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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
[x] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2010
 
[ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act for the transition period from _______________ to ______________
 
Commission file number 001-11174
 
MRV COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
06-1340090
 
 
(State or other jurisdiction
 
(I.R.S. employer
 
 
incorporation or organization)
 
identification no.)
 
 
20415 Nordhoff Street, Chatsworth, CA 91311
(Address of principal executive offices, zip code)
 
(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 [ ]
 
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 [ ]  No [ ]
 
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.
 
Large accelerated filer  [ ]
 
Accelerated filer  [x]
 
 
 
Non-accelerated filer [ ]
 
Smaller reporting company [ ]  
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ]   No [x]
 
As of August 4, 2010, 157,729,680 shares of MRV's Common Stock were outstanding.
 



MRV Communications, Inc.
 
Form 10-Q for the Quarter Ended June 30, 2010
 
Index
 
 
 
 
Page
Number
PART I
Financial Information
Item 1.
Condensed Consolidated Financial Statements:
 
Statements of Operations (unaudited) for the three and six months ended June 30, 2010 and 2009
 
Balance Sheets as of June 30, 2010 (unaudited) and December 31, 2009
 
Statements of Cash Flows (unaudited) for the six months ended June 30, 2010 and 2009
 
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 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 6.
Exhibits
 
Signatures
 

2


PART I - FINANCIAL INFORMATION
 
Item 1. Condensed Consolidated Financial Statements
 
MRV Communications, Inc.
Statements of Operations
(In thousands, except per share data)
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2010
 
2009
 
2010
 
2009
 
(unaudited)
 
(unaudited)
 
(unaudited)
 
(unaudited)
Revenue
$
122,224
 
 
$
104,943
 
 
$
231,299
 
 
$
208,543
 
Cost of goods sold
80,573
 
 
74,927
 
 
150,030
 
 
157,948
 
Gross profit
41,651
 
 
30,016
 
 
81,269
 
 
50,595
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
Product development and engineering
9,144
 
 
8,433
 
 
18,872
 
 
17,578
 
Selling, general and administrative
25,061
 
 
22,874
 
 
48,285
 
 
48,284
 
Amortization of intangibles
564
 
 
564
 
 
1,128
 
 
1,128
 
Total operating expenses
34,769
 
 
31,871
 
 
68,285
 
 
66,990
 
Operating income (loss)
6,882
 
 
(1,855
)
 
12,984
 
 
(16,395
)
 
 
 
 
 
 
 
 
Interest expense
(814
)
 
(746
)
 
(1,468
)
 
(1,597
)
Other income (expense), net
536
 
 
(1,260
)
 
1,129
 
 
1,136
 
 
 
 
 
 
 
 
 
Income (loss) from continuing operations before income taxes
6,604
 
 
(3,861
)
 
12,645
 
 
(16,856
)
 
 
 
 
 
 
 
 
Provision for income taxes
3,237
 
 
1,557
 
 
4,936
 
 
3,424
 
Income (loss) from continuing operations
3,367
 
 
(5,418
)
 
7,709
 
 
(20,280
)
 
 
 
 
 
 
 
 
Income from discontinued operations, net of income taxes of $180 and $321 for the three and six months in 2009, respectively
 
 
267
 
 
 
 
338
 
 
 
 
 
 
 
 
 
Net income (loss)
3,367
 
 
(5,151
)
 
7,709
 
 
(19,942
)
Less:
 
 
 
 
 
 
 
Income from continuing operations attributable to noncontrolling interests
400
 
 
569
 
 
1,120
 
 
1,118
 
Income from discontinued operations attributable to noncontrolling interests
 
 
12
 
 
 
 
10
 
Net income (loss) attributable to MRV
$
2,967
 
 
$
(5,732
)
 
$
6,589
 
 
$
(21,070
)
 
 
 
 
 
 
 
 
Income (loss) from continuing operations attributable to MRV
$
2,967
 
 
$
(5,987
)
 
$
6,589
 
 
$
(21,398
)
Income from discontinued operations attributable to MRV
 
 
255
 
 
 
 
328
 
 
 
 
 
 
 
 
 
Net income (loss) attributable to MRV per share - basic:
 
 
 
 
 
 
 
From continuing operations
$
0.02
 
 
$
(0.04
)
 
$
0.04
 
 
$
(0.14
)
From discontinued operations
 
 
 
 
 
 
 
Net income (loss) attributable to MRV per share - basic (1)
$
0.02
 
 
$
(0.04
)
 
$
0.04
 
 
$
(0.13
)
 
 
 
 
 
 
 
 
Net income (loss) attributable to MRV per share - diluted:
 
 
 
 
 
 
 
From continuing operations
$
0.02
 
 
$
(0.04
)
 
$
0.04
 
 
$
(0.14
)
From discontinued operations
 
 
 
 
 
 
 
Net income (loss) attributable to MRV per share - diluted (1)
$
0.02
 
 
$
(0.04
)
 
$
0.04
 
 
$
(0.13
)
 
 
 
 
 
 
 
 
Weighted average number of shares:
 
 
 
 
 
 
 
Basic
157,684
 
 
157,530
 
 
157,657
 
 
157,489
 
Diluted
158,621
 
 
157,530
 
 
158,552
 
 
157,489
 

(1) Amounts may not add due to rounding.
 
