Back to GetFilings.com



Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
_________

FORM 10-Q

(Mark One)

     
[X]   Quarterly report under section 13 or 15(d) of the Securities Exchange Act of 1934 for the
quarterly period ended March 31, 2003
     
[  ]   Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act for the
transition period from          to

Commission file number 0-25678
_________

MRV COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction
incorporation or organization)
  06-1340090
(I.R.S. Employer
identification No.)

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

PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Statements of Operations
Condensed Balance Sheets
Condensed Statements of Cash Flows
Notes To Financial Statements
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II — OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURE
CERTIFICATION
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO                      SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


Table of Contents

MRV Communications, Inc.

Form 10-Q, March 31, 2003

Index

             
        Page Number
       
PART I   Financial Information     3  
Item 1.   Financial Statements:     3  
   
Condensed Statements of Operations (unaudited) for the three months ended March 31, 2003 and 2002
    4  
   
Condensed Balance Sheets as of March 31, 2003 (unaudited) and December 31, 2002
    5  
   
Condensed Statements of Cash Flows (unaudited) for the three months ended March 31, 2003 and 2002
    7  
    Notes to Unaudited Condensed Financial Statements     9  
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations     15  
Item 3.   Quantitative and Qualitative Disclosures About Market Risk     39  
Item 4.   Controls and Procedures     40  
PART II   Other Information     40  
Item 6.   Exhibits and Reports on Form 8-K     40  
    Signatures     41  
    Certifications Pursuant to Rule 13a-14:        
            Certification of the Chief Executive Officer     42  
            Certification of the Chief Financial Officer     43  
   
Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
    44  

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)

                   
      Three Months Ended
     
      March 31,   March 31,
      2003   2002
     
 
      (Unaudited)
Net revenue
  $ 51,117     $ 62,418  
Cost of goods sold
    36,514       43,105  
 
   
     
 
Gross profit
    14,603       19,313  
Operating costs and expenses:
               
 
Product development and engineering
    8,736       15,620  
 
Selling, general and administrative
    11,905       23,539  
 
Amortization of intangibles
    13       28  
 
   
     
 
Total operating costs and expenses
    20,654       39,187  
 
   
     
 
Operating loss
    (6,051 )     (19,874 )
Other income (expense), net
    41       (9,878 )
 
   
     
 
Loss before minority interest, provision for taxes and cumulative effect of an accounting change
    (6,010 )     (29,752 )
Minority interest
    (38 )     105  
Provision for taxes
    428       186  
 
   
     
 
Loss before cumulative effect of an accounting change
    (6,400 )     (30,043 )
Cumulative effect of an accounting change
          (296,355 )
 
   
     
 
Net loss
  $ (6,400 )   $ (326,398 )
 
   
     
 
Earnings per share:
               
Basic and diluted loss per share:
               
 
Loss before cumulative effect of an accounting change
  $ (0.06 )   $ (0.35 )
 
Cumulative effect of an accounting change
  $     $ (3.50 )
 
Net loss
  $ (0.06 )   $ (3.85 )
Weighted average number of shares:
               
Basic and diluted
    98,930       84,789  
 
   
     
 

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)

                   
      March 31,   December 31,
      2003   2002
     
 
      (Unaudited)        
Assets
               
Current assets:
               
 
Cash and cash equivalents
  $ 95,543     $ 100,618  
 
Short-term marketable securities
    4,644       11,738  
 
Time deposits
    2,441       2,789  
 
Accounts receivable, net
    48,490       50,965  
 
Inventories
    41,044       32,695  
 
Other current assets
    9,244       11,283  
 
 
   
     
 
Total current assets
    201,406       210,088  
Property and equipment, net
    32,596       35,169  
Goodwill
    29,740       29,740  
Intangibles
    122       135  
Long-term marketable securities
    1,471       1,447  
Deferred income taxes
    3,445       2,637  
Investments
    3,063       3,063  
Other assets
    2,267       2,524  
 
 
   
     
 
 
  $ 274,110     $ 284,803  
 
 
   
     
 
Liabilities and stockholders’ equity
Current liabilities:
               
 
Current maturities of long-term debt
  $ 214     $ 393  
 
Convertible subordinated notes
    31,893       32,418  
 
Short-term obligations
    5,334       7,000  
 
Accounts payable
    47,801       41,308  
 
Accrued liabilities
    27,364       31,542  
 
Deferred revenue
    4,063       3,950  
 
Other current liabilities
    2,660       2,289  
 
 
   
     
 
Total current liabilities
    119,329       118,900  
Long-term debt
    330       390  
Other long-term liabilities
    4,016       3,666  
Minority interest
    7,333       7,371  
Commitments and contingencies
               

5


Table of Contents

MRV Communications, Inc.

Condensed Balance Sheets

(In thousands, except par values)

                     
        March 31,   December 31,
        2003   2002
       
 
        (Unaudited)        
Stockholders’ equity:
               
 
Preferred stock, $0.01 par value:
               
   
Authorized—1,000 shares; no shares issued or outstanding
           
 
Common stock, $0.0017 par value:
               
   
Authorized—160,000 shares
               
   
Issued—100,132 shares in 2003 and 2002
               
   
Outstanding—98,827 shares in 2002 and 98,965 in 2001
    168       168  
 
Additional paid-in capital
    1,142,689       1,149,635  
 
Accumulated deficit
    (983,842 )     (977,442 )
 
Deferred stock expense, net
    (2,573 )     (5,047 )
 
Treasury stock, 1,353 shares in 2002 and 1,215 shares in 2001
    (1,352 )     (1,207 )
 
Accumulated other comprehensive loss
    (11,988 )     (11,631 )
   
 
   
     
 
Total stockholders’ equity
    143,102       154,476  
   
 
   
     
 
 
  $ 274,110     $ 284,803  
   
 
   
     
 

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)

                       
          Three Months Ended
         
          March 31,   March 31,
          2003   2002
         
 
          (Unaudited)
Cash flows from operating activities
               
 
Net loss
  $ (6,400 )   $ (326,398 )
 
