecommunications services (such as voice telecommunications and data transmission and information technology support services) for functions including accounting, financial management, tax, payroll, stockholder and public relations, legal, procurement and other administrative functions. Services are generally cost plus 5%, but may increase to cost plus 10% if the services extend beyond a one-year period. Subsequent to the separation date, certain of these services were discontinued, including accounting, financial management, payroll, legal, procurement and other administrative functions. The transition period varies depending on the agreement but is generally one year. Although the fees provided for in the agreements are intended to represent the fair market value of these services, Luminent cannot assure that these fees necessarily reflect the costs of obtaining the services from unrelated third parties or of its providing these services internally. However, Luminent believes that purchasing these services from MRV provided an efficient means of obtaining these services during the transition period. With the Merger, these agreements have been terminated. BASIS OF PRESENTATION Luminent's consolidated financial statements have been carved out from the consolidated financial statements of MRV using the historical results of operations and historical bases of the assets and liabilities of the MRV businesses that Luminent's company comprises. The consolidated condensed financial statements through June 30, 2001 also include allocations to Luminent of certain MRV corporate assets, liabilities and expenses, including centralized legal, accounting, employee benefits, real estate, insurance services, information technology services, treasury and other MRV corporate and infrastructure costs. The expense allocations have been determined on bases that MRV and Luminent considered to be a reasonable reflection of the utilization of the services provided to MRV or the benefit received by us. The expense allocation methods included relative sales, headcount, square footage, transaction processing costs and adjusted operating expenses. No intercompany interest income or expense has been allocated to, or included in, Luminent's consolidated financial statements. The financial information presented in this prospectus supplement is not indicative of Luminent's financial position, results of operations or cash flows in the future nor is it necessarily indicative of what its financial position, results of operations or cash flows would have been had Luminent been a separate, stand-alone entity for the periods presented. The financial information presented in this prospectus supplement does not reflect many of the significant changes that will occur in Luminent's funding and operations as a result of its becoming a stand-alone entity and the distribution. 56 59 RESULTS OF OPERATIONS The following table sets forth selected condensed consolidated historical financial data for the years and periods indicated, expressed as a percentage of net sales:
SIX MONTHS YEAR ENDED DECEMBER 31, ENDED ----------------------------------- JUNE 30, PRO FORMA ------------- 1998 1999 2000 2000 2000 2001 ---- ---- ---- ----------- ---- ----- (UNAUDITED) (UNAUDITED) Net sales.................................... 100% 100% 100% 100% 100% 100% Cost of sales................................ 63 66 68 69 65 101 ---- ---- ---- ---- ---- ----- Gross profit............................ 37 34 32 31 35 (1) Operating costs and expenses: Selling, general and administrative........ 7 9 31 33 19 44 Research and development................... 13 13 15 15 15 11 Parent company allocations................. 2 1 -- -- -- -- Amortization of goodwill................... -- -- 38 57 22 44 ---- ---- ---- ---- ---- ----- 22 23 84 105 56 99 ---- ---- ---- ---- ---- ----- Operating income (loss)................. 15 11 (52) (74) (21) (100) Other income (loss), net..................... -- -- 2 1 -- 3 ---- ---- ---- ---- ---- ----- Income (loss) before provision for income taxes and minority interests... 15 11 (50) (73) (21) (97) Provision for income taxes................... 6 4 2 2 3 2 Minority interest............................ -- -- (1) 1 1 -- ---- ---- ---- ---- ---- ----- Net income (loss)....................... 9% 6% (52)% (74)% (25)% (99)% ==== ==== ==== ==== ==== =====
SIX MONTHS ENDED JUNE 30, 2001 AND 2000 Net Sales. Luminent recognizes revenue upon shipment of its products, at which time, customer acceptance of the products has been attained and collection is considered probable. Net sales for the six months ended June 30, 2001, increased 108%, to $89.3 million from $43.0 million for the six months ended June 30, 2000. The increase in net sales is primarily a result of the growth of the Internet and e-commerce and the corresponding increased bandwidth requirements. The following table sets forth Luminent's net sales to certain customers as a percentage of Luminent's total net sales during the six months ended June 30, 2000 and 2001:
SIX MONTHS ENDED JUNE 30, ---------------- 2000 2001 ----- ----- (UNAUDITED) Marconi Communications...................................... 17% 13% Cisco Systems............................................... 14 11 Other....................................................... 69 76 --- --- Net sales................................................... 100% 100% === ===
Luminent relies on one-time purchase orders rather than long-term contracts with both Cisco and Marconi, and, as a result, Luminent cannot predict the size, timing or terms of their incoming orders. Luminent has experienced variations in the purchase patterns of Marconi and Cisco in the past, and Luminent may experience continued variation in the future. Material reasons for historic variations in the purchase patterns of these customers, particularly Marconi, have included weather patterns that have delayed field installations of systems that incorporate Luminent's products and delays by its customers in qualifying Luminent's products that employ new components or features to assure compatibility with the components of other suppliers that are integrated with its products into Luminent's customers' systems. 57 60 The timing of this qualification process is totally within the control of these customers. Thus, even when Luminent's products prove compatible with the components of other suppliers, as has typically been the case in the past, delays by its customers in completing the qualification process has resulted in corresponding delays in Luminent's receipt of orders for them. Cisco and Marconi have recently announced that they expect declining revenues and profitability in the near term due to softening demand for telecommunications and networking equipment. This has resulted in reductions and rescheduling by Cisco and Marconi in purchases from their suppliers such as Luminent as they seek to reduce their existing inventories and adjust to reduced demand in the market. This will likely result in lower sales to Cisco and Marconi, and could result in lower revenues overall. Luminent's sales may decline significantly with resulting fluctuations or harm to its operating results and financial condition if either Cisco, Marconi or other material customers cancel, reduce or delay purchases of Luminent's products or unduly delays qualifying them. Gross Profit. Gross profit is equal to Luminent's net sales less its cost of sales. Luminent's cost of sales includes materials, direct labor and overhead. Cost of inventory is determined by the first-in, first-out method. Gross profit for the six months ended June 30, 2001, decreased 105%, down to a loss of $802,000 from $15.2 million for the six months ended June 30, 2000. Pro forma gross profit for the six months ended June 30, 2001, before inventory write-downs and other market-related one-time charges of $29.3 million for the three months ended June 30, 2001, and deferred compensation amortization expense of $744,000 and $1.2 million for the six months ended June 30, 2000 and 2001, respectively, would have increased 87%, to $29.8 million. Luminent's pro forma gross margin, before restructuring charges, inventory write-downs and other market-related one-time charges for the six months ended June 30, 2001, and deferred compensation amortization expense for the six months ended June 30, 2000 and 2001, decreased to 32% decreased to 33% for the six months ended June 30, 2001, from 37% for the six months ended June 30, 2000. Luminent's gross margins (defined as gross profit as a percentage of net sales) are generally affected by price changes over the life of the products and improved production efficiencies as a result of increased utilization. The former effect will generally decrease gross margins over the products' respective life cycles, whereas as the latter effect typically increases gross margins. Prices for existing products are generally expected to continue to decrease over their respective life cycles. Luminent's lower margin customers typically operate in highly competitive markets where the price of its products is a key factor. Although Luminent sacrifices margins to these customers, Luminent's volumes are typically greater than the volumes achieved with higher margin customers. As Luminent seeks to continue to diversify its customer base, Luminent plans to target markets with improved margins and less competitive end-markets. In the short term, Luminent expects margins to remain constant or decline slightly due to the integration of the acquired companies with historically lower margins. In the mid- to long term, Luminent expects margins to improve due to increased operating efficiencies associated with capacity utilization in Taiwan and People's Republic of China, diversification of sales to higher margin customers, and a favorable shift towards a higher margin customer base. Operating Costs and Expenses. Operating costs and expenses consist of selling, general and administrative, research and development costs, costs associated with acquisitions, and other operating related charges. Operating costs and expenses, increased to 99% of net sales, or $88.5 million, for the six months ended June 30, 2001, from 56% of net sales, or $24.3 million, for the six months ended June 30, 2000. Pro forma operating costs and expenses for the six months ended June 30, 2001, before market-related one-time charges of $11.9 million for the three months ended June 30, 2001, goodwill amortization of $9.6 million and $39.0 million and deferred compensation amortization expense of $2.2 million and $17.7 million for the six months ended June 30, 2000 and 2001, respectively, would have increased 60%, to $20.0 million. Pro forma operating costs and expenses, as a percentage of net sales, are lower for the six months ended June 30, 2001 than the six months ended June 30, 2000 due to an effort to realize greater efficiencies in the current down market. 58 61 Selling, general and administrative expenses for the six months ended June 30, 2001, increased to 44% of net sales, or $39.5 million, from 19% of net sales, or $8.1 million, for the six months ended June 30, 2000. Pro forma selling, general and administrative expenses for the six months ended June 30, 2001, before market-related one-time charges of $11.4 million for the three months ended June 30, 2001, deferred stock compensation expense of $1.1 million and $15.7 million for the six months ended June 30, 2000 and 2001, respectively, would have been 14% of net sales, or $12.4 million, an increase over the same period in the prior year by $5.4 million. The main reason for the increases is the inclusion of the new acquisitions of Fiber Optic Communications, Optronics and Quantum. Research and development expenses, decreased as a percentage of net sales from 15% to 11% of net sales during the six months ended June 30, 2001, respectively, from the same period in 2000. However, in terms of absolute dollars, research and development expenses increased from the six months ended June 30, 2000 to the six months ended June 30, 2001, from $6.6 million to $10.0 million, respectively. Pro forma research and development expenses for the six months ended June 30, 2001, before market-related one-time charges of $501,000 for the three months ended June 30, 2001, and deferred stock compensation of $1.2 million and 2.0 million for the six months ended June 30, 2000 and 2001, respectively, would have increased to $7.6 million from $5.5 million from the same period in 2000. Research and development expenses increased primarily due to the addition of Fiber Optics Communications, Optronics and Quantum. During the year ended December 31, 2000 Luminent began development of its next generation products for applications such as fiber-to-the-home and fiber-to-the-curb. Fiber-to-the-home and fiber-to-the-curb are industry terms referring to the deployment of fiber optic cable for residential access to communications networks. Research and development expenditures also included additional development of Luminent's duplexers, triplexers and high-speed transceivers. Luminent continues to invest heavily in areas targeted at broadening its customer base, product lines and end-product applications. Luminent expects absolute dollars spent on research and development to continue to increase as Luminent invests in key technical personnel, expand its current product lines and develop new product offerings. During the six months ended June 30, 2001, Luminent incurred amortization of goodwill and other intangibles and deferred stock compensation of $39.0 million and $5.9 million, respectively, relating to these acquisitions. Luminent expects to incur additional amortization of goodwill and other intangibles from these acquisitions of approximately $19.5 million each quarter through December 31, 2001. At January 1, 2002, Luminent intends to implement SFAS No. 142 (see Recent Accounting Pronouncements, below). Deferred stock compensation charges from these acquisitions will generate an additional $11.7 million of expense through 2004. Deferred stock compensation is amortized using the graded method over the related expected employee service period, in this case four years. Provision for Income Taxes. The provision for income taxes was $1.9 million for the six months ended June 30, 2001. The effective tax rate for the six months ended June 30, 2001 was negative 2.1%, resulting from a tax provision computed based on a net loss position. The rate was negatively impacted by the amortization of goodwill and certain deferred stock compensation, which are not tax deductible. Luminent's effective tax rates in future years may fluctuate due to amortization of goodwill and deferred stock compensation partially offset by favorable tax programs available in certain foreign tax jurisdictions where Luminent currently has operating facilities. YEARS ENDED DECEMBER 31, 2000 AND 1999, AND PRO FORMA RESULTS FOR THE YEAR ENDED DECEMBER 31, 2000 Net Sales. Net sales for the year ended December 31, 2000 increased 90%, to $124.2 million from $65.3 million for the year ended December 31, 1999. Luminent's growth is a result of the growth of the Internet and e-commerce and the corresponding increased bandwidth requirements, and its recent acquisitions. Approximately $23.5 million of this increase was due to the contribution of Fiber Optic Communications' net sales for the period from April 25, 2000 through December 31, 2000. Approximately $7.5 million of this increase was due to the contribution of Optronics' net sales for the period from July 13, 2000 through December 31, 2000 and approximately $2.5 million of this increase was due to the contribution of Quantum's net sales for the period from July 22, 2000 through December 31, 2000. Pro 59 62 forma results for the year ended December 31, 2000 as presented in Selected Financial Data, above, projects Luminent's results of operations as if we had made the acquisitions of Fiber Optic Communications, Optronics and Quantum as of January 1, 2000. Pro forma net sales for the year ended December 31, 2000 would have been $137.3 million. Luminent also experienced growth and increased acceptance in its transceiver business for the data networking market. Finally, Luminent experienced a significant improvement in customer diversification during year ended December 31, 2000. Sales during the years ended December 31, 1998, 1999 and 2000 to Luminent's customers accounting for 10% or more of its net sales during 2000 and to its other customers as a group are set forth below.
YEAR ENDED DECEMBER 31, -------------------- 1998 1999 2000 ---- ---- ---- Marconi Communications...................................... 18% 40% 18% Cisco Systems............................................... 5 6 11 Other....................................................... 77 54 71 --- --- --- Net sales................................................... 100% 100% 100% === === ===
Gross Profit. Gross profit is equal to Luminent's net sales less its cost of sales. Luminent's cost of sales includes materials, direct labor and overhead. Cost of inventory is determined by the first-in, first-out method. Gross profit for the year ended December 31, 2000, increased 79%, to $39.8 million from $22.2 million for the year ended December 31, 1999. Pro forma gross profit for the year ended December 31, 2000 would have been $42.6 million. Gross profit for the year ended December 31, 2000, before deferred compensation amortization expense of $2.8 million, would have increased 92%, to $42.6 million. Luminent's gross margins (defined as gross profit as a percentage of net sales) are generally affected by price changes over the life of the products and improved production efficiencies as a result of increased utilization. The former effect will generally decrease gross margins over the products' respective life cycles, whereas the latter effect typically increases gross margins. Prices for existing products are generally expected to continue to decrease over their respective life cycles. Luminent's gross margin decreased to 32% for the year ended December 31, 2000, from 34% for the year ended December 31, 1999. Pro forma gross margin for the year ended December 31, 2000 would have been 31%. Gross margin would have been 34% for the year ended December 31, 2000, before deferred compensation amortization expense of $2.8 million. While Luminent's customer diversification improved as a percentage of net sales, absolute dollars shipped to lower margin customers increased for the year ended December 31, 2000. Luminent's lower margin customers typically operate in highly competitive markets where the price of its products is a key factor. Although Luminent sacrifices margins to these customers, its volumes are greater than the volumes achieved with higher margin customers. As Luminent seeks to continue to diversify Luminent's customer base, Luminent plans to target markets with improved margins and less competitive end-markets. Gross margins for Fiber Optic Communications, which primarily supplies passive components, were 23% and 32%, for the years ended December 31, 2000 and 1999, respectively. Gross margins for Luminent's active components were 32% and 34%, for the years ended December 31, 2000 and 1999, respectively. In the short term, Luminent expects margins to remain constant or decline slightly due to the integration of the acquired companies with historically lower margins. In the mid- to long-term, Luminent expects margins to improve due to increased operating efficiencies associated with capacity utilization in Taiwan and People's Republic of China, diversification of sales to higher margin customers, and a favorable shift towards a higher margin customer base. Operating Costs and Expenses. Operating costs and expenses consist of selling, general and administrative, research and development costs, costs associated with acquisitions, and other operating related charges. Operating costs and expenses, increased to 85% of net sales, or $105.0 million, for the year ended December 31, 2000, from 23% of net 60 63 sales, or $15.3 million, for the year ended December 31, 1999. Pro forma operation costs and expenses for the year ended December 31, 2000 would have been $144.1 million. Operating costs and expenses, before deferred stock compensation and amortization expense of $73.5 million, would have increased to 25% of net sales, or $31.5 million, for the year ended December 31, 2000. Operating costs and expenses, as a percentage of net sales, are higher for the year ended December 31, 2000 than previous levels due to the amortization of goodwill and deferred stock compensation, the inclusion of Fiber Optic Communications, Optronics and Quantum, greater focus on selling and marketing efforts and an increase in spending on research and development. Fiber Optic Communications accounted for $47.2 million of operating costs and expenses for the year ended December 31, 2000. Approximately $14.2 million of the increase is due to the inclusion of Optronics and approximately $4.0 million of the increase is due to the inclusion of Quantum. Selling, general and administrative expenses for the year ended December 31, 2000, increased to 31% of net sales, or $38.8 million, from 9% of net sales, or $5.7 million, for the year ended December 31, 1999. Selling, general and administrative expenses for the year ended December 31, 2000, before deferred stock compensation expense of $21.7 million, would have increased to 14% of net sales, or $17.0 million. Approximately $6.5 million of the increase is due to the inclusion of Fiber Optic Communications. Approximately $3.1 million of the increase is due to the inclusion of Optronics and approximately $928,000 of the increase is due to the inclusion of Quantum. The balance of the increase in expenditures was due primarily to the overall growth of Luminent's business. In response to the growth of its markets, Luminent expanded its selling efforts and established new sales offices in Asia. Research and development expenses, increased to 15% of net sales, or $18.2 million, during the year ended December 31, 2000, from 13% of net sales, or $8.7 million, for the year ended December 31, 1999. Research and development expenses, prior to deferred stock compensation of $4.3 million, would have decreased to 11% of net sales, or $13.9 million, during the year ended December 31, 2000. Research and development expenses, as a percentage of net sales, increased primarily due to the addition of Fiber Optics Communications, Optronics and Quantum in the current period. During the year ended December 31, 2000 Luminent began development of its next generation products for applications such as fiber-to-the-home and fiber-to-the-curb. Fiber-to-the-home and fiber-to-the-curb are industry terms referring to the deployment of fiber optic cable for residential access to communications networks. Research and development expenditures also included additional development of its duplexers, triplexers and high-speed transceivers. Luminent continues to invest heavily in areas targeted at broadening its customer base, product lines and end-product applications. Luminent expects absolute dollars spent on research and development to continue to increase as Luminent invests in key technical personnel, expand its current product lines and develop new product offerings. During the year ended December 31, 2000, Luminent incurred amortization of goodwill and other intangibles and deferred stock compensation of $47.4 million and $12.5 million, respectively, relating to the acquisitions of Fiber Optic Communications, Optronics and Quantum. Luminent expects to incur additional amortization of goodwill and other intangibles from these acquisitions of approximately $19.5 million each quarter through 2001 (see Recent Accounting Pronouncements). Deferred stock compensation charges from these acquisitions will generate approximately an additional $17.6 million in total expense through 2004. Deferred stock compensation is amortized over the related expected employee service period, in this case four years. Provision for Income Taxes. The provision for income taxes was $2.8 million in the years ended December 31, 2000 and 1999. The effective tax rate for the year ended December 31, 2000 was negative 4%, causing a tax provision computed off a net loss position. The rate was negatively impacted by the amortization of goodwill and certain deferred stock compensation, which are not tax deductible. The effective tax rate for 1999 was 40%. Its effective tax rates in future years may fluctuate due to amortization of goodwill and deferred stock compensation partially offset by favorable tax programs available in certain foreign tax jurisdictions where Luminent currently has operating facilities. 61 64 YEARS ENDED DECEMBER 31, 1999 AND DECEMBER 31, 1998 Net Sales. Net sales for 1999 increased 69%, to $65.3 million from $38.6 million in 1998. The growth in net sales in 1999 was primarily driven by increased shipments of Luminent's duplexer and triplexer components to Marconi Communications. In 1999, Luminent also experienced greater acceptance and demand for its transceivers, which are designed for the data communications equipment market. Gross Profit. Gross profit for 1999 increased 55%, to $22.2 million from $14.3 million in 1998. The gross margins for 1999 and 1998 were 34% and 37%, respectively. The decline in gross margin was attributed to higher sales volume of lower margin products to Marconi Communications. Operating Costs and Expenses. Operating costs and expenses for 1999 increased 81% to $15.3 million from $8.4 million in 1998. Selling, general and administrative expenses grew 115% in 1999 over 1998. These increases reflect the investment Luminent made in hiring additional sales and administrative personnel to support a larger sales volume. Selling, general and administrative expenses increased rapidly in 1999 in order to facilitate the current and future expansion in its business. In 1999 and 1998, Luminent spent approximately $8.7 million, and $5.0 million, respectively, on research and development. The increase reflects an increase in the number of personnel and an increase in engineering expense related to design, development and testing of its transceiver, duplexer and triplexer product lines. Provision for Income Taxes. The provision for income taxes was $2.8 million in 1999 and $2.3 million in 1998. The effective tax rate for 1999 and 1998 remained constant at 40%. 62 65 QUARTERLY RESULTS OF OPERATIONS The following tables set forth Luminent's unaudited condensed consolidated statements of operations data for each of the ten quarters ended June 30, 2001, as well as that data expressed as a percentage of Luminent's net sales for the quarters presented. You should read this information in conjunction with Luminent's consolidated financial statements and related notes appearing elsewhere in this prospectus. Luminent has prepared this unaudited consolidated information on a basis consistent with its audited consolidated financial statements, and in the opinion of its management, it reflects all normal recurring adjustments that Luminent considers necessary for a fair presentation of its financial position and operating results for the quarters presented. You should not draw any conclusions about Luminent's future results from the operating results for any quarter.
FOR THE THREE MONTHS ENDED ------------------------------------------------------------------ MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, 1999 1999 1999 1999 2000 2000(1) --------- -------- --------- -------- --------- -------- (IN THOUSANDS EXCEPT PER SHARE DATA) (UNAUDITED) Net sales.................... $ 12,342 $ 16,127 $ 18,215 $ 18,580 $ 14,899 $ 28,107 Cost of sales(1)(2).......... 7,911 10,595 12,040 12,532 9,654 18,147 -------- -------- -------- -------- -------- -------- Gross profit............. 4,431 5,532 6,175 6,048 5,245 9,960 -------- -------- -------- -------- -------- -------- Operating costs and expenses: Selling, general and administrative(1)(2)..... 1,111 1,262 1,440 1,862 1,985 5,711 Research and development(1)(2)........ 1,889 2,121 2,363 2,320 2,449 4,175 Parent company allocations.............. 221 221 221 222 193 195 Amortization of goodwill... -- -- -- -- -- 9,580 -------- -------- -------- -------- -------- -------- Total operating costs........ 3,221 3,604 4,024 4,404 4,627 19,661 -------- -------- -------- -------- -------- -------- Operating income (loss)................. 1,210 1,928 2,151 1,644 618 (9,701) Other income (expense), net(2)..................... 3 7 5 (9) -- 192 -------- -------- -------- -------- -------- -------- Income (loss) before provision for income taxes and minority interests.............. 1,213 1,935 2,156 1,635 618 (9,509) -------- -------- -------- -------- -------- -------- Provision for income taxes... 483 771 859 651 246 1,223 Minority interest............ -- -- -- -- 190 128 -------- -------- -------- -------- -------- -------- Net income (loss).... $ 730 $ 1,164 $ 1,297 $ 984 $ 182 $(10,860) ======== ======== ======== ======== ======== ======== Basic and diluted income (loss) per share........... $ 0.01 $ 0.01 $ 0.01 $ 0.01 $ -- $ (0.08) Basic and diluted income average shares............. 144,000 144,000 144,000 144,000 144,000 144,000 FOR THE THREE MONTHS ENDED --------------------------------------------- SEPT. 30, DEC. 31, MARCH 31, JUNE 30, 2000(1) 2000(1) 2001(2) 2001(1)(2) --------- -------- --------- ---------- (IN THOUSANDS EXCEPT PER SHARE DATA) (UNAUDITED) Net sales.................... $ 35,958 $ 45,228 $ 48,241 $ 41,103 Cost of sales(1)(2).......... 25,866 30,717 32,212 57,934 -------- -------- -------- -------- Gross profit............. 10,092 14,511 16,029 (16,831) -------- -------- -------- -------- Operating costs and expenses: Selling, general and administrative(1)(2)..... 12,826 18,246 15,372 24,156 Research and development(1)(2)........ 6,128 5,452 5,196 4,834 Parent company allocations.............. 200 -- -- -- Amortization of goodwill... 18,353 19,488 19,488 19,488 -------- -------- -------- -------- Total operating costs........ 37,507 43,186 40,056 48,478 -------- -------- -------- -------- Operating income (loss)................. (27,415) (28,675) (24,027) (65,309) Other income (expense), net(2)..................... 334 1,719 1,850 972 -------- -------- -------- -------- Income (loss) before provision for income taxes and minority interests.............. (27,081) (26,956) (22,177) (64,337) -------- -------- -------- -------- Provision for income taxes... 1,240 57 100 1,754 Minority interest............ 73 (1,100) 21 (136) -------- -------- -------- -------- Net income (loss).... $(28,394) $(25,913) $(22,298) $(65,955) ======== ======== ======== ======== Basic and diluted income (loss) per share........... $ (0.20) $ (0.17) $ (0.14) $ (0.42) Basic and diluted income average shares............. 144,000 150,652 156,000 156,000
------------------------- (1) The quarters ended June 30, September 30, December 31, 2000, March 31, 2001 and June 30, 2001, include amounts related to deferred stock compensation of: $744,000, $1.2 million, $849,000, $683,000 and $566,000, respectively, in "costs of sales"; $1.1 million, $9.0 million, $11.7 million, $8.7 million and $7.0 million, respectively, in "selling, general and administrative" expenses; and $1.2 million, $1.7 million, $1.3 million, $1.1 million and $900,000 respectively, in "research and development" expenses. (2) Includes one-time charges of $29.3 million, $11.4 million, $501,000 and $16,000 presented in "cost of sales", "selling, general and administrative", "research and development" and "other income, net", respectively, for the three months ended June 30, 2001 to write-down inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other non-recurring items. These charges resulted from the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. 63 66
FOR THE THREE MONTHS ENDED ------------------------------------------------------------------------------ MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, 1999 1999 1999 1999 2000 2000 2000 --------- -------- --------- -------- --------- -------- --------- (UNAUDITED) AS A PERCENTAGE OF NET SALES: Net sales.............................. 100% 100% 100% 100% 100% 100% 100% Cost of sales.......................... 64 66 66 67 65 65 72 --- --- --- --- --- --- --- Gross profit....................... 36 34 34 33 35 35 28 --- --- --- --- --- --- --- Operating costs and expenses: Selling, general and administrative..................... 9 8 8 10 13 20 36 Research and development............. 15 13 13 12 16 15 17 Parent company allocations........... 2 1 1 1 1 1 1 Amortization of goodwill............. -- -- -- -- -- 34 51 --- --- --- --- --- --- --- Total operating costs.................. 26 22 22 24 31 70 104 --- --- --- --- --- --- --- Operating income (loss)............ 10 12 12 9 4 (35) (76) Other income (expense), net............ -- -- -- -- -- 1 1 --- --- --- --- --- --- --- Income (loss) before provision for income taxes and minority interests.......................... 10 12 12 9 4 (34) (75) --- --- --- --- --- --- --- Provision for income taxes............. 4 5 5 4 2 4 3 Minority interest...................... -- -- -- -- 1 -- -- --- --- --- --- --- --- --- Net income (loss).................. 6% 7% 7% 5% 1% (39)% (79)% === === === === === === === FOR THE THREE MONTHS ENDED ------------------------------- DEC. 31, MARCH 31, JUNE 30, 2000 2001 2001 -------- --------- -------- (UNAUDITED) AS A PERCENTAGE OF NET SALES: Net sales.............................. 100% 100% 100% Cost of sales.......................... 68 67 141 --- --- ---- Gross profit....................... 32 33 (41) --- --- ---- Operating costs and expenses: Selling, general and administrative..................... 40 32 59 Research and development............. 12 11 12 Parent company allocations........... -- -- -- Amortization of goodwill............. 43 40 47 --- --- ---- Total operating costs.................. 95 83 118 --- --- ---- Operating income (loss)............ (63) (50) (159) Other income (expense), net............ 4 4 2 --- --- ---- Income (loss) before provision for income taxes and minority interests.......................... (60) (46) (157) --- --- ---- Provision for income taxes............. -- -- 4 Minority interest...................... (2) -- -- --- --- ---- Net income (loss).................. (57)% (46)% (160)% === === ====
64 67 LIQUIDITY AND CAPITAL RESOURCES Luminent received $132.3 million in net proceeds from the sale of 12,000,000 shares of its common stock in its initial public offering completed in November 2000. Historically, MRV has managed cash on a centralized basis. Prior to September 8, 2000 (the separation date), cash receipts associated with Luminent's business were transferred to MRV on a daily basis, and MRV provided funds to cover Luminent's disbursements. Cash and cash equivalents at December 31, 1999 represented positive cash flows generated from Luminent's subsidiary. At December 31, 2000 and June 30, 2001, Luminent had cash and cash equivalents on hand of $131.8 million and $93.0 million. During the year ended December 31, 2000, MRV provided advances to Luminent to cover payroll and other operating expenses. Through December 31, 2000 these advances (which do not bear interest) amounted to $6.5 million and were due on demand. As of December 31, 2000, using cash generated from operations, Luminent repaid MRV for all amounts advanced. On June 30, 2001, Luminent had working capital of $123.0 million, compared with $161.7 million at December 31, 2000. The ratio of current assets to current liabilities at June 30, 2001 was 3.2 to 1, compared to 4.4 to 1 at December 31, 2000. Cash used by operating activities was $3.7 million and $23.0 million for the six months ended June 30, 2000 and 2001, respectively. Cash flows from operating activities were adversely affected by Luminent's net loss of $88.3 million for the six months ended June 30, 2001, increases in inventory for the three months ended March 31, 2001, increase in accounts receivable and deferred income taxes, payment of accounts payables, and establishing short-term deposits for capital acquisitions, all offset by non-cash charges for the amortization of goodwill of $19.5 million and $39.0 million for the six months ended June 30, 2001, deferred stock compensation of $18.9 million for the six months ended June 30, 2001, and restructure and other one-time charges incurred as a result of the current slowdown in the communication industry for the three months ended June 30, 2001. Inventory levels increased during the three months ended March 31, 2001 in anticipation of increased sales. However, due to the dramatic downturn in demand for communications equipment, Luminent wrote-off $26.1 million of inventory during the next three months ended June 30, 2001. The increase in accounts receivable was due primarily to increased sales. Capital expenditures for property and equipment represent the majority of cash used in investing activities. The capital expenditures for the six months ended June 30, 2001 of $13.7 million, plus another $9.0 million, in short-term deposits for the acquisition of capital assets, reflect Luminent's investment in expanding production and research and development capacity. Cash provided by operating activities was $13.4 million for the year ended December 31, 2000, compared to $748,000 for the year ended December 31, 1999. Cash flows from operating activities was affected by Luminent's net loss of $65.0 million offset by non-cash charges for the amortization of goodwill of $47.4 million and deferred stock compensation of $28.8 million. Cash provided by operating activities was $748,000 in 1999 and $1.8 million in 1998. Luminent experienced a decrease in operating cash flows from 1999 over 1998 despite an increase in net income year-over-year, due primarily to net accounts receivable of $10.5 million in 1999 compared to $6.4 million in 1998. The increase in accounts receivable was due primarily to increased sales. This increase in accounts receivable was partially offset by an increase in accounts payable. Inventory levels increased in anticipation of increased sales. Capital expenditures for property and equipment represent all of Luminent's cash used in investing activities in 1999 and 1998, and a significant portion of cash used in investing activities in 2000. Cash used by investing activities also included purchases of other assets and short-term investments offset by proceeds from the sale of short-term investments and property and equipment. The capital expenditures reflect Luminent's investment in expanding production and research and development capacity. Capital expenditures for property and equipment were $14.8 million for the year ended December 31, 2000. These expenditures are consistent with Luminent's future growth strategy. Furthermore, in connection with the acquisitions of Fiber Optic Communications, Optronics and Quantum, Luminent received net cash of $5.5 million. 65 68 Luminent believes that cash on hand, along with its cash flows from operations, will be sufficient to satisfy its working capital, capital expenditure and research and development requirements for at least the next 12 months. However, Luminent may require or choose to obtain additional debt or equity financing in order to finance acquisitions or other investments in its business. Luminent expects to continue to devote resources to purchases of capital equipment as Luminent continues to build and relocate its manufacturing capabilities and continue to expand Luminent's research and development programs. Luminent's future capital requirements will depend on many factors, including Luminent's rate of revenue growth, the timing and extent of spending to support development of new products and expansion of sales and marketing, the timing of new product introductions and enhancements to existing products and market acceptance of Luminent's products. FOREIGN CURRENCY Luminent operates on an international basis. A majority of Luminent's revenues and cost of sales are incurred in U.S. dollars. For the year ended December 31, 2000, approximately 31% and 29% of Luminent's revenues and cost of sales, respectively, were incurred in currencies other than the U.S. dollar. For the quarter ended March 31, 2001, approximately 36% and 39% of Luminent's revenues and cost of sales, respectively, were incurred in currencies other than the U.S. dollar. For the year ended December 31, 2000 and quarter ended March 31, 2001, approximately 63% and 65%, respectively, of Luminent's operating expenses were incurred in currencies other than the U.S. dollar, including the non-cash charges for deferred compensation expense and goodwill amortization incurred with the foreign subsidiary acquisitions. For the year ended December 31, 2000 and quarter ended March 31, 2001, the New Taiwan dollar is the most significant of these currencies. The New Taiwan dollar has been relatively stable in relation to the U.S. dollar in recent years, and accordingly, Luminent has not experienced any significant fluctuations in operating results due to exchange rate fluctuations in the New Taiwan dollar in relation to the U.S. dollar. Fluctuations in the value of the currencies in which Luminent conducts its business relative to the U.S. dollar will cause U.S. dollar translation of these currencies to vary from one period to another. Luminent cannot predict the effect of exchange rate fluctuations upon future operating results. However, because Luminent has expenses as well as revenues in each of the principal functional currencies, the exposure to its financial results to currency fluctuations is reduced. Luminent has not historically attempted to reduce Luminent's currency risks through hedging instruments, however, Luminent may do so in the future. INFLATION Luminent believes that its revenue and results of operations has not been significantly impacted by inflation during the last three years. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998 and June 1999, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Investments and Hedging Activities," and SFAS No. 137, which delayed the effective date of SFAS No. 133. In June 2000, the FASB issued SFAS No. 138 which provides additional guidance for the application of SFAS No. 133 for certain transactions. Luminent adopted this statement on January 1, 2001 and the adoption of this statement did not have a material impact on its financial position or results of operations. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements," as amended. SAB 101 summarizes certain of the Securities and Exchange Commission's views in applying generally accepted accounting principles to revenue recognition in financial statements. Luminent has applied the provisions of SAB 101 in the consolidated financial statements. The adoption of SAB 101 did not have a material impact on Luminent's financial condition or results of operations. 66 69 In March 2000, the FASB issued interpretation No. 44 (FIN 44), "Accounting for Certain Transactions involving Stock Compensation, (an interpretation of APB Opinion No. 25)." FIN 44 clarifies the application of APB No. 25 for certain issues, including the definition of an employee, the treatment of the acceleration of stock options and the accounting treatment for options assumed in business combinations. FIN 44 became effective on July 1, 2000, but is applicable for certain transactions dating back to December 1998. The adoption of FIN 44 did not have a significant impact on Luminent's financial position or results of operations. The FASB recently approved two pronouncements: SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", which provide guidance on the accounting for business combinations to be accounted for using the purchase method. Under the new rules, goodwill will no longer be subject to amortization over its useful life. Rather, goodwill will be subject to at least an annual impairment assessment. This assessment is a fundamentally different two-step approach and is based on a comparison between a reporting unit's fair value and its carrying value. Intangible assets have newly defined criteria and will be accounted for separately from goodwill and will continue to be amortized over their useful lives. Luminent plans to adopt these pronouncements on January 1, 2002. Luminent is currently reviewing these standards to determine the impact on its results of operations and its financial position. The most significant anticipated effect on Luminent's financial statements at adoption would be the discontinuing of the amortization of goodwill and the possible impairment loss measured as of the date of adoption. MARKET RISK Luminent does not hold any derivative securities. The majority of its net proceeds from the initial public offering are currently maintained in money market funds, which are subject to limited interest rate risk. 67 70 BUSINESS OF MRV OVERVIEW MRV Communications, Inc. creates, acquires, finances and operates companies, and through them, designs, develops, manufactures and markets products, which enable high-speed broadband communications. MRV concentrates on companies and products devoted to optical components and Internet infrastructure systems. MRV has leveraged its early experience in fiber optic technology into a number of focused operating units specializing in advanced fiber optic components, switching, routing, transaction management and wireless optical transmission systems which it has created, financed or acquired. MRV's principal operating units that constituted wholly or majority owned subsidiaries at September 30, 2001 were: - LUMINENT, INC. Luminent designs, manufactures and sells a comprehensive line of singlemode active and passive fiber optic components for high-capacity data transmission in the metropolitan and access markets. Prior to the Merger, MRV owned approximately 92% of the outstanding stock of Luminent. For further information about Luminent, see "Business of Luminent" later in this prospectus supplement. - OPTICAL ACCESS, INC. Optical Access designs, manufactures and markets optical wireless products that enable the delivery of high-speed communications traffic to the portion of the communications network commonly known as the last mile, which extends from the end user to the service provider's central office. Optical Access' solutions to the last-mile bottleneck bypass the incumbent carrier's copper access network with a comprehensive, integrated access solution, using optical wireless technology. The building blocks of Optical Access' solution include the TereScope(TM), for optical wireless links, and the OptiSwitch(TM), for switching, provisioning and mesh enabling. At September 30, 2001, we owned all of the outstanding capital stock of Optical Access. - CESCOMM, INC. CEScomm (formerly Creative Electronic Systems SA or CES) is developing and providing equipment to manufacturers of cellular network infrastructure equipment and mobile operators and service providers for the third generation of wireless solutions commonly known as 3G. 3G is the generic term used for the next generation of mobile communications systems. These new systems provide enhanced services to those available today i.e., voice, text and data. CEScomm specializes in products that provide the real-time conversion of radio signals generated by Internet ready mobile devices into asynchronous transfer mode, or ATM, traffic streams. At September 30, 2001, MRV owned all of the outstanding capital stock of CEScomm. - ITOUCH COMMUNICATIONS, INC. iTouch Communications, Inc. provides next-generation Internet infrastructure solutions that enable service providers and carriers to deliver and monitor, on a real-time basis, high-speed Internet services. iTouch's products combine transaction management with Internet protocol, or IP, routing and wide-area network, or WAN, technologies, which allow for faster development of feature rich high-speed data acquisition and management systems. At September 30, 2001, MRV owned all of the outstanding capital stock of iTouch. - NBASE-XYPLEX, INC. NBase-Xyplex provides products and services, such as the Fiber Driver, to enhance network infrastructures for city carriers, service providers, cable operators and campus and enterprise networks. Its products and technologies have been utilized in metropolitan area fiber-based networks, enabling smart access to the WAN, as well as in local area network, or LAN, switching, building enterprise/corporate data networks. At September 30, 2001, MRV owned all of the outstanding capital stock of NBase-Xyplex. MRV's development stage companies, which MRV founded or have invested in as of September 30, 2001 were: - CHARLOTTE'S NETWORKS, INC. Charlotte's Networks is a start-up company that is developing a core router for large service providers and carriers. The Aranea core router is Charlotte's first product. The Aranea router is capable of carrying both IP packets and time-division multiplexing, 68 71 or TDM, voice traffic and enables the current WAN to grow in high orders of magnitude both in processing power and rate of transmission. In addition, the router provides multi-services required by telecommunication companies for efficient and flexible transmission of voice over data networks. At September 30, 2001, MRV owned approximately 53% of the outstanding capital stock of Charlotte's Networks on a fully diluted basis. - ZUMA NETWORKS, INC. Zuma Networks is a startup company that is developing a next generation Gigabit Ethernet switch router platform. At September 30, 2001, MRV owned all of the outstanding capital stock of Zuma Networks. - OPTICAL CROSSING INC. Optical Crossing designs, develops and manufactures advanced fiber optic communication components and systems for the telecommunications industry. At September 30, 2001, MRV owned approximately 60% of the outstanding capital stock of Optical Crossing on a fully diluted basis. - ZAFFIRE, INC. Zaffire is focused on developing a next-generation, optical services networking system for service providers. At September 30, 2001, MRV owned approximately 22% of the outstanding capital stock of Zaffire on a fully diluted basis. In July 2001, Zaffire reached an agreement with Centerpoint Broadband Technologies, Inc., under which Centerpoint would acquire Zaffire in an all stock transaction. Upon completion of the acquisition, MRV expects to own less than 10% of Centerpoint. Centerpoint develops high capacity transport systems that maximize network performance for both optical and wireless networks. These highly scalable, dynamically flexible systems allow service providers advanced levels of bandwidth efficiency, capacity and high service velocity. - REDC OPTICAL NETWORKS, INC. RedC has developed a complete line of optical modules used for operating, monitoring and protecting optical networks including: optical amplifiers, add/drop modules, protection and restoration modules and dense wave division multiplexing, or DWDM, monitoring. At September 30, 2001, MRV owned approximately 35% of the outstanding capital stock of RedC on a fully diluted basis. - HYPERCHANNEL LTD. Hyperchannel, which does business under its trademark Hyporium is an independent Internet market maker for the information technology, or IT, industry, enabling IT vendors, distributors and resellers to trade online. Hyporium offers an alternative route to market through an online trading hub and reseller web storefronts. At September 30, 2001, MRV owned approximately 42% of the outstanding capital stock of Hyperchannel on a fully diluted basis. BACKGROUND MRV was organized in July 1988 as MRV Technologies, Inc., a California corporation and reincorporated in Delaware in April 1992, at which time it changed its name to MRV Communications, Inc. MRV's initial focus was in the design, manufacture and marketing of semiconductor laser diodes, light emitting diodes, or LEDs, and fiber optic transmitting and receiving modules for the transmission of large amounts of information at high speeds over long distances and LAN switching products for the computer networking industry. From 1995 to 1998, MRV made several acquisitions involving companies making networking equipment, including: - in 1995 of certain assets and the distribution businesses of Galcom Networking, Ltd. and Ace 400 Communications Ltd, both network equipment companies located in Israel, which provided MRV with experienced personnel and technology for the networking markets; - in 1996 certain of the liabilities and assets of Fibronics Ltd. and its subsidiaries, including its technology in progress and existing technology, its marketing channels, its GigaHub family of computer networking products and other rights, relating to Fibronics' computer networking and telecommunications businesses in Germany, the United States, the United Kingdom, the Netherlands and Israel, enabling MRV to enhance the development of Fast Ethernet and Gigabit Ethernet functions, to offer a broader range of networking products and to benefit from combined 69 72 distribution channels and sales in both the United States and Europe and greater product development capability; and - in 1998 of the outstanding capital stock of the entity owning the outstanding capital stock of Xyplex, Inc., a leading provider of access solutions between enterprise networks and wide area network and/or Internet service providers, or ISPs. This acquisition enabled MRV to expand its product lines with products that had WAN and remote access capabilities, permitting MRV to offer these solutions not only to MRV's own existing base of customers, but also to the customer base added by Xyplex. The acquisition of Xyplex (now known as iTouch Communications) also increased MRV's sales force, distribution channels and customer support and service capabilities. During 2000, MRV completed several strategic acquisitions. These acquisitions were made to expand MRV's product offering, enhance its technological experience and expand MRV's manufacturing capabilities. The table below summarizes MRV's more notable acquisitions in that year.
DATE OF TOTAL FORM OF CONSIDERATION ACQUIRED COMPANY ACQUISITION CONSIDERATION AND OTHER NOTES TO ACQUISITION ---------------- -------------- -------------- ---------------------------------- Fiber Optic Communications, Inc. April 24, 2000 $310.4 million $48.6 million in cash and 5.4 million shares of common stock and options issued; approximately 97% of capital stock assumed; goodwill and other intangibles recorded of $261.6 million; deferred stock compensation recorded of $14.1 million Jolt Limited May 1, 2000 $57.7 million 1.9 million shares of common stock and options issued; 100% of capital stock assumed; goodwill and other intangibles recorded of $33.7 million; deferred stock compensation recorded of $25.0 million Quantum Optech Inc. July 12, 2000 $36.2 million 1.2 million shares of common stock and options issued; 100% of capital stock assumed; goodwill and other intangibles recorded of $27.9 million; deferred stock compensation recorded of $2.7 million AstroTerra Corporation July 12, 2000 $160.3 million 2.4 million shares of common stock and options issued; 100% of capital stock assumed; goodwill and other intangibles recorded of $108.3 million; deferred stock compensation recorded of $50.0 million Optronics International Corp. July 21, 2000 $124.3 million 4.2 million shares of common stock and options issued; approximately 99% of capital stock assumed; goodwill and other intangibles recorded of $99.5 million; deferred stock compensation recorded of $13.4 million
Each of these acquisitions was accounted for using the purchase method and therefore, the results of operations of the acquired businesses have been included in MRV's consolidated financial statements from the respective dates of acquisition. 70 73 Fiber Optic Communications is a Taiwanese manufacturer of passive fiber optic components for wavelength division multiplexing and has facilities in both Taiwan and the People's Republic of China. Quantum Optech is a Taiwanese manufacturer of passive fiber optic components specializing in developing and manufacturing optical thin film coating and filters for dense wavelength division multiplexing. Optronics International is a Taiwanese manufacturer of active fiber optic components focused on developing and manufacturing high temperature semiconductor lasers, transceivers and detectors for optical networks. Fiber Optic Communications, Quantum Optech and Optronics International were acquired and contributed to Luminent in September 2000, prior to Luminent's initial public offering of its common stock. AstroTerra develops and manufactures free-space optical wireless communication systems to connect data and telecommunications networks. Jolt develops and manufactures multi-port wireless optics communications equipment. These acquisitions provided strategic components and technology for Optical Access' wireless optical solution. AstroTerra and Jolt were acquired and contributed to MRV's subsidiary, Optical Access, which focuses on optical wireless products that deliver high-speed communications traffic to the so-called last mile portion of the communications network. INDUSTRY BACKGROUND As e-commerce and the Internet continued to proliferate, business enterprises became increasingly reliant on communications networks and software applications as critical strategic assets. Communications networks are being expanded to deliver new services and distribute mission critical computing applications such as customer network management, transaction processing, enterprise resource planning, large enterprise databases, and sophisticated on-line connections with vendors, and the increased use of traditional applications, such as e-mail and video conferencing, to suppliers, customers and employees. Bandwidth intensive applications that contain voice, video and graphics through intranets and extranets, and growth in business-to-business e-commerce and other on-line transactions are encumbering the optical networking and internet infrastructure environment. Due to the significant growth of network users who increasingly rely on secure access for higher speed and quality of communications networks, even small network delays can result in lost revenue, decreased employee productivity and customer dissatisfaction. As a result, businesses and network service providers realize the critical nature of network and application performance and the requirement for optical networking and fiber optic equipment that increases capacity through high speed and more efficient transmission technologies. Optical networking and internet infrastructure systems enhance the carrier and network service provider networks by handling bandwidth and providing enhanced services. Fiber optic transmission components enhance the functionality of enterprise and residential access networks by enabling high-speed transmission of voice, video and data across fiber optic cable. Network service providers and carriers rely on higher value data centric network services and accordingly began deploying next generation solutions to accommodate the data service requirements. Growth in the use and availability of wide area networks was stimulated by many factors including the need to share information between centralized repositories and remote enterprise locations, to access and use the Internet for communications and marketing and to electronically access external resources used by the enterprise. Growth was also being fueled by the increasing availability of more cost-effective WAN services such as Frame Relay and Integrated Service Digital Network, or ISDN, making it more affordable for many organizations to set up a WAN or expand an existing one. The growth in the use and availability of the Internet coupled with increasing use, power, speed and complexity of metropolitan area networks and WANs resulted in the increasing need for equipment that permits high speed connections throughout the infrastructure of the Internet. Optical Networking and Internet Infrastructure Environment The Internet has evolved into a network of hundreds of public and private networks interconnected using Internet Protocol, or IP. Industry analysts expect continued dramatic growth worldwide in Internet 71 74 use and Internet traffic. As the Internet continues to explode, business enterprises are increasingly reliant on communications networks and software applications as strategic assets that are critical to business success. Communications networks are being expanded to deliver new services and distribute computing applications such as customer networks management, e-mail, video, conferencing, and Voice Over Internet Protocol to suppliers, customers and employees. While consumers use the Internet for education and communication, business and service providers are realizing the critical nature of network and application performance. To meet the growth in the demand for high-speed data services, service providers are invested heavily to construct and upgrade the transmission foundation of the public network infrastructure worldwide. The public network infrastructure, which was originally built for voice traffic, is inadequate to handle data and must be rapidly upgraded. Expenditures are spread across fiber deployment, dense wavelength division multiplexing, or DWDM, products, Synchronous Optical Network, or SONET, transmission equipment, and more recently, and intelligent optical networking solutions. Advances in emerging intelligent optical networking market should fundamentally change the architecture of the public network and create a host of new opportunities in infrastructure development, service delivery and applications. Intelligent optical networking offers a solution to public network scaling and high-speed service delivery. Intelligent optical networking will eventually deliver high speed data services provisioned over wavelengths and intelligent optical light paths. The flexibility and scalability of wave service is expected to offer service providers the ability to satisfy this demand for increased bandwidth while creating competitive differentiation in their service portfolio with "just-in-time" provisioning capability. Fiber Optic Environment Fiber optic cable can generally carry more information at less expense and with greater signal quality than copper wire. The higher the speed of transmission, the greater the capacity and the larger the span of the network, the more essential is fiber optic transmission. Fiber has long replaced copper as the preferred technology for long distance communications and major backbone telephony and data transmissions. Due to its advantages, fiber optic technology is also increasingly used to enhance performance and capacity within enterprise networks and access networks. Demand for fiber optic transmission components is driven by four factors: - fiber applications have expanded beyond traditional telephony applications and are being deployed in enterprise network backbones to support high-speed data communications; - within access networks, fiber is rapidly expanding downstream toward end-users as access networks deploy "Fiber-in-the-Loop" and fiber to the curb, or FTTC architectures to support services such as fast Internet access and interactive video; - the growth of cellular communications and PCs requires fiber to be deployed both within and between cells; and - the usage of fiber in short distances increases the demand for components as more are used per mile of fiber. As the size, number and complexity of these fiber networks increases, management expects that the demand for fiber optic components will grow significantly. Fiber Optic Transmission in Data Communications. As higher speed connections are implemented in LAN/WAN systems, fiber optic transmission becomes an essential element in computer networks. For transmission speeds of 100 Mbps and higher, and transmission distances of 100 meters and longer, fiber optic transmission must be deployed. Virtually all high-speed transmission standards, such as Fiber Distributed Data Interface, Asynchronous Transfer Mode, or ATM, Fast Ethernet and Gigabit Ethernet, specify fiber optic media as the most practical technology for transmission. The steady rise in high-speed 72 75 connections and the growth in the span of networks, including the need to connect remote workgroups, has been driving the deployment of fiber optic cable throughout enterprise networks. Fiber Optic Transmission in Access Networks. To meet end users' increased demand for content, software and services, network operators must acquire additional bandwidth by either enhancing their existing networks or constructing new ones. Cable TV operators are increasingly seeking to provide general telecommunication services, high-speed Internet access and video-on-demand. As a result, they are now faced with the need to transmit "upstream," from customer premises to the cable TV operator and to send different signals to individual end-users. Similarly, local exchange carriers are implementing new technological standards, such as SONET and fiber-intensive architectures such as FTTC to enable high-speed Internet access and the delivery of cable TV and Internet services to the home. Management believes that deployment of and upgrades to these systems will increase the demand for MRV's fiber optic components that typically are better able to endure environmental factors, such as rain, snow, heat and wind, cost-effectively. In addition, communications involving cellular and personal communication services, or PCS, represent a fast emerging market for fiber optic networks, including their usage in the backbone and landline portion of wireless networks. RECENT ECONOMIC SLOWDOWN Macroeconomic factors, such as an economic slowdown in the U.S. and abroad, have detrimentally impacted demand for communications products, thereby resulting in reduced demand for optical components and equipment. The unfavorable economic conditions and reduced capital spending has detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States during 2001 to date, and may continue to affect them for the remainder of 2001 and thereafter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories. For information, on charges MRV and Luminent have taken to their financial results as a result of these conditions, please see the discussion in "Management's Discussion and Analysis of Financial Condition and Results of Operations of MRV -- Market Conditions and Current Outlook" and "Management's Discussion and Analysis of Financial Condition and Results of Operations of Luminent -- Market Conditions and Current Outlook." MRV'S CONCENTRATION MRV creates, acquires, finances and operates companies, and through them, designs, develops, manufactures and market products, which enable high-speed broadband communications. MRV concentrates on companies and products devoted to optical components and network infrastructure systems. MRV has leveraged its early experience in fiber optic technology into a number of focused operating units specializing in advanced fiber optic components, switching, routing, transaction management and wireless optical transmission systems which it has created, financed or acquired. Products and product developments of MRV's wholly or majority owned subsidiaries include the following: Luminent, Inc. Luminent provides an extensive offering of active and passive singlemode fiber optic components that support a wide range of requirements for the metropolitan and access networks. It is currently shipping a variety of active and passive fiber optic components. Active components are the core technology for optical networks and require electrical power to generate, boost or transform optical signals. Luminent's passive fiber optic components are used to direct, split and merge optical signals without the use of electricity. These components have become critical due to the use of fiber amplifiers, passive networks and WDM technology. For further information concerning Luminent's business, see "Business of Luminent" later in this prospectus supplement. 73 76 Optical Access, Inc. Optical Access is an optical networking and Internet infrastructure company that designs, manufactures and markets optical wireless products enabling service providers to offer high-speed broadband access within the last mile of the communications network in a cost effective and timely manner. Optical Access' products are designed to be deployed in a switched mesh architecture, which means that its products allow transmission of data between any two points on the network and enable full re-routing of traffic around a transmission link or equipment failure. In addition, its products feature a backup wireless radio frequency option, which reduces problems associated with adverse weather conditions. Optical Access offers the TereScope family of products, which provide optical wireless links, and OptiSwitch(TM) products, which enable switching, provisioning and aggregation. All of these products can be remotely managed through Optical Access' MegaVision network management system. Because each of its products can perform independently, Optical Access's customers can also purchase products separately with no performance degradation. TereScope. TereScope products are optical wireless links that utilize high-powered optics, which allow for high-speed, long distance optical wireless transmission of data. By installing its TereScope products in a mesh configuration with a minimum of two connections into each building and utilizing Optical Access' OptiSwitch(TM) switching technology, Optical Access' products enable full re-routing of traffic around a link or equipment failure. Optical Access believes that its TereScope products offer one of the first commercially available wireless optic systems with built-in auto fallback to radio frequency links. TereScope devices can be installed on a building's rooftop or side or in an office behind a window rather than a radio tower. They are constructed with a transmitter, which emits light that does not damage the human eye, and a receiver that detects light. Optical Access offers a range of TereScope products, the smallest of which looks like a security camera and the largest of which is the size of a computer monitor. The products feature a number of recently developed technologies to account for issues that have historically limited the use of optical wireless systems, including a system that enables them to compensate for misalignment due to building movements or interference caused by flying objects such as birds. In addition, TereScope products feature high power laser transmitters and large optical receivers to permit connectivity over longer distances. The TereScope ranges in list price from approximately $4,000 to $120,000, depending on data rate and maximum range, with an additional $5,000 to $10,000 for a 10 megabit per second radio frequency backup. OptiSwitch(TM). Optical Access' family of OptiSwitch(TM) products enables a mesh architecture, bandwidth distribution, provisioning and termination for all-IP networks. The OptiSwitch is designed to provide customer premise connectivity to business users, smart aggregation and to enable execution of any service level agreement by advanced features and capabilities of traffic classification and quality of service. Direct connection of the OptiSwitch(TM) ports to TereScope products allow service providers to offer a complete cost-effective metropolitan solution. The system is designed to manage optical wireless mesh topology management and subscriber management in Ethernet broadband networks. The OptiSwitch(TM) products range in price from $1,400 to $190,000, depending upon data rate and number of ports. MegaVision. Optical Access' MegaVision management system provides software based graphical network management and monitoring that is fully integrated with its optical transmission and switching products. The MegaVision network management system allows service providers to provision their networks from a centralized location. With the graphical interface offered by Optical Access, the provider receives a comprehensive view of the network as well as fault isolation, configuration, performance and security management of the network. CEScomm, Inc. (formerly Creative Electronic Systems SA or CES) CEScomm is developing and providing products for manufacturers of cellular network infrastructure equipment and mobile operators and service providers for the third generation of wireless solutions commonly known as 3G. 3G is the generic term used for the next generation of mobile communications systems. These new systems provide enhanced wireless services to those available today i.e., voice, text and 74 77 data. CEScomm specializes in products that provide the real-time conversion of radio signals generated by Internet ready mobile devices into asynchronous transfer mode, or ATM, traffic streams. Its products are based on distributed architectures that cluster super computer multi-processing capabilities between the radio access network and the Internet protocol, or IP, core network. CEScomm's products make it possible for 3G mobile network operators and equipment vendors to deliver more efficient service with enhanced options. End users of CEScomm's products include leading 3G wireless network operators such as NTT DoCoMo, the cellular telephone arm of Nippon Telegraph and Telephone Corporation in Japan, and European operators using the Universal Mobile Telecommunications System, or UMTS. CEScomm sells its products to leading cellular equipment vendors, including Lucent Technologies, Nortel Networks and Ericsson. iTouch Communications, Inc. iTouch provides next-generation Internet infrastructure solutions that enable service providers and carriers to deliver and monitor, on a real-time basis, high-speed Internet services. iTouch's products utilize internet protocol, or IP, routing and wide area network, or WAN, technologies, which allow for faster development of feature rich high-speed data acquisition and management systems. iTouch's In-Reach product suite supports network element management and out-of-band management applications for large, heterogeneous communication networks. In-Reach products offer console, alarm, sensor and power management solutions and possess features ranging from simple network management protocol, or SNMP, -based discrete alarm signal collection and distribution to remote console management of routers, switches, and equipment from Sun Microsystems and other providers. Standalone and chassis-based In-Reach products enable upgrades at central sites and downloads of software to thousands of remote network elements. NBase-Xyplex, Inc. NBase-Xyplex provides products and services, such as the Fiber Driver family of products, to enhance network infrastructures for city carriers, service providers, cable operators and campus and enterprise networks. The Fiber Driver family of products focuses on providing more effective usage of fiber-optic cables for carriers, service providers, cable operators and campus and enterprise networks. The Fiber Driver product line is designed to address the growing need for connecting networks of different media and speed into today's expanding fiber optic infrastructure. The Fiber Driver family consists of over 150 different converters, repeaters, switches, distance extenders and coarse wave division multiplexer modules, all of which operate on the same modular, and scalable platform. Each module provides a different solution and together the family covers almost every communication protocol. The family includes a base chassis in one, two, four and 16 slot varieties and is fully managed through any network management system based on simple network management protocol, or SNMP, including the MegaVision network management system discussed above under Optical Access. Charlotte's Networks, Inc. Charlotte's Networks is developing a core router for large service providers and carriers. The Aranea core router is Charlotte's Networks' first product. The Aranea router is capable of carrying both IP packets and time-division multiplexing, or TDM, voice traffic and enables the current WAN to grow in high orders of magnitude both in processing power and rate of transmission. The router has the ability to emulate a class 4 or 5 switch, enabling its voice traffic capability. It offers various interfaces and allows multiple Aranea machines to be clustered into a single virtual router for ultra-high speed. This feature allows construction of a machine with an aggregate bandwidth of multiple terabits per second. The Aranea can be configured to combine up to 16 port interfaces of any kind into a single dense wavelength division multiplexing link of up to 40 Gbps. The clustered machines may be managed as a single virtual router through the operating system called "AROS." The Aranea is designed to meet the exact requirements of new generation telecommunication service providers in terms of bandwidth, differentiated services, 75 78 scalability and reliability and is positioned to take advantage of the explosive growth predicted for the WAN or terabit router segment of the router market. Zuma Networks, Inc. Zuma is developing a next generation gigabit Ethernet switch router platform. The platform is distinguished by very high gigabit Ethernet port density in a single chassis, outstanding packet forwarding performance; a multi-processor, multi-component hardware architecture supporting carrier class survivability; and a multi-processor software architecture supporting the coupling of wire speed switch routing functions with wire speed network services in a single platform. This router, named Zuma LightReef(TM) entered beta trials in December 2000 and shipments began in April 2001. Optical Crossing Optical Crossing's core experience is in free-space laser communications and semiconductor optoelectronic components. Optical Crossing has three internal product groups -- Optoelectronics Products, Optical Wireless Products and Networking Products and Services -- that address multiple aspects of optical wireless technology, from components to architectural implementation of all-optical networks. Products are currently in the prototyping and development stage. European Subsidiaries. MRV maintains European subsidiaries and branch offices in France, Germany, the United Kingdom, Italy, Switzerland, Sweden, Norway and Finland, which are involved in sales, services and distribution of data networking products. The activities of these companies include system design, integration and support as well as product sales to enterprise customers and carriers, including service providers. Products sold include products manufactured by other MRV companies or divisions, as well as products manufactured by third party vendors supplied as part of network system integration and distribution services. Such specialization allows MRV to penetrate targeted vertical and regional markets. As of September 30, 2001, MRV owned approximately 80% of its European subsidiaries. OTHER KEY TECHNOLOGY INTERESTS In addition to its wholly owned and majority owned companies, MRV has significant interests in other key technology companies, including Zaffire, Inc. RedC Optical Networks and Hyperchannel Ltd. Zaffire is focused on developing a next-generation, optical services networking system for regional and metropolitan telecommunications networks. Zaffire offers a packet-enabled, DWDM optical solution designed specifically for deployment in metropolitan and regional-area networks. In July 2001, Zaffire reached an agreement with Centerpoint Broadband Technologies, Inc., under which Centerpoint would acquire Zaffire in an all stock transaction. Upon completion of the acquisition, MRV expects to own less than 10% of Centerpoint. Centerpoint develops high capacity transport systems that maximize network performance for both optical and wireless networks. These highly scalable, dynamically flexible systems allow service providers advanced levels of bandwidth efficiency, capacity and high service velocity. RedC Optical Networks has developed a complete line of optical modules used for operating, monitoring and protecting optical networks including: optical amplifiers, add/drop modules, protection and restoration modules and DWDM monitoring. Hyperchannel, which does business under its trademark Hyporium is an independent net market maker for the information technology, or IT, industry, enabling IT vendors, distributors and resellers to trade online. Hyporium offers an alternative route to market through an online trading hub and reseller web storefronts. 76 79 SALES AND MARKETING Each MRV operating company maintains its own separate sales and marketing staffs, enabling the sales personnel to develop strong customer relationships and expertise in their respective areas. Each company has established its own direct sales force experienced in each subsidiary's business to address the new and evolving requirements of their business arena. MRV and its companies have sold their products worldwide to over 500 diverse customers in a wide range of industries; primarily, data communications, telecommunications and cable. No customer accounted for more than 10% of MRV's consolidated revenues in 1998, 1999 or 2000. MRV and its companies employ various methods, such as public relations, advertising, and trade shows to build awareness of their products. Public relations activities are conducted both internally and through relationships with outside agencies. Major public relation activities are focused around new product introductions, corporate partnerships and other events of interest to the market. MRV supplements its public relations through media advertising programs and attendance at various trade shows throughout the year, both in the United States and internationally. SALES, SUPPORT AND DISTRIBUTION MRV continually seeks to augment and increase its distribution channels and sales forces to accelerate growth. Products are sold through MRV and its operating companies' direct sales forces, VARs, systems integrators, distributors, manufacturer's representatives and OEM customers. Sales and distribution divisions are organized along the following primary lines: direct sales, including OEM; domestic and international distributors; value-added resellers, or VARs, and systems integrators; and manufacturer's representatives. Direct Sales. MRV's companies employ worldwide direct sales forces primarily to sell their products to large OEM accounts and in some cases to end users. MRV believes that a direct sales force can best serve large customers by allowing salespeople to develop strong, lasting relationships, which can effectively meet the customers' needs. Direct sales staffs are located across the United States, Europe and Israel. Domestic and International Distributors. MRV and its companies work with both domestic and international distributors. Geographic exclusivity is normally not awarded unless the distributor has demonstrated acceptable performance. Distributors must successfully complete MRV's training programs and provide system installation, technical support, sales support and follow-on service to local customers. Generally, distributors have agreements with a one year term subject to automatic renewal unless otherwise canceled by either party. In certain cases with major distributors, the agreements are terminable on 30 days' notice. MRV uses stocking distributors, which purchase its product and stock it in their warehouse for immediate delivery, and non-stocking distributors, which purchase its products after the receipt of an order. Internationally, MRV sells through over 100 distributors in Asia, Africa, Europe, Australia, the Middle East, Canada and Latin America. Value-Added Resellers and Systems Integrators. MRV and its companies use a select group of VARs and system integrators in the U.S., which are generally selected for their ability to offer MRV's products in combination with related products and services, such as system design, integration and support. This specialization allows MRV to penetrate targeted vertical markets such as telecommunications and cable TV. Generally, MRV uses a two-tier distribution system to reach a broader range of customers, however VARs may purchase the product directly from one or more of MRV's companies if the volume warrants a direct relationship. Manufacturers' Representatives. To supplement MRV's direct sales efforts, manufacturer's representatives are assigned by territory in the United States and work exclusively on commission. Customer Support and Service. MRV and its companies are committed to providing strong technical support to their customers. MRV operates customer service groups, and provide support through 77 80 engineering groups, sales staff, distributors, OEMs and VARs. Customer support personnel are currently located at offices in California, Massachusetts, Maryland, Germany, England, Italy and Israel. International Sales. International sales accounted for approximately 59%, 58% and 63% of MRV's consolidated net revenues in 1998, 1999 and 2000, respectively. MANUFACTURING MRV outsources the board-level assembly, test and quality control of its Internet infrastructure products to third party contract manufacturers, thereby allowing MRV to react quickly to market demand, to avoid the significant capital investment required to establish and maintain manufacturing and assembly facilities and to concentrate resources on product design and development. Final assembly, burn-in, final testing and pack-out are performed by MRV's companies and MRV and selected third-party contract manufacturers to maintain quality control. MRV's manufacturing teams are experienced in advanced manufacturing and testing, in engineering, in ongoing reliability/quality assurance and in managing third party contract manufacturer's capacity, quality standards and manufacturing process. Risks associated with the use of independent manufacturers include unavailability of or delays in obtaining adequate supplies of products and reduced control of manufacturing quality and production costs. If MRV's contract manufacturers fail to deliver products in the future on a timely basis, or at all, it would be extremely difficult for MRV to obtain adequate supplies of products from other sources on short notice. There can be no assurance that MRV's third party manufacturers will provide adequate supplies of quality products on a timely basis, or at all. While MRV could outsource with other vendors; a change in vendors may require significant time and result in shipment delays and expenses. The inability to obtain MRV's key products on a timely basis, the loss of a particular vendor or a change in the terms and conditions of the outsourcing could have a material adverse effect on MRV's business, operating results and financial condition. MRV relies extensively on MRV's and its companies own production capabilities for critical semiconductor lasers and LEDs used in MRV's products. MRV's optical transmission production process involves: - a wafer processing facility for semiconductor laser diode and LED chip manufacturing under stringent and accurate procedures using state-of-the-art wafer fabrication technology; - high precision electronic and mechanical assembly; and - final assembly and testing. Relevant assembly processes include die attach, wire bond, substrate attachment and fiber coupling. MRV also conducts tests throughout MRV's manufacturing processes using commercially available and internally built testing systems that incorporate proprietary procedures. MRV and its companies perform final product tests on all of their products prior to shipment to customers. Many of the key processes used in MRV's products are proprietary; and, therefore, many of the key components of its products are designed and produced internally. Because MRV and its companies manufacture these and other key components of their products at their own facilities and they are not readily available from other sources, any interruption of the manufacturing process could have a material adverse effect on MRV's operations. Furthermore, MRV and its companies have a limited number of employees dedicated to the operation and maintenance of wafer fabrication equipment, the loss of any of whom could result in their inability to effectively operate and service that equipment. Wafer fabrication is sensitive to a wide variety of factors, including variations and impurities in the raw materials, difficulties in the fabrication process and performance of the manufacturing equipment. There can be no assurance that MRV and its companies will be able to maintain acceptable production yields and avoid product shipment delays. In the event adequate production yields are not achieved resulting in product shipment delays, MRV's business, operating results and financial condition could be materially adversely affected. While MRV believes its companies have sufficient manufacturing capacity for growth in the coming years, at various times there have been shortages of parts in the electronics industry, and certain critical components have been subject 78 81 to limited allocations. Although shortages of parts and allocations have not had a material adverse effect on MRV's results of operations, there can be no assurance that any future shortages or allocations would not have that effect. MRV and its companies are subject to a variety of federal, state, and local governmental laws and regulations related to the storage, use, emission, discharge, and disposal of toxic, volatile or otherwise hazardous chemicals used in the manufacturing process. There can be no assurance that environmental laws and regulations will not result in the need for additional capital equipment or other requirements. Further, these laws and regulations could restrict MRV's ability to expand operations. Any failure by MRV or its companies to obtain required permits for, control of use of, or adequately restrict the discharge, emission or release of, hazardous substances under present or future laws and regulations could subject MRV to substantial liability or could cause MRV's manufacturing operations to be suspended. That liability or suspension of manufacturing operations could have a material adverse effect on MRV's operating results. To date, these environmental laws and regulations have not had a material adverse effect on MRV's operating results. COMPETITION The communications equipment and component industry is intensely competitive. MRV and its companies compete directly with a number of established and emerging computer, communications and networking device companies. Direct competitors in optical networking and Internet infrastructure, generally include Cisco Systems, Lucent Technologies, Nortel Networks and 3Com Corporation. Direct competitors for MRV's optical wireless technology include AirFiber, Canon and TeraBeam. Direct competitors in fiber optic components include Agilent Technologies, Corning Incorporated, Finisar Corporation, Fujitsu, Infineon AG, International Business Machines Corporation, JDS Uniphase Corp., Lucent Technologies, Inc., Sumitomo and Tyco International, Ltd. Many of MRV's competitors have significantly greater financial, technical, marketing, distribution and other resources and larger installed customer bases than MRV. Several of these competitors have recently introduced or announced their intentions to introduce new competitive products. Many of the larger companies with which MRV competes offer customers a broader product line, which provides a more comprehensive networking solution than the products of MRV and its companies. In addition to competitors competing with products that perform similar functions there are also several alternative network technologies. For example, in the local access market, MRV's products compete with telephone network technology known as "ADSL," an acronym for asymmetric digital subscriber line. In this technology, digital signals are transmitted through existing telephone lines from the central office to the home. MRV also expects that competitive pricing pressures could result in price declines for MRV and its companies and their competitors' products. This increased competition, if not accompanied by decreasing costs, could result in reduced margins and loss of market share which would materially and adversely affect MRV's business, operating results and financial condition. The communications industry has become increasingly concentrated in recent years as a result of consolidation. This consolidation is likely to permit MRV's various competitors to devote significantly greater resources to the development and marketing of new competitive products and the marketing of existing competitive products to their larger installed bases. MRV expects that competition will increase substantially as a result of these and other industry consolidations and alliances, as well as the emergence of new competitors. PROPRIETARY RIGHTS To date, MRV and its companies have relied principally upon copyrights and trade secrets to protect its proprietary technology. Generally, MRV enters into confidentiality agreements with its employees and key suppliers and otherwise seek to limit access to and distribution of the source code to software and other proprietary information. There can be no assurance that these steps will be adequate to prevent 79 82 misappropriation of MRV's technologies or that a third party will not independently develop technology similar or superior to any MRV possesses. MRV has received notices from third parties alleging possible infringement of patents with respect to product features or manufacturing processes. MRV believes these kind of notices are common in the communications industry because of the large number of patents that have been filed on these subjects. MRV's policy is to discuss these notices with the senders in an effort to demonstrate that its products and/or processes do not violate any patents. MRV is currently involved in these kind of discussions with Lucent Technologies, Nortel Networks, Ortel, Rockwell International Corporation and the Lemelson Medical, Education & Research Foundation. MRV does not believe that any of MRV's or its companies' products or processes violates any of the patents asserted by these parties and further believes that it has meritorious defenses if any legal action is taken by any of these parties. However, an assertion by one or more of these parties of a claim that results in a conclusion unfavorable to MRV could materially and adversely affect MRV's business, operating results and financial condition. In the future, litigation may be necessary to protect trade secrets and other intellectual property rights owned by MRV, to enforce any patents issued to MRV or its companies, to defend against claimed infringement of the rights of others and to determine the scope and validity of the proprietary rights of others. Any litigation of this kind could be costly and a diversion of the attention of the management involved, which could have a material adverse effect on MRV's business, operating results and financial condition. An adverse determination in that litigation could further result in the loss of MRV's proprietary rights, subject it to significant liabilities, require MRV to seek licenses from third parties or prevent MRV and its companies from manufacturing or selling their products, any of which could have a material adverse effect on MRV's business, operating results and financial condition. MRV typically has agreed to indemnify its customers and key suppliers for liability incurred in connection with the infringement of a third party's intellectual property rights. EMPLOYEES As of December 31, 2000, MRV and its consolidated companies employed a total of approximately 2,600 full-time employees. None of MRV's employees is represented by a union or governed by a collective bargaining agreement, and MRV believes its employee relationships are satisfactory. 80 83 PROPERTIES MRV's principal administrative, sales and marketing, research and development and manufacturing facility is located in Chatsworth, California. The table below lists the locations, square footage and expiration dates of MRV's owned and leased facilities for MRV's major operations.