The accompanying notes are an integral part of these financial statements.

3


MRV Communications, Inc.
 
Balance Sheets
 
(In thousands, except par values)
 
 
June 30, 2010
 
December 31, 2009
 
(unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
36,191
 
 
$
55,909
 
Short-term marketable securities
32,740
 
 
17,879
 
Restricted time deposits
18,940
 
 
18,680
 
Accounts receivable, net
112,632
 
 
103,247
 
Inventories
81,571
 
 
61,803
 
Deferred income taxes
2,868
 
 
3,217
 
Other current assets
27,370
 
 
35,492
 
Current assets of discontinued operations held for sale
 
 
42,705
 
Total current assets
312,312
 
 
338,932
 
 
 
 
 
Property and equipment, net
26,997
 
 
23,723
 
 
 
 
 
Goodwill
23,882
 
 
25,707
 
 
 
 
 
Intangibles, net
6,175
 
 
7,303
 
 
 
 
 
Deferred income taxes, net of current portion
 
 
185
 
 
 
 
 
Other assets
3,943
 
 
4,969
 
 
 
 
 
Total assets
$
373,309
 
 
$
400,819
 
 
 
 
 
Liabilities and stockholders' equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
78,711
 
 
$
60,552
 
Accrued liabilities
32,669
 
 
36,003
 
Short-term debt
51,646
 
 
66,088
 
Deferred consideration payable
5,062
 
 
8,012
 
Deferred revenue
16,724
 
 
14,048
 
Other current liabilities
4,962
 
 
4,615
 
Current liabilities of discontinued operations held for sale
 
 
27,109
 
Total current liabilities
189,774
 
 
216,427
 
 
 
 
 
Other long-term liabilities
8,028
 
 
7,322
 
 
 
 
 
Commitments and contingencies
 
 
 
 
 
 
 
Equity:
 
 
 
MRV stockholders' equity:
 
 
 
Preferred stock, $0.01 par value:
 
 
 
Authorized - 1,000 shares; no shares issued or outstanding
 
 
 
Common stock, $0.0017 par value:
 
 
 
Authorized - 320,000 shares
 
 
 
Issued - 159,055 shares as of June 30, 2010 and 158,971 shares as of December 31, 2009
 
 
 
Outstanding - 157,702 shares as of June 30, 2010 and 157,617 shares as of December 31, 2009
268
 
 
268
 
Additional paid-in capital
1,406,006
 
 
1,405,015
 
Accumulated deficit
(1,242,454
)
 
(1,249,043
)
Treasury stock - 1,353 shares in 2010 and 2009
(1,352
)
 
(1,352
)
Accumulated other comprehensive income
7,185
 
 
15,463
 
Total MRV stockholders' equity
169,653
 
 
170,351
 
Noncontrolling interests
5,854
 
 
6,719
 
Total equity
175,507
 
 
177,070
 
Total liabilities and stockholders' equity
$
373,309
 
 
$
400,819
 
 
The accompanying notes are an integral part of these financial statements.

4


MRV Communications, Inc.
 
Statements of Cash Flows
 
(In thousands)
 
 
2010
 
2009
Six months ended June 30:
(unaudited)
 
(unaudited)
 
 
 
 
Cash flows from operating activities:
 
 
 
Net income (loss)
$
7,709
 
 
$
(19,942
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
 
Depreciation and amortization
4,875
 
 
4,917
 
Share-based compensation expense
987
 
 
1,032
 
Provision for doubtful accounts, net of recoveries
(307
)
 
232
 
Deferred income taxes
1,399
 
 
(225
)
(Gain) loss on disposition of property and equipment
27
 
 
(12
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(14,462
)
 
(9,346
)
Inventories
(22,115
)
 
13,416
 
Other assets
(6,400
)
 
(3,956
)
Accounts payable
21,124
 
 
(11,773
)
Accrued liabilities
(5,224
)
 
(6,243
)
Income tax payable
1,554
 
 
2,311
 
Deferred revenue
3,402
 
 
3,391
 
Other current liabilities
137
 
 
(925
)
Net cash used in operating activities
(7,294
)
 
(27,123
)
 
 
 
 
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(7,831
)
 
(4,793
)
Proceeds from sale of property and equipment
66
 
 
43
 
Proceeds from sale of investments in unconsolidated entities
3,708
 
 
 
Proceeds from sale of EDSLan
11,308
 
 
 
Investment in restricted time deposits
(363
)
 
(484
)
Release of restricted time deposits
56
 
 
61
 
Purchases of investments
(35,854
)
 
(1,000
)
Proceeds from sale or maturity of investments
20,805
 
 
6,694
 
     Purchase of minority interest
 
 
(1,344
)
Net cash used in investing activities
(8,105
)
 
(823
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Net proceeds from exercise of stock options
80
 
 
37
 
Borrowings on short-term debt
75,289
 
 
77,943
 
Payments on short-term debt
(77,849
)
 
(52,601
)
Payments on long-term debt
(14
)
 
(26
)
Net cash (used in) provided by financing activities
(2,494
)
 
25,353
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
(1,825
)
 
10
 
Net decrease in cash and cash equivalents of continuing operations
(19,718
)
 
(2,583
)
 
 
 
 
Less: Net decrease in cash and cash equivalents of discontinued operations
 
 
16
 
Net decrease in cash and cash equivalents
(19,718
)
 
(2,599
)
 
 
 
 
Cash and cash equivalents, beginning of period
55,909
 
 
67,931
 
Cash and cash equivalents, end of period
$
36,191
 
 
$
65,332
 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for interest
$
1,010
 
 
$
1,386
 
Cash paid during the period for taxes
$
2,067
 
 
$
935
 
 
 
 
 
 
The accompanying notes are an integral part of these financial statements.