Adjustments to reconcile net loss to net cash used in operating activities:
               
   
Depreciation and amortization
    3,281       6,704  
   
Amortization of deferred stock expense, net of forfeited options
    (4,472 )     5,877  
   
Provision for doubtful accounts
    326        
   
Deferred income taxes
    (808 )     (520 )
   
Gain on extinguishment of debt
          (3,244 )
   
Cumulative effect of an accounting change
          296,355  
   
Loss on termination of interest rate swap
          3,198  
   
Gain on disposition of property and equipment
    (12 )      
   
Impairment of cost and equity method investments
          7,603  
   
Loss on equity method subsidiaries
          1,737  
   
Minority interests’ share of income (loss)
    (38 )     105  
 
Changes in operating assets and liabilities
               
   
Time deposits
    348       (262 )
   
Accounts receivable
    2,149       4,940  
   
Inventories
    (8,349 )     1,521  
   
Other assets
    2,296       2,636  
   
Accounts payable
    6,493       (1,316 )
   
Accrued liabilities
    (4,178 )     (7,494 )
   
Deferred revenue
    113       33  
   
Other current liabilities
    721       728  
 
 
   
     
 
     
Net cash used in operating activities
    (8,530 )     (7,797 )
Cash flows from investing activities
               
 
Purchases of property and equipment
    (844 )     (2,894 )
 
Proceeds from sale of property and equipment
    161        
 
Purchases of investments
          (605 )
 
Proceeds from maturity of (purchases of) investments
    7,070       (7,530 )
 
 
   
     
 
     
Net cash provided by (used in) investing activities
    6,387       (11,029 )

7


Table of Contents

MRV Communications, Inc.

Condensed Statements of Cash Flows

(In thousands)

                     
        Three Months Ended
       
        March 31,   March 31,
        2003   2002
       
 
        (Unaudited)
Cash flows from financing activities
               
 
Net proceeds from issuance of common stock
          76  
 
Payment for termination of interest rate swap
          (3,198 )
 
Borrowings on short-term obligations
    14,667       568  
 
Payments on short-term obligations
    (16,644 )      
 
Borrowings on long-term obligations
    41        
 
Payments on long-term obligations
    (494 )     (50,579 )
 
Purchase of treasury stock
    (145 )      
 
 
   
     
 
   
Net cash used in financing activities
    (2,575 )     (53,133 )
Effect of exchange rate changes on cash and cash equivalents
    (357 )     (2,032 )
 
 
   
     
 
   
Net decrease in cash and cash equivalents
    (5,075 )     (73,991 )
Cash and cash equivalents, beginning of period
    100,618       164,676  
 
 
   
     
 
Cash and cash equivalents, end of period
  $ 95,543     $ 90,685  
 
 
   
     
 

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):

                   
      March 31,   March 31,
      2003   2002
     
 
Net loss, as reported
  $ (6,400 )   $ (326,398 )
Additional compensation expense determined under the fair value based method
    (6,001 )     (6,194 )
 
   
     
 
Pro forma net loss
  $ (12,401 )   $ (332,592 )
 
   
     
 
Earnings per share:
               
 
Basic and diluted net loss per share – as reported
  $ (0.06 )   $ (3.85 )
 
   
     
 
 
Basic and diluted net loss per share – pro forma
  $ (0.13 )   $ (3.92 )
 
   
     
 

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):

                 
    March 31,   March 31,
    2003   2002
   
 
Networking group
  $ 41,800     $ 42,575  
Optical components group
    9,916       19,843  
Development stage enterprises
           
 
   
     
 
 
    51,716       62,418  
Intra-segment
    (599 )      
 
   
     
 
 
  $ 51,117     $ 62,418  
 
   
     
 

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

                 
    March 31,   March 31,
    2003   2002
   
 
Optical passive components
  $ 3,482     $ 6,641  
Optical active components
    9,443       15,642  
Switches and routers
    11,305       12,723  
Remote device management products
    3,397       3,901  
Network physical infrastructure equipment
    12,460       14,436  
Services
    4,887       4,694  
Other network products
    6,143       4,381  
 
   
     
 
 
  $ 51,117     $ 62,418  
 
   
     
 

     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

                 
    March 31,   March 31,
    2003   2002
   
 
United States
  $ 12,698     $ 18,232  
Europe
    35,519       37,244  
Asia Pacific
    2,825       6,619  
Other
    75       323  
 
   
     
 
 
  $ 51,117     $ 62,418  
 
   
     
 

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

                 
    March 31,   March 31,
    2003   2002
   
 
Networking group
  $ (1,429 )   $ (10,758 )
Optical components group
    (2,491 )     (1,775 )
Development stage enterprises
    (2,125 )     (7,341 )
 
   
     
 
 
    (6,045 )     (19,874 )
Adjustments
    (6 )      
 
   
     
 
 
  $ (6,051 )   $ (19,874 )
 
   
     
 

     Loss before provision for income taxes for the three months ended March 31, 2003 and 2002 are as follows (in thousands):

                 
    March 31,   March 31,
    2003   2002
   
 
Domestic
  $ (2,585 )   $ (88,452 )
Foreign
    (3,387 )     (237,760 )
 
   
     
 
 
  $ (5,972 )   $ (326,212 )
 
   
     
 

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

                 
    March 31,   December 31,
    2003   2002
   
 
Raw materials
    7,850       8,058  
Work in process
    7,698       5,867  
Finished goods
    25,496       18,770  
 
   
     
 
 
  $ 41,044     $ 32,695  
 
   
     
 

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):

                                   
      Original                   Remaining
      Provision   Utilized   Adjustment   Obligations
     
 
 
 
Exit costs:
                               
 
Asset impairment
  $ 10,441     $ (10,441 )   $     $  
 
Closed and abandoned facilities
    2,405       (1,713 )           692  
 
Purchase commitments
    6,173       (2,630 )     (2,013 )     1,530  
 
   
     
     
     
 
 
    19,019       (14,784 )     (2,013 )     2,222  
 
Employee severance costs
    1,281       (1,281 )            
 
