10-Q 1 e10-q.txt FORM 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT. FOR THE TRANSITION PERIOD FROM _______________ TO ______________ COMMISSION FILE NUMBER 0-25678 MRV COMMUNICATIONS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 06-1340090 (STATE OF OTHER JURISDICTION (IRS EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 8943 FULLBRIGHT AVE., CHATSWORTH, CA 91311 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 773-9044 Check whether the issuer: (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of June 30, 2000, there were 64,306,180 shares of Common Stock, $.0017 par value per share, outstanding. 2 MRV COMMUNICATIONS, INC. Form 10-Q March 31, 2000 INDEX
PAGE NUMBER ----------- PART I FINANCIAL INFORMATION Item 1: Financial Statements: Condensed Consolidated Balance Sheets as of June 30, 2000 (unaudited) and December 31, 1999 (audited) 3 Condensed Consolidated Statements of Operations (unaudited) for the Six and Three Months ended June 30, 2000 and 1999 4 Condensed Consolidated Statements of Cash Flows (unaudited) for the Six and Three Months ended June 30, 2000 and 1999 5 Notes to Condensed Consolidated Financial Statements (unaudited) 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II OTHER INFORMATION 22 Item 2. Changes in Securities and Use of Proceeds 22 Item 6. Exhibits and Reports on Form 8-K. 23 SIGNATURE 25
As used in this Report, "MRV" or the "Company" refers to MRV Communications, Inc. and its consolidated subsidiaries. 2 3 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
------------------------------------------------------------------------------------------------------------------ June 30, December 31, 2000 1999 (unaudited) (audited) ------------------------------------------------------------------------------------------------------------------ ASSETS CURRENT ASSETS: Cash & cash equivalents $ 45,207 $ 34,330 Short-term investments 3,427 10,141 Accounts receivable 63,555 60,637 Inventories (Including contract in progress of $1,682 in 2000) 49,616 35,392 Refundable income taxes -- 3,216 Deferred income taxes 7,663 6,907 Other current assets 5,872 6,336 ------------------------------------------------------------------------------------------------------------------ Total current assets 175,340 156,959 PROPERTY AND EQUIPMENT - At cost, net of depreciation and amortization 48,497 19,600 OTHER ASSETS: Goodwill & intangibles 321,764 27,214 U.S. treasury notes 95,014 97,704 Investments in partner companies 29,969 4,232 Deferred income taxes 6,827 5,324 Loan financing costs and other 6,655 3,500 ------------------------------------------------------------------------------------------------------------------ $ 684,066 $ 314,533 ------------------------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of financing lease obligations $ 1,097 $ 198 Accounts payable 33,485 33,455 Accrued liabilities 21,744 15,403 Short term debt 78,801 - Deferred revenue 1,293 1,478 Income taxes payable 714 - ------------------------------------------------------------------------------------------------------------------ Total current liabilities 137,134 50,534 LONG-TERM LIABILITIES: Convertible debentures 90,000 90,000 Capital lease obligations, net of current portion 1,589 1,481 Deferred income taxes 1,213 281 Other long-term liabilities 10,152 2,647 ------------------------------------------------------------------------------------------------------------------ Total long term liabilities 102,954 94,409 MINORITY INTERESTS 2,599 2,775 STOCKHOLDERS' EQUITY: Preferred stock, $0.01 par value: 1,000 shares authorized, no shares outstanding Common stock, $0.0017 par value: 160,000 shares authorized, 64,306 shares outstanding in 2000 and 56,234 shares outstanding in 1999 128 124 Additional paid-in capital 542,867 191,440 Treasury Stock (133) (133) Deferred compensation (40,795) - Retained earnings (deficit) (51,991) (18,377) Cumulative translation adjustments (8,697) (6,239) ------------------------------------------------------------------------------------------------------------------ Total stockholders' equity 441,379 166,815 ------------------------------------------------------------------------------------------------------------------ $ 684,066 $ 314,533 ------------------------------------------------------------------------------------------------------------------
See accompanying notes 3 4 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
Six Months Ended, Three Months Ended --------------------------------------------------------------------------------------------------------------------- June 30, June 30, June 30, June 30, 2000 1999 2000 1999 (Unaudited) (Unaudited) (Unaudited) (Unaudited) --------------------------------------------------------------------------------------------------------------------- REVENUES, net $ 139,007 $ 143,367 $ 73,935 $ 73,251 --------------------------------------------------------------------------------------------------------------------- COSTS AND EXPENSES: Cost of goods sold 88,529 93,961 45,793 47,595 Research and development expenses 13,367 12,098 7,307 5,969 Research and development expenses of consolidated development stage enterprises 13,282 4,939 7,451 2,603 Selling, general and administrative expenses 41,481 29,804 26,467 14,750 Amortization of goodwill and intangibles from acquisitions 13,069 1,933 12,055 1,142 --------------------------------------------------------------------------------------------------------------------- Operating (loss) income (30,721) 632 (25,138) 1,192 Interest expense (2,803) (2,250) (1,678) (1,125) Other income, net (1) 1,125 2,660 488 1,257 Provision for income taxes 883 1,409 1,377 782 Minority interests (332) (17) (45) (17) --------------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) $ (33,614) $ (384) $ (27,750) $ 525 --------------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) PER SHARE - BASIC $ (0.56) $ (0.01) $ (0.44) $ 0.01 NET INCOME (LOSS) PER SHARE - DILUTED $ (0.56) $ (0.01) $ (0.44) $ 0.01 --------------------------------------------------------------------------------------------------------------------- SHARES USED IN PER - SHARE CALCULATION - BASIC 59,839 53,358 62,754 53,472 SHARES USED IN PER - SHARE CALCULATION - DILUTED 59,839 53,358 62,754 57,621 ---------------------------------------------------------------------------------------------------------------------
(1) Includes cost of unconsolidated development stage enterprises of $1,437 and $951 for the six and three months ended June 30, 2000 See accompanying notes 4 5 MRV COMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED IN THOUSANDS)
Six Months Ended June 30, ------------------------ 2000 1999 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: ---------- ---------- Net cash (used in) provided by operating activities $ (5,039) $ 3,059 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (2,588) (3,325) Purchases of investments (9,096) (1,511) Investments in partner companies (10,785) -- Proceeds from sale or maturity of investments 12,216 13,984 Cash used in acquisitions and equity purchases, net of cash received (45,391) (5,595) ---------- ---------- Net cash provided by (used in) investing activities (55,644) 3,553 ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from line of credit 68,510 -- Net proceeds from issuance of common stock 6,001 689 Principal payments on capital lease obligations (493) (442) ---------- ---------- Net cash provided by financing activities 74,018 247 ---------- ---------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (2,458) (1,490) ---------- ---------- NET INCREASE IN CASH AND CASH EQUIVALENTS 10,877 5,369 CASH AND CASH EQUIVALENTS, beginning of period 34,330 20,692 ---------- ---------- CASH AND CASH EQUIVALENTS, end of period $ 45,207 $ 26,061 ========== ==========
See accompanying notes 5 6 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, 2000, and the results of their operations and their cash flows for the six and three months then ended. 2. BUSINESS COMBINATION On April 24, 2000, the Company completed the acquisition of approximately 97% of the outstanding capital stock of Fiber Optic Communications, Inc. (FOCI), a Republic of China corporation. FOCI is a manufacturer of passive fiber optic components for Wavelength Division Multiplexing. Under the terms of the purchase agreement, FOCI shareholders received approximately $48.6 million in cash and approximately 4.8 million shares of common stock and warrants for a total purchase price of approximately $310.4 million. The acquisition is being accounted for using the purchase method of accounting. The excess purchase price paid over the fair value of the net identifiable assets acquired of $262.5 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The results of operations of FOCI have been included in the Company's consolidated financial statements from April 25, 2000. The following unaudited pro forma financial information presents the combined results of operations of the Company and FOCI as if the acquisition had occurred as of January 1, 2000 and 1999, giving effect to certain adjustments, including amortization of goodwill and deferred compensation charges.
