10-K 1 mrv-20141231x10k.htm 10-K MRV-2014.12.31 - 10K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
FORM 10-K
_______________________
(Mark One)
 
x
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2014
OR
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _____________ t o _____________                                        

Commission file number: 001-11174
 
MRV COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware
06-1340090
(State or other jurisdiction of
(I.R.S. employer
incorporation or organization)
identification no.)

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

(818) 773-0900
(Registrant's telephone number, including area code)


Securities registered pursuant to Section 12(b) of the Exchange Act: None    
Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $0.0017 par value
Indicate by check mark whether the Registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes o No x
Indicate by check mark whether the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act of 1934. Yes o    No x
Indicate by check mark, whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No o
Indicate by check mark, whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files.) Yes x    No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405) is not contained herein, and will not be contained to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
 
Accelerated filer x
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No x
The aggregate market value of the Registrant's Common Stock held by non-affiliates based upon the closing price of a share of the Registrant's Common Stock on June 30, 2014 (based upon the closing sale price of such shares on the NASDAQ on June 30, 2014) was $111,708,379. The number of shares of Common Stock, $0.0017 par value, outstanding as of March 9, 20157,089,264.

DOCUMENTS INCORPORATED BY REFERENCE
If the Registrant files a definitive Proxy Statement relating to its next Annual Meeting of Stockholders on or prior to 120 days after the end of the fiscal year for which this report relates, portions of the Proxy Statement will be incorporated by reference into Part III of this Annual Report on Form 10-K where indicated. However, if this Proxy Statement is not filed within that time period, we will file an amendment to this Annual Report with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.




MRV Communications, Inc.

Annual Report on Form 10-K

For the Year Ended December 31, 2014

Table of Contents

 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




PART I
Item 1.    Business.
Company Background
MRV Communications, Inc. ("MRV" or the "Company"), through our business units, is a global provider of telecommunications devices and systems that feature converged packet and optical solutions that empower the optical edge and network integration services for leading communications service providers and enterprises. For more than two decades, the most demanding service providers, Fortune 1000 companies and governments worldwide have trusted MRV to provide best-in-class solutions for their mission-critical network operations. We help our customers overcome the challenge of orchestrating the ever-increasing need for capacity while improving service delivery and lowering network costs for critical applications such as cloud connectivity, high-capacity business services, mobile backhaul and data center connectivity.
MRV was organized in July 1988 as MRV Technologies, Inc., a California corporation. In April 1992, we reincorporated in Delaware and changed the company name to MRV Communications, Inc.
We operate in two reporting segments. Our Network Equipment segment includes two business units: our Optical Communications Systems division ("OCS"), and Appointech, Inc. ("Appointech"). Our Network Integration segment includes one business unit: Tecnonet S.p.A. ("Tecnonet").
Network Equipment:

OCS is headquartered in the United States and provides a comprehensive portfolio of packet and optical solutions enabling the access, aggregation, transport, and management of various communications traffic for fixed line, cable, content delivery, cloud-based and mobile communications networks leveraging both direct and channel sales through third party channel partners. As of December 31, 2014, OCS had 264 employees.
OCS is focused on the development of scalable optical edge solutions that combine packet and optical technologies and sophisticated network management software. Our optical metro edge solutions help our customers to generate more revenues from their networks and offer new differentiated services along with reductions in operational costs through automation, scale and infrastructure layer convergence.
Network Infrastructure management: Our infrastructure management solutions, which are part of our OCS division, complement our optical communications products and enable focused solutions for network monitoring and lab automation for equipment manufacturers, large networks, and network solutions providers. Our test management and automation products are designed to increase the efficiency in the test lab environment, enabling more tests in less time with fewer resources. Remote control and management of cable topologies, lab devices, and power distribution optimize the lab for responsiveness and help our customers get the most effective use of capital expenditures.
Appointech is based in Taiwan and provides high quality design and cost-effective manufacturing of fiber optic modules for the fiber-optic communications industry. As of December 31, 2014, Appointech had 13 employees.
Network Integration:
With best-in-class equipment, hardware and software offerings, the Network Integration segment provides end-to-end solutions including consulting, installation and support and managed services for fixed line, cable and mobile communications networks. Our Network Integration subsidiary, Tecnonet, is an Italian supplier of a wide range of communications equipment from leading global manufacturers, as well as telecommunications solutions and services, including network infrastructure, unified communications, mobility and wireless, network security, cloud computing services, managed call center services, network integration, and optimization serving the Italian market. As of December 31, 2014, Tecnonet had 168 full-time employees and 57 temporary employees.
On December 2, 2011, we announced that we entered into a stock purchase agreement with CES Holding SA, as purchaser, represented for purpose of the agreement by Vinci Capital Switzerland SA, for the sale of our former wholly-owned Swiss subsidiary, CES Creative Electronic Systems SA ("CES"). The sale of CES was subject to stockholder approval, which was obtained on January 9, 2012 and the sale was completed on March 29, 2012.