   
     
     
     
 
 
  $ 20,300     $ (16,065 )   $ (2,013 )   $ 2,222  
 
   
     
     
     
 

     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):

                 
    March 31,   March 31,
    2003   2002
   
 
Net loss
    (6,400 )     (326,398 )
Realized loss on interest rate swap
          3,198  
Foreign currency translation
    (357 )     (2,032 )
 
   
     
 
 
  $ (6,757 )   $ (325,232 )
 
   
     
 

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)

                 
    March 31,   March 31,
    2003   2002
   
 
Cash paid during the period for interest
  $ 380     $ 982  
 
   
     
 
Cash paid during the period for taxes
  $ 878     $ 287  
 
   
     
 

     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):

                                   
      Original                   Remaining
      Provision   Utilized   Adjustment   Obligations
     
 
 
 
Exit costs:
                               
 
Asset impairment
  $ 10,441     $ (10,441 )   $     $  
 
Closed and abandoned facilities
    2,405       (1,713 )           692  
 
Purchase commitments
    6,173       (2,630 )     (2,013 )     1,530  
 
   
     
     
     
 
 
    19,019       (14,784 )     (2,013 )     2,222  
 
Employee severance costs
    1,281       (1,281 )            
 
   
     
     
     
 
 
  $ 20,300     $ (16,065 )   $ (2,013 )   $ 2,222  
 
   
     
     
     
 

     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.

                   
      Three Months Ended
     
      March 31,   March 31,
      2003   2002
     
 
      (Unaudited)
Net revenue
    100 %     100 %
Cost of goods sold
    71       69  
Gross profit
    29       31  
Operating costs and expenses:
               
 
Product development and engineering
    17       25  
 
Selling, general and administrative
    23       38  
 
Amortization of intangibles
           
Total operating costs and expenses
    40       63  
Operating loss
    (12 )     (32 )
Other income (expense), net
          (16 )
Loss before minority interest, provision for taxes and cumulative effect of an accounting change
    (12 )     (48 )
Minority interest
           
Provision for taxes
    1        
Loss before cumulative effect of an accounting change
    (13 )     (48 )
Cumulative effect of an accounting change
          (475 )
Net loss
    (13 )     (523 )

     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):

                 
    2003   2002
   
 
Networking group
  $ 41,800     $ 42,575  
Optical components group
    9,916       19,843  
Development stage enterprises
           
 
   
     
 
 
    51,716       62,418  
Adjustments(1)
    (599 )      
 
   
     
 
 
  $ 51,117     $ 62,418  
 
   
     
 

     (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

                   
      2003   2002
     
 
Cash
               
 
Cash and cash equivalents
  $ 95,543     $ 100,618  
 
Short-term marketable securities
    4,644       11,738  
 
Time deposits
    2,441       2,789  
 
Long-term marketable securities
    1,471       1,447  
 
 
   
     
 
 
    104,099       116,592  
Debt
               
 
Current portion of long-term debt
    214       393  
 
Convertible subordinated notes
    31,893       32,418  
 
Short-term obligations
    5,334       7,000  
 
Long-term debt
    330       390  
 
 
   
     
 
 
    37,771       40,201  
 
 
   
     
 
Excess cash versus debt
  $ 66,328     $ 76,391  
 
 
   
     
 
Ratio of cash versus debt
  2.8 to 1   2.9 to 1
 
 
   
     
 

     Our working capital as of March 31, 2003 was $82.1 million compared to $91.2 million as of December 31, 2002. Our ratio of current assets to current liabilities as of March 31, 2003 was 1.7 to 1.0 compared to 1.8 to 1.0 as of December 31, 2002. The decrease in working capital is substantially attributed to our net operating losses. As of March 31, 2003 and December 31, 2002, we did not have any “off-balance sheet” financing arrangements.

     Cash used in operating activities was $8.5 million for the three months ended March 31, 2003, as compared to cash used in operating activities of $7.8 million for the three months ended March 31, 2002. Cash used in operating activities is a result of our net operating loss of $6.4 million, adjusted for non-cash items such as the depreciation and amortization, deferred stock expense, deferred income taxes, and cash used in operating assets and liabilities. Cash used in operating activities were positively affected by decreased time deposits, accounts receivables, other assets, accounts payable and other current liabilities offset by decreases in inventories and accrued liabilities, during the period. The decrease in accounts receivable is due to lower revenue volumes coupled with increased collection efforts, while the increases in inventory and accounts payable are primarily the result of production for orders to be complete during the second quarter of 2003. Decreases in accrued liabilities are the result of the dramatic slowdown in the communications equipment industry and reductions in overall expenses.

     Cash flows generated from investing activities were $6.4 million for the three months ended March 31, 2003, compared to cash used in investing activities of $11.0 million for the three months ended March 31, 2002. Cash flows generated from investing activities for the three months ended March 31, 2003 were the result of the maturity of short and long-term investments of $7.1 million and proceeds from the sale of property and equipment of $161,000, offset by capital expenditures of $844,000. As of March 31, 2003, we had no plans for major capital expenditures. Cash flows used in investing activities for the prior period resulted from the net cash used for capital expenditures investments in equity method subsidiaries and purchases of short-term and long-term investments.

     Cash flows used in financing activities were $2.6 million for the three months ended March 31, 2003, as compared to cash used in financing activities of $53.1 million for the three months ended March 31, 2002. Cash used in financing activities was primarily the result of paying off $2.5 million of short-term and long-term obligations and the repurchase of our common stock of $145,000 offset by borrowings on long-term obligations of $41,000. Cash flows used in financing activities in 2002 represent the cash paid on borrowings, payments to terminate of interest rate swap offset by borrowings on our short-term and proceeds from the issuance of common stock.

