UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

_________

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 September 30, 2004

[   ]	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.

20415 Nordhoff Street, Chatsworth, CA 91311
(Address of principal executive offices, Zip Code)

Registrant’s telephone number, including area code: (818) 773-0900

     Indicate by check mark, whether the issuer (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 9134 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 [  ]

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes [X]  No [  ]

     As of October 15, 2004, there were 103,904,965 shares of common stock, $.0017 par value per share, outstanding.

MRV Communications, Inc.

Form 10-Q, September 30, 2004

Index

     As used in this Report, “we, “us,” “our,” “MRV” or the “Company” refer to MRV Communications, Inc. and its consolidated subsidiaries.

2

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

          The 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. as of September 30, 2004, and the results of its operations and its cash flows for the three and nine months then ended.

          The results reported in these condensed financial statements should not be regarded as necessarily indicative of results that may be expected for any subsequent period or for the entire year.

3

MRV Communications, Inc.

Condensed Statements of Operations

(In thousands, except per share data)

          The accompanying notes are an integral part of these condensed financial statements

4

MRV Communications, Inc.

Condensed Balance Sheets

(In thousands, except par values)

5

MRV Communications, Inc.

Condensed Balance Sheets

(In thousands, except par values)

          The accompanying notes are an integral part of these condensed balance sheets.

6

MRV Communications, Inc.

Statements of Cash Flows

(In thousands)

7

MRV Communications, Inc.

Statements of Cash Flows

(In thousands)

          The accompanying notes are an integral part of these financial statements.

8

MRV Communications, Inc.

Notes To Financial Statements

September 30, 2004

1. Earnings (Loss) Per Share and Stock-Based Compensation

     Earnings (Loss) Per Share

          Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the sum of the weighted average number of common shares outstanding, plus all additional common shares that would have been outstanding if potentially dilutive securities or common stock equivalents had been issued. Stock options and warrants to purchase 10.5 million shares and 10.0 million shares for the three and nine months ended September 30, 2004 and 2003, respectively, were not included in the computation of diluted loss per share because such stock options and warrants were considered anti-dilutive. Shares associated with MRV’s 5% Convertible Subordinated Notes issued in June 1998 and paid in June 2003 and MRV’s outstanding 5% Convertible Notes issued June 2003 were not included in the computation of loss per share as they are anti-dilutive.

     Stock-Based Compensation

          MRV accounts for its employee stock plan under the intrinsic value method prescribed by Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” and as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123.”

9

          SFAS No. 123, and as amended by SFAS No. 148, permits companies to recognize, as expense over the vesting period, the fair value of all stock-based awards on the date of grant. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Because MRV’s stock-based compensation plans have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, management believes that the existing option valuation models do not necessarily provide a reliable single measure of the fair value of awards from the plan. Therefore, as permitted, MRV applies the existing accounting rules under APB No. 25 and provides pro forma net loss and pro forma loss per share disclosures for stock-based awards made during the year as if the fair value method defined in SFAS No. 123, as amended, had been applied. Net loss and net loss per share for each of the three and nine months ended September 30, 2004 and 2003 would have increased to the following pro forma amounts (in thousands, except per share data):

          The following assumptions were applied: (i) no expected dividend yield for all periods, (ii) expected volatility of 85% and 104% for 2004 and 2003, respectively, (iii) expected lives of 4 to 6 years for all periods, (iv) and risk-free interest rates ranging from 2.68% to 6.73% for all periods.

          Deferred stock expense is being amortized using the graded vesting method over four years. Using this method, approximately 57%, 26%, 13% and 4%, respectively, of each option’s compensation expense is amortized in each of the four years following the date of grant. Deferred stock expense was generated during 2001 and 2000 through acquisitions and stock options granted to LuminentOIC’s former President and its former Chief Financial Officer. For the three months ended September 30, 2004, there was no deferred stock expense. For the nine months ended September 30, 2004, MRV recognized deferred stock expense totaling $200,000, which was reduced by income from recapturing accelerated deferred stock expense totaling $12,000. For the three and nine months ended September 30, 2003, MRV recognized income from recapturing accelerated deferred stock expense due to terminations, net of the amortization of deferred stock expense of $597,000 and $3.2 million, respectively, totaling $861,000 and $8.4 million, respectively.

10

2. Segment Reporting and Geographical Information

          MRV divides and operates its business based on three segments: the networking group, the optical components group and development stage enterprise group. The networking group designs, manufactures and distributes optical networking solutions and Internet infrastructure products. The optical components group designs, manufactures and distributes optical components and optical subsystems. The development stage enterprise group that MRV has created or invested in is developing optical components, subsystems and networks and products for the infrastructure of the Internet. Segment information is therefore being provided on this basis.

          The accounting policies of the segments are the same as those described in the summary of significant accounting polices in MRV’s most recent Form 10-K. MRV evaluates segment performance based on revenues and operating expenses 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 revenues for the three and nine months ended September 30, 2004 and 2003 are as follows (in thousands):

          Revenues by product line for the three and nine months ended September 30, 2004 and 2003 are being presented differently from previous periods. “Optical active components” are being presented as “fiber optic components,” “remote device management products” are being presented as “console management products” and “optical passive components” and “network physical infrastructure equipment” are being presented as the combined product line “Physical layer products.” All periods presented are present on this basis. Revenues by product line for the three and nine months ended September 30, 2004 and 2003 are as follows (in thousands):

          For three and nine months ended September 30, 2004 and 2003, MRV had no single customer that accounted for 10% or more of revenues. As of September 30, 2004 and December 31, 2003, MRV had no single customer that accounted for 10% or more of accounts receivable. MRV does not track customer revenue by region for each individual reporting segment.

11

          A summary of external revenue by region for the three and nine months ended September 30, 2004 and 2003 is as follows (in thousands):

     Business segment operating income (loss) for the three and nine months ended September 30, 2004 and 2003 is as follows (in thousands):

     Income (loss) before provision for income taxes and extraordinary gain for the three and nine months ended September 30, 2004 and 2003 are as follows (in thousands):

3. Cash and Cash Equivalents, Time Deposits and Marketable Securities

          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 what management believes are highly qualified financial institutions. At various times such amounts are in excess of federally insured limits.

12

          MRV accounts for its marketable securities, which are available for sale, under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” During 2003, MRV changed its investment classification from “held-to-maturity” to “available for sale.” The original cost of MRV’s marketable securities approximated fair market value as of September 30, 2004 and December 31, 2003. As of September 30, 2004 and December 31, 2003, short-term and long-term marketable securities consisted principally of U.S. Treasury Bonds, Municipal Bonds and Corporate Bonds. Marketable securities mature at various dates through 2004. Purchase, sales and maturities of securities are presented in the accompanying Statements of Cash Flows.

4. 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):

5. Restructuring Costs

          During the second quarter of 2001, LuminentOIC’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 totaling $1.3 million, the abandonment of certain assets, including closed and abandoned facilities, amounting to $12.8 million and the cancellation and termination of purchase commitments totaling $6.2 million. MRV has a remaining obligation totaling $826,000 for its fulfillment of a lease obligation on an abandoned facility that it expects to pay through cash on-hand through August 2007.

6. 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. MRV did not repurchase any of its common stock during the three or nine months ended September 30, 2004. Total share repurchases under this program through September 30, 2004 were 1,305,000 shares of common stock at a cost of $1.2 million.

7. Comprehensive Income (Loss)

          The components of comprehensive income (loss) were as follows (in thousands):

13

8. Supplemental Statement of Cash Flow Information (in thousands)

          During the nine months ended September 30, 2003, MRV exchanged $5.9 million principal amount of 1998 Notes in exchange for 4.2 million shares of its common stock. This non-cash transaction has been excluded from the accompanying Statements of Cash Flows.

9. Recently Issued Accounting Pronouncements

          On October 13, 2004, the Financial Accounting Standards Board (“FASB”) concluded that the Proposed Statement of Financial Accounting Standards, Share-Based Payment, which would require all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value, would be effective for public companies for interim or annual periods beginning after June 15, 2005. MRV could adopt the new standard in one of two ways — the modified prospective transition method or the modified retrospective transition method. Assuming this new standard is implemented as scheduled, MRV presently plans to adopt this new standard in the third quarter of 2005 and is currently evaluating the effect that the adoption of this standard will have on its financial position and results of operations.

10. Reclassifications

          Certain prior year amounts have been reclassified to conform to the current year presentation.

14

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 our 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 design, manufacture, sell, distribute, integrate and support network infrastructure equipment and services, and optical components. We conduct our business along three principal segments: the networking group, the optical components group and development stage enterprise group. Our networking group provides equipment used by commercial customers, governments and telecommunications service providers, and include switches, routers, network physical infrastructure equipment and console management products as well as specialized networking products for defense and aerospace applications. Our optical components group designs, manufactures and sell optical communications components, primarily through our wholly owned subsidiary LuminentOIC, Inc. These components include fiber optic transceivers, discrete lasers and laser emitting diodes, or LEDs, as well as components for Fiber-to-the-Premises, or FTTP, applications. Our development stage enterprise group seeks to develop new optical components, subsystems and networks and other products for the infrastructure of the Internet.

          We market and sell our products worldwide, through a variety of channels, which include a dedicated direct sales force, manufacturers’ representatives, value-added-resellers, distributors and systems integrators. We have operations in Europe that provide network system design, integration and distribution services that include products manufactured by third-party vendors, as well as our products. We believe such specialization enhances access to customers and allows us to penetrate targeted vertical and regional markets.

          We were organized in July 1988 as MRV Technologies, Inc., a California corporation and reincorporated in Delaware in April 1992, at which time we changed our name to MRV Communications, Inc.

          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, except on rare occasions in which event our accounting is as described below. Sales of services and system support are deferred and recognized ratably over the contract period. Sales with contingencies, such as right of return, rotation rights, conditional acceptance provisions and price protection are rare and have historically been insignificant. We do not recognize such sales 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. Gross profit is equal to our revenues less our cost of goods sold. Our cost of goods sold includes materials, direct labor and overhead. Cost of inventory is determined by the first-in, first-out method. Our operating costs and expenses generally consist of product development and engineering costs, or R&D, selling, general and administrative costs, or SG&A, and other operating related costs and expenses.

          We divide and operate our business on the basis of our three principal segments. We evaluate segment performance based on the revenues and the operating expenses of each segment. We do not track segment data or evaluate segment performance on additional financial information. As such, there are no separately identifiable segment assets nor are there any separately identifiable Statements of Operations data below operating income (expense). The networking and optical components groups account for virtually all of our overall revenue.

15

          Our business involves reliance on foreign-based entities. Several of our divisions, outside subcontractors and suppliers are located in foreign countries, including Argentina, China, Denmark, Finland, France, Germany, Israel, Italy, Japan, Korea, the Netherlands, Norway, Russia, Singapore, South Africa, Switzerland, Sweden, Taiwan and the United Kingdom. For the nine months ended September 30, 2004 and 2003, foreign revenues constituted 76% and 78%, respectively, of our revenues. The vast majority of our foreign sales are to customers located in the European region. The remaining foreign sales are primarily to customers in the Asia Pacific region.

Critical Accounting Policies

          Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. There have been no material changes in our critical accounting policies from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003.

          We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. Certain of these critical accounting policies affect working capital account balances, including the policies for revenue recognition, allowance for doubtful accounts, inventory reserves and income taxes. These policies require that we make estimates in the preparation of our financial statements as of a given date. However, since our business cycle is relatively short, actual results related to these estimates are generally known within the six-month period following the financial statement date. Thus, these policies generally affect only the timing of reported amounts across two to three quarters.

          Within the context of these critical accounting policies, we are not currently aware of any reasonably likely events or circumstances that would result in materially different amounts being reported.

          Revenue Recognition. 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 of services and system support are deferred and recognized ratably over the contract period. 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: fiber optic components; switches and routers; console management products; and physical layer products.

          Allowance for Doubtful Accounts. We make ongoing estimates relating to the collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability of our customers to meet their financial obligations to us. In determining the amount of the reserve, we consider our historical level of credit losses and make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Since we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve may be required. In the event we determined that a smaller or larger reserve was appropriate, we would record a credit or a charge to selling and administrative expense in the period in which we made such a determination.

16

          Inventory Reserves. We also make ongoing estimates relating to the market value of inventories, based upon our assumptions about future demand and market conditions. If we estimate that the net realizable value of our inventory is less than the cost of the inventory recorded on our books, we record a reserve equal to the difference between the cost of the inventory and the estimated net realizable market value. This reserve is recorded as a charge to cost of goods sold. If changes in market conditions result in reductions in the estimated market value of our inventory below our previous estimate, we would increase our reserve in the period in which we made such a determination and record a charge to cost of goods sold.

