10-Q 1 v83712e10vq.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------- FORM 10-Q (Mark One) [X] Quarterly report under section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended JUNE 30, 2002 [ ] 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 or other jurisdiction (I.R.S. Employer 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 August 7, 2002, there were 94,453,254 shares of Common Stock, $.0017 par value per share, outstanding. MRV COMMUNICATIONS, INC. FORM 10-Q, JUNE 30, 2002 INDEX
Page Number ----------- PART I Financial Information 3 Item 1. Financial Statements: 3 Consolidated Condensed Statements of Operations (unaudited) for the 4 Three and Six Months ended June 30, 2002 and 2001 Consolidated Condensed Balance Sheets as of June 30, 2002 (unaudited) 5 and December 31, 2001 Consolidated Condensed Statements of Cash Flows (unaudited) for the Six 7 Months ended June 30, 2002 and 2001 Notes to Unaudited Consolidated Condensed Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results 14 of Operations PART II Other Information 37 Item 2. Changes in Securities and Use of Proceeds 37 Item 6. Exhibits and Reports in Form 8-K 37 Signatures 38 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to 39 Section 906 of the Sarbanes-Oxley Act of 2002
As used in this Report, "we, "us", "our", "MRV" or the "Company" refer to MRV Communications, Inc. and its consolidated subsidiaries. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS The consolidated condensed financial statements included herein have been prepared by MRV, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although MRV 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 MRV's latest annual report on Form 10-K. In the opinion of MRV, these unaudited statements contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of MRV Communications, Inc. and Subsidiaries as of June 30, 2002, and the results of their operations and their cash flows for the three and six months then ended. MRV COMMUNICATIONS, INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED Six Months Ended --------------------------- --------------------------- (Unaudited) (Unaudited) (Unaudited) (Unaudited) JUNE 30, June 30, JUNE 30, June 30, 2002 2001 2002 2001 --------- --------- --------- --------- NET REVENUE $ 61,627 $ 89,530 $ 124,045 $ 189,634 Cost of goods sold 40,723 88,765 83,828 155,156 --------- --------- --------- --------- GROSS PROFIT 20,904 765 40,217 34,478 OPERATING COSTS AND EXPENSES: Product development and engineering 14,425 25,782 30,045 50,787 Selling, general and administrative 24,320 43,711 47,859 82,123 Amortization of intangibles 2,330 29,028 4,834 57,167 --------- --------- --------- --------- Total operating costs and expenses 41,075 98,521 82,738 190,077 --------- --------- --------- --------- OPERATING LOSS (20,171) (97,756) (42,521) (155,599) Other expense, net 76 2,373 9,954 2,893 --------- --------- --------- --------- LOSS BEFORE MINORITY INTEREST AND PROVISION (BENEFIT) FOR TAXES (20,247) (100,129) (52,475) (158,492) Minority interest (3) (5,051) 102 (6,439) Provision (benefit) for taxes 856 (939) 1,042 (3,622) - - - - --------- --------- --------- --------- NET LOSS $ (21,100) $ (94,139) $ (53,619) $(148,431) ========= ========= ========= ========= EARNINGS PER SHARE: Basic and diluted loss per share $ (0.23) $ (1.24) $ (0.61) $ (1.97) ========= ========= ========= ========= WEIGHTED AVERAGE NUMBER OF SHARES: Basic and diluted 90,319 76,111 87,570 75,245 ========= ========= ========= =========
See accompanying notes MRV COMMUNICATIONS, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT PAR VALUES)
JUNE 30, December 31, 2002 2001 --------- --------- (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 95,639 $164,676 Short-term marketable securities 39,045 46,696 Time deposits 8,069 9,341 Accounts receivable, net 48,856 55,106 Inventories 48,442 57,308 Other current assets 12,138 10,044 -------- -------- TOTAL CURRENT ASSETS 252,189 343,171 PROPERTY, PLANT AND EQUIPMENT, NET 70,184 72,012 GOODWILL AND OTHER INTANGIBLES 390,085 395,312 LONG-TERM MARKETABLE SECURITIES 2,957 - DEFERRED INCOME TAXES 23,634 23,229 INVESTMENTS 6,358 16,937 OTHER NON-CURRENT ASSETS 9,562 13,834 -------- -------- $754,969 $864,495 -------- -------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term debt $ 2,314 $ 52,226 Convertible subordinated notes 61,346 - Short-term obligations 14,232 18,679 Accounts payable 47,451 48,586 Accrued liabilities 32,683 39,035 Other current liabilities 8,021 9,277 -------- -------- TOTAL CURRENT LIABILITIES 166,047 167,803 LONG-TERM DEBT 8,341 8,871 CONVERTIBLE SUBORDINATED NOTES - 89,646 OTHER LONG-TERM LIABILITIES 3,990 3,737 MINORITY INTEREST 9,522 9,762 COMMITMENTS AND CONTINGENCIES
MRV COMMUNICATIONS, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT PAR VALUES)
JUNE 30, December 31, 2002 2001 ----------- ----------- (UNAUDITED) 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 -- 90,638 shares in 2002 and 82,824 in 2001 Outstanding -- 90,570 shares in 2002 and 82,776 in 2001 154 141 Additional paid-in capital 1,143,056 1,118,942 Accumulated deficit (551,302) (497,683) Deferred stock compensation, net (14,228) (26,344) Treasury stock, 68 shares in 2002 and 48 shares in 2001 (156) (133) Accumulated other comprehensive loss (10,455) (10,247) ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 567,069 584,676 ----------- ----------- $ 754,969 $ 864,495 =========== ===========
See accompanying notes MRV COMMUNICATIONS, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Six Months Ended --------------------------- JUNE 30, June 30, 2002 2001 --------- --------- (UNAUDITED) (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: NET CASH USED IN OPERATING ACTIVITIES $ (7,293) $ (43,529) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment (5,659) (26,580) Proceeds from sale or maturity of investments 4,694 71,150 Investments in unconsolidated equity method subsidiaries - (59,521) Proceeds from sale of property, plant and equipment 137 - --------- --------- NET CASH USED IN INVESTING ACTIVITIES (828) (14,951) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of common stock 134 20,534 Payment to terminate interest rate swap (3,198) - Purchase of treasury shares (23) - Payments on short-term obligations (37,081) (92) Borrowings on short-term obligations 32,634 3,587 Payments on long-term obligations (50,442) (204) Borrowings on long-term obligations - 373 --------- --------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (57,976) 24,198 --------- --------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (2,940) (911) --------- --------- NET DECREASE IN CASH AND CASH EQUIVALENTS (69,037) (35,193) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 164,676 210,080 --------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 95,639 $ 174,887 ========= =========
See accompanying notes MRV COMMUNICATIONS, INC. NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 1. EARNINGS PER SHARE Basic earnings per common share are computed using the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the incremental shares issuable upon the assumed exercise of stock options, warrants and conversion of the convertible subordinated notes. The effect of the assumed conversion of $61.3 million and $89.6 million of convertible subordinated notes for the three and six months ended June 30, 2002 and 2001, respectively, have not been included, as it would be anti-dilutive. The dilutive effect of all of MRV's stock options and warrants outstanding for the three and six months ended June 30, 2002 and 2001, respectively, have not been included in the loss per share computation as their effect would be anti-dilutive. 2. GOODWILL AND OTHER INTANGIBLE ASSETS - ADOPTION OF SFAS 142 Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets", which was adopted on January 1, 2002, requires disclosure of what reported income before extraordinary items and net income would have been in all periods presented exclusive of amortization expense (including any related tax effects) recognized in those periods related to goodwill and other intangible assets that are no longer being amortized and changes in amortization periods for intangible assets that will continue to be amortized (including any related tax effects). Similarly, adjusted per share amounts also are required to be disclosed for all periods presented. MRV initially applied this statement as of January 1, 2002. The amortization of goodwill and net loss for the initial application and prior corresponding period follows (in thousands, except per share amounts).
