10-Q 1 v77074e10-q.txt FORM 10-Q 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 SEPTEMBER 30, 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 September 30, 2001, there were 77,494,009 shares of Common Stock, $.0017 par value per share, outstanding. MRV COMMUNICATIONS, INC. FORM 10-Q, SEPTEMBER 30, 2001 INDEX
PAGE NUMBER ----------- PART I Financial Information Item 1: Financial Statements: Condensed Consolidated Balance Sheets as of September 30, 2001 (unaudited) and December 31, 2000 3 Condensed Consolidated Statements of Operations (unaudited) for the Nine and Three Months ended September 30, 2001 and 2000 4 Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Months ended September 30, 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 SIGNATURES 28
As used in this Report, "we", "us", "our", "MRV" or the "Company" refer to MRV Communications, Inc. and its consolidated subsidiaries. 2 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PAR VALUES)
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------- ------------ UNAUDITED ASSETS CURRENT ASSETS: Cash and cash equivalents $ 158,049 $ 210,080 Restricted cash 53,332 56,181 Short-term investments 1,499 17,766 Accounts receivable 58,979 62,713 Inventories 65,818 77,005 Deferred income taxes 31,095 31,227 Other current assets 22,351 22,750 ----------- ----------- Total current assets 391,123 477,722 PROPERTY AND EQUIPMENT -- At cost, net of depreciation and amortization 75,844 72,269 OTHER ASSETS: Goodwill and other intangibles 437,227 504,027 Deferred income taxes 7,797 6,209 Investments 33,122 31,734 Other assets 12,049 5,660 ----------- ----------- $ 957,162 $ 1,097,621 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of financing lease obligations and long-term debt $ 2,547 $ 2,937 Accounts payable 59,336 56,088 Accrued liabilities 40,393 34,894 Short-term debt 10,551 9,104 Deferred revenue 1,434 1,470 Income taxes payable 2,401 6,477 Other current liabilities 3,429 -- ----------- ----------- Total current liabilities 120,091 110,970 LONG-TERM LIABILITIES: Convertible debentures 89,646 89,646 Capital lease obligations, net of current portion 610 621 Long-term debt 61,692 60,257 Other long-term liabilities 2,574 3,980 ----------- ----------- 154,522 154,504 COMMITMENTS AND CONTINGENCIES MINORITY INTEREST 40,809 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 -- 77,542 shares in 2001 and 73,327 in 2000 Outstanding -- 77,494 shares in 2001 and 73,279 in 2000 132 126 Additional paid-in capital 1,094,361 1,060,650 Accumulated deficit (409,408) (171,330) Deferred stock compensation, net (33,370) (100,862) Treasury stock, 48 shares at cost in 2001 and 2000 (133) (133) Accumulated other comprehensive loss (9,842) (6,896) ----------- ----------- Total stockholders' equity $ 641,740 $ 781,555 ----------- ----------- $ 957,162 $ 1,097,621 =========== ===========
The accompanying notes are an integral part of these condensed consolidated balance sheets. 3 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
NINE MONTHS ENDED THREE MONTHS ENDED ---------------------------- ---------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 ------------- ------------- ------------- ------------- (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) REVENUES, net $ 259,364 $ 221,727 $ 69,730 $ 82,720 --------- --------- --------- --------- COSTS AND EXPENSES: Cost of goods sold 212,777 136,439 57,621 47,910 Research and development expenses 70,094 48,452 19,307 21,803 Selling, general and administrative expenses 133,375 94,180 51,252 52,699 Amortization of goodwill and intangibles from acquisitions 84,385 40,417 27,218 27,348 --------- --------- --------- --------- Operating loss (241,267) (97,761) (85,668) (67,040) Other expense, net (4,303) (7,442) (1,410) (5,764) Credit for income taxes (2,593) (1,888) (6,215) (1,005) Minority interest 10,085 (902) 3,646 (570) --------- --------- --------- --------- NET LOSS $(238,078) $(107,993) $ (89,647) $ (74,379) ========= ========= ========= ========= NET LOSS PER SHARE -- BASIC AND DILUTED $ (3.13) $ (1.71) $ (1.16) $ (1.06) ========= ========= ========= ========= SHARES USED IN PER-SHARE CALCULATION -- BASIC AND DILUTED 75,973 63,286 77,404 70,122 ========= ========= ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 MRV COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
NINE MONTHS ENDED ----------------------------- SEPTEMBER 30, SEPTEMBER 30, 2001 2000 ------------- ------------- (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net cash used in operating activities $(84,432) $(11,619) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (3,528) (12,178) Proceeds from sale of property and equipment 36 -- Purchases of investments -- (14,269) Investments in unconsolidated partner companies (3,457) (10,785) Proceeds from sale or maturity of investments 16,267 31,914 Cash used in acquisitions and equity purchases, net of cash received -- (44,517) -------- -------- Net cash provided by (used in) investing activities 9,318 (49,835) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from line of credit -- 60,877 Net proceeds from issuance of common stock 18,989 6,995 Borrowings on long-term debt 2,890 -- Payments on long-term debt (1,682) -- Payments on short-term debt (16,860) Borrowings on short-term debt 18,307 Principal payments on capital lease obligations (174) (544) Net decrease in other long-term liabilities (1,719) -- -------- -------- Net cash provided by financing activities 19,751 67,328 -------- -------- EFFECT OF EXCHANGE RATE CHANGES ON CASH, CASH EQUIVALENTS AND RESTRICTED CASH 483 (1,698) -------- -------- NET (DECREASE) INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH (54,880) 4,176 CASH, CASH EQUIVALENTS AND RESTRICTED CASH, beginning of period 266,261 34,330 -------- -------- CASH, CASH EQUIVALENTS AND RESTRICTED CASH, end of period $211,381 $ 38,506 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 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 (SEC). 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 September 30, 2001, and the results of their operations and their cash flows for the nine and three months then ended. 2. Business Combinations No material business combinations occurred during the nine and three months ended September 30, 2001. See our latest annual report on Form 10-K and management's discussion and analysis of financial conditions and results of operations in this 10-Q. The following unaudited pro forma financial information presents the combined results of operations with the acquisitions as if the acquisitions had occurred as of January 1, 2000, giving effect to certain adjustments, including amortization of goodwill and other intangibles and deferred stock compensation charges. The unaudited pro forma share data assumes the shares issued in connection with these acquisitions were outstanding as of January 1, 2000. (in thousands, except per share amounts; unaudited)
NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 2001 2000 2001 2000 --------- --------- --------- --------- Pro forma revenue $ 259,364 $ 237,599 $ 69,730 $ 83,055 Pro forma net loss (229,990) (172,601) (93,194) (67,384) Pro forma basic and diluted net loss per share $ (3.03) $ (2.73) $ (1.20) $ (0.96)
3. Loss Per Share Basic loss per common share are computed using the weighted average number of common shares outstanding during the period. Diluted loss per common share include the incremental shares issuable upon the assumed exercise of stock options and conversion of the convertible debentures. The effect of the assumed conversion of $89.6 million convertible debentures has not been included, as it would be anti-dilutive. The dilutive effect of MRV's 10.6 million stock options outstanding and 889,000 warrants outstanding have not been included in the loss per share computation as their effect would be anti-dilutive. 4. Comprehensive Income On January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income." For year-end financial statements, SFAS No. 130 requires that net income (loss) and all other non-owner changes in equity be displayed in a financial statement with the same prominence as other consolidated financial statements. In addition, the standard requires companies to display the components of comprehensive income as follows (in thousands).
NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 2001 2000 2001 2000 --------- --------- --------- --------- Net loss $(238,078) $(107,993) $ (89,647) $ (74,379) Foreign currency translation 483 (1,698) 1,394 760 Unrealized loss on interest rate swap (3,429) - (1,049) - --------- --------- --------- --------- Comprehensive loss $(241,024) $(109,691) $ (89,302) $ (73,619) ========= ========= ========= =========
6 5. Cash, Cash Equivalents, Restricted Cash and Short-Term Investments MRV considers all highly liquid investments with an original maturity of 90 days or less to be cash equivalents. Investments with maturities of less than one year are considered short-term. In connection with MRV's interest rate swap and its long-term debt (see Note 10, Interest Rate Swap), $53.3 million in cash has been restricted until the term loan and the swap expire in 2003. Furthermore, MRV maintains cash balances and investments in highly qualified financial institutions. At various times such amounts are in excess of insured limits. As of September 30, 2001 and December 31, 2000, cash, cash equivalents and short-term investments of $93.7 million and $132.9 million, respectively, were held by MRV's publicly traded subsidiary, Luminent. 6. Inventories Inventories are stated at the lower of cost or market and consist of materials, labor and overhead. Cost is determined by the first in, first out method. Inventories consist of the following as of September 30, 2001 and December 31, 2000 (in thousands):
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------- ------------ Raw materials $ 25,714 $ 36,278 Work-in process 11,458 17,721 Finished goods 28,646 23,006 -------- -------- $ 65,818 $ 77,005 ======== ========
7. Stock Distribution On May 26, 2000, the Company completed a two-for-one stock split. The effect of this stock split has been reflected in the accompanying condensed consolidated financial statements for all periods presented. 8. Segment Reporting and Geographical Information The Company operates several business units as well as invests in and manages start-up companies. These companies fall into two segments: operating entities and development stage enterprises. Segment information is therefore being provided on this basis. The operating business units of the Company design, manufacture and distribute optical components, optical wireless and switching solutions, next generation mobile communications systems, remote device management and managed fiber optic infrastructure products. The development stage enterprises that the Company has invested in or created focus on: core routing, network transportation, switching and IP services, and fiber optic components and systems. The primary activities of development stage entities have been to develop solutions and technologies of which significant revenues have yet to be earned. 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 nine and three months ended September 30, 2001 and 2000 (in thousands):
NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ------------------------ 2001 2000 2001 2000 -------- -------- -------- -------- Operating entities $259,364 $221,727 $ 69,730 $ 82,720 Development stage enterprises -- -- -- -- -------- -------- -------- -------- Total revenues $259,364 $221,727 $ 69,730 $ 82,720 ======== ======== ======== ========
There were no inter-segment sales in the nine and three months ended September 30, 2001 and 2000. Net Revenues By Product for the nine and three months ended September 30, 2001 and 2000 (in thousands):
NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ------------------------ 2001 2000 2001 2000 -------- -------- -------- -------- Optical passive components $ 32,102 $ 15,430 $ 8,454 $ 7,740 Optical active components 83,100 55,342 13,315 22,270 Switches and routers 54,656 60,884 15,869 18,417 Remote device management 14,070 16,351 6,103 4,257 Network physical infrastructure equipment 47,347 47,386 15,714 17,617 Services 16,545 15,985 6,955 5,691 Other 11,544 10,349 3,320 6,728 -------- -------- ------- ------- Total Revenues $259,364 $221,727 $69,730 $82,720 ======== ======== ======= =======
7 Business segment loss for the nine and three months ended September 30, 2001 and 2000 (in thousands):
NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 2001 2000 2001 2000 --------- --------- --------- --------- Operating loss Operating entities $(199,419) $ (76,494) $(72,061) $(59,055) Development stage enterprises (41,848) (21,267) (13,607) (7,985) Other income (expense) Interest expense related to convertible debentures (3,375) (3,375) (1,125) (1,125) Other income (expense), net 1,986 2,661 (415) 652 Development stage enterprises (2,914) (6,728) 130 (5,291) --------- --------- -------- -------- Loss before provision (credit) for income taxes and minority interest $(245,570) $(105,203) $(87,078) $(72,804) ========= ========= ======== ========
For the nine months ended and as of September 30, 2001, the Company had no single customer that accounted for more than 10 percent of revenues or accounts receivable. The Company does not track customer revenues by region for each individual reporting segment. A summary of external revenue by region follows (in thousands):
NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 2001 2000 2001 2000 -------- -------- -------- -------- United States $ 93,789 $ 87,416 $ 21,597 $ 32,384 Asia Pacific 35,118 27,102 7,872 8,931 European 127,563 102,696 39,963 40,153 Other 2,894 4,513 298 1,252 -------- -------- -------- -------- Total net sales $259,364 $221,727 $ 69,730 $ 82,720 ======== ======== ======== ========
Loss before credit for income taxes (in thousands):
NINE MONTHS ENDED THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 2001 2000 2001 2000 --------- --------- --------- --------- United States $(126,385) $ (99,778) $ (43,567) $ (74,022) Foreign (109,100) (6,327) (39,865) 648 --------- --------- --------- --------- Loss before credit for income taxes $(235,485) $(106,105) $ (83,432) $ (73,374) ========= ========= ========= =========
9. RESTRUCTURING AND OTHER CHARGES In the second quarter of 2001, the management of Luminent, a publicly traded subsidiary of the Company, approved and implemented a restructuring plan and other actions in order to adjust operations and administration as a result of the dramatic slowdown in the communications equipment industry generally and the optical components sector in particular. Major actions comprising Luminent's restructuring activities primarily involve the reduction of facilities in the U.S. and in Taiwan, the reduction of workforce, the abandonment of certain assets, and the cancelation and termination of purchase commitments. These actions are expected to realign Luminent's business based on current and near term growth rates. All of these actions are scheduled for completion by the second quarter of 2002. During the three and nine months ended September 30, 2001, Luminent recorded restructuring charges totaling $3.0 million and $17.5 million, respectively. Costs for restructuring activities are limited to either incremental costs that directly result from the restructuring activities and provide no future revenue generating benefit or costs incurred under contractual obligations that existed before the restructuring plan and will continue with either no future revenue generating benefit or become a penalty incurred for termination of the obligation. Employee severance costs and related benefits of $1.1 million are related to approximately 500 and 600 layoffs during the three and nine months ended September 30, 2001, respectively, bringing Luminent's total workforce to approximately 1,100 employees as of September 30, 2001. As of September 30, 2001, the employee severance reserve balance has been reduced by cash payments of approximately $1.0 million resulting in an ending reserve balance of $38,000. Affected employees came from all divisions and areas of Luminent. The majority of affected employees were in the manufacturing group. In addition to the costs associated with employee severance, Luminent identified a number of assets, including leased facilities and equipment that are no longer required due to current market conditions, operations and expected growth rates. The net facility costs related to closed and abandoned facilities of approximately $1.6 million and $2.7 million for the three and nine months ended September 30, 2001, respectively, are primarily related to future obligations under operating leases. The total lease charge is net of approximately $3.7 million in expected sublease revenue on leases that Luminent cannot terminate. In connection with these closed and abandoned facilities, Luminent has recorded asset impairment charges of $8.9 million in selling, general, and administrative for the nine months ended September 30, 2001, consisting of leasehold improvements and certain equipment to write-down the value of this equipment. Due to the specialized nature of these assets, Luminent has determined that these assets have minimal or no future benefit and has recorded a provision reflecting the net book value relating to these assets. Luminent expects to complete disposal of this equipment early in 2002. Purchase commitments of $1.5 million and $3.9 million, recorded in cost of sales, for the three and nine months ended September 30, 2001, respectively, are to cancel or renegotiate outstanding contracts for materials and capital assets that are no longer required due to Luminent's significantly reduced orders for optical components and sales projections over the next twelve months. As of September 30, 2001, the provision has been reduced by cash payments of $1.1 million and $1.3 million for the three and nine months ended September 30, 2001, respectively, and non-cash related charges of $8.9 million for the nine months ended September 30, 2001, resulting in an ending balance of $7.4 million. Luminent expects to utilize the remaining balance by the end of the second quarter of 2002. Luminent expects that it will spend approximately $4.5 million through the next three quarters to carry out the plan, which will be paid through cash and cash equivalents and through operating cash flows. Luminent expects to begin to realize savings related to the workforce reductions in late 2001 with estimated ongoing quarterly net savings of $2.4 million. In addition, Luminent will realize reduced depreciation charges of approximately $384,000 per quarter through December 2004 and $163,000 per quarter through December 2005 for facility costs. These savings are expected to be realized as reductions in cost of sales, research and development and selling, general and administrative expenses. A summary of the restructuring costs for the nine months ended September 30, 2001 consist of the following:
Remaining Original Provision Additional Provision Utilized Balance ------------------ -------------------- ------------- ------------- Exit costs Asset impairment $ 8,904,000 $ -- $ 8,904,000 $ -- Closed and abandoned facilities 1,108,000 1,584,000 89,000 2,603,000 Purchase commitments 2,402,000 1,460,000 102,000 3,760,000 Other 991,000 -- 41,000 950,000 ------------- ------------- ------------- ------------- 13,405,000 3,044,000 9,136,000 7,313,000 Employee severance costs 1,072,000 -- 1,034,000 38,000 ------------- ------------- ------------- ------------- $ 14,477,000 $ 3,044,000 $ 10,170,000 $ 7,351,000 ============= ============= ============= =============
A summary of the restructuring costs by line item for the three and nine months ended September 30, 2001 consist of the following:
Three Months Ended Nine Months Ended September 30, 2001 September 30, 2001 ------------------ ------------------ Cost of sales $ 1,460,000 $ 4,628,000 Selling, general and administrative 1,584,000 12,376,000 Research and development -- 501,000 Other income, net -- 16,000 ----------- ----------- Total restructuring costs $ 3,044,000 $17,521,000 =========== ===========
As a result of the significant negative economic and industry trends impacting Luminent's expected sales over the next twelve months, Luminent also recorded a one-time $26.1 million charge to write-down the remaining book value of certain inventory related to certain transceivers, duplexors, and triplexors that are previous generation products to its realizable value during the three months ended June 30, 2001. The one-time charge to write-down inventory was subsequently reduced by $3.7 million during the three months ended September 30, 2001 to reflect the utilization of previously written-off items. An additional $3.1 million of inventory was written down during the three months ended September 30, 2001 to reflect the identification of additional inventory that is not expected to be utilized as a result of Luminent's significantly reduced orders for optical components and sales projections for the next twelve months. The inventory charges and recoveries were recorded in cost of sales. Also included in one-time charges is a $598,000 charge to bad debt recorded in selling, general and administrative expenses during the nine months ended September 30, 2001 to reflect customer bankruptcies that have resulted from the severe market downturn. In addition, as part of Luminent's review of the impairment of certain long-lived assets, Luminent's management performed an assessment of the carrying amount of goodwill recorded in connection with its various acquisitions. This assessment, based on the undiscounted future cash flows, determined that no write-down of goodwill was required for the nine months ended September 30, 2001 (see Note 8). 8 10. Interest Rate Swap MRV entered into an interest rate swap in the second quarter of 2000 to effectively change the interest rate characteristics of its $50.0 million variable-rate term loan presented in Long-Term Debt, with the objective of fixing its overall borrowing costs. The swap was entered into concurrently with the issuance of the related debt. The notional amount, interest payment and maturity dates of the swap match the principal, interest payment and maturity dates of the related debt. Accordingly, any market risk or opportunity associated with this swap is offset by the opposite market impact on the related debt. The interest rate swap is considered to be 100 percent effective and is therefore recorded using the short-cut method. The swap is designated as a cash flow hedge and changes in fair value of the debt are generally offset by changes in fair value of the related security, resulting in negligible net impact. The gain or loss from the change in fair value of the interest rate swap as well as the offsetting change in the hedged fair value of the long-term debt are recognized in Other Comprehensive Income. Prior to the adoption of SFAS 133, the interest rate swap related to this long-term debt was not recognized in the balance sheet, nor were the changes in the market value of the debt. The net settlements of the swap are included in interest expense. For the nine months ended September 30, 2001, the Company recorded an unrealized loss on its interest rate swap of $3.4 million included in Other Comprehensive Income. At September 30, 2001, the interest rate swap had a fair value of $3.4 million included in Other Current Liabilities. 11. 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 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. The FASB recently approved two statements: SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets," which provide guidance on the accounting for business combinations, requires all future business combinations to be accounted for using the purchase method, discontinues amortization of goodwill, defines when and how intangible assets are amortized, and requires an annual impairment test for goodwill. We plan to adopt these statements effective January 1, 2002. We are currently reviewing these standards to determine the impact on our results of operation and financial position. The most significant anticipated effect on our financial statement on adoption would be discontinuing goodwill amortization and the possible recording of a goodwill impairment loss measured as of the date of adoption. 12. Supplemental Statements of Cash Flows Information (in thousands):
NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 2001 2000 -------- -------- Supplemental disclosure of cash flow information: Cash paid during period for interest $ 6,937 $2,677 Cash paid during period for taxes $ 3,144 $ 417
9 13. Certain Relationships Prior to Luminent's separation from MRV, the companies entered into various agreements providing for MRV to supply transitional services and support to Luminent. As of September 30, 2001, Luminent had incurred $6.2 million in estimated income tax liability due to MRV. Luminent has repaid approximately $4.7 million of this obligation through offsetting amounts due from MRV on or before September 30, 2001. As of September 30, 2000, Luminent had recorded a total of $588,000 from MRV for corporate allocations and other operation related matters. Luminent repaid this amount to MRV through operating cash and offsetting amounts due from MRV on or before September 30, 2000. Although the fees provided for in the agreements are intended to represent fair market value of these services, MRV and Luminent cannot assure that these fees necessarily reflect the costs of providing these services from unrelated third parties. However, MRV believes that providing these services to Luminent provided an efficient means of obtaining them. In connection with the Merger, these agreements will be terminated. 14. Reclassifications Certain prior year amounts have been reclassified to conform with the current year presentation. 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 totaled $437.2 million as of September 30, 2001. For the three and nine months ended September 30, 2001, we recorded amortization of goodwill and other intangibles of $27.2 million and $84.4 million, respectively. We expect to record amortization charges of goodwill and other intangibles of approximately $27.2 million per quarter through December 31, 2001. At January 1, 2002, we intend to implement SFAS No. 142, "Goodwill and Other Intangible Assets." (see Recently Issued Accounting Standards). 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 $106.6 million and have been recorded as deferred stock compensation. Deferred stock compensation amortization expenses for the three and nine months ended September 30, 2001 relating to these stock options were approximately $28.1 million and $62.1 million, respectively, compared with $27.8 million and $35.3 million in the three and nine months ended September 30, 2000, respectively. We expect to incur approximately $33.4 million of additional 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 former President and Chief Executive Officer and its Vice President of Finance and Chief Financial Officer. The agreements provide for annual salaries, performance bonuses and combinations of stock options to purchase shares of 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 for the three and nine months ended September 30, 2001 was $22.3 million and $35.3 million, respectively, and we will incur additional deferred stock compensation of approximately $2.6 million through 2004. Luminent's President and Chief Executive Officer, Dr. William R. Spivey, resigned in September 2001. Dr. Spivey's resignation was considered by the parties to be a termination other than for cause under his employment agreement entitling him to the severance benefits of his employment agreement, including payment over a one-year period of an amount equal to two times the sum of his annual salary plus bonus and the vesting of all of his unvested Luminent options. Dr. Spivey's MRV and Luminent stock options are exercisable through September 11, 2003. During the quarter ended September 30, 2001, we recorded a charge of $1.0 million to reflect severance expense and an immediate write-down of deferred stock compensation expense of $18.9 million. 11 We reported a net loss of $89.6 million and $238.1 million for the three and nine months ended September 30, 2001 respectively. A significant portion of the net loss was due to the amortization of goodwill and other intangibles and deferred stock compensation related to our recent acquisitions and our employment arrangements with Luminent's former President and its Chief Financial Officer. Effective January 1, 2002, the adoption of SFAS 142 will stop amortization of goodwill, however, it may require us to record an impairment charge (see Recently Issued Accounting Standards). We will continue to record amortization of deferred stock compensation through 2004, relating to these acquisitions and our employment arrangements with Luminent's Chief Financial Officer. As a consequence of the amortization of 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. While we had planned to distribute all of our shares of Luminent common stock to our stockholders, unfavorable business and economic conditions in the fiber optic, data networking and telecommunications industries and the resulting adverse effects on the market prices of our common stock and the common stock of Luminent has caused us to abandon the distribution and effect a short-form merger of Luminent into our wholly-owned subsidiary, MRV Merger Sub Corp., thereby eliminating public ownership of Luminent. Upon consummation of this merger, MRV Merger Sub will become the surviving corporation and the corporate existence of Luminent will cease. Each outstanding share of Luminent common stock (except for shares held by MRV Merger Sub, which will be cancelled, and shares held by Luminent stockholders who perfect their statutory appraisal rights under Delaware law) will be converted in the merger. Former Luminent stockholders whose shares are converted will be entitled to receive 0.43 of a share of our common stock for each share of Luminent common stock owned at the effective time of the merger. If all these Luminent shares are converted in the merger, we will issue 5,160,000 shares of our common stock to the former Luminent stockholders. In addition, upon completion of the merger, we will assume in the merger, options to purchase Luminent common stock that are outstanding. These Luminent stock options will be converted into options to purchase approximately 5,245,580 shares of our common stock containing the same vesting provisions and intrinsic value. 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. This offering has not been completed and, based on current market conditions, we do not expect it to be completed in the foreseeable future, if ever. Accordingly, Optical Access will be submitting an application to the SEC to withdraw its registration statement. Because of the time lapse since the initial filing, in the nine months ended September 30, 2001, we expensed all costs ($1.1 million) of this offering. Optical Access designs, manufactures and markets an optical wireless solution that delivers high-speed communications traffic to the portion of the communications network commonly known as the last mile, which extends from the end user to the service provider's central office. In the second quarter of 2001, the management of Luminent, our publicly traded subsidiary, approved and implemented a restructuring plan and other actions in order to adjust operations and administration as a result of the dramatic slowdown in the communications equipment industry generally and the optical components sector in particular. Major actions comprising Luminent's restructuring activities primarily involve the reduction of facilities in the U.S. and in Taiwan, the reduction of workforce, the abandonment of certain assets, and the cancelation and termination of purchase commitments. These actions are expected to realign Luminent's business based on current and near term growth rates. All of these actions are scheduled for completion by the second quarter of 2002. During the three and nine months ended September 30, 2001, Luminent recorded restructuring charges totaling $3.0 million and $17.5 million, respectively. Costs for restructuring activities are limited to either incremental costs that directly result from the restructuring activities and provide no future revenue generating benefit or costs incurred under contractual obligations that existed before the restructuring plan and will continue with either no future revenue generating benefit or become a penalty incurred for termination of the obligation. Employee severance costs and related benefits of $1.1 million are related to approximately 500 and 600 layoffs during the three and nine months ended September 30, 2001, respectively, bringing Luminent's total workforce to approximately 1,100 employees as of September 30, 2001. As of September 30, 2001, the employee severance reserve balance has been reduced by cash payments of approximately $1.0 million resulting in an ending reserve balance of $38,000. Affected employees came from all divisions and areas of Luminent. The majority of affected employees were in the manufacturing group. In addition to the costs associated with employee severance, Luminent identified a number of assets, including leased facilities and equipment that are no longer required due to current market conditions, operations and expected growth rates. The net facility costs related to closed and abandoned facilities of approximately $1.6 million and $2.7 million for the three and nine months ended September 30, 2001, respectively, are primarily related to future obligations under operating leases. The total lease charge is net of approximately $3.7 million in expected sublease revenue on leases that Luminent cannot terminate. In connection with these closed and abandoned facilities, Luminent has recorded asset impairment charges of $8.9 million in selling, general, and administrative for the nine months ended September 30, 2001, consisting of leasehold improvements and certain manufacturing equipment to write-down the value of this equipment. Due to the specialized nature of these assets, Luminent has determined that these assets have minimal or no future benefit and has recorded a provision reflecting the net book value relating to these assets. Luminent expects to complete disposal of this equipment early in 2002. Purchase commitments of $1.5 million and $3.9 million, recorded in cost of sales, for the three and nine months ended September 30, 2001, respectively, are to cancel or renegotiate outstanding contracts for materials and capital assets that are no longer required due to Luminent's significantly reduced orders for optical components and sales projections over the next twelve months. As of September 30, 2001, the provision has been reduced by cash payments of $1.1 million and $1.3 million for the three and nine months ended September 30, 2001, respectively, and non-cash related charges of $8.9 million for the nine months ended September 30, 2001, resulting in an ending balance of $7.4 million. Luminent expects to utilize the remaining balance by the end of the second quarter of 2002. Luminent expects that it will spend approximately $4.5 million through the next three quarters to carry out the plan, which will be paid through cash and cash equivalents and through operating cash flows. Luminent expects to begin to realize savings related to the workforce reductions in late 2001 with estimated ongoing quarterly net savings of $2.4 million. In addition, Luminent will realize reduced depreciation charges of approximately $384,000 per quarter through December 2004 and $163,000 per quarter through December 2005 for facility costs. These savings are expected to be realized as reductions in cost of sales, research and development and selling, general and administrative expenses. A summary of the restructuring costs for the nine months ended September 30, 2001 consist of the following:
Remaining Original Provision Additional Provision Utilized Balance ------------------ -------------------- ------------- ------------- Exit costs Asset impairment $ 8,904,000 $ -- $ 8,904,000 $ -- Closed and abandoned facilities 1,108,000 1,584,000 89,000 2,603,000 Purchase commitments 2,402,000 1,460,000 102,000 3,760,000 Other 991,000 -- 41,000 950,000 ------------- ------------- ------------- ------------- 13,405,000 3,044,000 9,136,000 7,313,000 Employee severance costs 1,072,000 -- 1,034,000 38,000 ------------- ------------- ------------- ------------- $ 14,477,000 $ 3,044,000 $ 10,170,000 $ 7,351,000 ============= ============= ============= =============
A summary of the restructuring costs by line item for the three and nine months ended September 30, 2001 consist of the following:
Three Months Ended Nine Months Ended September 30, 2001 September 30, 2001 ------------------ ------------------ Cost of sales $ 1,460,000 $ 4,628,000 Selling, general and administrative 1,584,000 12,376,000 Research and development -- 501,000 Other income, net -- 16,000 ----------- ----------- Total restructuring costs $ 3,044,000 $17,521,000 =========== ===========
As a result of the significant negative economic and industry trends impacting Luminent's expected sales over the next twelve months, Luminent also recorded a one-time $26.1 million charge to write-down the remaining book value of certain inventory related to certain transceivers, duplexors, and triplexors that are previous generation products to its realizable value during the three months ended June 30, 2001. The one-time charge to write-down inventory was subsequently reduced by $3.7 million during the three months ended September 30, 2001 to reflect the utilization of previously written-off items. An additional $3.1 million of inventory was written down during the three months ended September 30, 2001 to reflect the identification of additional inventory that is not expected to be utilized as a result of Luminent's significantly reduced orders for optical components and sales projections for the next twelve months. The inventory charges and recoveries were recorded in cost of sales. Also included in one-time charges is a $598,000 charge to bad debt recorded in selling, general and administrative expenses during the nine months ended September 30, 2001 to reflect customer bankruptcies that have resulted from the severe market downturn. In addition, as part of Luminent's review of the impairment of certain long-lived assets, Luminent's management performed an assessment of the carrying amount of goodwill recorded in connection with its various acquisitions. This assessment, based on the undiscounted future cash flows, determined that no write-down of goodwill was required for the nine months ended September 30, 2001 (see Note 8). 12 MARKET CONDITIONS AND CURRENT OUTLOOK Macroeconomic factors, such as an economic slowdown in the U.S. and abroad, have detrimentally impacted demand for optical components and networking infrastructure equipment. The unfavorable economic conditions and reduced capital spending has detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the U.S. during the last nine months, and appear to continue to affect these industries in the fourth quarter of 2001 and may affect them beyond the fourth quarter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories. As a result of the current slowdown in the communications industry we have recorded in our consolidated results for the second quarter of 2001, a one-time charge for Luminent's write-down of inventory, cancelation and termination of purchase commitments, asset impairment, workforce reduction, restructuring costs and other non-recurring items. These charges, totaling $41.2 million, resulted from the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the general communications equipment industry and the optical components sector in particular. As a result of this restructuring program, Luminent recorded net additional restructuring and other charges of $2.4 million during the three months ended September 30, 2001, primarily as a result of adjusted inventory valuations, increased facility costs and other commitments. RESULTS OF OPERATIONS The following table sets forth certain operating data as a percentage of total net sales for the nine and three months ended September 30, 2001 and 2000.