SQUARE FOOTAGE LEASE LOCATION OWNED/LEASED EXPIRATION DATES -------- -------------- ----------------- Chatsworth, California, USA................................. 17,700 February 2004 Chatsworth, California, USA................................. 20,950 January 2003 Chatsworth, California, USA................................. 12,800 March 2002 Chatsworth, California, USA................................. 50,000 July 2004 Chatsworth, California, USA................................. 5,000 December 31, 2002 Chatsworth, California, USA................................. 22,200 December 2005 Ventura, California, USA.................................... 46,200 August 2008 Littleton, Massachusetts.................................... 101,000 September 2003 Yokneam, Israel............................................. 23,400 January 2002 Milan, Italy................................................ 46,600 March 2013 Hsinchu, Taiwan............................................. 165,910 March 2016 Hsinchu, Taiwan............................................. 12,712 Owned Hsinchu, Taiwan............................................. 18,895 June 2001 Hsinchu, Taiwan............................................. 9,437 February 2001 Hsinchu, Taiwan............................................. 7,876 September 2000 Hsinchu, Taiwan............................................. 3,907 December 2001 Hsinchu, Taiwan............................................. 31,043 December 2001 Hsinchu, Taiwan............................................. 5,834 December 2001 Hsinchu, Taiwan............................................. 6,372 December 2001 Miao-Li County, Taiwan...................................... 24,398 Owned Chu-Pei, Taiwan............................................. 15,989 Owned Shanghai, People's Republic of China........................ 48,495 October 2047 Shanghai, People's Republic of China........................ 139,008 January 2049 Stockholm, Sweden........................................... 52,200 June 2003 Rome, Italy................................................. 15,700 December 2012 Paris, France............................................... 19,400 Owned
MRV believes that its facilities are sufficient to meet its current needs and that adequate additional space will be available for lease when required. We believe that our facilities are sufficient to meet our current needs and that adequate space will be available for lease when required. LEGAL PROCEEDINGS MRV is involved in lawsuits, claims, investigations and proceedings, including patent, commercial and environmental matters, which arise in the ordinary course of business. There are no matters pending that MRV expects to be material in relation to MRV's business, consolidated financial condition, results of operations or cash flows. MRV has received notices from third parties alleging possible infringement of patents with respect to product features or manufacturing processes. For a discussion of these notices and the claims, see "Business of MRV -- Proprietary Rights" earlier in this prospectus supplement. 81 84 BUSINESS OF LUMINENT OVERVIEW Luminent designs, manufactures and sells a comprehensive line of fiber optic components that enable communications equipment manufacturers to provide optical networking equipment for the rapidly growing metropolitan and access segments of communications networks. Luminent's products are designed to meet the increasing bandwidth requirements between long-haul telecommunication networks and end users. Luminent specializes in singlemode fiber optic components and subsystems for high-capacity data transmission for long-reach applications in the metropolitan and access markets. Luminent provides a broad product line of high performance fiber optic components, the technical depth to offer next generation optical components, a quick response to new requirements and volume manufacturing for these components. Luminent's direct sales customers include communications equipment manufacturers, such as Cisco Systems, General Instrument, Marconi Communications and Pandacom. In addition, Luminent sells its products to distributors who, in turn sell to customers such as Cabletron Systems, Extreme Networks and Foundry Networks. INDUSTRY BACKGROUND For a discussion of the evolution of the demand for bandwidth and the deployment of optical networks, see the section entitled "Business of MRV -- Industry Background" earlier in this prospectus supplement. Optical fiber is currently being deployed across the three major segments of communications networks: long-haul, metropolitan and access. Long-haul networks. Long-haul networks connect the communications networks of metropolitan areas around the world and transport large amounts of data and voice traffic. To solve congestion problems, service providers have invested significant resources in the deployment of optical infrastructure including the use of dense WDM. As a result, current long-haul networks provide very high transmission capacity and speed, or bandwidth, for transmitting data over very long distances. The build-out of long-haul networks represents an important step in improving network infrastructure to support increased demand for new services and greater traffic volumes. Metropolitan networks. Metropolitan networks connect long-haul networks and access networks. Due to the increase in data traffic and the demand for enhanced services, the existing metropolitan network infrastructure has become a bottleneck for the provision of communication services to businesses. Accordingly, service providers have begun to invest in infrastructure to help reduce capacity constraints in this portion of the network. Access networks. Access networks include business and residential networks. Business access networks connect metropolitan networks and businesses. Traditional business access networks use existing copper based solutions, which are slow compared to high-speed networks commonly used within businesses. Established and new service providers are deploying new technologies in order to provide high bandwidth connectivity to the business user. Residential access networks provide connectivity between the metropolitan network and the home. Currently, multiple services such as cable television, satellite, telephony and high-speed data lines are being offered to home users based on multiple copper solutions. As high data rates and new services become widely available to the home user, copper solutions will become increasingly insufficient to meet the consumer's demands. Service providers are beginning to deploy fiber to neighborhoods, to the curb and to the home enabling the residential user to obtain a wide range of current and future services. Singlemode Optical Components Singlemode components are coupled to singlemode optical fiber and have superior transmission characteristics in high capacity, longer distance applications as compared to multimode fiber. Singlemode 82 85 fiber has physically pure pulses of light which do not overlap with each other as quickly as the pulses of light on multimode fiber. Pulses of light that overlap result in the information carried by the fiber being lost. As data transmission speeds have increased, singlemode fiber has become necessary for even relatively short transmission distances due to its superior performance. As a result, singlemode fiber has progressed from being the fiber of choice in the long-haul market to being accepted as the preferred fiber for most high-speed transmission applications. The increasing use of WDM technology in metropolitan and access markets has also driven demand for singlemode fiber optic components. WDM systems require extensive use of active and passive fiber optic components to enable communication equipment manufacturers to increase system capacity by adding additional light signals on a single optical fiber. THE LUMINENT SOLUTION Luminent designs, manufactures and sells a comprehensive line of singlemode fiber optic components that enable communications equipment manufacturers to build advanced fiber optic communications systems for the rapidly growing metropolitan and access markets. Luminent's approach combines its extensive research and development experience along with design, engineering and manufacturing capabilities to deliver a wide array of high quality, cost-effective and reliable, active and passive components. Luminent believes its ability to integrate active and passive technologies, its years of experience in fiber-to-the-curb and fiber-to-the-home components, Luminent's ability to provide innovative customer solutions, its strong relationships with key communication equipment manufacturers and its ability to scale manufacturing to meet high volume customer requirements provide Luminent with competitive advantages. Luminent believes its products provide the following key benefits to Luminent's customers: High performance, cost-effective components. Luminent's active and passive products are designed to maximize both distance and bandwidth over singlemode fiber while providing efficient and reliable transmission. Luminent offers high performance and reliable components that can be tailored to meet a wide range of customer specifications. Luminent's fiber optic components incorporate proprietary technology that delivers high performance under demanding environmental conditions. Luminent believes its high performance and reliable singlemode fiber optic components have enabled it to advance Luminent's position in the metro and access fiber optic markets. Broad product offerings. Luminent offers a broad product line of active and passive components in a variety of packaging configurations. Luminent's active components include custom wavelength distributed feedback lasers, high temperature lasers, vertical cavity surface emitting lasers, edge emitting light emitting diodes, or LEDs, surface emitting LEDs and detectors with electrical amplifiers. Luminent's passive components include WDM add/drop components, thin film filters, high-speed external modulators, fiber amplifiers, fused biconical couplers, fused biconical WDM couplers and WDM multiplexers, circulators, isolators and collimators. These broad product offerings allow Luminent to satisfy a wide array of customer requirements in metropolitan and access networks. In addition, Luminent offers a number of products integrating active and passive components. Innovation and flexibility. Luminent's over a decade of experience in device fabrication, packaging and integration provides Luminent with the knowledge and capability to meet the changing needs of its customers. Luminent's intellectual property and technical know-how enables Luminent to innovate next generation products for its customers. Luminent was an early developer of singlemode fiber WDM optical component technology for fiber-to-the-curb and fiber-to-the-home applications. These components currently provide next generation high-speed services to hundreds of thousands of homes. In addition, Luminent offers coarse WDM components that enable communication equipment manufacturers to implement WDM inside their equipment at a fraction of the cost of dense WDM. Coarse WDM utilizes Luminent's experience in laser fabrication, passive component fabrication, packaging and electronic design. As a result of its manufacturing capabilities in all these areas, Luminent can reduce its time to market for innovative product designs. Luminent has close working relationships with many key customers, allowing 83 86 Luminent to be involved in the initial stages of new designs. This exposure provides Luminent with a better understanding of customer demands and helps focus Luminent's development effort towards their evolving needs. Strong manufacturing capabilities. Luminent's ability to manufacture a broad range of active and passive components is key to Luminent's success and enables Luminent to respond to customers' requirements with reduced lead times. In addition, Luminent's advanced packaging process enables it to manufacture high volume, cost-effective, singlemode components. Luminent believes that its advanced laser fabrication facilities, its thin film deposition lab, its wave-guide fabrication facilities and its proprietary packaging technology provide Luminent with a competitive advantage for manufacturing fiber optic components. PRODUCTS Luminent provides an extensive offering of active and passive singlemode fiber optic components that support a wide range of requirements for the metropolitan and access networks. Prior to the acquisition of Fiber Optic Communications on April 24, 2000, Luminent's business consisted entirely of active fiber optic components. The acquisitions of Fiber Optic Communications and Quantum expanded Luminent's product offerings into passive components. Active Components Active components are the core technology for fiber optic networks and require electrical power to generate, boost or transform optical signals. Mixed signal, single fiber components. These components are capable of transmitting bi-directional digital and analog information over a single fiber. Luminent's products in this category are called duplexers and triplexers. A duplexer transmits and receives light simultaneously and independently. A triplexer is a component that both transmits and receives one wavelength of light, while also receiving a second wavelength of light. These components offer high performance in many critical parameters, including laser power, linearity, receiver responsivity, receiver frequency response and cross talk between the laser and receiver. These components are used to provide cable television, satellite distribution, data services and telephony, all over a single fiber for residential access. Transceivers. A transceiver, the most common fiber optic data link, has both a transmitter and receiver built into one unit. A transmitter converts electrical signals into optical signals and launches them into the fiber. A receiver receives the optical signal, converts it back to an electrical signal and amplifies it. Luminent offers a wide variety of transceivers designed for a number of applications. This broad product line enables Luminent to meet a wide variety of customer requirements for singlemode fiber-based transceivers. These transceivers vary in package style, distance requirements, speed requirements and protocols, including the most widely used protocols, asynchronous transfer mode, Fiber Channel and Ethernet. Luminent has packaged several of its transceivers to have advantages over its standard components. For example, the small form factor transceiver allows an equipment manufacturer to achieve twice the number of fibers connected from the equipment; the pluggable transceiver can be removed and inserted in an operational network, which makes it well suited for field upgrades; and the single fiber transceiver provides transceiver functionality over one fiber instead of two. Luminent is also aggressively adding next generation transceivers to this product line. Due to high output power and high receiver sensitivity, Luminent's products achieve long reach transmissions. Additional options include a wide operating temperature range, lower operating voltages for reduced power consumption and a wide range of wavelengths. Applications for custom wavelength transceivers include optical network monitoring and management of coarse WDM. Coarse WDM subsystems. Coarse WDM subsystems are a combination of active and passive components that can be integrated into a communication equipment vendor's product. These subsystems enable communications equipment manufacturers to implement wavelength division multiplexing inside 84 87 their equipment at a cost lower than that of dense WDM. Coarse WDM technology is more cost-effective because it uses un-cooled transceivers that do not require costly and power consuming thermoelectric coolers. Luminent offers coarse WDM subsystems in multiple versions for varying transmission speeds. LEDs for fiber optic communications. Luminent's light emitting diodes, or LEDs, are used as a light source for fiber optic transmission because they require less expensive control circuitry as compared to laser diodes. Luminent manufactures two types of LEDs: surface emitting LEDs and edge emitting LEDs. Luminent's surface emitting LEDs are designed for use in low cost, high volume, high speed and short-reach transceivers. In some singlemode fiber low speed applications, customers prefer to use edge emitting LEDs instead of laser diodes, as they are easier to use. Luminent's edge emitting LEDs provide high power performance for singlemode fiber. Laser diodes. Laser diodes convert electrical signals to optical signals and are the most widely used light sources for optical communications systems. Luminent's cost-effective packaging technology currently supports high-speed laser modulation for networks in its target market. Both cooled and un-cooled devices can be configured with high suppression of reflection. Luminent's extensive line of different packaging allows Luminent to provide flexible solutions for the customer's applications. Luminent provides distributed feedback and Fabry-Perot lasers that operate at standard wavelengths, as well as special wavelengths. Distributed feed back lasers use a mirror that reflects one wavelength while Fabry-Perot lasers use mirrors that reflect all wavelengths. Luminent's high temperature lasers are stable over a wide range of temperatures and can operate above 100 degrees Centigrade. These un-cooled lasers are particularly suitable for use in transceivers where heat dissipation is a concern and in uncontrolled environments, such as those involved with fiber-to-the-curb. Analog fiber optic links. Analog links, unlike digital links, do not use a single, high-speed data stream. Instead, a typical analog link is made up of multiple data streams. This, in turn, requires the laser and receiver to meet more stringent performance criteria. Luminent's analog technologies are used in cable television, cellular, satellite and wireless local area networks. In addition, its analog links are utilized throughout the cable television industry in both the downstream and upstream transmissions. Luminent's analog fiber optic links avoid the high losses associated with the transport of radio frequency signals over coaxial cables. Luminent's linear lasers and high-speed receivers enable the components to be used in very stringent analog applications. Luminent also offers high levels of integration of its analog sub-assemblies, which it believes results in greater overall value to its customers. Photo detectors and receivers. Photo detectors convert optical signals into electrical signals. In addition to photo detectors Luminent offers receivers that include photo detectors with electrical amplifiers for greater functionality. Luminent's packaging technology allows Luminent to improve performance and increase speeds over standard products. Electro-optic modulators. Lithium niobate electro-optic modulators are used to transfer information onto a light signal without the modifying wavelength of the light. These modulators enable data to travel extended transmission distances compared to a directly modulated laser. Electro-optic modulators can be used to modulate the phase or amplitude of an optical signal depending on the design of the device. Vertical cavity surface emitting lasers. Vertical cavity surface emitting lasers are one of Luminent's few products targeted for multimode applications. Vertical cavity surface emitting lasers emit light perpendicular to the semiconductor surface. Luminent's devices have stable fiber-coupled power, good high temperature characteristics and are designed for use in short reach gigabit Ethernet transceivers. Vertical cavity surface emitting lasers are ideal for applications involving short distances where they can be coupled to the fiber through passive alignment techniques allowing for very high volume, low cost manufacturing. Luminent's vertical cavity surface emitting lasers are carefully designed and processed to avoid signal degradation that can occur when operated at high speeds. 85 88 Passive Components Passive components are used to direct, split and merge optical signals without the use of electricity. These components have become critical due to the use of fiber amplifiers, passive networks and WDM technology. Couplers. Couplers are used to combine and/or split optical signals. Luminent offers a wide variety of singlemode and multimode fused biconical couplers. A fused biconical coupler is made when the cores of two fibers are fused together. By precisely controlling the manufacturing process not only can different ratios of power from each fiber be controlled, but also the coupler can act as a WDM element by coupling light of one wavelength over one fiber and light of a separate wavelength over the other fiber. Couplers are one of the most common components of any optical network, WDM system, optical amplifier, or optical switch. Luminent's couplers provide low reflection and low power loss and operate over a wide range of temperatures and wavelengths. Luminent's couplers are designed for robust operation under difficult environmental conditions. Isolators. Isolators allow transmission of optical signals in one direction but block transmission in the other direction. Luminent's high performance isolators are used with fiber amplifiers and lasers to prevent reflections from entering the device. Luminent's isolators are highly reliable and feature high suppression of reflection with low power loss over wide ranges of temperatures and wavelengths. WDM thin film add/drop components. Thin film filters enable the transmission of specific optical wavelengths and the reflection of others. These filters consist of multiple layers of differing materials deposited in vacuum chambers. Thin film filter add/drop components allow for the removal and insertion of wavelengths in WDM systems with minimal power losses. These modules are designed for building flexible solutions and for architectures where only a few wavelengths are dropped at one location. Luminent offers a family of thin film based WDM modules for band splitting, bi-directional multiplexing and demultiplexing, supervisory add/drop and band add/drop applications. Luminent's thin film filter products have important features, including low power loss, uniform performance over a wavelength band and high suppression of reflection. Circulators. Optical circulators are used in wavelength management applications to direct optical signals to the appropriate sections of the system. These circulators enable new services such as adding or dropping individual channels at defined points in the network. Luminent offers fiber-coupled circulators with wide bandwidth, high suppression of reflection, low polarization sensitivity and low power loss characteristics. Variable fiber optic attenuators. Attenuators reduce the amplitude of a signal without distorting the waveform. A variable fiber optical attenuator is a component used to equalize the power between different WDM channels before being amplified by a fiber amplifier. In addition, attenuators can protect receivers from excessively strong signals that might otherwise increase error rates. Fiber gratings. A grating is a series of reflections over a length of fiber. Several products can be made by tailoring the characteristic of the fiber grating, including dense WDM wavelength separation, dispersion compensation and wavelength locking. Luminent's fiber grating technology allows Luminent to support new system designs based on the flexibility of fiber grating components. Optical connectors and adapters. Optical connectors are used to couple light either directly from a component or from another fiber. Adapters are the components that facilitate the connection of any two connectors. The overall performance and reliability of various fiber optic network systems depends upon these components. These parts feature low power loss and low reflection over a wide range of temperatures, wavelengths and mechanical stresses. Luminent has developed a wide range of both normal and hybrid adapters to meet most industry requirements. 86 89 TECHNOLOGY Luminent's technical capabilities span several key areas. Luminent believes its technical depth can enable rapid development and deployment of new singlemode fiber optic components and subsystems. The development and manufacturing of superior singlemode fiber optic components require advanced knowledge in the following technology areas: Device fabrication. Active components are necessary elements for every optical communication link as electrical signals must be converted to optical signals in an optical network. Luminent operates two device fabrication facilities for the production of active components. Device fabrication is an extremely complex procedure that requires the use of multiple advanced processes. The key technology for optimized laser performance is the growth of material where an electrical signal is converted into an optical signal, which it performs with metal organic chemical vapor deposition. Metal organic chemical vapor deposition is the most advanced growth technology available and is capable of achieving atomic level thickness control and exact composition control allowing for the highest level of device performance. Luminent's control of these difficult processes enables Luminent to manufacture lasers that operate effectively at extremely high temperatures and lasers for WDM systems. Thin film filter fabrication. Thin film filter based add/drop components are used in WDM systems and allow for the removal and insertion of a particular wavelength while permitting other wavelengths to continue through the module. Thin film filters are comprised of multiple layers of differing materials deposited in a large vacuum chamber onto the surface of a glass like material. Band pass filters for dense WDM and coarse WDM applications require over one hundred layers of deposition with extremely tight tolerances. Manufacturing these filters to the required degree of precision is extremely difficult for tightly-spaced channels. Luminent's advanced thin film capabilities include 200 GHz dense WDM filters, coarse WDM band pass filters and advanced antireflective coatings for a variety of applications. Luminent's thin film filter products have important features, including low insertion loss, flat top band pass, high suppression of reflection and low polarization sensitivity. Luminent's ability to manufacture filters with high levels of performance is a direct result of substantial experience in process development and equipment enhancement. Optics. Micro-optics design is a critical element in order to achieve a high degree of coupling between components and a singlemode fiber. Luminent's experience in optical design has allowed Luminent to provide cost-effective source lasers with high output power. In addition, Luminent's passive component characteristics directly benefit from the experience Luminent has in optics design. Luminent utilizes optics design software, production experience and close relationships with optics suppliers to achieve new product development. Luminent's capability to manufacture individual fundamental components allows Luminent to maintain technological competitiveness in the design of integrated components, such as distributed feed back lasers with isolators, receivers with filters, coarse WDM transceiver modules and dense WDM add/drop switching modules. In addition to micro-optics, Luminent has developed advanced fiber based technology. The most common of the products developed from this technology are couplers used to combine and split signals in an optical network. A fused biconical coupler is made when the cores of two fibers are fused together. The light coming in on one fiber is then split between the two fibers on the output side. A WDM coupler either couples or splits the light of one wavelength on one fiber with light of a separate wavelength on the other fiber. Luminent's precise control of the manufacturing process allows Luminent to provide a wide range of WDM and fixed ratio couplers. Luminent's coupler manufacturing techniques allow it to meet varying customer specifications while achieving both high volume manufacturing and highly reliable components. Luminent has also developed advanced optical technologies based on the wave-guide approach. The design and manufacturing of wave-guides in materials such as silicon, lithium niobate and indium phosphide all require high degrees of wave-guide modeling, layer growth/deposition and process control. 87 90 Luminent's technology in the area has enabled Luminent to produce electro-optic modulators and lasers with high coupling efficiencies into singlemode fiber. Luminent is currently developing arrayed wave-guide gratings, and other components necessary for dense WDM and integrated WDM technologies. Packaging. For over a decade, Luminent has continued to develop packaging techniques needed for high volume, cost-effective, singlemode fiber optic component manufacturing. Luminent's active components employ proprietary packaging technology as well as automated laser-welding technology in order to achieve extremely accurate sub-micron alignment. Sub-micron alignment is required for coupling light out of a laser into singlemode fiber that has a diameter of 9 microns. Luminent's passive components also employ proprietary packaging technology to achieve the same degree of precision alignments. Luminent's packaging techniques provide coupling stability over the wide temperature range that is necessary to meet even the most demanding applications. The combination of Luminent's packaging technologies and its experience in lasers, filters and electronics has enabled Luminent to design several highly integrated modules. Examples of these products include small form factor transceivers, single fiber modules and coarse WDM subsystems. Electronic design. As data rates increase, circuit design becomes more critical to the performance of its products. Luminent has a team of digital design engineers dedicated to electronic design and development for integrated components such as transmitters, receivers and transceivers. Luminent also has a team of design engineers dedicated to analog product lines that include return path transmitters and receivers, cellular/personal communications services band transceivers and subsystems for a variety of outdoor applications. INTELLECTUAL PROPERTY Luminent relies on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect its proprietary rights. As of June 30, 2001, Luminent owned five issued patents in Taiwan and one issued patent in the U.S. relating to its technologies. These patents include: - "Optical Isolator with low polarization mode dispersion" applying to Luminent's family of isolators, which is valid in Taiwan until August 2008; - "Reflective Parallel Fiber Optic Circulator" applying to Luminent's circulator design and which is valid in Taiwan until March 2017; - "Optical Circulator" applying to Luminent's circulator design and is valid in the USA until August 2017 and Taiwan until March 2017; - "Optical Fiber Polisher" applying to the polishing equipment Luminent uses internally for manufacturing and is valid in Taiwan until October 2010; and - "Used on Solid State CCD Camera Optical Photometric Filter" apply to Luminent's deposition science and is used on coatings on crystals and applies in Taiwan until April 2009. Luminent has six additional patents pending: two in Taiwan and four in the U.S. Luminent also utilizes unpatented proprietary know-how and trade secrets and employ various methods to protect them. Luminent has no licenses which it believes are material to its business. From time to time, third parties, including Luminent's competitors, may assert patent, copyright and other intellectual property rights to technologies that are important to Luminent. Luminent expects that it will increasingly be subject to infringement claims as the number of products and competitors in its market grows and the functioning of products overlaps. In this regard, in early 1999, Luminent received a written notice from Rockwell Corporation in which Rockwell claimed to have patent rights in certain technology related to MRV's and Luminent's metal organic chemical vapor deposition processes. Rockwell requested them to review their processes in light of one of Rockwell's issued patents, which has been done and determined that the cited patent has expired. Luminent believes that none of its product sales relates to 88 91 the Rockwell claim. In October 1999, Luminent received a written notice from Ortel Corporation, which has since been acquired by Lucent Technologies, Inc., in which Ortel claimed to have patent rights in certain technology related to Luminent's triplexer and duplexer products. Ortel requested that Luminent review its products in connection with one of Ortel's issued patents. Luminent is evaluating the information provided to it thus far by Ortel and is also evaluating the validity of Ortel's patent noted in Ortel's letter. In January 2001, Luminent was advised that Lucent had assigned certain of its rights and claims to Agere Systems, Inc., including the claim made on the Ortel patent. To date, Luminent has not been contacted by Agere regarding this patent claim. MRV is presently seeking to determine whether it or Luminent may have violated and the extent of their usage of, and related revenues from, technology covered by this patent. Based on our evaluation to date, Luminent has concluded that the Ortel claim (evidently now the property of Agere) relates to an aspect of its triplexers. Net sales of Luminent's triplexers accounted for approximately 5% of total net sales during the year ended December 31, 2000. In May 2001, MRV and Luminent received written notice from IBM, which claims that several of Luminent's optical components make use of inventions covered by certain patents claimed by IBM. Luminent is presently seeking to determine whether it may have violated and the extent of its usage of, and related revenues from, technology covered by the IBM patents. Based on its evaluation to date, it has concluded that the IBM claim relates to certain of Luminent's transceivers. Net sales of the transceivers in question accounted for approximately 25% of Luminent's total net sales during the year ended December 31, 2000. The patents of Ortel and IBM and other patents of which MRV and Luminent are not presently aware that may relate to Luminent's products may be determined to be valid, or some of their products may ultimately be determined to infringe these patents, or those of other companies. Agere, IBM or other companies may pursue litigation with respect to these or other claims. The results of any litigation are inherently uncertain. In the event of an adverse result in any litigation with respect to intellectual property rights relevant to products that could arise in the future, that may require the company to pay substantial damages under applicable law, to cease the manufacture, use and sale of infringing products or to expend significant resources to develop non-infringing technology. In addition, litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail. Accordingly, any infringement claim or litigation against us could significantly harm Luminent's business, operating results and financial condition. RESEARCH AND DEVELOPMENT Luminent believes that in order to maintain its technological competitiveness, Luminent must enhance its existing products and continue to develop new products. Luminent's research and development expenses were approximately $5.0 million, $8.7 million and $18.2 million for the years ended December 31, 1998, 1999 and 2000, respectively. Luminent's research and development expenses were approximately $6.6 million and $10.0 million during the six months ended June 30, 2000 and 2001, respectively. At June 30, 2001, Luminent had 181 employees engaged in research and development, including 40 engineers with advanced degrees and 12 engineers who are PhDs. CUSTOMERS Luminent's customers include major communications equipment manufacturers in the U.S. and international markets, which incorporate Luminent's products into their equipment that they in turn sell to network service providers. 89 92 The following table provides information concerning Luminent's customer concentration, which accounted for 10% or more of Luminent's net sales in 2000, and their respective sales percentages for 1998 and 1999 and the six months ended June 30, 2000 and 2001:
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ----------------------- ------------ CUSTOMER 1998 1999 2000 2000 2001 -------- ----- ----- ----- ---- ---- Marconi Communications............................ 18% 40% 18% 17% 13% Cisco Systems..................................... 5% 6% 11% 14% 11%
Luminent has no long-term contracts with its customers and sales are typically made pursuant to individual purchase orders, often with extremely short lead times. A number of Luminent's current customers were acquired through the acquisitions of Fiber Optic Communications, Optronics and Quantum, and Luminent has only a limited history with them as customers. SALES, MARKETING AND TECHNICAL SUPPORT Luminent markets its products worldwide through a direct sales force as well as through distributors' and manufacturers' representatives. Luminent's sales force maintains close relationships with decision-makers at most of its key customers. The direct sales force also manages the relationship of Luminent's distributors' and manufacturers' representatives. Luminent's sales people have strong technical backgrounds, typically with at least a B.S. or the equivalent in engineering. Luminent's sales offices are located in Chatsworth, San Francisco and San Jose, California; Austin, Texas; Sandown, New Hampshire; Raleigh, North Carolina, and Nagold, Germany. Luminent's main distributor in North America is Unique Technologies, a subsidiary of the Veba Corporation. Unique Technologies provides extensive coverage in the United States and Canada for some of its customers. Other distributor relationships have been established in Germany, Japan, the United Kingdom, Taiwan, People's Republic of China, Korea, Benelux, Israel, South Africa, Australia, Spain, France and Denmark. Luminent's trained staff provides technical support to its customers, distributors and representatives. All customer support engineers are trained and typically have a degree in physics or electrical engineering. Luminent believes that customer service and support is as valuable and as important as its technology. COMPETITION The fiber optic component industry is highly competitive and subject to rapid technological change. Luminent believes that the principal competitive factors in the active fiber optic component market are support for multiple optical interfaces, output power, wavelength selection, electrical interface standards, mechanical packaging, price, lead times and reliability. Luminent believes that the principal competitive factors in the passive component market are optical performance of components, quality and reliability, manufacturing capacity, timely delivery, customer relationships, pricing, comprehensiveness of product offerings and customization to customer specifications. Luminent believes it competes favorably in each of these factors for both active and passive components. Luminent also believes that its products are favorably priced compared to equivalent products currently available from its competitors. Based on Luminent's assessment of the price performance ratio of competitive products, it believes that its products currently compare favorably with similar products, although Luminent cannot assure you that they will continue to do so. Luminent's current competitors include Agilent Technologies, Corning Incorporated, Finisar Corporation, Fujitsu, Infineon AG, International Business Machines Corporation, JDS Uniphase Corp., Lucent Technologies, Inc., Sumitomo, Tyco International, Ltd. and other companies that offer or have announced similar products. Many of Luminent's competitors have substantially greater financial, marketing, technical, human and other resources than us, and greater brand recognition and market share which may give them certain competitive advantages, including the ability to negotiate lower prices on raw materials 90 93 and components than those available to us. Luminent cannot assure you that it will be able to compete successfully with existing or future competitors or that competitive pressures will not seriously harm Luminent's business, operating results and financial condition. Fiber optic technology competes with other technologies such as satellite transmission and wireless technologies which are less expensive and easier to deploy. If these technologies are preferred over fiber optics, the demand for Luminent's products may decline, which would result in a material adverse effect on its business. MANUFACTURING Luminent designs and manufactures its products at its facilities in the United States, Taiwan, and People's Republic of China. Active components are manufactured in Hsinchu, Taiwan and Chatsworth, California. These manufacturing operations consist of wafer fabrication facilities for semiconductor laser diodes and LEDs; a high precision optical and mechanical assembly; electrical design; and assembly and final testing. Luminent currently designs and manufactures passive components in Hsinchu, Taiwan consisting of thin film filter manufacturing, wave-guide processing, precision optical and mechanical assembly and final testing. Luminent also manufactures passive components in Shanghai, People's Republic of China consisting of precision optical and mechanical assembly and final testing. Many of the key processes used in the manufacture and test of Luminent's products are proprietary. Consequently, many of the key components of Luminent's products are designed and produced internally. Although Luminent generally uses standard parts and raw materials, certain parts and components are only available from a limited number of suppliers. Luminent's policy is to maintain a reserve of necessary parts and raw materials to help minimize any disruption as a result of temporary unavailability of these parts. Luminent outsources certain board level products to contract manufacturers and it maintains a modular and flexible manufacturing approach to facilitate rapid changes of product mix. Luminent assembles substantially all its active and passive products in a clean room environment. Relevant assembly processes include die attach, wire bond, substrate attachment and fiber coupling. Luminent also conducts tests throughout its manufacturing process using commercially available and in-house built testing systems that incorporate proprietary procedures. To maintain reliability and quality, Luminent implements a stringent set of quality assurance programs throughout the design, assembly, integration and test processes. Luminent's policy is to perform final product tests on all of its products prior to shipment. Luminent typically purchases its components and materials through purchase orders, and it has no guaranteed supply arrangements with any of its suppliers. Luminent currently purchases several key components and materials used in the manufacture of its products from single or limited source suppliers, including Corning Incorporated, Mitsubishi Electric, Nippon Sheet Glass, Phillips Semiconductor and Sumitomo. Current softness in demand and pricing in the communications market have necessitated a review of Luminent's inventory, facilities and headcount. As a result, Luminent recorded in the second quarter of 2001 a one-time charge for additional write-down for inventory and inventory purchase commitments, among other things. Luminent is subject to a variety of federal, state and local government regulations related to the storage, use, discharge and disposal of toxic, volatile, or otherwise hazardous chemicals used in its manufacturing processes. Further, Luminent is subject to other safety, labeling and training regulations as required by local, state and federal law. Although Luminent believes that it is in material compliance and has complied with all applicable legal requirements, any failure by Luminent to comply with present and future regulations could subject Luminent to future liabilities or the suspension of production. In addition, these regulations could restrict Luminent's ability to expand its facilities or could require it to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. Luminent cannot assure you that these legal requirements will not impose on it the need for additional capital expenditures or other requirements. 91 94 EMPLOYEES At June 30, 2001, Luminent had a total of 1,550 full-time employees. Of these, employees with science or engineering degrees engaged in research and development activities numbered 90 with Bachelor of Science degrees (or four year equivalent), 40 with Masters degrees and 12 with Ph.D. degrees. Luminent's employees are not represented by any collective bargaining agreement and it has never suffered any work stoppage. Due to the downturn in the communications market, Luminent is in the process of reducing employee headcount to approximately 1,200 employees. Luminent believes that its relations with its employees are good. FACILITIES Luminent maintains its main manufacturing, development and office facilities in the United States, Taiwan and People's Republic of China. The table below lists the locations, square footage and expiration dates of its leased facilities for its major operations at December 31, 2000.
SQUARE FOOTAGE LEASE LOCATION LEASED/OWNED EXPIRATION DATES -------- -------------- ----------------- Chatsworth, California, USA............................... 22,200 December 31, 2005 Chatsworth, California, USA............................... 50,000 July 13, 2004(1) Chatsworth, California, USA............................... 5,000 December 31, 2002 Ventura, California, USA.................................. 46,200 August 2008 Hsinchu, Taiwan........................................... 165,910 March 14, 2016 Hsinchu, Taiwan........................................... 12,712 Owned Hsinchu, Taiwan........................................... 18,895 June 15, 2001 Hsinchu, Taiwan........................................... 9,437 February 15, 2001 Hsinchu, Taiwan........................................... 7,876 August 31, 2001 Miao-Li County, Taiwan.................................... 24,398 Owned Hsinchu, Taiwan........................................... 3,907 December 31, 2001 Hsinchu, Taiwan........................................... 31,043 December 31, 2001 Hsinchu, Taiwan........................................... 5,834 December 31, 2001 Hsinchu, Taiwan........................................... 6,372 December 31, 2001 Chu-Pei, Taiwan........................................... 15,989 Owned Shanghai, People's Republic of China...................... 48,495 October 20, 2047 Shanghai, People's Republic of China...................... 139,008 January 2049
------------------------- (1) Luminent has an option to renew this lease for three more years. LEGAL PROCEEDINGS From time to time, Luminent may become involved in litigation relating to claims arising from its ordinary course of business. Luminent is currently not a party to any material legal proceedings. For a description of certain intellectual property claims Luminent has received alleging infringement of third-party patents, see "Business of Luminent -- Intellectual Property" earlier in this prospectus supplement. 92 95 DESCRIPTION OF LUMINENT CAPITAL STOCK Luminent is authorized to issue 300,000,000 shares of common stock, $.001 par value per share, and 30,000,000 shares of undesignated preferred stock, $.001 par value per share. COMMON STOCK As of date of this prospectus supplement, there were 156,000,000 shares of Luminent common stock outstanding. The holders of common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Subject to preferences that may be applicable to any outstanding preferred stock, the holders of common stock are entitled to receive ratably dividends, if any, as may be declared from time to time by the board of directors out of funds legally available for that purpose. In the event of our liquidation, dissolution or winding up of, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock, if any, then outstanding. The common stock has no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and non-assessable. Luminent's common stock is listed on the Nasdaq National Market under the symbol "LMNE." PREFERRED STOCK Under Luminent's Certificate of Incorporation, the board of directors has the authority to issue 30,000,000 shares of preferred stock in one or more series and to fix the powers, designations, preferences and relative, participating, optional, or other rights of the preferred stock. No preferred stock has been issued. DESCRIPTION OF MRV CAPITAL STOCK The authorized capital stock of MRV consists of 160,000,000 shares of common stock and 1,000,000 shares of Preferred Stock COMMON STOCK As of September 30, 2001, there were 77,494,009 shares of MRV common stock outstanding. The holders of MRV common stock are entitled to one vote per share on all matters submitted to a vote of stockholders. Holders of MRV common stock also are entitled to receive ratably dividends as may be declared by the board of directors out of funds legally available therefore, subject to preferences that may be applicable to any outstanding Preferred Stock. In the event of liquidation, dissolution or winding up of MRV, holders of MRV common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preference of any outstanding Preferred Stock. Holders of MRV common stock have no preemptive, subscription, redemption, conversion or cumulative voting rights. All the outstanding shares of MRV common stock are, and the shares of MRV common stock offered by this prospectus supplement will be, when issued in exchange for Luminent common stock, validly authorized and issued, fully paid and nonassessable. PREFERRED STOCK Under MRV's Certificate of Incorporation, the board of directors has the authority to issue 1,000,000 shares of preferred stock in one or more series and to fix the powers, designations, preferences and relative, participating, optional, or other rights of preferred stock. No preferred stock has been issued, including: - dividend rights; - conversion rights; 93 96 - voting rights; - redemption terms; - liquidation preferences; and - the number of shares constituting any series. without any further vote or action by MRV's stockholders. The issuance of preferred stock in certain circumstances may have the effect of delaying, deferring, or preventing a change of control, may discourage bids for MRV common stock at a premium over the market price of the common stock, and may adversely affect the market price of, and the voting and other rights of the holders of, our common stock. MRV has no shares of preferred stock outstanding and has no plans to issue any of these shares. TRANSFER AGENT, REGISTRAR AND EXCHANGE AGENT The Transfer Agent, and Registrar of MRV's common stock is American Stock Transfer & Trust Co., New York, New York and it will act as the Exchange Agent to exchange certificates that represented shares of Luminent common stock prior to the Merger for the shares of MRV common stock to which they are entitled in the Merger. For information on how to surrender your Luminent's certificates for shares of MRV common stock and cash for any fractional shares, see "The Merger -- Surrender of Stock Certificates; Fractional Interests" earlier in this prospectus supplement. 94 97 COMPARATIVE STOCKHOLDER RIGHTS
LUMINENT COMMON STOCK MRV COMMON STOCK --------------------- ---------------- TRANSFERABILITY TRANSFERABILITY Luminent common stock (other than shares MRV common stock is freely transferable and held by MRV) was freely transferable and the the shares are listed on The Nasdaq National shares were listed on The Nasdaq National Market under the symbol "MRVC." Market under the symbol "LMNE." DIVIDEND POLICY DIVIDEND POLICY Luminent had never declared or paid any cash Since its inception, MRV never declared or dividends on its capital stock. It's paid cash dividends on its common stock. announced dividend policy was to retain It's announced dividend policy is that it future earnings, if any, to finance the currently intends to retain all of our expansion of its business, and it did not earnings, if any, for use in the operation expect to pay any cash dividends in the and expansion of its businesses and does not foreseeable future. intend to pay any cash dividends to stockholders in the foreseeable future. VOTING RIGHTS VOTING RIGHTS Holders of Luminent common stock had the Holders of MRV common stock have the right right on matters specified by Delaware law on matters specified by Delaware law affecting the corporate structure of affecting the corporate structure of MRV, Luminent, including the election of the including the election of the board of board of directors. Holders of Luminent directors. Holders of MRV common stock are common stock were entitled to one vote per entitled to one vote per share. Directors share. Directors were elected annually. are elected annually. The number of MRV However, because MRV, through its wholly shares issued in the Merger constitutes owned subsidiary MRV Merger Sub, owned over approximately 6.7% of MRV's outstanding 92% of Luminent's outstanding stock, it was shares. able to elect the entire board of directors of Luminent and had sufficient voting power to approve or defeat all corporate actions for which stockholder votes were required. REMOVAL OF MANAGEMENT REMOVAL OF MANAGEMENT Members of Luminent's board of directors Members of MRV's board of directors can be could be removed by the holders of a removed by the holders of a majority of majority of Luminent's common stock. MRV, MRV's common stock. To the knowledge of through its wholly owned subsidiary MRV MRV's management, no one entity or person Merger Sub, owned over 92% of Luminent's holds more than approximately 8.2% of MRV's outstanding stock. outstanding stock.
