10-Q 1 v75072e10-q.txt LUMINENT, INC. 6/30/1 FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO ____________. COMMISSION FILE NUMBER: 000-31393 LUMINENT, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4798130 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 20550 NORDHOFF ST. CHATSWORTH, CALIFORNIA 91311 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (818) 773-9044 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of July 31, 2001 156,000,000 shares of the registrant's common stock were outstanding. 2 LUMINENT, INC. FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 INDEX TO QUARTERLY REPORT ON FORM 10-Q PART I. Financial Information Item 1 Financial Statements Consolidated Condensed Balance Sheets as of June 30, 2001 (unaudited) and December 31, 2000 1 Unaudited Consolidated Condensed Statements of Operations for the three months and six months ended June 30, 2001 and 2000 3 Unaudited Consolidated Condensed Statements of Cash Flows for the three months and six months ended June 30, 2001 and 2000 4 Notes to Consolidated Condensed Financial Statements 5 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3 Quantitative and Qualitative Disclosures About Market Risk 26 PART II. Other Information Item 1 Legal Proceedings 26 Item 2 Changes in Securities and Use of Proceeds 26 Item 3 Defaults upon Senior Securities 27 Item 4 Submission of Matters to a Vote of Security Holders 27 Item 5 Other Information 28 Item 6 Exhibits and Reports on Form 8-K 29 Signatures 33

3 PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements LUMINENT, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (in thousands) ASSETS

The accompanying notes are an integral part of these consolidated condensed financial statements. 1 4 LUMINENT, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (in thousands, except share data) LIABILITIES AND STOCKHOLDERS' EQUITY

The accompanying notes are an integral part of these consolidated condensed financial statements. 2 5 LUMINENT, INC. CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (in thousands, except per share data) (unaudited)

(1) Includes amounts relating to deferred stock compensation of $744,000 and $566,000 presented in "cost of sales", $1.1 million and $7.0 million presented in "selling, general and administrative", and $1.2 million and $890,000 presented in "research and development" for the three months ended June 30, 2000 and 2001, respectively. (2) Includes amounts relating to deferred stock compensation of $744,000 and $1.2 million presented in "cost of sales", $1.1 million and $15.7 million presented in "selling, general and administrative", and $1.2 million and 2.0 million and "research and development" for the six months ended June 30, 2000 and 2001, respectively. (3) Includes one-time charges of $29.3 million, $11.4 million, $501,000 and $16,000 presented in "cost of sales", "selling, general and administrative", "research and development" and "other income, net", respectively, for the three months ended June 30, 2001 to write-down inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other non-recurring items. These charges resulted from the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. The accompanying notes are an integral part of these consolidated condensed financial statements. 3 6 LUMINENT, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)

The accompanying notes are an integral part of these consolidated condensed financial statements. 4 7 LUMINENT, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited) 1. BUSINESS AND BASIS OF PRESENTATION Business Luminent, Inc. ("Luminent" or the "Company") designs, manufactures, and sells a comprehensive line of fiber optic components that enable communications equipment manufacturers to provide optical networking solutions for the rapidly growing metropolitan and access segments of the communications network. The Company's products are designed to meet the increasing bandwidth requirements between long-haul telecommunication networks and end users. Luminent specializes in singlemode fiber optic components and subsystems for high-capacity data transmission for long-reach applications in the metropolitan and access markets. Luminent was incorporated in Delaware in March 2000 as a wholly owned subsidiary of MRV Communications, Inc. ("MRV"). Since the completion of Luminent's initial public offering in November 2000, MRV has owned approximately 92% of Luminent's outstanding common stock. On July 25, 2000, MRV and Luminent entered into a Master Separation and Distribution Agreement (the "Separation Agreement") which became effective as of September 8, 2000 (the "Separation Date"). MRV transferred to Luminent, substantially all of the assets and liabilities associated with Luminent's business. As of the Separation Date, Luminent began operating independently from MRV. For periods prior to the Separation Date, the accompanying consolidated condensed financial statements reflect MRV's historical bases in the assets and liabilities and the historical results of operations that were transferred to Luminent. Additionally, the consolidated condensed financial statements include allocations of certain MRV corporate expenses, including centralized legal, accounting, employee benefits, real estate, insurance services, information technology services, treasury and other MRV corporate and infrastructure costs. The expense allocations have been determined on bases that MRV and Luminent considered to be a reasonable reflection of the utilization of services provided or the benefit received by Luminent. The allocation methods are based on relative revenues, head counts or square footage. However, the financial information included herein may not reflect the consolidated financial position, operating results, changes in parent company investment and cash flows of Luminent in the future or what they would have been had Luminent been a separate, stand-alone entity during the periods presented. Luminent faces numerous risks related to the fact that it has no history as an independent company. In addition, Luminent faces risks common to many technology companies including but not limited to operating in a sector that is new and characterized by rapid technological change, evolving industry standards, the need to generate capital to fund operations and uncertainty regarding market acceptance of its products and products under development. Basis of Presentation The accompanying consolidated condensed financial statements have been prepared by the Company, in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to present a fair presentation have been included. The operating results for the three months and six months ended June 30, 2001 are not necessarily indicative of the results that may be expected for the fiscal year ended December 31, 2001. Earnings per share Basic and diluted earnings (loss) per common share are computed using the weighted average number of common shares outstanding. All share and per share amounts have been retroactively restated to give effect to the Company's 144,000-for-one stock split that occurred on July 25, 2000. The weighted average number of shares used for computation of basic and diluted earnings (loss) per share were 156,000,000 for June 30, 2001, and 144,000,000 for June 30, 2000. The 13.4 million stock options outstanding and 75,000 warrants outstanding have been excluded from the diluted computations of loss per share as of June 30, 2001 as their effect would be anti-dilutive. There were no options or warrants outstanding as of June 30, 2000. 2. BUSINESS ACQUISITIONS On April 24, 2000, MRV completed the acquisition of approximately 97% of the outstanding capital stock of Fiber Optic Communications, Inc., a Republic of China corporation. Fiber Optic Communications is a manufacturer of passive fiber optic components for Wavelength Division Multiplexing. Under the terms of the purchase agreement, Fiber Optic Communications shareholders received approximately $48.6 million in cash and approximately 4.7 million shares of MRV common stock and options to purchase 680,000 shares of MRV common stock for a total purchase price of approximately $310.4 million. The issuance price of the MRV common stock was approximately $53 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at 5 8 $3.00 per share, have an aggregate intrinsic value of $14.1 million at the acquisition date, and vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $261.6 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. On July 12, 2000, MRV completed the acquisition of all of the outstanding capital stock of Quantum Optech Inc., a Republic of China corporation. Quantum Optech is a manufacturer of optical thin film coating and filters for Dense Wavelength Division Multiplexing. Under the terms of the purchase agreement, Quantum Optech shareholders received approximately 1.0 million shares of MRV common stock and options to purchase approximately 160,000 shares of MRV common stock for a total purchase price of approximately $36.2 million. The issuance price of the MRV common stock was approximately $30 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at $3.00 per share, have an aggregate intrinsic value of $4.0 million at the acquisition date, of which $1.3 million is vested, and the remaining vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $27.9 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. On July 21, 2000, MRV completed the acquisition of approximately 99% of the outstanding capital stock of Optronics International Corp., a Republic of China corporation. Optronics International is a manufacturer of high temperature semiconductor lasers, transceivers and detectors for optical networks. Under the terms of the purchase agreement, Optronics International shareholders received approximately 3.4 million shares of MRV common stock and options to purchase approximately 800,000 shares of MRV common stock for a total purchase price of approximately $124.3 million. The issuance price of the MRV common stock was approximately $30 per share, which was determined based on the average market price five days before and after the terms were agreed upon. The options to purchase MRV common stock are exercisable at $3.00 per share, have an aggregate intrinsic value of $20.0 million at the acquisition date, of which $6.6 million is vested, and the remaining vest over a four-year period. The acquisition is being accounted for using the purchase method of accounting. The assets and liabilities of the acquired entity have been "pushed down" to Luminent. The excess purchase price paid over the fair value of the net identifiable assets acquired of $99.5 million has been recorded as goodwill and is being amortized on a straight-line basis over 5 years. The deferred compensation is being amortized using the graded vesting method over 4 years. The purchase price of Fiber Optic Communications, Quantum Optech and Optronics International in the aggregate were allocated as follows (in thousands, unaudited): Purchase price $420,861 Allocation of purchase price Net tangible assets 1,750 Deferred stock compensation 30,150 Goodwill 388,961

The outstanding capital stock of Fiber Optic Communications, Quantum Optech and Optronics International, purchased by MRV, has been contributed to Luminent. The results of operations of these acquisitions have been included in Luminent's consolidated financial statements from the date of acquisition. The following unaudited pro forma financial information presents the combined results of operations of Luminent, Fiber Optic Communications, Quantum Optech and Optronics International as if the acquisitions had occurred as of January 1, 2000, giving effect to certain adjustments, including amortization of goodwill and other intangibles and deferred compensation charges.

3. INVENTORIES Inventories consisted of the following (in thousands):

4. BUSINESS SEGMENTS AND CONCENTRATIONS OF RISK 6 9 Luminent operates under one reportable segment: fiber optic components and modules. Fiber optic components and modules include discrete components such as laser diodes and light emitting diodes and integrated components such as transmitters, receivers and transceivers. These products are sold primarily to original-equipment manufacturers and through distributors. The Company depends on single or limited source suppliers for some of the key components and materials in its products, which makes Luminent susceptible to supply shortages or price fluctuations that could adversely affect operating results. Management believes this will not have a significant impact on operations. For the three months ended June 30, 2001, the Company had one customer that accounted for approximately 13% of net sales. For the six months ended June 30, 2001, the Company had two customers that accounted for approximately 24% of net sales. As of June 30, 2001, one customer accounted for approximately 25% of total accounts receivable. Certain geographical area information follows (in thousands). Geographical Area Net Sales (in thousands):

5. RESTRUCTURING AND OTHER ONE-TIME CHARGES In the second quarter of 2001, the Company's management approved and implemented a restructuring plan and other actions in order to adjust operations and administration due to the dramatic slowdown in demand for communications equipment. During the three months ended June 30, 2001, the Company recorded restructure and other one-time charges totaling $41.2 million resulting from the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. The Company's restructuring activities primarily involve employee severance costs, abandonment and non-utilization of assets and other similar actions. Costs for restructuring activities are limited to either incremental costs that directly result from the restructuring activities and provide no future benefit or costs incurred under contractual obligations that existed before the restructuring plan and will continue with either no future benefit or become a penalty incurred for termination of the obligation. Restructuring costs totaling $14.5 million consisting of severance and outplacement of terminated employees and exit costs are included in the results of operations. The restructuring activities as described above, results in approximately 100 layoffs during the three months ended June 30, 2001 and will result in additional layoffs of approximately 500 personnel, bringing the Company's total workforce to approximately 1,200 employees. Affected employees will come from all divisions and areas of the Company. The majority of affected employees will be in the manufacturing group. A summary of the restructuring costs consist of the following:

In addition to the costs associated with the restructuring plan, the Company also recorded a one-time $26.1 million charge to write-down inventory to realizable value and an additional $598,000 charge to bad debt. Furthermore, the Company is undertaking a formal review of the goodwill generated in its acquisitions and it may record additional impairment charges when the review is completed in the fourth quarter of 2001. 6. SEPARATION FROM MRV COMMUNICATIONS, INC. 7 10 For purposes of governing the ongoing relationships between Luminent and MRV at and after the separation and to provide for an orderly transition, Luminent and MRV have entered into various agreements. A brief description of each of the agreements follows. Master Separation and Distribution Agreement MRV and Luminent have entered into a Master Separation Agreement, which contains key provisions relating to the separation, Luminent's initial funding, initial public offering and the distribution of Luminent's common stock to MRV's stockholders. The Master Separation and Distribution Agreement lists the documents and items that the parties must deliver in order to accomplish the transfer of assets and liabilities from MRV to Luminent, effective on the separation date. The Master Separation and Distribution Agreement also contains conditions that must occur prior to the distribution. The parties also entered into ongoing covenants that survive the transactions, including covenants to establish interim service level agreements, exchange information, engage in certain auditing practices and resolve disputes in particular ways. General Assignment and Assumption Agreement The General Assignment and Assumption Agreement identifies the assets and certain capital stock that MRV has transferred to Luminent and the liabilities that Luminent has assumed from MRV in the separation. The General Assignment and Assumption Agreement also describes when and how these transfers and assumptions occurred. In general, these assets and liabilities were those that appeared in the consolidated balance sheet as of September 30, 2000. Intellectual Property Agreements The Master Technology Ownership and License Agreement, the Master Patent Ownership and License Agreement and the Master Trademark Ownership and License Agreement collectively are referred to as the Intellectual Property Agreements. Under the Intellectual Property Agreements, MRV confirmed that Luminent owns or MRV transferred to Luminent certain rights in specified patents, patent applications, invention disclosures, specified trademarks and other intellectual property related to Luminent's current business, research and development efforts. Employee Matters Agreement The Employee Matters Agreement outlines how MRV and Luminent allocated assets, liabilities and responsibilities relating to current and former employees of Luminent and their participation in the benefits plans, including stock plans, that MRV currently sponsors and maintains. The Employee Matters Agreement also contains provisions describing some of Luminent's employee benefit and employee stock plans. All eligible Luminent employees continue to participate in the MRV benefits plans on comparable terms and conditions to those for MRV employees until the distribution date or until Luminent establishes benefit plans for its employees, or elects not to establish comparable plans if it is not legally or financially practical. Luminent intends to establish its own benefit program no later than the time of distribution. Once Luminent establishes it own benefits plans, it may modify or terminate each plan in accordance with the terms of that plan and its policies. No Luminent benefit plan will provide benefits that overlap benefits under the corresponding MRV benefit plan at the time of the distribution. Each Luminent benefit plan will provide that all service, compensation and other benefit determinations that, as of the distribution, were recognized under the corresponding MRV benefits plan, will be taken into account under that Luminent benefit plan. Following the date of MRV's distribution of its Luminent common stock to its stockholders, Luminent will be under no obligation to maintain these plans in the form in which they were established or at all. The transfer to Luminent of employees at certain of MRV's international operations, and of certain employee benefit plans, may not take place until Luminent receives consents or approvals or has satisfied other applicable requirements. Tax Sharing and Indemnification Agreement The Tax Sharing and Indemnification Agreement allocates MRV's and Luminent's responsibilities and rights for certain tax matters. The agreement requires Luminent to pay MRV for the incremental tax costs of Luminent's inclusion in consolidated, combined or unitary tax returns with affiliated corporations. In determining these incremental costs, the Tax Sharing and Indemnification Agreement takes into account not only the group's incremental tax payments to the Internal Revenue Service or other taxing authorities, but also the incremental use of tax losses of affiliates to offset Luminent's taxable income, and the incremental use of tax credits of affiliates to offset the tax on Luminent's income. The Tax Sharing and Indemnification Agreement also provides for compensation or reimbursement as appropriate to reflect redeterminations of Luminent's tax liability for periods during which Luminent joined in filing consolidated, combined or unitary tax returns. The Tax Sharing and Indemnification Agreement also requires Luminent to indemnify MRV for certain taxes and similar obligations, including (a) sales taxes on the sale of products purchased by MRV from Luminent before the distribution, (b) customs duties or harbor maintenance fees on products exported or imported by MRV on behalf of Luminent, (c) the additional taxes that would result if an acquisition of a controlling interest in Luminent's stock after the distribution causes the distribution not to qualify for tax-free treatment to MRV, and (d) any taxes resulting from transactions undertaken in preparation for the distribution. Luminent's indemnity obligations include any interest penalties on taxes, duties or fees for which Luminent must indemnify MRV. Each member of a consolidated group for U.S. federal income tax purposes is jointly and severally liable for the group's federal income tax liability. Accordingly, Luminent could be required to pay a deficiency in the group's federal income tax liability for a period during which Luminent was a member of the group even if the Tax Sharing and Indemnification Agreement allocates that liability to MRV or another member. 8 11 Master Transitional Services Agreement The Master Transitional Service Agreement governs the individual transitional services as requested by Luminent and provided by MRV, on an interim basis, for one year from the date of separation, unless extended for specific services or otherwise indicated in the agreement. The services include data processing and telecommunications services, such as voice telecommunications and data transmission, and information technology support services, for functions including accounting, financial management, tax, payroll, stockholder and public relations, legal, procurement, and other administrative functions. Specified charges for such services are generally intended to allow the providing company to recover the direct and indirect costs of providing the services. The Master Transitional Services Agreement also will cover the provision of certain additional transitional services identified from time to time after the Separation Date that were inadvertently or unintentionally omitted from the specified services, or that are essential to effectuate an orderly transition under the Master Separation and Distribution Agreement, so long as the provision of such services would not significantly disrupt MRV's operations or significantly increase the scope of its responsibility under the agreement. In addition, the Master Transitional Services Agreement will provide for the replication of some computer systems, including hardware, software, data storage or maintenance and support components. Generally, the party needing the replicated system will bear the costs and expenses of replication. Generally, the party purchasing new hardware or licensing new software will bear the costs and expenses of purchasing the new hardware or obtaining the new software licenses. Real Estate Matters Agreement The Real Estate Matters Agreement addresses real estate matters relating to certain MRV leased and owned properties that MRV will transfer to or share with Luminent. The Real Estate Matters Agreement describes the manner in which MRV will transfer to or share with Luminent various leased and owned properties. The Real Estate Matters Agreement provides that Luminent will be required to accept the transfer of all sites allocated to Luminent, even if a site has been damaged by a casualty before the separation date. The Real Estate Matters Agreement also provides that all reasonable costs required to effect the transfers, including landlord consent fees and landlord attorney's fees will be paid by MRV. Indemnification and Insurance Matters Agreement Effective as of the separation date, subject to specified exceptions, Luminent and MRV released the other from any liabilities arising from events occurring on or before the separation date, including events occurring in connection with the activities to implement the separation, the initial public offering and the distribution. The Indemnification and Insurance Matters Agreement also contains provisions governing indemnification. In general, Luminent and MRV will each indemnify the other from all liabilities arising from their respective businesses or contracts, as well as liabilities arising from a breach of the Master Separation and Distribution Agreement or any ancillary agreement. In addition, MRV and Luminent will each indemnify the other against liability for specified environmental conditions. Luminent will reimburse MRV for the cost of any insurance coverage from the separation date to the distribution date. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS All statements contained in this Report that are not historical facts, including but not limited to, statements regarding our business strategies and expectations concerning future operations, margins, profitability, liquidity, capital expenditures and capital resources, are based on current expectations. These statements are forward-looking in nature and involve a number of risks and uncertainties. Generally, words including but not limited to "anticipates," "believes," "estimates," "expects" and similar expressions as they relate to the Company and its management are intended to identify forward-looking statements. Although management believes that the expectations in such forward-looking statements are reasonable, it can give no assurance that any forward-looking statement will prove to be correct and actual results may differ materially. We caution readers not to place undue reliance on any forward-looking statements, which statements are made pursuant to the Private Litigation Reform Act of 1995. The factors identified under "Risk Factors" below and elsewhere in this Report are among the factors that could cause actual results to differ materially from the forward-looking statements. The forward-looking statements contained in this Report speak only as of the date that we have filed this Report. We expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained in this Report, including to reflect any change in our expectations with regard to that forward-looking statement or any change in events, conditions or circumstances on which that forward-looking statement is based. MARKET CONDITIONS AND CURRENT OUTLOOK Macroeconomic factors, such as an economic slowdown in the U.S. and abroad, have detrimentally impacted demand for communications products, thereby resulting in reduced demand for optical components in general. The unfavorable economic conditions and reduced capital spending detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States during the last six months, and appear to continue to affect these industries in the second quarter of 2001 and may affect them beyond the second quarter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories. Our two largest customers, Cisco and Marconi, have recently announced that they expect declining revenues and profitability in the near term due to softening demand for telecommunications and networking equipment. This has resulted in reductions and rescheduling by Cisco and Marconi in purchases from their suppliers such as us as they seek to reduce their existing inventories and adjust to reduced demand in the market. This will likely result in lower sales to Cisco and Marconi, and could result in lower revenues overall. Our sales may decline significantly with resulting fluctuations or harm to our operating results and financial condition if either Cisco or Marconi cancels, reduces or delays purchases of our products or unduly delays qualifying them. 9 12 During the three months ended June 30, 2001, we recorded restructuring and other one-time charges totaling $41.2 million, resulting from the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. These charges include the write-down of inventory of $26.1 million, asset impairment charges of $8.9 million, and other restructuring and non-recurring items related to the recent market conditions of $6.2 million. Additionally, during the quarter ended June 30, 2001, we began to reduce our workforce, which we expect will result in layoffs of approximately 600 people, bringing our total workforce to approximately 1,200 employees. Furthermore, the Company is undertaking a formal review of the goodwill generated in its acquisitions and it may record additional impairment charges when the review is completed in the fourth quarter of 2001. OVERVIEW We design, manufacture and sell a comprehensive line of fiber optic components that enable communications equipment manufacturers to provide optical networking equipment for the rapidly growing metropolitan and access segments of the communications network. Directly and through its subsidiaries, MRV designs, manufactures and sells data networking products, including networking and Internet infrastructure products such as switching and router management systems, and through Luminent, MRV was engaged in the fiber optics components business. Our fiber optic components business was the original business of MRV when MRV began operations in July 1988. From inception in 1988 until our separation on September 8, 2000, when MRV completed the contribution and transfer to us of our business, we operated as a division of MRV and conducted business using MRV's trade name. In March 2000, we were incorporated in Delaware as a wholly owned subsidiary of MRV. In April 2000, we began operating under the Luminent trade name. As of June 30, 2001, MRV owned approximately 92% of the outstanding shares of our common stock. MRV has announced its intention to divest its remaining equity interest in us by selling up to 18,720,000 shares of our common stock to the public and distributing the remainder of its shares of our common stock to the holders of MRV's common stock, although it is not obligated to do so. In August 2001, we registered 18,720,000 shares of our common stock on behalf of MRV in a prospectus dated August 8, 2001. In May 2001, MRV received a private letter ruling from the Internal Revenue Service that MRV's distribution of their shares of Luminent common stock to the holders of MRV common stock will be tax-free to its stockholders and MRV for United States federal income tax purposes if the distribution occurs within one year of the IPO, i.e., by November 8, 2001. According to MRV's public disclosures, there are other conditions that must be satisfied or waived by MRV, in their sole discretion, prior to the distribution of our common stock. These conditions include, among other things: - all required government approvals must be in effect; - MRV's redemption or repayment of their outstanding convertible subordinated debentures; - no legal restraints must exist preventing this distribution; and - nothing must have happened in the intervening time between the offering and the distribution, including a future change in market or economic conditions or in our or MRV's business and financial condition, that causes the MRV board of directors to conclude that the distribution is not in MRV's best interest or the best interest of MRV's stockholders. The exact distribution formula and record date to qualify for any distribution will be determined at a future date. On April 24, 2000, MRV acquired approximately 97% of the outstanding capital stock of Fiber Optic Communications, a Taiwanese manufacturer of passive fiber optic components with facilities in both Taiwan and the People's Republic of China. The purchase price paid was approximately $310.4 million in cash, common stock and options to purchase common stock of MRV, including amounts recorded as deferred stock compensation. On July 12, 2000, MRV acquired all of the outstanding capital stock of Quantum, a Taiwanese manufacturer of active and passive fiber optic components. The purchase price paid was approximately $36.2 million in common stock and options to purchase common stock of MRV, including amounts recorded as deferred stock compensation. On July 21, 2000, MRV acquired approximately 99% of the outstanding capital stock of Optronics, a Taiwanese manufacturer of active fiber optic components. The purchase price paid was approximately $124.3 million in common stock and options to purchase common stock of MRV, including amounts recorded as deferred stock compensation. The acquisitions were made to expand our product offerings, enhance our technology expertise and expand our manufacturing capabilities. These acquisitions were accounted for using the purchase method and the outstanding capital stock purchased by MRV in each of the acquisitions has been contributed to us as of the dates of acquisition. Therefore, the results of operations of Fiber Optic Communications, Optronics and Quantum have been included in our consolidated financial statements from April 25, 2000, July 13, 2000 and July 22, 2000, respectively. In connection with the acquisitions of Fiber Optic Communications, Optronics and Quantum, a portion of the purchase prices paid represented deferred stock compensation relating to options to purchase the common stock of MRV. These options had fair values of approximately $14.1 million, $13.4 million and $2.7 million for Fiber Optic Communications, Optronics and Quantum, respectively. Deferred stock compensation amortization expense for the three months and six months ended June 30, 2001 relating to these stock options was approximately $2.7 million and $5.9 million, respectively. In connection with these acquisitions, we expect to incur an additional $11.7 million of deferred stock compensation until fully amortized in 2004. Deferred stock compensation is amortized using the graded method over a four-year period. Goodwill resulting from the Fiber Optic Communications, Optronics and Quantum acquisitions totaled $261.6 million, $99.5 million and $27.9 million, respectively. For the three months and six months ended June 30, 2001, we recorded amortization of goodwill of approximately $19.5 million and $39.0 million, respectively, relating to these acquisitions. We expect to record amortization of goodwill for Fiber Optic Communications, 10 13 Optronics and Quantum of approximately $19.5 million per quarter until December 31, 2001. At January 1, 2002 we intend to implement SFAS No. 142. (see RECENT ACCOUNTING PRONOUNCEMENTS, below) Fiber Optic Communications was the largest and most significant of the acquisitions. Fiber Optic Communications produces margins similar to us; however, it has not experienced the growth in net sales or operating income that we have experienced during the last three fiscal years. We are not aware of any unusual trends specific to the businesses of our acquired companies, except that they are experiencing the same softness in demand and pricing that we and the rest of our industry are experiencing. In July 2000, MRV and the Company entered into four-year employment agreements with our President and Chief Executive Officer and Vice President of Finance and Chief Financial Officer. The agreements provide for annual salaries, performance bonuses and combinations of stock options to purchase shares of MRV's common stock and Luminent's common stock. The options to purchase MRV's common stock are immediately exercisable. The options to purchase Luminent's common stock vest over four years. These options were granted to our President and Chief Executive Officer and Vice President of Finance and Chief Financial Officer at exercise prices below market value, resulting in deferred stock compensation. Deferred stock compensation reported for the three months and six months ended June 30, 2001 was $5.8 million and $13.0 million, respectively, and we will incur additional deferred stock compensation of approximately $25.0 million through 2004. We reported a net loss of approximately $66.0 million and $88.3 million for the three months and six months ended June 30, 2001, respectively. The net loss was primarily due to amortization of goodwill and deferred stock compensation related to the acquisitions of Fiber Optic Communications, Optronics and Quantum for the three months and six months ended June 30, 2001, our employment arrangements with our President and Chief Executive Officer and Vice President of Finance and Chief Financial Officer for the three months and six months ended June 30, 2001 and recording restructuring and other one-time charges totaling $41.2 million resulting from the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular for the three months ended June 30, 2001. These one-time charges include the write-down of inventory of $26.1 million, asset impairment of $8.9 million, and other restructuring and non-recurring items related to the recent market conditions of $6.2 million. See RESULTS OF OPERATIONS section, below, for more discussion. In addition, we will record amortization of goodwill or other intangible assets and deferred stock compensation relating to the Fiber Optic Communications, Optronics and Quantum acquisitions and our employment arrangements going forward. As a consequence of these amortization charges, we do not expect to report net income in the foreseeable future. We have entered into various agreements related to interim and ongoing relationships with MRV. These agreements provide for transitional services and support in the areas of data processing and telecommunications services (such as voice telecommunications and data transmission and information technology support services) for functions including accounting, financial management, tax, payroll, stockholder and public relations, legal, procurement and other administrative functions. Services are generally cost plus 5%, but may increase to cost plus 10% if the services extend beyond a one year period. Subsequent to the Separation Date, certain of these services were discontinued, including accounting, financial management, payroll, legal, procurement and other administrative functions. The transition period varies depending on the agreement but is generally one year. Although the fees provided for in the agreements are intended to represent the fair market value of these services, we cannot assure that these fees necessarily reflect the costs of obtaining the services from unrelated third parties or of our providing these services internally. However, we believe that purchasing these services from MRV provides an efficient means of obtaining these services during the transition period. We must also negotiate new or revised agreements with various third parties as a separate, stand-alone entity. We cannot assure that the terms we will be able to negotiate will be as favorable as those that we enjoyed as part of MRV. In addition, as part of MRV, we benefited from various economies of scale including shared global administrative functions, facilities and volume purchase discounts. We expect our costs will increase as a result of the loss or renegotiation of these arrangements, although the amount of the cost increase is not determinable at this time. BASIS OF PRESENTATION Our consolidated financial statements have been carved out from the consolidated financial statements of MRV using the historical results of operations and historical bases of the assets and liabilities of the MRV businesses that our company comprises. The consolidated condensed financial statements through June 30, 2001 also include allocations to us of certain MRV corporate assets, liabilities and expenses, including centralized legal, accounting, employee benefits, real estate, insurance services, information technology services, treasury and other MRV corporate and infrastructure costs. The expense allocations have been determined on bases that MRV and we considered to be a reasonable reflection of the utilization of the services provided to us or the benefit received by us. The expense allocation methods included relative sales, headcount, square footage, transaction processing costs and adjusted operating expenses. No intercompany interest income or expense has been allocated to, or included in, our consolidated financial statements. The financial information presented in this Report is not indicative of our financial position, results of operations or cash flows in the future nor is it necessarily indicative of what our financial position, results of operations or cash flows would have been had we been a separate, stand-alone entity for the periods presented. The financial information presented in this Report does not reflect many of the significant changes that will occur in our funding and operations as a result of our becoming a stand-alone entity and the distribution. RESULTS OF OPERATIONS The following table sets forth selected consolidated historical financial data for the periods indicated, expressed as a percentage of net sales.

11 14 Gross profit 35 (41) 35 (1) Operating costs and expenses: Selling, general and administrative 21 59 19 44 Research and development 15 12 15 11 Amortization of goodwill 34 47 22 44 Total operating costs 70 118 56 99 Operating loss (35) (159) (21) (100) Other income, net 1 2 0 3 Loss before provision for income taxes (34) (157) (21) (97) Provision for income taxes 4 4 3 2 Minority interest 1 0 1 0 Net income (loss) (39)% (161)% (25)% (99)%

Net Sales We recognize revenue upon shipment of our products, at which time, customer acceptance of the products has been attained and collection is considered probable. Net sales for the three months ended June 30, 2001 increased 46%, to $41.1 million from $28.1 million for the three months ended June 30, 2000. Net sales for the six months ended June 30, 2001 increased 108%, to $89.3 million from $43.0 million for the six months ended June 30, 2000. Our increase in net sales is primarily a result of the growth of the Internet and e-commerce and the corresponding increased bandwidth requirements. The following table sets forth our net sales to certain customers as a percentage of our total net sales:

We rely on one-time purchase orders rather than long-term contracts with both Cisco and Marconi, and, as a result, we cannot predict the size, timing or terms of their incoming orders. We have experienced variations in the purchase patterns of Marconi and Cisco in the past, and we may experience continued variation in the future. Material reasons for historic variations in the purchase patterns of these customers, particularly Marconi, have included weather patterns that have delayed field installations of systems that incorporate our products and delays by our customers in qualifying our products that employ new components or features to assure compatibility with the components of other suppliers that are integrated with our products into our customers' systems. The timing of this qualification process is totally within the control of these customers. Thus, even when our products prove compatible with the components of other suppliers, as has typically been the case in the past, delays by our customers in completing the qualification process has resulted in corresponding delays in our receipt of orders for them. Cisco and Marconi have recently announced that they expect declining revenues and profitability in the near term due to softening demand for telecommunications and networking equipment. This has resulted in reductions and rescheduling by Cisco and Marconi in purchases from their suppliers such as us as they seek to reduce their existing inventories and adjust to reduced demand in the market. This will likely result in lower sales to Cisco and Marconi, and could result in lower revenues overall. Our sales may decline significantly with resulting fluctuations or harm to our operating results and financial condition if either Cisco, Marconi or other material customers cancel, reduce or delay purchases of our products or unduly delays qualifying them. Gross Profit Gross profit is equal to our net sales less our cost of sales. Our cost of sales includes materials, direct labor and overhead. Cost of inventory is determined by the first-in, first-out method. Gross profit for the three months ended June 30, 2001, decreased 269%, down to a loss of $16.8 million from a profit of $10.0 million for the three months ended June 30, 2000. Gross profit for the six months ended June 30, 2001, decreased 105%, down to a loss of $802,000 from $15.2 million for the six months ended June 30, 2000. Pro forma gross profit for the three months ended June 30, 2001, before restructuring charges, inventory write-downs and other market-related one-time charges of $29.3 million for the three months ended June 30, 2001, and deferred compensation amortization expense of $744,000 and $566,000 for the three months ended June 30, 2000 and 2001, respectively, would have increased 22%, to $13.1 million. Pro forma gross profit for the six months ended June 30, 2001, before inventory write-downs and other market-related one-time charges of $29.3 million for the three months ended June 30, 2001, and deferred compensation amortization expense of $744,000 and $1.2 million for the six months ended June 30, 2000 and 2001, respectively, would have increased 87%, to $29.8 million. Our pro forma gross margin, before restructuring charges, inventory write-downs and other market-related one-time charges for the three months ended June 30, 2001, and deferred compensation amortization expense for the three months and six months ended June 30, 2000 and 2001, decreased to 32% for the three months ended June 30, 2001, from 38% for the three months ended June 30, 2000 and decreased to 33% for the six months ended June 30, 2001, from 37% for the six months ended June 30, 2000. Our gross margins (defined as gross profit as a percentage of net sales) are generally affected by price changes over the life of the products and improved production efficiencies as a result of increased utilization. The former effect will generally decrease gross margins over the products' respective life cycles, whereas as the latter effect typically increases gross margins. Prices for existing products are generally expected to continue to decrease over their respective life cycles. Our lower margin customers typically operate in highly competitive markets where the price of our products is a key factor. Although we sacrifice margins to these customers, our volumes are typically 12 15 greater than the volumes achieved with higher margin customers. As we seek to continue to diversify our customer base, we plan to target markets with improved margins and less competitive end-markets. In the short term, we expect margins to remain constant or decline slightly due to the integration of the acquired companies with historically lower margins. In the mid- to long term, we expect margins to improve due to increased operating efficiencies associated with capacity utilization in Taiwan and People's Republic of China, diversification of sales to higher margin customers, and a favorable shift towards a higher margin customer base. Operating Costs and Expenses Operating costs and expenses consist of selling, general and administrative, research and development costs, costs associated with acquisitions, and other operating related charges. Operating costs and expenses, increased to 118% of net sales, or $48.5 million, for the three months ended June 30, 2001, from 70% of net sales, or $19.7 million, for the three months ended June 30, 2000. Operating costs and expenses, increased to 99% of net sales, or $88.5 million, for the six months ended June 30, 2001, from 56% of net sales, or $24.3 million, for the six months ended June 30, 2000. Pro forma operating costs and expenses for the three months ended June 30, 2001, before restructuring and other one-time charges of $11.9 million for the three months ended June 30, 2001, goodwill amortization of $9.6 million and $19.5 million and deferred compensation amortization expense of $2.2 million and $7.9 million for the three months ended June 30, 2000 and 2001, respectively, would have increased 17%, to $9.2 million. Pro forma operating costs and expenses for the six months ended June 30, 2001, before market-related one-time charges of $11.9 million for the three months ended June 30, 2001, goodwill amortization of $9.6 million and $39.0 million and deferred compensation amortization expense of $2.2 million and $17.7 million for the six months ended June 30, 2000 and 2001, respectively, would have increased 60%, to $20.0 million. Pro forma operating costs and expenses, as a percentage of net sales, are lower for the three months and six months ended June 30, 2001 than the three months and six months ending June 30, 2000 due to an effort to realize greater efficiencies in the current down market. Selling, general and administrative expenses for the three months ended June 30, 2001, increased to 59% of net sales, or $24.2 million, from 21% of net sales, or $5.9 million, for the three months ended June 30, 2000. Selling, general and administrative expenses for the six months ended June 30, 2001, increased to 44% of net sales, or $39.5 million, from 19% of net sales, or $8.1 million, for the six months ended June 30, 2000. Pro forma selling, general and administrative expenses for the three months ended June 30, 2001, before market-related one-time charges of $11.4 million for the three months ended June 30, 2001, deferred stock compensation expense of $1.1 million and $7.0 million for the three months ended June 30, 2000 and 2001, respectively, would have been 14% of net sales, or $5.8 million, an increase over the same period in the prior year by $920,000. Pro forma selling, general and administrative expenses for the six months ended June 30, 2001, before market-related one-time charges of $11.4 million for the three months ended June 30, 2001, deferred stock compensation expense of $1.1 million and $15.7 million for the six months ended June 30, 2000 and 2001, respectively, would have been 14% of net sales, or $12.4 million, an increase over the same period in the prior year by $5.4 million. The main reason for the increases is the inclusion of the new acquisitions of Fiber Optic Communications, Optronics and Quantum. Research and development expenses, decreased as a percentage of net sales from 15% to 12% and from 15% to 11% of net sales during the three months and six months ended June 30, 2001, respectively, from the same periods in 2000. However, in terms of absolute dollars, research and development expenses increased from the three months and six months ended June 30, 2000 to the three months and six months ended June 30, 2001, from $2.4 million to $5.2 million and from $6.6 million to $10.0 million, respectively. Pro forma research and development expenses for the three months ended June 30, 2001, before market-related one-time charges of $501,000 for the three months ended June 30, 2001, and deferred stock compensation of $1.2 million and $890,000 for the three months ended June 30, 2000 and 2001, respectively, would have increased to $3.4 million from $3.0 million from the same period in 2000. Pro forma research and development expenses for the six months ended June 30, 2001, before market-related one-time charges of $501,000 for the three months ended June 30, 2001, and deferred stock compensation of $1.2 million and 2.0 million for the six months ended June 30, 2000 and 2001, respectively, would have increased to $7.6 million from $5.5 million from the same period in 2000. Research and development expenses increased primarily due to the addition of Fiber Optics Communications, Optronics and Quantum. During the year ended December 31, 2000 we began development of our next generation products for applications such as fiber-to-the-home and fiber-to-the-curb. Fiber-to-the-home and fiber-to-the-curb are industry terms referring to the deployment of fiber optic cable for residential access to communications networks. Research and development expenditures also included additional development of our duplexers, triplexers and high-speed transceivers. We continue to invest heavily in areas targeted at broadening our customer base, product lines and end-product applications. We expect absolute dollars spent on research and development to continue to increase as we invest in key technical personnel, expand our current product lines and develop new product offerings. During the three months ended June 30, 2001, we incurred amortization of goodwill and deferred stock compensation of $19.5 million and $2.7 million, respectively, relating to the acquisitions of Fiber Optic Communications, Optronics and Quantum. During the six months ended June 30, 2001, we incurred amortization of goodwill and deferred stock compensation of $39.0 million and $5.9 million, respectively, relating to these acquisitions. We expect to incur additional amortization of goodwill from these acquisitions of approximately $19.5 million each quarter through December 31, 2001. At January 1, 2002 we intend to implement SFAS No. 142 (see RECENT ACCOUNTING PRONOUNCEMENTS, below). Deferred stock compensation charges from these acquisitions will generate an additional $11.7 million of expense through 2004. Deferred stock compensation is amortized using the graded method over the related expected employee service period, in this case four years. Provision for Income Taxes The provision for income taxes was $1.8 million and $1.9 million for the three months and six months ended June 30, 2001, respectively. The effective tax rate for the three months and six months ended June 30, 2001 was (2.1%), resulting from a tax provision computed based on a net loss position. The rate was negatively impacted by the amortization of goodwill and certain deferred stock compensation, which are not tax deductible. Our effective tax rates in future years may fluctuate due to amortization of goodwill and deferred stock compensation partially offset by favorable tax programs available in certain foreign tax jurisdictions where we currently have operating facilities. LIQUIDITY AND CAPITAL RESOURCES 13 16 We received $132.3 million in net proceeds from the sale of 12,000,000 shares of our common stock in our initial public offering completed in November 2000. On June 30, 2001, we had working capital of $123.0 million, compared with $161.7 million at December 31, 2000. The ratio of current assets to current liabilities at June 30, 2001 was 3.2 to 1, compared to 4.4 to 1 at December 31, 2000. Cash used by operating activities was $3.5 million and $23.0 million for the three months and six months ended June 30, 2001, respectively. Cash flows from operating activities was adversely affected by our net loss of $66.0 million and $88.3 million for the three months and six months ended June 30, 2001, respectively, increase in inventory for the three months ended March 31, 2001, increase in accounts receivable and deferred income taxes, payment of accounts payables, and establishing short-term deposits for capital acquisitions, all offset by non-cash charges for the amortization of goodwill of $19.5 million and $39.0 million for the three months and six months ended June 30, 2001, respectively, deferred stock compensation of $8.9 million and $18.9 million for the three months and six months ended June 30, 2001, respectively, and restructure and other one-time charges incurred as a result of the current slowdown in the communication industry for the three months ended June 30, 2001. Inventory levels increased during the three months ended March 31, 2001 in anticipation of increased sales. However, due to the dramatic downturn in demand for communications equipment, we wrote-off $26.2 million of inventory during the next three months ended June 30, 2001. The increase in accounts receivable was due primarily to increased sales. Capital expenditures for property and equipment represent the majority of cash used in investing activities. The capital expenditures for the three months and six months ended June 30, 2001 of $7.3 million and $17.2 million, respectively, plus another $3.0 million and $9.0 million, respectively, in short-term deposits for the acquisition of capital assets, reflect our investment in expanding production and research and development capacity. We believe that cash on hand, along with our cash flows from operations, will be sufficient to satisfy our working capital, capital expenditure and research and development requirements for at least the next 12 months. However, we may require or choose to obtain additional debt or equity financing in order to finance acquisitions or other investments in our business. We expect to continue to devote resources to purchases of capital equipment as we continue to build and relocate our manufacturing capabilities and continue to expand our research and development programs. 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. FOREIGN CURRENCY We operate on an international basis. A significant portion of our revenues and cost of sales are incurred in U.S. dollars. For the three months and six months ended June 30, 2001, approximately 52% and 43%, respectively, of our revenues and 50% and 43%, respectively, of our cost of sales were incurred in currencies other than the U.S. dollar. For the three months and six months ended June 30, 2001, approximately 71% and 68%, respectively, of our operating expenses were incurred in currencies other than the U.S. dollar, including the non-cash charges for deferred compensation expense and goodwill amortization incurred with the foreign subsidiary acquisitions. For the three months ended June 30, 2001, the New Taiwan dollar is the most significant of such currencies. The New Taiwan dollar has been relatively stable in relation to the U.S. dollar in recent years, and accordingly, we have not experienced any significant fluctuations in operating results due to exchange rate fluctuations in the New Taiwan dollar in relation to the U.S. dollar. Fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar will cause U.S. dollar translation of such currencies to vary from one period to another. We cannot predict the effect of exchange rate fluctuations upon future operating results. However, because we have expenses as well as revenues in each of the principal functional currencies, the exposure to our financial results to currency fluctuations is reduced. We have not historically attempted to reduce our currency risks through hedging instruments, however, we may do so in the future. INFLATION We believe that our revenue and results of operations have not been significantly impacted by inflation during the last three years. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998 and June 1999, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Investments and Hedging Activities," and SFAS No. 137, which delayed the effective date of SFAS No. 133. In June 2000, the FASB issued SFAS No. 138 which provides additional guidance for the application of SFAS No. 133 for certain transactions. We adopted this statement on January 1, 2001 and the adoption of this statement did not have a material impact on our financial position or results of operations. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements," as amended. SAB 101 summarizes certain of the Securities and Exchange Commission's views in applying generally accepted accounting principles to revenue recognition in financial statements. We have applied the provisions of SAB 101 in the consolidated financial statements. The adoption of SAB 101 did not have a material impact on our financial condition or results of operations. In March 2000, the FASB issued interpretation No. 44 (FIN 44), "Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25." FIN 44 clarifies the application of APB No. 25 for certain issues, including the definition of an employee, the treatment of the acceleration of stock options and the accounting treatment for options assumed in business combinations. FIN 44 became effective 14 17 on July 1, 2000, but is applicable for certain transactions dating back to December 1998. The adoption of FIN 44 did not have a significant impact on our financial position or results of operations. The FASB recently approved two statements: SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", which provide guidance on the accounting for business combinations, requires all future business combinations to be accounted for using the purchase method, discontinues amortization of goodwill, defines when and how intangible assets are amortized, and requires an annual impairment test for goodwill. We plan to adopt these statements effective January 1, 2002. We are currently reviewing these standards to determine the impact on our results of operation and financial position. The most significant anticipated effect on our financial statements on adoption would be discontinuing goodwill amortization and the possible recording of a goodwill impairment loss measured as of the date of adoption. RISK FACTORS Set forth below and elsewhere in this Report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Report and in public statements and press releases we make from time to time. WE CURRENTLY DERIVE A SIGNIFICANT PORTION OF OUR NET SALES FROM TWO CUSTOMERS, AND OUR NET SALES MAY DECLINE SIGNIFICANTLY IF EITHER OF THESE CUSTOMERS CANCELS, REDUCES OR DELAYS PURCHASES OF OUR PRODUCTS. Our future success depends on our ability to develop and manage relationships with significant customers. For the year ended December 31, 2000, our two largest customers, Marconi Communications and Cisco Systems, together accounted for approximately 29% of our net sales, with Marconi accounting for 18% and Cisco accounting for 11% of our net sales. For the six months and three months ended June 30, 2001, Marconi and Cisco, together accounted for approximately 24% and 22%, respectively, of our net sales, with Marconi accounting for 13% for each period and Cisco accounting for 11% and 9%, respectively, of our net sales. We rely on one-time purchase orders rather than long-term contracts with both Cisco and Marconi, and, as a result, we cannot predict the size, timing or terms of their incoming orders. We have experienced variations in the purchase patterns of Marconi and Cisco in the past, and we may experience continued variation in the future. Material reasons for historic variations in the purchase patterns of these customers, particularly by Marconi, have included weather patterns that have delayed field installations of systems that incorporate our products and delays by our customers in qualifying our products that employ new components or features to assure compatibility with the components of other suppliers that our customers integrate with our products into our customers' systems. The timing of this qualification process is totally within the control of these customers. Thus, even when our products prove compatible with the components of other suppliers, as has typically been the case in the past, delays by our customers in completing the qualification process has resulted in corresponding delays in our receipt of orders for them. Both Cisco and Marconi have recently announced that they expect declining revenues and profitability in the near term due to softening demand for telecommunications and networking equipment. This has resulted in reductions and rescheduling by Cisco and Marconi in purchases from their suppliers such as us as they seek to reduce their existing inventories and adjust to reduced demand in the market. This will likely result in lower sales to Cisco and Marconi, and could result in lower revenues overall. Our sales may decline significantly with resulting fluctuations or harm to our operating results and financial condition if either Cisco or Marconi cancels, reduces or delays purchases of our products or unduly delays qualifying them. WE INCURRED A NET LOSS IN THE YEAR ENDED DECEMBER 31, 2000 AND THE SIX MONTHS ENDED JUNE 30, 2001 AS A RESULT OF THE AMORTIZATION OF GOODWILL AND DEFERRED STOCK COMPENSATION FROM RECENT ACQUISITIONS AND EXECUTIVE EMPLOYMENT ARRANGEMENTS, AND AS A RESULT OF ONE-TIME CHARGES RECORDED TO REFLECT CURRENT MARKET CONDITIONS. DUE TO THE AMORTIZATION OF INTANGIBLE ASSETS AND DEFERRED STOCK COMPENSATION WE EXPECT TO CONTINUE TO INCUR NET LOSSES FOR THE FORESEEABLE FUTURE. Although we reported net income of $3.5 million and $4.2 million for the years ended December 31, 1998 and 1999, respectively, we reported a net loss of $65.0 million for the year ended December 31, 2000 and a net loss of $22.3 million for the quarter ended March 31, 2001. The net losses are due to amortization of goodwill and deferred stock compensation related to the acquisitions of Fiber Optic Communications, Optronics International and Quantum Optech and our employment arrangements with our President and Chief Executive Officer and Vice President of Finance and Chief Financial Officer. We will record amortization of intangibles, such as goodwill, and deferred stock compensation expenses relating to our acquisitions of Fiber Optic Communications, Optronics and Quantum going forward. As a consequence of these intangibles amortization charges and compensation expenses, we do not expect to report net income in the foreseeable future. In connection with the acquisitions of Fiber Optic Communications, Optronics and Quantum, we recorded a significant amount of goodwill, the amortization of which has significantly and adversely affected our operating results, which is being amortized over a five-year period. To the extent that we can not generate sufficient cash flow to recover the amount of the investment recorded, the investment may be considered impaired and could be subject to an immediate write-down of up to the full amount of the investment. In this event, our net loss in any given period could be greater than anticipated and the market price of our stock could be adversely affected. We incurred a net loss for the second quarter ended June 30, 2001 of approximately $66.0 million, which includes one-time charges totaling $41.2 million. The charges are the result of the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. These charges include the write-down of inventory of $26.1 million, asset impairment of $8.9 million, and other restructuring and non-recurring items related to the recent market conditions of $6.2 million. Furthermore, we are undertaking a formal review of the goodwill generated in our acquisitions and we may record additional impairment charges when the review is completed in the forth quarter of 2001. 15 18 OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS, AND YOU SHOULD NOT RELY ON THEM AS AN INDICATION OF OUR FUTURE PERFORMANCE. Our net sales and operating results have fluctuated significantly from quarter-to-quarter in the past and may fluctuate significantly in the future as a result of several factors, some of which are outside of our control. These factors include: - changes in our product mix, such as resulting from sales of passive components which typically have lower margins than active components; and - seasonality of customer demand typically resulting in lower demand in winter months and the observance of the Chinese New Year. - The level of demand for our customers' products 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. THE LONG SALES CYCLES FOR OUR PRODUCTS MAY CAUSE NET SALES 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 up to one year or more. In addition, some of our customers require that our products be subjected to life-time and reliability testing, which can take up to nine 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 or even cancel them. Because of the evolving nature of the optical networking market, 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. WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL SALES AND OPERATIONS THAT COULD HARM OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. For the year ended December 31, 2000 and the quarters ended March 31 and June 30, 2001, sales to customers located outside of the North America were 38%, 37% and 43%, respectfully, of our net sales. We expect that sales to customers located outside of the United States will increase in the future. Our international sales will be limited if we cannot establish relationships with international distributors, establish additional foreign operations, expand international sales channels, hire additional personnel and develop relationships with international service providers. Even if we are able to successfully continue international operations, we may not be able to maintain or increase international market demand for our products. In addition, the recent acquisition of our operations in Taiwan and People's Republic of China has increased both the administrative complications we must manage and our exposure to political, economic and other conditions affecting Taiwan and People's Republic of China. There has been significant political tension between Taiwan and People's Republic of China, which, if exacerbated, could lead to hostilities. Risks we face due to international sales and the use of overseas manufacturing include: - greater difficulty in accounts receivable collection and longer collection periods; - the impact of recessions in economies outside the United States; - unexpected changes in regulatory requirements; - seasonal reductions in business activities in some parts of the world, such as during the summer months in Europe or in the winter months in Asia when the Chinese New Year is celebrated; - certification requirements; - potentially adverse tax consequences; - unanticipated cost increases; 16 19 - unavailability or late delivery of equipment; - trade restrictions; - limited protection of intellectual property rights; - unforeseen environmental or engineering problems; and - personnel recruitment delays. In addition, a portion of our international sales and expenses may be denominated in foreign currencies in the future. Accordingly, we could experience the risks of fluctuating currencies and may choose to engage in hedging activities to reduce these risks. WE HAVE ONLY BEEN AN INDEPENDENT COMPANY FOR A SHORT WHILE AND HAVE A LIMITED HISTORY IN THE PASSIVE OPTICAL COMPONENTS MARKETS. THESE FACTORS MAY MAKE OUR BUSINESS MORE DIFFICULT TO EVALUATE AND HINDER OUR ABILITY TO IMPLEMENT OUR BUSINESS PLAN SUCCESSFULLY. From 1988 until our separation from MRV in September 2000, we operated as a division of MRV and conducted business using MRV's trade name. In March 2000, we were incorporated in Delaware as a wholly owned subsidiary of MRV. We formally separated from MRV in September 2000 and as a result of our IPO in November 2000, we became a public company. Our entire line of passive optical components was obtained through our acquisitions of Fiber Optic Communications and Quantum in April and July 2000. We expect that sales of our passive optical components will constitute a significant part of our future business. We have no history as an independent company or in operating in the passive components markets. Our lack of independence and our limited operating history in the passive optical components markets may limit your ability to evaluate our prospects due to: - our lack of historical financial data; and - our limited experience in addressing emerging trends that may affect our business. As a newly independent company with new product lines, we face risks and uncertainties relating to our ability to implement our business plan successfully. IF THE OPTICAL NETWORKING MARKET DOES NOT DEVELOP AND EXPAND AS WE ANTICIPATE, DEMAND FOR OUR PRODUCTS MAY DECLINE, WHICH WOULD NEGATIVELY IMPACT OUR NET SALES. Our business is completely dependent on the deployment of our optical component products. Our future success depends on the continued deployment of the optical networks in the metropolitan and access markets, the continuing increase in the amount of data transmitted over communications networks, or bandwidth, and the growth of optical networks to meet the increased demand for bandwidth. If the deployment of optical networks in the metropolitan and access markets does not continue to expand, the market for optical networking products may not continue to develop. Future demand for our products is uncertain and will depend to a great degree on the speed of the widespread adoption and upgrading of optical networks. If the transition to optical networks occurs too slowly, the market for our products and the growth of our business will be significantly limited. The optical networking market is new and characterized by rapid technological change, frequent new product introductions, changes in customer requirements, unpredictable rates of product deployment and evolving industry standards. Because this market is new, it is difficult to predict its potential size or future growth rate. Widespread adoption of optical networks is critical to our future success. Potential end-user customers who have invested substantial resources in their existing copper lines or other systems may be reluctant or slow to adopt a new approach, like optical networks. Our success in generating net sales in this emerging market will depend on: - maintaining and enhancing our relationships with our customers; - the awareness of potential end-user customers and network service providers about the benefits of optical networks; and - our ability to accurately predict and develop our products to meet industry standards. If we fail to address changing market conditions, the sales of our products may decline, which would harm our net sales and operating results. MACROECONOMIC FACTORS COULD AND HAVE NEGATIVELY IMPACTED OUR GROWTH PLAN. Macroeconomic factors, such as an economic slowdown in the U.S. and abroad, have detrimentally impacted demand for communications products, thereby resulting in reduced demand for optical components in general. If recent trends continue, these factors could negatively affect our ability to execute our growth plan. The unfavorable economic conditions and reduced capital spending detrimentally affected sales to service providers, network equipment companies, e-commerce and Internet businesses, and the manufacturing industry in the United States, during the last six months, and appear to 17 20 continue to affect these industries in the third quarter of 2001 and may affect them beyond the third quarter. Announcements by industry participants and observers indicate there is a slowdown in industry spending and participants are seeking to reduce existing inventories and we are experiencing such reductions in our business. This has resulted in lower demand for our products and pressures to reduce prices. As a result of these factors, our results for the quarter ended June 30, 2001 include one-time charges totaling $41.2 million, which include the write-off of inventory, purchase commitments, asset impairment, workforce reduction, restructuring costs and other non-recurring items. These charges are the result of the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. If the economic conditions in the United States continue to worsen generally or in the fiber optics equipment business particularly, or if a wider or global economic slowdown occurs, we may experience a longer-term material adverse impact on our business, operating results, and financial condition. IF WE FAIL TO MANAGE OUR GEOGRAPHICALLY DISPERSED OPERATIONS, OUR BUSINESS MAY NOT SUCCEED. Our ability to successfully offer our products and implement our business plan in a rapidly evolving market requires an effective planning and management process. We currently operate facilities in Chatsworth, California, Hsinchu, Taiwan and Shanghai, People's Republic of China. The challenges of managing geographically dispersed operations, has placed, and will continue to place, a significant strain on our management systems and resources. We expect that we will need to continue to improve our financial and managerial controls, reporting systems and procedures and continue to expand, train and manage our work force worldwide. While we are currently implementing stand-alone versions of most of the systems historically used by MRV, in some cases we have decided to purchase new systems that more closely match our business needs and have incurred some additional expense, and may incur significant additional expense, as well as diversion of management attention in connection with implementing those systems. In addition, difficulties in implementing those systems could disrupt our business and could result in an adverse impact on our business results. The failure to effectively manage our geographically dispersed operations could adversely impact our ability to manufacture and sell our products, which could reduce our net sales. OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO SUCCESSFULLY DEVELOP AND INTRODUCE NEW AND ENHANCED PRODUCTS THAT MEET THE NEEDS OF OUR CUSTOMERS. Our future success depends on our ability to anticipate our customers' needs and develop products that address those needs. Introduction of new products and product enhancements will require that we effectively transfer production processes from research and development to manufacturing and coordinate our efforts with those of our suppliers to rapidly achieve volume production. If we fail to effectively transfer production processes, develop product enhancements or introduce new products that meet the needs of our customers as scheduled, our net sales may decline. COMPETITION IN THE OPTICAL NETWORKING MARKET MAY INCREASE, WHICH COULD REDUCE OUR NET SALES AND GROSS MARGINS OR CAUSE US TO LOSE MARKET SHARE. Competition in the optical networking market in which we compete is intense. We face competition from several companies, including Agilent Technologies, Corning Incorporated, Finisar Corporation, Fujitsu, Infineon AG, International Business Machines Corporation, JDS Uniphase Corporation, Lucent Technologies, Inc., Sumitomo and Tyco International, Ltd. Many of our competitors are larger than we are and have longer operating histories and significantly greater financial, technical, marketing and other resources than we have. As a result, these competitors are able to devote greater resources than we can to the development, promotion, sale and support of their products. In addition, several of our competitors have large market capitalizations or cash reserves, and are much better positioned than we are to acquire other companies in order to gain new technologies or products that may displace our product lines. Any of these acquisitions could give our competitors a strategic advantage. Virtually all of our competitors have significantly more established sales and customer support organizations than we do. In addition, many of our competitors have much greater name recognition, more extensive customer bases, better-developed distribution channels and broader product offerings than we have. These companies can leverage their customer bases and broader product offerings and adopt aggressive pricing policies to gain market share. Additional competitors may enter the market, and we are likely to compete with new companies in the future. We expect to encounter potential customers that, due to existing relationships with our competitors, are committed to the products offered by these competitors. As a result of the foregoing factors, as well as weakening demand, we expect that competitive pressures may result in price reductions, reduced margins and loss of market share. In addition, the fiber optics networking industry is dominated by a small number of large companies and is currently consolidating. Consolidation reduces the number of potential customers in the industry, and may increase our dependence on a small number of customers. WE MUST CONTINUE TO GROW AND MAINTAIN OUR SALES ORGANIZATION IN ORDER TO INCREASE MARKET AWARENESS AND SALES OF OUR PRODUCTS OR OUR NET SALES MAY NOT INCREASE. The sale of our products requires long and involved efforts targeted at several key departments within our prospective customers' organizations. Sales of our products require the prolonged efforts of executive personnel and specialized systems and applications engineers working together with a small number of dedicated salespersons. Currently, our sales organization is limited. We will need to grow our sales force in order to increase market awareness and sales of our products, although we have no plans to do so in the short term. Competition for these individuals is intense, and we might not be able to hire the kind and number of sales personnel and applications engineers we need. If we are unable to expand our sales operations in the mid-to-long term, we may not be able to increase market awareness or sales of our products, which would prevent us from increasing our net sales. 18 21 OUR PRODUCTS ARE DEPLOYED IN LARGE AND COMPLEX SYSTEMS AND MAY CONTAIN DEFECTS THAT ARE NOT DETECTED UNTIL AFTER OUR PRODUCTS HAVE BEEN INSTALLED, WHICH COULD DAMAGE OUR REPUTATION AND CAUSE US TO LOSE CUSTOMERS. We design some of our products for deployment in large and complex optical networks. Because of the nature of these products, they can only be fully tested for reliability when deployed in networks for long periods of time. Our fiber optic products may contain undetected defects when first introduced or as new versions are released, and our customers may discover defects in our products only after they have been fully deployed and operated under peak stress conditions. In addition, our products are combined with products from other vendors. As a result, should problems occur, it may be difficult to identify the source of the problem. If we are unable to fix defects or other problems, we could experience, among other things: - loss of customers; - damage to our brand reputation; - failure to attract new customers or achieve market acceptance; - diversion of development and engineering resources; and - legal actions by our customers. The occurrence of any one or more of the foregoing factors could cause our net sales to decline. BECAUSE WE DO NOT HAVE LONG-TERM CONTRACTS WITH OUR CUSTOMERS, OUR CUSTOMERS MAY CEASE PURCHASING OUR PRODUCTS AT ANY TIME. We sell our products based on individual purchase orders, rather than long-term contracts. Our customers can generally cancel or reschedule orders on short or no notice and discontinue purchasing our products at any time. In addition, a number of our current customers were acquired through the acquisitions of Fiber Optic Communications, Optronics and Quantum, and we have only a limited history with these new customers. We cannot assure you that these customers will continue to purchase optical components from us. Because we cannot predict the size, timing or terms of incoming purchase orders, decreases in orders or failure to fulfill orders may cause our operating results to suffer. IF OUR SENIOR MANAGEMENT TEAM IS UNABLE TO WORK TOGETHER EFFECTIVELY, OUR BUSINESS MAY BE SERIOUSLY HARMED. Some of our senior management personnel only recently joined the Company. As a result, our senior management team has had limited time to work together. If they are unable to work together effectively to manage our organization as a public company, our business may be seriously harmed. WE DEPEND ON KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY CHANGING MARKET, AND IF WE ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL OR RETAIN EXISTING PERSONNEL, OUR ABILITY TO SELL OUR PRODUCTS COULD BE HARMED. Our future success depends upon the continued services of our executive officers and other key engineering, sales, marketing, manufacturing and support personnel. Any of our key employees, including our President and Chief Executive Officer and our Vice President of Finance and Chief Financial Officer may terminate his or her employment at any time. In addition, we do not have key person life insurance policies covering any of our employees. FUTURE ACQUISITIONS MAY HAVE AN ADVERSE EFFECT ON OUR FINANCIAL RESULTS OR COULD OTHERWISE HARM OUR BUSINESS. Our business has grown because of acquisitions of fiber optic components manufacturers Fiber Optic Communications in April 2000 and Optronics and Quantum in July 2000. In the event we make future acquisitions, we could: - issue stock that would dilute our current stockholders' percentage ownership; - incur debt such as the $12.6 million of consolidated debt incurred in connection with the acquisitions of Fiber Optic Communications, Optronics and Quantum; - incur additional liabilities such as the $21.2 million of additional consolidated liabilities incurred in connection with the acquisitions of Fiber Optic Communications, Optronics and Quantum; or - incur expenses related to the amortization of intangible assets and deferred compensation, like the expenses related to goodwill and other intangible assets aggregating $389.0 million and deferred compensation charges aggregating $30.2 million incurred in connection with the acquisitions of Fiber Optic Communications, Optronics and Quantum. Future acquisitions also involve numerous risks that could adversely affect our business, including: 19 22 - problems integrating the acquired operations, technologies or products; - unanticipated costs, capital expenditures or liabilities or changes related to in process research and development; - diversion of management's attention from our core business; - harm to our existing business relationships with suppliers and customers; - risks associated with entering markets in which we have no or limited prior experience; and - potential loss of key employees, particularly those of the acquired organizations. We face all of the above-mentioned risks related to the acquisitions of Fiber Optic Components, Optronics and Quantum. In particular, these acquisitions have brought large new manufacturing facilities and we face significant challenges in integrating these facilities before we can realize benefits from these acquisitions. Our entire line of passive optical components was established through our recent acquisitions of Fiber Optic Communications and Quantum and successful integration of that product line and the associated manufacturing facilities is essential to our business. We cannot assure that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future, and failure to successfully integrate them may harm our business. IF WE ARE UNABLE TO EXPAND OUR MANUFACTURING CAPACITY, EXPERIENCE DIFFICULTIES AND DISRUPTIONS IN THE MANUFACTURE OF OUR PRODUCTS, ARE UNABLE TO OBTAIN NEEDED CAPITAL EQUIPMENT, EXPERIENCE SHORTAGES IN RAW MATERIALS OR MANUFACTURING PERSONNEL OR FACE OTHER PROBLEMS OR DELAYS IN MANUFACTURING, WE MAY NOT BE ABLE TO MEET ORDERS TIMELY WHICH COULD ADVERSELY AFFECT SALES, GROSS MARGINS AND THE RESULTS OF OUR OPERATIONS. We currently manufacture a significant portion of our products in our facilities located in Chatsworth, California. We also conduct manufacturing at our facilities in Hsinchu, Taiwan and Shanghai, People's Republic of China. We could experience difficulties and disruptions in the manufacture of our products, which could prevent us from achieving timely delivery of products and could result in lost sales. We could also face the inability to procure and install additional capital equipment, a shortage of raw materials we use in our products, a lack of availability of manufacturing personnel to work in our facilities, difficulties in achieving adequate yields from new manufacturing lines and an inability to predict future order volumes. We may experience delays, disruptions, capacity constraints or quality control problems in our manufacturing operations, and, as a result, product shipments to our customers could be delayed, which would negatively impact our net sales, competitive position and reputation. If we experience disruptions in the future, it may result in lower yields or delays of our product shipments, which could adversely affect our sales, gross margins and results of operations. If we are unable to expand our manufacturing capacity in a timely manner, we will have insufficient capacity, which could seriously harm our results of operations. THE LOCATION OF OUR MANUFACTURING FACILITIES IN SOUTHERN CALIFORNIA AND TAIWAN SUBJECTS US TO INCREASED RISK THAT A NATURAL DISASTER COULD DISRUPT OUR OPERATIONS. Substantially all of our products are manufactured at our facilities in Chatsworth, California and Hsinchu, Taiwan. The risk of earthquakes in Southern California and Taiwan is significant due to the proximity of major earthquake fault lines to these manufacturing facilities. In January 1994 and September 1999, major earthquakes near Chatsworth and in Taiwan, respectively, affected the facilities of manufacturers in these areas including ours, causing power and communications outages and disruptions that impaired production capacity. While our facilities did not suffer material damage and these earthquakes did not materially disrupt our business, the occurrence of an earthquake or other natural disaster could result in the disruption of our manufacturing facilities. Any disruption in our manufacturing facilities arising from such events could cause significant delays in the production or shipment of our products until we are able to shift production to different facilities or arrange for third parties to manufacture our products. We may not be able to obtain alternate capacity on favorable terms or at all. 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, such 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. 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 six 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 20 23 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. Current softness in demand and pricing in the communications market have necessitated a review of our inventory, facilities and headcount. As a result, we recorded in the second quarter of 2001 one-time charges for the write down of inventory and inventory purchase commitments, among other things, of $41.2 million. IF WE CANNOT INCREASE OUR SALES VOLUMES, REDUCE OUR COSTS OR INTRODUCE HIGHER MARGIN PRODUCTS TO OFFSET ANTICIPATED REDUCTIONS IN THE AVERAGE SELLING PRICE OF OUR PRODUCTS, OUR OPERATING RESULTS WILL SUFFER. We have experienced decreases in the average selling prices of some of our products. We anticipate that as products in the optical networking market become more of a commodity, the average selling price of our products may decrease in response to competitive pricing pressures, new product introductions by us or our competitors or other factors. In addition, the current softness in the market could detrimentally affect our selling prices. If we are unable to offset the anticipated decrease in our average selling prices by increasing our sales volumes or product mix, our net sales and gross margins will decline. In addition, to maintain our gross margins, we must continue to reduce the manufacturing cost of our products and we must develop and introduce new products and product enhancements with higher margins. If we cannot maintain our gross margins, our financial position may be harmed and our stock price may decline. WE DEPEND ON SINGLE OR LIMITED SOURCE SUPPLIERS FOR SOME OF THE KEY COMPONENTS AND MATERIALS IN OUR PRODUCTS, WHICH MAKES US SUSCEPTIBLE TO SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR OPERATING RESULTS. We typically purchase our components and materials through purchase orders, and in general we have no guaranteed supply arrangements with any of our suppliers. We currently purchase several key components and materials used in the manufacture of our products from single or limited source suppliers, including Corning Incorporated, Mitsubishi Electric, Nippon Sheet Glass, Phillips Semiconductor and Sumitomo. If our relationship with any of these key suppliers terminates, we may not be able to find another manufacturer that can meet our specifications and anticipated supply requirements. We may fail to obtain required components in a timely manner in the future. We may experience difficulty identifying alternative sources of supply for certain components used in our products. We would experience further delays from evaluating and testing the products of these potential alternative suppliers. Furthermore, financial or other difficulties faced by these suppliers or significant changes in demand for these components or materials could limit the availability of these components. Any interruption or delay in the supply of any of these components or materials, or the inability to obtain these components and materials from alternate sources at acceptable prices and within a reasonable amount of time, would impair our ability to meet scheduled product deliveries to our customers and could cause customers to cancel orders. IF WE DO NOT ACHIEVE ACCEPTABLE MANUFACTURING YIELDS OR SUFFICIENT PRODUCT RELIABILITY, OUR ABILITY TO SHIP PRODUCTS TO OUR CUSTOMERS COULD BE AFFECTED AND OUR NET SALES MAY SUFFER. The manufacture of our products involves complex and precise processes. Changes in our manufacturing processes or those of our suppliers, or the use of defective components or materials, could significantly reduce our manufacturing yields and product reliability. Our manufacturing costs are relatively fixed, and, thus, manufacturing yields are critical to our results of operations. We may experience manufacturing problems in the future, which could result in lower than expected production yields, delayed product shipments and impaired gross margins. In some cases, existing manufacturing techniques involve substantial manual labor. In addition, we may experience manufacturing delays and reduced manufacturing yields upon introducing new products to our manufacturing lines. In order to improve our gross margins, we may need to develop new, more cost-effective manufacturing processes and techniques, and if we fail to do so, our gross margins may be adversely affected. IF OUR CUSTOMERS DO NOT QUALIFY OUR MANUFACTURING LINES FOR VOLUME SHIPMENTS, OUR OPERATING RESULTS COULD SUFFER. Generally, customers do not purchase our products, other than limited numbers of evaluation units, prior to qualification of the manufacturing line for volume production. Our existing manufacturing lines, as well as each new manufacturing line, must pass through varying levels of qualification with our customers. This customer qualification process determines whether our manufacturing lines meet the customers' quality, performance and reliability standards. If there are delays in qualification of our products, our customers may drop the product from a long-term supply program, which would result in significant lost revenue opportunity over the term of that program. Moreover, customers may require that we be registered under international quality standards, such as ISO 9000. Our Taiwan facilities have received ISO 9001 certification and our facilities in the People's Republic of China are certified ISO 9002. Our Chatsworth facilities have no ISO certification and we do not expect to receive ISO 9000 certification until sometime in 2002, at the earliest. WE WILL LOSE SIGNIFICANT CUSTOMER SALES AND OPPORTUNITIES AND MAY NOT BE SUCCESSFUL IF OUR CUSTOMERS DO NOT QUALIFY OUR PRODUCTS TO BE DESIGNED INTO THEIR PRODUCTS AND SYSTEMS. In the communications industry, service providers and communications equipment manufacturers often undertake extensive qualification processes prior to placing orders for large quantities of products such as ours, because these products must function as part of a larger system or network. Once they decide to use a particular supplier's product or component, these potential customers design the product into their system, which is known as a design-in win. Suppliers whose products or components are not designed in are unlikely to make sales to that company until at least the adoption of a future redesigned system. Even then, many companies may be reluctant to design entirely new products into their new systems, as it could involve significant additional redesign efforts. If we fail to achieve design-in wins in our potential customer's qualification process, we will lose the opportunity for significant sales to that customer for a lengthy period of time. 21 24 THE ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS MAY BE EXPENSIVE AND COULD DIVERT VALUABLE RESOURCES. 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 may need to engage in litigation to enforce our intellectual property rights, protect our trade secrets and determine the validity and scope of proprietary rights of others. Any such litigation, regardless of outcome, could be expensive and time consuming, and adverse determinations in any such litigation could seriously harm our business. WE COULD BECOME SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS, WHICH COULD BE COSTLY AND SUBJECT US TO SIGNIFICANT LIABILITY. From time to time, third parties, including our competitors, may assert patent, copyright and other intellectual property rights to technologies that are important to us. We expect we will increasingly be subject to infringement claims as the number of products and competitors in our market grows and the functioning of products overlaps. In this regard, in early 1999, we received a written notice from Rockwell Corporation in which Rockwell claimed to have patent rights in certain technology related to our metal organic chemical vapor deposition processes. Rockwell requested that we review our processes in light of one of Rockwell's issued patents, which we have done and determined that the cited patent has expired. We believe that none of our product sales relates to the Rockwell claim. In October 1999, we received a written notice from Ortel Corporation, which has since been acquired by Lucent Technologies, Inc., in which Ortel claimed to have patent rights in certain technology related to our triplexer and duplexer products. Ortel requested that we review our products in connection with one of Ortel's issued patents. We are evaluating the information provided to us thus far by Ortel and are also evaluating the validity of Ortel's patent noted in Ortel's letter. In January 2001, we were advised that Lucent had assigned certain of its rights and claims to Agere Systems, Inc., including the claim made on the Ortel patent. To date, we have not been contacted by Agere regarding this patent claim. We are presently seeking to determine whether we may have violated and the extent of our usage of, and related revenues from, technology covered by this patent. Based on our evaluation to date, we have concluded that the Ortel claim (evidently now the property of Agere) relates to an aspect of our triplexers. Net sales of our triplexers accounted for approximately 5% of total net sales during the year ended December 31, 2000. In May 2001, we received written notice from IBM, which claims that several of our optical components make use of inventions covered by certain patents claimed by IBM. We are presently seeking to determine whether we may have violated and the extent of our usage of, and related revenues from, technology covered by the IBM patents. Based on our evaluation to date, we have concluded that the IBM claim relates to certain of our transceivers. Net sales of the transceivers in question accounted for approximately 25% of total net sales during the year ended December 31, 2000. The patents of Ortel and IBM and other patents of which we are not presently aware that may relate to our products may be determined to be valid, or some of our products may ultimately be determined to infringe these patent, or those of other companies. Agere, IBM or other companies may pursue litigation with respect to these or other claims. The results of any litigation are inherently uncertain. In the event of an adverse result in any litigation with respect to intellectual property rights relevant to our products that could arise in the future, 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. In addition, litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail. Accordingly, any infringement claim or litigation against us could significantly harm our business, operating results and financial condition. In the future, we may initiate claims or litigation against third parties for infringement of our proprietary rights to protect these rights or to determine the scope and validity of our proprietary rights or the proprietary rights of competitors. These claims could result in costly litigation and the diversion of our technical and management personnel. NECESSARY LICENSES OF THIRD-PARTY TECHNOLOGY MAY NOT BE AVAILABLE TO US OR MAY BE VERY EXPENSIVE, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO MANUFACTURE AND SELL OUR PRODUCTS. From time to time we may be required to license technology from third parties to develop new products or product enhancements or to resolve infringement claims with respect to intellectual property rights in our existing products. We cannot assure you that third-party licenses such as from Rockwell, Agere or IBM 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 or to resolve infringement claims on our existing products 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 NO LONGER ABLE TO RELY ON MRV TO FUND OUR FUTURE CAPITAL REQUIREMENTS, AND FINANCINGS FROM OTHER SOURCES MAY NOT BE AVAILABLE ON FAVORABLE TERMS OR AT ALL. In the past, our capital needs were satisfied by MRV. However, as a result of our separation, MRV no longer provides funds to finance our working capital or other cash requirements. We cannot assure you that financing from other sources, if needed, will be available on favorable terms or at all. We believe our capital requirements will vary greatly from quarter to quarter, depending on, among other things, capital expenditures, fluctuations in our operating results, financing activities, acquisitions and investments and inventory and receivables management. We believe that our cash on hand and other working capital, along with cash flow from operations, will be sufficient to satisfy our working capital, capital expenditure and research and development requirements for at least the next 12 months. However, we may require or choose to obtain additional debt or equity financing in order to finance acquisitions or other investments in our business. Future equity financings would be dilutive to the existing holders of our common stock. Future debt financings could involve restrictive covenants. It is not likely that we will be able to obtain financing with interest rates as favorable as those that MRV could obtain. 22 25 OUR BUSINESS MAY SUFFER IF MRV DOES NOT COMPLETE ITS DISTRIBUTION OF OUR COMMON STOCK. MRV has announced its intention to divest its remaining equity interest in us by selling up to 18,720,000 shares of our common stock to the public and distributing the remainder of its shares of our common stock to the holders of MRV's common stock, although it is not obligated to do so. In August 2001, we registered 18,720,000 shares of our common stock on behalf of MRV in a prospectus dated August 8, 2001.. In May 2001, MRV received a private letter ruling from the Internal Revenue Service that MRV's distribution of their shares of Luminent common stock to the holders of MRV common stock will be tax-free to its stockholders and MRV for United States federal income tax purposes if the distribution occurs within one year of the IPO, i.e., by November 8, 2001. There are various conditions to the completion of the distribution, including various conditions that must be satisfied or waived by MRV, in its sole discretion, and we cannot assure you as to whether or when the distribution will occur. As described in MRV's public disclosures, these conditions include, among other things: - all required government approvals must be in effect; - MRV's redemption or repayment of its outstanding convertible subordinated notes; - no legal restraints must exist preventing this distribution; and - nothing must have happened in the intervening time between the time of our IPO and the distribution, including changes in market or economic conditions or in our or MRV's business and financial condition, that causes MRV's board of directors to conclude that the distribution is not in MRV's best interest or the best interest of MRV's stockholders. The exact distribution formula and record date to qualify for any distribution will be determined at a future date. If the distribution does occur, we may not obtain the benefits we expect as a result of this distribution, including direct access to capital markets, better incentives for employees, greater strategic focus, facilitated customer relationships and future partnerships and increased speed and responsiveness. In addition, until this distribution occurs, the risks discussed below relating to MRV's control of us and the potential business conflicts of interest between MRV and us will continue to be relevant to our stockholders. We will be controlled by MRV as long as it owns a majority of our common stock, and our other stockholders will be unable to affect the outcome of stockholder voting during such time. As a result of our IPO, MRV ownership of our shares was reduced to approximately 92% of our outstanding common stock. If MRV sells all of the shares of Luminent common stock that are the subject of a registration statement filed on behalf of MRV, MRV will own approximately 80.3% of our outstanding shares. As long as MRV owns a majority of our outstanding common stock, MRV will continue to be able to elect our entire board of directors and to remove any director, with or without cause, without calling a special meeting. Investors will not be able to affect the outcome of any stockholder vote prior to the planned distribution of our stock to the MRV stockholders. As a result, MRV will control all matters affecting us, including: - the composition of our board of directors and, through it, any determination with respect to our business direction and policies, including the appointment and removal of officers; - the allocation of business opportunities that may be suitable for us and MRV; - any determinations with respect to mergers or other business combinations; - our acquisition or disposition of assets; - our financing; - changes to the agreements providing for our separation from MRV; - the payment of dividends on our common stock; and - determinations with respect to our tax returns. 23 26 SALES OF A CONTROLLING INTEREST IN US BY MRV, OR SALES OF OUR SHARES BY MRV WHICH REDUCES ITS OWNERSHIP INTEREST IN US TO BELOW 80%, WOULD PREVENT THE PLANNED DISTRIBUTION OF OUR COMMON STOCK. MRV is not prohibited from selling any or a controlling interest in us to a third party. A sale of a controlling interest in us by MRV or sales of our shares by MRV or us which reduces MRV's ownership interest in us to below 80% (the minimum threshold to effect a tax free distribution) would prevent the distribution of our shares to MRV's shareholders as announced. Any such sales could have a depressive effect of the market price of our common stock. Moreover, because MRV can dispose of all or a portion of its ownership of our common stock at some future date, it may transfer a controlling interest in us without allowing you to participate or realize a premium. SALES OF SUBSTANTIAL AMOUNTS OF OUR SHARES BY MRV, OR EVEN THE AVAILABILITY OF SUCH SHARES FOR SALE, COULD CAUSE THE MARKET PRICE OF OUR SHARES TO DECLINE. MRV intends to offer for resale 18,720,000 of our common shares after the registration statement filed on MRV's behalf is declared effective. This represents approximately 12% of our outstanding shares as of the date of this report . 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. SO LONG AS MRV CONTINUES TO OWN MORE THAN 90 PERCENT OF OUR OUTSTANDING CAPITAL STOCK, IT MAY MERGE US INTO MRV AT ANY TIME. Because MRV may offer all or some of the shares pursuant to this prospectus, and, to our knowledge there are currently no agreements, arrangements or understandings with respect to the sale of any of the shares offered by this prospectus, we can provide no estimate as to the amount of shares that will be held by MRV after completion of this offering and MRV may continue to hold over 90 percent of our outstanding shares. Although MRV has announced plans to distribute our common stock that it owns to the holders of MRV common stock, it is not obligated to do so. It is possible that MRV may decide not to complete the distribution. Further, MRV may not sell sufficient shares pursuant to this prospectus to reduce its ownership to below 90 percent of our outstanding shares. Under Delaware law, a parent corporation that owns at least 90 percent of the outstanding capital stock of a subsidiary corporation may merge the subsidiary into the parent without the vote of the subsidiary's stockholders. Therefore, in the event MRV elects not to complete the distribution, it may merge us into itself without the vote of our stockholders. In such event, our outstanding shares of common stock would be converted into shares of common stock of MRV at an exchange ratio to be determined at the time of the transaction. Our stockholders would be entitled to appraisal rights under Delaware law, but these rights may not entitle our stockholders to receive consideration equivalent to the price they paid for our common stock. SUBSTANTIAL SALES OF COMMON STOCK MAY OCCUR IN CONNECTION WITH THE DISTRIBUTION OR OTHERWISE, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE. MRV has announced plans to distribute to its stockholders all of the shares of our common stock it owns by November 8, 2001, although it is not obligated to do so. If MRV completes the distribution, all of these shares would be eligible for immediate resale in the public market. Any sales of substantial amounts of common stock in the public market, or the perception that such sales might occur, whether as a result of this distribution or otherwise, could harm the market price of our common stock. We are unable to predict whether significant amounts of common stock will be sold in the open market in anticipation of, or following, this distribution or whether a sufficient number of buyers will be in the market at that time. AT THE TIME OF THE DISTRIBUTION BY MRV OF ITS LUMINENT COMMON STOCK, WE PLAN TO GRANT TO MRV OPTION HOLDERS OPTIONS TO PURCHASE A SUBSTANTIAL AMOUNT OF LUMINENT COMMON STOCK, WHICH WILL CAUSE DILUTION TO THE INTERESTS OF EXISTING LUMINENT STOCKHOLDERS AND MAY HAVE A DEPRESSIVE EFFECT ON THE MARKET PRICE OF LUMINENT'S COMMON STOCK. Concurrently with MRV's distribution of shares of our common stock to its stockholders, we intend to grant stock options to substantially all of the eligible employees, directors, or consultants of Luminent or MRV who hold an option to purchase MRV common stock granted prior to September 8, 2000 by MRV. We understand that MRV intends to simultaneously adjust options to purchase MRV stock to these same individuals. The MRV adjustment and our grant are intended, in the aggregate, to be in a number and at prices that will preserve the pre-distribution economic position of the options to purchase MRV stock held by these individuals on September 8, 2000. The number and exercise price of the new Luminent options to be issued will depend on the market prices of MRV's and our shares at the time of the distribution. The full exercise of these new Luminent options will dilute equity ownership of Luminent's stockholders. Further, the exercise, and even the existence of these options, could have an adverse effect on the market price of our shares. OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE REPRESENTATIVE OF OUR RESULTS AS A SEPARATE COMPANY. The historical financial information we have included herein for periods prior to January 1, 2001 has been carved out from MRV's consolidated financial statements and may not accurately reflect what our financial position, results of operations and cash flows would have been, had we been a separate, stand-alone entity during the periods presented. MRV did not account for us as, and we were not operated as, a single stand-alone entity for the periods presented prior to January 1, 2001. In addition, the historical information is not necessarily indicative of what our results of operations, financial position and cash flows will be in the future. We have not made adjustments to reflect many significant changes that will occur in our cost structure, funding and operations as a result of our separation from MRV, including changes in our employee base, changes in our tax structure, increased costs associated with reduced economies of scale, increased marketing expenses related to establishing a new brand identity and increased costs associated with being a public, stand-alone company. 24 27 WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH MRV WITH RESPECT TO OUR PAST AND ONGOING RELATIONSHIPS THAT COULD HARM OUR BUSINESS OPERATIONS. Conflicts of interest may arise between MRV and us in a number of areas relating to our past and ongoing relationships, including: - labor, tax, employee benefit, indemnification and other matters arising from our separation from MRV; - intellectual property matters; - employee retention and recruiting; - major business combinations involving us; - sales or distributions by MRV of all or any portion of its ownership interest in us; - the nature, quality and pricing of transitional services MRV has agreed to provide us; and - business opportunities that may be attractive to both MRV and us. In addition to the conflicts of interests relating to the separation of our operations from MRV as described above, we also may face business conflicts of interest with MRV because MRV and certain of its other subsidiaries are our customers. Like other customers, we do not have long-term contracts with MRV or its other subsidiaries for the purchase of our components. Because MRV controls all matters relating to us, MRV may be able to require us to enter into customer relationships with it or its other subsidiaries on terms that are less favorable to us than those we could negotiate with an unrelated customer. Nothing restricts MRV from competing with us. We may not be able to resolve any potential conflicts, and even if we do, the resolution may be less favorable than if we were dealing with an unaffiliated party. The agreements we have entered into with MRV may be amended upon agreement between the parties. While we are controlled by MRV, MRV may be able to require us to agree to amendments to these agreements that may be less favorable to us than the current terms of the agreement. OUR DIRECTORS AND EXECUTIVE OFFICERS MAY HAVE CONFLICTS OF INTEREST BECAUSE OF THEIR OWNERSHIP OF MRV COMMON STOCK. Some of our directors and executive officers have a substantial amount of their personal financial portfolios in MRV common stock and options to purchase MRV common stock. Ownership of MRV common stock by our directors and officers after our separation from MRV could create, or appear to create, potential conflicts of interest when directors and officers are faced with decisions that could have different implications for MRV and us. IF MRV'S PROPOSED DISTRIBUTION OF OUR COMMON STOCK IS NOT TAX-FREE, WE COULD BE LIABLE TO MRV FOR THE RESULTING TAXES, WHICH WOULD SIGNIFICANTLY HARM OUR BUSINESS. MRV currently plans to distribute to its stockholders the shares of our common stock that it owns by November 8, 2001. We have agreed to indemnify MRV in the event the distribution is not tax-free to MRV or its stockholders because of actions taken by us or our failure to take various actions, all as set forth in our tax sharing agreement with MRV. We may not be able to control some of the events that could trigger this liability. In particular, certain acquisitions of us by a third party within two years of the distribution could result in the distribution not being tax-free and therefore give rise to our obligation to indemnify MRV for any resulting tax or other liability. If we were to become obligated to indemnify MRV for this liability, our financial condition and business would be significantly harmed. WE ARE AT RISK OF SECURITIES CLASS ACTION 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 potential volatility of our stock price, we may be the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management's attention and resources. 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 30,000,000 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 the board of directors without further action by stockholders. The terms of any such series of preferred stock may include voting rights (including the right to vote as a series on particular matters), preferences as to dividend, liquidation, conversion and redemption rights and sinking fund provisions. No preferred stock is currently outstanding. The issuance of any such preferred stock could materially adversely affect the rights of the holders of 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. 25 28 Certain 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not hold any derivative securities. The majority of our net proceeds from the initial public offering are currently maintained by leading investment management firms in high-grade, short-term instruments that have maturities no longer than 14 months, and an average maturity of six months or less. While we believe such high-grade investments contain limited risk of loss of principal, we recognize the yield on these funds could vary depending upon market conditions. We operate on an international basis. A majority of our revenues and cost of sales are incurred in U.S. dollars. For the year ended December 31, 2000, approximately 31% and 29% of our revenues and cost of sales, respectively, were incurred in currencies other than the U.S. dollar. For the six months ended June 30, 2001, approximately 36% and 39% of our revenues and cost of sales, respectively, were incurred in currencies other than the U.S. dollar. For the year ended December 31, 2000 and the six months ended June 30, 2001, approximately 63% and 65%, respectively, of our operating expenses were incurred in currencies other than the U.S. dollar, including the non-cash charges for deferred compensation expense and goodwill amortization incurred with the foreign subsidiary acquisitions. For the year ended December 31, 2000 the New Taiwan dollar represented 87% of revenues, 88% of cost of sales, and 99% of operating expenses incurred in currencies other than the U.S. dollar. For the six months ended June 30, 2001 the New Taiwan dollar represented 97% of revenues and cost of sales, and 99% of operating expenses incurred in currencies other than the U.S. dollar. The New Taiwan dollar has been relatively stable in relation to the U.S. dollar in recent years, and accordingly, we have not experienced any significant fluctuations in operating results due to exchange rate fluctuations in the New Taiwan dollar in relation to the U.S. dollar, however, we cannot guarantee the same stability in the future. The following provides an example of how fluctuations in the New Taiwan dollar would affect our overall revenues and cost of sales based on the December 30, 2000 U.S. to New Taiwan dollar exchange rate of 33.17. We estimate that a hypothetical 10% decrease in the New Taiwan dollar exchange rate would result in our recognizing an increase of $3.4 million in our total revenues and an increase of $2.5 in our total cost of sales. We estimate that a hypothetical increase of 10% in the New Taiwan dollar exchange rate would result in our recognizing a decrease of $3.1 million in our total revenues and a decrease of $2.3 million in our total cost of sales. Fluctuations in the value of the currencies in which we conduct our business relative to the U.S. dollar will cause U.S. dollar translation of such currencies to vary from one period to another. We cannot predict the effect of exchange rate fluctuations upon future operating results. However, because we have expenses as well as revenues in each of the principal functional currencies, the exposure to our financial results to currency fluctuations is reduced. We have not historically attempted to reduce our currency risks through hedging instruments, however, we may do so in the future. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In the future, we may become involved in litigation relating to claims arising from our ordinary course of business which could have a material adverse effect on our business or results of operations. Other than the legal proceedings described below, we are currently not a party to any legal proceedings we reasonably expect could have a material adverse effect on our business or results of operations. From time to time, however, third parties, including our competitors, may assert patent, copyright and other intellectual property rights to technologies that are important to us. In early 1999, we received a written notice from Rockwell Corporation in which Rockwell claimed to have patent rights in certain technology related to metal organic chemical vapor deposition processes. Rockwell requested that we review our processes in light of one of Rockwell's issued patents. In the spring of 2000, we began to review Rockwell's claim in detail and thereafter determined that the patent upon which Rockwell based its claim expired in January 2000. This limits the scope of Rockwell's claim to damages, if any, for matters arising prior to expiration of the patent. MRV has agreed to indemnify us from any damages resulting from such claims. We are presently seeking to determine the validity of Rockwell's patent, whether the processes we have employed violated the patent, if valid, and the extent of our usage of, and related revenues derived from, the process covered. In October 1999, we received a written notice from Ortel Corporation, which has since been acquired by Lucent Technologies, Inc., in which Ortel claimed to have patent rights in certain technology related to our triplexer and duplexer products. Ortel requested that we review our products in connection with one of Ortel's issued patents. In August 2000, Lucent provided us the first detailed information concerning the basis of Ortel's patent claim and is continuing to provide follow-up information on the claim. We are also evaluating the validity of Ortel's patent and claim. We are presently seeking to determine whether we may have violated the patent and the extent of our usage of, and related revenues derived from, technology covered by Ortel's patents. See WE COULD BECOME SUBJECT TO LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS, WHICH COULD BE COSTLY AND SUBJECT US TO SIGNIFICANT LIABILITY under the RISK FACTORS section, above. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS RECENT SALES OF UNREGISTERED SECURITIES In connection with our incorporation and organization, in March 2000, we issued 1,000 shares of common stock to MRV for an aggregate offering price of $1,000. In July 2000, we effected a 144,000-for-one stock split of our outstanding common stock. We believe that the initial issuance was exempt under Section 4(2) of the Securities Act as a transaction not involving any public offering. We believe that the stock split was either not a "sale" of securities pursuant to the Securities or exempt under Section 3(a)(9) of the Securities Act. No underwriters were involved in connection with the sale of securities referred to in the paragraph above. MRV represented its intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were affixed to the share certificates and instruments issued. MRV had adequate access, through its relationships with us, to information about us. USE OF PROCEEDS 26 29 Our registration statement on Form S-1 filed under the Securities Act of 1933, Commission File No. 333-42238, was declared effective by the Commission on November 9, 2000. A total of 13,800,000 shares of our common stock were registered pursuant to this registration statement, including 1,800,000 that were subject to the underwriters' over allotment option which was not exercised. The aggregate price of the offering amount registered was $207,000,000. The managing underwriters for the offering were Credit Suisse First Boston Corporation, CIBC World Markets Corp., Robertson Stephens, Inc., U. S. Bancorp Piper Jaffray, Inc. and First Security Van Kasper, Inc. The offering was completed on November 9, 2000. We sold 12,000,000 registered shares at an initial public offering at an aggregate offering price of $144,000,000 or $12.00 per share. From November 9, 2000 to June 30, 2001, the aggregate underwriting discounts paid in connection with the offering was $10.1 million. We estimate that other expenses of the offering total $1.6 million. The net proceeds from the offering, after deducting the underwriting discount and the estimated offering expenses to be paid by us, were approximately $132.3 million. The net proceeds will be used for general corporate purposes, including capital expenditures and working capital. Pending these uses, the net proceeds have been invested in interest bearing, investment grade securities. None of the net proceeds of the offering have been paid, directly or indirectly, to any of our directors or officers or any of their associates, to any persons owning 10% or more of our common stock, or to any of our affiliates. ITEM 3. DEFAULTS UPON SENIOR SECURITIES NONE. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 27 30 ITEM 5. OTHER INFORMATION LUMINENT, INC. PRO FORMA(1) CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (in thousands, except per share data) (unaudited)

--------------------- (1) Pro forma statements exclude the non-cash charges recorded for the amortization of goodwill and deferred stock compensation related to the acquisitions of Fiber Optic Communications, Optronics, and Quantum; our employment arrangements with two of our executives; and the one-time restructure and other charges recorded as a result of the lower demand for our products and pricing pressures stemming from the continuing downturn in the communications equipment industry generally and the optical components sector in particular. The provision for income tax is computed using the statutory rates for each entity. 28 31 ITEM 6. EXHIBITS AND REPORTS ON FORM 8K (a) Exhibits. The following Exhibits are included as part of this report.

29 32 S-1, File No. 333-42238, on July 26, 2000). 10.10 First Amendment to Employment Agreement dated as of July 11, 2000 between William R. Spivey and the Registrant (incorporated by reference to Exhibit 10.10 filed with our Registration Statement on Form S-1, File No. 333-42238, on September 13, 2000). 10.11 Form of Indemnification Agreement (incorporated by reference to Exhibit 10.11 filed with our Registration Statement on Form S-1, File No. 333-42238, on September 13, 2000). 10.12 Stock Purchase Agreement by and between MRV Communications, Inc. ("MRV") and the shareholders of Fiber Optic Communications, Inc. ("FOCI"), dated February 21, 2000 (incorporated by reference to Exhibit 2.1(a) of the Form 8-K of MRV filed with the SEC, File No. 001-11174, on May 9, 2000). 10.13 Escrow Agreement dated as of 21st day of February, 2000, by and among MRV, the Selling Shareholders of FOCI and the law firm of Baker & McKenzie, Taipei Office (incorporated by reference to Exhibit 2.1(b) of the Form 8-K of MRV filed with the SEC, File No. 001-11174, on May 9, 2000). 10.14 Addendum to Stock Purchase Agreement dated as of April 14, 2000 by and among FOCI, Registrant and the selling shareholders of FOCI (incorporated by reference to Exhibit 2.1(c) of the Form 8-K of MRV filed with the SEC, File No. 001-11174, on May 9, 2000). 10.15 Addendum to Escrow Agreement dated as of April 14, 2000 by and among FOCI, Registrant and the selling shareholders of FOCI (incorporated by reference to Exhibit 2.1(d) of the Form 8-K of MRV filed with the SEC, File No. 001-11174, on May 9, 2000). 10.16 Addendum No. 2 to Escrow Agreement dated as of June 26, 2000 by and among FOCI, MRV and the selling shareholders of FOCI (incorporated by reference to Exhibit 2.1(d) of the Form 8-K/A of MRV filed with the SEC, File No. 001-11174, on July 7, 2000). 10.17 Addendum No. 2 to Stock Purchase Agreement dated as of June 26, 2000 by and among FOCI, MRV and the selling shareholders of FOCI (incorporated by reference to Exhibit 2.1(e) of the Form 8-K/A of MRV filed with the SEC, File No. 001-11174, on July 7, 2000). 10.18 Memorandum of Understanding dated as of June 26, 2000 between MRV and the remaining shareholders of FOCI (incorporated by reference to Exhibit 2.1(f) of the Form 8-K/A of MRV filed with the SEC, File No. 001-11174, on July 7, 2000). 10.19 Stock Purchase Agreement by and between MRV and the shareholders of Optronics International Corp. ("OIC") dated April 23, 2000 (incorporated by reference to Exhibit 10.19 filed with our Registration Statement on Form S-1, File No. 333-42238, on July 26, 2000). 10.20 Escrow Agreement, dated as of the 23rd day of April 2000, by and among MRV, the selling shareholders of OIC and the law firm of Baker & McKenzie, Taipei Office (incorporated by reference to Exhibit 10.20 filed with our Registration Statement on Form S-1, File No. 333-42238, on July 26,

30 33 2000). 10.21 Stock Purchase Agreement by and between MRV and the shareholders of Quantum Optech Inc. ("QOI") dated April 26, 2000 (incorporated by reference to Exhibit 10.21 filed with our Registration Statement on Form S-1, File No. 333-42238, on July 26, 2000). 10.22 Escrow and Stock Pledge Agreement dated as of April 26, 2000 by and between MRV and certain shareholders of QOI (incorporated by reference to Exhibit 10.22 filed with our Registration Statement on Form S-1, File No. 333-42238, on July 26, 2000). 10.23 Addendum to Stock Purchase Agreement made as of June 16th, 2000 by and among MRV, QOI and shareholders of QOI (incorporated by reference to Exhibit 10.23 filed with our Registration Statement on Form S-1, File No. 333-42238,on July 26, 2000). 10.24 Addendum to Escrow and Stock Pledge Agreement dated as of June 16, 2000 by and between MRV and certain shareholders of QOI (incorporated by reference to Exhibit 10.24 filed with our Registration Statement on Form S-1, File No. 333-42238, on July 26,2000). 10.25 Underwriting Agreement dated as of November 9, 2000 by and between MRV, the Registrant and Credit Suisse First Boston Corporation, acting on behalf of themselves and as the Representatives of the several Underwriters (incorporated by reference to Exhibit 10.25 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.26 Master Separation and Distribution Agreement dated as of July 25, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 2.1 filed with out Registration Statement on Form S-1, File No. 333-42238, on July 26, 2000). 10.27 Amendment to Master Separation and Distribution Agreement dated as of September 8, 2000, between MRV and the Registrant (incorporated by reference to Exhibit 10.27 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.28 General Assignment and Assumption Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.28 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.29 Master Technology Ownership and License Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.29 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.30 Employee Matters Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.30 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.31 Real Estate Matters Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.31 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.32 Master Transitional Services Agreement dated as of September 8, 2000 between MRV and the Registrant

