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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

(Mark One)

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934
      For the fiscal year ended December 31, 1998

[ ]   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

      For the transition period from _____________ to ___________

                         Commission file number 0-25678

                            MRV COMMUNICATIONS, INC.
                (Name of registrant as specified in its charter)

                Delaware                                06-1340090
     (State or other jurisdiction of                 (I.R.S. employer
     incorporation or organization)               identification number)

         8917 Fullbright Avenue                           91311
      Chatsworth, California 91311                      (Zip Code)
(Address of principal executive offices)

Issuer's telephone number: (818) 773-9044; (818) 773-0906 (Fax)

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:

                         Common Stock, $0.0034 par value

Indicate by checkmark whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 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 checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which common equity was
sold, or the average bid and asked prices of such stock, as of a specified date
within the past 60 days: $139,436,000 based on the closing sale price of a share
of Common Stock at March 19, 1999 as reported by The Nasdaq National Market.

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 26,671,831 shares of Common
Stock, $0.0034 par value at March 19, 1999.

DOCUMENTS INCORPORATED BY REFERENCE:

                                      None


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        The Annual Report on Form 10-K contains forward-looking statements.
These statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those anticipated in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in the Section under Item 1 Description
of Business -- Risk Factors.

        Readers should not place undue reliance on forward-looking statements,
which reflect management's view only as of the date of this Report. The Company
undertakes no obligation to publicly revise these forward-looking statements 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 Securities and Exchange commission.

        As used in this Report, "MRV" or the "Company" refers to MRV
Communications, Inc., its predecessor and its wholly-owned consolidated
subsidiaries, except where the context otherwise indicates. AccelerRouter, Any
Speed to Any Speed Ethernet, EdgeBlaster, EdgeGuardian, Fiber Driver, GigaHub,
MAXserver, MegaStack, MegaSwitch, MegaSwitch II, MegaVision, MRV Communications,
NBase, Network 3000, Network 9000, RouteRunner, West Hills LAN System and Xyplex
are trademarks or trade names of the Company. Trademarks of other companies are
also used in this Report and are the property of their respective owners.

                                     PART I

ITEM 1. DESCRIPTION OF BUSINESS

OVERVIEW

        MRV is a leading manufacturer and marketer of optical high speed
networks that integrate switching, routing, remote access and fiber optic
transmission systems. The Company designs, manufactures and sells two groups of
products: (i) computer networking products, primarily Ethernet LAN routing
switches, WAN and remote access devices and (ii) fiber optic components for the
transmission of voice, video and data across enterprise, telecommunications and
cable TV networks. The Company's advanced networking solutions greatly enhance
the functionality of local area network ("LANs") and wide area networks ("WANs")
by reducing network congestion while allowing end users to preserve their legacy
investments in pre-existing networks and providing cost-effective migration
paths to next generation technologies such as Gigabit Ethernet. The Company's
fiber optic components incorporate proprietary technology which delivers high
performance under demanding environmental conditions.

        The Company offers a family of network, switching and related products
that enhance LAN performance and facilitate the migration to next generation
technologies such as Fast Ethernet, Gigabit Ethernet and Asynchronous Transfer
Mode ("ATM"). MRV's MegaSwitch and GigaFrame families of switching products
range from complete switching systems to stackable switches which upgrade
performance of existing LANs by relieving network congestion without requiring
replacement of existing technologies. In addition, the Company offers
EdgeBlaster, a multi-functional remote access router that connects enterprise
LANs to remote offices and telecommuters securely through the Internet using
virtual private network ("VPN") technology.

        The Company complements its switching products with a family of optical
transmission components and modules designed for transmission over fiber optic
cable. These products enable the transmission of voice, data, and video across
fiber and are also used in optical fiber test equipment. The Company's products
include discrete components, such as laser diodes and LEDs, and integrated
components such as transmitters, receivers and transceivers. The Company's
components are used in data networks, telecommunication transmission and access
networks.


        The Company's principal executive offices are located at 8943 Fullbright
Avenue, Chatsworth, California 91311 and its telephone and fax numbers are (818)
773-9044 and (818) 773-0906, respectively. The Company maintains Web sites at
"http://www.mrv.com" and "http://www.nbase-xyplex.com." Information contained in
the Company's Web sites shall not be deemed part of this Report.





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BACKGROUND

        The Company was organized in July 1988 as MRV Technologies, Inc., a
California corporation and reincorporated in Delaware in April 1992, at which
time it changed its name to MRV Communications, Inc.

        On May 1, 1995, the Company acquired certain assets and the distribution
business of Galcom Networking, Ltd. ("Galcom"), a network equipment company
located in Israel. The purchase price paid by the Company was approximately
$900,000 in cash and the assumption of approximately $1,800,000 in liabilities
and debt. In connection with the acquisition of assets from Galcom, the Company
issued to Galcom and certain of its employees five-year warrants to purchase an
aggregate of 300,000 shares at prices ranging from $4.25 to $7.38 per share.

        On June 29, 1995, the Company acquired certain assets and the
distribution business of Ace 400 Communications Ltd. ("Ace"), a network
equipment company also located in Israel. The purchase price paid by the Company
was approximately $4,477,000 comprised of $100,000 in cash, the assumption of
approximately $467,000 in liabilities and debt and the issuance of approximately
855,000 shares of Common Stock valued at approximately $3,910,000 and extended a
right to Ace to sell to the Company up to $400,000 of Ace's inventory. In
connection with the acquisition of assets from Ace, the Company issued to the
trustee and an employee of Ace five-year warrants to purchase an aggregate of
330,000 shares of Common Stock at prices ranging from $4.57 to $4.67 per share.

        The Galcom and Ace acquisitions provided the Company with experienced
personnel and technology for the Token Ring LAN, IBM Connectivity and
Multi-Platform, Network Management IBM NetView and HP OpenView markets.
Following the acquisitions, the Company consolidated these operations in Israel
with its networking operations in the U.S.

        On September 26, 1996, the Company completed an acquisition (the
"Fibronics Acquisition") from Elbit Ltd. ("Elbit") of certain of the assets and
selected liabilities of Elbit's wholly-owned subsidiary, Fibronics Ltd. and its
subsidiaries (collectively "Fibronics") related to Fibronics' computer
networking and telecommunications businesses (the "Fibronics Business") in
Germany, the United States, the United Kingdom, the Netherlands and Israel. The
assets acquired included Fibronics' technology in progress and existing
technology, its marketing channels, its GigaHub family of computer networking
products and other rights. The purchase price for the Fibronics Business was
approximately $22,800,000. The purchase price was paid using a combination of
cash and shares of Common Stock, all of which Elbit subsequently resold in the
open market.

        The Fibronics Business has enabled MRV to enhance the development of
Fast Ethernet and Gigabit Ethernet functions through the Fibronics GigaHub
family of products, to offer a broader range of networking products and to
benefit from combined distribution channels and sales in both the United States
and Europe and greater product development capability.

        On January 30, 1998, MRV completed an acquisition from Whittaker
Corporation ("Whittaker") of all of the outstanding capital stock of Whittaker
Xyplex, Inc. a Delaware corporation (the "Xyplex Acquisition"). Whittaker
Xyplex, Inc. (whose name the Company has since changed to NBase Xyplex, Inc.),
is a holding corporation owning all of the outstanding capital stock of Xyplex,
Inc., a Massachusetts corporation ("Xyplex"). Xyplex is a leading provider of
access solutions between enterprise networks and wide area network and/or
Internet service providers ("ISPs"). The purchase price paid to Whittaker
consisted of $35,000,000 in cash and three-year warrants to purchase up
to 421,402 shares of Common Stock of the Company at an exercise price of $35 per
share.

        The Xyplex Acquisition is enabling MRV to expand its product lines with
products that have WAN and remote access capabilities, permitting the Company to
offer both discrete networking products and complete LAN/WAN end-to-end
solutions not only to MRV's own existing base of customers, but also to the
customer base added by Xyplex. The acquisition of Xyplex has also increased
MRV's sales force, distribution channels and customer support and service
capabilities.





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RISK FACTORS

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

        Risks of Technological Change; Development Delays. The Company is
engaged in the design and development of devices for the computer networking,
telecommunications and fiber optic communication industries. As with any new
technologies, there are substantial risks that the marketplace may not accept
the Company's new products. Market acceptance of the Company's products will
depend, in large part, upon the ability of the Company to demonstrate
performance and cost advantages and cost-effectiveness of its products over
competing products and the success of the sales efforts of the Company and its
customers. There can be no assurance that the Company will be able to continue
to market its technology successfully or that any of the Company's current or
future products will be accepted in the marketplace. Moreover, the computer
networking, telecommunications and fiber optic communication industries are
characterized by rapidly changing technology, evolving industry standards and
frequent new product introductions, any of which could render the Company's
existing products obsolete. The Company's success will depend upon its ability
to enhance existing products and to introduce new products to meet changing
customer requirements and emerging industry standards. The Company will be
required to devote continued efforts and financial resources to develop and
enhance its existing products and conduct research to develop new products. The
development of new, technologically advanced products is a complex and uncertain
process requiring high levels of innovation, as well as the accurate
anticipation of technological and market trends. There can be no assurance that
the Company will be able to identify, develop, manufacture, market or support
new or enhanced products successfully or on a timely basis, that new Company
products will gain market acceptance or that the Company will be able to respond
effectively to product announcements by competitors, technological changes or
emerging industry standards. Furthermore, from time to time, the Company may
announce new products or product enhancements, capabilities or technologies that
have the potential to replace or shorten the life cycle of the Company's
existing product offerings and that may cause customers to defer purchasing
existing Company products or cause customers to return products to the Company.

        Complexity of Product and Product Defects. Complex products, such as
those offered by the Company, may contain undetected software or hardware errors
when first introduced or when new versions are released. While the Company has
not experienced such errors in the past, the occurrence of such errors in the
future, and the inability to correct such errors, could result in the delay or
loss of market acceptance of the Company's products, material warranty expense,
diversion of engineering and other resources from the Company's product
development efforts and the loss of credibility with the Company's customers,
system integrators and end users, any of which could have a material adverse
effect on the Company's business, operating results and financial condition.

        Potential Fluctuations in Operating Results. The Company expects that in
the future it revenues may grow at a slower rate than was experienced in
previous periods and that on a quarter-to-quarter basis, the Company's growth in
revenue may be significantly lower than its historical quarterly growth rates.
As a consequence, operating results for a particular quarter are extremely
difficult to predict. The Company's revenue and operating results could
fluctuate substantially from quarter to quarter and from year to year. This
could result from any one or a combination of factors such as the cancellation
or postponement of orders, the timing and amount of significant orders from the
Company's largest customers, the Company's success in developing, introducing
and shipping product enhancements and new products, the product mix sold by the
Company, adverse effects to the Company's financial statements resulting from,
or necessitated by, past and possible future acquisitions, new product
introductions by the Company's competitors, pricing actions by the Company or
its competitors, the timing of delivery and availability of components from
suppliers, changes in material costs and general economic





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conditions. Moreover, the volume and timing of orders received during a quarter
are difficult to forecast. From time to time, the Company's customers encounter
uncertain and changing demand for their products. Customers generally order
based on their forecasts. If demand falls below such forecasts or if customers
do not control inventories effectively, they may cancel or reschedule shipments
previously ordered from the Company. The Company's expense levels during any
particular period are based, in part, on expectations of future sales. If sales
in a particular quarter do not meet expectations, operating results could be
materially adversely affected. Moreover, in certain instances, sales cycles are
becoming longer and more uncertain as MRV bids on larger projects. As a result,
MRV is finding it more difficult to predict the timing of the awards of
contracts and the actual placement of orders stemming from awards. There can be
no assurance that these factors or others, such as those discussed in
"International Operations" or those discussed immediately below would not cause
future fluctuations in operating results. Further, there can be no assurance
that the Company will be able to continue profitable operations.

        Share Prices Have Been and May Continue to Be Highly Volatile.
Historically, the market price of the Company's Common Stock has been extremely
volatile. The market price of the Common Stock is likely to continue to be
highly volatile and could be significantly affected by factors such as actual or
anticipated fluctuations in the Company's operating results, announcement of
technological innovations or new product introductions by the Company or its
competitors, changes of estimates of the Company's future operating results by
securities analysts, developments with respect to patents, copyrights or
proprietary rights, general market conditions and other factors. In addition,
the stock market has from time to time experienced significant price and volume
fluctuations that have particularly affected the market prices for the common
stocks of technology companies. These broad market fluctuations may adversely
affect the market price of the Company's Common Stock. In addition, it is
possible that in a future fiscal quarter, the Company's results of operations
will fail to meet the expectations of securities analysts or investors and, in
such event, the market price of the Company's Common Stock would be materially
adversely affected. For example, as a result of some of the factors discussed in
"-- Potential Fluctuations in Operating Results" above, specifically, weaker
than anticipated demand for its networking products, especially in Europe, and
delays in its transitions to next generation, higher margin, networking
products, in August 1998, MRV announced that it expected operating results in
the third quarter of 1998 to be adversely affected. Following that announcement,
the market price of the Company's Common Stock dropped substantially. Similarly,
in February 1999 following its release of fourth quarter and 1998 financial
results, the Company announced it did not expect revenues in the first quarter
of 1999 to be as strong as revenues reported for the fourth quarter of 1998 and
the market price of the Company's Common Stock again dropped significantly. See
Item 5. Market for Common Equity and Related Stockholder Matters.

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

        There has been a trend toward industry consolidation for several years.
The Company expects this trend toward industry consolidation to continue as
companies attempt to strengthen or hold their market positions in an evolving
industry.





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The Company believes that industry consolidation may provide stronger
competitors that are better able to compete. This could have a material adverse
effect on the Company's business, operating results and financial condition.

        Management of Growth. The Company has grown rapidly in recent years,
with revenues increasing from $17,526,000 for the year ended December 31, 1994,
to $39,202,000 for the year ended December 31, 1995, $88,815,000 for the year
ended December 31, 1996, $165,471,000 for the years ended December 31, 1997 and
$264,075,000 for the year ended December 31, 1998. The Company's recent growth,
both internally and through the acquisitions it has made since January 1, 1995,
has placed a significant strain on the Company's financial and management
personnel and information systems and controls, and the Company must implement
new and enhance existing financial and management information systems and
controls and must add and train personnel to operate such systems effectively.
While the strain placed on the Company's personnel and systems has not had a
material adverse effect on the Company to date, there can be no assurance that a
delay or failure to implement new and enhance existing systems and controls will
not have such an effect in the future. The Company's recent growth through the
acquisitions of the Fibronics Business and Xyplex discussed in "Risks Associated
with Recent Acquisitions" below and its intention to continue to pursue its
growth strategy through efforts to increase sales of existing and new products
can be expected to place even greater pressure on the Company's existing
personnel and compound the need for increased personnel, expanded information
systems, and additional financial and administrative control procedures. There
can be no assurance that the Company will be able to successfully manage
expanding operations.

        Risks Associated With Recent Acquisitions. On September 26, 1996, the
Company completed the Fibronics Acquisition from Elbit of certain of the assets
and selected liabilities of Fibronics related to Fibronics' computer networking
and telecommunications businesses in Germany, the United States, the United
Kingdom, the Netherlands and Israel. The assets acquired included Fibronics'
technology in progress and existing technology, its marketing channels, its
GigaHub family of computer networking products and other rights. The purchase
price for the Fibronics Business was approximately $22,800,000, which was paid
using a combination of cash and Common Stock of the Company. During the years
ended December 31, 1994 and 1995, and the period from January 1, 1996 through
September 25, 1996 (the day the Fibronics Business was acquired by the Company),
the Fibronics Business reported net revenues of $33,355,000, $35,003,000 and
$19,481,000, respectively, and net income (losses) of $(11,557,000), $79,000 and
$(6,143,000), respectively. In connection with the Fibronics Acquisition, the
Company incurred charges of $17,795,000, $6,974,000 and $5,200,000 for purchased
technology, restructuring and interest expense related to financing,
respectively. These charges caused the Company to incur a net loss of $9,654,000
for the year ended December 31, 1996.

        On January 30, 1998, MRV completed the Xyplex Acquisition from
Whittaker. Xyplex is a leading provider of access solutions between enterprise
networks and WAN and/or Internet service providers ("ISPs"). The purchase price
paid to Whittaker consisted of $35,000,000 in cash and three-year warrants to
purchase up to 421,402 shares of common stock of the Company at an exercise
price of $35 per share. During the year ended December 31, 1995, the period from
January 1, 1996 through April 9, 1996 (the day Xyplex was acquired by
Whittaker), the period from April 10, 1996 through October 31, 1996 and the
fiscal year ended October 31, 1997, Xyplex reported net revenues of
$107,617,000, $28,100,000, $52,021,000, and $75,663,000, respectively, and net
losses of $37,360,000, $2,269,000, $13,353,000 and $80,309,000, respectively. In
connection with the Xyplex Acquisition, the Company incurred charges of
$20,633,000 and $15,671,000 for purchased technology and restructuring during
the year ended December 31, 1998. While the Xyplex Acquisition added 11 months
of Xyplex' revenues to those of the Company, the charges resulting from the
Xyplex Acquisition resulted in MRV incurring a net loss of $20,106,000 or $0.86
per share during the year ended December 31, 1998.

        MRV originally recorded charges of $30,571,000 related to research and
development projects in progress at the time of the Xyplex Acquisition. Although
MRV reported these charges and its first, second and third quarter results of
1998 in accordance with established accounting practice and valuations of
Xyplex' purchased technology in progress provided by independent valuators,
these valuations have been reconsidered in light of very recent Securities and
Exchange Commission guidance regarding valuation methodology. Based on this new
valuation methodology, MRV has reduced the value of the purchased technology in
progress related to the Xyplex Acquisition to $20,633,000 and has increased the
amount of goodwill





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by $9,938,000. This has resulted in additional charges during 1998 of $759,000
for amortization of intangibles, including goodwill, resulting from the Xyplex
Acquisition and will result in charges of approximately $828,000 annually as
these intangibles are amortized through January 2010.

        Recent actions and comments from the Securities and Exchange Commission
have indicated that the Commission is reviewing the current valuation
methodology of purchased in-process research and development related to business
combinations. Unlike the case of many other companies, the Commission has not
notified MRV of any plans to review MRV's methodology for valuing purchased
in-process research and development. The Company's action to reconsider that
valuation of in process research and development related to the Xyplex
Acquisition has been voluntary. The Company believes it is in compliance with
all of the rules and related guidance as they currently exist. However, there
can be no assurance that the Commission will not review MRV's accounting for the
Xyplex Acquisition and seek to apply retroactively new guidance and further
reduce the amount of purchased in-process research and development expensed by
the Company. This would result in an additional restatement of previously filed
financial statements of the Company and could have a material adverse impact on
financial results for periods subsequent to the acquisition.

        International Operations. International sales have become an
increasingly important segment of the Company's operations, with the
acquisitions of Galcom and Ace in 1995, the Fibronics Business in 1996 and
Xyplex in 1998. Approximately 53%, 60% and 59%, respectively, of the Company's
net revenues for the years ended December 1996, 1997 and 1998, respectively,
were from sales to customers in foreign countries. The Company has offices in,
and conducts a significant portion of its operations in and from, Israel. MRV
is, therefore, directly influenced by the political and economic conditions
affecting Israel. Any major hostilities involving Israel, the interruption or
curtailment of trade between Israel and its trading partners or a substantial
downturn in the economic or financial condition of Israel could have a material
adverse effect on the Company's operations. Sales to foreign customers are
subject to government controls and other risks associated with international
sales, including difficulties in obtaining export licenses, fluctuations in
currency exchange rates, inflation, political instability, trade restrictions
and changes in duty rates. Although the Company has not experienced any material
difficulties in this regard to date, there can be no assurance that it will not
experience any such material difficulties in the future. The Company's sales are
currently denominated in U.S. dollars and to date its business has not been
significantly affected by currency fluctuations or inflation. However, the
Company conducts business in several different countries and thus fluctuations
in currency exchange rates could cause the Company's products to become
relatively more expensive in particular countries, leading to a reduction in
sales in that country. In addition, inflation or fluctuations in currency
exchange rates in such countries could increase the Company's expenses. The
Single European Currency (Euro) was introduced on January 1, 1999 with complete
transition to this new currency required by January 2002. The Company has made
and expects to continue to make changes to its internal systems in order to
accommodate doing business in the Euro. Any delays in the Company's ability to
be Euro-compliant could have an adverse impact on the Company's results of
operations or financial condition. To date, the Company has not hedged against
currency exchange risks. In the future, the Company may engage in foreign
currency denominated sales or pay material amounts of expenses in foreign
currencies and, in such event, may experience gains and losses due to currency
fluctuations. The Company's operating results could be adversely affected by
such fluctuations or as a result of inflation in particular countries where
material expenses are incurred. Moreover, the Company's operating results could
also be adversely affected by seasonality of international sales, which are
typically lower in Asia in the first calendar quarter and in Europe in the third
calendar quarter. These international factors could have a material adverse
effect on future sales of the Company's products to international end-users and,
consequently, the Company's business, operating results and financial condition.

        Slowdown in Industry Growth Rates. The Company's success is dependent,
in part, on the overall growth rate of the networking industry. In 1997 and
1998, industry growth was below historical rates according to industry reports.
There can be no assurance that the networking industry will continue to grow or
that it will achieve higher growth rates. The Company's business, operating
results or financial condition may be adversely affected by any further decrease
in industry growth rates. In addition, there can be no assurance that the
Company's results in any particular period will fall within the ranges for
growth forecast by market researchers.





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        Manufacturing And Dependence on Suppliers And Third Party Manufacturers.
The Company uses internally developed Application Specific Integrated Circuits
("ASICs"), which provide the functionality of multiple integrated circuits in
one chip, in the manufacture of its LAN switching products. To develop ASICs
successfully, the Company must transfer a code of instructions to a single mask
from which low cost duplicates can be made. Each iteration of a mask involves a
substantial upfront cost, which costs can adversely affect the Company's result
of operations and financial condition if errors or "bugs" occur following
multiple duplication of the masks. While the Company has not experienced
material expenses to date as a result of errors discovered in ASIC masks,
because of the complexity of the duplication process and the difficulty in
detecting errors, the Company could suffer a material adverse effect to its
operating results and financial condition if errors in developing ASICs were to
occur in the future. Moreover, the Company currently relies on a single,
unaffiliated foundry, Chip Express, to fabricate its ASICs. The Company does not
have a long-term supply contract with Chip Express, any other ASIC vendor or any
other of its limited source vendors, purchasing all of such components on a
purchase order basis under standard terms of sale. While the Company believes it
would be able to obtain alternative sources of supply for the ASICs or other key
components, a change in ASIC or other suppliers of key components could require
a significant lead time and, therefore, could result in a delay in product
shipments. While the Company has not experienced delays in the receipt of ASICs
or other key components, any future difficulty in obtaining any of these key
components could result in delays or reductions in product shipments which, in
turn, could have a material adverse effect on the Company's business, operating
results and financial condition.

        The Company outsources the board-level assembly, test and quality
control of material, components, subassemblies and systems relating to its
networking products to third party contract manufacturers. Though there are a
large number of contract manufacturers which the Company can use for its
outsourcing, it has elected to use a limited number of vendors for a significant
portion of board assembly requirements in order to foster consistency in quality
of the products. These independent third party manufacturers also provide these
services to other companies. Risks associated with the use of independent
manufacturers include unavailability of or delays in obtaining adequate supplies
of products and reduced control of manufacturing quality and production costs.
If the Company's contract manufacturers fail to deliver products in the future
on a timely basis, or at all, it could be difficult for the Company to obtain
adequate supplies of products from other sources in the near term. There can be
no assurance that the Company's third party manufacturers will provide adequate
supplies of quality products on a timely basis, or at all. While the Company
could outsource with other vendors, a change in vendors may require significant
lead time and may result in shipment delays and expenses. The inability to
obtain such products on a timely basis, the loss of a vendor or a change in the
terms and conditions of the outsourcing would have a material adverse effect on
the Company's business, operating results and financial condition.

        The Company relies almost exclusively on its own production capability
for critical semiconductor lasers and light emitting diodes ("LEDs") used in its
products. Because the Company manufactures these and other key components of its
products at its own facility and such components are not readily available from
other sources, any interruption of the Company's manufacturing process could
have a material adverse effect on the Company's operations. Furthermore, the
Company has a limited number of employees dedicated to the operation and
maintenance of its wafer fabrication equipment, the loss of any of whom could
result in the Company's inability to effectively operate and service such
equipment. Wafer fabrication is sensitive to many factors, including variations
and impurities in the raw materials, the fabrication process, performance of the
manufacturing equipment, defects in the masks used to print circuits on the
wafer and the level of contaminants in the manufacturing environment. There can
be no assurance that the Company will be able to maintain acceptable production
yields and avoid product shipment delays. In the event adequate production
yields are not achieved, resulting in product shipment delays, the Company's
business, operating results and financial condition could be materially
adversely affected.

        Risks Associated with Potential Future Acquisitions. An important
element of management's strategy is to review acquisition prospects that would
complement the Company's existing products, augment its market coverage and
distribution ability or enhance its technological capabilities. Accordingly, the
Company may acquire additional businesses, products or





                                       8
<PAGE>   9

technologies in the future. Future acquisitions by the Company could result in
charges similar to those incurred in connection with the Fibronics Acquisition
and the Xyplex Acquisition, potentially dilutive issuances of equity securities,
the incurrence of debt and contingent liabilities and amortization expenses
related to goodwill and other intangible assets, any of which could materially
adversely affect the Company's business, financial condition and results of
operations. Acquisitions entail numerous risks, including the assimilation of
the acquired operations, technologies and products, diversion of management's
attention to other business concerns, risks of entering markets in which the
Company has no or limited prior experience, the potential loss of key employees
of acquired organizations and difficulties in honoring commitments made to
customers by management of the acquired entity prior to the acquisition. Prior
to the Fibronics Acquisition, management had only limited experience in
assimilating acquired organizations. There can be no assurance as to the ability
of the Company to successfully integrate the products, technologies or personnel
of any business that might be acquired in the future, and the failure of the
Company to do so could have a material adverse effect on the Company's business,
financial condition and results of operations.