Six Months Ended Three Months Ended June 30 June 30 ------------------------- -------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Revenues, net $146,065 $152,220 $75,026 $78,436 Net income (loss) (33,087) (342) (27,398) 543 Basic and diluted net loss per share $ (0.55) $ (0.01) $ (0.44) $ 0.01
3. NET INCOME (LOSS) 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 assumed conversion of $90.0 million convertible debentures. For the six and three months ended June 30, 2000, common stock equivalents were not considered in the diluted computation, as their effect was antidilutive. 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 financial statements. In addition, the standard requires companies to display the components of comprehensive income.
(thousands) Six Months Ended June 30, Three Months Ended June 30 ------------------------- -------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Net Income (Loss) $(33,614) $ (384) $(27,750) $ 525 Change in foreign currency translation (2,458) (1,490) (2,691) (929) -------- ------- -------- ----- Comprehensive loss $(36,072) $(1,874) $(30,441) $(404) ======== ======= ======== =====
5. 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, 2000 and December 31, 1999 (in thousands):
June 30, 2000 December 31, 1999 ------------- ----------------- Raw materials $18,664 $ 8,475 Work-in-process 17,583 8,083 Finished goods 13,369 18,834 ------- ------- $49,616 $35,392
6 7 6. STOCK DISTRIBUTION On March 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. 7. 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 which differs from prior period presentations of portions of the operating entities as segments. Development stage enterprises that the Company has created or invested in are developing 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, 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. 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. BUSINESS SEGMENT NET REVENUES for the six and three months ended June 30, 2000 and 1999 (in thousands):
Six Months Ended June 30, Three Months Ended June 30, ------------------------- --------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Operating entities $ 139,007 $ 143,367 $ 73,935 $ 73,251 Development stage enterprises -- -- -- -- --------- --------- ----------- ---------- Total Revenues $ 139,007 $ 143,367 $ 73,935 $ 73,251 ========= ========= =========== ==========
There were no inter-segment sales in the six and three months ended June 30, 2000 and 1999. BUSINESS SEGMENT PROFIT (LOSS) for the six and three months ended June 30, 2000 and 1999 (in thousands):
Six Months Ended June 30, Three Months Ended June 30, ------------------------- --------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Operating income (loss): Operating entities $ (17,439) $ 5,571 $ (17,687) $ 3,795 Development stage enterprises (13,282) (4,939) (7,451) (2,603) --------- --------- ----------- ---------- $ (30,721) $ 632 $ (25,138) $ 1,192 ========= ========= =========== ==========
For the six and three months ended and as of June 30, 2000, the Company had no one customers that accounted for more than 10 percent of revenue or accounts receivable. A summary of external revenue by region follows. The Company does not track customer revenue by region for each individual reporting segment.
