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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Commission file number 001-11174

MRV COMMUNICATIONS, INC.

(Exact name of registrant as specified in its charter)

20415 Nordhoff Street, Chatsworth, CA  91311
(Address of principal executive offices, zip code)

(818) 773-0900

(Registrant’s telephone number, including area code)

Indicate by check mark, whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 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 o

Indicate by check mark, whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes  o  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

As of May 4, 2010, 157,681,208 shares of MRV’s Common Stock were outstanding.

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MRV Communications, Inc.

Form 10-Q for the Quarter Ended March 31, 2010

Index

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PART I - FINANCIAL INFORMATION

Item 1.     Financial Statements

MRV Communications, Inc.

Statements of Operations

(In thousands, except per share data)

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

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MRV Communications, Inc.

Balance Sheets

(In thousands, except par values)

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

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MRV Communications, Inc.

Statements of Cash Flows

(In thousands)

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

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MRV Communications, Inc.

Notes to Financial Statements

(Unaudited)

1.   Basis of Presentation

The consolidated financial statements include the accounts of MRV Communications, Inc. (“MRV” or the “Company”) and its wholly-owned and majority-owned subsidiaries.  All significant intercompany transactions and accounts have been eliminated.  MRV consolidates the financial results of less than majority-owned subsidiaries when it has effective control, voting control or has provided the entity’s working capital.  When investment by others in these enterprises reduces the Company’s voting control below 50%, MRV discontinues consolidation and uses the cost or equity method of accounting for these investments, unless otherwise required.

The consolidated financial statements included herein have been prepared by MRV, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) 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.  The information included in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 (this “Form 10-Q”) should be read in conjunction with “Risk Factors,” “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and the Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2009 (the “2009 Form 10-K”) filed with the SEC.

In the opinion of MRV’s management, these unaudited statements contain all adjustments, which include normal recurring adjustments, necessary to present fairly the financial position of MRV as of March 31, 2010, and the results of its operations and its cash flows for the three months then ended.  The results reported in these financial statements should not be regarded as necessarily indicative of results that may be expected for the full year or any future periods.

On December 24, 2009, the Company entered into an agreement to divest its 90% ownership in EDSLan, S.p.A., a communication equipment distribution company located in Milan, Italy.  EDSLan was part of the Company’s Network Integration group.  The sale was completed on January 7, 2010.  The historical financial results of EDSLan have been reclassified as discontinued operations for all periods presented as set forth in this Form 10-Q.  The related assets and liabilities of EDSLan have been classified as held for sale in the Balance Sheet as of December 31, 2009.  Cash flows from discontinued operations are presented combined with the cash flows from continuing operations in the accompanying Statement of Cash Flows.

2.   Cash and Cash Equivalents, Restricted Time Deposits and Marketable Securities

MRV treats highly liquid investments with an original maturity of 90 days or less as cash equivalents.  Investments with maturities of less than one year are considered short-term.  MRV maintains cash balances and investments in qualified financial institutions, and at various times such amounts are in excess of federal insured limits.

Restricted time deposits represent investments that are restricted as to withdrawal or use and are primarily in foreign subsidiaries. Restricted time deposits generally secure standby letters of credit, bank lines of credit, or bank loans. The Company had bank loans secured by restricted time deposits of $16.9 million as of March 31, 2010 and December 31, 2009 that, pursuant to a loan agreement, will be directly used to repay the loans when the time deposits and underlying bank loans mature.   Investments in and releases of restricted time deposits are included in investing activities on the Company’s Statement of Cash Flows unless the time deposits relate to an underlying bank loan and will be used to repay the loan, in which case the related cash flows are treated as financing activities.

MRV accounts for its marketable securities, which are available for sale, under the provisions of Accounting Standards Codification (“ASC”) Topic 320 Investments — Debt and Equity Securities.  The original cost of MRV’s marketable securities approximated fair market value as of March 31, 2010 and December 31, 2009.  Unrealized losses at March 31, 2010 and December 31, 2009 were $51,000 and $50,000, respectively.  Marketable securities mature at various dates through 2010 and consist of corporate and U.S. government issues.

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Marketable securities consisted of the following (in thousands):

3.   Fair Value Measurement

MRV’s financial instruments, including cash and cash equivalents, restricted time deposits, short-term and long-term marketable securities, accounts receivable, accounts payable, accrued liabilities and short-term debt obligations, are carried at cost, which approximates their fair market value. The fair value of long-term debt obligations is estimated based on current interest rates available for debt instruments with similar terms, degrees of risk and remaining maturities. The carrying values of these obligations approximate their fair values.

ASC 820-10 Fair Value Measurements defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820-10 establishes a three-level hierarchy that prioritizes the use of observable inputs, such as quoted prices in active markets, and minimizes the use of unobservable inputs, to measure fair value. All of MRV’s assets and liabilities that are measured at fair value are measured using the unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date. MRV adopted the provisions of ASC 820-10, effective January 1, 2008, for its financial assets and liabilities, and the adoption did not have a material impact on MRV’s consolidated financial statements. Under this standard, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

In determining the fair value of its financial assets and liabilities, the Company uses various valuation approaches. ASC 820-10 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available.

The Company’s available-for-sale securities consist of U.S. government agencies’ obligations and corporate debt securities and are valued using quoted market prices of recent transactions or are benchmarked to transactions of very similar securities which are considered Level 1 category items. There were no material re-measurements to fair value during the three months ended March 31, 2010 of financial assets and liabilities that are not measured at fair value on a recurring basis.

4.   Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk primarily consist of cash and cash equivalents placed with high credit quality institutions and accounts receivable due from customers. MRV evaluates the collectability of accounts receivable based on a combination of factors. If the Company becomes aware of a customer’s inability to meet its financial obligations after a sale has occurred, the Company records an allowance to reduce the net receivable to the amount which it reasonably believes to be collectable from the customer. For all other customers, the Company records allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment, and historical experience. If the financial conditions of MRV’s customers were to deteriorate or if economic conditions worsen, additional allowances may be required in the future.

The following table summarizes the changes in the allowance for doubtful accounts during the three months ended March 31, 2010 (in thousands):

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As of March 31, 2010 and December 31, 2009, amounts due to the Company from each of Huawei Technologies Co., Ltd. and Telecom Italia S.p.A. exceeded 10% of gross accounts receivables, and accounted for 30% and 26%, respectively, of gross accounts receivables on a combined basis. Huawei is a customer of our Optical Components group and Telecom Italia is a customer of our Network Integration group.

5.   Inventories

Inventories are stated at the lower of cost or market and consist of materials, labor and overhead.  Cost is determined by the first in, first out method.  Inventories, net of reserves, consisted of the following (in thousands):

The following table summarizes the change in inventory reserve during the three months ended March 31, 2010 (in thousands):

6.   Goodwill and Other Intangibles

In accordance with ASC 350 Intangibles — Goodwill and Other, goodwill and intangible assets with indefinite lives are not amortized, but instead measured for impairment at least annually or when events indicate that impairment exists.  No events occurred during the three months ended March 31, 2010 indicating impairment of goodwill existed, and accordingly, there was no change in the carrying balance of goodwill during that period.  Goodwill is recorded at the subsidiary level in local currencies and converted into U.S. dollars at the balance sheet date.  There was an unrealized loss of $0.6 million during the three months ended March 31, 2010 due to the change in foreign currency rates from December 31, 2009 to March 31, 2010.  The unrealized loss arising from the translation adjustment is recorded in accumulated other comprehensive income in the Balance Sheet.

Other intangible assets consist of intangible assets identified as a result of our acquisition of Fiberxon, Inc. on July 1, 2007.  Amortization of other intangible assets was $564,000 for the three months ended March 31, 2010 and 2009.

The following table summarizes MRV’s other intangible asset balances at March 31, 2010 (in thousands):

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7.   Product Warranty and Indemnification

As of March 31, 2010 and December 31, 2009, MRV’s product warranty liability recorded in accrued liabilities was $3.1 million and $3.6 million, respectively.  MRV accrues for warranty costs as part of cost of goods sold based on associated material product costs, technical support labor costs and associated overhead.  The products sold are generally covered by a warranty for periods of one to two years.

The following table summarizes the change in product warranty liability during the three months ended March 31, 2010 (in thousands):

8.   Noncontrolling Interests and Deconsolidation of Divested Subsidiary

The Company deconsolidated EDSLan in January 2010 when it ceased to have a controlling financial interest as a result of the sale of the 90% of the outstanding equity of EDSLan that it previously owned.  The Company recognized a loss of $3.8 million related to the write down of the assets of EDSLan to their net realizable value in 2009.   In accordance with ASC 810 Consolidations, the loss recognized in 2009 was measured as the difference between the fair value of the consideration received and MRV’s share of the carrying amount of EDSLan’s assets and liabilities.   In connection with the sale, the Company entered into a distribution agreement with EDSLan under which EDSLan will purchase a minimum of 2 million euros of the Company’s products over the following three years.

The following table summarizes the change in noncontrolling interests in subsidiaries for the three months ended March 31, 2010 (in thousands):

9.   Net Income (Loss) Per Share

Basic net income (loss) per share attributable to MRV is computed using the weighted average number of shares of Common Stock outstanding during the period.  Diluted net income (loss) per share attributable to MRV is computed using the weighted average number of shares of Common Stock outstanding and dilutive potential shares of Common Stock from stock options and warrants outstanding during the period.  Diluted shares outstanding include the dilutive effect of in-the-money options and warrants, which is calculated based on the average share price for each period using the treasury stock method.

Outstanding stock options and warrants to purchase 12.0 million shares were excluded from the computation of diluted net loss per share for the three months ended March 31, 2010, because such stock options and warrants were anti-dilutive since they were not in-the-money.  Outstanding stock options and warrants to purchase 14.2 million shares were excluded from the computation of diluted net loss per share for the three months ended March 31, 2009, because such stock options and warrants were anti-dilutive.

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10.  Share-Based Compensation

MRV records share-based compensation expense in accordance with ASC Topic 718 Compensation — Stock Compensation.  The following table summarizes the impact on MRV’s results of operations of recording share-based compensation for the three months ended March 31, 2010 and 2009 (in thousands):

(1)          Income tax benefits realized from stock option exercises and similar awards were immaterial in both periods.

There were no stock option awards granted during the three months ended March 31, 2010 or the three months ended March 31, 2009.  As of March 31, 2010, the total unrecorded deferred share-based compensation balance for unvested shares, net of expected forfeitures, was $1.8 million, which is expected to be amortized over a weighted-average period of 1.6 years.  MRV uses the Black-Scholes option pricing model to estimate the fair value of share-based awards.  The Black-Scholes model requires the use of subjective assumptions, including the option’s expected life and the underlying stock price volatility.

11.  Segment Reporting and Geographic Information

MRV operates its business in three segments: the Network Equipment group; the Network Integration group; and the Optical Components group.  The Network Equipment group designs, manufactures and distributes optical networking solutions and Internet infrastructure products.  The Network Integration group provides value-added integration and support services for customers’ networks.  The Optical Components group designs, manufactures and distributes optical components and optical subsystems.

The accounting policies of the segments are the same as those described in the summary of significant accounting polices disclosed in MRV’s 2009 Form 10-K.  MRV evaluates segment performance based on revenues, gross profit and operating income of each segment.  As such, there are no separately identifiable Statements of Operations data below operating income.

The following table summarizes revenues by segment, including intersegment revenues, (in thousands):

Network Equipment revenue primarily consists of Metro Ethernet equipment, optical transport equipment, out-of-band network equipment, defense and aerospace network applications, the related service revenue and fiber optic components sold as part of system solutions.  Network Integration revenue primarily consists of value-added integration and support service revenue, related third-party product sales (including third-party product sales through distribution) and fiber optic components sold as part of system solutions.  Optical Components revenue primarily consists of fiber optic components, such as those used in Fiber-to-the-Premises applications, fiber optic transceivers, discrete lasers and light-emitting diode products that generally are not sold as part of our Network Equipment or Network Integration solutions.

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One customer accounted for $15.2 million, or 14%, of total revenues for the three months ended March 31, 2010. Another customer accounted for $11.2 million, or 11%, of total revenues for the three months ended March 31, 2009. Both customers contributed to the Optical Components group revenues for the respective periods.

The following table summarizes external revenue by geographic region (in thousands):

The following table summarizes long-lived assets, consisting of property and equipment, by geographic region (in thousands):

The following table provides selected Statement of Operations information by business segment (in thousands):

(1) Adjustments reflect the elimination of intersegment revenue and profit in inventory.

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The following tables provide selected Balance Sheet information by business segment (in thousands):

12.  Comprehensive Loss

The following table summarizes the components of comprehensive loss (in thousands):

13.  Recently Issued Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (the “FASB”) issued ASC 810-10 Consolidations providing (a) guidance on identifying variable interest entities and determining whether such entities should be consolidated; (b) general consolidation guidance; and (c) guidance on the consolidation of entities controlled by contract. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impacts the other entity’s economic performance. ASC 810-10 became effective for the Company beginning January 1, 2010. The adoption of ASC 810-10 did not have a material impact on the Company’s financial condition, results of operations or liquidity.

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In June 2009, the FASB issued ASC 860 Transfers and Servicing which requires more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. ASC 860 is effective for interim and annual reporting periods ending after November 15, 2009 and has been applied prospectively. MRV adopted the provisions of ASC 860 on January 1, 2010; the application of ASC 860 did not have a material impact on the Company’s financial condition, results of operations or liquidity.

In October 2009, the FASB amended the guidance for ASC 605 Revenue Recognition. The amendments establish a hierarchy for determining the selling price of a deliverable in a multiple-element deliverable revenue arrangement. The selling price used for each deliverable will be based on (a) vendor-specific objective evidence if available; (b) third-party evidence if vendor-specific objective evidence is not available: or (c) estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The amendments also replace the term “fair value” in the revenue allocation guidance with “selling price” to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. The amendments eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The relative selling price method allocates any discount in the arrangement proportionally on the basis of the selling price of each deliverable. The amendments will become effective for the Company prospectively for revenue arrangements entered into or materially modified beginning January 1, 2011, with earlier adoption permitted. MRV believes that the adoption of this new standard may have a material effect on its financial position and results of operations. However, the Company is not able to estimate the effect on its financial position and results of operations.

In January 2010, the FASB issued amended standards that require additional fair value disclosures. These amended standards require disclosures about inputs and valuation techniques used to measure fair value as well as disclosures about significant transfers, beginning in the first quarter of 2010. Additionally, these amended standards require presentation of disaggregated activity within the reconciliation for fair value measurements using significant unobservable inputs (Level 3), beginning in the first quarter of 2011. The Company does not expect these new standards to significantly impact the financial statements.

14. Litigation

MRV has accrued a liability for a potential deferred consideration payment related to the acquisition by MRV of Fiberxon in July 2007. On March 25, 2009, MRV filed a complaint in the Superior Court of Los Angeles County, California, against former executives, directors and stockholders of Fiberxon seeking to recover damages in connection with the sale of Fiberxon to MRV in excess of the $31.5 million of potential deferred consideration to be paid in connection with the acquisition of Fiberxon. On December 20, 2009, MRV entered into a Settlement Agreement and Release (the “Settlement Agreement”), with Yoram Snir, personally and in his capacity as Stockholders’ Agent for the former stockholders of Fiberxon. Pursuant to the Settlement Agreement, MRV has fully settled any obligation to pay the first $18.0 million that was reserved for set-off in the original merger agreement, and the former Fiberxon stockholders, pursuant to the settlement, are entitled their pro rata portion of the $1.5 million settlement amount. Additionally, MRV agreed to pay up to $4.5 million to settle claims relating to the remaining $13.5 million of potential deferred compensation. The second portion of the settlement is with the former stockholders directly, and to date, approximately 33% of the $13.5 million remains in potential dispute. The Company recorded a $20.5 million gain during 2009, and a gain of $0.5 million during the three months ended March 31, 2010 for the reduction of the deferred payment obligation resulting from the settlement. Three former stockholders who owned approximately 12% of the former Fiberxon did not participate in the second portion of the settlement, and recently initiated litigation in Beijing, PRC. The Company and certain related co-defendants have not yet been served with this complaint, however a review of its allegations indicates that it sets forth a claim for approximately $1.7 million which is these former stockholders pro rata amount of the $13.5 million portion of the potential deferred compensation.

In connection with the Company’s past stock option grant practices, MRV and certain of its current and former directors and officers have been subjected to a number of ongoing stockholder lawsuits. Between June 10, 2008 and August 15, 2008, five purported stockholder derivative and securities class action lawsuits were filed in the U.S. District Court in the Central District of California and one derivative lawsuit was filed in the Superior Court of the State of California against the Company and certain of our current and former officers and directors. The five lawsuits filed in the Central District of California were consolidated. Claims are asserted under Section 10(b) and 20(a), of the Exchange Act and Rule 10b-5 promulgated thereunder. The allegations set forth in the complaints are based on facts disclosed in MRV’s press release of June 5, 2008, which stated that the Company’s financial statements could not be relied on due to the Company’s historical stock option practices and related accounting. The complaints seek to recover from the defendants unspecified compensatory and punitive damages, to require the Company to undertake reforms to corporate governance and internal control procedures, to obtain an accounting of stock option grants found to be improper, to impose a constructive trust over stock options and proceeds derived therefrom, to disgorge from any of the defendants who received allegedly improper stock options the profits obtained therefrom, to rescind improperly priced options and to recover costs of suit, including legal and other professional fees and other equitable relief. In April 2010, the parties to the securities class action lawsuits filed a stipulation and agreement of settlement of $10.0 million with the court, which settlement amount we expect to be covered by our director and officer insurance policies. The Company and plaintiffs in the federal and California state derivative lawsuits have attended two mediations but have not been successful in reaching a settlement on these claims. Motions to dismiss the complaints in both the federal and state derivative lawsuits are currently pending in those courts.

From time to time, MRV has received notices from third parties alleging possible infringement of patents with respect to product features or manufacturing processes. Management believes such notices are common in the communications industry because of the large number of patents that have been filed on these subjects. Our policy is to discuss these notices with the parties in an effort to demonstrate that MRV’s products and/or processes do not violate any patents. The Company has been involved in such discussions with International Business Machines, Alcatel-Lucent, Ortel Communications, Ltd., Nortel Networks Corporation, Rockwell Automation, Inc., The Lemelson Foundation, Finisar Corporation and Apcon, Inc. in the past. In addition, Finisar filed a lawsuit against MRV, Source Photonics and two other competitors in January 2010 alleging that each defendant’s optical transceiver products infringe Finisar patents and seeking unspecified monetary damages, up to treble the amount of actual damages, plus attorneys’ fees, costs and interest.  The defendants have agreed to joint representation of counsel, and the defendants answered the complaint in March 2010, asserting two claims of patent infringement and additional claims asserting that Finisar has violated state and federal competition laws. The judge in the case held a trial setting conference in April 2010, and both parties have since filed their initial objections and responses to requests for production of documents.  On May 5, 2010, the judge in the case issued an order severing the parties, and all defendants except Source Photonics were dismissed without prejudice.

MRV has been named as a defendant in lawsuits involving matters that the Company considers routine to the nature of its business. Management is of the opinion that the ultimate resolution of such matters will not have a material adverse effect on our business, operating results and financial condition.

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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 the Financial Statements and Notes thereto included elsewhere in this Form 10-Q, and Items 6, 7 and 8 of our 2009 Form 10-K.   The discussion in this Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and may qualify for the safe harbor provided for in Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Forward-looking statements are statements other than statements of historical fact and may be identified by use of such terms as “expects,” “anticipates,” “intends,” “potential,” “estimates,” “believes,” “may,”  “should,” “could,” “will,” “would,” and words of similar import.

Forward-looking statements involve known and unknown risks and uncertainties that could cause actual results to differ materially from those projected In addition, the statements in this Form 10-Q may involve certain risks, uncertainties and assumptions, the likelihood of which are difficult to assess and may not occur, including risks that each of its business segments may not make the expected progress in its respective market, or that management’s long term strategy may not achieve the expected results. Other risks and uncertainties relate to delayed lead times in receiving components and delayed delivery times to customers due to short-term capacity constraints, potential changes in relationships with MRV’s customers and suppliers and their financial condition, MRV’s success in developing, introducing and shipping product enhancements and new products, increased competition in our market segments, market acceptance of new products, continued market acceptance of existing products and continued success in selling the products of other companies, product price discounts, the timing and amount of significant orders from customers, obsolete inventory or product returns, warranty and other claims on products, the continued ability of MRV to protect its intellectual property rights and avoid onerous licensing fees, changes in product mix, maturing product life cycles, implementation of operating cost structures that align with revenue growth, political instability in areas of the world in which MRV operates, currency fluctuations, changes in accounting rules, general economic conditions, as well as changes in such conditions specific to our market segments, risks of manufacturing in Asia, maintenance of our inventory and production backlog, and litigation related to MRV’s historical stock option granting practices, its acquisition of Fiberxon, Inc., and patent infringement claims by others.

In light of the risks and uncertainties inherent whenever matters or events expected to occur or not occur in the future are discussed, there can be no assurance that the forward-looking information contained in this Form 10-Q will in fact transpire or prove to be accurate.  All subsequent written and oral forward-looking statements attributable to the Company or persons acting on our behalf are expressly qualified in their entirety by this introduction. In light of the risks and uncertainties in all such projected operational matters, the inclusion of forward-looking statements in this Form 10-Q should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved or that any of the Company’s operating expectations will be realized. Revenues and results of operations are difficult to forecast and could differ materially from those projected in the forward-looking statements contained in this Form 10-Q for the reasons detailed in Item 1A “Risk Factors” of our 2009 Form 10-K. Readers should not place undue reliance on forward-looking statements, which reflect management’s view only as of the date of this Form 10-Q. The Company undertakes no obligation to amend this Form 10-Q or revise publicly these forward-looking statements (other than pursuant to requirements imposed on registrants pursuant to Item 1A under Part II of Form 10-Q) to reflect subsequent events or circumstances.  Readers should also carefully review the risk factors described in other documents the Company files from time to time with the SEC and the cautionary statements contained in our press releases when we provide forward-looking information.

Overview

MRV Communications is a global supplier of communications equipment and services to carriers, governments and enterprise customers worldwide. We are also a supplier of optical components, primarily through our wholly-owned subsidiary Source Photonics, Inc. We conduct our business along three principal segments: (a) the Network Equipment group; (b) the Network Integration group; and (c) the Optical Components group. We evaluate segment performance based on the revenues, gross profit and operating expenses of each segment. We do not evaluate segment performance on additional financial information. As such, there are no separately identifiable Statements of Operations data below operating income (loss). Our Network Equipment group provides communications equipment that facilitates access, transport, aggregation and management of voice, data and video traffic in networks, data centers and laboratories used by telecommunications service providers, cable operators, enterprise customers and governments worldwide. Our Network Integration group operates primarily in Italy, France, Switzerland and Scandinavia, servicing Tier One carriers, regional carriers, large enterprises, and government institutions. The Network Integration group provides network system design, integration and distribution services that include products manufactured by third-party vendors, as well as

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products developed and manufactured by the Network Equipment group. Our Optical Components group designs, manufactures and sells optical communications products used in telecommunications systems and data communications networks. These products include passive optical network, or PON, subsystems, optical transceivers used in enterprise, access and metropolitan applications as well as other optical components, modules and subsystems. 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.

On December 24, 2009, we entered into an agreement to divest our 90% ownership of EDSLan, S.p.A., a communication equipment distribution company located in Milan, Italy.  The sale closed on January 7, 2010.  EDSLan was part of our Network Integration group and we have reclassified the historical financial results of EDSLan as discontinued operations in this Form 10-Q to reflect this reclassification. Accordingly, the related assets and liabilities of EDSLan have been classified as assets and liabilities from discontinued operations held for sale in the Balance Sheet at December 31, 2009, and we recognized a loss related to the write down of the assets of EDSLan to their net realizable value in 2009.

Our business involves reliance on foreign-based offices.  Several of our divisions, outside subcontractors and suppliers are located in foreign countries, including Argentina, Canada, Denmark, Finland, France, Germany, Israel, Italy, Japan, Korea, the Netherlands, Norway, PRC, Russia, Singapore, South Africa, Switzerland, Sweden, Taiwan and the United Kingdom. For the three months ended March 31, 2010 and 2009, foreign revenues constituted 73% and 68%, respectively, of total revenues.  The majority of foreign sales are to customers located in the European region, with remaining foreign sales primarily to customers in the Asia Pacific region.

Critical Accounting Policies

Our discussion and analysis of the Company’s financial condition and results of operations are based upon the financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).  We follow accounting standards set by the Financial Accounting Standards Board (“FASB”) to ensure we consistently report our financial condition, results of operations, and cash flows in conformity with GAAP.  References to GAAP issued by the FASB in this Form 10-Q are to the FASB Accounting Standards of Codification (“ASC”).

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.

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

Revenue Recognition.    MRV’s major revenue-generating products consist of fiber optic components, switches and routers, console management, and physical layer products. MRV generally recognizes product revenue, net of sales discounts, returns and allowances, in accordance with ASC 605 Revenue Recognition, 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 reasonably assured. Products are generally shipped “FOB shipping point,” with no right of return, and revenue is recognized upon shipment. If revenue is to be recognized upon delivery, such delivery date is tracked through information provided by the third party shipping company we use to deliver the product to the customer. Sales of services and system support are deferred and recognized ratably over the contract period in accordance with ASC 605-20 Services. Sales to end customers with contingencies, such as rights of return, rotation rights, conditional acceptance provisions and price protection, are infrequent and insignificant and are deferred until the contingencies have been satisfied or the contingent period has lapsed. For sales to distributors, we generally recognize revenue when a product is sold to the distributor rather than when the product is sold by the distributor to the end user. In certain circumstances, distributors have limited rights of return, including stock rotation rights, and/or are entitled to price protection, in which case a rebate credit may be provided to the customer if MRV lowers its price on products held in the distributor’s inventory. MRV estimates and establishes allowances for expected future product returns and credits in accordance with ASC 605. We record a reduction in revenue for estimated future product returns and future credits to be issued to the customer in the period in which revenues are recognized, and for future credits to be issued in relation to

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price protection at the time we make changes to our distributor price book. We monitor product returns and potential price adjustments on an ongoing basis and estimate future returns and credits based on historical sales returns, analysis of credit memo data and other factors known at the time of revenue recognition.

Arrangements with customers may include multiple deliverables involving combinations of equipment, services and software. In accordance with ASC 605-25 Multiple-Element Arrangements, the entire fee from the arrangement is allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element is met. Fair value for each element is established based on the sales price charged when the same element is sold separately. If multiple element arrangements include software or software related elements, we apply the provisions of ASC 985 Software to the software and software related elements, or to the entire arrangement if the software is essential to the functionality of the non-software elements.

MRV generally warrants its products against defects in materials and workmanship for one to two year periods. The estimated cost 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.

Allowance for Doubtful Accounts.    We make ongoing estimates relating to the collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability of 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. Because we cannot precisely 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 deteriorates, resulting in their inability to make payments, a larger reserve may be required. In the event we determine that a change in the allowance is appropriate, we would record a credit or a charge to selling, general and administrative expense in the period in which we make such a determination.

Concentration of Credit Risk.    Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents placed with high credit quality institutions and accounts receivable due from customers. We perform ongoing credit evaluations of our customers and maintain reserves for potential credit losses.

Inventory Reserves.    We 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 an adjustment to the cost basis equal to the difference between the cost of the inventory and the estimated net realizable market value. This adjustment 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 previous estimates, we would make further adjustments in the period in which we make such a determination and record a charge to cost of goods sold. The reserve includes estimates for excess quantities and obsolete inventory. This reserve is recorded as a charge to cost of goods sold. If changes in our projections of current demand indicate that the reserve should be higher or lower, the change in the reserve is recorded as a charge or credit to cost of goods sold.

Goodwill and Other Intangibles.    Goodwill represents the excess purchase price over amounts assigned to tangible or identifiable intangible assets acquired and liabilities assumed from our acquisitions. In accordance with ASC 350 Intangibles—Goodwill and Other, we do not amortize goodwill and intangible assets with indefinite lives, but instead measure these assets for impairment at least annually. We also test goodwill for impairment between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of the reporting unit below its carrying value.

Our annual assessment considers economic conditions and trends, estimated future operating results, and anticipated future economic conditions. We determine the fair value of each reporting unit using a discounted cash flow based valuation methodology. To validate reasonableness of the valuation, we reconcile the sum of the fair values across all reporting units to the Company’s market capitalization as of the valuation date. The first step is to compare the fair value of the reporting unit with the unit’s carrying amount, including goodwill. If this test indicates that the fair value is less than the carrying value, then step two is required to compare the implied fair value of the reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill. A non-cash goodwill impairment charge would have the effect of decreasing our earnings or increasing our losses in such period.

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

We utilize significant management judgment to determine the provision for income taxes, deferred income tax assets and liabilities, including uncertain tax positions, and any valuation allowance recorded against net deferred income tax assets. Management periodically evaluates the deferred income tax assets as to whether it is likely that the deferred income tax assets will be realized. We write down the deferred income tax asset at the time we determine the asset is not likely to be realized.

Share-Based Compensation.    We determine the fair value of stock options and warrants using the Black-Scholes valuation model as permitted under ASC 718 Compensation — Stock Compensation. The assumptions used in calculating the fair value of share-based payment awards represent our best estimates. Our estimates may be impacted by certain variables including stock price volatility, employee stock option exercise behaviors, additional stock option grants, estimates of forfeitures, and the related income tax impact. See Note 10 “Share-Based Compensation” to the Financial Statements in Item 1 of this Form 10-Q for further discussion.

Currency Rate Fluctuations

Changes in the relative values of non-U.S. currencies to the U.S. dollar affect our results.  We conduct a significant portion of our business in foreign currencies, including the euro, the Swiss franc, the Swedish krona, the Taiwan dollar, the Chinese renminbi and the Israeli new shekel. For the three months ended March 31, 2010, 67% of revenues and 68% of operating expenses were incurred at subsidiaries with a reporting currency other than the U.S. dollar.  Translation rate exposure for the Chinese renminbi is currently mitigated by the Chinese government’s decision to tie the renminbi rate to the U.S. dollar.   Excluding the renminbi, these currencies were stronger against the U.S. dollar for the three months ended March 31, 2010 compared to the three months ended March 31, 2009, so revenues and expenses in these countries translated into more dollars than they would have in the prior period.  Additional discussion of foreign currency risk and other market risks is included in Part I, Item 3 “Quantitative and Qualitative Disclosures About Market Risk” of this Form 10-Q.