Three Months Ended Six Months Ended ------------------------------ ------------------------------ JUNE 30, June 30, JUNE 30, June 30, 2002 2001 2002 2001 ----------- ----------- ----------- ----------- NET LOSS: Reported net loss $ (21,100) $ (94,139) $ (53,619) $ (148,431) Amortization of goodwill - 25,764 - 51,326 ----------- ----------- ----------- ----------- Adjusted net loss $ (21,100) $ (68,375) $ (53,619) $ (97,105) =========== =========== =========== =========== BASIC AND DILUTED EARNINGS PER SHARE: Reported net loss $ (0.23) $ (1.24) $ (0.61) $ (1.97) Amortization of goodwill - 0.34 - 0.68 ----------- ----------- ----------- ----------- Adjusted net loss $ (0.23) $ (0.90) $ (0.61) $ (1.29) =========== =========== =========== ===========
When a company initially adopts SFAS No. 142, it must perform a fair value-based goodwill impairment test. The first step ("Step One") of the impairment test involves comparing the estimated fair value of the reporting unit that houses acquired goodwill to the carrying value, or book value, of the reporting unit. MRV's reporting units are generally considered to be the business units that are one level below the operating segments underlying the segments identified in Note 6--Segment Reporting and Geographical Information. If the fair value of the reporting unit is less than its carrying amount, a second step ("Step Two") of the impairment test is performed to determine a goodwill impairment charge, if any. This second step requires a "memo" allocation of the reporting unit's estimated fair value to its assets and liabilities, as though the reporting unit had just been acquired in a business combination, with the remaining fair value allocated to goodwill. An impairment is recognized for the amount that the carrying amount of the goodwill exceeds its fair value. MRV completed Step One in the transitional goodwill impairment test during the quarter ended June 30, 2002. MRV expects to perform its annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002. Step One indicated that the carrying value of the reporting units exceeded the fair value by an estimated $290 million to $330 million in its operating enterprises segment. MRV will complete the second step of the impairment test during the quarter ended September 30, 2002. MRV anticipates reporting an impairment charge in the third quarter ended September 30, 2002. 3. COMPREHENSIVE INCOME (LOSS) The components of comprehensive income (loss) were as follows (in thousands):
Three Months Ended Six Months Ended --------------------------- --------------------------- JUNE 30, June 30, JUNE 30, June 30, 2002 2001 2002 2001 --------- --------- --------- --------- Net loss $ (21,100) $ (94,139) $ (53,619) $(148,431) Realized loss on interest rate swap - - 3,198 - Unrealized gain (loss) on interest rate swap - 167 - (2,379) Foreign currency translation (1,374) (1,898) (3,406) (911) --------- --------- --------- --------- $ (22,474) $ (95,870) $ (53,827) $(151,721) ========= ========= ========= =========
4. CASH AND CASH EQUIVALENTS, TIME DEPOSITS 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. Time deposits represent investments, which are restricted as to withdrawal or use based on maturity terms. Furthermore, MRV maintains cash balances and investments in highly qualified financial institutions. At various times such amounts are in excess of federally insured limits. MRV accounts for its investments under the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." As of June 30, 2002 and 2001, short-term investments consisted principally of U.S. Treasury Bonds, Municipal Bonds and Corporate Bonds. As defined by SFAS No. 115, MRV has classified these investments in debt securities as "held-to-maturity" investments and all investments are recorded at their amortized cost basis, which approximated their fair market value at June 30, 2002 and 2001. 5. INVENTORIES Inventories are stated at the lower of cost or market and consist of materials, labor and overhead. Cost is determined by the first-in, first-out method. Inventories consisted of the following (in thousands):
JUNE 30, December 31, 2002 2001 ------- ------- Raw materials $15,809 $15,444 Work-in process 9,237 19,230 Finished goods 23,396 22,634 ------- ------- $48,442 $57,308 ======= =======
6. SEGMENT REPORTING AND GEOGRAPHICAL INFORMATION MRV operates under a business model that includes its operating divisions as well as start-up enterprises. These companies provide network infrastructure products and services and fall into two business segments: operating enterprises and development stage enterprises. Segment information is therefore being provided on this basis. MRV's operating enterprises design, manufacture and distribute optical components, optical subsystems, optical networking solutions and Internet infrastructure products. The primary activities of operating enterprises are to provide solutions which enable high-speed broadband communications. Development stage enterprises, which MRV has created or invested in, focus on core routing, network transportation, switching and IP services, and fiber optic components and systems. The primary activities of development stage enterprises 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. MRV evaluates segment performance based on revenues and operating income (loss) of each segment. As such, there are no separately identifiable segment assets nor are there any separately identifiable statements of operations data below operating income. Business segment net revenues for the three and six months ended June 30, 2002 and 2001 were generated from operating enterprises. For the three and six months ended June 30, 2002, there were no significant net revenues generated by development stage enterprises. There were no inter-segment sales during the three and six months ended June 30, 2002 and 2001. Net revenues by product group for the three and six months ended June 30, 2002 and 2001 were as follows (in thousands):
Three Months Ended Six Months Ended ------------------------ ------------------------ JUNE 30, June 30, JUNE 30, June 30, 2002 2001 2002 2001 -------- -------- -------- -------- Optical passive components $ 8,685 $ 11,373 $ 15,326 $ 22,842 Optical active components 12,850 31,505 28,492 67,907 Switches and routers 11,689 18,492 24,412 37,815 Remote device management 4,734 4,930 8,635 8,995 Network physical infrastructure 12,947 13,248 27,382 31,336 Services 6,412 4,325 11,106 8,396 Other network products 4,310 5,657 8,692 12,343 -------- -------- -------- -------- $ 61,627 $ 89,530 $124,045 $189,634 ======== ======== ======== ========
For the three and six months ended and as of June 30, 2002 and 2001, MRV had no single customer that accounted for more than 10% of net revenues or accounts receivable, respectively. MRV does not track customer sales by geographical region for each individual reporting segment. A summary of external net revenues by geographical region is as follows (in thousands):
Three Months Ended Six Months Ended ------------------------ ------------------------ JUNE 30, June 30, JUNE 30, June 30, 2002 2001 2002 2001 -------- -------- -------- -------- United States $ 18,316 $ 27,675 $ 36,549 $ 69,578 Asia Pacific 7,127 11,634 13,746 26,454 Europe 35,834 48,432 73,078 89,750 Other 350 1,789 672 3,852 -------- -------- -------- -------- $ 61,627 $ 89,530 $124,045 $189,634 ======== ======== ======== ========
Business segment operating loss for the three and six months ended June 30, 2002 and 2001 was as follows (in thousands):
Three Months Ended Six Months Ended --------------------------- --------------------------- JUNE 30, June 30, JUNE 30, June 30, 2002 2001 2002 2001 --------- --------- --------- --------- Operating enterprises $ (13,086) $ (83,494) $ (27,193) $(127,358) Development stage enterprises (7,085) (14,262) (15,328) (28,241) --------- --------- --------- --------- $ (20,171) $ (97,756) $ (42,521) $(155,599) ========= ========= ========= =========
Loss before provision (benefit) for income taxes for the three and six months ended June 30, 2002 and 2001 was as follows (in thousands):
Three Months Ended Six Months Ended --------------------------- --------------------------- JUNE 30, June 30, JUNE 30, June 30, 2002 2001 2002 2001 --------- --------- --------- --------- United States $ (16,875) $ (53,335) $ (36,228) $ (82,818) Foreign (3,369) (41,743) (16,349) (69,235) --------- --------- --------- --------- $ (20,244) $ (95,078) $ (52,577) $(152,053) ========= ========= ========= =========
7. RESTRUCTURING CHARGES From November 9, 2000 through December 28, 2001, MRV owned approximately 92% of Luminent, Inc. and approximately 8% of Luminent's shares where publicly traded. During the second quarter of 2001, Luminent's management approved and implemented a restructuring plan 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 primarily involved the reduction of workforce, the abandonment of certain assets and the cancellation and termination of purchase commitments. These actions are expected to realign the business based on current and near-term growth rates. All of these actions are expected to be completed by the end of the fiscal year 2002. Employee severance costs and related benefits of $1.3 million are related to approximately 700 layoffs through June 30, 2002, bringing Luminent's total workforce to approximately 1,000 employees as of June 30, 2002. Affected employees came from all divisions and areas of Luminent. The majority of affected employees were in the manufacturing group. A summary of the restructuring costs through June 30, 2002 is as follows (in thousands):
2001 June 30, Provision Utilized Adjustment (1) 2002 --------- -------- ------------- -------- EXIT COSTS: Asset impairment $10,441 $10,441 $ - $ - Closed and abandoned facilities 2,405 537 - 1,868 Purchase commitments 6,173 1,841 1,094 3,238 ------- ------- ------- ------- 19,019 12,819 1,094 5,106 Employee severance costs 1,281 736 - 545 ------- ------- ------- ------- $20,300 $13,555 $ 1,094 $ 5,651 ======= ======= ======= =======
(1) Includes $457,000 in reduction of future liabilities based on current negotiations with vendors and $637,000 in usage of previously reserved purchase commitments for inventory and equipment. The provisions previously recognized for these items have been reversed in the six months ended June 30, 2002. A summary of the restructuring costs by line item for the six months ended June 30, 2002 and 2001 is as follows (in thousands):
Six Months Ended ---------------------------------- June 30, June 30, 2002 2001 -------------- -------------- EXIT COSTS: Cost of goods sold $(1,094) $ 3,168 Selling, general and administrative - 10,792 Product development and engineering - 501 Other income, net - 16 ------- ------- $(1,094) $14,477 ======= =======