NINE MONTHS ENDED THREE MONTHS ENDED ----------------------------- ----------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) ------------- ------------- ------------- ------------- REVENUES, net 100% 100% 100% 100% -------- -------- -------- -------- COSTS AND EXPENSES: Cost of goods sold 82 62 83 58 Research and development expenses 27 22 28 26 Selling, general and administrative expenses 51 42 74 64 Amortization of goodwill and intangibles from acquisitions 33 18 39 33 -------- -------- -------- -------- Operating (loss) income (93) (44) (123) (81) Other expense, net (2) (3) (2) (7) Provision (credit) for income taxes (1) (1) (9) (1) Minority interest 4 0 5 (1) -------- -------- -------- -------- NET LOSS (92)% (49)% (129)% (90)% -------- -------- -------- --------
13 THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 The following management discussion and analysis refers to and analyzes our results of operations into two segments as defined by our management. These two segments are Operating Entities and Development Stage Enterprises including all startups activities. REVENUES, NET. We generally recognize product revenue, net of sales discounts and allowances, when persuasive evidence of an arrangement exists, delivery has occurred and all significant contractual obligations have been satisfied, the fee is fixed or determinable and collection is considered probable. Products are generally shipped "FOB shipping point" with no rights of return. Sales with contingencies, such as rights of return, rotation rights, conditional acceptance provisions and price protection, are rare and insignificant and are deferred until the contingencies have been satisfied or the contingent period has lapsed. We generally warrant our products against defects in materials and workmanship for one year. The estimated costs of warranty obligations and sales returns and other allowances are recognized at the time of revenue recognition based on contract terms and prior claims experience. Our major revenue-generating products consist of: optical passive and active components; switches and routers; remote device management; and network physical infrastructure equipment. Revenue generated through the sales of services and systems support has been insignificant in relation to our consolidated revenues. OPERATING ENTITIES - Revenues for the three and nine months ended September 30, 2001 were $69.7 million and $259.4 million, respectively, compared to revenues of $82.7 million and $221.7 million for the three and nine months ended September 30, 2000, respectively. The change represented a decrease of $13.0 million or 15.7% for the three months ended September 30, 2001 and an increase of $37.6 million or 17.0% for the nine months ended September 30, 2001 over the three and nine months ended September 30, 2000, respectively. Revenue generated through our recent acquisitions for the three and nine months ended September 30, 2001, was $10.8 million and $51.6 million, respectively. Revenue from our existing business was $58.9 million and $207.8 million for the three and nine months ended September 30, 2001, respectively. The decrease in revenue for the three months ended September 30, 2001 is primarily due to decreases in optical passive and active component revenue of 27.5%, or $8.2 million. In contrast to the reduction in revenue realized during the three months ended September 30, 2001, revenue increases for the nine months ended September 30, 2001, are a result of increases in optical passive and active component revenue of 62.8%, or 44.4 million. The dramatic shift in optical passive and active components was a result of the continued downturn in the communication equipment industry, which occurred during the second and third quarters of 2001. DEVELOPMENT STAGE ENTERPRISES - No significant revenues were generated by those entities during the three and nine months ended September 30, 2000 and 2001. GROSS PROFIT. Gross profit is equal to our revenues less our cost of goods sold. Our cost of goods sold includes materials, direct labor and overhead. Cost of inventory is determined by the first-in, first-out method. OPERATING ENTITIES - Gross profit for the three and nine months ended September 30, 2001 was $12.1 and $46.6 million, compared to gross profit of $34.8 million and $85.3 million during the three and nine months ended September 30, 2000. The changes represented a decrease of $22.7 million or 65.2% for the three months ended September 30, 2001 over the three months ended September 30, 2000 and a decrease of $38.7 million or 45.4% for the nine months ended September 30, 2001 over the nine months ended September 30, 2000. Our gross margins (defined as gross profit as a percentage of revenues) 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 decreased to 17.3% and 18.0% for the three and nine months ended September 30, 2001 compared to gross margins of 42.0% and 38.4% for the three and nine months ended September 30, 2000. The decrease in gross margin was partially attributed to a write-off of inventory and other charges of $30.1 million taken by Luminent during the nine months ended September 30, 2001. The gross margin decreases for the three and nine months were also partially due to the increase of the inventory reserve taken by other MRV networking subsidiaries. In addition, certain profitable, but low margin projects in Europe, contributed to the reduction in gross margin for the three months ended September 30, 2001, resulting from the concentration of European revenue which increased from 48.5% for the nine months ended September 30, 2001 to 57.4% out of total sales in the three months ended September 30, 2001. The decrease in our gross margins was also partially attributable to increased deferred compensation amortization expense. Prior to Luminent's restructuring and other charges of $863,000 and deferred stock compensation amortization of $3.3 million for the three months ended September, 30 2001, and Luminent's inventory write-downs and other market related charges of $ 30.1 million and deferred stock compensation amortization of $8.0 million for the nine months ending September, 30 2001 and deferred stock compensation amortization of $3.6 million for the three months and $4.3 million for the nine months ended September 30, 2000, gross margin would have been $16.3 million or 23.3% and $84.7 million or 32.7%, respectively, for the three and nine months ended September 30, 2001, compared to $38.4 million or 46.4% and $89.6 or 40.4% for the three and nine months ended September 30, 2000. DEVELOPMENT STAGE ENTERPRISES - No significant gross margins were produced by those entities during the three and nine months ended September 30, 2000 and 2001. RESEARCH AND DEVELOPMENT EXPENSES (R&D). R&D expenses decreased by 11.4%, to $19.3 million for the three months and increased by 44.7 to $70.1 million for nine months ended September 30, 2001, over the same three and nine month periods in 2000. OPERATING ENTITIES - R&D expenses of the operating entities were $8.4 million or 12.1% of revenues for the three months and $35.8 million or 13.8% of revenues for the nine months ended September 30, 2001, as compared to $13.8 million or 16.7% of revenues for the three months, and $27.2 million or 12.3% of revenues for the nine months ended September 30, 2000. This represents a decrease of $5.4 million or 38.9% for the three months and increase of $8.6 million or 31.5% for the nine months ended September 30, 2001 compared to the same periods in 2000. Excluding a benefit to deferred stock compensation amortization expense of $554,000 for the three months ended September 30, 2001 and deferred stock compensation amortization of $9.6 million for the nine months ended September 30, 2001 and deferred stock compensation amortization of $5.6 million and $6.8 million for the three months and nine months ended September 30, 2000, R&D expenses would have increased by 9.9% from $8.2 million to $9.0 million for the three months ended September 30, 2000 and 2001, respectively. R&D expenses would have increased by 28.2% from $20.4 million to $26.1 million during the nine months ended September 30, 2000 and 2001, respectively. DEVELOPMENT STAGE ENTERPRISES -. R&D expenses of the development stage enterprises were $10.9 million or 15.6% of revenues for the three months and $34.3 million or 13.2% of revenues for the nine months ended September 30, 2001, as compared to $8.0 million or 9.7% of revenues for the three months, and $21.3 million or 9.6% of revenues for the nine months ended September 30, 2000. This represents an increase of $2.9 million or 36.1% for the three months and an increase of $13.0 million or 61.5% for the nine months ended September 30, 2001 compared to the same periods in 2000. 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). Overall SG&A expenses decreased 2.7% to $51.3 million for the three months and increased 41.6% to $133.4 million for the nine months ended September 30, 2001, compared to the same three and nine month periods in 2000. SG&A expenses were 73.5% of Revenues for the three months and 51.4% of Revenues for the nine months ended September 30, 2001, respectively. Prior to Luminent's restructuring and other charges of $2.6 million and deferred stock compensation amortization of $25.4 million for the three months ended September 30, 2001 and Luminent's restructuring and other charges of $14.0 million and deferred stock compensation amortization of $45.6 million for the nine months ended September 30, 2001 and deferred stock compensation amortization of $14.6 million for the three months and $16.6 million for the nine months ended September 30, 2000, SG&A would have decreased 39.0% to $23.2 million for the three months, and decreased 4.9% to $73.8 million for the nine months ended September 30, 2001, respectively. As a percentage of sales, SG&A prior to Luminent's restructuring and other charges and deferred stock compensation amortization expenses would have been 28.4% and 33.3% in the three and nine month periods ended September 30, 2001, respectively, compared to 46.1% and 35.0% of net sales in the three and nine months periods ended September 30, 2000, respectively. OPERATING ENTITIES - SG&A expenses increased 20.4% to $45.2 million for the three months and increased 61.2% to $121.8 million for the nine months ended September 30, 2001, over the same three and nine month periods in 2000. SG&A expenses were 64.8% of net sales for the three months and 47.0% of net sales for the nine months ended September 30, 2001, respectively. Prior to Luminent's restructuring and other charges of $2.6 million and deferred stock compensation amortization of $25.4 million for the three months ended September 30, 2001 and Luminent's restructuring and other charges of $14.0 million and deferred stock compensation amortization of $45.6 million for the nine months ended September 30, 2001 and deferred stock compensation amortization of $14.6 million for the three months and $16.6 million for the nine months ended September 30, 2000, SG&A would have decreased 25.1% to $17.2 million for the three months, and decreased 5.5% to $62.2 million for the nine months ended September 30, 2001, respectively. As a percentage of revenues, SG&A prior to deferred stock compensation expenses would have been 24.6% and 24.0% in the three and nine month periods ended September 30, 2001, respectively, compared to 27.7% and 26.6% of revenues in the three and nine months periods ended September 30, 2000, respectively. These decreases are mainly due to the reduction of overhead expenses. DEVELOPMENT STAGE ENTERPRISES - The Development Stage Enterprises did not report SG&A expenses during the three and nine months ended September 30, 2000. During 2001 these companies began to develop their administrative capabilities and reported $6.0 million for the three months and $11.5 million for the nine months ended September 30, 2001. AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES FROM ACQUISITIONS. OPERATING ENTITIES - Amortization of goodwill and other intangibles decreased to $27.2 million for the three months and increased to $84.4 million for the nine months ended September 30, 2001, from $27.3 million and $40.4 million in the corresponding periods ending September 30, 2000. The increase in these costs during the nine months ended September 30, 2001 was the result of our recent acquisitions in 2000. We expect to incur additional amortization of goodwill and other intangibles resulting from these acquisitions totaling approximately $27.2 million each quarter through December 31, 2001 (see Recently Issued Accounting Standards). Furthermore, as we continue to engage in strategic acquisitions, additional goodwill and intangibles may be recorded. DEVELOPMENT STAGE ENTERPRISES - No amortization of goodwill was recorded in any of the Development Stage Enterprises. OTHER EXPENSE, NET. 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 $3.4 million and $1.1 million in interest expense relating to the Notes during the three and nine months ended September 30, 2001, as well as during the three and nine months ended September 30, 2000. No significant other expenses had been recorded in the Development Stage Enterprises. Other Expenses, Net, were $1.4 million for the three months and $4.3 million for the nine months ended September 30, 2001, as compared to $5.8 million for the three months, and $7.4 million for the nine months ended September 30, 2000. This represents a decrease of $4.4 million for the three months and $3.1 million for the nine months ended September 30, 2001, compared to the same periods in 2000. The decrease in other expenses net is primarily due to the increase of interest income of $1.1 million for the three months and $5.1 million for the nine months ended September 30, 2001. An additional decrease is attributed to the MRV's net loss in unconsolidated partner companies of $5.1 million for the three months and $3.3 for nine months ended September 30, 2001. 14 LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and restricted cash were $211.4 million at September 30, 2001, a decrease of $54.9 million from cash, cash equivalents and restricted cash of $266.3 million at December 31, 2000. Working capital at September 30, 2001 was $271.0 million compared to $366.8 million at December 31, 2000. Our ratio of current assets to current liabilities at September 30, 2001 was 3.3 to 1.0 compared to 4.3 to 1.0 at December 31, 2000. The decrease in working capital is substantially attributed to the cash requirements of our development stage enterprises and our consolidated net operating losses. Cash used in operating activities was $84.4 million for the nine months ended September 30, 2001, compared to cash used in operating activities of $11.6 million for the nine months ended September 30, 2000. Cash used in operating activities is a result of our net operating loss of $238.1 million, adjusted for non-cash items such as depreciation and amortization and deferred stock compensation charges, and offset by cash generated from operating assets and liabilities. Cash used in operating activities were primarily the result of decreased accounts receivables and inventories and increases in accounts payable and accrued liabilities, partially offset by increases in other current assets and decreases in income taxes payable, during the period. The decrease in inventory is primarily the result of inventory write-downs taken by Luminent. Increases in accounts payable and accrued liabilities are the result of growth in our non-Luminent businesses. Cash flows from investing activities were $9.3 million for the nine months ended September 30, 2001, compared to cash used in investing activities of $49.8 million for the nine months ended September 30, 2000. Cash flows provided by investing activities were the result of net proceeds of $16.3 million for the sale of short-term investments, offset by capital expenditures and investments in unconsolidated partner companies. Cash flows used in investing activities in the prior period resulted from the net cash used in our recent acquisitions of $44.5 million. Cash flows from financing activities were $19.8 million for the nine months ended September 30, 2001, compared to cash provided in financing activities of $67.3 million for the nine months ended September 30, 2000. Cash generated from financing activities was the result of proceeds received from the issuance of our common stock of $19.0 million and short-term borrowing of $18.3 million, offset by payments on short-term borrowings of $16.9 million, during the period. Cash flows provided by financing activities in the prior period represent the cash received through borrowings on our line of credit and the issuance of common stock. On November 10, 2000, Luminent completed the initial public offering of its common stock, selling 12.0 million shares at $12 per share. Their initial public offering raised net proceeds of approximately $132.3 million. In June 1998, we issued $100.0 million principal amount of 5% convertible subordinated debentures due in 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% 15 per annum, which is payable semi-annually on June 15 and December 15 of each year. The debentures have a five-year term and have been callable by us since 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 on-hand and cash flows from operations will be sufficient to satisfy our working capital, capital expenditures 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 introductions and enhancements to existing products and market acceptance of our products. Additionally, following the proposed merger with Luminent (see Overview), we will increase our liquidity based on Luminent's cash, cash equivalents and short-term investments on hand as of the consummation of the merger, or $93.7 million at September 30, 2001. MARKET RISKS Market risk represents the risk of loss that may impact our Consolidated Financial Statements through adverse changes in financial market prices and rates and inflation. Our market risk exposure results primarily from fluctuations in interest rates and foreign exchange rates. We manage our exposure to these market risks through our regular operating and financing activities and have not historically hedged these risks through the use of derivative financial instruments. The term "hedge" is used to mean a strategy designed to manage risks of volatility in prices or interest and foreign exchange rate movements on certain assets, liabilities or anticipated transactions and creates a relationship in which gains or losses on derivative instruments are expected to counter-balance the losses or gains on the assets, liabilities or anticipated transactions exposed to such market risks. Interest Rates. We are exposed to interest rate fluctuations on our investments, short-term borrowings and long-term obligations. Our cash and short-term investments are subject to limited interest rate risk, and are primarily maintained in money market funds and bank deposits. Our variable-rate short-term borrowings are also subject to limited interest rate risk due to their short-term maturities. Our long-term obligations were entered into with fixed and variable interest rates. In connection with our $50.0 million variable-rate term loan due in 2003, we entered into a specific hedge, an interest rate swap, to modify the interest characteristics of this instrument. The interest rate swap was used to reduce our cost of financing and the fluctuations in the aggregate interest expense. The notional amount, interest payment and maturity dates of the swap match the principal, interest payment and maturity dates of the related debt. Accordingly, any market risk or opportunity associated with this swap is offset by the opposite market impact on the related debt. To date, we have not entered into any other derivative instruments, however, as we continue to monitor our risk profile, we may enter into additional hedging instruments in the future. Foreign Exchange Rates. We operate on an international basis with a portion of our revenues and expenses being incurred in currencies other than the U.S. dollar. Fluctuations in the value of these foreign 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 and 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. 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 material adverse effect on our operating results 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. The FASB recently approved two statements: SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets," which provide guidance on the accounting for business combinations, requires all future business combinations to be accounted for using the purchase method, discontinues amortization of goodwill, defines when and how goodwill and other intangible assets are amortized, and requires an annual impairment test for goodwill. We plan to adopt those statements effective January 1, 2002. We are currently reviewing these standards to determine the impact on our results of operation and financial position. The most significant anticipated effect on our financial statements on adoption would be discontinuing goodwill amortization and the possible recording of a goodwill impairment loss measured as of the date of adoption. 16 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 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 AND DURING THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2001, PRIMARILY AS A RESULT OF THE AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES AND DEFERRED COMPENSATION CHARGES FROM RECENT ACQUISITIONS. WE EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE FORESEEABLE FUTURE. We reported a net loss of $153.0 million for the year ended December 31, 2000 and $259.4 million for the nine months ended September 30, 2001. A major contributing factor to the net losses was the amortization of goodwill and other intangibles and deferred stock compensation related to our acquisitions of Fiber Optic Communications, Jolt, Quantum Optech, AstroTerra and Optronics and our employment arrangements with Luminent's former President and Luminent's Chief Financial Officer. We will continue to record amortization of goodwill and other intangibles and deferred stock compensation relating to these acquisitions and the employment arrangements with these executives going forward. Effective January 1, 2002, with the adoption of SFAS 142, we will stop amortization of goodwill, however, we may be required to record an impairment charge (see Recently Issued Accounting Standards). As a consequence of goodwill and other intangibles and deferred stock compensation charges, we do not expect to report net income in the foreseeable future. OUR BUSINESS HAS BEEN ADVERSELY IMPACTED BY THE WORLDWIDE ECONOMIC SLOWDOWN AND RELATED UNCERTAINTIES. Weaker economic conditions worldwide, particularly in the U.S. and Europe, have contributed to the current technology industry slowdown and impacted our business resulting in: - reduced demand for of our products, particularly Luminent's fiber optic components; - increased risk of excess and obsolete inventories; - increased price competition for our products; - excess manufacturing capacity under current market conditions; and - higher overhead costs, as a percentage of revenues. These unfavorable economic conditions and reduced capital spending in the telecommunications industry detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States during 2001 to date, and may affect them for the balance of 2001 and thereafter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories and we are experiencing these reductions in our business. As a result of these factors, we have recorded in the nine months ended September 30, 2001, consolidated charges from our subsidiary, Luminent, which include the write-off of inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs, severance expenses and other unusual items. The aggregate charges recorded during the nine months ended September 30, 2001 were $44.7 million. These charges are primarily the result of the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. Additionally, these economic conditions are making it very difficult for MRV, Luminent and our other companies, our customers and our vendors to forecast and plan future business activities. This level of uncertainty severely challenges our ability to operate profitably or to grow our businesses. In particular, it is difficult to develop and implement strategy, sustainable business models and 17 efficient operations, and effectively manage manufacturing and supply chain relationships. Many analysts are predicting a further downturn in the U.S. economy in the aftermath of the terrorist attacks on the World Trade Center in New York and the Pentagon in Washington DC in September 2001. As discussed below in the section of these Risk Factors entitled, "We may have difficulty managing our business," we have lost a key member of our management team in the attack on the World Trade Center and that loss has already had and may in the future have adverse consequences on our business. However, we do not know how the consequences of these attacks will additionally affect our business. If the economic or market conditions continue or further deteriorate, or if the economic downturn is exacerbated as a result of political, economic or military conditions associated with current domestic and world events, our businesses, financial condition and results of operations could be further impaired. OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND TO COMPETE EFFECTIVELY, WE MUST CONTINUALLY INTRODUCE NEW PRODUCTS THAT ACHIEVE MARKET ACCEPTANCE. The markets for our products are characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. We expect that new technologies will emerge as competition and the need for higher and more cost effective transmission capacity, or bandwidth, increases. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address these changes as well as current and potential customer requirements. The introduction of new and enhanced products may cause our customers to defer or cancel orders for existing products. We have in the past experienced delays in product development and these delays may occur in the future. Therefore, to the extent customers defer or cancel orders in the expectation of a new product release or there is any delay in development or introduction of our new products or enhancements of our products, our operating results would suffer. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements, or to license these technologies from third parties. Product development delays may result from numerous factors, including: - changing product specifications and customer requirements; - difficulties in hiring and retaining necessary technical personnel; - difficulties in reallocating engineering resources and overcoming resource limitations; - difficulties with contract manufacturers; - changing market or competitive product requirements; and - unanticipated engineering complexities. The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. In order to compete, we must be able to deliver products to customers that are highly reliable, operate with its existing equipment, lower the customer's costs of acquisition, installation and maintenance, and provide an overall cost-effective solution. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Any failure to respond to technological changes would significantly harm our business. DEFECTS IN OUR PRODUCTS RESULTING FROM THEIR COMPLEXITY OR OTHERWISE COULD HURT OUR FINANCIAL PERFORMANCE. Complex products, such as those our companies and we offer, may contain undetected software or hardware errors when we first introduce them or when we release new versions. The occurrence of these errors in the future, and our inability to correct these errors quickly or at all, could result in the delay or loss of market acceptance of our products. It could also result in material warranty expense, diversion of engineering and other resources from our product development efforts and the loss of credibility with, and legal actions by, our customers, system integrators and end users. Any of these or other eventualities resulting from defects in our products could cause our sales to decline and have a material adverse effect on our business, operating results and financial condition. 18 OUR GROWTH RATE MAY BE LOWER THAN HISTORICAL LEVELS AND OUR RESULTS COULD FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER. Our revenues may grow at a slower rate in the future than we have experienced in previous periods and, on a quarter-to-quarter basis, our growth in revenue may be significantly lower than our historical quarterly growth rates. Our operating results for a particular quarter are extremely difficult to predict. Our revenue and operating results could fluctuate substantially from quarter to quarter and from year to year. This could result from any one or a combination of factors such as: - the cancellation or postponement of orders; - the timing and amount of significant orders from our largest customers; - our success in developing, introducing and shipping product enhancements and new products; - the mix of products we sell; - adverse effects to our financial statements resulting from, or necessitated by, past and future acquisitions or deferred compensation charges; - new product introductions by our competitors; - pricing actions by our competitors or us; - the timing of delivery and availability of components from suppliers; - changes in material costs; and - general economic conditions. Moreover, the volume and timing of orders we receive during a quarter are difficult to forecast. From time to time, our customers encounter uncertain and changing demand for their products. Customers generally order based on their forecasts. If demand falls below these forecasts or if customers do not control inventories effectively, they may cancel or reschedule shipments previously ordered from us. Our expense levels during any particular period are based, in part, on expectations of future sales. If sales in a particular quarter do not meet expectations, our operating results could be materially adversely affected. Our success is dependent, in part, on the overall growth rate of the fiber optic components and networking industry. We can give no assurance that the Internet or the industries that serve it will continue to grow or that we will achieve higher growth rates. Our business, operating results or financial condition may be adversely affected by any decreases in industry growth rates. In addition, we can give no assurance that our results in any particular period will fall within the ranges for growth forecast by market researchers. Because of these and other factors, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance. It is possible that, in future periods, our results of operations may be below the expectations of public market analysts and investors. This failure to meet expectations could cause the trading price of our common stock to decline. Similarly, the failure by our competitors or customers to meet or exceed the results expected by their analysts or investors could have a ripple effect on us and cause our stock price to decline. THE LONG SALES CYCLES FOR OUR PRODUCTS MAY CAUSE REVENUES AND OPERATING RESULTS TO VARY FROM QUARTER TO QUARTER, WHICH COULD CAUSE VOLATILITY IN OUR STOCK PRICE. The timing of our revenue is difficult to predict because of the length and variability of the sales and implementation cycles for our products. We do not recognize revenue until a product has been shipped to a customer, all significant vendor obligations have been performed and collection is considered probable. Customers often view the purchase of our products as a significant and strategic decision. As a result, customers typically expend significant effort in evaluating, testing and qualifying our products and our manufacturing process. This customer evaluation and qualification process frequently results in a lengthy initial sales cycle of, depending on the products, many months or more. In addition, some of our customers require that our products be subjected to 19 lifetime and reliability testing, which also can take months or more. While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing and research and development expenses to customize our products to the customer's needs. We may also expend significant management efforts, increase manufacturing capacity and order long lead-time components or materials prior to receiving an order. Even after this evaluation process, a potential customer may not purchase our products. Even after acceptance of orders, our customers often change the scheduled delivery dates of their orders. Because of the evolving nature of the optical networking and network infrastructure markets, we cannot predict the length of these sales, development or delivery cycles. As a result, these long sales cycles may cause our net sales and operating results to vary significantly and unexpectedly from quarter-to-quarter, which could cause volatility in our stock price. THE PRICES OF OUR SHARES MAY CONTINUE TO BE HIGHLY VOLATILE. Historically, the market price of our shares has been extremely volatile. The market price of our common stock is likely to continue to be highly volatile and could be significantly affected by factors such as: - actual or anticipated fluctuations in our operating results; - announcements of technological innovations or new product introductions by us or our competitors; - changes of estimates of our future operating results by securities analysts; - developments with respect to patents, copyrights or proprietary rights; and - general market conditions and other factors. In addition, the stock market has experienced extreme price and volume fluctuations that have particularly affected the market prices for the common stocks of technology companies in particular, and that have been unrelated to the operating performance of these companies. These factors, as well as general economic and political conditions, may materially adversely affect the market price of our common stock in the future. Similarly, the failure by our competitors or customers to meet or exceed the results expected by their analysts or investors could have a ripple effect on us and cause our stock price to decline. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, all of whom have been granted stock options. OUR STOCK PRICE MIGHT SUFFER AS A CONSEQUENCE OF OUR INVESTMENTS IN AFFILIATES. We have created several start-up companies and formed independent business units in the optical technology and Internet infrastructure areas. We account for these investments in affiliates according to the equity or cost methods as required by accounting principles generally accepted in the United States. The market value of these investments may vary materially from the amounts shown as a result of business events specific to these entities or their competitors or market conditions. Actual or perceived changes in the market value of these investments could have a material impact on our share price and in addition could contribute significantly to volatility of our share price. OUR DECISION TO ABANDON THE SPIN-OFF OF LUMINENT TO OUR STOCKHOLDERS AND TO ELIMINATE PUBLIC OWNERSHIP OF LUMINENT'S COMMON STOCK COULD HARM THE MARKET PRICE OF OUR COMMON STOCK. In 2000, we announced our intention to distribute to our stockholders the outstanding common stock of Luminent that we owned assuming certain conditions were met. While we informed our stockholders that we were not obligated to make this distribution and might not if economic, market or other conditions caused our board to decide against it, stockholders and analysts may react negatively to our decision to abandon the distribution or to eliminate public ownership of Luminent's common stock through the merger. On September 17, 2001, the first trading day following the announcement of our decision to abandon the distribution and effect the merger the closing price of our stock decreased from $3.23 to $2.43. While September 17, 2001, was the first day of the reopening of the stock market in the United States following the terrorists events of September 11, 2001 and our stock price has since increased, the decrease in the market price of our stock immediately following the announcement of the merger could reflect a negative reaction to the news of the merger and, depending on investors' continuing assessment of the impact of these events on our company, this reaction could be sustained or cause the market price of our shares drop lower. 20 OUR BUSINESS IS INTENSELY COMPETITIVE AND THE EVIDENT TREND OF CONSOLIDATIONS IN OUR INDUSTRY COULD MAKE IT MORE SO. The markets for fiber optic components and networking products are intensely competitive and subject to frequent product introductions with improved price/performance characteristics, rapid technological change and the continual emergence of new industry standards. We compete and will compete with numerous types of companies including companies that have been established for many years and have considerably greater financial, marketing, technical, human and other resources, as well as greater name recognition and a larger installed customer base, than we do. This may give these competitors certain advantages, including the ability to negotiate lower prices on raw materials and components than those available to us. In addition, many of our large competitors offer customers broader product lines, which provide more comprehensive solutions than our current offerings. We expect that other companies will also enter markets in which we compete. Increased competition could result in significant price competition, reduced profit margins or loss of market share. We can give no assurance that we will be able to compete successfully with existing or future competitors or that the competitive pressures we face will not materially and adversely affect our business, operating results and financial condition. In particular, we expect that prices on many of our products will continue to decrease in the future and that the pace and magnitude of these price decreases may have an adverse impact on our results of operations or financial condition. There has been a trend toward industry consolidation for several years. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry. We believe that industry consolidation may provide stronger competitors that are better able to compete. This could have a material adverse effect on our business, operating results and financial condition. WE MAY HAVE DIFFICULTY MANAGING OUR BUSINESSES. We have grown rapidly in recent years, with revenues increasing from $88.8 million for the year ended December 31, 1996, to $319.4 million for the year ended December 31, 2000. Our growth, both internally and through the acquisitions we have made has placed a significant strain on our financial and management personnel and information systems and controls. As a consequence, we must continually implement new and enhance existing financial and management information systems and controls and must add and train personnel to operate these systems effectively. Our delay or failure to implement new and enhance existing systems and controls as needed could have a material adverse effect on our results of operations and financial condition in the future. Our intention to continue to pursue a growth strategy can be expected to place even greater pressure on our existing personnel and to compound the need for increased personnel, expanded information systems, and additional financial and administrative control procedures. We can give no assurance that we will be able to successfully manage operations if they continue to expand. Edmund Glazer, our Vice President of Finance and Administration and Chief Financial Officer was killed on September 11, 2001 in the terrorists' attack on the World Trade Center. His death has created a void in our management team that will exist until a suitable replacement or replacements are found. Until a successor or successors to Mr. Glazer are found and begin performing duties he previously handled and managed, we may face difficulties in compiling, reviewing and releasing financial information and this could result in delays in releasing this information to the public and our meeting deadlines to file the reports required of a public company. These difficulties could adversely affect the marketplace's perception of MRV resulting in decreases in our stock price. WE FACE RISKS FROM OUR INTERNATIONAL OPERATIONS. International sales have become an increasingly important segment of our operations. The following table sets forth the percentage of our total net revenues from sales to customers in foreign countries for the periods indicated below:
NINE MONTHS ENDED YEAR ENDED DECEMBER 31, SEPTEMBER 30, -------------------------- ------------------ 1998 1999 2000 2000 2001 ---- ---- ---- ---- ---- Percent of total revenue from foreign sales 59% 58% 63% 61% 64%
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 21 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. The majority of our sales are currently denominated in U.S. dollars and to date our business has not been significantly affected by currency fluctuations or inflation. However, as we conduct business in several different countries, fluctuations in currency exchange rates could cause our products to become relatively more expensive in particular countries, leading to a reduction in sales in that country. In addition, inflation or fluctuations in currency exchange rates in these countries could increase our expenses. The Single European Currency (Euro) was introduced on January 1, 1999 with complete transition to this new currency required by January 2002. We have made and expect to continue to make changes to our internal systems in order to accommodate doing business in the Euro. Any delays in our ability to be Eurocompliant could have an adverse impact on our results of operations or financial condition. Due to numerous uncertainties, we cannot reasonably estimate at this time the effects a common currency will have on pricing within the European Union and the resulting impact, if any, on our financial condition or results of operations. To date, we have not hedged against currency exchange risks. In the future, we may engage in foreign currency denominated sales or pay material amounts of expenses in foreign currencies and, in that event, may experience gains and losses due to currency fluctuations. Our operating results could be adversely affected by currency fluctuations or as a result of inflation in particular countries where material expenses are incurred. WE DEPEND ON THIRD-PARTY CONTRACT MANUFACTURERS FOR NEEDED COMPONENTS AND THEREFORE COULD FACE DELAYS HARMING OUR SALES. We outsource the board-level assembly, test and quality control of material, components, subassemblies and systems relating to our networking products to third-party contract manufacturers. Though there are a large number of contract manufacturers that we can use for outsourcing, we have elected to use a limited number of vendors for a significant portion of our board assembly requirements in order to foster consistency in quality of the products and to achieve economies of scale. These independent third-party manufacturers also provide the same services to other companies. Risks associated with the use of independent manufacturers include unavailability of or delays in obtaining adequate supplies of products and reduced control of manufacturing quality and production costs. If our contract manufacturers failed to deliver needed components timely, we could face difficulty in obtaining adequate supplies of products from other sources in the near term. We can give no assurance that our third party manufacturers will provide us with adequate 22 supplies of quality products on a timely basis, or at all. While we could outsource with other vendors, a change in vendors may require significant lead-time and may result in shipment delays and expenses. Our inability to obtain these products on a timely basis, the loss of a vendor or a change in the terms and conditions of the outsourcing would have a material adverse effect on our business, operating results and financial condition. WE MAY LOSE SALES IF SUPPLIERS OF OTHER CRITICAL COMPONENTS FAIL TO MEET OUR NEEDS. Our companies currently purchase several key components used in the manufacture of our products from single or limited sources. We depend on these sources to meet our needs. Moreover, we depend on the quality of the products supplied to us over which we have limited control. We have encountered shortages and delays in obtaining components in the past and expect to encounter shortages and delays in the future. If we cannot supply products due to a lack of components, or are unable to redesign products with other components in a timely manner, our business will be significantly harmed. We have no long-term or short-term contracts for any of our components. As a result, a supplier can discontinue supplying components to us without penalty. If a supplier discontinued supplying a component, our business may be harmed by the resulting product manufacturing and delivery delays. OUR INABILITY TO ACHIEVE ADEQUATE PRODUCTION YIELDS FOR CERTAIN COMPONENTS WE MANUFACTURE INTERNALLY COULD RESULT IN A LOSS OF SALES AND CUSTOMERS. We rely heavily on our own production capability for critical semiconductor lasers and light emitting diodes used in our products. Because we manufacture these and other key components at our own facilities and these components are not readily available from other sources, any interruption of our manufacturing processes could have a material adverse effect on our operations. Furthermore, we have a limited number of employees dedicated to the operation and maintenance of our wafer fabrication equipment, the loss of any of whom could result in our inability to effectively operate and service this equipment. Wafer fabrication is sensitive to many factors, including variations and impurities in the raw materials, the fabrication process, performance of the manufacturing equipment, defects in the masks used to print circuits on the wafer and the level of contaminants in the manufacturing environment. We can give no assurance that we will be able to maintain acceptable production yields and avoid product shipment delays. In the event adequate production yields are not achieved, resulting in product shipment delays, our business, operating results and financial condition could be materially adversely affected. FUTURE HARM COULD RESULT FROM ADDITIONAL ACQUISITIONS. An important element of our strategy is to review acquisition prospects that would complement our existing companies and products, augment our market coverage and distribution ability or enhance our technological capabilities. Future acquisitions could have a material adverse effect on our business, financial condition and results of operations because of the following: - possible charges to operations for purchased technology and restructuring similar to those incurred in connection with our acquisition of Xyplex in 1998; - potentially dilutive issuances of equity securities; - incurrence of debt and contingent liabilities; - incurrence of amortization expenses and impairment charges related to goodwill and other intangible assets and deferred compensation charges similar to those arising with the acquisitions of Fiber Optic Communications, Optronics, Quantum Optech, Jolt and Astroterra in 2000 (see Recently Issued Accounting Standards); - difficulties assimilating the acquired operations, technologies and products; - diversion of management's attention to other business concerns; - risks of entering markets in which we have no or limited prior experience; - potential loss of key employees of acquired organizations; and - difficulties in honoring commitments made to customers by management of the acquired entity prior to the acquisition. 23 We can give no assurance as to whether we can successfully integrate the companies, products, technologies or personnel of any business that we might acquire in the future. WE CANNOT PREDICT THE IMPACT OF POTENTIAL ACTIONS BY THE SEC WITH RESPECT TO OUR VALUATION METHODOLOGY FOR IN-PROCESS RESEARCH AND DEVELOPMENT RELATED TO BUSINESS COMBINATIONS. Actions and comments from the SEC have indicated it has been reviewing the valuation methodology of in-process research and development related to business combinations. We believe we are in compliance with all of the existing rules and related guidance as applicable to our business operations. However, the SEC may change these rules or issue new guidance applicable to our business in the future. There can be no assurance that the SEC will not seek to reduce the amount of in-process research and development previously expensed by us. This would result in the restatement of our previously filed financial statements and could have a material adverse effect on our operating results and financial condition for periods subsequent to the acquisitions. IF WE FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, WE MAY NOT BE ABLE TO COMPETE. We rely on a combination of trade secret laws and restrictions on disclosure and patents, copyrights and trademarks to protect our intellectual property rights. We cannot assure you that our pending patent applications will be approved, that any patents that may be issued will protect our intellectual property or that third parties will not challenge any issued patents. Other parties may independently develop similar or competing technology or design around any patents that may be issued to us. We cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Any of this kind of litigation, regardless of outcome, could be expensive and time consuming, and adverse determinations in any of this kind of litigation could seriously harm our business. WE COULD BECOME SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS, WHICH COULD BE COSTLY AND SUBJECT US TO SIGNIFICANT LIABILITY. From time to time, third parties, including our competitors, may assert patent, copyright and other intellectual property rights to technologies that are important to us. We expect we will increasingly be subject to license offers and infringement claims as the number of products and competitors in our market grows and the functioning of products overlaps. In this regard, in March 1999, we received a written notice from Lemelson Foundation Partnership in which Lemelson claimed to have patent rights in our vision and automatic identification operations, which are widely used in the manufacture of electronic assemblies. In April 1999, we received a written notice from Rockwell International Corporation in which Rockwell claimed to have patent rights in certain technology related to our metal organic chemical vapor deposition, or MOCVD, processes. In October 1999, we received written notice from Lucent Technologies, Inc. in which Lucent claimed we have violated certain of Lucent's patents falling into the general category of communications technology, with a focus on networking functionality. In October 1999, we received a written notice from Ortel Corporation, which has since been acquired by Lucent, in which Ortel claimed to have patent rights in certain technology related to our photodiode module products. In January 2001, we were advised that Lucent had assigned certain of its rights and claims to Agere Systems, Inc., including the claim made on the Ortel patent. To date, we have not been contacted by Agere regarding this patent claim. In July 2000, we received written notice from Nortel Networks, which claimed we violated Nortel's patent relating to technology associated with local area networks. In May 2001, we received written notice from IBM, which claims that several of our optical components and Internet infrastructure products make use of inventions covered by certain patents claimed by IBM. We are evaluating the patents noted in the letters. Aggregate net sales potentially subject to the foregoing claims amounted to approximately 30% of our total net sales during the year ended December 31, 2000, and 26% of our total net sales during the nine months ended September 30, 2001. Others' patents, including Lemelson's, Rockwell's, Lucent's, Agere's, Nortel's and IBM's, may be determined to be valid, or some of our products may ultimately be determined to infringe the Lemelson, Rockwell, Lucent, Agere, Nortel or IBM patents, or those of other companies. Lemelson, Rockwell, Lucent, Agere, Nortel or IBM, or other companies may pursue litigation with respect to these or other claims. The results of any litigation are inherently uncertain. In the event of an 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. 