-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Qp43994fb3MdrYiCjghC2PL2DcPdhJfrAkU+fl4Mw0PJDGSnUNpgxJ9BMkYlWJnT 2476gocoVyje965KhO1aCQ== 0000950148-01-500756.txt : 20010516 0000950148-01-500756.hdr.sgml : 20010516 ACCESSION NUMBER: 0000950148-01-500756 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MRV COMMUNICATIONS INC CENTRAL INDEX KEY: 0000887969 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 061340090 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11174 FILM NUMBER: 1639357 BUSINESS ADDRESS: STREET 1: 20415 NORDHOFF ST CITY: CHATSWORTH STATE: CA ZIP: 91311 BUSINESS PHONE: 8187730900 MAIL ADDRESS: STREET 1: 20415 NORDHOFF ST CITY: CHATSWORTH STATE: CA ZIP: 91311 10-Q 1 v72389e10-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 MARCH 31, 2001 [ ] 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.) 20415 NORDHOFF STREET, CHATSWORTH, CA 91311 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 773-0900 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 April 30, 2001, there were 76,229,235 shares of Common Stock, $.0017 par value per share, outstanding. 2 MRV COMMUNICATIONS, INC. Form 10-Q March 31, 2001 Index
PAGE NUMBER ----------- PART I Financial Information Item 1: Financial Statements: Condensed Consolidated Balance Sheets as of March 31, 2001 (unaudited) and December 31, 2000 (audited) 3 Condensed Consolidated Statements of Operations (unaudited) for the Three Months ended March 31, 2001 and 2000 4 Condensed Consolidated Statements of Cash Flows (unaudited) for the Three Months ended March 31, 2001 and 2000 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 27 Item 6. Exhibits and Reports on Form 8-K 27 SIGNATURE 28
As used in this Report, "we, "us", "our", "MRV" or the "Company" refer to MRV Communications, Inc. and its consolidated subsidiaries. 2 3 MRV Communications, Inc. Condensed Consolidated Balance Sheets (In thousands, except par values)
March 31, December 31, 2001 2000 (unaudited) (audited) - ------------------------------------------------------------------------------------------------ ASSETS CURRENT ASSETS: Cash and cash equivalents $ 190,545 $ 210,080 Short-term investments, $54,871 and $56,181 restricted in 2001 and 2000, respectively 57,163 73,947 Accounts receivable 64,314 61,863 Inventories 102,921 77,005 Deferred income taxes 33,307 31,227 Other current assets 23,687 22,750 - ------------------------------------------------------------------------------------------------ Total current assets 471,937 476,872 PROPERTY AND EQUIPMENT - At cost, net of depreciation and amortization 82,183 72,269 OTHER ASSETS: Goodwill and other intangibles, net 494,585 504,027 Deferred income taxes 7,009 6,209 Investments 31,728 31,734 Loan financing costs and other 7,436 5,660 - ------------------------------------------------------------------------------------------------ $1,094,878 $1,096,771 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Current maturities of financing lease obligations and long-term debt $ 3,094 $ 2,937 Accounts payable 69,185 56,088 Accrued liabilities 32,750 34,044 Short-term debt 12,773 9,104 Deferred revenue 2,034 1,470 Income taxes payable 5,843 6,477 - ------------------------------------------------------------------------------------------------ Total current liabilities 125,679 110,120 LONG-TERM LIABILITIES Convertible debentures 89,646 89,646 Capital lease obligations, net of current portion 642 621 Long-term debt 60,822 60,257 Other long-term liabilities 4,251 3,980 - ------------------------------------------------------------------------------------------------ Total long-term liabilities 155,361 154,504 MINORITY INTEREST 48,767 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 - 74,634 shares in 2001 and 73,327 in 2000 - Outstanding - 74,586 shares in 2001 and 73,279 in 2000 132 126 Additional paid-in capital 1,080,886 1,060,650 Accumulated deficit (225,622) (171,330) Deferred stock compensation, net (84,283) (100,862) Treasury stock, 18 shares at cost in 2001 and 2000 (133) (133) Accumulated other comprehensive loss (5,909) (6,896) - ------------------------------------------------------------------------------------------------ STOCKHOLDERS' EQUITY 765,071 781,555 - ------------------------------------------------------------------------------------------------ $1,094,878 $1,096,771
See accompanying notes 3 4 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