5


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 June 30, 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 June 30, 2010, and the results of its operations for the three and six months and its cash flows for the six 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 prior to that date have been reclassified as discontinued operations for all periods presented. 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 June 30, 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 June 30, 2010 and December 31, 2009. Unrealized losses at June 30, 2010 and December 31, 2009 were $34,000 and $50,000, respectively. Marketable securities mature at various dates in the next twelve months and consist of corporate and U.S. government issues.

6


 
Marketable securities consisted of the following (in thousands):
 
 
June 30, 2010
 
December 31, 2009
 
 
 
 
Corporate issues
$
1,996
 
 
$
5,798
 
U.S. government issues
30,744
 
 
12,081
 
Total
$
32,740
 
 
$
17,879
 
 
 
 
 
 
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. 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 these securities which are considered Level 1 category items within the fair value hierarchy. There were no material re-measurements to fair value during the three and six months ended June 30, 2010 of financial assets and liabilities that are not measured at fair value on a recurring basis.
 

7


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 six months ended June 30, 2010 (in thousands):
 
 
Six months ended June 30, 2010
 
 
Balance at beginning of period
$
5,508
 
Charged to expense, net of recoveries
(307
)
Write-offs
(874
)
Foreign currency translation adjustment
(295
)
Balance at end of period
$
4,032
 
 
 
 
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):
 
 
June 30, 2010
 
December 31, 2009
 
 
 
 
Raw materials
$
43,242
 
 
$
30,523
 
Work-in-process
8,889
 
 
8,926
 
Finished goods
29,440
 
 
22,354
 
Total
$
81,571
 
 
$
61,803
 
 
 
 
 
 
The following table summarizes the change in inventory reserve during the six months ended June 30, 2010 (in thousands):
 
 
Six months ended June 30, 2010
 
 
Balance at beginning of period
$
26,870
 
Charged to expense, net of recoveries
555
 
Write-offs
(1,350
)
Foreign currency translation adjustment
(1,242
)
Balance at end of period
$
24,833
 
 
 
 

8


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 six months ended June 30, 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 $1.8 million during the six months ended June 30, 2010 due to the change in foreign currency rates from December 31, 2009 to June 30, 2010. The unrealized loss arising from the translation adjustment is recorded in accumulated other comprehensive income on 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 $0.6 million for the three months ended June 30, 2010 and 2009 and $1.1 million for the six months ended June 30, 2010 and 2009.
 
The following table summarizes MRV's other intangible asset balances at June 30, 2010 (in thousands):
 
 
Gross
carrying
amount
 
Accumulated
amortization
 
Net
carrying
amount
Developed technology
$
8,500
 
 
$
(4,638
)
 
$
3,862
 
Customer relationships
4,800
 
 
(2,487
)
 
2,313
 
Customer backlog
600
 
 
(600
)
 
 
Total other intangible assets
$
13,900
 
 
$
(7,725
)
 
$
6,175
 
 
 
 
 
 
 
 
7. Product Warranty and Indemnification
 
As of June 30, 2010 and December 31, 2009, MRV's product warranty liability recorded in accrued liabilities was $2.3 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 six months ended June 30, 2010 (in thousands):
 
 
Six months ended June 30, 2010
 
 
Beginning balance
$
3,588
 
Cost of warranty claims
(1,540
)
Accruals for product warranties
282
 
Foreign currency translation adjustment
(2
)
Total
$
2,328
 
 
 
 

9


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 2.0 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 six months ended June 30, 2010 (in thousands):
 
 
Six months ended June 30, 2010
 
 
Noncontrolling interests at December 31, 2009
$
6,719
 
Net income attributable to noncontrolling interests
1,120
 
Increase in noncontrolling interest due to share-based compensation in subsidiaries
60
 
Translation adjustment attributable to noncontrolling interests
(823
)
Divestiture of EDSLan
(1,222
)
Noncontrolling interests at June 30, 2010
$
5,854
 
 
 
 
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 9.4 million shares and 13.8 million shares were excluded from the computation of diluted net loss per share for the three months ended June 30, 2010 and 2009, respectively, because such stock options and warrants were anti-dilutive. Outstanding stock options and warrants to purchase 9.7 million shares and 13.8 million shares were excluded from the computation of diluted net loss per share for the six months ended June 30, 2010 and 2009, respectively, because such stock options and warrants were anti-dilutive.
 