24 IN THE FUTURE, WE MAY INITIATE CLAIMS OR LITIGATION AGAINST THIRD PARTIES FOR INFRINGEMENT OF OUR PROPRIETARY RIGHTS TO PROTECT THESE RIGHTS OR TO DETERMINE THE SCOPE AND VALIDITY OF OUR PROPRIETARY RIGHTS OR THE PROPRIETARY RIGHTS OF COMPETITORS. THESE CLAIMS COULD RESULT IN COSTLY LITIGATION AND THE DIVERSION OF OUR TECHNICAL AND MANAGEMENT PERSONNEL. Necessary licenses of third-party technology may not be available to us or may be very expensive, which could adversely affect our ability to manufacture and sell our products. From time to time we may be required to license technology from third parties to develop new products or product enhancements. We cannot assure you that third-party licenses will be available to us on commercially reasonable terms, if at all. The inability to obtain any third-party license required to develop new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost, either of which could seriously harm our ability to manufacture and sell our products. WE ARE DEPENDENT ON CERTAIN MEMBERS OF OUR SENIOR MANAGEMENT. We are substantially dependent upon Dr. Shlomo Margalit, our Chairman of the Board of Directors and Chief Technical Officer, and Mr. Noam Lotan, our President and Chief Executive Officer. The loss of the services of either of these officers could have a material adverse effect on us. We have entered into employment agreements with Dr. Margalit and Mr. Lotan and are the beneficiary of key man life insurance policies in the amounts of $1.0 million each on their lives. However, we can give no assurance that the proceeds from these policies will be sufficient to compensate us in the event of the death of either of these individuals, and the policies are not applicable in the event that either of them becomes disabled or is otherwise unable to render services to us. OUR BUSINESS REQUIRES US TO ATTRACT AND RETAIN QUALIFIED PERSONNEL. Our ability to develop, manufacture and market our products, run our companies and our ability to compete with our current and future competitors depends, and will depend, in large part, on our ability to attract and retain qualified personnel. Competition for executives and qualified personnel in the networking and fiber optics industries is intense, and we will be required to compete for that personnel with companies having substantially greater financial and other resources than we do. To attract executives, we have had to enter into compensation arrangements, which have resulted in substantial deferred compensation charges and adversely affected our results of operations. We may enter into similar arrangements in the future to attract qualified executives, including a new executive or executives to assume the duties previously handled and managed by Edmund Glazer, our recently deceased Vice President of Finance and Administration and Chief Financial Officer. If we should be unable to attract and retain qualified personnel, our business could be materially adversely affected. We can give no assurance that we will be able to attract and retain qualified personnel. ENVIRONMENTAL REGULATIONS APPLICABLE TO OUR MANUFACTURING OPERATIONS COULD LIMIT OUR ABILITY TO EXPAND OR SUBJECT US TO SUBSTANTIAL COSTS. We are subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during our manufacturing processes. Further, we are subject to other safety, labeling and training regulations as required by local, state and federal law. Any failure by us to comply with present and future regulations could subject us to future liabilities or the suspension of production. In addition, these kinds of regulations could restrict our ability to expand our facilities or could require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. We cannot assure you that these legal requirements will not impose on us the need for additional capital expenditures or other requirements. If we fail to obtain required permits or otherwise fail to operate within these or future legal requirements, we may be required to pay substantial penalties, suspend our operations or make costly changes to our manufacturing processes or facilities. 25 IF WE FAIL TO ACCURATELY FORECAST COMPONENT AND MATERIAL REQUIREMENTS FOR OUR MANUFACTURING FACILITIES, WE COULD INCUR ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS. We use rolling forecasts based on anticipated product orders to determine our component requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials. Lead times for components and materials that we order vary significantly and depend on factors such as specific supplier requirements, the size of the order, contract terms and current market demand for the components. For substantial increases in production levels, some suppliers may need nine months or more lead time. If we overestimate our component and material requirements, we may have excess inventory, which would increase our costs. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively impact our net sales. Current softness in demand and pricing in the communications market have necessitated a review of our inventory, facilities and headcount. As a result, we and Luminent recorded in the nine months ended September 30, 2001, a charges, to write-down inventory to realizable value and inventory purchase commitments of approximately $43.7 million. WE ARE AT RISK OF SECURITIES CLASS ACTION OR OTHER LITIGATION THAT COULD RESULT IN SUBSTANTIAL COSTS AND DIVERT MANAGEMENT'S ATTENTION AND RESOURCES. In the past, securities class action litigation has been brought against a company following periods of volatility in the market price of its securities. Due to the volatility and potential volatility of our stock price or the volatility of Luminent's stock price following its initial public offering, we may be the target of securities litigation in the future. Additionally, while Luminent and we informed investors that we were under no obligation to, and might not, make the distribution to our stockholders of our Luminent common stock and that we could and might eliminate public ownership of Luminent through a short-form merger with us, our decisions to abandon our distribution of Luminent's common stock to our stockholders or to eliminate public ownership of Luminent's common stock through the merger may result in securities or other litigation. Securities or other litigation could result in substantial costs and divert management's attention and resources. WE MAY INCUR SIGNIFICANT COSTS TO AVOID INVESTMENT COMPANY STATUS AND MAY SUFFER ADVERSE CONSEQUENCES IF DEEMED TO BE AN INVESTMENT COMPANY. We may incur significant costs to avoid investment company status and may suffer other adverse consequences if deemed to be an investment company under the Investment Company Act of 1940. The Investment Company Act of 1940 requires registration for companies that are engaged primarily in the business of investing, reinvesting, owning, holding or trading in securities. A company may be deemed to be an investment company if it owns "investment securities" with a value exceeding 40% of the value of its total assets (excluding government securities and cash items) on an unconsolidated basis, unless an exemption or safe harbor applies. Securities issued by companies other than majority-owned subsidiaries are generally counted as investment securities for purposes of the Investment Company Act. Investment companies are subject to registration under, and compliance with, the Investment Company Act unless a particular exclusion or safe harbor provision applies. If we were to be deemed an investment company, we would become subject to the requirements of the Investment Company Act. As a consequence, we would be prohibited from engaging in business or issuing our securities as we have in the past and might be subject to civil and criminal penalties for noncompliance. In addition, certain of our contracts might be voidable. Registration as an investment company would subject us to restrictions that are inconsistent with our fundamental business strategy of equity growth through creating, acquiring, building and operating optical components and network infrastructure companies. Although our investment securities currently comprise substantially less than 40% of our total assets, fluctuations in the value of these securities or of our other assets, or the sale of one or more of companies in exchange for the securities of the purchaser, may cause this limit to be exceeded. In that case, unless an exclusion or safe harbor was available to us, we would have to attempt to reduce our investment securities as a percentage of our total assets. This reduction can be attempted in a number of ways, including the disposition of investment securities and the acquisition of non-investment security assets. If we were required to sell investment securities, we may sell them sooner than we otherwise would. These sales may be at depressed prices and we may never realize anticipated benefits from, or may incur losses on, these investments. We may be unable to sell some investments due to contractual or legal restrictions or the inability to locate a suitable buyer. Moreover, we may incur tax liabilities when we sell assets. We may also be unable to purchase additional investment securities that may be important to our operating strategy. If we decide to acquire non-investment security 26 assets, we may not be able to identify and acquire suitable assets and businesses or the terms on which we are able to acquire these assets may be unfavorable. 27 PART II -- OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. Not applicable (b) Reports on Form 8-K Three reports on Form 8-K were filed during the quarter covered by this Report. (1) The first Report, dated and filed on July 11, 2001, reported under Item 5 the announcement on July 5, 2001 of the preliminary financial results for the second quarter ended June 30, 2001 of Luminent, Inc., registrant's 92.3%-owned subsidiary. (2) The second Report, dated and filed July 31, 2001, reported under Item 5 registrant's financial results for the three and six months ended June 30, 2001. (3) The third Report, dated and filed September 17, 2001, reported under Item 5: (i) the announcement of the death on September 11, 2001 of Edgar Glazer, registrant's Vice President of Finance and Administration and Chief Financial Officer and (ii) the joint announcement on September 13, 2001 by registrant and Luminent of registrant's intent to effect a short-form merger with Luminent. 28 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 November 14, 2001. MRV COMMUNICATIONS, INC By: /s/ Noam Lotan --------------------------------------------- Noam Lotan, President and Chief Executive Officer (Principal Executive Officer) By: /s/ Shay Gonen --------------------------------------------- Shay Gonen Interim Chief Financial Officer (Principal Financial and Accounting Officer) 29