Three Months Ended - ------------------------------------------------------------------------------ March 31, March 31, 2001 2000 (Unaudited) (Unaudited) - ------------------------------------------------------------------------------ REVENUES, net $ 100,104 $ 65,072 - ------------------------------------------------------------------------------ COSTS AND EXPENSES: Cost of goods sold 66,391 42,736 Research and development expenses 25,005 11,891 Selling, general and administrative expenses 38,412 15,014 Amortization of goodwill and other intangibles 28,139 1,014 - ------------------------------------------------------------------------------ Operating loss (57,843) (5,583) Other expense, net (520) (488) Credit for income taxes (2,683) (494) Minority interest (1,388) 287 - ------------------------------------------------------------------------------ NET LOSS $ (54,292) $ (5,864) - ------------------------------------------------------------------------------ NET LOSS PER SHARE - BASIC $ (0.73) $ (0.10) NET LOSS PER SHARE - DILUTED $ (0.73) $ (0.10) - ------------------------------------------------------------------------------ SHARES USED IN PER - SHARE CALCULATION - BASIC 74,370 56,850 SHARES USED IN PER - SHARE CALCULATION - DILUTED 74,370 56,850 - ------------------------------------------------------------------------------
See accompanying notes 4 5 MRV Communications, Inc. Condensed Consolidated Statements Of Cash Flows (In thousands)
Three Months Ended ------------------------- March 31, March 31, 2001 2000 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net cash used in operating activities $ (25,677) $ (9,354) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment, net of sales (16,432) 590 Investments in partner companies -- (9,680) Purchases of investments 6 (7,266) Proceeds from sale or maturity of investments 16,784 9,000 --------- --------- Net cash provided by (used in) investing activities 358 (7,356) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of common stock 385 1,903 Payments on long-term debt (430) -- Payments on short-term debt (5,075) -- Borrowings on short-term debt 10,212 -- Principal payments on capital lease obligations (295) (289) --------- --------- Net cash provided by financing activities 4,797 1,614 --------- --------- EFFECT OF EXCHANGE RATE CHANGES Cash and Cash Equivalents 987 233 --------- --------- NET DECREASE IN CASH AND CASH EQUIVALENTS (19,535) (14,863) CASH AND CASH EQUIVALENTS, beginning of period 210,080 34,330 --------- --------- CASH AND CASH EQUIVALENTS, end of period $ 190,545 19,467 ========= ======
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 March 31, 2001, and the results of their operations and their cash flows for the three months then ended. 2. Business Combinations No material business combinations took place during the three months ended March 31, 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 our 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)
Three Months Ended March 31, --------------------------------- 2001 2000 -------- -------- Pro forma revenue $100,104 $ 78,706 Pro forma net loss (48,208) $(71,900) Pro forma basic and diluted net loss per share (0.65) $ (1.04) Pro forma basic and diluted shares outstanding 74,370 69,176
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. The effect of the assumed conversion of $90.0 million convertible debentures has not been included, as it would be antidilutive. For the three months ended March 31, 2001 and 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 as follows (in thousands).
Three months ended March 31, ---------------------------- 2001 2000 ------- ------- Net loss $(54,292) $(5,864) Foreign currency translation 987 233 -------- ------- Comprehensive loss $(53,305) $(5,631) ======== =======
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 March 31, 2001 and December 31, 2000 (in thousands): 6 7
March 31, December 30, 2001 2000 --------- ------------ Raw materials 53,244 $36,278 Work-in process 24,478 17,721 Finished goods 25,199 23,006 -------- ------- $102,921 $77,005 ======== =======
6. 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. 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. 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 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. Business Segment Net Revenues for the three months ended March 31, 2001 and 2000 (in thousands):
Three months ended March 31, ---------------------------- 2001 2000 ------- ------- Operating entities 100,104 $65,072 Development stage enterprises -- -- ------- ------- Total revenues 100,104 $65,072 ======= =======
There were no inter-segment sales in the three months ended March 31, 2001 and 2000. Business Segment Profit (Loss) for the three months ended March 31, 2001 and 2000 (in thousands): 7 8
Three months ended March 31, ---------------------------- 2001 2000 ------- ------- Operating income (loss): Operating entities $(43,864) $ 248 Development stage enterprises (13,979) (5,831) Other income (expense) Interest expense related to convertible notes (1,125) (1,125) Other income, net 1,856 1,123 Development stage enterprises (1,251) (486) -------- ------- Loss before credit for income taxes and minority interest $(58,363) $(6,071) ======== =======
For the three months ended and as of March 31, 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).