10


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 and six months ended June 30, 2010 and 2009 (in thousands):
 
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2010
 
2009
 
2010
 
2009
 
 
 
 
 
 
 
 
Cost of goods sold
$
41
 
 
$
56
 
 
$
83
 
 
$
114
 
Product development and engineering
96
 
 
51
 
 
194
 
 
226
 
Selling, general and administrative
404
 
 
316
 
 
710
 
 
676
 
Total share-based compensation expense (1)
$
541
 
 
$
423
 
 
$
987
 
 
$
1,016
 
 
 
 
 
 
 
 
 
 
(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 six months ended June 30, 2010 or the six months ended June 30, 2009. As of June 30, 2010, the total unrecorded deferred share-based compensation balance for unvested shares, net of expected forfeitures, was $1.2 million, which is expected to be amortized over a weighted-average period of 1.4 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. In connection with the separation of the Company's former CEO, the Company modified certain options and recognized $0.3 million in share-based compensation expense.
 
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):
 
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2010
 
2009
 
2010
 
2009
 
 
 
 
 
 
 
 
Network Equipment group
$
28,916
 
 
$
23,262
 
 
$
58,964
 
 
$
48,178
 
Network Integration group
33,522
 
 
33,741
 
 
66,265
 
 
66,814
 
Optical Components group
64,317
 
 
50,085
 
 
113,810
 
 
98,147
 
All others
 
 
114
 
 
 
 
136
 
Before intersegment adjustments
126,755
 
 
107,202
 
 
239,039
 
 
213,275
 
Intersegment adjustments
(4,531
)
 
(2,259
)
 
(7,740
)
 
(4,732
)
Total
$
122,224
 
 
$
104,943
 
 
$
231,299
 
 
$
208,543
 
 
 
 
 
 
 
 
 
 
Network Equipment revenue primarily consists of Metro Ethernet equipment, optical transport equipment, out-of-band network equipment, defense and aerospace network applications, related services and fiber optic

11


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.
 
Two customers accounted for $30.3 million, or 13%, and $22.9, or 10%, of total revenues for the six months ended June 30, 2010. Both customers contributed to the Optical Components group revenues for the respective periods. No single customer accounted for 10% or more of total revenues for the six months ended June 30, 2009.
 
The following table summarizes external revenue by geographic region (in thousands):
 
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2010
 
2009
 
2010
 
2009
 
 
 
 
 
 
 
 
Americas
$
36,583
 
 
$
29,706
 
 
$
67,441
 
 
$
63,176
 
Europe
44,825
 
 
43,950
 
 
92,112
 
 
88,763
 
Asia Pacific
40,814
 
 
31,437
 
 
71,735
 
 
56,585
 
Other regions
2
 
 
(150
)
 
11
 
 
19
 
Total
$
122,224
 
 
$
104,943
 
 
$
231,299
 
 
$
208,543
 
 
 
 
 
 
 
 
 
 
The following table summarizes long-lived assets, consisting of property and equipment, by geographic region (in thousands):
 
 
June 30,
2010
 
December 31,
2009
 
 
 
 
Americas
$
5,572
 
 
$
5,079
 
Europe
5,819
 
 
5,961
 
Asia Pacific
15,606
 
 
12,683
 
Total
$
26,997
 
 
$
23,723
 
 
 
 
 
 

12


The following table provides selected Statement of Operations information by business segment (in thousands):
 
 
 
Three months ended
 
Six months ended
 
 
June 30,
 
June 30,
 
 
2010
 
2009
 
2010
 
2009
Gross profit
 
 
 
 
 
 
 
 
Network Equipment group
 
$
17,161
 
 
$
13,190
 
 
$
34,725
 
 
$
25,776
 
Network Integration group
 
9,248
 
 
10,255
 
 
20,029
 
 
19,592
 
Optical Components group
 
15,242
 
 
6,641
 
 
26,541
 
 
4,986
 
All others
 
 
 
73
 
 
 
 
85
 
Before intersegment adjustments
 
41,651
 
 
30,159
 
 
81,295
 
 
50,439
 
Corporate unallocated and intersegment adjustments (1)
 
 
 
(143
)
 
(26
)
 
156
 
Total
 
$
41,651
 
 
$
30,016
 
 
$
81,269
 
 
$
50,595
 
 
 
 
 
 
 
 
 
 
Depreciation expense
 
 
 
 
 
 
 
 
Network Equipment group
 
$
468
 
 
$
411
 
 
$
892
 
 
$
799
 
Network Integration group
 
117
 
 
6
 
 
219
 
 
216
 
Optical Components group
 
1,350
 
 
1,254
 
 
2,595
 
 
2,484
 
All others
 
 
 
3
 
 
 
 
6
 
Corporate
 
14
 
 
16
 
 
28
 
 
31
 
Total
 
$
1,949
 
 
$
1,690
 
 
$
3,734
 
 
$
3,536
 
 
 
 
 
 
 
 
 
 
Operating income (loss)
 
 
 
 
 
 
 
 
Network Equipment group
 
$
3,521
 
 
$
(697
)
 
$
6,231
 
 
$
(2,849
)
Network Integration group
 
2,872
 
 
4,144
 
 
6,316
 
 
7,381
 
Optical Components group
 
3,873
 
 
(2,245
)
 