8. INTEREST RATE SWAP MRV entered into an interest rate swap (the "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 considered to be 100% effective and was therefore recorded using the short-cut method. The Swap was designated as a cash flow hedge and changes in fair value of the debt were 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 Swap as well as the offsetting change in the hedged fair value of the long-term debt were recognized in other comprehensive loss. In February 2002, MRV paid off the long-term debt of $50.0 million (see Note 9) and terminated the Swap. The realized loss on the Swap of $3.2 million has been recorded as interest expense and included in other expense, net in the accompanying consolidated condensed statements of operations. 9. LONG-TERM DEBT AND CONVERTIBLE SUBORDINATED NOTES In February 2002, MRV paid off a $50.0 million term loan. Additionally, during the six months ended June 30, 2002, MRV acquired $28.3 million in convertible subordinated notes (the "Notes") in exchange for MRV's issuance of 7.8 million shares of its common stock to the holders of the Notes. In connection therewith, MRV recognized a gain of $3.8 million, net of associated taxes. MRV retired the Notes acquired in the exchange. 10. STOCK REPURCHASE PROGRAM On June 13, 2002, MRV announced that its Board of Directors had approved a program to repurchase up to 7.0 million shares of its common stock. As of June 30, 2002, MRV had repurchased 20,000 shares of its common stock at a cost of $23,000 under this program. 11. RECENT ACCOUNTING PRONOUNCEMENTS In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which the obligation is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. This statement is effective on January 1, 2003 with earlier application encouraged. MRV has reviewed this statement and does not expect a material impact on its financial position, results of operations or cash flows. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 requires that long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. MRV adopted this statement on January 1, 2002 and there has not been a material impact on its financial position, results of operations or cash flows. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". This statement is effective for fiscal years beginning after May 15, 2002. For certain provisions, including the rescission of Statement No. 4, early application is encouraged. MRV has adopted this statement for the six months ended June 30, 2002, and the immediate impact of its application was the reclassification of the gain on the extinguishment of debt (see Note 9) from an extraordinary item to other income. 12. SUPPLEMENTAL STATEMENT OF CASH FLOW INFORMATION
Six Months Ended --------------------- JUNE 30, June 30, 2002 2001 ------- ------- SUPPLEMENTAL STATEMENT OF CASH FLOW INFORMATION (IN THOUSANDS): Cash paid during period for interest $2,645 $4,578 ------ ------ Cash paid during period for taxes $1,414 $2,075 ------ ------
During the six months ended June 30, 2002, MRV exchanged $28.3 million in convertible subordinated notes for 7.8 million shares of its common stock. This non-cash transaction has been excluded from the accompanying statements of cash flows. 13. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Consolidated Condensed Financial Statements and Notes thereto included elsewhere in this Report. In addition to historical information, the discussion in this Report contains certain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated by these forward-looking statements due to factors, including but not limited to, those set forth in the following and elsewhere in this Report. We assume no obligation to update any of the forward-looking statements after the date of this Report. 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 solutions. We have leveraged our early experience in fiber optic technology into a number of well-focused operating enterprises and development stage enterprises specializing in optical passive components, optical active components, network physical infrastructure, switches, routers, remote device management and wireless optical transmission. We market and sell our products world-wide, through a variety of channels, which include a dedicated direct sales force, manufacturers' representatives, value-added-resellers, distributors and systems integrators. In addition, we maintain subsidiaries in France, Italy, Switzerland and Sweden, which are involved in sales, distribution and services. The activities of these subsidiaries include system design, integration and support as well as product sales to enterprise customers and service providers. Products sold include products manufactured by MRV, as well as products manufactured by third party vendors. Such specialization enhances access to customers and allows us to penetrate targeted vertical and regional markets. Revenues for the three and six months ended June 30, 2002 were $61.6 million and $124.0 million, respectively, compared to $89.5 million and $189.6 million, respectively for the three and six months ended June 30, 2001, a decrease of 31% and 35%. We reported a net loss of $21.1 million and $94.1 million for the three months ended June 30, 2002 and 2001, respectively. A significant portion of these losses were due to the amortization of goodwill and other intangibles and deferred stock compensation related to our acquisitions in 2000 and our employment arrangements with Luminent's former President and its former Chief Financial Officer. We will continue to amortize deferred stock compensation through 2004 relating to these acquisitions. Effective January 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, and we no longer amortize goodwill. However, our adoption of SFAS 142 has required, and we expect in the future it will require, us to record impairment charges. We completed the first step in the transitional goodwill impairment test during the quarter ended June 30, 2002. The first step indicated that the carrying value of the reporting units exceeded the fair value by an estimated $290 million to $330 million. We will complete the second step of the impairment test during the quarter ended September 30, 2002 and anticipate reporting an impairment charge at that time. We expect to perform our annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002. For the six months ended June 30, 2002, we recorded impairment charges of $7.6 million in connection with certain equity method investments as the fair value of these assets was less than their carrying value. As a consequence of deferred stock compensation charges and anticipated impairment charges, we do not expect to report net income in the foreseeable future. TRANSACTIONS WITH STOCK OF SUBSIDIARIES In November 2000, Luminent completed the initial public offering of its common stock, selling 12.0 million shares at $12.00 per share for net proceeds of approximately $132.3 million. Luminent designs, manufactures and sells a comprehensive line of fiber optic components that enable communications equipment manufacturers to provide optical networking equipment for the 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 Luminent common stock, caused us to determine to abandon the distribution and effect a short-form merger of Luminent into one of our wholly-owned subsidiaries, thereby eliminating public ownership of Luminent. This merger was completed on December 28, 2001. In July 2000, we and Luminent, entered into employment agreements with Luminent's former President and Chief Executive Officer and its former 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 stock options were granted to Luminent's executives at exercise prices below market value, resulting in deferred stock compensation. Luminent's President and Chief Executive Officer resigned in September 2001 and its Vice President of Finance and Chief Financial Officer resigned in June 2002. The resignations were considered by the parties to be terminations other than for cause under the employment agreements, providing severance benefits based on the employment agreements, and the vesting of all of the unvested Luminent options. The MRV and Luminent stock options are now exercisable at various dates through June 2004. RESTRUCTURING CHARGES In the second quarter of 2001, when Luminent's common stock was still publicly traded, Luminent's management 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 primarily involved the reduction of facilities in the U.S. and in Taiwan, the reduction of workforce, the abandonment of certain assets and the cancellation 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 expected to be completed in 2002. Employee severance costs and related benefits of $1.3 million were associated with approximately 700 layoffs through June 30, 2002, bringing Luminent's total workforce to approximately 1,000 employees as of June 30, 2002. Affected employees came from all divisions and areas of Luminent. The majority of affected employees were in the manufacturing group. A summary of the restructuring costs for the six months ended June 30, 2002 is as follows (in thousands):
2001 June 30, Provision Utilized Adjustment (1) 2002 --------- -------- ------------- -------- EXIT COSTS: Asset impairment $10,441 $10,441 $ - $ - Closed and abandoned facilities 2,405 537 - 1,868 Purchase commitments 6,173 1,841 1,094 3,238 ------- ------- ------- ------- 19,019 12,819 1,094 5,106 Employee severance costs 1,281 736 - 545 ------- ------- ------- ------- $20,300 $13,555 $ 1,094 $ 5,651 ======= ======= ======= =======
(1) Includes $457,000 in reduction of future liabilities based on current negotiations with vendors and $637,000 in usage of previously reserved purchase commitments for inventory and equipment. The provisions previously recognized for these items have been reversed in the six months ended June 30, 2002. A summary of the restructuring costs by line item for the six months ended June 30, 2002 and 2001 is as follows (in thousands):
Six Months Ended ---------------------------------- June 30, June 30, 2002 2001 -------------- -------------- EXIT COSTS: Cost of goods sold $(1,094) $ 3,168 Selling, general and administrative - 10,792 Product development and engineering - 501 Other income, net - 16 ------- ------- $(1,094) $14,477 ======= =======
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 network infrastructure products and services. The unfavorable economic conditions and reduced capital spending has detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States during 2002 to date, and may continue to affect them for the remainder of 2002 and thereafter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, our statements of operations data expressed as a percentage of net revenues.