Three months ended March 31, ---------------------------- 2001 2000 ------- ------- United States $ 41,903 $26,919 Asia Pacific 14,820 10,508 European 41,318 26,198 Other 2,063 1,447 -------- ------- Total net sales $100,104 $65,072 ======== =======
Income (loss) before provision for income taxes (in thousands):
Three months ended March 31, ---------------------------- 2001 2000 ------- ------- United States $(29,483) $(3,817) Foreign (27,492) (2,541) -------- ------- Loss before credit for income taxes $(56,975) $(6,358) ======== =======
8. 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. 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. 9. Supplemental Statement of Cash Flow Information (in thousands)
For the three months ended March 31, ------------------------------------ 2001 2000 ------- ------- Supplemental disclosure of cash flow information: Cash paid during period for interest $ 1,197 $ - Cash paid during period for taxes $ 4,540 $ 212
8 9 10. Supplemental Unaudited Pro Forma Financial Data The purpose of the following unaudited pro forma condensed consolidated statements of operations for the three months ended March 31, 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 compensation expense and expenses associated with development stage enterprises (in thousands, except per share data).
Pro Forma ------------------ Three Months Ended - ------------------------------------------------------------------------------- March 31, March 31, 2001 2000 (Unaudited) (Unaudited) - ------------------------------------------------------------------------------- REVENUES, net $100,104 $ 65,072 - ------------------------------------------------------------------------------- COSTS AND EXPENSES: Cost of goods sold 64,108 42,736 Research and development expenses 9,246 6,060 Selling, general and administrative expenses 23,527 15,014 - ------------------------------------------------------------------------------- Operating income 3,223 1,262 Other income (expense), net 731 (2) Provision for income taxes 1,773 669 Minority interests 820 287 - ------------------------------------------------------------------------------- NET INCOME $ 1,361 $ 304 - ------------------------------------------------------------------------------- NET INCOME PER SHARE - BASIC $ 0.02 $ 0.01 NET INCOME PER SHARE - DILUTED $ 0.02 $ 0.00 - ------------------------------------------------------------------------------- SHARES USED IN PER - SHARE CALCULATION - BASIC 74,370 56,850 SHARES USED IN PER - SHARE CALCULATION - DILUTED 80,434 63,162 - ------------------------------------------------------------------------------- RECONCILIATION NET INCOME, pro forma $ 1,361 $ 304 LESS: Amortization of goodwill and other intangibles 28,139 1,014 Deferred compensation expense 18,948 -- Expenses of development stage enterprises 15,230 5,154 Tax effects of above items (4,456) -- Minority interest in above items (2,208) -- - ------------------------------------------------------------------------------- NET LOSS, as reported $(54,292) $ (5,864) - -------------------------------------------------------------------------------
9 10 ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations YOU SHOULD READ THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS TOGETHER WITH THE CONDENSED FINANCIAL STATEMENTS AND THE NOTES TO CONDENSED FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS FORM 10-Q. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS BASED ON OUR CURRENT EXPECTATIONS, ASSUMPTIONS, ESTIMATES AND PROJECTIONS ABOUT US AND OUR INDUSTRY. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, AS MORE FULLY DESCRIBED IN THE "FORWARD LOOKING STATEMENTS" SECTION AND THE "CERTAIN RISK FACTORS THAT COULD AFFECT FUTURE RESULTS" SECTION OF THIS FORM 10-Q. WE UNDERTAKE NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS FOR ANY REASON, EVEN IF NEW INFORMATION BECOMES AVAILABLE OR OTHER EVENTS OCCUR IN THE FUTURE. OVERVIEW We create, acquire, finance and operate companies, and through them, design, develop, manufacture and market products, which enable high-speed broadband communications. We concentrate on companies and products devoted to optical components and network infrastructure systems. We have leveraged our 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 we have created, financed or acquired. During 2000, we completed several strategic acquisitions. These acquisitions were made to expand our product offering, enhance our technological expertise and expand our manufacturing capabilities. These acquisitions are summarized in