6,381
 
 
(13,341
)
All others
 
 
 
(309
)
 
 
 
(668
)
Before intersegment adjustments
 
10,266
 
 
893
 
 
18,928
 
 
(9,477
)
Corporate unallocated operating loss and adjustments (1)
 
(3,384
)
 
(2,748
)
 
(5,944
)
 
(6,918
)
Total
 
$
6,882
 
 
$
(1,855
)
 
$
12,984
 
 
$
(16,395
)
 

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

13


The following tables provide selected Balance Sheet information by business segment (in thousands):
 
 
Six months ended
 
June 30,
 
2010
 
2009
Additions to Fixed Assets
 
 
 
Network Equipment group
$
1,514
 
 
$
902
 
Network Integration group
565
 
 
753
 
Optical Components group
5,730
 
 
2,665
 
Corporate
22
 
 
249
 
Discontinued operations
 
 
224
 
Total
$
7,831
 
 
$
4,793
 
 
 
 
 
 
 
June 30,
2010
 
December 31,
2009
Total Assets
 
 
 
Network Equipment group
$
73,166
 
 
$
71,893
 
Network Integration group
90,431
 
 
100,308
 
Optical Components group
166,245
 
 
155,578
 
All others
 
 
796
 
Corporate and intersegment eliminations
43,467
 
 
29,539
 
Discontinued operations held for sale
 
 
42,705
 
Total
$
373,309
 
 
$
400,819
 
 
 
 
 
 
 
June 30,
2010
 
December 31,
2009
Goodwill
 
 
 
Network Equipment group
$
11,122
 
 
$
11,628
 
Network Integration group
12,760
 
 
14,079
 
Total
$
23,882
 
 
$
25,707
 
 
 
 
 
 
12. Comprehensive Loss
 
The following table summarizes the components of comprehensive loss (in thousands):
 
 
Three months ended
 
Six months ended
 
June 30,
 
June 30,
 
2010
 
2009
 
2010
 
2009
 
 
 
 
 
 
 
 
Net income (loss)
$
3,367
 
 
$
(5,151
)
 
$
7,709
 
 
$
(19,942
)
Unrealized loss from available-for-sale securities
16
 
 
(16
)
 
15
 
 
(45
)
Foreign currency translation
(3,953
)
 
5,511
 
 
(9,116
)
 
(643
)
Comprehensive loss
(570
)
 
344
 
 
(1,392
)
 
(20,630
)
Less: comprehensive income attributable to noncontrolling interests
(99
)
 
984
 
 
297
 
1286
Comprehensive loss attributable to MRV
$
(471
)
 
$
(640
)
 
$
(1,689
)
 
$
(21,916
)
 
 
 
 
 
 
 
 
 

14


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.
 
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 issued Update No. 2009-13, which amends ASC 605 Revenue Recognition. The amendment establishes 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 update eliminates the residual method of allocation and requires 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 update 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 October 2009, the FASB issued Update No. 2009-14, which amends ASC 985 Software. The amendments in this update change the accounting model for revenue arrangements that include both tangible products and software elements. Tangible products containing software components and non-software components that function together to deliver the tangible product's essential functionality is no longer within the scope of the software revenue guidance in Subtopic 985-605 of the Codification. In addition, the amendments in this update require that hardware components of a tangible product containing software components always be excluded from the software revenue guidance. In that regard, the amendments provide additional guidance on how to determine which software, if any, relating to the tangible product also would be excluded from the scope of the software revenue guidance. The amendments also provide guidance on how a vendor should allocate arrangement consideration to deliverables in an arrangement that includes both tangible products and software. The amendments also provide further guidance on how to allocate arrangement consideration when an arrangement includes deliverables both included and excluded from the scope of the software revenue guidance. 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 Update No. 2010-06 which amends the Fair Value Measurements and Disclosures topic of the Codification. The amended standards in the update 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, the amended standards in the update 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 its financial statements.
 

15


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 to 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 six months ended June 30, 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 initiated litigation against MRV, Source Photonics, Inc. and related parties in Beijing, PRC alleging 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 was preliminarily approved. The settlement amount has been covered by our director and officer insurance policies pending final approval by the court in November 2010. The Company and plaintiffs in the federal and California state derivative lawsuits have attended mediations but have not been successful in reaching a settlement on these claims. Motions to dismiss the defendants 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.  In May 2010, the judge in the lawsuit issued an order severing the parties, and all defendants except Source Photonics were dismissed without prejudice. MRV subsequently entered into a standstill agreement with Finisar whereby Finisar agreed not to commence litigation against MRV until at least 90 days after a jury verdict, settlement, or stay of the proceedings in the litigation against Source Photonics. The parties participated in a mediation on July 19, 2010, which did not come to resolution, and a jury trial has been scheduled for July 2011. While the Company believes it has meritorious defenses against the suit, we have estimated a potential range of loss of $1.4 million to $8.1 million for past damages if we reach settlement on the matter with the plaintiffs. The Company has recognized an expense of $1.4 million reflected in selling, general and administrative expenses in the period ended June 30, 2010 related to this matter.