(In thousands) Six Months Ended Three Months Ended June 30 June 30 ------------------------- -------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- United States $ 55,032 $ 61,419 $28,113 $32,716 Asia Pacific 18,171 14,193 14,084 6,445 European 62,543 65,516 30,050 33,051 Other 3,261 2,239 1,688 1,039 -------- -------- ------- ------- Total net sales $139,007 $143,367 $73,935 $73,251 ======== ======== ======= =======
Income (loss) before provision for income taxes:
(In thousands) Six Months Ended Three Months Ended June 30 June 30 ------------------------- -------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- United States $(25,756) $ 1,965 $(22,224) $ 1,038 Non-United States (6,975) (940) (4,149) 269 -------- -------- -------- ------- Income (loss) before provision for income taxes $(32,731) $ 1,025 $(26,373) $ 1,307 ======== ======== ======== =======
7 8 8. SUBSEQUENT EVENTS On July 12, 2000, the Company completed the acquisition of all of the outstanding capital stock of Quantum Optech, Inc. (QOI), a Republic of China corporation. The acquisition was accounted for using the purchase method. Under the terms of the agreement, QOI shareholders received 1,028,562 shares of common stock and 80,000 options to purchase common stock for a total purchase price of approximately $31.2 million. QOI is a manufacturer of optical thin film coating and filters for Dense Wavelength Division Multiplexing. On July 12, 2000, the Company completed the acquisition of all of the outstanding capital stock of AstroTerra Corporation (AstroTerra), a California corporation. The acquisition was accounted for using the purchase method. Under the terms of the agreement, AstroTerra shareholders received 1,587,302 shares of common stock and 809,143 options to purchase common stock for a total purchase price of approximately $159.3 million. AstroTerra develops and manufactures free-space optical laser communication systems for data and telecommunication networks. On July 21, 2000, the Company completed the acquisition of approximately 99.9% of the outstanding capital stock of Optronics International Corporation (OIC), a Republic of China corporation. The acquisition was accounted for using the purchase method. Under the terms of the agreement, OIC shareholders received 3,399,975 shares of common stock and 800,000 options to purchase common stock for a total purchase price of approximately $103.2 million. OIC is a manufacturer of high temperature semiconductor lasers, transceivers and detectors for optical networks. 8 9 9. SUPPLEMENTAL UNAUDITED PRO FORMA FINANCIAL DATA The purpose of the following unaudited pro forma Condensed Consolidated Statements of Operations for the six and three months ended June 30, 2000 and 1999 is to present the results of operations excluding certain charges such as non-cash amortization of intangibles from acquisitions, non-cash deferred compensation expense and expenses associated with development stage enterprises. (In thousands, except per share data)
Six Months Ended, Three Months Ended ----------------------------------------------------------------------------------------------------------------------- June 30, June 30, June 30, June 30, 2000 1999 2000 1999 (Unaudited) (Unaudited) (Unaudited) (Unaudited) ----------------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) AS REPORTED $ (33,614) $ (384) $ (27,750) $ 525 AMORTIZATION OF INTANGIBLES FROM ACQUISITIONS, net of tax effects 13,069 1,933 12,055 1,142 DEFERRED COMPENSATION EXPENSE, net of tax effects 7,328 -- 7,328 -- DEVELOPMENT STAGE ENTERPRISES, net of tax effects 14,719 4,939 9,565 2,603 ----------------------------------------------------------------------------------------------------------------------- UNAUDITED PRO FORMA NET INCOME BEFORE AMORTIZATION OF ACQUISITION INTANGIBLES AND RECOGNIZED DEVELOPMENT STAGE ENTERPRISE COSTS $ 1,502 $ 6,488 $ 1,198 $ 4,270 ----------------------------------------------------------------------------------------------------------------------- UNAUDITED PRO FORMA EARNINGS PER SHARE BEFORE AMORTIZATION OF ACQUISITION INTANGIBLES AND RECOGNIZED DEVELOPMENT STAGE ENTERPRISE COSTS - BASIC $ 0.03 $ 0.12 $ 0.02 $ 0.08 UNAUDITED PRO FORMA EARNINGS PER SHARE BEFORE AMORTIZATION OF ACQUISITION INTANGIBLES AND RECOGNIZED DEVELOPMENT STAGE ENTERPRISE COSTS - DILUTED $ 0.02 $ 0.12 $ 0.02 $ 0.07 ----------------------------------------------------------------------------------------------------------------------- SHARES USED IN PER - SHARE CALCULATION - BASIC 59,839 53,358 62,754 53,472 SHARES USED IN PER - SHARE CALCULATION - DILUTED 66,767 56,391 68,925 58,326 -----------------------------------------------------------------------------------------------------------------------
9 10 ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations OVERVIEW MRV is in the business of creating and managing growth companies in optical technology and Internet infrastructure. The Company has created several start-up companies and formed independent business units in the optical technology and Internet infrastructure area. The Company's core operations include the design, manufacture and sale of two groups of products: (i) optical networking and internet infrastructure products, primarily subscribers' management, Network Element Management, and physical layer, switching and routing management systems in fiber optic metropolitan networks and (ii) fiber optic components for the transmission of voice, video and data across enterprise, telecommunications and cable TV networks. The Company's advanced optical networking and Internet infrastructure solutions greatly enhance the functionality of carrier and network service provider networks. The Company's fiber optic components incorporate proprietary technology, which delivers high performance under demanding environmental conditions. On April 24, 2000, the Company completed the acquisition of approximately 97% of the outstanding capital stock of Fiber Optic Communications, Inc. (FOCI), a Republic of China corporation. FOCI is a manufacturer of passive fiber optic components for Wavelength Division Multiplexing. Under the terms of the purchase agreement, FOCI shareholders received approximately $48.6 million in cash and approximately 4.8 million shares of common stock and warrants for a total purchase price of approximately $310.4 million. The acquisition is being accounted for using the purchase method of accounting. The excess purchase price paid over the fair value of the net identifiable assets acquired of $262.5 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. On July 12, 2000, the Company completed the acquisition of all of the outstanding capital stock of Quantum Optech, Inc. (QOI), a Republic of China corporation. The acquisition was accounted for using the purchase method. Under the terms of the agreement, QOI shareholders received 1,028,562 shares of common stock and 80,000 options to purchase common stock for a total purchase price of approximately $31.2 million. QOI is a manufacturer of optical thin film coating and filters for Dense Wavelength Division Multiplexing. On July 12, 2000, the Company completed the acquisition of all of the outstanding capital stock of AstroTerra Corporation (AstroTerra), a California corporation. The acquisition was accounted for using the purchase method. Under the terms of the agreement, AstroTerra shareholders received 1,587,302 shares of common stock and 809,143 options to purchase common stock for a total purchase price of approximately $159.3 million. AstroTerra develops and manufactures free-space optical laser communication systems for data and telecommunication networks. On July 21, 2000, the Company completed the acquisition of approximately 99.9% of the outstanding capital stock of Optronics International Corporation (OIC), a Republic of China corporation. The acquisition was accounted for using the purchase method. Under the terms of the agreement, OIC shareholders received 3,399,975 shares of common stock and 800,000 options to purchase common stock for a total purchase price of approximately $103.2 million. OIC is a manufacturer of high temperature semiconductor lasers, transceivers and detectors for optical networks. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated statements of operations data of the Company expressed as a percentage of revenues.