        Present Lack of Patent Protection; Dependence on Proprietary Technology.
The Company holds no patents and only recently has filed two patent applications
and a provisional patent application in the United States with respect to
certain aspects of its technology. With the Xyplex Acquisition, MRV acquired
five additional provisional patent applications filed by Xyplex on certain
aspects of its technology. The Company currently relies on copyrights, trade
secrets and unpatented proprietary know-how, which may be duplicated by others.
The Company employs various methods, including confidentiality agreements with
employees and suppliers, to protect its proprietary know-how. Such methods may
not afford complete protection, however, and there can be no assurance that
others will not independently develop such know-how or obtain access to it or
independently develop technologies that are substantially equivalent or superior
to the Company's technology. In the event that protective measures are not
successful, the Company's business, operating results and financial condition
could be materially and adversely affected. In addition, the laws of some
foreign countries do not protect the Company's proprietary rights to the same
extent as do the laws of the United States. There can be no assurance that any
patents will be issued as a result of the pending applications, including the
provisional patent application, or any future patent applications, or, if
issued, will provide the Company with meaningful protection from competition. In
addition, there can be no assurance that any patents issued to the Company will
not be challenged, invalidated or circumvented. The electronics industry has
been characterized by extensive litigation regarding patents and other
intellectual property rights, and companies in the electronics industry have
employed intellectual property litigation to gain a competitive advantage. Since
United States patent applications are presently maintained in secrecy until
patents issue and since the publication of inventions in technical or patent
literature tends to lag behind such patent application filings by several
months, the Company cannot be certain that it was the first inventor of
inventions covered by pending United States patent applications or that the
Company is not infringing on the patents of others. Litigation may be necessary
to enforce any patents that may be issued to the Company or other intellectual
property rights of the Company, to protect the Company's trade secrets, to
determine the validity and scope of the proprietary rights of others or to
defend against claims of infringement. Such litigation could result in
substantial costs and diversion of resources and could have a material adverse
effect on the Company's business, financial condition and results of operations
regardless of the final outcome of such litigation. In the event that any of the
Company's products are found to infringe on the intellectual property rights of
third parties, the Company would be required to seek a license with respect to
such patented technology, or incur substantial costs to redesign the infringing
products. There can be no assurance that any such license would be available on
terms acceptable to the Company or at all, that any of the Company's products
could be redesigned on an economical basis or at all, or that any such
redesigned products would be competitive with the products of the Company's
competitors.

        For a discussion of the intellectual property claims and litigation in
which the Company is currently involved, see Item 3. Legal Proceedings.

        Risks From Year 2000 Issues. Many existing computer programs, including
some programs used by the Company, use only two digits to identify a year in the
date field. These programs were designed without considering the impact of the
upcoming change in the century. If not corrected, these computer applications
and systems could fail or create erroneous





                                       9
<PAGE>   10

results by, at, or after the year 2000. Based on the Company's investigation to
date, management believes that Year 2000 readiness compliance will occur before
January 1, 2000 and does not anticipate that the Company will incur material
operating expenses or be required to incur material costs to be year 2000
compliant. See Item 7. Management `s Discussion and Analysis of Financial
Condition and Results of Operations -- Year 2000 Issues. The dates on which the
Company believes the Year 2000 Compliance Program ("Y2K Program") will be
completed are based on management's estimates, which were derived utilizing
numerous assumptions of future events, including the continued availability of
certain resources, third-party modification plans and other factors. However,
there can be no guarantee that all Year 2000 issues have been identified and
would be addressed by the Y2K Program, that the estimates of the Y2K Program
will be achieved, or that there will not be a delay in, or increased costs
associated with, the implementation of the Y2K Program. Specific factors that
might cause differences between the estimates and actual results include, but
are not limited to, the availability and cost of personnel trained in these
areas, the ability to locate and correct all relevant computer code, timely
responses to and corrections by third-parties and suppliers of their Year 2000
issues and similar uncertainties. Due to the general uncertainty inherent in the
Year 2000 problem, resulting in part from the uncertainty of the Year 2000
readiness of third-parties and the interconnection of global businesses, the
Company cannot ensure its ability to timely and cost-effectively resolve
problems associated with the Year 2000 issue that may affect its operations and
business, or expose it to third-party liability.

        Year 2000 compliance is an issue for virtually all businesses whose
computer systems and applications may require significant hardware and software
upgrades or modifications. Companies owning and operating such systems may plan
to devote a substantial portion of their information systems' spending to fund
such upgrades and modifications and divert spending away from networking or
fiber optic solutions. Such changes in customers' spending patterns could have a
material adverse impact on the Company's sales, operating results or financial
condition.

        Dependence on Key Personnel. The Company is substantially dependent upon
a number of key employees, including Dr. Shlomo Margalit, its Chairman of the
Board of Directors and Chief Technical Officer, Dr. Zeev Rav-Noy, its Chief
Operating Officer, and Noam Lotan, its President and Chief Executive Officer.
The loss of the services of any one or more of these officers could have a
material adverse effect on the Company. The Company has entered into employment
agreements with each officer and owns and is the beneficiary of key man life
insurance policies in the amounts of $1,000,000 each on the lives of Drs.
Margalit and Rav-Noy and Mr. Lotan. There can be no assurance that the proceeds
from these policies will be sufficient to compensate the Company in the event of
the death of any of these individuals, and the policies do not cover the Company
in the event that any of them becomes disabled or is otherwise unable to render
services to the Company.

        Attraction And Retention of Qualified Personnel. The Company's ability
to develop, manufacture and market its products and its ability to compete with
its current and future competitors depends, and will depend, in large part, on
its ability to attract and retain qualified personnel. Competition for qualified
personnel in the networking and fiber optics industries is intense, and the
Company will be required to compete for such personnel with companies having
substantially greater financial and other resources than the Company. If the
Company should be unable to attract and retain qualified personnel, the business
of the Company could be materially adversely affected. There can be no assurance
that the Company will be able to attract and retain qualified personnel.

        Possible Issuance of Preferred Stock; Anti-takeover Provisions. The
Company is authorized to issue up to 1,000,000 shares of Preferred Stock, par
value $.01 per share (the "Preferred Stock"). The Preferred Stock may be issued
in one or more series, the terms of which may be determined at the time of
issuance by the Board of Directors without further action by stockholders. The
terms of any such series of preferred stock may include voting rights (including
the right to vote as a series on particular matters), preferences as to
dividend, liquidation, conversion and redemption rights and sinking fund
provisions. No preferred stock is currently outstanding. The issuance of any
such preferred stock could materially adversely affect the rights of the holders
of Common Stock, and therefore, reduce the value of the Common Stock. In
particular, specific rights granted to future holders of preferred stock could
be used to restrict the Company's ability to merge with, or sell its assets to,
a third party, thereby preserving control of the Company by the present owners.





                                       10
<PAGE>   11

        Forward-looking Statements. This Report contains forward-looking
statements within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. Such forward-looking statements may be deemed to
include the Company's plans to develop and offer new and enhanced networking and
optical transmission products and its efforts to expand its customer base. Such
forward-looking statements may also be deemed to include the Company's
expectations concerning factors affecting the markets for its products, the
growth in those markets in general, the timing of new product introductions by
the Company and anticipated benefits from such product introductions or
technological developments. Such forward-looking statements also may include the
Company's expectations of benefits from the acquisition of Xyplex or its OEM or
other arrangements with certain of its customers. Actual results could differ
from those projected in any forward-looking statements for, among other things,
the reasons detailed in the other sections of this "Risk Factors" portion of
this Report. The forward-looking statements are made as of the date of this
Report and the Company assumes no obligation to update the forward-looking
statements or to update the reasons why actual results could differ from those
projected in the forward-looking statements.

INDUSTRY BACKGROUND

        The global communications industry has undergone significant
transformation and growth as a result of increased demand for communications
services and applications, as well as advances in technology and changes in
network architectures and public policy. The client server network architecture
with its shared information and resources, the increased power of conventional
applications as well as the proliferation of graphic intensive applications such
as multimedia, the Internet and intranets, have resulted in a strong demand for
additional bandwidth. This trend is expected to continue as additional bandwidth
intensive applications, such as video conferencing, are increasingly used.
Further, as a result of changes in communications regulations and the adoption
of common standards, enterprise networks, such as LANs and WANs, and access
networks, such as telecommunications and cable TV, are expected to converge. The
demand for high bandwidth applications, as well as the convergence of data
communications and telecommunications, has significantly increased the
requirement for networking and fiber optic equipment that increases the capacity
of networks through high speed and more efficient transmission technologies.

        High-speed switching systems enhance the bandwidth of LANs so that a
greater number of users can utilize more complex applications without
experiencing network congestion. Fiber optic transmission components also
enhance the functionality of enterprise and access networks by enabling
high-speed transmission of voice, video and data across fiber optic cable.
Market research firms forecast growth in both of these sectors. In 1997 and
1998, however, networking industry growth was below historical rates according
to industry reports. There can be no assurance that the networking industry will
continue to grow or that it will achieve higher growth rates. The Company's
business, operating results or financial condition may be adversely affected by
any further decrease in industry growth rates.

        Growth in the use and availability of wide area networks is being
stimulated by many factors including the need to share information between
centralized repositories and remote enterprise locations, to access and use the
Internet for communications and marketing and to electronically access external
resources used by the enterprise. Growth is also being fueled by the increasing
availability of more cost-effective WAN services such as Frame Relay and
Integrated Service Digital Network ("ISDN") making it more affordable for many
organizations to set up a WAN or expand an existing one. The growth in the use
and availability of wide area networks coupled with increasing use, power, speed
and complexity of local area networks has resulted in the increasing need for
equipment that permits high speed connections between LANs, WANs and ISPs.

NETWORKING ENVIRONMENT

        The most common LAN architecture, "shared-media" networking, cannot
effectively accommodate the market's requirements for high-speed networking.
Shared-media networks require computers to alternate communication over a single
LAN, thereby allowing a computer to send information only when other computers
are not doing so. As more computers are





                                       11
<PAGE>   12

added to a single LAN, demand for access to the network increases and, as a
result, individual users experience slower network response times and data
transfer rates. Most of these networks operate with the Ethernet protocol, which
is significantly less expensive than the closest competing technology, Token
Ring.

        There are two fundamentally different but complementary approaches to
alleviating network congestion. The first approach, referred to as
"segmentation," reduces the number of desktops connected to a single LAN
segment, which increases the available bandwidth per user. The segmentation of
users into smaller LANs alleviates network congestion by allowing fewer users to
share a given amount of capacity. The second approach is to increase the
capacity of networks through new high-speed transmission technologies and high
bandwidth fiber optic applications. LAN switching technology is an innovation
that enables both of these solutions. A switch is a device that partitions a
network into multiple segments which enables several simultaneous
"conversations," thereby reducing the traffic on each segment while allowing
access to the entire network. A switch also allows connection with different
speeds, thereby facilitating faster backbones and migration to faster
technologies.

        Enhanced LAN Performance through Segmentation and Switching. LAN
switching systems have emerged as the preferred method for segmenting networks
because these systems are implemented more easily, efficiently and
cost-effectively than hub architectures which once dominated the networking
equipment industry. In contrast to hubs, which indiscriminately forward data to
all ports, Ethernet switches only forward network traffic to the designated
receiving port or ports. Ethernet switches can also support different data rates
on different ports with some ports operating at 10 Mbps and others at
substantially higher speeds, thus enabling Any Speed to Any Speed Ethernet
transmission. A major driver to the growth in Ethernet switching is the large
installed base. Ethernet is the dominant LAN architecture. As a result, Ethernet
switching offers fast and cost-effective upgrades without impacting network
performance or requiring infrastructure changes to existing cabling and network
adapters. Switching also allows LANs based on different architectures, such as
Ethernet and Token Ring, to be connected efficiently and allows these systems to
access servers and backbones which use a variety of high-speed technologies,
such as Fast Ethernet, Gigabit Ethernet, Fiber Distributed Data Interface
("FDDI") and ATM.

        Another important benefit of switches is their ability to combine groups
of computers into virtual LANs ("VLANs"). As a result, workgroups can be set up
according to business relationships rather than physical proximity. Unlike hub
and router systems, which require segment users to be physically grouped
together, VLANs simplify network administration as users relocate. VLANs can
also be used for controlling bandwidth and directing excess capacity to
workgroups and users as needed. Moreover, by confining traffic to desired
workgroups, VLANs improve network security.

        Enhanced LAN Performance Through High-speed Transmission Technologies
and Switching. While Ethernet switching is being used to increase the efficiency
of existing capacity, switching technology also incorporates high-speed
transmission technologies that increases a system's capacity. High-speed
technologies such as Fast Ethernet, Gigabit Ethernet, FDDI and ATM increase
transmission speeds from 10 Mbps to 100 Mbps and from 100 Mbps to 1,000 Mbps (1
Gbps). Higher transmission speeds have helped to increase the demand for LAN
switches in two important ways. First, LAN switches create uplinks between slow
desktop connections and high-speed fiber backbones, which are necessary if data
transfer is to occur between devices that operate at different speeds. Second,
as high-speed file servers or fiber backbones are upgraded, the system's
switches must be upgraded as well.

        Two alternative high-speed networking technologies, FDDI and ATM, are
used in networking backbones, but because of their high cost for end-users they
are rarely used to connect desktop computers within a LAN. Both FDDI and ATM
transmit data in unique formats which also make them difficult to incorporate
into pre-existing Ethernet LANs.

        Fast Ethernet has emerged as a cost-effective, interoperable technology
that enables the integration of ATM and FDDI backbones with Ethernet switches
and provides a non-disruptive, tenfold increase in speed from 10 Mbps to 100
Mbps. Furthermore, unlike FDDI and ATM, Fast Ethernet is based on fully defined
standards which use the same data format and core communication protocol as
Ethernet. This similarity permits easy integration with existing Ethernet
networks and allows





                                       12
<PAGE>   13

organizations to retain the benefit of network administrators who have been
trained in the management of Ethernet networks. Thus, migration from Ethernet to
Fast Ethernet involves a simple change of adapter cards and an upgrade of hubs
and switches.

        Similar benefits are being offered by the next generation of Ethernet
technology, Gigabit Ethernet, which provides raw data bandwidth of 1,000 Mbps
while maintaining full compatibility with the installed base of Ethernet nodes.
Management believes that demand for Gigabit Ethernet is likely to grow as more
LANs move to Fast Ethernet, generating substantial traffic loads on backbone
networks.

FIBER OPTIC ENVIRONMENT

        Fiber optic cable can generally carry more information at less expense
and with greater signal quality than copper wire. The higher the speed of
transmission, the greater the capacity and the larger the span of the network,
the more essential is fiber optic transmission. Fiber has long replaced copper
as the preferred technology for long distance communications and major backbone
telephony and data transmissions. Due to its advantages, fiber optic technology
is also increasingly used to enhance performance and capacity within enterprise
networks and access networks. As a result, the market for fiber optic products
continues to grow both domestically and internationally.

        Demand for fiber optic transmission components is driven by four
factors: (i) fiber applications have expanded beyond traditional telephony
applications and are being deployed in enterprise network backbones to support
high-speed data communications; (ii) within access networks, fiber is rapidly
expanding downstream toward end-users as access networks deploy
Fiber-in-the-Loop and FTTC architectures to support services such as fast
Internet access and interactive video; (iii) the growth of cellular
communications and PCS requires fiber to be deployed both within and between
cells; and (iv) the usage of fiber in short distances increases the demand for
components as more are used per mile of fiber. As the size, number and
complexity of these fiber networks increases, management expects that the demand
for fiber optic components will grow significantly.

        Fiber Optic Transmission in Data Communications. As higher speed
connections are implemented in LAN/WAN systems, fiber optic transmission becomes
an essential element in computer networks. For transmission speeds of 100 Mbps
and higher, and transmission distances of 100 meters and longer, fiber optic
transmission must be deployed. Virtually all high-speed transmission standards,
such as FDDI, ATM, Fast Ethernet and Gigabit Ethernet, specify fiber optic media
as the most practical technology for transmission. The steady rise in high-speed
connections and the growth in the span of networks, including the need to
connect remote workgroups, are driving the deployment of fiber optic cable
throughout enterprise networks.

        Fiber Optic Transmission in Access Networks. To meet end users'
increased demand for content, software and services, network operators must
acquire additional bandwidth by either enhancing their existing networks or
constructing new ones. Cable TV operators are increasingly seeking to provide
general telecommunication services, high-speed Internet access and
video-on-demand. As a result, they are now faced with the need to transmit
"upstream," from customer premises to the cable TV operator and to send
different signals to individual end-users. Similarly, local exchange carriers
("LECs") are implementing new technological standards, such as Synchronous
Optical Network ("SONET") and fiber-intensive architectures such as FTTC to
enable high-speed Internet access and the delivery of cable TV and Internet
services to the home. Management believes that deployment of and upgrades to
these systems will increase the demand for the Company's fiber optic components
which typically are better able to endure environmental factors, such as rain,
snow, heat and wind, cost-effectively. In addition, cellular and PCS
communications represent a fast emerging market for fiber optic networks,
including their usage in the backbone and landline portion of wireless networks.





                                       13

<PAGE>   14

PRODUCTS AND TECHNOLOGY

        MRV offers advanced solutions for network connectivity requirements by
providing high speed LAN switching and fiber optic transmission products which
serve the computer networking and the broadband sections of the communications
industry. The Company designs and sells two groups of products: (i) high-speed
networking equipment, including LAN switches and WAN connectivity solutions, and
(ii) fiber optic transmission solutions for SONET, ATM, FDDI, Fast Ethernet,
cable TV and wireless infrastructure.

ENTERPRISE NETWORKING SOLUTIONS

        The Company designs network switching systems that increase the
productivity and functionality of LANs. MRV offers its customers a family of
network, switching and related products that enhance LAN performance and
facilitate the migration to next generation technologies such as Fast Ethernet,
Gigabit Ethernet and ATM.

        The GigaFrame Product Family. In 1997, the Company announced a GigaFrame
product strategy, the architecture for which consists of a Gigabit Ethernet
Switch, a GigaHub enterprise switch, MegaSwitch and two new low cost 10 Mbps to
100 Mbps stackable switches, all of which are now available. The Company shipped
its first GigaFrame switch, the 12 port GFS 3012, in the fourth quarter of 1997.
This switch, which also provides Gigabit Ethernet transmission over fiber optic
cable to a distance of 100 kilometers, won a best switching product award at
ComNet '98 and the Editor's choice award by Communications News magazine. In the
first quarter of 1999,the Company began shipping a new router switch in the
GigaFrame family of products, a Gigabit routing switch supporting IP routing,
Ethernet, Fast Ethernet, Gigabit Ethernet, and long distance fiber connections
for use in building metropolitan area networks ("MANs"), LANs and campus
networks. This router switch also includes several available modules, including
a wave division multiplexing ("WDM") module that combines four Gigabit Ethernet
data streams onto one fiber for transmission of data up to 50 kilometers.

        The GigaFrame family of products is a group of routing switches
providing a wide range of choices that fit current enterprise networking
requirements. With layer 3 routing, long distance fiber optic connections,
differentiated quality and class of services and the ability to handle video and
voice traffic the GigaFrame line is well positioned for the convergence of
voice, video and data on today's networks. MRV's GigaFrame products are designed
for corporate, campus and metropolitan deployment.

        The MegaSwitch Product Family. The Company's MegaSwitch products are a
family of Fast Ethernet and Gigabit Ethernet switches which are marketed under
MRV's NBase and Xyplex trade names. The MegaSwitch products range from complete
switching systems to stackable switches which upgrade performance of existing
LANs by relieving congestion of overloaded network segments, enable full duplex
and flow control and provide an easy, cost-effective migration to higher
transmission speeds without requiring replacement of existing infrastructure.
The Company's MegaSwitch products are a family of workgroup switches designed
for deployment as a cost-effective method of connecting existing networks with
higher-speed backbones and are based on Any Speed to Any Speed Ethernet
switching, including Gigabit Ethernet with access to ATM, FDDI and ISDN. Fast
Ethernet, Gigabit and ATM uplink modules incorporate InterSwitch VLAN
capabilities. InterSwitch VLANs enable the network administrator to define
separate VLANs spanning multiple switches in order to achieve optimal network
performance and serve multiple workgroups.

        WAN Connectivity Solutions. The Company provides access solutions
between LANs and WANs and ISPs. Principal network access and Internetworking
products are summarized in the table below.





                                       14
<PAGE>   15

<TABLE>
<CAPTION>
PRODUCT NAME                         APPLICATION AND FUNCTIONALITY
------------                         -----------------------------
<S>                        <C>
EdgeBlaster                EdgeBlaster is a multi-function WAN access router
                           that combines industry-standard routing protocols
                           with state-of-the-art access technologies to allow
                           branch and enterprise offices to connect users,
                           employees and remote offices using the latest digital
                           techniques. EdgeBlaster advances WAN access
                           convergence technology by integrating a full range of
                           WAN protocols for Internet and intranet, digital
                           modems, voice technologies and VPNs in a single unit,
                           replacing multi-device solutions such as routers and
                           Remote Access Services

Network 9000               This hub enables the integration of routing,
                           switching, access serving and media concentration
                           technologies. Primarily used at the central site of
                           corporate networks and at the edge of ISP networks,
                           the Network 9000 supports any combination of
                           Ethernet, Token Ring, FDDI, ISDN, ATM, local and
                           remote bridge/router connectivity.

Network 3000               This family of branch office routers provides a
                           modular, scalable solution geared toward accessing
                           the corporate network and the Internet from remote
                           offices. Any combination of Ethernet, ISDN, Frame
                           Relay and asynchronous connections is available.
                           RouteRunner is a low-cost ISDN router designed to
                           meet the WAN needs of small offices, home offices and
                           branch offices such as doctors' offices or sales
                           offices.

MAXserver                  This family of low-cost, scalable remote access
                           server solutions enables terminals, PCs, modems,
                           printers and other asynchronous devices to connect to
                           the LAN and/or WAN. Ideal for supporting workgroups,
                           the stackable MAXserver offers 8-40 ports (and up to
                           280 ports in the modular Network 9000 solution) to
                           provide network access locally and remotely via
                           dial-up services. A variety of protocols are
                           supported including TCP/IP, IPX, and Appletalk.
                           Security capabilities such as Kerberos, RADIUS,
                           SecurID, password and dial-back are also offered.
</TABLE>

        Hubs and Network Management. To implement network segments, the Company
offers GigaHub, a multi-platform switchable hub, and MegaStack, a stackable hub.
In addition, MRV has developed and offers MegaVision, which enables management
and control of its switching products and hub products.

<TABLE>
<CAPTION>
PRODUCT NAME                         APPLICATION AND FUNCTIONALITY
------------                         -----------------------------
<S>                        <C>
GigaHub                    This enterprise network solution for medium to large
                           corporate networks requiring both shared and switched
                           connectivity in a mixed protocol environment,
                           provides a 12 Gbps modular enterprise switching
                           supporting Ethernet, Fast Ethernet, Gigabit Ethernet,
                           FDDI, ATM and Token Ring, and allowing integration of
                           LAN distribution and switching in a single hub.

MegaStack                  This high-speed auto-sensing stackable hub system
                           implements Ethernet/Fast Ethernet LAN segments,
                           provides performance for mission-critical and
                           bandwidth-intensive networks. It connects from 24
                           to 196 users, is stackable with fiber optic
                           connectivity to remote locations and offers
                           plug-and-play convenience and built-in
                           auto-partitioning for instant isolation of network
                           failures.

MegaVision                 This full-featured network management system provides
                           affordable and comprehensive management and control
                           of all MegaSwitch and MegaStack products and
                           automatically detects and monitors any SNMP compliant
                           devices. It operates on all major NMS including
                           Windows 3.1, Windows 95, Windows 98, Windows NT
                           Client, Novell NMS, HP/Open View for Windows or UNIX.
</TABLE>





                                       15
<PAGE>   16

        Related Networking Products. The Company also offers a number of other
products supporting network connectivity. Examples of such products are
summarized in the table below.

<TABLE>
<CAPTION>
PRODUCT NAME                         APPLICATION AND FUNCTIONALITY
------------                         -----------------------------
<S>                        <C>
Fiber Drivers              This line of products consists of high density,
                           multi-media, multi-protocol, optical media converters
                           and switches. The Fiber Driver family provides the
                           interfaces between switches, hubs, routers and the
                           fiber or copper plan to allow existing fiber to be
                           used more efficiently, while providing network
                           management across the entire LAN, WAN or metropolitan
                           area network infrastructure. The Fiber Driver family
                           maximizes the use of existing fiber by combining
                           transmit and receive signals onto a single fiber
                           strand freeing up the second strand in a fiber paid
                           for additional data. Fiber Driver does this for all
                           speeds of Ethernet as well as ATM, SONET, SDH and
                           FDDI. In addition, the Fiber Driver family increases
                           efficiency through a WDM module.

Fiber Optic Transceivers   These products consist of Ethernet and Fast Ethernet
and converters             fiber optic transceivers that enable campus or
                           metropolitan deployment of Ethernet or Fast Ethernet
                           networks through fiber optic interconnection of LANs
                           to a distance of over 100 km, and multimode to single
                           mode fiber for FDDI, ATM and SONET that extend the
                           range of FDDI, ATM and SONET via fiber.

Token Ring                 These products consist of multimedia Token Ring hubs
                           with fiber, coax, UTP and STP connectivity which
                           extends the distance between segments of Token Ring
                           networks, and fiber optic transceivers with multimode
                           and single mode fiber, which allow flexible
                           implementation of IBM mid-range and mainframe
                           terminal connectivity.

Mid-range Connectivity     These products consist of Twinax Star panels,
                           multiplexers and repeaters which allow flexible
                           implementation of IBM mid-range and mainframe
                           terminal connectivity.
</TABLE>

        DirectIP Switching. The Company has developed, and recently introduced
as part of its MegaSwitch product line a series of DirectIP switching products
which provides the control and security of traditional routing with the
performance of switching. The Company has also incorporated its DirectIP
switching technology into its GigaFrame switch.

        AccelerRouter. In the first quarter of 1999, the Company introduced
AccelerRouter, the first in a Open Switch Router family that the Company plans
to introduce. A router accelerator, AccelerRouter provides existing routers with
performance improvements of up to 100-fold without requiring any network
configuration changes. The AccelerRouter is protocol-independent, permitting it
to work with routers from any vendor, and automatically configures itself to
work with existing network architectures.

OPTICAL TRANSMISSION PRODUCTS

        The Company offers a family of optical transmission components and
modules designed for transmission over fiber optic cable. These products address
transmission of voice, data and video across fiber and are also used in optical
fiber test equipment. The Company's products include discrete components, such
as laser diodes and LEDs and integrated components such as transmitters,
receivers and transceivers. The Company's components are used in data networks,
telecommunication transmission and access networks. Management believes that the
Company is benefitting from three major demand trends in this area: first, the
growth of the market, especially computer networking and the access networks, by
both LECs and cable




                                       16
<PAGE>   17

TV providers; second, the convergence of datacom and telecom; and third, as
transmission speed and capacity grow, a larger portion of all network traffic is
transmitted via fiber optic versus copper wires.

        Discrete Components. Discrete components include laser diodes and LEDs.
Every fiber optic communication system utilizes semiconductor laser diodes or
LEDs as its source of optical power. Laser diodes and LEDs are solid state
semiconductor devices that efficiently convert electronic signals into pulses of
light of high purity and brightness. The Company believes that its lasers and
LEDs, which can carry data over distances in excess of 20 kilometers are among
the most powerful in their wavelength range in terms of optical power coupled
into single mode fiber.

        Integrated Components. The Company's integrated components include an
LED and laser based transmitter/receiver product line, designed for computer
networking applications and data link products designed for SONET and ATM
transmission standards. This product line consists of products compatible with
single mode fiber optic cable, which is more suitable for long distance and
high-speed transmission than multimode fiber optic cable. As most currently
available data link modules are designed for multimode fiber optic cable, the
Company has designed its products to be adaptable, providing for easy conversion
from a multimode type data link to a single mode optical fiber.

        The Company recently began shipping a transmitter/receiver product
incorporating WDM and two-way transmission over single fiber, thus increasing
bandwidth and facilitating the deployment of FTTC in residential networks.

        Products for the Access Network. The Company offers a line of products
that addresses the rapidly growing deployment of the access network. These
products include fiber optic transmission by both LECs and cable TV providers to
address the increasing demand for telephony, Internet access and interactive
cable TV services. The following is a brief description of these products.