16


 
MRV has been named as a defendant in other 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.
 
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, 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 or sells its products and services, currency fluctuations, changes in accounting rules, general economic conditions, as well as changes in such conditions specific to our market segments, risks of manufacturing and maintaining its intellectual property in Asia, maintenance of our inventory and production backlog, and litigation, including but not limited 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. Revenue 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 revenue, 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

17


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. Through a wholly owned subsidiary headquartered in Switzerland, we also design, develop and sell specialized products for aerospace and defense applications. 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 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, Thailand and the United Kingdom. For the three months ended June 30, 2010 and 2009, foreign revenue constituted 72% and 72%, respectively, of total revenue. For the six months ended June 30, 2010 and 2009, foreign revenue constituted 72% and 70%, respectively, of total revenue. 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, revenue 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

18


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 revenue is recognized, and for future credits to be issued in relation to 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

19


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.
 
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 establish a valuation allowance on 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 and six months ended June 30, 2010, 80% and 70% of revenue and 40% and 48% of operating expenses, respectively, 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, and the euro for the three months ended June 30, 2010, these currencies were stronger against the U.S. dollar for the three and six months ended June 30, 2010 compared to the three and six months ended June 30, 2009, so revenue and expenses in these currencies translated into more dollars than they would have in the prior period. The euro was weaker against the U.S. dollar for the three months ended June 30, 2010 compared to the second quarter of 2009, so revenue and expenses incurred in euros translated into fewer 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.
 

20


Management Discussion Snapshot
 
The following table summarizes certain consolidated and segment Statements of Operations data as a percentage of revenue (dollars in thousands):
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2010
 
 
 
2009
 
 
 
2010
 
 
 
2009
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
%
 
 
 
%    
 
 
 
%
 
 
 
%    
Revenue
$
122,224
 
 
100
%
 
$
104,943
 
 
100
%
 
$
231,299
 
 
100
%
 
$
208,543
 
 
100
%
Network Equipment group (1) (2)
28,916
 
 
24
 
 
23,262
 
 
22
 
 
58,964
 
 
25
 
 
48,178
 
 
23
 
Network Integration group (1)(2)
33,522
 
 
27
 
 
33,741
 
 
32
 
 
66,265
 
 
29
 
 
66,814
 
 
32
 
Optical Components group (1)(2)
64,317
 
 
53
 
 
50,085
 
 
48
 
 
113,810
 
 
49
 
 
98,147
 
 
47
 
All others (1)(2)
 
 
 
 
114
 
 
0
 
 
 
 
 
 
136
 
 
0
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit (2)
$
41,651
 
 
34
 
 
$
30,016
 
 
29
 
 
$
81,269
 
 
35
 
 
$
50,595
 
 
24
 
Network Equipment group
17,161
 
 
59
 
 
13,190
 
 
57
 
 
34,725
 
 
59
 
 
25,776
 
 
54
 
Network Integration group
9,248
 
 
28
 
 
10,255
 
 
30
 
 
20,029
 
 
30
 
 
19,592
 
 
29
 
Optical Components group
15,242
 
 
24
 
 
6,641
 
 
13
 
 
26,541
 
 
23
 
 
4,986
 
 
5
 
All others
 
 
 
 
73
 
 
64
 
 
 
 
 
 
85
 
 
63
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses (2)
$
34,769
 
 
28
 
 
$
31,871
 
 
30
 
 
$
68,285
 
 
30
 
 
$
66,990
 
 
32
 
Network Equipment group
13,640
 
 
47
 
 
13,887
 
 
60
 
 
28,494
 
 
48
 
 
28,625
 
 
59
 
Network Integration group
6,376
 
 
19
 
 
6,111
 
 
18
 
 
13,713
 
 
21
 
 
12,211
 
 
18
 
Optical Components group
11,369
 
 
18
 
 
8,886
 
 
18
 
 
20,160
 
 
18
 
 
18,327
 
 
19
 
All others
 
 
 
 
382
 
 
335
 
 
 
 
 
 
753
 
 
554
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss) (2)
$
6,882
 
 
6
 
 
$
(1,855
)
 
(2
)
 
$
12,984
 
 
6
 
 
$
(16,395
)
 
(8
)
Network Equipment group
3,521
 
 
12
 
 
(697
)
 
(3
)
 
6,231
 
 
11
 
 
(2,849
)
 
(6
)
Network Integration group
2,872
 
 
9
 
 
4,144
 
 
12
 
 
6,316
 
 
10
 
 
7,381
 
 
11
 
Optical Components group
3,873
 
 
6
 
 
(2,245
)
 
(4
)
 
6,381
 
 
6
 
 
(13,341
)
 
(14
)
All others
 
 
 
 
(309
)
 
(271
)
 
 
 
 
 
(668
)
 
(491
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(1) Revenue information by segment includes intersegment revenue, primarily reflecting sales of fiber optic components to the Network Equipment group and sales of network equipment to the Network Integration group.
 
(2) Statements of Operations data express percentages as a percentage of consolidated revenue. Statement of Operations data by segment express percentages as a percentage of applicable segment revenue.
 