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On October 12, 2012, we sold all of the issued and outstanding capital stock of our former wholly-owned operating subsidiary, Alcadon-MRV AB ("Alcadon").
On October 16, 2012, we sold all of the issued and outstanding capital stock of our former wholly-owned operating subsidiary, Pedrena Enterprises B.V. ("Pedrena"). Pedrena is the parent company of Interdata, and Interdata in turn is the parent company of J3TEL.
The historical financial results of each of CES, Alcadon, and Pedrena prior to the date of sale were reclassified as discontinued operations for all periods presented. Cash flows from discontinued operations are presented combined with the cash flows from continuing operations in the accompanying Consolidated Statements of Cash Flows.
Industry Background
Network Equipment
Telecommunications networks are evolving to support the increasing demand for high-bandwidth applications such as mobile services, Internet Protocol video services, or "IP-video," peer-to-peer networking, content-rich, transactional websites and cloud services. Connectivity is now vital to daily life and many providers are emerging from content delivery, social networks, data centers and application service providers, in addition to traditional telecommunications companies. The growth in new applications and services is driving the need for flexible service capability and additional bandwidth capacity in many portions of the world's networks. This significant transformation is most evident in metro networks, where the business models of traditional communications providers continues to be challenged to offer new differentiated services in a cost-effective and efficient manner. To meet this demand, our customers are upgrading their legacy network infrastructure with new optical communications solutions to broaden their service offerings and improve management and automation, resulting in increased capacity and efficiency focusing on lower total cost of ownership of their networks.
Through our global MRV-branded OCS business unit and our Network Integration business unit in Italy, we provide a broad array of product and service offerings, including integrated packet and optical equipment and services connecting communication networks that transport digital data, voice and video across metropolitan and regional networks. OCS comprehensive product portfolio for metro networks enable the delivery of new generation high-capacity services over any fiber infrastructure, facilitating network transformation and increasing efficiency, while reducing complexity and costs. As a pioneer and technological leader for over 25 years, OCS has established a reputation for high quality and is an established brand among multinational and regional telecommunications service providers, wireless backhaul operators, content providers, MSOs, Fortune 1000 companies and governments worldwide. OCS's product portfolio of packet and optical platforms places it at the nexus of two important trends in networking today: the convergence of optical and packet networking and the extension of fiber-based networking technologies to connect the end user to content and interconnect data intensive cloud traffic from data centers to data centers.
OCS's comprehensive portfolio of field-proven packet and optical products, along with decades of experience and established relationships with communications service providers, position MRV as a leading vendor in optical networking convergence. Our optical communications systems empower digital network transformation in access and metro networks, enabling convergence of historically separated transport technologies to expand capacity and provide the packet-level intelligence needed to support today's services.
We believe the long-term growth of metro networking investments and the demand for our optical products will be fueled by the increasing demand for more bandwidth capacity, higher connection speeds, and more service flexibility. The massive proliferation of video media creation and sharing, the shift to mobile and the rise of cloud-based services and remote data storage networks are collectively driving exponential growth in bandwidth consumption.
In a report issued on June 10, 2014, Cisco Systems, Inc. ("Cisco") estimated that metro traffic will surpass long-haul traffic in 2015, and will account for 62% of total IP traffic by 2018. Metro traffic will grow nearly twice as fast as long-haul traffic from 2013 to 2018. The higher growth in metro networks is due to the increasingly significant role of content delivery networks, which bypass long-haul networks and deliver traffic to metro and regional backbones.
As a result of ongoing bandwidth demand and network architectural changes, Communication Service Providers ("CSPs") are upgrading their metro network infrastructure. Further fueling this investment is the growing competition among wireless service providers, wireline telecom providers, cable, Multiple System Operator's ("MSOs") and Over the Top providers to penetrate each other's incumbent markets. Global telecom services continue to be the largest portion of information technology ("IT") spending. Gartner, Inc., a market research company in the telecommunications industry, forecasts that of the estimated $3.8 trillion in total worldwide IT spending in 2014, telecommunications services are expected to represent $1.742 trillion, a rise of 2.4% over the $1.701 trillion in 2013.