item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations - General" in our Annual Report on Form 10-K for the year ended December 31, 2000. We plan to continue to pursue and seek out future acquisitions that provide synergies with existing product offerings and technology or allow us to penetrate into new markets and grow our business model. Goodwill and other intangibles from these acquisitions totaled $463.9 million. For the three months ended March 31, 2001, we recorded amortization of goodwill and other intangibles from these acquisitions of $28.1 million. We expect to record amortization charges of goodwill for these acquisitions of approximately $494.6 million until they are fully amortized in 2005. In connection with these acquisitions, a portion of the purchase prices paid represented deferred stock compensation relating to options to purchase our 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 three months ended March 31, 2001 relating to these stock options was approximately $17.7 million. We expect 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, we and our subsidiary, Luminent, entered into four year employment agreements with Luminent's 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 our common stock and Luminent's common stock. The options were granted to Luminent's executives at exercise prices below market value, resulting in deferred stock compensation. Deferred stock compensation from these option grants reported 10 11 for the three months ended March 31, 2001 was $1.3 million and we will incur additional deferred stock compensation of approximately $5.5 million through 2004. We reported a net loss of $54.3 million for the three months ended March 31, 2001. A significant portion of the net loss was due to the amortization of goodwill and intangibles and deferred stock compensation related to our recent acquisitions and our employment arrangements with Luminent's President and Chief Financial Officer. We will continue to record amortization of goodwill and other intangibles through 2005 and deferred stock compensation through 2004 relating to these acquisitions and our employment arrangements with Luminent's executives. As a consequence of this amortization of goodwill and deferred stock compensation charges, we do not expect to report net income in the foreseeable future. On November 10, 2000, Luminent, our publicly owned subsidiary, 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. We have announced plans to distribute all of our shares of Luminent common stock to our stockholders on the later of three months after the receipt of a favorable private letter ruling from the Internal Revenue Service or six months after Luminent's public offering, although we are not obligated to do so. There are various conditions that must be satisfied or waived by us in our sole discretion, prior to the distribution. These conditions include, among other things: - the receipt of a private letter ruling from the Internal Revenue Service that our distribution of our shares of Luminent common stock to the holders of our common stock will be tax-free to our stockholders and us for United States federal income tax purposes; - all required government approvals must be in effect; - our redemption or repayment of our outstanding convertible subordinated debentures; - no legal restraints must exist preventing this distribution; and - nothing must have happened in the intervening time between the Luminent offering and the distribution, including a future change in market or economic conditions or in our or Luminent's business and financial condition, that causes our board of directors to conclude that the distribution is not in our best interest or the best interest of our stockholders. The exact distribution formula and record date to qualify for any distribution will be determined at a future date. On October 6, 2000, our wholly owned subsidiary Optical Access filed a registration statement with the Securities and Exchange Commission for the initial public offering of its common stock. Optical Access designs, manufactures and markets an optical wireless solution that delivers 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. The registration statement related to these securities 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 11 12 unlawful prior to registration or qualification under the securities laws of any such State. RESULTS OF OPERATIONS The following table sets forth certain operating data as a percentage of total net sales for the three months ended March 31, 2001 and 2000.