          Goodwill and Other Intangibles. We adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” effective January 1, 2002. In accordance with SFAS No. 142, we no longer amortize goodwill and intangible assets with indefinite lives, but instead measure these assets for impairment at least annually, or when events indicate that impairment exists. We generally perform our annual impairment analysis as of October 1^st of each year. We continue to amortize intangible assets that have definite lives over their useful lives.

          Income Taxes. As part of the process of preparing our financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Balance Sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the Statements of Operations.

          Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. Management continually evaluates our deferred tax asset as to whether it is likely that the deferred tax assets will be realized. If management ever determined that our deferred tax asset was not likely to be realized, a write-down of that asset would be required and would be reflected in the provision for taxes in the accompanying period.

17

Results of Operations

          The following table sets forth, for the periods indicated, our statements of operations data expressed as a percentage of revenues.

          The following management discussion and analysis refers to and analyzes our results of operations into three segments as defined by our management. These three segments are our networking group, optical components group and development stage enterprise group, which includes all our start-up activities.

18

Three Months Ended September 30, 2004 (“2004”) Compared
To Three Months Ended September 30, 2003 (“2003”)

     Revenue

          Revenues for 2004 increased $6.1 million, or 11%, to $62.9 million from $56.8 million for 2003. We realized increases in revenues from sales of our fiber optic components and switches and routers. Geographically, revenues increased 39% in the Americas. We attribute the increase in our revenues in the Americas to initial shipments of FTTP products for early deployments. Shipments of FTTP products for 2004 totaled approximately $7.5 million. Recent announcements suggest that FTTP deployments in North America are expected to make services available to at least one million residential homes by the end of the year; however the number of actual residential homes subscribing to such services is expected to be a fraction of the total deployments. We expect sales of FTTP products to continue to grow in the fourth quarter of 2004. However, this forward looking statement may not come to pass if the actual deployments do meet the expectations of industry announcements, if the orders we expect to receive do not materialize, are delayed or cancelled or if we are unable to ship the products during the fourth quarter.

          For 2004 and 2003, 45% of our revenues were generated from the sale of third-party products through our system integration and distribution offices. Our revenues by segment for 2004 and 2003 were as follows (in thousands):

          Networking Group. Our networking group provides equipment used by commercial customers, governments and telecommunications service providers, which includes switches, routers, physical layer products and console management products as well as specialized networking products for defense, aerospace and other applications, including cellular communications. External revenues generated from our networking group increased $2.3 million, or 5%, to $50.6 million for 2004 as compared to $48.3 million for 2003. The increase is due to increases in sales of switches and routers, partially offset by slight decreases in sales of each of our remaining networking products. External revenues generated from the sales of switches and routers increased $3.3 million, or 24%, to $17.2 million for 2004 compared to $13.8 million for 2003. External revenues generated from services increased $754,000, or 15%, to $5.8 million for 2004 compared to $5.1 million for 2003.

          Optical Components Group. Our optical components group designs, manufactures and sells optical communications components and primarily consists of products manufactured by our wholly owned subsidiary, LuminentOIC. These components include fiber optic transceivers, discrete lasers and LEDs, as well as components for Fiber-to-the-Premises applications, or FTTP. Revenues, including intersegment revenue, generated from our optical components group increased $3.6 million, or 39%, to $12.7 million for 2004 as compared to $9.1 million for 2003. We attribute the increase in optical components revenue to initial shipments of FTTP components for North America. Additionally, shipments of FTTP products were the primary catalyst for our increase in sales in the Americas.

          Development Stage Enterprise Group. No revenues were generated by these entities for 2004 and 2003.

19

     Gross Profit

          Gross profit for 2004 was $20.1 million, compared to gross profit of $18.4 million for 2003. Gross profit increased $1.7 million, or 9%, in 2004 compared to 2003. Our gross margin for 2004 and 2003 was 32%. The increase in gross profit, generated primarily through our optical components group, is the result of the increase in revenue and the composition of product sales.

          Networking Group. Gross profit for our networking group remained unchanged and was $18.7 million for 2004 and 2003. Gross margins decreased to 37% for 2004, compared to gross margin of 39% for 2003. We attribute the decrease in gross margin during 2004 to the composition of our product revenue. More specifically, we realized an increase in the sales of switches and routers which generally generate gross margin at rates lower than our company-wide average, while sales of our console management and physical layers products slightly decreased and which typically generate gross margin at rates greater than the company-wide averages.

          Optical Components Group. Gross profit for 2004 was $1.4 million, compared to a gross deficit of $247,000 for 2003, an improvement of $1.7 million, primarily as a result of the increase in optical component sales. Gross margins improved to 11% for 2004, compared to gross margin of (3)% for 2003. The improvement in gross margin for 2004 is attributed to the composition of product sales. We realized lower than anticipated gross margins from the initial shipments of FTTP product for early deployments. These margins were lower than the average margins realized from the sales of our other optical components. We expect to improve gross margins from the sales of FTTP products through manufacturing efficiencies and economies of scale.

          Development Stage Enterprise Group. As we had no sales by these entities, we had no gross margins were produced by these entities for 2004 and 2003.

     Operating Costs and Expenses

          Operating costs and expenses were $23.2 million, or 37% of revenues, for 2004, compared to $25.3 million, or 45% of revenues, for 2003. Operating costs and expenses decreased $2.1, or 8%, in 2004 compared to 2003. For 2004, operating costs and expenses did not include any deferred stock expense, while 2003 included income from the recapture of accelerated deferred stock expense due to terminations that amounted to $832,000. These changes in deferred stock expense (i.e., no expense in 2004 compared to income reported in 2003) accounted for the increase in operating costs and expenses totaling $832,000. The increase in operating costs and expenses resulting from the changes in deferred stock expense was offset by cost savings efforts, including head count reductions and lower spending in product development and engineering.

          Networking Group. Operating costs and expenses for 2004 were $18.5 million, or 37% of revenues, compared to $20.5 million, or 43% of revenues, for 2003. Operating costs and expenses decreased $2.1 million, or 10%, in 2004 compared to 2003. For 2004, operating costs and expenses did not include any deferred stock expense, while 2003 included income from recapturing accelerated deferred stock expense due to terminations totaling $365,000. Changes in deferred stock expenses accounted for an increase in our operating costs and expenses of $365,000. The increase in operating costs and expenses resulting from changes in deferred stock expense was offset by costs savings including lower spending in both product development and engineering expenses and sales, general and administrative expenses during 2004.

          Optical Components Group. Operating costs and expenses for 2004 were $4.2 million, or 33% of revenues, compared to $3.2 million, or 35% of revenues, for 2003. Operating costs and expenses increased $1.0 million, or 32%, in 2004 compared to 2003. For 2004, operating costs and expenses did not include any deferred stock expense, while 2003 included income from recapturing accelerated deferred stock expense due to terminations totaling $467,000. Changes in deferred stock expenses (i.e. no expense in 2004 compared to income of $467,000 reported in 2003) accounted for half of the increase in our operating costs and expenses. We attributed the remaining increase in our operating costs and expenses to an increase in selling, general and administrative expenses in conjunction with the improvement in our optical components business.

20

          Development Stage Enterprise Group. Operating costs and expenses for 2004 were $564,000, compared to $1.6 million for 2003. Operating costs and expenses decreased $1.0 million, or 64%, in 2004 compared to 2003. We attribute the decrease in operating costs and expenses to our cost saving efforts, which mainly consisted of head count reductions to align these costs with current development activities.

     Operating Income (Loss)

          We reported an operating loss of $3.1 million, or 5% of revenues, for 2004 compared to $6.9 million, or 12% of revenues, for 2003. We reduced our operating loss by $3.8 million, or 55%, in 2004 compared to 2003. This improvement is the result of our cost reduction efforts and the realignment of our costs and expenses with current operations along with our overall increase in sales, improvement in gross profit, primarily through our optical components group, and the reduction of operating expenses in our networking group.

          Networking Group. Our networking group reported operating income totaling $221,000 for 2004, compared to an operating loss of $1.9 million, or 4% of revenues, for 2003, an improvement of $2.1 million. This improvement is the result of our continued cost containment efforts including a reduction in spending for operating costs and expenses and changes in deferred stock expense.

          Optical Components Group. Our optical components group reported an operating loss of $2.8 million, or 22% of revenues, for 2004, compared to $3.4 million, or 37% of revenues, for 2003. Our operating loss improved $664,000, or 19%, in 2004 compared to 2003. Our reduction in operating loss was the result of improved sales and gross profit, partially offset by increases in operating costs and expenses resulting.

          Development Stage Enterprise Group. Our development stage enterprise group reported an operating loss of $564,000 for 2004, compared to $1.6 million for 2003. Our operating loss improved $1.0 million, or 64%, in 2004 compared to 2003. The improvement is the result of a significant reduction in spending for operating costs and expenses.

     Other Income (Expense), Net

          During 2004 and 2003, other income (expense), net represented interest expense on our obligations and interest income on cash and investments.

     Provision For Taxes

          We record valuation allowances against our deferred tax assets, when necessary, in accordance with SFAS No. 109, “Accounting for Income Taxes.” Realization of deferred tax assets (such as net operating loss carryforwards and income tax credits) is dependent on future taxable earnings and is therefore uncertain. At least quarterly, we assess the likelihood that our deferred tax asset balance will be recovered from future taxable income. Our tax expense fluctuates primarily due to the tax jurisdictions where we currently have operating facilities and the varying tax rates in those jurisdictions.

21

Nine Months Ended September 30, 2004 (“2004”) Compared
To Nine Months Ended September 30, 2003 (“2003”)

     Revenue

          Revenues for 2004 increased $19.9 million, or 12%, to $189.8 million from $169.9 million for 2003. We realized increases in all of our product lines, except our physical layer products which reported a slight decline. More specifically, we experienced significant growth in sales of our fiber optic components, console management and other networking products. Geographically, revenues increased 25% and 8% in the Americas and Europe, respectively. During the third quarter, we realized revenues in the Americas from initial shipments of FTTP products for early deployments.

          For 2004, 46% of our revenues were generated from the sale of third-party products through our system integration and distribution offices, as compared to 48% during 2003. Our revenues by segment for 2004 and 2003 were as follows (in thousands):

          Networking Group. External revenues generated from our networking group increased $15.2 million, or 11%, to $159.3 million for 2004 as compared to $144.0 million for 2003. The increase is due to increases in sales of the majority of our product lines, offset by slight decreases in sales of our physical layer products. External revenues generated from the sales of our console management products increased $4.4 million, or 36%, to $16.5 million for 2004 compared to $12.1 million for 2003. External revenues generated from the sales of our other networking products, which include defense, aerospace and other applications, including cellular communication, increased $6.3 million, or 28%, to $28.7 million for 2004 compared to $22.4 million for 2003. External revenues generated from sales of our switches and routers increased $2.8 million, or 6%, to $48.8 million for 2004 as compared to $46.1 million for 2003. Over the past year, we have focused our sales and marketing efforts in the Americas. This focus has resulted in an increase of $9.2 million, or 25%, to $45.7 million for 2004 compared to $36.6 million for 2003. Revenues in Europe increased $10.1 million, or 8% to $132.6 million for 2004 compared to $122.5 million for 2003.

          Optical Components Group. Revenues, including intersegment revenue, generated from our optical components group increased $4.2 million, or 15%, to $31.8 million for 2004 as compared to $27.6 million for 2003. We attribute the increase in optical components revenue to sales of FTTP components for residential deployments in North America.

          Development Stage Enterprise Group. No revenues were generated by these entities for 2004 and 2003.

     Gross Profit

          Gross profit for 2004 was $64.1 million, compared to gross profit of $52.8 million for 2003. Gross profit increased $11.3 million, or 21%, in 2004 compared to 2003. The increase in gross profit, primarily through our networking group, is the result of the increase in revenue and the composition of product sales.

22

          Our gross margin increased to 34% for 2004, compared to gross margin of 31% for 2003. We attribute the increase in our gross margin to an improvement in the composition of our product revenues and manufacturing efficiencies through economies of scale.

          Networking Group. Gross profit for 2004 was $59.8 million, compared to gross profit of $50.6 million for 2003. Gross profit increased $9.1 million, or 18%, in 2004 compared to 2003. Gross margins increased to 38% for 2004, compared to gross margin of 35% for 2003. We attribute the increase in gross profit during 2004 to the increase in sales, the composition of our product revenue, effects of improved manufacturing efficiencies through economies of scale and cost reduction efforts.

          Optical Components Group. Gross profit for 2004 was $4.4 million, compared to gross profit of $2.2 million for 2003. Gross profit increased $2.1 million, or 96%, in 2004 compared to 2003. Gross margins improved to 14% for 2004 as compared to 8% for 2003. The improvement in gross margin is due to increased revenues, product compositions and manufacturing efficiencies, some of which are due to a transition of manufacturing to our facility in Taiwan.

          Development Stage Enterprise Group. As we had no sales by these entities, we had no gross margins were produced by these entities for 2004 and 2003.

     Operating Costs and Expenses

          Operating costs and expenses were $72.2 million, or 38% of revenues, for 2004, compared to $69.5 million, or 41% of revenues, for 2003. Operating costs and expenses increased $2.7 million, or 4%, for 2004 as compared to 2003. For 2004, operating costs and expenses include deferred stock expense that amounted to $168,000, while 2003 included income from the recapture of accelerated deferred stock expense due to terminations that amounted to $7.3 million. These changes in deferred stock expense (i.e., the expense in 2004 compared to income reported in 2003) accounted for an increase in operating costs and expenses totaling $7.4 million. The increase in operating costs and expenses resulting from the changes in deferred stock expense was offset by cost savings efforts, including head count reductions and lower spending in product development and engineering, to align these costs with current operations.

          Networking Group. Operating costs and expenses for 2004 were $59.0 million, or 37% of revenues, compared to $52.9 million, or 37% of revenues, for 2003. Operating costs and expenses increased $6.1 million, or 12%, in 2004 compared to 2003. For 2004, operating costs and expenses include deferred stock expense that amounted to $141,000, while 2003 included income from recapturing accelerated deferred stock expense due to terminations totaling $7.0 million. Changes in deferred stock expenses accounted for an increase in operating costs and expenses totaling $7.1 million. We decreased spending on product development and engineering during 2004, partially offset by increased efforts on selling and marketing in the Americas and in Europe.

          Optical Components Group. Operating costs and expenses for 2004 were $11.5 million, or 36% of revenues, compared to $10.9 million, or 39% of revenues, for 2003. Operating costs and expenses increased $616,000, or 6%, in 2004 compared to 2003. For 2004, operating costs and expenses include deferred stock expense that amounted to $27,000, while 2003 included income from recapturing accelerated deferred stock expense due to terminations totaling $278,000. Changes in deferred stock expenses accounted for $305,000, or half, of the increase in our operating costs and expenses. We attributed the remaining increase in our operating costs and expenses to increases in product development and engineering, partially offset by decreased expenses for selling, generally and administration.

          Development Stage Enterprise Group. Operating costs and expenses for 2004 were $1.6 million, compared to $5.7 million for 2003. Operating costs and expenses decreased $4.1 million, or 71%, in 2004 compared to 2003. We attribute the decrease in operating costs and expenses to our cost saving efforts, which mainly consisted of head count reductions, to align these costs with current development activities.

23

     Operating Income (Loss)

          We reported an operating loss of $8.1 million, or 4% of revenues, for 2004 compared to $16.7 million, or 10% of revenues, for 2003. We reduced our operating loss by $8.6 million, or 52%, in 2004 compared to 2003. This improvement is the result of our cost reduction efforts and the realignment of our costs and expenses with current operations along with our improvement in gross profit, primarily through our networking group.

          Networking Group. Our networking group reported operating income totaling $713,000 for 2004, compared to an operating loss of $2.3 million, or 2% of revenues, for 2003. This improvement is the result of our increased sales and gross margin partially offset by the reduction in income reported in 2003 resulting from the recapturing of deferred stock expense for terminated employees.

          Optical Components Group. Our optical components group reported an operating loss of $7.1 million, or 22% of revenues, for 2004, compared to $8.7 million, or 31% of revenues, for 2003. Our operating loss decreased by $1.5 million, or 18%, in 2004 compared to 2003. Our reduction in operating loss was the result of improved gross margin and the effect of our cost savings efforts to align these costs with current operations.

          Development Stage Enterprise Group. Our development stage enterprise group reported an operating loss of $1.6 million for 2004, compared to $5.7 million for 2003. Our operating loss decreased by $4.1 million, or 71%, in 2004 compared to 2003. The improvement is the result of a significant reduction in spending for operating costs and expenses.

     Other Expense, Net

          During 2004 and 2003, other expense, net represented interest expense on our obligations and interest income on cash and investments. Other expense, net for 2003 also includes a loss on the extinguishment of debt that amounted to $5.4 million, net of associated taxes.

     Provision For Taxes

          We record valuation allowances against our deferred tax assets, when necessary, in accordance with SFAS No. 109, “Accounting for Income Taxes.” Realization of deferred tax assets (such as net operating loss carryforwards and income tax credits) is dependent on future taxable earnings and is therefore uncertain. At least quarterly, we assess the likelihood that our deferred tax asset balance will be recovered from future taxable income. Our tax expense fluctuates primarily due to the tax jurisdictions where we currently have operating facilities and the varying tax rates in those jurisdictions.

     Recently Issued Accounting Pronouncements

          On October 13, 2004, the Financial Accounting Standards Board (“FASB”) concluded that the Proposed Statement of Financial Accounting Standards, Share-Based Payment, which would require all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value, would be effective for public companies for interim or annual periods beginning after June 15, 2005. We could adopt the new standard in one of two ways — the modified prospective transition method or the modified retrospective transition method. Assuming this new standard is implemented as scheduled, we presently plan to adopt this new standard in the third quarter of 2005 and are currently evaluating the effect that the adoption of this standard will have on our financial position and results of operations.

24

Liquidity and Capital Resources

          We had cash and cash equivalents of $66.4 million as of September 30, 2004, a decrease of $22.3 million from the cash and cash equivalents of $88.7 million as of December 31, 2003. The decrease in cash and cash equivalent is primarily the result of cash used in our operations, timing of cash collections from customers, cash used to procure necessary inventories, cash used to satisfy vendor obligations and net payments on short-term and long-term obligations. The following table illustrates as of September 30, 2004 and December 31, 2003 our cash position, which we define as cash, cash equivalents, time deposits and short-term and long-term marketable securities, as it relates to our current debt position, which we define as all short-term and long-term obligations including our convertible notes due in June 2008 (in thousands):

          Our working capital as of September 30, 2004 was $104.2 million compared to $108.1 million as of December 31, 2003. Our ratio of current assets to current liabilities as of September 30, 2004 was 2.4 to 1.0 compared to 2.3 to 1.0 as of December 31, 2003. Fluctuations in our working capital are typical due to the timing of: shipments of our products to customers, payments by customers of their balances, receipt of inventories for our vendors and payments to our vendors for raw materials.

          Cash Flows Related to Operating Activities. Cash used in operating activities was $23.0 million for the nine months ended September 30, 2004. Cash used in operating activities is a result of our net operating loss of $11.6 million, adjusted for non-cash items such as depreciation and amortization, deferred stock expense, deferred income taxes and losses on the disposition of fixed assets. Decreased time deposits and other assets positively affected cash used in operating activities. Cash used in operating activities was negatively affected by increases in accounts receivable and inventories and decreases in accounts payable, deferred revenue and other current liabilities. The increase in accounts receivables is due to a general increase in business worldwide. The increase in inventories results from an increases in FTTP products for future shipments, along with increases through out our networking group in response to an increase in business worldwide. Decreases in accounts payable are the result of the timing of payments to our vendors.

          Cash Flows Related to Investing Activities. Cash used in investing activities were $2.7 million for the nine months ended September 30, 2004, compared to cash provided by investing activities totaling $382,000 for the nine months ended September 30, 2003. Cash used in investing activities for the nine months ended September 30, 2004 were primarily the result of the purchase of short-term marketable securities and capital expenditures. As of September 30, 2004, we had no plans for major capital expenditures. Cash flows provided by investing activities for the prior period resulted from the maturities of short-term and long-term marketable securities, partially offset by the cash used for capital expenditures and the purchase of a minority interest.

25

          Cash Flows Related to Financing Activities. Cash flows provided by financing activities were $2.8 million for the nine months ended September 30, 2004, as compared to cash flows used in financing activities of $8.0 million for the nine months ended September 30, 2003. Cash provided by financing activities was primarily the result of our net borrowings of $2.2 million on our short-term and long-term obligations, partially offset by net proceeds from the exercise of employee stock options. Cash flows used in financing activities in 2003 represent the cash paid on borrowings, our final payment on our 5% convertible subordinated notes which came due in June 2003, proceeds form the issuance of 5% convertible notes due in June 2008 and the repurchase of our common stock.

     Off-Balance Sheet Arrangements

          We do not have transactions, arrangements and other relationships with unconsolidated entities that are reasonably likely to affect our liquidity or capital resources. We have no special purpose or limited purpose entities that provided off-balance sheet financing, liquidity or market or credit risk support, engage in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected on the face of the financials.

     Contractual Cash Obligations

          The following table illustrates our total contractual cash obligations as of September 30, 2004 (in thousands):

          Our total contractual cash obligations as of September 30, 2004, were $62.5 million, of which, $19.8 million were due by September 30, 2005. These total contractual cash obligations primarily consist of short-term and long-term obligations, including our 5% convertible notes due June 2008, operating leases for our equipment and facilities and unconditional purchase obligations for necessary raw materials. Historically, these obligations have been satisfied through cash generated from our operations or other avenues, which is further discussed below, and we expect that this will continue to be the case.

          We believe that our cash on hand and cash flows from operations will be sufficient to satisfy our working capital, capital expenditures and product development and engineering requirements for at least the next 12 months. However, we may choose to obtain additional debt or equity financing if we believe it appropriate. We are limited in the amount of debt financing we may obtain and the price per share of common stock at which we may conduct equity financings without triggering an acceleration of, or obtaining a waiver from holders of, our 5% convertible notes due June 2008. For a discussion of these limitations and other restrictions of our 5% convertible notes due June 2008, see the discussion under “Certain Risk Factors That Could Affect Future Results – Our 2003 Notes Provide For Various Events Of Default That Would Entitle The Holders To Require Us To Immediately Repay The Outstanding Principal Amount, Plus Accrued And Unpaid Interest, In Cash.” Our future capital requirements will depend on many factors, including 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.

26

Internet Access to Our Financial Documents

          We maintain a website at www.mrv.com. We make available free of charge, either by direct access or a link to the SEC website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Our reports filed with, or furnished to, the SEC are also available directly at the SEC’s website at www.sec.gov.

Certain Risk Factors That Could Affect Future Results

          You should carefully consider and evaluate all of the information in this Form 10-Q, including the risk factors listed below. The risks described below are not the only ones facing our company. Additional risk not now known to us or that we currently deem immaterial may also impair our business operations.

          If any of these risks actually occur, our business could be materially harmed. If our business is harmed, the trading price of our common stock could decline.

          This Form 10-Q also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this Form 10-Q. We undertake no duty to update any of the forward-looking statements after the date of this Form 10-Q.

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;
-		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;
-		our annual reviews of goodwill and other intangibles that lead to impairment charges;
-		new product introductions by our competitors;
-		pricing actions by our competitors or us;
-		the timing of delivery and availability of components from suppliers;
-		political stability in the areas of the world we operate in;
-		changes in material costs;
-		currency fluctuations; and
-		general economic conditions.

27

          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. The Internet or the industries that serve it may not continue to grow and even if it does or they do, we may not achieve increased growth. 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.

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 may not be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, our new products may not gain market acceptance or we may not be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Our failure to respond effectively to technological changes would significantly harm our business.

28

Defects In Our Products Resulting From Their Complexity Or Otherwise Could Hurt Our Financial Performance.

          Complex products, such as those we offer, may contain undetected software or hardware errors when we first introduce them or when we release new versions. The occurrence of these errors in the future, and our inability to correct these errors quickly or at all, could result in the delay or loss of market acceptance of our products. It could also result in material warranty expense, diversion of engineering and other resources from our product development efforts and the loss of credibility with, and legal actions by, our customers, system integrators and end users. Any of these or other eventualities resulting from defects in our products could cause our sales to decline and have a material adverse effect on our business, operating results and financial condition.

Cost Containment And Expense Reductions Are Critical To Achieving Positive Cash Flow From Operations And Profitability

          We are continuing efforts to reduce our expense structure. We believe strict cost containment and expense reductions are essential to achieving positive cash flow from operations in future quarters and returning to profitability, especially since the outlook for future quarters is subject to numerous challenges. Additional measures to contain costs and reduce expenses may be undertaken if revenues and market conditions do not improve. A number of factors could preclude us from successfully bringing costs and expenses in line with our revenues, such as our inability to accurately forecast business activities and further deterioration of our revenues. If we are not able to effectively reduce our costs and achieve an expense structure commensurate with our business activities and revenues, we may have inadequate levels of cash for operations or for capital requirements, which could significantly harm our ability to operate the business.

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.

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 fiber optic components;

-

increased risk of excess and obsolete inventories;

-

increased price competition for our products;

29

-		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, 2002 and 2003 and may affect them for 2004 and thereafter. As a result of these factors, our revenues declined during the last three years and we reported net losses of $27.0 million, $479.8 million and $326.4 million for the years ended December 31, 2003, 2002 and 2001, respectively. Our business may continue to suffer from adverse economic conditions worldwide. Our operating results for future periods are subject to numerous uncertainties, and we may not be able to achieve and maintain profitability. Recent geopolitical and social turmoil in many parts of the world, including actual incidents and potential future acts of terrorism and war, may continue to put pressure on global economic conditions. These geopolitical and social conditions, together with the resulting economic uncertainties, make it extremely difficult for our customers, our vendors and us to accurately forecast and plan future business activities. In particular, it is difficult to develop and implement strategy, sustainable business models and efficient operations, and effectively manage manufacturing and supply chain relationships. If the economic or market environment deteriorates 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.

We Face Risks In Reselling The Products Of Other Companies.

          We distribute products manufactured by other companies. To the extent we succeed in reselling the products of these companies, or products of other vendors with which we may enter into similar arrangements, we may be required by customers to assume warranty and service obligations. While these suppliers have agreed to support us with respect to those obligations, if they should be unable, for any reason, to provide the required support, we may have to expend our own resources on doing so. This risk is amplified by the fact that the equipment has been designed and manufactured by others, and is thus subject to warranty claims whose magnitude we are currently unable to fully evaluate.

The Price 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 shares of 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.

30

Our 2003 Notes Provide For Various Events Of Default That Would Entitle The Holders To Require Us To Immediately Repay The Outstanding Principal Amount, Plus Accrued And Unpaid Interest, In Cash.

          On June 4, 2003, we completed the sale of $23 million principal amount of 2003 Notes to Deutsche Bank AG, London Branch in a private placement pursuant to Regulation D under the Securities Act of 1933. We will be considered in default of the 2003 Notes if any of the following events, among others, occurs:

-		our default in payment of any principal amount of, interest on or other amount due under the 2003 Notes when and as due;
-		the effectiveness of the registration statement, which registered for resale the shares of our common stock issuable upon conversion of the 2003 Notes, lapses for any reason or is unavailable to the holder of the 2003 Notes for resale of all of the shares issuable upon conversion, other than during allowable grace periods, for a period of five consecutive trading days or for more than an aggregate of 10 trading days in any 365-day period;
-		the suspension from trading or failure of our common stock to be listed on the Nasdaq Stock Market for a period of five (5) consecutive trading days or for more than an aggregate of ten (10) trading days in any 365-day period;
-		we or our transfer agent notify any holder of our intention not to issue shares of our common stock to the holder upon receipt of any conversion notice delivered in respect of a Note by the holder;
-		we fail to deliver shares of our common stock to the holder within 12 business days of the conversion date specified in any conversion notice delivered in respect of a Note by the holder;
-		we breach any material representation, warranty, covenant or other term or condition of the 2003 Notes or the Securities Purchase Agreement, or the Registration Rights Agreement relating to 2003 Notes and the breach, if curable, is not cured by us within 10 days;
-		failure by us for 10 days after notice to comply with any other provision of the 2003 Notes in all material respects, which include abiding by our covenants not to

o		incur any form of unsecured indebtedness in excess of $17 million, plus obligations arising from the sale of receivables with recourse through our foreign offices, in the ordinary course of business and consistent with past practices;
o		repurchase our common stock for an aggregate amount in excess of $5,000,000; pursuant to a stock purchase program that was approved by our Board of Directors and publicly announced on June 13, 2002; or
o		declare or pay any dividend on any of our capital stock, other than dividends of common stock with respect to our common stock;

-

we breach provisions of the 2003 Notes prohibiting us from either issuing

o		our common stock or securities that are convertible into or exchangeable or exercisable for shares of our common at a per share price less than the conversion price per share of the 2003 Notes then in effect, except in certain limited cases; or
o		securities that are convertible into or exchangeable or exercisable for shares of our common stock at a price that varies or may vary with the market price of our common stock;

-		we breach any of our obligations under any other debt or credit agreements involving an amount exceeding $3,000,000; or
-		we become bankrupt or insolvent.

31

          If an event of default occurs, any holder of the 2003 Notes can elect to require us to pay the outstanding principal amount, together with all accrued and unpaid interest.

          Some of the events of default include matters over which we may have some, little or no control. If a default occurs and we do not pay the amounts payable under the 2003 Notes in cash (including any interest on such amounts and any applicable default interest under the 2003 Notes), the holders of the 2003 Notes may protect and enforce their rights or remedies either by suit in equity or by action at law, or both, whether for the specific performance of any covenant, agreement or other provision contained in the 2003 Notes. Any default under the 2003 Notes could have a material adverse effect on our business, operating results and financial condition or on the market price of our common stock.

In The Event Of A Change Of Control, Holders Of The 2003 Notes Have The Option To Require Immediately Repayment Of The 2003 Notes At A Premium And This Right Could Prevent A Takeover Otherwise Favored By Stockholders.

          In the event of our “Change of Control,” which essentially means someone acquiring or merging with us, each holder of 2003 Notes has the right to require us to redeem the 2003 Notes in whole or in part at a redemption price of 105% of the principal amount of the 2003 Notes, plus accrued and unpaid interest or if the amount is greater, an amount equal to the number of shares issuable upon conversion of the 2003 Notes based on the conversion price at the date the holder gives us notice of redemption, multiplied by the average of the weighted average prices of our common stock during the five days immediately proceeding that date. If a Change of Control were to occur, we might not have the financial resources or be able to arrange financing on acceptable terms to pay the redemption price for all the 2003 Notes as to which the purchase right is exercised. Further, the existence of this right in favor of the holders may discourage or prevent someone from acquiring or merging with us.

Sales Of Substantial Amounts Of Our Shares By Selling Stockholders Could Cause The Market Price Of Our Shares To Decline.

          Selling stockholders are offering for resale under an effective registration statement up to 9,913,914 shares of our common stock issuable upon conversion of the 2003 Notes. This represents approximately 9.5% of the outstanding shares of our common stock on October 15, 2004 (or 8.7% of the outstanding shares of our common stock on that date if pro forma effect were given to the full conversion of the 2003 Notes). Sales of substantial amounts of these shares at any one time or from time to time, or even the availability of these shares for sale, could adversely affect the market price of our shares.

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.

32

Economic Conditions May Require Us To Reduce The Size Of Our Business Further.

          In 2002, and to a lesser extent 2003, we undertook significant reductions in force, some of which were accompanied by dispositions of assets, as part of our effort to reduce the size of our operations to better match the reduced sales of our products and services. Weakness in the global economy generally and the fiber optics and telecommunications equipment markets in particular continue to adversely affect our business. We may be required to undertake further reductions in force. Any such steps would likely result in significant charges from write-downs or write-offs of assets, costs of lease terminations, and expenses resulting from the termination of personnel.

33

We Face Risks From Our International Operations.

          International sales have become an increasingly important part of our operations. The following table sets forth the percentage of our total revenues from sales to customers in foreign countries for the periods identified:

          We have offices in, and conduct a significant portion of our operations in and from Israel. Similarly, some of our development stage enterprises are located in 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. LuminentOIC has a minority interest in a large manufacturing facility in the People’s Republic of China in which it manufactures passive fiber optic components and both LuminentOIC and we make sales of our products in the People’s Republic of China. The political tension between Taiwan and the People’s Republic of China that continues to exist, could eventually 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;
-		difficulties in managing operations across disparate geographic areas;
-		difficulties associated with enforcing agreements through foreign legal systems;
-		the payment of operating expenses in local currencies, which exposes us to risks of currency fluctuations;
-		higher credit risks requiring cash in advance or letters of credit;
-		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.

34

          The majority of our sales are currently denominated in U.S. dollars. As we conduct business in several different countries, we have recently benefited from sales made in currencies other than the U.S. dollar because of the weakness of the U.S. dollar in relation to the currencies in which these sales have been made. However, if this trend ceases or reverses, 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 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. Our third party manufacturers may not 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.

We May Suffer Losses As A Result Of Entering Into Fixed Price Contracts.

     From to time we enter into contracts with certain customers where the price we charge for particular products is fixed. Although our estimated production costs for these products is used to compute the fixed price for sale, if our actual production cost exceeds the estimated production cost due to our inability to obtain needed components timely or at all or for other reasons, we may incur a loss on the sale. Sales of material amounts of products on a fixed price basis where we have not accurately predicted the production costs could have a material adverse affect on our results of operations.

35

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 may not be able to maintain acceptable production yields or 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.

If We Fail To Adequately Protect Our Intellectual Property, We May Not Be Able To Compete.

          We rely on a combination of trade secret laws and restrictions on disclosure and patents, copyrights and trademarks to protect our intellectual property rights. We cannot assure you that our pending patent applications will be approved, that any patents that may be issued will protect our intellectual property or that third parties will not challenge any issued patents. Other parties may independently develop similar or competing technology or design around any patents that may be issued to us. We cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Any of this kind of litigation, regardless of outcome, could be expensive and time consuming, and adverse determinations in any of this kind of litigation could seriously harm our business.

We Could 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. Over the years, we have received notices from third parties alleging possible infringement of patents with respect to certain features of our products or our manufacturing processes and in connection with these notices have been involved in discussions with the claimants, including IBM, Lucent, Ortel, Nortel, Rockwell, the Lemelson Foundation and Finisar. Aggregate revenues potentially subject to the foregoing claims amounted to approximately 18%, 20% and 28% of our revenues for the years ended December 31, 2003, 2002 and 2001, respectively. These 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 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.

36

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, Chief Technical Officer and Secretary, 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 operations 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 those 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 stock expense 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.

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.

Our Headquarters Are Located In Southern California, And Certain Of Our Manufacturing Facilities Are Located In Southern California And Taiwan, Where Disasters May Occur That Could Disrupt Our Operations And Harm Our Business

          Our corporate headquarters are located in the San Fernando Valley of Southern California and some of our manufacturing facilities are located in Southern California and Taiwan. Historically, these regions has been vulnerable to natural disasters and other risks, such as earthquakes, fires and floods, which at times have disrupted the local economies and posed physical risks to our property.

37

          In addition, terrorist acts or acts of war targeted at the United States, and specifically Southern California, could cause damage or disruption to us, our employees, facilities, partners, suppliers, distributors and resellers, and customers, which could have a material adverse effect on our operations and financial results.

If We Fail To Accurately Forecast Component And Material Requirements For Our Manufacturing Facilities, We Could Incur Additional Costs Or Experience Manufacturing Delays.

          We use rolling forecasts based on anticipated product orders to determine our component requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials. Lead times for components and materials that we order vary significantly and depend on factors such as specific supplier requirements, the size of the order, contract terms and current market demand for the components. For substantial increases in production levels, some suppliers may need nine months or more lead-time. If we overestimate our component and material requirements, we may have excess inventory, which would increase our costs. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively impact our net sales.

Legislative Actions, Higher Insurance Costs and Potential New Accounting Pronouncements are Likely to Impact Our Future Financial Position and Results of Operations.

          There have been regulatory changes, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules and there may be potential new accounting pronouncements or regulatory rulings, which will have an impact on our future financial position and results of operations. These regulatory changes and other legislative initiatives have increased general and administrative costs. In addition, insurers are likely to increase rates as a result of high claims rates recently and our rates for our various insurance policies are likely to increase. Further, proposed initiatives could result in changes in accounting rules, including legislative and other proposals to account for employee stock options as an expense. These and other potential changes could materially increase the expenses we report under accounting principles generally accepted in the United States, and adversely affect our operating results.

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 LuminentOIC’s stock price following its initial public offering, we may be the target of securities litigation in the future. Securities or other litigation could result in substantial costs and divert management’s attention and resources.

If Our Cash Flow Significantly Deteriorates In The Future, Our Liquidity And Ability To Operate Our Business Could Be Adversely Affected.

          We incurred net losses in 2001, 2002 and 2003, and our combined cash and short-term investments declined in each of those years as well. We also incurred net losses for the nine months ended September 30, 2004, and our combined cash, cash equivalents, time deposits and short-term and long-term marketable securities declined at September 30, 2004 by approximately $21.3 million, or approximately 22%, since December 31, 2003. Although we generate cash from operations, we may continue to experience negative overall cash flow in future quarters. If our cash flow significantly deteriorates in the future, our liquidity and ability to operate our business could be adversely affected. For example, our ability to raise financial capital may be hindered due to our net losses and the possibility of future negative cash flow. An inability to raise financial capital would limit our operating flexibility.

38

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 our 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.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

          Some of the information in this Form 10-Q and in the documents that are incorporated by reference, including the risk factors in this section, contains forward-looking statements that involve risks and uncertainties. These statements relate to future events or our future financial performance. In many cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” or the negative of these terms and other comparable terminology. These statements are only predictions. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors including the risks faced by us described above and elsewhere in this Form 10-Q.

39

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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. 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 do not regularly attempt 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.

40

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

          As of the end of the period covered by this report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by the report on Form 10-Q, the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s Exchange Act filings.

Changes in Internal Controls

          There have been no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or 15d-15 under the Exchange Act that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits

(b)

One report on Form 8-K was filed during the period covered by this Report. That Form 8-K, dated April 22, 2004 and filed on April 28, 2004, reported matters under Item 5 and Item 12.

41

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 October 27, 2004.

42