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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K (Mark One) þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the fiscal year ended December 31, 2004 OR o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act For the transition period from  to Commission file number 0-25678  (MRV LOGO) MRV COMMUNICATIONS, INC.  Delaware
    
    06-1340090(State or other jurisdiction
    
    (I.R.S. Employerincorporation or organization)
    
    identification No.)
 20415 Nordhoff Street, Chatsworth, CA 91311
(Address of principal executive offices, Zip Code) Registrants telephone number, including area code: (818) 773-0900 Securities registered under Section 12(b) of the Exchange Act: Name of each exchange onTitle of each class
    
    which registeredNone
    
    None
 Securities registered under Section 12(g) of the Exchange Act: Common stock, $0.0017 par
value   Indicate by check mark, whether the issuer (1) has filed all reports required to be filed by
section 13 or 15(d) of the Securities Exchange Act of 9134 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ  No o Indicate by a check mark 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. o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes þ  No o Aggregate market value of the voting and non-voting common stock held by non-affiliates
computed by reference to the price at which the common stock was last sold, or the average bid and
asked price of such common stock, as of the last business day of the Registrants most recently
completed second fiscal quarter - $289,351,072 (As of June 30, 2004). Number
of shares of common stock, $0.0017 par value, outstanding as of
February 15, 2005 
104,135,290. DOCUMENTS INCORPORATED BY REFERENCE None.




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MRV Communications, Inc. Index to Form 10-K For the fiscal year ended December 31, 2004 PageNumberPART I3Item 1.
    
    Business
    
    
    3Item 2:
    
    Properties
    
    
    22Item 3.
    
    Legal Proceedings
    
    
    23Item 4.
    
    Submission of Matters to a Vote of Security
Holders
    
    
    23PART II
    
    
    
    
    
    
    24Item 5.
    
    Market for the Registrants Common Equity and
Related Stockholder Matters
    
    
    24Item 6.
    
    Selected Financial Data
    
    
    25Item 7.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    26Item 7a.
    
    Quantitative and Qualitative Disclosures About
Market Risks
    
    
    44Item 8.
    
    Consolidated Financial Statements and
Supplementary Data
    
    
    45Item 9.
    
    Changes in or Disagreements with Accountants on
Accounting and Financial Disclosure
    
    
    72Item 9A.
    
    Controls and Procedures
    
    
    72Item 9B.
    
    Other Information
    
    
    74PART III
    
    
    
    
    
    
    75Item 10.
    
    Directors and Executive Officers of the
Registrant
    
    
    75Item 11.
    
    Executive Compensation
    
    
    78Item 12.
    
    Security Ownership of Certain Beneficial Owners
and Management
    
    
    84Item 13.
    
    Certain Relationships and Related Transactions
    
    
    86PART IV
    
    
    
    
    
    
    86Item 14.
    
    Principal Accountant Fees and Services
    
    
    86Item 15.
    
    Exhibits, Financial Statement Schedules and
Reports on Form 8-K
    
    
    87Signatures
    
    
    89EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  As used in this Report, we, us, our, MRV or the Company refer to MRV Communications,
Inc. and its consolidated subsidiaries. 2




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PART I This Annual Report on Form 10-K for the year ended December 31, 2004, (the Form 10-K)
contains certain forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of
1934, as amended (the Exchange Act). Forward-looking statements are statements other than
historical information or statements of current condition and relate to future events or the future
financial performance of the Company. Some forward-looking statements may be identified by use of
such terms as expects, anticipates, intends, estimates, believes and words of similar
import. These forward-looking statements relate to plans, objectives and expectations for future
operations. In light of these risks and uncertainties, there can be no assurance that the
forward-looking information contained in this Form 10-K will in fact transpire or prove to be
accurate. All subsequent written and oral forward-looking statements attributable to us or persons
acting on our behalf are expressly qualified in their entirety by this introduction. In light of the risks and uncertainties inherent in all such projected operational matters,
the inclusion of forward-looking statements in this Form 10-K should not be regarded as a
representation by the Company or any other person that the objectives or plans of the Company will
be achieved or that any of the Companys operating expectations will be realized. Revenues and
results of operations are difficult to forecast and could differ materially from those projected in
the forward-looking statements contained in this Form 10-K for the reasons detailed in the Risk
Factors section of this Form 10-K, beginning on page 9 or elsewhere in this Form 10-K. Readers
should not place undue reliance on forward-looking statements, which reflect managements view only
as of the date of this Form 10-K. 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. 
 ITEM 1. BUSINESS Overview We design, manufacture, sell, distribute, integrate and support communication equipment and
services, and optical components. We conduct our business along three principal segments: the
networking group, the optical components group and development stage enterprise group. Our
networking group provides equipment used by commercial customers, governments and
telecommunications service providers, and include switches, routers, physical layer products and
console management products as well as specialized networking products for aerospace, defense and
other applications including voice and cellular communication. Our optical components group
designs, manufactures and sells optical communications components, primarily through our wholly
owned subsidiary LuminentOIC, Inc. These components include fiber optic transceivers for
metropolitan, access and Fiber-to-the-Premises, or FTTP, applications. Our development stage
enterprise group seeks to develop new optical components, subsystems and network equipment and
other products for the infrastructure of the Internet. We market and sell our products worldwide, through a variety of channels, which include a
dedicated direct sales force, manufacturers representatives, value-added-resellers, distributors
and systems integrators. We have operations in Europe that provide network system design,
integration and distribution services that include products manufactured by third-party vendors, as
well as our products. We believe such specialization enhances access to customers and allows us to
penetrate targeted vertical and regional markets. We were organized in July 1988 as MRV Technologies, Inc., a California corporation and
reincorporated in Delaware in April 1992, at which time we changed our name to MRV Communications,
Inc. 3




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Industry Background Over the past decade, businesses, governments, educational institutions and other
organizations have become increasingly reliant on communications networks and software applications
as critical strategic assets. With the proliferation of Internet access to consumer households,
communications networks have been expanded to deliver new services providing both internal and
external connectivity. Productivity gains obtained by investments in network infrastructure have
fueled the growth of the global economy. Increased demands for capacity in network infrastructure
have resulted in greater bandwidth requirements and increased deployment of optical components and
optical networks. In the late 1990s and through 2000, our customers deployed a large volume of networking
equipment in anticipation of high network traffic growth. During this period, we experienced a
period of rapid revenue growth. Subsequent to 2000 the global economy entered a recessionary
period and the demand for information technology products declined as telecommunications carriers
and service providers, enterprise customers and governments reduced spending on technology. In
particular these enterprises cut their IT budgets for networking equipment and optical components
due to overcapacity as the anticipated increase in network growth in the years 2002 through 2003
did not materialize. We believe this phenomenon adversely affected demand for our products and
made it more difficult to accurately forecast demand for network equipment and optical components. Products and Services We provide integrated, secure network equipment and services to connect data, voice and/or
video (both analog and digital), within single buildings, across private networks located in
multiple buildings such as college or campus environments (campus networks) and in metropolitan
areas. At the access point to the network, we provide standard-based products, including Ethernet
connectivity over telephone wires. Access speeds (data rates) vary, scaling up to
Gigabits-per-second (Gbps), and providing security features such as intrusion control and traffic
rate control. Our products aggregate network traffic using standard protocols to interconnect
high-speed networks. Additional features enable new services such as virtual private networks
(VPN), permitting remote private network access over the Internet and quality of service (QoS),
permitting the ability to deliver time-sensitive data, control the bandwidth, set priorities for
specific network traffic and provide an appropriate level of security. For campus networks and
metropolitan networks, where fiber optic cabling is not available, or cannot easily be deployed, we
provide point-to-point connectivity using free-space optics (FSO) technology, a line-of-sight
technology that uses lasers to provide optical bandwidth connections that can send and receive
voice, video, and data information on invisible beams of light. These products can be deployed
quickly carrying network traffic from building to building without digging up the street to install
fiber optic cabling, or can be used in disaster recovery and back-up applications. We also provide
wave division multiplexing (WDM) technology to expand the capacity of existing fiber optic
infrastructure by enabling simultaneous transmission of information over multiple wavelengths on
the same fiber optic strand. In addition, we provide network management systems that allow users
and network administrators to control remote network elements, including network equipment,
temperature and alarm sensors and power supply. Our offerings fall into several product groups. For revenue breakdown by product group,
please see Note 16, Segment Reporting included in the Notes to Financial Statements appearing
elsewhere in this Form 10-K our product groups include: Physical
Layer Products - Optical Connectivity. Cabling and network transmission equipment
constitute the physical infrastructure, which is essential for computer connectivity, telephony
systems and video distribution. We provide a broad range of connectivity products for
copper-to-fiber media conversion, signal repeating, and fiber-optimization, including WDM systems
and FSO. Like fiber optic cable, FSO communications systems use lasers and light from LEDs to
transmit a digital signal between two transceivers. However, unlike fiber, light is transmitted
through the air (free-space) instead of through a glass strand. 4




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We also offer both coarse wave division multiplexing (CWDM) and dense wave division
multiplexing (DWDM) systems. CWDM and DWDM use a technology that puts data from different
sources together on an optical fiber, with each signal carrier at the same time on its own separate
light wavelength. CWDM combines up to 16 wavelengths onto a single fiber. DWDM combines up to 64
wavelengths onto a single fiber. We also provide network access technology for data and voice over
standard telephone wire. This includes long range Ethernet, and voice-over-Ethernet products for
converged voice and data networks. Switches
and Routers - Ethernet Connectivity.Switching and routing technologies are
essential for computer networking. Switches direct the flow of data traffic between individual
computers, servers and other elements on a network and routers direct the flow of data traffic
between computer networks. We provide a wide range of switching and routing products that scale
from small systems designed for small business applications, to very large, high capacity systems
for enterprise and telecommunications carrier applications.In some cases, we also offer switches
or routers manufactured by third-party vendors, supplied as part of our network system integration
and distribution services. Console Management.Our console management products allow network managers to manage, monitor
and control, from a central point, the real-time elements such as temperature, humidity, electrical
power and the status of other equipment that exist in the network at a remotely located network. We also provide a network management system (NMS) with comprehensive management and control
for our products as well as other vendors products. Our NMS combines complete end-to-end network
viewing and performance monitoring with network configuration and fault management including
automatic detection and monitoring of devices from other vendors. Other Networking Products. We provide networking products for aerospace, defense and other
applications including voice and cellular communication. Our aerospace and defense networks apply
real-time data acquisition technology allowing high-speed, packet-by-packet transaction processing
for flight test validation and simulation systems. These products provide in-flight parameter
recording systems in military and commercial aircrafts. We also provide ground test systems as
well as protocol analyzers and network performance-testing equipment. In addition, we provide
networking data test equipment and a multi-service computing platform for wireless cellular
telephony. Services. Our products perform critical networking tasks and are often used in conjunction
with network equipment manufactured by other vendors. We believe that pre and post-sales services
ensure high-availability, reduce cost of ownership, support business goals and promote customer
loyalty. Accordingly, we provide a broad range of service offerings including pre-sale network
design, consultation, and site-surveys. We also provide system integration and on-site
installation. Post-sales support includes in-warranty as well as out-of-warranty repair and
on-site maintenance. Our services include a choice of technical support services including
around-the-clock response. Optical Components. We design, manufacture and sell optical communications components.
LuminentOIC offers a broad product portfolio in transceivers, FTTP/EFM
(Ethernet in the First Mile) applications, CWDM/DWDM systems, and discrete active components.
Products in the transceiver product line for access to metropolitan
networks support Gigabit Ethernet, SONET/SDH (an acronym for
Synchronous Optical Network/Synchronous Digital Hierarchy) and Fibre Channel protocols, and span
a complete set of data rates, power levels, and form factors. The
breadth of this product line ranges from mass volume, critically low cost transceivers to small form factor pluggable (SFP) transceivers for
high end metropolitan access network applications. The FTTP product
line offers products for
multiplexing video and bi-directional data over single fibers,
providing for superior video
quality with high data throughput. The FTTP/EFM products include bi-directional
transceivers and integrated triplexer subsystems, integrating voice, video, and data in a single
managed transceiver. Offerings in CWDM/DWDM include an extensive set of wavelengths covering a full
18-wavelength CWDM/ 64 wavelength DWDM system in a number of transceiver or discrete laser form
factors. 5




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Sales and Marketing We employ various methods, such as public relations, advertising, and trade shows in an effort
to build awareness of our products as well as establishing our brand name, MRV. We conduct our
public relations activities both internally and through relationships with outside agencies. We
focus on major public relations activities focused around new product introductions, corporate
partnerships and other events of interest to the market. We supplement our public relations
through media advertising programs, including electronic media, and attendance at various trade
shows throughout the year, both in the United States and internationally. Worldwide Sales Our worldwide sales and marketing organization, at December 31, 2004, consisted of
approximately 300 employees, including sales representatives, technical support and management. We
have field sales offices in more than 20 countries and sell our products and services both directly
and through channel partners with support from their sales force. Our channel partners include
distributors, value-added resellers, and system integrators. We conduct international operations
in branch offices located in Argentina, Belgium, Brazil, China, Denmark, Finland, France, Germany,
Israel, Italy, Mexico, the Netherlands, Norway, Russia, Singapore, Spain, Sweden,
Switzerland, Taiwan and the United Kingdom. Our international field offices are involved in the
sales and distribution of our products and provide system installation, technical support, and
follow-up services to end users of our products. Additionally, our offices in Denmark, Finland, France, Italy, Norway, Sweden and Switzerland
sell and market our products along with other products manufactured by third-party vendors,
supplied as part of network system integration and distribution services. These operations provide
system design, network integration and post-sales support. These services enhance our ability to
penetrate targeted vertical and regional markets. We believe that partnering with successful
third-party vendors in certain areas helps to provide growth opportunities beyond the limitations
of our product line. No single customer accounted for more than 10% of our revenue or accounts receivable as of
December 31, 2004 or for any of the three years in the period ended December 31, 2004. Markets Served We primarily serve the following markets: Enterprise Market. We provide both optical transport and Ethernet access equipment, including
switching and routing for inter-building and intra-building networking through our optical and
free-space optics connectivity equipment (inter-building) and our Ethernet access equipment
(intra-building). We also provide data-center management services, and our console management
products manage large enterprise data centers. Telecommunication Carrier and Service Provider Markets. We provide both optical transport and
Ethernet access equipment, including switching and routing to regional and national
telecommunication carriers and service providers. Vertical and Regional Markets. For certain products, we focus on vertical markets, including
defense and aerospace. Optical Components. Our optical components are designed for use by original equipment
manufacturers (OEMs) or end-users that employ our components for optical interfaces on
communications equipment. Markets served by these systems vendors include multiple building
private networks, or campus networks, as well as metropolitan and access markets including the FTTP
market. We also sell components to other optical components vendors. 6




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Competition The communications equipment and optical component industries are intensely competitive. We
compete directly with a number of established and emerging networking and optical components
companies. Direct competitors in networking products, switches and routers generally include ADVA Optical
Networks, Alcatel, Allied Telesyn, Ciena, Cisco Systems, Enterasys Networks, Extreme Networks,
Foundry Networks, Lucent Technologies, Nortel Networks and Riverstone Networks. Our competitors in
fiber optic components include Agilent Technologies, Avanex, Bookham Technology, Finisar, Fujitsu,
Infineon AG, JDS Uniphase, Optical Communication Products, Sumitomo, TriQuint Semiconductor and
Tyco International. Many of our competitors have significantly greater financial, technical,
marketing, distribution and other resources and larger installed customer bases than we do. Several
of these competitors have recently introduced or announced their intentions to introduce new
competitive products. Many of our larger competitors offer customers a broader product line, which
provides a more comprehensive networking solution than we provide. Accordingly, in certain
regional markets we have partnered with other vendors in an effort to enhance our overall
capability in providing products and services.  We believe the principal competitive factors in the markets in which we compete include:-
    Product performance, features, quality and price;-
    A comprehensive range of complementary products and services;-
    Customer service and technical support;-
    Lead and delivery times;-
    Timeliness of new products introductions;-
    Global presence, including distribution network;-
    Conformance to standards; and-
    Brand name. Recent consolidation is likely to permit various of our 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 customer bases. We expect that competition
will increase substantially as a result of these and other industry consolidations and alliances,
as well as the emergence of new competitors. Product Development and Engineering We believe that in order to maintain our technological competitiveness and to better serve our
customers, we must enhance our existing products and continue to develop new products.
Accordingly, we focus a significant amount of resources on product development and engineering. Our product development and engineering expenses were $24.9 million, $31.0 million and $49.4
million for the years ended December 31, 2004, 2003 and 2002, respectively. Details regarding
product development and engineering expenses by segments follow. 7




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Networking Group. Product development and engineering expenses from our networking group were
$16.2 million, $18.4 million and $21.0 million for the years ended December 31, 2004, 2003 and
2002, respectively. In the year ended December 31, 2003, these expenses were offset by income from
recapturing accelerated deferred stock expense due to terminations that amounted to $488,000, while
in years ended December 31, 2004 and 2002 these expenses include deferred stock expense totaling
$79,000 and $2.1 million, respectively. Optical Components Group. Product development and engineering expenses from our optical
components group were $7.2 million, $6.9 million and $10.5 million for the years ended December 31,
2004, 2003 and 2002, respectively. These expenses include income from recapturing accelerated
deferred stock expense due to terminations that amounted to $1.6 million for the year ended
December 31, 2002. Development Stage Enterprise Group. Product development and engineering expenses from our
development stage enterprise group were $1.5 million, $5.7 million and $17.8 million for the years
ended December 31, 2004, 2003 and 2002, respectively. Manufacturing We outsource our board-level assembly and on some occasions, complete turnkey production to
independent contract manufacturers for our networking products, which include switches and routers,
remote device management products and networking physical infrastructure equipment. Outsourcing,
we believe, allows us to react more quickly to market demand, avoid the significant capital
investment required to establish automated manufacturing and assembly facilities and concentrate
resources on product design and development. Our in-house manufacturing operations primarily
perform the functions of materials management, and, in an effort to ensure quality and reliabity,
quality assurance, equipment burn-in (testing new equipment by turning the power on), as well as
inspection and final testing. Our manufacturing processes and procedures are generally ISO 9000
certified and so are those of our vendors. Our optical components are designed and manufactured in our ISO 9001 certified manufacturing
and production facilities in California and Taiwan. LuminentOIC remains one of a handful of
vendors in the fiber optics industry with in-house epitaxial crystal growth and device fabrication
capabilities, enabling a broad portfolio of products from discrete components to managed integrated
transceivers. LuminentOIC utilizes advanced metal organic chemical vapor deposition
(MOCVD) laser growth process to produce high caliber distributed feedback (DFB) and fabry perot (FP)
laser diodes. Vertical integration enables us to deliver high
quality, advanced fiber optic
components at lower cost. LuminentOIC has developed and acquired the
sophisticated equipment required for evaluating and characterizing
products to seek to ensure that quality levels are maintained.
Comprehensive in-line quality control is incorporated
throughout the mass production process. All devices produced at
LuminentOIC are designed to comply with Telcordia
GR-468-CORE standards. In addition, LuminentOIC has been certified under TL9000, ISO9001, ISO14001,
TUV and CSA. Components We utilize a wide variety of components, supplies and products from a substantial number of
vendors around the world. Certain of our products rely on a single or limited number of suppliers,
although we seek to locate alternative sources if the need arises. The failure of delivery by our
vendors in a timely manner of critical components could adversely affect our business. For a
discussion of the risks associated with suppliers, please see the portion of this Form 10-K
entitled Risk Factors, including but not limited to the risk factor entitled, We May Lose Sales
if Suppliers of Critical Components and Products Fail to Meet Our Needs. 8




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Intellectual Property To date, we have relied principally on a combination of patents, copyrights and trade secrets
to protect proprietary technology. Generally, we enter into confidentiality agreements with our
employees and key suppliers and otherwise seek to limit access to and distribution of the source
code to software and other proprietary information. These steps may not be adequate to prevent
misappropriation of our technologies or a third party may independently develop technology similar
or superior to any of our possesses. Employees As of December 31, 2004, we employed a total of approximately 1,330 full-time employees
compared with approximately 1,250 at December 31, 2003. Of these 1,330 employees, approximately
675 are in manufacturing, 190 in product development and engineering and 465 in sales, marketing
and general administration. Approximately 925 employees are in locations outside the United
States. None of our employees are represented by a union or governed by a collective bargaining
agreement, and we believe our employee relationships are satisfactory. We also believe that our
long-term success depends in part on our continued ability to recruit and retain qualified
personnel. The risks associated with dependence on qualified personnel are more fully discussed in
the Risk Factors section contained in Item 1 of this Form 10-K. Certain Risk Factors That Could Affect Future Results You should carefully consider and evaluate all of the information in this Form 10-K, including the
risk factors listed below. The risks described below are not the only ones facing our company.
Additional risk not now known to us or that we currently deem immaterial may also impair our
business operations. If any of these risks actually occur, our business could be materially harmed. If our business is
harmed, the trading price of our common stock could decline. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward looking statements
as a result of certain factors, including the risks faced by us described below and elsewhere in
this Form 10-K. We undertake no duty to update any of the forward-looking statements after the
date of this Form 10-K. Our Operating Results Could Fluctuate Significantly From Quarter To Quarter. Our operating results for a particular quarter are extremely difficult to predict. Our
revenue and operating results could fluctuate substantially from quarter to quarter and from year
to year. This could result from any one or a combination of factors such as:  -
    the cancellation or postponement of orders;-
    the timing and amount of significant orders;-
    our success in developing, introducing and shipping product enhancements and new products;-
    the mix of products we sell;-
    software, hardware or other errors in the products we sell requiring
replacements or increased warranty reserves;-
    our annual reviews of goodwill and other intangibles that lead to impairment charges;-
    new product introductions by our competitors;-
    pricing actions by our competitors or us; 9




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-
    the timing of delivery and availability of components from suppliers;-
    political stability in the areas of the world we operate in;-
    changes in material costs;-
    currency fluctuations; and-
    general economic conditions. Moreover, the volume and timing of orders we receive during a quarter are difficult to
forecast. From time to time, our customers encounter uncertain and changing demand for their
products. Customers generally order based on their forecasts. If demand falls below these
forecasts or if customers do not control inventories effectively, they may cancel or reschedule
shipments previously ordered from us. Our expense levels during any particular period are based,
in part, on expectations of future sales. If sales in a particular quarter do not meet
expectations, our operating results could be materially adversely affected. Our success is dependent, in part, on the overall growth rate of the fiber optic components
and networking industry. The Internet or the industries that serve it may not continue to grow and
even if it does or they do, we may not achieve increased growth. Our business, operating results
or financial condition may be adversely affected by any decreases in industry growth rates. In
addition, we can give no assurance that our results in any particular period will fall within the
ranges for growth forecast by market researchers. Because of these and other factors, you should not rely on quarter-to-quarter comparisons of
our results of operations as an indication of our future performance. It is possible that, in
future periods, our results of operations may be below the expectations of public market analysts
and investors. This failure to meet expectations could cause the trading price of our common stock
to decline. Similarly, the failure by our competitors or customers to meet or exceed the results
expected by their analysts or investors could have a ripple effect on us and cause our stock price
to decline. Our Markets Are Subject To Rapid Technological Change, And To Compete Effectively, We Must
Continually Introduce New Products That Achieve Market Acceptance. The markets for our products are characterized by rapid technological change, frequent new
product introductions, changes in customer requirements and evolving industry standards. We expect
that new technologies will emerge as competition and the need for higher and more cost effective
transmission capacity, or bandwidth, increases. Our future performance will depend on the
successful development, introduction and market acceptance of new and enhanced products that
address these changes as well as current and potential customer requirements. The introduction of
new and enhanced products may cause our customers to defer or cancel orders for existing products.
We have in the past experienced delays in product development and these delays may occur in the
future. Therefore, to the extent customers defer or cancel orders in the expectation of a new
product release or there is any delay in development or introduction of our new products or
enhancements of our products, our operating results would suffer. We also may not be able to
develop the underlying core technologies necessary to create new products and enhancements, or to
license these technologies from third parties. Product development delays may result from numerous
factors, including:  -
    changing product specifications and customer requirements;-
    difficulties in hiring and retaining necessary technical personnel;-
    difficulties in reallocating engineering resources and overcoming resource limitations;-
    difficulties with contract manufacturers;-
    changing market or competitive product requirements; and 10




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-
    unanticipated engineering complexities. The development of new, technologically advanced products is a complex and uncertain process
requiring high levels of innovation and highly skilled engineering and development personnel, as
well as the accurate anticipation of technological and market trends. In order to compete, we must
be able to deliver products to customers that are highly reliable, operate with its existing
equipment, lower the customers costs of acquisition, installation and maintenance, and provide an
overall cost-effective solution. We may not be able to identify, develop, manufacture, market or
support new or enhanced products successfully, if at all, or on a timely basis. Further, our new
products may not gain market acceptance or we may not be able to respond effectively to product
announcements by competitors, technological changes or emerging industry standards. Our failure to
respond effectively to technological changes would significantly harm our business. Defects In Our Products Resulting From Their Complexity Or Otherwise Could Hurt Our Financial
Performance. Complex products, such as those we offer, may contain undetected software or hardware errors
when we first introduce them or when we release new versions. The occurrence of these errors in
the future, and our inability to correct these errors quickly or at all, could result in the delay
or loss of market acceptance of our products. It could also result in material warranty expense,
diversion of engineering and other resources from our product development efforts and the loss of
credibility with, and legal actions by, our customers, system integrators and end users. Any of
these or other eventualities resulting from defects in our products could cause our sales to
decline and have a material adverse effect on our business, operating results and financial
condition. The Long Sales Cycles For Our Products May Cause Revenues And Operating Results To Vary From
Quarter To Quarter, Which Could Cause Volatility In Our Stock Price. The timing of our revenue is difficult to predict because of the length and variability of the
sales and implementation cycles for our products. We do not recognize revenue until a product has
been shipped to a customer, all significant vendor obligations have been performed and collection
is considered probable. Customers often view the purchase of our products as a significant and
strategic decision. As a result, customers typically expend significant effort in evaluating,
testing and qualifying our products and our manufacturing process. This customer evaluation and
qualification process frequently results in a lengthy initial sales cycle of, depending on the
products, many months or more. In addition, some of our customers require that our products be
subjected to lifetime and reliability testing, which also can take months or more. While our
customers are evaluating our products and before they place an order with us, we may incur
substantial sales and marketing and research and development expenses to customize our products to
the customers needs. We may also expend significant management efforts, increase manufacturing
capacity and order long lead-time components or materials prior to receiving an order. Even after
this evaluation process, a potential customer may not purchase our products. Even after acceptance
of orders, our customers often change the scheduled delivery dates of their orders. Because of the
evolving nature of the optical networking and network infrastructure markets, we cannot predict the
length of these sales, development or delivery cycles. As a result, these long sales cycles may
cause our net sales and operating results to vary significantly and unexpectedly from
quarter-to-quarter, which could cause volatility in our stock price. Our Business Has Been Adversely Impacted By The Worldwide Economic Slowdown And Related
Uncertainties. Weaker economic conditions worldwide, particularly in the U.S. and Europe, have contributed to
the current technology industry slowdown and impacted our business resulting in:  -
    reduced demand for our products, particularly fiber optic components;-
    increased risk of excess and obsolete inventories; 11




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-
    increased price competition for our products;-
    excess manufacturing capacity under current market conditions; and-
    higher overhead costs, as a percentage of revenues. We reported losses for the years ended December 31, 2004, 2003 and 2002 and have not achieved
profitability for a full year since 1997. While we were profitable in
the fourth quarter of the
year ended December 31, 2004, we anticipate continuing to incur significant sales and marketing,
product development and general and administrative expenses and, as a result, we will continue to
need to contain expense levels and increase revenue levels to continue to achieve profitability in
future fiscal quarters. Cost Containment Is Critical To Achieving Positive Cash Flow From Operations And Profitability
Consistently. We are continuing efforts at strict cost containment and believe that such efforts are
essential to achieving positive cash flow from operations in future quarters and maintaining
profitability on a consistent basis, especially since the outlook for future quarters is subject to
numerous challenges. Additional measures to contain costs and reduce expenses may be undertaken if
revenues do not continue to improve. A number of factors could preclude us from consistently
bringing costs and expenses in line with our revenues, such as our inability to accurately forecast
business activities and the deterioration of our revenues. If we are not able to maintain an
expense structure commensurate with our business activities and revenues, we may have inadequate
levels of cash for operations or for capital requirements, which could significantly harm our
ability to operate the business. Our Business And Future Operating Results Are Subject To A Wide Range Of Uncertainties Arising Out
Of The Continuing Threat Of Terrorist Attacks And Ongoing Military Action In The Middle East Like other U.S. companies, our business and operating results are subject to uncertainties
arising out of the continuing threat of terrorist attacks on the United States and ongoing military
action in the Middle East, including the potential worsening or extension of the current global
economic slowdown, the economic consequences of the war in Iraq or additional terrorist activities
and associated political instability, and the impact of heightened security concerns on domestic
and international travel and commerce. In particular, due to these uncertainties we are subject
to:  -
    increased risks related to the operations of our manufacturing facilities in
China;-
    greater risks of disruption in the operations of our Asian contract
manufacturers and more frequent instances of shipping delays; and-
    the risk that future tightening of immigration controls may adversely affect
the residence status of non-U.S. engineers and other key technical and other employees
in our U.S. facilities or our ability to hire new non-U.S. employees in such
facilities. We Face Risks In Reselling The Products Of Other Companies. We distribute products manufactured by other companies. To the extent we succeed in reselling
the products of these companies, or products of other vendors with which we may enter into similar
arrangements, we may be required by customers to assume warranty and service obligations. While
these suppliers have agreed to support us with respect to those obligations, if they should be
unable, for any reason, to provide the required support, we may have to expend our own resources on
doing so. This risk is amplified by the fact that the equipment has been designed and manufactured
by others, and is thus subject to warranty claims whose magnitude we are currently unable to fully
evaluate. 12