        FTTC: Telephone and High-speed Internet Access and Cable TV. The Company
offers a bidirectional optical transmission and reception module for two-way
simultaneous transmission of telephony and data over one fiber instead of the
two fibers normally used to transmit and receive information. This product is
integrated into a system currently deployed by Bell South and other LECs.

        The Company believes it is one of the few companies that offers
subsystems for an FTTC solution that can be deployed economically within 500
feet of the subscriber. Because the final drop is within 500 feet of the
subscriber, the physical characteristics of the drop cable (the "baseband"
characteristics) permit signal transmission at rates up to 155 Mbps without
requiring the addition of passband modulation electronics such as ISDN or xDSL.
In addition, the Company's fiber solution requires only a single fiber (as
opposed to separate upstream and downstream fibers). As a result, the Company
believes that its fiber solution, in certain new network buildouts, such as in
apartment complexes, can be currently deployed at a cost comparable to the cost
of deploying a copper-based system. In addition, the Company believes that the
lifetime cost of its fiber solution system will be significantly lower than
copper-based systems due to the inherently lower maintenance requirements of
fiber-based systems.

        The Company has developed WDM technology for its fiber solution that
allows users to deliver simultaneous high-speed Internet access, analog and
digital broadcast and interactive video services. This technology allows the
delivery of high-speed Internet access using an Ethernet connection. Individual
users connect to the Internet using broadly available traditional LAN connection
devices such as an Ethernet network interface card. Access via the Company's
fiber solution provides a reliable "always on" connection to the Internet with
lower power requirements than other FTTC alternatives.

        Downstream Cable TV. The Company has recently engaged in new business
opportunities for linear lasers and receivers for cable TV and believes its
products are well positioned to serve this market. The Company further believes
that the upgrade of existing cable networks and the deployment of fiber by the
telephone companies to provide cable TV delivery services is expected to
increase the demand for the Company's products.





                                       17
<PAGE>   18

        Return Path Laser Transmitters. The Company's return path laser
transmitters send video, voice and data signals from the end user to the cable
TV operator. For interactive applications such as cable modems and Fast Internet
access, a cable network must have two-way optical transmitters and receivers in
place before those services can be offered. Most of today's cable networks still
have just a one-way downstream path.

        DFB Laser Module for Cable TV (Narrowcasting). The Company offers DFB
laser modules with high power and stable analog transmission which enable cable
TV operators to send different signals to individual end users, a capability
known as narrowcasting.

PRODUCT DEVELOPMENT

        All of the Company's research and development projects are geared toward
technological advances with the goal of enabling the Company to introduce
innovative products early to market. New networking and fiber optic components
are constantly introduced to the market. This product introduction is driven by
a combination of rapidly evolving technology and standards, as well as changing
customer needs. MRV's research and product development strategy emphasizes
continuing evaluation of emerging trends and technical challenges in order to
identify new markets and product opportunities. The Company believes that its
success is due in part to its ability to maintain sophisticated technology
research programs while simultaneously focusing on practical applications to its
customers' strategic needs.

        In order to meet its customers' price and performance demands, MRV has
focused on developing custom ASICs to implement its core switching technologies.
The Company spends significant resources to maintain and extend its
comprehensive ASIC design and test expertise. All custom ASICs are developed
internally using third party state of the art design tools and the Company's
proprietary methodologies. The Company's ASIC expertise in conjunction with its
innovative product architectures and firmware enable the Company to develop
products characterized by high performance, reliability and low cost.

        The Company has successfully integrated Fibronics' research and
development projects with its own programs and has integrated its MegaSwitch
technology, including Gigabit Ethernet, with Fibronics' GigaHub architecture.
The Company has completed the consolidation of Xyplex' research and development
projects with its own and to date has integrated certain aspects of MegaSwitch
with Xyplex' networking products, including its Network 9000 and has also
introduced EdgeBlaster.

        The Company has a number of new networking product development programs
underway, including new multi-Gigabit Ethernet switching, ATM and FDDI uplink
modules. These products are being developed in response to current technological
trends and end user demands for greater bandwidth and product flexibility. In
addition, the Company is developing new networking products, which incorporate
new operating systems and additional protocols. These product development
efforts target enterprise customers as well as LECs and competitive local
exchange carriers and aim at providing backbone connectivity for IP networks.

        New products under development in the area of fiber optics include
transmission products for cellular and personal communication systems which
allow transmission over fiber optic cable between sites and also fiber optic
components that will improve cable TV transmission and technologies that add
intelligence and manageability to optical layers.

        There can be no assurance that the technologies and applications under
development by the Company will be successfully developed, or, if they are
successfully developed, that they will be successfully marketed and sold to the
Company's existing and potential customers.

        At December 31, 1998, the Company had 190 employees dedicated to
research and product development. Research and development expenditures totaled
approximately $8,201,000, $13,093,000 and $25,817,000 for years ended December
31, 1996, 1997 and 1998, respectively.




                                       18
<PAGE>   19

CUSTOMERS

        The Company has sold its products worldwide to over 500 diverse
customers in a wide range of industries, primarily; data communications,
telecommunications and cable TV. The Company anticipates that these customers
will continue to purchase its products in the foreseeable future. No customer
accounted for more than 10% of the Company's revenues in 1996, 1997 or 1998.
Current customers include:

                                NETWORK SWITCHING

<TABLE>
<S>                                          <C>
COMPUTERS AND ELECTRONICS                    GOVERNMENT AGENCIES
  - AMP Incorporated                           - General Services Administration
  - Black Box Corporation                      - Ministry of Agriculture, Germany
  - Engel GmbH & Co.                           - Ministry of Justice, Netherlands
  - Fujitsu Ltd. (Japan)                       - Ministry of Social Security (Belgium)
  - Intel Corporation                          - MITI (Japan)
  - International Business Machines Corp.      - South African Police
  - Newbridge Networks                         - US Coast Guard

BANKING, FINANCE AND INSURANCE               DIVERSIFIED AND OTHER
  - Bankgarot Sweden                           - ADP
  - Chase Manhattan Bank                       - Bayer AG
  - GE Capital                                 - Eastman Kodak
  - HBOC                                       - Tele-Communications, Inc.
  - Nationsbank                                - The Walt Disney Co.

                             FIBER OPTIC COMPONENTS

DATA COMMUNICATIONS                          TELECOMMUNICATIONS
  - Cabletron                                  - Broadband Network Inc.
  - Cisco Systems, Inc.                        - Ciena
  - Packet Engines                             - Reltec
  - Nortel Networks                            - Tellabs
  - Xylan                                      - Transcom

VIDEO AND VOICE COMMUNICATIONS               INSTRUMENTATION
  - Augat Communication Products Inc.          - EXFO
  - C-COR                                      - GN Nettest
  - General Instrument                         - Noyes Fiber Systems
  - Kathrein Werke                             - 3M
  - Texscan                                    - Wandel & Goltermann
</TABLE>

MARKETING

        The Company markets and sells its products under the NBase
Communications, MRV Communications, West Hills LAN Systems, Xyplex and Xyplex
Networks brand names. Each product line has a dedicated sales and marketing
organization. At December 31, 1998, the Company had 325 employees engaged in
marketing and sales. The Company employs various methods, such as public
relations, advertising, and trade shows to build awareness of its products.
Public relations activities are conducted both internally and through
relationships with outside agencies. Major public relation activities are
focused around new product introductions, corporate partnerships and other
events of interest to the market. The Company supplements its public relations
through media advertising programs and attendance at various trade shows
throughout the year, both in the United States and internationally.





                                       19
<PAGE>   20

        The Company also establishes working relationships with trade analysts,
testing facilities and high visibility corporate and government accounts. Since
the results obtained by these organizations can often influence customers'
purchase decisions, a positive response from these organizations regarding the
Company's technology is important to product acceptance and purchase. Other
activities include attendance at technology seminars, preparation of competitive
analyses, sales training, publication of technical and educational articles,
maintenance of a Web site and direct mailing of Company literature. The Company
also believes that its participation in high-profile interactive projects such
as Bell South's FTTC project significantly enhances its reputation and name
recognition among existing and potential customers.

SALES, SUPPORT AND DISTRIBUTION

        The Company continually seeks to augment and increase its distribution
channels and sales force to accelerate its growth. Products are sold through the
Company's direct sales force, VARs, systems integrators, distributors,
manufacturer's representatives and OEM customers. The Company's sales and
distribution divisions are organized along five primary lines: direct sales,
OEM, domestic and international distributors, VARs and systems integrators and
manufacturer's representatives; and domestic and international distributors.

        Direct Sales. The Company employs a worldwide direct sales force
primarily to sell its products to large OEM accounts and to a lesser extent to
end users of the Fibronics product line. MRV believes that a direct sales force
can best serve large customers by allowing salespeople to develop strong,
lasting relationships which can effectively meet the customers' needs. The
direct sales staff is located across the United States, Europe and Israel. The
acquisition of the Fibronics Business more than doubled the Company's sales
force from the period immediately preceding the acquisition and the Xyplex
Acquisition increased the total sales force again by over 70% from the period
immediately preceding the acquisition. The largest portion of the increase from
the Xyplex Acquisition was to the Company's domestic sales force which increased
over 175% from the level existing immediately preceding the acquisition.

        OEM. Each of the Company's OEM partners resells the products under its
own name. The Company believes that the OEM partnerships enhance its ability to
sell its products in significant quantities to large organizations. Since these
OEM partners provide their own technical and sales support to their customers,
the Company is able to focus on other sales channels. The Company customarily
enters into contracts with OEM customers to establish the terms and conditions
of sales made pursuant to orders from OEMs. These OEMs incorporate the Company's
product into systems or subsystems, which are then sold to end users via various
distribution channels. The Company has established OEM relationships in
connection with its switching equipment with leading communications and
networking companies including Newbridge Networks, Fujitsu and Intel. The
Company's fiber optic components are sold only to OEMs.

        Domestic and International Distributors. The Company works with both
domestic and international distributors. Geographic exclusivity is normally not
awarded unless the distributor has exceptional performance. Distributors must
successfully complete the Company's training programs and provide system
installation, technical support, sales support and follow-on service to local
customers. Generally, distributors have agreements with a one year term subject
to automatic renewal unless otherwise canceled by either party. In certain cases
with major distributors, the agreements are terminable on 30 days' notice. The
Company uses stocking distributors, which purchase the Company's product and
stock it in their warehouse for immediate delivery, and non-stocking
distributors, which purchase the Company's product after the receipt of an
order. Internationally, the Company sells through approximately 80 distributors
in Asia, Africa, Europe, Australia, the Middle East, Canada and Latin America.

        Value-Added Resellers and Systems Integrators. MRV uses a select group
of VARs and system integrators in the U.S. which are generally selected for
their ability to offer the Company's products in combination with related
products and services, such as system design, integration and support. Such
specialization allows the Company to penetrate targeted vertical markets such as
telecommunications and cable TV. Generally, the Company uses a two-tier
distribution system to





                                       20
<PAGE>   21

reach a broader range of customers, however VARs may purchase the product
directly from the Company if the volume warrants a direct relationship.

        Through the Xyplex Acquisition, the Company has added a network of over
300 VARs to its distribution channel. The Company seeks to build dedication and
loyalty from its resellers by offering special programs, the most recent
providing its reseller base of companies dedicated marketing resources and an
exclusive training and support program to help them grow their business.

        Manufacturers' Representatives. To supplement the Company's direct sales
efforts, manufacturer's representatives are assigned by territory in the United
States and work exclusively on commission.

        Customer Support and Service. The Company is committed to providing
strong technical support to its customers. MRV operates a customer service
group, and provides support through its engineering group, sales staff,
distributors, OEMs and VARs. Customer support personnel are currently located at
the Company's offices in California, Massachusetts, Maryland, Germany, England,
Italy and Israel.

        International Sales. International sales accounted for approximately
53%, 60% and 59% of the Company's net revenues in 1996, 1997 and 1998,
respectively.

MANUFACTURING

        The Company has developed proprietary ASICs to implement high level
component integration in its networking product development and manufacturing
processes. To develop ASICs successfully, the Company must transfer a code of
instructions to a single mask from which low cost duplicates can be made. Each
iteration of a mask involves a substantial up-front cost which can adversely
affect the Company's result of operations and financial condition if errors or
"bugs" occur following multiple duplication of the masks. While the Company has
not experienced material expenses to date as a result of errors discovered in
ASIC masks, because of the complexity of the duplication process and the
difficulty in detecting errors, the Company could suffer a material adverse
effect to its operating results and financial condition if errors in developing
ASICs were to occur in the future. The Company does not have a long-term supply
contract with any ASIC vendor or any other of its limited source vendors,
purchasing all of such components on a purchase order basis under standard terms
of sale. While the Company believes it would be able to obtain alternative
sources of supply for the ASICs or other key components, a change in ASIC or
other key suppliers of key components could require a significant lead time and,
therefore, could result in a delay in product shipments. While the Company has
not experienced delays in the receipt of ASICs or other key components, any
future difficulty in obtaining any of these key components could result in
delays or reductions in product shipments which, in turn, could have material
adverse effect on the Company's business, operating results and financial
condition.

        The Company outsources the board-level assembly, test and quality
control of its computer networking products to third party contract
manufacturers, thereby allowing it to react quickly to market demand, to avoid
the significant capital investment required to establish and maintain
manufacturing and assembly facilities and to concentrate its resources on
product design and development. Final assembly, burn-in, final testing and
pack-out are performed by the Company and selected third-party contract
manufacturers to maintain quality control. The Company's manufacturing team is
experienced in advanced manufacturing and testing, in engineering, in ongoing
reliability/quality assurance and in managing third party contract
manufacturer's capacity, quality standards and manufacturing process. Risks
associated with the use of independent manufacturers include unavailability of
or delays in obtaining adequate supplies of products and reduced control of
manufacturing quality and production costs. If the Company's contract
manufacturers fail to deliver products in the future on a timely basis, or at
all, it would be extremely difficult for the Company to obtain adequate supplies
of products from other sources on short notice. There can be no assurance that
the Company's third party manufacturers will provide adequate supplies of
quality products on a timely basis, or at all. The Company could outsource with
other vendors; however, such a





                                       21
<PAGE>   22

change in vendors may require significant time and result in shipment delays and
expenses. The inability to obtain such products on a timely basis, the loss of a
particular vendor or a change in the terms and conditions of the outsourcing
would have a material adverse effect on the Company's business, operating
results and financial condition.

        The Company relies almost exclusively on its own production capability
for critical semiconductor lasers and LEDs used in its products. The Company's
optical transmission production process involves (i) a wafer processing facility
for semiconductor laser diode and LED chip manufacturing under stringent and
accurate procedures using state-of-the-art wafer fabrication technology, (ii)
high precision electronic and mechanical assembly, and (iii) final assembly and
testing. Relevant assembly processes include die attach, wirebond, substrate
attachment and fiber coupling. The Company also conducts tests throughout its
manufacturing process using commercially available and in-house built testing
systems that incorporate proprietary procedures. The Company performs final
product tests on all of its products prior to shipment to customers. Many of the
key processes used in the Company's products are proprietary; and, therefore,
many of the key components of the Company's products are designed and produced
internally. Because the Company manufactures these and other key components of
its products at its own facility and such components are not readily available
from other sources, any interruption of the Company's manufacturing process
could have a material adverse effect on the Company's operations. Furthermore,
the Company has a limited number of employees dedicated to the operation and
maintenance of its wafer fabrication equipment, the loss of any of whom could
result in the Company's inability to effectively operate and service such
equipment. Wafer fabrication is sensitive to a wide variety of factors,
including variations and impurities in the raw materials, difficulties in the
fabrication process and performance of the manufacturing equipment. There can be
no assurance that the Company will be able to maintain acceptable production
yields and avoid product shipment delays. In the event adequate production
yields are not achieved resulting in product shipment delays, the Company's
business, operating results and financial condition could be materially
adversely affected. The Company believes that it has sufficient manufacturing
capacity for growth in the coming years. In addition, at various times there
have been shortages of parts in the electronics industry, and certain critical
components have been subject to limited allocations. Although shortages of parts
and allocations have not had a material adverse effect on the Company's results
of operations, there can be no assurance that any future shortages or
allocations would not have such an effect.

        The Company is subject to a variety of federal, state, and local
governmental laws and regulations related to the storage, use, emission,
discharge, and disposal of toxic, volatile or otherwise hazardous chemicals used
in the manufacturing process. There can be no assurance that environmental laws
and regulations will not result in the need for additional capital equipment or
other requirements. Further, such laws and regulations could restrict the
Company's ability to expand its operations. Any failure by the Company to obtain
required permits for, control of use of, or adequately restrict the discharge,
emission or release of, hazardous substances under present or future laws and
regulations could subject the Company to substantial liability or could cause
its manufacturing operations to be suspended. Such liability or suspension of
manufacturing operations could have a material adverse effect on the Company's
operating results. To date, such laws and regulations have not had a material
adverse effect on the Company's operating results.

COMPETITION

        The communications equipment and component industry is intensely
competitive. The Company competes directly with a number of established and
emerging computer, communications and networking device companies. Direct
competitors in network switching include Cabletron Systems, Inc., Cisco Systems
Inc., FORE Systems, Inc., Lucent Technologies, Nortel Networks, 3Com Corporation
and Xylan. Direct competitors in the network access market include Ascend, Cisco
Systems, Inc., Lucent Technologies, Nortel Networks, Shiva and 3Com. Direct
competitors in fiber optic transmission products include AMP Incorporated,
Fujitsu, Hewlett-Packard Company, Lucent Technologies Inc., Mitsubishi, NEC
Electronics Inc., Ortel Corporation and Siemens Components, Inc. Many of the
Company's competitors have significantly greater financial, technical,
marketing, distribution and other resources and larger installed customer bases
than MRV. Several of these competitors have recently introduced or announced
their intentions to introduce new competitive products. Many of the larger
companies with which the Company competes offer customers a broader product line
which provides a more comprehensive





                                       22
<PAGE>   23

networking solution than the Company's products. The ability to act as a single
source vendor and provide a customer with an enterprise-wide networking solution
has increasingly become an important competitive factor. In addition, there are
a number of early stage companies which are developing Fast Ethernet, Gigabit
Ethernet switching and alternative solutions. If developed successfully, these
solutions could be higher in performance or more cost-effective than the
Company's products.

        Moreover, there are also several alternative network technologies. For
example, in the local access market, the Company's products compete with
telephone network technology known as "ADSL." In this technology, digital
signals are transmitted through existing telephone lines from the central office
to the home. The Company also expects that competitive pricing pressures could
result in price declines for the Company's and its competitors' products. Such
increased competition, if not accompanied by decreasing costs, could result in
reduced margins and loss of market share which would materially and adversely
affect the Company's business, operating results and financial condition.

        The networking industry has become increasingly concentrated in recent
years as a result of consolidation. This consolidation is likely to permit the
Company's competitors to devote significantly greater resources to the
development and marketing of new competitive products and the marketing of
existing competitive products to their larger installed bases. The Company
expects that competition will increase substantially as a result of these and
other industry consolidations and alliances, as well as the emergence of new
competitors.

PROPRIETARY RIGHTS

        To date, the Company has relied principally upon copyrights and trade
secrets to protect its proprietary technology. The Company generally enters into
confidentiality agreements with its employees and key suppliers and otherwise
seeks to limit access to and distribution of the source code to its software and
other proprietary information. There can be no assurance that such steps will be
adequate to prevent misappropriation of the Company's technology or that a third
party will not independently develop technology similar or superior to the
Company's technology. The Company has recently filed two patent applications and
a provisional patent application in the United States. With the Xyplex
Acquisition, MRV acquired five additional provisional patent applications filed
by Xyplex on certain aspects of its technology. There can be no assurance that
patents will be issued with respect to the pending applications or that, if
issued, such patents will be upheld as valid or will prevent the development of
competitive products. In addition, the laws of some foreign countries may not
permit the protection of the Company's proprietary rights to the same extent as
do the laws of the United States.

        There has been substantial industry litigation regarding intellectual
property rights involving technology companies. By letter to the Company dated
March 19, 1997, a party has made a claim against the Company alleging that the
Company's DirectIP switching products make use of unspecified information and
know-how covered by a pending patent application of such party. This allegation
is under review by the Company and the Company believes that the allegation is
without merit. However, a complete assessment cannot be made with respect to the
merits of the allegation until further details of the information and know-how
are provided by such third party. Currently, sales of DirectIP products are not
material to the Company, however, if the DirectIP switching products comprise a
material part of the Company's revenues in the future and a conclusion in
respect of the claim unfavorable to the Company is reached, the claim, if
pursued by such party, could materially and adversely affect the business,
operating results and financial condition of the Company. In addition, on
December 27, 1996 Datapoint Corporation ("Datapoint") brought an action against
NBase Communications, Inc., a subsidiary of the Company ("NBase"), and others
alleging infringement of two of Datapoint's patents. The other defendants
include Dayna Communications, Inc., Sun Microsystems, Inc., Adaptec, Inc.,
International Business Machines Corporation, Lantronix and SVEC America Computer
Corporation. Intel and Cisco Systems, Inc. have also had actions brought against
them by Datapoint with respect to the same two patents. The Company is
cooperating with several of these companies in pursuit of common defenses and
believes it has meritorious defenses to this action. If a conclusion unfavorable
to the Company is reached, however, Datapoint's claim could materially and
adversely affect the business, operating results and financial condition of the
Company. For further information concerning this litigation, see Item 3. Legal
Proceedings.





                                       23
<PAGE>   24

        In the future, additional litigation may be necessary to protect trade
secrets and other intellectual property rights owned by the Company, to enforce
any patents issued to the Company, to defend the Company against claimed
infringement of the rights of others and to determine the scope and validity of
the proprietary rights of others. Any such litigation could be costly and a
diversion of management's attention, which could have a material adverse effect
on the Company's business, operating results and financial condition. An adverse
determination in such litigation could further result in the loss of the
Company's proprietary rights, subject the Company to significant liabilities,
require the Company to seek licenses from third parties or prevent the Company
from manufacturing or selling its products, any of which could have a material
adverse effect on the Company's business, operating results and financial
condition. The Company typically has agreed to indemnify its customers and key
suppliers for liability incurred in connection with the infringement of a third
party's intellectual property rights.

EMPLOYEES

        As of December 31, 1998, the Company had 824 full-time employees,
including six executive officers, 227 in production, 325 in marketing and sales,
190 in research and development and 76 in general administration. None of the
Company's employees are represented by a union or governed by a collective
bargaining agreement, and the Company believes its relationship with its
employees is good.












                                       24

<PAGE>   25


ITEM 2. PROPERTIES

        The Company's principal administrative, sales and marketing, research
and development and manufacturing facility is located in Chatsworth, California.
The facility covers approximately 17,700 square feet and is leased from an
unaffiliated third party at an annual base rent of approximately $122,260
through March 31, 1999 and approximately $150,000 through the end of the lease
term in February 2004. In addition, the Company leases space in buildings near
its primary facility in Chatsworth. One of these facilities, consisting of
approximately 20,950 square feet, is leased from an unaffiliated third party at
an annual base rental of approximately $131,000 with a term expiring in January
2003. Another facility covers approximately 12,800 square feet and is leased fom
an unaffiliated party at an annual base rent of approximately $98,000 through
March 1999. The Company is in the process of negotiating an extension to this
lease.


        Xyplex occupies a facility in Littleton, Massachusetts, consisting of
approximately 101,000 square feet under a lease that expires in September 2003.
Annual base rent under this lease is approximately $1,061,00 through September
2001 and $1,086,000 thereafter through expiration of the lease. Most of the
square footage is used for manufacturing, engineering, and product development,
while the remainder is used for sales, marketing, and other general and
administrative support.

        The Company's administrative, sales and marketing, research and
development and manufacturing operations in Israel are located in Yokneam,
Israel in facilities that cover approximately 23,400 square feet, are leased for
a total annual base rent of approximately $206,000 for a lease term expiring in
January 2002.

        The Company leases approximately 1,600 square feet of space from an
unaffiliated third party in Frankfurt, Germany, which it uses for sales,
marketing and warehousing. The premises are leased for total annual base rents
of approximately $221,000 for a lease term expiring in August 1999.

        The Company also occupies space under a capital lease with an
unaffiliated third party in Milan, Italy which it uses for sales offices and
warehousing. Annual payments under the lease are approximately $220,000 and the
lease expires in March 2004.

        The Company believes that its present facilities are sufficient to meet
its current needs and that adequate additional space will be available for lease
when required.












                                       25

<PAGE>   26

ITEM 3. LEGAL PROCEEDINGS

        On December 27, 1996, Datapoint brought an action against NBase and
several other defendants in the United States District Court for the Eastern
District of New York alleging infringement of two of Datapoint's patents related
to LANs. More particularly Datapoint claims relate to allegedly improved LANs
which interoperatively combine additional enhanced capability and/or which
provide multiple different operational capabilities. In the same lawsuit,
Datapoint alleges that other defendants including Dayna Communications, Inc.,
Sun Microsystems, Inc., Adaptec, Inc., International Business Machines
Corporation, Lantronix and SVEC America Computer Corporation have infringed the
same two patents. The Company has been advised that several other companies,
including Intel Corporation and Cisco Systems, Inc. have also had actions
brought against them by Datapoint with respect to the same two patents. The
action against NBase and its codefendants seeks, among other things, an
injunction against the manufacture or sale of products which embody the
inventions set forth in the two patents and single and treble damages for the
alleged infringement. Datapoint's complaint also seeks to have the court
determine that the named defendants shall serve as representatives of a
defendant class of manufacturers, vendors and users of products allegedly
infringing on Datapoint's claimed patents from which defendant class Datapoint
seeks the same relief as from the individual defendants. In February 1999, the
court entered judgment in favor of the defendants and plaintiff filed a notice
of appeal. The Company is cooperating with several of the defendants in pursuit
of common defenses and believes it has meritorious defenses to this action. If a
conclusion unfavorable to the Company is reached, however, Datapoint's claim
could materially affect the business, operating results and financial condition
of the Company.




















                                       26

<PAGE>   27

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        On October 30, 1998, the Company held its Annual Meeting of Shareholders
(the "Annual Meeting") at which, among other things, the Company's entire board
of directors was elected. The name of each director elected at the Annual
Meeting, and the number of votes cast for and against (or withheld) were as
follows:

                                 Number of Votes

<TABLE>
<CAPTION>
      Name                                  For           Against or Withheld
      ----                                  ---           -------------------
<S>                                     <C>                     <C>    
Noam Lotan                              24,596,324              354,796

Shlomo Margalit                         24,596,774              354,346

Zeev Rav-Noy                            24,596,774              354,346

Igal Shidlovsky                         24,596,774              354,346

Guenter Jaensch                         24,596,774              354,346
</TABLE>

        The other matters voted upon at the meeting and the number of votes cast
for, against or withheld, including abstentions and broker non-votes, as to each
matter were as follows:

<TABLE>
<CAPTION>
                 PROPOSAL                                        FOR        AGAINST         ABSTAIN
                 --------                                        ---        -------         -------
<S>                                                          <C>           <C>              <C>   
To approve an amendment to the Company's
Certificate of Incorporation to increase the number
of authorized shares of the Company's Common Stock
from 40,000,000 to 80,000,000 shares.                        23,805,393    1,073,563        72,164

To approve amendments to the Company's 1997
Incentive and Nonstatutory Stock Option Plan to
increase by 500,000 shares the number of shares
of Common Stock that can be optioned and sold under
such Stock Option Plan.                                      23,812,024    1,016,011      123,085

To ratify the selection of Arthur
Andersen LLP as independent auditors for
the Company for the fiscal year ending
December 31, 1998.                                           24,688,763      192,734      69,623

To consider and act upon any matters
incidental to the foregoing and any
other matters which may properly come
before the meeting or any adjournment or
adjournments thereof.                                        23,131,572    1,478,081     341,467
</TABLE>






                                       27

<PAGE>   28


PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        The Company's Common Stock is traded in the over-the-counter market and
has been included in the Nasdaq National Market since February 28, 1994 under
the symbol "MRVC." The following table sets forth the high and low closing sale
prices of the Common Stock for the periods indicated as reported by The Nasdaq
National Market.

<TABLE>
<CAPTION>

                                                               HIGH      LOW
                                                              ------    ------
<S>                                                          <C>       <C>    
1997:
  First Quarter............................................. $ 29.88   $ 18.25
  Second Quarter............................................   30.75     18.25
  Third Quarter.............................................   38.75     25.75
  Fourth Quarter............................................   37.75     21.13

1998:
  First Quarter............................................. $ 29.00   $ 21.13
  Second Quarter............................................   28.38     19.38
  Third Quarter.............................................   24.00      5.06
  Fourth Quarter............................................    9.06      5.13
</TABLE>

        At March 19, 1999, the Company had 290 stockholders of record, as
indicated on the records of the Company's transfer agent, who held, management
believes, for approximately 19,523 beneficial holders.

        The Company has never declared or paid cash dividends on the Common
Stock since its inception. The Company currently intends to retain all of its
earnings, if any, for use in the operation and expansion of its business and
does not intend to pay any cash dividends to its stockholders in the foreseeable
future.








                                       28


<PAGE>   29



ITEM 6. SELECTED FINANCIAL DATA

        The following selected statement of operations data for the three years
in the period ended December 31, 1998 and the balance sheet data as of December
31, 1997 and 1998 are derived from the financial statements and notes thereto
included elsewhere herein audited by Arthur Andersen LLP, independent public
accountants, as set forth in their report included elsewhere herein. The
selected statement of operations data for the two years in the period ended
December 31, 1995 and the balance sheet data as of December 31, 1994, 1995 and
1996 were derived from audited financial statements of the Company not included
herein. The following data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements of the Company, including the notes
thereto, included elsewhere in this Report.

<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
                                                                              Year ended December 31,
                                                            ------------------------------------------------------------
                                                               1994        1995         1996         1997         1998
                                                            ---------   ---------    ---------    ---------    ---------
                                                                     (In thousands, except per share amounts)
<S>                                                         <C>         <C>          <C>          <C>          <C>      
Revenues, net ...........................................   $  17,526   $  39,202    $  88,815    $ 165,471    $ 264,075
Cost of goods sold ......................................      10,328      22,608       51,478       94,709      162,284
Write-down of discontinued products .....................        --          --           --           --          3,101
Research and development expenses .......................       2,144       4,044        8,201       13,093       25,817
Selling, general and administrative expenses ............       2,615       6,799       14,025       27,365       56,753
                                                            ---------   ---------    ---------    ---------    ---------
Operating income before purchased technology in progress 
and restructuring costs..................................       2,439       5,751       15,111       30,304       16,120
Purchased technology in progress(1) .....................        --         6,211       17,795         --         20,633
Restructuring costs(1) ..................................        --         1,465        6,974         --         15,671
                                                            ---------   ---------    ---------    ---------    ---------
Operating income (loss) .................................       2,439      (1,925)      (9,658)      30,304      (20,184)
Other income (expense), net .............................         162         654          153        2,744        6,819
Interest expense related to convertible 
debentures/notes(2)......................................        --          --         (4,357)        (843)      (2,480)
                                                            ---------   ---------    ---------    ---------    ---------
Income (loss) before provision for income taxes, minority
interests and extraordinary item.........................       2,601      (1,271)     (13,862)      32,205      (15,845)
Provision (credit) for income taxes .....................         983           2       (4,404)       9,474        5,707
Minority interests ......................................        --          --            196          146        1,345
Gain on repurchase of convertible notes, net of tax .....        --          --           --           --          2,791
                                                            ---------   ---------    ---------    ---------    ---------
Net income (loss)(1) ....................................   $   1,618   $  (1,273)   $  (9,654)   $  22,585    $ (20,106)
                                                            =========   =========    =========    =========    =========
Net income (loss)  per share - Basic(1) .................   $    0.13   $   (0.07)   $   (0.49)   $    0.95    $   (0.76)
                                                            =========   =========    =========    =========    =========
Net income (loss)  per share - Diluted(1) ...............   $    0.13   $   (0.07)   $   (0.49)   $    0.88    $   (0.76)
                                                            =========   =========    =========    =========    =========
Shares used in per share calculation - Basic ............      12,335      18,377       19,739       23,670       26,532
Shares used in per share calculation - Diluted ..........      12,560      18,377       19,739       25,734       26,532
</TABLE>

<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEET DATA:
                                                                                 At December 31,
                                                            ------------------------------------------------------------
                                                               1994        1995         1996         1997         1998
                                                            ---------   ---------    ---------    ---------    ---------
                                                                                  (In thousands)
<S>                                                         <C>         <C>          <C>          <C>          <C>      
Working capital .........................................   $  11,303   $  22,019    $  56,973    $ 111,559    $ 115,318
Total assets ............................................      16,667      33,307       96,943      236,236      320,192
Long-term  debt, net of current portion .................        --           271       18,892        2,853       94,317
Stockholders' equity ....................................      12,906      25,258       41,771      189,969      174,429
</TABLE>

-----------------
    (1) Purchased technology in progress and restructuring charges were incurred
    as a result of acquisitions. Purchased technology in progress for the year
    ended December 31, 1995 was for research and development ("R&D") projects in
    progress at the time of acquisition of assets from Ace and Galcom.
    Restructuring costs during the year ended December 31, 1995 were associated
    with a plan adopted by the Company in 1995 calling for the merger of the
    newly acquired subsidiaries and the Company's LAN product division. The plan
    also called for the closure of some facilities, termination of redundant
    employees and cancellation of representation agreements. Purchased
    technology in progress for the year ended December





                                       29
<PAGE>   30

    31, 1996 was in conjunction with the Fibronics Acquisition. Restructuring
    costs during the year ended December 31, 1996 were associated with a plan
    adopted by the Company on September 30, 1996 calling for the reduction of
    workforce, closing of certain facilities, retraining of certain employees
    and elimination of particular product lines due to this acquisition.
    Purchased technology in progress for the year ended December 31, 1998 was in
    conjunction with the Xyplex Acquisition. Restructuring costs during the year
    ended December 31, 1998 were associated with a plan adopted by the Company
    in March 1998 calling for the reduction of workforce, closing of certain
    facilities, elimination of particular product lines, settlement of
    distribution agreements and other costs.

    (2) Interest expenses for the years ended December 31, 1996 and 1997 were
    in connection with the private placement of $30 million principal amount of
    Debentures, the proceeds from which the Company used to finance the cash
    portion of the Fibronics Acquisition. Interest expenses for the year ended
    December 31, 1998 were connected with the private placement of $100 million
    principal amount of 5% Convertible Subordinated Notes.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS

        This Report contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in the following and elsewhere in this Report. The
following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto appearing elsewhere in this Report.

GENERAL

        Since its inception in 1988, the Company has manufactured and marketed
semiconductor optical transmission products for the fiber optics communications
industry. In 1993, the Company expanded its product line to include products
incorporating Ethernet switching technology that improved network throughput and
enhanced efficiency of LANs and introduced its first switch marketed under the
NBase trademark in the fourth quarter of 1993. During 1994, the Company expanded
commercial shipments of its LAN switching products. In 1995, the Company
augmented its networking products with the acquisitions of certain assets of
Galcom and Ace, which resulted in charges of $6,211,000 and $1,465,000 for
purchased technology in progress and restructuring, respectively. Net revenues
from sales of networking products and semiconductor optical transmission
products were approximately 69.4% and 30.6%, respectively, during the year ended
December 31, 1996, approximately 76.1% and 23.9%, respectively, during the year
ended December 31, 1997 and approximately 81.5% and 18.5%, respectively, during
the year ended December 31, 1998.

        In September 1996, the Company completed the Fibronics Acquisition,
acquiring assets related to Fibronics' computer networking and
telecommunications businesses in Germany, the United States, the United Kingdom,
the Netherlands and Israel. The assets acquired include Fibronics' technology in
progress and existing technology, its marketing channels, its GigaHub family of
computer networking products and other rights. This acquisition also resulted in
charges in the amount $17,795,000 and $6,974,000 for purchased technology in
progress and restructuring, respectively. Through the restructuring of September
30, 1996, the Company expected to improve Fibronics' operations in, among
others, the following key areas: (i) the elimination of unprofitable products
and operations that appeared detrimental to overall profit margins; (ii) the
reduction of payroll by eliminating redundant staff; (iii) the merger and
relocation of research and development resources to place qualified individuals
on the most appropriate projects; (iv) and the reduction of overhead costs by
the closure of redundant facilities. The costs incurred to complete the research
and development in process at the time of the Fibronics Acquisition have not had
a material effect on MRV's research and development expenses as a percentage of
net sales. These projects were completed as of 1997.

        In September 1996, the Company completed a private placement of an
aggregate of $30,000,000 principal amount of 5% convertible subordinated
debentures due August 6, 1999 (the "Debentures"). Proceeds from this private
placement were used to purchase the Fibronics Business. The Debentures were
convertible into Common Stock of the Company at any time at the option of the
holders at a discount from the market price of the Common Stock at the time of
conversion that decreased over the life of the Debentures until it reached a
floor. At a meeting of the Emerging Issues Task Force held on March 13,





                                       30
<PAGE>   31

1997, the staff of the Securities and Exchange Commission ("SEC") announced its
position on the accounting treatment for the issuance of convertible preferred
stock and debt securities with a beneficial conversion feature such as that
contained in the Debentures. As announced, the SEC requires that a beneficial
conversion feature attached to instruments such as the Debentures that are
convertible into equity be recognized and measured by allocating a portion of
the proceeds equal to the intrinsic value of that feature to additional paid-in
capital and charging it to interest expense. As a result of the SEC's position,
the Company added a non-recurring, non-cash charge to its results of operations
for the years ended December 31, 1996 and 1997 related to the issuance of the
Debentures in the amounts of $4,357,000 and $843,000, respectively. The
outstanding principal and accrued interest on the Debentures were paid in full
at April 4, 1997 through conversion into Common Stock. See "Liquidity and
Capital Resources" below.

        On January 30, 1998, MRV completed the Xyplex Acquisition from
Whittaker. The purchase price paid to Whittaker consisted of $35,000,000 in cash
and 3-year warrants to purchase up to 421,402 shares of common stock of the
Company at an exercise price of $35 per share. During the year ended December
31, 1995, the period from January 1, 1996 through April 9, 1996 (the day Xyplex
was acquired by Whittaker), the period from April 10, 1996 through October 31,
1996 and the fiscal year ended October 31, 1997, Xyplex reported net revenues of
$107,617,000, $28,100,000, $52,021,000, and $75,663,000, respectively, and net
losses of $37,360,000, $2,269,000, $13,353,000 and $80,309,000, respectively. In
connection with the Xyplex Acquisition, the Company incurred charges of
$20,633,000 and $15,671,000 for purchased technology and restructuring.

        MRV originally recorded charges of $30,571,000 related to research and
development projects in progress at the time of the Xyplex Acquisition. Although
MRV reported these charges and its first, second and third quarter results of
1998 in accordance with established accounting practice and valuations of
Xyplex' purchased technology in progress provided by independent valuators,
these valuations have been reconsidered in light of very recent Securities and
Exchange Commission guidance regarding valuation methodology. Based on this new
valuation methodology, MRV has reduced the value of the purchased technology in
progress related to the Xyplex Acquisition to $20,633,000 and increased the
amount of goodwill by $9,938,000. This has resulted in additional charges during
1998 of $759,000 for intangibles, including goodwill, resulting from the Xyplex
Acquisition and will result in charges of approximately $828,000 annually as
these intangibles are amortized through January 2010.

        Recent actions and comments from the Securities and Exchange Commission
have indicated that the Commission is reviewing the current valuation
methodology of purchased in-process research and development related to business
combinations. Unlike the case of many other companies, the Commission has not
notified MRV of any plans to review MRV's methodology for valuing purchased
in-process research and development. The Company's action to reconsider that
valuaton of in process research and development related to the Xyplex
Acquisition has been voluntary. The Company believes it is in compliance with
all of the rules and related guidance as they currently exist. However, there
can be no assurance that the Commission will not review MRV's accounting for the
Xyplex Acquisition and seek to apply retroactively new guidance and further
reduce the amount of purchased in-process research and development expensed by
the Company. This would result in an additional restatement of previously filed
financial statements of the Company and could have a material adverse impact on
financial results for periods subsequent to the acquisition.

        The Company's international sales are not concentrated in any specific
country. The estimated operating profit from international sales for the years
ended December 31, 1996, 1997 and 1998 were $8,009,000, $18,113,000 and
$11,733,000, respectively. The amount for the year ended December 31, 1996 is
before non-recurring charges. Including non-recurring charges, operating loss
from international sales for the year ended December 31, 1996 was $16,054,000.
At December 31, 1996 and 1997, 14.2% and 17.1%, respectively, of the Company's
assets were located in the Middle East. At December 31, 1998, the Company's
assets in the Middle East were not material. At December 31, 1997 and 1998,
14.4% and 20.7%, respectively, of the Company's assets were located in the
European Community. Except for such assets, there were no significant assets
located in geographic regions outside of the U.S. at December 31, 1996, 1997 or
1998.





                                       31
<PAGE>   32

RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
                                                                            Year ended December 31,
                                                                         ----------------------------
                                                                          1996       1997       1998
                                                                         ------     ------     ------
          <S>                                                            <C>        <C>        <C>   
          Revenues, net ...........................................      100.0%     100.0%     100.0%
          Cost of goods sold ......................................       58.0       57.2       61.5
          Write-down of discontinued products .....................         --         --        1.2
          Research and development expenses .......................        9.2        7.9        9.8
          Selling, general and administrative expenses ............       15.8       16.5       21.5
                                                                         ------     ------     ------
          Operating income before purchased technology in
            progress and restructuring costs ......................       17.0       18.3        6.1
          Purchased technology in progress ........................       20.0         --        7.8
          Restructuring costs .....................................        7.9         --        5.9
                                                                         ------     ------     ------
          Operating income (loss) .................................      (10.9)      18.3       (7.6)
          Other income (expense), net .............................        0.2        1.7        2.6
          Interest expense related to convertible debentures/notes        (4.9)      (0.5)      (0.9)
                                                                         ------     ------     ------
          Income (loss) before provision for income taxes, minority
            interests and extraordinary item ......................      (15.6)      19.5       (6.0)
          Provision (credit) for income taxes .....................       (5.0)       5.7        2.2
          Minority interests ......................................        0.2        0.1        0.5
          Gain on repurchase of convertible notes, net of tax .....         --         --        1.1
                                                                         ------     ------     ------
          Net income (loss) .......................................      (10.9)%     13.6%      (7.6)%
                                                                         ======     ======     ======
</TABLE>

Years ended December 31, 1998 and 1997

        Revenues. Revenues for the year ended December 31, 1998 were
$264,075,000, compared to $165,471,000 for the year ended December 31, 1997, an
increase of 59.6%. Revenues from sales of networking products and optical
transmission products were 81.5% and 18.5%, respectively, of total revenues
during the year ended December 31, 1998 as compared to 76.1% and 23.9%,
respectively, of total revenues during the year ended December 31, 1997.
Revenues increased as a result of a larger sales force, greater marketing
efforts and greater market acceptance of the Company's products, both
domestically and internationally. The increase in sales of networking products
during the year ended December 31, 1998 over 1997 was the result of an
increased number of networking products available for sale and a larger sales,
marketing and customer support organization to support such sales. International
sales accounted for approximately 59.3% of revenues for year ended December 31,
1998, as compared to 59.8% of revenues for year ended December 31, 1997.

        Gross Profit; Write-down of Discontinued Products. Gross profit for the
year ended December 31, 1998 was $101,791,000 compared to $70,762,000 for the
year ended December 31, 1997. The changes represented an increase of $31,029,000
or 43.8% for the year ended December 31, 1997. Gross Profit as a percentage of
revenues decreased from 42.8% during the year ended December 31, 1997 to 38.5%
for the year ended December 31, 1998 as a result of intense price competition
from competitors. The Company had planned to compensate for such price
competition by introducing new lower cost products during the latter half of
1998. However, while the Company did begin shipping such products during the
last quarter of 1998, they were introduced too late in the year to make
meaningful contributions to revenue.





                                       32
<PAGE>   33

        During the last quarter of 1998, the Company determined to discontinue
some of its low-end networking products that were not sufficiently profitable
and this resulted in a one time write-down of $3,101,000.

        Research and Development. For the years ended December 31, 1998 and
1997, research and development expenses ("R&D") expenses were $25,817,000 and
$13,093,000, respectively. R&D expenses as a percentage of revenues increased
from 7.9% of revenues during year ended December 31, 1997, to 9.8% of revenues
for year ended December 31, 1998. This increase was primarily caused by
additional developed projects commenced during the year and associated personnel
costs as well as increased expenses resulting from personnel added to existing
projects.. The Company intends to continue to invest in the research and
development of new products. Management believes that the ability of the Company
to develop and commercialize new products is a key competitive factor.

        Selling, General and Administrative. For the years ended December 31,
1998 and 1997, selling, general and administrative ("SG&A") expenses increased
to $56,753,000 rom $27,365,000. As a percentage of revenues, SG&A increased from
16.5% for the year ended December 31, 1997 to 21.5% for the year ended December
31, 1998. The increases in SG&A expense, both in dollar amounts and as a
percentage of sales were due primarily to substantially increased marketing
efforts as well as the addition of personnel and overhead costs in additional
and expanded locations.

        Purchased Technology in Progress and Restructuring Costs. Purchased
technology in progress for the year ended December 31, 1998 was $20,633,000. The
purchased technology in 1998 was related to R&D projects of Xyplex in progress
at the time of the Xyplex Acquisition on January 30, 1998, which had not yet
reached technological feasibility and for which the Company had no alternative
future use. Restructuring costs during the year ended December 31, 1998 were
$15,671,000. The restructuring costs in 1998 were associated with a plan adopted
by the Company in March 1998 calling for the reduction of workforce, closing of
certain facilities, elimination of particular product lines, settlement of
distribution agreements and other costs. The restructuring costs incurred in
first quarter of 1998 as a result of the Xyplex Acquisition was offset by a
restructuring credit of $7,523,000 booked during the last quarter of 1998 in
connection with Company's decision to consolidate the Xyplex and NBase
organizations. This credit principally resulted from the renegotiation of
Xyplex' lease in Littletown, Massachusetts and a reevaluation reducing the
anticipated cost of discontinuing some of Xyplex' legacy products. The Company
did not incur these charges or receive a similar credit in 1997.

        Interest Expense Related to Convertible Debt. In September 1996, the
Company completed a private placement of $30,000,000 principal amount of
convertible Debentures. See "Liquidity and Capital Resources," below. To give
effect to the accounting treatment announced by the staff of the Securities and
Exchange Commission at the March 13, 1997 meeting of the Emerging Issues Task
Force relevant to the Company's issuance of the Debentures having "beneficial
conversion" features, the value of the fixed discount has been reflected in the
Company's consolidated financial statements for the years ended December 31,
1996 and 1997 as additional interest expense and such fixed discount was
accreted through the first possible conversion date of the respective issuance.
These interest charges amounted to $843,000 from January 1 to April 4, 1997,
when the Company paid the outstanding principal and accrued interest of the
Debentures in full through conversion into Common Stock.

        On June 26, 1998, the Company sold $100,000,000 principal amount of 5%
convertible subordinated notes due 2003 (the "Notes") in a 144A private
placement to qualified institutional investors at 100% of their principal
amount, less a selling discount of 3% of the principal amount. This resulted in
interest expense of $2,480,000 for the year ended December 31, 1998.

        Gain on Repurchase of Notes. The Company recorded a gain of $2,791,000,
net of tax, when it repurchased at a discount from par during the last quarter
of 1998 $10,000,000 principal amount of the Notes.





                                       33
<PAGE>   34

        Net Income (Loss). The Company reported a net loss of $20,106,000 during
the year ended December 31, 1998. Net income for the year ended December 31,
1998 would have been $14,869,000, excluding charges associated with the Xyplex
Acquisition of $20,633,000 for purchased technology in progress and $15,671,000
for restructuring and the $3,101,000 write-down of discontinued products and a
$4,430,000 gain on the repurchase of the Notes during the fourth quarter of
1998. This compares to net income of $22,585,000 the Company reported for the
year ended December 31, 1997.

Years ended December 31, 1997 and 1996

        Revenues. Revenues for the year ended December 31, 1997 were
$165,471,000, compared to $88,815,000 for the year ended December 31, 1996, an
increase of 86.3%. Revenues from sales of networking products and optical
transmission products were 76.1% and 23.9%, respectively, of total revenues
during the year ended December 31, 1997 as compared to 69.4% and 30.6%,
respectively, of total revenues during the year ended December 31, 1996.
Revenues increased as a result of greater marketing efforts and greater market
acceptance of the Company's products, both domestically and internationally.
International sales accounted for approximately 59.8% of revenues for year ended
December 31, 1997, as compared to 53.0% of revenues for year ended December 31,
1996. International sales, as a percentage of total revenues, increased mainly
as a result of increased sales, marketing and support resources in place in
Europe and increased sales to the Pacific Rim region. While the Company has
achieved significant revenue growth in previous periods, there can be no
assurance that the Company will sustain such growth.

        Gross Profit. Gross profit for the year ended December 31, 1997 was
$70,762,000 compared to $37,337,000 for the year ended December 31, 1996. The
changes represented an increase of $33,425,000 or 89.5% for the year ended
December 31, 1997. Gross Profit as a percentage of revenues increased from 42.0%
during the year ended December 31, 1996 to 42.8% for the year ended December 31,
1997 as a result of increased sales of higher margin products such as the
MegaSwitch family of products as well as lower cost production techniques.

        Research and Development. For the years ended December 31, 1997 and
1996, R&D expenses were $13,093,000 and $8,201,000, respectively. In the case of
absolute dollars, the 59.7% increase in R&D spending during the year ended
December 31, 1997 over the year ended December 31, 1996 was attributable to the
continued development of the Company's networking and fiber optic products
including Ethernet/Fast Ethernet/Gigabit Ethernet switches, GigaHub modules,
GigaFrame switch and fiber optic components. Additional costs were also
associated with the hiring of new research and development personnel and
consultants. R&D expenses as a percentage of revenues declined from 9.2% of
revenues during year ended December 31, 1996, to 7.9% of revenues for year ended
December 31, 1997. This decrease was primarily caused because the Company's
revenues during the periods increased at a faster rate than R&D expenses. The
Company intends to continue to invest in the research and development of new
products. Management believes that the ability of the Company to develop and
commercialize new products is a key competitive factor.

        Selling, General and Administrative. For the years ended December 31,
1997 and 1996, SG&A expenses increased to $27,365,000 from $14,025,000. As a
percentage of revenues, SG&A increased from 15.8% for the year ended December
31, 1996 to 16.5% for the year ended December 31, 1997. The increases in SG&A
expense, both in dollar amounts and as a percentage of sales were due primarily
to substantially increased marketing efforts as well as the addition of
personnel and overhead costs in additional and expanded locations.

        Purchased Technology in Progress and Restructuring Costs. Purchased
technology in progress for the year ended December 31, 1996 was $17,795,000. The
purchased technology in 1996 was for R&D projects of Fibronics in progress at
the time of the Fibronics Acquisition on September 26, 1996. Restructuring costs
during the year ended December 31, 1996 were $6,974,000. The restructuring in
1996 was associated with a plan adopted by the Company on September 30, 1996, in
conjunction with the Fibronics Acquisition, calling for the reduction of
workforce, closing of certain facilities,





                                       34
<PAGE>   35

retraining of certain employees and elimination of particular product lines.
Purchased technology in progress for the year ended December 31, 1995 was
$6,211,000. The Company did not incur these charges in 1997.

        Interest Expense Related to Convertible Debentures and Acquisition. In
September 1996, the Company completed a private placement of $30,000,000
principal amount of convertible Debentures. See "Liquidity and Capital
Resources," below. To give effect to the accounting treatment announced by the
staff of the Securities and Exchange Commission at the March 13, 1997 meeting of
the Emerging Issues Task Force relevant to the Company's issuance of the
Debentures having "beneficial conversion" features, the value of the fixed
discount has been reflected in the Company's consolidated financial statements
for the years ended December 31, 1996 and 1997 as additional interest expense
and such fixed discount was accreted through the first possible conversion date
of the respective issuance. The Company paid the outstanding principal and
accrued interest of the Debentures in full at April 4, 1997 through conversion
into Common Stock. See "Liquidity and Capital Resources" below.

        Net Income. Net income increased to $22,585,000 for the year ended
December 31, 1997 from a net loss of $9,654,000 for the year ended December 31,
1996. Net losses during the year ended December 31, 1996 were the result of
aggregate charges related to the Company's acquisition of Fibronics from Elbit,
including charges from purchased technology in progress, restructuring costs and
the interest on the Debentures. Excluding these non-recurring charges, net of
tax effects, of $20,209,000, net income for the year ended December 31, 1996
would have been $10,555,000. Excluding non-recurring charges from interest on
the Debentures, net income for the year ended December 31, 1997 would have been
$23,428,000.

Selected Quarterly Financial Data

The following table sets forth certain selected operating data for the quarters
indicated. This information has been derived from the unaudited consolidated
financial statements of the Company which in the opinion of management contain
all adjustments (consisting of normal recurring adjustments) necessary for a
fair presentation of such information. These operating results are not
necessarily indicative of results for any future period and results may
fluctuate significantly from quarter to quarter in the future.

<TABLE>
<CAPTION>
                                                                       (Amounts in thousands)
                                                  1996                           1997                            1998
                                    ------------------------------- ------------------------------- -------------------------------
                                       Q1      Q2      Q3      Q4      Q1      Q2      Q3     Q4       Q1      Q2      Q3      Q4
                                    ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
<S>                                 <C>     <C>     <C>     <C>     <C>     <C>     <C>     <C>     <C>     <C>     <C>     <C>    
Revenues, net.....................  $15,529 $19,586 $22,664 $31,036 $35,564 $39,528 $41,979 $48,400 $60,826 $65,742 $62,624 $74,883
Gross profit......................    6,540   8,175   9,382  13,240  15,388  16,643  18,174  20,557  26,821  28,993  24,280  21,697

Operating income (loss) before
  purchased technology in progress
  and restructuring costs.........    2,720   3,224   3,558   5,609   6,865   7,370   8,131   7,938   9,978  11,385   1,619  (6,862)
Operating income (loss)...........    2,720   3,224 (21,211)  5,609   6,865   7,370   8,131   7,938 (33,849) 11,385   1,619     661
Net income (loss).................    1,879   2,283 (15,504)  1,688   4,343   5,209   5,922   7,111 (30,221)  8,528   1,348     239
</TABLE>

LIQUIDITY AND CAPITAL RESOURCES

        In September 1997, the Company completed a follow-on public offering of
2,785,000 shares of Common Stock raising net proceeds of approximately
$93,320,000 (the "1997 Public Offering"). In June 1998, the Company sold an
aggregate $100,000,000 principal amount of 5% convertible subordinated notes due
2003 (the "Notes") in a private placement raising net proceeds of $96,423,000
(the "1998 Private Placement"). The Notes are convertible into Common Stock of
the Company at a conversion price of $27.0475 per share (equivalent to a
conversion rate of approximately 36.97 shares per $1,000 principal amount of
notes), representing an initial conversion premium of 24%, for a total of
approximately 3.7 million shares of Common Stock of the Company. The Notes have
a five-year term and are not callable for the first three years. Interest on the
Notes is at 5% per annum and is payable semi-annually on June 15 and December
15, commencing on December 15, 1998.





                                       35
<PAGE>   36
        Net cash used in operating activities for the year ended December 31,
1998 was $6,946,000. The funds were used primarily to pay down accounts payable
and accrued expenses and for restructuring costs in connection with the Xyplex
Acquisition. Net cash used in investing activities for the year ended December
31, 1998 was $84,164,000. Cash used in the Xyplex Acquisition and net purchases
of United States treasury securities accounted for the majority of the cash used
in investing activities for the year ended December 31, 1998 and cash provided
by the sale of investments to finance the Xyplex Acquisition accounted for most
of the cash provided by investing activities for the same period. The sale of
the Notes in the 1998 Private Placement accounted for substantially all of the
$92,438,000 of cash provided by financing activities during the year ended
December 31, 1998.

        Net cash used in operating activities for the years ended December 31,
1997 was $2,761,000. The funds were used primarily for increased inventories and
receivables as a result of increased revenues. Net cash provided by financing
activities for the years ended December 31, 1997 and 1996 were $95,153,000 and
$38,882,000, respectively. The cash provided by financing activities in 1997
came principally from the proceeds from the 1997 Public Offering, which were
partially offset by the repurchase of the Common Stock from Elbit. Net cash used
in investing activities for the year ended December 31, 1997 was $87,454,000.
The cash used in investing activities was primarily used to purchase investments
in U.S. Government securities.

        Accounts receivable were $54,596,000 at December 31, 1998 as compared to
$47,258,000 at December 31, 1997. The increase in accounts receivable was
primarily attributable to the increase in overall sales.

        Inventories were $47,467,000 at December 31, 1998 as compared to
$41,689,000 at December 31, 1997. The increase in inventories was primarily
attributable to the Company's decision to add larger inventories to shorten lead
times for customers and the Xyplex Acquisition. Management believes that the
Company's inventory levels at various points in time may not necessarily be
comparable to those of many other companies in its industry. This is because MRV
conducts significant in-house manufacturing of various components used in its
products and thus carries substantial raw materials and work-in-progress in
addition to finished products in its inventories. In contrast, many competitors
outsource to turnkey contract manufacturers substantial portions of their
production requirements and thus do not include material amounts of raw
materials or work in progress in inventories and may in some circumstances not
even include finished products in inventory if the contract manufacturer ships
directly to the competitors' customers.

        Royalties are payable by the Company, as the successor to Galcom, Ace
and Fibronics, to the Office of the Chief Scientist of Israel ("OCS") at rates
of approximately 2% to 3% on proceeds from the sale of products arising from the
research and development activities for which OCS has provided grants. The total
amount of royalties may not exceed the amount of the grants. The Company does
not expect that revenues from royalty bearing products will result in material
royalty payment obligations in the future.

EFFECTS OF INFLATION AND CURRENCY EXCHANGE RATES

        The Company believes that the relatively moderate rate of inflation in
the United States over the past few years has not had a significant impact on
the Company's sales or operating results or on the prices of raw materials.
However, in view of the Company's recent expansion of operations in Israel which
has experienced substantial inflation, there can be no assurance that inflation
in Israel will not have a materially adverse effect on the Company's operating
results in the future.

        The Company's sales are currently denominated in U.S. dollars and to
date its business has not been significantly affected by currency fluctuations
or inflation. However, the Company conducts business in several different
countries and thus fluctuations in currency exchange rates could cause the
Company's products to become relatively more expensive in particular countries,
leading to a reduction in sales in that country. In addition, inflation or
fluctuations in currency exchange rates in such countries could increase the
Company's expenses. To date, the Company has not hedged against





                                       36
<PAGE>   37

currency exchange risks. In the future, the Company may engage in foreign
currency denominated sales or pay material amounts of expenses in foreign
currencies and, in such event, may experience gains and losses due to currency
fluctuations. The Company's operating results could be adversely affected by
such fluctuations or as a result of inflation in particular countries where
material expenses are incurred.

POST-RETIREMENT BENEFITS

        The Company does not provide post-retirement benefits affected by SFAS
106.

YEAR 2000

        Many existing computer programs, including some programs used by the
Company, use only two digits to identify a year in the date field. These
programs were designed without considering the impact of the upcoming change in
the century. If not corrected, these computer applications and systems could
fail or create erroneous results by, at, or after the year 2000. The Company is
currently conducting a company-wide Year 2000 compliance program ("Y2K
Program"). The Y2K Program is addressing the issue of computer programs and
embedded computer chips being unable to distinguish between the year 1900 and
the year 2000. Therefore, some computer hardware and software will need to be
modified prior to the Year 2000 in order to remain functional. The Company
anticipates that Year 2000 compliance will be substantially complete by
September 1999.

         The Company's Y2K Program is divided into four major sections: Company
manufactured products, internal information systems, non-information technology
systems, and third-party suppliers and customers. The general phases common to
all sections are: (1) inventorying Year 2000 items; (2) assessing the Year 2000
compliance of items determined to be material to the Company; and (3) repairing
or replacing material items that are determined not to be Year 2000 compliant.

          The Company has completed the review of all its products for Year 2000
compliance purposes. The Company believes that its products are either Year 2000
compliant or at the election of the customer can be upgraded to be Year 2000
compliant.

        The Company is currently evaluating and addressing Year 2000 issues
associated with its internal information systems. Most of the Company's
information computer systems are already Year 2000 compliant. The Company
expects to finish the evaluation by April 1999. Other internal information
systems that have been identified as non-compliant will be upgraded to be Year
2000 compliant by September 1999.

          The Company is currently evaluating and addressing Year 2000 issues
associated with its non-information technology systems. Most of these systems
are already Year 2000 compliant. The Company expects to finish the evaluation by
April 1999. Those non-information technology systems that are not Year 2000
compliant will be repaired or replaced September 1999.

          The Company is currently assessing the possible effects on the
Company's operations of the Year 2000 compliance of its key suppliers and
contract manufacturers. The Company expects this assessment will be completed by
April 1999. The Company's reliance on suppliers and contract manufacturers and,
therefore, on the proper functioning of their information systems and software,
means that failure to address Year 2000 issues could have a material impact on
the Company's operations and financial results. However, the potential impact
and related costs are not known at this time.

        Through December 31, 1998 the Company spent approximately $200,000 to
implement the Year 2000 compliance program. That amount has been expensed as
incurred. The Company estimates that it may spend up to an additional $500,000





                                       37
<PAGE>   38

for other replacements or upgrades and for communicating with key suppliers and
customers. That amount will also be expensed as incurred.

          The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The Y2K Program is expected to
significantly reduce the Company's level of uncertainty about the Year 2000
problem and, in particular, about the Year 2000 compliance and readiness of its
material key suppliers and customers. The Company believes that, with the
implementation of new business systems and completion of the Y2K Program as
scheduled, the possibility of significant interruptions of normal operations
should be reduced. The Company does not have a contingency plan to address the
Y2000 problem.

        Year 2000 compliance is an issue for virtually all businesses whose
computer systems and applications may require significant hardware and software
upgrades or modifications. Companies owning and operating such systems may plan
to devote a substantial portion of their information systems' spending to fund
such upgrades and modifications and divert spending away from networking or
fiber optic solutions. Such changes in customers' spending patterns could have a
material adverse impact on the Company's sales, operating results or financial
condition.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following financial statements are filed as part of this Report:

<TABLE>
<CAPTION>
                                                                                  PAGE
                                                                                  ----
<S>                                                                                <C>
Report of Independent Public Accountants.........................................  F-1

Consolidated Balance Sheets as of December 31, 1997 and 1998.....................  F-2

Consolidated Statements of Operations and Comprehensive Income (Loss)
for each of the three years in the period ended December 31, 1998................  F-4

Consolidated Statements of Stockholders' Equity for each of the three
years in the period ended December 31, 1998......................................  F-6

Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 1998...............................................  F-8

Notes to Consolidated Financial Statements.......................................  F-10
</TABLE>

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

Not applicable.





                                       38

<PAGE>   39

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To MRV Communications, Inc.:

We have audited the accompanying consolidated balance sheets of MRV
COMMUNICATIONS, INC. (a Delaware corporation) and subsidiaries as of December
31, 1997 and 1998, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of MRV Communications, Inc. and
subsidiaries as of December 31, 1997 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.

                                             
                                            /s/ Arthur Andersen LLP 

                                            ARTHUR ANDERSEN LLP




Los Angeles, California
February 15, 1999



                                      F-1
<PAGE>   40

                            MRV COMMUNICATIONS, INC.

                          CONSOLIDATED BALANCE SHEETS

                                     ASSETS

                                 (In Thousands)




<TABLE>
<CAPTION>
                                                           December 31,
                                                    -------------------------
                                                      1997            1998
                                                    ---------       ---------
<S>                                                 <C>             <C>      
CURRENT ASSETS:
  Cash and cash equivalents                         $  19,428       $  20,692
  Short-term investments                               36,413          30,493
  Accounts receivable, net of allowance of
    $4,252 in 1997 and $8,487 in 1998                  47,258          54,596
  Inventories                                          41,689          47,467
  Deferred income tax asset                             2,280           5,035
  Other current assets                                  7,248           5,508
                                                    ---------       ---------
               Total current assets                   154,316         163,791
                                                    ---------       ---------

PROPERTY, PLANT AND EQUIPMENT, at cost:
  Building                                              3,127           3,814
  Machinery and equipment                               4,294          10,141
  Furniture and fixtures                                  560           3,906
  Computer hardware and software                        2,134           9,169
  Leasehold improvements                                  710           1,528
                                                    ---------       ---------
                                                       10,825          28,558
  Less--Accumulated depreciation and
    amortization                                       (2,642)         (9,201)
                                                    ---------       ---------
                                                        8,183          19,357
                                                    ---------       ---------
OTHER ASSETS:
  Investments                                          62,382         100,138
  Deferred income tax asset                             6,231           5,661
  Intangibles and goodwill, net of accumulated
    amortization of $372 in 1997
    and $3,405 in 1998                                  5,077          26,666
  Other                                                    47           4,579
                                                    ---------       ---------
                                                       73,737         137,044
                                                    ---------       ---------
TOTAL ASSETS                                        $ 236,236       $ 320,192
                                                    =========       =========
</TABLE>



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



                                      F-2
<PAGE>   41

                            MRV COMMUNICATIONS, INC.

                           CONSOLIDATED BALANCE SHEETS

                      LIABILITIES AND STOCKHOLDERS' EQUITY

                                 (In Thousands)




<TABLE>
<CAPTION>
                                                       December 31,
                                                -------------------------
                                                  1997             1998
                                                ---------       ---------
<S>                                             <C>             <C>      
CURRENT LIABILITIES:
  Current portion of capital
    lease obligations                           $     111       $     185
  Accounts payable                                 30,439          29,757
  Accrued liabilities                               8,429          13,606
  Accrued restructuring cost                           --              82
  Customer deposit                                    293              --
  Income taxes payable                              3,485             445
  Deferred revenue                                     --           4,398
                                                ---------       ---------
               Total current liabilities           42,757          48,473
                                                ---------       ---------

LONG-TERM LIABILITIES:
  Convertible notes                                    --          90,000
  Capital lease obligations, net of
    current portion                                   788           1,400
  Other long-term liabilities                       2,065           2,917
                                                ---------       ---------
               Total long-term liabilities          2,853          94,317
                                                ---------       ---------

COMMITMENTS AND CONTINGENCIES (Note 9)

MINORITY INTEREST                                     657           2,973

STOCKHOLDERS' EQUITY:
  Preferred stock, $0.01 par value:
    Authorized - 1,000 shares;
      no shares issued or outstanding                  --              --
  Common stock, $0.0034 par value:
    Authorized - 80,000 shares
    Issued and outstanding - 26,360
      shares in 1997; 26,663 and 
      26,639 in 1998, respectively                     88              88
  Capital in excess of par value                  175,874         180,656
  Retained earnings (deficit)                      14,635          (5,471)
  Treasury stock                                       --            (133)
  Accumulated other comprehensive
    income (loss)                                    (628)           (711)
                                                ---------       ---------
                                                  189,969         174,429
                                                ---------       ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY      $ 236,236       $ 320,192
                                                =========       =========
</TABLE>



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



                                      F-3
<PAGE>   42

                            MRV COMMUNICATIONS, INC.

      CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

                    (In Thousands, except for per share data)


<TABLE>
<CAPTION>
                                                      Year Ended December 31,
                                             -----------------------------------------
                                                1996            1997            1998   
                                             ---------       ---------       ---------
<S>                                          <C>             <C>             <C>      
REVENUES, net:                               $  88,815       $ 165,471       $ 264,075
                                             ---------       ---------       ---------
COSTS AND EXPENSES:
  Cost of goods sold                            51,478          94,709         165,385
  Research and development expenses              8,201          13,093          25,817
  Selling, general and
    administrative expenses                     14,025          27,365          56,753
  Purchased technology in
    progress                                    17,795              --          20,633
  Restructuring costs                            6,974              --          15,671
                                             ---------       ---------       ---------
                                                98,473         135,167         284,259
                                             ---------       ---------       ---------
      Operating income (loss)                   (9,658)         30,304         (20,184)
                                             ---------       ---------       ---------
OTHER INCOME (EXPENSE):
  Interest expense related to
    convertible debentures
    and acquisition                             (4,357)           (843)             --
  Interest expense related to
    convertible notes                               --              --          (2,480)
  Minority interest                               (196)           (146)         (1,345)
  Interest income                                  702           2,841           4,661
  Interest expense                                (743)           (118)           (700)
  Other                                            194              21           2,858
                                             ---------       ---------       ---------
                                                (4,400)          1,755           2,994
                                             ---------       ---------       ---------
      Income (loss) before provision
        (benefit) for income taxes
        and extraordinary item                 (14,058)         32,059         (17,190)

PROVISION (BENEFIT) FOR INCOME TAXES            (4,404)          9,474           5,707
                                             ---------       ---------       ---------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM         (9,654)         22,585         (22,897)
                                             ---------       ---------       ---------

EXTRAORDINARY ITEM--
  Gain on repurchase of convertible
  notes, net of tax of $1,639                       --              --           2,791
                                             ---------       ---------       ---------

NET INCOME (LOSS)                               (9,654)         22,585         (20,106)
                                             ---------       ---------       ---------
OTHER COMPREHENSIVE INCOME
  (LOSS), net of tax:
  Foreign currency translation
    adjustment                                      15            (643)            (83)
                                             ---------       ---------       ---------
COMPREHENSIVE LOSS                           $  (9,639)      $  21,942       $ (20,189)
                                             =========       =========       =========
</TABLE>



                                      F-4
<PAGE>   43

                            MRV COMMUNICATIONS, INC.

      CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

                    (In Thousands, except for per share data)



<TABLE>
<CAPTION>
                                             Year Ended December 31,
                                     ------------------------------------- 
                                      1996          1997           1998
                                     -------      --------      ---------- 
<S>                                  <C>          <C>           <C>        
EARNINGS (LOSS) PER COMMON SHARE
  INFORMATION:

      Basic earnings (loss) per
        common share                 $ (0.49)     $   0.95      $    (0.76)
                                     =======      ========      ==========
      Diluted earnings (loss)
        per common share             $ (0.49)     $   0.88      $    (0.76)
                                     =======      ========      ==========
WEIGHTED AVERAGE NUMBER OF
  COMMON SHARES OUTSTANDING:

      Basic                           19,739        23,670          26,532
                                     =======      ========      ==========
      Diluted                         19,739        25,734          26,532
                                     =======      ========      ==========
</TABLE>



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



                                      F-5
<PAGE>   44

                            MRV COMMUNICATIONS, INC.

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                                 (In Thousands)



<TABLE>
<CAPTION>
                                       Common Stock           Capital in    Retained                   Other
                                 -----------------------      Excess of     Earnings     Treasury  Comprehensive
                                  Shares         Amount       Par Value     (Deficit)      Stock   Income (loss)      Total 
                                 --------       --------      --------      --------       ----    -------------     --------
<S>                              <C>            <C>           <C>           <C>          <C>       <C>               <C>   
BALANCE,
  December 31, 1995                19,049       $     63      $ 23,491       $ 1,704         --            --        $25,258
                                                                                                     
Shares held by trustee                                                                               
  relating to Fibronics                                                                              
  acquisition                         137             --            --            --         --            --             --
                                                                                                     
Conversion of debentures              812              2        12,851            --         --            --         12,853
                                                                                                     
Exercise of stock warrants                                                                            
  and options                       1,088              4         4,938            --         --            --          4,942
                                                                                                     
Issuance of common stock                                                                             
  for cash                            200              1         3,999            --         --            --          4,000
                                                                                                     
Interest expense related to                                                                          
  convertible debentures                                                                             
  and acquisitions                                                                                   
  (see Note 4)                         --             --         4,357            --         --            --          4,357
                                                                                                     
Translation adjustments                --             --            --            --         --            15             15
                                                                                                     
Net loss                               --             --            --        (9,654)        --            --         (9,654)
                                 --------       --------      --------      --------       ----      --------       --------
                                                                                                     
BALANCE,                                                                                             
  December 31, 1996                21,286             70        49,636        (7,950)        --            15         41,771
                                 --------       --------      --------      --------       ----      --------       --------
                                                                                                     
Issuance of common stock                                                                             
  in connection with                                                                                 
  public offering                   2,785              9        93,311            --         --            --         93,320
                                                                                                     
Issuance of common stock                                                                             
  in connection with                                                                                 
  the acquisition of                                                                                 
  Fibronics Ltd.                      275              1         6,299            --         --            --          6,300
                                                                                                     
Return of shares held                                                                                
  by trustee relating                                                                                
  to Fibronics acquisition           (137)            --            --            --         --            --             --
                                                                                                     
Conversion of debentures            1,013              4        17,737            --         --            --         17,741
                                                                                                     
Exercise of stock warrants                                                                           
  and options                       1,138              4         8,464            --         --            --          8,468
                                                                                                     
Interest expense related                                                                             
  to convertible debentures                                                                          
  and acquisition                      --             --           427            --         --            --            427
                                                                                                     
Translation adjustments                --             --            --            --         --          (643)          (643)
                                                                                                     
Net income                             --             --            --        22,585         --            --         22,585
                                 --------       --------      --------      --------       ----      --------       --------
BALANCE,                                                                                             
  December 31, 1997                26,360             88       175,874        14,635         --          (628)       189,969
                                 --------       --------      --------      --------       ----      --------       --------
</TABLE>



                                      F-6
<PAGE>   45

                            MRV COMMUNICATIONS, INC.
                                        
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                        
                                 (In Thousands)



<TABLE>
<CAPTION>
                                 Common Stock            Capital in     Retained                         Other
                          -------------------------      Excess of      Earnings        Treasury      Comprehensive
                            Shares          Amount       Par Value      (Deficit)         Stock       Income (loss)       Total
                          ---------       ---------      ---------      ---------       ---------     -------------     ---------
<S>                       <C>             <C>            <C>            <C>            <C>            <C>               <C>
Exercise of stock
  warrants and options          303              --          1,510             --              --              --           1,510

Issuance of warrants
  in connection with
  the acquisition of
  Xyplex                         --              --          3,272             --              --              --           3,272

Purchase of treasury
  stock                         (24)             --             --             --            (133)             --            (133)

Translation adjustments          --              --             --             --              --             (83)            (83)

Net loss                         --              --             --        (20,106)             --              --         (20,106)
                          ---------       ---------      ---------      ---------       ---------       ---------       ---------
BALANCE,
  December 31, 1998          26,639       $      88      $ 180,656      $  (5,471)      $    (133)      $    (711)      $ 174,429
                          =========       =========      =========      =========       =========       =========       =========
</TABLE>



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



                                      F-7
<PAGE>   46

                            MRV COMMUNICATIONS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (In Thousands)




<TABLE>
<CAPTION>
                                                       Year Ended December 31,
                                               -----------------------------------------
                                                 1996            1997            1998
                                               ---------       ---------       ---------
<S>                                            <C>             <C>             <C>       
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                            $  (9,654)      $  22,585       $ (20,106)
  Adjustments to reconcile net income
    (loss) to net cash used in
    operating activities:
      Depreciation and amortization                  943           1,439           7,902
      Provision for losses on accounts
        receivable                                 1,643           1,951           2,591
      Loss on sale of property and
        equipment                                    192              --              --
      Realized gain on investment                   (180)           (215)         (2,535)
      Purchased technology in progress            17,795              --          20,633
      Extraordinary gain on repurchase
        of convertible notes                          --              --          (2,791)
      Interest related to convertible
        debentures and acquisition                 4,357             843              --
      Other                                           --              37             324
      Minority interests' share of income            196             146           1,345
      Changes in assets and
        liabilities, net of effects
        from acquisitions:
        Decrease (increase) in:
          Accounts receivable                    (10,937)        (22,568)         12,263
          Inventories                             (5,697)        (21,867)          3,453
          Deferred income taxes                   (6,839)            185           1,408
          Other assets                            (3,031)         (2,824)          2,008
        Increase (decrease) in:
          Accounts payable                         1,912          17,435         (19,505)
          Accrued liabilities and
            restructuring                          6,623          (2,092)         (7,438)
          Income taxes payable                       798           3,622          (7,006)
          Customer deposits                        1,500          (1,207)             --
          Accrued severance pay                      231            (231)             --
          Deferred revenue                            --              --             508
                                               ---------       ---------       ---------
             Net cash used in operating
               activities                           (148)         (2,761)         (6,946)
                                               ---------       ---------       ---------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment             (2,593)         (1,207)         (6,337)
  Purchases of investments                       (45,612)       (148,948)       (206,846)
  Proceeds from sale of investments               29,133          67,990         173,714
  Restricted cash                                  6,272              --              --
  Cash used in acquisitions, net of
    cash received                                (13,247)         (5,289)        (44,695)
                                               ---------       ---------       ---------
             Net cash used in
               investing activities              (26,047)        (87,454)        (84,164)
                                               ---------       ---------       ---------
</TABLE>



                                      F-8
<PAGE>   47

                            MRV COMMUNICATIONS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (In Thousands)




<TABLE>
<CAPTION>
                                                   Year Ended December 31,
                                            --------------------------------------
                                              1996           1997           1998
                                            --------       --------       --------
<S>                                         <C>            <C>            <C>     
CASH FLOWS FROM FINANCING ACTIVITIES:
  Net proceeds from issuance of
    common stock                               8,942         99,638          1,510
  Proceeds from the issuance of
    debentures                                30,000             --             --
  Repurchase of common stock issued in
    connection with acquisition                   --         (4,230)            --
  Proceeds from issuance of
    convertible notes                             --             --         96,423
  Principal payments on capital
    lease obligations                            (60)          (255)           (62)
  Repurchase of convertible notes                 --             --         (5,300)
  Purchase of treasury stock                      --             --           (133)
                                            --------       --------       --------
             Net cash provided by
               financing activities           38,882         95,153         92,438
                                            --------       --------       --------

EFFECT OF EXCHANGE RATE CHANGES
  ON CASH AND CASH EQUIVALENTS                     3           (151)           (64)

NET INCREASE IN CASH
  AND CASH EQUIVALENTS                        12,690          4,787          1,264

CASH AND CASH EQUIVALENTS,
  beginning of year                            1,951         14,641         19,428
                                            --------       --------       --------
CASH AND CASH EQUIVALENTS,
  end of year                               $ 14,641       $ 19,428       $ 20,692
                                            ========       ========       ========
</TABLE>



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



                                      F-9

<PAGE>   48

                            MRV COMMUNICATIONS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

1. BACKGROUND

   MRV Communications, Inc. (the Company) designs, manufactures, markets and
sells high speed network switching and fiber optic transmission systems which
enhance the performance of existing data and telecommunications networks. The
Company sells two groups of products: (1) computer networking products,
primarily Ethernet local area network (LAN) switches, wide area network (WAN)
and remote access devices, and (2) fiber optic components for the transmission
of voice, video and data across enterprise telecommunications and cable TV
networks. The Company's networking solutions enhance the functionality of LAN's
and WAN's by reducing network congestion while allowing end users to preserve
their investments in pre-existing networks and providing cost-effective
migration paths to next generation technologies such as Gigabit Ethernet. The
Company markets and sells its products both domestically and internationally.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

   The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, NBase Communications, Inc., NBase Communications,
Ltd. (Nbase Ltd.), NBase Europe GmbH (Nbase Europe), NBase Fibronics, Ltd.
(Fibronics), Netsoft Solutions, Ltd. (Netsoft), Turnkey, Kempton Communications,
Nbase Xyplex, its 70 percent-owned subsidiary, EDSLAN SRL (EDS) and its 50
percent-owned subsidiary, RDS. All significant intercompany transactions and
accounts have been eliminated.

Foreign Currency Translation

   The financial statements of NBase Ltd. and Fibronics have been prepared in
U.S. dollars as the currency of the primary economic environment in which the
operations of these companies are conducted is the U.S. dollar. Thus, the
functional currency of these companies is the U.S. dollar.

   Transactions and balances originally denominated in U.S. dollars are
presented at their original amounts. Transactions and balances in other
currencies are converted into U.S. dollars in accordance with Statement of
Financial Accounting Standards No. 52, and are included in determining net
income or loss.

   The financial statements of NBase Europe, Netsoft, Turnkey, Kempton
Communications, EDS and RDS have been prepared in the companies' local
currencies and have been translated into U.S. dollars. The functional currency
for these companies is their local currency.

   Assets and liabilities are translated from the local currencies into U.S.
dollars at the exchange rate prevailing at the balance sheet date. Revenues,
expenses and cash flows are translated at weighted average exchange rates for
the period to approximate translation at the exchange rates prevailing at the
dates those elements are recognized in the financial statements. Translation
adjustments resulting from the process of translating the local currency
financial statements into U.S. dollars are included in determining comprehensive
income(loss). 

Use of Estimates

   The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.



                                      F-10
<PAGE>   49

Stock-Based Compensation Plan

   The Company accounts for its stock based compensation plans under the
provisions of APB Opinion No. 25. The Company has elected to follow the
disclosure provisions of Statement of Financial Accounting Standards No. 123
(SFAS 123), "Accounting for Stock-Based Compensation", beginning January 1, 1995
for employee awards. See Note 10 for disclosure of pro forma income (loss) and
income (loss) per common share amounts for the years ended December 31, 1996,
1997 and 1998 as required by SFAS 123.

Revenue Recognition

     The Company realizes revenue from sales of hardware products, from the sale
of related software and from maintenance contracts. Revenue on product sales is
recognized at the time of shipment. Revenue related to software and software
maintenance contracts is recognized in accordance with the American Institute of
Certified Public Accountants (AICPA) Statement of Position No. 97-2, "Software
Revenue Recognition." Maintenance revenues for customer support are deferred and
recognized ratably over the term of the maintenance period (generally one to
three years).

Cash and Cash Equivalents

   The Company considers all highly liquid investments with an original maturity
of 90 days or less to be cash equivalents.

Concentration of Credit Risk

   The Company maintains cash balances and investments in highly qualified
financial institutions. At various times such amounts are in excess of insured
limits.

Investments

   The Company accounts for its investments under the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities."

   At December 31, 1997 and 1998, short- and long-term investments consisted
principally of U.S. Treasury notes. As defined by the standard, the Company has
classified its investments in these debt securities as "held-to-maturity"
investments and all investments are recorded at their amortized cost basis,
which approximated their fair value at December 31, 1997 and 1998. All
short-term investments mature by December 1999.

Inventories

   Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of material, labor and overhead.

   Inventories consisted of the following as of December 31, 1997 and 1998 (in
thousands):

<TABLE>
<CAPTION>
                                               1997       1998
                                               ----       ----
<S>                                          <C>        <C>    
Raw materials............................    $17,568    $17,409
Work-in-process..........................     13,436     10,118
Finished goods...........................     10,685     19,940
                                             -------    -------
                                             $41,689    $47,467
                                             =======    =======
</TABLE>

Software Development Costs

   In accordance with SFAS No. 86, "Accounting for the Costs of Computer
Software to be Sold, Leased, or Otherwise Marketed", development costs related
to software products are expensed as incurred until the technological
feasibility of the product has been established. Technological feasibility in
the Company's circumstances occurs when a working model is completed. After
technological feasibility is established, additional costs would be capitalized.
The Company believes its process for developing software is essentially
completed concurrent with the establishment of technological feasibility, and,
accordingly, no software development costs have been capitalized to date.


                                      F-11
<PAGE>   50
Property and Equipment

   Property and equipment are stated at cost. Maintenance and repairs are
charged to expense as incurred, while significant replacements and betterments
are capitalized.

   Depreciation and amortization are provided using the straight-line method
based upon the estimated useful lives of the related assets. Useful lives range
from three to thirty-three years.

Intangibles and Goodwill

   The intangibles and goodwill resulted from the Company's acquisitions between
1995 and 1998. It is amortized on a straight-line basis over 8 to 12 years. The
Company continually evaluates the recoverability of goodwill by assessing
whether the recorded value will be recovered through future expected operating
results.

Warranty

   The Company warrants its products against defects in materials and
workmanship for one to five year periods. The estimated cost of warranty
obligations is recognized at the time of revenue recognition.

Statements of Cash Flows

   Cash paid for income taxes was $1,620,000 in 1996, $5,473,000 in 1997 and
$9,945,000 in 1998. Cash paid for interest was $150,000 in 1996, $214,000 in
1997 and $2,569,000 in 1998.

   During 1996, the Company acquired property and equipment with a cost of
$1,147,000 through a capital lease agreement. Also in 1996, $12,675,000
principal amount of debentures and $178,000 of accrued interest was converted
into approximately 812,000 shares of common stock.

     In 1997, $17,325,000 of convertible debentures and $843,000 of interest
were converted into approximately 1,013,000 of shares common stock. Also, the
Company received $2,150,000 of tax benefits relating to the exercise of
non-qualified stock options.

   These non-cash transactions are excluded from the Statements of Cash Flows.

Common Stock Splits

   On May 20, 1996, the Company effected a 3 for 2 stock split of its common
stock, and on July 29, 1996, the Company effected a 2 for 1 stock split of its
common stock. All share amounts set forth in these consolidated financial
statements have been retroactively restated to give effect to these stock
splits.

Net Income (loss) per Common Share

   In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share". 


                                      F-12
<PAGE>   51
   The following schedule summarizes the information used to compute earnings
per common share (in thousands except per share data):

<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                    ----------------------------------------
                                                       1996           1997           1998
                                                    ----------       -------      ----------
<S>                                                 <C>              <C>          <C>        
Income (loss) before extraordinary item ......      $   (9,654)      $22,585      $  (22,897)

Extraordinary item-gain on repurchase
of convertible notes, net of the tax (see 
Note 5).......................................              --            --           2,791
                                                    ----------       -------      ----------

Net income (loss) ............................      $   (9,654)      $22,585      $  (20,106)
                                                    ==========       =======      ==========
Weighted average number of common
shares used to compute basic net income
per common share  ............................          19,739        23,670          26,532

Dilutive effect of common share equivalents ..              --         2,064              --
                                                    ----------       -------      ----------

Weighted average number of common
shares used to compute diluted net income
per common share .............................          19,739        25,734          26,532
                                                    ==========       =======      ==========

Basic income (loss) per common share
before extraordinary item ....................            (.49)          .95            (.86)

Diluted  income (loss) per common
share before extraordinary item ..............            (.49)          .88            (.86)

Effect of extraordinary item per basic
common share .................................              --            --             .10

Effect of extraordinary item per
diluted common share .........................              --            --             .10

Basic net income (loss) per common share .....            (.49)          .95            (.76)

Diluted net income (loss) per common share ...            (.49)          .88            (.76)
</TABLE>


Comprehensive Income

     On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". For year end financial statements SFAS 130 requires that
comprehensive income, which is the total of net income and all other non-owner
changes in equity, be displayed in the consolidated financial statement with the
same prominence as other consolidated financial statements.


                                      F-13
<PAGE>   52
3. ACQUISITIONS

EDSLAN

   In May 1996, the Company purchased 50 percent of the outstanding stock of
EDSLAN SRL, an Italian networking company. The purchase price paid by the
Company was approximately $1,050,000. The purchase agreement calls for the
Company to receive 80 percent of EDS' profits or losses from the date of
acquisition. In June and November 1997, the Company purchased an additional 10
percent of the outstanding stock of EDSLAN SRL, for $500,000, respectively.

Fibronics

   On September 26, 1996, the Company acquired certain assets and the
distribution business of Fibronics, Ltd., a computer networking and
telecommunications company located primarily in Israel and Germany. On the date
of acquisition, Fibronics, Ltd. was a wholly-owned subsidiary of Elbit, Ltd.
(Elbit). The purchase price paid by the Company was $22,770,000, of which
$12,240,000 was paid in cash and $10,530,000 was paid through the delivery of
approximately 459,000 shares of the Company's common stock.

   The Company guaranteed Elbit that it would realize at least $10,530,000 from
the shares of common stock, plus interest thereon at 0.67% per month from
January 1, 1997 until such shares were resold. The Company secured the guarantee
with a letter of credit from a major bank in the amount of approximately
$4,300,000 and by issuing to a trustee an additional 137,000 shares of common
stock. After January 14, 1997, Elbit could, under certain circumstances, elect
to cause the Company to repurchase up to approximately 275,000 shares for
$6,300,000, plus interest thereon at 0.67% per month from January 1, 1997
through the date of purchase.

     In March 1997, the Company and Elbit agreed to amend their agreement
regarding the common stock portion of the purchase price paid to Elbit for the
distribution business of Fibronics, Ltd. First, the Company repurchased
approximately 184,000 shares, paying Elbit $4,230,000 (approximately $23.00 per
share) (plus accrued interest thereon at 0.67% per month from January 1, 1997
through March 13, 1997). Second, with respect to the remaining 275,000 shares
(the "Additional Shares"), the Company guaranteed that the Additional Shares
could be resold by Elbit for at least $6,300,000 (approximately $23.00 per
share), plus interest thereon at 0.67% per month from January 1, 1997 through
the date of Elbit's resale. As part of the amended agreement, Elbit also
returned the 137,000 shares to the Company.

   Subsequent to the acquisition date, the Company formed a new subsidiary in
Israel named NBase Fibronics, Ltd. and a new subsidiary in Germany named NBase
Europe GmbH.

Netsoft

   In November 1997, the Company agreed to purchase Netsoft Solutions, Ltd.
(Netsoft). Under the agreement, the Company acquired certain assets and the
business operations of Netsoft, a French networking company. The purchase price
paid by the Company was approximately $4,700,000, of which approximately
$2,300,000 was goodwill.

Xyplex

   On January 30, 1998, the Company acquired all of the outstanding stock of
Whittaker Xyplex, Inc. (whose name the Company subsequently changed to Nbase
Xyplex), a subsidiary of the Whittaker Corporation engaged in the design and
manufacture of computer networking products primarily for use in wide area
networks (WAN). The purchase price was $35,000,000 in cash and three-year
warrants to purchase up to 421,402 shares of the Company's common stock at $35
per share.

RDS

   In January 1998, the Company acquired 50 percent of the outstanding stock of
RDS, a Swedish networking company. The purchase price was $8,000,000 in cash.



                                      F-14
<PAGE>   53

   All acquisitions were accounted for using the purchase method of accounting,
and accordingly, the purchase price was allocated to assets acquired and
liabilities assumed based on their estimated fair values, as follows (in
thousands):

<TABLE>
<CAPTION>
                                                            1996           1998
                                                          --------       --------
<S>                                                       <C>            <C>     
Inventory ..........................................      $  3,574       $  9,231
Accounts receivable ................................         2,686         23,528
Property and equipment .............................         1,793          9,274
Other assets .......................................           315          1,223
Current liabilities and debt .......................        (3,962)       (38,026)
                                                          --------       --------
          Net assets acquired or liabilities assumed         4,406          5,230

Cash paid for legal, consulting and other costs ....          (450)        (1,426)
Accrued legal, consulting and others costs .........          (365)          (574)
Common stock issued to sellers .....................       (10,530)        (3,271)
Cash paid to sellers ...............................       (13,287)       (44,695)
                                                          --------       --------
          Paid or accrued ..........................       (24,632)       (49,966)
Allocated to purchased technology in progress ......        17,795         20,633
                                                          --------       --------
Goodwill ...........................................      $  2,431       $ 24,103
                                                          ========       ========
</TABLE>

4. CONVERTIBLE DEBENTURES

   In September 1996, the Company completed a private placement of $30,000,000
principal amount of convertible debentures. The proceeds from the private
placement were primarily used to finance the Company's 1996 acquisition of
certain assets from Fibronics, Ltd. (see Note 3). The debentures bore interest
at 5 percent per annum, payable semi-annually, and were convertible into common
stock at any time at the option of the holders. A discount from the market price
at the time of conversion applied beginning 90 days after the first issuance of
debentures. The Company could force conversion under certain circumstances and
after certain dates, and the debentures would automatically convert into common
stock at maturity if not previously converted. The conversion price was a
specified percentage of the prevailing market price of the Company's common
stock on the conversion date, which was defined in the debenture agreement as
the average of the closing bid price of a share of the Company's stock for the
five trading days immediately preceding the conversion date. The conversion
price was 85.5 percent of the applicable market price if the debentures were
converted during the 30 days beginning December 6, 1996. The conversion price
decreased by an additional one percent each 30 days after January 4, 1997 until
it reached a floor of 77.5 percent. In 1996, $4,357,000 was recorded as
additional interest expense and as an increase to stockholders' equity relating
to the "beneficial conversion" feature and the fair value of the warrants.

   The value of the fixed discount has been reflected in the accompanying
consolidated financial statements as additional interest expense and such fixed
discount has been accreted through the first possible conversion date of the
respective issuance.

   As part of the private placement, the Company also issued to the holders
three-year warrants to purchase an aggregate of up to 600,000 shares of common
stock at an exercise price of $26.67 per share. In accordance with SFAS 123, the
fair value of the warrants ($852,000) was recorded as an increase to
stockholders' equity and amortized as additional interest expense over the life
of the debentures.

   As of December 31, 1997, all debentures had been converted to common stock. 

5. CONVERTIBLE NOTES

   In June 1998, the Company completed a private placement of $100,000,000
principal amount five year, convertible subordinated notes. The notes bear
interest at five percent per year, payable semi-annually, and are convertible
into common stock at any time after September 1998, at the option of the
holders. The conversion rate is 36.972 shares of common stock per $1,000
principal amount of notes, equivalent to a conversion price of $27.0475 per
share, an initial premium above market price. The conversion rate is subject to
adjustment in certain circumstances, including dividends payable in common
stock, issuance of stock rights to all holders of common stock or stock splits
or distributions to common stockholders in connection with a tender offer. If a
change in control, as defined, occurs, the holders of the notes have the right
to require the Company to repurchase the notes at face value together with
interest accrued. The Company has the right, after June 2001, to redeem the
notes at 102 percent of face value, and after June 2002 for 101 percent of face
value. The notes are not entitled to the benefits of any sinking fund.



                                      F-15
<PAGE>   54

In connection with the private placement, the Company incurred costs of
$3,577,000. These costs are being amortized over five years, the life of the
notes. Amortization expense for the year ended December 31, 1998 was $360,000.

In November 1998, the Company repurchased $10,000,000 of the notes for
$5,300,000. The Company has recorded an extraordinary gain of $2,791,000, net of
tax, related to the repurchase of the notes. Included in this amount is the
portion of the amortization of expense of the costs attributable to the
repurchased notes.

6. WARRANTS

Common Stock Purchase Warrants

   In connection with various public and private offerings of common stock and
acquisitions the Company has issued warrants to purchase additional shares of
common stock.

   A summary of warrant activities for 1996, 1997 and 1998 is as follows (number
of shares in thousands):

<TABLE>
<CAPTION>
                                  NUMBER         EXERCISE
                                OF SHARES         PRICES
                                -------       --------------
<S>                            <C>            <C>
Balance, December 31, 1995        2,132       $  .27 to  7.38
  Issued .................        2,106         8.42 to 26.65
  Exercised ..............         (776)         .27 to  8.42
  Redeemed ...............           --                    --
                                -------       ---------------
Balance, December 31, 1996        3,462       $  .27 to 26.65
  Issued .................           10                 32.50
  Exercised ..............         (766)        1.67 to 14.25
  Redeemed ...............           --                    --
  Canceled ...............         (100)                20.00 
                                -------       ---------------
Balance, December 31, 1997        2,606       $  .27 to 32.50
  Issued .................          421                 35.00
  Exercised ..............           66         4.25 to  5.60
  Redeemed ...............           --                    --
  Canceled ...............          (76)                 8.42
                                -------       ---------------
Balance, December 31, 1998        3,017       $  .27 to 35.00
                                =======       ===============
</TABLE>


7. PURCHASED TECHNOLOGY IN PROGRESS AND RESTRUCTURING COSTS

   In connection with the Company's acquisitions (see Note 3), the Company
acquired incomplete research and development (R&D) projects that will be
included in the current R&D activities of the Company. For projects that will
have no alternative future use to the Company and where technological
feasibility had not yet been established, the Company allocated $17,795,000 and
$20,633,000 to technology in progress and recorded the expense during the years
ended December 31, 1996 and 1998, respectively.

   The value of technology in progress acquired as part of the Fibronics
transaction was determined by estimating the costs to the Company to achieve the
same level of completion in such technology had it undertaken to develop the
technology on its own. These estimates were based on the Company's known costs
to employ and support engineers required for such projects at the time of the
acquisition. These products have been substantially completed since the
acquisition. The technologies acquired included systems designed to enhance
enterprise networks with advanced functionality such as support for large
numbers of protocols and high port densities. The technology in progress was
approximately 60 percent complete at the time of acquisition.

   The technology in progress acquired as part of the Xyplex transaction in 1998
was valued according to the "milestone" or percentage complete method. This
method established a total estimated cost to complete the projects that
constituted the purchased technology in progress. An estimate was then made as
to the percentage of completion that had been achieved in these projects at the
date of acquisition and this was applied to the overall estimated cost. The
large majority of the value was assigned to the "Edgeblaster", a multifunction
WAN access router designed to combine routing protocols with access technologies
to allow branch and enterprise offices to connect users, employees and remote
offices using digital techniques. The Edgeblaster was approximately 70 percent
complete at the time of the acquisition and its completion depended upon
successful development of digital signal processing technology required to
enable it to compete with similar products in development by other companies.
The development of the Edgeblaster has been substantially completed since the
acquisition.



                                      F-16
<PAGE>   55

   Also in connection with the Company's acquisitions, during the years ended
December 31, 1996 and 1998, the Company recorded $6,974,000 and $15,671,000 as
restructuring costs, respectively, which primarily related to the closing of
facilities, a reduction of its workforce, elimination of product lines and the
settlement of distribution agreements. The reduction of the workforce in 1996
related to 95 employees, of which seven were upper management personnel. The
reduction of the workforce in 1998 related to 183 employees, of which eight were
upper management personnel.

8. INCOME TAXES

   The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109 (SFAS 109).

   Under SFAS 109, deferred income tax assets or liabilities are computed based
on temporary differences between the financial statement and income tax bases of
assets and liabilities using the enacted marginal income tax rate in effect for
the year in which the differences are expected to reverse. Deferred income tax
expenses or credits are based on the changes in the deferred income tax assets
or liabilities from period to period.

   The components of the net deferred income tax asset at December 31, 1997 and
1998 are as follows (in thousands):

<TABLE>
<CAPTION>
                                        1997         1998
                                      --------      --------
<S>                                   <C>           <C>     
Allowance for bad debts ........      $  1,071      $  2,203
Inventory reserve ..............           466         1,512
Warranty reserve ...............           320           992
State income taxes .............           331           400
Other, net .....................            92           (72)
                                      --------      --------
  Current portion ..............         2,280         5,035
Purchased technology in progress         6,231         5,778
Depreciation ...................            --          (117)
                                      --------      --------
                                         6,231         5,661
                                      --------      --------
                                      $  8,511      $ 10,696
                                      ========      ========
</TABLE>

   The provision (benefit) for income taxes for the years ended December 31,
1996, 1997 and 1998 (including provision of $1,639 related to the extraordinary
gain) is as follows (in thousands):

<TABLE>
<CAPTION>
                                          1996          1997          1998
                                         -------       -------       -------
<S>                                      <C>           <C>           <C>    
Current
  Federal .........................      $ 1,692       $ 7,635       $ 3,306
  State ...........................          324           828         1,093
  Foreign .........................          547         1,356         3,324
                                         -------       -------       -------
                                           2,563         9,819         7,723
                                         -------       -------       -------
Deferred
  Federal .........................       (5,694)          157          (176)
  State ...........................       (1,022)           28           (31)
  Foreign .........................         (251)         (530)         (170)
                                         -------       -------       -------
                                          (6,967)         (345)         (377)
                                         -------       -------       -------
Provision (benefit)for income taxes      $(4,404)      $ 9,474       $ 7,346
                                         =======       =======       =======
</TABLE>

   Differences between the provision (benefit) for income taxes and income taxes
at the statutory federal income tax rate based on U.S. pre-tax income for the
years ended December 31, 1996, 1997 and 1998 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                   1996                         1997                      1998
                                          ---------------------       ---------------------       --------------------- 
                                           AMOUNT        PERCENT       AMOUNT        PERCENT       AMOUNT      PERCENT
                                          --------        -----       --------        -----       --------      ---- 
<S>                                       <C>             <C>         <C>             <C>         <C>           <C>  
Income tax provision (benefit) at
  statutory federal rate ...........      $ (4,780)      (34.0)%       $ 11,222        35.0%       $  6,017      35.0%
State and local income taxes, net of
  federal income tax effect ........           563         4.0           1,924         6.0           1,031       6.0
Non-deductible interest expense ....         1,542        11.0             175          .5              --        --
Research and development credit ....          (374)       (2.7)         (1,669)       (5.2)         (1,024)     (6.0)
Income tax on extraordinary gain ...            --          --              --          --           1,639       9.5
Foreign taxes at rates different
than domestic rates, other .........        (1,892)       (13.4)        (1,216)       (3.8)           (317)     (1.8)
                        
Change in valuation reserve ........           537         3.8            (962)       (3.0)             --        --
                                          --------        -----       --------        -----       --------      ---- 
                                          $ (4,404)       (31.3)%     $  9,474         29.5%      $  7,346      42.7%
                                          ========        =====       ========        =====       ========      ==== 
</TABLE>


   In 1995, NBase Ltd. qualified for a program under which it will be eligible
for a tax exemption on its income for a period of ten years from the beginning
of the benefits period. This benefit is due to expire in 2006. NBase Ltd.
received a tax benefit of approximately $1,600,000 in 1998.

   The Company does not provide U.S. federal income taxes on the undistributed
earnings of its foreign operations. The Company's policy is to leave the income
permanently invested in the country of origin. Such amounts will only be
distributed to the United States to the extent any federal income tax can be
fully offset by foreign tax credits.



                                      F-17
<PAGE>   56

9. COMMITMENTS AND CONTINGENCIES

Lease Commitments

   The Company leases its primary facilities in Chatsworth, California from
unaffiliated third parties at an annual combined base rent of approximately
$425,000 with lease terms expiring through 2002. The Company also leases office
and warehouse space in Boston, Israel, England, Switzerland, Germany, Sweden and
Italy at a combined annual base rent of approximately $2,375,000, with lease
terms expiring from 1999 through 2006.

   The Company leases all of its facilities and certain equipment under
noncancelable capital and operating leases. Minimum future obligations under
such agreements at December 31, 1998 are as follows (in thousands):

<TABLE>
<CAPTION>
                               CAPITAL        OPERATING
                                LEASES         LEASES
                               --------       --------
<S>                            <C>            <C>     
1999 .....................     $    202       $  2,724
2000 .....................          284          2,385
2001 .....................          258          2,235
2002 .....................          251          1,874
2003 .....................          250          1,492
Thereafter ...............          625            354
                               --------       --------
                                  1,870       $ 11,064
                                              ========
Less -- Amount
representing interest ....         (285)
                               --------

                                  1,585
Less -- Current portion ..         (185)
                               --------
                               $  1,400
                               ========
</TABLE>

   Rent expense under noncancelable operating lease agreements for the years
ended December 31, 1996, 1997 and 1998 was $684,000, $706,000, and $2,759,000,
respectively.

Royalty Commitment

   As part of the purchase agreements of the Israeli companies referred to in
Note 3, the selling companies' commitments to pay royalties to the State of
Israel were assigned to the Company. The commitments arose as a consequence of
the participation of the Israeli Government in product development through the
payment of grants.

   The royalties are payable at a rate of between 1.5 percent and 5.0 percent of
the sales proceeds of the products developed up to 150 percent of the amount of
the grants received. $276,000 was provided for in 1998 for royalties to be paid
under these agreements.

Accounts Receivable

   The Company (through foreign subsidiaries) has agreements with several
financial institutions to sell its receivables with recourse; in the event of
customer's default, the Company must repurchase the receivables. At December 31,
1998 the Company is contingently liable in the amount of $16,041,000 relating to
such receivables sold with recourse. The Company believes that adequate
provision has been made for losses on receivables with recourse.

Litigation

   In December, 1996, Datapoint brought an action against Nbase Communications,
Inc., a subsidiary of the Company ("Nbase") and several other defendants in the
United States District Court, for the Eastern District of New York alleging
infringement of two of Datapoint's patents related to LANs, more particularly to
claimed improved LANs which interoperatively combine additional enhanced
capability and/or which provide multiple different operational capabilities. In
the same lawsuit, Datapoint alleges that other defendants including Dayna
Communications, Inc. Sun Microsystems, Inc., Adaptec, Inc., International
Business Machines Corporation, Lantronix and SVEC America Computer Corporation
have infringed the same two patents. The Company has been advised that several
other companies, including Intel Corporation and Cisco Systems, Inc. have also
had actions brought against them by Datapoint with respect to the same two
patents. The action against Nbase and its codefendants seeks, among other
things, an injunction against the manufacture or sale of products which embody
the inventions set forth in the two patents and single and treble damages for
the alleged infringement. Datapoint's complaint also seeks to have the court
determine that the named defendants shall serve as representatives of a
defendant class of manufacturers, vendors and users of products allegedly
infringing on Datapoint's claimed patents from which defendant class Datapoint
seeks the same relief as from the individual defendants. In February 1999, the
court entered judgement in favor of the defendants and Datapoint filed a notice
of appeal. The Company is cooperating with several of the defendants in pursuit
of common defenses and believes the claim is without merit. If a conclusion
unfavorable to the Company is reached, however, Datapoint's claim could
materially affect the business, operating results and financial condition of the
Company.



                                      F-18
<PAGE>   57

10. STOCK-BASED COMPENSATION PLANS

     The Company's stock option plans (a 1992 and 1997 Plan) provide for the
granting of options to purchase up to 2,950,000 shares of common stock,
consisting of both incentive stock options and non-qualified options. Incentive
stock options are issuable only to employees of the Company. Non-qualified stock
options may be issued to non-employee directors, consultants and others, as well
as to employees. The exercise price of all stock options granted under the Plans
have been at least equal to the fair market value of such shares on the date of
grant. The options generally vest over three years and expire ten years from the
grant date.

     The Company has two other outstanding option and warrant programs: (1) its
1998 Non-statutory Stock Option Plan provides for the granting of options to
purchase up to 1,421,500 shares of common stock to non-employees who perform
consulting or advisory services, as well as to employees of the Company. The
exercise price of all stock options granted must be at least equal to the fair
market value of the common stock on the date of grant. The options vest over a
two year period and expire five years from the grant date, and (2) its German
Employees Warrant Program which provides for the granting of warrants to
purchase up to 100,000 shares of common stock to employees of its German
subsidiary, at fair market value. The warrants vest over a five year period and
expire six years from the grant date. Directors and officers of the Company are
not eligible to participate in either of these plans.

     The Company accounts for these plans under APB Opinion No. 25, under which
no compensation cost has been recognized. Had compensation cost for these plans
and the warrants (see Note 6) been determined consistent with SFAS 123, the
Company's net (loss) income and (loss) income per diluted common share amounts
would have been reduced to the following pro forma (amounts are in thousands,
except per share data):

<TABLE>
<CAPTION>
                                                              1996     1997     1998
                                                            -------  --------  ------
<S>                            <C>                          <C>      <C>      <C>      
 Net Income (Loss):            As Reported................  $(9,654) $22,585  $(20,106)
                               Pro Forma..................  (11,254) $20,943   (21,317)
 Income (Loss) Per Common                                                      
 Share:
   Basic:                      As Reported................  $ (0.49)  $ 0.95  $  (0.76)
                               Pro Forma..................    (0.57)  $ 0.88     (0.80)
   Diluted:                    As Reported................  $ (0.49)  $ 0.88  $  (0.76)
                               Pro Forma..................    (0.57)  $ 0.81     (0.80)
</TABLE>

     The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1996, 1997 and 1998: risk-free interest rates of
5.5 percent to 6.6 percent; no expected dividend yield; expected lives of 4 to 6
years; expected volatility of 22 percent to 65 percent.

   A summary of the status of the Company's outstanding stock options at
December 31, 1996, 1997 and 1998 and changes during the years then ended is
presented in the table below (shares are in thousands):

<TABLE>
<CAPTION>
                                       1996                     1997                    1998
                                -------------------      -------------------      -------------------
                                            WTD. AVG.                WTD. AVG.                WTD. AVG.
                                SHARES      EX.PRICE     SHARES      EX.PRICE     SHARES      EX.PRICE
                                ------       ------      ------       ------      ------       ------
<S>                             <C>         <C>          <C>         <C>          <C>         <C>   
Outstanding at beginning
of year ..................       1,156       $ 3.59       1,475       $ 6.02       1,208       $ 8.77
Granted ..................         672        12.45         110        19.45       1,000        18.47
Exercised ................        (312)        3.28        (372)        4.86        (118)        4.51
Forfeited ................        (312)        3.28        (372)        4.86         (49)       11.09
Cancelled in repricing ...          --           --          --           --       1,498        17.86
Granted in repricing .....          --           --          --           --       1,498         5.25
Outstanding at end of year       1,475       $ 6.02       1,208       $ 8.77       2,041       $ 4.98
                                ------       ------      ------       ------      ------       ------
Exercisable at end of year         172       $ 3.05         548         5.31         516         3.73
                                ------       ------      ------       ------      ------       ------
Weighted average fair
value of options granted .                   $ 4.28                   $ 5.89                   $ 6.21
                                             ------                   ------                   ------
</TABLE>




                                      F-19
<PAGE>   58

11. SEGMENT REPORTING AND GEOGRAPHIC INFORMATION

   The Company designs, manufactures and sells computer networking products and
fiber optic components and modules. Each of these is a business segment with its
respective financial performance detailed in this report.

   Computer networking consists of Ethernet LAN routing switches and WAN and
remote access devices. These products are sold to end user customers,
distributors and value added resellers.

   Fiber optic components and modules include discrete components such as lazer
diodes and light emitting diodes and integrated components such as transmitters,
receivers and transceivers. These products are sold primarily to
original-equipment manufactures and through distributors.

BUSINESS SEGMENT NET REVENUES (in thousands):

<TABLE>
<CAPTION>

                                        ------------------------------------
                                          1996          1997          1998
                                        --------      --------      --------
<S>                                     <C>           <C>           <C>     
Computer Networking                     $ 61,614      $125,968      $215,230

Fiber Optic Components and Modules        27,201        39,503        48,845
                                        --------      --------      --------
Total revenues                          $ 88,815      $165,471      $264,075
                                        ========      ========      ========
</TABLE>

Intersegment Sales from Fiber Optic Components and Modules to Computer
Networking were $2,984,000, $4,561,000 and $6,152,000 in 1996, 1997 and 1998,
respectively.

BUSINESS SEGMENT PROFIT (LOSS) (in thousands):

<TABLE>
<CAPTION>

                                               -----------------------------------------
                                                  1996            1997            1998
                                               ---------       ---------       ---------
<S>                                            <C>             <C>             <C>      
Operating income (loss):
  Computer Networking                          $ (14,286)      $  23,070       $ (23,739)
  Fiber Optic Components and Modules               4,628           7,234           3,555

Other income (expense):
  Interest expense related to convertible
  debentures and acquisition                      (4,357)           (843)             --

  Interest expense related to convertible
  Notes                                               --              --          (2,480)

  Interest income                                    702           2,841           4,661

  Interest expense                                  (743)           (118)           (700)

  Other                                               (2)           (125)          1,513

Extraordinary item, gross                             --              --           4,430
                                               ---------       ---------       ---------
Income (loss) before taxes and
  other comprehensive income (loss)            $ (14,058)      $  32,059       $ (12,760)
                                               =========       =========       =========
</TABLE>



                                      F-20
<PAGE>   59

BUSINESS SEGMENT ASSETS (in thousands):

<TABLE>
<CAPTION>

                                     -------------------------------------
                                       1996           1997           1998   
                                     -------        --------       -------
<S>                                  <C>            <C>            <C>
Computer Networking                  $56,856        $113,638       $170,758

Fiber Optic Components and Modules    13,075          17,229         16,871

Other                                 27,012         105,369        132,563 
                                     -------        --------       --------
Total                                $96,943        $236,236       $320,192
                                     =======        ========       ========
</TABLE>

BUSINESS SEGMENT ASSETS (in thousands):

<TABLE>
<CAPTION>

                                     -------------------------------------
                                       1996          1997          1998   
                                     -------        -------        -------
<S>                                  <C>            <C>            <C>
     Depreciation

Computer Networking                  $   722        $   928        $ 3,994

Fiber Optic Components and Modules       209            225            443
                                     -------        -------        -------
Total                                $   931        $ 1,153        $ 4,437
                                     =======        =======        =======
</TABLE>

<TABLE>
<CAPTION>

                                     -------------------------------------
                                       1996          1997          1998   
                                     -------        -------        -------
<S>                                  <C>            <C>            <C>
      Additions

Computer Networking                  $ 1,997        $   623        $ 5,481

Fiber Optic Components and Modules       596            584            856
                                     -------        -------        -------
Total                                $ 2,593        $ 1,207        $ 6,337
                                     =======        =======        =======
</TABLE>

GEOGRAPHIC AREA NET TRADE REVENUE (attributed to regions based on location of
customer), (in thousands):

<TABLE>
<CAPTION>

                        ------------------------------------
                          1996          1997          1998
                        --------      --------      --------
<S>                     <C>           <C>           <C>     
United States           $ 41,712      $ 66,562      $107,376

European Community        34,256        68,719       118,881

Middle East                4,593         5,178         5,634

Pacific Rim                6,401        21,607        24,892

All Other Areas            1,853         3,405         7,292
                        --------      --------      --------
Total                   $ 88,815      $165,471      $264,075
                        ========      ========      ========
</TABLE>


                                      F-21
<PAGE>   60
GEOGRAPHIC AREA PROPERTY, PLANT AND EQUIPMENT (in thousands):

<TABLE>
<CAPTION>

                        ---------------------------------
                         1996         1997         1998
                        -------      -------      -------
<S>                     <C>          <C>          <C>    
United States           $ 2,047      $ 2,437      $11,035

European Community        2,093        3,869        5,930

Middle East               2,108        1,877        2,392
                        -------      -------      -------
Total                   $ 6,248      $ 8,183      $19,357
                        =======      =======      =======
</TABLE>

OPERATING INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE OTHER INCOME 
(EXPENSE), PROVISION (BENEFIT) FOR INCOME TAXES AND EXTRAORDINARY ITEM
(in thousands):

<TABLE>
<CAPTION>

          -------------------------------------- 
            U. S.         Non-U.S.        Total
          --------       --------       -------- 
<S>       <C>            <C>            <C>      
1996      $  2,524       $(12,182)      $ (9,658)

1997      $ 21,915       $  8,389       $ 30,304 

1998      $(28,280)      $  8,096       $(20,184)
</TABLE>

No customer accounted for more than ten percent of revenues in 1996, 1997 or 
1998.

12. 401(k) PLANS

   In February 1997, the Company established a 401(k) savings plan (the Plan)
under which all eligible employees may participate. The Plan calls for the
Company to make matching contributions to all eligible employees. In 1997 and
1998, approximately $34,000 and $60,000, respectively was charged to operations
related to this plan.

   Xyplex also sponsors a 401(k) plan covering a majority of its domestic
employees. The Plan includes a matching contribution. From the date of the
acquisition through December 31, 1998, the Company charged $194,000 to
operations related to this plan.


                                      F-22
<PAGE>   61

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The current executive officers and directors of the Company are as follows:

<TABLE>
<CAPTION>
          NAME            AGE                        POSITION
          ----            ---                        --------
<S>                       <C>       <C>
Noam Lotan(1)             48        President, Chief Executive Officer and Director
Shlomo Margalit(1)        58        Chairman of the Board of Directors, Chief Technical Officer
                                       and Secretary
Zeev Rav-Noy(1)           51        Chief Operating Officer, Treasurer and Director
Edmund Glazer             39        Vice President of Finance and Administration and Chief
                                       Financial Officer
Khalid (Ken) Ahmad        47        Vice President of Marketing and Sales
Ofer Iny                  32        Vice President of Engineering
Igal Shidlovsky(2)(3)     63        Director
Guenter Jaensch(2)(3)     60        Director
</TABLE>

(1)   Member of the Executive Committee.
(2)   Member of the Compensation Committee.
(3)   Member of the Audit Committee.

        Noam Lotan has been the President, Chief Executive Officer and a
Director of the Company since May 1990 and became Chief Financial Officer of the
Company in October 1993, in which position he served until June 1995. From March
1987 to January 1990, Mr. Lotan served as Managing Director of Fibronics (UK)
Ltd., the United Kingdom subsidiary of Fibronics International Inc.
("Fibronics"), a manufacturer of fiber optic communication networks. The Company
purchased the Fibronics Business in September 1996. From January 1985 to March
1987, Mr. Lotan served as a Director of European Operations for Fibronics. Prior
to such time, Mr. Lotan held a variety of sales and marketing positions with
Fibronics and Hewlett-Packard. Mr. Lotan holds a Bachelor of Science degree in
Electrical Engineering from the Technion, the Israel Institute of Technology,
and a Masters degree in Business Administration from INSEAD (the European
Institute of Business Administration, Fontainebleau, France).

        Dr. Shlomo Margalit, a co-founder of the Company, has been Chairman of
the Board of Directors and Chief Technical Officer since the Company's inception
in July 1988. From May 1985 to July 1988, Dr. Margalit served as a founder and
Vice President of Research and Development for LaserCom, Inc. ("LaserCom"), a
manufacturer of semiconductor lasers. From 1982 to 1985, Dr. Margalit served as
a Senior Research Associate at the California Institute of Technology
("Caltech"), and from 1976 to 1982, a Visiting Associate at Caltech. From 1972
to 1982, Dr. Margalit served as a faculty member and Associate Professor at the
Technion. During his tenure at the Technion, Dr. Margalit was awarded the
"Israel Defense" prize for his work in developing infrared detectors for heat
guided missiles and the David Ben Aharon Award for Novel Applied Research. Dr.
Margalit holds a Bachelor of Science degree, a Masters degree and a Ph.D. in
Electrical Engineering from the Technion.

        Dr. Zeev Rav-Noy, a co-founder of the Company, has been its Chief
Operating Officer and a Director of the Company since inception and served as
its President until May 1990. From May 1985 to July 1988, Dr. Rav-Noy co-founded
and served as Vice President of Operations of LaserCom and, from 1982 to 1985,
served as a research fellow at Caltech. From 1979 to 1982, Dr. Rav-Noy served as
a consultant to a number of companies, including Tadiran Electronic Industries,
Inc., an Israeli telecommunication, military, and consumer electronics
conglomerate, and the Yeda Research and Development Co. Ltd., a technology
exploitation and application company affiliated with the Weizman Institute in
Israel. Dr. Rav-Noy holds a Bachelor of Science degree and a Masters degree in
physics from Tel Aviv University and a Ph.D. in Applied Physics from





                                       39
<PAGE>   62

the Weizman Institute in Israel. Edmund Glazer was appointed Vice President of
Finance and Administration and Chief Financial Officer in June 1995. He has been
with the Company since October 1994 serving as Operations Manager. In 1993 and
1994, Mr. Glazer served as a consultant providing document imaging and
information systems to clients. From 1986 to 1993, Mr. Glazer served as Vice
President of Finance at Concord Electrical Supply, a distributor of electrical
and electronic products. From 1984 to 1986, Mr. Glazer worked as a certified
public accountant at the accounting firm of Singer, Lewak Greenbaum & Goldstein.
From 1981 to 1984, Mr. Glazer worked as an auditor at the accounting firm of
Weber, Lipshie & Co. In 1983, Mr. Glazer qualified as a Certified Public
Accountant from the State of California. Mr. Glazer holds a Bachelor of Science
Degree in Business Administration from the University of Southern California.

        Khalid (Ken) Ahmad has been employed as Vice President of Marketing and
Sales since July 1990 and an Executive Officer since May 1992. From April 1990
to July 1990, Mr. Ahmad served as a consultant to the Company. From January 1990
to March 1990, Mr. Ahmad served as a consultant to Welwyn Microcircuits, a
British manufacturer, providing market research information on fiber optic
technology. From October 1988 to November 1989, Mr. Ahmad served as marketing
manager and regional sales manager for STC Components, a manufacturer of optical
transmission components. From 1985 to 1988, he served as marketing operations
manager for PCO, Inc. a manufacturer of optical transmission devices and data
links. From 1977 to 1985, Mr. Ahmad also held a variety of marketing and sales
management positions with Canoga Data Systems, a data communications equipment
manufacturer, and Deutsch Company, an aerospace manufacturer. Mr. Ahmad holds a
Bachelor of Science degree in Biology from California State University at San
Bernardino.

        Ofer Iny has been Vice President of Engineering of the Company since May
1994. From January 1993 to May 1994, he served as a consultant to the Company.
From September 1991 to January 1993, Mr. Iny was a researcher at Jet Propulsion
Laboratory, Microgravity and Microwave Group. From May 1990 to March 1992, Mr.
Iny held the position of Senior Engineer at Whittaker Electronic Systems, a
manufacturer. Mr. Iny holds a Bachelor of Science degree in Physics from
California State University, Northridge, and a Masters degree in Physics from
University of California, Los Angeles ("UCLA").

        Dr. Igal Shidlovsky became a Director of the Company in May 1997. Dr.
Shidlovsky serves as Managing Director of Global Technologies, an investment and
consulting organization, which he founded in 1994. He has extensive management
and consulting experience with international companies and start up technology
companies. Dr. Shidlovsky is a Director of the Omega Point Foundation. From 1982
to 1991, Dr. Shidlovsky was a Director of Sentex Sensing Technologies. Dr.
Shidlovsky held several executive positions including Vice President Corporate
Development at Siemens Pacesetter, a division of Siemens AG Medical Group,
Director of Strategic Planning and Technology Utilization, and Director of the
Microelectronics Department at Siemens Corporate Research. From 1969 to 1982 he
was with RCA Laboratories, a leading electronic R&D organization. Dr. Shidlovsky
holds a Bachelor of Science degree in Chemistry from the Technion and Master and
Ph.D. degrees from the Hebrew University in Israel.

        Dr. Guenter Jaensch became a Director of the Company in December 1997,
agreeing to serve after Mr. Eddie Kawamura, who had been elected a Director at
the Company's annual meeting of shareholders, became too ill to serve. Dr.
Jaensch serves as Managing Director of The McKenzie Companies, Inc. and McKenzie
Ventures LTD. and as President of Jaensch Enterprises, each firm engaged in
management consulting, mergers and acquisitions and investments. For over 20
years, Dr. Jaensch held several executive positions with Siemens or its
subsidiaries. Among his executive positions in the United States were service as
President of Siemens Communications Systems, Inc.; Chairman of Siemens Corporate
Research and Support, Inc.; Chairman and Chief Executive Officer of Pacesetter;
and head of the cardiac management division of Siemens AG Medical Group. Dr.
Jaensch also served as controller of Siemens Data Processing Group and Director
of Siemens Internal Accounting and Budgeting operations. Dr. Jaensch holds a
Master degree in Business Administration and Ph.D. degree in Finance from the
University of Frankfurt. He also served as an Associate Professor at the
University of Frankfurt prior to joining Siemens.





                                       40
<PAGE>   63

        Each director is elected for a period of one year at the Company's
annual meeting of stockholders and serves until the next annual meeting and
until his successor is duly elected and qualified. Officers are elected by, and
serve at the discretion of, the Board of Directors, subject to relevant
employment agreements. None of the Directors of the Company are related by
blood, marriage or adoption to any of the Company's Directors or executive
officers.

Compliance with Section 16(a) of the Securities Exchange Act of 1934.

        Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors and executive officers and persons who own more than 10% of
a registered class of the Company's equity securities, to file with the
Securities and Exchange Commission ("SEC") initial reports of ownership and
reports of changes in ownership of Common Stock and other equity securities of
the Company. Directors, executive officers and 10% or greater shareholders are
required by the SEC regulations to furnish the Company with copies of all
Section 16(a) forms they file.

        The Company believes, based solely on a review of the copies of such
reports furnished to the Company, that each report required of the Company's
executive officers, directors and 10% or greater shareholders was duly and
timely filed during the year ended December 31, 1997.

ITEM 11. EXECUTIVE COMPENSATION

        The following table sets forth a summary of all compensation paid by the
Company to its Chief Executive Officer and for the four other highest paid
executive officers whose total annual salary and bonus exceeded $100,000 (the
"Named Executive Officers") during the year ended December 31, 1998:

<TABLE>
<CAPTION>
                                                                                LONG-TERM
                                                   ANNUAL COMPENSATION        COMPENSATION
                                               --------------------------     ------------
                                                                               SECURITIES
                                                                               UNDERLYING
        NAME AND PRINCIPAL POSITIONS           YEAR    SALARY      BONUS       OPTIONS (#)
---------------------------------------------  ----   --------    -------      -----------
<S>                                            <C>    <C>         <C>            <C>      
Noam Lotan                                     1998   $100,000    $     0        30,000(1)
President and Chief Executive Officer          1997   $100,000    $     0             0
                                               1996   $100,000    $     0        30,000

Shlomo Margalit                                1998   $110,000    $     0             0
Chairman of the Board of Directors,            1997   $110,000    $     0             0
Chief Technical Officer and Secretary          1996   $110,000    $     0             0

Zeev Rav-Noy                                   1998   $110,000    $60,000             0
Chief Operating Officer and Treasurer          1997   $110,000    $60,000             0
                                               1996   $110,000    $60,000             0

Ken Ahmad                                      1998   $ 90,000    $89,000             0
Vice President of Marketing and Sales          1997   $ 90,000    $45,000             0
                                               1996   $ 90,000    $57,170             0

Edmund Glazer                                  1998   $107,000    $     0        89,000(1)(2)
Vice President of Finance and Administration   1997   $ 71,000    $     0        15,000
and Chief Financial Officer                    1996   $ 56,000    $     0        24,000
</TABLE>





                                       41
<PAGE>   64

--------------------

(1)  Consists of repriced options granted under the Company's Stock Option Plans
     that were issued in replacement of all earlier options granted to the Named
     Executive Officers under the Stock Option Plans. The Options vest at their
     original vesting schedules except that no options (including vested
     options) were exercisable earlier than nine months from the date of the
     grant of the repriced options.

(2)  Excludes options to purchase 50,000 shares of Common Stock granted in
     January 1998 that were replaced with an equivalent number of repriced
     options granted later in the year.

        Neither Drs. Margalit nor Rav-Noy were granted any stock options during
1998. The following table provides certain information regarding stock option
grants made to the other Named Executive Officers during 1998.

                        OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
                                                                                  POTENTIAL REALIZABLE
                                           PERCENT OF                                VALUE AT ASSUMED
                               NUMBER OF      TOTAL                               ANNUAL RATES OF STOCK
                              SECURITIES     OPTIONS                               PRICE APPRECIATION
                              UNDERLYING     GRANTED TO  EXERCISE                  FOR OPTION TERM(1)
                                OPTIONS     EMPLOYEES      PRICE    EXPIRATION   ---------------------
               NAME          GRANTED(#)(2)   1998(2)      ($/SH)       DATE         %5           10%
               ----          -------------  ---------     -------   ----------   --------     --------
          <S>                   <C>         <C>            <C>       <C>         <C>          <C>     
          Noam Lotan             30,000      1.2%           5.25      7/7/2000   $171,243     $184,987

          Edmund Glazer           9,000                               1/9/2002    $54,939      $62,629
                                 15,000      3.5%           5.25     7/15/2002    $93,583     $108,416
                                 15,000                              3/18/2003    $96,237     $113,724
                                 50,000                               1/9/2004   $331,469     $400,438
</TABLE>

---------------
(1)  The dollar amounts under these columns are the result of calculations
     assuming the price of Common Stock on the date of the grant of the option
     ($5.25) increases at the hypothetical 5% and 10% rates set by the
     Securities and Exchange Commission for the term of the option. Neither the
     amounts reflected nor the rates applied are intended to forecast possible
     future appreciation, if any, of the Company's stock price.

(2)  Consists of repriced options granted under the Company's Stock Option Plans
     that were issued in replacement of all earlier options granted to the Named
     Executive Officers under the Stock Option Plans. The Options vest at their
     original vesting schedules except that no options (including vested
     options) were exercisable earlier than nine months from the date of the
     grant of the repriced options.

(3)  The exercise price per share of the options granted represented the fair
     market value of the underlying shares on the date of grant of the repriced
     options.

                          FISCAL YEAR-END OPTION VALUES

        Neither Drs. Margalit nor Rav-Noy or any of the other Named Executive
Officers exercised any stock options during 1998. nor held any stock options at
December 31, 1998. The following table provides certain information concerning
stock options held by the other Named Executive Officers at December 31, 1998:

<TABLE>
<CAPTION>
                             Number of Shares Underlying     Value of Unexercised
                               Unexercised Options at       In-the-Money Options at
                                  December 31, 1998           December 31, 1998(1)
                              --------------------------  --------------------------
               Name           Exercisable  Unexercisable  Exercisable  Unexercisable
               ----           -----------  -------------  -----------  -------------
          <S>                      <C>        <C>              <C>        <C>    
          Noam Lotan               0          30,000           0          $28,125
          Edmund Glazer            0          89,000           0          $83,438
</TABLE>

----------

(1)  Based on the difference between $6.1875 per share (the closing price per
     share of Common Stock on December 31, 1998 as reported on The Nasdaq
     National Market) and the per share exercise price.

Report on Repricing of Stock Options





                                       42
<PAGE>   65

        In October 1998, the board of directors authorized the reduction of the
exercise price of outstanding options (other than outstanding options having an
exercise price lower than then market price) granted to employees, including
executive officers, and directors, pursuant to the Company's Stock Option Plans.
The only Named Executive Officers affected were Noam Lotan and Edmund Glazer.
The Company accomplished this repricing (the "Repricing") by an exchanging each
option held by an optionee at the time of the Repricing (the "Surrendered
Options") for an option with a lower exercise price (the "Repriced Options").
The board concluded that the Repricing would effectively serve the board's
intended purpose and the purposes of the stock option plan to promote the growth
and general prosperity of the Company and to help the Company attract it and
retain the best available persons for positions of substantial responsibility
and provide key employees with an additional incentive to contribute to the
success of the Company. In making this conclusion, the board took into account
the following factors, among others:

        - The services rendered or to be rendered by the optionees bore a
reasonable relationship to the compensation awarded to such employees;

        - The Repricing was necessary in order to retain employees, particularly
in light of competitive pressures for the Company's remaining employees;

        - No greater dilution would be caused by the Repricing;

        - Substantial premiums would have to be paid to new key employees or
executives in order to replace key personnel who could not be retained without
the Repricing; and

        - That without the Repricing competitors' compensation programs would be
substantially more generous than the Company's and more likely to lure talented
personnel.

        Even though the board felt that the above factors, among others,
justified repricing, the board believed it would be appropriate to delay the
vesting of the Repriced Options for some period of time so that the Company
would receive new and valuable consideration from the optionee in return for the
Repricing. In the case of Repriced Options to members of the board, the board
noted that the Repricing appeared appropriate for many of the same factors
considered by the board in the case of employees. Accordingly, while the
Repriced Options had a lower exercise price than the Surrendered Options, the
board determined that all Repriced Options were granted subject to a new vesting
period beginning on the date of Repricing. Generally, the vesting schedule of
the Repriced Options continued the vesting scheduled of the Surrendered Options
with respect to unvested shares (except for unvested shares that were to vest
within nine months of the date of grant of the Repriced Options, which were
extended until nine months of the date of grant of the Repriced Options). Shares
of the Surrendered Options that had vested as of the Repricing, became unvested
in the Repriced Options until one year of the date of grant of the Repriced
Options.

                                       /s/ Igal Shidlovsky
                                       Igal Shidlovsky

                                       /s/ Guenter Jaensch
                                       Guenter Jaensch

                                       Members of the Compensation Committee





                                       43
<PAGE>   66

        The following table provides certain information regarding all
repricings of stock options held by any executive officer undertaking by the
Company since January 1, 1989:

                         TEN-YEAR OPTION/SAR REPRICINGS

<TABLE>
<CAPTION>
                                                                                                Length of
                                             Securities                                          original
                                             underlying   Market price    Exercise              option term
                                              number of     of stock        price              remaining at
                                            options/SARs   at time of    at time of     New      at date of
                                             repriced or  repricing or  repricing or  exercise  repricing or
         Name                      Date       amended(#)  amendment($)  amendment($)    price    amendment
         ----                      ----      -----------  ------------  ------------  ---------  -----------
<S>                              <C>            <C>         <C>             <C>         <C>       <C>
Noam Lotan, President and        10/8/98        30,000      $5.25           $8.42       $5.25     1/9/2000
Chief Executive Officer

Edmund Glazer, Vice              10/8/98         9,000      $5.25           $8.42       $5.25     1/9/2002
President of Finance and                        15,000                     $12.00                7/15/2002
Administration and                              15,000                     $18.25                3/18/2003
Chief Financial Officer                         50,000                     $20.25                 1/9/2004
                                                
                                                
                                                

Ofer Iny, Vice President of      10/8/98        15,000      $5.25           $8.42       $5.25     1/9/2002
Engineering                                     80,000                     $14.75                 4/7/2002
                                                60,000                     $20.25                 1/9/2004
                                                
</TABLE>

EMPLOYMENT AGREEMENTS

        In March 1992, the Company entered into three-year employment agreements
with Mr. Lotan, Dr. Margalit and Dr. Rav-Noy. Upon expiration, these agreements
automatically renew for one year terms unless either party terminates them by
giving the other three months' notice of non-renewal prior to the expiration of
the current term. Pursuant to the agreements, Mr. Lotan serves as President,
Chief Executive Officer and a Director of the Company, Dr. Margalit serves as
Chairman of the Board of Directors, Chief Technical Officer and Secretary, and
Dr. Rav-Noy serves as a Chief Operating Officer, Treasurer and a Director. Mr.
Lotan, Dr. Margalit and Dr. Rav-Noy receive base annual salaries of $100,000,
$110,000 and $110,000, respectively, and each is entitled to receive a bonus
determined and payable at the discretion of the Board of Directors upon the
recommendation of the Compensation Committee of the Board. Recommendations with
respect to bonus levels are based on achievement of specified goals, such as new
product introductions, profitability levels, revenue goals, market expansion and
other criteria as established by the Compensation Committee.

        Each officer also receives employee benefits, such as vacation, sick pay
and insurance, in accordance with the Company's policies which are applicable to
all employees. The Company has obtained, and is the beneficiary of, key man life
insurance policies in the amount of $1,000,000 on the lives of each of Drs.
Margalit and Rav-Noy and Mr. Lotan. All benefits under these policies will be
payable to the Company upon the death of an insured.





                                       44
<PAGE>   67

COMPENSATION OF OUTSIDE DIRECTORS

        Outside directors, i.e., directors who are not employees of the Company,
receive cash compensation of $800 per month and $500 for each Board of
Directors' meeting attended, while serving as Directors. All Outside Directors
received Repriced Options in exchange for options granted to them before the
Repricing on the same terms as were provided to all other optionees in the
Repricing. The following table provides information concerning the repriced
options granted to the Outside Directors:

<TABLE>
<CAPTION>
                                      Securities
                                      underlying
                                      number of
                        Date of        options      Exercise   Expiration
     Name                Grant        repriced(#)   price($)     Date
     ----               -------       ----------    --------   ---------
<S>                     <C>              <C>          <C>       <C>
Igal Shidlovsky         10/8/98          15,000       $5.25     4/21/2003
                                         65,000                 1/9/2004
Guenter Jaensch         10/8/98          65,000       $5.25     1/9/2004
</TABLE>

STOCK OPTION PLANS

        1992 Plan. On March 27, 1992, the Board of Directors and stockholders of
the Company adopted the 1992 Stock Option Plan (the "1992 Plan"), which provides
for the grant to employees, officers, directors and consultants of options to
purchase up to 900,000 shares of Common Stock, consisting of both "incentive
stock options" within the meaning of Section 422 of the United States Internal
Revenue Code of 1986, as amended (the "Code"), and non-qualified options.
Incentive stock options are issuable only to employees of the Company, while
non-qualified options may be issued to non-employee directors, consultants and
others, as well as to employees of the Company. The Board increased the 1992
Plan by 900,000 shares in February 1995, which was approved by stockholders in
June 1995 and in May 1996 increased the 1992 Plan by 150,000 shares, which was
approved by stockholders in July 1996.

        Under the 1992 Plan, the Compensation Committee has the authority to
determine the persons to whom options will be granted, the number of shares to
be covered by each option, whether the options granted are intended to be
incentive stock options, the duration and rate of exercise of each option, the
option price per share, the manner of exercise and the time, manner and form of
payment upon exercise of an option.

        The exercise price per share of Common Stock subject to incentive stock
options may not be less than the fair market value of the Common Stock on the
date the option is granted. The exercise price per share of Common Stock subject
to non-qualified options will be established by the Board of Directors. The
aggregate fair market value (determined as of the date the option is granted) of
the Common Stock that any employee may purchase in any calendar year pursuant to
the exercise of incentive stock options may not exceed $100,000. No person who
owns, directly or indirectly, at the time of the granting of an incentive stock
option to him, more than 10% of the total combined voting power of all classes
of stock of the Company shall be eligible to receive any incentive stock options
under the 1992 Plan unless the exercise price is at least 110% of grant.
Nonqualified options are not subject to this limitation.

        No incentive stock option may be transferred by an optionee other than
by will or the laws of descent and distribution and, during the lifetime of an
optionee, the option will be exercisable only by the optionee. In the event of
termination of employment other than by death or disability, the optionee will
have three months after such termination or until the expiration of such option,
whichever occurs first, to exercise the option. Upon termination of employment
of an optionee by reason of death or permanent total disability, options remain
exercisable for one year thereafter or until





                                       45
<PAGE>   68

the expiration of such option, whichever occurs first, to the extent they were
exercisable on the date of such termination. No similar limitation applies to
non-qualified options.

        Stock options under the 1992 Plan must be granted within 10 years from
the effective date of the 1992 Plan. Incentive stock options granted under the
1992 Plan cannot be exercised more than 10 years from the date of grant, except
that incentive stock options issued to 10% or greater stockholders are limited
to five year terms. All options granted under the 1992 Plan provide for the
payment of the exercise price in cash or by delivery to the Company of shares of
Common Stock already owned by the optionee having a fair market value equal to
the exercise price of the options being exercised, or by a combination of such
methods of payment. Therefore, an optionee may be able to tender shares of
Common Stock to purchase additional shares of Common Stock and may theoretically
exercise all of his stock options without making any additional cash investment.

        Any unexercised options that expire or that terminate upon an employee's
ceasing to be employed with the Company become available once again for
issuance. At December 31 1998, options for 828,120 shares were outstanding under
the 1992 Plan and 30,700 were reserved thereunder for options available for
future grant.

        1997 Plan. On November 11, 1997 and December 12, 1997, respectively, the
Board of Directors and stockholders of the Company adopted the 1997 Incentive
and Nonstatutory Stock Option Plan (the "1997 Plan"), which provides for the
grant of options to purchase up to 500,000 shares of Common Stock. On October
30, 1998 stockholders approved the board's proposal to increase by 500,000
shares the number of shares of Company Stock that may be optioned and sold under
the 1997 Plan. The Company's 1997 Plan provides for the granting of (i)
incentive stock options to key employees and (ii) nonstatutory stock options to
key employees and non-employee directors of the Company and any person who
performs consulting or advisory services for the Company and who is, by the
Board of Directors or the Stock Option Committee, determined to be eligible to
participate. For information concerning the federal income tax distinctions of
incentive and nonstatutory stock options, see "Federal Income Tax Consequences
of Incentive Stock Options and Nonstatutory Stock Options," below.

        The maximum number of shares of the Company's Common Stock that may be
issued pursuant to the exercise of options granted under the 1997 Plan is
1,000,000 shares (subject to adjustment in the event of stock dividends, splits,
reverse splits, recapitalizations, mergers or other similar changes in the
Company's capital structure). No more than 1,000,000 shares may be optioned and
sold to directors or non-director officers under the Stock Option Plan as
amended. All options must be granted, if at all, not later than November 10,
2007. The aggregate fair market value (determined as of the date the option is
granted) of the shares of Common Stock to which incentive stock options granted
under the Stock Option Plan are exercisable for the first time by any employee
of the Company during any calendar year may not exceed $100,000. This limitation
does not apply with respect to nonstatutory stock options.

        The 1997 Plan is to be administered by the full Board of Directors,
which will determine the terms of options granted, including the exercise price,
the number of shares subject to the option and the terms and conditions of
exercise. No option granted under the 1997 Plan is transferable by the optionee
other than by will or the laws of descent and distribution and each option is
exercisable during the lifetime of the optionee only by such optionee. Incentive
stock options and nonstatutory stock options may be and typically are granted
for exercise for up to ten years from the date granted and typically vest in
equal installments over three years from the date of grant.

        Options granted under the 1997 Plan are evidenced by written agreements
specifying the number of shares covered thereby and the option price, the
exercise period and all other terms, restrictions and conditions of the option.
The exercise price of all stock options granted under the 1997 Plan must be at
least equal to the fair market value of such shares on the date of grant. With
respect to any optionee who owns stock possessing more than 10% of the voting
rights of the Company's outstanding capital stock, the exercise price of any
stock option must be not less than 110% of the fair market value on the date of
grant.





                                       46
<PAGE>   69

        Options must be exercised only by written notice from the optionee (or
his estate or other legal representative) to the Company accompanied by payment
of the option price in full. The option price may be paid in cash, cash
equivalents (certified or cashier's check), or with shares of Common Stock of
the Company.

        As of December 31, 1998, options to purchase an aggregate of 1,000,000
shares of Common Stock were outstanding, no options granted under the 1997 Plan
had been exercised and none were available for future grant.

        Other Option Plans. The Company also has two other outstanding option
programs: (1) its 1998 Nonstatutory Stock Option Plan, under which the Company
may grant nonstatutory stock options to purchase up to 1,421,500 shares of
Common Stock to employees the Company and any person who performs consulting or
advisory services for the Company and who is, by the Board of Directors or the
Stock Option Committee, determined to be eligible to participate, and (2) its
German Employees Warrant Program under which the Company may grant warrants to
purchase up to 100,000 shares of Common Stock to employees of its German
subsidiaries. Directors and officers of the Company are not eligible to
participate in either of these plans. At December 31, 1998 options for 1,421,500
shares were outstanding under the 1998 Nonstatutory Stock Option Plan and none
were reserved thereunder for options available for future grant. At December 31,
1998, warrants for 100,000 shares were outstanding under the German Employees
Warrant Program and none were reserved thereunder for warrants available for
future grant.

LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS

        The Company's Certificate of Incorporation includes a provision that
eliminates or limits the personal financial liability of the Company's
directors, except in situations where there has been a breach of the director's
duty of loyalty to the Company or its stockholders, acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law, liability under Section 174 of the Delaware General Corporation Law
("Section 174") relative to unlawful payment of dividends, stock purchases or
redemptions, or any transaction from which the director derived an improper
personal benefit. Furthermore, Section 174 eliminates monetary liability for
gross negligence in exercising the duty of due care related to the directors'
fiduciary duties under state corporate law, however, such section does not
eliminate monetary liability of directors under the federal Securities laws. In
addition, the Company's Bylaws include provisions to indemnify its officers and
directors and other persons against expenses, judgments, fines and amounts paid
in settlement in connection with threatened, pending or completed suits or
proceedings against such persons by reason of serving or having served as
officers, directors or in other capacities, except that in relation to matters
with respect to which such persons shall be determined to be liable for
misconduct or negligence in the performance of their duties, the Company's
Bylaws provide for indemnification only to the extent that the Company
determines that such person acted in good faith and in a manner not opposed to
the best interests of the Company. Insofar as indemnification for liabilities
arising under the Securities Act of 1933 may be permitted to directors, officers
or persons controlling the Company pursuant to the foregoing provisions, the
Company has been informed that in the opinion of the Securities and Exchange
Commission such indemnification is against the public policy as expressed in the
Act and is therefore unenforceable.









                                       47

<PAGE>   70

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

        The following table sets forth certain information regarding the
beneficial ownership of the Common Stock as of March 19, 1999, of (i) each
person known by the Company to own beneficially 5% or more of the Common Stock,
(ii) each current director of the Company owning Common Stock, (iii) each of the
Named Executive Officers owning Common Stock, and (iv) all current directors and
executive officers as a group.

<TABLE>
<CAPTION>
                                                   Number of Shares
                   Name and Address(1)               Beneficially     Percentage of
                   of Beneficial Owner                 Owned(2)           Class
                   -------------------             ----------------   -------------
          <S>                                         <C>                 <C> 
          Shlomo Margalit ....................        1,843,930           6.9%
          Zeev Rav-Noy .......................        1,713,915           6.4%
          Noam Lotan .........................          863,437           3.2%
          Ken Ahmad (3) ......................          313,464           1.2%
          All Directors and Executive Officers
            as a Group (8 persons) (3) .......        4,734,746          17.7%
</TABLE>

----------

(1)  Except as noted below, the address of each of the persons listed is c/o MRV
     Communications, Inc., 8943 Fullbright Avenue, Chatsworth, CA 91311.

(2)  Pursuant to the rules of the Commission, shares of Common Stock that an
     individual or group has a right to acquire within 60 days pursuant to the
     exercise of options or warrants are deemed to be outstanding for the
     purpose of computing the percentage ownership of such individual or group,
     but are not deemed to be outstanding for the purpose of computing the
     percentage ownership of any other person shown in the table.

(3)  Includes 150,000 shares issuable pursuant to stock options exercisable
     within 60 days from March 19, 1999.












                                       48

<PAGE>   71


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        In July 1998, the Company and New Access Communications, Inc. ("New
Access") entered into a Securities Purchase Agreement, under which the Company
purchased for $950,000 shares of the capital stock of New Access equal to
approximately 19% of the capital stock of New Access then outstanding and
warrants to purchase additional capital stock of New Access, which, if fully
exercised for an aggregate of $2,050,000, the Company would own an aggregate of
approximately 60% of New Access's capital stock (when the shares purchased upon
exercise of the warrants are added to the Company's existing stake in New
Access). The warrants are exercisable in two installments (provided the first
installment is exercised) by July 1, 1999 and January 4, 2000, respectively. New
Access is engaged in the development of new products based on wave division
multiplexing technology. Dr. Margalit is the Chairman of the Board and Chief
Executive Officer of New Access and a principal shareholder of it. Dr. Near
Margalit is the son of Dr. Shlomo Margalit, a principal shareholder of the
Company and the Company's Chairman of the Board of Directors and Chief Technical
Officer.

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a)     (1) The financial statements filed as a part of this Report consist of
            the financial statements listed under Item 8.

        (2) The financial statement schedules filed as a part of this Report
            consist of the following:

                  Schedule II Valuation and Qualifying Accounts
                  Report of Independent Public Accountants on Financial 
                  Statement Schedule.

        (3) The following exhibits are filed as part of this Report:

<TABLE>
<CAPTION>
Exhibit No.                           Description
-----------                           -----------   
<S>           <C>
    2.1       Agreement and Plan of Merger by and between MRV Technologies,
              Inc. (a California corporation) and MRV Technologies, Inc. (a
              Delaware corporation), as amended (incorporated by reference to
              Exhibit 2a filed as part of Registrant's Registration Statement on
              Form S-1 (File No. 33-48003)).

    2.2       Certificate of Merger by and between MRV Technologies, Inc. (a
              California corporation) and MRV Technologies, Inc. (a Delaware
              corporation) (incorporated by reference to Exhibit 2b filed as
              part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

    3.1       Certificate of Incorporation, as amended (incorporated by
              reference to Exhibit 3a filed as part of Registrant's Registration
              Statement on Form S-1 (File No. 33-48003)).

    3.2       Certificate of Amendment of Certificate of Incorporation filed
              with the Delaware Secretary of State on March 20, 1996
              (incorporated by reference to Exhibit 3.2 of the Company's Form
              10-Q for the quarter ended June 30, 1998 filed August 14, 1998).

    3.3       Certificate of Amendment of Certificate of Incorporation filed
              with the Delaware Secretary of State on July 29, 1996
              (incorporated by reference to Exhibit 3.3 of the Company's Form
              10-Q for the quarter ended June 30, 1998 filed August 14, 1998)

    3.4       Certificate of Amendment of Certificate of Incorporation filed
              with the Delaware Secretary of State on November 19, 1998.
</TABLE>



                                       49
<PAGE>   72

<TABLE>
<S>           <C>
    3.5       Bylaws (incorporated by reference to Exhibit 3b filed as part of
              Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

    4.1       Specimen certificate of Common Stock (incorporated by reference to
              Exhibit 4.5 filed as part of Registrant's Registration Statement
              on Form S-3 (File No. 333-64017). 

    4.2       Specimen of Restricted Global Security (incorporated by reference 
              to Exhibit 4.3 of the Company's Form 10-Q for the quarter ended 
              June 30, 998 filed August 14, 1998).

   10.1       Form of Underwriter's Warrant issued to Hampshire Securities
              (incorporated by reference to Exhibit 4f filed as part of 
              Registrant's Registration Statement on Form S-1 
              (File No. 33-86516)).

   10.2       Lease for premises at 8917 Fullbright Avenue, Chatsworth, CA dated
              August 5, 1991 (incorporated by reference to Exhibit 10a filed as
              part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.3       Lease for premises at 8943 Fullbright Avenue, Chatsworth, CA dated
              March 3, 1993 (incorporated by reference to Exhibit 10a(1) filed
              as part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.4       Key Employee Agreement between the Company and Noam Lotan dated
              March 23, 1993 (incorporated by reference to Exhibit 10b(1) filed
              as part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.5       Letter amending Key Employee Agreement between the Company and
              Noam Lotan (incorporated by reference to Exhibit 10b(1)1 filed as
              part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.6       Letter amending Key Employee Agreement between the Company and
              Noam Lotan (incorporated by reference to Exhibit 10b(1)2 filed as
              part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.7       Key Employee Agreement between the Company and Zeev Rav-Noy dated
              march 23, 1992 (incorporated by reference to Exhibit 10b(2) filed
              as part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.8       Letter amending Key Employee Agreement between the Company and
              Zeev Rav-Noy (incorporated by reference to Exhibit 10b(2) filed as
              part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.9       Letter amending Key Employee Agreement between the Company and
              Zeev Rav-Noy (incorporated by reference to Exhibit 10b(2) filed as
              part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.10      Key Employee Agreement between the Company and Shlomo Margalit
              (incorporated by reference to Exhibit 10b(3) filed as part of
              Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.11      Letter amending Key Employee Agreement between the Company and
              Shlomo Margalit (incorporated by reference to Exhibit 10b(3)1
              filed as part of Registrant's Registration Statement on Form S-1
              (File No. 33-48003)).
</TABLE>





                                       50
<PAGE>   73

<TABLE>
<S>           <C>
   10.12      Form of Letter amending Key Employee Agreement between the Company
              and Shlomo Margalit (incorporated by reference to Exhibit
              10b(3) 2 filed as part of Registrant's Registration Statement on
              Form S-1 (File No. 33-48003)).

   10.13      Employment Letter between the Company and Khalid (Ken) Ahmad dated
              August 8, 1990 (incorporated by reference to Exhibit 10b(4) filed
              as part of Registrant's Registration Statement on Form S-1 (File
              No. 33-48003)).

   10.14      Agreement for Purchase of Galcom Assets dated March 21, 1995
              (incorporated by reference to Exhibit No. 2.1 and 2.1a of
              Registrant's Report on Form 8-K (0-23452) dated May 1, 1995, with
              respect to the Galcom Acquisition).

   10.15      MRV Communications Inc. Incentive Plan for Grant of Warrants to
              Employees Subsidiaries (incorporated by reference to Exhibit No.
              10.21 of Registrant's Annual Report on Form 10-K (0-23452) for the
              year ended December 31, 1996 filed April 15, 1997).

   10.16      Asset Purchase Agreement dated September 26, 1996 between the
              Company, Elbit Ltd and certain of its Fibronics subsidiaries
              (incorporated by reference to Exhibit No. 2.1 of Registrant's
              Report on Form 8-K (0-23452), dated October 9, 1996 with respect
              to the Fibronics Acquisition).

   10.17      First Amendment to Asset Purchase Agreement dated March 13,
              1997 between Elbit Ltd. and Registrant (incorporated by reference
              to Exhibit No. 10.22.1 of Registrant's Annual Report on Form 10-K
              for the year ended December 31, 1996 filed April 15, 1997).

   10.18      Standard Industrial/Commercial Single-Tenant Lease dated October
              8, 1996 between the Company and Nordhoff Development relating to
              the premises located at 20415 Nordhoff Street, Chatsworth,
              California (incorporated by reference to Exhibit No. 10.23 of
              Registrant's Annual Report on Form 10-K for the year ended
              December 31, 1996 filed April 15, 1997).

   10.19      Form of Debenture (aggregating $30,000,000 principal amount)issued
              in private placement completed in September 1996 (incorporated by
              reference to Exhibit No. 10.24 of Registrant's Annual Report on
              Form 10-K (0-23452) for the year ended December 31, 1996 filed
              April 15, 1997).

   10.20      Form of Warrants (aggregating 600,000) issued in private placement
              completed in September 1996 (incorporated by reference to Exhibit
              No. 10.25 of Registrant's Annual Report on Form 10-K (0-23452) for
              the year ended December 31, 1996 filed April 15, 1997).

   10.21      Form of Registration Rights Agreement entered into with investors
              in private placement completed in September 1996 (incorporated by
              reference to Exhibit No. 10.26 of Registrant's Annual Report on
              Form 10-K (0-23452) for the year ended December 31, 1996 filed
              April 15, 1997).

   10.22      Common Stock Purchase Agreement dated November 26, 1996 between
              the Company and Intel Corporation (incorporated by reference to
              Exhibit No. 10.27 of Registrant's Annual Report on Form 10-K
              (0-23452) for the year ended December 31, 1996 filed April 15,
              1997). 

   10.23      Investor Agreement dated November 26, 1996 between the Company
              and Intel Corporation (incorporated by reference to Exhibit 
              No. 10.28 of Registrant's Annual Report on Form 10-K (0-23452)
              for the year ended December 31, 1996 filed April 15, 1997).

   10.24      Warrant to Purchase 300,000 shares of Common Stock in favor of
              Intel Corporation (incorporated by reference to Exhibit No. 10.29
              of Registrant's Annual Report on Form 10-K (0-23452) for the year
              ended December 31, 1996 filed April 15, 1997).
</TABLE>





                                       51
<PAGE>   74

<TABLE>
<S>           <C>
   10.25      Warrant to Purchase 100,000 shares of Common Stock in favor of
              Intel Corporation (incorporated by reference to Exhibit No. 10.29
              of Registrant's Annual Report on Form 10-K (0-23452) for the year
              ended December 31, 1996 filed April 15, 1997).

   10.26      Stock Purchase Agreement dated January 19, 1998 by and between
              Whittaker and Registrant (incorporated by reference to Exhibit No.
              2.1(a) of Registrant's Report on Form 8-K filed February 13, 1998
              with respect to the Xyplex Acquisition).

   10.27      Warrant Agreement dated January 30, 1998 by and between Whittaker
              and Registrant (incorporated by reference to Exhibit No. 2.1(b) of
              Registrant's Report on Form 8-K filed February 13, 1998 with
              respect to the Xyplex Acquisition).

   10.28      Warrant Certificate No. Whittaker # 1 to purchase 421,402 shares
              of Common Stock of Registrant issued to Whitaker on January 30,
              1998 (incorporated by reference to Exhibit No. 2.1(c) of
              Registrant's Report on Form 8-K filed February 13, 1998 with
              respect to the Xyplex Acquisition).

   10.29      American Industrial Real Estate Association, Standard
              Industrial/Commercial Single-Tenant Lease - Net dated November 17,
              1997 by and between Ruth G Fisher Living Trust U/D/T dated June 28
              1990 and Registrant relating to the premises located at 8928
              Fullbright Avenue, Chatsworth, California (incorporated by
              reference to Exhibit No. 10.35 of Registrant's Report on Form 10-K
              for the year ended December 31, 1997 filed April 15, 1998).

   10.30      New Lease dated February 22, 1993 by and between 495 Littleton
              Associates and Xyplex, Inc. relating to the premises located at
              295 Foster Street, Littleton, Mass, Amendments Nos. 1 through 4
              thereto (incorporated by reference to Exhibit No. 10.36 of
              Registrant's Report on Form 10-K for the year ended December 31,
              1997 filed April 15, 1998).

   10.31      Fifth Amendment to Lease relating to the premises located at 295
              Foster Street, Littleton, Mass. with attached Lease Guaranty of
              Registrant.

   10.32      Underwriting Agreement dated September 18, 1997 by and among
              Registrant, the Selling Stockholders named on Schedule I thereto
              and the Underwriters named on Schedule II thereto (incorporated by
              reference to Exhibit No. 10.37 of Registrant's Report on Form 10-K
              for the year ended December 31, 1997 filed April 15, 1998).

   10.33      Indenture, dated as of June 26, 1998, between the Company and
              American Stock Transfer & Trust Company, as Trustee, relating to
              the Company's 5% Convertible Subordinated Notes Due 2003 (the
              "Notes") (incorporated by reference to Exhibit 4.2 of the
              Company's Form 10-Q for the quarter ended June 30, 1998, filed
              August 14, 1998).

   10.34      Purchase Agreement, dated June 23, 1998, between the Company and
              Prudential Securities Incorporated and Bear, Stearns & Co. Inc.
              relating to the Notes (incorporated by reference to Exhibit 4.1 of
              the Company's Form 10-Q for the quarter ended June 30, 1998 filed
              August 14, 1998).

   10.35      Indenture, dated as of June 26, 1998, between the Company and
              American Stock Transfer & Trust Company, as Trustee, relating to
              the Notes (incorporated by reference to Exhibit 4.2 of the
              Company's Form 10-Q for the quarter ended June 30, 1998, filed
              August 14, 1998).

   10.36      Registration Rights Agreement dated June 26, 1998 between the
              Company and Prudential Securities Incorporated and Bear, Stearns &
              Co. Inc. relating to the shares of Common Stock issuable upon
              conversion of the Notes (incorporated by reference to Exhibit 4.4
              of the Company's Form 10-Q for the quarter ended June 30, 1998
              filed August 14, 1998).
</TABLE>





                                       52
<PAGE>   75

<TABLE>
<S>           <C>
   10.37      Underlease dated September 16, 1998 between Lowe Azure Limited,
              NBase Europe Gmbh and the Company relating to property at Unit 16,
              Campbell Court, Campbell Road, Bramley Basingstoke Hampshire,
              England.

   10.38      Standard Industrial/Commercial Single-Tenant Lease - Net dated 
              December 1, 1998 by and between Radar Investments, Inc. and
              Registrant relating to the premises located at 8943 Fullbright
              Avenue, Chatsworth, California. 

   21         Subsidiaries of the Registrant.

   23         Consent of Arthur Andersen LLP to incorporation of Report on
              Financial Statements into Company's Registration Statements on
              Form S-8 (File No. 33- 96458), Form S-3 (File No. 333-17537) and
              Form S-3 (File No.333-64017) .

   25         Power of Attorney (contained on Signature Page).
</TABLE>

(b) Reports on Form 8-K.

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









                                       53
<PAGE>   76


                                   SIGNATURES


        In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934 (the "Exchange Act"), the Registrant caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Chatsworth,
State of California, on March 30, 1999

                                        MRV COMMUNICATIONS, INC.



                                        By:  /s/  Noam Lotan 
                                            -----------------------------------
                                            Noam Lotan, President and
                                            Chief Executive Officer

                                POWER OF ATTORNEY

        KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes an appoints Noam Lotan, Zeev Rav-Noy and Edmund
Glazer, and each of them, as his true and lawful attorneys-in-fact and agents,
with full power of substitution for him in any and all capacities, to sign any
and all amendments to this Annual Report on Form 10-K and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorneys-in-fact and agents, or any of
them, or their or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.

        Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed by the following persons in the capacities and on
the dates indicated.

<TABLE>
<CAPTION>
              Names                                 Title                         Date
              -----                                 -----                         ----
<S>                                 <C>                                      <C>
        /s/ Noam Lotan              President, Chief Executive Officer
-------------------------------     (Principal Executive Officer), and a     March 30, 1999
        Noam Lotan                  Director


        /s/ Zeev Rav-Noy            Chief Operating Officer,                 March 30, 1999
-------------------------------     Treasurer, and a Director
        Zeev Rav-Noy


        /s/ Shlomo Margalit         Chairman of the Board, Chief             March 30, 1999
-------------------------------     Technical Officer, Secretary,
        Shlomo Margalit             and a Director


        /s/ Edmund Glazer           Vice President of Finance  and           March 30, 1999
-------------------------------     Administration, Chief Financial
        Edmund Glazer               Officer (Principal Financial and
                                    Accounting Officer)


        /s/ Igal Shidlovsky         Director                                 March 30, 1999
-------------------------------
        Igal Shidlovsky


        /s/ Guenter Jaensch        Director
-------------------------------                                              March 30, 1999
        Guenter Jaensch
</TABLE>









                                       54


<PAGE>   77

                                                                     SCHEDULE II




   VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                           Balance at   Charged to     Charged to                     Balance
                           beginning    costs and       other                        at end of
Description                of period     expenses      accounts       Deductions      period 
-----------                ---------     --------      --------       ----------      ------ 
<S>                        <C>          <C>           <C>             <C>            <C>
Accounts receivable
  reserve                   $ 4,252      $ 2,591      $ 2,647(3)      $ 1,003(1)      $ 8,487

Accrued restructuring       $    --       23,194           --          23,112(2)           82
</TABLE>
------------------
(1)     Uncollectible accounts receivable written off agains and mergers.

(2)     Computed as follows:

<TABLE>
<S>                                                        <C>
        Termination benefits for 183 employees             $6,721
        Closure of facilities                               1,190
        Relocation of employees                               154
        Settlement of distribution agreements               5,033
        Elimination of product lines                        2,831
        Reversal of accrual primarily related to
          renegotiation of lease for principal facility in
          Littleton, Massachusetts                          6,748
        Other                                                 435
</TABLE>

(3) Addition to reserve booked as part of Xyplex acquisition.




<PAGE>   78
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


     Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Schedule of Valuation and Qualifying
Accounts, Schedule II, is presented for purposes of additional analysis and is
not a required part of the basic financial statements. This information has been
subjected to the auditing procedures applied in our audit of the basic
financial statements and, in our opinion, is fairly stated in all material
respects in relation to the basic financial statements taken as a whole.



                                                  /s/ ARTHUR ANDERSEN LLP

                                                  ARTHUR ANDERSEN LLP


Los Angeles, California
February 15th, 1999