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To improve network capacity and provide the packet-level intelligence needed in the wireless and wireline last mile, CSPs are converging historically separate network technologies. Ethernet technology has long been deployed within enterprises. Over the past several years Carrier-grade Ethernet has been implemented by CSPs in metro area networks ("MANs") as a result of improved quality-of-service, reliability and inclusion of features traditionally found in SONET or ATM based equipment. By keeping traffic packetized, CSPs provide customers with improved network utilization and value-added managed services in addition to raw transport or bandwidth. Carrier Ethernet devices, such as those offered by OCS, provide CSPs a scalable and cost effective way to improve traffic handling within the metro access network and demarcation points while grooming the traffic being routed into the core network. By managing traffic effectively at the metro edge of the network, service providers can reduce the number of core router ports needed, leading to significant cost savings. In a report issued on September 30, 2014, Infonetics Research forecasts that the Ethernet over fiber access device market is projected to reach $976 Million in 2018, with a compound annual growth rate ("CAGR") from 2013-2018 of 7.65%.
Similarly, Optical Transport technology, historically deployed deep within the core of CSPs' networks, has been pushed out to the metro and access areas of the network, reflecting both the increased need for bandwidth and the improved price-performance characteristics of optical networking gear. Additionally, metro optical build-outs by communications providers are anticipated to keep up with the local demand for cloud-based business and consumer services and data center interconnects.
Optical Transport refers to the transmission of digital data over optical wavelengths through a fiber optic cable and can scale to Terabits of traffic over single fiber strand. One of the more common techniques utilized for Optical Transport optimization is Wave-Division Multiplexing (WDM). Multiple wavelengths are combined, or multiplexed, utilizing different wavelengths of light as individual communications transport channels, and passed through a single optical fiber. To more efficiently utilize the fiber infrastructure, CSPs have increased, and continue to increase, the transmission speeds from 1Gbps to 10Gbps to 40Gbps and to 100Gbps. In addition, up until recently, optical networks were static with fixed wavelength transponders, fixed multiplexing, and fixed, non-optimal assignment of packet services over lightpaths. However, new advances in optical technology can allow network operators to configure and automate the optical layer. Using these programming capabilities, the Reconfigurable Optical Add Drop Multiplexes, or ROADM-based dynamic optical transport solutions are essential for network applications were changeable traffic patterns and projections make advance wavelength planning difficult or where network demands make static wavelength designed inefficient. According to Infonetics Research (Optical hardware Market Share and Forecast 2014), the WDM metro market is projected to reach $7.2 Billion in 2018, with a compound annual growth rate ("CAGR") from 2013-2018 of 9.6%.
Mobility continues to be an influential theme within communications, as the number of connected devices rises and the usage of such devices expands. According to Cisco's Visual Networking Index ("VNI") published on February 5, 2014, by the end of 2018, the number of mobile-connected devices will be 1.4 times greater than the number of people on earth. There will be over 10 billion mobile-connected devices in 2018, including machine-to-machine modules-exceeding the world's population at that time (7.6 billion). Moreover, new data-enabled mobile computing devices such as laptops, tablets, and smart phones carry a much higher usage profile and require faster access speeds compared with legacy devices. Consumer video content sharing and the rise of mobile oriented online services and cloud-based services are driving mobile data traffic. According to Cisco's VNI, global mobile data traffic is expected to grow at a 61% compound annual growth rate (CAGR) from 2013 to 2018, three times faster than the growth of global IP fixed traffic during the same period. By 2018, global mobile data traffic will reach 15.9 exabytes monthly, or a run rate of 190 exabytes annually. The use of fiber as a backhaul medium is also increasing due to its advantages of high speed throughput and long transport distance. 

Network Integration

According to the Assinform, a national association of IT companies in Italy, the Italian Information and Communication Technology ("ICT") market is comprised of two major segments: (i) the IT segment, which includes IT services, software, technical assistance and hardware, and (ii) the telecommunication segment, which includes mobile and fixed phone services. The IT segment of the ICT market has three sub-segments: (i) services, (ii) software, and (iii) hardware and technical assistance. Our European business unit competes only in the IT services market. The major carriers we serve within the Italian ICT market are engaged in significant contracts with the Italian government to provide support and expand and modernize the Italian communication infrastructure. Due to the life cycle of these government contracts, companies, such as MRV, that partner with these major carriers require a significant commitment of working capital to fund these projects to maturity. The market is highly competitive and price sensitive requiring businesses to operate with a highly efficient support structure.

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Markets Served
MRV primarily serves the following markets:
Telecommunications Service Providers
Our telecommunications service provider customer base includes international, national and regional telecommunications carriers, both wireline and wireless. Telecommunications service providers are under increasing competitive pressure, primarily from emerging competitors that offer similar services at competitive prices. Additionally, as the Internet has become ubiquitous and the consumers significantly more mobile, providers of content delivery and cloud-based services are driving the need for more flexible high bandwidth applications. Our products and services enable both established and emerging telecommunications service providers to transition their existing network infrastructures to deliver a broader mix of higher bandwidth services to consumers and enterprises. We provide products that enable telecommunications service providers to support demand for video delivery, broadband data and video and wireless broadband services. Additionally, we enable these telecommunications service providers to sell wholesale services to each other thereby building wider network access for the end user.
Content Providers and Data Center Operators
Among our customers are leading content providers and data center operators. This market segment includes a wide range of data centers, including co-location companies, Internet exchange centers, web service companies, cloud & content providers, and large enterprises. These customers are witnessing an increased demand for flexible bandwidth between sites. Driven by the ever-growing use of streaming video services (enterprise demand for cloud services as well as the virtualization of data center operations) data center operators are faced with the challenge of quickly connecting large campuses with very high bandwidth across metro and regional distances. The data center market is an important growth area also for traditional service providers and for enterprises that continue to transition towards cloud services. Cloud services are an important offering for service providers to enable them to retain customers and as a source of revenue in a market segment that will expand for many years to come. In light of these facts, we see this market segment as a guiding reference to service provider market.
Cable Operators/Multiple System Operators
Our customers include leading cable and multiple system operators in the United States and internationally. These customers rely upon us for a wide range of products including Carrier-grade, optical Ethernet transport and switching equipment. Our networking products allow our cable operator customers to integrate voice, video and data applications over a converged packet-optical infrastructure. This enables our customers to grow bandwidth capacity and lower the operational expense of supporting disparate networks. By enabling this network convergence, cable operators can expand their end user offerings to include high-value service bundles. Our products support key cable applications including broadcast video, Voice over Internet Protocol ("VoIP"), video on demand, broadband data services and services for enterprises.
Network Equipment Manufacturers
Our network equipment manufacturer customers incorporate our infrastructure management and automation products to increase the efficiency in the test lab environment enabling more tests in less time with fewer resources and with added flexibility.
Enterprise/Educational Institutions
Our enterprise customers include small to large commercial organizations from every industry with IT requirements, including end users in the healthcare, financial, retail, industrial and technology industries, as well as schools and universities. We offer equipment and services focused on key enterprise applications including data center connectivity, local area network ("LAN") consolidation and storage extension for business continuance and disaster recovery. Our products enable inter-site connectivity between data centers, sales offices, manufacturing plants, and research and development centers, using private fiber infrastructure or external service provider networks. We also enable our enterprise customers to meet increasing demand for high availability, globalization, and the spread of IT to distributed branches, by preventing unexpected downtime and improving the safety, security and availability of their IT infrastructure.