Three Months Ended Six Months Ended ------------------------- ------------------------- JUNE 30, June 30, JUNE 30, June 30, 2002 2001 2002 2001 --------- --------- --------- --------- (Unaudited) (Unaudited) NET REVENUES 100% 100% 100% 100% Cost of goods sold 66 99 68 82 GROSS PROFIT 34 1 32 18 OPERATING COSTS AND EXPENSES: Product development and engineering 23 29 24 27 Selling, general and administrative 39 49 39 43 Amortization of intangibles 4 32 4 30 Total operating costs and expenses 67 110 67 100 OPERATING LOSS (33) (109) (34) (82) Other expense, net - 3 8 2 LOSS BEFORE MINORITY INTEREST AND PROVISION (BENEFIT) FOR TAXES (33) (112) (42) (84) Minority interest - (6) - (3) Provision (benefit) for taxes 1 (1) 1 (2) NET LOSS (34) (105) (43) (78)
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 Enterprises and Development Stage Enterprises, which includes all start-up activities. THREE MONTHS ENDED JUNE 30, 2002 AND 2001 NET REVENUES 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 right of return. Sales with contingencies, such as right 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. Revenue generated through the sales of services and systems support has been insignificant. Operating Enterprises. Revenues for the three months ended June 30, 2002 decreased $27.9 million, or 31%, to $61.6 million from $89.5 million for the three months ended June 30, 2001. Overall, the communications equipment industry was extremely depressed, as were the end markets that we serve. Revenues generated from our optical passive and active components represented the most significant impact on revenues, decreasing $21.4 million, or 50%, during the three months ended June 30, 2002 to $21.5 million from $42.9 million for the same period last year. The decrease in our optical passive and active components was primarily the result of the dramatic downturn in the communications equipment industry and specifically the optical components sector. Revenues generated from our switches and routers decreased $6.8 million, or 37%, to $11.7 million for the three months ended June 30, 2002 as compared to $18.5 million for the three months ended June 30, 2001. Revenues to the United States decreased $9.4 million, or 34%, for the three months ended June 30, 2002, to $18.3 million as compared to $27.7 million for the three months ended June 30, 2001. Revenues to the Asia Pacific decreased $4.5 million, or 39%, for the three months ended June 30, 2002 to $7.1 million as compared to $11.6 million for the three months ended June 30, 2001. Revenue to Europe decreased $12.6 million, or 26%, for the three months ended June 30, 2002 to $35.8 million as compared to $48.4 million for the three months ended June 30, 2001. Development Stage Enterprises. No significant revenues were generated by these entities for the three months ended June 30, 2002 and 2001. GROSS PROFIT Gross profit is equal to our net 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 Enterprises. Gross profit for the three months ended June 30, 2002 was $20.9 million, compared to gross profit of $765,000 for the three months ended June 30, 2001. Gross profit increased $20.1 million for the three months ended June 30, 2002 as compared to the three months ended June 30, 2001. Our gross margins (defined as gross profit as a percentage of net 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 increased to 34% for the three months ended June 30, 2002, compared to gross margin of 1% for the three months ended June 30, 2001. The improvement in gross margin was attributed to the write-off of inventory and other market-related one-time charges of $29.3 million taken by Luminent during the three months ended June 30, 2001. Prior to deferred stock compensation amortization of $1.0 million and $2.4 million for the three months ended June 30, 2002 and 2001, respectively, and Luminent's inventory write-downs and other market-related charges of $29.3 million for the three months ended June 30, 2001, gross margins would have been $21.9 million, or 36% of net revenues and $32.5 million, or 36% of net revenues, respectively. Development Stage Enterprises. No significant gross margins were produced by these entities for the three months ended June 30, 2002 and 2001. PRODUCT DEVELOPMENT AND ENGINEERING Product development and engineering expenses decreased 44%, to $14.4 million for the three months ended June 30, 2002 as compared to $25.8 million for the three months ended June 30, 2001. Operating Enterprises. Product development and engineering expenses from our operating enterprises were $8.9 million, or 14% of net revenues, for the three months ended June 30, 2002, as compared to $14.7 million, or 16% of net revenues, for the three months ended June 30, 2001. This represents a decrease of $5.8 million, or 39%, for the three months ended June 30, 2002. Prior to deferred stock compensation amortization charges of $1.6 million and $4.1 million for the three months ended June 30, 2002 and 2001, respectively, and Luminent's restructuring and other market-related charges of $501,000, product development and engineering expenses would have decreased by 28% to $7.3 million, or 12% of net revenues, from $10.1 million, or 11% of net revenues, for the three months ended June 30, 2002 and 2001, respectively. Development Stage Enterprises. Product development and engineering expenses of the development stage enterprises were $5.5 million, or 9% of net revenues, for the three months ended June 30, 2002, as compared to $11.1 million, or 12% of net revenues, for the three months ended June 30, 2001. This represents a decrease of $5.6 million, or 50%, for the three months ended June 30, 2002. This decrease was substantially due to cost reduction efforts in line with current operations. SELLING, GENERAL AND ADMINISTRATIVE (SG&A) SG&A expenses decreased $19.4 million to $24.3 million for the three months ended June 30, 2002, compared to $43.7 million for the three months ended June 30, 2001. SG&A expenses were 40% and 49% of net revenues for the three months ended June 30, 2002 and 2001, respectively. Prior to deferred stock compensation amortization charges of $3.6 million and $12.6 million for the three months ended June 30, 2002 and 2001, respectively, and Luminent's restructuring and other market-related charges of $11.4 million, SG&A would have increased 5% to $20.8 million from $19.8 million for the three months ended June 30, 2001. As a percentage of net revenue, SG&A prior to deferred stock compensation amortization expenses and restructuring and other market-related charges would have been 34% for the three months ended June 30, 2002 and 22% for the three months ended June 30, 2001. Operating Enterprises. SG&A expenses decreased 45% over the prior period to $22.4 million for the three months ended June 30, 2002. SG&A expenses were 36% and 46% of our net revenue for the three months ended June 30, 2002 and 2001, respectively. Prior to deferred stock compensation amortization charges of $3.6 million and $12.6 million for the three months ended June 30, 2002 and 2001, respectively, and Luminent's restructuring and other market-related charges of $11.4 million, SG&A would have increased 11% to $18.8 million for the three months ended June 30, 2002, as compared to $16.9 million for the three months ended June 30, 2001. As a percentage of net revenues, SG&A prior to deferred stock compensation charges and restructuring and other market-related charges would have been 31% for the three months ended June 30, 2002, as compared to 19% for the three months ended June 30, 2001. These decreases are mainly due to the reduction of overhead expenses to align operations with current revenue levels. Development Stage Enterprises. SG&A expenses decreased 31% over the prior period to $2.0 million for the three months ended June 30, 2002, as compared to $2.9 million for the three months ended June 30, 2001. SG&A expenses for these entities also decreased due to reductions in overhead expenses. AMORTIZATION OF INTANGIBLES Operating Enterprises. Amortization of intangibles decreased to $2.3 million for the three months ended June 30, 2002, as compared to $29.0 million for the three months ended June 30, 2001. The decrease of $26.7 million was the result of the adoption of SFAS No. 142. In accordance with SFAS No. 142, the amortization of goodwill and certain other intangibles was discontinued effective on January 1, 2002. However, instead of amortization, an annual impairment analysis is to be performed. We completed the first step in the transitional goodwill impairment test during the quarter ended June 30, 2002. We expect to perform our annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002. The first step indicated that the carrying value of the reporting units exceeded the fair value by an estimated $290 million to $330 million. We will complete the second step of the impairment test during the quarter ended September 30, 2002 and anticipate reporting an impairment charge at that time. Development Stage Enterprises. No significant amortization of intangibles was recorded for these entities for the three months ended June 30, 2002 and 2001. OTHER EXPENSE, NET In June 1998, we issued $100.0 million principal amount of 5% convertible subordinated notes (the Notes) due in June 2003. The Notes were offered in a 144A private placement to qualified institutional investors at the stated amount, less a selling discount of 3%. During the three months ended June 30, 2002, we acquired $4.0 million in Notes in exchange for our issuance of 1.4 million shares of our common stock to the holders of the Notes. In connection with the acquisition and retirement of these Notes, we recognized a gain of $393,000, net of associated taxes. This gain has been reported in other expense, net in the accompanying consolidated condensed statements of operations. In late 1998, we repurchased $10.0 million principal amount of these notes for cash at a discount from the stated amount. We incurred $923,000 and $1.3 million in interest expense relating to the Notes for the three months ended June 30, 2002 and 