Six Months Ended, Three Months Ended ----------------------------------------------------------------------------------------------------------------------- June 30, June 30, June 30, June 30, 2000 1999 2000 1999 (Unaudited) (Unaudited) (Unaudited) (Unaudited) ----------------------------------------------------------------------------------------------------------------------- REVENUES, net 100.0% 100.0% 100.0% 100.0% ----------------------------------------------------------------------------------------------------------------------- COSTS AND EXPENSES: Cost of goods sold 63.7 65.5 61.9 65.0 Research and development expenses 9.6 8.4 9.9 8.1 Research and development expenses of consolidated development stage enterprises 9.6 3.4 10.1 3.6 Selling, general and administrative expenses 29.8 20.8 35.8 20.1 Amortization of goodwill and intangibles from acquisitions 9.4 1.3 16.3 1.6 ----------------------------------------------------------------------------------------------------------------------- Operating (loss) income (22.1) 0.4 (34.0) 1.6 Interest expense related to convertible notes 2.0 1.6 2.3 1.5 Other income, net 0.8 1.9 0.7 1.7 Provision for income taxes 0.6 1.0 1.9 1.1 Minority interests 0.2 0.0 0.1 0.0 ----------------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) (24.2)% (0.3)% (37.5)% 0.7 % -----------------------------------------------------------------------------------------------------------------------
Revenues Revenues for the three and six months ended June 30, 2000 were $73,935,000 and $139,007,000, respectively, as compared to revenues for the three and six months ended June 30, 1999 of $73,251,000 and $143,367,000, respectively. The change represented increases of $684,000 or 0.9% for the three months ended June 30, 2000 and decreases of $4,360,000 or 3.0% for the six months ended June 30, 2000 over the six months ended June 30, 1999. Revenues remained constant or decreased during the periods principally as result of the Company's decision to exit the LAN switching business. International sales accounted for approximately 62.0% and 60.4% of revenues for the three and six months ended June 30, 2000 as compared to 55.3% and 57.2% of revenues for the three and six months ended June 30, 1999. The increases in revenues from international sales were primarily the result of incorporating results of FOCI which has the majority of its sales outside the U.S. for April 25, 2000 until June 30, 2000. Gross Profit Gross profit for the three and six months ended June 30, 2000 was $28,142,000 and $50,478,000 compared to gross profit of $25,656,000 and $49,406,000 during the three and six months ended June 30, 1999. The changes represented an increase of $2,486,000 or approximately 9.7% for the three months ended June 30, 2000 over the three months ended June 10 11 30, 1999 and an increase of $1,072,000 or approximately 2.2% for the six months ended June 30, 2000 over the six months ended June 30, 1999. Gross Margin defined as a percentage of revenues, increased from 35.0% during the three months ended June 30, 1999 to 38.1% during the three months ended June 30, 2000 and from 34.5% during the six months ended June 30, 1999 to 36.3% during the six months ended June 30, 2000. The increases in gross profit were principally the result of sales of a more favorable mix of products with higher gross margins. Research and Development Research and development ("R&D") expenses were $7,307,000 and $13,367,000, and represented 9.9% and 9.6% of revenues, for the three and six months ended June 30, 2000, respectively. R&D expenses were $5,969,000 and $12,098,000, and represented 8.1% and 8.4% of revenues, for the three and six months ended June 30, 1999, respectively. The increase of $1,338,000 or 22.4% in R&D spending during the three months ended June 30, 2000 over the three months ended in June 30, 1999 and the increase of $1,269,000 or 10.5% in R&D spending during the six months ended June 30, 2000 over the six months ended in June 30, 1999 was primarily attributable to the Company's decision to end further development of LAN switching products. R&D expenses of consolidated development stage enterprises reflects the costs incurred by consolidated development stage enterprises. These expenses were $7,451,000 or 10.1% of revenues for the three months ended June 30, 2000 as compared to $2,603,000 or 3.6% of revenue for the three months ended June 30, 1999 and $13,282,000 or 9.6% of revenues for the six months ended June 30, 2000 as compared to $4,939,000 or 3.4% of revenue for the six months ended June 30, 1999. The increases of $4,848,000 or 186.2% and $8,343,000 or 168.9% in R&D expenses of consolidated development stage enterprises during the three and six months ended June 30, 2000 over the comparable periods in 1999 is the result of increased development activities at existing enterprises and initiated enterprises during the current periods. The Company intends to continue to invest in the research and development of new products both in its operating entities and in new and existing development stage enterprises. Management believes that the ability of the Company to foster such development and commercialize new products is an important competitive factor. Selling, General and Administrative Selling, general and administrative expenses ("SG&A") increased to $26,467,000 and $41,481,000 for the three and six months ended June 30, 2000, respectively, from $14,750,000 and 29,804,000 for the three and six months ended June 30, 1999, respectively. As a percentage of revenues, SG&A increased from 20.1% and 20.8% for the three and six months ended June 30, 1999 to 35.8% and 29.8% for the three and six months ended June 30, 2000. The increases in SG&A expenses both in dollar amounts and as a percentage of revenues were due primarily to substantially increased marketing efforts as well as the addition of personnel and deferred compensation expenses incurred in connection with acquisitions occurring during the three months ended June 30, 2000. Amortization of Goodwill and Intangibles from Acquisitions. Expenses related to amortization of goodwill and intangibles from acquisitions increased to $12,055,000 and $13,069,000 for the three and six months ended June 30, 2000, respectively, from $1,142,000 and $1,933,000 for the three and six months ended June 30, 1999, respectively. The increases in expenses related to amortization of goodwill and intangibles of revenues were due primarily to the substantial amount of acquisition activities during 2000, primarily concentrated in the three months ended June 30, 2000. Interest expense In June 1998, the Company sold $100,000,000 principal amount of 5% convertible subordinated notes due 2003 (the "Notes") in a 144A private placement to qualified institutional investors at 100% of their principal amount, less a selling discount of 3% of the principal amount. The principal amount of the Notes was reduced to $90,000,000 when the Company repurchased $10,000,000 principal amount of the Notes at a discount from par during the last quarter of 1998. The outstanding Notes resulted in interest expenses of $1,125,000 for each of the three and six months ended June 30, 2000 11 12 and 1999. Other Income Other income, net decreased from $1,257,000 and $2,660,000 during the three and six months ended June 30, 1999 to $488,000 and $1,125,000 during the three and six months ended June 30, 2000. As a percentage of revenues, other income, net decreased from 1.7% and 1.9% for the three and six months ended June 30, 1999, respectively, to 0.7% and 0.8% for the three and six months ended June 30, 2000, respectively. The decreases in other income, net resulted primarily from the Company's equity in the costs of development stage enterprises, which it does not consolidate. Provision for Income Taxes The Company recorded provisions for income taxes of $1,377,000 and $883,000 during the three and six months ended June 30, 2000, respectively, as compared to provisions for income taxes of $782,000 and $1,409,000 during the three and six months ended June 30, 1999, respectively. The differences between tax amounts during the periods in 2000 and 1999 represent the variance in the amount of income and loss realized by the Company in the various countries in which it operates and the varying tax rates that are applicable in those countries. Minority Interests Minority interests represent