31 34 (incorporated by reference to Exhibit 10.32 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.33 Master Trademark Ownership and License Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.33 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.34 Master Patent Ownership and License Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.34 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.35 Indemnification and Insurance Matters Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.35 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.36 Master Confidential Disclosure Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.36 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.37 Tax Sharing Agreement dated as of September 8, 2000 between MRV and the Registrant (incorporated by reference to Exhibit 10.37 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.38 Employment Agreement dated September 25, 2000 between James S. Locke and the Registrant (incorporated by reference to Exhibit 10.38 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.39 Employment Agreement dated October 16, 2000 between Monika Arboles, Esq. and the Registrant (incorporated by reference to Exhibit 10.39 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.40 Employment Agreement dated November 9, 2000 between Glenn A. Weinman, Esq. and the Registrant (incorporated by reference to Exhibit 10.40 filed with our 10-K, File No. 000-31393, on April 2, 2001). 10.41 Employment Agreement dated April 23, 2001 between Aaron Uri Levy and the Registrant (incorporated by reference to Exhibit 10.41 filed with our 10-Q, File No. 000-31393, on May 15, 2001). 10.42 Lease Agreement dated January 30, 2001 between Abronson, Cole & Eisele, a California General Partnership and the Registrant (incorporated by reference to Exhibit 10.42 filed with our 10-Q, File No. 000-31393, on May 15, 2001). 21.1 List of Registrant's Subsidiaries (incorporated by reference to Exhibit 21.1 filed with our Registration Statement on Form S-1, File No. 333-42238, on September 13, 2000).

(b) Reports on Form 8-K. No reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this Report. 32 35 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"), the Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Chatsworth, State of California, on August 14, 2001. LUMINENT, INC. By: /s/ WILLIAM R. SPIVEY ---------------------------------- William R. Spivey, President and Chief Executive Officer By: /s/ ERIC I. BLACHNO ---------------------------------- Eric I. Blachno, Vice President, Finance and Chief Financial Officer 33

LUMINENT INC 10-Q