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Government

Our government customers include federal, state and local agencies in the United States and internationally. Our customers include domestic and international defense agencies, public administrations and municipalities. Our solutions are used to provide high bandwidth, managed and flexible connectivity within their networks and to their end users.

Major Customers

As of December 31, 2014 and 2013, amounts due from Telecom Italia S.p.A. and FastWeb S.p.A., Network Integration segment customers, accounted for 34% and 49% of our consolidated gross accounts receivables, respectively. Revenue from FastWeb S.p.A., accounted for 24%, 28% and 29% of our consolidated revenues for the years ended December 31, 2014, 2013 and 2012, respectively. Revenue from Telecom Italia S.p.A., accounted for 16%, 14% and 13% of our consolidated revenues for the years ended December 31, 2014, 2013 and 2012, respectively.

Products and Services

Our comprehensive portfolio of field-proven optical communications solutions empower digital network transformation in access and metro networks, enabling convergence of historically separate Ethernet and Optical Transport technologies to expand capacity and provide the packet-level intelligence needed to support today's services. MRV Optical and Packet products can be used as complete solution to design metro service network, or as independent elements as part of large heterogeneous network with field-proven interoperability.

Our products and services include:

Optical Transport products;
Carrier Ethernet products;
Network management products;
Infrastructure management products; and
Network integration and services.
Optical Transport Products
Optical Transport refers to the transmission of data signals through a fiber optic cable. One of the more common techniques utilized for Optical Transport optimization is WDM. Multiple wavelengths are combined, or multiplexed, utilizing different wavelengths of light as individual communications transport channels, and passed through a single optical fiber. MRV's Optical Transport portfolio addresses the rapidly increasing demand for transport capacity, multiple services and end-to-end management to the network optical edge enabling access, metro and long-haul optical communications. With the integration of WDM and Ethernet packet functionality, MRV is delivering advanced packet-optical transport solutions. MRV’s best-of-breed optical transport proposition provides a scalable and flexible Optical Transport solution with a robust and simplified system architecture that provides entry level access platforms to high-end solutions that can support up to 8 Tbps per fiber pair. MRV's optical transport portfolio offers a pay-as-you-grow cost-effective business model to meet the significantly increasing bandwidth demands in today’s networks.  Our products provide carriers, enterprises, data center and Internet exchange providers with a comprehensive solution that features simplicity, compact size, low latency small foot print and low power consumption. 

OptiDriver® is the most recent addition to MRV’s comprehensive family of advanced optical transport network elements. Designed to offer the industry’s highest density 10Gbps and 100Gbps transport, with more than 80 wavelengths in only 10RU, OptiDriver is engineered to support the latest advances in optical technologies, including intelligent optical automated ROADM networks and 100Gbps transport. OptiDriver is designed from the ground up to reduce the capital costs and operational expenses of our customers. A flexible shelf and component architecture dramatically lowers initial and ongoing hardware costs, simplifies operations, and minimizes power and space requirements. Multifunction hardware allows a minimum number of components to serve the maximum variety of applications, including Ethernet, OTN, TDM (T1/E1 to 100G), Fibre Channel, ESCON/FICON, Infiniband, and others. Built-in testing and rapid turn up features lower the operational cost of installation and significantly decrease time to revenue. OptiDriver is fully integrated into MRV’s advanced Pro-Vision® service provisioning and management software, which operates seamlessly in a mixed network of MRV’s Optical and Carrier Ethernet systems. As the Company's next generation optical transport product, OptiDriver® is intended to ultimately replace the Company's LambdaDriver® and FiberDriver® products.

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LambdaDriver® has been OCS’s premiere optical transport system for building high-performance enterprise access, metropolitan carrier and long haul transport networks. The LambdaDriver is a multi-functional, compact, modular WDM system that supports both dense and coarse WDM technology. LambdaDriver also serves as a packet optical transport system by integrating Carrier Ethernet connection-oriented services and ROADM for automated optical mesh topologies with wavelength-level switching. The LambdaDriver series can support data rates from 8 Mbps up to 40 Gbps with future upgrade-path to 100 Gbps.

The Fiber Driver® optical multi-service access product line provides a full range of services including demarcation, media conversion, signal repeating and fiber-optimization solutions. The Fiber Driver line includes several families of products with the flexibility for any type of optical or copper technology, covering virtually every protocol in use in networking today.

Packet/Carrier Ethernet Products
Carrier Ethernet service growth is driven by the fact that many service providers and organizations seek to reduce their network costs and improve their service flexibility. Customers and service providers get a better per-bit cost for Ethernet services and enjoy the scalability over fiber optic network. The maturity of carrier Ethernet technology and massive infrastructure changes from legacy to next generation packet network requires highly intelligent demarcation and first mile aggregation equipment to serve both wireline and wireless/mobile services.
The OptiSwitch® Carrier Ethernet service demarcation and first-mile aggregation series delivers best-of-breed capabilities that enable carriers and service providers to deliver assured SLA services that create new revenue streams with a rapid return on investment. Major Tier-1 service providers have deployed OptiSwitch in their networks and will benefit from the new standardized Carrier Ethernet 2.0 features, including multi class of service, interconnect and manageability. These features are critical for enabling high-revenue services like LTE 4G mobile backhaul, business Ethernet services and cloud access services. An integral part of the OptiSwitch CE 2.0 solution is MRV's Pro-Vision®, an industry recognized and award-wining Service Provisioning and Management software, that enables carriers to simplify Ethernet service delivery, accelerate time-to-market for new applications and provides centralized service visibility, intelligence along with substantial OPEX reduction.
OptiPacket® is the most recent addition to MRV’s comprehensive packet transport portfolio. Metro networks continue to expand and require more intelligent high-density aggregation with focus on 10G and 100G packet switched services. This product opens new market segments in Metro Service Edge that enables a broader solution to our customers' needs while providing more strategic value with end-to-end solutions for smaller service providers and carriers. OptiPacket upgrades our solution from the metro access market to the metro service edge market. Our strategy is to combine a broader metro solution that extends from OptiSwitch in the access domain to OptiPacket in the metro service aggregation domain to OptiDriver in the optical transport domain, all manageable and operable with our Pro-Vision® service delivery software. The OptiPacket series is a carrier-class, high capacity provider edge aggregator with a packet-optical roadmap positioned for multi-layer service convergence, intelligence, and high capacity aggregation needed for next-gen Metro networks. The new OptiPacket® (OP-X models) combines the field-proven technology and expertise of MRV’s optical and packet product families into an all-in-one, highly flexible, intelligent architecture. Our vision is to help service providers to simplify and converge their networks, by optimizing the platform for packet-only, optical-only, and converged packet-optical networks, MRV is enabling service providers to seamlessly deliver multi-layer services over the same metro service edge. This, along with the solution’s industry-leading bandwidth capacity, port density, and power efficiency makes it easier for service providers to manage unpredictable bandwidth demand and create a strong foundation for Software-Defined Networking (SDN), Network Functions Virtualization (NFV), and consequently enable highly beneficial metro network transformation.
Capitalizing on the latest innovations in packet and optical technologies, the new OptiPacket® platform offers outstanding efficiency and intelligence to support ultra-high-density 10G and 100G services. Service providers are able to deploy the OptiPacket® platform as a packet-only solution in high-capacity mega POPs for broadband aggregation applications.

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Network Management

Pro-Vision® is designed to improve operational efficiency by unifying the management of packet switching and optical transport equipment. Pro-Vision is the orchestration software overlay that enables convergence of the packet and optical layers into a robust network capable of efficiently supporting new and existing services. Pro-Vision® is MRV's service orchestration platform that gives service providers the automated tools to design, provision, manage, diagnose, visualize and optimize both packet and optical access networks. It seamlessly automates the provisioning, orchestration and management for thousands of network elements and millions of services. Pro-Vision's packet and optical tools bring a new level of service control to networks and provide a suite of applications for automated service provisioning, assurance, monitoring, reporting, inventory and maintenance. It is a centralized carrier-class, web based platform that uses intuitive GUI based displays and offers powerful methods to reduce operational expense and paves the way for the software defined network of the future. Pro-Vision replaced the Company's previous software solution, MegaVision®.

Infrastructure Management Products

MRV's physical layer switches are scalable, OSI layer 1 switches that allows users to connect any port to any other port within the system using a non-blocking matrix. The Media Cross Connect is an optical/electrical/optical (OEO) switch used for data rates and media up to 10Gbps. The Optical Cross Connect is an all optical (OOO) switch for single mode fiber rates up to 100Gbps. Deploying these switches in a lab environment allows test commitments to be met without compromising quality or responsiveness, or increasing capital or operational expenses.