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The Price Of Our Shares May Continue To Be Highly Volatile. Historically, the market price of our shares has been extremely volatile. The market price of
our common stock is likely to continue to be highly volatile and could be significantly affected by
factors such as:  -
    actual or anticipated fluctuations in our operating results;-
    announcements of technological innovations or new product introductions by us
or our competitors;-
    changes of estimates of our future operating results by securities analysts;-
    developments with respect to patents, copyrights or proprietary rights; and-
    general market conditions and other factors. In addition, the stock market has experienced extreme price and volume fluctuations that have
particularly affected the market prices for shares of the common stocks of technology companies in
particular, and that have been unrelated to the operating performance of these companies. These
factors, as well as general economic and political conditions, may materially adversely affect the
market price of our common stock in the future. Similarly, the failure by our competitors or
customers to meet or exceed the results expected by their analysts or investors could have a ripple
effect on us and cause our stock price to decline. Additionally, volatility or a lack of positive
performance in our stock price may adversely affect our ability to retain key employees, all of
whom have been granted stock options. Our 2003 Notes Provide For Various Events Of Default That Would Entitle The Holders To Require Us
To Immediately Repay The Outstanding Principal Amount, Plus Accrued And Unpaid Interest, In Cash. On June 4, 2003, we completed the sale of $23 million principal amount of 2003 Notes to
Deutsche Bank AG, London Branch in a private placement pursuant to Regulation D under the
Securities Act of 1933. We will be considered in default of the 2003 Notes if any of the following
events, among others, occurs:  -
    our default in payment of any principal amount of, interest on or other amount
due under the 2003 Notes when and as due;-
    the effectiveness of the registration statement, which registered for resale
the shares of our common stock issuable upon conversion of the 2003 Notes, lapses for
any reason or is unavailable to the holder of the 2003 Notes for resale of all of the
 shares issuable upon conversion, other than during allowable grace periods, for a
period of five consecutive trading days or for more than an aggregate of 10 trading
days in any 365-day period;-
    the suspension from trading or failure of our common stock to be listed on the
Nasdaq Stock Market for a period of five (5) consecutive trading days or for more than
an aggregate of ten (10) trading days in any 365-day period;-
    we or our transfer agent notify any holder of our intention not to issue shares
of our common stock to the holder upon receipt of any conversion notice delivered in
respect of a Note by the holder;-
    we fail to deliver shares of our common stock to the holder within 12 business
days of the conversion date specified in any conversion notice delivered in respect of
a Note by the holder; 13




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-
    we breach any material representation, warranty, covenant or other term or
condition of the 2003 Notes or the Securities Purchase Agreement, or the Registration
Rights Agreement relating to 2003 Notes and the breach, if curable, is not cured by us
within 10 days;-
    failure by us for 10 days after notice to comply with any other provision of
the 2003 Notes in all material respects, which include abiding by our covenants not to  o
    incur any form of unsecured indebtedness in excess of $17.0
million, plus obligations arising from accounts receivable financing
transactions with recourse through our foreign offices, in the ordinary course
of business and consistent with past practices;o
    repurchase our common stock for an aggregate amount in excess
of $5.0 million; pursuant to a stock purchase program that was approved by our
Board of Directors and publicly announced on June 13, 2002; oro
    declare or pay any dividend on any of our capital stock, other
than dividends of common stock with respect to our common stock;  -
    we breach provisions of the 2003 Notes prohibiting us from either issuing  o
    our common stock or securities that are convertible into or
exchangeable or exercisable for shares of our common at a per share price less
than the conversion price per share of the 2003 Notes then in effect, except in
certain limited cases; oro
    securities that are convertible into or exchangeable or
exercisable for shares of our common stock at a price that varies or may vary
with the market price of our common stock;  -
    we breach any of our obligations under any other debt or credit agreements
involving an amount exceeding $3,000,000; or-
    we become bankrupt or insolvent. If an event of default occurs, any holder of the 2003 Notes can elect to require us to pay the
outstanding principal amount, together with all accrued and unpaid interest. Some of the events of default include matters over which we may have some, little or no
control. If a default occurs and we do not pay the amounts payable under the 2003 Notes in cash
(including any interest on such amounts and any applicable default interest under the 2003 Notes),
the holders of the 2003 Notes may protect and enforce their rights or remedies either by suit in
equity or by action at law, or both, whether for the specific performance of any covenant,
agreement or other provision contained in the 2003 Notes. Any default under the 2003 Notes could
have a material adverse effect on our business, operating results and financial condition or on the
market price of our common stock. In The Event Of A Change Of Control, Holders Of The 2003 Notes Have The Option To Require
Immediately Repayment Of The 2003 Notes At A Premium And This Right Could Prevent A Takeover
Otherwise Favored By Stockholders. In the event of our Change of Control, which essentially means someone acquiring or merging
with us, each holder of 2003 Notes has the right to require us to redeem the 2003 Notes in whole or
in part at a redemption price of 105% of the principal amount of the 2003 Notes, plus accrued and
unpaid interest or if the amount is greater, an amount equal to the number of shares issuable upon
conversion of the 2003 Notes based on the conversion price at the date the holder gives us notice
of redemption, multiplied by the average of the weighted average prices of our common stock during
the five days immediately proceeding that date. If a Change of Control were to occur, we might not
have the financial resources or be able to arrange financing on acceptable terms to pay the
redemption price for all the 2003 Notes as to which the purchase right is exercised. Further, the
existence of this right in favor of the holders may discourage or prevent someone from acquiring or
merging with us. 14




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Sales Of Substantial Amounts Of Our Shares By Selling Stockholders Could Cause The Market Price Of
Our Shares To Decline. Selling stockholders are offering for resale under an effective registration statement up to
9,913,914 shares of our common stock issuable upon conversion of the 2003 Notes. This represents
approximately 9.5% of the outstanding shares of our common stock on February 15, 2005 (or 8.7% of
the outstanding shares of our common stock on that date if pro forma effect were given to the full
conversion of the 2003 Notes). Sales of substantial amounts of these shares at any one time or from
time to time, or even the availability of these shares for sale, could adversely affect the market
price of our shares. Our Business Is Intensely Competitive And The Evident Trend Of Consolidations In Our Industry Could
Make It More So. The markets for fiber optic components and networking products are intensely competitive and
subject to frequent product introductions with improved price/performance characteristics, rapid
technological change and the continual emergence of new industry standards. We compete and will
compete with numerous types of companies including companies that have been established for many
years and have considerably greater financial, marketing, technical, human and other resources, as
well as greater name recognition and a larger installed customer base, than we do. This may give
these competitors certain advantages, including the ability to negotiate lower prices on raw
materials and components than those available to us. In addition, many of our large competitors
offer customers broader product lines, which provide more comprehensive solutions than our current
offerings. We expect that other companies will also enter markets in which we compete. Greater concentration of purchasing power and decreased demand for communications networking
products and optical components in recent years have resulted in increased competitive pressures.
We expect aggressive competitive tactics to continue, and perhaps become more severe. These tactics
include:  -
    intense price competition in sales of new equipment, resulting in lower profit
margins;-
    discounting resulting from sales of used equipment or inventory that a
competitor has written down or written off;-
    early announcements of competing products and other extensive marketing efforts;-
    customer financing assistance;-
    marketing and advertising assistance; and-
    intellectual property disputes. Tactics such as those described above can be particularly effective in a concentrated base of
potential customers such as communications service providers. Our service provider customers are
under increasing competitive pressure to deliver their services at the lowest possible cost. This
pressure may result in the pricing of communications networking equipment becoming a more important
factor in customer decisions. This may favor larger competitors that can spread the effect of
price discounts across a larger array of products and services and across a larger customer base
than ours. If we are unable to offset any reductions in the average sales price for our products
by a reduction in the cost of our products, our gross profit margins will be adversely affected.
Our inability to compete successfully and maintain our gross profit margins would harm our
business, financial condition and results of operations. 15




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There has been a trend toward industry consolidation for several years. We expect this trend
toward industry consolidation to continue as companies attempt to strengthen or hold their market
positions in an evolving industry. We believe that industry consolidation may provide stronger
competitors that are better able to compete. This could have a material adverse effect on our
business, operating results and financial condition. We Face Risks From Our International Operations. International sales have become an increasingly important part of our operations. The
following table sets forth the percentage of our total revenues from sales to customers in foreign
countries for the periods identified: Year ended December 31:
    
    2004
    
    2003
    
    2002Percentage of total revenue from foreign sales
    
    
    77
    %
    
    
    78
    %
    
    
    74
    %
 We have offices in, and conduct a significant portion of our operations in and from
Israel. Similarly, some of our development stage enterprises are located in Israel. We are,
therefore, directly influenced by the political and economic conditions affecting Israel. Any
major hostilities involving Israel, the interruption or curtailment of trade between Israel and its
trading partners or a substantial downturn in the economic or financial condition of Israel could
have a material adverse effect on our operations. LuminentOIC has a minority interest in a large
manufacturing facility in the Peoples Republic of China in which it manufactures passive fiber
optic components and both LuminentOIC and we make sales of our products in the Peoples Republic of
China. The political tension between Taiwan and the Peoples Republic of China that continues to
exist, could eventually lead to hostilities. Risks we face due to international sales and the use
of overseas manufacturing include:  -
    greater difficulty in accounts receivable collection and longer collection periods;-
    the impact of recessions in economies outside the United States;-
    unexpected changes in regulatory requirements;-
    seasonal reductions in business activities in some parts of the world, such as
during the summer months in Europe or in the winter months in Asia when the Chinese New
Year is celebrated;-
    difficulties in managing operations across disparate geographic areas;-
    difficulties associated with enforcing agreements through foreign legal systems;-
    the payment of operating expenses in local currencies, which exposes us to
risks of currency fluctuations;-
    higher credit risks requiring cash in advance or letters of credit;-
    potentially adverse tax consequences;-
    unanticipated cost increases;-
    unavailability or late delivery of equipment;-
    trade restrictions;-
    limited protection of intellectual property rights;-
    unforeseen environmental or engineering problems; and-
    personnel recruitment delays. 16




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The majority of our sales are currently denominated in U.S. dollars. As we conduct business
in several different countries, we have recently benefited from sales made in currencies other than
the U.S. dollar because of the weakness of the U.S. dollar in relation to the currencies in which
these sales have been made. However, if this trend ceases or reverses, fluctuations in currency
exchange rates could cause our products to become relatively more expensive in particular
countries, leading to a reduction in sales in that country. In addition, inflation or fluctuations
in currency exchange rates in these countries could increase our expenses. To date, we have not hedged against currency exchange risks. In the future, we may engage in
foreign currency denominated sales or pay material amounts of expenses in foreign currencies and,
in that event, may experience gains and losses due to currency fluctuations. Our operating results
could be adversely affected by currency fluctuations or as a result of inflation in particular
countries where material expenses are incurred. We Depend On Third-Party Contract Manufacturers And Therefore Could Face Delays Harming Our Sales. We outsource the board-level assembly, test and quality control of material, components,
subassemblies and systems relating to our networking products to third-party contract
manufacturers. Though there are a large number of contract manufacturers that we can use for
outsourcing, we have elected to use a limited number of vendors for a significant portion of our
board assembly requirements in order to foster consistency in quality of the products and to
achieve economies of scale. These independent third-party manufacturers also provide the same
services to other companies. Risks associated with the use of independent manufacturers include
unavailability of or delays in obtaining adequate supplies of products and reduced control of
manufacturing quality and production costs. If our contract manufacturers failed to deliver needed
components timely, we could face difficulty in obtaining adequate supplies of products from other
sources in the near term. Our third party manufacturers may not provide us with adequate supplies
of quality products on a timely basis, or at all. While we could outsource with other vendors, a
change in vendors may require significant lead-time and may result in shipment delays and expenses.
Our inability to obtain these products on a timely basis, the loss of a vendor or a change in the
terms and conditions of the outsourcing would have a material adverse effect on our business,
operating results and financial condition. We May Lose Sales If Suppliers Of Other Critical Components Fail To Meet Our Needs. Our companies currently purchase several key components used in the manufacture of our
products from single or limited sources. We depend on these sources to meet our needs. Moreover,
we depend on the quality of the products supplied to us over which we have limited control. We
have encountered shortages and delays in obtaining components in the past and expect to encounter
shortages and delays in the future. If we cannot supply products due to a lack of components, or
are unable to redesign products with other components in a timely manner, our business will be
significantly harmed. We have no long-term or short-term contracts for any of our components. As
a result, a supplier can discontinue supplying components to us without penalty. If a supplier
discontinued supplying a component, our business may be harmed by the resulting product
manufacturing and delivery delays. We May Suffer Losses As A Result Of Entering Into Fixed Price Contracts. From time to time we enter into contracts with certain customers where the price we charge for
particular products is fixed. Although our estimated production costs for these products is used
to compute the fixed price for sale, if our actual production cost exceeds the estimated production
cost due to our inability to obtain needed components timely or at all or for other reasons, we may
incur a loss on the sale. Sales of material amounts of products on a fixed price basis where we
have not accurately predicted the production costs could have a material adverse affect on our
results of operations. 17




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Our Inability To Achieve Adequate Production Yields For Certain Components We Manufacture
Internally Could Result In A Loss Of Sales And Customers. We rely heavily on our own production capability for critical semiconductor lasers and light
emitting diodes used in our products. Because we manufacture these and other key components at our
own facilities and these components are not readily available from other sources, any interruption
of our manufacturing processes could have a material adverse effect on our operations.
Furthermore, we have a limited number of employees dedicated to the operation and maintenance of
our wafer fabrication equipment, the loss of any of whom could result in our inability to
effectively operate and service this equipment. Wafer fabrication is sensitive to many factors,
including variations and impurities in the raw materials, the fabrication process, performance of
the manufacturing equipment, defects in the masks used to print circuits on the wafer and the level
of contaminants in the manufacturing environment. We may not be able to maintain acceptable
production yields or avoid product shipment delays. In the event adequate production yields are
not achieved, resulting in product shipment delays, our business, operating results and financial
condition could be materially adversely affected. If We Fail To Adequately Protect Our Intellectual Property, We May Not Be Able To Compete. We rely on a combination of trade secret laws and restrictions on disclosure and patents,
copyrights and trademarks to protect our intellectual property rights. We cannot assure you that
our pending patent applications will be approved, that any patents that may be issued will protect
our intellectual property or that third parties will not challenge any issued patents. Other
parties may independently develop similar or competing technology or design around any patents that
may be issued to us. We cannot be certain that the steps we have taken will prevent the
misappropriation of our intellectual property, particularly in foreign countries where the laws may
not protect our proprietary rights as fully as in the United States. Any of this kind of
litigation, regardless of outcome, could be expensive and time consuming, and adverse
determinations in any of this kind of litigation could seriously harm our business. We Could In The Future Become Subject To Litigation Regarding Intellectual Property Rights, Which
Could Be Costly And Subject Us To Significant Liability. From time to time, third parties, including our competitors, may assert patent, copyright and
other intellectual property rights to technologies that are important to us. Over the years, we
have received notices from third parties alleging possible infringement of patents with respect to
certain features of our products or our manufacturing processes and in connection with these
notices have been involved in discussions with the claimants, including IBM, Lucent, Ortel, Nortel,
Rockwell, the Lemelson Foundation and Finisar. To date, our aggregate revenues potentially subject
to the foregoing claims have not been material. However, these or other companies may pursue
litigation with respect to these or other claims. The results of any litigation are inherently
uncertain. In the event of an adverse result in any litigation with respect to intellectual
property rights relevant to our products that could arise in the future, we could be required to
obtain licenses to the infringing technology, to pay substantial damages under applicable law, to
cease the manufacture, use and sale of infringing products or to expend significant resources to
develop non-infringing technology. Licenses may not be available from third parties either on
commercially reasonable terms or at all. In addition, litigation frequently involves substantial
expenditures and can require significant management attention, even if we ultimately prevail.
Accordingly, any infringement claim or litigation against us could significantly harm our business,
operating results and financial condition. 18




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In The Future, We May Initiate Claims Or Litigation Against Third Parties For Infringement Of Our
Proprietary Rights To Protect These Rights Or To Determine The Scope And Validity Of Our
Proprietary Rights Or The Proprietary Rights Of Competitors. These Claims Could Result In Costly
Litigation And The Diversion Of Our Technical And Management Personnel. Necessary licenses of third-party technology may not be available to us or may be very
expensive, which could adversely affect our ability to manufacture and sell our products. From
time to time we may be required to license technology from third parties to develop new products or
product enhancements. We cannot assure you that third-party licenses will be available to us on
commercially reasonable terms, if at all. The inability to obtain any third-party license required
to develop new products and product enhancements could require us to obtain substitute technology
of lower quality or performance standards or at greater cost, either of which could seriously harm
our ability to manufacture and sell our products. We Are Dependent On Certain Members Of Our Senior Management. We are substantially dependent upon Dr. Shlomo Margalit, our Chairman of the Board of
Directors, Chief Technical Officer and Secretary, and Mr. Noam Lotan, our President and Chief
Executive Officer. The loss of the services of either of these officers could have a material
adverse effect on us. We have entered into employment agreements with Dr. Margalit and Mr. Lotan
and are the beneficiary of key man life insurance policies in the amounts of $1.0 million each on
their lives. However, we can give no assurance that the proceeds from these policies will be
sufficient to compensate us in the event of the death of either of these individuals, and the
policies are not applicable in the event that either of them becomes disabled or is otherwise
unable to render services to us. Our Business Requires Us To Attract And Retain Qualified Personnel. Our ability to develop, manufacture and market our products, run our operations and our
ability to compete with our current and future competitors depends, and will depend, in large part,
on our ability to attract and retain qualified personnel. Competition for executives and qualified
personnel in the networking and fiber optics industries is intense, and we will be required to
compete for those personnel with companies having substantially greater financial and other
resources than we do. To attract executives, we have had to enter into compensation arrangements,
which have resulted in substantial deferred stock expense and adversely affected our results of
operations. We may enter into similar arrangements in the future to attract qualified executives.
If we should be unable to attract and retain qualified personnel, our business could be materially
adversely affected. Environmental Regulations Applicable To Our Manufacturing Operations Could Limit Our Ability To
Expand Or Subject Us To Substantial Costs. We are subject to a variety of environmental regulations relating to the use, storage,
discharge and disposal of hazardous chemicals used during our manufacturing processes. Further, we
are subject to other safety, labeling and training regulations as required by local, state and
federal law. Any failure by us to comply with present and future regulations could subject us to
future liabilities or the suspension of production. In addition, these kinds of regulations could
restrict our ability to expand our facilities or could require us to acquire costly equipment or to
incur other significant expenses to comply with environmental regulations. We cannot assure you
that these legal requirements will not impose on us the need for additional capital expenditures or
other requirements. If we fail to obtain required permits or otherwise fail to operate within
these or future legal requirements, we may be required to pay substantial penalties, suspend our
operations or make costly changes to our manufacturing processes or facilities. 19




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Our Headquarters Are Located In Southern California, And Certain Of Our Manufacturing Facilities
Are Located In Southern California And Taiwan, Where Disasters May Occur That Could Disrupt Our
Operations And Harm Our Business Our corporate headquarters are located in the San Fernando Valley of Southern California and
some of our manufacturing facilities are located in Southern California and Taiwan. Historically,
these regions have been vulnerable to natural disasters and other risks, such as earthquakes, fires
and floods, which at times have disrupted the local economies and posed physical risks to our
property. In addition, terrorist acts or acts of war targeted at the United States, and specifically
Southern California, could cause damage or disruption to us, our employees, facilities, partners,
suppliers, distributors and resellers, and customers, which could have a material adverse effect on
our operations and financial results. If We Fail To Accurately Forecast Component And Material Requirements For Our Manufacturing
Facilities, We Could Incur Additional Costs Or Experience Manufacturing Delays. We use rolling forecasts based on anticipated product orders to determine our component
requirements. It is very important that we accurately predict both the demand for our products and
the lead times required to obtain the necessary components and materials. Lead times for
components and materials that we order vary significantly and depend on factors such as specific
supplier requirements, the size of the order, contract terms and current market demand for the
components. For substantial increases in production levels, some suppliers may need nine months or
more lead-time. If we overestimate our component and material requirements, we may have excess
inventory, which would increase our costs. If we underestimate our component and material
requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay
delivery of our products to our customers. Any of these occurrences would negatively impact our
net sales. Legislative Actions, Higher Insurance Costs And Potential New Accounting Pronouncements Are Likely
To Impact Our Future Financial Position And Results Of Operations And In The Case Of FASBs New
Pronouncement Regarding The Expensing Of Stock Options Will Adversely Impact Our Financial Results. There have been regulatory changes, including the Sarbanes-Oxley Act of 2002, new SEC
regulations and Nasdaq Stock Market rules and there may be potential new accounting pronouncements
or regulatory rulings, which will have an impact on our future financial position and results of
operations. These regulatory changes and other legislative initiatives have increased general and
administrative costs. In addition, insurers are likely to increase rates as a result of high claims
rates recently and our rates for our various insurance policies are likely to increase. The
Financial Accounting Standards Boards recent change to mandate the expensing of stock options will
require us to record charges to earnings for stock option grants to employees and directors and
will adversely affect our financial results after we implement the new pronouncement, which we
expect will be in the third quarter of 2005. We Are At Risk Of Securities Class Action Or Other Litigation That Could Result In Substantial
Costs And Divert Managements Attention And Resources. In the past, securities class action litigation has been brought against a company following
periods of volatility in the market price of its securities. Due to the volatility and potential
volatility of our stock price or the volatility of LuminentOICs stock price following its initial
public offering, we may be the target of securities litigation in the future. Securities or other
litigation could result in substantial costs and divert managements attention and resources. 20




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If Our Cash Flow Significantly Deteriorates In The Future, Our Liquidity And Ability To Operate Our
Business Could Be Adversely Affected. We incurred net losses in 2004, 2003 and 2002, and our combined cash and short-term
investments declined in each of those years as well. Our combined cash, cash equivalents, time
deposits and short-term and long-term marketable securities declined at December 31, 2004 by
approximately $11.9 million, or approximately 12%, since December 31, 2003. Although we generate
cash from operations, we may continue to experience negative overall cash flow in future quarters.
If our cash flow significantly deteriorates in the future, our liquidity and ability to operate our
business could be adversely affected. For example, our ability to raise financial capital may be
hindered due to our net losses and the possibility of future negative cash flow. An inability to
raise financial capital would limit our operating flexibility. Delaware Law And Our Ability To Issue Preferred Stock May Have Anti-Takeover Effects That Could
Prevent A Change In Control, Which May Cause Our Stock Price To Decline. We are authorized to issue up to 1,000,000 shares of preferred stock. This preferred stock
may be issued in one or more series, the terms of which may be determined at the time of issuance
by our board of directors without further action by stockholders. The terms of any series of
preferred stock may include voting rights (including the right to vote as a series on particular
matters), preferences as to dividend, liquidation, conversion and redemption rights and sinking
fund provisions. No preferred stock is currently outstanding. The issuance of any preferred stock
could materially adversely affect the rights of the holders of our common stock, and therefore,
reduce the value of our common stock. In particular, specific rights granted to future holders of
preferred stock could be used to restrict our ability to merge with, or sell our assets to, a third
party and thereby preserve control by the present management. We are also subject to the
anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibit us
from engaging in a business combination with an interested stockholder for a period of three years
after the date of the transaction in which the person became an interested stockholder unless the
business combination is approved in the manner prescribed under Section 203. These provisions of
Delaware law also may discourage, delay or prevent someone from acquiring or merging with us, which
may cause the market price of our common stock to decline. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Some of the information in this Form 10-K and in the documents that are incorporated by
reference, including the risk factors in this section, contains forward-looking statements that
involve risks and uncertainties. These statements relate to future events or our future financial
performance. In many cases, you can identify forward-looking statements by terminology such as
may, will, should, expect, plan, anticipate, believe, estimate, predict,
potential, or continue, or the negative of these terms and other comparable terminology. These
statements are only predictions. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of a number of factors including the risks faced by
us described above and elsewhere in this Form 10-K. 21




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ITEM 2. PROPERTIES Our principal administrative, sales and marketing, product development and engineering and
manufacturing facility is located in Chatsworth, California. The table below lists the locations,
square footage and expiration dates of our principal owned and leased facilities used for our major
operations. Location
    
    Square Feet
    
    
    Lease Expiration
    
    
    PurposeChatsworth, CA
    
    USA
    
    
    13,300
    
    
    3/31/2007
    
    
    AdministrationChatsworth, CA
    
    USA
    
    
    22,200
    
    
    12/31/2005
    
    
    Manufacturing and product
developmentChatsworth, CA
    
    USA
    
    
    49,920
    
    
    7/14/2014
    
    
    Administration, product
development, manufacturing and
salesChatsworth, CA
    
    USA
    
    
    17,710
    
    
    2/28/2006
    
    
    Manufacturing and product
developmentLittleton, MA
    
    USA
    
    
    54,411
    
    
    2/28/2015
    
    
    Administration, product
development, manufacturing and
salesHsinchu
    
    Taiwan
    
    
    81,861
    
    
    12/31/2005
    
    
    Administration, product
development, manufacturing and
salesGeneva
    
    Switzerland
    
    
    29,428
    
    
    12/31/2010
    
    
    Administration, product
development, manufacturing and
salesZurich
    
    Switzerland
    
    
    9,343
    
    
    3/31/2013
    
    
    Administration and salesStockholm
    
    Sweden
    
    
    48,825
    
    
    6/30/2006
    
    
    Administration and salesOslo
    
    Norway
    
    
    6,986
    
    
    6/30/2005
    
    
    Administration and distributionMilan
    
    Italy
    
    
    7,535
    
    
    Owned
    
    
    Administration and distributionMilan
    
    Italy
    
    
    9,688
    
    
    Owned
    
    
    Administration and distributionMilan
    
    Italy
    
    
    9,688
    
    
    6/30/2010
    
    
    Administration and distributionMilan
    
    Italy
    
    
    5,382
    
    
    11/28/2006
    
    
    Administration and distributionMilan
    
    Italy
    
    
    8,611
    
    
    Owned
    
    
    Administration and distributionRome
    
    Italy
    
    
    6,512
    
    
    1/31/2009
    
    
    Administration and distributionYokneam
    
    Israel
    
    
    26,910
    
    
    8/31/2005
    
    
    Administration, product
development, manufacturing and
salesYokneam
    
    Israel
    
    
    19,526
    
    
    12/31/2007
    
    
    Administration, product
development, manufacturing and
salesYokneam
    
    Israel
    
    
    7,202
    
    
    12/31/2007
    
    
    Administration, product
development, manufacturing and
salesFrankfurt
    
    Germany
    
    
    6,512
    
    
    7/31/2011
    
    
    Administration and salesGif Sur Yvette
    
    France
    
    
    17,222
    
    
    Owned
    
    
    Administration and distribution
 We believe that our existing leased and owned space is more than adequate for our current
operations, and that suitable replacement and additional space will be available in the future on
commercially reasonable terms. 22




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##### Table of Contents



ITEM 3. LEGAL PROCEEDINGS We have received notices from third parties alleging possible infringement of patents with
respect to product features or manufacturing processes. We believe such notices are common in the
communications industry because of the large number of patents that have been filed on these
subjects. Our policy is to discuss these notices with the senders in an effort to demonstrate that
our products and/or processes do not violate any patents. From time to time we have been involved
in such discussions with IBM, Lucent, Ortel, Nortel, Rockwell, the Lemelson Foundation and Finisar.
We do not believe that any of our products or processes violates any of the patents asserted by
these parties and we further believe that we have meritorious defenses if any legal action is taken
by any of these parties. However, if one or more of these parties was to assert a claim and gain a
conclusion unfavorable to us, such claims could materially and adversely affect our business,
operating results and financial condition. We have been named as a defendant in lawsuits involving matters that we consider routine to
the nature of our business. We are of the opinion that the ultimate resolution of all such matters
will not have a material adverse effect on our business, operating results and financial condition. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On December 15, 2004, we held our Annual Meeting of Stockholders 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:
    
    
    For
    
    
    Against or WithheldNoam Lotan
    
    
    
    
    
    
    93,528,937
    
    
    
    626,034Shlomo Margalit
    
    
    
    
    
    
    93,534,998
    
    
    
    619,973Igal Shidlovsky
    
    
    
    
    
    
    93,449,710
    
    
    
    705,261Guenter Jaensch
    
    
    
    
    
    
    93,493,219
    
    
    
    661,752Daniel Tsui
    
    
    
    
    
    
    93,498,469
    
    
    
    656,502Baruch
Fischer
    
    
    
    
    
    
    93,530,965
    
    
    
    624,406
 The other matter voted upon at the meeting and the number of votes cast for, against or
withheld, including abstentions and broker non-votes, was as follows: Number of VotesProposal
    
    For
    
    
    Against
    
    
    AbstainedTo ratify the selection of Ernst & Young LLP as
    
    
    93,358,644
    
    
    
    744,438
    
    
    
    51,889independent auditors for the Company for the fiscal
year ending December 31,2004.
 23




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##### Table of Contents



PART II 
 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information and Holders Our common stock, $0.0017 par value, is traded on the Nasdaq National Market under the symbol
MRVC. The following table sets forth, for the periods indicated, the high and low closing prices
of our common stock, as reported on the Nasdaq National Market, giving effect to all stock splits
through the date hereof. High
    
    
    LowFiscal Year Ended December 31, 2004First Quarter
    
    $
    4.96
    
    
    $
    2.78Second Quarter
    
    $
    3.48
    
    
    $
    2.17Third Quarter
    
    $
    3.02
    
    
    $
    2.22Fourth Quarter
    
    $
    4.06
    
    
    $
    2.62Fiscal Year Ended December 31, 2003First Quarter
    
    $
    1.48
    
    
    $
    1.02Second Quarter
    
    $
    2.62
    
    
    $
    1.11Third Quarter
    
    $
    3.40
    
    
    $
    1.82Fourth Quarter
    
    $
    4.05
    
    
    $
    2.95
 As of February 15, 2005, we had approximately 2,986 common stockholders of record. Dividends The payment of dividends on our common stock is within the discretion of our board of
directors. Currently, we intend to retain earnings to finance the growth of our business. We have
not paid cash dividends on our common stock and the board of directors does not expect to declare
cash dividends on the common stock in the foreseeable future. Securities Authorized Under Equity Compensation Plans Information regarding securities authorized for issuance under equity compensation plans, as
required pursuant to Rule 201(d) of Regulation S-K, is included
in Item 12  Equity Compensation
Plan Information included elsewhere in this Annual Report on Form 10-K. 24




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ITEM 6. SELECTED FINANCIAL DATA The following selected Statement of Operations data for each of the three years in the period
ended December 31, 2004 and the Balance Sheet data as of December 31, 2004 and 2003 are derived
from our audited financial statements included elsewhere in this Form 10-K. The selected Statement
of Operations data for each of the two years in the period ended December 31, 2001 and the Balance
Sheet data as of December 31, 2002, 2001 and 2000 were derived from our audited financial
statements, which are not included in this Form 10-K. The following data should be read in
conjunction with Managements Discussion and Analysis of Financial Condition and Results of
Operations and the financial statements of the Company, including the notes thereto, included
elsewhere in this Form 10-K. For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Statement of Operations Data:Revenue
    
    $
    271,658
    
    
    $
    238,983
    
    
    $
    252,532
    
    
    $
    332,844
    
    
    $
    319,394Cost of goods sold
    
    
    179,780
    
    
    
    164,893
    
    
    
    169,566
    
    
    
    267,389
    
    
    
    203,371Gross profit
    
    
    91,878
    
    
    
    74,090
    
    
    
    82,966
    
    
    
    65,455
    
    
    
    116,023Operating costs and expenses:Product development and engineering
    
    
    24,949
    
    
    
    30,972
    
    
    
    49,358
    
    
    
    94,813
    
    
    
    74,078Selling, general and administrative
    
    
    74,083
    
    
    
    62,868
    
    
    
    90,047
    
    
    
    164,785
    
    
    
    124,700Amortization of intangibles
    
    
    34
    
    
    
    33
    
    
    
    140
    
    
    
    126,484
    
    
    
    66,814Impairment of goodwill and other
intangibles
    
    
    
    
    
    
    356
    
    
    
    72,697
    
    
    
    
    
    
    
    Impairment of long-lived assets
    
    
    
    
    
    
    
    
    
    
    17,038
    
    
    
    
    
    
    
    Total operating costs and expenses
    
    
    99,066
    
    
    
    94,229
    
    
    
    229,280
    
    
    
    386,082
    
    
    
    265,592Operating loss
    
    
    (7,188
    )
    
    
    (20,139
    )
    
    
    (146,314
    )
    
    
    (320,627
    )
    
    
    (149,569
    )Other expense, net
    
    
    456
    
    
    
    6,438
    
    
    
    23,695
    
    
    
    11,200
    
    
    
    8,782Loss before provision (benefit) for taxes,
extraordinary gain and cumulative effect of
an accounting change
    
    
    (7,644
    )
    
    
    (26,577
    )
    
    
    (170,009
    )
    
    
    (331,827
    )
    
    
    (158,351
    )Provision (benefit) for taxes
    
    
    3,036
    
    
    
    2,361
    
    
    
    13,395
    
    
    
    4,475
    
    
    
    (5,398
    )Loss before extraordinary gain and
cumulative effect of an accounting change
    
    
    (10,680
    )
    
    
    (28,938
    )
    
    
    (183,404
    )
    
    
    (336,302
    )
    
    
    (152,953
    )Extraordinary gain, net of tax
    
    
    
    
    
    
    1,950
    
    
    
    
    
    
    
    9,949
    
    
    
    Cumulative effect of an accounting change
    
    
    
    
    
    
    
    
    
    
    (296,355
    )
    
    
    
    
    
    
    Net loss
    
    $
    (10,680
    )
    
    $
    (26,988
    )
    
    $
    (479,759
    )
    
    $
    (326,353
    )
    
    $
    (152,953
    )Basic and diluted loss per share
    
    $
    (0.10
    )
    
    $
    (0.26
    )
    
    $
    (5.25
    )
    
    $
    (4.27
    )
    
    $
    (2.33
    )Basic and diluted weighted average shares
outstanding
    
    
    104,793
    
    
    
    102,022
    
    
    
    91,421
    
    
    
    76,369
    
    
    
    65,669
 At December 31:
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Balance Sheet Data:Cash and cash equivalents
    
    $
    77,226
    
    
    $
    87,602
    
    
    $
    99,445
    
    
    $
    164,676
    
    
    $
    210,080Working capital
    
    
    113,995
    
    
    
    108,051
    
    
    
    91,188
    
    
    
    175,966
    
    
    
    366,752Total assets
    
    
    272,078
    
    
    
    272,684
    
    
    
    302,980
    
    
    
    887,260
    
    
    
    1,097,621Total long-term liabilities
    
    
    28,663
    
    
    
    27,415
    
    
    
    4,056
    
    
    
    102,254
    
    
    
    154,504Stockholders equity
    
    
    135,559
    
    
    
    140,128
    
    
    
    154,476
    
    
    
    584,676
    
    
    
    781,555
 25




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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should
be read in conjunction with Consolidated Condensed Financial Statements and Notes thereto included
elsewhere in this Form 10-K. In addition to historical information, the discussion in this Form
10-K contains certain forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those anticipated by these forward-looking statements due to
factors, including but not limited to, those set forth in the following and elsewhere in this Form
10-K. We assume no obligation to update any of the forward-looking statements after the date of
this Form 10-K. Overview We design, manufacture, sell, distribute, integrate and support communication equipment and
services, and optical components. We conduct our business along three principal segments: the
networking group, the optical components group and development stage enterprise group. Our
networking group provides equipment used by commercial customers, governments and
telecommunications service providers, and include switches, routers, physical layer products and
console management products as well as specialized networking products for aerospace, defense and
other applications including voice and cellular communication. Our optical components group
designs, manufactures and sells optical communications components, primarily through our wholly
owned subsidiary LuminentOIC, Inc. These components include fiber optic transceivers for
metropolitan, access and Fiber-to-the-Premises, or FTTP, applications. Our development stage
enterprise group seeks to develop new optical components, subsystems and networks and other
products for the infrastructure of the Internet. We market and sell our products worldwide, through a variety of channels, which include a
dedicated direct sales force, manufacturers representatives, value-added-resellers, distributors
and systems integrators. We have operations in Europe that provide network system design,
integration and distribution services that include products manufactured by third-party vendors, as
well as our products. We believe such specialization enhances access to customers and allows us to
penetrate targeted vertical and regional markets. We were organized in July 1988 as MRV Technologies, Inc., a California corporation and
reincorporated in Delaware in April 1992, at which time we changed our name to MRV Communications,
Inc. We generally recognize product revenue, net of sales discounts and allowances, when persuasive
evidence of an arrangement exists, delivery has occurred and all significant contractual
obligations have been satisfied, the fee is fixed or determinable and collection is considered
probable. Products are generally shipped FOB shipping point with no right of return, except on
rare occasions in which event our accounting is as described below. Sales of services and system
support are deferred and recognized ratably over the contract period. Sales with contingencies,
such as right of return, rotation rights, conditional acceptance provisions and price protection
are rare and have historically been insignificant. We do not recognize such sales until the
contingencies have been satisfied or the contingent period has lapsed. We generally warrant our
products against defects in materials and workmanship for one to two year periods. The estimated
costs of warranty obligations and sales returns and other allowances are recognized at the time of
revenue recognition based on contract terms and prior claims experience. Gross profit is equal to
our revenues less our cost of goods sold. Our cost of goods sold includes materials, direct labor
and overhead. Cost of inventory is determined by the first-in, first-out method. Our operating
costs and expenses generally consist of product development and engineering costs, or R&D, selling,
general and administrative costs, or SG&A, and other operating related costs and expenses. 26




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We divide and operate our business on the basis of our three principal segments. We evaluate
segment performance based on the revenues and the operating expenses of each segment. We do not
track segment data or evaluate segment performance on additional financial information. As such,
there are no separately identifiable segment assets nor are there any separately identifiable
Statement of Operations data below operating income (expense). The networking and optical
components groups account for virtually all of our overall revenue. Our business involves reliance on foreign-based entities. Several of our divisions, outside
subcontractors and suppliers are located in foreign countries, including Argentina, China, Denmark,
Finland, France, Germany, Israel, Italy, Japan, Korea, the Netherlands, Norway, Russia, Singapore,
South Africa, Switzerland, Sweden, Taiwan and the United Kingdom. For the years ended December 31,
2004, 2003 and 2002, foreign revenues constituted 77%, 78% and 74%, respectively, of our revenues.
The vast majority of our foreign sales are to customers located in the European region. The
remaining foreign sales are primarily to customers in the Asia Pacific region. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based
upon our financial statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities. We believe that the estimates, assumptions and judgments involved in the accounting policies
described below have the greatest potential impact on our financial statements, so we consider
these to be our critical accounting policies. Because of the uncertainty inherent in these
matters, actual results could differ from the estimates we use in applying the critical accounting
policies. Certain of these critical accounting policies affect working capital account balances,
including the policies for revenue recognition, allowance for doubtful accounts, inventory reserves
and income taxes. These policies require that we make estimates in the preparation of our
financial statements as of a given date. However, since our business cycle is relatively short,
actual results related to these estimates are generally known within the six-month period following
the financial statement date. Thus, these policies generally affect only the timing of reported
amounts across two to three quarters. Within the context of these critical accounting policies, we are not currently aware of any
reasonably likely events or circumstances that would result in materially different amounts being
reported. Revenue Recognition.We generally recognize product revenue, net of sales discounts and
allowances, when persuasive evidence of an arrangement exists, delivery has occurred and all
significant contractual obligations have been satisfied, the fee is fixed or determinable and
collection is considered probable. Products are generally shipped FOB shipping point with no
right of return. Sales of services and system support are deferred and recognized ratably over the
contract period. Sales with contingencies, such as right of return, rotation rights, conditional
acceptance provisions and price protection are rare and insignificant and are deferred until the
contingencies have been satisfied or the contingent period has lapsed. We generally warrant our
products against defects in materials and workmanship for one to two year periods. The estimated
costs of warranty obligations and sales returns and other allowances are recognized at the time of
revenue recognition based on contract terms and prior claims experience. Our major
revenue-generating products consist of: fiber optic components; switches and routers; console
management products; and physical layer products. 27




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Allowance for Doubtful Accounts.We make ongoing estimates relating to the collectability of
our accounts receivable and maintain a reserve for estimated losses resulting from the inability of
our customers to meet their financial obligations to us. In determining the amount of the reserve,
we consider our historical level of credit losses and make judgments about the creditworthiness of
significant customers based on ongoing credit evaluations. Since we cannot predict future changes
in the financial stability of our customers, actual future losses from uncollectable accounts may
differ from our estimates. If the financial condition of our customers were to deteriorate,
resulting in their inability to make payments, a larger reserve may be required. In the event we
determined that a smaller or larger reserve was appropriate, we would record a credit or a charge
to selling and administrative expense in the period in which we made such a determination. Inventory Reserves.We also make ongoing estimates relating to the market value of
inventories, based upon our assumptions about future demand and market conditions. If we estimate
that the net realizable value of our inventory is less than the cost of the inventory recorded on
our books, we record a reserve equal to the difference between the cost of the inventory and the
estimated net realizable market value. This reserve is recorded as a charge to cost of goods sold.
If changes in market conditions result in reductions in the estimated market value of our
inventory below our previous estimate, we would increase our reserve in the period in which we made
such a determination and record a charge to cost of goods sold. Goodwill and Other Intangibles.We adopted SFAS No. 142, Goodwill and Other Intangible
Assets, effective January 1, 2002. In accordance with SFAS No. 142, we no longer amortize
goodwill and intangible assets with indefinite lives, but instead measure these assets for
impairment at least annually, or when events indicate that impairment exists. We continue to
amortize intangible assets that have definite lives over their useful lives. Income Taxes. As part of the process of preparing our financial statements, we are required
to estimate our income taxes in each of the jurisdictions in which we operate. This process
involves us estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items, such as deferred revenue, for tax and
accounting purposes. These differences result in deferred tax assets and liabilities, which are
included in our Balance Sheet. We must then assess the likelihood that our deferred tax assets
will be recovered from future taxable income and to the extent we believe that recovery is not
likely, we must establish a valuation allowance. To the extent we establish a valuation allowance
or increase this allowance in a period, we must include an expense within the tax provision in the
Statement of Operations. Significant management judgment is required in determining our provision for income taxes,
deferred tax assets and liabilities and any valuation allowance recorded against our net deferred
tax assets. Management continually evaluates our deferred tax asset as to whether it is likely
that the deferred tax assets will be realized. If management ever determined that our deferred tax
asset was not likely to be realized, a write-down of that asset would be required and would be
reflected in the provision for taxes in the accompanying period. Currency Rate Fluctuations Changes in the relative values of non-U.S. currencies to the U.S. dollar affect our results.
During 2004, we conducted a significant portion of our business in foreign currencies, including
the Euro, the Swedish Krona, the Swiss Franc and the Taiwan dollar. At December 31, 2004, currency
changes resulted in assets, liabilities, revenues and expenses being translated into more U.S.
dollars than at December 31, 2003. The U.S. dollar weakened 9% compared to the Euro and Swedish
Krona, 8% compared to the Swiss Franc and 3% compared to the Taiwan dollar during the year ended
December 31, 2004. The Euro, the Swedish Krona and the Swiss Franc primarily impact our networking
business, while the Taiwan dollar affects our optical components business. However, because we
have revenues and expenses in each of these foreign currencies, the
effect on our results of
operations from currency fluctuations is reduced. We do not regularly attempt to reduce our
currency risks through hedging instruments, however, we may do so in the future. 28




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Management Discussion Snapshot The following table sets forth, for the periods indicated, certain Statement of Operations
data (dollars in thousands): 2004
    
    
    2003
    
    
    2002For the year ended December 31,
    
    $
    
    
    
    %
    
    
    $
    
    
    
    %
    
    
    $
    
    
    
    %Revenue(1)
    
    $
    271,658
    
    
    
    100
    %
    
    $
    238,983
    
    
    
    100
    %
    
    $
    252,532
    
    
    
    100
    %Networking group
    
    
    227,192
    
    
    
    84
    
    
    
    202,399
    
    
    
    85
    
    
    
    185,662
    
    
    
    74Optical components group
    
    
    46,431
    
    
    
    17
    
    
    
    38,790
    
    
    
    16
    
    
    
    67,284
    
    
    
    27Gross margin(2)
    
    
    91,878
    
    
    
    34
    
    
    
    74,090
    
    
    
    31
    
    
    
    82,966
    
    
    
    33Networking group
    
    
    85,405
    
    
    
    38
    
    
    
    70,839
    
    
    
    35
    
    
    
    67,453
    
    
    
    36Optical components group

    
    
    6,473
    
    
    
    14
    
    
    
    3,251
    
    
    
    8
    
    
    
    16,341
    
    
    
    24Operating costs and expenses(2)
    
    
    99,066
    
    
    
    36
    
    
    
    94,229
    
    
    
    39
    
    
    
    229,280
    
    
    
    91Networking group
    
    
    80,659
    
    
    
    36
    
    
    
    73,046
    
    
    
    36
    
    
    
    126,217
    
    
    
    68Optical components group
    
    
    16,313
    
    
    
    35
    
    
    
    14,363
    
    
    
    37
    
    
    
    78,996
    
    
    
    117Development stage enterprise group
    
    
    2,094
    
    

    NM
    
    
    
    6,820
    
    

    NM
    
    
    
    24,067
    
    
    NMOperating income (loss)(2)
    
    
    (7,188
    )
    
    
    (3
    )
    
    
    (20,139
    )
    
    
    (8
    )
    
    
    (146,314
    )
    
    
    (58
    )Networking group
    
    
    4,746
    
    
    
    2
    
    
    
    (2,207
    )
    
    
    (1
    )
    
    
    (58,764
    )
    
    
    (32
    )Optical components group
    
    
    (9,840
    )
    
    
    (21
    )
    
    
    (11,112
    )
    
    
    (29
    )
    
    
    (62,655
    )
    
    
    (93
    )Development stage enterprise group
    
    
    (2,094
    )
    
    NM

    
    
    (6,820
    )
    
    NM
    
    
    
    (24,067
    )
    
    NM
   NM not
meaningful
 (1)   Revenue information by segment includes intersegment revenue, primarily reflecting
sales of fiber optic components to the networking group. No revenues were generated by the
development stage enterprise group for the periods presented. (2)   Statement of Operations data express percentages as a percentage of revenue. Statement
of Operations data by segment express percentages as a percentage of applicable segment
revenue. No revenues or corresponding gross profit were generated by the Development stage
enterprise group in 2004 or 2003. The following management discussion and analysis refers to and analyzes our results of
operations among three segments as defined by our management. These three segments are our
networking group, optical components group and development stage enterprise group, which includes
all start-up activities. 29




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##### Table of Contents



Year Ended December 31, 2004 (2004) Compared
To Year Ended December 31, 2003 (2003) Revenue % ChangeConstantFor the year ended December 31:
    
    2004
    
    
    2003
    
    
    $ Change
    
    
    % Change
    
    
    Currency (2)Networking group
    
    $
    227,192
    
    
    $
    202,399
    
    
    $
    24,793
    
    
    
    12
    %
    
    
    5
    %Optical components group
    
    
    46,431
    
    
    
    38,790
    
    
    
    7,641
    
    
    
    20
    
    
    
    18Development stage enterprise group
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0
    
    
    
    0273,623
    
    
    
    241,189
    
    
    
    32,434
    
    
    
    13
    
    
    
    7Adjustments (1)
    
    
    (1,965
    )
    
    
    (2,206
    )
    
    
    241
    
    
    
    (11
    )
    
    
    (11
    )Total
    
    $
    271,658
    
    
    $
    238,983
    
    
    $
    32,675
    
    
    
    14
    
    
    
    7
   (1)
    
    Adjustments represent the elimination of intersegment revenue in order to reconcile to
consolidated revenues.(2)
    
    Percentage information in constant currencies
in the table and in the text below excludes the effect of foreign
currency translation on reported results. Constant currency results
are calculated by translating the current year results at prior year
average exchange rates. Revenues for 2004 increased $32.7 million, or 14%, to $271.7 million from $239.0 million
for 2003. We realized increases in revenues from sales of all of our product lines. The weakening
of the U.S. dollar during the year compared with certain European currencies, in which we do
business, contributed $16 million to the year-over-year increase in revenues. On a constant
currency basis, revenues increased 7%. In absolute dollars, sales of our fiber optic components
and switches and routers generated the strongest product line growth. Our console management
products also reported strong growth with an increase of 24% year-over-year. Geographically,
revenues increased 24% in the Americas. We attribute the increase in our revenues in the Americas
to initial shipments of FTTP products for early deployments. FTTP networks use fiber optic cables,
rather than copper cables, to deliver voice, video and high speed data to customer premises. These
networks can transmit voice, data and video signals at speeds and capacities far exceeding the
traditional broadband services currently offered by telecommunication providers. FTTP will allow
these providers to offer superior services at very competitive prices. Shipments of FTTP products
for 2004 totaled approximately $24 million ($17 million was generated in the last half of 2004).
Recent announcements suggest that FTTP deployments in North America are expected to make services
available to at least one million residential homes by the end of the year; however the number of
actual residential homes subscribing to such services is expected to be a fraction of the total
deployments. We expect sales of FTTP products to continue to grow in 2005 and beyond. However,
this forward looking statement may not come to pass if the actual deployments do not meet the
expectations of industry announcements, if the orders we expect to receive do not materialize, are
delayed or cancelled or if we are unable to ship the products as required. For 2004, 46% of our revenues were generated from the sale of third-party products through our
system integration and distribution offices as compared to 48% of our revenues in 2003. Revenues
generated from internally produced products increased $21.3 million during 2004. 30




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##### Table of Contents



Networking Group. Our networking group provides equipment used by commercial customers,
governments and telecommunications service providers, which includes switches, routers, physical
layer products and console management products as well as specialized networking products for
defense, aerospace and other applications, including cellular communications. External revenues
generated from our networking group increased $24.8 million, or 12%, to $227.2 million for 2004 as
compared to $202.4 million for 2003. The increase is due to increases in sales of all of our
networking products. Sales of our console management products, other networking products and
switches and routers generated the largest percentage gains year-over-year. The effect of currency
fluctuations contributed $15 million to the year-over-year increase in revenues. On a constant
currency basis, revenues increased 5%. External revenues generated from the sales of console
management products increased $3.9 million, or 24%, to $20.6 million for 2004 compared to $16.6
million for 2003. External revenues generated from the sales of our other networking products
increased $6.4 million, or 20%, to $38.7 million for 2004 compared to $32.3 million for 2003.
External revenues generated from the sales of our switches and routers increased $8.2 million, or
13%, to $72.2 million for 2004 compared to $64.0 million for 2003. Optical Components Group.Our optical components group designs, manufactures and sells
optical communications components and primarily consists of products manufactured by our wholly
owned subsidiary, LuminentOIC. These components include fiber optic transceivers, discrete lasers
and LEDs, as well as components for FTTP applications. Revenues, including intersegment revenue,
generated from our optical components group increased $7.6 million, or 20%, to $46.4 million for
2004 as compared to $38.8 million for 2003. We attribute the increase in optical components
revenue to initial shipments of FTTP components for North American deployments, which generated
revenues totaling $24 million in 2004 ($17 million was generated in the last half of 2004).
Additionally, shipments of FTTP products were the primary catalyst for our increase in sales in the
Americas. The effect of currency fluctuations contributed $1 million to the year-over-year
increase in revenues. On a constant currency basis, revenues increased 18%. Development Stage Enterprise Group. No revenues were generated by these entities for 2004 and
2003. Gross Profit % ChangeConstantFor the year ended December 31:
    
    2004
    
    
    2003
    
    
    $ Change
    
    
    % Change
    
    
    Currency (1)Networking group
    
    $
    85,405
    
    
    $
    70,839
    
    
    $
    14,566
    
    
    
    21
    %
    
    
    15
    %Optical components group
    
    
    6,473
    
    
    
    3,251
    
    
    
    3,222
    
    
    
    99
    
    
    
    93Development stage enterprise group
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    91,878
    
    
    $
    74,090
    
    
    $
    17,788
    
    
    
    24
    
    
    
    18
   (1)
    
    Percentage information in constant currencies
in the table and in the text below excludes the effect of foreign
currency translation on reported results. Constant currency results
are calculated by translating the current year results at prior year
average exchange rates. Gross profit for 2004 was $91.9 million, compared to gross profit of $74.1 million for
2003. Gross profit increased $17.8 million, or 24%, in 2004 compared to 2003. Our gross margin
for 2004 improved to 34% compared to 31% for 2003, representing year-over-year improvement of $14.6
million, or 21%. The increase in gross profit is the result of the increase in revenue and the
composition of product sales, primarily the increase in internally produced products. Revenues
generated from internally produced products increased $21.3 million during 2004, which generate
gross margins at rates higher than our company-wide averages. The effect of currency fluctuations
also contributed $4 million to the year-over-year increase in gross profit. On a constant currency
basis, gross profit increased 18%. 31




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##### Table of Contents



Networking Group. Gross profit for our networking group was $85.4 million for 2004 compared
to $70.8 million for 2003. Gross margins improved to 38% for 2004, compared to gross margin of 35%
for 2003. We attribute the improvement in gross margin during 2004 to the composition of our
product revenue, specifically the increase in sales of our internally produced products. Gross
margins generated from these product sales are at rates higher than our company-wide averages. The
effect of currency fluctuations also contributed $4 million to the year-over-year increase in gross
profit. On a constant currency basis, gross profit increased 15%. Optical Components Group. Gross profit for 2004 was $6.5 million, compared to $3.3 million
for 2003, an improvement of $3.2 million, primarily as a result of the increase in FTTP sales.
Gross margins improved to 14% for 2004, compared to gross margin of 8% for 2003. The improvement
in gross margin for 2004 is attributed to the increase in product sales, including the contribution
from the initial shipments of FTTP products for early deployments. Gross margins are expected to
continue to improve as a result of anticipated operational efficiencies and economies of scale. We
continued transitioning volume manufacturing to our Taiwanese optical components facility which
resulted in significant savings in direct labor in the fourth quarter of 2004 compared to the third
quarter of 2004. Further, we began to realize efficiencies in material costs due to increased
volumes and purchasing power. The effect of currency fluctuations did not have a significant
impact on the year-over-year increase in gross profit in absolute dollars. Development Stage Enterprise Group. As we had no sales by these entities, no gross margins
were produced by these entities for 2004 and 2003. Operating Costs and Expenses % ChangeConstantFor the year ended December 31:
    
    2004
    
    
    2003
    
    
    $ Change
    
    
    % Change
    
    
    Currency (1)Networking group
    
    $
    80,659
    
    
    $
    73,046
    
    
    $
    7,613
    
    
    
    10
    %
    
    
    7
    %Optical components group
    
    
    16,313
    
    
    
    14,363
    
    
    
    1,950
    
    
    
    14
    
    
    
    12Development stage enterprise group
    
    
    2,094
    
    
    
    6,820
    
    
    
    (4,726
    )
    
    
    (69
    )
    
    
    (69
    )Total
    
    $
    99,066
    
    
    $
    94,229
    
    
    $
    4,837
    
    
    
    5
    
    
    
    2
   (1)
    
    Percentage information in constant currencies
in the table and in the text below excludes the effect of foreign
currency translation on reported results. Constant currency results
are calculated by translating the current year results at prior year
average exchange rates. Operating costs and expenses were $99.1 million, or 36% of revenues, for 2004, compared
to $94.2 million, or 39% of revenues, for 2003. Operating costs and expenses increased $4.8
million, or 5%, in 2004 compared to 2003. For 2004, operating costs and expenses included deferred
stock expense totaling $168,000, while 2003 included income from recapturing accelerated deferred
stock expense due to terminations that amounted to $7.0 million . These changes in
deferred stock expense (i.e., expense in 2004 compared to income reported in 2003) accounted for an
increase in operating costs and expenses totaling $7.2 million. The effect of currency
fluctuations contributed $3 million to the year-over-year increase in operating costs and expenses.
On a constant currency basis, operating costs and expenses increased 2%. The increase in
operating costs and expenses resulting from the changes in deferred stock expense and foreign
currency exchange rates was offset by cost savings efforts, including head count reductions and
lower spending in product development and engineering. 32




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##### Table of Contents



Networking Group. Operating costs and expenses for 2004 were $80.7 million, or 36% of
revenues, compared to $73.0 million, or 36% of revenues, for 2003. Operating costs and expenses
increased $7.6 million, or 10%, in 2004 compared to 2003. For 2004, operating costs and expenses
included deferred stock expense totaling $141,000, while 2003 included income from recapturing
accelerated deferred stock expense due to terminations that amounted to $6.7 million. Changes in
deferred stock expenses accounted for an increase in our operating costs and expenses of $6.9
million. The effect of currency fluctuations contributed $3 million to the year-over-year increase
in operating costs and expenses. On a constant currency basis, operating costs and expenses
increased 7%. For 2004, we also experienced additional sales and marketing expenses associated
with higher revenues, such as sales commissions. These increases were partially offset by
reductions in our product development and engineering expenses as we continue to focus our efforts
on strategic high-growth, high-return markets. Optical Components Group. Operating costs and expenses for 2004 were $16.3 million, or 35% of
revenues, compared to $14.4 million, or 37% of revenues, for 2003. Operating costs and expenses
increased $2.0 million, or 14%, in 2004 compared to 2003. We attributed the increase in our
operating costs and expenses to an increase in selling, general and administrative expenses in
conjunction with the improvement in our optical components business. The effect of currency
fluctuations did not have a significant impact on the year-over-year increase in operating costs
and expenses in absolute dollars. Development Stage Enterprise Group. Operating costs and expenses for 2004 were $2.1 million,
compared to $6.8 million for 2003. Operating costs and expenses decreased $4.7 million, or 69%, in
2004 compared to 2003. We attribute the decrease in operating costs and expenses to our cost saving
efforts, which mainly consisted of significant head count reductions to align these costs with
current development activities. Operating Income (Loss) % ChangeConstantFor the year ended December 31:
    
    2004
    
    
    2003
    
    
    $ Change
    
    
    % Change
    
    
    Currency (1)Networking group
    
    $
    4,746
    
    
    $
    (2,207
    )
    
    $
    6,953
    
    
    
    (315
    )%
    
    
    (251
    )%Optical components group
    
    
    (9,840
    )
    
    
    (11,112
    )
    
    
    1,272
    
    
    
    (11
    )
    
    
    (11
    )Development stage enterprise group
    
    
    (2,094
    )
    
    
    (6,820
    )
    
    
    4,726
    
    
    
    (69
    )
    
    
    (69
    )Total
    
    $
    (7,188
    )
    
    $
    (20,139
    )
    
    $
    12,951
    
    
    
    (64
    )
    
    
    (57
    )
   (1)
    
    Percentage information in constant currencies
in the table and in the text below excludes the effect of foreign
currency translation on reported results. Constant currency results
are calculated by translating the current year results at prior year
average exchange rates. We reported an operating loss of $7.2 million, or 3% of revenues, for 2004 compared to
$20.1 million, or 8% of revenues, for 2003. We reduced our operating loss by $13.0 million, or
64%, in 2004 compared to 2003. This improvement is the result of our cost reduction efforts and
the realignment of our costs and expenses with current operations along with our overall increase
in sales and gross profit, primarily through our networking group. The effect of currency
fluctuations contributed $1 million to the year-over-year improvement in our operating loss. On a
constant currency basis, our operating loss improved 57%. Networking Group. Our networking group reported operating income totaling $4.7 million, or 2%
of revenues, for 2004, compared to an operating loss of $2.2 million, or 1% of revenues, for 2003,
an improvement of $7.0 million. This improvement is the result of our increased sales and gross
profit, partially offset by changes in deferred stock expense and increase sales and marketing
expenses. The effect of currency fluctuations contributed $1 million to the year-over-year
increase in our operating income. 33




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##### Table of Contents



Optical Components Group. Our optical components group reported an operating loss of $9.8
million, or 21% of revenues, for 2004, compared to $11.1 million, or 29% of revenues, for 2003.
Our operating loss improved $1.3 million, or 11%, in 2004 compared to 2003. Our reduction in
operating loss was the result of improved sales and gross profit, partially offset by increases in
operating costs and expenses resulting. The effect of currency fluctuations did not have a
significant impact on the year-over-year improvement in our operating loss in absolute dollars. Development Stage Enterprise Group. Our development stage enterprise group reported an
operating loss of $2.1 million for 2004, compared to $6.8 million for 2003. Our operating loss
improved $4.7 million, or 69%, in 2004 compared to 2003. The improvement is the result of a
significant reduction in spending for operating costs and expenses. Interest Expense And Other Income (Expense), Net Interest expense was $3.1 million and $3.2 million for 2004 and 2003, respectively. Other
income (expense), net principally includes interest income on cash and investments. During 2004,
other income (expense), net includes a gain on the sale of an investment totaling $2.0 million.
During 2003, we retired $5.9 million principal amount of our 1998 Notes in exchange for the
issuance of 4.2 million shares of our common stock to the holders of these notes. As a result of
this exchange, we recognized a loss on the extinguishment of debt totaling $5.4 million, net of
associated taxes. Provision For Taxes The provision for income taxes for 2004, principally foreign taxes, was $3.0 million, compared
to $2.4 million for 2003. The increase in tax expense in 2004
versus 2003 was primarily due to increases in income in various
jurisdictions where we pay income tax. During 2004, we recorded an additional valuation
allowance against additional deferred income tax assets, principally domestic net operating losses
and unrealized tax credits. 34




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##### Table of Contents



Year Ended December 31, 2003 (2003) Compared
To Year Ended December 31, 2002 (2002) Revenue Revenues for 2003 decreased $13.5 million, or 5%, to $239.0 million from $252.5 million for
2002. The decrease was due to the worldwide economic slowdown in general and specifically the
downturn in telecommunications spending for optical components, partially offset by the positive
impact resulting from the weakened U.S. dollar compared to our other functional currencies.
Additionally, the decrease in revenues is the result of the loss of revenues from our divestiture
of FOCI Fiber Optic Communications, Inc., or FOCI, and Quantum Optech, Inc., or QOI, in October
2002 that amounted to $17.0 million in 2002. For 2003, 48% of our revenues were generated from the sale of third-party products through our
system integration and distribution offices, as compared to 39% during 2002. Our revenues by
segments for 2003 and 2002 were as follows (in thousands): For the year ended December 31:
    
    2003
    
    
    2002
    
    
    $ Change
    
    
    % ChangeNetworking group
    
    $
    202,399
    
    
    $
    185,662
    
    
    $
    16,737
    
    
    
    9
    %Optical components group
    
    
    38,790
    
    
    
    67,284
    
    
    
    (28,494
    )
    
    
    (42
    )%Development stage enterprise group
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0
    %241,189
    
    
    
    252,946
    
    
    
    (11,757
    )
    
    
    (5
    )%Adjustments (1)
    
    
    (2,206
    )
    
    
    (414
    )
    
    
    (1,792
    )
    
    
    433
    %Total
    
    $
    238,983
    
    
    $
    252,532
    
    
    $
    (13,549
    )
    
    
    (5
    )%
   (1)
    
    Adjustments represent the elimination of intersegment revenue in order to reconcile to
consolidated revenues. Networking Group.Our networking group provides equipment used by commercial customers,
governments and telecommunications service providers, which includes switches, routers, network
physical infrastructure equipment and remote device management equipment as well as specialized
networking products for defense, aerospace and other applications, including cellular
communications. External revenues generated from our networking group increased $16.7 million, or
9%, to $202.4 million for 2003 as compared to $185.7 million for 2002. The increase is due to
increases in sales of switches and routers, services and other networking products. External
revenues generated from sales of switches and routers increased $6.5 million, or 11%, to $64.0
million for 2003 as compared to $57.6 million for 2002. The external revenues from our networking
group were also positively impacted by the effect of the weakened U.S. dollar compared to our other
functional currencies, primarily the Euro. External revenues generated from sales of switches and
routers are heavily dependent on our international offices. External revenues generated from sales
of our remote device management products decreased $735,000, or 4%, to $16.6 million for 2003 as
compared to $17.4 million for 2002. External revenues generated from sales of our network physical
infrastructure products decreased by $5.1 million, or 9%, to $50.5 million for 2003 as compared to
$55.6 million for 2002. External revenues from sales of our other networking products, which
include defense, aerospace and other applications, including cellular communications, increased
$11.8 million, or 57%, during 2003 to $32.3 million from $20.6 million for 2002. We attribute the
increase in our overall external revenues to an increased number of governmental projects and
improved penetration into the markets served by these products. 35




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Optical Components Group.Our optical components group designs, manufactures and sells
optical communications components and primarily consists of products manufactured by our wholly
owned subsidiary, LuminentOIC. These components include fiber optic transceivers, discrete lasers
and LEDs, as well as components for FTTP applications. Revenues, including intersegment revenue,
generated from our optical components group decreased $28.5 million, or 42%, to $38.8 million for
2003 as compared to $67.3 million for 2002. We attribute the decrease in optical components
revenue to the current slowdown in telecommunications spending for optical components. External
revenues generated from optical passive components decreased $13.9 million, or 48%, to $14.9
million for 2003 as compared to $28.7 million for 2002. The decrease in revenues from sales of
optical passive components is primarily due to the loss of revenues from our divestiture of FOCI
and QOI in October 2002 that amounted to $17.0 million in 2002, in addition to decreases in our
sales of these components through our remaining offices. External revenue generated from optical
active components decreased $12.3 million, or 24%, to $39.0 million for 2003 as compared to $51.3
million for 2002. We attribute the decrease in revenues from optical active components to a
sector-wide oversupply, which has adversely impacted the average selling prices of these
components. Development Stage Enterprise Group. No significant revenues were generated by these entities
for 2003 and 2002. Gross Profit Gross profit for 2003 was $74.1 million, compared to gross profit of $83.0 million for 2002.
Gross profit decreased $8.9 million, or 11%, in 2003 compared to 2002. For 2003 and 2002, gross
profit includes income from recapturing accelerated deferred stock expense due to terminations that
amounted to $1.1 million and $878,000, respectively. Gross profit for 2003 was also positively
affected by the utilization of $1.7 million of the product credit received from the divestiture of
FOCI and QOI in 2002. Our gross margin slightly decreased to 31% for 2003, compared to gross margin of 33% for 2002.
We attribute the decrease in our gross margin to a change in the composition of our product
revenues. Our percentage of third-party equipment revenues increased during 2003, which generated
lower gross margins. The weakened U.S. dollar compared to the Euro resulted in an increase in our
cost of goods sold, particularly in lower margin business through our European offices. Networking Group. Gross profit for 2003 was $70.8 million, compared to gross profit of $67.5
million for 2002. Gross profit increased $3.4 million, or 5%, in 2003 compared to 2002. Gross
margins decreased to 35% for 2003, compared to gross margin of 36% for 2002. For 2003, our
networking groups gross profit includes income from the recapture of accelerated deferred stock
expense due to terminations totaling $1.1 million, compared to deferred stock expense totaling
$297,000 for 2002. Changes in deferred stock expense amounted to $1.4 million of the gross margin
improvement. In addition to the decrease in deferred stock expense, we attribute the increase in
gross profit during 2003 to the effects of improved operating efficiencies and cost reduction
efforts. Optical Components Group. Gross profit for 2003 was $3.3 million, compared to gross profit of
$16.4 million for 2002. Gross profit decreased $13.1 million, or 80%, in 2003 compared to 2002.
Gross margins decreased to 8% for 2003, compared to gross margin of 24% for 2002. For 2003 and
2002, the optical components groups gross profit includes income from recapturing accelerated
deferred stock expense due to terminations that amounted to $50,000 and $1.2 million, respectively.
Changes in deferred stock expense accounted for $1.1 million of the decrease in gross profit in
2003. Gross profit decreased due to the sale of FOCI and QOI in October 2002, which contributed
gross profit that amounted to $2.0 million in 2002, along with increased competition and continued
market contraction resulting in lower average selling prices. Development Stage Enterprise Group. No significant gross margins were produced by these
entities for 2003 and 2002. 36




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##### Table of Contents



Operating Costs and Expenses Operating costs and expenses were $94.2 million, or 39% of revenues, for 2003, compared to
$229.3 million, or 91% of revenues, for 2002. Operating costs and expenses decreased $135.1
million, or 59%, in 2003 compared to 2002. For 2003, operating costs and expenses include income
from the recapture of accelerated deferred stock expense due to terminations that amounted to $7.0
million, while 2002 includes $7.5 million in deferred stock expense. Changes in deferred stock
expenses accounted for $14.5 million of the decrease in our operating costs and expenses. For
2003, operating costs and expenses include an impairment of goodwill and other intangibles that
amounted to $356,000. Operating costs and expenses for 2002, includes impairment losses on
goodwill and other intangibles and long-lived assets that amount to $72.7 million and $17.0
million, respectively. In addition to the income from the recapture of deferred stock expense and
the substantial reduction in impairment losses on goodwill and other tangibles and long-lived
assets, we attribute the decrease in operating costs and expenses during 2003 to our overall cost
reduction efforts to align these costs with current operations. We reduced spending in product
development and engineering and selling, general and administrative expenses. Networking Group. Operating costs and expenses for 2003 were $73.0 million, or 36% of
revenues, for 2003, compared to $126.2 million, or 68% of revenues, for 2002. Operating costs and
expenses decreased $53.2 million, or 42%, in 2003 compared to 2002. For 2003, operating costs and
expenses include income from recapturing accelerated deferred stock expense due to terminations
that amounted to $6.7 million, while 2002 includes $6.8 million in deferred stock expense. Changes
in deferred stock expenses accounted for $13.5 million of the decrease in our operating costs and
expenses. For 2003, operating costs and expenses include an impairment of goodwill and other
intangibles that amounted to $356,000. Operating costs and expenses for 2002, includes impairment
losses on goodwill and other intangibles and long-lived assets that amount to $20.1 million and
$17.0 million, respectively. In addition to the impact from income from the recapture of deferred
stock expense and impairment losses, we attribute the decrease in operating costs and expenses
during 2003 to our cost saving efforts, including head count reductions, to align these costs with
current operations. We reduced spending in the areas of product development and engineering and
general and administrative expense, while slightly increasing spending for selling and marketing
efforts. Optical Components Group. Operating costs and expenses for 2003 were $14.4 million, or 37% of
revenues, for 2003, compared to $79.0 million, or 117% of revenues, for 2002. Operating costs and
expenses decreased $64.6 million, or 82%, in 2003 compared to 2002. For 2003, operating costs and
expenses include income from recapturing accelerated deferred stock expense due to terminations
that amounted to $240,000, while 2002 includes $624,000 in deferred stock expense. Changes in
deferred stock expenses accounted for $864,000 of the decrease in our operating costs and expenses.
Operating costs and expenses for 2002, includes an impairment loss on goodwill and other
intangibles that amounted to $51.9 million. We attributed the remaining decrease in our operating
costs and expenses to our cost saving efforts, including head count reductions, to align these
costs with current operations. We reduced spending in the areas of product development and
engineering, selling, general and administrative expenses. Development Stage Enterprise Group. Operating costs and expenses for 2003 were $6.8 million
for 2003, compared to $24.1 million for 2002. Operating costs and expenses decreased $17.2
million, or 72%, in 2003 compared to 2002. We attribute the decrease in operating costs and
expenses to our cost saving efforts, including head count reductions, to align these costs with
current development activities. 37




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Operating Loss We reported an operating loss of $20.1 million, or 8% of revenues, for 2003 compared to $146.3
million, or 58% of revenues, for 2002. We reduced our operating loss by $126.2 million, or 86%, in
2003 compared to 2002. For 2003, our operating loss includes an impairment of goodwill and other
intangibles that amounted to $356,000. Our operating loss for 2002 includes impairment losses on
goodwill and other intangibles and long-lived assets that amount to $72.7 million and $17.0
million, respectively. This improvement is the result of our cost reduction efforts and the
realignment of our costs and expenses with current operations along with our improvement in gross
profit. Our reduction in net loss was also positively impacted by income resulting from our
reversal of deferred stock expense in 2003 compared to reporting such expenses in 2002 and the
substantial reduction in impairment losses on goodwill and other tangibles and long-lived assets in
2003. Networking Group. Our networking group reported an operating loss of $2.2 million, or 1% of
revenues, for 2003, compared to an operating loss of $58.8 million, or 32% of revenues, for 2002.
This improvement is the result of our reduced spending for operating costs and expenses, along with
the substantial reduction in impairment losses in 2003. Our results in 2003 were also positively
impacted by income resulting from our reversal of deferred stock expenses in 2003 compared to
reporting such expenses in 2002. Optical Components Group. Our optical components group reported an operating loss of $11.1
million, or 29% of revenues, for 2003, compared to $62.7 million, or 93% of revenues, for 2002.
Our operating loss improved $51.5 million, or 82%, in 2003 compared to 2002. Our reduction in
operating loss was the result of the substantial reduction in impairment loss on goodwill and other
intangibles in 2003 along with the favorable impact from our reversal of deferred stock expense in
2003 compared to reporting such expenses in 2002. Development Stage Enterprise Group. Our development stage enterprise group reported an
operating loss of $6.8 million for 2003, compared to $24.1 million for 2002. Our operating loss
improved $17.2 million, or 72%, in 2003 compared to 2002. The improvement is the result of a
significant reduction in spending for operating costs and expenses. Amortization of Intangibles During the fourth quarter of 2003, we conducted our annual review of our goodwill and
intangible assets as required by SFAS 142. The review resulted in no further reduction in the
carrying amount of goodwill. During 2003, we impaired $356,000 in goodwill from a foreign office
that ceased operations. We recorded a $296.4 million cumulative effect of an accounting change in 2002, as the result
of our adoption of SFAS No. 142 effective January 1, 2002. As a consequence of our adoption of
SFAS No. 142, we no longer amortize goodwill and intangibles with indefinite lives, but instead
measure goodwill and other intangibles for impairment at least annually, or when events indicate
that impairment exists. We continue to amortize intangible assets that we determine to have
definite lives over their useful lives. As required by SFAS No. 142, we performed the transitional
impairment test on goodwill and other intangibles, which consisted of patents and assembled work
forces. Of the $296.4 million cumulative effect of an accounting change, $84.6 million was
associated with our networking group and $211.8 million was associated with our optical components
group. Beginning October 1, 2002, we also performed the annual impairment review required by SFAS No.
142. As a result of the annual review, we further reduced the carrying amount of goodwill and
other intangibles by recording an impairment charge of $72.7 million in the third quarter of 2002.
Of the $72.7 million impairment, $20.1 million was associated with our networking group, $51.9
million was associated with our optical components group and $641,000 was associated with our
development stage enterprise group. 38




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##### Table of Contents



Interest Expense and Other Income (Expense), Net In June 2003, we completed the sale of $23.0 million principal amount of five-year 5%
convertible notes due in 2008 (the 2003 Notes), to an institutional investor, in a private
placement. The 2003 Notes bear interest at 5% per annum and are convertible into our common stock
at a conversion price of $2.32 per share. We are using the net proceeds from the sale of the 2003
Notes for general corporate purposes and working capital. Interest expense relating to these notes
was $672,000 for 2003. In June 1998, we issued $100.0 million principal amount of our 1998 Notes. During 2003, we
retired $5.9 million principal amount of 1998 Notes in exchange for the issuance of 4.2 million
shares of our common stock to the holders of these notes, resulting in a remaining outstanding
balance of $26.0 million at maturity. On June 15, 2003, the balance of our outstanding 1998 Notes
matured and we repaid and retired them. For 2003, we recognized a loss on the extinguishment of
debt totaling $5.4 million, net of associated taxes. This loss was recognized in accordance with
Emerging Issues Task Force Issue 02-15 released in September 2002. During the year ended December
31, 2002, we acquired $31.6 million in principal amount of these notes in exchange for our issuance
of 12.3 million shares of our common stock to the holders of these notes. During 2002, we also
purchased $21.4 million in principal amount of these notes in exchange for $19.7 million in cash.
During 2002, we recognized a gain of $393,000 in connection with the extinguishment of debt. We
incurred $773,000 and $3.2 million in interest expense relating to the 1998 Notes for 2003 and
2002, respectively. During 2003, other income (expense), net totaling $3.3 million, represented our loss on the
extinguishment of debt, partially offset by interest income on cash and investments. Interest
expense was $3.2 million and $6.0 million for 2003 and 2002, respectively. We account for certain
unconsolidated subsidiaries using the cost and equity methods. During 2002, we impaired $11.7
million on our investments in these subsidiaries along with $4.3 million from our share of losses
from our equity method investments. For 2002, we recognized $3.2 million in interest expense
associated with the termination of our interest rate swap. Provision For Taxes We record valuation allowances against our deferred tax assets, when necessary, in accordance
with SFAS No. 109, Accounting for Income Taxes. Realization of deferred tax assets (such as net
operating loss carryforwards and income tax credits) is dependent on future taxable earnings and is
therefore uncertain. At least quarterly, we assess the likelihood that our deferred tax asset
balance will be recovered from future taxable income. Our tax expense fluctuates primarily due to
the tax jurisdictions where we currently have operating facilities and the varying tax rates in
those jurisdictions. The provision for income taxes for 2003, principally foreign taxes, was $2.4 million, compared
to $13.4 million for 2002. During 2002, we recorded an additional valuation allowance, or
additional tax expense, totaling $21.2 million relating to the expected realization of our deferred
income tax assets based on likely future recovery. For 2003 and 2002, there was no benefit
provided for net operating losses. Recently Issued Accounting Standards In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 clarify that abnormal amounts of idle facility
expense, freight, handling costs and wasted materials (spoilage) should be recognized as
current-period charges and require the allocation of fixed production overheads to inventory based
on the normal capacity of the production facilities. The pronouncement is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted
for inventory costs incurred during fiscal years after November 23, 2004. The adoption of this
pronouncement is not expected to have a material effect on the financial condition, the results of
operations or liquidity. 39




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On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment,
which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R)
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95,
Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach
described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the income statement
based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) must be adopted no later than July 1, 2005. Early adoption will be permitted
in periods in which financial statements have not yet been issued. We expect to adopt SFAS No.
123(R) on July 1, 2005, the beginning of our third quarter of 2005. We are currently evaluating
the two methods of adoption allowed by SFAS No. 123(R): the modified-prospective transition method
and the modified-retrospective transition method. The impact of adopting this pronouncement cannot
be predicted at this time because it will depend on many factors, including the levels of
share-based payments granted in the future. However, had we adopted this pronouncement in prior
periods, the impact of this pronouncement would approximate the impact of SFAS No. 123 described in
the disclosure of the pro forma results in Note 2, Summary of Significant Accounting Policies 
Stock-Based Compensation in our Notes to Financial Statements included elsewhere in this Form
10-K. Liquidity and Capital Resources We had cash and cash equivalents of $77.2 million as of December 31, 2004, a decrease of $10.4
million from the cash and cash equivalents of $87.6 million as of December 31, 2003. The decrease
in cash and cash equivalent is primarily the result of cash used in our operations, timing of cash
collections from customers, cash used to procure necessary inventories, cash used to satisfy vendor
obligations and net payments on short-term and long-term obligations. The following table
illustrates our cash position, which we define as cash, cash equivalents, time deposits and
short-term and long-term marketable securities, as it relates to our debt position, which we define
as all short-term and long-term obligations including our 2003 Notes (in thousands): At December 31:
    
    2004
    
    
    2003 (1)CashCash and cash equivalents
    
    $
    77,226
    
    
    $
    87,602Short-term marketable securities
    
    
    3,395
    
    
    
    5,221Time deposits
    
    
    1,559
    
    
    
    1,411Long-term marketable securities
    
    
    1,839
    
    
    
    1,70584,019
    
    
    
    95,939DebtCurrent portion of long-term debt
    
    
    92
    
    
    
    2045% convertible notes due 2008
    
    
    23,000
    
    
    
    23,000Short-term obligations
    
    
    25,194
    
    
    
    20,622Long-term debt
    
    
    112
    
    
    
    20048,398
    
    
    
    44,026Excess cash versus debt
    
    $
    35,621
    
    
    $
    51,913Ratio of cash versus debt (2)
    
    
    1.7:1
    
    
    
    2.2:1
   (1)
    
    Reclassified to conform with 2004 presentation.(2)
    
    Determined by dividing total cash by total debt, in each case as reflected in the
table. 40




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Working Capital At December 31:
    
    2004
    
    
    2003 (1)Current assets
    
    $
    216,533
    
    
    $
    207,901Current liabilities
    
    
    102,538
    
    
    
    99,850Working capital
    
    $
    113,995
    
    
    $
    108,501Current ratio
    
    
    2.1:1
    
    
    
    2.1:1
   (1)
    
    Reclassified to conform with 2004 presentation. Current assets increased $8.6 million due to increases in all current asset categories
with accounts receivables and inventory representing the largest increases, partially offset by
decreases in cash and cash equivalents and short-term marketable securities. The increases were
also affected by foreign currency. Fluctuations in current assets are typically due to the timing
of: shipments of our products to customers, receipts of inventories from our vendors, cash used for
capital expenditures and the affects of foreign currency. Current liabilities increased $2.7 million primarily due to increases in short-term
obligations and accrued liabilities. These increases were partially offset by decreases in
accounts payable. These increases were also affected by foreign currency. Fluctuations in current
liabilities are typically due to the timing of: payments to our vendors for raw materials, timing
of payments for accrued liabilities, such as payroll related expenses and interest on our
short-term and long-term obligations, changes in deferred income, income tax liabilities and the
affects of foreign currency. Cash Flow For the year ended December 31:
    
    2004
    
    
    2003Net cash provided by (used in):Operating activities
    
    $
    (21,559
    )
    
    $
    (16,987
    )Investing activities
    
    
    (448
    )
    
    
    3,697Financing activities
    
    
    6,322
    
    
    
    (1,246
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    5,309
    
    
    
    2,693Net change in cash and cash equivalents
    
    $
    (10,376
    )
    
    $
    (11,843
    )
 Cash Flows Related to Operating Activities. Cash used in operating activities was $21.6
million for the year ended December 31, 2004, compared to cash used in operating activities of
$17.0 million for the year ended December 31, 2003. Cash used in operating activities is a result
of our net loss of $10.7 million, adjusted for non-cash items such as depreciation and
amortization, additional allowances for doubtful accounts, deferred stock expense, deferred income
taxes and losses on the disposition of fixed assets. Decreased accrued liabilities and deferred
revenue positively affected cash used in operating activities. Cash used in operating activities
was negatively affected by increases in time deposits, accounts receivable, inventories and other
assets and decreases in accounts payable and other current liabilities. The increase in accounts
receivables is due to a general increase in business worldwide. The increase in inventories
results from an increase in FTTP products for future shipments, along with increases throughout our
networking group in response to an increase in business worldwide. Decreases in accounts payable
are the result of the timing of payments to our vendors. Cash used in operating activities for the
prior period was the result of our net loss adjusted for non-cash items and changes in assets
working capital. 41




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##### Table of Contents



Cash Flows Related to Investing Activities. Cash used in investing activities was $448,000
for the year ended December 31, 2004, compared to cash provided by investing activities totaling
$3.7 million for the year ended December 31, 2003. Cash used in investing activities for the year
ended December 31, 2004 was primarily the result of capital expenditures, partially offset by
maturities of investments and proceeds from the sale of property and equipment. As of December 31,
2004, we had no plans for major capital expenditures. Cash flows provided by investing activities
for the prior period resulted from the maturities of short-term and long-term marketable
securities, partially offset by the cash used for capital expenditures and the purchase of a
minority interest. Cash Flows Related to Financing Activities. Cash flows provided by financing activities were
$6.3 million for the year ended December 31, 2004, as compared to cash flows used in financing
activities of $1.2 million for the year ended December 31, 2003. Cash provided by financing
activities was primarily the result of our net borrowings of $4.4 million on our short-term and
long-term obligations, net proceeds from the exercise of employee stock options and increases in
other long-term liabilities. Cash flows used in financing activities for the prior period
represent the cash paid on borrowings, our final payment on our 5% convertible subordinated notes
which came due in June 2003, proceeds from the issuance of 5% convertible notes due in June 2008
and the repurchase of our common stock. In June 1998, we issued $100.0 million principal amount of our 1998 Notes in a private
placement raising net proceeds of $96.4 million. During 2003, prior to their maturity on June 15,
2003, we acquired  
    $5.9 million in principal amount of these notes in exchange for our issuance of 4.2
million shares of our common stock to the holders of the 1998 Notes; and
    $500,000 in principal amount of these notes in exchange for $502,000 in cash. During the year ended December 31, 2002, we acquired $31.6 million in principal amount of
these notes in exchange for our issuance of 12.3 million shares of our common stock to the holders
of these notes. During 2002, we also purchased $21.4 million in principal amount of these notes in
exchange for $19.7 million in cash. At maturity on June 15, 2003, we repaid in full the $26.0
million outstanding balance of our outstanding 1998 Notes using cash on-hand. In June 2003, we completed the sale of $23.0 million principal amount of our 2003 Notes to an
institutional investor in a private placement under the Securities Act of 1933. These notes have
an annual interest rate of 5% and are convertible into our common stock at a conversion price of
$2.32 per share. We are using the net proceeds from the sale of these notes for general corporate
purposes and working capital. During October 2003, we issued and sold 1,667,000 shares of our common stock to several
institutional investors that are managed client accounts of a large investment management firm,
raising net proceeds of approximately $5.0 million. These shares were taken from our shelf
registration statement that was declared effective by the SEC in June 2003, which registered $20.0
million of our common stock that we may issue and sell from time to time. Off-Balance Sheet Arrangements We do not have transactions, arrangements and other relationships with unconsolidated entities
that are reasonably likely to affect our liquidity or capital resources. We have no special
purpose or limited purpose entities that provided off-balance sheet financing, liquidity or market
or credit risk support, engage in leasing, hedging, research and development services, or other
relationships that expose us to liability that is not reflected on the face of the financials. 42




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Contractual Cash Obligations The following table illustrates our total contractual cash obligations as of December 31, 2004
(in thousands): Less than 1
    
    
    
    
    
    
    
    
    
    
    After 5Cash Obligations
    
    Total
    
    
    Year
    
    
    1  3 Years
    
    
    4  5 Years
    
    
    YearsShort-term obligations
    
    $
    25,194
    
    
    $
    25,194
    
    
    $
    
    
    
    $
    
    
    
    $
    Long-term debt
    
    
    204
    
    
    
    92
    
    
    
    112
    
    
    
    
    
    
    
    5% convertible notes
due June 2008
    
    
    23,000
    
    
    
    
    
    
    
    
    
    
    
    23,000
    
    
    
    Unconditional
purchase obligations
    
    
    7,619
    
    
    
    7,064
    
    
    
    
    
    
    
    
    
    
    
    555Operating leases
    
    
    28,158
    
    
    
    5,979
    
    
    
    8,035
    
    
    
    5,677
    
    
    
    8,467Total contractual cash
obligations
    
    $
    84,175
    
    
    $
    38,329
    
    
    $
    8,147
    
    
    $
    28,677
    
    
    $
    9,022
 Our total contractual cash obligations as of December 31, 2004, were $84.2 million, of which,
$38.3 million are due by December 31, 2005. These total contractual cash obligations primarily
consist of short-term and long-term obligations, including our 5% convertible notes due June 2008,
operating leases for our equipment and facilities and unconditional purchase obligations for
necessary raw materials. Historically, these obligations have been satisfied through cash
generated from our operations or other avenues and we expect that this will continue to be the
case. We believe that our cash on hand and cash flows from operations will be sufficient to satisfy
our current operations, capital expenditures and product development and engineering requirements
for at least the next 12 months. However, we may choose to obtain additional debt or equity
financing if we believe it appropriate. We are limited in the amount of debt financing we may
obtain and the price per share of common stock at which we may conduct equity financings without
triggering an acceleration of, or obtaining a waiver from holders of, our 5% convertible notes due
June 2008. For a discussion of these limitations and other restrictions of our 5% convertible
notes due June 2008, see the discussion under Business  Certain Risk Factors That Could Affect
Future Results  Our 2003 Notes Provide For Various Events Of Default That Would Entitle The
Holders To Require Us To Immediately Repay The Outstanding Principal Amount, Plus Accrued And
Unpaid Interest, In Cash. Our future capital requirements will depend on many factors, including
our rate of revenue growth, the timing and extent of spending to support development of new
products and expansion of sales and marketing, the timing of new product introductions and
enhancements to existing products and market acceptance of our products. Internet Access to Our Financial Documents We maintain a website at www.mrv.com. We make available free of charge, either by direct
access or a link to the SEC website, our annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably
practicable after such reports are electronically filed with, or furnished to, the SEC. Our
reports filed with, or furnished to, the SEC are also available directly at the SECs website at
www.sec.gov. 43




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##### Table of Contents



ITEM 7a. QUANITITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS Market Risks Market risk represents the risk of loss that may impact our Consolidated Financial Statements
through adverse changes in financial market prices and rates and inflation. Our market risk
exposure results primarily from fluctuations in foreign exchange rates. We manage our exposure to
these market risks through our regular operating and financing activities and have not historically
hedged these risks through the use of derivative financial instruments. The term hedge is used to
mean a strategy designed to manage risks of volatility in prices or interest and foreign exchange
rate movements on certain assets, liabilities or anticipated transactions and creates a
relationship in which gains or losses on derivative instruments are expected to counter-balance the
losses or gains on the assets, liabilities or anticipated transactions exposed to such market
risks. Interest Rates. We are exposed to interest rate fluctuations on our investments, short-term
borrowings and long-term obligations. Our cash and short-term investments are subject to limited
interest rate risk, and are primarily maintained in money market funds and bank deposits. Our
variable-rate short-term borrowings are also subject to limited interest rate risk due to their
short-term maturities. Our long-term obligations were entered into with fixed and variable
interest rates. In connection with our $50.0 million variable-rate term loan due in 2003, we
entered into a specific hedge, an interest rate swap, to modify the interest characteristics of
this instrument. The interest rate swap was used to reduce our cost of financing and the
fluctuations in the aggregate interest expense. The notional amount, interest payment and maturity
dates of the swap match the principal, interest payment and maturity dates of the related debt.
Accordingly, any market risk or opportunity associated with this swap is offset by the opposite
market impact on the related debt. In February 2002, we paid off our $50.0 million term loan and
terminated our interest rate swap for $3.2 million. To date, we have not entered into any other
derivative instruments, however, as we continue to monitor our risk profile, we may enter into
additional hedging instruments in the future. Foreign Exchange Rates. We operate on an international basis with a portion of our revenues
and expenses being incurred in currencies other than the U.S. dollar. Fluctuation in the value of
these foreign currencies in which we conduct our business relative to the U.S. dollar affect our
results and will cause U.S. dollar translation of such currencies to vary from one period to
another. We cannot predict the effect of exchange rate fluctuations upon future operating results.
However, because we have revenues and expenses in each of these
foreign currencies, the effect on our results of operations from currency fluctuations is reduced. We do not regularly attempt to
reduce our currency risks through hedging instruments, however, we may do so in the future. During 2004, we conducted a significant portion of our business in the Euro, the Swedish
Krona, the Swiss Franc and the Taiwan dollar. At December 31, 2004, currency changes resulted in
assets, liabilities, revenues and expenses being translated into more U.S. dollars than at December
31, 2003. The U.S. dollar weakened 9% compared to each of the Euro and Swedish Krona, 8% compared
to the Swiss Franc and 3% compared to the Taiwan dollar during the year ended December 31, 2004.
The Euro, the Swedish Krona and the Swiss Franc primarily impact our networking business, while the
Taiwan dollar affects our optical components business. The effect of currency fluctuations on our
results is described in Managements Discussion and Analysis of Financial Condition and Results of
Operations included herein. Inflation. We believe that the relatively moderate rate of inflation in the United States
over the past few years has not had a significant impact on our sales or operating results or on
the prices of raw materials. However, in view of our recent expansion of operations in Taiwan,
Israel and other countries, which have experienced greater inflation than the United States, there
can be no assurance that inflation will not have a material adverse effect on our operating results
in the future. 44




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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders of MRV Communications, Inc. We have audited the accompanying consolidated balance sheets of MRV Communications, Inc. (and
subsidiaries) as of December 31, 2004 and 2003, and the related consolidated statements of
operations, stockholders equity and comprehensive income (loss), and cash flows for each of the
three years in the period ended December 31, 2004. 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 the standards of the Public Company Accounting
Oversight Board (United States). 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 consolidated financial position of MRV Communications, Inc. (and subsidiaries) as of
December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 2004, in conformity with U.S.
generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of MRV Communication, Inc.s (and subsidiaries)
internal control over financial reporting as of December 31, 2004, based on criteria established in
Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated February 25, 2005 expressed an unqualified opinion
thereon. /s/ ERNST & YOUNG LLP Woodland Hills, California
February 25, 2005 45




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MRV Communications, Inc. Statement of Operations (In thousands, except per share data) For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Revenue
    
    $
    271,658

    
    
    $
    238,983
    
    
    $
    252,532Cost of goods sold
    
    
    179,780
    
    
    
    164,893
    
    
    
    169,566Gross profit
    
    
    91,878
    
    
    
    74,090
    
    
    
    82,966Operating costs and expenses:Product development and engineering
    
    
    24,949
    
    
    
    30,972
    
    
    
    49,358Selling, general and administrative
    
    
    74,117
    
    
    
    62,901
    
    
    
    90,187Impairment of goodwill and other intangibles
    
    
    
    
    
    
    356
    
    
    
    72,697Impairment of long-lived assets
    
    
    
    
    
    
    
    
    
    
    17,038Total operating costs and expenses
    
    
    99,066
    
    
    
    94,229
    
    
    
    229,280Operating loss
    
    
    (7,188
    )
    
    
    (20,139
    )
    
    
    (146,314
    )Interest expense
    
    
    (3,141
    )
    
    
    (3,170
    )
    
    
    (6,010
    )Other income (expense), net
    
    
    2,685
    
    
    
    (3,268
    )
    
    
    (17,685
    )Loss before taxes, extraordinary gain and
cumulative effect of an accounting change
    
    
    (7,644
    )
    
    
    (26,577
    )
    
    
    (170,009
    )Provision for taxes
    
    
    3,036
    
    
    
    2,361
    
    
    
    13,395Loss before extraordinary gain and cumulative
effect of an accounting change
    
    
    (10,680
    )
    
    
    (28,938
    )
    
    
    (183,404
    )Extraordinary gain, net of tax
    
    
    
    
    
    
    1,950
    
    
    
    Cumulative effect of an accounting change
    
    
    
    
    
    
    
    
    
    
    (296,355
    )Net loss
    
    $
    (10,680
    )
    
    $
    (26,988
    )
    
    $
    (479,759
    )Earnings per share:Basic and diluted loss per share:Loss before extraordinary gain and
cumulative effect of an accounting change
    
    $
    (0.10
    )
    
    $
    (0.28
    )
    
    $
    (2.01
    )Extraordinary gain
    
    $
    
    
    
    $
    0.02
    
    
    $
    Cumulative effect of an accounting change
    
    $
    
    
    
    $
    
    
    
    $
    (3.24
    )Net loss
    
    $
    (0.10
    )
    
    $
    (0.26
    )
    
    $
    (5.25
    )Weighted average number of shares:Basic and diluted
    
    
    104,793
    
    
    
    102,202
    
    
    
    91,421
 The accompanying notes are an integral part of these financial statements. 46




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MRV Communications, Inc. Balance Sheets (In thousands, except par values) At December 31:
    
    2004
    
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    77,226
    
    
    $
    87,602Short-term marketable securities
    
    
    3,395
    
    
    
    5,221Time deposits
    
    
    1,559
    
    
    
    1,411Accounts receivable, net
    
    
    80,755
    
    
    
    72,489Inventories
    
    
    42,264
    
    
    
    35,799Deferred income taxes
    
    
    2,395
    
    
    
    Other current assets
    
    
    8,939
    
    
    
    5,379Total current assets
    
    
    216,533
    
    
    
    207,901Property and equipment, net
    
    
    19,089
    
    
    
    25,416Goodwill
    
    
    29,965
    
    
    
    29,965Long-term marketable securities
    
    
    1,839
    
    
    
    1,705Deferred income taxes
    
    
    
    
    
    
    2,594Investments
    
    
    3,063
    
    
    
    3,063Other assets
    
    
    1,589
    
    
    
    2,040$
    272,078
    
    
    $
    272,684Liabilities and stockholders equity
Current liabilities:Current maturities of long-term debt
    
    $
    92
    
    
    $
    204Short-term obligations
    
    
    25,194
    
    
    
    20,622Accounts payable
    
    
    43,209
    
    
    
    46,811Accrued liabilities
    
    
    26,915
    
    
    
    25,523Deferred revenue
    
    
    4,556
    
    
    
    3,754Other current liabilities
    
    
    2,572
    
    
    
    2,936Total current liabilities
    
    
    102,538
    
    
    
    99,850Long-term debt
    
    
    112
    
    
    
    200Convertible notes
    
    
    23,000
    
    
    
    23,000Other long-term liabilities
    
    
    5,551
    
    
    
    4,215Minority interest
    
    
    5,318
    
    
    
    5,291Commitments and contingencies
 47




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MRV Communications, Inc. Balance Sheets (In thousands, except par values) At December 31:
    
    2004
    
    
    2003Stockholders equity:Preferred stock, $0.01 par value:Authorized  1,000 shares; no shares issued or outstanding
    
    
    
    
    
    
    Common stock, $0.0017 par value:Authorized  160,000 sharesIssued  105,426 shares in 2004 and 106,794 shares in 2003Outstanding  104,073 shares in 2004 and 105,441 shares
in 2003
    
    
    176
    
    
    
    179Additional paid-in capital
    
    
    1,155,474
    
    
    
    1,154,869Accumulated deficit
    
    
    (1,015,110
    )
    
    
    (1,004,430
    )Deferred stock expense, net
    
    
    
    
    
    
    (200
    )Treasury stock  1,353 shares in 2004 and 2003
    
    
    (1,352
    )
    
    
    (1,352
    )Accumulated other comprehensive loss
    
    
    (3,629
    )
    
    
    (8,938
    )Total stockholders equity
    
    
    135,559
    
    
    
    140,128$
    272,078
    
    
    $
    272,684
 The accompanying notes are an integral part of these balance sheets. 48




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MRV Communications, Inc. Statements of Stockholders Equity and Comprehensive Income (Loss) (In thousands) Additional
    
    
    DeferredCommon Stock
    
    
    Paid-In
    
    
    Stock
    
    
    Accumulated
    
    
    Treasury
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Capital
    
    
    Expense
    
    
    Deficit
    
    
    Stock
    
    
    Income (Loss)
    
    
    TotalBalance, December 31, 2001
    
    
    82,728
    
    
    $
    141
    
    
    $
    1,118,942
    
    
    $
    (26,344
    )
    
    $
    (497,683
    )
    
    $
    (133
    )
    
    $
    (10,247
    )
    
    $
    584,676Exercise of stock options
and warrants
    
    
    50
    
    
    
    
    
    
    
    131
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    131Issuance of common stock
in connection with
acquisitions
    
    
    4,996
    
    
    
    8
    
    
    
    7,044
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,052Issuance of common stock
in exchange for
convertible subordinated
notes
    
    
    12,310
    
    
    
    21
    
    
    
    38,211
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38,232Purchase of treasury stock
    
    
    (1,167
    )
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,074
    )
    
    
    
    
    
    
    (1,076
    )Forfeited stock options
    
    
    
    
    
    
    
    
    
    
    (14,693
    )
    
    
    2,990
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,703
    )Amortization of deferred
stock expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,307
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,307Comprehensive income
(loss):
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (479,759
    )
    
    
    
    
    
    
    
    
    
    
    (479,759
    )Realized loss on
interest rate swap
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,198
    
    
    
    3,198Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,582
    )
    
    
    (4,582
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (481,143
    )Balance, December 31, 2002
    
    
    98,917
    
    
    
    168
    
    
    
    1,149,635
    
    
    
    (5,047
    )
    
    
    (977,442
    )
    
    
    (1,207
    )
    
    
    (11,681
    )
    
    
    154,476Exercise of stock options
and warrants
    
    
    758
    
    
    
    1
    
    
    
    1,752
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,753Issuance of common stock
in connection with
private placement
    
    
    1,667
    
    
    
    3
    
    
    
    4,982
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,985Issuance of common stock
in exchange for
convertible subordinated
notes
    
    
    4,237
    
    
    
    7
    
    
    
    11,445
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,452Purchase of treasury stock
    
    
    (138
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (145
    )
    
    
    
    
    
    
    (145
    )Forfeited stock options
    
    
    
    
    
    
    
    
    
    
    (12,945
    )
    
    
    1,369
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,576
    )Amortization of deferred
stock expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,478
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,478Comprehensive income
(loss):Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (26,988
    )
    
    
    
    
    
    
    
    
    
    
    (26,988
    )Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,693
    
    
    
    2,693Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (24,295
    )Balance, December 31,
2003
    
    
    105,441
    
    
    
    179
    
    
    
    1,154,869
    
    
    
    (200
    )
    
    
    (1,004,430
    )
    
    
    (1,352
    )
    
    
    (8,938
    )
    
    
    140,128
 49




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MRV Communications, Inc. Statements of Stockholders Equity and Comprehensive Income (Loss) (In thousands) Additional
    
    
    DeferredCommon Stock
    
    
    Paid-In
    
    
    Stock
    
    
    Accumulated
    
    
    Treasury
    
    
    ComprehensiveShares
    
    
    Amount
    
    
    Capital
    
    
    Expense
    
    
    Deficit
    
    
    Stock
    
    
    Income (Loss)
    
    
    TotalBalance, December 31, 2003
    
    
    105,411
    
    
    
    179
    
    
    
    1,154,869
    
    
    
    (200
    )
    
    
    (1,004,430
    )
    
    
    (1,352
    )
    
    
    (8,938
    )
    
    
    140,128Exercise of stock options
and warrants
    
    
    381
    
    
    
    
    
    
    
    614
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    614Retirement of common stock
    
    
    (1,749
    )
    
    
    (3
    )
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeited stock options
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (12
    )Amortization of deferred
stock expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    200
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    200Comprehensive income
(loss):Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,680
    )
    
    
    
    
    
    
    
    
    
    
    (10,680
    )Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,309
    
    
    
    5,309Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,371
    )Balance, December 31,
2003
    
    
    104,073
    
    
    $
    176
    
    
    $
    1,155,474
    
    
    $
    
    
    
    $
    (1,015,110
    )
    
    $
    (1,352
    )
    
    $
    (3,629
    )
    
    $
    135,559
 The accompanying notes are an integral part of these financial statements. 50




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MRV Communications, Inc. Statement of Cash Flows (In thousands) For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net loss
    
    $
    (10,680
    )
    
    $
    (26,988
    )
    
    $
    (479,759
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization
    
    
    8,266
    
    
    
    11,411
    
    
    
    16,169Amortization of deferred stock expense, net of forfeited options
    
    
    188
    
    
    
    (8,098
    )
    
    
    6,604Provision for doubtful accounts
    
    
    1,367
    
    
    
    1,829
    
    
    
    2,188Deferred income taxes
    
    
    199
    
    
    
    43
    
    
    
    20,592Loss on extinguishment of debt
    
    
    
    
    
    
    5,438
    
    
    
    1,363Impairment of goodwill and other intangibles
    
    
    
    
    
    
    356
    
    
    
    72,697Cumulative effect of an accounting change
    
    
    
    
    
    
    
    
    
    
    296,355Loss on termination of interest rate swap
    
    
    
    
    
    
    
    
    
    
    3,198Extraordinary gain
    
    
    
    
    
    
    (1,950
    )
    
    
    (Gain) loss on disposition of property and equipment
    
    
    235
    
    
    
    306
    
    
    
    243Impairment of long-lived assets
    
    
    
    
    
    
    
    
    
    
    17,038Impairment of cost and equity method investments
    
    
    
    
    
    
    
    
    
    
    11,741Loss on equity method subsidiaries
    
    
    
    
    
    
    
    
    
    
    4,283Minority interests share of income
    
    
    27
    
    
    
    (80
    )
    
    
    230Changes in operating assets and liabilities, net of effects from
acquisitions:Time deposits
    
    
    (148
    )
    
    
    1,378
    
    
    
    1,843Accounts receivable
    
    
    (9,633
    )
    
    
    (4,003
    )
    
    
    5,361Inventories
    
    
    (6,465
    )
    
    
    (3,104
    )
    
    
    24,613Other assets
    
    
    (3,143
    )
    
    
    6,540
    
    
    
    11,404Accounts payable
    
    
    (3,602
    )
    
    
    5,503
    
    
    
    (6,996
    )Accrued liabilities
    
    
    1,486
    
    
    
    (4,136
    )
    
    
    (7,280
    )Deferred revenue
    
    
    802
    
    
    
    (196
    )
    
    
    (215
    )Other current liabilities
    
    
    (458
    )
    
    
    (1,236
    )
    
    
    375Net cash provided by (used in) operating activities
    
    
    (21,559
    )
    
    
    (16,987
    )
    
    
    2,047Cash flows from investing activities:Purchases of property and equipment
    
    
    (2,737
    )
    
    
    (2,380
    )
    
    
    (13,947
    )Proceeds from sale of property and equipment
    
    
    597
    
    
    
    449
    
    
    
    323Purchases of investments
    
    
    
    
    
    
    
    
    
    
    (4,150
    )Proceeds from sale of FOCI and QOI
    
    
    
    
    
    
    
    
    
    
    5,735Proceeds from maturity of investments
    
    
    1,692
    
    
    
    6,259
    
    
    
    33,426Investment in subsidiaries
    
    
    
    
    
    
    (631
    )
    
    
    Net cash provided by (used in) investing activities
    
    
    (448
    )
    
    
    3,697
    
    
    
    21,387
 51




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MRV Communications, Inc. Statement of Cash Flows (In thousands) For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Cash flows from financing activities:Net proceeds from issuance of convertible notes
    
    
    
    
    
    
    22,950
    
    
    
    Net proceeds from issuance of common stock
    
    
    614
    
    
    
    6,738
    
    
    
    131Payment for termination of interest rate swap
    
    
    
    
    
    
    
    
    
    
    (3,198
    )Borrowings on short-term obligations
    
    
    59,042
    
    
    
    50,198
    
    
    
    63,303Payments on short-term obligations
    
    
    (54,582
    )
    
    
    (54,431
    )
    
    
    (70,956
    )Payments on long-term obligations
    
    
    (88
    )
    
    
    (583
    )
    
    
    (52,495
    )Repurchase of convertible subordinated notes
    
    
    
    
    
    
    (26,522
    )
    
    
    (19,721
    )Purchase of treasury stock
    
    
    
    
    
    
    (145
    )
    
    
    (1,076
    )Other long-term liabilities
    
    
    1,336
    
    
    
    549
    
    
    
    (71
    )Net cash provided by (used in) financing activities
    
    
    6,322
    
    
    
    (1,246
    )
    
    
    (84,083
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    5,309
    
    
    
    2,693
    
    
    
    (4,582
    )Net decrease in cash and cash equivalents
    
    
    (10,376
    )
    
    
    (11,843
    )
    
    
    (65,231
    )Cash and cash equivalents, beginning of year
    
    
    87,602
    
    
    
    99,445
    
    
    
    164,676Cash and cash equivalents, end of year
    
    $
    77,226
    
    
    $
    87,602
    
    
    $
    99,445
 The accompanying notes are an integral part of these financial statements. 52




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MRV Communications, Inc. Notes To Financial Statements December 31, 2004  1.
    Description of Business MRV Communications, Inc, (a Delaware corporation, MRV or the Company) designs,
manufactures, sells, distributes, integrates and supports communication equipment and services, and
optical components. MRV conducts its business along three principal segments: the networking
group, the optical components group and development stage enterprise group. MRVs networking group
provides equipment used by commercial customers, governments and telecommunications service
providers, and include switches, routers, physical layer products and console management products
as well as specialized networking products for aerospace, defense and other applications including
voice and cellular communication. MRVs optical components group designs, manufactures and sells
optical communications components, primarily through its wholly owned subsidiary LuminentOIC, Inc.
These components include fiber optic transceivers for metropolitan, access and
Fiber-to-the-Premises, or FTTP, applications. MRVs development stage enterprise group seeks to
develop new optical components, subsystems and networks and other products for the infrastructure
of the Internet.  2.
    Summary of Significant Accounting PoliciesPrinciples of Consolidation The accompanying financial statements include the accounts of MRV and its wholly owned and
majority owned subsidiaries. All significant intercompany transactions and accounts have been
eliminated. MRV consolidates the financial results of related development stage enterprises when
it has effective control, voting control or has provided the entitys working capital. When others
invest in these enterprises reducing its voting control below 50%, MRV discontinues consolidation
and uses the cost or equity method of accounting for these investments unless otherwise required. Foreign Currency Transactions originally denominated in other currencies are converted into U.S. dollars in
accordance with Statement of Financial Accounting Standards (SFAS) No. 52, Foreign Currency
Translation. Increases or decreases in the resulting assets or liabilities, which are denominated
in a foreign currency, are recorded as foreign currency gains and losses and are included in other
income (expense) in determining net income (loss). For foreign operations with the local currency as the functional 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 rate 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). 53




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Revenue Recognition MRV generally recognizes product revenue, net of sales discounts, returns and allowances, when
persuasive evidence of an arrangement exits, delivery has occurred and all significant contractual
obligations have been satisfied, the fee is fixed or determinable and collection is considered
probable. Products are generally shipped FOB shipping point with no right of return. Sales of
services and system support are deferred and recognized ratably over the contract period. Sales
with contingencies, such as rights of return, rotation rights, conditional acceptance provisions
and price protection, are rare and insignificant and are deferred until the contingencies have been
satisfied or the contingent period has lapsed. MRVs major revenue-generating products consist of:
fiber optic components; switches and routers; console management; and physical layer products. MRV generally warrants its products against defects in materials and workmanship for one to
two year periods. The estimated cost of warranty obligations and sales returns and other
allowances are recognized at the time of revenue recognition based on contract terms and prior
claims experience. Cash, Cash Equivalents and Time Deposits MRV considers all highly liquid investments with an original maturity of 90 days or less to be
cash equivalents. MRV maintains cash balances and investments in highly qualified financial
institutions. At various times such amounts are in excess of insured limits. Time deposits of
$1.6 million and $1.4 million as of December 31, 2004 and 2003, respectively, are restricted by
short-term obligations. Marketable Securities MRV accounts for its marketable securities, which are available for sale, under the provisions
of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. During 2003,
MRV changed its investment classification from held-to-maturity to available for sale. The
original cost of MRVs marketable securities approximated fair market value as of December 31, 2004
and 2003. As of December 31, 2004 and 2003, short-term and long-term marketable securities
consisted principally of U.S. Treasury Bonds, Municipal Bonds and Corporate Bonds. Marketable
securities mature at various dates through 2005. Purchase, sales and maturities of securities are
presented in the accompanying Statement of Cash Flows. Accounts Receivable As of December 31, 2004, 2003 and 2002, the allowance for doubtful accounts totaled $9.4
million, $10.7 million and $15.0 million, respectively. Increases in the allowance for doubtful
accounts totaled $1.4 million, $1.8 million and $2.2 million for the years ended December 31, 2004,
2003 and 2002, respectively. Write-offs against the allowance for doubtful accounts totaled $1.1
million, $6.1 million and $1.9 million for the years ended December 31, 2004, 2003 and 2002,
respectively. During the year ended December 31, 2004, $1.6 million of the allowance for doubtful
accounts was reduced based on period-end assessments of required allowances and has been included
in the accompanying Statement of Operations in the period in which such determination was made. If
the financial condition of MRVs customers were to deteriorate, resulting in their inability to
make payments, additional provisions would be recorded in that period. 54




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Inventories Inventories are stated at the lower of cost or market and consist of material, labor and
overhead. Cost is determined by the first in, first out method. Inventories consisted of the
following (in thousands): At December 31 :
    
    2004
    
    
    2003Raw materials
    
    $
    7,272
    
    
    $
    5,886Work-in process
    
    
    10,055
    
    
    
    7,274Finished goods
    
    
    24,937
    
    
    
    22,639Total
    
    $
    42,264
    
    
    $
    35,799
 Property and Equipment Property and equipment are stated at cost. Depreciation is computed using the straight-line
method over the estimated useful lives of the related assets, ranging from three to thirty-three
years. Maintenance and repairs are charged to expense as incurred and the costs of additions and
betterments that increase the useful lives of the assets are capitalized. Property and equipment
consisted of the following (in thousands): At December 31:
    
    2004
    
    
    2003Property and equipment, at costLand
    
    $
    62
    
    
    $
    57Building
    
    
    3,975
    
    
    
    3,674Machinery and equipment
    
    
    43,804
    
    
    
    43,611Furniture and fixtures
    
    
    6,507
    
    
    
    5,709Computer hardware and software
    
    
    18,219
    
    
    
    18,021Leasehold improvements
    
    
    6,178
    
    
    
    5,848Construction in progress
    
    
    76
    
    
    
    65378,821
    
    
    
    77,573Less  accumulated depreciation and amortization
    
    
    (59,732
    )
    
    
    (52,157
    )Total
    
    $
    19,089
    
    
    $
    25,416
 Goodwill and Other Intangibles MRV adopted SFAS No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002.
In accordance with SFAS No. 142, goodwill and intangible assets with indefinite lives will no
longer be amortized, but instead will be measured for impairment at least annually, or when events
indicate that impairment exists. Intangible assets that are determined to have definite lives will
continue to be amortized over their useful lives (See Note 3, Goodwill and Other Intangible
Assets). 55




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Investments MRV accounts for its investments in unconsolidated entities (see Note 2, Principles of
Consolidation) under the provisions of Accounting Principles Board Opinions (APB) No. 18, The
Equity Method of Accounting for Investments in common stock, and related interpretations.
Unconsolidated investments, for which MRV does not have the ability to exercise significant
influence over operating and financial polices, are accounted for under the cost method. Those
investments, for which MRV does have the ability to exercise significant influence over operating
and financial policies, are accounted for under the equity method. In general, all investments in
which MRV owns greater than 20% of the voting stock, are accounted for under the equity method.
Cost and equity method investments totaled $3.1 million as of December 31, 2004 and 2003. Under the cost and equity method, a loss in value of an investment, which is deemed to be
other than a temporary decline, is recognized. Evidence of a loss in value might include, but
would not necessarily be limited to, absence of an ability to recover the carrying amount of the
investment or inability of the investee to sustain an earnings capacity, which would justify the
carrying amount of the investment. During 2004, MRV sold its remaining ownership in an equity
method investment resulting in a gain on the sale totaling $2.0 million. This investment had
previously been fully impaired. During the year ended December 31, 2002, MRV recognized impairment
on investments totaling $11.7 million, which has been included in Other Expense, net. Impairment of Long-Lived Assets MRV evaluates its long-term assets, such as property and equipment and other long-term assets,
for impairment whenever events or changes in circumstances indicate that the carrying value of an
asset may be impaired. MRV considers events or changes such as product discontinuance, plant
closures, product dispositions and history of operating losses or other changes in circumstances to
indicate that the carrying amount may not be recoverable. The carrying value of an asset is
considered impaired when the anticipated undiscounted cash flow from such assets is less than its
carrying value. In that event, a loss is recognized based on the amount by which the carrying
value exceeds the fair market value. Fair market value is determined using the anticipated cash
flows discounted at a rate based on MRVs weighted average costs of capital, which represents the
blended after-tax costs of debt and equity. For the year ended December 31, 2002, MRV determined that $17.0 million in long-lived assets,
primarily property and equipment, were impaired. This amount was determined to be impaired using
the method discussed above. The remaining carrying values of the long-lived assets were determined
to be realizable. This process and analysis requires management to use significant judgment and
apply assumptions regarding the future cash flows expected to result from the use of the assets and
the eventual disposition of such assets. While management believes the carrying value of its
assets are realizable based on its analysis, changes in the assumptions used in its models could
produce significantly different results. The impairment of long-lived assets of $17.0 million for
the year ended December 31, 2002 has been included in the determination of operating loss in the
accompanying Statement of Operations. The vast majority of these impairments were from the optical
components group. There were no impairment losses recorded for the years ended December 31, 2004
and 2003. Fair Value of Financial Instruments MRVs financial instruments, including cash and cash equivalents, time deposits, short-term
and long-term marketable securities, accounts receivable, accounts payable, accrued liabilities and
short-term debt obligations are carried at cost, which approximates their fair market value due to
the short-term nature of those instruments. The fair value of long-term debt obligations is
estimated based on current interest rates available to MRV for debt instruments with similar terms,
degrees of risk and remaining maturities. The carrying values of these obligations approximate
their fair values. 56




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Product Development and Engineering Product development and engineering costs are charged to expense as incurred. 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 MRVs circumstances occurs when a working model is completed. After technological
feasibility is established, additional costs would be capitalized. MRV 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. Advertising Costs Advertising costs are charged to expense as incurred. Income Taxes Deferred income tax assets and liabilities are computed based on the temporary differences
between the financial statement and income tax bases of assets and liabilities using the statutory
marginal income tax rate in effect for the years 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. Earnings (Loss) Per Share Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted
average number of common shares outstanding during the period. Diluted earnings (loss) per share
is calculated by dividing net income (loss) by the sum of the weighted average number of common
shares outstanding, plus all additional common shares that would have been outstanding if
potentially dilutive securities or common stock equivalents had been issued. Stock options and
warrants to purchase 11.0 million, 10.0 million and 12.6 million shares were not included in the
computation of years 2004, 2003 and 2002 diluted loss per share because such stock options and
warrants were considered anti-dilutive. Shares associated with MRVs outstanding 5% Convertible
Notes issued in June 2003 (2003 Notes) and 5% Convertible Subordinated Notes issued in June 1998
and paid in June 2003 (1998 Notes) were not included in the computation of loss per share as they
are anti-dilutive. Stock-Based Compensation MRV accounts for its employee stock plan under the intrinsic value method prescribed by APB
No. 25, Accounting for Stock Issued to Employees, and related interpretations, and has adopted
the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation and as
amended by SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure, an
amendment of FASB Statement No. 123. 57




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SFAS No. 123, as amended by SFAS No. 148, permits companies to recognize, as expense over the
vesting period, the fair value of all stock-based awards on the date of grant. The Black-Scholes
option valuation model was developed for use in estimating the fair value of traded options, which
have no vesting restrictions and are fully transferable. Because MRVs stock-based compensation
plans have characteristics significantly different from those of traded options and because changes
in the subjective input assumptions can materially affect the fair value estimate, management
believes that the existing option valuation models do not necessarily provide a reliable single
measure of the fair value of awards from the plan. Therefore, as permitted, MRV applies the
existing accounting rules under APB No. 25 and provides pro forma net loss and pro forma loss per
share disclosures for stock-based awards made during the year as if the fair value method defined
in SFAS No. 123, as amended, had been applied. Net loss and net loss per share for each of the
three years in the period ended December 31, 2004 would have increased to the following pro forma
amounts (in thousands, except per share data): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Net loss, as reported
    
    $
    (10,680
    )
    
    $
    (26,988
    )
    
    $
    (479,759
    )Add: Stock-based employee compensation expense
(income) included in reported net loss
    
    
    188
    
    
    
    (8,098
    )
    
    
    6,604Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards
    
    
    (17,593
    )
    
    
    (23,520
    )
    
    
    (24,775
    )Pro forma net loss
    
    $
    (28,085
    )
    
    $
    (58,606
    )
    
    $
    (497,930
    )Earnings per share:Basic and diluted net loss per share  as reported
    
    $
    (0.10
    )
    
    $
    (0.26
    )
    
    $
    (5.25
    )Basic and
diluted net loss per share  pro forma
    
    $
    (0.27
    )
    
    $
    (0.57
    )
    
    $
    (5.45
    )
 The following assumptions were applied: (i) no expected dividend yield for all periods,
(ii) expected volatility ranging from 69% to 84% for 2004, 84% for 2003 and 104% for 2002, (iii)
expected lives of 4 to 6 years for all years, (iv) and risk-free interest rates ranging from 2.68%
to 6.73% for all years. MRV accounts for option and warrant grants to non-employees using the guidance prescribed by
SFAS No. 123, FASB Interpretation No. (FIN) 44, Accounting for Certain Transactions Involving
Stock Compensation (an interpretation of APB Opinion No. 25), and Emerging Issue Task Force
(EITF) No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or In Conjunction with Selling, Goods, or Services, whereby the fair value of such
option and warrant grants are measured using the fair value at the earlier of the date at which the
non-employees performance is completed or a performance commitment is reached. 58




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Deferred stock expense is being amortized using the graded vesting method over four years.
Using this method, approximately 57%, 26%, 13% and 4%, respectively, of each options compensation
expense is amortized in each of the four years following the date of grant. Deferred stock expense
generated during 2001 was $7.1 million generated through acquisitions. Deferred stock expense
generated during 2000 was $160.8 million of which $106.6 million was generated through acquisitions
and $54.2 million was generated through stock options granted to LuminentOICs former President and
its former Chief Financial Officer (CFO). There has been no deferred stock expense generated
since December 31, 2001. In June 2002 and September 2001, LuminentOICs former CFO and its former
President, respectively, resigned. As result of their resignations and as defined in their
employment agreements, all outstanding stock options immediately vested and were exercisable
through July 12, 2004 and September 11, 2003, respectively. MRV immediately recognized the
remaining unamortized deferred stock expense of $1.7 million and $18.9 million during the years
ended December 31, 2002 and 2001, respectively, as a result of their resignations. The following
table presents deferred stock expense (income) recognized for the periods presented (in thousands). For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Amortization of deferred stock expense
    
    $
    200
    
    
    $
    3,478
    
    
    $
    18,307Income from recapturing accelerated
deferred stock expense due to
terminations
    
    
    (12
    )
    
    
    (11,576
    )
    
    
    (11,703
    )Total
    
    $
    188
    
    
    $
    (8,098
    )
    
    $
    6,604
 During the three years in the period ended December 31, 2004, certain stock option
holders ceased to be employees of MRV, either through termination or sale. Since MRV used the
graded vesting method of accounting to recognize the compensation over the related employment
period, MRV recognized deferred stock expense related to options that were unvested. For the years
ended December 31, 2004, 2003 and 2002, MRV reversed $12,000, $11.6 million and $11.7 million,
respectively, related to unvested, forfeited stock options for which compensation expense was
previously recognized. Unamortized deferred stock expense totaling $1.4 million and $3.0 million
for the years ended December 31, 2003 and 2002, respectively, has been reversed to additional
paid-in capital relating to these employees. There was no unamortized deferred stock expense
reversed to additional paid-in capital relating to these employees for the year ended December 31,
2004. Transactions with Stock of a Subsidiary In September 2003, MRV acquired 666,666 shares of Series A Preferred Stock, or 1.9% additional
ownership interest, in Charlottes Networks from a minority interest in exchange for $50,000 in
cash. This acquisition of a minority interest resulted in an extraordinary gain of $2.0 million
for the year ended December 31, 2003. MRVs ownership interest following this acquisition is
approximately 60%. Charlottes Networks is included in MRVs development stage enterprise group. Recently Issued Accounting Standards In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 clarify that abnormal amounts of idle facility
expense, freight, handling costs and wasted materials (spoilage) should be recognized as
current-period charges and require the allocation of fixed production overheads to inventory based
on the normal capacity of the production facilities. The pronouncement is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted
for inventory costs incurred during fiscal years after November 23, 2004. The adoption of this
pronouncement is not expected to have a material effect on the financial condition, the results of
operations or liquidity. 59




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On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment,
which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R)
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95,
Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach
described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the income statement
based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) must be adopted no later than July 1, 2005. Early adoption will be permitted
in periods in which financial statements have not yet been issued. MRV expects to adopt SFAS No.
123(R) on July 1, 2005, the beginning of its third quarter of 2005. MRV is currently evaluating
the two methods of adoption allowed by SFAS No. 123(R): the modified-prospective transition method
and the modified-retrospective transition method. The impact of adopting this pronouncement cannot
be predicted at this time because it will depend on many factors, including the levels of
share-based payments granted in the future. However, had MRV adopted this pronouncement in prior
periods, the impact would approximate the impact of SFAS No. 123 described in the disclosure of the
pro forma results in Note 2, Summary of Significant Accounting Policies  Stock-Based Compensation. Use of Estimates The preparation of financial statements in conformity with accounting principles generally
accepted in the United States 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. Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation.
These reclassifications include the increase in accounts receivable and short-term obligations in
the amount of $22.0 million and $19.0 million at December 31, 2004 and 2003, respectively, relating
to the recording of accounts receivable financing transactions with recourse, which were previously
recorded as sales of accounts receivable with recourse.  3.
    Goodwill and Other Intangible Assets As required by SFAS No. 142, MRV performed transitional impairment tests on goodwill and other
intangibles assets with indefinite lives, which consisted of patents and assembled work forces, as
of January 1, 2002. As a result of the impairment tests, MRV recorded a charge of $296.4 million
for the cumulative effect of an accounting change. Under SFAS No. 142, goodwill impairment exists
if the net book value of a reporting unit exceeds its fair value. MRV, with the assistance of
valuation experts, estimated the fair value of its reporting units using a combination of
discounted cash flow analyses and comparisons with the market values of similar publicly traded
companies. Included in MRVs $296.4 million impairment was a $247.3 million charge related to the
impairment of the goodwill associated with the Foreign Optical Components and Free-Space Optics
reporting units. The Foreign Optical Components reporting unit included the goodwill generated
from the FOCI Fiber Optic Communications, Inc. (FOCI) and Quantum Optech, Inc. (QOI)
acquisitions (see Note 5, Disposition of Assets). The optical components, active and passive,
markets continued to deteriorate and had contracted significantly. As a result, MRV determined
that a significant portion of the goodwill acquired had been impaired. The goodwill impairment in
the Free-Space Optics reporting unit reflected the significantly lower fair value calculated on the
basis of reduced operating revenues and income as a result of a depressed market for those
products. 60




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The remaining $49.1 million of impairment charge related to patents and assembled work forces
associated with the Free-Space Optics reporting unit. The impairment of these patents and
assembled work forces reflected the same circumstances as described above. During the third quarter of 2002 and in addition to the transitional impairment testing, MRV
reviewed its remaining goodwill and other intangible assets as required annually pursuant to SFAS
No. 142. This impairment reduced the carrying value of goodwill and other intangible assets by
recording an impairment charge of $72.7 million, which consisted of $70.4 million relating to
goodwill and $2.3 million relating to patents. MRV has determined that the annual impairment test
will be performed on October 1st of each year. MRV, with the assistance of valuation
experts, estimated the fair value of its reporting units using a combination of discounted cash
flow analyses and comparisons with the market values of similar publicly traded companies. During
2003, MRV impaired $356,000 in goodwill from a foreign office that ceased operations. During the
fourth quarter of 2004 and 2003, MRV completed the annual review of its remaining goodwill and
other intangible assets. With the assistance of valuation experts, MRV determined that no further
reductions in the carrying value of its goodwill and intangible assets were necessary. For the year ended December 31, 2004, there were no changes in the carrying amounts of
goodwill. The following table summarizes MRVs goodwill balances (in thousands): At December 31:
    
    2004
    
    
    2003Gross carrying amount
    
    $
    195,869
    
    
    $
    195,869Accumulated amortization
    
    
    (165,904
    )
    
    
    (165,904
    )Total
    
    $
    29,965
    
    
    $
    29,965
  4.
    Restructuring costs During the second quarter of 2001, LuminentOICs management approved and implemented a
restructuring plan in order to adjust operations and administration as a result of the dramatic
slowdown in the communications equipment industry generally and the optical components sector in
particular. Major actions primarily involved the reduction of workforce totaling $1.3 million, the
abandonment of certain assets, including closed and abandoned facilities, amounting to $12.8
million and the cancellation and termination of purchase commitments totaling $6.2 million. MRV
has a remaining obligation totaling $607,000 for its fulfillment of a lease obligation on an
abandoned facility that it expects to pay through cash on-hand through August 2007.  5.
    Disposition of Assets On October 15, 2002, MRVs wholly owned subsidiary LuminentOIC, in a single transaction, sold
(i) 53.4 million shares of the capital stock of FOCI amounting to approximately 78% of the total
issued and outstanding share capital of FOCI and (ii) 19.0 million shares of the capital stock of
QOI, representing approximately 100% of the total issued and outstanding share capital of QOI. The
purchasers consisted of employees of FOCI, including its President. LuminentOIC continues to hold
approximately 17% of the outstanding share capital of FOCI and no remaining ownership in QOI. The
remaining ownership in FOCI has been recorded as a cost method investment in the accompanying
Balance Sheet. The consideration received by LuminentOIC for the sale of the FOCI and QOI shares, which was
determined through arms length negotiations between LuminentOIC and MRV on the one hand, and the
purchasers on the other, consisted of $8.0 million in cash and $2.0 million in credit against
future purchases of components. These net assets have been included in MRVs optical components
group segment. 61




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Prior to the sale of FOCI and QOI, MRV recorded an impairment loss on long-lived assets
totaling $15.9 million, which was measured, based on the lower of its carrying amount or fair value
less cost to sell. The fair value less cost to sell was based on the sale price described above.
The adjusted carrying amounts of the major classes of assets and liabilities sold along with the
consideration received as of October 15, 2002 were as follows (in thousands): Consideration received:Cash
    
    $
    8,000Future product credit
    
    
    2,00010,000Assets and liabilities disposed of:Assets (primarily receivables, inventory and fixed assets)
    
    
    36,322Liabilities (primarily short-term and long-term obligations)
    
    
    (23,614
    )$
    12,708
 The loss on disposition of FOCI and QOI has been included in Other Expense, net in the
accompanying Statement of Operations for the year ended December 31, 2002. Through December 31,
2003, MRV utilized $1.9 million of the future product credit, with the remaining $86,000 of product
credit utilized during the year ended December 31, 2004.  6.
    Accrued Liabilities Accrued liabilities consisted of the following (in thousands): At December 31:
    
    2004
    
    
    2003Payroll and related
    
    $
    11,582
    
    
    $
    8,850Product warranty
    
    
    5,255
    
    
    
    5,337Other
    
    
    10,078
    
    
    
    11,336Total
    
    $
    29,915
    
    
    $
    25,523
  7.
    Income Taxes The provision for income taxes is as follows (in thousands): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Current:Federal
    
    $
    
    
    
    $
    
    
    
    $
    (329
    )State
    
    
    151
    
    
    
    (10
    )
    
    
    (3
    )Foreign
    
    
    3,084
    
    
    
    2,414
    
    
    
    2,8023,235
    
    
    
    2,404
    
    
    
    2,470Deferred:Federal
    
    
    
    
    
    
    
    
    
    
    11,870State
    
    
    
    
    
    
    
    
    
    
    Foreign
    
    
    (199
    )
    
    
    (43
    )
    
    
    (945
    )(199
    )
    
    
    (43
    )
    
    
    10,925Total
    
    $
    3,036
    
    
    $
    2,361
    
    
    $
    13,395
 62




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The income tax provision differs from the amount computed by applying the federal
statutory income tax rate to income before taxes as follows: For the year ended December 31:
    
    2004

    

2003

    

2002Income tax provision
(benefit, at statutory
federal rate)
    
    
    (34
    )%
    
    
    (34
    )%
    
    
    (34
    )%State and local income
taxes, net of federal income
taxes effect
    
    
    (6
    )%
    
    
    (6
    )%
    
    
    (1
    )%Permanent differences
    
    
    1
    %
    
    
    24
    %
    
    
    31
    %Foreign taxes at rates
different than domestic
rates
    
    
    (10
    )%
    
    
    25
    %
    
    
    1
    %Change in valuation allowance
    
    
    89
    %
    
    
    
    %
    
    
    6
    %Total
    
    
    40
    %
    
    
    9
    %
    
    
    3
    %
 The components of deferred income taxes are as follows (in thousands): At December 31:
    
    2004
    
    
    2003Allowance for doubtful accounts
    
    $
    1,537
    
    
    $
    994Inventory reserve
    
    
    11,256
    
    
    
    10,425Accrued liabilities
    
    
    4,322
    
    
    
    2,610Other
    
    
    1,236
    
    
    
    4,25018,351
    
    
    
    18,279Valuation allowance
    
    
    (15,956
    )
    
    
    (18,279
    )Net short-term deferred income tax assets
    
    
    2,395
    
    
    
    Net operating losses
    
    
    62,150
    
    
    
    40,587Tax credits
    
    
    6,538
    
    
    
    3,153Depreciation and amortization
    
    
    5,008
    
    
    
    7,466Investments
    
    
    67
    
    
    
    16,926Capital loss carryforwards
    
    
    104,188
    
    
    
    88,717Other
    
    
    
    
    
    
    (136
    )177,951
    
    
    
    156,713Valuation allowance
    
    
    (177,951
    )
    
    
    (154,119
    )Net long-term deferred income tax assets
    
    
    
    
    
    
    2,594Total
    
    $
    2,395
    
    
    $
    2,594
 MRV records valuation allowances against its deferred tax assets, when necessary, in
accordance with SFAS No. 109, Accounting for Income Taxes. Realization of deferred tax assets
(such as net operating loss carryforwards and income tax credits) is dependent on future taxable
earnings and is therefore uncertain. At least quarterly, MRV assesses the likelihood that its
deferred tax asset balance will be recovered from future taxable income. To the extent management
believes that recovery is unlikely, MRV establishes a valuation allowance against its deferred tax
asset, increasing its income tax expense in the period such determination is made. During 2004,
MRV recorded an additional valuation allowance totaling $21.5 million against additional deferred
income tax assets, principally domestic net operating losses and unrealized tax credits due to a
history of domestic net losses. Although realization is not assured, management believes it is
more likely than not that the net deferred tax assets will be realized. 63




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As of December 31, 2004, MRV had federal and state net operating loss carryforwards available
of $145.2 million and $148.2 million, respectively. For the year ended December 31, 2004, MRV
generated additional federal and state net operating losses of
$28.1 million and $5.6 million, respectively. For
federal and state income tax purposes, the net operating losses are available to offset future
taxable income through 2024 and 2014, respectively. Tax credits of $3.9 million and $3.2 million
as of December 31, 2004 and 2003, respectively, expire at various dates through 2024. Capital loss
carryforwards totaling $227.4 million and $221.8 million as of December 31, 2004 and 2003, respectively, begin to expire in
2006. In 1995, MRV, through a subsidiary in Israel, qualified for a program under which it is
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. Due to operating losses at this
subsidiary, no tax benefit was received for any of the years ended December 31, 2004, 2003 and
2002. MRV has not recorded U.S. income tax expense for foreign earnings that it has declared as
indefinitely reinvested offshore, thus reducing its overall income tax expense. At December 31,
2004, MRV had approximately $17 million of accumulated but undistributed earnings at certain
foreign entities. The amount of earnings designated as indefinitely reinvested offshore is based
upon MRVs expectations of the future cash needs of its foreign entities. Income tax considerations
are also a factor in determining the amount of foreign earnings to be repatriated. In the event actual cash needs of MRVs U.S. entities exceeds its current expectations or the
actual cash needs of its foreign entities are less than expected, MRV may need to repatriate
foreign earnings which have been designated as indefinitely reinvested offshore. This would result
in additional income tax expense being recorded. American Jobs Creation Act of 2004Repatriation of Foreign Earnings In December 2004, the FASB issued FASB Staff Position No. FAS 109-2 (FAS 109-2), Accounting
and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs
Creations Act of 2004 (AJCA). The AJCA introduces a limited time 85% dividends received
deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation
provision), provided certain criteria are met. FAS 109-2 provides accounting and disclosure
guidance for the repatriation provision. Although FAS 109-2 is effective immediately, MRV does not
expect to be able to complete its evaluation of the repatriation provision until after Congress or
the Treasury Department provides additional clarifying language on key elements of the provision.
In January 2005, the Treasury Department began to issue the first of a series of clarifying
guidance documents related to this provision. MRV expects to complete its evaluation of the effects
of the repatriation provision within the second and third quarters of 2005.  8.
    Short-Term and Long-Term Obligations Short-term obligations consist of secured and unsecured lines of credit, short-term loans and
notes entered into with certain financial institutions. As of December 31, 2004 and 2003, these
short-term obligations totaled $25.2 million and $20.6 million, respectively. Certain assets of
MRVs subsidiaries including customer accounts receivables have been pledged as collateral on these
borrowings. The weighted average interest rate on these obligations was approximately 4% and 5% as
of December 31, 2004 and 2003, respectively. These obligations are incurred and settled in the
local currencies of the respective subsidiaries. Long-term debt consisted of secured notes payable to financial institutions bearing interest
at rates ranging from 4.7% to 9.4%. Principal and interest is payable in monthly and quarterly
installments through December 2005. As of December 31, 2004 and 2003, long-term debt totaled
$204,000 and $404,000, respectively. As of December 31, 2004, $92,000 of long-term debt is due
during 2005 with the remaining balance of $112,000 due in 2006.  9.
    Interest Rate Swap MRV entered into an interest rate swap (the Swap) in the second quarter of 2000 to
effectively change the interest rate characteristics of its $50.0 million variable-rate term loan
presented in Long-Term Debt, with the objective of fixing its overall borrowing costs. The Swap
was considered to be 100% effective and was therefore recorded using the short-cut method. The
Swap was designated as a cash flow hedge and changes in fair value of the debt were generally
offset by changes in fair value of the related security, resulting in negligible net impact. The
gain or loss from the change in fair value of the Swap as well as the offsetting change in the
hedged fair value of the long-term debt were recognized in other comprehensive loss. In February
2002, MRV paid off the Long-Term Debt of $50.0 million and terminated the Swap. The realized loss
on the Swap of $3.2 million has been recorded as interest expense and is included in other expense,
net in the accompanying Statement of Operations for 2002. 64




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10.
    Convertible Debt In June 2003, MRV completed the sale of $23.0 million principal amount of five-year 5%
convertible notes due in 2008, to an institutional investor, in a private placement. The 2003
Notes bear interest at 5% per annum and are convertible into shares of MRVs common stock at a
conversion price of $2.32 per share. As a condition of the 2003 Notes, MRV may not: (i) incur any
form of unsecured indebtedness in excess of $17.0 million, plus obligations arising from accounts
receivable financing transactions with recourse in the ordinary course of business and consistent
with past practices, (ii) repurchase its common stock for an aggregate amount in excess of $5.0
million, or (iii) declare or pay any dividend on any of its capital stock, other than dividends of
common stock with respect to its common stock. As of
December 31, 2004, MRV was in compliance with the conditions of
the 2003  Notes. MRV is using the net proceeds from the sale of the
2003 Notes for general corporate purposes and working capital. Interest Expense related to these
2003 Notes amounted to $1.2 million and $672,000 for the years ended December 31, 2004 and 2003,
respectively. In June 1998, MRV issued $100.0 million principal amount of its 1998 Notes. During 2003, MRV
retired $5.9 million principal amount of 1998 Notes in exchange for the issuance of 4.2 million
shares of its common stock to the holders of these notes, resulting in a remaining outstanding
balance of $26.0 million at maturity. On June 15, 2003, the balance of MRVs outstanding 1998
Notes matured and MRV repaid and retired them. For 2003, MRV recorded a loss on the extinguishment
of debt totaling $5.4 million, net of associated taxes, in other expense, net in the accompanying
Statement of Operations. This loss was recognized in accordance with Emerging Issues Task Force
Issue 02-15 released in September 2002. During the year ended December 31, 2002, MRV acquired
$53.0 million in principal amount of these notes in exchange for its issuance of 12.3 million
shares of its common stock and $19.7 million in cash to the holders of these notes. During 2002,
MRV recognized a gain of $393,000 in connection with the extinguishment of debt. MRV incurred
$809,000 and $3.2 million in interest expense relating to the 1998 Notes for 2003 and 2002,
respectively.  11.
    Commitments and Contingencies Lease Commitments The Company leases all of its facilities and certain equipment under non-cancelable operating
lease agreements expiring in various years through 2015. The aggregate minimum annual lease
payments under leases in effect as of December 31, 2004 were as follows (in thousands): Year Ending December 31,2005
    
    $
    5,9792006
    
    
    4,4922007
    
    
    3,5432008
    
    
    2,9452009
    
    
    2,732Thereafter
    
    
    8,467Total
    
    $
    28,158
 Annual rental expense under non-cancelable operating lease agreements for the years ended
December 31, 2004, 2003 and 2002, was $6.3 million, $6.0 million and $9.6 million, respectively. 65




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Royalty Commitment Through subsidiaries in Israel, MRV is obligated to the Office of the Chief Scientist of the
Government of Israel (Chief Scientist) with respect to the governments participation in research
and development expenses for certain products. Amounts received by MRV from the participation of
the Chief Scientist were offset against the related research and development expenses incurred.
Accordingly, MRVs royalty to the Chief Scientist is calculated at a rate of 2% to 5% of sales of
such products developed with the participation up to the dollar amount of such participation. MRV
received participation from the Chief Scientist that amounted to $31,000, $287,000 and $746,000 for
the years ended December 31, 2004, 2003 and 2002, respectively. The remaining future obligation as
of December 31, 2004 is approximately $1.4 million which is contingent on generating sufficient
sales of this selected product line. Litigation MRV has received notices from third parties alleging possible infringement of patents with
respect to product features or manufacturing processes. Management believes such notices are
common in the communications industry because of the large number of patents that have been filed
on these subjects. MRVs policy is to discuss these notices with the senders in an effort to
demonstrate that MRVs products and/or processes do not violate any patents. From time to time,
MRV has been involved in such discussions with IBM, Lucent, Ortel, Nortel, Rockwell, the Lemelson
Foundation and Finisar. MRV does not believe that any of its products or processes violates any of
the patents asserted by these parties and MRV further believes that it has meritorious defenses if
any legal action is taken by any of these parties. However, if one or more of these parties was to
assert a claim and gain a conclusion unfavorable to MRV such claims could materially and adversely
affect the business, operating results and financial condition of MRV. MRV has been named as a defendant in lawsuits involving matters that MRV considers routine to
the nature of its business. Management is of the opinion that the ultimate resolution of all such
matters will not have a material adverse effect on the accompanying financial statements.  12.
    Stockholders Equity Authorized Shares On May 10, 2000, the Board of Directors and stockholders of MRV approved an increase in the
authorized number of shares of its $0.0017 par value common stock from 80.0 million to 160.0
million shares relating to the two-for-one stock split distributed on May 26, 2000. MRV is
authorized to issue up to 1.0 million shares of its $0.01 par value preferred stock, of which none
is issued or outstanding as of December 31, 2004 and 2003. In October 2003, MRV issued and sold 1,667,000 shares of its common stock to several
institutional investors, raising net proceeds of approximately $5.0 million. These shares were
taken from its shelf registration statement that was declared effective by the SEC in June 2003,
which registered $20.0 million of its common stock that MRV may issue and sell from time to time. Stock Repurchase Program On June 13, 2002, MRV announced that its Board of Directors had approved a program to
repurchase up to 7.0 million shares of its common stock. Through December 31, 2004, MRV had
repurchased a total of 1.3 million shares of its common stock at a cost of $1.3 million under this
program. MRV did not repurchase any of its common stock during the year ended December 31, 2004.
MRV can repurchase up to 5.7 million additional shares of its common stock under this program. 66




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Stock Options MRV has stock option and warrant plans that provide for granting options and warrants to
purchase shares of MRVs common stock to employees, directors and non-employees performing
consulting or advisory services for MRV. The plans provide for the granting of options, which meet
the Internal Revenue Code requirements for qualification as incentive stock options, as well as
nonstatutory options and are at the discretion of the board of directors. Under these plans,
stocks option and warrant exercise prices generally equal the fair market value of MRVs common
stock at the date of grant. The options and warrants generally vest over three to five years with
expiration dates ranging from six and ten years from the date of grant depending on the plan. The
plans provide for the issuance of 4.8 million shares of common stock over the remaining life of the
plans. Information with respect to MRVs stock option and warrant plans is as follows (in thousands,
except per share data): 2004
    
    
    2003
    
    
    2002Wtd. Avg.
    
    
    
    
    
    
    Wtd. Avg.
    
    
    
    
    
    
    Wtd. Avg.Shares
    
    
    Ex. Price
    
    
    Shares
    
    
    Ex. Price
    
    
    Shares
    
    
    Ex. PriceOutstanding, beginning of
year
    
    
    10,029
    
    
    $
    3.58
    
    
    
    12,626
    
    
    $
    6.90
    
    
    
    12,549
    
    
    $
    9.93Granted
    
    
    2,438
    
    
    $
    3.08
    
    
    
    2,543
    
    
    $
    2.00
    
    
    
    3,116
    
    
    $
    0.90Exercised
    

    
    (381
    )
    
    $
    1.61
    
    
    
    (758
    )
    
    $
    2.31
    
    
    
    (50
    )
    
    $
    2.60Cancelled and forfeited
    
    
    (1,123
    )
    
    $
    7.58
    
    
    
    (4,382
    )
    
    $
    12.44
    
    
    
    (2,989
    )
    
    $
    13.47Outstanding, end of year
    
    
    10,963
    
    
    $
    3.66
    
    
    
    10,029
    
    
    $
    3.58
    
    
    
    12,626
    
    
    $
    6.90Exercisable, end of year
    
    
    5,363
    
    
    $
    4.91
    
    
    
    4,483
    
    
    $
    6.00
    
    
    
    6,811
    
    
    $
    10.76Weighted average fair value
of options granted during
year
    
    
    
    
    
    $
    1.77
    
    
    
    
    
    
    $
    1.58
    
    
    
    
    
    
    $
    0.83
 Information about MRV stock options outstanding at December 31, 2004 is summarized as
follows (in thousands, except per share data and remaining contractual lives): Number
    
    
    
    
    
    
    Wtd. Avg.
    
    
    NumberOutstanding
    
    
    Wtd. Avg.
    
    
    Remaining
    
    
    Exercisable
    
    
    Wtd. Avg.Exercise Prices Per Share
    
    as of 2004
    
    
    Ex. Price
    
    
    Contract Life
    
    
    as of 2004
    
    
    Ex. Price$0.67 - $1.10
    
    
    2,424
    
    
    $
    0.91
    
    
    7.62 Years
    
    
    1,109
    
    
    $
    0.91$1.11 - $2.63
    
    
    2,497
    
    
    $
    1.99
    
    
    5.89 Years
    
    
    1,339
    
    
    $
    2.29$2.66 - $2.99
    
    
    2,273
    
    
    $
    2.83
    
    
    7.45 Years
    
    
    631
    
    
    $
    2.85$3.00 - $3.67
    
    
    2,250
    
    
    $
    3.22
    
    
    7.32 Years
    
    
    988
    
    
    $
    3.07$3.82 - $50.38
    
    
    1,519
    
    
    $
    12.64
    
    
    4.45 Years
    
    
    1,296
    
    
    $
    13.46$0.67 - $50.38
    
    
    10,963
    
    
    $
    3.66
    
    
    6.69 Years
    
    
    5,363
    
    
    $
    4.91
  13.
    Segment Reporting and Geographical Information MRV divides and operates its business based on three segments: the networking group, the
optical components group and development stage enterprise group. The networking group designs,
manufactures and distributes optical networking solutions and Internet infrastructure products.
The optical components group designs, manufactures and distributes optical components and optical
subsystems. The development stage enterprise group develops optical components, subsystems and
networks and products for the infrastructure of the Internet. Segment information is therefore
being provided on this basis. 67




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The accounting policies of the segments are the same as those described in the summary of
significant accounting polices previously described. MRV evaluates segment performance based on
revenues and operating expenses of each segment. As such, there are no separately identifiable
segment assets nor are there any separately identifiable Statement of Operations data below
operating income. Business segment revenues are as follows (in thousands): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Networking group
    
    $
    227,192
    
    
    $
    202,399
    
    
    $
    185,662Optical components group
    
    
    46,431
    
    
    
    38,790
    
    
    
    67,284Development stage enterprise group
    
    
    
    
    
    
    
    
    
    
    273,623
    
    
    
    241,189
    
    
    
    252,946Intersegment adjustment
    
    
    (1,965
    )
    
    
    (2,206
    )
    
    
    (414
    )Total
    
    $
    271,658
    
    
    $
    238,983
    
    
    $
    252,532
 Revenues by product line are as follows (in thousands): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Fiber optic components
    
    $
    48,466
    
    
    $
    39,037
    
    
    $
    68,348Switches and routers
    
    
    72,179
    
    
    
    64,028
    
    
    
    57,571Console management products
    
    
    20,561
    
    
    
    16,626
    
    
    
    17,361Physical layer products
    
    
    67,349
    
    
    
    65,349
    
    
    
    67,258Services
    
    
    24,375
    
    
    
    21,612
    
    
    
    21,444Other networking products
    
    
    38,728
    
    
    
    32,331
    
    
    
    20,550Total
    
    $
    271,658
    
    
    $
    238,983
    
    
    $
    252,532
 For the years ended December 31, 2004, 2003 and 2002, MRV had no single customer that
accounted for 10% or more of revenues. As of December 31, 2004 and 2003, MRV had no single
customer that accounted for 10% or more of accounts receivable. MRV does not track customer
revenue by region for each individual reporting segment. A summary of external revenue by geographical region is as follows (in thousands): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Americas
    
    $
    63,736
    
    
    $
    51,505
    
    
    $
    64,675Europe
    
    
    192,021
    
    
    
    171,957
    
    
    
    157,998Asia Pacific
    
    
    13,172
    
    
    
    14,277
    
    
    
    28,560Other regions
    
    
    2,729
    
    
    
    1,244
    
    
    
    1,299Total
    
    $
    271,658
    
    
    $
    238,983
    
    
    $
    252,532
 68




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A summary of long-lived assets, consisting principally of property and equipment, by
geographical region is as follows (in thousands): At December 31:
    
    2004
    
    
    2003
    
    
    2002Americas
    
    $
    1,955
    
    
    $
    2,966
    
    
    $
    7,295Europe
    
    
    8,136
    
    
    
    8,787
    
    
    
    10,362Asia Pacific
    
    
    8,998
    
    
    
    13,663
    
    
    
    17,512Other regions
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    19,089
    
    
    $
    25,416
    
    
    $
    35,169
 Business segment operating income (loss) is as follows (in thousands): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Networking group
    
    $
    4,746
    
    
    $
    (2,207
    )
    
    $
    (58,764
    )Optical components group
    
    
    (9,840
    )
    
    
    (11,112
    )
    
    
    (62,655
    )Development stage enterprise group
    
    
    (2,094
    )
    
    
    (6,820
    )
    
    
    (24,067
    )(7,188
    )
    
    
    (20,139
    )
    
    
    (145,486
    )Intersegment adjustment
    
    
    
    
    
    
    
    
    
    
    (828
    )Total
    
    $
    (7,188
    )
    
    $
    (20,139
    )
    
    $
    (146,314
    )
 Income (loss) before provision for income taxes is as follows (in thousands): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Domestic
    
    $
    (9,344
    )
    
    $
    (12,917
    )
    
    $
    (143,119
    )Foreign
    
    
    1,700
    
    
    
    (11,710
    )
    
    
    (323,245
    )Total
    
    $
    (7,644
    )
    
    $
    24,627
    
    
    $
    (466,364
    )
 14. 401(K) Plans MRV has 401(K) savings plans (the Plans) at certain subsidiaries under which all eligible
employees may participate. The Plans provide for MRV to make matching contributions to all
eligible employees. For the years ended December 31, 2004, 2003 and 2002, approximately $575,000,
$627,000 and $568,000, respectively, was charged as expense related to these plans. 69




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15.
    Supplemental Statements of Cash Flow Information Supplemental Statements of Cash Flow information for each of the years ended December 31,
2004, 2003 and 2002 is as follows (in thousands): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Supplemental disclosure of cash flow information:Cash paid during year for interest
    
    $
    2,736
    
    
    $
    2,464
    
    
    $
    2,168Cash paid during year for income taxes
    
    $
    3,380
    
    
    $
    3,098
    
    
    $
    2,724Supplemental schedule of non-cash investing and
financing activities:Common stock issued in connection with
investments in subsidiaries
    
    $
    
    
    
    $
    
    
    
    $
    7,052Common stock issued in connection with
exchange of 1998 Notes
    
    $
    
    
    
    $
    6,014
    
    
    $
    31,647Non-cash deferred stock expense
    
    $
    
    
    
    $
    1,369
    
    
    $
    2,990Non-cash consideration received in sale
of FOCI and QOI
    
    $
    
    
    
    $
    
    
    
    $
    2,000
  16.
    Other Income (Expense), Net Other income (expense), net consisted of the following (in thousands): For the year ended December 31:
    
    2004
    
    
    2003
    
    
    2002Interest income
    
    $
    1,084
    
    
    $
    1,079
    
    
    $
    3,071Gain on sale of investment
    
    
    2,000
    
    
    
    
    
    
    
    Loss on disposition of assets
    
    
    (235
    )
    
    
    (306
    )
    
    
    (243
    )Loss on early extinguishment of debt
    
    
    
    
    
    
    (5,438
    )
    
    
    (1,363
    )Share of losses on equity method investments
    
    
    
    
    
    
    
    
    
    
    (4,283
    )Impairment loss on cost and equity method
investments
    
    
    
    
    
    
    
    
    
    
    (11,741
    )Loss on termination of interest rate swap
    
    
    
    
    
    
    
    
    
    
    (3,198
    )Other, net
    
    
    (164
    )
    
    
    1,397
    
    
    
    72Total
    
    $
    2,685
    
    
    $
    (3,268
    )
    
    $
    (17,685
    )
 70




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17.
    Quarterly Financial Data (Unaudited) Mar. 31,
    
    
    June 30,
    
    
    Sept. 30,
    
    
    Dec. 31,For the three months ended:
    
    2004
    
    
    2004
    
    
    2004
    
    
    2004Revenue
    
    $
    59,614
    
    
    $
    67,231
    
    
    $
    62,941
    
    
    $
    81,872Cost of goods sold
    
    
    39,189
    
    
    
    43,669
    
    
    
    42,807
    
    
    
    54,115Gross profit
    
    
    20,425
    
    
    
    23,562
    
    
    
    20,134
    
    
    
    27,757Operating costs and expenses:Product development and engineering
    
    
    6,338
    
    
    
    5,805
    
    
    
    6,373
    
    
    
    6,433Selling, general and administrative
    
    
    18,150
    
    
    
    18,676
    
    
    
    16,855
    
    
    
    20,436Total operating costs and expenses
    
    
    24,488
    
    
    
    24,481
    
    
    
    23,228
    
    
    
    26,869Operating income (loss)
    
    
    (4,063
    )
    
    
    (919
    )
    
    
    (3,094
    )
    
    
    888Interest Expense
    
    
    (593
    )
    
    
    (707
    )
    
    
    (720
    )
    
    
    (1,121
    )Other income (expense), net
    
    
    418
    
    
    
    (333
    )
    
    
    801
    
    
    
    1,799Income (loss) before taxes
    
    
    (4,238
    )
    
    
    (1,959
    )
    
    
    (3,013
    )
    
    
    1,566Provision for taxes
    
    
    539
    
    
    
    1,110
    
    
    
    739
    
    
    
    648Net income (loss)
    
    $
    (4,777
    )
    
    $
    (3,069
    )
    
    $
    (3,752
    )
    
    $
    918Earnings per share:Basic
    
    $
    (0.05
    )
    
    $
    (0.03
    )
    
    $
    (0.04
    )
    
    $
    0.01Diluted
    
    $
    (0.05
    )
    
    $
    (0.03
    )
    
    $
    (0.04
    )
    
    $
    0.01Weighted average number of shares:Basic
    
    
    105,504
    
    
    
    105,596
    
    
    
    104,114
    
    
    
    103,973Diluted
    
    
    105,504
    
    
    
    105,596
    
    
    
    104,114
    
    
    
    107,582Mar. 31,
    
    
    June 30,
    
    
    Sept. 30,
    
    
    Dec. 31,For the three months ended:
    
    2003
    
    
    2003
    
    
    2003
    
    
    2003Revenue
    
    $
    51,117
    
    
    $
    61,958
    
    
    $
    56,817
    
    
    $
    69,091Cost of goods sold
    
    
    36,514
    
    
    
    42,133
    
    
    
    38,397
    
    
    
    47,849Gross profit
    
    
    14,603
    
    
    
    19,825
    
    
    
    18,420
    
    
    
    21,242Operating costs and expenses:Product development and engineering
    
    
    8,736
    
    
    
    6,890
    
    
    
    8,088
    
    
    
    7,258Selling, general and administrative
    
    
    11,918
    
    
    
    16,698
    
    
    
    16,841
    
    
    
    17,444Impairment of goodwill and other intangibles
    
    
    
    
    
    
    
    
    
    
    356
    
    
    
    Total operating costs and expenses
    
    
    20,654
    
    
    
    23,588
    
    
    
    25,285
    
    
    
    24,702Operating loss
    
    
    (6,051
    )
    
    
    (3,763
    )
    
    
    (6,865
    )
    
    
    (3,460
    )Interest expense
    
    
    (873
    )
    
    
    (855
    )
    
    
    (586
    )
    
    
    (856
    )Other income (expense), net
    
    
    952
    
    
    
    (4,656
    )
    
    
    9
    
    
    
    427Loss before taxes and extraordinary gain
    
    
    (5,972
    )
    
    
    (9,274
    )
    
    
    (7,442
    )
    
    
    (3,889
    )Provision for taxes
    
    
    428
    
    
    
    493
    
    
    
    412
    
    
    
    1,028Loss before extraordinary gain
    
    
    (6,400
    )
    
    
    (9,767
    )
    
    
    (7,854
    )
    
    
    (4,917
    )Extraordinary gain, net of tax
    
    
    
    
    
    
    
    
    
    
    1,950
    
    
    
    Net loss
    
    $
    (6,400
    )
    
    $
    (9,767
    )
    
    $
    (5,904
    )
    
    $
    (4,917
    )Loss before extraordinary gain
    
    $
    (0.06
    )
    
    $
    (0.10
    )
    
    $
    (0.08
    )
    
    $
    (0.05
    )Extraordinary gain, net of tax
    
    $
    
    
    
    $
    
    
    
    $
    0.02
    
    
    $
    Basic and diluted net loss per share
    
    $
    (0.06
    )
    
    $
    (0.10
    )
    
    $
    (0.06
    )
    
    $
    (0.05
    )Basic and diluted weighted average
shares outstanding
    
    
    98,930
    
    
    
    101,383
    
    
    
    103,097
    
    
    
    104,747
 71




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##### Table of Contents



ITEM 9. CHANGES IN OR DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 
 ITEM 9A. CONTROLS AND PROCEDURES Evaluation Of Disclosure Controls And Procedures We maintain disclosure controls and procedures that are designed to ensure that information
required to be disclosed in our Exchange Act reports is recorded, processed, summarized and
reported within the timelines specified in the Securities and Exchange Commissions rules and
forms, and that such information is accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well designed and operated,
can only provide reasonable assurance of achieving the desired control objectives, and in reaching
a reasonable level of assurance, management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures. As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the
supervision and with the participation of the Companys management, including the Companys Chief
Executive Officer and the Companys Chief Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and procedures as of the end of the year covered by
this Report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective at the reasonable assurance
level. Managements Report on Internal Control Over Financial Reporting Internal control over financial reporting refers to the process designed by, or under the
supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board
of Directors, management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in the United States, and
includes those policies and procedures that:  -
    Pertain to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of our assets:-
    Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with accounting principles
generally accepted in the United States, and that our receipts and expenditures are
being made only in accordance with authorization of our management and directors; and-
    Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have a material
effect on the financial statements. 72




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Internal control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal control over
financial reporting is a process that involves human diligence and compliance and is subject to
lapses in judgment and breakdowns resulting from human failures. Internal control over financial
reporting also can be circumvented by collusion or improper management override. Because of such
limitations, there is a risk that material misstatements may not be prevented or detected on a
timely basis by internal control over financial reporting. However, these inherent limitations are
known features of the financial reporting process. Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, this risk. Management is responsible for
establishing and maintaining adequate internal control over financial reporting for the Company. Management has used the framework set forth in the report entitled Internal Control 
Integrated Frameworkpublished by the Committee of Sponsoring Organizations of the Treadway
Commission, known as COSO, to evaluate the effectiveness of the Companys internal control over
financial reporting. Management has concluded that our internal control over financial reporting
was effective as of December 31, 2004. Ernst & Young LLP, our independent registered public
accounting firm, has issued an attestation report on managements assessment of our internal
control over financial reporting, which is included below. Changes in Internal Control Over Financial Reporting There has been no change in our internal controls over financial reporting during our most
recent fiscal quarter that has materially affected, or is reasonably likely to materially affect,
our internal controls over financial reporting. Report of Independent Registered Public Accounting Firm on Internal Control Over Financial
Reporting The Board of Directors and Stockholders of MRV Communications, Inc. We have audited managements assessment, included in the accompanying Managements Report on
Internal Control Over Financial Reporting, that MRV Communications, Inc. maintained effective
internal control over financial reporting as of December 31, 2004 based on criteria established in
Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). MRV Communications, Inc.s management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the effectiveness of the companys internal
control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion. 73




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A companys internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting
principles. A companys internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys assets that could have
a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that MRV Communications, Inc. maintained effective
internal control over financial reporting as of December 31, 2004, is fairly stated, in all
material respects, based on the COSO criteria. Also, in our opinion, MRV Communications, Inc.
maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2004, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of
MRV Communications, Inc. (and
subsidiaries) as of December 31, 2004 and 2003, and the related consolidated statements of
operations, stockholders equity and comprehensive income (loss), and cash flows for each of the
three years in the period ended December 31, 2004 of MRV Communications, Inc. and our report dated
February 25, 2005 expressed an unqualified opinion thereon. /s/ ERNST & YOUNG LLP Woodland Hills, California
February 25, 2005 
 ITEM 9B. OTHER INFORMATION Not applicable. 74




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PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers and directors of the Registrant at February 15, 2005 are as follows: Name
    
    Age
    
    PositionNoam Lotan
    
    
    53
    
    
    President, Chief Executive Officer and DirectorShlomo Margalit
    
    
    63
    
    
    Chairman, Chief Technical Officer and SecretaryShay Gonen
    
    
    39
    
    
    Chief Financial OfficerNear Margalit
    
    
    32
    
    
    Chief Executive Officer, LuminentOIC, Inc.Igal Shidlovsky
    
    
    68
    
    
    DirectorGuenter Jaensch
    
    
    66
    
    
    DirectorProfessor Daniel Tsui
    
    
    65
    
    
    DirectorProfessor
Baruch
    
    
    54
    
    
    DirectorFischer
 Noam Lotanhas 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 Margalita 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. Shay Gonenbecame Chief Financial Officer in September 2001. Since September 1996, Mr. Gonen
has served in various executive capacities for certain MRV subsidiaries, including as the Vice
President of Finance, Chief Financial Officer and Secretary of Optical Access, Inc. from September
2000; as General Manager of European Activity for Fiber Driver from January 1999 to September 2000;
as Chief Operating Officer of Fiber Driver Communications from September 1996 to December 1998.
Mr. Gonen served as Vice President of Operations and Finance for Silver Arrow, L.P. from April 1994
to September 1996. Mr. Gonen holds a B.S. degree in industrial engineering from the Technion, and
an M.B.A. degree from Bar-Ilan University in Tel Aviv. 75




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Near Margalit, Ph.D. re-joined MRV in May 2002 as Vice President of Marketing and
Business Development. From 1998 until re-joining MRV, Dr. Margalit was founder, Chairman and Chief
Technology Officer for Zaffire, Inc., a DWDM Metro Platform company, which was acquired by
Centerpoint in October 2001. At Zaffire, Dr. Margalit was responsible for product vision and
architecture of integrating DWDM and SONET technology. Prior to founding Zaffire, Dr. Margalit was
employed by MRV, both in the optical component and networking divisions. Dr. Margalit holds a B.S.
in applied physics from Caltech and a Ph.D. in optoelectronics from the University of California,
Santa Barbara. In February 2003, Dr. Margalit was appointed Chief Executive Officer of
LuminentOIC, Inc. Dr. Igal Shidlovskybecame 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. 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 Jaenschbecame a Director of the Company in December 1997. Dr. Jaensch serves as
President of Jaensch Enterprises, a firm engaged in management and project consulting, and serves
as Chairman of the Board for Biophan Technologies, Inc. For over 20 years, he held executive
positions with Siemens or its subsidiaries in Europe and the United States. Among his assignments
were service as President of Siemens Communications Systems, Inc.; President and Chairman of
Siemens Corporate Research and Support, Inc.; Chairman and Chief Executive Officer at Siemens
Pacesetter, Inc.; and head of the Cardiac Arrhythmia Division of Siemens AG Medical Group. Dr.
Jaensch holds a Masters degree in Business Administration and Ph.D. degree in Business and Finance
from the University of Frankfurt; he also taught business at the University of Frankfurt. Professor Daniel Tsuiis the Arthur Le Grand Doty Professor of Electrical Engineering at
Princeton University and was awarded the 1998 Nobel Prize in Physics for the discovery and
explanation of the fractional quantum Hall effect. Professor Tsui was a recipient of the American
Physical Society 1984 Buckley Prize, the 1998 Benjamin Franklin Medal and was elected to the
National Academy of Sciences. He is a fellow of the American Physical Society and the American
Association for the Advancement of Science. He is currently engaged in research activity relating
to properties of thin films and microstructures of semiconductors and solid-state physics. He
received his Ph.D. in physics from the University of Chicago in 1967 and for 13 years was with Bell
Laboratories before joining Princeton University, where he has been for more than 20 years. Professor Baruch Fischercurrently serves as a professor at the Electrical Engineering Faculty
at the Technion. Professor Fischer had served as Dean of the Electrical Engineering Faculty at the
Technion. Professor Fischers current Research Activities include solid state devices, lasers and
optical amplifiers; WDM technology; fiber gratings; all optical networks; non-linear effect in
fiber, wave mixing; and optical computing, optical data storage and optical image processing. He
has authored or co-authored approximately 180 papers and holds several patents in the field of
optics and opto-electronics. He received his Ph.D. from Bar-Ilan University, Israel in 1980. He
subsequently became a Post-Doctorate Fellow at CalTech and joined the faculty of the Technion in
1983. Each director is elected for a period of one year at MRV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. Except for Dr. Near Margalit, who is the son of Dr. Shlomo
Margalit, none of the Directors or executive officers of MRV are related by blood, marriage or
adoption to any of MRVs Directors or executive officers. 76




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Compliance withSection 16(a)of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934 requires our directors and executive
officers and persons who own more than 10% of a registered class of our equity securities, to file
with the 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
stockholders are required by the SEC regulations to furnish us with copies of all Section 16(a)
forms they file. We believe, 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
stockholders was duly and timely filed for the year ended December 31, 2004, except that, (a)
Daniel C. Tsui, a director of MRV, inadvertently failed to report his acquisition of 215 shares of
MRV common stock in connection with the short form merger of Luminent, Inc. in exchange for the
cancellation of 500 shares of Luminent, Inc. having a market value of $1.85 per share, on December
28, 2001, which transaction should have been reported on Professor Tsuis Form 5 filed February 14,
2002, and (b) Noam Lotan, a director and the President and Chief Executive Officer of MRV, due to a
clerical error, incorrectly reported his beneficial ownership of MRV shares of MRV Common Stock in
various Form 4s and Form 5s filed since at least 2000. Professor Tsui reported the transaction in
an amendment to his Form 5 filed on February 7, 2005 and Mr. Lotan corrected the error in the
number of MRV shares he beneficially owns in an amendment to his Form 5 filed on February 14, 2005. Code of Business Conduct and Corporate Governance We have adopted a Code of Business Conduct and Corporate Governance that applies to all of our
directors, officers and employees. In compliance with the applicable rules of the SEC, special
ethics obligations of our Chief Executive Officer, Chief Financial Officer, Controller and other
employees who perform financial or accounting functions are set forth in the section of our Code of
Business Conduct and Corporate Governance, entitled Special Ethics Obligations of Employees with
Financial Reporting Responsibilities. The Code is available through our web site at www.mrv.com.
Printed copies are available free of charge and may be requested by contacting our Investor
Relations Department either by mail at our corporate headquarters, by telephone at (818) 886-6782
or by e-mail at if@mrv.com. We intend to satisfy the disclosure requirements under the Securities Exchange Act of 1934, as
amended, regarding an amendment to, or a waiver from, our Code of Business Conduct and Corporate
Governance by posting such information on our web site at www.mrv.com. Audit Committee Financial Expert Our Board of Directors has determined that at least one person serving on the Audit Committee
is an audit committee financial expert as defined under Item 401(h) of Regulation S-K and Rule
4200(a)(15) of the Nasdaq Marketplace Rules. Dr. Guenter Jaensch, the Chairman of the Audit
Committee, is an audit committee financial expert and is independent as defined under Item
7(d)(3)(iv) of Schedule 14A of the Exchange Act. 77




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ITEM 11. EXECUTIVE COMPENSATION The following table shows information regarding the total compensation paid to the Chief
Executive Officer and each of its other executive officers whose total annual compensation exceeds
$100,000 (collectively, the Named Executive Officer) for services rendered to MRV in all
capacities during each of the past three fiscal years. S U M M A R Y   C O M P
E N S A T I O N   T A B L E Long-termCompensationSecuritiesUnderlying 
    
    
    All OtherYear
    
    
    Salary
    
    
    Bonus
    
    
    Options (#)
    
    
    Compensation(1)Noam Lotan
    
    
    2004
    
    
    $
    150,000
    
    
    $
    
    
    
    
    25,000
    
    
    $
    4,394President and Chief Executive
    
    
    2003
    
    
    $
    150,000
    
    
    $
    
    
    
    
    20,000
    
    
    $
    4,462Officer
    
    
    2002
    
    
    $
    150,000
    
    
    $
    
    
    
    
    112,000
    
    
    $
    1,500Shlomo Margalit
    
    
    2004
    
    
    $
    110,000
    
    
    $
    
    
    
    
    
    
    
    $
    3,240Chairman, Chief Technical Officer
    
    
    2003
    
    
    $
    110,000
    
    
    $
    
    
    
    
    
    
    
    $
    3,300and Secretary
    
    
    2002
    
    
    $
    110,000
    
    
    $
    
    
    
    
    
    
    
    $
    1,100Shay Gonen
    
    
    2004
    
    
    $
    155,000
    
    
    $
    24,836
    
    
    
    75,000
    
    
    $
    5,250Chief Financial Officer
    
    
    2003
    
    
    $
    155,000
    
    
    $
    25,000
    
    
    
    50,000
    
    
    $
    5,4002002
    
    
    $
    146,346
    
    
    $
    18,000
    
    
    
    64,500
    
    
    $
    1,021Near Margalit
    
    
    2004
    
    
    $
    160,000
    
    
    $
    
    
    
    
    36,000
    
    
    $
    4,800Chief Executive Officer,
    
    
    2003
    
    
    $
    160,000
    
    
    $
    
    
    
    
    20,000
    
    
    $
    4,800LuminentOIC, Inc.
    
    
    2002
    
    
    $
    113,847
    
    
    $
    15,000
    
    
    
    190,000
    
    
    $
    369
   (1)
    
    All other Compensation includes
Company contributions to its 401(K) savings plan on behalf of the
Named Executive Officer. 78




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##### Table of Contents



Option Grants in Last Fiscal Year The following table sets forth information with respect to option grants to the Named
Executive Officers during 2004:  -
    the number of shares of MRV common stock underlying options granted during the year;-
    the percentage that such options represent of all options granted to employees during the year;-
    the exercise price (which in each case was equal to the fair market value of
the stock on the date of grant);-
    the expiration date; and-
    the hypothetical present value, as of the grant date, of the options under the
option pricing model discussed below. The hypothetical present value of the options as of their date of grant has been calculated
using the Black-Scholes option pricing model, as permitted by SEC rules, based upon a set of
assumptions set forth in footnote (2) to the table. It should be noted that this model is only one
method of valuing options, and the Companys use of the model should not be interpreted as an
endorsement of its accuracy. The actual value of the options may be significantly different, and
the value actually realized, if any, will depend upon the excess of the market value of the common
stock over the option exercise price at the time of exercise. O P T I O N   G R A N T S   D U R I N G   F I S C A L   2 0 0 4 Potential RealizableNumber of
    
    
    Percentage
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Value at AssumedSecurities
    
    
    of Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Annual Rate of StockUnderlying
    
    
    Options
    
    
    Exercise
    
    
    
    
    
    
    Hypothetical
    
    
    Appreciation for OptionOptions
    
    
    Granted to
    
    
    Price
    
    
    Expiration
    
    
    Value at
    
    
    TermGranted
    
    
    Employees in 2004
    
    
    ($/sh)
    
    
    Date
    
    
    Grant Date (2)
    
    
    5% (1)
    
    
    10% (1)Noam Lotan
    
    
    25,000
    
    
    
    1.0
    %
    
    $
    2.80
    
    
    
    3/22/2014
    
    
    $
    43,703
    
    
    $
    38,593
    
    
    $
    95,056Shlomo Margalit
    
    
    
    
    
    
    
    
    
    $
    
    
    
    
    N/A
    
    
    
    N/A
    
    
    $
    
    
    
    $
    Shay Gonen
    
    
    20,000
    
    
    
    0.8
    %
    
    $
    2.80
    
    
    
    3/22/2014
    
    
    $
    34,962
    
    
    $
    30,874
    
    
    $
    76,04535,000
    
    
    
    1.4
    %
    
    $
    2.18
    
    
    
    5/17/2014
    
    
    $
    46,589
    
    
    $
    42,066
    
    
    $
    103,61120,000
    
    
    
    0.8
    %
    
    $
    2.22
    
    
    
    8/31/2014
    
    

    $
    24,954
    
    
    $
    24,479
    
    
    $
    60,293Near Margalit
    
    
    18,000
    
    
    
    0.7
    %
    
    $
    2.80
    
    
    
    3/22/2014
    
    
    $
    31,466
    
    
    $
    27,787
    
    
    $
    68,44118,000
    
    
    
    0.7
    %
    
    $
    2.22
    
    
    
    8/31/2014
    
    
    $
    22,459
    
    
    $
    22,031
    
    
    $
    54,264
   (1)
    The dollar amounts under these columns are the result of calculations assuming the
price of MRVs common stock on the date of the grant of the option increases at the
hypothetical 5% and 10% rates set by the SEC 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)
    The hypothetical present value at grant date of options granted during 2004 has
been calculated using the Black-Scholes option pricing model, based upon the following
assumptions: estimated time until exercise is four years; risk free interest rates
ranging from 2.69% to 3.83%; volatility ranging from 69% to 85%; and a dividend yield
of 0%. The approach used in developing the assumptions upon which the Black-Scholes
valuations were calculated is consistent with the requirements of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. The
options generally vest over four equal installments beginning on the first anniversary
of the date of grant. 79




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##### Table of Contents



Option Exercises and Values for Fiscal 2004 The table below sets forth the following information with respect to option exercises during
fiscal 2004 by each of the Named Executive Officers and the status of their options at December 31,
2004:  -
    the number of shares of MRV common stock acquired upon exercise of options during 2004;-
    the aggregate dollar value realized upon the exercise of those options;-
    the total number of exercisable and non-exercisable stock options held at
December 31, 2004; and-
    the aggregate dollar value of in-the-money exercisable and non-exercisable
options at December 31, 2004. A G G R E G A T E D
  O P T I O N   E X E R C I S E S   D U R I N G   2 0 0 4
A N D
O P T I O N   V A L U E S   O N   D E C E M B E R   3 1,   2 0 0 4 Number of Shares Underlying
    
    
    Value of Unexercised In-The-Number of Shares
    
    
    
    
    
    Unexercised Options at
    
    
    Money Options atAcquired Upon
    
    
    Value Realized Upon
    
    
    December 31, 2004
    
    
    December 31, 2004 (1)Exercise of Options

    
    
    Exercise

    
    
    Exercisable
    
    
    Unexercisable
    
    
    Exercisable
    
    
    UnexercisableNoam Lotan
    
    $
    
    
    
    $
    
    
    
    
    185,200
    
    
    
    69,800
    
    
    $
    64,240
    
    
    $
    341,670Shlomo Margalit
    
    $
    
    
    
    $
    
    
    
    
    
    
    
    
    
    
    
    $
    
    
    
    $
    Shay Gonen
    
    $
    
    
    
    $
    
    
    
    
    139,750
    
    
    
    149,750
    
    
    $
    212,080
    
    
    $
    224,480Near Margalit
    
    $
    
    
    
    $
    
    
    
    
    100,000
    
    
    
    146,000
    
    
    $
    245,750
    
    
    $
    290,710
   (1)
    
    Based on the difference between the closing price of MRV common stock on December
31, 2004 and the exercise price. Employment Agreements In March 1992, MRV entered into three-year employment agreements with Mr. Lotan and Dr.
Margalit. 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 MRV and Dr. Margalit serves as Chairman of the Board of
Directors, Chief Technical Officer and Secretary. For 2005, Mr. Lotan and Dr. Margalit receive
base annual salaries of $200,000 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. Each officer also receives employee benefits, such as vacation, sick pay and insurance, in
accordance with MRVs policies, which are applicable to all employees. MRV 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
Dr. Margalit and Mr. Lotan. All benefits under these policies will be payable to MRV upon the
death of an insured. 80




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##### Table of Contents



Compensation of Outside Directors Outside directors, i.e., directors who are not employees of MRV, receive cash compensation of
$1,500 per month and $1,000 for each board of directors meeting and committee meeting attended,
while serving as Directors. In March 2004, MRV granted to each outside director options to
purchase 8,000 shares of its common stock at $2.80 per share. In July 2004, MRV granted to each
outside director options to purchase 22,000 shares of its common stock at $3.02 per share. In
December 2004, MRV granted to each audit committee member, Dr. Jaensch, Dr. Shidlovsky and
Professor Tsui, options to purchase 10,000 shares of its common stock at $3.67 per share. Board Committees The system of governance practices followed by the Company is memorialized in the MRV
Communications, Inc. Corporate Governance Guidelines and the charters of the four committees of the
Board of Directors. The Governance Guidelines and charters are intended to assure that the Board
will have the necessary authority and practices in place to review and evaluate the Companys
business operations and to make decisions that are independent of the Companys management. The
Governance Guidelines also are intended to align the interests of directors and management with
those of MRVs stockholders. The Governance Guidelines establish the practices the Board will
follow with respect to board composition and selection, board meetings and involvement of senior
management, Chief Executive Officers performance evaluation, board committees, and director
compensation. The Board annually conducts a self-evaluation to assess compliance with the
Governance Guidelines and identify opportunities to improve Board performance. The Governance Guidelines and committee charters are reviewed periodically and updated as
necessary to reflect changes in regulatory requirements and evolving oversight practices. The
Governance Guidelines were most recently modified by the Board effective September 24, 2004 to,
among other things, assure compliance with corporate governance requirements contained in both the
Nasdaq Stock Market (Nasdaq) and make other enhancements to the Companys corporate governance
policies, including creating the role of lead independent director. The chair of the Nomination
and Governance Committee currently serves as the lead independent director. The lead independent
director is responsible for coordinating the activities of the non-management directors, coordinate
with the Chairman to set the agenda for Board meetings, chairing meetings of the non-management
directors, and leading the Boards review of the Chief Executive Officer. The Board has four
committees: an Audit Committee, a Compensation Committee, a Nomination and Governance Committee and
an Executive Committee. The Governance Guidelines, as well as the Charter for the Audit Committee,
the Compensation Committee and the Nomination and Governance Committee may be viewed at
www.mrv.com/investor. The Board of Directors, and the Audit Committee, the Compensation Committee and the Nomination
and Governance Committee, hold regularly scheduled quarterly meetings. In addition to the
quarterly meetings, there may be special meetings from time to time as the Board or its committees
deem necessary. At each quarterly board meeting, time is set aside for the non-management
directors to meet without management present. The Board of Directors met four times during the last
fiscal year. All directors attended 75% or more of the Board meetings and meetings of the
committees on which they served during 2004. 81




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##### Table of Contents



The table below provides current membership and information for each of the Board committees
for the current year. Committee memberships changed during 2004. In September 2004, the Board of
Directors established the Nomination and Governance Committee. Dr. Shidlovsky, Dr. Jaensch and
Professor Tsui were appointed to the Nomination and Governance Committee. In October 2004,
Professors Tsui and Fischer were appointed to the Compensation Committee, joining Dr. Shidlovsky
and Dr. Jaensch on that committee. C O M M I T T E E S Nomination andName
    
    Audit
    
    Compensation
    
    Governance
    
    ExecutiveMr. Lotan
    
    
    
    
    
    
    
    XDr. Margalit
    
    
    
    
    
    
    
    XDr. Shidlovsky
    
    X
    
    X*
    
    X*Dr. Jaensch
    
    X*
    
    X
    
    XProfessor Tsui
    
    X
    
    X
    
    XProfessor Fischer
    
    
    
    X
   *
    Committee Chairperson   Audit Committee: The Audit Committee assists the Board of Directors in its oversight of the
quality and integrity of the accounting, auditing, and reporting practices of the Company. The
Audit Committees role includes overseeing the work of the Companys internal accounting and
auditing processes and discussing with management the Companys processes to manage business and
financial risk, and for compliance with significant applicable legal, ethical, and regulatory
requirements. The Audit Committee is responsible for the appointment, compensation, retention, and
oversight of the independent auditor engaged to prepare or issue audit reports on the financial
statements of the Company. The Audit Committee relies on the expertise and knowledge of management
and the independent auditor in carrying out its oversight responsibilities. The Committees
specific responsibilities are delineated in the Audit Committee Charter, which may be viewed at
www.mrv.com/investor. The Board of Directors has determined that each Audit Committee member has
sufficient knowledge in financial and auditing matters to serve on the Committee. In addition, the
Board has determined that Dr. Guenter Jaensch is an audit committee financial expert as defined
by Item 401(h) of Regulation S-K of Securities and Exchange Commission (SEC) regulations and that
he is independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Securities
Exchange Act of 1934. 82




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Compensation Committee: The Directors who served and currently serve on the Compensation
Committee are all independent for purposes of the rules of the Nasdaq Stock Market. The primary
responsibilities of the Compensation Committee are: (a) In consultation with senior management, to
make recommendations to the Board as to the Companys general compensation philosophy and to
oversee the development and implementation of compensation programs; (b) To evaluate the
performance of the CEO in light of Board-approved goals and objectives, and to recommend to the
Board the CEOs compensation level based on this evaluation; (c) To make recommendations to the
board regarding the compensation (including any new compensation programs) of the other executive
officers, following its review of performance evaluations of the other executive officers; and (d)
to review and make recommendations to the Board with respect to the Companys incentive
compensation plans and equity-based plans. The Compensation Committees role includes producing
the report on executive compensation required by SEC rules and regulations. The specific
responsibilities and functions of the Compensation Committee are delineated in the Compensation
Committee Charter, which may be viewed at www.mrv.com/investor. Nomination and Governance Committee: The principal responsibilities of the Nomination and
Governance Committee are: (a)·To lead the search for qualified individuals for election as
directors to ensure the Board has the right mix of skills and expertise; (b) To retain and
terminate any search firm to be used to identify director candidates, as it may deem appropriate in
its discretion; (c) To solicit the views of the Chief Executive Officer, other members of the
Companys senior management, and other members of the Board regarding the qualifications and
suitability of candidates; (d) To establish policies and procedures for the evaluation of
candidates put forth by the Companys stockholders; (e) To review and recommend to the full Board a
set of corporate governance principles and a code of business conduct and ethics applicable to the
Board and the Company, and, if deemed necessary by the Board, propose from time to time any
amendments to such principles and such code; (f) To oversee and evaluate compliance by the Board
and management of the Company with the Companys corporate governance principles and ethics
standards and its code of conduct. The Nomination and Governance Committees role also includes
periodically reviewing the compensation paid to non-employee directors, and making recommendations
to the Board for any adjustments. In addition, the Chair of the Nomination and Governance
Committee acts as the lead independent director and is responsible for leading the Board of
Directors annual review of the chief executive officers performance. The specific
responsibilities and functions of the Nomination and Governance Committee are delineated in the
Nomination and Governance Committee Charter, which may be viewed at www.mrv.com/investor. Nominees for the Board of Directors should be committed to enhancing long-term stockholder
value and must possess a high level of personal and professional ethics, sound business judgment
and integrity. The Nomination and Governance Committee annually reviews with the Board the
applicable skills and characteristics required of Board nominees in the context of current Board
composition and Company circumstances. In making its recommendations to the Board, the Nomination
and Governance Committee considers, among other things, the qualifications of individual director
candidates. The Nomination and Governance Committee works with the Board to determine the
appropriate characteristics, skills, and experiences for the Board as a whole and its individual
members with the objective of having a Board with business experience, diversity, and personal
skills in technology, finance, marketing, international business, financial reporting and other
areas that are expected to contribute to an effective Board. In evaluating the suitability of
individual Board members, the Board takes into account many factors, including general
understanding of marketing, finance, and other disciplines relevant to the success of a publicly
traded company in todays business environment; understanding of the Companys business and
technology; educational and professional background; and personal accomplishment. The Board
evaluates each individual in the context of the Board as a whole, with the objective of
recommending a group that can best perpetuate the success of the Companys business and represent
stockholder interests through the exercise of sound judgment, using its diversity of experience.
In determining whether to recommend a director for re-election, the Nomination and Governance
Committee also considers the directors past attendance at meetings and participation in and
contributions to the activities of the Board. 83




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##### Table of Contents



Executive Committee: The Executive Committee consists of Mr. Lotan and Dr. Margalit. The
primary responsibility of the Executive Committee is to take any action that the Board is
authorized to act upon, with the exception of the issuance of stock, the sale of all or
substantially all of MRVs assets and other significant corporate transactions. Compensation Committee Interlocks And Insider Participation No member of the Compensation Committee was, during 2004, an officer or employee of MRV or any
of its subsidiaries; or was formerly an officer of MRV or any of its subsidiaries. During 2004, no
executive officer of MRV served as an executive officer, director or member of the compensation
committee (or other board committee performing equivalent functions, or in the absence of such
committee, the entire board of directors) of another entity, one of whose executive officers served
as a member of the Compensation Committee or as a director of MRV. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information known to MRV with respect to beneficial ownership
of MRV common stock as of February 15, 2005 for (i) each current director, (ii) MRVs Chief
Executive Officer and each of the Named Executive Officers and (iii) all executive officers and
directors as a group. The table below indicates the number of shares owned by each person known to
MRV to be the beneficial owner of 5% or more of the outstanding shares of MRVs common stock. Beneficial ownership is determined under the rules of the Securities and Exchange Commission
and generally includes voting or investment power with respect to securities. Except as indicated
in the footnotes to this table and pursuant to applicable community property laws, the persons
named in the table below have sole voting and investment power with respect to all shares of common
stock beneficially owned. The number of shares beneficially owned by each person or group as of
February 15, 2005 includes shares of common stock that such person or group had the right to
acquire on or within 60 days after February 15, 2005, including, but not limited to, upon the
exercise of options. References to options in the footnotes of the table below include only options
to purchase shares that were exercisable on or within 60 days after February 15, 2005. For each
individual and group included in the table below, percentage ownership is calculated by dividing
the number of shares beneficially owned by such person or group by the sum of the 104,135,290
shares of common stock outstanding on February 15, 2005 plus the number of shares of common stock
that such person or group had the right to acquire on or within 60 days after February 15, 2005. Common StockName and Address (1) of Beneficial
    
    Number of
    
    
    
    
    
    
    PercentageOwner or Identity of Group
    
    Shares
    
    
    
    
    
    
    OwnershipDeutsche Bank, AG London Branch31 West 52nd Street, New York, NY 10019
    
    
    9,913,794
    
    
    
    (2
    )
    
    
    8.7
    %Shlomo Margalit
    
    
    3,245,660
    
    
    
    
    
    
    
    3.0
    %Noam Lotan
    
    
    1,527,690
    
    
    
    (3
    )
    
    
    1.4Shay Gonen
    
    
    146,900
    
    
    
    (4
    )
    
    
    *Near Margalit
    
    
    104,500
    
    
    
    (5
    )
    
    
    *Igal Shidlovsky
    
    
    238,150
    
    
    
    (6
    )
    
    
    *Guenter Jaensch
    
    
    139,750
    
    
    
    (5
    )
    
    
    *Professor Daniel Tsui
    
    
    137,465
    
    
    
    (7
    )
    
    
    *Professor Baruch Fischer
    
    
    127,250
    
    
    
    (5
    )
    
    
    *All executive officers and directors as a group
    
    
    5,667,365
    
    
    
    (8
    )
    
    
    5.2
   *
    
    Less than 1%  (1)
    Unless otherwise indicated below, each person has sole voting and investment power
with respect to the shares listed. Unless otherwise indicated in the table above, the
address of each person is c/o MRV Communications, Inc., 20415 Nordhoff Street,
Chatsworth, California 91311. 84




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##### Table of Contents



(2)
    Consists of shares issuable upon conversion of MRVs $23.0 million principle
amount of five-year 5% convertible notes due June 2008 that MRV sold in June 2003. The
notes are convertible at any time prior to maturity into MRVs common stock at a
conversion price of $2.32 per share.(3)
    Includes 79,650 shares issuable pursuant to stock options exercisable within 60
days of February 15, 2005.(4)
    Includes 144,750 shares issuable pursuant to stock options exercisable within
60 days of February 15, 2005.(5)
    Consists of shares issuable pursuant to stock options exercisable within 60
days of February 15, 2005.(6)
    Includes 231,350 shares issuable pursuant to stock options exercisable within
60 days of February 15, 2005.(7)
    Includes 137,250 shares issuable pursuant to stock options exercisable within
60 days of February 15, 2005.(8)
    Includes 964,500 shares issuable pursuant to stock options exercisable within
60 days of February 15, 2005. Equity Compensation Plan Information The table below set forth information with respect to shares of common stock that may be
issued under our stock option and warrant plans as of December 31, 2004. Number of SecuritiesNumber of
    
    
    
    
    
    
    Remaining Available forSecurities to be
    
    
    
    
    
    
    Future Issuance UnderIssued Upon
    
    
    Weighted Average
    
    
    Equity CompensationExercise of
    
    
    Exercise Price of
    
    
    Plans (excludingOutstanding Options
    
    
    Outstanding Options
    
    
    securities reflected inPlan Category
    
    and Warrants
    
    
    and Warrants
    
    
    column (a))(a)
    
    
    
    (b)
    
    
    
    (c)Stock option and
warrant plans
approved by
security holders
(1)
    
    
    2,743,275
    
    
    $
    4.17
    
    
    
    1,066,083Stock option and
warrant plans not
approved by
security holders
(2),(3)
    
    
    8,219,507
    
    
    $
    3.49
    
    
    
    3,758,894Total
    
    
    10,962,782
    
    
    $
    3.66
    
    
    
    4,824,977
   (1)
    
    Includes the:  §
    1992 Stock Option Plan (no securities available for future issuance); and§
    1997 Incentive and Nonstatutory Stock Option Plan.  (2)
    
    Includes the:  §
    Non-Director and Non-Executive Officer Consolidated Long-Term Stock Incentive Plan§
    1998 Nonstatutory Stock Option Plan (no securities available for future issuance);§
    2001 MRV Communications, Inc. Stock Option Plan for Employees of Appointech,
Inc. (no securities available for future issuance);§
    2000 MRV Communications, Inc. Stock Option Plan for Employees of AstroTerra
Corporation (no securities available for future issuance); 85




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##### Table of Contents



§
    MRV Communications, Inc. 2002 International Stock Option Plan (no securities
available for future issuance);§
    Warrants provided to Nathan Shilo as trustee for employees and designated
consultants of NBase Communications, Ltd. exercisable on July 19, 1996, July
13, 1997, July 13, 1998, February 1, 1998, January 2, 1998 and January 4, 1999
(no securities available for future issuance);§
    Italian Employees Warrant Program (no securities available for future
issuance);§
    Stock option issued and outstanding on the effective date of the merger of
LuminentOIC under the LuminentOIC Amended and Restated 2000 Stock Option Plan
that were assumed by MRV and are exercisable for 0.43 shares of Common Stock
for each share of LuminentOIC held under the relevant option (no securities
available for future issuance);§
    MRV Communications, Inc. 2002 Nonstatutory Stock Option Plan for Employees
of LuminentOIC, Inc. (no securities available for future issuance); and§
    2000 MRV Communications, Inc. Stock Option Plan for Employees
of Optronics
International Corp. (no securities available for future issuance).  (3)
    See Note 15, Stockholders Equity  Stock Options to the Financial Statements
included in Item 8  Financial Statements and Supplementary Data. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. 
 PART IV 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Ernst & Young LLP has audited MRVs consolidated financial statements annually since 2002.
The following is a summary of the fees billed to MRV by Ernst & Young LLP and Arthur Andersen LLP
for professional services rendered for the years ended December 31, 2003 and 2002: Fee Category
    
    2004
    
    
    2003Audit Fees
    
    $
    1,638,000
    
    
    $
    628,000Audit-Related Fees
    
    
    9,000
    
    
    
    24,000Tax Fees
    
    
    118,000
    
    
    
    218,000All Other Fees
    
    
    
    
    
    
    Total
    
    $
    1,765,000
    
    
    $
    870,000
 Audit Fees. Consists of fees billed for professional services rendered for the audits of
MRVs consolidated financial statements and internal control over financial reporting and review of
the interim consolidated financial statements included in quarterly reports and services that are
normally provided by Ernst & Young LLP in connection with statutory and regulatory filings or
engagements. Audit-Related Fees. Consists of fees billed for assurance and related services that are
reasonably related to the performance of the audit or review of MRVs consolidated financial
statements and are not reported under Audit Fees. These services include employee benefit plan
audits, consultations in connection with acquisitions, attest services that are not required by
statute or regulation and consultation concerning financial accounting and reporting standards. Tax Fees. Consists of fees billed for professional services for tax compliance, tax advice
and tax planning. These services include assistance regarding federal, state and international tax
compliance, tax audit defense and international tax planning. 86




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All Other Fees. Consists of fees for products and services other than the services reported
above. Policy On Audit Committee Pre-Approval Of Audit And Permissible Non-Audit Services Of Independent
Auditors The Audit Committees policy is to pre-approve all audit and permissible non-audit related
services provided by the independent audits. These services may include audit services,
audit-related services, tax services and other services. Pre-approval is generally provided for up
to one year and any pre-approval is detailed as to the particular service or category of services
and generally subject to a specific budget. The independent auditors and management are required
to periodically report to the Audit Committee regarding the extent of services provided by the
independent auditors in accordance with this pre-approval, and the fees for the services performed
to date. The Audit Committee may also pre-approve particular services on a case-by-case basis. 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) (1) The financial statements and the Report of Ernst & Young LLP are included in Part II
of this Form 10-K on the pages indicated: Form 10-KPage No.Consolidated Financial Statements:Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
    
    
    45Statement of Operations for the years ended December 31, 2004, 2003 and 2002,
    
    
    46Balance Sheets as of December 31, 2004 and 2003
    
    
    47Statements of Stockholders Equity and Comprehensive Income (Loss) for the years endedDecember 31, 2004, 2003 and 2002,
    
    
    49Statement of Cash Flows for the years ended December 31, 2004, 2003 and 2002,
    
    
    49Notes to Financial Statements
    
    
    53
 (2) All schedules are omitted because they are not applicable or the required information
is shown in the financial statements or notes thereto. (3) Exhibits Exhibit No.
    
    Description2.1
    
    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)).2.3
    
    Certificate of Merger Merging LuminentOIC, Inc. into MRV Sub
Corp. (incorporated by reference to Exhibit 4.1 of MRVs 8-K
filed with the SEC on January 8, 2002).3.1
    
    Certificate of Incorporation, as amended (incorporated by
referenced to Exhibit 3a filed as part of Registrants
Registration Statement on Form S-1 (File No. 33-48003)).
 87




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##### Table of Contents



Exhibit No.
    
    Description3.2
    
    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 MRV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 MRV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
(incorporated by reference to Exhibit 3.4 of MRVs Form 10-K
for the year ended December 31, 1998 filed March 31, 1999).3.5
    
    Certificate of Amendment of Certificate of Incorporation filed
with the Delaware Secretary of State on May 11, 2000
(incorporated by reference to Exhibit 3.5 of MRVs Form 10-K
for the year ended December 31, 2000 filed April 17, 2001).3.6
    
    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).10.1
    
    Key Employee Agreement between MRV 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)).10.2
    
    Letter amending Key Employee Agreement between MRV 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. 33-86516)).10.3
    
    Letter amending Key Employee Agreement between MRV 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)).10.4
    
    Key Employee Agreement between MRV 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)).10.5
    
    Letter amending Key Employee Agreement between MRV 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)).10.6
    
    Form of Letter amending Key Employee Agreement between MRV 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. 33-86516)).10.7
    
    Standard Industrial/Commercial Single-Tenant Lease dated
October 8, 1996 between MRV 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).
 88




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##### Table of Contents



Exhibit No.
    
    Description10.7.1
    
    Amendment to Lease between Nordhoff Industrial and the Registrant dated
December 14, 2001 relating to premises located at 20415 Nordhoff Street
(incorporated by reference to Exhibit 10.65 of MRVs Form 10-K filed with
the SEC on March 21, 2002).10.8
    
    1997 Incentive and Nonstatutory Stock Option Plan, as amended (incorporated
by reference to Appendix A to the Registrants Definitive Proxy Statement
filed with the SEC on November 14, 2001).10.9
    
    Form of Stock Option Agreement under the 1997 Incentive and Nonstatutory
Stock Option Plan (incorporated by reference to Exhibit 4.2 to the
Registrants Registration Statement on Form S-8 filed with the SEC on
September 24, 1999 (file no. 333-87735)).10.10
    
    Securities Purchase Agreement dated as of June 1, 2003 between MRV
Communications, Inc. and Deutsche Bank AG, London Branch, with form of
Convertible Note attached as Exhibit A thereto (incorporated by reference
to Exhibit 4.1 of registrants Current Report on Form 8-K filed June 3,
2003).10.11
    
    Amendment #1 to Convertible Note dated as of June 13, 2003 (incorporated by
reference to Exhibit 4.3 of the Registration Statement on Form S-3 filed
with the SEC on June 16, 2003 (file no. 333-106169)).10.12
    
    Registration Rights Agreement dated as of June 1, 2003 (incorporated by
reference to Exhibit 4.2 of registrants Current Report on Form 8-K filed
June 3, 2003).10.13
    
    Non-Director and Non-Executive Officer Consolidated Long-Term Stock
Incentive Plan (incorporated by reference to Exhibit 4.1 of the
Registration Statement on Form S-8 filed with the SEC on July 17, 2003
(file no. 333-107109)).10.14
    
    Form of Stock Option Agreement for the Non-Director and Non-Executive
Officer Consolidated Long-Term Stock Incentive Plan Stock Option Agreement
(incorporated by reference to Exhibit 4.2 of the Registration Statement on
Form S-8 filed with the SEC on July 17, 2003 (file no. 333-107109)).21.1
    
    Subsidiaries of Registrant.23.1
    
    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.25.1
    
    Power of Attorney (included on signature page).31.1
    
    Certification of the Chief Executive Officer required by Rule 13a-14(a) of
the Exchange Act.31.2
    
    Certification of the Chief Financial Officer required by Rule 13a-14(a) of
the Exchange Act.32.1
    
    Certification pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350.
 (b) One report on Form 8-K was filed during the period covered by this Report. That Form 8-K
Report, dated October 21, 2004 and filed on October 25, 2004, reported matters under Items 2.02,
8.01 and 9.01. 89




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SIGNATURE Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized on March 7, 2005. MRV COMMUNICATIONS, INCBy:
    /s/ Noam LotanNoam LotanPresident and Chief Executive Officer By:
    /s/ Shay GonenShay GonenChief Financial Officer 90




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##### Table of Contents



POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes
and appoints Noam Lotan, his true and lawful attorney-in-fact and agent with full power of power
substitution and resubstitution, for him and in his name, place, and stead, in any and all
capacities, to sign this Annual Report on Form 10-K, and to file any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits
thereto, and all documents in connection therewith, with Securities and Exchange Commission,
granting unto said attorney-in-fact and agents, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in and about the premises, as fully to
all intents and purposes as he might or could do in person, hereby ratifying and confirming all
that said attorney-in-fact and agent thereof. Pursuant
to the requirements of the Securities Exchange Act
of 1934, this Annual Report on Form 10-K has been signed below
by the following persons on behalf of the Registrant in the capacity and
on the dates indicated. Signature
    
    Title
    
    Date/s/ Noam Lotan

(Noam Lotan)
    
    President and Chief Executive Officer
(Principal Executive Officer)
    
    March 7, 2005/s/ Shlomo Margalit

(Shlomo Margalit)
    
    Chairman of the Board, Chief
Technology Officer, and Secretary
    
    March 7, 2005/s/ Shay Gonen

(Shay Gonen)
    
    Chief Financial Officer
(Principal Finance and Accounting
Officer)
    
    March 7, 2005/s/ Igal Shidlovsky

(Igal Shidlovsky)
    
    Director
    
    March 7, 2005/s/ Guenter Jaensch

(Guenter Jaensch)
    
    Director
    
    March 7, 2005/s/ Daniel Tsui

(Daniel Tsui)
    
    Director
    
    March 7, 2005/s/ Baruch Fischer

(Baruch Fischer)
    
    Director
    
    March 7, 2005
 91