24


Table of Contents

     In June 1998, we issued $100.0 million principal amount of 5% convertible subordinated notes (the “Notes”) due in June 2003, in a private placement raising net proceeds of $96.4 million. The share (equivalent to a conversion rate of approximately 73.94 share per $1,000 principal amount of Notes), representing an initial conversion premium of 24% for a total of approximately 7.4 million shares of our common stock. The Notes bear interest at 5% per annum, which is payable semi-annually on June 15 and December 15 of each year. The Notes have a five-year term and have been callable by us since June 15, 2001. The premiums payable to call these Notes are 102% of the outstanding principal amount during the 12 months ending June 14, 2002 and 101% during the 12 months ending June 14, 2003, plus accrued interest through the date of redemption. During 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.

     The following table illustrates our total contractual cash obligations as of March 31, 2003 (in thousands):

                                         
            Less than 1                        
Cash Obligations   Total   Year   1 – 3 Years   4 – 5 Years   After 5 Years

 
 
 
 
 
Short-term obligations
  $ 5,334     $ 5,334     $     $     $  
Long-term debt
    544       214       330              
Convertible subordinated notes
    31,893       31,893                    
Unconditional purchase obligations
    9,217       9,200       17              
Operating leases
    28,583       8,019       9,683       5,575       5,306  
 
   
     
     
     
     
 
Total contractual cash obligations
  $ 75,571     $ 54,660     $ 10,030     $ 5,575     $ 5,306  
 
   
     
     
     
     
 

     Our total contractual cash obligations as of March 31, 2003, were $75.6 million, of which, $54.7 million are due within the next 12 months. These total contractual cash obligations primarily consist of short-term obligations including our convertible subordinated notes, long-term financing obligations, 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 (see discussion below), and we expect that this will continue to be the case.

     Our unconditional purchase obligations are to secure the necessary raw materials and components required for production of our products. As part of Luminent’s restructure plan (see our discussion above and the Notes to our Financial Statements), there is a remaining obligation totaling $1.5 million for unconditional purchase obligations and Luminent is in continued negotiations to cancel or renegotiate contracts that are no longer required due to its significantly reduced orders for optical components and sales projections. The remaining purchase commitments are part of our ordinary course of business.

     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. 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, market acceptance of our products and acquisitions.

25


Table of Contents

Certain Risk Factors That Could Affect Future Results

     From time to time we may make written or oral forward-looking statements. Written forward-looking statements may appear in documents filed with the Securities and Exchange Commission, in press releases, and in reports to stockholders. The Private Securities Reform Act of 1995 contains a safe harbor for forward-looking statements on which the Company relies in making such disclosures. In connection with this “safe harbor” we are hereby identifying important factors that could cause actual results to differ materially from those contained in any forward-looking statements made by or on behalf of the Company. Any such statement is qualified by reference to the following cautionary statements:

We Incurred Net Losses For The Three Months Ended March 31, 2003 and 2002 And For The Years Ended December 31, 2002, 2001 And 2000, Primarily As A Result Of The Impairment And Amortization Of Goodwill And Other Intangibles And Deferred Stock Expense From Recent Acquisitions. We Expect To Continue To Incur Net Losses For The Foreseeable Future.

     We reported net losses of $6.4 million and $326.4 million for the three months ended March 31, 2003 and 2002, respectively, and $479.8 million, $326.4 million and $153.0 million for the years ended December 31, 2002, 2001 and 2000, respectively. A major contributing factor to the net losses was the cumulative effect of an accounting change and the impairment of goodwill and other intangibles in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, the amortization of goodwill and intangibles and deferred stock expense related to our acquisitions during 2000 of Fiber Optic Communications, Jolt, Quantum Optech, AstroTerra and Optronics International and the employment arrangements we made in 2000 with the former President and Chief Financial Officer of Luminent. We will continue to record deferred stock expense relating to these acquisitions through 2004. Effective January 1, 2002, we adopted SFAS No. 142, and we no longer amortize goodwill and intangibles with indefinite lives, but instead we 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 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. As a result of the transitional impairment test, we recorded a $296.4 million cumulative effect of an accounting change during 2002. In addition to the transitional impairment test, we reviewed our remaining goodwill and other intangibles as required annually pursuant to SFAS No. 142. As a result of the annual review, we further reduced the carrying amount of goodwill and other intangibles by recording an impairment charge of $72.7 million during 2002. We will continue to perform our annual impairment review as of October 1st each year. We expect to record impairment charges in the future from time to time as a result of this standard. As a consequence of the current economic environment and potential impairment charges, we do not expect to report net income in the foreseeable future.

Our Business Has Been Adversely Impacted By The Worldwide Economic Slowdown And Related Uncertainties.

     Weaker economic conditions worldwide, particularly in the U.S. and Europe, have contributed to the current technology industry slowdown and impacted our business resulting in:

  -   reduced demand for our products, particularly fiber optic components;
 
  -   increased risk of excess and obsolete inventories;
 
  -   increased price competition for our products;
 
  -   excess manufacturing capacity under current market conditions; and
 
  -   higher overhead costs, as a percentage of revenues.

26


Table of Contents

     These unfavorable economic conditions and reduced capital spending in the telecommunications industry detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States, during 2001 and 2002 and may affect them for 2003 and thereafter. Announcements by industry participants and observers indicate there is a continuing slowdown in industry spending and participants are seeking to reduce existing inventories and we are experiencing these reductions in our business. As a result of these factors, we recorded, during the year ended December 31, 2001, consolidated charges from our subsidiary, Luminent, which included the write-off of inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other unusual items. The aggregate charges recorded during the year ended December 31, 2001 were $49.5 million. We did not record similar charges during the year ended December 31, 2002. These charges were the result of the lower demand for Luminent’s products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular.

     Additionally, these economic conditions are making it very difficult for us, our customers and our vendors to forecast and plan future business activities. This level of uncertainty severely challenges our ability to operate profitably or to grow our businesses. In particular, it is difficult to develop and implement strategy, sustainable business models and efficient operations, and effectively manage manufacturing and supply chain relationships. We believe that a decrease in business and consumer confidence in the economy and the financial markets will result from current political tensions or the outbreak of war with Iraq. Concerns over accounting practices of service providers and faltering growth prospects among equipment manufactures could delay the economic recovery in the telecommunications industry beyond 2003. In addition, further disruptions of the air transport system such as those resulting from the terrorist attacks of September 11, 2001 in the United States and abroad may negatively impact our ability to deliver products to customers, to visit potential customers, to provide support and service to our existing customers and to obtain components in a timely fashion. If the economic or market conditions continue to languish or further deteriorate, or if the economic downturn is exacerbated as a result of political, economic or military conditions associated with current domestic and world events, our businesses, financial condition and results of operations could be further impaired.