Out-of-band LX Series

An out-of-band network leveraging our LX product line provides secure remote service port access and remote power control to devices in an organization's networks and infrastructures, including data centers, remote sites, and test labs. Rich security and management features are supported, in addition to distributed clustering, sophisticated automation capabilities, very strong encryption, and security certifications.
Network Integration and Services
We believe that pre-sales engineering and post-sales support services help reduce cost of ownership, support business goals and promote customer loyalty. Accordingly, we provide a broad range of service offerings including pre-sale network design, consultation, site-surveys, on-site installation, network integration, technical assistance, and specialist support. Post-sales support includes in-warranty as well as out-of-warranty repair and on-site maintenance. Our services include a choice of technical support services including around-the-clock response and managing services for fixed line, cable and mobile communications networks. Additionally, we provide network system design, integration and distribution services that are primarily based on products manufactured by third-party vendors to telecommunication service providers in Italy. We also provide Network Operations Center services in Italy. These services are provided by our Italian subsidiary.
Worldwide Sales and Marketing
As of December 31, 2014, our OCS worldwide sales and marketing organization consisted of 97 employees, including sales representatives, pre- & post- sales technical support, product line management, technical marketing, marketing communications and management. We have field sales personnel in more than 10 countries involved in the sales and distribution of our products, as well as providing pre- & post- sales technical support to end users of our products. We sell and service our products both directly and through channel partners including distributors, value-added resellers and system integrators. Outside the United States, we maintain direct sales and service operations in Argentina, Australia, Canada, Germany, Israel, Italy, the Netherlands, Taiwan, Thailand, Poland, and the United Kingdom.
Additionally, our Italian subsidiary sells and markets products manufactured by third-party vendors, supplied as part of our network integration and distribution services. They provide system design, network integration and post-sales support, as well as Network Operations Center services. These services enhance our ability to penetrate targeted vertical and regional markets. We believe that collaborating with successful third-party vendors in certain areas helps to provide growth opportunities beyond the targeted applications of our product lines.

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We employ various methods, such as public relations, advertising, and trade shows in an effort to build awareness of our products and to establish our corporate MRV brand name, as well as that of our Italian operating subsidiary, Tecnonet. We conduct our public relations activities both internally and through relationships with outside agencies. We focus on major public relations activities concentrated around new product introductions, corporate partnerships and other events of interest to the market. We supplement our public relations through media advertising programs, including electronic media and attendance at various trade shows worldwide throughout the year.
Competition
The communications equipment industry is intensely competitive. We compete directly with a number of established and emerging networking companies.
Our direct competitors in networking products, switches, routers and media converters generally include: ADVA Optical Networking, Alcatel-Lucent, Adtran, BATM Advanced Communications, BTI Systems, Inc., Ciena Corporation, Cisco Systems, Inc., Cyan, ECI Telecom Ltd., Ekinops, Ericsson, Fujitsu Limited, Huawei Technologies Ltd., Nokia Siemens Networks BV, RAD Data Communications, Ltd., Coriant, and Transmode. Most of our competition in the Network Integration segment comes from other regional service providers in Italy such as Italtel S.p.A., Alpitel S.p.A., Maticmind S.p.A., NextiraOne Italia S.r.l., and Lutech S.p.A.
Many of our larger competitors in Network Equipment offer customers a broader product line, which provides a more comprehensive networking solution than we provide. Accordingly, in certain regional markets we have collaborated with other vendors in an effort to enhance our overall capability in providing products and services.
We believe the principal competitive factors in the markets in which we compete include:
Product performance, features, quality and price;
A comprehensive range of complementary products and services;
Customer service and technical support;
Lead and delivery times;
Timeliness of new product introductions;
Global presence, including distribution network;
Conformance to standards; and
Brand name recognition.
Product Development and Engineering
We believe that in order to maintain our technological competitiveness and to serve our customers better, we must enhance our existing products and continue to develop new products. Accordingly, our Network Equipment segment focuses a significant amount of resources on product development and engineering. Product development and engineering expenses were $20.8 million, $19.4 million, and $15.3 million for the years ended December 31, 2014, 2013, and 2012, respectively.
Financial information for each of the principal segments for revenue, measures of profit or loss and total assets, and breakdown by geographic regions, are included in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 8 "Financial Statements and Supplemental Data" of this Form 10-K.
Global Operations
We outsource the manufacturing of our network equipment products to world class contract manufacturers. These products include: switches and optical transport platforms, remote device management products and networking physical infrastructure equipment. Outsourcing allows us to react more quickly to market demand; avoid the significant capital investment required to establish automated manufacturing and assembly facilities; and allocate resources on product design and development. Our Operations personnel primarily perform: supply chain management, commodity management, quality compliance and assurance, supplier engineering, test software development, and NPI Program Management. Our processes and procedures are ISO 9001 certified and so are those of our electronic manufacturing service providers.

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Intellectual Property
To date, we have relied principally on a combination of patents, copyrights and trade secrets to protect proprietary technology. We have 17 U.S. patents and two foreign patents which expire through 2026. In addition, we have four U.S. patent applications and one foreign patent application pending. However, we have not actively defended our patent portfolio in the past and do not consider our patents critical to our revenue stream. Our products rely principally on a combination of industry standard technology, our trade secrets, and software copyrights. Generally, we enter into confidentiality agreements with our employees and key suppliers and otherwise seek to limit access to and distribution of the source code to our software and other proprietary information. These steps may not be adequate to prevent misappropriation of our technologies, or a third party may independently develop technologies similar or superior to any that we possess.
Employees
As of December 31, 2014, MRV employed 445 full-time employees. Of these employees, 181 were in manufacturing, 101 were in product development and engineering, and 163 were in sales, marketing and general administration. Of these employees, 295 work in locations outside the United States.
We believe our employee relationships are satisfactory. We believe that our long-term success depends in part on our continued ability to recruit and retain qualified personnel. The risks associated with dependence on qualified personnel are more fully discussed under the heading "The loss of key management could negatively affect our business" in the "Risk Factors" section contained in Item 1A of this Form 10-K.
Revenue by Segment
Please refer to Note 14 Segment Reporting and Geographic Information of our Consolidated Financial Statements located in Item 8 of this Form 10-K for our revenue for the last three years by segment.

Internet Access to Our Financial Documents

We maintain a website at www.mrv.com. We make available on our website, free of charge, reports that we electronically file with or furnish to the SEC. We make the reports available on our website as soon as reasonably practicable after filing or furnishing such reports to the SEC. These reports include Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. These reports are also available directly through the SEC's website at www.sec.gov.


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Item 1A.    Risk Factors.
The following risk factors and other information included in this Form 10-K should be carefully considered. The Company is subject to numerous risks and uncertainties, the outcome of which may impact future results of operations and the Company's financial condition. The risks and uncertainties described below are not all encompassing and should be considered carefully together with the other information contained in this report and in the other reports and materials filed by us with the Securities and Exchange Commission (“SEC”), as well as news releases and other information we publicly disseminate from time to time. Additional risks and uncertainties not presently known to us or which we currently deem immaterial also may impair our business operations. If any of the following risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected and the trading price of our Common Stock could decline.
We did not achieve profitability on a consolidated basis for the years ended December 31, 2014 and 2013, and may not achieve profitability in the future.
We did not achieve profitability for the years ended December 31, 2014 and 2013 on a consolidated basis, and we expect to continue to incur significant product development, sales and marketing and general and administrative expenses, and costs related to improving manufacturing efficiency in the near term. As a result, we will need to continue our efforts to contain expense levels and increase revenue levels in an effort to achieve profitability in the future. We may not be successful in our efforts to contain expense levels and increase revenue levels, and we may not attain profitability on a sustained basis or at all.

Our operating results may be adversely impacted by worldwide economic and political uncertainties and specific conditions in the markets we address, including the cyclical nature of and volatility in the network equipment and network integration industries.

We operate in the network equipment and network integration industries. Our Network Integration business is concentrated in the Italian market, which has been experiencing a downturn for a significant period, and it is unknown when this market will recover, if at all. Our Network Equipment business is global, but has a significant presence in Europe which is also experiencing a downturn. Such downturns are characterized by decreases in product demand, excess customer inventories, and accelerated erosion of prices, and may be interspersed with, or followed by, significant and temporary increased demand in products. Further, these industries are cyclical and subject to rapid change and evolving industry standards. These factors could cause substantial fluctuations in our revenue, gross margins and results of operations, and may cause difficulty in predicting demand and short-term production needs. In addition, during these downturns some competitors become more aggressive in their pricing practices, which may adversely impact our product gross margins. Any downturns in the network equipment and network integration industries may be severe and prolonged or intermittent, and any failure to fully recover from downturns of these industries or the markets in which we operate could seriously impact our revenue and harm our business, financial condition and results of operations. The network equipment and network integration industries also periodically experience increased demand and production capacity constraints, which may affect our ability to ship products in a timely manner and may cause delivery time penalties. Accordingly, our operating results may vary significantly as a result of the general conditions in the network equipment and integration industries, which could cause large fluctuations in our stock price.


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Many other factors have the potential to significantly impact our business, such as concerns about inflation and deflation, deterioration in credit availability due to economic downturns or instability on a local or global level, volatility in energy costs, decreased consumer confidence, reduced corporate profits and capital spending, adverse business conditions and liquidity concerns in the communications markets, reduced availability of insurance coverage or reduced ability to pay claims by insurance carriers, international conflicts and terrorist and military activity, and the impact of natural disasters and public health emergencies. These conditions may make it extremely difficult for our customers, our vendors and us to accurately forecast and plan future business activities, and they could cause U.S. and foreign businesses to reduce spending on our products and services, which would delay and lengthen sales cycles. Furthermore, during challenging economic times our customers may face issues gaining timely access to sufficient credit or could even need to file for bankruptcy. Either of these circumstances could result in an impairment of their ability to make timely payments to us. If these circumstances were to occur, we may be required to increase our allowance for doubtful accounts. Historically, our business does not come from the end customer directly, and we have experienced growth patterns that are different than what the end customer demand might be, particularly during periods of high volatility. This can manifest itself in periods of growth in excess of our customers' growth followed by periods of under-shipment before the volatility abates as our customers adjust their inventory levels. Given recent economic conditions it is possible that any correlation will continue to be less predictable and will result in increased volatility in our operating results and stock price. We cannot predict the timing, strength or duration of any economic slowdown or recovery, worldwide, in the network equipment and integration industries or in the markets in which we operate. If the economy or the markets in which we operate deviate from present levels or deteriorate, we may record additional charges related to restructuring costs and the impairment of goodwill and long-lived assets, and our business, financial condition and results of operations may be materially and adversely affected. Additionally, the combination of our lengthy sales to delivery cycle coupled with challenging macroeconomic conditions could have a synergistic negative impact on the results of our operations. The impact of market volatility is not limited to revenue but may also affect our product gross margins and other financial metrics. Such impact could be manifested in, but not limited to, factors such as fixed cost overhead absorption.