95 98 MANAGEMENT OF MRV FOLLOWING THE MERGER The executive officers and directors of MRV at , 2001 are as follows:
NAME AGE POSITION ---- --- -------- Noam Lotan(1).................. 49 President, Chief Executive Officer and Director Shlomo Margalit(1)............. 60 Chairman of the Board of Directors, Chief Technical Officer and Secretary Guy Avidan..................... 39 President and Chief Executive Officer of Optical Access, Inc. Shay Gonen..................... 36 Interim Chief Financial Officer Igal Shidlovsky(2)(3).......... 64 Director Guenter Jaensch(2)(3).......... 62 Director Professor Daniel Tsui(3)....... 62 Director Professor Baruch Fischer....... 50 Director
------------------------- (1) Member of the Executive Committee. (2) Member of the Compensation Committee. (3) Member of the Audit Committee. NOAM LOTAN has been the President, Chief Executive Officer and a Director of MRV since May 1990 and became Chief Financial Officer of MRV in October 1993, in which position he served until June 1995. From March 1987 to January 1990, Mr. Lotan served as Managing Director of Fibronics (UK) Ltd., the United Kingdom subsidiary of Fibronics International Inc. ("Fibronics"), a manufacturer of fiber optic communication networks. MRV purchased the Fibronics business in September 1996. From January 1985 to March 1987, Mr. Lotan served as a Director of European Operations for Fibronics. Prior to that time, Mr. Lotan held a variety of sales and marketing positions with Fibronics and Hewlett-Packard. Mr. Lotan holds a Bachelor of Science degree in Electrical Engineering from the Technion, the Israel Institute of Technology, and a Masters degree in Business Administration from INSEAD (the European Institute of Business Administration, Fontainebleau, France). DR. SHLOMO MARGALIT, a founder of MRV, has been Chairman of the board of directors and Chief Technical Officer since MRV's inception in July 1988. From May 1985 to July 1988, Dr. Margalit served as a founder and Vice President of Research and Development for LaserCom, Inc. ("LaserCom"), a manufacturer of semiconductor lasers. From 1982 to 1985, Dr. Margalit served as a Senior Research Associate at the California Institute of Technology ("Caltech"), and from 1976 to 1982, a Visiting Associate at Caltech. From 1972 to 1982, Dr. Margalit served as a faculty member and Associate Professor at the Technion. During his tenure at the Technion, Dr. Margalit was awarded the "Israel Defense" prize for his work in developing infrared detectors for heat guided missiles and the David Ben Aharon Award for Novel Applied Research. Dr. Margalit holds a Bachelor of Science degree, a Masters degree and a Ph.D. in Electrical Engineering from the Technion. GUY AVIDAN has served as the Chief Executive Officer and President of Optical Access, Inc. MRV's optical wireless products subsidiary since September 2000. From 1995 to September 2000, Mr. Avidan served in various executive capacities for other subsidiaries of MRV, including as President of NBase- Xyplex International from January 1999 until joining Optical Access and as Managing Director of NBase-Communications, from 1995 until January 1999. Mr. Avidan holds a B.A. degree in business management, economics and accounting from Haifa University and also is licensed as a Certified Public Accountant. SHAY GONEN became Interim Chief Financial Officer in September 2001 following the death of Edmund Glazer. Since September 1996, Mr. Gonen has served in various executive capacities for certain of MRV's subsidiaries, including as the Vice President of Finance, Chief Financial Officer and Secretary of, Optical Access, Inc. from September 2000; as General Manager of European Activity for NBase-Xyplex from January 1999 to September 2000; and as Chief Operating Officer of NBase Communications from September 1996 to December 1998. Mr. Gonen served as Vice President of Operations and Finance for Silver Arrow, L.P. from April 1994 to September 1996. Mr. Gonen holds a B.S. degree in industrial engineering from the Technion, and an M.B.A. degree from Bar-Ilan University in Tel Aviv. 96 99 DR. IGAL SHIDLOVSKY became a Director of MRV in May 1997. Dr. Shidlovsky serves as Managing Director of Global Technologies, an investment and consulting organization, which he founded in 1994. He has extensive management and consulting experience with international companies and start up technology companies. Dr. Shidlovsky is a Director of the Omega Point Foundation. From 1982 to 1991, Dr. Shidlovsky was a Director of Sentex Sensing Technologies. Dr. Shidlovsky held several executive positions including Vice President Corporate Development at Siemens Pacesetter, a division of Siemens AG Medical Group, Director of Strategic Planning and Technology Utilization, and Director of the Microelectronics Department at Siemens Corporate Research. From 1969 to 1982 he was with RCA Laboratories, a leading electronic R&D organization. Dr. Shidlovsky holds a Bachelor of Science degree in Chemistry from the Technion and Master and Ph.D. degrees from the Hebrew University in Israel. DR. GUENTER JAENSCH became a Director of MRV in December 1997. Dr. Jaensch serves as Managing Director of The McKenzie Companies, Inc. and McKenzie Ventures LTD. and as President of Jaensch Enterprises, each firm is engaged in management consulting, mergers and acquisitions and investments. For over 20 years, Dr. Jaensch held several executive positions with Siemens or its subsidiaries. Among his executive positions in the United States were as President of Siemens Communications Systems, Inc.; Chairman of Siemens Corporate Research and Support, Inc.; Chairman and Chief Executive Officer of Pacesetter; and head of the cardiac management division of Siemens AG Medical Group. Dr. Jaensch also served as controller of Siemens Data Processing Group and Director of Siemens Internal Accounting and Budgeting operations. Dr. Jaensch holds a Masters degree in Business Administration and Ph.D. degree in Finance from the University of Frankfurt. He also served as an Associate Professor at the University of Frankfurt prior to joining Siemens. PROFESSOR DANIEL TSUI became a Director of MRV in December 1999. Professor Tsui is the Arthur Le Grand Doty Professor of Electrical Engineering at Princeton University and was awarded the 1998 Nobel prize in Physics for the discovery and explanation of the fractional quantum hall effect. Professor Tsui was a recipient of the American Physical Society 1984 Buckley Prize, the 1998 Benjamin Franklin Medal and was elected to the National Academy of Sciences. He is a fellow of the American Physical Society and the American Association for the Advancement of Science. He is currently engaged in research activity relating to properties of thin films and microstructures of semiconductors and solid-state physics. He received his Ph.D. in physics from the University of Chicago in 1967 and for 13 years was with Bell Laboratories before joining Princeton University, where he spent the last 16 years. PROFESSOR BARUCH FISCHER became a Director of MRV in December 1999. Professor Fischer currently serves as Dean of the Electrical Engineering Faculty at the Technion. Professor Fischer's current Research Activities include solid state devices, lasers and optical amplifiers; WDM technology; fiber gratings; all optical networks; non-linear effect in fiber, wave mixing; and optical computing, optical data storage and optical image processing. He has authored or co-authored approximately 180 papers and holds several patents in the field of optics and opto-electronics. He received his Ph.D. from Bar-Ilan University, Israel in 1980. He subsequently became a Post-Doctorate Fellow at CalTech and joined the faculty of the Technion in 1983. Each director is elected for a period of one year at MRV's annual meeting of stockholders and serves until the next annual meeting and until his successor is duly elected and qualified. Officers are elected by, and serve at the discretion of, the board of directors, subject to relevant employment agreements. None of the Directors of MRV are related by blood, marriage or adoption to any of MRV's Directors or executive officers. EXECUTIVE COMPENSATION The members of the board of directors who are not employees of MRV receive cash compensation of $800 per month and $500 for each board of directors' meeting attended, while serving as Directors. 97 100 The following table sets forth a summary of all compensation paid by MRV to its Chief Executive Officer and for each of its other executive officers whose total annual salary and bonus exceeded $100,000 (the "Named Executive Officers") during the fiscal year ended December 31, 2000:
LONG-TERM COMPENSATION ANNUAL COMPENSATION SECURITIES ------------------------- UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITIONS YEAR SALARY BONUS OPTIONS(#) COMPENSATION ---------------------------- ---- -------- ------- ------------ ------------ Noam Lotan.............................. 2000 $100,000 $ -- -- -- President and Chief Executive Officer 1999 $100,000 $ -- -- -- 1998 $100,000 $ -- 60,000(1) -- Shlomo Margalit......................... 2000 $110,000 $ -- -- -- Chairman of the Board of Directors, 1999 $110,000 $ -- -- -- Chief Technical Officer and Secretary 1998 $110,000 $ -- -- -- Edmund Glazer(3)........................ 2000 $140,000 $ -- 40,000 -- Vice President of Finance and 1999 $140,000 $ -- 60,000 -- Administration and Chief Financial Officer 1998 $107,000 $ -- 178,000(2) -- William R. Spivey(4).................... 2000 $138,000 $90,000 316,315 $48,682(5) President and Chief Executive Officer of 1999 N/A N/A N/A N/A Luminent, Inc. 1998 N/A N/A N/A N/A Guy Avidan.............................. 2000 $125,000 $39,000 -- -- President and Chief Executive Office of 1999 $102,000 $39,000 -- -- Optical Access, Inc. 1998 $102,000 $39,000 60,000 --
------------------------- (1) Consists of repriced options granted under MRV's stock option plans that were issued in replacement of earlier options granted to the Named Executive Officer under MRV's stock option plans. The Options vest at their original vesting schedules. (2) Includes 78,000 repriced options granted under MRV's stock option plans that were issued in replacement of earlier options granted to the Named Executive Officer under the Stock Option Plans. The Options vest at their original vesting schedules. (3) Mr. Glazer was killed in the air crash of American Airlines Flight 11 into North Tower of the World Trade Center on September 11, 2001. (4) Dr. Spivey joined Luminent in July 2000 and resigned in September 2001. (5) Consists of a reimbursement of legal fees Dr. Spivey incurred in 2000 in connection with negotiation of his employment contract. OPTION GRANTS IN LAST FISCAL YEAR The following table provides certain information regarding stock option grants made to the Named Executive Officers in the year ended December 31, 2000.
PERCENT POTENTIAL REALIZABLE VALUE OF TOTAL AT ASSUMED ANNUAL RATE OF STOCK NUMBER OF OPTIONS PRICE APPRECIATION FOR SECURITIES GRANTED TO OPTION TERM UNDERLYING EMPLOYEES EXERCISE EXPIRATION --------------------------------------- NAME OPTIONS GRANTED IN 2000 PRICE($/SH) DATE 0%(1) 5%(2) 10%(2) ---- --------------- ---------- ----------- ---------- ----------- ----------- ----------- Noam Lotan................. -- -- $ -- N/A N/A N/A N/A Shlomo Margalit............ -- -- $ -- N/A N/A N/A N/A Edmund Glazer.............. 40,000 0.7 $20.50 4/16/2006 -- $ 278,878 $ 632,680 William R. Spivey(3)....... 316,315 5.3 $32.56 7/10/2005 $10,300,000 $16,006,758 $22,898,476 Guy Avidan................. -- -- $ -- N/A N/A N/A N/A
98 101 ------------------------- (1) Based upon the difference between the closing price of a share of MRV Common Stock on the date of grant and the exercise price per share of the options. (2) The dollar amounts under these columns are the result of calculations assuming the price of MRV's common stock on the date of the grant of the option increases at the hypothetical 5% and 10% rates set by the SEC for the term of the option. Neither the amounts reflected nor the rates applied are intended to forecast possible future appreciation, if any, of MRV's stock price. (3) Excludes separate options granted on July 11, 2000 by Luminent, MRV's subsidiary, to Dr. Spivey exercisable at $6.25 per share. These options are described under the Employment Agreements section below. If the market value of the underlying shares of Luminent common stock on the grant date is assumed to equal Luminent's IPO price of $12 per share (determined on November 9, 2000), the intrinsic value of Dr. Spivey's options (the market price of the underlying common stock less the exercise price) on the grant date was $27,600,000. The potential realizable value of these options at assumed annual rate of stock price appreciation of 5% and 10% for the option term calculated like the amounts in the table accompanying footnote (2) are $63,824,331 and $119,399,566, respectively. FISCAL YEAR END OPTION VALUES The following table provides certain information concerning MRV stock options exercised by the Named Executive Officers during the year ended, and held by them at, December 31, 2000.
NUMBER OF SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED NUMBER OF OPTIONS AT IN-THE-MONEY OPTIONS AT SHARES DECEMBER 31, 2000 DECEMBER 31, 2000(2) ACQUIRED UPON VALUE ---------------------------- ---------------------------- NAME EXERCISE REALIZED(1) EXERCISABLE UN-EXERCISABLE EXERCISABLE UN-EXERCISABLE ---- ------------- ----------- ----------- -------------- ----------- -------------- Noam Lotan........... 48,000 $2,634,000 -- 12,000 $ -- $129,000 Shlomo Margalit...... -- $ -- -- -- $ -- $ -- Edmund Glazer........ 96,400 $4,295,160 36,400 101,600 $391,300 $662,200 William R. Spivey(3).......... -- $ -- 316,315 -- $ -- $ -- Guy Avidan........... -- $ -- 24,000 36,000 $258,000 $387,000
------------------------- (1) Based on difference between the closing price of MRV common stock on the date of exercise and the exercise price. (2) Based on difference between the closing price of MRV common stock on December 29, 2000 and the exercise price. (3) Excludes separate options granted on July 11, 2000 by Luminent, MRV's subsidiary, to Dr. Spivey exercisable at $6.25 per share. These options are described under the Employment Agreements section below. Of these options, 1,200,000 were exercisable on December 31, 2000 and 3,600,000 were not exercisable. None of Dr. Spivey's options was in the money at December 29, 2000. EMPLOYMENT AGREEMENTS In March 1992, MRV entered into three-year employment agreements with Mr. Lotan and Dr. Margalit. Upon expiration, these agreements automatically renew for one-year terms unless either party terminates them by giving the other three months' notice of non-renewal prior to the expiration of the current term. Pursuant to the agreements, Mr. Lotan serves as President, Chief Executive Officer and a Director of MRV and Dr. Margalit serves as Chairman of the Board of Directors, Chief Technical Officer and Secretary. Mr. Lotan and Dr. Margalit receive base annual salaries of $100,000 and $110,000, respectively, and each is entitled to receive a bonus determined and payable at the discretion of the board of directors upon the recommendation of the Compensation Committee of the Board. Recommendations with respect to bonus levels are based on achievement of specified goals, such as new product 99 102 introductions, profitability levels, revenue goals, market expansion and other criteria as established by the Compensation Committee. In July 2000, MRV and its subsidiary, Luminent, entered into a four-year employment agreement with Dr. William R. Spivey, Luminent's former President and Chief Executive Officer. Under the agreement, Luminent agreed to pay to Dr. Spivey an annual salary of $300,000 with a bonus targeted at $75,000 for 2000 and at $150,000 for the following years as determined at the discretion of our board of directors. MRV granted Dr. Spivey an option to purchase 316,315 shares of MRV common stock exercisable at $32.56 per share for five years. Luminent granted to Dr. Spivey an option to purchase 4,800,000 shares of Luminent common stock at an exercise price of $6.25 per share. Dr. Spivey's option to purchase MRV common stock was fully exercisable as of the date of grant, and his option to purchase Luminent common stock vested in annual installments of 25%, beginning on July 11, 2000, provided, however, that in the event his employment was terminated other than for cause he was entitled to receive from the date of termination over a one year period an amount equal to two times the sum of his annual salary plus bonus and all of his unvested Luminent options will automatically vest and become exercisable. Dr. Spivey's resignation on September 12, 2001 was considered by the parties to be a termination other than for cause under his employment agreement entitling him to the severance benefits of his employment agreement therefor. As a consequence of Dr. Spivey's resignation, his MRV and Luminent options are now exercisable through September 11, 2003. Each officer also receives employee benefits, such as vacation, sick pay and insurance, in accordance with MRV's policies, which are applicable to all employees. MRV has obtained, and is the beneficiary of, key man life insurance policies in the amount of $1,000,000 on the lives of each of Drs. Margalit and Mr. Lotan. All benefits under these policies will be payable to MRV upon the death of an insured. COMPENSATION OF OUTSIDE DIRECTORS Outside directors, i.e., directors who are not employees of MRV, receive cash compensation of $800 per month and $500 for each board of directors' meeting attended, while serving as Directors. MRV did not grant any stock options to outside directors during 2000. BOARD COMMITTEES MRV's board of directors has established the Compensation Committee, the Audit Committee and the Executive Committee. The Compensation Committee reviews and recommends to the board of directors the compensation and benefits of all MRV's officers and establishes and reviews general policies relating to compensation and benefits of our employees. The Compensation Committee consists of Igal Shidlovsky and Guenter Jaensch. The Audit Committee reviews MRV internal accounting procedures and consults with and reviews the services provided by its independent accountants. The Audit Committee consists of Igal Shidlovsky, Guenter Jaensch and Daniel Tsui. The Executive Committee is empowered to take any action that the board of directors is authorized to act upon, with the exception of the issuance of stock, the sale of all or substantially all of MRV's assets and other significant corporate transactions. The Executive Committee consists of Noam Lotan and Shlomo Margalit. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION None of the members of the Compensation Committee has ever been an officer or employee of MRV. None of MRV's executive officers has served or currently serves on a board of directors or on a compensation committee of any other entity that had officers who served on MRV's board of directors. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In July 1998, MRV and Zaffire, Inc. (formerly New Access Communications, Inc.) entered into a Securities Purchase Agreement, under which MRV purchased for $950,000 shares of the capital stock of Zaffire equal to approximately 19% of the capital stock of Zaffire then outstanding and warrants to 100 103 purchase additional capital stock of Zaffire, which, if fully exercised for an aggregate of $2,050,000, MRV would own an aggregate of approximately 60% of Zaffire's capital stock (when the shares purchased upon exercise of the warrants were added to MRV's existing stake in Zaffire). The warrants were exercisable in two installments (provided the first installment was exercised) by July 1, 1999 and January 4, 1999, respectively. These warrants were fully exercised in 1999. In May 2000, MRV, along with 36 other accredited investors, and Zaffire entered into a Series C Preferred Stock Purchase Agreement under which MRV purchased for $5,000,000 shares of Series C Preferred Stock of Zaffire. At December 31, 2000, MRV had an approximate 22% ownership interest in Zaffire. Zaffire is engaged in the development of new products based on wave division multiplexing technology. Dr. Near Margalit is the Chairman of the Board and Chief Executive Officer of Zaffire and a principal stockholder of it. Dr. Near Margalit is the son of Dr. Shlomo Margalit, a principal stockholder of MRV and MRV's Chairman of the Board of Directors and Chief Technical Officer. Divisions and subsidiaries of MRV are customers of Luminent and purchase substantial quantities of Luminent's fiber optic components. These customers accounted for Luminent sales of $2.1 million during 1998, $2.5 million during 1999 and $4.9 million during the year ended December 31, 2000. At December 31, 2000, using cash generated from operations Luminent had repaid approximately $6.5 million to MRV for interest-free advances Luminent made to MRV to cover payroll and other operating expenses. Like other customers, sales by Luminent to MRV-related customers are based on purchase orders and none of MRV or its companies has any long long-term arrangements with Luminent regarding purchases. MRV believes that its and its companies purchases from Luminent have been on terms no less or more favorable that those Luminent provided to its other customers. Prior to Luminent's separation from MRV, Luminent entered into various agreements related to interim and ongoing relationships with MRV. These agreements provided for transitional services and support in the areas of data processing and telecommunications services (such as voice telecommunications and data transmission and information technology support services) for functions including accounting, financial management, tax, payroll, stockholder and public relations, legal, procurement and other administrative functions. Services were generally cost plus 5%, but could have increased to cost plus 10% if the services extended beyond a one-year period. Subsequent to the separation date, certain of these services were discontinued, including accounting, financial management, payroll, legal, procurement and other administrative functions. The transition period varies depending on the agreement but was generally one year. Although the fees provided for in the agreements were intended to represent the fair market value of these services, MRV and Luminent cannot assure that these fees necessarily reflected the costs of providing these services from unrelated third parties or of Luminent providing these services internally. However, Luminent and MRV believed that purchasing these services from MRV, and providing these services to Luminent, provided an efficient means of obtaining them during the transition period. With the Merger, these agreements have been terminated. 101 104 PRINCIPAL STOCKHOLDERS PRINCIPAL STOCKHOLDERS OF MRV The following table sets forth certain information regarding the beneficial ownership of the MRV common stock as of September 30, 2001, of - each person known by MRV to own beneficially 5% or more of MRV's common stock, - each current director of MRV owning MRV common stock, - each of MRV's Named Executive Officers, and - all current directors and executive officers as a group. The table does not give effect to the issuance of MRV Common Stock in the Merger.
COMMON STOCK ----------------------- NAME AND ADDRESS(1) NUMBER OF PERCENTAGE OF BENEFICIAL OWNER(2) OR IDENTITY OF GROUP SHARES OWNERSHIP ------------------------------------------- --------- ---------- Pilgrim Baxter & Associates Ltd.(3)......................... 6,387,600 8.2% Shlomo Margalit............................................. 3,342,060 4.3% Noam Lotan.................................................. 1,497,874(4) 1.9% Edmund Glazer............................................... 130,800(5) 0.2% William R. Spivey........................................... 316,315(6) 0.4% Guy Avidon.................................................. 36,000(6) * Igal Shidlovsky............................................. 62,000(6) * Guenter Jaensch............................................. 32,000(6) * Professor Daniel Tsui....................................... 6,000(6) * Professor Baruch Fischer.................................... 6,000(6) * All current executive officers and directors as a group (8 persons)(11).............................................. 4,981,934(7) 6.4%
------------------------- * Less than 1% (1) Except as noted below, the address of each of the person listed is c/o MRV Communications, Inc., 20415 Nordhoff Street, Chatsworth, California, Chatsworth, CA 91311. (2) Pursuant to the rules of the Securities and Exchange Commission, shares of MRV common stock that an individual or group has a right to acquire within 60 days pursuant to the exercise of options or warrants are deemed to be outstanding for the purpose of computing the percentage ownership of a particular individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table. (3) Based on Amendment No. 1 to Schedule 13D filed with the SEC on February 14, 2001. According to this document, the address of the firm listed is 825 Duportail Road, Wayne, PA 19087. Percentage ownership is based on number of shares beneficially owned, as reflected in the filing, divided by the number of shares outstanding on September 30, 2001. (4) Includes 12,000 shares issuable pursuant to stock options exercisable within 60 days of September 30, 2001. (5) Includes 36,400 shares issuable pursuant to stock options exercisable within 60 days of September 30, 2001. Mr. Glazer was killed in the terrorists attack on the World Trade Center on September 11, 2001 and the table reflects options owned by his estate. (6) Consists of shares issuable upon exercise of stock options within 60 days of September 30, 2001. Dr. Spivey resigned in September 2001. (7) Includes 186,000 shares issuable upon exercise of stock options within 60 days of September 30, 2001. 102 105 PRINCIPAL STOCKHOLDERS OF LUMINENT The table below sets forth certain information known to us with respect to the beneficial ownership of our common stock at September 30, 2001 by: - each stockholder owning 5% or more of Luminent's common stock; - each of Luminent's directors who beneficially owns Luminent common stock; - each of Luminent's current executive officers who beneficially owns Luminent common stock; and - all of Luminent's directors and executive officers as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of September 30, 2001 are deemed outstanding, while these shares are not deemed outstanding for purposes of computing percentage ownership of any other person. To MRV's knowledge, the persons and entities named in the table have sole voting and investment power with respect to all shares beneficially owned, subject to community property laws where applicable.
COMMON STOCK ------------------------- NAME AND ADDRESS OF NUMBER OF PERCENTAGE BENEFICIAL OWNER OR IDENTITY OF GROUP SHARES OWNERSHIP ------------------------------------- ----------- ---------- MRV Communications, Inc.(1)................................. 144,000,000 93.2% Eric Blachno(2)............................................. 400,000(3) * All directors and executive officers as a group............. 400,000(3) *
------------------------- * Less than one percent. (1) MRV's address is 20415 Nordhoff Street, Chatsworth, California 91311. (2) Mr. Blachno's address is Luminent, Inc., 20550 Nordhoff Street, Chatsworth, California 91311 (3) Consists of shares of Luminent common stock issuable upon exercise of stock options, which are currently exercisable or exercisable within 60 days of September 30, 2001. LEGAL MATTERS The validity of the issuance of MRV common stock offered hereby is being passed upon for MRV by Kirpatrick & Lockhart, LLP, Los Angeles, California. EXPERTS The consolidated financial statements of MRV Communications, Inc. included in this prospectus supplement and incorporated be reference elsewhere in the registration statement, to the extent and for the periods indicated in their report, have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said reports. The consolidated financial statements of Luminent, Inc. included in this prospectus supplement and elsewhere in the registration statement, to the extent and for the periods indicated in their report, have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said report. The financial statements of AstroTerra Corporation included in this prospectus supplement, to the extent and for the periods indicated in their report, have been audited by Arthur Andersen LLP, 103 106 independent public accountants, as indicated in their report with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said report. The financial statements of Fiber Optic Communications, Inc. and Optronics International Corp. included in this prospectus and elsewhere in the registration statement, to the extent and for the periods indicated in their report, have been audited by T N Soong & Co., a Member Firm of Andersen Worldwide, SC, independent public accountants, as indicated in their report with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said report. The consolidated financial statements of Quantum Optech Incorporation and Subsidiary as of December 31, 1998 and 1999 and for the period from May 27, 1999 (inception) to December 31, 1997 and for the years ended December 31, 1998 and 1999 have been included herein and in the registration statement in reliance upon the report of KPMG Certified Public Accountants, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. 104 107 INDEX TO FINANCIAL STATEMENTS
PAGE ----- CONSOLIDATED FINANCIAL STATEMENTS OF MRV COMMUNICATIONS, INC. Report of Independent Public Accountants.................... F-3 Consolidated Balance Sheets at December 31, 1999 and 2000... F-4 Consolidated Statements of Operations for the years ended December 31, 1998, 1999 and 2000.......................... F-5 Consolidated Statements of Stockholders' Equity and Comprehensive Loss for the years ended December 31, 1998, 1999 and 2000............................................. F-6 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1999 and 2000.......................... F-7 Notes to Consolidated Financial Statements.................. F-8 UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS OF MRV COMMUNICATIONS, INC. Condensed Consolidated Balance Sheets at December 31, 2000 and June 30, 2001 (unaudited)............................. F-29 Unaudited Condensed Consolidated Statements of Operations for the six months ended June 30, 2000 and 2001........... F-30 Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2000 and 2001........... F-31 Notes to Unaudited Condensed Consolidated Financial Statements................................................ F-32 CONSOLIDATED FINANCIAL STATEMENTS OF LUMINENT, INC. Report of Independent Public Accountants.................... F-38 Consolidated Balance Sheets at December 31, 1999 and 2000... F-39 Consolidated Statements of Operations for the years ended December 31, 1998, 1999 and 2000.......................... F-40 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1999 and 2000.............. F-41 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1999 and 2000.......................... F-42 Notes to Consolidated Financial Statements.................. F-43 UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS OF LUMINENT, INC. Condensed Consolidated Balance Sheets at December 31, 2000 and June 30, 2001 (unaudited)............................. F-59 Unaudited Condensed Consolidated Statements of Operations for the six months ended June 30, 2000 and 2001........... F-60 Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2000 and 2001........... F-61 Notes to Unaudited Condensed Consolidated Financial Statements................................................ F-62 FINANCIAL STATEMENTS OF ASTROTERRA CORPORATION Report of Independent Public Accountants.................... F-69 Balance Sheets at December 31, 1998 and 1999 and June 30, 2000 (unaudited).......................................... F-70 Statements of Operations for the years ended December 31, 1997, 1998 and 1999 and the six months ended June 30, 1999 and 2000 (unaudited)...................................... F-71 Statements of Stockholders' Equity for the years ended December 31, 1997, 1998 and 1999 (audited) and the six months ended June 30, 1999 and 2000 (unaudited)........... F-72 Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999 and the six months ended June 30, 1999 and 2000 (unaudited)...................................... F-73 Notes to Financial Statements............................... F-74 CONSOLIDATED FINANCIAL STATEMENTS OF FIBER OPTIC COMMUNICATIONS, INC. Independent Auditors' Report................................ F-82 Consolidated Balance Sheets at December 31, 1997, 1998 and 1999...................................................... F-83 Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 1997, 1998 and 1999...................................................... F-84
F-1 108
PAGE ----- Consolidated Statements of Shareholders' Equity for the years ended December 31, 1997, 1998 and 1999.............. F-85 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999.......................... F-86 Notes to Consolidated Financial Statements.................. F-87 FINANCIAL STATEMENTS OF OPTRONICS INTERNATIONAL CORP. Independent Auditors' Report................................ F-103 Balance Sheets at December 31, 1997, 1998 and 1999.......... F-104 Statements of Operations and Comprehensive Income for the years ended December 31, 1997, 1998 and 1999.............. F-105 Statements of Shareholders' Equity for the years ended December 31, 1997, 1998 and 1999.......................... F-106 Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999....................................... F-107 Notes to Financial Statements............................... F-108 Balance Sheets at December 31, 1999 and June 30, 2000 (unaudited)............................................... F-119 Statements of Operations and Comprehensive Income for the six months ended June 30, 1999 and 2000 (unaudited)....... F-120 Statements of Cash Flows for the six months ended June 30, 1999 and 2000 (unaudited)................................. F-121 Notes to Financial Statements (Unaudited)................... F-122 CONSOLIDATED FINANCIAL STATEMENTS OF QUANTUM OPTECH INCORPORATION AND SUBSIDIARY Independent Auditors' Report................................ F-131 Consolidated Balance Sheets at December 31, 1998 and 1999... F-132 Consolidated Statements of Operations and Comprehensive Income (Loss) for the period from May 27, 1997 (inception) to December 31, 1997 and years ended December 31, 1998 and 1999...................................................... F-133 Consolidated Statements of Stockholders' Equity for the period for May 27, 1997 (inception) to December 31, 1997 and years ended December 31, 1998 and 1999................ F-134 Consolidated Statements of Cash Flows for the period from May 27, 1997 (inception) to December 31, 1997 and years ended December 31, 1998 and 1999.......................... F-135 Notes to Consolidated Financial Statements.................. F-136 Consolidated Balance Sheet at June 30, 2000 (unaudited)..... F-146 Consolidated Statements of Operations and Comprehensive Income (Loss) for the six months ended June 30, 1999 and 2000 (unaudited).......................................... F-147 Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and 2000 (unaudited).................. F-148 Notes to Consolidated Financial Statements (unaudited)...... F-149 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION OF MRV COMMUNICATIONS, INC. Unaudited Pro Forma Condensed Consolidated Financial Information............................................... F-153 Unaudited Pro Forma Condensed Consolidated Balance Sheet at June 30, 2001............................................. F-154 Unaudited Pro Forma Condensed Consolidated Statement of Operations for the six months ended June 30, 2001......... F-155 Unaudited Pro Forma Condensed Consolidated Statement of Operations for the year ended December 31, 2000........... F-156 Notes to Unaudited Pro Forma Condensed Consolidated Financial Information..................................... F-157 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION OF LUMINENT, INC. Unaudited Pro Forma Condensed Consolidated Financial Information............................................... F-150 Unaudited Pro Forma Condensed Consolidated Statements of for the year ended December 31, 2000.......................... F-151 Notes to Unaudited Pro Forma Condensed Consolidated Financial Information..................................... F-152
F-2 109 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To MRV Communications, Inc.: We have audited the accompanying consolidated balance sheets of MRV Communications, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1999 and 2000, and the related consolidated statements of operations, stockholders' equity and comprehensive loss and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MRV Communications, Inc. and subsidiaries as of December 31, 1999 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP -------------------------------------- Arthur Andersen LLP Los Angeles, California February 19, 2001 (except for matters discussed in Note 18 as to which the date is October 4, 2001) F-3 110 MRV COMMUNICATIONS, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, ---------------------- 1999 2000 -------- ---------- ASSETS Current assets: Cash and cash equivalents.......................................................... $ 34,330 $ 210,080 Short-term investments............................................................. 10,141 73,947 Accounts receivable, net of allowance of $8,451 in 1999 and $10,330 in 2000........ 60,637 61,863 Inventories........................................................................ 35,392 77,005 Refundable income taxes............................................................ 3,216 -- Deferred income taxes.............................................................. 6,907 31,227 Other current assets............................................................... 6,336 22,750 -------- ---------- Total current assets......................................................... 156,959 476,872 Property and equipment, at cost: Land............................................................................... -- 3,559 Building........................................................................... 3,814 19,563 Machinery and equipment............................................................ 12,598 57,369 Furniture and fixtures............................................................. 4,233 12,824 Computer hardware and software..................................................... 12,913 10,823 Leasehold improvements............................................................. 3,053 7,221 Construction in progress........................................................... -- 3,815 -------- ---------- 36,611 115,174 Less -- Accumulated depreciation and amortization.................................. (17,011) (42,905) -------- ---------- 19,600 72,269 Other assets: Investments........................................................................ 101,936 31,734 Deferred income taxes.............................................................. 5,324 6,209 Goodwill and other intangibles, net................................................ 27,214 504,027 Other.............................................................................. 3,500 5,660 -------- ---------- 137,974 547,630 -------- ---------- $314,533 $1,096,771 ======== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of capital lease obligations....................................... $ 198 $ 163 Current portion of long-term debt.................................................. -- 2,774 Short-term obligations............................................................. -- 9,104 Accounts payable................................................................... 33,455 56,088 Accrued liabilities................................................................ 15,403 34,044 Income taxes payable............................................................... -- 6,477 Deferred revenue................................................................... 1,478 1,470 -------- ---------- Total current liabilities.................................................... 50,534 110,120 Long-term liabilities: Convertible subordinated notes..................................................... 90,000 89,646 Capital lease obligations, net of current portion.................................. 1,481 621 Long-term debt, net of current portion............................................. -- 60,257 Other long-term liabilities........................................................ 2,928 3,980 -------- ---------- Total long-term liabilities.................................................. 94,409 154,504 Commitments and contingencies Minority interest.................................................................... 2,775 50,592 Stockholders' equity: Preferred stock, $0.01 par value: Authorized -- 1,000 shares; no shares issued or outstanding...................... -- -- Common stock, $0.0017 par value: Authorized -- 160,000 shares Issued -- 56,282 shares in 1999 and 73,327 in 2000 Outstanding -- 56,234 shares in 1999 and 73,279 in 2000.......................... 96 126 Additional paid-in capital......................................................... 191,468 1,060,650 Accumulated deficit................................................................ (18,377) (171,330) Deferred stock compensation, net................................................... -- (100,862) Treasury stock, 48 shares at cost in 1999 and 2000................................. (133) (133) Accumulated other comprehensive loss............................................... (6,239) (6,896) -------- ---------- Total stockholders' equity................................................... 166,815 781,555 -------- ---------- $314,533 $1,096,771 ======== ==========
The accompanying notes are an integral part of these consolidated balance sheets. F-4 111 MRV COMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 1998 1999 2000 -------- -------- --------- Revenues, net............................................. $264,075 $288,524 $ 319,394 Costs and expenses: Cost of goods sold(1)................................... 165,385 197,442 203,371 Research and development(1)............................. 25,817 35,319 74,078 Selling, general and administrative(1).................. 53,852 67,859 124,700 Amortization of goodwill and other intangibles.......... 2,901 3,898 66,814 Purchased technology in progress........................ 20,633 -- -- Restructuring costs..................................... 15,671 -- -- -------- -------- --------- 284,259 304,518 468,963 -------- -------- --------- Operating loss....................................... (20,184) (15,994) (149,569) Other income (expense): Interest expense........................................ (2,480) (4,500) (10,129) Minority interest....................................... (1,345) 610 796 Interest income and other............................... 6,819 4,822 551 -------- -------- --------- 2,994 932 (8,782) -------- -------- --------- Loss before provision (benefit) for income taxes and extraordinary item................................. (17,190) (15,062) (158,351) Provision (benefit) for income taxes...................... 5,707 (2,153) (5,398) -------- -------- --------- Loss before extraordinary item....................... (22,897) (12,909) (152,953) Extraordinary item: Gain on repurchase of convertible notes, net of tax of $1,639............................................... 2,791 -- -- -------- -------- --------- Net loss............................................. $(20,106) $(12,909) $(152,953) ======== ======== ========= Loss per share information: Basic and diluted loss per share.......................... $ (0.38) $ (0.24) $ (2.33) Basic and diluted weighted average shares outstanding..... 53,064 53,920 65,669 ======== ======== =========
------------------------- (1) Includes amounts relating to deferred stock compensation of $8.3 million, $13.2 million and $38.4 million presented in "cost of goods sold", "research and development" and "selling, general and administrative", respectively, for the year ended December 31, 2000. The accompanying notes are an integral part of these consolidated financial statements. F-5 112 MRV COMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS (IN THOUSANDS)
ACCUMULATED COMMON STOCK ADDITIONAL RETAINED OTHER --------------- PAID-IN DEFERRED STOCK EARNINGS TREASURY COMPREHENSIVE SHARES AMOUNT CAPITAL COMPENSATION (DEFICIT) STOCK LOSS TOTAL ------ ------ ---------- -------------- --------- -------- ------------- --------- BALANCE, DECEMBER 31, 1997..... 52,720 $ 90 $ 175,872 $ -- $ 14,635 $ -- $ (628) $ 189,969 Exercise of stock warrants and options................ 606 1 1,509 -- -- -- -- 1,510 Issuance of warrants in connection with the acquisition of Xyplex...... -- -- 3,272 -- -- -- -- 3,272 Purchase of treasury stock... (48) -- -- -- -- (133) -- (133) Comprehensive loss: Translation adjustments.... -- -- -- -- -- -- (83) (83) Net loss................... -- -- -- -- (20,106) -- -- (20,106) --------- Comprehensive loss........... -- -- -- -- -- -- -- (20,189) ------ ---- ---------- --------- --------- ----- ------- --------- BALANCE, DECEMBER 31, 1998..... 53,278 91 180,653 -- (5,471) (133) (711) 174,429 Exercise of stock warrants and options................ 2,156 4 2,816 -- -- -- -- 2,820 Exercise of stock warrants by Intel Corporation.......... 800 1 7,999 -- -- -- -- 8,000 Other........................ -- -- -- -- 3 -- -- 3 Comprehensive loss: Translation adjustments.... -- -- -- -- -- -- (5,528) (5,528) Net loss................... -- -- -- -- (12,909) -- -- (12,909) --------- Comprehensive loss........... -- -- -- -- -- -- -- (18,437) ------ ---- ---------- --------- --------- ----- ------- --------- BALANCE, DECEMBER 31, 1999..... 56,234 96 191,468 -- (18,377) (133) (6,239) 166,815 Exercise of stock options.... 2,896 5 7,757 -- -- -- -- 7,762 Tax benefit from exercise of stock options.............. -- -- 11,417 -- -- -- -- 11,417 Issuance of common stock in connection with acquisitions............... 14,123 25 639,172 -- -- -- -- 639,197 Issuance of common stock in connection with conversion of convertible subordinated notes...................... 26 -- 354 -- -- -- -- 354 Effect of subsidiary equity transactions............... -- -- 49,679 -- -- -- -- 49,679 Deferred stock compensation............... -- -- 160,803 (160,803) -- -- -- -- Amortization of deferred stock compensation......... -- -- -- 59,941 -- -- -- 59,941 Comprehensive loss: Net loss................... -- -- -- -- (152,953) -- -- (152,953) Translation adjustments.... -- -- -- -- -- -- (657) (657) --------- Comprehensive loss........... -- -- -- -- -- -- -- (153,610) ------ ---- ---------- --------- --------- ----- ------- --------- BALANCE, DECEMBER 31, 2000..... 73,279 $126 $1,060,650 $(100,862) $(171,330) $(133) $(6,896) $ 781,555 ====== ==== ========== ========= ========= ===== ======= =========
The accompanying notes are an integral part of these consolidated financial statements. F-6 113 MRV COMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE THREE YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1999 2000 ----------- ---------- ----------- Cash Flows From Operating Activities: Net loss.................................................. $ (20,106) $(12,909) $(152,953) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization......................... 7,902 12,501 77,871 Amortization of deferred stock compensation expense... -- -- 59,941 Allowance for doubtful accounts....................... 2,591 1,416 4,683 Deferred income taxes................................. 1,408 (1,302) (25,205) Realized gain on investment........................... (2,535) -- (50) Purchased technology in progress...................... 20,633 -- -- Extraordinary gain on repurchase of convertible subordinated notes................................. (2,791) -- -- Loss on disposition of property and equipment......... -- -- 16 Tax benefit from stock option exercises............... -- -- 11,417 Other................................................. 324 -- -- Minority interests' share of income (loss)............ 1,345 (610) (796) Changes in operating assets and liabilities, net of effects from acquisitions: Accounts receivable..................................... 12,263 (7,457) 4,949 Inventories............................................. 3,453 12,075 (28,869) Refundable income taxes................................. -- -- 3,216 Other assets............................................ 2,008 (519) (12,020) Accounts payable........................................ (19,505) 3,698 28,939 Accrued liabilities..................................... (7,438) 1,715 4,040 Income taxes payable.................................... (7,006) (3,661) (5,154) Deferred revenue........................................ 508 (2,920) 175 --------- -------- --------- Net cash provided by (used in) operating activities....................................... (6,946) 2,027 (29,800) Cash Flows From Investing Activities: Purchases of property and equipment....................... (6,337) (8,053) (23,977) Proceeds from sale of property and equipment.............. -- -- 1,520 Purchases of investments.................................. (206,846) (19,242) (21,566) Proceeds from sale of investments......................... 173,714 38,293 97,704 Cash used in acquisitions, net of cash received........... (44,695) (4,773) (44,517) --------- -------- --------- Net cash provided by (used in) investing activities....................................... (84,164) 6,225 9,164 Cash Flows From Financing Activities: Net proceeds from subsidiary equity transaction........... -- -- 132,290 Net proceeds from issuance of common stock................ 1,510 10,820 7,762 Proceeds from issuance of convertible debentures, net..... 96,423 -- -- Borrowings on short-term obligations...................... -- -- 35,887 Payments on short-term obligations........................ -- -- (35,949) Principal payments on capital lease obligations........... (62) 94 (163) Borrowings on long-term debt.............................. -- -- 62,696 Payments on long-term debt................................ -- -- (4,002) Repurchase of convertible notes........................... (5,300) -- -- Purchase of treasury stock................................ (133) -- -- --------- -------- --------- Net cash provided by financing activities.......... 92,438 10,914 198,521 Effect of exchange rate changes on cash and cash equivalents............................................... (64) (5,528) (2,135) Net increase in cash and cash equivalents................... 1,264 13,638 175,750 Cash and cash equivalents, beginning of year................ 19,428 20,692 34,330 --------- -------- --------- Cash and cash equivalents, end of year...................... $ 20,692 $ 34,330 $ 210,080 ========= ======== =========
The accompanying notes are an integral part of these consolidated financial statements. F-7 114 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 1. BUSINESS AND BASIS OF PRESENTATION MRV Communications, Inc. (a Delaware corporation, MRV or the Company) creates, acquires, finances and operates companies, and through them, designs, develops, manufactures and markets products, which enable high-speed broadband communications. MRV concentrates on companies and products devoted to optical components and Internet infrastructure systems. Such products include fiber optic components, switching, routing, transaction management and wireless optical transmission systems. MRV's strategy involves creating value for its stockholders and the other owners of its subsidiaries by helping the companies grow and access the public and private capital markets. As of December 31, 2000, MRV's more significant subsidiaries, development stage enterprises and other affiliated companies were as follows: Luminent, Inc, -- Luminent is a 92 percent-owned subsidiary of MRV designing, manufacturing and selling fiber optic components that enable communications equipment manufacturers to provide optical networking solutions for the rapidly growing metropolitan and access segments of the communications network. Its products are designed to meet the increasing bandwidth requirements between long-haul telecommunication networks and end users. Luminent specializes in singlemode fiber optic components and subsystems for high-capacity data transmission for long-reach applications in the metropolitan and access markets. Optical Access, Inc. -- Optical Access is a wholly-owned subsidiary of MRV designing, manufacturing and marketing optical wireless products that enable the delivery of high-speed communications traffic to the portion of the communications network commonly known as the last mile, which extends from the end user to the service provider's central office. Management believes its solution provides higher transmission capacity, or bandwidth, at a lower cost compared to other commercially available last mile solutions. CEScomm, Inc. -- CEScomm, formerly Creative Electronic Systems SA, is a wholly-owned subsidiary of MRV developing and providing equipment to manufacturers of cellular network infrastructure equipment and mobile operators and service providers for the third generation of wireless solutions for the next generation of mobile communications systems. These new systems provide enhanced services to those available today i.e. voice, text and data. CEScomm specializes in products that provide the real-time conversion of radio signals generated by Internet ready mobile devices into asynchronous transfer mode traffic streams. iTouch Communications, Inc. -- iTouch is wholly-owned subsidiary of MRV providing next-generation Internet infrastructure solutions that enable service providers and carriers to deliver and monitor, on a real-time basis, high-speed Internet services. iTouch's products combine transaction management with Internet protocol (IP) routing and wide area networks (WAN), high-speed data acquisition and management systems. NBase-Xyplex, Inc. -- NBas-Xyplex is a wholly-owned subsidiary of MRV providing products and services to enhance network infrastructures for city carriers, service providers, cable operators and campus and enterprise networks. Its products and technologies have been utilized in metropolitan area based fiber-based networks, enabling smart access to WAN, as well as in local area networks (LAN), switching, building enterprise/corporate data networks. Charlotte's Networks, Inc. -- Charlotte is a 90 percent-owned subsidiary of MRV developing a core router for large service providers and carriers. Its product is capable of carrying both IP packets and time-division multiplexing voice traffic and enables the current WAN to increase processing power and rate of transmission. In addition, the router provides multi-services required by telecommunication companies for efficient and flexible transmission of voice over data networks. F-8 115 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 Zuma Networks, Inc. -- Zuma is a wholly-owned subsidiary of MRV developing a next generation gigabit Ethernet switch router platform. Optical Crossing, Inc. -- Optical Crossing is a 60 percent-owned subsidiary of MRV designing, developing and manufacturing advanced fiber optic communication components and systems for the telecommunications industry. Zaffire, Inc. -- Zaffire is a 22 percent-owned, on a fully diluted basis, affiliate of MRV focused on developing a next-generation, optical services networking system for service providers. RedC Optical Networks, Inc. -- RedC is a 35 percent-owned, on a fully diluted basis, affiliate of MRV that has developed a complete line of optical modules used for operating, monitoring and protecting optical networks including: optical amplifiers, add/drop modules, protection and restoration modules and dense wave division multiplexing monitoring. Hyperchannel Ltd. -- Hyperchannel, which does business under its trademark Hyporium, is a 42 percent-owned, on a fully diluted basis, affiliate of MRV and an independent Internet market maker for the information technology industry (IT), enabling IT vendors, distributors and resellers to trade online. In November 2000, Luminent, a publicly owned subsidiary, completed an initial public offering of its common stock, selling 12.0 million shares at $12 per share and raising net proceeds of approximately $132.3 million. As of December 31, 2000, MRV owned 92% of the outstanding capital stock of Luminent. MRV has announced plans to distribute all of its shares of Luminent common stock to its stockholders on the later of three months after receipt of a favorable private letter ruling from the Internal Revenue Service or six months after the offering, although it is not obligated to do so. As of December 31, 2000, MRV owned all of the outstanding capital stock of Optical Access. On October 6, 2000, Optical Access filed a registration statement with the Securities and Exchange Commission (SEC) for the initial public offering of its common stock, which has not yet become effective. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of MRV and its wholly-owned and majority owned subsidiaries. All significant intercompany transactions and accounts have been eliminated. FOREIGN CURRENCY TRANSLATION Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Transactions and balances in other currencies are converted into U.S. dollars in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, "Foreign Currency Translation," and are included in determining net income or loss. 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 rates 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 loss. F-9 116 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 REVENUE RECOGNITION MRV generally recognizes product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable. Revenue related to software and software maintenance contracts (both of which are immaterial, individually and in aggregate) is recognized in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position No. 97-2, "Software Revenue Recognition." Maintenance revenues for customer support are deferred and recognized ratably over the term of the maintenance period, generally one to three years. MRV generally warrants its products against defects in materials and workmanship for one year. The estimated cost of warranty obligations is recognized at the time of revenue recognition. CASH AND CASH EQUIVALENTS MRV considers all highly liquid investments with an original maturity of 90 days or less to be cash equivalents. MRV maintains cash balances and investments in highly qualified financial institutions. At various times such amounts are in excess of insured limits. As of December 31, 2000, $132.9 million of cash, cash equivalents and short-term investments were held by MRV's publicly traded subsidiary, Luminent. INVESTMENTS MRV accounts for its investments under the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." As of December 31, 1999 and 2000, short and long-term investments consisted principally of U.S. Treasury notes. As defined by SFAS No. 115, MRV has classified its investments in these debt securities as "held-to-maturity" investments and all investments are recorded at their amortized cost basis, which approximated their fair value at December 31, 1999 and 2000. 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. Inventories consisted of the following as of December 31, 1999 and 2000 (in thousands):
1999 2000 ------- ------- Raw materials............................................... $ 8,475 $36,278 Work-in-process............................................. 8,083 17,721 Finished goods.............................................. 18,834 23,006 ------- ------- $35,392 $77,005 ======= =======
PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Useful lives range from three to thirty-three years. 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. F-10 117 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 GOODWILL AND OTHER INTANGIBLES Intangible assets represent intellectual property acquired, purchased intangible assets and the excess acquisition cost over the fair value of tangible and identified intangible net assets of the businesses acquired (goodwill). Purchased intangible assets include patents, assembled work forces, customer contracts and goodwill. Intangible assets are being amortized using the straight-line method over estimated useful lives ranging from 1 to 12 years. The components of intangible assets as of December 31, 1999 and 2000 are as follows (in thousands):
1999 2000 ------- -------- Patents..................................................... $ -- $ 64,600 Assembled work forces....................................... -- 1,790 Customer contracts.......................................... -- 720 Goodwill.................................................... 33,909 510,426 ------- -------- 33,909 577,536 Less -- Accumulated amortization............................ (6,695) (73,509) ------- -------- $27,214 $504,027 ======= ========
IMPAIRMENT OF INTANGIBLES AND OTHER LONG-LIVED ASSETS MRV evaluates its long-lived assets, such as patents, assembled work forces, customer contracts, goodwill and property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may be impaired. MRV considers a history of operating losses to be its primary indicator of potential impairment. An asset is deemed to be impaired if a forecast of undiscounted future operating cash flows directly related to the asset, including disposal value, if any, is less than its carrying amount. If an asset is determined to be impaired, the loss is measured as the amount by which the carrying value of the asset exceeds fair value. Considerable management judgment is necessary to estimate fair value. FAIR VALUE OF FINANCIAL INSTRUMENTS MRV's financial instruments, including cash and cash equivalents, investments, accounts receivable, accounts payable, accrued liabilities and short-term debt obligations are carried at cost, which approximates their fair market value due to the short-term nature of those instruments. The fair value of long-term debt obligations is estimated based on current interest rates available to MRV for debt instruments with similar terms, degrees of risk and remaining maturities. The carrying values of these obligations approximate their fair values. SOFTWARE DEVELOPMENT COSTS In accordance with SFAS No. 86, "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 in MRV's circumstances occurs when a working model is completed. After technological feasibility is established, additional costs would be 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. F-11 118 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 INCOME TAXES Deferred income tax assets and liabilities are computed based on the temporary differences between the financial statement and income tax bases of assets and liabilities using the statutory marginal income tax rate in effect for the years in which the differences are expected to reverse. Deferred income tax expenses or credits are based on the changes in the deferred income tax assets or liabilities from period to period. EARNINGS PER SHARE The following schedule summarizes the information used to compute earnings per share (in thousands, except per share data) for each of the three years in the period ended December 31, 2000:
1998 1999 2000 -------- -------- --------- Loss before extraordinary item............................ $(22,897) $(12,909) $(152,953) Extraordinary item -- gain on repurchase of convertible subordinated notes, net of tax.......................... 2,791 -- -- -------- -------- --------- Net loss........................................ $(20,106) $(12,909) $(152,953) ======== ======== ========= Weighted average number of shares used to compute basic and diluted loss per share.............................. 53,064 53,920 65,669 ======== ======== ========= Basic and diluted loss per share before extraordinary item.................................................... (0.43) (0.24) (2.33) Extraordinary gain per basic and diluted share............ 0.05 -- -- -------- -------- --------- Basic and diluted loss per share.......................... (0.38) (0.24) (2.33) ======== ======== =========
STOCK-BASED COMPENSATION MRV accounts for its employee stock plan under the intrinsic value method prescribed by Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," and related interpretations, and has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." MRV accounts for option and warrant grants to non-employees using the guidance prescribed by SFAS No. 123, Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 44, "Accounting for Certain Transactions Involving Stock Compensation (an interpretation of APB Opinion No. 25)," and Emerging Issue Task Force (EITF) No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or In Conjunction with Selling, Goods, or Services," whereby the fair value of such option and warrant grants are measured using the fair value at the earlier of the date at which the non-employee's performance is completed or a performance commitment is reached. Deferred stock compensation charges are being amortized using the graded vesting method. Using this method, approximately 57%, 26%, 13% and 4%, respectively, of each option's compensation expense is amortized in each of the four years following the date of grant. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998 and June 1999, the FASB issued SFAS No. 133, "Accounting for Derivative Investments and Hedging Activities," and SFAS No. 137, which delayed the effective date of SFAS No. 133. In June 2000, the FASB issued SFAS No. 138, which provides additional guidance for the application of SFAS No. 133 for certain transactions. MRV will adopt the statement in January 2001 and F-12 119 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 does not expect the adoption of this statement to have a material impact on its financial position or results of operations. In December 1999, the SEC issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements," and related interpretations. SAB 101 summarizes certain of the SEC's views in applying accounting principles generally accepted in the Unites States to revenue recognition in financial statements. MRV has applied the provisions of SAB 101, which did not have a material impact on its financial position or results of operations. In March 2000, the FASB issued FIN 44, which clarifies the application of APB No. 25 for certain issues, including the definition of an employee, the treatment of the acceleration of stock options and the accounting treatment for options assumed in business combinations. FIN 44 became effective on July 1, 2000, but is applicable for certain transactions dating back to December 1998. The adoption of FIN 44 did not have a significant impact on MRV's financial position or results of operations. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect 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. F-13 120 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform with the current year presentation. 3. BUSINESS ACQUISITIONS The following table presents information about acquisitions by MRV in each of the three years in the period ended December 31, 2000. All of these acquisitions were accounted for under the purchase method of accounting, and the results of operations of each business have been included in the accompanying consolidated statements of operations from the date of acquisition.
DATE OF TOTAL FORM OF CONSIDERATION AND ACQUIRED COMPANY ACQUISITION CONSIDERATION OTHER NOTES TO ACQUISITION ---------------- ---------------- -------------- ------------------------------ YEAR ENDED DECEMBER 31, 2000 Fiber Optic Communications, April 24, 2000 $310.4 million $48.6 million in cash and 5.4 Inc. million shares of common stock and options issued; approximately 97% of capital stock assumed; goodwill recorded of $261.6 million; deferred stock compensation recorded of $14.1 million. Jolt Limited May 1, 2000 $57.7 million 1.9 million shares of common stock and options issued; 100% of capital stock assumed; goodwill and intangibles recorded of $33.7 million; deferred stock compensation recorded of $25.0 million. Quantum Optech Inc. July 12, 2000 $36.2 million 1.2 million shares of common stock and options issued; 100% of capital stock assumed; goodwill recorded of $27.9; deferred stock compensation recorded of $2.7 million. AstroTerra Corporation July 12, 2000 $160.3 million 2.4 million shares of common stock and options issued; 100% of capital stock assumed; goodwill and intangibles recorded of $108.3 million; deferred stock compensation recorded of $50.0 million. Optronics International Corp. July 21, 2000 $124.3 million 4.2 million shares of common stock and options issued; approximately 99% of capital stock assumed; goodwill recorded of $99.5 million; deferred stock compensation recorded of $13.4 million.
F-14 121 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000
DATE OF TOTAL FORM OF CONSIDERATION AND ACQUIRED COMPANY ACQUISITION CONSIDERATION OTHER NOTES TO ACQUISITION ---------------- ---------------- -------------- ------------------------------ Other Various $15.0 million 507,000 shares of common stock issued; 100% of capital stock assumed; goodwill recorded of $14.4 million. YEAR ENDED DECEMBER 31, 1998 Whittaker Xyplex, Inc.(1) January 30, 1998 $38.3 million $35.0 million in cash and 843,000 options to purchase common stock issued. 100% of capital stock assumed; $20.6 million in-process technology expensed(2); goodwill recorded of $10.3 million.
------------------------- (1) Whittaker Xyplex, Inc.'s name was subsequently changed to Nbase-Xyplex and most recently, to iTouch Communications. (2) Technology In-process was valued according to the "milestone" or percentage complete method. The following unaudited pro forma financial information presents the combined results of operations of these acquisitions as if the acquisitions had occurred as of January 1, 1999, giving effect to certain adjustments, including amortization of goodwill and other intangibles and deferred stock compensation charges. The unaudited pro forma share data assumes the shares issued in connection with these acquisitions were outstanding as of January 1, 1999. (in thousands, except per share amounts, unaudited).
DECEMBER 31, ---------------------- 1999 2000 --------- --------- Pro forma revenue........................................... $ 322,645 $ 335,486 Pro forma net loss.......................................... $(115,775) $(143,044) Pro forma basic and diluted net loss per share.............. $ (1.75) $ (1.83) Pro forma basic and diluted weighted average shares outstanding............................................... 66,247 77,996 ========= =========
F-15 122 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 4. INVESTMENTS IN SUBSIDIARIES The following table presents information regarding investments made by MRV in subsidiaries accounted for under the equity method of accounting or consolidated. Subsidiaries in which MRV owns greater than 50% ownership or exercises control have been consolidated in the accompanying consolidated financial statements.
SUBSIDIARY OWNERSHIP % FORM OF CONSIDERATION ---------- ----------- --------------------- EDSLan SRL 80%(1) Purchased an additional 10% ownership in 2000 for approximately $1.5 million; purchased an additional 10% ownership in 1999 for approximately $1.5 million; purchased an additional 10% ownership in 1997 for approximately $500,000; purchased 50% ownership in 1996 for approximately $1.1 million. Tecnonet SRL 60%(2) Purchased an additional 10% ownership in 1999 for approximately $600,000; purchased 50% ownership in 1998 for approximately $3.1 million. RDS 62.5% Purchased an additional 12.5% ownership in 1999 for approximately $2.4 million; purchased 50% ownership in 1998 for approximately $8.0 million. Charlotte's Networks 90%(3) Issued 1.0 million shares of common stock valued at approximately $61.5 million for approximately 10% in 2000. RedC Optical 35% $5.0 in cash and issued 150,000 shares of common stock valued at approximately $11.5 million for approximately 32% in 2000. Other Various(4) Issued 646,000 shares of common stock valued at approximately $16.7 million for ownership interest in various non-consolidated equity investments.