Some Of Our Customers May Not Have The Resources To Pay For Our Products As A Result Of The Current Economic Environment

     With the current economic slowdown, some of our customers are forecasting that their revenue for the foreseeable future will generally be lower than originally anticipated. Some of these customers are experiencing, or are likely to experience, serious cash flow problems and, as a result, find it increasingly difficult to obtain financing, if at all. If some of these customers are not successful in generating sufficient revenue or securing alternate financing arrangements, they may not be able to pay, or may delay payment for, the amounts that they owe us. Furthermore, they may not order as many products from us as originally forecast, or cancel orders with us entirely. The inability of some of our potential customers to pay us for our products may adversely affect our cash flow, the timing of our revenue recognition and the amount of revenue, which may 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;

27


Table of Contents

  -   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.

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. For instance, during late 2000, we were informed that certain Luminent transceivers sold to Cisco were experiencing field failures. Through discussions with Cisco through September 2001, Luminent’s management agreed to replace the failed units, which we believe resolves this issue. We expect the ultimate replacement of these failed transceivers will cost approximately $3.6 million, which has been fully reserved. As of March 31, 2003, we had a remaining obligation to replace approximately $2.9 million additional transceivers. 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.

We Face Risks In Reselling The Products Of Other Companies.

     We have recently begun to distribute the products of 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.

Our Operating Results Could Fluctuate Significantly From Quarter To Quarter.

     Our operating results for a particular quarter are extremely difficult to predict. Our revenue and operating results could fluctuate substantially from quarter to quarter and from year to year. This could result from any one or a combination of factors such as:

  -   the cancellation or postponement of orders;
 
  -   the timing and amount of significant orders from our largest customers;
 
  -   our success in developing, introducing and shipping product enhancements and new products;

28


Table of Contents

  -   the mix of products we sell;
 
  -   software, hardware or other errors in the products we sell requiring replacements or increased warranty reserves;
 
  -   adverse effects to our financial statements resulting from, or necessitated by, past and future acquisitions or deferred stock expense;
 
  -   our periodic 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; and
 
  -   general economic conditions.

     Moreover, the volume and timing of orders we receive during a quarter are difficult to forecast. From time to time, our customers encounter uncertain and changing demand for their products. Customers generally order based on their forecasts. If demand falls below these forecasts or if customers do not control inventories effectively, they may cancel or reschedule shipments previously ordered from us. Our expense levels during any particular period are based, in part, on expectations of future sales. If sales in a particular quarter do not meet expectations, our operating results could be materially adversely affected.

     Our success is dependent, in part, on the overall growth rate of the fiber optic components and networking industry. The Internet or the industries that serve it may not continue to grow and even if it does, 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.

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.

29


Table of Contents

The Long Sales Cycles For Our Products May Cause Revenues And Operating Results To Vary From Quarter To Quarter, Which Could Cause Volatility In Our Stock Price.

     The timing of our revenue is difficult to predict because of the length and variability of the sales and implementation cycles for our products. We do not recognize revenue until a product has been shipped to a customer, all significant vendor obligations have been performed and collection is considered probable. Customers often view the purchase of our products as a significant and strategic decision. As a result, customers typically expend significant effort in evaluating, testing and qualifying our products and our manufacturing process. This customer evaluation and qualification process frequently results in a lengthy initial sales cycle of, depending on the products, many months or more. In addition, some of our customers require that our products be subjected to lifetime and reliability testing, which also can take months or more. While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing and research and development expenses to customize our products to the customer’s needs. We may also expend significant management efforts, increase manufacturing capacity and order long lead-time components or materials prior to receiving an order. Even after this evaluation process, a potential customer may not purchase our products. Even after acceptance of orders, our customers often change the scheduled delivery dates of their orders. Because of the evolving nature of the optical networking and network infrastructure markets, we cannot predict the length of these sales, development or delivery cycles. As a result, these long sales cycles may cause our net sales and operating results to vary significantly and unexpectedly from quarter-to-quarter, which could cause volatility in our stock price.

The Prices Of Our Shares May Continue To Be Highly Volatile.

     Historically, the market price of our shares has been extremely volatile. The market price of our common stock is likely to continue to be highly volatile and could be significantly affected by factors such as:

  -   actual or anticipated fluctuations in our operating results;
 
  -   announcements of technological innovations or new product introductions by us or our competitors;
 
  -   changes of estimates of our future operating results by securities analysts;
 
  -   developments with respect to patents, copyrights or proprietary rights; and
 
  -   general market conditions and other factors.

     In addition, the stock market has experienced extreme price and volume fluctuations that have particularly affected the market prices for 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.

Our Stock Price Might Suffer As A Consequence Of Our Investments In Affiliates.

     We have created several start-up companies and formed independent business units in the optical technology and Internet infrastructure areas. We account for these investments in affiliates according to the equity or cost methods as required by accounting principles generally accepted in the United States. The market value of these investments may vary materially from the amounts shown as a result of business events specific to these entities or their competitors or market conditions. Actual or perceived changes in the market value of these investments could have a material impact on our share price and in addition could contribute significantly to volatility of our share price.

30


Table of Contents

Our Business Is Intensely Competitive And The Evident Trend Of Consolidations In Our Industry Could Make It More So.