21


The following management discussion and analysis refers to and analyzes the results of operations among our three reporting segments, the Network Equipment group, Network Integration group, and the Optical Components group.
 
Three Months Ended June 30, 2010 Compared To Three Months Ended June 30, 2009
 
Revenue
 
The following table summarizes revenue by segment, including intersegment sales (dollars in thousands):
 
 
 
 
 
 
 
Favorable/ (Unfavorable)
Three months ended June 30:
 
2010
 
2009
 
$
Change
 
%
Change
 
% Change constant
currency
(2)
 
 
 
 
 
 
 
 
 
 
 
Network Equipment group
 
$
28,916
 
 
$
23,262
 
 
$
5,654
 
 
24
%
 
24
%
Network Integration group
 
33,522
 
 
33,741
 
 
(219
)
 
(1
)
 
4
 
Optical Components group
 
64,317
 
 
50,085
 
 
14,232
 
 
28
 
 
28
 
All others
 
 
 
114
 
 
(114
)
 
(100
)
 
(100
)
Before intersegment adjustments
 
126,755
 
 
107,202
 
19,553
 
 
18
 
 
19
 
Intersegment adjustments (1)
 
(4,531
)
 
(2,259
)
 
(2,272
)
 
(101
)
 
(101
)
Total
 
$
122,224
 
 
$
104,943
 
 
$
17,281
 
 
16
%
 
18
%
 
 
 
 
 
 
 
 
 

 
(1) Adjustments represent the elimination of intersegment revenue.
(2) Percentage information in constant currencies in the table above and in the text below excludes the effect of foreign currency translation on reported results. Constant currency results were calculated by translating the current year results at prior year average exchange rates.
 

22


The following table summarizes segment revenue, excluding intersegment sales, by geographic region (dollars in thousands):
 
 
 
 
 
 
 
Favorable/ (Unfavorable)
Three months ended June 30:
 
2010
 
2009
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
 
Network Equipment group:
 
 
 
 
 
 
 
 
Americas
 
$
13,932
 
 
$
12,316
 
 
$
1,616
 
 
13
%
Europe
 
8,868
 
 
7,238
 
 
1,630
 
 
23
 
Asia Pacific
 
2,391
 
 
2,429
 
 
(38
)
 
(2
)
Other regions
 
 
 
10
 
 
(10
)
 
(100
)
Total Network Equipment
 
25,191
 
 
21,993
 
 
3,198
 
 
15
 
Network Integration group:
 
 
 
 
 
 
 
 
Europe
 
33,522
 
 
33,741
 
 
(219
)
 
(1
)
Total Network Integration
 
33,522
 
 
33,741
 
 
(219
)
 
(1
)
Optical Component group:
 
 
 
 
 
 
 
 
Americas
 
22,651
 
 
17,390
 
 
5,261
 
 
30
 
Europe
 
2,435
 
 
2,970
 
 
(535
)
 
(18
)
Asia Pacific
 
38,423
 
 
29,008
 
 
9,415
 
 
32
 
Other regions
 
2
 
 
(161
)
 
163
 
 
101
 
Total Optical Components
 
63,511
 
 
49,207
 
 
14,304
 
 
29
 
All others
 
 
 
2
 
 
(2
)
 
(100
)
Total
 
$
122,224
 
 
$
104,943
 
 
$
17,281
 
 
16
%
 
 
 
 
 
 
 
 
 
 
Consolidated revenue for the second quarter of 2010 increased $17.3 million, or 16%, compared to the second quarter of 2009, due primarily to a $14.2 million, or 28%, increase in Optical Component revenue, and to a lesser extent an increase of $5.7 million, or 24%, in Network Equipment revenue. These revenue increases were partially offset by a decrease of $0.2 million in Network Integration revenue, and a $2.3 million increase in intercompany revenue eliminations. Revenue would have been $1.3 million higher in the second quarter of 2010 had foreign currency exchange rates remained the same as they were in the second quarter of 2009.
 
Network Equipment Group.  Revenue, including intersegment revenue, for the second quarter of 2010 generated from the Network Equipment group increased $5.7 million compared to the second quarter of 2009, due to a 23% increase in Europe and a 13% increase in the Americas region. Our Optical Communications Systems division accounted for $4.0 million of the growth primarily through the FiberDriver™, OptiSwitch™, and Media Cross Connect™ products, partially offset by a decline in our out-of-band networking product. CES, our aerospace and defense business, had an increase in revenue of $1.7 million. Foreign currency fluctuations did not have a significant impact on Network Equipment revenue in the second quarter compared to the second quarter of 2009.
 
Network Integration Group.  Revenue, including intersegment revenue, for the second quarter of 2010 generated from the Network Integration group decreased $0.2 million compared to the second quarter of 2009 due to the impact of changes in foreign currency exchange rates.  Revenue would have been $1.4 million higher in the second quarter of 2010 had foreign currency exchange rates remained the same as they were in the second quarter of 2009. Revenue increases on a constant dollar basis in Alcadon-MRV AB, Tecnonet S.r.l. and Interdata, our Swedish, Italian and French Network Integration units, were partially offset by a $1.9 million dollar decrease at MRV Switzerland AG, our Swiss unit, which operates under the trade name TurnKey.
 