ownership by third parties in some of the Company's partner companies that are consolidated. Net Loss The Company incurred net losses of $27,750,000 and $33,614,000 during the three and six months ended June 30, 2000, respectively, compared to net income of $525,000 and a net loss of $384,000 during the three and six months ended June 30, 1999. The net losses during 2000 were principally the result of the Company's amortization of goodwill and intangibles and deferred compensation expenses from its acquisitions, primarily in the quarter ended June 30, 2000, and its costs recognized in connection with the Company's investments in consolidated and unconsolidated development stage enterprises. Unaudited pro forma net income for the three months and six months ended June 30, 2000 would have been $1,198,000 and $1,502,000, respectively, if certain charges were not incurred such as the amortization of goodwill and intangibles and deferred compensation expenses incurred primarily in connection with the acquisition of Fiber Optic Communications, Inc. (FOCI), a Taiwanese manufacturer of passive optical components, and costs recognized in connection with the Company's investments in consolidated and unconsolidated development stage enterprises. Unaudited pro forma net income for the three months and six months ended June 30, 1999 would have been $4,270,000 and $6,488,000, respectively, if certain charges were not incurred such as the amortization of intangibles principally resulting from the Company's acquisition of Xyplex in 1998 and costs recognized in connection with the Company's investments in consolidated and unconsolidated development stage enterprises. In July 2000, the Company completed three additional acquisitions including the acquisition of the outstanding capital stock of Quantum Optech Inc. ("QOI"), a Taiwanese manufacturer of active and passive fiber optic components, Optronics International Corp., a Taiwanese manufacturer of active fiber optic components, and Astroterra Corporation, a California developer of free-space optical wireless technology. The Company expects to record amortization of goodwill charges for these and the other acquisitions it has made thus far in 2000 of approximately $21,237,000 during the three months ending September 30, 2000. This excludes goodwill amortization charges that the Company will incur as a result of the acquisition of Astroterra, which have not yet been determined. A portion of the purchase prices paid in connection with certain acquisitions the Company has made thus far in 2000, represented deferred stock compensation relating to options to purchase the common stock of the Company. These options had fair values aggregating approximately $63,915,000. Deferred stock compensation expense for the three and six months ended June 30, 2000 relating to these stock options totaled approximately $7,328,000. In connection with these acquisitions, the Company expects to incur approximately $13,306,000 of deferred stock compensation expenses in 12 13 the three months ending September 30, 2000. This excludes deferred stock compensation expenses that the Company will incur as a result of the acquisition of AstroTerra, which have not yet been determined. Deferred stock compensation will be amortized over the related employee service period. In July 2000, the Company and its wholly-owned subsidiary, Luminent, Inc. entered into four year employment agreements with Luminent's President and Chief Executive Officer and 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 the Company's common stock and Luminent's common stock. The options to purchase the Company's common stock are immediately exercisable and are expected to result in deferred compensation charges of $2,240,000 during the three months ending September 30, 2000. The options to purchase Luminent's common stock vest over four years. The options granted by Luminent to its Chief Executive Officer and Chief Financial Officer represent the right to purchase the number of shares of Luminent common stock equal to 3.5% of the outstanding capital stock of Luminent reflected on a fully diluted basis immediately prior to its initial public offering ("IPO") at an exercise price per share equal to lower of (a) the amount determined by dividing one billion dollars by the number of Luminent shares outstanding prior to the IPO reflected on a fully diluted basis or (b) 60% of the low end of the filing range for Luminent's common stock as initially filed with the Securities and Exchange Commission. The Company will incur deferred stock compensation expenses relating to these options in an amount to be determined once the number of shares underlying the options, the exercise price of the option and the initial public offering price of the Luminent shares are known. The deferred compensation expense will be amortized through 2004. On July 26, 2000, Luminent filed a registration statement with the Securities and Exchange Commission for the initial public offering of its common stock. The Company currently plans, within six to twelve months after the offering, to distribute all of the shares of Luminent common stock owned by the Company to the holders of the Company's common stock, subject to certain conditions including its receipt of a favorable tax ruling from the Internal Revenue Service, board approval as well as market conditions. A registration statement related to these securities has been filed with the Securities and Exchange Commission by Luminent, Inc., but has not yet become effective. These securities may not be sold nor may offers to buy be accepted, prior to the time the registration statement becomes effective. This announcement does not constitute an offer to sell or the solicitation of an offer to buy. There will not be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. LIQUIDITY AND CAPITAL RESOURCES In June 1998, the Company sold an aggregate $100,000,000 principal amount of 5% convertible subordinated notes due 2003 (the "Notes") in a private placement raising net proceeds of $96,423,000. The Notes are convertible into Common Stock of the Company at a conversion price of $13.52375 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 Common Stock of the Company. Interest on the Notes is at 5% per annum and is payable semi-annually on June 15 and December 15 of each year. The Notes have a five-year term and are not callable until June 15, 2001. The premiums payable to call the Notes will be 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 to the date of redemption. Cash and cash equivalents were $45,207,000 at June 30, 2000 as compared to $34,330,000 at December 31, 1999. Net cash used in investing activities for the six months ended June 30, 2000 was $49,416,000. The cash was primarily used for the FOCI acquisition and to establish or increase ownership in partner companies and to help fund their capital needs. Net cash provided by financing activities for the six months ended June 30, 2000 was $74,018,000. The cash was provided primarily by the issuance of short term debt to Bank of America. 13 14 EFFECTS OF INFLATION The Company believes that the relatively moderate rate of inflation in the United States over the past few years has not had a significant impact on the Company's sales or operating results or on the prices of raw materials. However, in view of the Company's recent expansion of operations in Israel, which has experienced substantial inflation, there can be no assurance that inflation in Israel will not have a materially adverse effect on the Company's operating results in the future. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS As a global enterprise, the Company faces exposure to adverse movements in foreign currency exchange rates. Thus fluctuations in currency exchange rates could cause the Company's 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 such countries could increase the Company's expenses. The Company's foreign currency exposures may change over time as the level of activity in foreign markets grows and could have an adverse impact upon the Company's financial results. Certain of the Company's assets, including certain bank accounts and accounts receivable, exist in non-dollar-denominated currencies, which are sensitive to foreign currency exchange rate fluctuations. The non-dollar-denominated currencies are principally Taiwanese Dollars, Italian Lire, Swedish Krona, French Francs and Swiss Francs. Additionally, certain of the Company's current and long-term liabilities are denominated principally in Italian lire, German deutsch marks and Swedish krona, which are also sensitive to foreign currency exchange rate fluctuations. To date, the Company has not hedged against currency exchange risks. In the future, the Company may engage in foreign currency denominated sales or pay material amounts of expenses in foreign currencies and, in such event, may experience gains and losses due to currency fluctuations. The Company's operating results could be adversely affected by such fluctuations. CERTAIN RISK FACTORS THAT COULD AFFECT FUTURE RESULTS WE HAVE INCURRED NET LOSS IN THE SIX MONTHS ENDED JUNE 30, 2000 PRIMARILY AS A RESULT OF THE FOCI ACQUISITION. AS A RESULT OF THAT ACQUISITION AND OTHERS AND ADDITIONAL DEFERRED COMPENSATION CHARGES, WE EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE FORESEEABLE FUTURE. We reported a net loss of $33.6 million for the six months ended June 30, 2000. The net loss was primarily due to amortization of goodwill and deferred stock compensation related to the FOCI acquisition. Between July 1 and August 1, 2000, we completed additional acquisitions, including the acquisitions of OIC, QOI and Astroterra. We expect to record amortization of goodwill charges of approximately $22,851,000 in the three months ended September 30, 2000 and deferred compensation expenses of $13,306,000 in the three months ended September 30, 2000. We also expect to incur substantial charges for goodwill amortization and deferred compensation expenses in connection with the Astroterra acquisition, the amount of which has not yet been determined. In July 2000, we and our wholly-owned subsidiary, Luminent, Inc. entered into four year employment agreements with Luminent's President and Chief Executive Officer and 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 the Company's common stock and Luminent's common stock. The options to purchase the Company's common stock are immediately exercisable and are expected to result in deferred compensation charges of $2,240,000 during the three months ending September 30, 2000. The options to purchase 14 15 Luminent's common stock vest over four years. The options granted by Luminent to its Chief Executive Officer and Chief Financial Officer represent the right to purchase the number of shares of Luminent common stock equal to 3.5% of the outstanding capital stock of Luminent reflected on a fully diluted basis immediately prior to its initial public offering at an exercise price per share equal to lower of (a) the amount determined by dividing one billion dollars by the number of Luminent shares outstanding prior to the IPO reflected on a fully diluted basis or (b) 60% of the low end of the filing range for Luminent's common stock as initially filed with the Securities and Exchange Commission. We will incur deferred stock compensation expenses relating to these options in an amount to be determined once the number of shares underlying the options, the exercise price of the option and the initial public offering price of the Luminent shares are known. The deferred compensation expense will be amortized through 2004. OUR PERFORMANCE MAY BE MATERIALLY ADVERSELY AFFECTED BY TECHNOLOGICAL CHANGES AND PRODUCT DEVELOPMENT DELAYS. We are engaged in the design and development of devices for the computer networking, telecommunications and fiber optic communication industries. As with any new technologies, there are substantial risks that the marketplace may not accept our new products. Market acceptance of our products will depend, in large part, upon our ability to demonstrate performance and cost advantages and cost-effectiveness of our products over competing products and the success of our and our customers' sales efforts. We can give no assurance that we will be able to continue to market our technology successfully, or that any of our current products will continue to, or that our future products will, be accepted in the marketplace. Moreover, the computer networking, telecommunications and fiber optic communication industries are characterized by rapidly changing technology, evolving industry standards and frequent new product introductions, any of which could render our existing products obsolete. Our success will depend upon our ability to enhance existing products and to introduce new products to meet changing customer requirements and emerging industry standards. We are and will be required to devote continued efforts and financial resources to develop and enhance our existing products and conduct research to develop new products. The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation. It also requires the accurate anticipation of technological and market trends. We can give no assurance that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully or on a timely basis. Nor can we give assurances that new products we introduce will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Furthermore, from time to time, we may announce new products or product enhancements, capabilities or technologies that have the potential to replace or shorten the life cycle of our existing product offerings. This may cause customers to defer purchasing our existing products or cause customers to return products to us. DEFECTS IN OUR PRODUCT RESULTING FROM THEIR COMPLEXITY OR OTHERWISE COULD HURT OUR FINANCIAL PERFORMANCE. Complex products, such as those we offer, may contain undetected software or hardware errors when we first introduce them or when we release new versions. The occurrence of such errors in the future, and our inability to correct such 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 our customers, system integrators and end users. Any of these or other eventualities resulting from defects in our products could 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, 15 16 - 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, - new product introductions by our competitors, - pricing actions by us or our competitors, - 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 such forecasts or if customers do not 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. Furthermore, in certain instances, sales cycles are becoming longer and more uncertain as we bid on larger projects. As a result, we are finding it more difficult to predict the timing of the awards of contracts and the actual placement of orders stemming from awards. We can give no assurance that these factors or others, such as those discussed below regarding the risks we face from our international operations or the risks discussed immediately below, would not cause future fluctuations in operating results. Further, there can be no assurance that we will be able to continue profitable operations. THE PRICES OF OUR SHARES HAVE BEEN AND MAY CONTINUE TO BE HIGHLY VOLATILE. Historically, the market price of our shares has been extremely volatile. The market price of our common sock 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 from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the common stocks of technology companies. These broad market fluctuations may adversely affect the market price of our common stock. For example, during the period of less than 30 days from March 7, 2000 to April 4, 2000, our stock price (adjusted for a two-for-one stock split effective on May 11, 2000) ranged from a high of $96.94 to a low of $30. In addition, it is possible that in a future fiscal quarter, our results of operations will fail to meet the expectations of securities analysts or investors and, in such event, the market price of our common stock would be materially adversely affected. For example, as a result of weaker than anticipated demand for our networking products, especially in Europe, and delays in transitions to next generation, higher margin, networking products, in August 1998, we announced that we expected operating results in the third quarter of 1998 to be adversely affected. Following that announcement, the market price of our common stock dropped substantially. Similarly, in February 1999, following our release of fourth quarter and 1998 financial results, we announced that we did not expect revenues in the first quarter of 1999 to be as strong as revenues reported for the fourth quarter of 1998. Following that announcement, the market price of our stock again dropped significantly. See the section of this prospectus captioned "Price Range of Common Stock" below. 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 16 17 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 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 such 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 such price decreases may have an adverse impact on our results of operations or financial condition. 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 GROWTH. We have grown rapidly in recent years, with revenues increasing from $39,202,000 for the year ended December 31, 1995, to $288,524,000 for the year ended December 31, 1999. Our recent growth, both internally and through the acquisitions we have made since January 1, 1995, has placed a significant strain on our financial and management personnel and information systems and controls. As a consequence, we must implement new and enhance existing financial and management information systems and controls and must add and train personnel to operate such 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. 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 last three years:
Percent of total Year ended revenue December 31, from foreign sales ------------ ------------------ 1997 60% 1998 59 1999 58
We have offices in, and conduct a significant portion of our operations in and from, Israel, Taiwan and China. We are, therefore, directly influenced by the political and economic conditions affecting Israel, Taiwan and China. Any major hostilities involving Israel, Taiwan or China, the 17 18 interruption or curtailment of trade between Israel, Taiwan or China and their respective trading partners or a substantial downturn in the economic or financial condition of Israel, Taiwan or China could have a material adverse effect on our operations. Sales to foreign customers are subject to government controls and other risks associated with international sales, including difficulties in obtaining export licenses, fluctuations in currency exchange rates, inflation, political instability, trade restrictions and changes in duty rates. Although we have not experienced any material difficulties in this regard to date, we can give no assurance that we will not experience material difficulties in the future. 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 such 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 such event, may experience gains and losses due to currency fluctuations. Our operating results could be adversely affected by such fluctuations or as a result of inflation in particular countries where material expenses are incurred. Moreover, our operating results could also be adversely affected by seasonality of international sales, which are typically lower in Asia in the first calendar quarter and in Europe in the third calendar quarter. These international factors could have a material adverse effect on future sales of our products to international end users and, consequently, our business, operating results and financial condition. THE SLOWDOWN IN GROWTH RATES IN OUR INDUSTRY COULD ADVERSELY AFFECT OUR GROWTH. Our success is dependent, in part, on the overall growth rate of the networking industry. We can give no assurance that the Internet or the industries that serve it will continue to grow or that the Company will achieve higher growth rates. Our business, operating results or financial condition may be adversely affected by any decrease 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. WE FACE RISKS INVOLVED IN THE MANUFACTURE AND SUPPLY OF CRITICAL COMPONENTS FOR OUR PRODUCTS. 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. 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 such 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. 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 facility and such components are not readily available from other sources, any interruption of our manufacturing process could have a material adverse 18 19 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 such 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. WE HAVE SUFFERED ADVERSE FINANCIAL CONSEQUENCES AS A RESULT OF THE XYPLEX ACQUISITION. On January 30, 1998, we completed the Xyplex acquisition from Whittaker Corporation. Xyplex is a leading provider of access solutions between enterprise networks and WAN and/or Internet service providers. The purchase price paid to Whittaker consisted of $35 million in cash and three-year warrants to purchase up to 842,804 shares of our common stock at an exercise price of $17.50 per share. In connection with the Xyplex acquisition, we incurred charges of $20,633,000 and $15,671,000 for purchased technology and restructuring during the year ended December 31, 1998. The charges resulting from the Xyplex acquisition resulted in our incurring a net loss of $20,106,000 or $0.43 per share during the year ended December 31, 1998. We originally recorded charges of $30.6 million related to research and development projects in progress at the time of the Xyplex acquisition. Although we reported these charges in our first, second and third quarter results of 1998 in accordance with established accounting practice and valuations of Xyplex' purchased technology in progress provided by independent valuators, we reconsidered these valuations in light of subsequent SEC guidance regarding valuation methodology. Based on this newer valuation methodology, we reduced the value of the purchased technology in progress related to the Xyplex acquisition to $20,633,000 and increased the amount of goodwill by $9,938,000. This has resulted in additional charges during 1998 of $759,000 and charges during 1999 of approximately $828,000 for amortization of intangibles, including goodwill, resulting from the Xyplex acquisition charges and will continue to result in annual charges of approximately $828,000 after 1999 as these intangibles are amortized through January 2010. Recent actions and comments from the SEC have indicated that the SEC is reviewing the current valuation methodology of purchased in-process research and development related to business combinations. Unlike the case of many other companies, the SEC has not notified us of any plans to review our methodology for valuing purchased in-process research and development. Our action in 1998 to reconsider that valuation of in process research and development related to the Xyplex acquisition was voluntary. We believe we are in compliance with all of the rules and related guidance as they currently exist. However, there can be no assurance that the SEC will not review our accounting for the Xyplex acquisition and seek to apply retroactively new guidance and further reduce the amount of purchased in-process research and development we have expensed. This would result in an additional restatement of our previously filed financial statements and could have a material adverse impact on our financial results for periods subsequent to the acquisition. FUTURE HARM COULD RESULT FROM ADDITIONAL ACQUISITIONS. An important element of our strategy is to review acquisition prospects that would complement our existing 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 - possible charges to operations for purchased technology and restructuring similar to those incurred in connection with the Xyplex acquisition mentioned above, - potentially dilutive issuances of equity securities, 19 20 - incurrence of debt and contingent liabilities; - incurrence of amortization expenses related to goodwill and other intangible assets and deferred compensation charges similar to those arising with the acquisitions of FOCI, OIC, QOI and Astroterra mentioned above, - 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. We can give no assurance as to whether we can successfully integrate the products, technologies or personnel of any business that we might acquire in the future. 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 issue 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 such litigation, regardless of outcome, could be expensive and time consuming, and adverse determinations in any such 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 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 triplexer and duplexer products. We are evaluating the patents noted in the letters. Others' patents, including Lemelson's, Rockwell's, Lucent's and Ortel's, may be determined to be valid, or some of our products may ultimately be determined to infringe the Lemelson, Rockwell, Lucent and Ortel patents, or those of other companies. Lemelson, Rockwell, Lucent or Ortel 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 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 20 21 significant resources to develop non-infringing technology. Licenses may not be available from third parties, including Lemelson, Rockwell, Lucent or Ortel, 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 $1,000,000 on each of 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 any of these individuals, and the policies are not applicable in the event that any 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 and our ability to compete with our current and future competitors depends, and will continue to depend, in large part, on our ability to attract and retain qualified personnel. Competition for qualified personnel in the networking and fiber optics industries is intense, and we will be required to compete for such personnel with companies having substantially greater financial and other resources than we do. 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. OUR ABILITY TO ISSUE PREFERRED STOCK COULD ADVERSELY AFFECT THE RIGHTS OF HOLDERS OF COMMON STOCK AND DETER A TAKE-OVER. 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 such 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 such 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. 21 22 PART II - OTHER INFORMATION Item 2. Changes in Securities (a) Not applicable (b) Not applicable (c) (i) In April 2000, the Company issued an aggregate of 4,663,458 shares of its common stock to the shareholders of Fiber Optic Communications, Inc. ("FOCI"), a Republic of China corporation in exchange for the Company's acquisition of approximately 97% of the outstanding capital stock of FOCI from these shareholders. (ii) In April 2000, the Company issued an aggregate of 367,000 shares of its common stock to the shareholders of Creative Electronic Systems SA ("CES"), a Swiss corporation, in exchange for the Company's acquisition of the outstanding capital stock of CES from these shareholders. (iii) In April 2000 the Company issued an aggregate of 81,494 shares of its Common Stock to Optical Crossing, Inc. one of its partner companies in connection with its investment in this partner company receiving for such shares and other consideration 12,000 shares of Series A Convertible Preferred Stock, $.001 par value per share of the partner company. (iv) In April 2000, the Company issued an aggregate of 1,061,174 shares of its common stock and options to purchase 349,377 shares of its common stock to the 26 shareholders of Jolt, Ltd., an Israeli corporation, in exchange for the Company's acquisition of the outstanding capital stock of Jolt from these shareholders. (v) In April 2000, the Company issued an aggregate of 30,000 shares of its common stock to the one shareholder of Multiport Corp., a Massachusetts corporation, in exchange for the Company's acquisition of the outstanding capital stock of Multiport from this shareholder. The issuance of the shares referred to above were not effected through a broker-dealer, and no underwriting discounts or commissions were paid in connection with such issuance. As to the transactions described in subsection (c)(i) and (ii), exemption from registration requirements is claimed under the Securities Act of 1933 (the "Securities Act") in reliance on Regulation S under the Securities Act. The Company believed that the buyers were outside the United States and no directed selling efforts were made in the United States. Each Investor (all of whom had addresses outside the United States) represented that it was not a "U.S. Person" as defined in Regulation S and, at the time the buy order for these transaction was originated, each Investor was outside the United States and no offer to purchase the Securities was made in the United States. Each Investor agreed not to reoffer or sell the securities, or to cause any transferee permitted under the Securities Purchase Agreement to reoffer or sell the Securities, within the United States, or for the account or benefit of a U.S. person, (i) as part of the distribution of the securities at any time, or (ii) otherwise, only in a transaction meeting the requirements of Regulation S, including without limitation, where the offer (i) is not made to a person in the United States and either (A) at the time the buy order is originated, the buyer is outside the United States or the Company and any person acting on its behalf reasonably believe that the buyer is outside the United States, or (B) the transaction is executed in, on or through the facilities of a designated offshore securities market and neither the seller nor any person acting on its behalf knows that the transaction has been pre- arranged with a buyer in the United States, and (ii) no direct selling efforts shall be made in the United States by the buyer, an affiliate or any person acting on their behalf, or in a transaction registered under the Securities Act or pursuant to an exemption from such registration. Appropriate legends were affixed to the certificates evidencing the securities in such transaction. As to the transactions described in subsection (c)(iii) through (v), exemption from registration requirements is claimed under the Securities Act of 1933 (the "Securities Act") in reliance on in reliance on Section 4(2) of the Securities Act or Regulation D promulgated thereunder. The purchasers represented their intention to acquire the securities for investment only and not with a view to, or for sale in connection with, any distribution thereof and appropriate legends 22 23 were affixed to the certificates evidencing the securities in such transactions. The purchasers had adequate access to information about the Company. (d) Not applicable. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 27 Financial Data Schedule (b) Reports on Form 8-K Two reports on Form 8-K were filed during the quarter covered by this Report, as follows: (i) A report on Form 8-K dated May 3, 2000 was filed on May 3, 2000 reporting under Item 5. (ii) A report on Form 8-K dated May 8, 2000 was filed on May 9, 2000 reporting the acquisition of FOCI under Item 2 and 7. (iii) A report on Form 8-K/A dated July 7, 2000 was filed on July 8, 2000 supplementing and completing the Form 8-K referred to in subparagraph (ii) above. In that Form 8-K/A, the following financial statements and pro forma financial information were filed under Item 7: Financial statements of Fiber Optics Communications, Inc. as follows: Audited Consolidated Financial Statements As Of December 31, 1997, 1998 And 1999: Report of Independent Auditors Consolidated Balance Sheets at December 31, 1997, 1998 and 1999 Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 1997, 1998 and 1999 Consolidated Statements of Changes in Stockholders Equity for the year ended December 31, 1997, 1998 and 1999 Consolidated Statements of Cash Flows for the year ended December 31, 1997, 1998 and 1999 Notes to Consolidated Financial Statements Unaudited Consolidated Financial Statements as of March 31, 1999 and 2000: Consolidated Balance Sheets at March 31, 1999 and 2000 Consolidated Statements of Operations And Comprehensive Income for the Periods Ended March 31, 1999 and 2000 Consolidated Statements Of Cash Flows For the Periods Ended March 31, 1999 and 2000 Notes to Consolidated Financial Statements 23 24 Pro Forma Financial Information: Unaudited Pro Forma Condensed Consolidated Financial Information Unaudited Pro Forma Condensed Consolidated Balance Sheet as of March 31, 2000 Unaudited Pro Forma Condensed Consolidated Statement of Operations for the Year Ended December 31, 1999 Unaudited Pro Forma Condensed Consolidated Statement of Operations for the Three Months Ended March 31, 2000 Notes to Unaudited Pro Forma Condensed Consolidated Financial Information 24 25 SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant certifies that it has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on August 14, 2000. MRV COMMUNICATIONS, INC. By: /s/ Edmund Glazer ---------------------------------- Edmund Glazer Vice President of Finance and Administration and Chief Financial Officer 25