Three Months Ended March 31, March 31, 2001 2000 (Unaudited) (Unaudited) REVENUES, net 100% 100% ---- ---- COSTS AND EXPENSES: Cost of goods sold 66 66 Research and development expenses 25 18 Selling, general and administrative expenses 38 23 Amortization of goodwill and other intangibles 28 2 ---- ---- Operating loss (58) (9) Other expense, net (1) (1) Credit for income taxes (3) (1) Minority interest (1) 0 ---- ---- NET LOSS (54)% (9)% ==== ====
THREE MONTHS ENDED MARCH 31, 2001 AND 2000 Net Sales. We generally recognize revenue upon shipment of our products. We defer revenue recognition on shipment of products where return privileges exist until the products are sold through to end-users. Net sales for the first quarter increased 54%, to $100.1 million from $65.1 million for the three months ended March 31, 2000. This increase was due in part to an increase in our fiber optic components business, specifically relating to existing business and growth through recent acquisitions. The expansion of the fiber optic industry in recent quarters has also contributed to our increase in net sales. Further growth was due to the Internet infrastructure products, such as greater acceptance of our In-Reach(TM) product line, which enables remote management of data networks, and products designed for wireless networks. Gross Profit. Gross profit is equal to our net sales less our cost of sales. Our 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 first quarter of 2001 increased 51%, to $33.7 million from $22.3 million for the three months ended March 31, 2000. Prior to deferred stock compensation expenses, gross profit would have increased 61%, to $36.0 million for the three months ended March 31, 2001. Our 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. Our gross margin remained constant at 34% for the both three months ended March 31, 2001 and 2000. Prior to deferred stock compensation expenses, gross margin would have increased to 36% for the three months ended March 31, 2001. Our increase in gross margin prior to deferred stock 12 13 compensation expenses is partly a result of our decision in February 2000 to discontinue the production and sale of low margin LAN switches for enterprise networks. It was also attributable to the increased sale of higher margin products such as those for 3G wireless networks and other Internet infrastructure products. Research and Development (R&D). R&D expenses increased 110%, to $25.0 million for the first quarter of 2001 from $11.9 million for the three months ended March 31, 2000. R&D expenses of consolidated development stage enterprises reflects the costs incurred by consolidated development stage enterprises. These expenses were $8.0 million or 8% of revenues for the three months ended March 31, 2001 as compared to $5.8 million or 9% of revenues for the three months ended March 31, 2000, an increase of $3.2 million or 38%. Prior to deferred stock compensation expenses, R&D expenses would have increased 53%, to $9.2 million. The growth in R&D expense demonstrates our commitment to product development and continuing technological advancement. 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 156%, to $38.4 million for the first quarter of 2001 from $15.0 million for the three months ended March 31, 2000. SG&A expenses were 38% of net sales for the first quarter of 2001, compared to 23% of net sales for the three months ended March 31, 2000. Prior to deferred stock compensation expenses, SG&A would have increased 57%, to $23.5 million and would have been 24% of net sales, compared to 23% of net sales for the three months ended March 31, 2000. The increases principally resulted from our recent acquisitions. Furthermore, we have increased personnel and related costs in our operating entities in line with our business expansion. Amortization of Goodwill and Other Intangibles. Amortization of goodwill and other intangibles increased to $28.1 million for the first quarter of 2001 from $1.0 million for the three months ended March 31, 2000. The increase in these costs was affected by our recent acquisitions. We expect to incur additional amortization of goodwill and other intangibles resulting from these acquisitions totaling approximately $26.5 million each quarter until fully amortized in 2005. Furthermore, as we continue to engage in strategic acquisitions, additional goodwill and intangibles may be recorded. Interest and Other Income and Expense. In June 1998, we issued $100.0 million principal amount of 5% convertible subordinated debentures due in 2003. The debentures were offered in a 144A private placement to qualified institutional investors at the stated amount, less a selling discount of 3%. In late 1998, we repurchased $10.0 million principal amount of the Notes at a discount from the stated amount. We incurred $1.2 million in interest expense relating to the Notes for the three months ended March 31, 2001 and 2000. The increase in expense in other expenses, net is primarily attributed to the costs of our unconsolidated development stage enterprises of $1.3 million for the three months ended March 31, 2001 as compared to $486,000 for the three months ended March 31, 2000. The remaining components of other expense, net is primarily interest income recognized from short-term and long-term investments. Credit for Income Taxes. The credit for income taxes for the three months ended March 31, 2001 was $2.7 million, compared to a credit of $494,000 for three months ended March 31, 2000. The increase in the credit for income taxes in 2001 over 2000 was primarily attributable to a larger loss for tax purposes in 2001. Our income tax expense fluctuates primarily due to the tax jurisdictions where we currently have operating facilities and varying tax rates in those jurisdictions. 