Optical Components Group.  Revenue, including intersegment revenue, for the second quarter of 2010 generated from the Optical Components group increased $14.2 million compared to the second quarter of 2009, which was due primarily to a $9.4 million increase in sales in the Asia Pacific region and a $5.3 million increase in the Americas region, partially offset by a $0.5 million decrease in sales in Europe. Revenue from sales, including intersegment sales, of PON subsystems for applications in Fiber-to-the-Premises deployments, increased $10.2 million to $39.0 million for the three months ended June 30, 2010 from $28.8 million for the three months ended June 30 2009.  Revenue

23


from sales of datacom/telecom (D/T) transceivers, was $24.9 million and $21.0 million in 2010 and 2009, respectively representing an increase of $3.9 million.  Revenue would have been $0.1 million higher in 2010 had foreign currency exchange rates remained the same as they were in 2009.
 
Gross Profit
 
The following table summarizes certain gross profit data from our Statements of Operations (dollars in thousands):
 
 
 
 
 
 
 
Favorable/ (Unfavorable)
Three months ended June 30:
 
2010
 
2009
 
$
Change
 
%
Change
 
 % Change constant
currency (2)
 
 
 
 
 
 
 
 
 
 
 
Network Equipment group
 
$
17,161
 
 
$
13,190
 
 
$
3,971
 
 
30
%
 
30
%
Network Integration group
 
9,248
 
 
10,255
 
 
(1,007
)
 
(10
)
 
(6
)
Optical Components group
 
15,242
 
 
6,641
 
 
8,601
 
 
130
 
 
128
 
All others
 
 
 
73
 
 
(73
)
 
(100
)
 
(100
)
Before intersegment adjustments
 
41,651
 
 
30,159
 
 
11,492
 
 
38
 
 
39
 
Corporate unallocated cost of goods sold and adjustments (1)
 
 
 
(143
)
 
143
 
 
100
 
 
(100
)
Total
 
$
41,651
 
 
$
30,016
 
 
$
11,635
 
 
39
%
 
40
%
 
 
 
 
 
 
 
 
 

(1) Adjustments represent the elimination of intersegment revenue and related cost of goods sold in order to reconcile to consolidated gross profit.
 
(2) Percentage information in constant currencies in the table above and in the text below excludes the effect of foreign currency translation on reported results. Constant currency results were calculated by translating the current year results at prior year average exchange rates.
 
Consolidated gross profit increased $11.6 million for the second quarter of 2010 compared to the second quarter of 2009 due to an increase of $8.6 million in the Optical Components segment and to a lesser extent an increase of $4.0 million in the Network Equipment partially offset by a decrease of $1.0 million in the Network Integration segment.  The 39% increase in gross profit was due to a combination of a 16% increase in revenue and an increase in average gross margins from 29% to 34%.  The improvement in gross margin was due primarily to the Optical Components group, which had a gross margin increase from 13% to 24%, and to a lesser extent by an improvement in gross margin in the Network Equipment segment, partially offset by a decline in gross margin in the Network Integration segment.  Gross profit would have been $0.2 million higher in the second quarter of 2010 had foreign currency exchange rates remained the same as they were in the second quarter of 2009.  Cost of goods sold did not include significant share-based compensation in 2009 or 2010.
 
Network Equipment Group.  Gross profit increased $4.0 million for the second quarter of 2010 compared to the second quarter of 2009.  The 30% increase in gross profit was due to the 24% increase in revenue, and to a lesser extent the improvement in gross margin from 57% to 59%, driven primarily by the Optical Communications Systems.  Foreign currency fluctuations did not have a significant impact on gross profit in the Network Equipment segment in the second quarter of 2010 compared to the second quarter of 2009.
 
Network Integration Group.  Gross profit decreased $1.0 million for the second quarter of 2010 compared to the second quarter of 2009. The decrease was due to a decrease in gross margin from 30% to 28%, and to a lesser extent to the impact of foreign currency exchange rates. The decrease in gross margins was primarily at Tecnonet which had unusually low gross margins on product sales during the quarter. Gross profit would have been $0.3 million higher in 2010 had foreign currency exchange rates remained the same as they were in 2009. 
  
Optical Components Group.  Gross profit increased $8.6 million for the second quarter of 2010 to $15.2 million due to several factors.  We began to recognize the increased manufacturing efficiencies as a result of the consolidation

24


of in-house manufacturing in our new factory in Chengdu, PRC, and a significant shift from third party manufacturing services to in-house manufacturing.  In addition, we benefited from a shift in product mix during the quarter as a higher percentage of revenue came from sales of certain D/T transceivers product lines with higher gross margins. Finally, we continue to benefit from ongoing product cost reduction efforts across nearly all product categories. There was an improvement in gross margins from 13% for the second quarter of 2009 to 24% for the second quarter of 2010. Gross profit would have been $0.1 million higher in 2010 had foreign currency exchange rates remained the same as they were in 2009. 
 
Operating Expenses
 
The following table summarizes certain operating expenses data from our Statements of Operations (dollars in thousands):
 
 
 
 
 
 
 
Favorable/ (Unfavorable)
Three months ended June 30: