Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

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  [  ]  No  [X]

     As of April 28, 2003, there were 99,327,963 shares of common stock, $.0017 par value per share, outstanding.

Table of Contents

MRV Communications, Inc.

Form 10-Q, March 31, 2003

Index

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

2

Table of Contents

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 March 31, 2003, and the results of its operations and its cash flows for the three months then ended.

3

Table of Contents

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

Table of Contents

MRV Communications, Inc.

Condensed Balance Sheets

(In thousands, except par values)

5

Table of Contents

MRV Communications, Inc.

Condensed Balance Sheets

(In thousands, except par values)

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

6

Table of Contents

MRV Communications, Inc.

Condensed Statements of Cash Flows

(In thousands)

7

Table of Contents

MRV Communications, Inc.

Condensed Statements of Cash Flows

(In thousands)

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

8

Table of Contents

MRV Communications, Inc.

Notes To Financial Statements

March 31, 2003

1. Stockholders’ Equity

   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 12.4 million and 12.6 million shares for the three months ended March 31, 2003 and 2002, 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 outstanding Convertible Subordinated Notes (“Notes”) 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 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.”

     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 months ended March 31, 2003 and 2002 would have increased to the following pro forma amounts (in thousands, except per share data):

9

Table of Contents

     The following assumptions were applied: (i) no expected dividend yield for all periods, (ii) expected volatility of 104% for 2003 and 2002, (iii) expected lives of 4 to 6 years for all periods, (iv) and risk-free interest rates ranging from 2.69% to 6.73% for all periods.

2. Segment Reporting and Geographical Information

     MRV divides and operates its business based on three reportable segments: the networking group, the optical components group and development stage enterprises. 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. Development stage enterprises that MRV has created or invested in are developing optical components, subsystems and networks and products for the infrastructure of the Internet. Segment information is therefore being provided on this basis, which differs from prior period presentations.

     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 months ended March 31, 2003 and 2002 are as follows (in thousands):

     Revenues by product line for the three months ended March 31, 2003 and 2002 are as follows (in thousands):

     For each of the three years ended and as of December 31, 2002, MRV had no single customer that accounted for more than 10% of revenues or accounts receivable. MRV does not track customer revenue by region for each individual reporting segment. A summary of external revenue by region for the three months ended March 31, 2003 and 2002 are as follows (in thousands):

10

Table of Contents

     Business segment operating loss for the three months ended March 31, 2003 and 2002 are as follows (in thousands):

     Loss before provision for income taxes for the three months ended March 31, 2003 and 2002 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 highly qualified financial institutions. At various times such amounts are in excess of federally insured limits.

     MRV accounts for its investments under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” As of March 31, 2003 and December 31, 2002, short-term investments consisted principally of U.S. Treasury Bonds, Municipal Bonds and Corporate Bonds. As defined by SFAS No. 115, MRV has classified these investments in debt securities as “held-to-maturity” investments and all investments are recorded at their amortized cost basis, which approximated their fair market value at March 31, 2003 and December 31, 2002.

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):

11

Table of Contents

5. Restructuring costs

     From November 9, 2000 through December 28, 2001, MRV owned approximately 92% of Luminent, Inc. and approximately 8% of Luminent’s shares were publicly traded. During the second quarter of 2001, Luminent’s management approved and implemented a restructuring plan in order to adjust operations and administration as a result of the dramatic slowdown in the communications equipment industry generally and the optical components sector in particular. Major actions primarily involved the reduction of workforce, the abandonment of certain assets and the cancellation and termination of purchase commitments. These actions are expected to realign the business based on current and near-term growth rates. All of these actions are expected to be completed by the end of fiscal year 2003.

     Employee severance costs and related benefits of $1.3 million are related to approximately 750 layoffs through March 31, 2003, bringing Luminent’s total workforce to approximately 460 employees as of March 31, 2003. Affected employees came from all divisions and areas of Luminent. The majority of affected employees were in the manufacturing group.

     A summary of the restructuring costs and the remaining liability through and as of March 31, 2003 is as follows (in thousands):

     Through March 31, 2003, $2.0 million in purchase commitments have been reduced related to future liabilities based on current negotiations with vendors and in usage of previously reserved purchase commitments for inventory and equipment. For the three months ended March 31, 2003 and 2002, $539,000 and $1.1 million have been reversed to cost of goods sold, respectively.

12

Table of Contents

6. Interest Rate Swap

     MRV entered into an interest rate swap (the “Swap”) in the second quarter of 2000 to effectively change the interest rate characteristics of its $50.0 million variable-rate term loan presented in long-term debt, with the objective of fixing its overall borrowing costs. The Swap was considered to be 100% effective and was therefore recorded using the short-cut method. The Swap was designated as a cash flow hedge and changes in fair value of the debt were generally offset by changes in fair value of the related security, resulting in negligible net impact. The gain or loss from the change in fair value of the Swap as well as the offsetting change in the hedged fair value of the long-term debt were recognized in other comprehensive loss. In February 2002, MRV paid off the long-term debt of $50.0 million (see Note 7, Long-term Debt and Convertible Subordinated Notes) and terminated the Swap. The realized loss on the Swap of $3.2 million has been recorded as interest expense and is included in other expense, net in the accompanying condensed statements of operations.

7. Long-Term Debt and Convertible Subordinated Notes

     During the three months ended March 31, 2003, MRV acquired $500,000 in convertible subordinated notes (the “Notes”) in exchange for $502,000 in cash. During the three months ended March 31, 2002, MRV acquired $24.3 million in Notes in exchange for MRV’s issuance of 6.3 million shares of its common stock to the holders of the Notes. In connection with these acquisitions, MRV realized a loss for the three months ended March 31, 2003 totaling $4,000 and a gain for the three months ended March 31, 2002 totaling $3.2 million, net of associated taxes. MRV retired all Notes acquired. Additionally, in February 2002, MRV paid off a $50.0 million term loan.

8. 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. For the three months ending March 31, 2003, MRV repurchased 138,000 shares of its common stock at a cost of $145,000. Total share repurchases under this program as of March 31, 2003 were 1,305,000 shares of common stock at a cost of $1.2 million.

9. Comprehensive Income (Loss)

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

10. Recent Accounting Pronouncements

     In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This statement, among other amendments and corrections, rescinds Statement 4, “Reporting Gains and Losses from Extinguishment of Debt – an amendment of APB Opinion 30,” which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria set forth by APB Opinion 30 will now be used to classify those gains and losses. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002, with early application encouraged. MRV has adopted this statement for the year ended December 31, 2002, and the immediate impact of its application was the inclusion of the gains and losses on the extinguishment of debt (see Note 7, Long-term Debt and Convertible Subordinated Notes) in other income (expense), net in the accompanying Statements of Operations.

13

Table of Contents

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement supercedes EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability is recognized at the date an entity commits to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The provisions of SFAS No. 146 will be effective for any exit and disposal activities initiated after December 31, 2002. MRV has reviewed this statement and does not expect a material impact on its financial position, results of operations or cash flows.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123.” This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirement of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. MRV adopted this statement and its adoption did not have a material impact on its financial position, results of operations or cash flows (see Note 1, Earnings (Loss) Per Share).

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

     During the three months ended March 31, 2002, MRV exchanged $24.3 million in Notes in exchange for 6.3 million shares of its common stock. This non-cash transaction has been excluded from the accompanying statements of cash flows.

12. Reclassifications

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

14

Table of Contents

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 Condensed Financial Statements and Notes thereto included elsewhere in this Report. In addition to historical information, the discussion in this Report contains certain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated by these forward-looking statements due to factors, including but not limited to, those set forth in the following and elsewhere in this Report. We assume no obligation to update any of the forward-looking statements after the date of this Report.

Overview

     We 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 enterprises. Our networking group provides equipment used by commercial customers, governments and telecommunications service providers, and include switches, routers, network physical infrastructure equipment and remote device management equipment as well as specialized networking products for defense and aerospace applications. Our optical components group designs, manufactures and sells optical communications components. These components include fiber optic transceivers, discrete lasers and LEDs, as well as components for Fiber-to-the-Home applications.

     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. In addition, we have operations in France, Italy, Switzerland and Sweden that provide network system design, integration and distribution services that include our products, as well as products manufactured by third-party vendors. Such specialization enhances access to customers and allows us to penetrate targeted vertical and regional markets.

     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. 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 (R&D), selling, general and administrative costs (SG&A) and other operating related costs and expenses.

15

Table of Contents

     Revenues for the three months ended March 31, 2003 were $51.1 million, compared to $62.4 million for the three months ended March 31, 2002, a decrease of 18%. We reported a net loss of $6.4 million and $326.4 million for the three months ended March 31, 2003 and 2002, respectively. A significant portion of the loss for the three months ended March 31, 2002, was due to charges for impairment of goodwill and other intangibles recorded in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Accounting for Goodwill and Other Intangible Assets,” amortization of goodwill and other intangibles and deferred stock expense related to our acquisitions in 2000 and the employment arrangements that we entered into with Luminent’s Chief Financial Officer in 2000. We expect to continue to amortize deferred stock expense through 2004. Effective January 1, 2002, we adopted SFAS No. 142, and we no longer amortize goodwill and intangibles with indefinite lives, but instead measure goodwill and intangibles for impairment at least annually, or when events indicate that impairment exists. We will continue to amortize intangible assets that we determine have definite lives over their useful lives. As required by SFAS No. 142, we performed the transitional impairment test on goodwill and other intangibles, which consisted of patents and assembled work forces. As a result of the transitional impairment test, we recorded a $296.4 million cumulative effect of an accounting change in 2002. As a consequence of the current economic environment and potential impairment charges, we do not expect to report net income in the foreseeable future.

     We divide and operate our business based on three reportable segments: the networking group, the optical components group and development stage enterprises. 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 consist of substantially all of our overall revenue. The development stage enterprises segment develops optical components, subsystems and networks and products for the infrastructure of the Internet.

     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, France, Finland, Germany, Israel, Italy, Japan, Korea, the Netherlands, Norway, Russia, Singapore, South Africa, Switzerland, Sweden, Taiwan and the United Kingdom. For the three months March 31, 2003 and 2002, foreign revenues constituted 75%, and 71%, respectively, of our revenue. 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 following are based upon our consolidated 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.

     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.

16

Table of Contents

     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: passive and active optical components; switches and routers; remote device management products; and network physical infrastructure equipment.

     Allowance for Doubtful Accounts. We make ongoing estimates relating to the collectibility 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.

     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 will no longer amortize goodwill and intangible assets with indefinite lives, but instead will measure these assets for impairment at least annually, or when events indicate that impairment exists. We will 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 its deferred tax asset as to whether it is likely that the deferred tax assets will be realized. If management ever determined that its 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

Table of Contents

Restructuring costs

     From November 9, 2000 through December 28, 2001, MRV owned approximately 92% of Luminent, Inc. and approximately 8% of Luminent’s shares were publicly traded. During the second quarter of 2001, Luminent’s management approved and implemented a restructuring plan in order to adjust operations and administration as a result of the dramatic slowdown in the communications equipment industry generally and the optical components sector in particular. Major actions primarily involved the reduction of workforce, the abandonment of certain assets and the cancellation and termination of purchase commitments. These actions are expected to realign the business based on current and near-term growth rates. All of these actions are expected to be completed by the end of fiscal year 2003.

     Employee severance costs and related benefits of $1.3 million are related to approximately 750 layoffs through March 31, 2003, bringing Luminent’s total workforce to approximately 460 employees as of March 31, 2003. Affected employees came from all divisions and areas of Luminent. The majority of affected employees were in the manufacturing group.

     A summary of the restructuring costs and the remaining liability through and as of March 31, 2003 is as follows (in thousands):

     Through March 31, 2003, $2.0 million in purchase commitments have been reduced related to future liabilities based on current negotiations with vendors and in usage of previously reserved purchase commitments for inventory and equipment. For the three months ended March 31, 2003 and 2002, $539,000 and $1.1 million have been reversed to cost of goods sold, respectively.

Market Conditions and Current Outlook

     Macroeconomic factors, such as an economic slowdown in the U.S. and abroad, have detrimentally impacted demand for optical components and network infrastructure products and services. The unfavorable economic conditions and reduced capital spending has detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States during 2001 to date, and may continue to affect them for the remainder of 2003 and thereafter.

18

Table of Contents

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 reportable segments are our networking group, optical components group and development stage enterprises, which includes all start-up activities.

19

Table of Contents

Three Months Ended March 31, 2003 (“2003”) Compared
To Three Months Ended March 31, 2002 (“2002”)

   Revenue

     Revenues for 2003 decreased $11.3 million, or 18%, to $51.1 million from $62.4 million for 2002. The decrease was broadly due to the worldwide economic slowdown in general and specifically the downturn in telecommunications spending. Our revenues by reportable segments for 2003 and 2002 were as follows (in thousands):

     (1)  Adjustments represent the elimination of inter-segment revenue in order to reconcile to consolidated revenues.

     Networking Group. Our networking group provides equipment used by commercial customers, governments and telecommunications service providers, and include switches, routers, network physical infrastructure equipment and remote device management equipment as well as specialized networking products for defense and aerospace applications. External revenues generated from our networking group decreased $775,000, or 2%, to $41.8 million for 2003 as compared to $42.6 million for 2002. The decrease is generally due to the current economic conditions, and more specifically due to revenues from “other networking products,” which partially offset decreases in our main product lines. External revenues generated from our switches and routers decreased $1.4 million, or 11%, to $11.3 million for 2003 as compared to $12.7 million for 2002. External revenues generated from our switches and routers are heavily dependent on our international offices. In light of the current global economic environment, European sales decreased $1.7 million from 2002. External revenues generated from our network physical infrastructure products decreased $2.0 million, or 14%, to $12.5 million for 2003 as compared to $14.4 million for 2002. External revenues from other networking products, which include aerospace applications, increased $1.8 million, of 40%, during 2003 to $6.1 million from $4.4 million for 2002. The increase in external revenues is attributed to increased governmental projects and improved penetration into the markets served by these products. For 2003, 47% of our networking revenue was generated through the sale of third-party products through our system integration and distribution offices.

     Optical Components Group. Our optical components group designs, manufactures and sells optical communications components. These components include fiber optic transceivers, discrete lasers and LEDs, as well as components for Fiber-to-the-Home applications. Revenues, including intra-segment revenue, generated from our optical components group decreased $9.9 million, or 50%, to $9.9 million for 2003 as compared to $19.8 million for 2002. The decrease in optical components revenue is attributed to the continued weakness in the telecommunications market and the competition in the optical components sector. External revenues generated from optical passive components decreased $3.2 million, or 48%, to $3.5 million for 2003 as compared to $6.6 million for 2002. The decrease in optical passive components is substantially due to the divestiture of FOCI Fiber Optic Communications, Inc., or FOCI, and Quantum Optech, Inc., or QOI, in October 2002 totaling $4.2 million, partially offset by sales of these components through existing offices. External revenue generated from optical active components decreased $6.2 million, or 40%, to $9.4 million for 2003 as compared to $15.6 million for 2002. The decrease in optical active components is substantially due to oversupply sector wide, which has significantly impacted average selling prices.

20

Table of Contents

     Development stage enterprises. No significant revenues were generated by these entities for 2003 and 2002.

   Gross Profit

     Gross profit for 2003 was $14.6 million, compared to gross profit of $19.3 million for 2002. Gross profit decreased $4.7 million, or 24%, in 2003 compared to 2002. For 2003 and 2002, gross profit includes $27,000 and $1.2 million, respective, in deferred stock expense. The decrease in margin was attributed to current economic environment, primarily in the optical components group.

     Our gross margin decreased to 29% for 2003, compared to gross margin of 31% for 2002. The deterioration of gross margin was attributed to our composition of product revenues, increased competition and continued pressure on average selling prices due to the current economic environment.

     Networking Group. Gross profit for 2003 was $13.2 million, compared to gross profit of $13.3 million for 2002. Gross profit decreased $57,000, in 2003 compared to 2002. Gross margins improved slightly to 32% for 2003, compared to gross margin of 31% for 2002. For 2003 and 2002, the networking group’s gross profit includes $65,000 and $884,000, respectively, in deferred stock expense. Gross profit slightly improved due to improved operating efficiencies and cost cutting efforts.

     Optical Components Group. Gross profit for 2003 was $1.4 million, compared to gross profit of $6.0 million for 2002. Gross profit decreased $4.7 million, or 77%, in 2003 compared to 2002. Gross margins decreased to 14% for 2003, compared to gross margin of 30% for 2002. For 2003, the optical components group’s gross profit includes income from recapturing accelerated deferred stock expense due to terminations totaling $38,000 while 2002 includes deferred stock expense totaling $342,000, respectively, in deferred stock expense. Gross profit decreased due to the sale of FOCI and QOI in October 2002, which contributed $804,000, along with increased competition and continued market contraction resulting in lower average selling prices.

     Development stage enterprises. No significant gross margins were produced by these entities for 2003 and 2002.

    Operating Costs and Expenses

     Operating costs and expenses for 2003 were $20.6 million, or 40% of revenues, for 2003, compared to $39.2 million, or 63% of revenues, for 2002. Operating costs and expenses decreased $18.5 million, or 47%, in 2003 compared to 2002. For 2003, operating costs and expenses include income from recapturing accelerated deferred stock expense due to terminations totaling $4.5 million, while 2002 includes deferred stock expense totaling $5.8 million in deferred stock expense. The substantial decrease in operating costs and expenses is attributed to overall cost saving efforts to align these costs with current operations. More specifically, we reduced spending in product development and engineering and general and administrative expenses. Selling and marketing expenses increased slightly as we continued to promote our brand name, MRV, and intensified our selling efforts worldwide.

     Networking Group. Operating costs and expenses for 2003 were $14.6 million, or 35% of revenues, for 2003, compared to $24.0 million, or 56% of revenues, for 2002. Operating costs and expenses decreased $9.4 million, or 39%, in 2003 compared to 2002. For 2003, operating costs and expenses include income from recapturing accelerated deferred stock expense due to terminations totaling $4.6 million, while 2002 includes deferred stock expense totaling $2.8 million in deferred stock expense. The decrease in operating costs and expenses is attributed to cost saving efforts, including head count reductions, to align these costs with current operations. We reduced spending in the areas of product development and engineering and general and administrative expense, while slightly increasing spending for selling and marketing efforts.

21

Table of Contents

          Optical Components Group. Operating costs and expenses for 2003 were $3.9 million, or 39% of revenues, for 2003, compared to $7.8 million, or 39% of revenues, for 2002. Operating costs and expenses decreased $3.9 million, or 50%, in 2003 compared to 2002. Operating costs and expenses include deferred stock expense totaling $57,000 and $1.7 million for 2003 and 2002, respectively. FOCI and QOI contributed $2.4 million in operating costs and expenses in 2002. The decrease in operating costs and expenses is attributed to cost saving efforts, including head count reductions, to align these costs with current operations. More specifically, we reduced spending in the areas of product development and engineering, selling, general and administrative expenses.

          Development stage enterprises. Operating costs and expenses for 2003 were $2.1 million for 2003, compared to $7.3 million for 2002. Operating costs and expenses decreased $5.2 million, or 71%, in 2003 compared to 2002. For 2002, operating costs and expenses include deferred stock expense totaling $51,000. The decrease in operating costs and expenses is attributed to cost saving efforts, including head count reductions, to align these costs with current development activities.

    Operating Loss

          We reported an operating loss of $6.1 million, or 12% of revenues, for 2003 compared to $19.9 million, or 32% of revenues, for 2002. Our operating loss improved $13.8 million, or 70%, in 2003 compared to 2002. The dramatic improvement is the result of costs reduction efforts and the realignment of operations with current operations even though revenues decreased. The improvement was also positively impacted by income from deferred stock expense in 2003 compared to expense for 2002.

          Networking Group. Our networking group reported an operating loss of $1.4 million, or 3% of revenues, for 2003, compared to $10.8 million, or 25% of revenues, for 2002. Our operating loss improved $9.3 million, or 87%, in 2003 compared to 2002. The dramatic improvement is the result of reduced spending for operating costs and expenses. The improvement was also positively impacted by income from deferred stock expense in 2003 compared to expense for 2002.

          Optical Components Group. Our optical components group reported an operating loss of $2.5 million, or 25% of revenues, for 2003, compared to $1.8 million, or 9% of revenues, for 2002. Our operating loss declined $716,000, or 40%, in 2003 compared to 2002. The decline is the result of a significant reduction in gross margin offset by reduced spending for operating costs and expenses.

          Development stage enterprises. Our development stage enterprises reported an operating loss of $2.1 million for 2003, compared to $7.3 million for 2002. Our operating loss declined $5.2 million, or 71%, in 2003 compared to 2002. The decline is the result of a significant reduction in operating costs and expenses spending.

    Amortization Of Intangibles

          We recorded a $296.4 million cumulative effect of an accounting change in 2002, as the result of our adoption of SFAS No. 142 effective January 1, 2002. As a consequence, we no longer amortize goodwill and intangibles with indefinite lives, but instead measure goodwill and other intangibles for impairment at least annually, or when events indicate that impairment exists. We will continue to amortize intangible assets we determine to have definite lives over their useful lives. As required by SFAS No. 142, we performed the transitional impairment test on goodwill and other intangibles, which consisted of patents and assembled work forces. Of the $296.4 million cumulative effect of an accounting change, $84.6 million was associated with our networking group and $211.8 million was associated with our optical components group.

    Other Income (Expense), Net

          In June 1998, we issued $100.0 million principal amount of 5% convertible subordinated notes (the Notes) due in June 2003. The Notes were offered in a 144A private placement to qualified institutional investors at the stated amount, less a selling discount of 3%. During 2003, we retired $500,000 in Notes in exchange for $502,000 in cash resulting in a loss on the extinguishment of debt totaling $4,000, net of associated taxes. During 2002, we retired $24.3 million in Notes in exchange for 6.3 million shares of our common stock. During 2002, we recognized a gain of the extinguishment of debt totaling $3.2 million, net of associated taxes. We incurred $459,000 and $1.1 million in interest expense relating to the Notes for 2003 and 2002, respectively.

22

Table of Contents

     During 2003, other income totaling $36,000, which represents interest income on cash and investments, was partially offset our interest expense on debt. We account for certain unconsolidated subsidiaries using the cost and equity methods. During 2002, we reported impairment charges of $7.6 million on our cost and equity method investments and $1.3 million from our share of losses in these 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. For 2002, there was no benefit provided for net operating losses.

Recently Issued Accounting Standards

     In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This statement, among other amendments and corrections, rescinds Statement 4, “Reporting Gains and Losses from Extinguishment of Debt — an amendment of APB Opinion 30,” which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria set forth by APB Opinion 30 will now be used to classify those gains and losses. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002, with early application encouraged. We have adopted this statement for the year ended December 31, 2002, and the immediate impact of its application was the inclusion of the gains and losses on the extinguishment of debt in other income (expense), net in the accompanying Statements of Operations.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement supercedes EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability is recognized at the date an entity commits to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The provisions of SFAS No. 146 will be effective for any exit and disposal activities initiated after December 31, 2002. We have reviewed this statement and do not expect a material impact on our financial position, results of operations or cash flows.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an Amendment of FASB Statement No. 123.” This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirement of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We adopted this statement and its adoption did not have a material impact on our financial position, results of operations or cash flows.

Liquidity and Capital Resources

     Cash and cash equivalents were $95.5 million as of March 31, 2003, a decrease of $5.1 million from cash and cash equivalents of $100.6 million as of December 31, 2002. The decrease in cash and cash equivalent is substantially the result of our cash used in operations and use to satisfy our obligations, partially offset by proceeds from maturities of our investments. The following table illustrates our current 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 subordinated notes, as of March 31, 2003 and December 31, 2002 (in thousands):

23

Table of Contents