2001, respectively. We account for certain unconsolidated subsidiaries using the equity method. The decrease in other expense from $2.4 million to $76,000 for the three months ended June 30, 2002 is primarily attributable to our share of losses from our unconsolidated subsidiaries, partially offset by interest income. Our share of losses from our unconsolidated subsidiaries was $1.3 million for the three months ended June 30, 2002, as compared to $1.8 million for the three months ended June 30, 2001. PROVISION (BENEFIT) FOR TAXES The provision for taxes for the three months ended June 30, 2002 was $856,000, compared to a benefit for taxes of $939,000 for the three months ended June 30, 2001. Our tax expense fluctuates primarily due to the tax jurisdictions where we currently have operating facilities and the varying tax rates in those jurisdictions. For the three months ended June 30, 2002, there was no benefit provided for net operating losses. SIX MONTHS ENDED JUNE 30, 2002 AND 2001 NET REVENUES Operating Enterprises. Revenues for the six months ended June 30, 2002 decreased $65.6 million, or 35%, to $124.0 million from $189.6 million for the six months ended June 30, 2001. Overall, the communications equipment industry was extremely depressed, as was the end markets that we serve. Revenues generated from our optical passive and active components represented the most significant impact on revenues, decreasing $46.9 million, or 52%, during the six months ended June 30, 2002 to $43.8 million from $90.7 million for the same period last year. The decrease in our optical passive and active components was primarily the result of the dramatic downturn in the communications equipment industry and specifically the optical components sector. Revenues generated from our switches and routers decreased $13.4 million, or 35%, to $24.4 million for the six months ended June 30, 2002 as compared to $37.8 million for the six months ended June 30, 2001. Network physical infrastructure revenues decreased $3.9 million, or 13%, to $27.4 million for the six months ended June 30, 2002 as compared to $31.3 million for the six months ended June 30, 2001. Revenues to the United States decreased $33.0 million, or 48%, for the six months ended June 30, 2002, to $36.5 million as compared to $69.6 million for the six months ended June 30, 2001. Revenues to the Asia Pacific decreased $12.7 million, or 48%, for the six months ended June 30, 2002 to $13.7 million as compared to $26.4 million for the six months ended June 30, 2001. Revenue to Europe decreased $16.7 million, or 19%, for the six months ended June 30, 2002 to $73.1 million as compared to $89.8 million for the six months ended June 30, 2001. Development Stage Enterprises. No significant revenues were generated by these entities for the six months ended June 30, 2002 and 2001. GROSS PROFIT Gross profit is equal to our net 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 Enterprises. Gross profit for the six months ended June 30, 2002 was $40.2 million, compared to gross profit of $34.5 million for the six months ended June 30, 2001. Gross profit improved $5.8 million for the six months ended June 30, 2002 as compared to the six months ended June 30, 2001. Our gross margins (defined as gross profit as a percentage of net 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 increased to 32% for the six months ended June 30, 2002, compared to gross margin of 18% for the six months ended June 30, 2001. The improvement in gross margin was attributed to improved operating efficiencies and the write-off of inventory and other market-related one-time charges of $29.3 million taken by Luminent during the six months ended June 30, 2001. Prior to deferred stock compensation amortization of $4.1 million and $9.8 million for the six months ended June 30, 2002 and 2001, respectively, and Luminent's inventory write-downs and other market-related charges of $29.3 million for the six months ended June 30, 2001, gross margins would have been $42.3 million, or 34% of net revenues and $68.0 million, or 36% of net revenues, respectively. Development Stage Enterprises. No significant gross margins were produced by these entities for the six months ended June 30, 2002 and 2001. PRODUCT DEVELOPMENT AND ENGINEERING Product development and engineering expenses decreased 41%, to $30.0 million for the six months ended June 30, 2002 as compared to $50.8 million for the six months ended June 30, 2001. Operating Enterprises. Product development and engineering expenses from our operating enterprises were $19.1 million, or 15% of net revenues, for the six months ended June 30, 2002, as compared to $27.9 million, or 15% of net revenues, for the six months ended June 30, 2001. This represents a decrease of $8.8 million, or 32%, for the six months ended June 30, 2002. Prior to deferred stock compensation amortization charges of $4.1 million and $9.8 million for the six months ended June 30, 2002 and 2001, respectively, and Luminent's restructuring and other market-related charges of $501,000, product development and engineering expenses would have decreased by 15% to $15.0 million, or 12% of net revenues, from $17.5 million, or 9% of net revenues, for the six months ended June 30, 2002 and 2001, respectively. The decrease is due to cost reduction efforts in line with current operations. Development Stage Enterprises. Product development and engineering expenses of the development stage enterprises were $11.0 million, or 9% of net revenues, for the six months ended June 30, 2002, as compared to $22.9 million, or 12% of net revenues, for the six months ended June 30, 2001. This represents a decrease of $12.0 million, or 52%, for the six months ended June 30, 2002. The decrease is due to cost reduction efforts in line with current operations. SELLING, GENERAL AND ADMINISTRATIVE (SG&A) SG&A expenses decreased $34.3 million to $47.9 million for the six months ended June 30, 2002, compared to $82.1 million for the six months ended June 30, 2001. SG&A expenses were 39% and 43% of net revenues for the six months ended June 30, 2002 and 2001, respectively. Prior to deferred stock compensation amortization charges of $5.8 million and $19.9 million for the six months ended June 30, 2002 and 2001, respectively, and Luminent's restructuring and other market-related charges of $11.4 million, SG&A would have decreased 17% to $42.1 million from $50.9 million for the six months ended June 30, 2001. As a percentage of net revenue, SG&A prior to deferred stock compensation amortization expenses and restructuring and other market-related charges would have been 34% for the six months ended June 30, 2002 and 27% for the six months ended June 30, 2001. Operating Enterprises. SG&A expenses decreased 43% over the prior period to $44.0 million for the six months ended June 30, 2002. SG&A expenses were 36% and 41% of our net revenue for the six months ended June 30, 2002 and 2001, respectively. Prior to deferred stock compensation amortization charges of $5.8 million and $19.9 million for the six months ended June 30, 2002 and 2001, respectively, and Luminent's restructuring and other market-related charges of $11.4 million, SG&A would have decreased 16% to $38.2 million for the six months ended June 30, 2002, as compared to $45.5 million for the six months ended June 30, 2001. As a percentage of net revenues, SG&A prior to deferred stock compensation charges and restructuring and other market-related charges would have been 31% for the six months ended June 30, 2002, as compared to 24% for the six months ended June 30, 2001. These decreases are mainly due to the reduction of overhead expenses to align operations with current revenue levels. Development Stage Enterprises. SG&A expenses decreased 27% over the prior period to $3.9 million for the six months ended June 30, 2002, as compared to $5.3 million for the six months ended June 30, 2001. SG&A expenses for these entities decreased due to reductions in overhead expenses. AMORTIZATION OF INTANGIBLES Operating Enterprises. Amortization of intangibles decreased to $4.8 million for the six months ended June 30, 2002, as compared to $57.2 million for the six months ended June 30, 2001. The decrease of $52.3 million was the result of the adoption of SFAS No. 142. In accordance with SFAS No. 142, the amortization of goodwill and certain other intangibles was discontinued effective on January 1, 2002. However, instead of amortization, an annual impairment analysis is to be performed. We completed the first step in the transitional goodwill impairment test during the quarter ended June 30, 2002. We expect to perform our annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002. The first step indicated that the carrying value of the reporting units exceeded the fair value by an estimated $290 million to $330 million. We will complete the second step of the impairment test during the quarter ended September 30, 2002 and anticipate reporting an impairment charge at that time. Development Stage Enterprises. No significant amortization of intangibles was recorded for these entities for the six months ended June 30, 2002 and 2001. OTHER EXPENSE, NET In June 1998, we issued $100.0 million principal amount of 5% convertible subordinated notes (the Notes) due in June 2003. The Notes were offered in a 144A private placement to qualified institutional investors at the stated amount, less a selling discount of 3%. During the six months ended June 30, 2002, we acquired $28.3 million in Notes in exchange for our issuance of 7.8 million shares of our common stock to the holders of the Notes. In connection with the acquisition and retirement of these Notes, we recognized a gain of $3.7 million, net of associated taxes. This gain has been reported in other expense, net in the accompanying consolidated condensed statements of operations. In late 1998, we repurchased $10.0 million principal amount of these notes for cash at a discount from the stated amount. We incurred $2.0 million and $2.6 million in interest expense relating to the Notes for the six months ended June 30, 2002 and 2001, respectively. We account for certain unconsolidated subsidiaries using the equity method. The increase in other expense from $2.9 million to $10.0 million for the six months ended June 30, 2002 is primarily attributable to impairment charges of $7.6 million on our investments in these subsidiaries, $2.5 million from our share of losses from our unconsolidated subsidiaries and interest expense of $3.2 million associated with the termination of our interest rate swap, partially offset by interest income. Our share of losses from our unconsolidated subsidiaries was $3.0 million for the six months ended June 30, 2001. PROVISION (BENEFIT) FOR TAXES The provision for taxes for the six months ended June 30, 2002 was $1.0 million, compared to a benefit for taxes of $3.6 million for the six months ended June 30, 2001. Our tax expense fluctuates primarily due to the tax jurisdictions where we currently have operating facilities and the varying tax rates in those jurisdictions. For the six months ended June 30, 2002, there was no benefit provided for net operating losses. CRITICAL ACCOUNTING POLICIES In response to the SEC's Release No. 33-8040, "Cautionary Advice Regarding Disclosure About Critical Accounting Policy," we identified the most critical accounting principles upon which our financial status depends. We determined the critical principles considering accounting principles to be related to revenue recognition, inventory valuation and impairment of intangibles and other long-lived assets. We state these accounting policies in the Footnotes to our Consolidated Financial Statements and in relevant sections in this management's discussion and analysis, including the Recently Issued Accounting Standards discussed below. RECENTLY ISSUED ACCOUNTING STANDARDS In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which the obligation is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized costs are depreciated over the useful life of the related asset. This statement is effective on January 1, 2003 with earlier application encouraged. We have reviewed this statement and do not expect a material impact on our financial position, results of operations or cash flows. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 requires that long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. We adopted this statement on January 1, 2002, and there has not been a material impact on our financial position, results of operations or cash flows. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement is effective for fiscal years beginning after May 15, 2002. For certain provisions, including the rescission of Statement No. 4, early application is encouraged. We adopted this statement for the six months ended June 30, 2002 and the immediate impact of its application was the reclassification of our gain on the extinguishment of debt from an extraordinary item to other income. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents were $95.6 million as of June 30, 2002, a decrease of $69.0 million from cash and cash equivalents of $164.7 million as of December 31, 2001. The decrease in cash and cash equivalent is substantially the result of paying off $50.0 million of long-term debt, terminating our interest rate swap for $3.2 million and net payments on short-term obligations of $4.7 million. Working capital as of June 30, 2002 was $86.1 million compared to $175.4 million as of December 31, 2001. Our ratio of current assets to current liabilities as of June 30, 2002 was 1.5 to 1.0 compared to 2.0 to 1.0 as of December 31, 2001. The decrease in working capital is substantially attributed to our consolidated net operating losses and the classification, beginning at June 30, 2002, of our convertible subordinated notes, which are due in June 2003, as a current liability. As of June 30, 2002 and December 31, 2001, we did not have any "off-balance sheet" financing arrangements. Cash used in operating activities was $7.3 million for the six months ended June 30, 2002, as compared to cash used in operating activities of $43.5 million for the six months ended June 30, 2001. Cash used in operating activities is a result of our net operating loss of $53.6 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 positively affected by decreased accounts receivables, inventories and other assets partially offset by decreases in accounts payable and accrued liabilities, during the period. The decrease in accounts receivable is due to lower revenue volumes coupled with increased collection efforts, while the decrease in inventory is primarily the result of the utilization of inventories on hand. Decreases in accounts payable and accrued liabilities are the result of dramatic slowdown in the communications equipment industry and reductions in overhead expenses. Cash flows used in investing activities were $828,000 for the six months ended June 30, 2002, compared to cash used in investing activities of $15.0 million for the six months ended June 30, 2001. Cash flows used in investing activities for the three months ended June 30, 2002 were the result of capital expenditures of $5.7 million, partially offset by maturities of short-term and long-term marketable securities of $4.7 million and proceeds from the dispositions of property, plant and equipment of $137,000. As of June 30, 2002, there were no plans for major capital expenditures. Cash flows provided by investing activities for the prior period resulted from the net cash provided by the maturity of investments, offset by net cash used for capital expenditures and investments in consolidated equity method subsidiaries. Cash flows from financing activities were $58.0 million for the six months ended June 30, 2002, as compared to cash provided in financing activities of $24.2 million for the six months ended June 30, 2001. Cash used in financing activities was primarily the result of paying off $50.0 million of long-term debt, terminating our interest rate swap for $3.2 million and net payments on short-term obligations of $4.4 million, offset by proceeds received from the exercise of stock options of $134,000. Cash flows provided by financing activities in the prior period represent the cash received through borrowings on our short-term obligations and the exercise of stock options, offset by payments on our short-term and long-term obligations. 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 December 2001, we reacquired, through a short-form merger, the minority interest of Luminent representing approximately 8% of Luminent's outstanding common stock (see the discussion above). Following this merger, we increased our liquidity based on Luminent's cash, cash equivalents, restricted cash and cash equivalents and short-term investments on hand as of the consummation of the merger, or $107.7 million at December 31, 2001. In June 1998, we issued $100.0 million principal amount of 5% Convertible Subordinated Notes (the Notes) due in June 2003, in a private placement raising net prioceeds of $96.4 million. The share (equivalent to a conversion rate of approximately 73.94 share 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 notes bear interest at 5% per annum, which is payable semi-annually on June 15 and December 15 of each year. The notes have a five-year term and have been callable by us since June 15, 2001. The premiums payable to call these notes are 102% of the outstanding principal amount during the 12 months ending June 14, 2002 and 101% during the 12 months ending June 14, 2003, plus accrued interest through the date of redemption. During the six months ended June 30, 2002, we acquired $28.3 million in Notes in exchange for the issuance of 7.8 million shares of our common stock. In connection with the acquisition and retirement of these Notes, we recognized a gain of $3.8 million net of associated taxes. The following table illustrates our total contractual cash obligations as of June 30, 2002 (in thousands):
Less than 1 1 - 3 4 - 5 After 5 Cash Obligations TOTAL Year Years Years Years -------- -------- -------- -------- -------- Long-term debt $ 10,655 $ 2,314 $ 4,719 $ 2,616 $ 1,006 Convertible subordinated notes 61,346 61,346 - - - Unconditional purchase obligations 11,518 10,823 681 14 - Operating leases 21,638 4,262 7,930 4,760 4,686 Investments 2,144 1,232 912 - - -------- -------- -------- -------- -------- Total contractual cash obligations $107,301 $ 79,977 $ 14,242 $ 7,390 $ 5,692 ======== ======== ======== ======== ========
Our total contractual cash obligations as of June 30, 2002, were $107.3 million, of which, $80.0 million are due within the next 12 months. These total contractual cash obligations primarily consist of long-term financing obligations including our convertible subordinated notes, operating leases for our equipment and facilities, unconditional purchase obligations for necessary raw materials and funding commitments for certain development stage enterprises. Historically, these obligations have been satisfied through cash generated from our operations or other avenues (see discussion below), and we expect that this will continue to be the case. Our remaining short-term obligations of $80.0 million consist primarily of $61.3 million in remaining convertible subordinated notes, $4.3 million for operating leases, $10.8 million for unconditional purchase obligations and $1.2 million for funding commitments for our development stage enterprises. Our unconditional purchase obligations are to secure the necessary raw goods for production of our products. As part of Luminent's restructure plan (see our discussion above and the Footnotes to our Consolidated Condensed Financial Statements), $3.2 million in unconditional purchase obligations have been recorded as a liability and Luminent is in negotiations to cancel or renegotiate contracts that are no longer required due to its significantly reduced orders for optical components and sales projections. The remaining purchase commitments are part of our ordinary course of business. Our remaining long-term obligations as of June 30, 2002 of $27.3 million consist primarily of $17.4 million of long-term financing obligations, $8.3 million in operating leases for our equipment and facilities and $912,000 for funding commitments for certain development stage enterprises. Our remaining long-term financing obligations consist of financing obtained for capital expenditures and production expansion. Our operating leases expire at various dates through 2049. 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 choose to obtain additional debt or equity financing if we believe it appropriate. 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. 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. In February 2002, we paid off our $50.0 million term loan and terminated our interest rate swap for $3.2 million. 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. Fluctuation 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 greater inflation than the United States, there can be no assurance that inflation will not have a material adverse effect on our operating results in the future. 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 NET LOSSES IN THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001, YEARS ENDED DECEMBER 31, 2001 AND 2000, PRIMARILY AS A RESULT OF THE AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES AND DEFERRED COMPENSATION CHARGES FROM RECENT ACQUISITIONS. WE EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE FORESEEABLE FUTURE. We reported net losses of $53.6 million and $148.4 million for the six months ended June 30, 2002 and 2001, respectively, $326.4 million for the year ended December 31, 2001 and $153.0 million for the year ended December 31, 2000. A major contributing factor to the net losses was the amortization of goodwill and 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 deferred stock compensation relating to these acquisitions and the employment arrangements with these executives going forward. In accordance with SFAS No. 142, the amortization of goodwill and certain other intangibles was discontinued effective on January 1, 2002. However, instead of amortization, an annual impairment analysis is to be performed. We completed the first step in the transitional goodwill impairment test during the quarter ended June 30, 2002. For the six months ended June 30, 2002, we recorded impairment charges of $7.6 million in connection with certain equity method investments, as the fair value of these assets was less than their carrying value. We expect to perform our annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002. The first step indicated that the carrying value of the reporting units exceeded the fair value by an estimated $290 million to $330 million. We will complete the second step of the impairment test during the quarter ended September 30, 2002 and anticipate reporting an impairment charge at that time. As a consequence of deferred stock compensation charges and anticipated impairment 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 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 and the first six months of 2002, appear to continue to affect these industries in the third quarter of 2002 and may affect them for the balance of 2002 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 recorded, during the year ended December 31, 2001, consolidated charges from our subsidiary, Luminent, which include the write-off of inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other unusual items. The aggregate charges recorded during the year ended December 31, 2001 were $49.5 million. These charges are the result of the lower demand for Luminent's products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. Additionally, these economic conditions are making it very difficult for MRV and our other companies, our customers and our vendors to forecast and plan future business activities. This level of uncertainty severely challenges our ability to operate profitably or to grow our businesses. In particular, it is difficult to develop and implement strategy, sustainable business models and efficient operations, and effectively manage manufacturing and supply chain relationships. We lost a key member of our management team in the terrorists attacks on the World Trade Center of September 11, 2001 and thus the attacks have already had adverse consequences on our business. However, we do not know how the consequences of these attacks will additionally affect our business. It is possible that a decrease in business and consumer confidence in the economy and the financial markets may lead to delays or reductions in capital expenditures by our customers and potential customers. Concerns over accounting practices of service providers and faltering growth prospects among equipment manufactures could delay the economic recovery in the telecommunications industry beyond 2002. In addition, further disruptions of the air transport system in the United States and abroad may negatively impact our ability to deliver products to customers, visit potential customers, to provide support and service to our existing customers and to obtain components in a timely fashion. If the economic or market conditions continue to languish 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. For instance, during late 2000, we were informed that certain Luminent transceivers sold to Cisco were experiencing field failures. Through discussions with Cisco through September 2001, Luminent's management agreed to replace the failed units, which we believe resolves this issue. We expect the ultimate replacement of these failed transceivers will cost approximately $2.9 million which has been fully reserved. Any of these or other eventualities resulting from defects in our products could cause our sales to decline and have a material adverse effect on our business, operating results and financial condition. OUR OPERATING RESULTS COULD FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER. 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, - software, hardware or other errors in the products we sell requiring replacements or increased warranty reserves, - 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 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 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. Our growth in recent years, 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. WE FACE RISKS FROM OUR INTERNATIONAL OPERATIONS. International sales have become an increasingly important segment of our operations. The following table sets forth the percentage of our total net revenues from sales to customers in foreign countries for the periods indicated below:
Six Months Ended Year Ended -------------------- -------------------------------------------- June 30, June 30, December 31, December 31, December 31, 2002 2001 2001 2000 1999 ------- ------- ----------- ----------- ----------- Percent of total revenue from foreign sales 71% 63% 67% 63% 58%
We have companies and offices in, and conduct a significant portion of our operations in and from, Israel. We are, therefore, directly influenced by the political and economic conditions affecting Israel. Any major hostilities involving Israel, the interruption or curtailment of trade between Israel and its trading partners or a substantial downturn in the economic or financial condition of Israel could have a material adverse effect on our operations. In addition, the recent acquisition of operations in Taiwan and People's Republic of China has increased both the administrative complications we must manage and our exposure to political, economic and other conditions affecting Taiwan and People's Republic of China. Luminent has a large manufacturing facility in the People's Republic of China in which it manufactures passive fiber optic components and both Luminent and we make sales of our products in the People's Republic of China. Our total sales in the People's Republic of China amounted to approximately $10.4 million during the year ended December 31, 2001 and $2.7 million during the year ended December 31, 2000. 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. To date, we have not hedged against currency exchange risks. In the future, we may engage in foreign currency denominated sales or pay material amounts of expenses in foreign currencies and, in that event, may experience gains and losses due to currency fluctuations. Our operating results could be adversely affected by currency fluctuations or as a result of inflation in particular countries where material expenses are incurred. WE DEPEND ON THIRD-PARTY CONTRACT MANUFACTURERS FOR NEEDED COMPONENTS AND THEREFORE COULD FACE DELAYS HARMING OUR SALES. We outsource the board-level assembly, test and quality control of material, components, subassemblies and systems relating to our networking products to third-party contract manufacturers. Though there are a large number of contract manufacturers that we can use for outsourcing, we have elected to use a limited number of vendors for a significant portion of our board assembly requirements in order to foster consistency in quality of the products and to achieve economies of scale. These independent third-party manufacturers also provide the same services to other companies. Risks associated with the use of independent manufacturers include unavailability of or delays in obtaining adequate supplies of products and reduced control of manufacturing quality and production costs. If our contract manufacturers failed to deliver needed components timely, we could face difficulty in obtaining adequate supplies of products from other sources in the near term. We can give no assurance that our third party manufacturers will provide us with adequate supplies of quality products on a timely basis, or at all. While we could outsource with other vendors, a change in vendors may require significant lead-time and may result in shipment delays and expenses. Our inability to obtain these products on a timely basis, the loss of a vendor or a change in the terms and conditions of the outsourcing would have a material adverse effect on our business, operating results and financial condition. 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. WE MAY BE HARMED BY OUR FAILURE TO PURSUE ACQUISITIONS AND IF WE DO PURSUE ACQUISITIONS HARM COULD RESULT. An important element of our strategy has been to review acquisition prospects that would complement our existing companies and products, augment our market coverage and distribution ability or enhance our technological capabilities. We expect that our acquisitions of businesses or product lines will decrease in comparison to historical levels. The networking business is highly competitive and our failure to pursue future acquisitions could hamper our ability to enhance existing products and introduce new products on a timely basis. If we do choose to pursue acquisitions, they 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. - 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. 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 ARE CURRENTLY, AND COULD IN THE FUTURE 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 Automation Technologies Corporation in which Rockwell claimed to have patent rights in certain technology related to our metal organic chemical vapor deposition, or MOCVD, processes and this claim initially resulted in litigation, which has since been dismissed pending the results of litigation not directly involving us. - 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 28% of our total sales during the year ended December 31, 2001 and 30% of our total sales during the year ended December 31, 2000. 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. As was the case with Rockwell, Lemelson, 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. 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 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. IF WE FAIL TO ACCURATELY FORECAST COMPONENT AND MATERIAL REQUIREMENTS FOR OUR MANUFACTURING FACILITIES, WE COULD INCUR ADDITIONAL COSTS OR EXPERIENCE MANUFACTURING DELAYS. We use rolling forecasts based on anticipated product orders to determine our component requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials. Lead times for components and materials that we order vary significantly and depend on factors such as specific supplier requirements, the size of the order, contract terms and current market demand for the components. For substantial increases in production levels, some suppliers may need six months or more lead-time. If we overestimate our component and material requirements, we may have excess inventory, which would increase our costs. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively impact our net sales. Current softness in demand and pricing in the communications market have necessitated a review of our inventory, facilities and headcount. As a result, we and Luminent recorded in the year ended December 31, 2001 one-time charges to write down inventory to realizable value and inventory purchase commitments of approximately $35.4 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 of Luminent into one of our wholly-owned subsidiaries may result in securities or other litigation. Securities or other litigation could result in substantial costs and divert management's attention and resources. DEPENDING ON OUR FUTURE ACTIVITIES OR AS A RESULT OF THE POSSIBLE SALE OF ONE OR MORE OF OUR PORTFOLIO COMPANIES, WE COULD BE FORCED TO INCUR SIGNIFICANT COSTS TO AVOID INVESTMENT COMPANY STATUS AND MAY SUFFER ADVERSE CONSEQUENCES IF DEEMED TO BE AN INVESTMENT COMPANY. In the past through 2000, we embarked upon a business strategy of creating, acquiring and managing companies in the optical technology and Internet infrastructure areas, with a view toward creating equity growth by operating or investing in these companies and then potentially spinning them off, taking them public or selling them or our interest in them. If this strategy proved successful, we were concerned that we might incur significant costs to avoid investment company status and would 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. As a result of the current economic slowdown in the communications industry generally and the fiber optic components industry particularly, we have abandoned plans to spin-off Luminent, one of our subsidiaries, and withdrawn the initial public offering of Optical Access, another of our subsidiaries. The economic slowdown and its consequences have caused us to reevaluate our strategy and to focus currently on holding and operating our existing businesses. This current focus makes it less likely that we would attain investment company status. However, if economic and market conditions recover to the point at which they existed prior to the fourth quarter of 2000, we may return to our prior strategy which, depending on future events, might again subject us to the potential risks associated with investment company status, including registration as an investment company. Moreover, although our portfolio of investment securities currently comprises substantially less than 40% of our total assets, fluctuations in the value of these securities or of our other assets as a result of future economic conditions or events, or, more likely, the sale of one or more of companies in exchange for the securities of the purchaser, may cause this limit to be exceeded. In any case where our investment securities resulting from a sale of one or more of our companies or otherwise were in excess of the 40% limit, we would have to attempt to reduce our investment securities as a percentage of our total assets unless an exclusion or safe harbor was available to us. This reduction could be attempted in a number of ways, including the disposition of investment securities and the acquisition of non-investment security assets. If we were required to sell investment securities, we may sell them sooner than we otherwise would. These sales may be at depressed prices and we may never realize anticipated benefits from, or may incur losses on, these investments. We may be unable to sell some investments due to contractual or legal restrictions or the inability to locate a suitable buyer. Moreover, we may incur tax liabilities when we sell assets. We may also be unable to purchase additional investment securities that may be important to our operating strategy. If we decide to acquire non-investment security assets, we may not be able to identify and acquire suitable assets and businesses or the terms on which we are able to acquire these assets may be unfavorable. The mere existence of these issues could cause us to forego a transaction, which might otherwise have been beneficial to us. DELAWARE LAW AND OUR ABILITY TO ISSUE PREFERRED STOCK MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE IN CONTROL, WHICH MAY CAUSE OUR STOCK PRICE TO DECLINE. We are authorized to issue up to 1,000,000 shares of preferred stock. This preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the board of directors without further action by stockholders. The terms of any series of preferred stock may include voting rights (including the right to vote as a series on particular matters), preferences as to dividend, liquidation, conversion and redemption rights and sinking fund provisions. No preferred stock is currently outstanding. The issuance of any preferred stock could materially adversely affect the rights of the holders of our common stock, and therefore, reduce the value of our common stock. In particular, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell our assets to, a third party and thereby preserve control by the present management. We are also subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibit us from engaging in a business combination with an interested stockholder for a period of three years after the date of the transaction in which the person became an interested stockholder unless the business combination is approved in the manner prescribed under Section 203. These provisions of Delaware law also may discourage, delay or prevent someone from acquiring or merging with us, which may cause the market price of our common stock to decline. PART II - OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (a) Not applicable. (b) Not applicable. (c) During the three months ended June 30, 2002, registrant issued an aggregate of 1,438,495 shares of its common stock to two holders of its 5% Convertible Subordinated Notes due 2003 (the "Notes") in exchange for $4.0 million principal amount of the Notes. Exemption from the registration requirements is claimed under the Securities Act of 1933 (the "Securities Act") in reliance on Section 3(a)(9) of the Securities Act in that the shares were exchanged by registrant with its existing security holders exclusively where no commission or other remuneration was paid or given directly or indirectly for soliciting such exchange. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 11.1 - Computation of per share earnings - See Note 1 of Notes to Unaudited Consolidated Condensed Financial Statements. (b) Reports on Form 8-K One report on Form 8-K were filed during the period covered by this Report, as follows: A report on Form 8-K dated June 18, 2002 was filed on June 18, 2002 reporting matters under Item 4. SIGNATURE Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant certifies that it has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on August 14, 2002. MRV COMMUNICATIONS, INC. By: /s/ Noam Lotan ------------------------------------------------ Noam Lotan President and Chief Executive Officer By: /s/ Shay Gonen ------------------------------------------------ Shay Gonen Chief Financial Officer CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of MRV Communications, Inc. (the "Company") on Form 10-Q for the period ended June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned, in the capacities and on August 14, 2002, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. MRV COMMUNICATIONS, INC. By: /s/ Noam Lotan ------------------------------------------------ Noam Lotan President and Chief Executive Officer By: /s/ Shay Gonen ------------------------------------------------ Shay Gonen Chief Financial Officer