     The markets for fiber optic components and networking products are intensely competitive and subject to frequent product introductions with improved price/performance characteristics, rapid technological change and the continual emergence of new industry standards. We compete and will compete with numerous types of companies including companies that have been established for many years and have considerably greater financial, marketing, technical, human and other resources, as well as greater name recognition and a larger installed customer base, than we do. This may give these competitors certain advantages, including the ability to negotiate lower prices on raw materials and components than those available to us. In addition, many of our large competitors offer customers broader product lines, which provide more comprehensive solutions than our current offerings. We expect that other companies will also enter markets in which we compete. Increased competition could result in significant price competition, reduced profit margins or loss of market share. We can give no assurance that we will be able to compete successfully with existing or future competitors or that the competitive pressures we face will not materially and adversely affect our business, operating results and financial condition. In particular, we expect that prices on many of our products will continue to decrease in the future and that the pace and magnitude of these price decreases may have an adverse impact on our results of operations or financial condition.

     There has been a trend toward industry consolidation for several years. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry. We believe that industry consolidation may provide stronger competitors that are better able to compete. This could have a material adverse effect on our business, operating results and financial condition.

We May Have Difficulty Managing Our Businesses.

     We must continually implement new and enhance existing financial and management information systems and controls and must add and train personnel to operate these systems effectively. Our delay or failure to implement new and enhance existing systems and controls as needed could have a material adverse effect on our results of operations and financial condition in the future. Should we continue to pursue a growth strategy, such a strategy can be expected to place even greater pressure on our existing personnel and compound the need for increased personnel, expanded information systems, and additional financial and administrative control procedures. We can give no assurance that we will be able to successfully manage operations if they continue to expand.

Adjustments To The Size Of Our Operations May Require Us To Incur Unanticipated Costs.

     Prior to 2001, we experienced growth and expansion that placed, and may in the future place, a significant strain on our resources. Subsequent to the quarter ended March 31, 2001, we have incurred unanticipated costs to downsize our operations to a level consistent with downward forecasts in sales. Even if we manage the current period of instability effectively, as well as possible expansion in the future, we may make mistakes in restructuring or operating our business such as inaccurate sales forecasting or incorrect material planning. Any of these mistakes may lead to unanticipated fluctuations in our operating results. We may not be able to size our operations in accordance with growth or decline of our business in the future.

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

     In 2002, 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 affect our business substantially. 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.

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 three months ended March 31, 2003 and 2002 and for the years ended December 31, 2002:

31


Table of Contents

                                         
    Three Months Ended   For The Years Ended
   
 
    Mar. 31,   Mar. 31,   Dec. 31,   Dec. 31,   Dec. 31,
    2003   2002   2002   2001   2000
   
 
 
 
 
Percentage of total revenue from foreign sales
    75 %     71 %     74 %     67 %     63 %

     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. Luminent 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 Luminent and we make sales of our products in the People’s Republic of China. Our total sales in the People’s Republic of China amounted to approximately $18.2 million, $10.4 million and $2.7 million for the years ended December 31, 2002, 2001 and 2000, respectively. 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;
 
  -   certification requirements;
 
  -   potentially adverse tax consequences;
 
  -   unanticipated cost increases;
 
  -   unavailability or late delivery of equipment;
 
  -   trade restrictions;
 
  -   limited protection of intellectual property rights;
 
  -   unforeseen environmental or engineering problems; and
 
  -   personnel recruitment delays.

     The majority of our sales are currently denominated in U.S. dollars and to date our business has not been significantly affected by currency fluctuations or inflation. However, as we conduct business in several different countries, fluctuations in currency exchange rates could cause our products to become relatively more expensive in particular countries, leading to a reduction in sales in that country. In addition, inflation or fluctuations in currency exchange rates in these countries could increase our expenses.

     To date, we have not hedged against currency exchange risks. In the future, we may engage in foreign currency denominated sales or pay material amounts of expenses in foreign currencies and, in that event, may experience gains and losses due to currency fluctuations. Our operating results could be adversely affected by currency fluctuations or as a result of inflation in particular countries where material expenses are incurred.

32


Table of Contents

     There has been a recent outbreak of severe acute respiratory syndrome, or SARS, in southern China and elsewhere in Southeast Asia. This outbreak is being investigated by the World Health Organization, among other health agencies. We are continuing to monitor the possible implications of the SARS outbreak but at this time it is difficult to quantify the potential impact on our business. For example, the SARS outbreak could result in quarantines or closures to our factories in Taiwan if our employees are infected with SARS and ongoing concerns regarding SARS, particularly its effect on travel, could negatively impact our China-based customers and our business and operating results.

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.

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.

33


Table of Contents

We May Be Harmed By Our Failure To Pursue Acquisitions And If We Do Pursue Acquisitions Harm Could Result.

     An important element of our strategy has been to review acquisition prospects that would complement our existing operations and products, augment our market coverage and distribution ability or enhance our technological capabilities. Since the end of 2000, we have not made any acquisitions of businesses or product lines and we have no plans to do so in the foreseeable future. The networking business is highly competitive and our failure to pursue future acquisitions could hamper our ability to enhance existing products and introduce new products on a timely basis. If we do choose to pursue acquisitions, they could have a material adverse effect on our business, financial condition and results of operations because of the following:

  -   possible charges to operations for purchased technology and restructuring similar to those we incurred in connection with our acquisition of Xyplex in 1998;
 
  -   potentially dilutive issuances of equity securities;
 
  -   incurrence of debt and contingent liabilities;
 
  -   incurrence of amortization expenses and impairment charges related to goodwill and other intangible assets and deferred stock expense similar to those arising with the acquisitions of Fiber Optic Communications, Optronics, Quantum Optech, Jolt and AstroTerra in 2000;
 
  -   difficulties assimilating the acquired operations, technologies and products;
 
  -   diversion of management’s attention to other business concerns;
 
  -   risks of entering markets in which we have no or limited prior experience;
 
  -   potential loss of key employees of acquired organizations; and
 
  -   difficulties in honoring commitments made to customers by management of the acquired entity prior to the acquisition.

     We can give no assurance as to whether we can successfully integrate the companies, products, technologies or personnel of any business that we might acquire in the future.

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

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

We Are Currently, And Could In The Future Become, Subject To Litigation Regarding Intellectual Property Rights, Which Could Be Costly And Subject Us To Significant Liability.

     From time to time, third parties, including our competitors, may assert patent, copyright and other intellectual property rights to technologies that are important to us. We expect we will increasingly be subject to license offers and infringement claims as the number of products and competitors in our market grows and the functioning of products overlaps. In this regard:

34


Table of Contents

  -   In March 1999, we received a written notice from Lemelson Foundation Partnership in which Lemelson claimed to have patent rights in our vision and automatic identification operations, which are widely used in the manufacture of electronic assemblies.
 
  -   In April 1999, we received a written notice from Rockwell Automation Technologies Corporation in which Rockwell claimed to have patent rights in certain technology related to our metal organic chemical vapor deposition, or MOCVD, processes and this claim initially resulted in litigation, which has since been dismissed pending the results of litigation not directly involving us.
 
  -   In October 1999, we received written notice from Lucent Technologies, Inc. in which Lucent claimed we have violated certain of Lucent’s patents falling into the general category of communications technology, with a focus on networking functionality.
 
  -   In October 1999, we received a written notice from Ortel Corporation, which has since been acquired by Lucent, in which Ortel claimed to have patent rights in certain technology related to our photodiode module products. In January 2001, we were advised that Lucent had assigned certain of its rights and claims to Agere Systems, Inc., including the claim made on the Ortel patent. To date, we have not been contacted by Agere regarding this patent claim. In July 2000, we received written notice from Nortel Networks, which claimed we violated Nortel’s patent relating to technology associated with local area networks.
 
  -   In May 2001, we received written notice from IBM, which claims that several of our optical components and Internet infrastructure products make use of inventions covered by certain patents claimed by IBM. We are evaluating the patents noted in the letters.

     Aggregate revenues potentially subject to the foregoing claims amounted to approximately 20%, 28% and 30% of our revenues for the years ended December 31, 2002, 2001 and 2000, respectively. Others’ patents, including Lemelson’s, Rockwell’s, Lucent’s, Agere’s, Nortel’s and IBM’s, may be determined to be valid, or some of our products may ultimately be determined to infringe the Lemelson, Rockwell, Lucent, Agere, Nortel or IBM patents, or those of other companies.

     As was the case with Rockwell, Lemelson, Lucent, Agere, Nortel or IBM, or other companies may pursue litigation with respect to these or other claims. The results of any litigation are inherently uncertain. In the event of an adverse result in any litigation with respect to intellectual property rights relevant to our products that could arise in the future, we could be required to obtain licenses to the infringing technology, to pay substantial damages under applicable law, to cease the manufacture, use and sale of infringing products or to expend significant resources to develop non-infringing technology. Licenses may not be available from third parties, including Lemelson, Rockwell, Lucent, Ortel, Nortel or IBM, either on commercially reasonable terms or at all. In addition, litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail. Accordingly, any infringement claim or litigation against us could significantly harm our business, operating results and financial condition.

In The Future, We May Initiate Claims Or Litigation Against Third Parties For Infringement Of Our Proprietary Rights To Protect These Rights Or To Determine The Scope And Validity Of Our Proprietary Rights Or The Proprietary Rights Of Competitors. These Claims Could Result In Costly Litigation And The Diversion Of Our Technical And Management Personnel.

     Necessary licenses of third-party technology may not be available to us or may be very expensive, which could adversely affect our ability to manufacture and sell our products. From time to time we may be required to license technology from third parties to develop new products or product enhancements. We cannot assure you that third-party licenses will be available to us on commercially reasonable terms, if at all. The inability to obtain any third-party license required to develop new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost, either of which could seriously harm our ability to manufacture and sell our products.

35


Table of Contents

We Are Dependent On Certain Members Of Our Senior Management.

     We are substantially dependent upon Dr. Shlomo Margalit, our Chairman of the Board of Directors and Chief Technical Officer, and Mr. Noam Lotan, our President and Chief Executive Officer. The loss of the services of either of these officers could have a material adverse effect on us. We have entered into employment agreements with Dr. Margalit and Mr. Lotan and are the beneficiary of key man life insurance policies in the amounts of $1.0 million each on their lives. However, we can give no assurance that the proceeds from these policies will be sufficient to compensate us in the event of the death of either of these individuals, and the policies are not applicable in the event that either of them becomes disabled or is otherwise unable to render services to us.

Our Business Requires Us To Attract And Retain Qualified Personnel.

     Our ability to develop, manufacture and market our products, run our 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.

     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.

36


Table of Contents

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.

     Softness in demand and pricing in the communications market have necessitated a review of our inventory, facilities and headcount. As a result, we recorded in the year ended December 31, 2001 one-time charges to write down inventory to realizable value and inventory purchase commitments of approximately $35.4 million. We did not recognize similar charges for the year ended December 31, 2002.

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, 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. The Sarbanes-Oxley Act of 2002 and other rule changes and proposed legislative initiatives are likely to increase general and administrative costs. In addition, insurers are likely to increase rates as a result of high claims rates over the past year 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 generally accepted accounting principles, 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 Luminent’s stock price following its initial public offering, we may be the target of securities litigation in the future. Additionally, while Luminent and we informed investors that we were under no obligation to, and might not, make the distribution to our stockholders of our Luminent common stock and that we could and might eliminate public ownership of Luminent through a short-form merger with us, our decisions in 2001 to abandon our distribution of Luminent’s common stock to our stockholders or to eliminate public ownership of Luminent’s common stock through the merger of Luminent into one of our wholly-owned subsidiaries may result in securities or other litigation. Securities or other litigation could result in substantial costs and divert management’s attention and resources.

If The Price Of Our Common Stock Again Trades Below $1.00 Per Share For A Prolonged Period, Our Common Stock May Be Delisted From Nasdaq

     Nasdaq has established certain standards for the continued listing of a security on its National Market and its SmallCap Market. The standards for continued listing on either market require, among other things, that the minimum bid price for the listed common stock be at least $1.00 per share. A deficiency in the bid price maintenance standard will be deemed to exist if the issuer fails the minimum bid-price requirement for 30 consecutive trading days, within a 90-day cure period, with respect to the Nasdaq National Market, and a 180-day cure period with respect to the Nasdaq SmallCap Market (which may be extended by an additional 180 days if the issuer meets certain specified criteria at the end of the initial 180-day period).

37


Table of Contents

     From September 19, 2002 to October 25, 2002, a period of 27 consecutive trading days, our common stock traded at less than $1.00 per share and thus we just avoided receiving notice from the Nasdaq Stock Market, Inc. of a failure to comply with the $1.00 minimum bid price per share requirement. While the price per share of our common stock has recently exceeded the $1.00 per share minimum bid requirement, because of current economic or market conditions or other factors the price of our common stock may again fall below $1.00 per share. If that deficiency were sustained for a prolonged period, it could result in our common stock being delisted from the Nasdaq Stock Market. In that event, public trading, if any, in our common stock would be limited to the over-the-counter markets in the so-called “pink sheets” or the NASD’s OTC Electronic Bulletin Board. Consequently, the liquidity of our common stock could be impaired and the ability of holders to sell our stock could be adversely affected as would our ability to raise additional capital.

If The Nasdaq Stock Market Delisted Our Common Stock We Could Become Subject To The SEC’s Penny Stock Rules. In That Event, Because Of The Burden Placed On Broker-Dealers To Comply With The Rules Applicable To Penny Stocks, Investors May Have Difficulty Selling Our Common Stock In The Open Market.

     If the Nasdaq Stock Market delisted our common stock, our common stock could become subject to Rule 15g-9 under the Securities Exchange Act of 1934. This rule imposes additional sales practice requirements on broker-dealers who sell so-called “penny” stocks to persons other than established customers and “accredited investors.” Subject to some exceptions, the SEC’s regulations define a “penny stock” to be any non-Nasdaq or non-exchange listed equity security that has a market price of less than $5.00 per share. Generally, accredited investors are individuals with a net worth more than $1,000,000 or annual incomes exceeding $200,000 (or $300,000 together with their spouses). For transactions covered by this rule, a broker-dealer must, among other requirements, make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction before sale. Consequently, the rule may adversely affect the interest or ability of broker-dealers in selling our shares in the secondary market and this in turn could adversely affect both the market liquidity for our common stock and the ability of holders to sell our stock.

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.

38


Table of Contents

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. In connection with our $50.0 million variable-rate term loan due in 2003, we entered into a specific hedge, an interest rate swap, to modify the interest characteristics of this instrument. The interest rate swap was used to reduce our cost of financing and the fluctuations in the aggregate interest expense. The notional amount, interest payment and maturity dates of the swap match the principal, interest payment and maturity dates of the related debt. Accordingly, any market risk or opportunity associated with this swap is offset by the opposite market impact on the related debt. In February 2002, we paid off our $50.0 million term loan and terminated our interest rate swap for $3.2 million. To date, we have not entered into any other derivative instruments, however, as we continue to monitor our risk profile, we may enter into additional hedging instruments in the future.

     Foreign Exchange Rates. We operate on an international basis with a portion of our revenues and expenses being incurred in currencies other than the U.S. dollar. Fluctuation in the value of these foreign currencies in which we conduct our business relative to the U.S. dollar will cause U.S. dollar translation of such currencies to vary from one period to another. We cannot predict the effect of exchange rate fluctuations upon future operating results. However, because we have expenses and revenues in each of the principal functional currencies, the exposure to our financial results to currency fluctuations is reduced. We have not historically attempted to reduce our currency risks through hedging instruments, however, we may do so in the future.

     Inflation. We believe that the relatively moderate rate of inflation in the United States over the past few years has not had a significant impact on our sales or operating results or on the prices of raw materials. However, in view of our recent expansion of operations in Taiwan, Israel and other countries, which have experienced greater inflation than the United States, there can be no assurance that inflation will not have a material adverse effect on our operating results in the future.

39


Table of Contents

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

     Within the 90-day period prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that 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 significant changes in the Company’s internal controls or in other factors, which could significantly affect internal controls subsequent to the date the Company carried out its evaluation.

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

     (a)  Exhibits

     
11.1   Computation of per share earnings – See Note 1 of Notes to Unaudited Condensed Financial Statements.

     (b)  Reports on Form 8-K

       No reports on Form 8-K were filed during the period covered by this Report.

40


Table of Contents

SIGNATURE

     Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant certifies that it has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on May 14, 2003.

     
    MRV COMMUNICATIONS, INC
     
    By: /s/ Noam Lotan
Noam Lotan
President and Chief Executive Officer
     
    By: /s/ Shay Gonen

Shay Gonen
Chief Financial Officer

41


Table of Contents

CERTIFICATION

I, Noam Lotan, certify that:

1.    I have reviewed this quarterly report on Form 10-Q of MRV Communications, Inc.;

2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.    Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.    The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

  a.   designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
  b.   evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
  c.   presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.    The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

  a.   all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
  b.   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.    The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

     
    Date: May 14, 2003
     
    /s/ Noam Lotan
Noam Lotan
President and Chief Executive Officer

42


Table of Contents

CERTIFICATION

I, Shay Gonen, certify that:

1.    I have reviewed this quarterly report on Form 10-Q of MRV Communications, Inc.;

2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.    Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.    The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

  a.   designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
  b.   evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
  c.   presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.    The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

  a.   all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
  b.   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.    The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

     
    Date: May 14, 2003
     
    /s/ Shay Gonen

Shay Gonen
Chief Financial Officer

43


Table of Contents

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

     In connection with the Quarterly Report of MRV Communications, Inc. (the “Company”) on Form 10-Q for the period ended March 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned, in the capacities and on May 14, 2003, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge:

  1.   The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
  2.   The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

     
    MRV COMMUNICATIONS, INC
     
    By: /s/ Noam Lotan
Noam Lotan
President and Chief Executive Officer
     
    By: /s/ Shay Gonen

Shay Gonen
Chief Financial Officer

44