------------------------- (1) MRV receives 95 percent of EDSLan's profits or losses from the date of each investment. (2) MRV receives 90 percent of Tecnonet's profits or losses from the date of each investment. (3) MRV's ownership on a fully diluted basis (assuming exercise of all stock options) is approximately 53 percent. (4) Represents various investments, all of which are less than 50% ownership and not consolidated. Income and losses from non-consolidated equity method subsidiaries are included in "other income (expense)" in the accompanying consolidated statements of operations. 5. ACCRUED LIABILITIES Accrued liabilities consisted of the following (in thousands):
1999 2000 ------- ------- Payroll and related......................................... $ 7,055 $16,851 Other....................................................... 8,348 17,193 ------- ------- $15,403 $34,044 ======= =======
F-16 123 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 6. INCOME TAXES The provision (benefit) for income taxes for the three years in the period ended December 31, 2000 (including provision of $1.6 million related to the extraordinary gain in 1998) is as follows (in thousands):
1998 1999 2000 ------ ------- -------- Current Federal............................................. $3,306 $(2,139) $ 7,344 State............................................... 1,093 (413) 5,622 Foreign............................................. 3,324 1,701 6,841 ------ ------- -------- 7,723 (851) 19,807 Deferred Federal............................................. (176) (1,487) (17,354) State............................................... (31) 45 (7,137) Foreign............................................. (170) 140 (714) ------ ------- -------- (377) (1,302) (25,205) ------ ------- -------- $7,346 $(2,153) $ (5,398) ====== ======= ========
The income tax provision (benefit) differs from the amount computed by applying the federal statutory income tax rate to income before taxes as follows:
FOR THE YEARS ENDED DECEMBER 31, -------------------- 1998 1999 2000 ---- ---- ---- Income tax provision (benefit) at statutory federal rate.... (35)% 34% 34% State and local income taxes, net of federal income tax effect.................................................... (6) 6 6 Permanent differences....................................... -- (15) (30) Research and development credit............................. 6 6 -- Income tax on extraordinary gain............................ (10) -- Foreign taxes at rates different than domestic rates........ 2 (17) (3) Change in valuation reserve................................. -- -- (10) --- --- --- (43)% 14% (3)% === === ===
F-17 124 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 The components of deferred income taxes as of December 31, 1999 and 2000 are as follows (in thousands):
1999 2000 ------- -------- Allowance for doubtful accounts............................. $ 2,548 $ 2,083 Inventory reserve........................................... 3,811 6,133 Warranty reserve............................................ 1,072 647 Deferred stock compensation................................. -- 6,630 Net operating losses........................................ -- 29,014 Accrued liabilities......................................... -- 2,158 Other....................................................... (524) 1,463 ------- -------- 6,907 48,128 Valuation allowance.................................... -- (16,901) ------- -------- Net short-term deferred income tax assets.............. 6,907 31,227 Purchased technology in progress............................ 5,724 -- Depreciation and amortization............................... (400) 6,209 ------- -------- Net long-term deferred income tax assets............... 5,324 6,209 ------- -------- $12,231 $ 37,436 ======= ========
Realization of the net deferred tax assets is dependent on MRV's ability to carry losses back to prior periods or on generating sufficient taxable income during the periods in which temporary differences will reverse. Management reviews its deferred tax assets and has provided a valuation allowance based on its assessment of the expected future benefit to be ultimately received from each asset identified. Although realization is not assured, management believes it is more likely than not that the net deferred tax assets will be realized. As of December 31, 2000, MRV had net operating loss carryforwards available of approximately $106.8 million and $56.4 million for federal and state income tax purposes, respectively, which can be used to offset future taxable income, expiring through 2015. In 1995, MRV, through a subsidiary in Israel, qualified for a program under which it is eligible for a tax exemption on its income for a period of ten years from the beginning of the benefits period. This benefit is due to expire in 2006. Due to operating losses at this subsidiary, no tax benefit was received in 2000. MRV received a tax benefit of approximately $300,000 in 1999. MRV does not provide United States federal income taxes on the undistributed earnings of its foreign operations. MRV's policy is to leave the income permanently invested in the country of origin. Such amounts will only be distributed to the United States to the extent any federal income tax can be fully offset by foreign tax credits. 7. SHORT-TERM OBLIGATIONS Short-term obligations consist of secured and unsecured lines of credit, short-term loans and notes entered into with certain financial institutions. As of December 31, 2000, these short-term obligations totaled $9.1 million. Approximately $2.9 million in assets of MRV's subsidiaries have been pledged as collateral on these borrowings. The weighted average interest rate on these obligations is 6.1 percent. These obligations are incurred and settled in the local currencies of the respective subsidiaries. As of December 31, 2000, MRV had approximately $8.7 million of available short-terms borrowings. F-18 125 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 8. LONG-TERM DEBT Long-term debt consisted of the following as of December 31, 2000 (in thousands): Secured notes payable to financial institutions bearing interest ranging from 6.5% to 18.0%, payable in monthly and quarterly installments of principal and interest through October 2012...................................... $13,031 Term loan with a financial institution bearing interest at 7.0% as of December 31, 2000, payable in full in 2003..... 50,000 ------- 63,031 Less -- Current portion................................... (2,774) ------- $60,257 =======
The following summarizes the required principal payments on long-term debt as of December 31, 2000 (in thousands):
YEAR ENDING DECEMBER 31, 2001...................................................... $ 2,774 2002...................................................... 1,905 2003...................................................... 52,061 2004...................................................... 1,666 2005...................................................... 1,608 Thereafter................................................ 3,017 ------- $63,031 =======
Certain assets of MRV, primarily through its foreign subsidiaries, have been pledged as collateral under these obligations. 9. INTEREST RATE SWAP In April 2000, MRV purchased an interest rate swap agreement with a financial institution. The purpose of this agreement is to establish a specific hedge to prevent interest fluctuations due to floating rate term debt. Under the agreement, MRV is committed to pay the financial institution interest based on a principal balance of $50.0 million at a fixed rate of 7.11 percent as of December 31, 2000) in exchange for the financial institution's commitment to pay MRV interest on the same principal at the one-month LIBOR rate (6.6 percent as of December 31, 2000). MRV includes the outcome of this interest rate swap agreement in interest expense ($217,000 for the year ended December 31, 2000). 10. CONVERTIBLE SUBORDINATED NOTES In June 1998, MRV completed a private placement of $100.0 million principal amount five-year, convertible subordinated notes (the Notes). The Notes bear interest at five percent per year, payable semi-annually, and are convertible into common stock at the option of the holders. The conversion rate is 73.94 shares of common stock per $1,000 principal amount of the Notes, equivalent to a conversion price of $13.52 per share, an initial premium above market price. The conversion rate is subject to adjustment in certain circumstances, including dividends payable in common stock, issuance of stock rights to all holders of common stock or stock splits or distributions to common stockholders in connection with a tender offer. If a change in control, as defined, occurs, the holders of the Notes have the right to require MRV to repurchase the Notes at face value along with any interest accrued. MRV has the right, after June 2001, F-19 126 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 to redeem the Notes at 102 percent of face value, and after June 2002 for 101 percent of face value. The Notes are not entitled to the benefits of any sinking fund. In connection with the private placement, MRV incurred costs of $4.0 million. These costs are being amortized using the effective interest method over five years, the life of the Notes. Amortization expense for the years ended December 31, 1999 and 2000 was $681,000 and $723,000, respectively. In November 1998, MRV repurchased $10.0 million of the Notes for $5.3 million. MRV recorded an extraordinary gain of $2.8 million, net of tax, related to the repurchase of the Notes. Included in this amount is the portion of the Notes amortization of expense of the costs attributable to the Notes repurchased. 11. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company leases all of its facilities and certain equipment under noncancelable capital and operating lease agreements expiring in various years through 2049. The aggregate minimum annual lease payments under leases in effect on December 31, 2000 were as follows (in thousands):
CAPITAL OPERATING LEASES LEASES ------- --------- 2001...................................................... $ 207 $ 3,756 2002...................................................... 200 3,007 2003...................................................... 200 2,256 2004...................................................... 152 777 2005...................................................... 64 467 Thereafter................................................ 68 2,242 ----- ------- $ 891 $12,505 ======= Less -- Amount representing interest...................... (107) ----- 784 Less -- Current portion................................... (163) ----- $ 621 =====
Annual rental expense under noncancelable operating lease agreements for the years ended December 31, 1998, 1999 and 2000 was $2.8 million, $4.7 million and $4.9 million, respectively. Subsequent to December 31, 2000 and subject to certain conditions, MRV has agreed to issue stock options to purchase MRV common stock and a subsidiary is common stock to former employees. Additionally, MRV will receive approximately 24% ownership in a new company formed by these former employees in exchange for the transfer of intellectual property from MRV to the new company. Should the certain conditions not be met, no stock options to purchase common stock or the transfer of intellectual property will result. Accordingly, due to the uncertainty, no amounts have been provided in the accompanying statements of operations for these items. ROYALTY COMMITMENT Through subsidiaries in Israel, MRV is obligated to the Office of the Chief Scientist of the Government of Israel (Chief Scientist) with respect to the government's participation in research and development expenses for certain products. Accordingly, MRV's royalty to the Chief Scientist is calculated F-20 127 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 at a rate of three percent to five percent of sales of such products developed with the participation up to the dollar amount of such participation. MRV received participation of $350,000 and $500,000 for the year ended December 31, 1998 and 1999, respectively. No participation was received for the year ended December 31, 2000. The remaining future obligation as of December 31, 2000 is approximately $913,000 which is contingent on generating sufficient sales of this selected product line. ACCOUNTS RECEIVABLE MRV, through foreign subsidiaries, has agreements with several financial institutions to sell its receivables with recourse; in the event of customer's default, MRV must repurchase the receivables. At December 31, 2000 the Company is contingently liable for approximately $23.4 million relating to such receivables sold with recourse. MRV believes that adequate provision has been made for losses on receivables with recourse. LITIGATION In December, 1996, Datapoint brought an action against Nbase Communications, Inc., a subsidiary of the Company ("Nbase") and several other defendants in the United States District Court, for the Eastern District of New York alleging infringement of two of Datapoint's patents related to LANs, more particularly to claimed improved LANs which interoperatively combine additional enhanced capability and/or which provide multiple different operational capabilities. In the same lawsuit, Datapoint alleges that other defendants including Dayna Communications, Inc., Sun Microsystems, Inc., Adaptec, Inc., International Business Machines Corporation, Lantronix and SVEC America Computer Corporation have infringed the same two patents. The Company has been advised that several other companies, including Intel Corporation and Cisco Systems, Inc., have also had actions brought against them by Datapoint with respect to the same two patents. The action against Nbase and its codefendants seeks, among other things, an injunction against the manufacture or sale of products which embody the inventions set forth in the two patents and single and treble damages for the alleged infringement. Datapoint's complaint also seeks to have the court determine that the named defendants shall serve as representatives of a defendant class of manufacturers, vendors and users of products allegedly infringing on Datapoint's claimed patents from which defendant class Datapoint seeks the same relief as from the individual defendants. In February 1999, the court entered judgement in favor of the defendants and Datapoint filed a notice of appeal. The Company is cooperating with several of the defendants in pursuit of common defenses and believes the claim is without merit. If a conclusion unfavorable to the Company is reached, however, Datapoint's claim could materially affect the business, operating results and financial condition of the Company. The Company has received notices from third party alleging possible infringement of patents with respect to product features or manufacturing processes. Management believes such notices are common in the communications industry because of the large number of patents that have been filed on these subjects. The Company's policy is to discuss these notices with the senders in an effort to demonstrate that the Company's products and/or processes do not violate any patents. The Company is currently involved in such discussions with Lucent, Ortel, Rockwell and the Lemelson Foundation. The Company does not believe that any of its products or processes violate any of the patents asserted by these parties and the Company further believes that it has meritorious defenses if any legal action is taken by any of these parties. However, if one or more of these parties was to assert a claim and gain a conclusion unfavorable to the Company such claims could materially and adversely affect the business, operating results and financial condition of the Company. F-21 128 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 From time to time, MRV is a defendant in lawsuits involving matters which are routine to the nature of its business. Management is of the opinion that the ultimate resolution of all such matters will not have a material adverse effect on the accompanying consolidated financial statements. 12. STOCKHOLDERS' EQUITY AUTHORIZED SHARES On May 10, 2000, the Board of Directors and stockholders of MRV approved an increase in the authorized number of shares of its $0.0017 par value common stock from 80.0 million to 160.0 million shares relating to the two-for-one stock split distributed on May 26, 2000. MRV is authorized to issue up to 1.0 million shares of its $0.01 par value preferred stock, of which none has been issued or outstanding as of December 31, 1999 and 2000. STOCK SPLIT The Board of Directors authorized the splitting of MRV's common stock on a two-for-one basis for stockholders of record on May 11, 2000 and the resulting shares from the split were distributed on May 26, 2000. All references to share and per-share data for all periods presented have been adjusted to give effect to this two-for-one stock split. STOCK OPTIONS MRV has various stock option and warrant plans that provide for granting options and warrants to purchase shares of MRV's common stock to employees, directors and non-employees performing consulting or advisory services for MRV. The plans provide for the granting of options, which meet the Internal Revenue Code requirements for qualification as incentive stock options, as well as nonstatutory options. Under these plans, stocks option and warrant exercise prices generally equal the fair market value of MRV's common stock at the date of grant. The options and warrants generally vest over three to five years with expiration dates ranging from six and ten years from the date of grant depending on the plan. The plans provide for the issuance of 13.4 million shares of common stock over the remaining life of the plans. Stock option information with respect to MRV's stock option and warrant plans is as follows:
1998 1999 2000 ------------------ ------------------ ------------------ WTD. AVG. WTD. AVG. WTD. AVG. SHARES EX. PRICE SHARES EX. PRICE SHARES EX. PRICE ------ --------- ------ --------- ------ --------- Outstanding, beginning of year.............. 2,416 $4.39 4,082 $2.49 3,980 $4.36 Granted..................................... 2,000 9.24 1,122 9.21 5,959 8.14 Exercised................................... (236) 2.26 (744) 2.31 (1,660) 2.52 Forfeited................................... (98) 5.55 (480) 2.63 (67) 2.56 Cancelled in repricing...................... (2,996) 8.93 -- -- -- -- Granted in repricing........................ 2,996 2.63 -- -- -- -- Outstanding, end of year.................... 4,082 $2.49 3,980 $4.36 8,212 $6.29
F-22 129 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 Information about stock options outstanding at December 31, 2000 is summarized as follows:
NUMBER OUTSTANDING WEIGHTED AVERAGE NUMBER EXERCISABLE EXERCISE PRICE AS OF 2000 REMAINING CONTRACT LIFE AS OF 2000 -------------- ------------------ ----------------------- ------------------ $1.82 - $2.63 3,511 6.29 Years 3,337 $2.75 - $2.94 1,081 8.09 Years 221 $3.00 - 33.00 3,620 9.55 Years 322 ----- ----- 8,212 3,880 ===== =====
ACCOUNTING FOR STOCK-BASED COMPENSATION SFAS No. 123 permits companies to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Because MRV's stock-based compensation plans have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, management believes that the existing option valuation models do not necessarily provide a reliable single measure of the fair value of a wards from the plan. Therefore, as permitted, MRV applies the existing accounting rules under APB No. 25 and provides pro forma net income (loss) and pro forma earnings (loss) per share disclosures for stock-based awards made during the year as if the fair value method defined in SFAS No. 123 had been applied. Net loss and net loss per share for each of the three years in the period ended December 31, 2000 would have increased to the following pro forma amounts (in thousands, except per share data):
1998 1999 2000 -------- -------- --------- Additional compensation expense................... $ 1,835 $ 2,888 $ 24,998 Pro forma net loss................................ $(21,941) $(15,797) $(177,951) Pro forma basic net loss per share................ $ (0.41) $ (0.29) $ (2.71) Pro forma diluted net loss per share.............. $ (0.41) $ (0.29) $ (2.71)
The following assumptions were applied: (i) no expected dividend yield for all periods, (ii) expected volatility ranging from 22 percent to 162 percent, (iii) expected lives of 4 to 6 years for all years, (iv) and risk-free interest rates ranging from 4.23 percent to 6.73 percent for all years. COMMON STOCK PURCHASE WARRANTS In connection with various public and private offerings of common stock and acquisitions MRV has issued warrants to purchase additional shares of common stock. F-23 130 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 A summary of warrant activities for the three years ended December 31, 2000 is as follows (in thousands, except share prices):
NUMBER OF SHARES EXERCISE PRICES ---------------- --------------- Balance, December 31, 1997............................. 5,212 $0.14 to 16.25 Issued............................................... 842 17.50 Exercised............................................ (132) 2.13 to 2.80 Canceled............................................. (152) 4.21 ------ -------------- Balance, December 31, 1998............................. 5,770 0.14 to 17.50 Issued............................................... -- -- Exercised............................................ (874) 2.40 to 10.00 Canceled............................................. (1,556) 0.14 to 13.38 ------ -------------- Balance, December 31, 1999............................. 3,340 2.13 to 17.50 Issued............................................... -- -- Exercised............................................ (895) 2.29 to 16.25 Canceled............................................. (5) 2.13 ------ -------------- Balance, December 31, 2000............................. 2,440 $2.13 to 17.50 ====== ==============
13. SEGMENT REPORTING AND GEOGRAPHICAL INFORMATION MRV operates under a business model that creates and manages start-up companies and independent business units. These companies fall into two segments: operating entities and development stage enterprises. Segment information is therefore being provided on this basis which differs from prior period presentations. Development stage enterprises that MRV has created or invested in are developing optical components, subsystems and networks and products for the infrastructure of the Internet. Operating entities of MRV design, manufacture and distribute optical components, optical subsystems, optical networking solutions, and Internet infrastructure products. The accounting policies of the segments are the same as those described in the summary of significant accounting polices. MRV evaluates segment performance based on revenues and operating income (loss) of each segment. As such, there are no separately identifiable segment assets nor are there any separately identifiable statements of operations data below operating income. Business Segment Net Revenues for each of the three years in the period ended December 31, 2000 (in thousands):
YEARS ENDED DECEMBER 31, -------------------------------- 1998 1999 2000 -------- -------- -------- Operating entities................................. $264,075 $288,524 $319,394 Development stage enterprises...................... -- -- -- -------- -------- -------- Total revenues........................... $264,075 $288,524 $319,394 ======== ======== ========
There were no inter-segment sales for the years ended December 31, 2000, 1998 and 1999. F-24 131 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 Business Segment Operating Income (Loss) for each of the three years in the period ended December 31, 2000 (in thousands):
YEARS ENDED DECEMBER 31, --------------------------------- 1998 1999 2000 -------- -------- --------- Operating entities................................ $(18,141) $ 4,017 $(100,759) Development stage enterprises..................... (2,043) (20,011) (48,810) -------- -------- --------- Total operating loss.................... $(20,184) $(15,994) $(149,569) ======== ======== =========
For each of the three years in the period ended and as of December 31, 2000, MRV had no single customer that accounted for more than 10 percent of revenues or accounts receivable. MRV does not track customer revenue by region for each individual reporting segment. A summary of external revenue by region follows (in thousands):
YEAR ENDED DECEMBER 31, -------------------------------- 1998 1999 2000 -------- -------- -------- United States...................................... $107,376 $122,054 $119,190 European Community................................. 118,881 129,994 160,398 Middle East........................................ 5,634 4,166 2,483 Pacific Rim........................................ 24,892 28,921 31,891 Other.............................................. 7,292 3,389 5,432 -------- -------- -------- Total net sales.......................... $264,075 $288,524 $319,394 ======== ======== ========
Operating loss before other income (expense), provision (benefit) for income taxes and extraordinary item (in thousands):
YEAR ENDED DECEMBER 31, --------------------------------- 1998 1999 2000 -------- -------- --------- United States..................................... $(28,280) $ (5,781) $ (69,671) Foreign........................................... 8,096 (10,213) (79,898) -------- -------- --------- Operating loss.......................... $(20,184) $(15,994) $(149,569) ======== ======== =========
14. LAN BUSINESS In February 2000, MRV discontinued manufacturing and supporting its LAN product lines. In connection with his decision, MRV recorded one-time charges of approximately $13.8 million primarily related to the write-down of inventories. These charges have been included in "cost of goods sold" for the year ended December 31, 1999 in the accompanying consolidated statement of operations. 15. 401(K) PLANS MRV has 401(K) savings plans (the Plans) at certain subsidiaries under which all eligible employees may participate. The Plans provide for MRV to make matching contributions to all eligible employees. In 1999 and 2000, approximately $679,000 and $731,000, respectively, was charged as expense related to these plans. F-25 132 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 16. SUPPLEMENTAL STATEMENTS OF CASH FLOW INFORMATION (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1998 1999 2000 -------- -------- ---------- Supplemental disclosure of cash flow information: Cash paid during period for interest................. $2,569 $1,652 $ 3,635 Cash paid during period for income taxes............. $9,945 $4,887 $ 130 Supplemental schedule of noncash investing and financing activities: Fair value of asset acquired, net of cash received... $ -- $ -- $ 48,611 Less: Liabilities assumed............................ -- -- (44,190) ------ ------ -------- Cash received in acquisitions........................ $ -- $ -- $ 4,421 ------ ------ -------- Cash used in acquisitions............................ -- -- 48,938 ------ ------ -------- Cash used in acquisitions, net of cash received...... $ -- $ -- $ 44,517 ====== ====== ======== Common stock issued in connection with investments in subsidiaries......................................... $ -- $ -- $ 90,126
F-26 133 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 17. QUARTERLY FINANCIAL DATA (UNAUDITED) (in thousands, except per share amounts)
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER ------------- -------------- ------------- -------------- YEAR ENDED DECEMBER 31, 2000 Revenues, net......................... $65,072 $ 73,935 $ 82,720 $ 97,667 Costs and expenses: Cost of goods sold.................. 42,736 45,793 47,910 66,932 Research and development............ 11,891 14,758 21,803 25,626 Selling, general and administrative................... 16,028 26,467 52,699 29,506 Amortization of goodwill and other intangibles...................... -- 12,055 27,348 27,411 ------- -------- -------- -------- 70,655 99,073 149,760 149,475 Operating loss................... (5,583) (25,138) (67,040) (51,808) Other income (expense), net........... (488) (1,190) (5,764) (2,136) ------- -------- -------- -------- Loss before provision (benefit) for income taxes and minority interest....................... (6,071) (26,328) (72,804) (53,944) Provision (benefit) for income taxes............................... (494) 1,377 1,005 (7,286) Minority interest..................... (287) (45) (570) 1,698 ------- -------- -------- -------- Net loss......................... $(5,864) $(27,750) $(74,379) $(44,960) ======= ======== ======== ======== Basic and diluted earnings per share............................... $ (0.10) $ (0.44) $ (1.06) $ (0.62) Basic and diluted weighted averages shares.............................. 56,850 62,754 70,122 72,768 ======= ======== ======== ======== YEAR ENDED DECEMBER 31, 1999 Revenues, net......................... $70,116 $ 73,251 $ 71,254 $ 73,903 Costs and expenses: Cost of goods sold.................. 46,366 47,595 44,653 58,828 Research and development............ 9,592 8,572 8,476 9,806 Selling, general and administrative................... 14,718 14,750 15,581 22,474 Amortization of goodwill and other intangibles...................... -- 1,142 951 1,014 ------- -------- -------- -------- 70,676 72,059 69,661 92,122 Operating income (loss).......... (560) 1,192 1,593 (18,219) Other income (expense), net........... 278 132 165 (253) ------- -------- -------- -------- Income (loss) before provision (benefit) for income taxes and minority interest.............. (282) 1,324 1,758 (18,472) Provision (benefit) for income taxes............................... 627 782 1,169 (4,731) Minority interest..................... -- (17) (22) 649 ------- -------- -------- -------- Net income....................... $ (909) $ 525 $ 567 $(13,092) ======= ======== ======== ======== Basic earnings (loss) per share....... $ (0.02) $ 0.01 $ 0.01 $ (0.24) Diluted earnings (loss) per share..... $ (0.02) $ 0.01 $ 0.01 $ (0.24) Basic weighted averages shares........ 53,300 53,472 53,868 55,082 Diluted weighted averages shares...... 53,300 57,621 60,154 55,082 ======= ======== ======== ========
F-27 134 MRV COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000 18. EVENTS SUBSEQUENT TO FEBRUARY 19, 2001 During the second quarter of 2001, the management of Luminent, MRV's publicly traded subsidiary, approved and implemented a restructuring plan as a result of the dramatic slowdown in demand for communications equipment. During the six months ended June 30, 2001, Luminent recorded restructuring and other one-time charges totaling $41.2 million resulting from the lower demand for Luminent's products and pricing pressures stemming from the continuing deterioration in the communications equipment industry, specifically the optical components sector. In June, 2001, the FASB approved two pronouncements: SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", which provide guidance on the accounting for business combinations to be accounted for using the purchase method. Under the new rules, goodwill will no longer be subject to amortization over its useful life. Rather, goodwill will be subject to at least an annual impairment assessment. This assessment is a fundamentally different two-step approach and is based on a comparison between a reporting unit's fair value and its carrying value. Intangible assets have newly defined criteria and will be accounted for separately from goodwill and will continue to be amortized over their useful lives. MRV plans to adopt these pronouncements on January 1, 2002. MRV is currently reviewing these standards to determine the impact on its results of operations and its financial position. The most significant anticipated effect on MRV's financial statements at adoption would be the discontinuing of the amortization of goodwill and the possible impairment loss measured as of the date of adoption. In September 2001, Luminent's President and Chief Executive Officer resigned. In connection with the resignation, Luminent's President and Chief Executive Officer received a severance package, as defined in the employment agreement dated July 2000, providing severance payments of approximately $1.0 million and the immediate vesting of all outstanding MRV and Luminent stock options held as of the date of resignation. The MRV and Luminent stock options are exercisable through September 11, 2003. Additionally, an immediate recognition of deferred compensation expenses of $18.9 million will be recorded during the third quarter of 2001 as a result of the acceleration of these stock options. In September 2001, MRV and Luminent jointly announced that MRV intends to merge Luminent into MRV through the filing of a short-form merger. All Luminent shareholders are entitled to receive 0.43 shares of MRV common stock for each share of Luminent common stock held. Furthermore, outstanding Luminent employee stock options will convert into options to purchase MRV common stock at the same ratio. The merger is expected to be completed during the fourth quarter of 2001. F-28 135 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PAR VALUES)
DECEMBER 31, JUNE 30, 2000 2001 ------------ ----------- (UNAUDITED) ASSETS Current Assets: Cash and cash equivalents................................. $ 210,080 $ 174,887 Short-term investments, $56,181 and $52,907 restricted in 2000 and 2001, respectively............................ 73,947 55,704 Accounts receivable....................................... 61,863 59,731 Inventories............................................... 77,005 72,123 Deferred income taxes..................................... 31,227 34,307 Other current assets...................................... 22,750 26,812 ---------- ---------- Total current assets................................. 476,872 423,564 Property and Equipment -- At cost, net of depreciation and amortization.............................................. 72,269 75,291 Other Assets: Goodwill and intangibles.................................. 504,027 475,496 Deferred income taxes..................................... 6,209 7,797 Investments............................................... 31,734 28,164 Other non-current assets.................................. 5,660 12,835 ---------- ---------- $1,096,771 $1,023,147 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current maturities of capital lease obligations and long-term debt......................................... $ 2,937 $ 2,642 Accounts payable.......................................... 56,088 68,644 Accrued liabilities....................................... 34,044 31,867 Short-term debt........................................... 9,104 12,976 Deferred revenue.......................................... 1,470 1,663 Income taxes payable...................................... 6,477 -- ---------- ---------- Total current liabilities............................ 110,120 117,792 Long-Term Liabilities: Convertible debentures.................................... 89,646 89,646 Capital lease obligations, net of current portion......... 621 566 Long-term debt............................................ 60,257 60,399 Other long-term liabilities............................... 3,980 4,571 Minority Interest........................................... 50,592 39,868 Stockholders' Equity: Preferred stock, $0.01 par value: Authorized -- 1,000 shares; no shares issued or outstanding Common stock, $0.0017 par value: Authorized -- 160,000 shares Issued -- 73,327 shares in 2000 and 77,317 in 2001 Outstanding -- 73,279 shares in 2000 and 77,269 in 2001.................................................. 126 132 Additional paid-in capital................................ 1,060,650 1,097,915 Accumulated deficit....................................... (171,330) (319,761) Deferred stock compensation, net.......................... (100,862) (60,041) Treasury stock, 48 shares at cost in 2000 and 2001........ (133) (133) Accumulated other comprehensive loss...................... (6,896) (7,807) ---------- ---------- Total stockholders' equity........................... $ 781,555 $ 710,305 ---------- ---------- $1,096,771 $1,023,147 ========== ==========
See accompanying notes F-29 136 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED -------------------------- JUNE 30, JUNE 30, 2000 2001 ----------- ----------- (UNAUDITED) (UNAUDITED) Revenues, net............................................... $139,007 $ 189,634 -------- --------- Costs and Expenses: Cost of goods sold........................................ 88,529 155,156 Research and development expenses......................... 26,649 50,787 Selling, general and administrative expenses.............. 41,481 82,123 Amortization of goodwill and intangibles from acquisitions........................................... 13,069 57,167 -------- --------- Operating loss............................................ (30,721) (155,599) Other expense, net.......................................... (1,678) (2,893) Provision (credit) for income taxes......................... 883 (3,622) Minority interest........................................... 332 (6,439) -------- --------- Net Loss.................................................. $(33,614) $(148,431) ======== ========= Net Loss Per Share -- Basic and Diluted..................... $ (0.56) $ (1.97) ======== ========= Shares Used in Per-Share Calculation -- Basic and Diluted... 59,839 75,245 ======== =========
See accompanying notes F-30 137 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
SIX MONTHS ENDED -------------------------- JUNE 30, JUNE 30, 2000 2001 ----------- ----------- (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net cash used in operating activities.................. $ (5,039) $ (43,529) -------- ----------- Cash flows from investing activities: Purchases of property and equipment....................... (2,588) (26,580) Investments in unconsolidated partner companies........... (10,785) -- Purchases of minority interest in consolidated subsidiaries and short-term investments................ (9,096) (59,521) Proceeds from sale or maturity of investments............. 12,216 71,150 Cash used in acquisitions and equity purchases, net of cash received.......................................... (45,391) -- -------- ----------- Net cash used in investing activities.................. (55,644) (14,951) -------- ----------- Cash flows from financing activities: Proceeds from line of credit.............................. 68,510 -- Net proceeds from issuance of common stock................ 6,001 20,534 Borrowings on long-term debt.............................. -- 373 Payments on short-term debt............................... -- (92) Borrowings on short-term debt............................. -- 3,587 Principal payments on capital lease obligations........... (493) (204) -------- ----------- Net cash provided by financing activities.............. 74,018 24,198 -------- ----------- Effect of exchange rate changes on cash and cash equivalents............................................... (2,458) (911) -------- ----------- Net (decrease) increase in cash and cash equivalents........ 10,877 (35,193) Cash and cash equivalents, beginning of period.............. 34,330 210,080 -------- ----------- Cash and cash equivalents, end of period.................... $ 45,207 $ 174,887 ======== ===========
See accompanying notes F-31 138 MRV COMMUNICATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. GENERAL The accompanying condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that these condensed financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's latest annual report on Form 10-K. In the opinion of the Company, these unaudited statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position of MRV Communications and Subsidiaries as of June 30, 2001, and the results of their operations and their cash flows for the six and three months then ended. 2. BUSINESS COMBINATIONS No material business combinations took place during the six months ended June 30, 2001. See our latest annual report on Form 10-K and management's discussion and analysis of financial conditions and results of operations in this 10-Q. The following unaudited pro forma financial information presents the combined results of operations with the acquisitions as if the acquisitions had occurred as of January 1, 2000, giving effect to certain adjustments, including amortization of goodwill and other intangibles and deferred stock compensation charges. The unaudited pro forma share data assumes the shares issued in connection with these acquisitions were outstanding as of January 1, 2000. (in thousands, except per share amounts; unaudited)
SIX MONTHS ENDED JUNE 30, ------------------------- 2000 2001 ---------- ----------- Pro forma revenue........................................... $146,065 $ 189,634 Pro forma net loss.......................................... (33,087) (148,431) Pro forma basic and diluted net loss per share.............. $ (0.55) $ (1.97)
3. EARNINGS PER SHARE Basic earnings (loss) per common share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share include the incremental shares issuable upon the assumed exercise of stock options and conversion of the convertible debentures. The effect of the assumed conversion of $89.6 million convertible debentures has not been included, as it would be anti-dilutive. For the six months ended June 30, 2001 and 2000, common stock equivalents were also not considered in the diluted computation, as their effect was anti-dilutive. 4. COMPREHENSIVE INCOME On January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income." For year-end financial statements, SFAS No. 130 requires that net income (loss) and all other non-owner changes in equity be displayed in a financial statement with the same prominence as other consolidated F-32 139 MRV COMMUNICATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) financial statements. In addition, the standard requires companies to display the components of comprehensive income as follows (in thousands).
SIX MONTHS ENDED JUNE 30, ------------------------- 2000 2001 ---------- ----------- Net loss.................................................... $(33,614) $(148,431) Foreign currency translation................................ (2,458) (911) -------- --------- Comprehensive loss........................................ $(36,072) $(149,342) ======== =========
5. CASH AND CASH EQUIVALENTS MRV considers all highly liquid investments with an original maturity of 90 days or less to be cash equivalents. MRV maintains cash balances and investments in highly qualified financial institutions. At various times such amounts are in excess of insured limits. As of June 30, 2001 and December 31, 2000, cash, cash equivalents and short-term investments of $93.0 million and $132.9 million, respectively, were held by MRV's publicly traded subsidiary Luminent. 6. INVENTORIES Inventories are stated at the lower of cost or market and consist of materials, labor and overhead. Cost is determined by the first in, first out method. Inventories consist of the following as of June 30, 2001 and December 31, 2000 (in thousands):
DECEMBER 31, JUNE 30, 2000 2001 ------------ -------- Raw materials............................................... $ 36,278 $28,033 Work-in process............................................. 17,721 24,249 Finished goods.............................................. 23,006 19,841 -------- ------- $ 77,005 $72,123 ======== =======
7. STOCK DISTRIBUTION On May 26, 2000, the Company completed a two-for-one stock split. The effect of this stock split has been reflected in the accompanying condensed consolidated financial statements for all periods presented. 8. SEGMENT REPORTING AND GEOGRAPHICAL INFORMATION The Company operates under a business model that creates and manages start-up companies and independent business units. These companies fall into two segments: operating entities and development stage enterprises. Segment information is therefore being provided on this basis. Development stage enterprises that the Company has created or invested in develop optical components, subsystems and networks and products for the infrastructure of the Internet. Operating entities of the Company design, manufacture and distribute optical components, optical subsystems, optical networking solutions and Internet infrastructure products, and provide IT system integration services. The accounting policies of the segments are the same as those described in the summary of significant accounting polices in our latest annual report on Form 10-K. The Company evaluates segment performance based on revenues, operating income (loss) and total assets of each segment. As such, there are no separately identifiable segment assets nor are there any separately identifiable statements of operations data below operating income. F-33 140 MRV COMMUNICATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Business Segment Net Revenues for the six months ended June 30, 2001 and 2000 (in thousands):
SIX MONTHS ENDED JUNE 30, -------------------- 2000 2001 -------- -------- Operating entities.......................................... $139,007 $189,634 Development stage enterprises............................... -- -- -------- -------- Total revenues............................................ $139,007 $189,634 ======== ========
There were no inter-segment sales in the six months ended June 30, 2001 and 2000. Business Segment Loss for the six months ended June 30, 2001 and 2000 (in thousands):
SIX MONTHS ENDED JUNE 30, ------------------------- 2000 2001 ---------- ----------- Operating loss Operating entities........................................ $(17,439) $(127,358) Development stage enterprises............................. (13,282) (28,241) Other income (expense) Interest expense related to convertible debentures........ (2,250) (2,250) Other income, net......................................... 2,009 2,401 Development stage enterprises............................. (1,437) (3,044) -------- --------- Loss before provision (credit) for income taxes and minority interest.................................................. $(32,399) $(158,492) ======== =========
For the six months ended and as of June 30, 2001, the Company had no single customer that accounted for more than 10 percent of revenue or accounts receivable. The Company does not track customer revenue by region for each individual reporting segment. A summary of external revenue by region follows (in thousands).
SIX MONTHS ENDED JUNE 30, -------------------- 2000 2001 -------- -------- United States............................................... $ 55,032 $ 69,578 Asia Pacific................................................ 18,171 26,454 European.................................................... 62,543 89,750 Other....................................................... 3,261 3,852 -------- -------- Total net sales........................................... $139,007 $189,634 ======== ========
Loss before provision (credit) for income taxes (in thousands):
SIX MONTHS ENDED JUNE 30, ------------------------- 2000 2001 ---------- ----------- United States............................................... $(25,756) $ (82,818) Foreign..................................................... (6,975) (69,235) -------- --------- Loss before provision (credit) for income taxes........... $(32,731) $(152,053) ======== =========
9. RESTRUCTURING AND OTHER ONE-TIME CHARGES In the second quarter of 2001, the management of Luminent, MRV's publicly traded subsidiary, approved and implemented a restructuring plan and other one-time charges as a result of the dramatic F-34 141 MRV COMMUNICATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) slowdown in demand for communications equipment. During the six months ended June 30, 2001, Luminent recorded restructure and other one-time charges totaling $41.2 million resulting from the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. Luminent's restructuring activities primarily involve employee severance costs, abandonment and non-utilization of assets and other similar actions. Costs for restructuring activities are limited to either incremental costs that directly result from the restructuring activities and provide no future benefit or costs incurred under contractual obligations that existed before the restructuring plan and will continue with either no future benefit or become a penalty incurred for termination of the obligation. Restructuring costs totaling $14.5 million consisting of severance and outplacement of terminated employees and exit costs are included in the results of operations. The restructuring activities as described above, resulted in 150 layoffs during the six months ended June 30, 2001 and will result in additional layoffs of approximately 450 personnel, bringing Luminent's total workforce to approximately 1,200 employees. Affected employees will come from all divisions and areas of Luminent. The majority of affected employees will be in the manufacturing group. A summary of the restructuring costs consists of the following (in thousands):
REMAINING PROVISION UTILIZED BALANCE --------- -------- --------- Exit Costs Asset impairment.................................... $ 8,904 $8,904 $ -- Closed and abandoned facilities..................... 1,108 -- 1,108 Other commitments................................... 2,402 -- 2,402 Other............................................... 991 -- 991 ------- ------ ------ 13,405 8,904 4,501 Employee severance costs.............................. 1,072 196 876 ------- ------ ------ $14,477 $9,100 $5,377 ======= ====== ======
In addition to the costs associated with the restructuring plan, Luminent also recorded a one-time $26.1 million charge to write-down inventory to realizable value and an additional $598,000 charge to bad debt. Furthermore, Luminent is undertaking a formal review of the goodwill generated in its acquisitions and it may record additional impairment charges when the review is completed in the fourth quarter of 2001. 10. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Investments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138. The Company adopted the statement in January 2001 and the adoption of this statement did not have a material impact on the Company's financial position or results of operations. In December 1999, the Securities and Exchange Commissions (SEC) issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition." SAB No. 101 provides additional guidance on the recognition, presentation and disclosure of revenue in financial statements. The Company has reviewed this bulletin and believes that its current revenue recognition policy is consistent with the guidance of SAB No. 101. F-35 142 MRV COMMUNICATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In March 2000, the FASB issued interpretation No. 44 (FIN 44), "Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25." FIN 44 clarifies the application of APB No. 25 for certain issues, including the definition of an employee, the treatment of the acceleration of stock options and the accounting treatment for options assumed in business combinations. FIN 44 became effective on July 1, 2000, but is applicable for certain transactions dating back to December 1998. The adoption of FIN 44 did not have a significant impact on MRV's financial position or results of operations. The FASB recently approved two pronouncements: SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", which provide guidance on the accounting for business combinations to be accounted for using the purchase method. Under the new rules, goodwill will no longer be subject to amortization over its useful life. Rather, goodwill will be subject to at least an annual impairment assessment. This assessment is a fundamentally different two-step approach and is based on a comparison between a reporting unit's fair value and its carrying value. Intangible assets have newly defined criteria and will be accounted for separately from goodwill and will continue to be amortized over their useful lives. MRV plans to adopt these pronouncements on January 1, 2002. MRV is currently reviewing these standards to determine the impact on its results of operations and its financial position. The most significant anticipated effect on MRV's financial statements at adoption would be the discontinuing of the amortization of goodwill and the possible impairment loss measured as of the date of adoption. 11. SUPPLEMENTAL STATEMENT OF CASH FLOW INFORMATION (IN THOUSANDS):
SIX MONTHS ENDED JUNE 30, ---------------- 2000 2001 ------ ------ (UNAUDITED) Supplemental disclosure of cash flow information: Cash paid during period for interest...................... $1,718 $4,675 Cash paid during period for taxes......................... $ 417 $6,455
F-36 143 MRV COMMUNICATIONS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. SUPPLEMENTAL UNAUDITED PRO FORMA FINANCIAL DATA The purpose of the following unaudited pro forma condensed consolidated statements of operations for the six months ended June 30, 2001 and 2000 is to present the results of operations excluding certain charges such as non-cash amortization of goodwill and other intangibles, non-cash deferred stock compensation expenses, cost incurred in connection with the Optical Access IPO, and expenses associated with development stage enterprises (in thousands, except per share data).
SIX MONTHS ENDED -------------------------- JUNE 30, JUNE 30, 2000 2001 ----------- ----------- (UNAUDITED) (UNAUDITED) Revenues, net............................................... $139,007 $ 189,634 -------- --------- Costs and expenses: Cost of goods sold........................................ 88,529 121,804 Research and development expenses......................... 13,367 17,137 Selling, general and administrative expenses.............. 34,153 45,051 -------- --------- Operating income.......................................... 2,958 5,642 Other income (expense), net................................. (241) 167 Provision for income taxes.................................. 883 2,124 Minority interests.......................................... 332 1,031 -------- --------- Net income................................................ $ 1,502 $ 2,654 ======== ========= Net income per share -- basic............................... $ 0.03 $ 0.04 ======== ========= Net income per share -- diluted............................. $ 0.02 $ 0.03 ======== ========= Shares used in per-share calculation -- basic............... 59,839 75,245 Shares used in per-share calculation -- diluted............. 66,767 80,847 -------- --------- Reconciliation Net income, pro forma....................................... $ 1,502 $ 2,654 Less: Amortization of goodwill and other intangibles............ 13,069 57,167 Deferred stock compensation expense....................... 7,328 33,796 One-time charges reported by Luminent..................... -- 41,232 Expenses of development stage enterprises................. 14,719 31,285 Costs incurred in connection with Optical Access' IPO..... -- 1,003 Tax effects of above items................................ -- (5,928) Minority interest in above items.......................... -- (7,470) -------- --------- Net loss, as reported....................................... $(33,614) $(148,431) ======== =========
F-37 144 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of Luminent, Inc.: We have audited the accompanying consolidated balance sheets of Luminent, Inc. (a Delaware corporation and a wholly owned subsidiary of MRV Communications, Inc.) and subsidiaries as of December 31, 1999 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Luminent, Inc. and subsidiaries as of December 31, 1999 and 2000, and the results of their operations and their cash flows for the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP Los Angeles, California January 25, 2001 (except for Note 14 as to which the date is October 4, 2001) F-38 145 LUMINENT, INC. CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, ------------------- 1999 2000 ------- -------- (IN THOUSANDS) ASSETS Current Assets: Cash and cash equivalents................................. $ 220 $131,778 Short-term investments.................................... -- 1,082 Accounts receivable, net of allowance of $1,724 in 1999 and $4,455 in 2000...................................... 10,544 21,613 Inventories............................................... 8,755 39,428 Deferred income taxes..................................... 2,190 6,220 Prepaids and other current assets......................... 5 9,106 ------- -------- Total current assets.................................... 21,714 209,227 Property and Equipment, net: Land...................................................... -- 3,559 Buildings................................................. -- 18,006 Machinery and equipment................................... 4,483 34,096 Furniture and fixtures.................................... 12 1,950 Computer hardware and software............................ 890 2,180 Leasehold improvements.................................... 180 2,694 Construction in progress.................................. -- 3,815 ------- -------- 5,565 66,300 Less -- Accumulated depreciation and amortization......... (4,152) (14,934) ------- -------- 1,413 51,366 Goodwill and other intangibles, net......................... -- 341,540 Other assets................................................ -- 3,247 ------- -------- Total assets............................................ $23,127 $605,380 ======= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt......................... $ -- $ 2,607 Short-term borrowings..................................... -- 7,957 Accounts payable.......................................... 4,200 20,021 Accrued expenses.......................................... 1,163 10,337 Income taxes payable...................................... 3,790 6,634 ------- -------- Total current liabilities............................... 9,153 47,556 Long-term debt, net of current portion...................... -- 9,550 Other long-term liabilities................................. -- 779 Minority interest........................................... -- 444 Commitments and contingencies Stockholders' Equity: Preferred stock, $.001 par value, 30,000,000 shares authorized; none issued and outstanding................. -- -- Common stock, $.001 par value, 300,000,000 shares authorized; 156,000,000 shares issued and outstanding... -- 156 Additional paid-in capital................................ -- 635,066 Equity of MRV Communications.............................. 13,974 -- Accumulated deficit....................................... -- (29,241) Deferred stock compensation, net.......................... -- (55,570) Accumulated other comprehensive loss...................... -- (3,360) ------- -------- Total stockholders' equity.............................. 13,974 547,051 ------- -------- Total liabilities and stockholders' equity.............. $23,127 $605,380 ======= ========
The accompanying notes are an integral part of these consolidated balance sheets. F-39 146 LUMINENT, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------- 1998 1999 2000 ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales.................................................. $ 38,596 $ 65,264 $124,193 Cost of sales(1)........................................... 24,289 43,078 84,384 -------- -------- -------- Gross profit.......................................... 14,307 22,186 39,809 Operating Costs and Expenses: Selling, general and administrative(1)................... 2,642 5,675 38,768 Research and development(1).............................. 4,974 8,693 18,204 Parent company allocations............................... 808 885 588 Amortization of goodwill and other intangibles........... -- -- 47,421 -------- -------- -------- 8,424 15,253 104,981 -------- -------- -------- Operating income (loss)............................... 5,883 6,933 (65,172) Other income, net.......................................... -- 6 2,246 -------- -------- -------- Income (loss) before provision for income taxes and minority interest................................... 5,883 6,939 (62,926) Provision for income taxes................................. 2,343 2,764 2,766 Minority interest.......................................... -- -- (707) -------- -------- -------- Net Income (loss)..................................... $ 3,540 $ 4,175 $(64,985) ======== ======== ======== Basic and diluted earnings (loss) per share................ $ 0.02 $ 0.03 $ (0.45) ======== ======== ======== Basic and diluted weighted average shares.................. 144,000 144,000 145,677 ======== ======== ========
------------------------- (1) Includes amounts relating to deferred stock compensation of $2.8 million, $21.7 million and $4.3 million presented in "cost of sales", "selling, general and administrative" and "research and development", respectively, for the year ended December 31, 2000. The accompanying notes are an integral part of these consolidated financial statements. F-40 147 LUMINENT, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
DEFERRED ACCUMULATED COMMON STOCK ADDITIONAL STOCK OTHER ---------------- PAID-IN ACCUMULATED EQUITY OF COMPENSATION, COMPREHENSIVE SHARES AMOUNT CAPITAL DEFICIT MRV NET LOSS TOTAL ------- ------ ---------- ----------- --------- ------------- ------------- -------- (IN THOUSANDS) BALANCE AT DECEMBER 31, 1997....................... -- $ -- $ -- $ -- $ 5,782 $ -- $ -- $ 5,782 Net income................. -- -- -- -- 3,540 -- -- 3,540 Net distributions to MRV Communications, Inc...... -- -- -- -- (1,232) -- -- (1,232) ------- ---- -------- -------- --------- -------- ------- -------- BALANCE AT DECEMBER 31, 1998....................... -- -- -- -- 8,090 -- -- 8,090 Net income................. -- -- -- -- 4,175 -- -- 4,175 Net advances from MRV Communications, Inc...... -- -- -- -- 1,709 -- -- 1,709 ------- ---- -------- -------- --------- -------- ------- -------- BALANCE AT DECEMBER 31, 1999....................... -- -- -- -- 13,974 -- -- 13,974 Comprehensive loss: Net loss................. -- -- -- (29,241) (35,744) -- -- (64,985) Foreign translation adjustment............. -- -- -- -- -- -- (3,360) (3,360) -------- Comprehensive loss......... (68,345) Net advances from MRV Communications, Inc...... -- -- -- -- 439,657 -- -- 439,657 Deferred stock compensation............. -- -- -- -- 84,350 (84,350) -- -- Amortization of deferred stock compensation....... -- -- -- -- -- 28,780 -- 28,780 Allocation of Equity of MRV...................... 144,000 144 502,093 -- (502,237) -- -- -- Stock options issued in exchange for consulting services................. -- -- 683 -- -- -- -- 683 Common stock issued in connection with initial public offering.......... 12,000 12 132,290 -- -- -- -- 132,302 ------- ---- -------- -------- --------- -------- ------- -------- BALANCE AT DECEMBER 31, 2000....................... 156,000 $156 $635,066 $(29,241) $ -- $(55,570) $(3,360) $547,051 ======= ==== ======== ======== ========= ======== ======= ========
The accompanying notes are an integral part of these consolidated financial statements. F-41 148 LUMINENT, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 1998 1999 2000 -------- -------- --------- (IN THOUSANDS) Cash flows from operating activities: Net income (loss)......................................... $ 3,540 $ 4,175 $(64,985) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization........................... 1,000 1,461 52,020 Provision for doubtful accounts......................... 778 500 2,915 Amortization of deferred stock compensation............. -- -- 28,780 Loss on disposition of fixed assets..................... -- -- 16 Gain on sale of short-term investments.................. -- -- (50) Minority interest....................................... -- -- (707) Deferred income taxes................................... (168) (1,026) (4,030) Changes in operating assets and liabilities, net of effects from acquisitions: Accounts receivable..................................... (326) (4,605) (3,194) Inventories............................................. (2,172) (2,253) (16,903) Prepaid and other current assets........................ -- (5) 753 Accounts payable........................................ (72) 842 13,118 Accrued expenses........................................ 116 381 3,058 Income taxes payable.................................... (915) 1,278 2,656 ------- ------- -------- Net cash provided by operating activities............. 1,781 748 13,447 Cash flows from investing activities: Purchases of property and equipment....................... (549) (2,237) (14,846) Proceeds from sale of property and equipment.............. -- -- 1,520 Purchases of short-term investments....................... -- -- (3,022) Proceeds from sale of short-term investments.............. -- -- 2,524 Net cash received in connection with acquisitions......... -- -- 5,472 Other assets.............................................. -- -- (5,822) ------- ------- -------- Net cash used in investing activities................. (549) (2,237) (14,174) Cash flows from financing activities: Net proceeds from issuance of common stock................ -- -- 132,302 Borrowings on long-term debt.............................. -- -- 6,092 Payments on long-term debt................................ -- -- (4,002) Borrowings on short-term debt............................. -- -- 19,079 Payments on short-term debt............................... -- -- (21,349) Net change in other liabilities........................... -- -- 190 Net cash (distributions to) advances from MRV Communications.......................................... (1,232) 1,709 1,568 ------- ------- -------- Net cash provided by (used in) financing activities... (1,232) 1,709 133,880 Effect of exchange rate on cash and cash equivalents........ -- -- (1,595) ------- ------- -------- Net increase in cash and cash equivalents................... -- 220 131,558 Cash and cash equivalents, beginning of year................ -- -- 220 ------- ------- -------- Cash and cash equivalents, end of year...................... $ -- $ 220 $131,778 ======= ======= ========
The accompanying notes are an integral part of these consolidated financial statements. F-42 149 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS AND BASIS OF PRESENTATION Luminent, Inc. ("Luminent" or the "Company") designs, manufactures, and sells a comprehensive line of fiber optic components that enable communications equipment manufactures to provide optical networking solutions for the rapidly growing metropolitan and access segments of the communications network. Its products are designed to meet the increasing bandwidth requirements between long-haul telecommunication networks and end users. Luminent specializes in singlemode fiber optic components and subsystems for high-capacity data transmission for long-reach applications in the metropolitan and access markets. On April 29, 2000, MRV Communications, Inc. (MRV) announced its plan to create a separate company, Luminent, comprised of MRV's fiber optic transmission business. Luminent was incorporated in Delaware in March 2000, as a wholly owned subsidiary of MRV. Since the completion of Luminent's initial public offering in November 2000, MRV owns approximately 92% of Luminent's outstanding common stock. On July 25, 2000, MRV and Luminent entered into a Master Separation and Distribution Agreement (the "Separation Agreement") effective on September 8, 2000 (the "separation date"), under which MRV continued to fund working capital and other needs for the first few months of operations as a separate, stand-alone entity. Additionally, MRV transferred to Luminent, substantially all of the assets and liabilities associated with Luminent's business. As of the separation date, Luminent began operating independently from MRV. For periods prior to the separation date, the accompanying consolidated financial statements reflect MRV's historical bases in the assets and liabilities and the historical results of operations that were transferred to Luminent. Additionally, the consolidated financial statements include allocations of certain MRV corporate expenses, including centralized legal, accounting, employee benefits, real estate, insurance services, information technology services, treasury and other MRV corporate and infrastructure costs. The expense allocations have been determined on bases that MRV and Luminent considered to be a reasonable reflection of the utilization of services provided or the benefit received by Luminent. The allocation methods are based on relative revenues, head counts or square footage. However, the financial information included herein may not reflect the consolidated financial position, operating results, changes in parent company investment and cash flows of Luminent in the future or what they would have been had Luminent been a separate, stand-alone entity during the periods presented. Luminent faces numerous risks related to the fact that it has no history as an independent company. In addition, Luminent faces risks commonly associated with a technology company such as operating in a sector that is new and characterized by rapid technological change, evolving industry standards, the need to generate capital to fund operations and uncertainty regarding market acceptance of its products and products under development. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES EQUITY OF MRV COMMUNICATIONS, INC. The MRV equity account represents the book value of net assets transferred to Luminent. No intercompany interest income or expense has been allocated to, or included in, the accompanying consolidated financial statements (see Note 7 for additional information regarding transactions with MRV). As of the separation date, the remaining balance of MRV Communications' equity was transferred to paid-in capital, and Luminent began to generate retained earnings as a stand-alone company. F-43 150 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of Luminent and its wholly and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. FOREIGN CURRENCY TRANSLATION The reporting currency for the consolidated financial statements of the Company is the U.S. dollar. The assets and liabilities of companies whose functional currency is other than the U.S. dollar are included in the consolidation by translating the assets and liabilities at the exchange rates applicable at the end of the reporting period, while capital accounts are translated at historical rates. The statements of operations and cash flows of such companies are translated at the average exchange rates during the applicable period. Translation gains or losses are accumulated as a separate component of shareholders' equity. The Company has not tax effected the cumulative translation adjustment as there is no intention to remit the earnings. REVENUE RECOGNITION Luminent recognizes product revenue upon shipment of products, at which time, customer acceptance of the products have been attained and collection is considered probable. Products are shipped "FOB shipping point" with no rights of return other than normal warranty rights. Luminent generally warrants its products against defects in material and workmanship for one year. The estimated cost of warranty obligations is recognized at the time of revenue recognition. Sales to MRV and its affiliates are made in the ordinary course of business under terms and conditions that Luminent believes are substantially equal to terms and conditions granted to third party customers (See Note 7). CASH AND CASH EQUIVALENTS The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents. Luminent's short-term investments have initial maturities of greater than three months. These securities are classified as "available-for-sale" in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." These investments are carried at fair market value with any unrealized gains and losses recorded as a separate component of stockholders' equity. Fair value is based upon market prices quoted on the last day of the year. Unrealized gains or losses on securities were insignificant as of December 31, 2000. Luminent maintains cash balances and investments in highly qualified financial institutions. At various times, such amounts are in excess of insured limits. INVENTORIES Inventories are stated at the lower of cost or market and consist of materials, labor and overhead. Cost is determined by the first-in, first-out method. F-44 151 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives: Buildings........................... 20 years Machinery and equipment............. 3 years Furniture and fixtures.............. 5 years Computer hardware and software...... 3 years Leasehold improvements.............. Lesser of lease term or useful lives
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. GOODWILL AND OTHER INTANGIBLES, NET Goodwill and other intangibles, net represents the excess cost over the fair value of net assets of the businesses acquired. Goodwill and other intangibles are being amortized using the straight-line method over estimated useful lives of 5 years. Amortization of goodwill and other intangibles of $47.4 million has been included in the accompanying consolidated statement of operations for the year ended December 31, 2000. IMPAIRMENT OF LONG-LIVED ASSETS Luminent evaluates its long-lived assets, including certain intangibles, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows (undiscounted and without interest charges) expected to be generated by the asset. If these assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and long-term debt are carried at cost, which approximates their fair market value. INCOME TAXES Deferred income tax assets or liabilities are computed based on the temporary differences between the financial statement and income tax bases of assets and liabilities using the statutory marginal income tax rate in effect for the years in which the differences are expected to reverse. Deferred income tax expenses or credits are based on the changes in the deferred income tax assets or liabilities from period to period. For purposes of these financial statements, income taxes have been calculated as if Luminent had prepared a tax return on a stand-alone basis. STOCK-BASED COMPENSATION Luminent accounts for its employees stock plan under the intrinsic value method prescribed by Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," and related interpretations, and has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Luminent accounts for option and warrant grants to non-employees using the guidance prescribed by SFAS No. 123, Financial Accounting Standards Board (FASB) Interpretation No. 44 (FIN 44), F-45 152 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) "Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB Opinion No. 25," and Emerging Issues Task Force (EITF) No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods, or Services," whereby the fair value of such option and warrant grants are determined using the Black-Scholes option pricing model at the earlier of the date at which the non-employee's performance is completed or a performance commitment is reached. Deferred stock compensation is being amortized using the graded vesting method. Using this method, approximately 57%, 26%, 13% and 4%, respectively, of each option's compensation expense is amortized in each of the 4 years following the date of grant. EARNINGS PER SHARE Basic and diluted earnings per common share are computed using the weighted average number of common shares outstanding (adjusted for the effect of the stock split discussed in Note 10). The weighted average number of shares used for computation of basic and diluted earnings (loss) per share were 144,000,000 for 1998 and 1999, and 145,677,000 for 2000. The 10.3 million stock options outstanding and 75,000 warrants outstanding have been excluded from the diluted computations of earnings per share as their effect would be anti-dilutive. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998 and June 1999, the FASB issued SFAS No. 133, "Accounting for Derivative Investments and Hedging Activities," and SFAS No. 137, which delayed the effective date of SFAS No. 133. In June 2000, the FASB issued SFAS No. 138, which provides additional guidance for the application of SFAS No. 133 for certain transactions. Luminent will adopt the statement in January 2001 and does not expect the adoption of this statement to have a material impact on its financial position or results of operations. In December 1999, the Securities and Exchange Commissions (SEC) issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements," and related interpretations. SAB No. 101 summarizes certain of the Securities and Exchange Commission's views in applying generally accepted accounting principles to revenue recognition in financial statements. Luminent has adopted the provisions of SAB No. 101, which did not have a material impact on its financial position or results of operations. In March 2000, the FASB issued FIN 44. FIN 44 clarifies the application of APB No. 25 for certain issues, including the definition of an employee, the treatment of the acceleration of stock options and the accounting treatment for options assumed in business combinations. FIN 44 became effective on July 1, 2000, but is applicable for certain transactions dating back to December 1998. The adoption of FIN 44 did not have a significant impact on Luminent's financial position or results of operations. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect 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. F-46 153 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. BUSINESS ACQUISITIONS In December 1999, MRV acquired 51% of the outstanding stock of Luminent Korea in exchange for approximately $250,000 in cash. This investment was accounted for using the purchase method. The assets and liabilities of this acquired entity have been "pushed down" to Luminent. On April 24, 2000, MRV completed the acquisition of approximately 97% of the outstanding capital stock of Fiber Optic Communications, Inc., a Republic of China corporation. Fiber Optic Communications is a manufacturer of passive fiber optic components for Wavelength Division Multiplexing. Under the terms of the purchase agreement, Fiber Optic Communications shareholders received approximately $48.6 million in cash and approximately 4.7 million shares of MRV common stock and options to purchase 680,000 shares of MRV common stock for a total purchase price of approximately $310.4 million. The issuance price of the MRV common stock was approximately $53 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at $3.00 per share, have an aggregate intrinsic value of $14.1 million, and vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $261.6 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. On July 12, 2000, MRV completed the acquisition of all of the outstanding capital stock of Quantum Optech Inc., a Republic of China corporation. Quantum Optech is a manufacturer of optical thin film coating and filters for Dense Wavelength Division Multiplexing. Under the terms of the purchase agreement, Quantum Optech shareholders received approximately 1.0 million shares of MRV common stock and options to purchase approximately 160,000 shares of MRV common stock for a total purchase price of approximately $36.2 million. The issuance price of the MRV common stock was approximately $30 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at $3.00 per share, have an aggregate intrinsic value of $4.0 million, of which $1.3 million is vested, and the remaining vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $27.9 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. On July 21, 2000, MRV completed the acquisition of approximately 99% of the outstanding capital stock of Optronics International Corp., a Republic of China corporation. Optronics International is a manufacturer of high temperature semiconductor lasers, transceivers and detectors for optical networks. Under the terms of the purchase agreement, Optronics International shareholders received approximately 3.4 million shares of MRV common stock and options to purchase approximately 800,000 shares of MRV common stock for a total purchase price of approximately $124.3 million. The issuance price of the MRV common stock was approximately $30 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at $3.00 per share, have an aggregate intrinsic value of $20.0 million, of which $6.6 million is vested, and the remaining vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $99.5 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. F-47 154 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The purchase price of Fiber Optic Communications, Quantum Optech and Optronics International were allocated as follows (in thousands, unaudited): Purchase price............................................ $420,861 Allocation of purchase price Net tangible assets.................................. 1,750 Deferred stock compensation.......................... 30,150 Goodwill............................................. 388,961
The outstanding capital stock of Fiber Optic Communications, Quantum Optech and Optronics International, purchased by MRV, has been contributed to Luminent. The results of operations of these acquisitions have been included in Luminent's consolidated financial statements from the date of acquisition. The following unaudited pro forma financial information presents the combined results of operations of Luminent, Fiber Optic Communications, Quantum Optech and Optronics International as if the acquisitions had occurred as of January 1, 1999, giving effect to certain adjustments, including amortization of goodwill and other intangibles and deferred compensation charges.
DECEMBER 31, -------------------- 1999 2000 -------- -------- (UNAUDITED) Pro forma net sales.................................... $ 93,262 $137,782 Pro forma net loss..................................... $(95,557) $(91,830) Pro forma basic and diluted net loss per share......... $ (0.66) $ (0.63)
4. INVENTORIES Inventories consisted of the following (in thousands):
DECEMBER 31, ----------------- 1999 2000 ------ ------- Raw materials............................................. $4,291 $22,896 Work in process........................................... 3,655 12,402 Finished goods............................................ 809 4,130 ------ ------- Total inventories....................................... $8,755 $39,428 ====== =======
5. BUSINESS SEGMENTS AND CONCENTRATIONS OF RISK Luminent operates under one reportable segment: fiber optic components and modules. Fiber optic components and modules include discrete components such as laser diodes and light emitting diodes and integrated components such as transmitters, receivers and transceivers. These products are sold primarily to original-equipment manufacturers and through distributors. The Company depends on single or limited source suppliers for some of the key components and materials in its products, which makes Luminent susceptible to supply shortages or price fluctuations that could adversely affect operating results. Management believes this will not have a significant impact on operations. For the two years ended December 31, 1998 and 1999, the Company had one customer that accounted for more than 18% and 40% of net sales, respectively. As of December 31, 1999, one customer accounted for approximately 30% of total accounts receivable. For the year ended December 31, 2000, the Company had 2 customers that accounted for approximately 29% of net sales. As of December 31, 2000, the Company had one customer that accounted for approximately 13% of accounts receivable. Certain geographical area information follows. F-48 155 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Geographical Area Net Sales (in thousands):
YEARS ENDED DECEMBER 31, ------------------------------ 1998 1999 2000 ------- ------- -------- North America........................................ $22,808 $52,737 $ 76,995 Asia-Pacific......................................... 7,646 3,812 25,773 Europe............................................... 3,056 4,678 18,575 Other................................................ 5,086 4,037 2,850 ------- ------- -------- Total net sales.................................... $38,596 $65,264 $124,193 ======= ======= ========
6. INCOME TAXES The provision for income taxes consisted of the following (in thousands):
YEARS ENDED DECEMBER 31, ---------------------------- 1998 1999 2000 ------ ------- ------- Current Federal.............................................. $1,944 $ 2,968 $ 4,988 State................................................ 567 822 1,358 Foreign.............................................. -- -- 450 ------ ------- ------- 2,511 3,790 6,796 Deferred Federal.............................................. (121) (817) (3,156) State................................................ (47) (209) (874) Foreign.............................................. -- -- -- ------ ------- ------- (168) (1,026) (4,030) ------ ------- ------- Provision for income taxes............................. $2,343 $ 2,764 $ 2,766 ====== ======= =======
The income tax provision differs from the amount computed by applying the federal statutory income tax rate to income before provision for income taxes as follows:
YEARS ENDED DECEMBER 31, ------------------------ 1998 1999 2000 ---- ---- ---- Tax computed at federal statutory rate...................... 34% 34% 35% State income taxes, net of federal effect................... 6 6 (1) Foreign taxes at rates less than domestic rates............. -- -- 4 Permanent differences....................................... -- -- (32) Change in valuation allowance............................... -- -- (10) -- -- --- Provision for income taxes................................ 40% 40% (4)% == == ===
F-49 156 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The components of the net deferred income tax assets at December 31, 1999 and 2000 are as follows (in thousands):
DECEMBER 31, ----------------- 1999 2000 ------ ------- Accrued expenses.......................................... $ 320 $ 209 Allowance for doubtful accounts........................... 687 1,307 Deferred stock compensation............................... -- 6,630 Inventory reserves........................................ 905 3,543 State income taxes........................................ 278 475 Other..................................................... -- 276 ------ ------- 2,190 12,440 Valuation allowance....................................... -- (6,220) ------ ------- Net deferred tax asset.................................. $2,190 $ 6,220 ====== =======
Realization of the net deferred tax assets is dependent on its ability to carry losses back to prior periods or on generating sufficient taxable income during the periods in which temporary differences will reverse. Management reviews its deferred tax assets and has provided a valuation allowance based on its assessment of the expected future benefit to be ultimately received from each asset identified. Although realization is not assured, management believes it is more likely than not that the net deferred tax assets will be realized. Income (Loss) before Provision for Income Taxes (in thousands):
YEARS ENDED DECEMBER 31, ---------------------------- 1998 1999 2000 ------ ------ -------- United States.......................................... $5,883 $6,940 $ (8,277) Non-United States...................................... -- (1) (53,942) ------ ------ -------- Income (loss) before provision for income taxes...... $5,883 $6,939 $(62,219) ====== ====== ========
7. TRANSACTIONS WITH MRV COMMUNICATIONS, INC. Luminent's sales of products to MRV and its affiliates was $2.1 million in 1998, $2.5 million in 1999, and $4.9 million in 2000. Through December 31, 2000, Luminent had received a total of $6.5 million from MRV to fund payroll and other operations related matters. Luminent repaid this amount to MRV through operating cash and offsetting amounts due from MRV on or before December 31, 2000. For the three years in the period ended December 31, 2000, intercompany transactions between Luminent and MRV consisted of the following (in thousands):
YEARS ENDED DECEMBER 31, ------------------------------ 1998 1999 2000 ------- ------- -------- Sales to MRV and its affiliates...................... $ 2,104 $ 2,503 $ 4,878 Operating expenses................................... 7,218 9,512 14,213 Fair value of acquisitions........................... -- 250 440,628 Deferred stock compensation.......................... -- -- 40,950 Net cash advances (distributions).................... (1,232) 1,709 1,568 ------- ------- -------- Equity of MRV Communications, Inc.................. $ 8,090 $13,974 $502,237 ======= ======= ========
F-50 157 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Luminent's costs and expenses include allocations from MRV for centralized legal, accounting, employee benefits, real estate, insurance services, information technology services, treasury and other MRV corporate and infrastructure costs. These allocations have been determined on bases that MRV and Luminent considered to be a reasonable reflection of the utilization of services provided for the benefit received by Luminent. The allocation methods are based on relative revenues, headcount or square footage. No intercompany interest income or expense has been allocated to, or included in, the accompanying consolidated financial statements. For purposes of governing the ongoing relationships between Luminent and MRV at and after the separation and to provide for an orderly transition, Luminent and MRV have entered into various agreements. A brief description of each of the agreements follows. Master Separation and Distribution Agreement MRV and Luminent have entered into a Master Separation Agreement, which contains key provisions relating to the separation, Luminent's initial funding, initial public offering and the distribution of Luminent's common stock to MRV's stockholders. The Master Separation and Distribution Agreement lists the documents and items that the parties must deliver in order to accomplish the transfer of assets and liabilities from MRV to Luminent, effective on the separation date. The Master Separation and Distribution Agreement also contains conditions that must occur prior to the distribution. The parties also entered into ongoing covenants that survive the transactions, including covenants to establish interim service level agreements, exchange information, engage in certain auditing practices and resolve disputes in particular ways. General Assignment and Assumption Agreement The General Assignment and Assumption Agreement identifies the assets that MRV has transferred to Luminent and the liabilities that Luminent has assumed from MRV in the separation. The Agreement General Assignment and Assumption also describes when and how these transfers and assumptions occurred. In general, these assets and liabilities were those that appeared in the consolidated balance sheet as of September 30, 2000. Intellectual Property Agreements The Master Technology Ownership and License Agreement, the Master Patent Ownership and License Agreement and the Master Trademark Ownership and License Agreement together are referred to as the Intellectual Property Agreements. Under the Intellectual Property Agreements, MRV confirmed that Luminent owns or transferred to Luminent its rights in specified patents, patent applications, invention disclosures, specified trademarks and other intellectual property related to Luminent's current business and research and development efforts. Employee Matters Agreement The Employee Matters Agreement outlines how MRV and Luminent allocated assets, liabilities and responsibilities relating to current and former employees of Luminent and their participation in the benefits plans, including stock plans, that MRV currently sponsors and maintains. The Employee Matters Agreement also contains provisions describing some of Luminent's employee benefit and employee stock plans. All eligible Luminent employees continue to participate in the MRV benefits plans on comparable terms and conditions to those for MRV employees until the distribution date or until Luminent establishes F-51 158 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) benefit plans for its employees, or elects not to establish comparable plans if it is not legally or financially practical. Luminent intends to establish its own benefit program no later than the time of distribution. Once Luminent establishes it own benefits plans, it may modify or terminate each plan in accordance with the terms of that plan and its policies. No Luminent benefit plan will provide benefits that overlap benefits under the corresponding MRV benefit plan at the time of the distribution. Each Luminent benefit plan will provide that all service, compensation and other benefit determinations that, as of the distribution, were recognized under the corresponding MRV benefits plan will be taken into account under that Luminent benefit plan. Following the date of MRV's distribution of its Luminent common stock to its stockholders, Luminent will be under no obligation to maintain these plans in the form in which they were established or at all. The transfer to Luminent of employees at certain of MRV's international operations, and of certain employee benefit plans, may not take place until Luminent receives consents or approvals or has satisfied other applicable requirements. Tax Sharing Agreement The Tax Sharing Agreement allocates MRV's and Luminent's responsibilities for certain tax matters. The agreement requires Luminent to pay MRV for the incremental tax costs of Luminent's inclusion in consolidated, combined or unitary tax returns with affiliated corporations. In determining these incremental costs, the Tax Sharing Agreement takes into account not only the group's incremental tax payments to the Internal Revenue Service or other taxing authorities, but also the incremental use of tax losses of affiliates to offset Luminent's taxable income, and the incremental use of tax credits of affiliates to offset the tax on Luminent's income. The Tax Sharing Agreement also provides for compensation or reimbursement as appropriate to reflect redeterminations of Luminent's tax liability for periods during which Luminent joined in filing consolidated, combined or unitary tax returns. The Tax Sharing Agreement also requires Luminent to indemnify MRV for certain taxes and similar obligations, including (a) sales taxes on the sale of products purchased by MRV from Luminent before the distribution, (b) customs duties or harbor maintenance fees on products exported or imported by MRV on behalf of Luminent, (c) the additional taxes that would result if an acquisition of a controlling interest in Luminent's stock after the distribution causes the distribution not to qualify for tax-free treatment to MRV, and (d) any taxes resulting from transactions undertaken in preparation for the distribution. Luminent's indemnity obligations include any interest penalties on taxes, duties or fees for which Luminent must indemnify MRV. Each member of a consolidated group for U.S. federal income tax purposes is jointly and severally liable for the group's federal income tax liability. Accordingly, Luminent could be required to pay a deficiency in the group's federal income tax liability for a period during which Luminent was a member of the group even if the Tax Sharing Agreement allocates that liability to MRV or another member. Master Transitional Services Agreement The Master Transitional Service Agreement governs the provision of information technology services by MRV and Luminent to each other, on an interim basis, for one year from the date of separation, unless extended for specific services or otherwise indicated in the agreement. The services include data processing and telecommunications services, such as voice telecommunications and data transmission, and information technology support services, for functions including accounting, financial management, tax, payroll, stockholder and public relations, legal, procurement, and other administrative functions. Specified charges for such services are generally intended to allow the providing company to recover the direct and indirect F-52 159 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) costs of providing the services. The Master Transitional Services Agreement also will cover the provision of certain additional transitional services identified from time to time after the separation date that were inadvertently or unintentionally omitted from the specified services, or that are essential to effectuate an orderly transition under the Master Separation and Distribution Agreement, so long as the provision of such services would not significantly disrupt MRV's operations or significantly increase the scope of its responsibility under the agreement. In addition, the Master Transitional Services Agreement will provide for the replication of some computer systems, including hardware, software, data storage or maintenance and support components. Generally, the party needing the replicated system will bear the costs and expenses of replication. Generally, the party purchasing new hardware or licensing new software will bear the costs and expenses of purchasing the new hardware or obtaining the new software licenses. Real Estate Matters Agreement The Real Estate Matters Agreement addresses real estate matters relating to the MRV leased and owned properties that MRV will transfer to or share with Luminent. The Real Estate Matters Agreement describes the manner in which MRV will transfer to or share with Luminent various leased and owned properties. The Real Estate Matters Agreement provides that Luminent will be required to accept the transfer of all sites allocated to Luminent, even if a site has been damages by a casualty before the separation date. The Real Estate Matters Agreement also provides that all reasonable costs required to effect the transfers, including landlord consent fees and landlord attorney's fees will be paid by MRV. Indemnification and Insurance Matters Agreements Effective as of the separation date, subject to specified exceptions, Luminent and MRV will each release the other from any liabilities arising from events occurring on or before the separation date, including events occurring in connection with the activities to implement the separation, the initial public offering and the distribution. The Indemnification and Insurance Matters Agreement also contains provisions governing indemnification. In general, Luminent and MRV will each indemnify the other from all liabilities arising from their respective businesses or contracts, as well as liabilities arising from a breach of the Master Separation and Distribution Agreement or any ancillary agreement. In addition, MRV and Luminent will each indemnify the other against liability for specified environmental conditions. Luminent will reimburse MRV for the cost of any insurance coverage from the separation date to the distribution date. 8. SHORT-TERM BORROWINGS The Company's short-term borrowings consist of secured and unsecured short-term loans and notes entered into with certain financial institutions. As of December 31, 2000, these short-term borrowings totaled approximately $8.0 million and approximately $2.9 million of two Taiwanese subsidiaries' assets have been pledged as collateral on these borrowings. The weighted average interest rate on these notes is 6.2% and the notes are incurred and paid in the New Taiwan Dollar. The unused line of credit is $446,000 at December 31, 2000. F-53 160 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. LONG-TERM DEBT Long-term debt consisted of the following as of December 31, 2000 (in thousands): Notes payable to financial institutions bearing interest ranging from 6.5% to 8.9%, payable in monthly or quarterly installments of principal and interest through October 2012, secured by $15.0 in pledged assets of two Taiwanese subsidiaries................................... $12,157 Less -- Current Portion.................................. (2,607) ------- $ 9,550 =======
The following summarizes the required principal payments on long-term debt as of December 31, 2000 (in thousands): Year ending December 31, 2001..................................................... $ 2,607 2002..................................................... 1,586 2003..................................................... 1,690 2004..................................................... 1,649 2005..................................................... 1,608 Thereafter............................................... 3,017 ------- $12,157 =======
10. STOCKHOLDERS' EQUITY Luminent's Board of Directors authorized 30,000,000 shares of its $.001 par value of preferred stock, of which none was issued or outstanding as of December 31, 1999 and 2000. Luminent's Board of Directors also authorized 300,000,000 of its $.001 par value common stock with 144,000,000 and 156,000,000 shares issued and outstanding as of December 31, 1999 and 2000, respectively. Effective July 25, 2000, the Board of Directors declared a 144,000-for-one stock split. All references to share and per-share data for all periods presented have been restated to give effect to this stock split. On November 9, 2000, Luminent issued 12,000,000 shares of its common stock for $12 per share, or $144.0 million, to complete its initial public offering. Net proceeds of $132.3 million were received after deducting the underwriters' discount and other costs of the offering. STOCK OPTIONS In July 2000, the Board of Directs adopted, and the stockholder approved the 2000 Stock Option Plan (the Plan). The Plan provides for grants of qualified incentive stock options, non-qualified stock options, restricted stock awards and other stock-based awards to officers, employees, directors, consultants and advisors of the Company. Stock-based awards are generally granted at not less than fair market value at the grant date, and typically vest over a four-year period and expire ten years after the grant date. 10,400,000 shares of common stock have been reserved for issuance under the Plan. As of December 31, 2000 4,685,100 options have been granted under the Plan, and 5,715,000 are available for future grant under the Plan. In July 2000, Luminent and MRV entered into four-year employment contracts with the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) of Luminent. The agreements provide for annual salaries, performance bonuses and a combination of stock options to purchase common stock of MRV and Luminent. The CEO received approximately 316,000 options to purchase shares of MRV F-54 161 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) common stock at $32.56 per share (a substantial discount) expiring in five years. The CFO received approximately 22,000 options to purchase shares of MRV common stock at $33.44 per share (a substantial discount) expiring in five years. These options are immediately exercisable, however they provide for the repurchase in the event of voluntary termination. These grants have been accounted for under APB No. 25 and the intrinsic value (fair market value less exercise price) results in additional deferred stock compensation of approximately $11.1 million that is being amortized over the four year vesting period. Furthermore, Luminent granted 4.8 million and 800,000 of its stock options to the CEO and CFO, respectively. The options are exercisable at $6.25 per share and vest over 4 years. These grants have been accounted for in accordance with APB No. 25 and the intrinsic value (original mid point of filing range, $14, less $6.25) resulted in aggregate deferred stock compensation of approximately $43.4 million. The deferred stock compensation is being amortized using the graded vesting method over four years. Stock option information with respect to options granted under the Plan and MRV options granted to Luminent employees is as follows (in thousands, except share prices): Options granted by Luminent (in thousands, except share prices):
YEAR ENDED DECEMBER 31, 2000 ------------------- WTD. AVG. SHARES EX. PRICE ------ --------- Outstanding, beginning of year........................... -- -- Granted.................................................. 10,285 $8.77 Exercised................................................ -- -- Forfeited................................................ -- -- ------ ----- Outstanding, end of year................................. 10,285 $8.77 ====== =====
Information about Luminent stock options outstanding at December 31, 2000 is summarized as follows (in thousands, except share prices):
NUMBER OUTSTANDING WEIGHTED AVERAGE NUMBER EXERCISABLE EXERCISE AT DECEMBER 31, REMAINING AT DECEMBER 31, PRICE 2000 CONTRACT LIFE 2000 ------------- ------------------ ---------------- ------------------ $ 6.00 - 6.25 5,767 9.53 years 1,400 $12.00 4,518 9.85 years 40 ------ ----- 10,285 1,440 ====== =====
Options granted by MRV (in thousands, except share prices):
YEARS ENDED DECEMBER 31, ----------------------------------------------------------------- 1998 1999 2000 ------------------- ------------------- ------------------- WTD. AVG. WTD. AVG. WTD. AVG. SHARES EX. PRICE SHARES EX. PRICE SHARES EX. PRICE ------ --------- ------ --------- ------ --------- Outstanding, beginning of year..... 140 $4.27 242 $2.62 434 $4.37 Granted............................ 102 3.85 256 5.59 2,060 8.81 Exercised.......................... -- -- (64) 2.68 (85) 3.44 Forfeited.......................... -- -- -- -- -- -- Canceled in repricing.............. (193) 4.47 -- -- -- -- Granted in repricing............... 193 2.63 -- -- -- -- ---- ----- --- ----- ----- ----- Outstanding, end of year........... 242 $2.62 434 $4.37 2,409 $8.20 ==== ===== === ===== ===== =====
F-55 162 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Information about MRV stock options outstanding at December 31, 2000 is summarized as follows (in thousands, except share prices):
NUMBER OUTSTANDING WEIGHTED AVERAGE NUMBER EXERCISABLE EXERCISE AT DECEMBER 31, REMAINING AT DECEMBER 31, PRICE 2000 CONTRACT LIFE 2000 --------------- ------------------ ---------------- ------------------ $ 2.63 - $ 2.97 180 7.20 years 21 $ 6.69 - $ 6.82 169 8.50 years 11 $14.63 - $33.44 354 9.54 years 338 $42.13 - $64.88 83 9.29 years -- $ 3.00 1,623 9.44 years -- ----- --- 2,409 370 ===== ===
In July 2000, Luminent granted 75,000 warrants to purchase common stock to a non-employee in connection with the hiring of its CEO. The warrants had a fair value on the date of grant of approximately $635,000, are immediately exercisable and expire in July 2010. In November 2000, Luminent granted 10,000 options to purchase common stock to a non-employee in connection consulting services received. The options had a fair value on the date of grant of approximately $48,000, are immediately exercisable and expire in November 2010. The expense related to the issuance of these warrants and options is included the accompanying consolidated statements of operations. ACCOUNTING FOR STOCK-BASED COMPENSATION SFAS No. 123 permits companies to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. In management's opinion, the existing stock option valuation models do not necessarily provide a reliable single measure of the fair value of stock-based awards. Therefore, as permitted, the Company applies the existing accounting rules under APB No. 25 and provides pro forma net income and pro forma earnings per share disclosures for stock based awards made during the year as if the fair-value-based method defined in SFAS No. 123 had been applied. Net loss and net loss per share would have been reduced to the following pro forma amounts (in thousands, except per share amounts):
YEARS ENDED DECEMBER 31, ---------------------------- 1998 1999 2000 ------ ------ -------- Additional compensation expense........................ $ 86 $ 195 $ 25,544 Pro forma net income (loss)............................ $3,454 $3,980 $(90,529) Pro forma basic and diluted net earnings (loss) per share................................................ $ 0.02 $ 0.03 $ (0.62)
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. Option valuation models also require the input of highly subjective assumptions such as expected option life and expected stock price volatility. The following assumptions were applied for all periods presented: (i) expected dividend yield of 0%, (ii) expected volatility rate ranging from 64% to 230%, (iii) expected lives ranging from 5 to 10 years, and (iv) the risk-free interest rate ranging from 4.29 to 6.23%. Because the Company's employee stock-based compensation plan has characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, the Company believes that the existing option valuation models do not necessarily provide a reliable single measure of the fair value of awards from the plan. F-56 163 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company leases facilities and certain equipment under lease arrangements expiring in various years through July 2005. The aggregate minimum annual lease payments under leases in effect on December 31, 2000 were as follows (in thousands):
OPERATING LEASES --------- 2001....................................................... $1,556 2002....................................................... 972 2003....................................................... 929 2004....................................................... 603 2005....................................................... 295 Thereafter................................................. 1,012 ------ $5,367 ======
Rental expense under lease agreements for the years ended December 31, 1998, 1999 and 2000 was $54,000, $349,000 and $882,000 million, respectively. Through foreign subsidiaries, Luminent has open letters of credit totaling approximately $4.0 million. The letters of credit expire through August 2001. LITIGATION Luminent has received notices from third party alleging possible infringements of patents with respect to product features or manufacturing processes. Management believes such notices are common in the communications industry because of the large number of patents that have been filed on these subjects. The Company's policy is to discuss these notices with the senders in an effort to demonstrate that the Company's products and/or processes do not violate any patents. The Company is currently involved in such discussions with Ortel and Rockwell. The Company is evaluating these claims and presently does not believe that any of its products or processes violates any of the patents asserted by these parties, and the claims are without merit. Additionally the Company intends to vigorously defend its positions if any legal action is taken. Management believes the ultimate outcome of such claims will not have a material impact on the results of operations or financial position. 12. RELATED PARTY TRANSACTION During the year the Company reimbursed $48,000 to the Chief Executive Officer for legal fees incurred in connection with the negotiation of his employment agreement. F-57 164 LUMINENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. SUPPLEMENTAL STATEMENTS OF CASH FLOWS INFORMATION Supplemental information regarding the Statements of Cash Flows is as follows (in thousands):
YEARS ENDED DECEMBER 31, -------------------------- 1998 1999 2000 ----- ----- -------- Supplemental disclosure of cash flow information Cash paid during the year for interest.................... $-- $-- $ 975 Cash paid during the year for income taxes................ $-- $-- $ 88 Supplemental schedule of noncash investing activities Fair value of assets acquired, net of cash received....... $-- $-- $39,263 Less: Liabilities assumed................................. -- -- 33,791 -- -- ------- Cash acquired in acquisitions.......................... $-- $-- $ 5,472 == == =======
14. EVENTS SUBSEQUENT TO JANUARY 25, 2001 During the second quarter of 2001, the management of Luminent approved and implemented a restructuring plan as a result of the dramatic slowdown in demand for communications equipment. During the six months ended June 30, 2001, Luminent recorded restructuring and other one-time charges totaling $41.2 million resulting from the lower demand for Luminent's products and pricing pressures stemming from the continuing deterioration in the communications equipment industry, specifically the optical components sector. In June, 2001, the FASB approved two pronouncements: SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", which provide guidance on the accounting for business combinations to be accounted for using the purchase method. Under the new rules, goodwill will no longer be subject to amortization over its useful life. Rather, goodwill will be subject to at least an annual impairment assessment. This assessment is a fundamentally different two-step approach and is based on a comparison between a reporting unit's fair value and its carrying value. Intangible assets have newly defined criteria and will be accounted for separately from goodwill and will continue to be amortized over their useful lives. Luminent plans to adopt these pronouncements on January 1, 2002. Luminent is currently reviewing these standards to determine the impact on its results of operations and its financial position. The most significant anticipated effect on Luminent's financial statements at adoption would be the discontinuing of the amortization of goodwill and the possible impairment loss measured as of the date of adoption. In September 2001, Luminent's President and Chief Executive Officer resigned. In connection with the resignation, Luminent's President and Chief Executive Officer received a severance package, as defined in the employment agreement dated July 2000, providing severance payments of approximately $1.0 million and the immediate vesting of all outstanding MRV and Luminent stock options held as of the date of resignation. The MRV and Luminent stock options are exercisable through September 11, 2003. Additionally, an immediate recognition of deferred compensation expenses of $18.9 million will be recorded during the third quarter of 2001 as a result of the acceleration of these stock options. In September 2001, MRV and Luminent jointly announced that MRV intends to merge Luminent into MRV through the filing of a short-form merger. All Luminent shareholders are entitled to receive 0.43 shares of MRV common stock for each share of Luminent common stock held. Furthermore, outstanding Luminent employee stock options will convert into options to purchase MRV common stock at the same ratio. The merger is expected to be completed during the fourth quarter of 2001. F-58 165 LUMINENT, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, JUNE 30, 2000 2001 ------------ ----------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $131,778 $ 93,037 Short-term investments.................................... 1,082 81 Accounts receivable, net of allowance of $4,455 at December 31, 2000, and $6,003 at June 30, 2001......... 21,613 24,628 Inventories............................................... 39,428 29,886 Deferred income taxes..................................... 6,220 9,863 Prepaid and other current assets.......................... 9,106 21,398 -------- --------- Total current assets................................... 209,227 178,893 Property and equipment, net................................. 51,366 52,129 Goodwill and other intangibles, net......................... 341,540 302,564 Other assets................................................ 3,247 8,039 -------- --------- Total assets........................................... $605,380 $ 541,625 ======== ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt......................... $ 2,607 $ 2,152 Short-term borrowings..................................... 7,957 12,822 Accounts payable.......................................... 20,021 21,143 Accrued expenses.......................................... 10,337 12,720 Income taxes payable...................................... 6,634 7,049 -------- --------- Total current liabilities.............................. 47,556 55,886 Long-term debt, net of current portion...................... 9,550 8,596 Other long-term liabilities................................. 779 702 -------- --------- Total liabilities...................................... 57,885 65,184 Minority interest........................................... 444 329 Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value, 30,000,000 shares authorized; none issued and outstanding................ -- -- Common stock, $.001 par value, 300,000,000 shares authorized; 156,000,000 shares issued and outstanding............................................ 156 156 Additional paid-in capital................................ 635,066 635,066 Accumulated deficit....................................... (29,241) (117,492) Deferred stock compensation, net.......................... (55,570) (36,659) Accumulated other comprehensive loss...................... (3,360) (4,959) -------- --------- Total stockholders' equity............................. 547,051 476,112 -------- --------- Total liabilities and shareholders' equity............. $605,380 $ 541,625 ======== =========
The accompanying notes are an integral part of these consolidated condensed financial statements. F-59 166 LUMINENT, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, -------------------- 2000 2001 -------- -------- Net Sales................................................... $ 43,006 $ 89,344 Cost of sales(1)(2)......................................... 27,801 90,146 -------- -------- Gross Profit........................................... 15,205 (802) Operating costs and expenses: Selling, general and administrative(1)(2)................. 8,084 39,528 Research and development(1)(2)............................ 6,624 10,030 Amortization of goodwill and other intangibles............ 9,580 38,976 -------- -------- 24,288 88,534 -------- -------- Operating loss......................................... (9,083) (89,336) Other income, net(2)........................................ 192 2,822 -------- -------- Loss before provision for income taxes and minority interest.............................................. (8,891) (86,514) Provision for income taxes.................................. 1,469 1,854 Minority interest........................................... 318 (115) -------- -------- Net loss............................................... $(10,678) $(88,253) ======== ======== Net loss per share, basic and diluted....................... $ (0.07) $ (0.57) ======== ======== Shares used in per-share calculation, basic and diluted..... 144,000 156,000 ======== ========
------------------------- (1) Includes amounts relating to deferred stock compensation of $744,000 and $1.2 million presented in "cost of sales", $1.1 million and $15.7 million presented in "selling, general and administrative", and $1.2 million and 2.0 million and "research and development" for the six months ended June 30, 2000 and 2001, respectively. (2) Includes one-time charges of $29.3 million, $11.4 million, $501,000 and $16,000 presented in "cost of sales", "selling, general and administrative", "research and development" and "other income, net", respectively, for the six months ended June 30, 2001 to write-down inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other non-recurring items. These charges resulted from the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. The accompanying notes are an integral part of these consolidated condensed financial statements. F-60 167 LUMINENT, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, -------------------- 2000 2001 -------- -------- Cash Flows from Operating Activities: Net (loss) income......................................... $(10,678) $(88,253) Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortization........................ 9,953 43,046 Amortization of deferred stock compensation.......... 2,973 18,911 Impairment loss on property and equipment............ -- 8,904 Minority interest.................................... 332 (115) Deferred income taxes................................ (350) (3,643) Changes in operating assets and liabilities Accounts receivable.................................... 1,281 (3,015) Inventories............................................ 426 9,542 Prepaid and other current assets....................... (1,879) (12,292) Accounts payable....................................... 4,225 1,122 Accrued expenses....................................... (1,093) 2,383 Income taxes payable................................... (1,452) 415 -------- -------- Net cash provided by (used in) operating activities...................................... 3,738 (22,995) Cash Flows from Investing Activities: Purchases of property and equipment....................... (1,243) (13,735) Sale of short-term investments............................ -- 1,001 Other assets.............................................. 1,463 (4,792) -------- -------- Net cash provided by (used in) investing activities...................................... 220 (17,526) Cash flows from financing activities: Payments on long-term debt................................ (116) (1,409) Borrowings on long-term debt.............................. -- -- Payments on short-term debt............................... -- (9,077) Borrowings on short-term debt............................. 3,383 13,942 Net change in other liabilities........................... (77) (77) Net cash distributions to MRV Communications, Inc. ....... (1,723) -- -------- -------- Net cash provided by financing activities......... 1,467 3,379 Effect of exchange rate on cash and cash equivalents........ (663) (1,599) -------- -------- Net increase (decrease) in cash and cash equivalents........ 4,762 (38,741) Cash and cash equivalents, beginning of period.............. 220 131,778 -------- -------- Cash and cash equivalents, end of period.................... $ 4,982 $ 93,037 ======== ======== Supplemental Cash Flow Information: Cash paid for Income taxes........................................... -- 5,023 Interest............................................... -- 647
The accompanying notes are an integral part of these consolidated condensed financial statements. F-61 168 LUMINENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BUSINESS AND BASIS OF PRESENTATION BUSINESS Luminent, Inc. ("Luminent" or the "Company") designs, manufactures, and sells a comprehensive line of fiber optic components that enable communications equipment manufacturers to provide optical networking solutions for the rapidly growing metropolitan and access segments of the communications network. The Company's products are designed to meet the increasing bandwidth requirements between long-haul telecommunication networks and end users. Luminent specializes in singlemode fiber optic components and subsystems for high-capacity data transmission for long-reach applications in the metropolitan and access markets. Luminent was incorporated in Delaware in March 2000 as a wholly owned subsidiary of MRV Communications, Inc. ("MRV"). Since the completion of Luminent's initial public offering in November 2000, MRV has owned approximately 92% of Luminent's outstanding common stock. On July 25, 2000, MRV and Luminent entered into a Master Separation and Distribution Agreement (the "Separation Agreement") which became effective as of September 8, 2000 (the "Separation Date"). MRV transferred to Luminent, substantially all of the assets and liabilities associated with Luminent's business. As of the Separation Date, Luminent began operating independently from MRV. For periods prior to the Separation Date, the accompanying consolidated condensed financial statements reflect MRV's historical bases in the assets and liabilities and the historical results of operations that were transferred to Luminent. Additionally, the consolidated condensed financial statements include allocations of certain MRV corporate expenses, including centralized legal, accounting, employee benefits, real estate, insurance services, information technology services, treasury and other MRV corporate and infrastructure costs. The expense allocations have been determined on bases that MRV and Luminent considered to be a reasonable reflection of the utilization of services provided or the benefit received by Luminent. The allocation methods are based on relative revenues, head counts or square footage. However, the financial information included herein may not reflect the consolidated financial position, operating results, changes in parent company investment and cash flows of Luminent in the future or what they would have been had Luminent been a separate, stand-alone entity during the periods presented. Luminent faces numerous risks related to the fact that it has no history as an independent company. In addition, Luminent faces risks common to many technology companies including but not limited to operating in a sector that is new and characterized by rapid technological change, evolving industry standards, the need to generate capital to fund operations and uncertainty regarding market acceptance of its products and products under development. BASIS OF PRESENTATION The accompanying consolidated condensed financial statements have been prepared by the Company, in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. F-62 169 LUMINENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to present a fair presentation have been included. The operating results for the six months ended June 30, 2001 are not necessarily indicative of the results that may be expected for the fiscal year ended December 31, 2001. EARNINGS PER SHARE Basic and diluted earnings (loss) per common share are computed using the weighted average number of common shares outstanding. All share and per share amounts have been retroactively restated to give effect to the Company's 144,000-for-one stock split that occurred on July 25, 2000. The weighted average number of shares used for computation of basic and diluted earnings (loss) per share were 156,000,000 for June 30, 2001, and 144,000,000 for June 30, 2000. The 13.4 million stock options outstanding and 75,000 warrants outstanding have been excluded from the diluted computations of loss per share as of June 30, 2001 as their effect would be anti-dilutive. There were no options or warrants outstanding as of June 30, 2000. 2. BUSINESS ACQUISITIONS On April 24, 2000, MRV completed the acquisition of approximately 97% of the outstanding capital stock of Fiber Optic Communications, Inc., a Republic of China corporation. Fiber Optic Communications is a manufacturer of passive fiber optic components for Wavelength Division Multiplexing. Under the terms of the purchase agreement, Fiber Optic Communications shareholders received approximately $48.6 million in cash and approximately 4.7 million shares of MRV common stock and options to purchase 680,000 shares of MRV common stock for a total purchase price of approximately $310.4 million. The issuance price of the MRV common stock was approximately $53 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at $3.00 per share, have an aggregate intrinsic value of $14.1 million at the acquisition date, and vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $261.6 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. On July 12, 2000, MRV completed the acquisition of all of the outstanding capital stock of Quantum Optech Inc., a Republic of China corporation. Quantum Optech is a manufacturer of optical thin film coating and filters for Dense Wavelength Division Multiplexing. Under the terms of the purchase agreement, Quantum Optech shareholders received approximately 1.0 million shares of MRV common stock and options to purchase approximately 160,000 shares of MRV common stock for a total purchase price of approximately $36.2 million. The issuance price of the MRV common stock was approximately $30 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at $3.00 per share, have an aggregate intrinsic value of $4.0 million at the acquisition date, of which $1.3 million is vested, and the remaining vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $27.9 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. On July 21, 2000, MRV completed the acquisition of approximately 99% of the outstanding capital stock of Optronics International Corp., a Republic of China corporation. Optronics International is a F-63 170 LUMINENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) manufacturer of high temperature semiconductor lasers, transceivers and detectors for optical networks. Under the terms of the purchase agreement, Optronics International shareholders received approximately 3.4 million shares of MRV common stock and options to purchase approximately 800,000 shares of MRV common stock for a total purchase price of approximately $124.3 million. The issuance price of the MRV common stock was approximately $30 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at $3.00 per share, have an aggregate intrinsic value of $20.0 million at the acquisition date, of which $6.6 million is vested, and the remaining vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $99.5 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. The purchase price of Fiber Optic Communications, Quantum Optech and Optronics International in the aggregate were allocated as follows (in thousands, unaudited): Purchase price.............................................. $420,861 Allocation of purchase price Net tangible assets....................................... 1,750 Deferred stock compensation............................... 30,150 Goodwill and other intangibles............................ 388,961
The outstanding capital stock of Fiber Optic Communications, Quantum Optech and Optronics International, purchased by MRV, has been contributed to Luminent. The results of operations of these acquisitions have been included in Luminent's consolidated financial statements from the date of acquisition. The following unaudited pro forma financial information presents the combined results of operations of Luminent, Fiber Optic Communications, Quantum Optech and Optronics International as if the acquisitions had occurred as of January 1, 2000, giving effect to certain adjustments, including amortization of goodwill and other intangibles and deferred compensation charges.
SIX MONTHS ENDING JUNE 30, -------------------- 2000 2001 -------- -------- (UNAUDITED) Pro forma net sales......................................... $ 55,575 $ 89,344 Pro forma net loss.......................................... $(48,743) $(86,820) Pro forma basic and diluted net loss per share.............. $ (0.34) $ (0.56)
3. INVENTORIES Inventories consisted of the following (in thousands):
DECEMBER 31, JUNE 30, 2000 2001 ------------ ----------- (UNAUDITED) Raw materials............................................... $22,896 $18,130 Work in process............................................. 12,402 8,832 Finished goods.............................................. 4,130 2,924 ------- ------- Total inventories......................................... $39,428 $29,886 ======= =======
F-64 171 LUMINENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 4. BUSINESS SEGMENTS AND CONCENTRATIONS OF RISK Luminent operates under one reportable segment: fiber optic components and modules. Fiber optic components and modules include discrete components such as laser diodes and light emitting diodes and integrated components such as transmitters, receivers and transceivers. These products are sold primarily to original-equipment manufacturers and through distributors. The Company depends on single or limited source suppliers for some of the key components and materials in its products, which makes Luminent susceptible to supply shortages or price fluctuations that could adversely affect operating results. Management believes this will not have a significant impact on operations. For the three months ended June 30, 2001, the Company had one customer that accounted for approximately 13% of net sales. For the six months ended June 30, 2001, the Company had two customers that accounted for approximately 24% of net sales. As of June 30, 2001, one customer accounted for approximately 25% of total accounts receivable. Certain geographical area information follows (in thousands). Geographical Area Net Sales (in thousands):
SIX MONTHS ENDING JUNE 30, ------------------ 2000 2001 ------- ------- (UNAUDITED) North America............................................... $28,754 $54,223 Asia-Pacific................................................ 7,630 21,092 Europe and others........................................... 6,622 14,029 ------- ------- Total net sales........................................... $43,006 $89,344 ======= =======
5. RESTRUCTURING AND OTHER ONE-TIME CHARGES In the second quarter of 2001, the Company's management approved and implemented a restructuring plan and other actions in order to adjust operations and administration due to the dramatic slowdown in demand for communications equipment. During the six months ended June 30, 2001, the Company recorded restructure and other one-time charges totaling $41.2 million resulting from the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. The Company's restructuring activities primarily involve employee severance costs, abandonment and non-utilization of assets and other similar actions. Costs for restructuring activities are limited to either incremental costs that directly result from the restructuring activities and provide no future benefit or costs incurred under contractual obligations that existed before the restructuring plan and will continue with either no future benefit or become a penalty incurred for termination of the obligation. Restructuring costs totaling $14.5 million consisting of severance and outplacement of terminated employees and exit costs are included in the results of operations. The restructuring activities as described above, results in approximately 100 layoffs during the six months ended June 30, 2001 and will result in additional layoffs of approximately 500 personnel, bringing the Company's total workforce to approximately 1,200 employees. Affected employees will come from all divisions and areas of the Company. The majority of affected employees will be in the manufacturing group. F-65 172 LUMINENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) A summary of the restructuring costs consist of the following:
REMAINING PROVISION UTILIZED BALANCE ----------- ---------- ---------- Exit costs Asset impairment............................ $ 8,904,000 $8,904,000 $ -- Closed and abandoned facilities............. 1,108,000 -- 1,108,000 Other commitments........................... 2,402,000 -- 2,402,000 Other....................................... 991,000 -- 991,000 ----------- ---------- ---------- 13,405,000 8,904,000 4,501,000 Employee severance costs...................... 1,072,000 196,000 876,000 ----------- ---------- ---------- $14,477,000 $9,100,000 $5,377,000 =========== ========== ==========
In addition to the costs associated with the restructuring plan, the Company also recorded a one-time $26.1 million charge to write-down inventory to realizable value and an additional $598,000 charge to bad debt. Furthermore, the Company is undertaking a formal review of the goodwill generated in its acquisitions and it may record additional impairment charges when the review is completed in the fourth quarter of 2001. 6. SEPARATION FROM MRV COMMUNICATIONS, INC. For purposes of governing the ongoing relationships between Luminent and MRV at and after the separation and to provide for an orderly transition, Luminent and MRV have entered into various agreements. A brief description of each of the agreements follows. MASTER SEPARATION AND DISTRIBUTION AGREEMENT MRV and Luminent have entered into a Master Separation Agreement, which contains key provisions relating to the separation, Luminent's initial funding, initial public offering and the distribution of Luminent's common stock to MRV's stockholders. The Master Separation and Distribution Agreement lists the documents and items that the parties must deliver in order to accomplish the transfer of assets and liabilities from MRV to Luminent, effective on the separation date. The Master Separation and Distribution Agreement also contains conditions that must occur prior to the distribution. The parties also entered into ongoing covenants that survive the transactions, including covenants to establish interim service level agreements, exchange information, engage in certain auditing practices and resolve disputes in particular ways. GENERAL ASSIGNMENT AND ASSUMPTION AGREEMENT The General Assignment and Assumption Agreement identifies the assets and certain capital stock that MRV has transferred to Luminent and the liabilities that Luminent has assumed from MRV in the separation. The General Assignment and Assumption Agreement also describes when and how these transfers and assumptions occurred. In general, these assets and liabilities were those that appeared in the consolidated balance sheet as of September 30, 2000. INTELLECTUAL PROPERTY AGREEMENTS The Master Technology Ownership and License Agreement, the Master Patent Ownership and License Agreement and the Master Trademark Ownership and License Agreement collectively are referred to as the Intellectual Property Agreements. Under the Intellectual Property Agreements, MRV confirmed F-66 173 LUMINENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) that Luminent owns or MRV transferred to Luminent certain rights in specified patents, patent applications, invention disclosures, specified trademarks and other intellectual property related to Luminent's current business, research and development efforts. EMPLOYEE MATTERS AGREEMENT The Employee Matters Agreement outlines how MRV and Luminent allocated assets, liabilities and responsibilities relating to current and former employees of Luminent and their participation in the benefits plans, including stock plans, that MRV currently sponsors and maintains. The Employee Matters Agreement also contains provisions describing some of Luminent's employee benefit and employee stock plans. All eligible Luminent employees continue to participate in the MRV benefits plans on comparable terms and conditions to those for MRV employees until the distribution date or until Luminent establishes benefit plans for its employees, or elects not to establish comparable plans if it is not legally or financially practical. Luminent intends to establish its own benefit program no later than the time of distribution. Once Luminent establishes it own benefits plans, it may modify or terminate each plan in accordance with the terms of that plan and its policies. No Luminent benefit plan will provide benefits that overlap benefits under the corresponding MRV benefit plan at the time of the distribution. Each Luminent benefit plan will provide that all service, compensation and other benefit determinations that, as of the distribution, were recognized under the corresponding MRV benefits plan, will be taken into account under that Luminent benefit plan. Following the date of MRV's distribution of its Luminent common stock to its stockholders, Luminent will be under no obligation to maintain these plans in the form in which they were established or at all. The transfer to Luminent of employees at certain of MRV's international operations, and of certain employee benefit plans, may not take place until Luminent receives consents or approvals or has satisfied other applicable requirements. TAX SHARING AND INDEMNIFICATION AGREEMENT The Tax Sharing and Indemnification Agreement allocates MRV's and Luminent's responsibilities and rights for certain tax matters. The agreement requires Luminent to pay MRV for the incremental tax costs of Luminent's inclusion in consolidated, combined or unitary tax returns with affiliated corporations. In determining these incremental costs, the Tax Sharing and Indemnification Agreement takes into account not only the group's incremental tax payments to the Internal Revenue Service or other taxing authorities, but also the incremental use of tax losses of affiliates to offset Luminent's taxable income, and the incremental use of tax credits of affiliates to offset the tax on Luminent's income. The Tax Sharing and Indemnification Agreement also provides for compensation or reimbursement as appropriate to reflect redeterminations of Luminent's tax liability for periods during which Luminent joined in filing consolidated, combined or unitary tax returns. The Tax Sharing and Indemnification Agreement also requires Luminent to indemnify MRV for certain taxes and similar obligations, including (a) sales taxes on the sale of products purchased by MRV from Luminent before the distribution, (b) customs duties or harbor maintenance fees on products exported or imported by MRV on behalf of Luminent, (c) the additional taxes that would result if an acquisition of a controlling interest in Luminent's stock after the distribution causes the distribution not to qualify for tax-free treatment to MRV, and (d) any taxes resulting from transactions undertaken in preparation for the distribution. F-67 174 LUMINENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Luminent's indemnity obligations include any interest penalties on taxes, duties or fees for which Luminent must indemnify MRV. Each member of a consolidated group for U.S. federal income tax purposes is jointly and severally liable for the group's federal income tax liability. Accordingly, Luminent could be required to pay a deficiency in the group's federal income tax liability for a period during which Luminent was a member of the group even if the Tax Sharing and Indemnification Agreement allocates that liability to MRV or another member. MASTER TRANSITIONAL SERVICES AGREEMENT The Master Transitional Service Agreement governs the individual transitional services as requested by Luminent and provided by MRV, on an interim basis, for one year from the date of separation, unless extended for specific services or otherwise indicated in the agreement. The services include data processing and telecommunications services, such as voice telecommunications and data transmission, and information technology support services, for functions including accounting, financial management, tax, payroll, stockholder and public relations, legal, procurement, and other administrative functions. Specified charges for such services are generally intended to allow the providing company to recover the direct and indirect costs of providing the services. The Master Transitional Services Agreement also will cover the provision of certain additional transitional services identified from time to time after the Separation Date that were inadvertently or unintentionally omitted from the specified services, or that are essential to effectuate an orderly transition under the Master Separation and Distribution Agreement, so long as the provision of such services would not significantly disrupt MRV's operations or significantly increase the scope of its responsibility under the agreement. In addition, the Master Transitional Services Agreement will provide for the replication of some computer systems, including hardware, software, data storage or maintenance and support components. Generally, the party needing the replicated system will bear the costs and expenses of replication. Generally, the party purchasing new hardware or licensing new software will bear the costs and expenses of purchasing the new hardware or obtaining the new software licenses. REAL ESTATE MATTERS AGREEMENT The Real Estate Matters Agreement addresses real estate matters relating to certain MRV leased and owned properties that MRV will transfer to or share with Luminent. The Real Estate Matters Agreement describes the manner in which MRV will transfer to or share with Luminent various leased and owned properties. The Real Estate Matters Agreement provides that Luminent will be required to accept the transfer of all sites allocated to Luminent, even if a site has been damaged by a casualty before the separation date. The Real Estate Matters Agreement also provides that all reasonable costs required to effect the transfers, including landlord consent fees and landlord attorney's fees will be paid by MRV. INDEMNIFICATION AND INSURANCE MATTERS AGREEMENT Effective as of the separation date, subject to specified exceptions, Luminent and MRV released the other from any liabilities arising from events occurring on or before the separation date, including events occurring in connection with the activities to implement the separation, the initial public offering and the distribution. The Indemnification and Insurance Matters Agreement also contains provisions governing indemnification. In general, Luminent and MRV will each indemnify the other from all liabilities arising from their respective businesses or contracts, as well as liabilities arising from a breach of the Master Separation and Distribution Agreement or any ancillary agreement. In addition, MRV and Luminent will each indemnify the other against liability for specified environmental conditions. Luminent will reimburse MRV for the cost of any insurance coverage from the separation date to the distribution date. F-68 175 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To AstroTerra Corporation: We have audited the accompanying balance sheets of AstroTerra Corporation (a California corporation) as of December 31, 1998 and 1999, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of AstroTerra Corporation as of December 31, 1998 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP -------------------------------------- Arthur Andersen LLP San Diego, California August 24, 2000 F-69 176 ASTROTERRA CORPORATION BALANCE SHEETS
DECEMBER 31, ------------------------- JUNE 30, 1998 1999 2000 ---------- ----------- ----------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents.......................... $ 699,567 $ 1,192,250 $ 113,141 Accounts receivable................................ 429,266 559,114 805,394 Inventories........................................ 227,588 582,027 1,416,410 Prepaid expenses and other......................... 10,137 64,391 28,641 Refundable and deferred income taxes............... 37,048 85,567 107,067 ---------- ----------- ----------- Total current assets............................ 1,403,606 2,483,349 2,470,653 Property and equipment, net.......................... 57,000 300,994 453,875 Other assets......................................... 1,000 56,478 51,879 ---------- ----------- ----------- Total assets.................................... $1,461,606 $ 2,840,821 $ 2,976,407 ========== =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable................................... $ 21,012 $ 221,847 $ 234,266 Accrued expenses................................... 286,000 323,287 300,909 Income taxes payable............................... 71,981 -- -- Deferred revenues.................................. 17,239 87,376 298,898 Line of credit..................................... -- -- 136,000 Non-revolving credit facility...................... -- -- 182,000 ---------- ----------- ----------- Total current liabilities....................... 396,232 632,510 1,152,073 ---------- ----------- ----------- Commitments and contingencies Stockholders' equity: Common stock, 20,000,000 shares authorized; 10,000,000, 10,526,316 and 10,526,316 issued and outstanding, respectively....................... 647,994 1,689,636 1,689,636 Additional paid-in capital......................... 318,948 3,387,986 10,851,535 Notes receivable from stockholders................. (30,000) (4,020) -- Deferred compensation.............................. -- (1,602,517) (6,678,402) Retained earnings (accumulated deficit)............ 128,432 (1,262,774) (4,038,435) ---------- ----------- ----------- Total stockholders' equity...................... 1,065,374 2,208,311 1,824,334 ---------- ----------- ----------- Total liabilities and stockholders' equity...... $1,461,606 $ 2,840,821 $ 2,976,407 ========== =========== ===========
The accompanying notes are an integral part of these financial statements. F-70 177 ASTROTERRA CORPORATION STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS FOR THE YEARS ENDED DECEMBER 31, ENDED JUNE 30, --------------------------------------- -------------------------- 1997 1998 1999 1999 2000 ---------- ---------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) Revenues: Products................. $ 410,481 $ 842,901 $ 1,684,825 $ 630,047 $ 1,733,257 Contracts................ 2,441,665 3,284,976 2,966,051 1,331,444 818,737 ---------- ---------- ----------- ---------- ----------- 2,852,146 4,127,877 4,650,876 1,961,491 2,551,994 ---------- ---------- ----------- ---------- ----------- Cost of Revenues: Products................. 375,749 562,913 1,100,516 423,342 1,317,680 Contracts................ 1,905,020 2,758,922 3,053,468 1,281,209 1,075,924 ---------- ---------- ----------- ---------- ----------- 2,280,769 3,321,835 4,153,984 1,704,551 2,393,604 ---------- ---------- ----------- ---------- ----------- Gross margin.......... 571,377 806,042 496,892 256,940 158,390 ---------- ---------- ----------- ---------- ----------- Operating Expenses: Selling, general and administrative........ 222,633 808,450 1,698,027 540,871 1,971,382 Research and development........... 246,884 108,429 164,566 17,876 968,524 ---------- ---------- ----------- ---------- ----------- 469,517 916,879 1,862,593 558,747 2,939,906 ---------- ---------- ----------- ---------- ----------- Income (loss) from operations.......... 101,860 (110,837) (1,365,701) (301,807) (2,781,516) Interest Income............ 534 430 5,835 8,246 12,766 Interest Expense........... (1,462) (3,247) (259) (152) (6,911) ---------- ---------- ----------- ---------- ----------- Income (loss) before provision for income taxes............... 100,932 (113,654) (1,360,125) (293,713) (2,775,661) Provision for Income Taxes.................... 36,000 98,056 31,081 89,590 -- ---------- ---------- ----------- ---------- ----------- Net Income (loss).......... $ 64,932 $ (211,710) $(1,391,206) $ (383,303) $(2,775,661) ========== ========== =========== ========== ===========
The accompanying notes are an integral part of these financial statements. F-71 178 ASTROTERRA CORPORATION STATEMENTS OF STOCKHOLDERS' EQUITY
NOTES RETAINED COMMON STOCK ADDITIONAL RECEIVABLE EARNINGS TOTAL ----------------------- PAID-IN FROM DEFERRED (ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL STOCKHOLDERS COMPENSATION DEFICIT) EQUITY ---------- ---------- ----------- ------------ ------------ ------------ ------------- Balance, December 31, 1996... 7,500,000 $ 76,000 $ -- $ -- $ -- $ 275,210 $ 351,210 Net income................. -- -- -- -- -- 64,932 64,932 ---------- ---------- ----------- -------- ----------- ----------- ----------- Balance, December 31, 1997... 7,500,000 76,000 -- -- -- 340,142 416,142 Repurchases of common stock from employees........... (500,000) (5,000) -- -- -- -- (5,000) Sales of common stock to employees................ 2,300,000 76,994 -- (30,000) -- -- 46,994 Sale of common stock to investor................. 700,000 500,000 -- -- -- -- 500,000 Compensation expense for stock issued to employees................ -- -- 318,948 -- -- -- 318,948 Net loss................... -- -- -- -- -- (211,710) (211,710) ---------- ---------- ----------- -------- ----------- ----------- ----------- Balance, December 31, 1998... 10,000,000 647,994 318,948 (30,000) -- 128,432 1,065,374 Repurchase of common stock from employees........... (982,046) (76,205) -- 30,000 -- -- (46,205) Sales of common stock to employees................ 982,046 117,847 -- (4,020) -- -- 113,827 Sale of common stock to investor................. 526,316 1,000,000 -- -- -- -- 1,000,000 Deferred compensation for stock issued to employees................ -- -- 3,069,038 -- (3,069,038) -- -- Amortization of deferred compensation............. -- -- -- -- 1,466,521 -- 1,466,521 Net loss................... -- -- -- -- -- (1,391,206) (1,391,206) ---------- ---------- ----------- -------- ----------- ----------- ----------- Balance, December 31, 1999... 10,526,316 1,689,636 3,387,986 (4,020) (1,602,517) (1,262,774) 2,208,311 The following information is unaudited: Repurchase of common stock from employees........... -- -- -- 4,020 -- -- 4,020 Deferred compensation for stock issued to employees................ -- -- 7,463,549 -- (7,463,549) -- Amortization of deferred compensation............. -- -- -- -- 2,387,664 -- 2,387,664 Net loss................... -- -- -- -- -- (2,775,661) (2,775,661) ---------- ---------- ----------- -------- ----------- ----------- ----------- Balance, June 30, 2000 (unaudited)................ 10,526,316 $1,689,636 $10,851,535 $ -- $(6,678,402) $(4,038,435) $ 1,824,334 ========== ========== =========== ======== =========== =========== ===========
The accompanying notes are an integral part of these financial statements. F-72 179 ASTROTERRA CORPORATION STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30, ------------------------------------- --------------------------- 1997 1998 1999 1999 2000 --------- --------- ----------- ----------- ------------ (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net income (loss).............................. $ 64,932 $(211,710) $(1,391,206) $(383,303) $(2,775,661) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization................ 47,825 45,929 83,284 42,619 129,506 Deferred income taxes........................ -- (3,925) (21,521) (22,245) -- Non-cash employee stock compensation......... -- 318,948 1,466,521 463,725 2,387,664 Changes in assets and liabilities: Accounts receivable.......................... 302,165 (301,519) (129,848) (400,872) (246,280) Inventories.................................. (373,023) 145,435 (354,439) (255,393) (834,383) Prepaid expenses and other................... (519) (9,576) (54,254) 9,716 35,750 Refundable income taxes...................... -- -- (26,998) -- (21,500) Other assets................................. -- (1,000) (55,478) (17,115) (9,545) Accounts payable............................. 23,346 (48,478) 200,835 112,395 12,419 Accrued expenses............................. 72,661 48,643 37,287 (124,477) (22,378) Income taxes payable......................... (16,601) 69,981 (71,981) 43,834 -- Deferred revenues............................ -- 17,239 70,137 (10,548) 211,521 --------- --------- ----------- --------- ----------- Net cash provided by (used in) operating activities............................ 120,786 69,967 (247,661) (541,664) (1,132,887) --------- --------- ----------- --------- ----------- Net cash used in investing activities: Purchases of property and equipment............ (79,269) (39,219) (327,278) (60,615) (268,242) --------- --------- ----------- --------- ----------- Cash flows from financing activities: Net (repayments) borrowings on line of credit....................................... 127,292 (127,292) -- -- 136,000 Borrowings on non-revolving credit facility.... -- -- -- -- 182,000 Proceeds from issuances of common stock........ -- 546,994 1,113,827 -- -- Payments for repurchases of common stock....... -- (5,000) (46,205) (46,205) 4,020 --------- --------- ----------- --------- ----------- Net cash provided by (used in) financing activities............................ 127,292 414,702 1,067,622 (46,205) 322,020 --------- --------- ----------- --------- ----------- Net increase (decrease) in cash and cash equivalents.................................... 168,809 445,450 492,683 (648,484) (1,079,109) Cash and cash equivalents, beginning of year..... 85,308 254,117 699,567 699,567 1,192,250 --------- --------- ----------- --------- ----------- Cash and cash equivalents, end of year........... $ 254,117 $ 699,567 $ 1,192,250 $ 51,083 $ 113,141 ========= ========= =========== ========= =========== Non-cash activities: Common stock issued for notes receivable from stockholders................................. $ -- $ 30,000 $ 4,020 $ -- $ -- ========= ========= =========== ========= =========== Repurchase of common stock from employee in exchange for notes receivable................ $ -- $ -- $ 30,000 $ 30,000 $ -- ========= ========= =========== ========= =========== Deferred compensation for stock issued to employees.................................... $ -- $ -- $ 3,069,038 $ -- $ 7,463,549 ========= ========= =========== ========= =========== Supplemental cash flow disclosures: Cash paid during the year for: Interest..................................... $ 1,462 $ 3,247 $ 259 $ 152 $ 6,911 ========= ========= =========== ========= =========== Income taxes................................. $ 35,298 $ 32,000 $ 83,525 $ 60,742 $ 16,000 ========= ========= =========== ========= ===========
The accompanying notes are an integral part of these financial statements. F-73 180 ASTROTERRA CORPORATION NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 1. LINE OF BUSINESS AND SALE OF COMPANY AstroTerra Corporation (the "Company") develops and manufactures free-space optical laser communication systems to connect data and telecommunications networks. The Company's optical communication systems are practical high-speed wireless alternatives to fiber optic cable and microwave systems. The Company also performs contract research and development for the U.S. government and commercial customers. During July 2000, the Company entered into a stock purchase agreement with MRV Communications, Inc. ("MRV"), whereby MRV acquired the entire share capital of the Company in an exchange for shares of MRV common stock. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect 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. INTERIM FINANCIAL STATEMENTS The accompanying consolidated financial statements for the interim periods included herein are unaudited. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted, although the Company believes that the disclosures made are adequate to make the information presented not misleading. These unaudited financial statements reflect, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to fairly present the results of operations, changes in cash flows and financial position as of and for the periods presented. The results for the interim periods presented are not necessarily indicative of results to be expected for a full year. REVENUE RECOGNITION Product revenues are recognized upon shipment and transfer of title and risk of loss to the customer. Research and development contract revenues are recognized using the percentage-of-completion method on a cost-to-cost basis. Contract costs include all direct material and labor costs, and those indirect costs related to contract performance. If a loss is projected on a contract, the entire estimated loss is charged to operations during the period that the loss becomes determinable. Payments received from customers in advance of shipment of products or performance of contract services are deferred and recognized upon completion of the related obligations. F-74 181 ASTROTERRA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999, 1998 AND 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as incurred. CASH AND CASH EQUIVALENTS Cash and cash equivalents include all highly liquid investments with original maturities of three months or less and consist primarily of money market accounts. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method and includes materials, direct labor and manufacturing overhead. PROPERTY AND EQUIPMENT Property and equipment are stated at cost and depreciated using an accelerated method over the estimated useful lives of the assets, ranging from 3 to 5 years. Maintenance and repairs are charged to expense as incurred, and the costs of additions and betterments that increase the useful lives of the related assets are capitalized. Upon retirement or disposal of assets, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is reflected in operations. LONG-LIVED ASSETS The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of future undiscounted cash flows expected to result from the use of the asset and its eventual disposition is less than the carrying amount of the asset, an impairment loss is recognized. In the opinion of management, there have been no events or changes in circumstances that indicate impairment of the Company's long-lived assets. INCOME TAXES Deferred income tax assets or liabilities are recognized based on the temporary differences between financial statement and income tax bases of assets and liabilities using enacted statutory tax rates in effect for the years in which the differences are expected to reverse. Deferred income tax expenses or credits are based on the changes in the deferred income tax assets or liabilities from period to period. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of certain of the Company's financial instruments, including accounts receivable, accounts payable and accrued expenses approximates fair value due to their short term nature. STOCK-BASED COMPENSATION The Company accounts for stock-based compensation in accordance with Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." The Company has elected, as permitted under SFAS No. 123, to continue to account for stock-based employee compensation using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25 and to F-75 182 ASTROTERRA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999, 1998 AND 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 disclose pro forma net income (loss) as if stock-based employee compensation were computed using the fair value method under SFAS No. 123. Transactions with other than employees, in which goods or services are the consideration received for the issuance of equity instruments, are accounted for on a fair value basis under SFAS No. 123. For the years ended December 31, 1997, 1998 and 1999 and for the six months ended June 30, 1999, the differences between pro forma net income (loss) in accordance with SFAS No. 123 and net income (loss) as reported in the accompanying statements of operations was not material. There were no additional shares issued to employees during the six months ended June 30, 2000. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities and measure those instruments at fair value. SFAS No. 133 was amended by SFAS No. 137, which defers the effective date to all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 is not expected to have a material effect on the Company's financial position or results of operations as the Company has not been engaged in the use of derivative instruments. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." SAB No. 101, as amended, must be adopted no later than the fourth quarter of the fiscal year beginning after December 15, 1999. The Company does not anticipate the adoption of SAB No. 101 to have a material impact on the Company's financial position or results of operations. 3. COMPONENTS OF CERTAIN BALANCE SHEET CAPTIONS Accounts receivable consists of the following:
DECEMBER 31, -------------------- JUNE 30, 1998 1999 2000 -------- -------- ----------- (UNAUDITED) Billed receivables................................ $366,730 $415,905 $652,193 Costs incurred in excess of billings on uncompleted contracts........................... 62,536 143,209 153,201 -------- -------- -------- $429,266 $559,114 $805,394 ======== ======== ========
Inventories consist of the following:
DECEMBER 31, -------------------- JUNE 30, 1998 1999 2000 -------- -------- ----------- (UNAUDITED) Raw materials..................................... $ 27,774 $204,173 $ 438,275 Work in process................................... 102,965 236,938 657,612 Finished goods.................................... 96,849 140,916 320,523 -------- -------- ---------- $227,588 $582,027 $1,416,410 ======== ======== ==========
F-76 183 ASTROTERRA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999, 1998 AND 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 Property and equipment consists of the following:
DECEMBER 31, ---------------------- JUNE 30, 1998 1999 2000 --------- --------- ----------- (UNAUDITED) Machinery and equipment......................... $ 230,415 $ 384,964 $ 621,934 Computers and software.......................... 21,780 121,169 121,169 Furniture and fixtures.......................... 4,387 18,646 49,918 --------- --------- --------- 256,582 524,779 793,021 Less: accumulated depreciation.................. (199,582) (223,785) (339,146) --------- --------- --------- $ 57,000 $ 300,994 $ 453,875 ========= ========= =========
Depreciation expense for the years ended December 31, 1997, 1998 and 1999 totaled $47,825, $45,929 and $83,284 respectively. Depreciation expense for the six months ended June 30, 1999 and 2000 totaled $42,619 and $115,361 respectively. Accrued expenses consist of the following:
DECEMBER 31, -------------------- JUNE 30, 1998 1999 2000 -------- -------- ----------- (UNAUDITED) Compensation and related taxes..................... $286,000 $253,012 $257,318 Warranty reserve................................... -- 33,500 33,500 Other.............................................. -- 36,775 10,091 -------- -------- -------- $286,000 $323,287 $300,909 ======== ======== ========
4. INCOME TAXES Provision for income taxes consists of the following:
YEARS ENDED DECEMBER 31, ------------------------------- 1997 1998 1999 ------- -------- -------- Current: Federal........................................... $25,227 $ 79,341 $ 39,628 State............................................. 10,773 22,640 12,974 ------- -------- -------- 36,000 101,981 52,602 ------- -------- -------- Deferred: Federal........................................... -- (3,336) (18,293) State............................................. -- (589) (3,228) ------- -------- -------- -- (3,925) (21,521) ------- -------- -------- Provision for income taxes.......................... $36,000 $ 98,056 $ 31,081 ======= ======== ========
Realization of deferred income taxes is dependent on generating sufficient taxable income during the periods in which temporary differences will reverse. Although realization is not assured, management believes it is more likely than not that the deferred income taxes will be realized. The amount of deferred income taxes considered realizable, however, could be adjusted in the near term if estimates of future taxable income during the reversal periods are revised. F-77 184 ASTROTERRA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999, 1998 AND 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 Deferred income taxes consist of the following:
DECEMBER 31, ------------------ 1998 1999 ------- ------- Accrued expenses............................................ $34,326 $58,569 Other....................................................... 2,722 -- ------- ------- Deferred income taxes....................................... $37,048 $58,569 ======= =======
Provision for income taxes reconciles to the expected provision (benefit) for income taxes based on the federal statutory tax rate as follows:
YEARS ENDED DECEMBER 31, -------------------------------- 1997 1998 1999 ------- -------- --------- Expected federal income taxes...................... $36,987 $(41,313) $(462,443) State income taxes, net of federal benefit......... 6,527 (7,291) (81,608) Employee stock compensation........................ -- 127,579 586,608 Other.............................................. (7,514) 19,081 (11,476) ------- -------- --------- Provision for income taxes....................... $36,000 $ 98,056 $ 31,081 ======= ======== =========
5. CREDIT FACILITIES In May 1998, the Company obtained a $300,000 revolving line of credit with a bank, bearing interest at the bank's prime rate plus 1.5% (10.0% at December 31, 1999), collateralized by substantially all assets of the Company and personally guaranteed by three majority stockholders of the Company. No amounts were outstanding under the line of credit at December 31, 1999 and 1998. The line of credit was terminated by the Company during February 2000. In February 2000, the Company entered into a $1,300,000 credit agreement with a bank, consisting of a $1,000,000 revolving line of credit and a $300,000 non-revolving credit facility for equipment purchases. The credit agreement bears interest at variable rates based on either the banks' reference rate plus 0.5% or LIBOR plus 2.75%, as elected by borrower, is secured by substantially all assets of the Company, and is subject to certain financial and non-financial covenants. As of June 30, 2000, the Company had $136,000 outstanding under the revolving line of credit and $182,000 outstanding under the non-revolving credit facility for equipment purchases. The credit agreement is collateralized by the assets of the Company. The credit agreement contains certain covenants, which among other things requires the Company to maintain a minimum effective tangible net worth, certain financial ratios and no consecutive losses. As of June 30, 2000, the Company was in default with certain financial covenants; therefore, the components of the credit agreement are classified as short-term. The credit agreement was terminated by the Company during August 2000 and all amounts outstanding were repaid. 6. STOCKHOLDERS' EQUITY CAPITAL STRUCTURE The Company is authorized to issue up to 20,000,000 shares of common stock, no par value. Common shares are voting shares with equal dividend participation, when and if declared, and equal rights in the event of liquidation. F-78 185 ASTROTERRA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999, 1998 AND 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 EMPLOYEE STOCK PURCHASE PLANS In August 1997, the Company implemented a book value employee stock purchase plan (the "Plan") and determined that 2,000,000 shares would be made available for purchases. The Plan allowed each full time employee with at least one year of service to purchase up to 2,000 shares of common stock at book value per share, as determined by the board of directors. Additionally, the board of directors determined that an additional 500,000 shares of common stock would be made available for purchases by key employees on a discretionary basis. Under the Plan, the Company retains the option to repurchase shares sold to employees upon their termination. If an employee leaves the Company within a year after purchasing shares, the Company's repurchase price per share is the original issuance price. If an employee leaves the Company more than one year after purchasing shares, the Company's repurchase price per share is the greater of the original issuance price or current book value. Discretionary shares sold to key employees carry terms determined by the board of directors, and generally allow for employee vesting (elimination of the Company repurchase option) over a period of four years. Further, upon a substantial change in control of the Company or employee termination without cause, the Company repurchase option terminates. Stock issued to employees under the above plans are accounted for using the variable method of accounting in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," Emerging Issues Task Force Release ("EITF") No. 87-23, "Book Value Stock Purchase Plans" and EITF No. 88-6 "Book Value Stock Plans in an Initial Public Offering." Accordingly, outstanding shares under the book value purchase plan are marked to book value per share during each reporting period. Outstanding shares issued to employees on a discretionary basis with vesting provisions (elimination of the Company's repurchase option) are marked to fair value during each reporting period. At the point when restrictions related to employee shares lapse, any unamortized deferred compensation expenses are recognized in operations. Compensation expense for shares issued to employees during fiscal 1998, 1999 and the six months ended June 30, 1999 and 2000 totaled $318,948, $1,466,521, $463,725 and $2,387,664 respectively, and is included in the accompanying statements of operations. As of December 31, 1999 and June 30, 2000, deferred compensation included as a component of stockholders' equity totals $1,602,517 and $6,678,402, respectively, and is expected to be amortized in full during fiscal year 2000 as a result of the acquisition of the Company by MRV (see Note 1). F-79 186 ASTROTERRA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999, 1998 AND 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 Stock based compensation expense has been included in the accompanying statement of operations as follows:
DECEMBER 31, JUNE 30, ---------------------- -------------------------- 1998 1999 1999 2000 -------- ---------- ----------- ----------- (UNAUDITED) (UNAUDITED) Allocation of compensation expense: Cost of revenues: Products................................. $ 3,844 $ 233,707 $ 73,900 $ 380,502 Contracts................................ 40,144 574,645 188,865 518,904 Operating expenses: Selling, general and administrative...... 273,382 627,199 198,325 1,021,154 Research and development................. 1,578 30,970 2,635 467,104 -------- ---------- -------- ---------- Total stock-based compensation expense............................. $318,948 $1,466,521 $463,725 $2,387,664 ======== ========== ======== ==========
7. COMMITMENTS AND CONTINGENCIES OPERATING LEASES The Company leases its facilities and certain equipment under operating leases expiring at various dates through April 2002. The Company has the right to terminate the lease with at least 120 days prior written notice and has an option to renew the lease for an additional two years at a rate increase of ten percent. Rent expense for the years ended December 31, 1997, 1998 and 1999 was $56,300, $81,089 and $127,746, respectively. Rent expense for the six months ended June 30, 1999 and 2000 was $58,314 and $137,398, respectively. Future minimum lease payments under operating leases are as follows:
YEAR ENDING DECEMBER 31: ------------ 2000...................................................... $256,120 2001...................................................... 246,352 2002...................................................... 36,063 -------- $538,535 ========
LEGAL MATTERS In the ordinary course of business, the Company is subject to claims and, from time to time, is named in various legal proceedings. In the opinion of management, the amount of ultimate liability, if any, with respect to any of these matters will not have a material adverse affect on the financial position or results of operations of the Company. 8. RETIREMENT SAVINGS PLAN The Company maintains a 401(k) retirement savings plan that covers substantially all of its employees. Eligible employees may contribute to the plan subject to certain Internal Revenue Service limitations. Company contributions to the plan are discretionary. During fiscal 1997, 1998 and 1999, the Company contributed $61,723, $82,823 and $77,907, respectively. For the six months ended June 30, 1999 and 2000, the Company contributed $22,020 and $67,323 respectively. F-80 187 ASTROTERRA CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999, 1998 AND 1997 AND FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 9. CONCENTRATIONS OF RISK During fiscal 1997, 1998 and 1999, the Company had 7, 7 and 6 contracts, respectively, with government agencies that accounted for 98%, 99% and 69% of contract revenues, respectively. Additionally, the Company had a contract with a commercial customer that accounted for 31% of contract revenues in fiscal 1999. During both of the six month periods ended June 30, 1999 and 2000, the Company had 5 contracts with government agencies that accounted for 73% and 100% of contract revenues, respectively. Additionally, the Company had a commercial customer that accounted for 27% of contract revenues for the six months ended June 30, 1999. During fiscal 1997, 1998 and 1999, 1, 3 and 1 customers represented 37%, 34% and 10% of product revenues, respectively. During the six months ended June 30, 1999 and 2000, 3 and 1 customers represented 39% and 58% of product revenues, respectively. Government agency contracts accounted for 43% and 63% of accounts receivable at December 31, 1998 and 1999, respectively, and 31% of accounts receivable at June 30, 2000. One commercial customer accounted for 15% of accounts receivable at December 31, 1998, and another commercial customer accounted for 48% of accounts receivable at June 30, 2000. 10. SEGMENT REPORTING The Company operates in one industry segment, which includes developing, manufacturing and selling free-space optical laser communications systems to connect data and telecommunication networks. The Company derives revenues in this segment from both product shipments and research and development contracts. The accompanying statements of operations separately reflect the revenues and cost of revenues for products and research and development contracts. F-81 188 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of FOCI Fiber Optic Communications, Inc. We have audited the accompanying consolidated balance sheets of FOCI Fiber Optic Communications, Inc. as of December 31, 1997, 1998 and 1999, and the related consolidated statements of operations and comprehensive income, shareholders' equity, and cash flows for the years ended December 31, 1997, 1998 and 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FOCI Fiber Optic Communications, Inc. at December 31, 1997, 1998 and 1999 and the results of its operations and its cash flows for the years ended December 31, 1997, 1998 and 1999, in conformity with accounting principles generally accepted in the United States of America. T N Soong & Co A Member Firm of Andersen Worldwide, SC Taipei, Taiwan, the Republic of China June 12, 2000 F-82 189 FOCI FIBER OPTIC COMMUNICATIONS, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1997, 1998 AND 1999
DECEMBER 31, ----------------------------- NOTES 1997 1998 1999 --------- ------- ------- ------- (IN THOUSAND U.S. DOLLARS EXCEPT SHARE AMOUNTS) ASSETS Current Assets Cash...................................................... 2C $ 532 $ 2,236 $ 3,344 Marketable securities..................................... 2D, 15 911 1,527 174 Notes and accounts receivable -- net...................... 2C, 3, 14 8,119 9,361 10,348 Inventories............................................... 2E, 4 2,787 8,504 11,541 Prepaid expenses and other current assets................. 15 1,252 3,217 4,444 ------- ------- ------- Total Current Assets.................................... 13,601 24,845 29,851 ------- ------- ------- Long-Term Stock Investments................................. 2F, 5 -- 40 31 ------- ------- ------- Properties -- Net........................................... 2G, 6, 15 9,231 15,723 25,559 ------- ------- ------- Intangible Assets........................................... 2I Patent.................................................... 149 107 66 Land occupancy rights..................................... -- 270 502 ------- ------- ------- Total Intangible Assets................................. 149 377 568 ------- ------- ------- Other Assets Deferred charges -- net................................... 2J -- 197 265 Deferred income tax....................................... 2N, 13 490 368 331 Refundable deposits....................................... 28 100 85 Others.................................................... 10 1,029 789 ------- ------- ------- Total Other Assets...................................... 528 1,694 1,470 ------- ------- ------- Total Assets............................................ $23,509 $42,679 $57,479 ======= ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Short-term bank loans..................................... 7 $ 2,099 $ 2,686 $ 8,700 Commercial papers......................................... 8 -- -- 1,659 Notes payable............................................. 867 1,607 1,225 Accounts payable.......................................... 304 940 1,787 Income tax payable........................................ 2N, 13 25 185 188 Current portion of long-term debts........................ 9, 15 317 641 429 Accrued expenses and other current liabilities............ 13 1,337 1,579 2,195 ------- ------- ------- Total Current Liabilities............................... 4,949 7,638 16,183 ------- ------- ------- Long-Term Debts -- Net of Current Portion................... 9, 15 2,473 1,892 7,429 ------- ------- ------- Other Liabilities Accrued pension cost...................................... 2M, 12 44 66 70 Others.................................................... 254 313 373 ------- ------- ------- Total Other Liabilities................................. 298 379 443 ------- ------- ------- Total Liabilities....................................... 7,720 9,909 24,055 ------- ------- ------- Shareholders' Equity........................................ 10 Capital stock, $0.3 par value; Authorized -- 35,000 thousand shares in 1997, 110,000 thousand shares in 1998 and 1999; Issued -- 35,000 thousand shares in 1997, 56,720 thousand shares in 1998 and 68,984 thousand shares in 1999.......................................... 12,975 19,787 23,891 Capital surplus........................................... 5,456 13,358 11,592 Retained earnings: Legal reserve............................................. -- 62 267 Unappropriated earnings................................... 426 1,871 (755) Cumulative translation adjustment......................... (3,068) (2,308) (1,571) ------- ------- ------- Total Shareholders' Equity.............................. 15,789 32,770 33,424 ------- ------- ------- Total Liabilities and Shareholders' Equity.............. $23,509 $42,679 $57,479 ======= ======= =======
The accompanying notes are an integral part of the financial statements. F-83 190 FOCI FIBER OPTIC COMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
YEARS ENDED DECEMBER 31, -------------------------------------- NOTES 1997 1998 1999 ------ ---------- ---------- ---------- (IN THOUSAND U.S. DOLLARS EXCEPT PER SHARE AMOUNTS) Sales Products, net...................................... $ 7,506 $16,939 $19,158 Engineering contracts.............................. -- 3,442 600 ------- ------- ------- Net Sales............................................ 7,506 20,381 19,758 Cost of Sales Cost of goods sold................................. 2,688 12,274 12,739 Cost of engineering contracts...................... -- 1,115 668 ------- ------- ------- 2,688 13,389 13,407 ------- ------- ------- Gross Profit......................................... 4,818 6,992 6,351 ------- ------- ------- Operating Expenses Research and development........................... 2L 895 871 1,256 General and administrative......................... 1,506 3,358 3,321 Marketing.......................................... 1,067 2,132 1,692 ------- ------- ------- Total Operating Expenses........................ 3,468 6,361 6,269 ------- ------- ------- Income from Operations............................... 1,350 631 82 ------- ------- ------- Non-Operating Income (Expenses) Foreign exchange gain (losses) -- net.............. 2P 1,003 (403) (599) Interest -- net.................................... (9) (63) (322) Loss on disposal of properties -- net.............. (71) (19) (65) Long-term investment permanent loss................ 2F -- (57) (9) Unrealized holdings gains (loss) of market securities...................................... 2D (437) 211 170 Loss on sale of marketable securities.............. (421) (106) -- Other -- net....................................... 30 (132) 114 ------- ------- ------- Total Non-Operating Income (Expenses)........... 95 (569) (711) ------- ------- ------- Income (Loss) Before Income Tax and Minority Interests.......................................... 1,445 62 (629) Income Tax Benefit (Expense)......................... 2N, 13 174 129 (68) ------- ------- ------- Net Income Before Minority Loss...................... 1,619 191 (697) Minority Loss........................................ 15 1,316 36 ------- ------- ------- Net Income (Loss).................................... $ 1,634 $ 1,507 $ (661) ======= ======= ======= Other Comprehensive Income Translation adjustment............................... $(3,068) $ 760 $ 737 ------- ------- ------- Comprehensive Income (Loss).......................... 2S $(1,434) $ 2,267 $ 76 ======= ======= ======= Earnings (Loss) Per Share -- Retroactively adjusted outstanding common stock 44,665 thousand shares in 1997 and 60,213 thousand shares in 1998 and 68,447 thousand shares in 1999.................................. $ 0.04 $ 0.03 $ (0.01) ======= ======= =======
The accompanying notes are an integral part of the financial statements. F-84 191 FOCI FIBER OPTIC COMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
CAPITAL SURPLUS RETAINED EARNINGS CAPITAL STOCK ISSUED ------------------------------- (NOTE 10) ------------------------------------------- GAIN ON ------------------------ LONG- DISPOSAL OF UNAPPROPRIATED SHARES PAID-IN TERM PROPERTIES LEGAL EARNINGS (THOUSAND) AMOUNT CAPITAL INVESTMENT (2G) TOTAL RESERVE (DEFICIT) TOTAL ---------- ------- ------- ---------- ----------- ------- ------- -------------- ------- (IN THOUSAND U.S. DOLLARS) BALANCE, JANUARY 1, 1997................. 19,980 $ 7,519 $ -- $-- $-- $ -- $ -- $(1,208) $(1,208) Issuance of capital stock for cash....... 15,020 5,456 5,456 -- -- 5,456 -- -- -- Net income for 1997.... -- -- -- -- -- -- -- 1,634 1,634 Translation adjustment........... -- -- -- -- -- -- -- -- -- ------ ------- ------- -- -- ------- ---- ------- ------- BALANCE, DECEMBER 31, 1997................. 35,000 12,975 5,456 -- -- 5,456 -- 426 426 Issuance of capital stock for cash....... 16,470 4,905 9,809 -- -- 9,809 -- -- -- Appropriations of 1997 earnings: Legal reserve.......... -- -- -- -- -- -- 62 (62) -- Capital surplus transferred into capital.............. 5,250 1,907 (1,907) -- -- (1,907) -- -- -- Net income for 1998.... -- -- -- -- -- -- -- 1,507 1,507 Translation adjustment........... -- -- -- -- -- -- -- -- -- ------ ------- ------- -- -- ------- ---- ------- ------- BALANCE, DECEMBER 31, 1998................. 56,720 19,787 13,358 -- -- 13,358 62 1,871 1,933 Appropriations of 1998 earnings: Legal reserve.......... -- -- -- -- -- -- 205 (205) -- Stock dividends -- 10%..... 5,672 1,759 -- -- -- -- -- (1,759) (1,759) Capital surplus transferred into capital.............. 5,672 2,060 (2,060) -- -- (2,060) -- -- -- Stocks issued as payment of bonus to employees............ 920 285 285 -- -- 285 -- -- -- Net loss for 1999...... -- -- -- -- -- -- -- (661) (661) Gain on disposal of properties........... -- -- -- -- 1 1 -- (1) (1) Adjustment of capital reserve due to change in equity in long-term investments.......... -- -- -- 8 -- 8 -- -- -- Translation adjustments.......... -- -- -- -- -- -- -- -- -- ------ ------- ------- -- -- ------- ---- ------- ------- BALANCE, DECEMBER 31, 1999................. 68,984 $23,891 $11,583 $8 $1 $11,592 $267 $ (755) $ (488) ====== ======= ======= == == ======= ==== ======= ======= CUMULATIVE TRANSLATION TOTAL ADJUSTMENT SHAREHOLDERS' (NOTE 2Q) EQUITY ----------- ------------- (IN THOUSAND U.S. DOLLARS) BALANCE, JANUARY 1, 1997................. $ -- $ 6,311 Issuance of capital stock for cash....... -- 10,912 Net income for 1997.... -- 1,634 Translation adjustment........... (3,068) (3,068) ------- ------- BALANCE, DECEMBER 31, 1997................. (3,068) 15,789 Issuance of capital stock for cash....... -- 14,714 Appropriations of 1997 earnings: Legal reserve.......... -- -- Capital surplus transferred into capital.............. -- -- Net income for 1998.... -- 1,507 Translation adjustment........... 760 760 ------- ------- BALANCE, DECEMBER 31, 1998................. (2,308) 32,770 Appropriations of 1998 earnings: Legal reserve.......... -- -- Stock dividends -- 10%..... -- -- Capital surplus transferred into capital.............. -- -- Stocks issued as payment of bonus to employees............ -- 570 Net loss for 1999...... -- (661) Gain on disposal of properties........... -- -- Adjustment of capital reserve due to change in equity in long-term investments.......... -- 8 Translation adjustments.......... 737 737 ------- ------- BALANCE, DECEMBER 31, 1999................. $(1,571) $33,424 ======= =======
The accompanying notes are an integral part of the financial statements. F-85 192 FOCI FIBER OPTIC COMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
YEARS ENDED DECEMBER 31, ------------------------------ 1997 1998 1999 ------- ------- -------- (IN THOUSAND U.S. DOLLARS) Operating Activities Net income (loss)......................................... $ 1,634 $ 1,507 $ (661) Adjustments to reconcile net income (loss) to net cash provided used in operating activities: Depreciation and amortization........................... 697 972 1,475 Loss on disposal of properties.......................... 71 19 65 Long-term investment permanent loss..................... -- 57 9 Accrued pension costs................................... (4) 22 4 Unrealized holding losses (gains) on marketable securities............................................. 437 (211) (170) Minority interest in net income of consolidated subsidiaries........................................... (15) (1,316) (36) Deferred income tax..................................... (485) 122 37 Loss on sale of marketable securities................... 421 106 -- Changes in operating assets and liabilities Notes and accounts receivable......................... (5,483) (1,242) (987) Inventories........................................... (1,354) (5,717) (3,037) Prepaid expenses and other current assets............. (237) (2,157) (1,227) Notes and accounts payable............................ (189) 1,376 465 Accrued expenses and other current liabilities........ 907 402 619 ------- ------- -------- Net Cash Used in Operating Activities............... (3,600) (6,060) (3,444) ------- ------- -------- Investing Activities Acquisitions of: Marketable securities................................... (1,769) (511) 1,523 Long-term stock investments............................. -- (40) -- Properties.............................................. (6,316) (7,175) (11,388) Proceeds from disposals of: Properties.............................................. 17 190 56 Long-term stock investment.............................. -- 135 -- Increase in deferred charges.............................. -- (459) (541) Decrease (increase) in refundable deposits................ 176 (72) 15 Decrease (increase) in other assets....................... -- (1,019) 240 ------- ------- -------- Net Cash Used in Investing Activities............... (7,892) (8,951) (10,095) ------- ------- -------- Financing Activities Proceeds from (payments of): Short-term bank loans................................... 1,605 587 6,014 Commercial paper........................................ -- -- 1,659 Long-term debts......................................... 971 (257) 5,325 Issuance of capital stock............................... 10,912 14,714 570 Increase in minority interest........................... -- 1,375 96 ------- ------- -------- Net Cash Provided by Financing Activities........... 13,488 16,419 13,664 ------- ------- -------- Effects of Changes in Foreign Exchange Rate................. (1,754) 296 983 ------- ------- -------- Net Increase in Cash........................................ 242 1,704 1,108 Cash at Beginning of Year................................... 290 532 2,236 ------- ------- -------- Cash at End of Year......................................... $ 532 $ 2,236 $ 3,344 ======= ======= ======== Supplemental Disclosures of Cash Flow Information Cash paid for interest.................................... $ 118 $ 284 $ 385 ======= ======= ======== Cash paid for income tax.................................. $ 12 $ 34 $ 29 ======= ======= ========
The accompanying notes are an integral part of the financial statements. F-86 193 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 1. GENERAL Business FOCI Fiber Optic Communications, Inc. (the "Company") was incorporated under the Company Law of the Republic of China on June 14, 1995 and started its operation in September 1995. The Company designs, installs, manufactures and markets fiber optic related products such as components, testing systems, instruments, network installation, CATV engineering and sensing systems. The Company has the following subsidiaries:
DATE, PLACE AND OTHER DETAILS NAME OWNERSHIP RELATED TO INCORPORATION NATURE OF BUSINESS ---- --------- ----------------------------- ------------------ FOCI USA, Inc.......... 100% Incorporated on March 11, Selling of fiber optic 1999 in the State of related products California, United States of including components, America. testing systems, instruments, network installation, CATV engineering, and sensing systems. FOCI Optronic Components, Inc...... 94% Incorporated on February 6, Designs, installs, 1999 in the Republic of manufactures and China. markets fiber optic related products including components, testing systems, instruments, network installation, CATV engineering, and sensing systems. FIOPTEC Inc............ 93% Incorporated on April 9, 1993 Manufacture and markets in the Republic of China. The fiber optic related Company's 93% investment was products including acquired on June 29, 1998. fiber optic components. Also, it has indirect investment in Shanghai FOCI Fiber Optic Communications Equipment, Inc. through FIOPTEC Inc. (Cayman Islands). FIOPTEC Inc. (Cayman Islands)............. 100% owned by Incorporated on August 28, Investment holding FIOPTEC, Inc. 1998 in Cayman Islands. company.
F-87 194 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS)
DATE, PLACE AND OTHER DETAILS NAME OWNERSHIP RELATED TO INCORPORATION NATURE OF BUSINESS ---- --------- ----------------------------- ------------------ Shanghai FOCI Fiber Optic Communications Equipment, Inc....... 100% owned by Incorporated on August 1, Designs, installs, FIOPTEC (Cayman 1995 in Shanghai, People's manufactures and Islands) Republic of China. FIOPTEC markets fiber optic Inc.'s investment was made on related products June 29, 1998. including components, testing systems, instruments, network installation, CATV engineering, and sensing systems. Yuan-Tai Enterprises Pte, Ltd............. 100% owned by Incorporated on October 23, Import fiber optic FIOPTEC Inc. 1993 in Singapore. FIOPTEC products from the Inc. made its investment to Company for export the Company on December 5, outside Singapore. 1995 and the investment was disposed by FIOPTEC Inc. on October 29, 1998.
2. ACCOUNTING POLICIES A. Basis of Presentation The consolidated financial statements included the following: (a) 1997 -- the Company, FIOPTEC Inc., Shanghai FOCI Fiber Optic Communications Equipment, Inc., and Yuan-Tai Enterprises Pte., Ltd.; (b) 1998 -- the Company, FIOPTEC Inc., FIOPTEC Inc. (Cayman Islands), and Shanghai FOCI Fiber Optic Communications Equipment, Inc.; and (c) 1999 -- the Company, FIOPTEC Inc., FIOPTEC Inc. (Cayman Islands), and Shanghai FOCI Fiber Optic Communications Equipment, Inc., FOCI Optronic Components, Inc., and FOCI USA, Inc. All transactions and balances with consolidated companies have been eliminated. B. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. C. Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and accounts receivable. Cash is deposited with high credit quality financial institutions. As far as the accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and the Company maintains its allowance for doubtful accounts receivable based on a review of the collectibility of individual receivable taking into account the age of the receivables. F-88 195 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) D. Marketable Securities Marketable securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. The costs of investment sold are determined by the weighted average method. E. Inventories Inventories are stated at cost using the weighted average method and are valued at the lower of cost or market value at balance sheet date. The market value of raw materials is determined based on current replacement cost, while work-in-process and finished goods are determined by net realizable value. F. Investments in Shares of Stock These investments are equity securities without readily available market value. Accordingly, they were carried at costs. The unrealized loss resulting from the decline in market value of such investment is reported as deduction from stockholders' equity in the current year's income. When it becomes evidently clear that there has been a permanent impairment in value and the chance of recovery is minimal, loss is recognized in the current year's income. G. Properties Properties are stated at cost less accumulated depreciation. Major additions, renewals and betterment and interest expense incurred during the construction period are capitalized, while maintenance and repairs are expensed currently. Depreciation is provided on the straight-line method over the estimated useful lives of the assets. Salvage values of fixed assets still in use after the end of their original estimated useful lives are depreciated over the remaining new estimated useful lives. The useful lives of the fixed assets are 2 - 10 years, except for buildings which are 20 - 25 years. Upon sale or disposal of properties, the related cost and accumulated depreciation are removed from the accounts, and any gain or loss is credited or charged to income. Any such gain, less applicable income tax, is transferred to capital surplus at the end of the year. H. Asset Impairment Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", ("SFAS No. 121") requires recognition of impairment of long-lived assets in the event the net book value of these assets exceeds the future undiscounted cash flows attributable in use to these assets. SFAS No. 121 has not had an impact on the consolidated financial statements of the Company. I. Intangible Assets Intangible assets are stated at cost and amortized on straight-line basis over the following years: patent -- 5 years; land occupancy rights -- 50 years. F-89 196 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) J. Deferred Charges Deferred charges consisting of computer software purchased, and payments under technology transfer agreements are stated at cost and amortized on straight basis over 2 - 5 years. K. Revenue Recognition The Company derives its revenue from the sale of fiber optic related components and contracted projects on engineering services. Revenue from product sales is recognized when all of following conditions are met: the product has been shipped, the Company has the right to invoice the customer at a fixed price, the collection of the receivable is probable and there are no significant obligations remaining. Revenue and cost on engineering contracts are accounted for under completed contract method or the percentage of completion method. The use of the percentage of completion method depends on the ability to make reasonable dependable estimates. That is, the Company can estimate the extent of progress toward completion, contract revenues, and contract costs. The completed contract method may be used as the Company's basic accounting policy in circumstances in which financial position and results of operations would not vary materially from those resulting from use of the percentage of completion method. Anticipated losses on engineering contracts are provided for when determined. When the balances of contract in progress excess the one of billing on contract, the billing on contract is shown in the current asset as a deduction, on the contrary, the contract in progress is shown in the current liability as a deduction. Provisions for sales return and allowances are recorded based on historical experience at the time revenue is recognized based on the Company's historical experience. Generally, the Company provides one-year warranty period for its product sold and engineering contracts provided. Estimated expenses for warranty obligations are based on its historical field return rates and are accrued as revenue is recognized and included in cost of goods sold. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company currently complies with SAB 101 and therefore SAB 101 will not have any effect on our financial position or results of operations. L. Research and Development Research and development costs consist of expenditures incurred during the course of planned search and investigation aimed at the discovery of new knowledge that will be useful in developing new products or processes, or at significantly enhancing existing products or production processes. And the implementation of such is through design, testing of product alternatives or construction of prototypes. The Company expenses all research and development costs as they are incurred. M. Pension Costs The Company, FOCI Optronic Components, Inc. and FIOPTEC Inc. have non-contributory and funded defined benefit retirement plans covering all their regular employees. The contribution to an independent fund is deposited with the Central Trust of China, as the custodian. Net pension cost, with F-90 197 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) includes service cost, interest cost, expected return on plan assets and amortization of net asset or obligation at transition, is recognized based on an actuarial valuation. N. Income Tax The Company, FOCI Optronic Component, Inc. and FIOPTEC Inc. are subject to tax in the Republic of China (ROC), FIOPTEC Inc. (Cayman Island) is not subject to income or other taxes in Cayman Island, while FOCI USA, Inc. is subject to tax in the United States of America and Shanghai FOCI Fiber Optic Communications Equipment, Inc. is subject to tax in the People Republic of China (PRC). The Company adopted the provisions of SFAS No. 109 "Accounting for Income Tax"; the provision for income tax represents income tax paid and payable for the current year plus the changes in the deferred income tax assets and liabilities during the years. Deferred income taxes are recognized for the tax effects of temporary differences, unused tax credit and operating loss carryforwards. Valuation allowance is provided for deferred tax assets that are not certain to be realized. A deferred tax asset or liability should, according to the classification of its related asset or liability, be classified as current or noncurrent. However, if a deferred asset or liability cannot be related to a asset or liability in the financial statements, then it should be classified as current or noncurrent based on the expected reversal dates of temporary differences. O. Bonuses to Employees, Directors and Supervisors According to ROC regulations and the Articles of Incorporation of FOCI, a portion of distributable earnings should be set aside as bonuses to employees, directors and supervisors. Bonuses to directors and supervisors are always paid in cash. However, bonuses to employees may be granted in cash or stock or both. All of these appropriations, including stock bonuses which are valued at par value of $0.30, are charged against retained earnings under ROC GAAP, after such appropriations are formally approved by the shareholders in the following year. Under U.S. GAAP, such bonuses are charged to income currently in the year earned. Stock issued as part of these bonuses is recorded at fair market value, determined by an independent third parties. Since the amount and form of such bonuses are not finally determinable until the shareholders' meeting in the subsequent year, the total amount of the aforementioned bonuses is initially accrued based on management's estimate regarding the amount to be paid based on the Company's Articles of Incorporation. Any difference between the initially accrued amount and the fair market value of the bonuses settled by the issuance of shares is recognized in the year of approval by shareholders. P. Foreign-currency Transactions The functional currency of the Company, FOCI Optronic Components, Inc. and FIOPTEC Inc. is New Taiwan dollars, that of Shanghai FOCI Fiber Optic Communications Equipment, Inc. is Remibi, and that of FOCI USA, Inc. and FIOPTEC Inc. (Cayman Islands) is US dollars. The foreign-currency transactions of the Company and its subsidiary, except that of FOCI USA, Inc. and FIOPTEC Inc. (Cayman Islands), are recorded using their respective functional currencies at the rates of exchange in effect when the transactions occur. Gains or losses, resulting from the application of different foreign exchange rates when cash in foreign currency is converted into New Taiwan dollars and Remibi, or when foreign-currency receivables and payables are settled, are credited or charged to income in the year of conversion or settlement. At the balance sheet dates, the balances of foreign-currency assets and liabilities are restated into the respective functional currencies based on prevailing exchange rates and any resulting gains or losses are credited or charged to income. F-91 198 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) Q. Translation of Foreign-currency Financial Statements The financial statements of the foreign subsidiary are translated into U.S. dollars at the following exchange rates: assets and liabilities -- current rate; income and expenses -- weighted average rate during the year. The resulting translation adjustment is recorded as separate component of shareholders' equity. R. Comprehensive Income The Company adopted the provisions of SFAS No. 130 "Reporting Comprehensive Income". Comprehensive income, as defined, includes all changes in equity during a period from non-owner sources. As of December 31, 1999, comprehensive income of the Company included only the translation adjustments on subsidiaries. S. Earnings (Loss) Per Share Earnings per share is calculated by dividing net income by the average number of shares outstanding in each period, adjusted retroactively for stock dividends issued subsequently. 3. NOTES AND ACCOUNTS RECEIVABLE -- NET
DECEMBER 31, ---------------------------- 1997 1998 1999 ------ ------- ------- Receivable from related parties (Note 14).............. $ 919 $ 3,140 $ 3,619 Notes receivable....................................... 211 316 320 Accounts receivable -- third parties................... 7,154 7,303 7,332 ------ ------- ------- 8,284 10,759 11,271 Allowance for doubtful accounts........................ (165) (1,398) (923) ------ ------- ------- $8,119 $ 9,361 $10,348 ====== ======= =======
4. INVENTORIES A. The details of inventories are summarized as follows:
DECEMBER 31, --------------------------- 1997 1998 1999 ------ ------ ------- Finished goods.......................................... $1,177 $ 41 $ 1,780 Work in process......................................... -- 1,798 1,427 Raw materials........................................... 1,658 4,134 4,236 Contract in progress -- net............................. -- 2,607 4,198 ------ ------ ------- 2,835 8,580 11,641 Allowance for losses.................................... (48) (76) (100) ------ ------ ------- $2,787 $8,504 $11,541 ====== ====== =======
F-92 199 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) B. The details of contract in progress are summarized as follows:
ESTIMATED CONTRACT CONTRACT CONTRACT PAID-IN BILLING ON IN ACCOUNTING METHOD PRICE COST COST CONTRACT PROGRESS ----------------- --------- -------- ------- ---------- -------- 1999 Applied system of fiber optic.................. Completed contract method $5,400 $5,348 $4,813 $722 $4,091 Others................... Completed contract method 492 394 107 -- 107 ------ ------ ------ ---- ------ $5,892 $5,742 $4,920 $722 $4,198 ====== ====== ====== ==== ====== 1998 Applied system of fiber optic.................. Completed contract method $5,400 $4,657 $3,312 $705 $2,607 ====== ====== ====== ==== ======
The completion percentage of the construction -- Applied system of fiber optic was 90% as of December 31, 1999 and will be completed in 2000. 5. INVESTMENTS IN SHARES OF STOCK The details of the investments are as follows:
DECEMBER 31, ----------------------------------------------------------------------- 1997 1998 1999 --------------------- --------------------- --------------------- CARRYING % OF CARRYING % OF CARRYING % OF VALUE OWNERSHIP VALUE OWNERSHIP VALUE OWNERSHIP -------- --------- -------- --------- -------- --------- Ganso Corp. .................. $-- -- $22 -- $13 -- Winluck Group Ltd. ........... -- -- 18 -- 18 -- -- --- --- $-- $40 $31 == === ===
F-93 200 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 6. PROPERTIES -- NET
DECEMBER 31, ----------------------------- 1997 1998 1999 ------- ------- ------- Cost Land................................................ $ -- $ -- $ 3,186 Buildings........................................... 5,386 5,458 15,255 Machinery and equipment............................. 3,733 5,093 6,852 Test equipment...................................... 343 340 551 Transportation equipment............................ 18 183 195 Furniture and fixtures.............................. 830 1,041 1,448 Leasehold improvements.............................. -- 76 -- Construction in progress and prepayments............ 41 5,628 1,704 ------- ------- ------- 10,351 17,819 29,191 ------- ------- ------- Accumulated depreciation Buildings........................................... 69 280 699 Machinery and equipment............................. 763 1,326 2,151 Test equipment...................................... 50 82 135 Transportation equipment............................ 3 17 39 Furniture and fixtures.............................. 235 386 608 Leasehold improvements.............................. -- 5 -- ------- ------- ------- 1,120 2,096 3,632 ------- ------- ------- $ 9,231 $15,723 $25,559 ======= ======= =======
Interest expense were amounting to $95 and $151 were capitalized in 1997 and 1999, respectively. 7. SHORT-TERM LOANS
DECEMBER 31, -------------------------- 1997 1998 1999 ------ ------ ------ Secured loans from Tai-sin Bank, Far Eastern Bank, Dah An Commercial Bank and Land Bank of Taiwan............ $ 248 $2,686 $5,426 Unsecured loans from The International Commercial Bank of China.............................................. 1,851 -- 2,479 Working capital loans from The International Commercial Bank of China......................................... -- -- 795 ------ ------ ------ $2,099 $2,686 $8,700 ====== ====== ====== 3.00% 6.67% 1.12% (8.15)% (7.75)% (7.77)% ====== ====== ======
As of December 31, 1999, unused credit for short-term bank borrowings is about $407. 8. COMMERCIAL PAPERS Commercial paper will mature between January to May 2000. It bore annual interest rates ranging from 4.85% to 5.10% and is secured by a guaranty issued by Tai-sin Bank, Far Eastern Bank and Dah An Commercial Bank. F-94 201 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) As of December 31, 1999, unused credit for issuance of commercial paper is about $2,451. 9. LONG-TERM DEBTS
DECEMBER 31, -------------------------- 1997 1998 1999 ------ ------ ------ Land Bank of Taiwan: Loan for plant expansion. Payable in 60 monthly installments starting from December 1998 to November 2003. Interest at floating rate and actual annual interest rate was 7.5% in 1997 and 1998................ $1,904 $1,893 $ -- Loan for plant expansion. Payable in 72 monthly installments starting from December 2000 to November 2006. Interest at an annual rate of 7.5%............... -- -- 6,161 Loan for the purchase machinery and equipment. Payable in 48 monthly installments starting from July 1997 to June 2001. Interest at floating rate and actual annual interest rate was 7.5%................................. 886 640 393 The International Commercial Bank of China -- loan for the purchase land. Payable in 16 quarterly installments starting from October 2000 to September 2004. Interest at floating rate and actual applicable rate for 1999 was 7.5% per annum..................................... -- -- 1,304 ------ ------ ------ 2,790 2,533 7,858 Current portion.......................................... (317) (641) (429) ------ ------ ------ $2,473 $1,892 $7,429 ====== ====== ======
As of December 31, 1999, long-term bank loans mature as follows:
DECEMBER 31, 1999 ------------ During the year 2000.................................... $ 429 During the year 2001.................................... 1,484 During the year 2002.................................... 1,352 During the year 2003.................................... 1,353 During the year 2004.................................... 1,272 During the year 2005.................................... 1,027 During the year 2006.................................... 941
10. SHAREHOLDERS' EQUITY According to the ROC Company Law, capital surplus can only be used to offset a deficit or transferred to capital. The Company's Articles of Incorporation provide that the following shall be appropriated from the annual net income (less deficit, if any): (a) 10% thereof as legal reserve; (b) Not over 15% special bonus to employees; (c) Not over 5% compensation to directors and supervisors; and (d) The remaining amount shall be appropriated as common stockholders' bonus. F-95 202 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) The appropriations and the disposition of the remaining net income shall be resolved by the shareholders in the following year and given effect to in the financial statements of that year. The aforementioned appropriation for legal reserve shall be made until the reserve equals the Company's capital. Such reserve can only be used to offset a deficit; or, when it has reached 50% of the paid-in capital, up to 50% thereof can be transferred to capital. 11. LONG-TERM OPERATING LEASES The Company has an operating lease agreement covering certain parcels of land with an area of 4,494 square meters. The agreement will is valid until December 2015 and required payment of fixed annual rental of $58. 12. PENSION PLAN The Company has a defined benefit pension plan for all regular employees, which provides benefits based on length of service and average monthly salary for the last six months prior to retirement. The Company makes monthly contributions, equal to 2% of salaries and wages, to a pension fund which is administered by a pension fund monitoring committee and deposited in the committee's name in the Central Trust of China which acts as trustee. Certain pension information are summarized as follows: The components of net periodic benefit costs are as follows: a. Net periodic pension cost
1997 1998 1999 ---- ---- ---- Service cost................................................ $34 $83 $74 Interest cost............................................... 4 9 12 Projected return on plan assets............................. (1) (3) (8) Amortization of unrecognized loss........................... -- 5 -- --- --- --- Net periodic benefit cost................................... $37 $94 $78 === === ===
The change in benefit obligation and plan assets and reconciliation of fund status are as follows: b. Change in benefit obligation:
1997 1998 1999 ---- ---- ---- Projected benefit obligation at beginning of year........... $ 56 $144 $188 For the years: Service cost.............................................. 34 83 74 Interest cost............................................. 4 9 12 Actuarial loss (gain)..................................... 49 (57) 24 Foreign currency exchanges.................................. 1 9 8 ---- ---- ---- Projected benefit obligation at end of year................. $144 $188 $306 ==== ==== ====
F-96 203 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) c. Change in plan assets:
1997 1998 1999 ---- ---- ---- Fair value of plan assets at beginning of year.............. $15 $ 45 $124 Employer contributions...................................... 29 76 82 Interest income............................................. 1 3 8 --- ---- ---- Fair value of plan assets at end of year.................... $45 $124 $214 === ==== ====
d. Reconciliation of fund status
1997 1998 1999 ----- ---- ---- Funded status............................................... $ 99 $64 $ 92 Unrecognized actuarial loss................................. (58) (1) (25) ----- --- ---- Net amount of "Prepaid pension costs" shown in the balance sheets.................................................... $ 41 $63 $ 67 ===== === ====
e. Actuarial assumptions Discount rate used in determining present values............ 6.75% 6.5% 6.0% Rate of long-term rate of return on plan assets............. 7.0% 6.5% 6.0% Rate of compensation increase............................... 6.5% 6.5% 6.0%
13. INCOME TAX A. Income tax benefit and income tax payable:
DECEMBER 31, ---------------------- 1997 1998 1999 ----- ----- ---- Income tax expense -- current............................... $ 42 $ 189 $44 Income tax expense (benefit) -- deferred.................... (216) (319) 24 Translation adjustment...................................... -- 1 -- ----- ----- --- Income tax expense (benefit)................................ $(174) $(129) $68 ===== ===== ===
F-97 204 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) B. As of December 31, 1997, 1998 and 1999, deferred income tax assets and liabilities are as follows:
DECEMBER 31, --------------------- 1997 1998 1999 ----- ---- ---- Current: Taxable temporary differences............................. $(132) $241 $354 Investment tax credits.................................... 66 155 69 ----- ---- ---- Total.................................................. (66) 396 423 Valuation allowance....................................... -- (4) -- ----- ---- ---- (66) 392 423 ----- ---- ---- Noncurrent: Taxable temporary differences............................. 7 4 (4) Investment tax credits.................................... 483 364 335 Operating loss carryforwards.............................. -- 35 -- ----- ---- ---- Total.................................................. 490 403 331 Valuation allowance....................................... -- (35) -- ----- ---- ---- 490 368 331 ----- ---- ---- $ 424 $760 $754 ===== ==== ====
C. The Company's income tax returns through taxable year ended December 31, 1997 have been examined by the tax authorities. The Company did not receive any tax assessment from the tax authorities as a result from the foregoing tax examinations. D. Pursuant to the "Statute for the Establishment and Administration of Science-Based Industrial Park," the Company was granted several periods of tax holidays with respect to income derived from approved investments and are eligible until December, 2002. E. As of December 31, 1999, the Company's unused investment tax credits amounted to $405. Such tax credits can be utilized until December 2003. 14. RELATED PARTY TRANSACTIONS A. Name and Relationship of Related Parties
RELATIONSHIP WITH THE COMPANY NAME AND RELATIONSHIP OF RELATED PARTIES ----------------------------- Pacriminvesting & Developing Co., Ltd. .............. A shareholder. Winluck Group Ltd. .................................. The supervisor is the board chairman of the Company Yuan-Tai Enterprises Pte., Ltd. ..................... A consolidated entity until October 29, 1998 (see Note 1)
F-98 205 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) B. Significant Related Party Transactions (1) Sales
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------- 1997 1998 1999 ------------- ------------- ------------- AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- Winluck Group Ltd. ............................ $1,033 14 $1,755 9 $ 878 4 Yuan-Tai Enterprises Pte., Ltd. ............... -- -- 2,058 10 387 2 Pacriminvesting & Developing Co., Ltd. ........ 6 -- -- -- -- -- ------ -- ------ -- ------ -- $1,039 14 $3,813 19 $1,265 6 ====== == ====== == ====== ==
The above sales are dealt with in the ordinary course of business similar to that with other companies, and the collection period is at sight in the average 60 days. (2) Engineering revenues
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------- 1997 1998 1999 ------------- ------------- ------------- AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- Winluck Group Ltd. ............................ $-- -- $3,050 89 $-- -- === == ====== == === ==
(3) Accounts Receivable
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------- 1997 1998 1999 ------------- ------------- ------------- AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- Winluck Group Ltd. ............................ $919 11 $3,140 29 $3,137 28 Yuan-Tai Enterprises Pte, Ltd. ................ -- -- -- -- 482 4 ---- -- ------ -- ------ -- 919 11 3,140 29 3,619 32 ==== == ====== == ====== == Allowance for doubtful accounts................ (75) (543) -- ---- ------ ------ $844 $2,597 $3,619 ==== ====== ======
F-99 206 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 15. FINANCIAL INSTRUMENTS The Company's financial instruments are carried at cost, which approximates their fair value and listed as follows:
DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1999 ----------------- ----------------- ------------------ CARRYING FAIR CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE VALUE VALUE -------- ------ -------- ------ -------- ------- ASSETS Cash.................................... $ 532 $ 532 $2,236 $2,236 $ 3,344 $ 3,344 Marketable securities................... 911 911 1,527 1,527 174 174 Notes and accounts receivable -- net.... 8,119 8,119 9,361 9,361 10,348 10,348 Long-term investment.................... -- -- 40 40 31 31 Refundable deposits..................... 28 28 100 100 85 85 LIABILITIES Short-term bank loans................... 2,099 2,099 2,686 2,686 8,700 8,700 Commercial papers payable............... -- -- -- -- 1,659 1,659 Notes payable........................... 867 867 1,607 1,607 1,225 1,225 Accounts payable........................ 304 304 940 940 1,787 1,787 Long-term bank borrowing (including current portion)...................... 2,790 2,790 2,533 2,533 7,858 7,868
16. ASSETS PLEDGED AS COLLATERAL
DECEMBER 31, --------------------------- ASSETS 1997 1998 1999 SUBJECT OF COLLATERAL ------ ------ ------ ------- --------------------- Land................................. $ -- $ -- $ 3,186 Long-term loans Marketable securities................ 361 -- -- Financed stock Time deposit (shown in other current 154 1,466 3,022 Short-term guarantee and assets)............................ endorse for the bank loan of subsidiary Machinery and equipment.............. 1,307 1,088 905 Long-term loans Buildings............................ 5,354 5,317 12,741 Long-term loans ------ ------ ------- $7,176 $7,871 $19,854 ====== ====== =======
17. COMMITMENTS AND CONTINGENT LIABILITIES A. On July 27, 1995, the Company has acquired from Industrial Technology Research Institute specific product technology know-how related to light source driver, FBT Fiber Couplers, WIC and WBC, WDM attenuators and FBT attenuators. In consideration for the foregoing, the Company shall pay royalty, until 2001, equivalent to 1% of the sales value of the products covered by the agreement. ITRI, however, have agreed to waive the royalty payments in 1997 and 1998, and, in 1999, the Company paid royalties of US$5. B. FIOPTEC Inc. and FOCI Optronic Components Inc. signed several contracts with third parties for the construction of its new plant amounting to $1,639. As of December 31, 1999, the two subsidiaries has outstanding obligations of $608 related to these contracts. 18. SEGMENT INFORMATION The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14 "Financial Reporting for Segments of a Business Enterprise," replacing the "industry segment" approach with "management" approach. The management F-100 207 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS 131 also requires disclosures about products and services, geographic areas and major customers. A. Industry: The Company is engaged in a single industry, which is manufacturing, selling, designing and installation of fiber optic related products. B. Foreign markets
YEARS ENDED DECEMBER 31, ---------------------------- AREA 1997 1998 1999 ---- ------ ------- ------- Asia................................................... $6,671 $ 8,731 $ 7,834 United States.......................................... 1,869 2,003 5,196 Europe................................................. 1,303 2,695 4,165 Other.................................................. 114 217 303 ------ ------- ------- $9,957 $13,646 $17,498 ====== ======= =======
C. Major customers
YEARS ENDED DECEMBER 31, ----------------------------------------------- 1997 1998 1999 ------------- ------------- ------------- CUSTOMERS AMOUNT % AMOUNT % AMOUNT % --------- ------ --- ------ --- ------ --- A...................................... $ -- -- $3,050 15 $2,285 12 ==== === ====== === ====== ===
F-101 208 FOCI FIBER OPTIC COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) D. Geographic information
ADJUSTMENTS AND ELIMINATING OVERSEAS TAIWAN ENTRIES CONSOLIDATED -------- ------- ----------- ------------ 1997 Sales to customers other than the parent and its subsidiaries.................. $ -- $ 7,506 $ -- $ 7,506 Intercompany revenue.................... -- 4,914 (4,914) -- ------ ------- ------- ------- Total sales........................... $ -- $12,420 $(4,914) $ 7,506 ====== ======= ======= ======= Gross profit............................ $ -- $ 9,732 $(4,914) $ 4,818 ====== ======= ======= ======= Operating expenses...................... (3,468) Non-operating income (expenses)......... 95 ------- Income before income tax................ 1,445 Income tax benefit...................... 174 Minority loss........................... 15 ------- Net income.............................. $ 1,634 ======= Identifiable assets..................... $5,743 $23,317 $(5,551) $23,509 ====== ======= ======= ======= 1998 Sales to customers other than the parent and its subsidiaries.................. $ -- $20,381 $ -- $20,381 Intercompany revenue.................... -- 108 (108) -- ------ ------- ------- ------- Total sales........................... $ -- $20,489 $ (108) $20,381 ====== ======= ======= ======= Gross profit............................ $ -- $ 7,100 $ (108) $ 6,992 ====== ======= ======= ======= Operating expenses...................... (6,361) Non-operating income (expenses)......... (569) ------- Income before income tax................ 62 Income tax benefit...................... 129 Minority loss........................... 1,316 ------- Net income.............................. $ 1,507 ======= Identifiable assets..................... $ -- $42,730 $ (91) $42,639 ====== ======= ======= ======= 1999 Sales to customers other than the parent and its subsidiaries.................. $3,480 $16,278 $ -- $19,758 Intercompany revenue.................... -- 1,082 (1,082) -- ------ ------- ------- ------- Total sales........................... $3,480 $17,360 $(1,082) $19,758 ====== ======= ======= ======= Gross profit............................ $ 793 $ 6,640 $(1,082) $ 6,351 ====== ======= ======= ======= Operating expenses...................... (6,269) Non-operating income (expenses)......... (711) ------- Loss before income tax.................. (629) Income tax expense...................... (68) Minority loss........................... 36 ------- Net loss................................ $ (661) ------- Identifiable assets..................... $1,188 $56,510 $ (250) $57,448 ====== ======= ======= =======
F-102 209 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of Optronics International Corp. We have audited the accompanying balance sheets of Optronics International Corp. as of December 31, 1997, 1998 and 1999, and the related statements of operations and comprehensive income, changes in shareholders' equity, and cash flows for the years ended December 31, 1997, 1998 and 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Optronics International Corp. at December 31, 1997, 1998 and 1999 and the results of its operations and its cash flows for the years ended December 31, 1997, 1998 and 1999, in conformity with accounting principles generally accepted in the United States of America. T N Soong & Co A Member Firm of Andersen Worldwide, SC Taipei, Taiwan, the Republic of China June 23, 2000 F-103 210 OPTRONICS INTERNATIONAL CORP. BALANCE SHEETS DECEMBER 31, 1997, 1998 AND 1999
DECEMBER 31, ----------------------------- NOTES 1997 1998 1999 ------------- ------- ------- ------- (IN THOUSAND U.S. DOLLARS EXCEPT SHARE AMOUNTS) ASSETS Current Assets Cash........................................ 2B $ 4,734 $ 6,510 $ 1,841 Restricted cash............................. 2D 742 64 967 Marketable securities....................... 2B, 2E 1,607 -- 2,307 Notes and accounts receivable -- net........ 2B, 3, 10 486 2,076 476 Inventories................................. 2F, 4 248 694 1,046 Prepaid expenses and other current assets... 53 39 102 ------- ------- ------- Total Current Assets..................... 7,870 9,383 6,739 ------- ------- ------- Properties -- Net............................. 2G, 2H, 5, 10 2,741 4,920 5,197 Other Assets Prepaid long-term investment................ -- 1 -- Deferred pension cost....................... 2L, 8 33 13 -- Deferred charges -- net of accumulated amortization cost of $2 in 1999.......... 2I -- -- 32 Refundable deposits......................... 38 62 41 ------- ------- ------- Total Other Assets....................... 71 76 73 ------- ------- ------- Total Assets............................. $10,682 $14,379 $12,009 ======= ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Notes and accounts payable.................. 10 $ 97 $ 701 $ 537 Income tax payable.......................... 2N, 9 -- 14 62 Current portion of long-term debts.......... 6, 12 -- -- 253 Accrued expenses and other current liabilities.............................. 520 1,809 841 ------- ------- ------- Total Current Liabilities................ 617 2,524 1,693 Long-Term Debts -- Net of Current Portion..... 6, 12 -- 495 253 Accrued Pension Cost.......................... 2L, 8 34 39 86 ------- ------- ------- Total Liabilities........................ 651 3,058 2,032 ------- ------- ------- Shareholders' Equity.......................... 7 Capital stock, $0.3 par value; Authorized -- 25,000 thousand shares in 1997 and 45,000 thousand shares in 1998 and 1999; Issued -- 20,000 thousand shares in 1997 and 35,000 thousand shares in 1998 and 1999......................... 7,266 11,833 11,833 Advanced capital............................ 4,324 -- Retained earnings: Legal reserve............................ -- -- 50 Unappropriated earnings (Deficit)........ (499) 365 (1,261) Cumulative translation adjustment............. 2P (1,060) (877) (645) ------- ------- ------- Total Shareholders' Equity............... 10,031 11,321 9,977 ------- ------- ------- Total Liabilities and Shareholders' Equity................................. $10,682 $14,379 $12,009 ======= ======= =======
The accompanying notes are an integral part of the financial statements. F-104 211 OPTRONICS INTERNATIONAL CORP. STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
YEARS ENDED DECEMBER 31, ---------------------------- NOTES 1997 1998 1999 ------ ------- ------ ------- (IN THOUSAND U.S. DOLLARS EXCEPT PER SHARE AMOUNTS) Sales................................................. $ 1,280 $7,940 $ 4,998 Sales Returns and Allowances.......................... (2) (318) (191) ------- ------ ------- Net Sales............................................. 2J, 10 1,278 7,622 4,807 Cost of Sales......................................... 2J, 10 1,164 4,336 4,684 ------- ------ ------- Gross Profit.......................................... 114 3,286 123 ------- ------ ------- Operating Expenses Research and development............................ 2K 888 2,086 1,453 General and administrative.......................... 187 646 453 Marketing........................................... 169 638 318 ------- ------ ------- Total Operating Expenses......................... 1,244 3,370 2,224 ------- ------ ------- Loss From Operations.................................. (1,130) (84) (2,101) ------- ------ ------- Non-Operating Income Interest revenue.................................... 67 236 206 Subsidy............................................. 2M 492 704 339 Gain on sale of marketable securities............... 2E 177 132 48 Unrealized holding gains on marketable securities... 13 -- -- Foreign exchange gain............................... 2O 10 -- -- Gain on disposal of properties...................... 10 -- -- 4 Other............................................... -- 1 39 ------- ------ ------- Total Non-Operating Income....................... 759 1,073 636 ------- ------ ------- Non-Operating Expense Foreign exchange loss............................... 2O -- 15 49 Loss on disposal of properties...................... -- 27 -- ------- ------ ------- Total Non-Operating Expense...................... -- 42 49 ------- ------ ------- Income (Loss) Before Income Tax....................... (371) 901 (1,514) Income Tax Expense.................................... 2N, 9 -- (37) (62) ------- ------ ------- Net Income (Loss)..................................... $ (371) $ 864 $(1,576) ======= ====== ======= Other Comprehensive Income Translation adjustments............................. 2Q (1,060) 183 232 ------- ------ ------- Comprehensive Income (Loss)........................... $(1,431) $1,047 $(1,344) ======= ====== ======= Earnings (Loss) Per Share -- 2R Based on weighted average outstanding common stock 18,085 thousand shares in 1997, 33,125 thousand shares in 1998 and 35,000 thousand shares 1999... $ (0.02) $ 0.03 $ (0.05) ======= ====== =======
The accompanying notes are an integral part of the financial statements. F-105 212 OPTRONICS INTERNATIONAL CORP. STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
RETAINED EARNINGS (NOTE 7) ---------------------------------- CUMULATIVE CAPITAL STOCK ISSUED UNAPPROPRIATED TRANSLATION TOTAL -------------------- ADVANCED LEGAL EARNINGS ADJUSTMENT SHAREHOLDERS' SHARES AMOUNT CAPITAL RESERVE (DEFICIT) TOTAL (NOTE 20) EQUITY ---------- ------- -------- ------- -------------- ------- ----------- ------------- (THOUSAND) (IN THOUSAND U.S. DOLLARS) BALANCE, JANUARY 1, 1997.................... 14,000 $5,093 $ -- $-- $ (128) $ (128) $ -- $ 4,965 Issuance of capital stock for cash................ 6,000 2,173 -- -- -- -- -- 2,173 Advanced capital.......... -- -- 4,324 -- -- -- -- 4,324 Net loss for 1997......... -- -- -- -- (371) (371) -- (371) Translation adjustments... -- -- -- -- -- -- (1,060) (1,060) ------ ------- ------- --- ------- ------- ------- ------- BALANCE, DECEMBER 31, 1997.................... 20,000 7,266 4,324 -- (499) (499) (1,060) 10,031 Issuance of capital stock for cash................ 15,000 4,567 (4,324) -- -- -- -- 243 Net income for 1998....... -- -- -- -- 864 864 -- 864 Translation adjustments... -- -- -- -- -- -- 183 183 ------ ------- ------- --- ------- ------- ------- ------- BALANCE, DECEMBER 31, 1998.................... 35,000 11,833 -- -- 365 365 (877) 11,321 Appropriations of 1998 earnings: Legal reserve............. -- -- -- 50 (50) -- -- -- Net loss for 1999......... -- -- -- -- (1,576) (1,576) -- (1,576) Translation adjustments... -- -- -- -- -- -- 232 232 ------ ------- ------- --- ------- ------- ------- ------- BALANCE, DECEMBER 31, 1999.................... 35,000 $11,833 $ -- $50 $(1,261) $(1,211) $ (645) $ 9,977 ====== ======= ======= === ======= ======= ======= =======
The accompanying notes are an integral part of the financial statements. F-106 213 OPTRONICS INTERNATIONAL CORP. STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
YEARS ENDED DECEMBER 31, ----------------------------- 1997 1998 1999 ------- ------- ------- (IN THOUSAND U.S. DOLLARS) Operating Activities Net income (loss)......................................... $ (371) $ 864 $(1,576) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.......................... 190 480 647 Loss (gain) on disposal of properties.................. -- 27 (4) Accrued pension cost................................... 1 25 60 Unrealized holding gains on marketable securities...... (13) -- -- Gain on sale of marketable securities.................. (177) (132) (48) Transfer of properties to expense...................... 10 -- -- Changes in operating assets and liabilities Notes and accounts receivable........................ (486) (1,590) 1,600 Inventories.......................................... (248) (446) (352) Prepaid expenses and other current assets............ (39) 14 (63) Notes and accounts payable........................... 97 604 (164) Income tax payable................................... -- 14 48 Accrued expenses and other current liabilities....... 179 1,289 (968) ------- ------- ------- Net Cash Provided by (Used in) Operating Activities...................................... (857) 1,149 (820) ------- ------- ------- Investing Activities Acquisitions of properties................................ (2,550) (2,575) (834) Decrease (increase) in restricted cash.................... (742) 678 (903) Proceeds from disposals of properties..................... 2 -- 39 Decrease (increase) in marketable securities.............. 2,680 1,739 (2,259) Decrease (increase) in prepaid long-term investments...... -- (1) 1 Increase in deferred charges.............................. -- -- (33) Decrease (increase) in refundable deposits................ (9) (24) 21 ------- ------- ------- Net Cash Used in Investing Activities............. (619) (183) (3,968) ------- ------- ------- Financing Activities Proceeds from issuance of capital stock................... 6,497 243 -- Long-term debts........................................... -- 495 -- ------- ------- ------- Net Cash Provided by Financing Activities......... 6,497 738 -- ------- ------- ------- Effects of Changes in Foreign Exchange Rate................. (658) 72 119 ------- ------- ------- Net Increase (Decrease) in Cash............................. 4,363 1,776 (4,669) Cash at Beginning of Year................................... 371 4,734 6,510 ------- ------- ------- Cash at End of Year......................................... $ 4,734 $ 6,510 $ 1,841 ======= ======= ======= Supplemental Disclosures of Cash Flow Information Cash paid for income tax.................................. $ -- $ 24 $ 15 ======= ======= =======
The accompanying notes are an integral part of the financial statements. F-107 214 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 1. GENERAL Business Optronics International Corp. (the "Company") was incorporated under the Company Law of the Republic of China on November 21, 1996 and started its operations in February 1997. The Company is primarily engaged in research, development, production, manufacture and sale of visible laser diode and module, communication laser diode and module and high power laser diode and module. 2. ACCOUNTING POLICIES A. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. B. Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, marketable securities and accounts receivable. Cash and marketable securities are deposited or placed with high credit quality financial institutions. The Company is exposed to credit risk in the event of default by these institutions to the extent of the amount recorded on the balance sheet. As far as the accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and the Company maintains an allowance for doubtful accounts receivable based upon review of the expected collectibility of individual accounts receivable. C. Fair Value of Financial Instruments The Company's financial instruments, including cash, restricted cash, marketable securities, notes and accounts receivable, refundable deposits, and notes and accounts payable are carried at cost, which approximates their fair value because of the short-term maturity of these instruments. Fair value of long-term debts is estimated based on current interest rates available to the Company with similar terms, degrees of risks and remaining maturities. The carrying values of long-term debts approximate their respective fair value. D. Restricted Cash Restricted cash is composed of time deposits that the Company maintains as collateral for obtaining letters of credits. E. Marketable Securities Marketable securities are open-end bond funds that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. The costs of investment sold are determined by the weighted average method. F-108 215 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) F. Inventories Inventories are stated at cost using the weighted average method and are valued at the lower of cost or market value at balance sheet date. The market value of raw materials is determined based on current replacement cost, while work-in-process and finished goods are determined by net realizable value. G. Properties Properties are stated at cost less accumulated depreciation. Major additions, renewals and betterment are capitalized, while maintenance and repairs are expensed currently. Depreciation is provided on the straight-line method over the estimated useful lives that range as follows: machinery and equipment -- 3 to 8 years; computer equipment -- 3 years; office equipment -- 5 years; leasehold improvements -- 5 years; transportation equipment -- 5 years; other equipment -- 5 to 20 years. Upon sale or disposal of properties, the related cost and accumulated depreciation are removed from the accounts, and any gain or loss is credited or charged to income. H. Asset Impairment Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", ("SFAS No. 121") requires recognition of impairment of long-lived assets in the event the net book value of these assets exceeds the future undiscounted cash flows attributable in use to these assets. SFAS No. 121 has not had an impact on the financial statements of the Company. I. Deferred Charges Deferred charges are stated at cost and amortized on straight-line basis over the following years: tools -- 3 years. J. Revenue Recognition Revenue is mainly from product sales to customers and is recognized at the time of shipment, indicating that revenue has been realized and earned. The four criteria for revenue being realized and earned are the existence of evidence of sale, actual shipment, fixed or determinable selling price, and reasonable assurance of collectibility. Allowances for sales return and discounts are provided at the time of the recognition of the related revenues based on experience and these provisions are deducted from sales. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company currently complies with SAB 101 and therefore SAB 101 will not have any effect on our financial position or results of operations. K. Research and Development Research and development costs consist of expenditures incurred during the course of planned search and investigation aimed at the discovery of new knowledge that will be useful in developing new products or processes, or at significantly enhancing existing products or production processes. And the F-109 216 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) implementation of such is through design, testing of product alternatives or construction of prototypes. The Company expenses all research and development costs as they are incurred. L. Pension Costs The Company has non-contributory and funded defined benefit retirement plans covering all its regular employees. The contribution to an independent fund is deposited with the Central Trust of China, as the custodian. Net pension cost, with includes service cost, interest cost, expected return on plan assets and amortization of net asset or obligation at transition, is recognized based on an actuarial valuation. M. Subsidy Income The company recognized subsidy income on a straight-line basis over the term of the agreements entered into with two Bureaus of ROC Government, Industrial Development Bureau (IDB) and Administration of Hsin-chu Science-based Industrial Park (SBIP), for new product developments. N. Income Tax The Company adopted the provisions of SFAS No. 109 "Accounting for Income Tax"; the provision for income tax represents income tax paid and payable for the current year plus the changes in the deferred income tax assets and liabilities during the years. Deferred income taxes are recognized for the tax effects of temporary differences, unused tax credit and operating loss carryforwards. Valuation allowance is provided for deferred tax assets that are not certain to be realized. A deferred tax asset or liability should, according to the classification of its related asset or liability, be classified as current or noncurrent. However, if a deferred asset or liability cannot be identified to an asset or a liability in the financial statements, then it should be classified as current or noncurrent based on the expected reversal date of temporary difference. O. Foreign-currency Transactions The functional currency of the Company is New Taiwan dollars. The foreign-currency transactions of the Company are recorded using their respective functional currencies at the rates of exchange in effect when the transactions occur. Gains or losses, resulting from the application of different foreign exchange rates when cash in foreign currency is converted into New Taiwan dollars, or when foreign-currency receivables and payables are settled, are credited or charged to income in the year of conversion or settlement. At the balance sheet dates, the balances of foreign-currency assets and liabilities are restated into the respective functional currencies based on prevailing exchange rates and any resulting gains or losses are credited or charged to income. P. Translation of Foreign-currency Financial Statements The financial statements are translated into U.S. dollars at the following exchange rates: assets and liabilities -- current rate; income and expenses -- weighted average rate during the year. The resulting translation adjustment is recorded as separate component of shareholders' equity. Q. Comprehensive Income The Company adopted the provisions of SFAS No. 130 "Reporting Comprehensive Income"; SFAS No. 130 establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income, as defined, includes all changes in equity during a period from non- F-110 217 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) owner sources. To date, the Company has only translation adjustments that are required to be reported in comprehensive income. R. Earnings (Loss) Per Share SFAS No. 128 "Earnings Per Share", establishes standards for computing and presenting earnings per share. Basic earnings per share is calculated using the average shares of common share outstanding. Diluted earnings per share is calculated using the weighted average number of common and dilutive common equivalent shares outstanding during the period, using either as if converted method for convertible preferred share or the treasury stock method for options and warrants. Since the Company's capital structure is simple, therefore, its basic earnings per share is the same as diluted earnings per share. 3. NOTES AND ACCOUNTS RECEIVABLE -- NET
DECEMBER 31, ------------------------ 1997 1998 1999 ----- ------ ----- Receivable from related parties (Note 10)................. $ -- $ 13 $ 46 Notes receivable.......................................... 207 1,676 46 Accounts receivable -- third parties...................... 397 915 861 ----- ------ ----- 604 2,604 953 Allowance for doubtful accounts........................... (118) (528) (477) ----- ------ ----- $ 486 $2,076 $ 476 ===== ====== =====
4. INVENTORIES
DECEMBER 31, ---------------------- 1997 1998 1999 ---- ---- ------ Finished goods.............................................. $ 34 $246 $ 233 Work in process............................................. 152 297 320 Raw materials............................................... 62 151 493 ---- ---- ------ $248 $694 $1,046 ==== ==== ======
F-111 218 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 5. PROPERTIES -- NET
DECEMBER 31, -------------------------- 1997 1998 1999 ------ ------ ------ Cost Machinery and equipment................................ $2,042 $4,090 $5,018 Computer equipment..................................... 41 47 60 Office equipment....................................... 27 33 36 Leasehold improvements................................. 100 71 81 Transportation equipment............................... 41 56 58 Other equipment........................................ 24 1,167 1,230 Prepayments............................................ 632 106 33 ------ ------ ------ 2,907 5,570 6,516 ------ ------ ------ Accumulated depreciation Machinery and equipment................................ 137 558 1,076 Computer equipment..................................... 7 19 32 Office equipment....................................... 2 8 13 Leasehold improvements................................. 15 16 29 Transportation equipment............................... 4 12 21 Other equipment........................................ 1 37 148 ------ ------ ------ 166 650 1,319 ------ ------ ------ $2,741 $4,920 $5,197 ====== ====== ======
6. LONG-TERM DEBTS
DECEMBER 31, --------------------- 1997 1998 1999 ---- ---- ----- Industrial Bureau -- Innovation Products Matching Fund to be repaid in installment with final payment due in October 2001 (Note 12)............................................ $-- $495 $ 506 Current portion............................................. -- -- (253) ---- ---- ----- $-- $495 $ 253 ==== ==== =====
As of December 31, 1999, long-term debts mature as follows:
DECEMBER 31, 1999 ------------ During the year 2000........................................ $253 During the year 2001........................................ 253
7. SHAREHOLDERS' EQUITY The Company's Articles of Incorporation provide that the following shall be appropriated from the annual net income after deducting any previously accumulated deficit and 10% legal reserve: (a) 5% - 10% special bonus to employees; (b) 1% - 3% compensation to directors and supervisors; and F-112 219 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) (c) Special retained earnings reserve and unappropriated earnings can be set aside when necessary, and the remaining amount shall be appropriated as common shareholders' bonus. The appropriations and the disposition of the remaining net income shall be resolved by the shareholders in the following year and given effect to in the financial statements of that year. The aforementioned appropriation for legal reserve shall be made until the reserve equals the Company's capital. Such reserve can only be used to offset a deficit; or, when it has reached 50% of the paid-in capital, up to 50% thereof can be transferred to capital. 8. PENSION PLAN The Company has a defined benefit pension plan for all regular employees, which provides benefits based on length of service and average monthly salary for the last six months prior to retirement. The Company makes monthly contributions, equal to 2% of salaries and wages, to a pension fund which is administered by a pension fund monitoring committee and deposited in the committee's name in the Central Trust of China which acts as trustee. Certain pension information are summarized as follows: The components of net periodic benefit costs are as follows: a. Net periodic pension cost
1997 1998 1999 ---- ---- ---- Service cost................................................ $51 $47 $ 87 Interest cost............................................... -- 4 10 Projected return on plan assets............................. -- (1) (3) Amortization of transition obligation....................... -- 4 4 Amortization of unrecognized loss........................... -- -- 1 ---- ---- ---- Net periodic benefit cost................................... $51 $54 $ 99 ==== ==== ====
The change in benefit obligation and plan assets and reconciliation of fund status are as follows: b. Change in benefit obligation:
1997 1998 1999 ---- ---- ---- Projected benefit obligation at beginning of year........... $-- $ 68 $148 For the years: Service cost.............................................. 51 47 87 Interest cost............................................. -- 4 10 Actuarial loss (gain)..................................... 26 26 (6) Amortization.............................................. -- -- 1 Foreign currency exchanges.................................. (9) 3 6 ---- ---- ---- Projected benefit obligation at end of year................. $68 $148 $246 ==== ==== ====
F-113 220 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) c. Change in plan assets:
1997 1998 1999 ---- ---- ---- Fair value of plan assets at beginning of year.............. $-- $12 $ 43 Contributions............................................... 12 30 41 Interest income............................................. -- 1 3 ---- ---- ---- Fair value of plan assets at end of year.................... $12 $43 $ 87 ==== ==== ====
d. Reconciliation of fund status
1997 1998 1999 ---- ---- ---- Funded status............................................... $ 57 $105 $156 Unrecognized transition obligation.......................... (56) (53) (50) Unrecognized actuarial loss................................. -- (26) (20) Additional liability........................................ 33 13 -- ---- ---- ---- Net amount of accrued pension cost shown in the balance sheets.................................................... $ 34 $ 39 $ 86 ==== ==== ====
e. Actuarial assumptions
1997 1998 1999 ----- ----- ----- Discount rate used in determining present values........... 6.75% 6.50% 6.00% Rate of long-term rate of return on plan assets............ 6.50% 6.25% 6.00% Rate of compensation increase.............................. 6.00% 6.00% 6.00%
9. INCOME TAX A. Income tax benefit and income tax payable:
DECEMBER 31, -------------------- 1997 1998 1999 ---- ---- ---- Income tax expense -- current............................... $-- $126 $ -- Income tax benefit -- deferred.............................. -- (82) -- Estimated permanent differences............................. -- (7) -- Additional 10% income tax on undistributed earnings......... -- -- 60 Adjustment of prior year's income tax....................... -- -- 2 ---- ---- ---- Income tax expense.......................................... $-- $ 37 $ 62 ==== ==== ====
F-114 221 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) B. As of December 31, 1997, 1998 and 1999, deferred income tax assets and liabilities are as follows:
DECEMBER 31, ------------------------- 1997 1998 1999 ----- ----- ------- Current: Taxable temporary differences.......................... $ 33 $ 112 $ 119 Investment tax credits................................. 21 156 5 Operating loss carryforward............................ 109 -- 338 ----- ----- ------- Total............................................... 163 268 462 Valuation allowance.................................... (163) (268) (462) ----- ----- ------- Noncurrent: Taxable temporary differences.......................... 33 23 31 Investment tax credits................................. 329 -- 1,279 Operating loss carryforwards........................... -- 670 51 ----- ----- ------- Total............................................... 362 693 1,361 Valuation allowance.................................... (362) (693) (1,361) ----- ----- ------- $ -- $ -- $ -- ===== ===== =======
C. The Company's income tax returns through taxable year ended December 31, 1996 have been examined by the tax authorities. D. As of December 31 1999, the Company's unused investment tax credits and the tax effect of loss carryforward amounted to approximately $1,284 and $389, respectively, and are available for future use through 2003 and 2004, respectively. 10. RELATED PARTY TRANSACTIONS A. Name and Relationship of Related Parties
NAME AND RELATIONSHIP OF RELATED PARTIES RELATIONSHIP WITH THE COMPANY ---------------------------------------- ----------------------------- Wah Lee Industrial Corp. (WAH LEE)................. Its chairman is the supervisor of the Company Delta Electronics Int. Ltd. (DELTA LTD.)........... Same chairman Delta Electronics Inc. (DELTA INC.)................ Same chairman Cyntec Co., Ltd. (CYNTEC).......................... Same chairman
F-115 222 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) B. Significant Related Party Transactions For the period:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------- 1997 1998 1999 ------------- ------------- ------------- AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- Sales DELTA INC. .......................... $ -- -- $ 22 -- $148 3 WAH LEE.............................. -- -- 274 4 95 2 ---- --- ---- --- ---- --- $ -- -- $296 4 $243 5 ==== === ==== === ==== === Purchases CYNTEC............................... $ -- -- $ 1 -- $ -- -- DELTA LTD. .......................... -- -- 121 4 265 12 ---- --- ---- --- ---- --- $ -- -- $122 4 $265 12 ==== === ==== === ==== ===
At end of period:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------- 1997 1998 1999 ------------- ------------- ------------- AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- Receivable DELTA INC. .......................... $ -- -- $ 2 -- $ 25 5 WAH LEE.............................. -- -- 11 1 21 4 ---- --- ---- --- ---- --- $ -- -- $ 13 1 $ 46 9 ==== === ==== === ==== === Accounts payable -- DELTA LTD. ........ $ -- -- $ 65 9 $ 52 10 ==== === ==== === ==== ===
a. Sales to related parties are based on normal selling prices. The collection period is 30 - 75 days after shipment for related parties and 15 - 60 days for other companies. b. The payment terms for purchases from related parties are the same as those from other suppliers. c. As of December 1999, the Company sold certain machinery and equipment to DELTA INC. for $38 and generated a gain of $4. F-116 223 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 11. FINANCIAL INSTRUMENTS The Company's financial instruments are carried at cost, which approximates their fair value and are listed as follows:
DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1999 ------------------ ------------------ ------------------ CARRYING FAIR CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE VALUE VALUE -------- ------ -------- ------ -------- ------ ASSETS Cash............................... $4,734 $4,734 $6,510 $6,510 $1,841 $1,841 Restricted cash.................... 742 742 64 64 967 967 Marketable securities.............. 1,607 1,607 -- -- 2,307 2,307 Notes and accounts receivable -- net................ 486 486 2,076 2,076 476 476 Prepaid long-term investment....... -- -- 1 1 -- -- Refundable deposits................ 38 38 62 62 41 41 LIABILITIES Notes and accounts payable......... 97 97 701 701 537 537 Long-term debts (including current portion)......................... -- -- 495 495 506 506
12. COMMITMENTS AND CONTINGENT LIABILITIES In 1997 and 1999, the Company entered into loan agreements with Industrial Development Bureau, Ministry of Economic Affairs and Administration of Hsin-chu Science-based Industrial Park, respectively, for developing new products. Under the agreements, the Company starts to repay the loan by installment after the prototypes are completed for one year. In addition, when the new products begin to sell, the Company shall pay 2% of net sales as feedback fund each quarter for three years, but the total feedback fund should not be more than 30% of the loan. The major subsidy income contracts are summarized as follows:
BUREAU CONTRACT TERM SUBSIDY INCOME ------ --------------------- -------------- Industry Development Bureau, Ministry of Economic Affairs (IDB)............ 1997.7.1 - 1998.12.31 $508 Administration of Hsin-chu Science-based Industrial Park (SBIP)............................... 1997.7.1 - 1998.12.31 711 Administration of Hsin-chu Science-based Industrial Park (SBIP)............................... 1999.10.1 - 2000.9.30 319
Generally, if the company can follow the contract policy, the bureaus will not terminate the contract no matter new products can be produced or not. 13. SEGMENT INFORMATION The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14 "Financial Reporting for Segments of a Business Enterprise", replacing the "industry segment" approach with "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS 131 also requires disclosures about products and services, geographic areas and major customers. F-117 224 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) A. Industry: The Company is engaged in a single industry, which is research, development, production, manufacture and sale of visible laser diode and module, communication laser diode and module and high power laser diode and module. B. Foreign markets: Export sales were under 10% of total revenues for 1997 and 1998. Sales to Asia and other area in 1999 were $1,865 and $683, respectively. C. Major customers
YEARS ENDED DECEMBER 31, ----------------------------------------------- 1997 1998 1999 ------------- ------------- ------------- CUSTOMERS AMOUNT % AMOUNT % AMOUNT % --------- ------ --- ------ --- ------ --- A.................................... $484 27 $ -- -- $ -- -- B.................................... 276 16 -- -- -- -- C.................................... -- -- 1,212 15 -- --
D. Geographic information. The Company's operations are entirely in the Republic of China. F-118 225 OPTRONICS INTERNATIONAL CORP. BALANCE SHEETS DECEMBER 31, 1999 (AUDITED) AND JUNE 30, 2000 (UNAUDITED)
DECEMBER 31, JUNE 30, NOTES 1999 2000 ------------- ------------- --------- (IN THOUSAND U.S. DOLLARS EXCEPT SHARE AMOUNTS) ASSETS Current Assets Cash................................................ 2B $ 1,841 $ 2,058 Restricted cash..................................... 2D 967 1,163 Marketable securities............................... 2B, 2E 2,307 -- Notes and accounts receivable -- net................ 2B, 3, 9 476 1,330 Inventories......................................... 2F, 4 1,046 1,740 Prepaid expenses and other current assets........... 102 126 ------- ------- Total Current Assets............................. 6,739 6,417 ------- ------- Properties -- Net..................................... 2G, 2H, 5, 9 5,197 5,618 ------- ------- Other Assets Prepaid long-term investment........................ -- -- Deferred pension cost............................... 2L -- -- Deferred charges -- net of accumulated amortization cost of $2 as of December 31, 1999 and $13 as of June 30, 2000.................................... 2I 32 108 Refundable deposits................................. 41 51 ------- ------- Total Other Assets............................... 73 159 ------- ------- Total Assets..................................... $12,009 $12,194 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Notes and accounts payable.......................... 9 $ 537 $ 1,306 Income tax payable.................................. 2M, 8 62 -- Current portion of long-term debts.................. 6, 11 253 259 Accrued expenses and other current liabilities...... 841 753 ------- ------- Total Current Liabilities........................ 1,693 2,318 Long-Term Debts -- Net of Current Portion............. 6, 11 253 129 Accrued Pension Cost.................................. 2L 86 141 ------- ------- Total Liabilities................................ 2,032 2,588 ------- ------- Shareholders' Equity.................................. 7 Capital stock -- $0.3 par value; Authorized -- 45,000 thousand shares Issued -- 35,000 thousand shares................. 11,833 11,833 Retained earnings: Legal reserve....................................... 50 50 Unappropriated earnings (deficit)................... (1,261) (1,843) Cumulative translation adjustment................... 2O, 2P (645) (434) ------- ------- Total Shareholders' Equity....................... 9,977 9,606 ------- ------- Total Liabilities and Shareholders' Equity....... $12,009 $12,194 ======= =======
The accompanying notes are an integral part of the financial statements. F-119 226 OPTRONICS INTERNATIONAL CORP. STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
SIX MONTHS ENDED JUNE 30, ------------------- NOTES 1999 2000 ----- -------- ------- (UNAUDITED) (IN THOUSAND U.S. DOLLARS EXCEPT PER SHARE AMOUNTS) Net Sales................................................... 2J, 9 $ 2,968 $3,207 Cost of Sales............................................... 9 2,117 2,917 ------- ------ Gross Profit................................................ 851 290 ------- ------ Operating Expenses Research and development.................................. 2K 901 599 General and administrative................................ 217 354 Marketing................................................. 261 143 ------- ------ Total Operating Expenses............................... 1,379 1,096 ------- ------ Loss from Operations........................................ (528) (806) ------- ------ Non-Operating Income (Expense) Interest revenue.......................................... 130 38 Subsidy................................................... 235 174 Gain on sale of marketable securities..................... 2E -- 22 Unrealized holding gains on marketable securities......... -- -- Foreign exchange gain loss................................ 2N 10 (10) Gain on disposal of properties............................ 9 4 -- ------- ------ Total Non-Operating Income............................. 379 224 ------- ------ Loss Before Income Tax...................................... (149) (582) Income Tax Expense.......................................... 2M, 8 2 -- ------- ------ Net Loss.................................................... $ (151) $ (582) ======= ====== Other Comprehensive Income Translation adjustments................................... 2O (97) 211 ------- ------ Comprehensive Loss.......................................... $ (248) $ (371) ======= ====== Loss Per Share -- Based on weighted average outstanding common stock 35,000 thousand shares........................................ 2Q $(0.004) $(0.02) ======= ======
The accompanying notes are an integral part of the financial statements. F-120 227 OPTRONICS INTERNATIONAL CORP. STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
FOR THE SIX MONTHS ENDED JUNE 30, ------------------ 1999 2000 ------- ------- (UNAUDITED) (IN THOUSAND U.S. DOLLARS) Operating Activities Net loss.................................................. $ (151) $ (582) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization.......................... 314 405 Gain on disposal of properties......................... (4) -- Accrued pension cost................................... 44 55 Gain on sale of marketable securities.................. -- (22) Changes in operating assets and liabilities Notes and accounts receivable.......................... 1,564 (854) Inventories.......................................... (463) (694) Prepaid expenses and other current assets............ (281) (24) Notes and accounts payable........................... 99 769 Income tax payable................................... (14) (62) Accrued expenses and other current liabilities....... (1,021) (88) ------- ------- Net Cash Provided by (Used in) Operating Activities....................................... 87 (1,097) ------- ------- Investing Activities Acquisitions of properties................................ (450) (709) Increase in restricted cash............................... (887) (196) Proceeds from disposal of properties...................... 38 -- Decrease (increase) in marketable securities.............. (400) 2,329 Increase in deferred charges.............................. (2) (86) Decrease (increase) in refundable deposits................ 23 (10) ------- ------- Net Cash Provided by (Used in) Investing Activities....................................... (1,678) 1,328 ------- ------- Financing Activity Payment of long-term debts................................ -- (124) ------- ------- Effects of Changes in Foreign Exchange Rate................. (60) 110 ------- ------- Net Increase (Decrease) in Cash............................. (1,651) 217 Cash At Beginning of Period................................. 6,510 1,841 ------- ------- Cash at End of Period....................................... $ 4,859 $ 2,058 ======= ======= Supplemental Disclosures of Cash Flow Information Cash paid for income tax.................................. $ 15 $ 62 ======= =======
The accompanying notes are an integral part of the financial statements. F-121 228 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 1. GENERAL Business Optronics International Corp. (the "Company") was incorporated under the Company Law of the Republic of China on November 21, 1996 and started its operations in February 1997. The Company is primarily engaged in research, development, production, manufacture and sale of visible laser diode and module, communication laser diode and module and high power laser diode and module. 2. ACCOUNTING POLICIES A. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. B. Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, marketable securities and accounts receivable. Cash and marketable securities are deposited or placed with high credit quality financial institutions to the extent of the amount recorded on the balance sheet. As far as the accounts receivable, the Company performs ongoing credit evaluations of its customers' financial condition and the Company maintains an allowance for doubtful accounts receivable based upon review of the expected collectibility of individual accounts receivable. C. Fair Value of Financial Instruments The Company's financial instruments, including cash, restricted cash, marketable securities, notes and accounts receivable, refundable deposits, and notes and accounts payable are carried at cost, which approximates their fair value because of the short-term maturity of these instruments. Fair value of long-term debts is estimated based on current interest rates available to the Company with similar terms, degrees of risks and remaining maturities. The carrying values of long-term debts approximate their respective fair value. D. Restricted Cash Restricted cash is composed of time deposits that the Company maintains as collateral for obtaining letters of credits. E. Marketable Securities Marketable securities are open-end bond funds that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. The costs of investment sold are determined by the weighted average method. F-122 229 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) F. Inventories Inventories are stated at cost using the weighted average method and are valued at the lower of cost or market value at balance sheet date. The market value of raw materials is determined based on current replacement cost, while work-in-process and finished goods are determined by net realizable value. G. Properties Properties are stated at cost less accumulated depreciation. Major additions, renewals and betterment are capitalized, while maintenance and repairs are expensed currently. Depreciation is provided on the straight-line method over the estimated useful lives that range as follows: machinery and equipment -- 3 to 8 years; computer equipment -- 3 years; office equipment -- 5 years; leasehold improvements -- 5 years; transportation equipment -- 5 years; other equipment -- 5 to 20 years. Upon sale or disposal of properties, the related cost and accumulated depreciation are removed from the accounts, and any gain or loss is credited or charged to income. H. Asset Impairment Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", ("SFAS No. 121") requires recognition of impairment of long-lived assets in the event the net book value of these assets exceeds the future undiscounted cash flows attributable in use to these assets. SFAS No. 121 has not had an impact on the financial statements of the Company. I. Deferred Charges Deferred charges are stated at cost and amortized on straight-line basis over the following years: tools -- 3 years. J. Revenue Recognition Revenue is mainly from product sales to customers and is recognized at the time of shipment, indicating that revenue has been realized and earned. The four criteria for revenue being realized and earned are the existence of sale, actual shipment, fixed or determinable selling price, and reasonable assurance of collectibility. Allowances for sales returns and discounts are provided at the time of the recognition of the related revenues based on experience and these provisions are deducted from sales. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. SAB 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company currently complies with SAB 101 and therefore SAB 101 will not have any effect on our financial position or result of operations. K. Research and Development Research and development costs consist of expenditures incurred during the course of planned search and investigation aimed at the discovery of new knowledge that will be useful in developing new products or processes, or at significantly enhancing existing products or production processes. And the F-123 230 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) implementation of such is through design, testing of product alternatives or construction of prototypes. The Company expenses all research and development costs as they are incurred. L. Pension Costs The Company has non-contributory and funded defined benefit retirement plans covering all its regular employees. The contribution to an independent fund is deposited with the Central Trust of China, as the custodian. Net pension cost, with includes service cost, interest cost, expected return on plan assets and amortization of net asset or obligation at transition, is recognized based on an actuarial valuation. The Company has a defined benefit pension plan for all regular employees, which provides benefits base on length of service and average monthly salary for the last six month prior to retirement. The Company makes monthly contributions, equal to 2% of salaries and wages, to a pension fund which is administered by a pension fund monitoring committee and deposited as the committee's name in the Central Trust of China which acts as trustee. M. Income Tax The Company adopted the provisions of SFAS No. 109 "Accounting for Income Tax"; the provision for income tax represents income tax paid and payable for the current year plus the changes in the deferred income tax assets and liabilities during the years. Deferred income taxes are recognized for the tax effects of temporary differences, unused tax credit and operating loss carryforwards. Valuation allowance is provided for deferred tax assets that are not certain to be realized. A deferred tax asset or liability should, according to the classification of its related asset or liability, be classified as current or noncurrent. However, if a deferred asset or liability cannot be identified to an asset or a liability in the financial statements, then it should be classified as current or noncurrent based on the expected reversal date of temporary difference. N. Foreign-currency Transactions The functional currency of the Company is New Taiwan dollars. The foreign-currency transactions of the Company are recorded using their respective functional currencies at the rates of exchange in effect when the transactions occur. Gains or losses, resulting from the application of different foreign exchange rates when cash in foreign currency is converted into New Taiwan dollars, or when foreign-currency receivables and payables are settled, are credited or charged to income in the year of conversion or settlement. At the balance sheet dates, the balances of foreign-currency assets and liabilities are restated into the respective functional currencies based on prevailing exchange rates and any resulting gains or losses are credited or charged to income. O. Translation of Foreign-Currency Financial Statements The financial statements are translated into U.S. dollars at the following exchange rates: assets and liabilities -- current rate; income and expenses -- weighted average rate during the year. The resulting translation adjustment is recorded as separate component of shareholders' equity. Q. Comprehensive Income The Company adopted the provisions of SFAS No. 130 "Reporting Comprehensive Income"; SFAS No. 130 establishes standards for reporting comprehensive income and its components in financial statements. Comprehensive income, as defined, includes all changes in equity during a period from non- F-124 231 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) owner sources. To date, the Company has only translation adjustment that are required to be reported in comprehensive income. R. Earnings (Loss) Per Share SFAS No. 128 "Earnings Per Share", establishes standards for computing and presenting earnings per share. Basic earnings per share is calculated using the average shares of common share outstanding. Diluted earnings per share is calculated using the weighted average number of common and dilutive common equivalent shares outstanding during the period, using either as if converted method for convertible preferred share or the treasury stock method for options and warrants. Since the Company's capital structure is simple, therefore, its basic earnings per share is the same as diluted earnings per share. S. Unaudited Interim Financial Statements The interim financial information contained herein is unaudited but, in the opinion of management, reflects all adjustments which are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. All adjustments are of a normal, recurring nature. Results of operations for interim periods presented herein are not necessarily indicative of results of operations for the entire year. 3. NOTES AND ACCOUNTS RECEIVABLE -- NET
DECEMBER 31, JUNE 30, 1999 2000 ------------ -------- Receivable from related parties (Note 9)............... $ 46 $ 331 Notes receivable....................................... 46 12 Accounts receivable -- third parties................... 861 1,474 ----- ------ 953 1,817 Allowance for doubtful accounts........................ (477) (487) ----- ------ $ 476 $1,330 ===== ======
4. INVENTORIES
DECEMBER 31, JUNE 30, 1999 2000 ------------ -------- Finished goods......................................... $ 233 $ 323 Work in process........................................ 320 626 Raw materials.......................................... 493 791 ------ ------ $1,046 $1,740 ====== ======
F-125 232 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 5. PROPERTIES -- NET
DECEMBER 31, JUNE 30, 1999 2000 ------------ -------- Cost Machinery and equipment.............................. $5,018 $5,381 Computer equipment................................... 60 85 Office equipment..................................... 36 69 Leasehold improvements............................... 81 176 Transportation equipment............................. 58 59 Other equipment...................................... 1,230 1,291 Prepayments.......................................... 33 292 ------ ------ 6,516 7,353 ------ ------ Accumulated depreciation Machinery and equipment.............................. $1,076 $1,407 Computer equipment................................... 32 42 Office equipment..................................... 13 18 Leasehold improvements............................... 29 32 Transportation equipment............................. 21 27 Other equipment...................................... 148 209 ------ ------ 1,319 1,735 ------ ------ $5,197 $5,618 ====== ======
6. LONG-TERM DEBTS
DECEMBER 31, JUNE 30, 1999 2000 ------------ -------- Industrial Bureau -- Innovation Products Matching Fund to be repaid in installment with final payment due in October 2001 (Note 12)............................... $ 506 $ 388 Current portion........................................ (253) (259) ----- ----- $ 253 $ 129 ===== =====
As of June 30, 2000, long-term debts mature as follows:
JUNE 30, 2000 -------- During the year 2000........................................ $259 During the year 2001........................................ 129
7. SHAREHOLDERS' EQUITY The Company's Articles of Incorporation provide that the following shall be appropriated from the annual net income after deducting any previously accumulated deficit and 10% legal reserve: (a) 5% - 10% special bonus to employees; (b) 1% - 3% compensation to directors and supervisors; and F-126 233 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) (c) Special retained earnings reserve and unappropriated earnings can be set aside when necessary, and the remaining amount shall be appropriated as common shareholders' bonus. The appropriations and the disposition of the remaining net income shall be resolved by the shareholders in the following year and given effect to in the financial statements of that year. The aforementioned appropriation for legal reserve shall be made until the reserve equals the Company's capital. Such reserve can only be used to offset a deficit; or, when it has reached 50% of the paid-in capital, up to 50% thereof can be transferred to capital. 8. INCOME TAX A. Income tax benefit: The Company expects no income tax benefits and income tax payable for the six months ended June 30, 2000. Income tax expense of $2 for the six months ended June 30, 1999 represents the prior year's income tax adjustment. B. As of December 31, 1999 and June 30, 2000, deferred income tax assets and liabilities are as follows:
DECEMBER 31, JUNE 30, 1999 2000 ------------ -------- Current: Taxable temporary differences....................... $ 119 $ 105 Investment tax credits.............................. 5 -- Operating loss carryforwards........................ 338 284 ------- ------- Total............................................ 462 389 Valuation allowance................................... (462) (389) ------- ------- -- -- ------- ------- Noncurrent: Taxable temporary differences....................... 31 5 Investment tax credits.............................. 1,279 1,214 Operating loss carryforwards........................ 51 59 ------- ------- Total............................................ 1,361 1,278 Valuation allowance................................... (1,361) (1,278) ------- ------- $ -- $ -- ======= =======
C. The Company's income tax returns through taxable year ended December 31, 1996 have been examined by the tax authorities. D. As of June 30, 2000, the Company's unused investment tax credits and the tax effect of loss carryforwards amounted to approximately $1,214 and $343, respectively, and are available for future use through 2003 and 2004, respectively. F-127 234 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 9. RELATED PARTY TRANSACTIONS A. Name and Relationship of Related Parties
NAME AND RELATIONSHIP OF RELATED PARTIES RELATIONSHIP WITH THE COMPANY ---------------------------------------- ----------------------------- Wah Lee Industrial Corp. (WAH LEE)........ Its chairman is the supervisor of the Company Delta Electronics Int. Ltd. (DELTA LTD.)................................... Same chairman Delta Electronics Inc. (DELTA INC.)....... Same chairman
B. Significant Related Party Transactions For the period:
FOR THE SIX MONTHS ENDED JUNE 30, ------------------------------------ 1999 2000 ---------------- ---------------- AMOUNT % AMOUNT % ------- ----- ------- ----- Sales DELTA INC. ............................................... $ 86 3 $314 5 WAH LEE................................................... 86 3 176 10 ---- ---- ---- ---- $172 6 $490 15 ==== ==== ==== ==== Purchases................................................... $160 8 $ 8 -- DELTA LTD. ............................................... 2 -- -- -- ---- ---- ---- ---- DELTA INC. ............................................... $162 8 $ 8 -- ==== ==== ==== ====
At end of period:
DECEMBER 31, JUNE 30, 1999 2000 -------------- -------------- AMOUNT % AMOUNT % ------ ---- ------ ---- Receivable DELTA INC. ............................................... $ 25 5 $272 20 WAH LEE................................................... 21 4 59 5 ---- ---- ---- ---- $ 46 9 $331 25 ==== ==== ==== ==== Accounts payable -- DELTA LTD. ............................. $ 52 10 $ 1 -- ==== ==== ==== ====
a. Sales to related parties are based on normal selling prices. The collection period is 30 - 75 days after shipment for related parties and 15 - 60 days for other companies. b. The payment terms for purchases from related parties are the same as those from other suppliers. c. As of June 30, 1999, the Company sold certain machinery and equipment to DELTA INC. for $38 and generated a gain of $4. F-128 235 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) 10. FINANCIAL INSTRUMENTS The Company's financial instruments are carried at cost, which approximates their fair value and are listed as follows:
DECEMBER 31, 1999 JUNE 30, 2000 ------------------ ------------------ CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE -------- ------ -------- ------ ASSETS Cash................................................... $1,841 $1,841 $2,058 $2,058 Restricted cash........................................ 967 967 1,163 1,163 Marketable securities.................................. 2,307 2,307 -- -- Notes and accounts receivable -- net................... 476 476 1,330 1,330 Prepaid long-term investment........................... -- -- -- -- Refundable deposits.................................... 41 41 51 51 LIABILITIES Notes and accounts payable............................. 537 537 1,306 1,306 Long-term debts (including current portion)............ 506 506 388 388
11. COMMITMENTS AND CONTINGENT LIABILITIES A. In 1997 and 1999, the Company entered into loan agreements with Industrial Development Bureau, Ministry of Economic Affairs and Administration of Hsin-chu Science-based Industrial Park, respectively, for developing new products. Under the agreements, the loans are paid in installments starting one year after the prototypes are completed. In addition, the Company shall make quarterly payment for a period of three years equivalent to 2% of net sales as feedback fund starting when sales are generated from the new products begin. However, the total feedback fund should not be more than 30% of the loan. B. As of June 30, 2000, unused letters of credit aggregate about US$129 thousand and JPY 32,683 thousand. 12. SEGMENT INFORMATION The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 requires companies to disclose certain information about operating segments. Based on the criteria within SFAS 131, the Company has determined that it has one reportable segment, laser diode products. A. Foreign markets:
FOR THE SIX MONTHS ENDED JUNE 30, ------------------ AREA 1999 2000 ---- ------- ------- Asia....................................................... $1,234 $ 907 America.................................................... 94 762 Europe..................................................... 16 234 Other...................................................... -- 7 ------ ------ $1,344 $1,910 ====== ======
F-129 236 OPTRONICS INTERNATIONAL CORP. NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) (IN THOUSAND U.S. DOLLARS, EXCEPT SHARE AMOUNTS) B. Major customers
FOR THE SIX MONTHS ENDED JUNE 30, ---------------------------------- 1999 2000 --------------- --------------- CUSTOMERS AMOUNT % AMOUNT % --------- ------- ---- ------- ---- A...................................................... $410 14 $ -- -- B...................................................... 400 13 -- -- C...................................................... -- -- 380 12 D...................................................... -- -- 314 10
C. Geographic information. The Company's operations are entirely in the Republic of China. F-130 237 INDEPENDENT AUDITORS' REPORT The Board of Directors Quantum Optech Incorporation We have audited the accompanying consolidated balance sheets of Quantum Optech Incorporation and subsidiary as of December 31, 1998 and 1999 and the related consolidated statements of operations and comprehensive income (loss), stockholders' equity, and cash flows for the period from May 27, 1997 (inception) to December 31, 1997 and for the years ended December 31, 1998 and 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Quantum Optech Incorporation and subsidiary as of December 31, 1998 and 1999 and the results of their operations and their cash flows for the period from May 27, 1997 (inception) to December 31, 1997 and for the years ended December 31, 1998 and 1999, in conformity with accounting principles generally accepted in the United States of America. KPMG Certified Public Accountants Hsin Chu, Taiwan May 25, 2000 F-131 238 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1999
1998 1999 ---------- ----------- ASSETS Current assets: Cash and cash equivalents................................. $1,978,930 $ 1,521,481 Marketable securities..................................... -- 581,423 Accounts receivable, net of allowance for doubtful accounts of $6,713 and $6,878 as of December 31, 1998 and 1999, respectively................................. 705,854 1,070,429 Inventories............................................... 1,094,718 1,506,436 Prepaid expenses.......................................... 26,190 16,616 Other current assets...................................... 37,860 121,683 ---------- ----------- Total current assets................................... 3,843,552 4,818,068 Property, plant and equipment, net........................ 2,766,572 4,316,607 ---------- ----------- Total assets........................................... $6,610,124 $ 9,134,675 ========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings..................................... $ 178,581 $ 428,634 Current portion of long-term debt......................... 155,231 353,546 Due to related parties.................................... 129,143 13,898 Accounts payable.......................................... 417,037 1,075,277 Advance from customers.................................... 263 795,877 Accrued expenses and other current liabilities............ 185,196 321,170 ---------- ----------- Total current liabilities.............................. 1,065,451 2,988,402 Long-term debt............................................ 956,225 1,094,609 Accrued pension........................................... 39,863 95,070 ---------- ----------- Total liabilities...................................... 2,061,539 4,178,081 ---------- ----------- Stockholders' equity: Common stock, par value of 10 New Taiwan dollars, authorized shares of 15,000,000 and 30,000,000; issued and outstanding shares of 15,000,000 and 19,000,000, as of December 31, 1998 and 1999, respectively............ 4,815,382 6,076,019 Additional paid-in capital................................ 565,789 943,980 Accumulated deficit....................................... (677,173) (1,983,792) Accumulated other comprehensive loss...................... (155,413) (79,613) ---------- ----------- Total stockholders' equity............................. 4,548,585 4,956,594 Commitments Total liabilities and stockholders' equity............. $6,610,124 $ 9,134,675 ========== ===========
See accompanying notes to consolidated financial statements. F-132 239 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) PERIOD FROM MAY 27, 1997 (INCEPTION) TO DECEMBER 31, 1997 AND YEARS ENDED DECEMBER 31, 1998 AND 1999
1997 1998 1999 --------- ---------- ----------- Net sales............................................. $ -- $2,116,317 $ 3,433,449 Cost of goods sold.................................... -- 2,016,479 3,555,303 --------- ---------- ----------- Gross profit (loss)................................... -- 99,838 (121,854) Selling, general and administrative expense........... 43,075 508,384 853,904 Research and development expense...................... -- 73,519 281,076 --------- ---------- ----------- Operating loss........................................ (43,075) (482,065) (1,256,834) Interest expense...................................... (5,416) (165,125) (100,451) Interest income....................................... 1,333 7,086 15,095 Foreign exchange gain (loss), net..................... -- 8,876 (8,259) Other gain (loss), net................................ (993) 2,206 43,830 --------- ---------- ----------- Net loss.............................................. $ (48,151) $ (629,022) $(1,306,619) ========= ========== =========== Other comprehensive income (loss): Foreign currency translation adjustment............. $(136,108) $ (19,305) $ 86,292 Unrealized holding loss on marketable securities.... -- -- (10,492) --------- ---------- ----------- Comprehensive loss.................................. $(184,259) $ (648,327) $(1,230,819) ========= ========== ===========
See accompanying notes to consolidated financial statements. F-133 240 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY PERIOD FOR MAY 27, 1997 (INCEPTION) TO DECEMBER 31, 1997 AND YEARS ENDED DECEMBER 31, 1998 AND 1999
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) --------------------------- FOREIGN UNREALIZED COMMON SHARES ADDITIONAL CURRENCY HOLDING LOSS TOTAL ----------------------- PAID-IN ACCUMULATED TRANSLATION ON MARKETABLE STOCKHOLDERS' SHARES AMOUNT CAPITAL DEFICIT ADJUSTMENT SECURITIES EQUITY ---------- ---------- ---------- ----------- ----------- ------------- ------------- Issuance of common stock upon inception on May 27, 1997.... 1,500,000 $ 538,406 $ -- $ -- $ -- $ -- $ 538,406 Net loss....................... -- -- -- (48,151) -- -- (48,151) Foreign currency translation adjustment................... -- -- -- -- (136,108) -- (136,108) ---------- ---------- -------- ----------- --------- -------- ----------- BALANCE AT DECEMBER 31, 1997... 1,500,000 538,406 -- (48,151) (136,108) -- 354,147 Issuance of common stock....... 13,500,000 4,276,976 565,789 -- -- -- 4,842,765 Net loss....................... -- -- -- (629,022) -- -- (629,022) Foreign currency translation adjustment................... -- -- -- -- (19,305) -- (19,305) ---------- ---------- -------- ----------- --------- -------- ----------- BALANCE AT DECEMBER 31, 1998... 15,000,000 4,815,382 565,789 (677,173) (155,413) -- 4,548,585 Issuance of common stock....... 4,000,000 1,260,637 378,191 -- -- -- 1,638,828 Net loss....................... -- -- -- (1,306,619) -- -- (1,306,619) Foreign currency translation adjustment................... -- -- -- -- 86,292 -- 86,292 Unrealized holding loss on marketable securities........ -- -- -- -- -- (10,492) (10,492) ---------- ---------- -------- ----------- --------- -------- ----------- BALANCE AT DECEMBER 31, 1999... 19,000,000 $6,076,019 $943,980 $(1,983,792) $ (69,121) $(10,492) $ 4,956,594 ========== ========== ======== =========== ========= ======== ===========
See accompanying notes to consolidated financial statements. F-134 241 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS PERIOD FROM MAY 27, 1997 (INCEPTION) TO DECEMBER 31, 1997 AND YEARS ENDED DECEMBER 31, 1998 AND 1999
1997 1998 1999 ----------- ----------- ----------- Cash Flows from Operating Activities: Net loss.......................................... $ (48,151) $ (629,022) $(1,306,619) Adjustments to reconcile net loss to cash used in operating activities: Bad debt expense............................... -- 6,472 -- Provision for inventory obsolescence........... -- 13,891 140,256 Depreciation and amortization.................. 2,233 206,551 375,748 Gain on disposal of marketable securities...... -- -- (27,674) Changes in operating assets and liabilities: Accounts receivable.......................... -- (686,974) (337,622) Inventories.................................. (109,052) (974,763) (514,451) Prepaid expenses and other current assets.... (14,351) (49,312) (70,659) Accounts payable............................. 70,540 340,914 629,992 Due to related parties....................... 4,104 120,947 (115,113) Accrued expenses and other current liabilities............................... 7,183 172,573 901,289 Accrued pension.............................. -- 38,432 52,721 ----------- ----------- ----------- Cash used in operating activities......... (87,494) (1,440,291) (272,132) ----------- ----------- ----------- Cash Flows from Investing Activities: Purchase of marketable securities................. -- -- (1,303,750) Purchase of property, plant and equipment......... (1,078,411) (1,940,915) (1,816,066) Proceeds from the sale of marketable securities... -- -- 755,982 ----------- ----------- ----------- Cash used in investing activities......... (1,078,411) (1,940,915) (2,363,834) ----------- ----------- ----------- Cash Flows from Financing Activities: Net increase in short-term borrowings............. -- 172,167 238,842 Net increase in long-term debt.................... 310,773 802,155 300,866 Issuance of common stock.......................... 538,406 4,403,067 1,638,828 Advance payments from stockholders................ 439,698 -- -- ----------- ----------- ----------- Cash provided by financing activities..... 1,288,877 5,377,389 2,178,536 ----------- ----------- ----------- Effect of exchange rate changes on cash............. (37,152) (103,073) (19) ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents....................................... 85,820 1,893,110 (457,449) Cash and cash equivalents at beginning of period.... -- 85,820 1,978,930 ----------- ----------- ----------- Cash and cash equivalents at end of period.......... $ 85,820 $ 1,978,930 $ 1,521,481 =========== =========== =========== Supplemental Disclosure of Cash Flow Information: Cash paid for: Interest....................................... $ 3,965 $ 160,695 $ 106,290 =========== =========== ===========
See accompanying notes to consolidated financial statements. F-135 242 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) (1) ORGANIZATION AND PRINCIPAL ACTIVITIES Quantum Optech Incorporation (the "Company") was incorporated on May 27, 1997 under the Company Law of the Republic of China ("Taiwan"). Prior to January 31, 1998, the Company was in a developmental stage. During the developmental stage, the Company's activities primarily consisted of financial planning, raising capital, recruiting and training employees, research and development and preparing its facility for production. Subsequent to the developmental stage, the Company's business activities primarily consists of the manufacture, sales and development of quartz crystal, optical equipment components, electro-optical materials, optical crystal products, telecommunication products, optical and opto-electronic instruments, crystal cutting machines, lapping machines, and super-hard thin film coating machines. In 1998, the Company incorporated Quantum Optech (Singapore) Pte Ltd. as a wholly owned subsidiary of the Company. Quantum Optech (Singapore) Pte Ltd., acts as a intermediary for the Company's operations in the Peoples' Republic of China. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Accounting Principles The accompanying consolidated financial statements have been prepared on a historical cost basis to reflect the financial position and results of operations of the Company in accordance with accounting principles generally accepted in the United States of America ("US GAAP"). The consolidated financial statements are stated in US dollars, the reporting currency of the Company. Use of Estimates The preparation of the consolidated financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates. Principles of Consolidation The consolidated financial statements include the financial statements of the Company and its wholly owned subsidiary, Quantum Optech (Singapore) Pte Ltd. All significant intercompany balances and transactions are eliminated in consolidation. Foreign Currency Transactions and Translation The functional currency of the Company's operations in Singapore and the People's Republic of China is the US dollar. The functional currency of the Company's operations in Taiwan is the New Taiwan dollar. The translation of the Company's operations in Taiwan from New Taiwan dollars to US dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date, and for revenue and expense accounts using a weighted average exchange rate during the period. Gains and losses, net of applicable income taxes, resulting from such translation are reported as a separate component of other comprehensive income (loss). Foreign currency transaction gains or losses are included in results of operations. F-136 243 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) Revenue Recognition Revenues are recognized upon shipment of product. The Company does not have any obligations beyond the shipment of the product nor does the Company offer its customers a product warranty. Management establishes an allowance for doubtful accounts against the related accounts receivable balance when factors indicate that collectibility is not reasonably assured. Research and Development Expenses Research and development costs are expensed as incurred. Cash and Cash Equivalents The Company considers time deposits with an original maturity of less than three months to be cash equivalents. Start-Up Activities The Company adopted SOP 98-5, "Reporting on the Costs of Start-Up Activities" for all periods presented. SOP 98-5 requires costs of start-up activities and organization costs to be expensed as incurred. These costs are included in "selling, general and administrative" expenses in the accompanying consolidated statements of operations and comprehensive income (loss). Comprehensive Income (Loss) Comprehensive income (loss) consists of the Company's net loss, foreign currency translation adjustments and unrealized holding gains (losses) on marketable securities and is presented in the consolidated statements of operations and comprehensive income (loss). Concentration of Credit Risk Financial instruments, which subject the Company to concentrations of credit risk, primarily consist of cash, cash equivalents, and accounts receivable. The Company maintains its cash and cash equivalents deposits in financial institutions of high-credit standing. Less than ten customers represented a majority of total accounts receivable as of December 31, 1998 and 1999. The Company does not require collateral from its customers related to their accounts receivable balance. Management performs ongoing credit evaluations of its customers and believes that the Company has adequately provided for any exposure to potential credit losses. Marketable Securities The Company accounts for its investment in marketable securities in accordance Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Marketable securities held by the Company include common stock and mutual funds publicly listed in Taiwan. The Company has classified the securities as available for sale. Management intends to sell the securities in fiscal year 2000 and has classified the asset as a current asset in the accompanying consolidated balance sheet as of December 31, 1999. The unrealized holding loss related to the securities as of December 31, 1999 amounted to $10,492. Realized gains from the sales of marketable securities amounted to $32,000 for the year ended December 31, 1999. There were no sales of marketable securities for the period from May 27, 1997 (inception) to December 31, 1997 or for the year ended December 31, 1998. F-137 244 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) Inventories Inventories are stated at the lower of cost or market on a weighted average basis. Property, Plant and Equipment Property, plant and equipment are stated at cost. Depreciation is provided for financial reporting purposes using the straight-line method, less salvage value, over the following estimated useful lives: Building................................................ 25 years Machinery and equipment................................. 5 years Furniture and fixtures.................................. 3 to 5 years Leasehold improvements.................................. 3 years Computer software....................................... 3 years
Impairment of Long-Lived Assets The Company reviews long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the carrying amounts of existing assets and liabilities in the financial statements and their respective tax bases, and operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded for deferred income tax assets where it is more likely than not that such assets will not be realized. Retirement Benefits Pursuant to the ROC Labor Standards Law (the "Law"), the Company has established a defined benefit retirement plan for all full-time employees in Taiwan. This plan provides for lump-sum retirement benefits to retiring employees based on length of service, age and certain other factors. In addition, the Law requires that the Company fund the plan annually at a rate of 2% to 15% of total employee salaries. The plan is funded through deposits with the Central Trust of China, a governmental institution that administrates pension investments for all entities in Taiwan. The Company records and discloses pension expense and the related liability in accordance with SFAS No. 87, "Employers' Accounting for Pensions" and SFAS No. 132, "Employers' Disclosure About Pensions and Other Postretirement Benefits" in the accompanying consolidated financial statements. Recent Accounting Pronouncements SFAS No. 133, "Accounting for Derivatives and Hedging Activities," was issued in June 1998. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging F-138 245 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) activities. SFAS No. 133, as amended, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. As the Company does not currently engage in derivatives or hedging transactions, there will be no current impact on the Company's results of operations or financial position upon adoption of SFAS No. 133. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition." SAB No. 101 provides additional guidance on the recognition, presentation and disclosure of revenue in financial statements. The Company has reviewed this bulletin and believes that its current revenue recognition policy is consistent with the guidance of SAB No. 101. (3) TRANSACTION WITH RELATED PARTIES The Company entered into transactions with the following related parties in 1998 and 1999:
NAME OF RELATED PARTY RELATIONSHIP WITH THE COMPANY --------------------- ----------------------------- Chu, Chen-Chung ("CC Chiu").......................... Director and general manager of the Company and owns 3.25% of the Company's shares as of December 31, 1999 Liou, Keh-Shium ("KS Liou").......................... Director of the Company, and owns 2.41% of the Company's shares Chiu, Shuan-Sou ("SS Chiu").......................... CC Chiu's father Q-Lin Technology Co., Ltd. ("Q-Lin")................. CC Chiu is the general manager and stockholder of this company Quantum Crystal Inc. ("Crystal")..................... SS Chiu is the president of this company TAI Mow Machinery Co., Ltd. ("TAI Mow").............. Its president is CC Chiu's brother ADI Corporation. ("ADI")............................. Director of the Company, and owns 26.45% of the Company's shares Peace light Investments Ltd. ("Peace light")......... A wholly owned subsidiary of ADI
The Company had sales of $108,671 to Crystal in 1998 and sales of $5,489 to ADI in 1999. These amounts were fully paid to the Company as of December 31, 1998 and 1999. The Company purchased inventory from Q-Lin, TAI Mow and Crystal for $848,418, $13,261 and $141,440, respectively in 1998. In 1999, the Company purchased $12,284 of inventory from TAI Mow. Amounts due to these related parties totaled $129,143 and $7,351 as of December 31, 1998 and 1999, respectively. The Company purchased equipment aggregating $78,300 from Q-Lin, TAI Mow and Crystal in 1998. The Company entered into lease agreements for office and packing lot space with Q-Lin and SS Chiu. Total rental expense related to those leases amounted to $13,828 and $18,429 for the years ended December 31, 1998 and 1999, respectively. The amount due to SS Chiu was $945 as of December 31, 1999. The lease agreements expire in fiscal year 2000. The Company paid Crystal $42,579 in 1998 and Peace light $9,078 in 1999 for miscellaneous expenditures. The amount due to Peace light was $5,602 at December 31, 1999. F-139 246 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) The Company borrowed funds for working capital purposes from the following related parties in 1998:
WEIGHTED MAXIMUM AVERAGE INTEREST BALANCE INTEREST RATE EXPENSE ---------- ------------- -------- Q-Lin............................................ $1,131,089 9.75% $85,242 Crystal.......................................... 68,503 9.75% 5,777 KS Liou.......................................... 485,334 8.9% 850 CC Chiu.......................................... 85,304 8.9% 3,052 ------- $94,921 =======
These balances were fully paid as of December 31, 1998. There were no transactions with related parties during the period from May 27, 1997 (inception) to December 31, 1997. (4) INVENTORIES Inventories at December 31, 1998 and 1999 consisted of the following:
1998 1999 ---------- ---------- Finished goods.............................................. $ 352,213 $ 428,850 Work in process............................................. 606,445 811,356 Raw material................................................ 150,469 401,928 Merchandise................................................. -- 23,335 ---------- ---------- 1,109,127 1,665,469 Less: provision for inventory obsolescence.................. (14,409) (159,033) ---------- ---------- $1,094,718 $1,506,436 ========== ==========
(5) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following as of December 31, 1998 and 1999:
1998 1999 ---------- ---------- Land........................................................ $ 541,358 $ 554,616 Building.................................................... 878,432 1,182,220 Machinery and equipment..................................... 1,330,302 1,906,044 Miscellaneous equipment..................................... 156,810 480,748 Furniture and fixtures...................................... 58,172 76,408 Computer software........................................... 17,100 39,758 Construction in progress, including advance payments for equipment................................................. -- 683,602 ---------- ---------- 2,982,174 4,923,396 Less: accumulated depreciation and amortization............. (215,602) (606,789) ---------- ---------- $2,766,572 $4,316,607 ========== ==========
The unamortized computer software amounted to $15,027 and $23,192, as of December 31, 1998 and 1999, respectively. The amortization expense of computer software amounted to $1,999 and $14,761, for the years ended December 31, 1998 and 1999, respectively. F-140 247 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) (6) SHORT-TERM BORROWINGS Short-term borrowings consisted of the following as of December 31, 1998 and 1999:
1998 1999 -------- -------- Unsecured loan......................................... $ -- $159,033 Letter of credit....................................... 178,581 147,941 Notes payable.......................................... -- 121,660 -------- -------- $178,581 $428,634 ======== ========
The Company has several lines of credit with banks which provide for maximum borrowings of approximately $1,611,456 and $4,505,089 as of December 31, 1998 and 1999, respectively. The unsecured loan and letter of credit balances stated above were outstanding against these lines of credit at December 31, 1998 and 1999. There are no commitment fees associated with these lines of credit. The lines of credit bear various interest rates. The weighted interest rates of the borrowings were 8.45% and 8.75% as of December 31, 1998 and 1999, respectively. The weighted average interest rate of the notes payable was 6.18% at December 31, 1999. These short-term borrowings are guaranteed by the Company's four major stockholders. (7) LONG-TERM DEBT Long-term debt consists of the following at December 31, 1998 and 1999:
BANK REPAYMENT TERMS 1998 1999 ---- --------------- ---------- ---------- Taiwan Medium Bank................... Payable in 49 quarterly installments beginning in October 2000 $ 279,416 $ 286,260 Taiwan Medium Bank................... Payable in 16 quarterly installments beginning in March 1999 620,925 477,099 Taiwan Medium Bank................... Payable in 32 quarterly installments beginning in June 2000 211,115 216,285 Taiwan Medium Bank................... Payable in 36 monthly installments beginning in July 1999 -- 396,946 Taiwan Medium Bank................... Payable in 17 quarterly installments beginning in September 2000 -- 37,214 Taiwan Medium Bank................... Payable in 17 monthly installments beginning in September 2000 -- 34,351 ---------- ---------- 1,111,456 1,448,155 Less: current portion....................................................... (155,231) (353,546) ---------- ---------- Total long-term debt excluding current position........................... $ 956,225 $1,094,609 ========== ==========
All of the above debt bears interest at variable rates. The weighted average interest rate of the above debt was 6.76% and 6.93% as of December 31, 1998 and 1999, respectively. F-141 248 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) Maturities of long-term debt were as follows as of December 31, 1999: Year ending December 31, 2000................................................... $ 353,546 2001................................................... 384,924 2002................................................... 305,534 2003................................................... 67,112 2004................................................... 62,914 Thereafter............................................. 274,125 ---------- $1,448,155 ==========
The agreements for the above debt require the Company to pledge property, plant and equipment with the following book values as of December 31, 1998 and 1999:
1998 1999 ---------- ---------- ASSETS Land................................................ $ 541,358 $ 554,616 Building............................................ 822,282 737,128 Machinery and equipment............................. 724,773 711,157 ---------- ---------- $2,088,413 $2,002,901 ========== ==========
(8) INCOME TAXES The Company's operations in Taiwan are subject to income tax at a rate of 25%. The Company's operations outside Taiwan are subject to income tax rates applicable to the related foreign jurisdiction. For the period from May 27, 1997 (inception) to December 31,1997 and the years ended December 31, 1998 and 1999, pre-tax losses were recorded in the following tax jurisdictions:
1997 1998 1999 -------- --------- ----------- Taiwan.................................. $(48,151) $(629,022) $ (886,494) Singapore............................... -- -- (420,125) -------- --------- ----------- $(48,151) $(629,022) $(1,306,619) ======== ========= ===========
A reconciliation of the expected income tax benefit at the Taiwan statutory rate of 25% to the actual income tax benefit for the period from May 27, 1997 (inception) to December 31, 1997 and the years ended December 31, 1998 and 1999 is as follows:
1997 1998 1999 -------- --------- --------- Income taxes benefit computed at the Taiwan statutory rate of 25%.......................... $(12,038) $(157,256) $(326,655) Expenses disallowed for tax purposes............. 1,409 3 2,915 Income not recognized for tax purposes........... (195) (8,574) Investment tax credits earned.................... -- (94,861) (18,907) Change in valuation allowance.................... 9,451 259,133 367,458 Foreign currency translation adjustment.......... 1,178 (6,002) (16,274) Other............................................ -- (822) 37 -------- --------- --------- Actual income tax benefit........................ $ -- $ -- $ -- ======== ========= =========
F-142 249 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) The components of deferred income tax assets and liabilities consisted of the following as of December 31, 1998 and 1999:
1998 1999 --------- --------- Deferred income tax assets: Provision for inventory obsolescence............... $ 68,899 $ 39,758 Unrealized investment loss......................... -- 108,027 Net operating loss carryforwards................... 94,365 336,800 Investment tax credits............................. 94,861 113,768 Property, plant and equipment...................... 7,019 23,159 Other.............................................. 3,440 14,530 --------- --------- 268,584 636,042 Less: valuation allowance............................ (268,584) (636,042) --------- --------- Net deferred income tax assets....................... $ -- $ -- ========= =========
A full valuation allowance was recorded against the deferred income tax asset balance primarily due to the Company's history of losses. The Company earns investment tax credits in Taiwan related to certain research and development expenditures. Credits are based on a percentage of the total cost of research and development expenditures and can be used to offset either current income taxes or be carried forward for four years. The expiration dates of the Company's investment tax credits as of December 31, 1999 are shown below:
EXPIRATION YEAR AMOUNT --------------- -------- 2002...................................................... $ 97,184 2003...................................................... 16,584 -------- $113,768 ========
As of December 31, 1999, the Company had net operating losses available for carryforward in Taiwan of approximately $1.3 million which will expire from fiscal year 2002 to 2004. (9) RETIREMENT BENEFITS The following table sets forth a reconciliation of the benefit obligation and accrued pension balance related to the Company's defined benefit retirement plan for the years ended December 31, 1998 and 1999:
1998 1999 ------- -------- Projected benefit obligation at beginning of period..... $ -- $ 39,863 Service cost............................................ 39,863 62,771 Interest cost........................................... -- 2,566 Foreign currency translation adjustment................. -- 2,847 ------- -------- Benefit obligation at end of period..................... 39,863 108,047 Fair value of plan assets............................... -- (12,977) ------- -------- Accrued pension at end of period........................ $39,863 $ 95,070 ======= ========
F-143 250 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) There is no pension cost for the period from May 27 (inception) to December 31, 1997. The components of net pension cost for the years ended December 31, 1998 and 1999 are summarized as follows:
1998 1999 ------- ------- Service cost............................................. $39,863 $62,771 Interest cost............................................ -- 2,566 Expected return on plan assets........................... -- 216 ------- ------- Net pension cost......................................... $39,863 $65,553 ======= =======
The discount rate and rate of compensation increase used by the Company to calculate its net pension expense for the years ended December 31, 1998 and 1999 were as follows:
1998 1999 ---- ---- Discount rate............................................... 6.5% 6.5% Rate of compensation increase............................... 5.0% 5.0%
The Company's contribution to the fund deposited in the Central Trust of China amounted to $12,413 for the year ended December 31, 1999. (10) ADVANCE PAYMENT FROM CUSTOMER The Company has entered into an agreement with a customer for the future sale of DWDM filters. In accordance with the agreement, the customer has made an advance payment of $795,165 for the filters. This payment will be applied against the future shipment of the product. Consistent with the Company's revenue recognition policy, the advance payment will be recognized as revenue upon shipment. As of December 31, 1999, the Company was in the process of developing the filters and the related manufacturing process. Management expects to begin the manufacturing and shipment of the filters in the second half of fiscal year 2000. As of December 31, 1999, the advance payment has been included in current liabilities in the accompanying consolidated balance sheet. (11) STOCKHOLDERS' EQUITY On September 1, 1997, the Company's stockholders approved the issuance of 4,040,000 new shares through cash subscription at 10 New Taiwan dollars per share. As of December 31, 1997, the stockholders made advance payments aggregating to $439,698 to the Company. The common stock was issued in 1998 upon completion of the final stock agreement between the Company and stockholders. (12) COMMITMENTS As of December 31, 1999, the Company had commitments to purchase equipment with a total estimated cost of $1,234,097. F-144 251 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (ALL AMOUNTS EXPRESSED IN U.S. DOLLARS UNLESS OTHERWISE STATED.) (13) FAIR VALUE OF FINANCIAL INSTRUMENTS
DECEMBER 31, 1998 DECEMBER 31, 1999 ------------------------ ------------------------ CARRYING ESTIMATED CARRYING ESTIMATED AMOUNT FAIR VALUE AMOUNT FAIR VALUE ---------- ---------- ---------- ---------- ASSETS: Marketable securities..................... $ -- $ -- $ 581,423 $ 581,423 Accounts receivable....................... 705,854 705,854 1,070,429 1,070,429 LIABILITIES: Short-term borrowings..................... 178,581 178,581 428,634 428,634 Due to related parties.................... 129,143 129,143 13,898 13,898 Accounts payable.......................... 417,037 417,037 1,075,277 1,075,277 Long-term debt (including current portion)................................ $1,111,456 $1,111,456 $1,448,155 $1,448,155
The carrying amount of accounts receivable, short-term borrowings, due to related parties and accounts payable approximate fair value due to the short-term nature of these instruments. The carrying amount of the Company's marketable securities is stated at the fair value based on the publicly quoted market prices of the securities. The carrying amount of long-term debt approximates fair value since the variable interest rates on the debt approximate market interest rates. (14) SEGMENT INFORMATION AND MAJOR CUSTOMERS The Company principally operated in one segment, optical crystal products. The following table presents net sales based on the customer's country of domicile for the years ended December 31, 1998 and 1999:
1998 1999 ---------- ---------- Taiwan.............................................. $1,691,440 $2,667,761 Peoples' Republic of China.......................... 239,206 703,217 Other countries in Asia............................. 185,671 58,982 United States....................................... -- 3,489 ---------- ---------- $2,116,317 $3,433,449 ========== ==========
Net sales to one customer exceeded 10% of total net sales for the year ended December 31, 1998. Total net sales to this customer amounted to $268,567 and $223,265 for the years ended December 31, 1998 and 1999, respectively. Property, plant and equipment were located in the following countries as of December 31, 1998 and 1999:
1998 1999 ---------- ---------- Taiwan.............................................. $2,741,141 $3,361,467 Peoples' Republic of China.......................... -- 1,000,096 ---------- ---------- $2,741,141 $4,361,563 ========== ==========
F-145 252 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEET JUNE 30, 2000 (UNAUDITED)
2000 ----------- ASSETS Current assets: Cash and cash equivalents................................. $ 1,014,183 Marketable securities..................................... 437,880 Accounts receivable, net of allowance for doubtful accounts of $5,767 as of June 30, 2000................. 1,519,313 Inventories............................................... 2,516,904 Prepaid expenses and other current assets................. 107,061 ----------- Total current assets................................... 5,595,341 Property, plant and equipment, net.......................... 5,322,200 ----------- Total assets........................................... $10,917,541 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings..................................... $ 1,356,118 Current portion of long-term debt......................... 575,755 Accounts payable.......................................... 1,077,525 Advance from customers.................................... 817,577 Accrued expenses and other current liabilities............ 497,208 ----------- Total current liabilities.............................. 4,324,183 ----------- Long-term debt.............................................. 1,835,925 Accrued pension............................................. 139,092 ----------- Total liabilities...................................... 6,299,200 ----------- Stockholders' equity: Common stock, par value of 10 New Taiwan dollars, authorized shares of 30,000,000; issued and outstanding shares of 19,000,000, as of June 30, 2000.............. 6,076,019 Additional paid-in capital................................ 943,980 Accumulated deficit....................................... (2,353,871) Accumulated other comprehensive loss...................... (47,787) ----------- Total stockholders' equity............................. 4,618,341 Commitments Total liabilities and stockholders' equity............. $10,917,541 ===========
See accompanying notes to consolidated financial statements. F-146 253 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) SIX-MONTH PERIODS ENDED JUNE 30, 1999 AND 2000 (UNAUDITED)
1999 2000 ---------- ---------- Net sales................................................... $1,532,760 $2,858,881 Cost of goods sold.......................................... 1,443,155 2,335,930 ---------- ---------- Gross profit................................................ 89,605 522,951 Selling, general and administrative expense................. 263,833 261,912 Research and development expense............................ 120,715 455,060 ---------- ---------- Operating loss.............................................. (294,943) (194,021) Interest expense............................................ (44,201) (99,825) Interest income............................................. 6,899 4,092 Foreign exchange gain (loss), net........................... 76,555 (108,391) Other gain, net............................................. 36,074 28,066 ---------- ---------- Net loss.................................................... $ (219,616) $ (370,079) ========== ========== Other comprehensive income (loss): Foreign currency translation adjustment................... $ (30,565) 101,098 Unrealized holding loss on marketable securities.......... -- (69,272) ---------- ---------- Comprehensive loss........................................ $ (250,181) $ (338,253) ========== ==========
See accompanying notes to consolidated financial statements. F-147 254 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS SIX-MONTH PERIODS ENDED JUNE 30, 1999 AND 2000 (UNAUDITED)
1999 2000 ----------- ----------- Cash flows from operating activities: Net loss.................................................. $ (219,616) $ (370,079) Adjustments to reconcile net loss to cash provided by (used in) operating activities: Depreciation and amortization.......................... 175,357 324,619 Gain on disposal of marketable securities.............. (6,069) (58,345) Changes in operating assets and liabilities: Accounts receivable.................................. (486,730) (429,086) Inventories.......................................... (431,484) (984,458) Prepaid expenses and other current assets............ (113,224) 75,704 Accounts payable..................................... 770,131 (34,086) Due to related parties............................... (127,247) -- Accrued expenses and other current liabilities....... 463,816 173,026 Accrued pension...................................... 11,001 42,284 ----------- ----------- Cash provided by (used in) operating activities... 35,935 (1,260,421) ----------- ----------- Cash flows from investing activities: Purchase of marketable securities......................... (782,097) (815,395) Purchase of property, plant and equipment................. (1,251,111) (1,190,187) Proceeds from the sale of marketable securities........... 115,940 913,242 ----------- ----------- Cash used in investing activities................. (1,917,268) (1,092,340) ----------- ----------- Cash flows from financing activities: Net increase in short-term borrowings..................... 495,289 923,215 Net increase (decrease) in long-term debt................. (76,476) 938,482 ----------- ----------- Cash provided by financing activities............. 418,813 1,861,697 ----------- ----------- Effect of exchange rate changes on cash..................... (25,154) (16,234) ----------- ----------- Net decrease in cash and cash equivalents................... (1,487,674) (507,298) Cash and cash equivalents at beginning of period............ 1,978,930 1,521,481 ----------- ----------- Cash and cash equivalents at end of period.................. $ 491,256 $ 1,014,183 =========== =========== Supplemental disclosure of cash flow information: Cash paid for: Interest............................................... $ 57,660 $ 102,523 =========== ===========
See accompanying notes to financial statements. F-148 255 QUANTUM OPTECH INCORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) BASIS OF PRESENTATION The accompanying unaudited interim consolidated financial statements have been prepared in applicable to interim financial information and do not include all the notes required by accounting principles generally accepted in the United States of America. In the opinion of management, the unaudited interim consolidated financial statements include all adjustment, consisting primarily of recurring accruals, considered necessary for a fair presentation of the financial position and the results of operations. (2) INVENTORIES Inventories at June 30, 2000 consisted of the following:
2000 ---------- Finished goods........................................... $ 722,051 Work in process.......................................... 1,485,391 Raw material............................................. 416,888 Merchandise.............................................. 23,422 ---------- 2,647,752 Less: provision for inventory obsolescence............... (130,848) ---------- $2,516,904 ==========
(3) SIGNIFICANT EVENT Quantum Optech Incorporation (the "Company"), shareholders of the Company and MRV communications, Inc. ("MRV") entered into a stock purchase agreement relating to the sale and purchase of up to 100% of the Company's shares and the sale and purchase of certain number of ordinary shares of MRV on April 26, 2000. The Company's special shareholders meeting dated May 24, 2000, approved the above agreement. In accordance with the agreement, MRV shall issue and sell to the Company's shareholders, and the shareholders of the Company shall purchase the MRV shares from MRV pro rata in accordance with their percentage shareholdings in the Company at and for an aggregate purchase price of US$36,000,000. The closing date of the transaction was July 12, 2000. F-149 256 LUMINENT, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION On April 24, 2000, MRV completed the acquisition of approximately 97% of the outstanding capital stock of Fiber Optic Communications, Inc., a Republic of China corporation, in exchange for approximately 4.7 million shares of MRV's common stock, options to purchase 300,000 shares of common stock and approximately $48.6 million in cash. On July 12, 2000, MRV acquired all of the outstanding capital stock of Quantum Optech Inc., a Republic of China corporation, in exchange for approximately 1.1 million shares of MRV's common stock and options to purchase common stock. On July 21, 2000, MRV acquired approximately 99.9% of the outstanding capital stock of Optronics International Corp., a Republic of China corporation, in exchange for approximately 4.2 million shares of MRV's common stock and options to purchase common stock. The outstanding capital stock of Fiber Optic Communications, Quantum and Optronics, purchased by MRV, has been contributed to Luminent as of the date of each acquisition as part of the Master Separation and Distribution Agreements. As such, Luminent's management has prepared the following unaudited pro forma condensed consolidated financial information to give effect to these acquisitions. The Unaudited Pro Forma Condensed Consolidated Statement of Operations for the year ended December 31, 2000 give effect to the Fiber Optic Communications, Quantum and Optronics acquisitions as if they had taken place on January 1, 2000. The pro forma adjustments, which are based upon available information and certain assumptions that the Company believes are reasonable in the circumstances, are applied to the historical financial statements of Luminent, Fiber Optic Communications, Quantum and Optronics. The acquisition of Fiber Optic Communications was accounted for using the purchase method. The acquisitions of Quantum and Optronics will be accounted for using the purchase method. Luminent's allocation of purchase price for each acquisition is based upon management's current estimates of the fair value of assets acquired and liabilities assumed in accordance with Accounting Principles Board No. 16. The accompanying unaudited pro forma condensed consolidated financial information should be read in conjunction with the historical financial statements and the notes thereto for Luminent, Fiber Optic Communications, Quantum and Optronics. The unaudited pro forma condensed consolidated financial information is provided for informational purposes only and does not purport to represent what Luminent's financial position or results of operations would actually have been had the these acquisitions occurred on such dates or to project Luminent's results of operation or financial position for any future period. F-150 257 LUMINENT, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2000
FIBER OPTIC PRO FORMA LUMINENT, INC. COMMUNICATIONS OPTRONICS QUANTUM ADJUSTMENTS TOTAL -------------- -------------- --------- ------- ----------- --------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales............... $124,193 $7,058 $3,207 $2,859 $ -- $ 137,317 Cost of sales........... 84,384 4,229 2,917 2,336 888(2) 94,754 -------- ------ ------ ------ -------- --------- Gross profit....... 39,809 2,829 290 523 (888) 42,563 -------- ------ ------ ------ -------- --------- Operating costs and expenses: Selling, general and administrative..... 38,768 1,520 497 262 3,606(2),(3) 44,653 Research and development........ 18,204 527 599 455 1,400(2) 21,185 Parent company allocation......... 588 -- -- -- -- 588 Amortization of goodwill and other intangibles........ 47,421 -- -- -- 30,323(1) 77,744 -------- ------ ------ ------ -------- --------- 104,981 2,047 1,096 717 35,329 144,170 -------- ------ ------ ------ -------- --------- Operating income (loss)........... (65,172) 782 (806) (194) (36,217) (101,607) -------- ------ ------ ------ -------- --------- Other income (expense), net................... 2,246 (286) 224 (176) -- 2,008 -------- ------ ------ ------ -------- --------- Income (loss) before provision for income taxes............ (62,926) 496 (582) (370) (36,217) (99,599) -------- ------ ------ ------ -------- --------- Provision (credit) for income taxes.......... 2,766 -- -- -- -- 2,766 Minority interest....... (707) (31) -- -- -- (738) -------- ------ ------ ------ -------- --------- Net income (loss)........... $(64,985) $ 527 $ (582) $ (370) $(36,217) $(101,627) ======== ====== ====== ====== ======== ========= Basic and diluted net loss per share........ $ (0.45) $ (0.70) ======== ========= Basic and diluted weighted average shares................ 145,677 --(4) 145,677 ======== ======== =========
See notes to unaudited pro forma condensed consolidated financial information. F-151 258 LUMINENT, INC. NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION The following adjustments were applied to Luminent's historical financial statements and those of Fiber Optic Communications, Optronics and Quantum to arrive at the pro forma financial information: (1) The pro forma adjustment is to record the amortization of goodwill and other intangible assets related to the acquisitions of Fiber Optic Communications, Optronics and Quantum as if the transactions occurred on January 1, 2000. Goodwill recorded in relation to these acquisitions was approximately $389.0 million and is being amortized on a straight-line basis over 5 years or approximately $77.7 million on a pro forma basis for the year ended December 31, 2000. (2) The pro forma adjustment is to record deferred stock compensation related to the acquisitions of Fiber Optic Communications, Optronics and Quantum as if the transactions occurred on January 1, 2000. Deferred stock compensation recorded in relation to theses acquisitions was approximately $30.2 million and is being amortized using the graded method over 4 years or approximately $17.3 million on a pro forma basis for the year ended December 31, 2000. (3) The pro forma adjustment is to record additional depreciation expense on the step-up of net assets related to the acquisitions of Fiber Optic Communications, Optronics, and Quantum as if the transactions occurred on January 1, 2000. Additional depreciation expense recorded in relation to theses acquisitions is being amortized over 5 years or approximately $1.1 million on a pro forma basis for the year ended December 31, 2000. (4) Weighted average shares used to calculate pro forma basic and diluted net loss per share for the year presented is computed using the weighted average number of common stock outstanding for the year presented. In connection with the "push down" of the assets and liabilities of Fiber Optic Communications, Optronics and Quantum, no additional shares were exchanged with MRV. Therefore, no dilutive effect has been provided for these acquisitions. F-152 259 MRV COMMUNICATIONS, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION On April 24, 2000, MRV Communications, Inc. (MRV) completed the acquisition of approximately 97% of the outstanding capital stock of Fiber Optic Communications, Inc. (FOCI), a Republic of China corporation, in exchange for approximately 4.7 million shares of MRV's common stock, options to purchase 300,000 shares of common stock and approximately $48.6 million in cash. On July 21, 2000, MRV acquired approximately 99.9% of the outstanding capital stock of Optronics International Corp. (OIC), a Republic of China corporation, in exchange for approximately 4.0 million shares of MRV's common stock and options to purchase common stock. On July 12, 2000, MRV acquired all of the outstanding capital stock of AstroTerra, a California corporation, in exchange for approximately 2.4 million shares of MRV's common stock and options to purchase common stock. On September 13, 2000, MRV announced its intention to purchase the minority interest of Luminent, Inc. Luminent stockholders will receive 0.43 shares of MRV common stock for each share of Luminent common stock. MRV will exchange approximately 5.2 million shares of common stock to purchase approximately 7.7% of the outstanding common stock of Luminent. The issuance price of the common stock is estimated to be approximately $2.91 per share, for an estimated purchase price of $15.0 million. MRV's management has prepared the following unaudited pro forma condensed consolidated financial information to give effect to these acquisitions and purchase. The Unaudited Pro Forma Condensed Consolidated Balance Sheet as of June 30, 2001 gives effect to the purchase, by MRV, of the minority interest of Luminent as if it had taken place on such date. The Unaudited Pro Forma Condensed Consolidated Statement of Operations for the six months ended June 30, 2001 gives effect to the purchase, by MRV, of the minority interest in Luminent as if it had taken place on January 1, 2000. The Unaudited Pro Forma Condensed Consolidated Statement of Operations for the year ended December 31, 2000 gives effect to the FOCI, OIC and AstroTerra acquisitions and the purchase, by MRV, of the minority interest in Luminent as if they had taken place on January 1, 2000. The pro forma adjustments, which are based upon available information and certain assumptions that the Company believes are reasonable in the circumstances, are applied to the historical financial statements of MRV, Luminent, FOCI, OIC and AstroTerra. The acquisitions of FOCI, OIC and AstroTerra were accounted for using the purchase method. The purchase of the minority interest in Luminent was accounted for using the purchase method. MRV's allocation of purchase price for each acquisition and the merger of Luminent is based upon management's current estimates of the fair value of assets acquired and liabilities assumed in accordance with Accounting Principles Board No. 16. The accompanying unaudited pro forma condensed consolidated financial information should be read in conjunction with the historical financial statements and the notes thereto for MRV, Luminent, FOCI, OIC and Astroterra. The unaudited pro forma condensed consolidated financial information is provided for informational purposes only and does not purport to represent what MRV's financial position or results of operations would actually have been had the these acquisitions occurred on such dates or to project MRV's results of operation or financial position for any future period. F-153 260 MRV COMMUNICATIONS, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 2001
PRO FORMA MRV ADJUSTMENTS TOTAL ---------- -------------- ---------- (IN THOUSANDS) ASSETS Current Assets: Cash and cash equivalents.......................... $ 174,887 -- $ 174,887 Short-term investments............................. 55,704 -- 55,704 Accounts receivable................................ 59,731 -- 59,731 Inventories........................................ 72,123 -- 72,123 Deferred income taxes.............................. 34,307 -- 34,307 Other current assets............................... 26,812 -- 26,812 ---------- -------- ---------- Total current assets............................ 423,564 -- 423,564 Property and Equipment, net.......................... 75,291 -- 75,291 Other Assets: Goodwill and other intangibles..................... 475,496 (27,774)(5) 447,722 Deferred income taxes.............................. 7,797 -- 7,797 Investments........................................ 28,164 -- 28,164 Other non-current assets........................... 12,835 -- 12,835 ---------- -------- ---------- $1,023,147 $(27,774)(5) $ 995,373 ========== ======== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current maturities of capital lease obligations and long-term debt.................................. 2,642 -- 2,642 Accounts payable................................... 68,644 -- 68,644 Accrued liabilities................................ 31,867 -- 31,867 Short-term debt.................................... 12,976 -- 12,976 Deferred revenue................................... 1,663 -- 1,663 ---------- -------- ---------- Total current liabilities....................... 117,792 -- 117,792 Long-Term Liabilities: Convertible debentures............................. 89,646 -- 89,646 Capital lease obligations, net of current portion......................................... 566 -- 566 Long-term debt..................................... 60,399 -- 60,399 Other long-term liabilities........................ 4,571 -- 4,571 Minority Interest.................................... 39,868 (35,292)(5) 4,576 Stockholders' Equity Preferred stock.................................... -- -- -- Common stock....................................... 132 -- 132 Additional paid-in capital......................... 1,097,915 15,005(5) 1,112,920 Accumulated deficit................................ (319,761) (7,487)(5) (327,248) Deferred stock compensation, net................... (60,041) -- (60,041) Treasury stock..................................... (133) -- (133) ---------- -------- ---------- Accumulated other comprehensive loss............... (7,807) -- (7,807) ---------- -------- ---------- Total stockholders' equity...................... 710,305 7,518 717,823 $1,023,147 $(27,774) $ 995,373 ========== ======== ==========
F-154 261 MRV COMMUNICATIONS, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2001
PRO FORMA MRV ADJUSTMENTS TOTAL -------- ----------- -------- Net sales................................................. 189,634 -- 189,634 Cost of sales............................................. 155,156 -- 155,156 -------- ------ -------- Gross profit......................................... 34,478 -- 34,478 -------- ------ -------- Operating Costs and Expenses: Selling, general and administrative expenses............ 82,123 -- 82,123 Research and development................................ 50,787 -- 50,787 Amortization of goodwill and other intangibles.......... 57,167 (2,777)(6) 54,390 -------- ------ -------- 190,077 (2,777) 187,300 -------- ------ -------- Operating (loss)..................................... (155,599) 2,777 (152,822) -------- ------ -------- Other income (expense), net............................... (2,893) -- (2,893) -------- ------ -------- Loss before provision for income taxes.................... (158,492) 2,777 (155,715) -------- ------ -------- Provision (credit) for income taxes....................... (3,622) -- (3,622) Minority interest......................................... (6,439) 6,789(4) 350 -------- ------ -------- Net (loss)........................................... (148,431) (4,012) (152,443) ======== ====== ======== Basic and diluted net loss per share...................... (1.97) -- (1.90) ======== ======== Basic and diluted weighted average shares................. 75,245 5,160(7) 80,405 ======== ====== ========
F-155 262 MRV COMMUNICATIONS, INC. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2000
FIBER OPTIC COMMUNICATIONS OPTRONICS ASTROTERRA THROUGH THROUGH THROUGH PRO FORMA MRV APRIL 24, 2000 JULY 21, 2000 JULY 12, 2000 ADJUSTMENTS TOTAL -------- -------------- ------------- ------------- ----------- -------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales................... 319,394 7,058 3,207 2,552 -- 332,211 Cost of sales............... 203,371 4,229 2,917 2,394 3,292(2) 216,203 -------- ----- ----- ------ ------- -------- Gross profit............ 116,023 2,829 290 158 (3,292) 116,008 -------- ----- ----- ------ ------- -------- Operating Costs and Expenses: Selling, general and administrative expenses................ 124,700 1,520 497 1,971 5,605(2),(3) 134,293 Research and development............. 74,078 527 599 969 6,439(2) 82,612 Amortization of goodwill and other intangibles... 66,814 -- -- -- 32,208(1)(6) 99,022 -------- ----- ----- ------ ------- -------- 265,592 2,047 1,096 2,940 44,252 315,927 -------- ----- ----- ------ ------- -------- Operating (loss)............ (149,569) 782 (806) (2,782) (47,544) (199,919) -------- ----- ----- ------ ------- -------- Other income (expense), net....................... (9,578) (286) 224 6 -- (9,634) -------- ----- ----- ------ ------- -------- Income (loss) before provision for income taxes and minority interest..... (159,147) 496 (582) (2,776) (47,544) (209,553) -------- ----- ----- ------ ------- -------- Provision (credit) for income taxes.............. (5,398) -- (5,398) Minority interest........... (796) (31) -- -- 698(4) (129) -------- ----- ----- ------ ------- -------- Net income (loss)........... (152,953) 527 (582) (2,776) (48,242) (204,026) ======== ===== ===== ====== ======= ======== Basic and diluted net loss per share................. (2.33) (2.72) ======== ======== Basic and diluted weighted average shares............ 65,669 9,338(7) 75,007 ======== ======= ========
F-156 263 MRV COMMUNICATIONS, INC. NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL INFORMATION (1) The pro forma adjustment is to record the amortization of goodwill and other intangibles related to the acquisitions of Fiber Optic Communications, Optronics, and AstroTerra as if the transactions occurred on January 1, 2000. Goodwill and other intangibles recorded in relation to these acquisitions was approximately $469.2 million and is being amortized on a straight-line basis over 1 to 7 years or approximately $92.3 million for the year ended December 31, 2000. (2) The pro forma adjustment is to record deferred stock compensation related to the acquisitions of Fiber Optic Communications, Optronics, and AstroTerra as if the transactions occurred on January 1, 2000. Deferred stock compensation recorded in relation to these acquisitions was approximately $77.5 million and is being amortized using the graded method over 4 years or approximately $45.2 million for the year ended December 31, 2000. (3) The pro forma adjustment is to record additional depreciation expense on the step-up of net assets related to the acquisitions of Fiber Optic Communications and Optronics as if the transactions occurred on January 1, 2000. Additional depreciation expense recorded in relation to these acquisitions is being amortized over 5 years or approximately $900,000 for the year ended December 31, 2000. (4) The pro forma adjustment is to eliminate the minority interest in the net loss of Luminent for the six months ended June 30, 2001 and the year ended December 31, 2000 as if the merger with Luminent occurred on January 1, 2000. (5) The pro forma adjustment is to record the purchase, by MRV, of the minority interest in Luminent as if the merger occurred on June 30, 2001. Based on an exchange ratio of 0.43 MRV shares of stock to each share of Luminent stock, MRV exchanged approximately 5.2 million shares of common stock to purchase approximately 7.7% of the outstanding common stock of Luminent. The issuance price of the common stock was approximately $2.91 per share, for a total purchase price of $15.0 million. Additionally, MRV recorded a reduction of goodwill and other intangibles based on the excess fair market value over cost of $27.8 million as of June 30, 2001. (6) The pro forma adjustment is to record a reduction in the amortization of goodwill and other intangibles as if the reduction of goodwill and other intangibles of $27.8 million based on the excess fair market value over cost recorded in relation to the merger of Luminent occurred on January 1, 2000 for the six months ended June 30, 2001 and the year ended December 31, 2000. The reduction of amortization expense was $2.8 million and $5.6 million for the periods ended June 30, 2001 and the year ended December 31, 2000, respectively. (7) Weighted average shares used to calculate pro forma basic and diluted net loss per share for the year presented is computed using the weighted average number of common stock outstanding for the period presented and the shares issued in connection with the acquisitions of Fiber Optic Communications, Optronics, and AstroTerra and the shares to be issued to effect the merger of Luminent. The pro forma shares included in the basic and diluted net loss per share for the six months ended June 30, 2001 only include the effect of the proposed merger of Luminent had it occurred on January 1, 2000. The pro forma shares included in the basic and diluted net loss per share for the year ended December 31, 2000, include the effect of these transactions had they occurred on January 1, 2000. F-157 264 ANNEX A SECTION 262 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE SEC. 262. Appraisal rights. (a) Any stockholder of a corporation of this State who holds shares of stock on the date of the making of a demand pursuant to subsection (d) of this section with respect to such shares, who continuously holds such shares through the effective date of the merger or consolidation, who has otherwise complied with subsection (d) of this section and who has neither voted in favor of the merger or consolidation nor consented thereto in writing pursuant to sec. 228 of this title shall be entitled to an appraisal by the Court of Chancery of the fair value of the stockholder's shares of stock under the circumstances described in subsections (b) and (c) of this section. As used in this section, the word "stockholder" means a holder of record of stock in a stock corporation and also a member of record of a nonstock corporation; the words "stock" and "share" mean and include what is ordinarily meant by those words and also membership or membership interest of a member of a nonstock corporation; and the words "depository receipt" mean a receipt or other instrument issued by a depository representing an interest in one or more shares, or fractions thereof, solely of stock of a corporation, which stock is deposited with the depository. (b) Appraisal rights shall be available for the shares of any class or series of stock of a constituent corporation in a merger or consolidation to be effected pursuant to sec. 251 (other than a merger effected pursuant to sec. 251(g) of this title), sec. 252, sec. 254, sec. 257, sec. 258, sec. 263 or sec. 264 of this title: (1) Provided, however, that no appraisal rights under this section shall be available for the shares of any class or series of stock, which stock, or depository receipts in respect thereof, at the record date fixed to determine the stockholders entitled to receive notice of and to vote at the meeting of stockholders to act upon the agreement of merger or consolidation, were either (i) listed on a national securities exchange or designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc. or (ii) held of record by more than 2,000 holders; and further provided that no appraisal rights shall be available for any shares of stock of the constituent corporation surviving a merger if the merger did not require for its approval the vote of the stockholders of the surviving corporation as provided in subsection (f) of sec. 251 of this title. (2) Notwithstanding paragraph (1) of this subsection, appraisal rights under this section shall be available for the shares of any class or series of stock of a constituent corporation if the holders thereof are required by the terms of an agreement of merger or consolidation pursuant to sec.sec. 251, 252, 254, 257, 258, 263 and 264 of this title to accept for such stock anything except: a. Shares of stock of the corporation surviving or resulting from such merger or consolidation, or depository receipts in respect thereof; b. Shares of stock of any other corporation, or depository receipts in respect thereof, which shares of stock (or depository receipts in respect thereof) or depository receipts at the effective date of the merger or consolidation will be either listed on a national securities exchange or designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc. or held of record by more than 2,000 holders; c. Cash in lieu of fractional shares or fractional depository receipts described in the foregoing subparagraphs a. and b. of this paragraph; or d. Any combination of the shares of stock, depository receipts and cash in lieu of fractional shares or fractional depository receipts described in the foregoing subparagraphs a., b. and c. of this paragraph. A-1 265 (3) In the event all of the stock of a subsidiary Delaware corporation party to a merger effected under sec. 253 of this title is not owned by the parent corporation immediately prior to the merger, appraisal rights shall be available for the shares of the subsidiary Delaware corporation. (c) Any corporation may provide in its certificate of incorporation that appraisal rights under this section shall be available for the shares of any class or series of its stock as a result of an amendment to its certificate of incorporation, any merger or consolidation in which the corporation is a constituent corporation or the sale of all or substantially all of the assets of the corporation. If the certificate of incorporation contains such a provision, the procedures of this section, including those set forth in subsections (d) and (e) of this section, shall apply as nearly as is practicable. (d) Appraisal rights shall be perfected as follows: (1) If a proposed merger or consolidation for which appraisal rights are provided under this section is to be submitted for approval at a meeting of stockholders, the corporation, not less than 20 days prior to the meeting, shall notify each of its stockholders who was such on the record date for such meeting with respect to shares for which appraisal rights are available pursuant to subsection (b) or (c) hereof that appraisal rights are available for any or all of the shares of the constituent corporations, and shall include in such notice a copy of this section. Each stockholder electing to demand the appraisal of such stockholder's shares shall deliver to the corporation, before the taking of the vote on the merger or consolidation, a written demand for appraisal of such stockholder's shares. Such demand will be sufficient if it reasonably informs the corporation of the identity of the stockholder and that the stockholder intends thereby to demand the appraisal of such stockholder's shares. A proxy or vote against the merger or consolidation shall not constitute such a demand. A stockholder electing to take such action must do so by a separate written demand as herein provided. Within 10 days after the effective date of such merger or consolidation, the surviving or resulting corporation shall notify each stockholder of each constituent corporation who has complied with this subsection and has not voted in favor of or consented to the merger or consolidation of the date that the merger or consolidation has become effective; or (2) If the merger or consolidation was approved pursuant to sec. 228 or sec. 253 of this title, each constituent corporation, either before the effective date of the merger or consolidation or within ten days thereafter, shall notify each of the holders of any class or series of stock of such constituent corporation who are entitled to appraisal rights of the approval of the merger or consolidation and that appraisal rights are available for any or all shares of such class or series of stock of such constituent corporation, and shall include in such notice a copy of this section; provided that, if the notice is given on or after the effective date of the merger or consolidation, such notice shall be given by the surviving or resulting corporation to all such holders of any class or series of stock of a constituent corporation that are entitled to appraisal rights. Such notice may, and, if given on or after the effective date of the merger or consolidation, shall, also notify such stockholders of the effective date of the merger or consolidation. Any stockholder entitled to appraisal rights may, within 20 days after the date of mailing of such notice, demand in writing from the surviving or resulting corporation the appraisal of such holder's shares. Such demand will be sufficient if it reasonably informs the corporation of the identity of the stockholder and that the stockholder intends thereby to demand the appraisal of such holder's shares. If such notice did not notify stockholders of the effective date of the merger or consolidation, either (i) each such constituent corporation shall send a second notice before the effective date of the merger or consolidation notifying each of the holders of any class or series of stock of such constituent corporation that are entitled to appraisal rights of the effective date of the merger or consolidation or (ii) the surviving or resulting corporation shall send such a second notice to all such holders on or within 10 days after such effective date; provided, however, that if such second notice is sent more than 20 days following the sending of the first notice, such second notice need only be sent to each stockholder who is entitled to appraisal rights and who has demanded appraisal of such holder's shares in accordance with this subsection. An affidavit of the secretary or assistant secretary or of the transfer agent of the corporation that is required to give either notice that such notice has been given shall, in the absence of fraud, be prima facie evidence of the facts stated A-2 266 therein. For purposes of determining the stockholders entitled to receive either notice, each constituent corporation may fix, in advance, a record date that shall be not more than 10 days prior to the date the notice is given, provided, that if the notice is given on or after the effective date of the merger or consolidation, the record date shall be such effective date. If no record date is fixed and the notice is given prior to the effective date, the record date shall be the close of business on the day next preceding the day on which the notice is given. (e) Within 120 days after the effective date of the merger or consolidation, the surviving or resulting corporation or any stockholder who has complied with subsections (a) and (d) hereof and who is otherwise entitled to appraisal rights, may file a petition in the Court of Chancery demanding a determination of the value of the stock of all such stockholders. Notwithstanding the foregoing, at any time within 60 days after the effective date of the merger or consolidation, any stockholder shall have the right to withdraw such stockholder's demand for appraisal and to accept the terms offered upon the merger or consolidation. Within 120 days after the effective date of the merger or consolidation, any stockholder who has complied with the requirements of subsections (a) and (d) hereof, upon written request, shall be entitled to receive from the corporation surviving the merger or resulting from the consolidation a statement setting forth the aggregate number of shares not voted in favor of the merger or consolidation and with respect to which demands for appraisal have been received and the aggregate number of holders of such shares. Such written statement shall be mailed to the stockholder within 10 days after such stockholder's written request for such a statement is received by the surviving or resulting corporation or within 10 days after expiration of the period for delivery of demands for appraisal under subsection (d) hereof, whichever is later. (f) Upon the filing of any such petition by a stockholder, service of a copy thereof shall be made upon the surviving or resulting corporation, which shall within 20 days after such service file in the office of the Register in Chancery in which the petition was filed a duly verified list containing the names and addresses of all stockholders who have demanded payment for their shares and with whom agreements as to the value of their shares have not been reached by the surviving or resulting corporation. If the petition shall be filed by the surviving or resulting corporation, the petition shall be accompanied by such a duly verified list. The Register in Chancery, if so ordered by the Court, shall give notice of the time and place fixed for the hearing of such petition by registered or certified mail to the surviving or resulting corporation and to the stockholders shown on the list at the addresses therein stated. Such notice shall also be given by 1 or more publications at least 1 week before the day of the hearing, in a newspaper of general circulation published in the City of Wilmington, Delaware or such publication as the Court deems advisable. The forms of the notices by mail and by publication shall be approved by the Court, and the costs thereof shall be borne by the surviving or resulting corporation. (g) At the hearing on such petition, the Court shall determine the stockholders who have complied with this section and who have become entitled to appraisal rights. The Court may require the stockholders who have demanded an appraisal for their shares and who hold stock represented by certificates to submit their certificates of stock to the Register in Chancery for notation thereon of the pendency of the appraisal proceedings; and if any stockholder fails to comply with such direction, the Court may dismiss the proceedings as to such stockholder. (h) After determining the stockholders entitled to an appraisal, the Court shall appraise the shares, determining their fair value exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, together with a fair rate of interest, if any, to be paid upon the amount determined to be the fair value. In determining such fair value, the Court shall take into account all relevant factors. In determining the fair rate of interest, the Court may consider all relevant factors, including the rate of interest which the surviving or resulting corporation would have had to pay to borrow money during the pendency of the proceeding. Upon application by the surviving or resulting corporation or by any stockholder entitled to participate in the appraisal proceeding, the Court may, in its discretion, permit discovery or other pretrial proceedings and may proceed to trial upon the appraisal prior to the final determination of the stockholder entitled to an appraisal. Any stockholder whose name appears on the list filed by the surviving or resulting corporation pursuant to subsection (f) of this section and who has A-3 267 submitted such stockholder's certificates of stock to the Register in Chancery, if such is required, may participate fully in all proceedings until it is finally determined that such stockholder is not entitled to appraisal rights under this section. (i) The Court shall direct the payment of the fair value of the shares, together with interest, if any, by the surviving or resulting corporation to the stockholders entitled thereto. Interest may be simple or compound, as the Court may direct. Payment shall be so made to each such stockholder, in the case of holders of uncertificated stock forthwith, and the case of holders of shares represented by certificates upon the surrender to the corporation of the certificates representing such stock. The Court's decree may be enforced as other decrees in the Court of Chancery may be enforced, whether such surviving or resulting corporation be a corporation of this State or of any state. (j) The costs of the proceeding may be determined by the Court and taxed upon the parties as the Court deems equitable in the circumstances. Upon application of a stockholder, the Court may order all or a portion of the expenses incurred by any stockholder in connection with the appraisal proceeding, including, without limitation, reasonable attorney's fees and the fees and expenses of experts, to be charged pro rata against the value of all the shares entitled to an appraisal. (k) From and after the effective date of the merger or consolidation, no stockholder who has demanded appraisal rights as provided in subsection (d) of this section shall be entitled to vote such stock for any purpose or to receive payment of dividends or other distributions on the stock (except dividends or other distributions payable to stockholders of record at a date which is prior to the effective date of the merger or consolidation); provided, however, that if no petition for an appraisal shall be filed within the time provided in subsection (e) of this section, or if such stockholder shall deliver to the surviving or resulting corporation a written withdrawal of such stockholder's demand for an appraisal and an acceptance of the merger or consolidation, either within 60 days after the effective date of the merger or consolidation as provided in subsection (e) of this section or thereafter with the written approval of the corporation, then the right of such stockholder to an appraisal shall cease. Notwithstanding the foregoing, no appraisal proceeding in the Court of Chancery shall be dismissed as to any stockholder without the approval of the Court, and such approval may be conditioned upon such terms as the Court deems just. (l) The shares of the surviving or resulting corporation to which the shares of such objecting stockholders would have been converted had they assented to the merger or consolidation shall have the status of authorized and unissued shares of the surviving or resulting corporation. A-4 268 ANNEX B [DUFF & PHELPS ADDRESS] [DUFF & PHELPS LOGO] October 4, 2001 Board of Directors Luminent, Inc. 20550 Nordhoff Street Chatsworth, CA 91311 To The Board of Directors of Luminent, Inc.: Duff & Phelps, LLC ("Duff & Phelps") has been engaged by the Board of Directors of Luminent, Inc. ("Luminent" or the "Company"), as its independent financial advisor, in connection with a short-form merger (the "Merger") of Luminent with and into MRV Merger Sub Corp., a wholly-owned subsidiary of MRV Communications, Inc. and Subsidiaries ("MRV"). MRV is a publicly traded company which owns approximately 92.3% of Luminent's outstanding common stock. MRV intends to issue new shares of common stock to the Luminent minority stockholders in the Merger. Specifically, Duff & Phelps has been engaged to render an opinion (the "Opinion") to the Board of Directors of Luminent as to whether a merger exchange ratio of .43 shares of MRV common stock for each share of Luminent stock not held by MRV (the "Merger Exchange Ratio") is fair to the minority common stockholders of Luminent from a financial point of view. Previously, Duff & Phelps has not provided financial advisory services to Luminent or MRV. In connection with this Opinion, we have made such reviews, analyses and inquiries as we have deemed necessary and appropriate under the circumstances. Among other things, we have: 1. Met with certain members of senior management of Luminent to discuss the history, financial condition, future prospects and projected performance of the Company and toured their facilities in Chatsworth, California; 2. Met with certain members of senior management of MRV to discuss the history, financial condition, future prospects and projected performance of MRV and its divisions and subsidiaries and toured the MRV's facilities in Chatsworth, California; 3. Met with certain members of senior management of MRV's divisions, Nbase-Xyplex, Inc. and Optical Access, Inc., at MRV's headquarters, to discuss the history, financial condition, future prospects and projected performance of these divisions; 4. Met with certain members of senior management of Broadband Highway, Inc. to discuss the history, financial condition, future prospects and projected performance of Broadband Highway, Inc. and toured their facilities in Woodland Hills, California; 5. Met with certain members of senior management of Zuma Networks, Inc. to discuss the history, financial condition, future prospects and projected performance of Zuma Networks, Inc. and toured their facilities in West Hills, California; 6. Met with representatives from Arthur Andersen LLP, auditor for both Luminent and MRV, to discuss the historical financial statements and consolidating statements for both Luminent and MRV; Corporate Advisors Since 1932 B-1 269 7. Reviewed Luminent's financial statements and SEC filings, including the annual report on Form 10-K for the year ended December 31, 2000, and quarterly report on Form 10-Q the six-month period ended June 30, 2001; 8. Reviewed MRV's financial statements and SEC filings, including the annual report on Form 10-K for the year ended December 31, 2000, and quarterly report on Form 10-Q for the six-month period ended June 30, 2001; 9. Reviewed MRV's internally generated consolidating financial statements for the fiscal year ended December 31, 2000, and six-month period ended June 30, 2001; 10. Reviewed revenue estimates for third quarter 2001 provided by Luminent and MRV management; 11. Reviewed the historical trading price and trading volume of Luminent and MRV common stock; 12. Reviewed certain articles and press releases regarding Luminent and MRV; 13. Reviewed other operating and financial information provided by management of Luminent and MRV; and 14. Reviewed economic and industry information and conducted such studies, analyses and investigations as we deemed appropriate. Our Opinion is based upon an analysis of the foregoing in light of our assessment of the general, economic and financial market conditions, as they can be evaluated by us, as of the date hereof. Events occurring after the date hereof could materially affect the assumptions used in preparing our Opinion. In connection with our Opinion, with your permission and without any independent verification, we have assumed that all information reviewed by us with respect to the Company, MRV or the Merger, whether supplied by Luminent, MRV or its advisors, or obtained by us from publicly available sources, is true, correct and complete in all material respects and does not contain any untrue statements of material fact or omit to state a material fact necessary to make the information supplied to us not misleading. Any inaccuracies in or omissions from the information on which we relied could materially affect our Opinion. CONCLUSIONS Based on our analysis and relying upon the accuracy and completeness of all information provided to us, it is our opinion that as of this date, a Merger Exchange Ratio of .43 shares of MRV common stock for each share of Luminent common stock not held by MRV is fair to Luminent's minority common stockholders from a financial point of view. Respectfully submitted, /s/ Duff & Phelps, LLC Duff & Phelps, LLC B-2 270 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth the costs and expenses payable by the Registrant in connection with the sale of the Common Stock being registered hereby, all of which are estimated except for the SEC filing fees.
ITEM AMOUNT ---- -------- SEC registration fee........................................ $132,000 Printing expenses........................................... 100,000 Legal fees and expenses..................................... 100,000 Accounting fees and expenses................................ 100,000 Miscellaneous expenses...................................... 18,000 -------- Total..................................................... $450,000 ========
ITEM 16. EXHIBITS 4.1 Form of Common Stock certificate (incorporated by reference to Exhibit 4.5 of the Registrant's Registration Statement of Form S-3 (file no. 333-64017).(1) 5.1 Opinion of Kirkpatrick & Lockhart LLP as to the validity of the securities being registered(1) 5.2 Opinion of Kirkpatrick & Lockhart LLP as to the validity of the securities being issued in the merger(2) 23.1 Consent of Arthur Andersen LLP.(1) 23.2 Consent of Kirkpatrick & Lockhart LLP (contained in Exhibit 5.2). 23.3 Consent of Arthur Andersen LLP to use of MRV financial statements(3) 23.4 Consent of Arthur Andersen LLP to use of Luminent financial statements(3) 23.5 Consent of Arthur Andersen LLP to use of AstraTerrra financial statements(3) 23.6 Consent of T N Soong & Co.(3) 23.7 Consent of KPMG Certified Public Accountants(3) 23.8 Consent of Duff & Phelps, LLC(3) 24.1 Power of Attorney(1).
------------------------- (1) Previously filed. (2) To be filed by amendment (3) Filed herewith. II-1 271 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Post-Effective Amendment to Registration Statement on Form S-4 to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Chatsworth, State of California, on the 5th day of October, 2001. MRV COMMUNICATIONS, INC. By: /s/ NOAM LOTAN ------------------------------------ Noam Lotan, President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this Post-Effective Amendment to Registration Statement on Form S-4 has been signed by the following persons in the capacities and on the dates indicated.
NAMES TITLE DATE ----- ----- ---- /s/ NOAM LOTAN President, Chief Executive October 5, 2001 ----------------------------------------------------- Officer (Principal Executive Noam Lotan Officer), and a Director /s/ SHLOMO MARGALIT Chairman of the Board, Chief October 5, 2001 ----------------------------------------------------- Technical Officer, Secretary, Shlomo Margalit and a Director /s/ SHAY GONEN Interim Chief Financial Officer October 5, 2001 ----------------------------------------------------- (Principal Financial and Shay Gonen Accounting Officer) /s/ IGAL SHIDLOVSKY* Director October 5, 2001 ----------------------------------------------------- Igal Shidlovsky /s/ GUENTER JAENSCH* Director October 5, 2001 ----------------------------------------------------- Guenter Jaensch /s/ DANIEL TSUI* Director October 5, 2001 ----------------------------------------------------- Daniel Tsui /s/ BARUCH FISCHER* Director October 5, 2001 ----------------------------------------------------- Baruch Fischer *By: /s/ NOAM LOTAN Attorney-In-Fact ------------------------------------------------ Noam Lotan
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