13 14 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 $190.5 million at March 31, 2001, compared to $210.1 million at December 31, 2000. As of March 31, 2001, we had working capital of $346.3 million, compared with $366.8 million as of December 31, 2000. The ratio of current assets to current liabilities at March 31, 2001 was 3.8 to 1, compared to 4.3 to 1 at December 31, 2000. These decreases are primarily attributable to capital expenditures. Cash used in operating activities was $25.7 million for the three months ended March 31, 2001, compared to cash used in operating activities of $9.4 million for the three months ended March 31, 2000. Cash used in operating activities was primarily impacted by our net loss, partially offset by the amortization of goodwill and amortization of deferred stock compensation. The increase in cash used in operating activities was also a result of an overall increase in our current assets. Cash provided by investing activities was $358,000 for the three months ended March 31, 2001, compared to cash used in investing activities of $7.4 million for the three months ended March 31, 2000. We spent approximately $16.4 million on the purchase of property and equipment for business expansion and increased manufacturing capacity. We received cash of $16.8 million from the sale of investments. Cash provided by financing activities was primarily generated through short-term borrowings during the three months ended March 31, 2001 and through proceeds from the issuance of common stock during the three months ended March 31, 2000. In June 1998, we issued $100.0 million principal amount of 5% convertible subordinated debentures due 2003 in a private placement raising net proceeds of $96.4 million. The debentures are convertible into our 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 our common stock. The debentures bear interest at 5% per annum, which is payable semi-annually on June 15 and December 15 of each year. The debentures have a five-year term and are callable by us on or after June 15, 2001. The premiums payable to call the debentures 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. We believe that our cash flows from operations will be sufficient to satisfy our working capital, capital expenditure and research and development requirements for at least the next 12 months. However, we may require or choose to obtain additional debt or equity financing in order to finance acquisitions or other investments in our business. We will continue to devote resources for expansion and other business requirements. Our future capital requirements will depend on many factors, including acquisitions, our 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 14 15 introductions and enhancements to existing products and market acceptance of our products. Effects of Inflation We believe that the relatively moderate rate of inflation in the United States over the past few years has not had a significant impact on our sales or operating results or on the prices of raw materials. However, in view of our 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 our operating results in the future. Quantitative and Qualitative Disclosure about Market Risks We operate on an international basis. A majority of our revenues and expenses are incurred in U.S. dollars, however, a significant portion of our revenues and expenses are incurred in other currencies. Fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar will cause U.S. dollar translation of such currencies to vary from one period to another. We cannot predict the effect of exchange rate fluctuations upon future operating results. However, because we have expenses as well as revenues in each of the principal functional currencies, the exposure to our financial results to currency fluctuations is reduced. We have not historically attempted to reduce our currency risks through hedging instruments, however, we 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. We adopted this statement in January 2001 and the adoption of this statement did not have a material impact on our 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. We have applied the provisions of SAB 101 in the consolidated financial statements. The adoption of SAB 101 did not have a material impact on our 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 our financial position or results of operations. Certain Risk Factors That Could Affect Future Results From time to time we may make written or oral forward-looking statements. Written forward-looking statements may appear in documents filed with the Securities and Exchange Commission, in press releases, and in reports to stockholders. The Private 15 16 Securities Reform Act of 1995 contains a safe harbor for forward-looking statements on which the Company relies in making such disclosures. In connection with this "safe harbor" we are hereby identifying important factors that could cause actual results to differ materially from those contained in any forward-looking statements made by or on behalf of the Company. Any such statement is qualified by reference to the following cautionary statements: WE INCURRED A NET LOSS IN THE YEAR ENDED DECEMBER 31, 2000, 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 $54.2 million for the three months ended March 31, 2001. A major contributing factor to the net losses was the amortization of goodwill 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 President and Chief Financial Officer. We will continue to record amortization of goodwill and deferred stock compensation relating to these acquisitions and our employment arrangements with Luminent's executives going forward. As a consequence of this amortization of goodwill and deferred stock compensation charges, we do not expect to report net income in the foreseeable future. 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 such 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; - 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 16 17 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 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, - 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. 17 18 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. 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 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. MACROECONOMIC FACTORS COULD NEGATIVELY IMPACT OUR GROWTH PLAN. Macroeconomic factors, such as an economic slowdown in the U.S. and abroad, could detrimentally impact demand for communication products, thereby resulting in reduced demand for optical components in general. These factors could negatively affect our ability to execute our growth plan. As a result of recent unfavorable economic conditions and reduced capital spending, sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States, were impacted during the last quarter of 2000, the first quarter of 2001 and may be similarly impacted in the second quarter of 2001. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories. If the economic conditions in the United States worsen generally or in the fiber optics and networking equipment businesses particularly, or if a wider or global economic slowdown occurs, we may experience a material adverse impact on our business, operating results, and financial condition. 18 19 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 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. FLUCTUATIONS IN THE PRICE OF THE COMMON STOCK OF OUR PUBLICLY TRADED SUBSIDIARY, LUMINENT, INC., MAY AFFECT THE PRICE OF OUR COMMON STOCK. The stock of our subsidiary, Luminent began trading publicly in November 2000. We own approximately 92% of Luminent. On April 30, 2001, our equity interest in Luminent had a market value of approximately $613.4 million (based on Luminent's closing price of $4.26 per share on that date and our ownership of 144 million shares of Luminent's common stock), which is significant with respect to our market value of approximately $578.6 million (based on a closing price of $7.59 per share of our common stock and 76,229,235 shares of our common stock outstanding on that date). Fluctuations in the price of Luminent's common stock are likely to affect the price of our common stock. The market price of Luminent's common stock has been highly volatile and subject to fluctuations unrelated or disproportionate to its operating performance. 19 20 OUR BUSINESS STRATEGY MAY NOT BE SUCCESSFUL IF VALUATIONS OF OPTICAL TECHNOLOGY AND NETWORKING INFRASTRUCTURE COMPANIES CONTINUE TO DECLINE. Our strategy involves creating value for our stockholders and the owners of our subsidiaries and partner companies by helping our subsidiaries and partner companies grow and access the public and private capital markets. Therefore, our success is dependent on acceptance by the public and private capital markets of optical technology and networking infrastructure companies in general and of initial public offerings of those companies in particular. If the capital markets for networking infrastructure companies or the market for initial public offerings of those companies remains weak for an extended period of time, our subsidiaries and partner companies may not be able to complete initial public offerings and thus the value we hope to create for our stockholders may not be realized. 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 $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 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 20 21 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 periods indicated below:
Three months ended Percent of total revenue March 31, from foreign sales ------------------- ------------------ 2000 59% 2001 58%
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; - 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. 21 22 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. 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 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 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 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 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 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 22 23 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 such 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 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. 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 - 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 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; - 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 23 24 - 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 companies, products, technologies or personnel of any business that we might acquire in the future. WE CANNOT PREDICT THE IMPACT OF RECENT ACTIONS AND COMMENTS BY THE SEC. Actions and comments from the SEC have indicated they are reviewing the current 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 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 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 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, Ortel's, Nortel's and IBM's, may be determined 24 25 to be valid, or some of our products may ultimately be determined to infringe the Lemelson, Rockwell, Lucent, Ortel, Nortel or IBM patents, or those of other companies. Lemelson, Rockwell, Lucent, Ortel, 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 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 such personnel with companies having substantially greater financial and other resources than we do. To attract executives, we have had to enter into compensation arrangements, like those with Dr. William R. Spivey, the President and Chief Executive of Luminent, that have resulted in substantial deferred compensation charges and adversely affected our results of operations. We may enter into similar 25 26 arrangements in the future to attract qualified executives. 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. 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 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 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 such assets may be unfavorable. 26 27 PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. Not applicable (b) Reports on Form 8-K No report on Form 8-K was filed during the quarter covered by this Report. 27 28 Signature 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 May 15, 2001. MRV COMMUNICATIONS, INC. By: /s/ Edmund Glazer ----------------------------------- Edmund Glazer Vice President of Finance and Administration and Chief Financial Officer 28 -----END PRIVACY-ENHANCED MESSAGE-----