A few customers account for a substantial portion of our sales, increasing both our dependence on a few revenue sources and the risk that our operations will suffer materially if a significant customer stops ordering from us or substantially reduces its business with us.

One customer in the Network Integration segment, FastWeb S.p.A., accounted for 24%, 28% and 29% of total consolidated revenues for the years ended December 31, 2014, 2013 and 2012, respectively. The same customer in the Network Integration segment accounted for 5% and 22% of accounts receivable as of December 31, 2014 and 2013, respectively. Another customer in the Network Integration segment, Telecom Italia S.p.A., accounted for 16%, 14% and 13% of total consolidated revenues for the years ended December 31, 2014, 2013 and 2012, respectively. The same customer in the Network Integration segment accounted for 29% and 27% of accounts receivable as of December 31, 2014 and 2013, respectively. While our financial performance benefited from substantial sales to these customers, because of the magnitude of sales to these customers, our results would suffer if we were to lose their business. Additionally, if those customers, or other significant customers, made substantial reductions in orders or stopped paying their invoices when due, our results of operations would suffer unless we were able to replace the orders or collect on the payments due. Both customers are major telecom companies operating predominately in Italy.


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Our quarterly operating results are subject to significant fluctuations, and you should not rely on them as an indication of our future performance. Our operating results could fluctuate significantly from quarter to quarter and year to year.

Our operating results for a particular quarter are difficult to predict. Our revenue, gross margins and operating results could fluctuate substantially from quarter to quarter and from year to year as a whole, and within our business segments. This could result from any one or a combination of factors such as:

the cancellation or postponement of orders from one period to the next;
the timing and amount of significant orders;
the mix in any period of higher and lower margin products and services;
software, hardware or other errors in the products we sell requiring replacements or increased warranty reserves;
charges for excess or obsolete inventory;
our annual reviews of other intangibles that may lead to impairment charges;
the ability of our suppliers to produce and deliver components and parts, including sole or limited source components, in a timely manner, in the quantity and quality desired and at the prices we have budgeted;
readiness of customer sites for installation;
political stability in the areas of the world in which we operate;
price reductions that we make, such as marketing decisions that we have made in the past to reduce the price for our products in an effort to secure new customers or to provide competitive bulk discounts;
decreases in average selling prices of our products which result from factors such as overcapacity and market conditions, the introduction of new and more technologically advanced products, and increased sales discounts;
the relative success of our efforts to continually reduce product manufacturing costs;
our introduction of new products, with initial sales at relatively small volumes with resulting higher production costs, and the rate of market acceptance of the products;
delays or reductions in customer purchases of our products in anticipation of the introduction of new and enhanced products by us or our competitors;
the timing of capital spending of our customers;
currency fluctuations;
the ability of our customers to pay for our products;
general economic conditions; and
changes in conditions specific to our business segments.
Moreover, the volume and timing of orders we receive during a quarter are difficult to forecast. 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. We may also expend significant management effort, increase manufacturing capacity and order long lead-time components or materials prior to receiving an order. Further, our customers encounter uncertain and changing demand for their products. Customers generally order based on their forecasts. If demand falls below these forecasts or if customers do not control inventories effectively, they may cancel or reschedule shipments previously ordered from us even after acceptance of orders. 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 reasonably assured. Our expense levels during any particular period are based, in part, on expectations of future sales. If sales in a particular quarter do not meet expectations, our operating results could be materially adversely affected.
We expect revenue and gross margins generally and for specific products and services to continue to fluctuate from quarter to quarter and year to year. Changes in service gross margin may result from various factors such as changes in the mix between technical support services and advanced services, as well as the timing of support service contract initiations and renewals. It is possible that, in future periods, our results of operations will 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, by association, cause our stock price to decline.


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Changes in the seasonality of our business could cause our operating results to fluctuate.
Sales of our products are subject to seasonality. Sales have typically increased significantly in the fourth quarter of each fiscal year, sometimes followed by significant declines in the first quarter of the following fiscal year. However, the current global economic environment may impact typical seasonal trends, making it more difficult for us to forecast our business. Changes in the product or channel mix of our business can also impact seasonal patterns, adding to complexity in forecasting demand. If our forecasts are inaccurate, we may lose market share or procure excess inventory or inappropriately increase or decrease our operating expenses, any of which could harm our business, financial condition and operating results. Changes in seasonality may also lead to greater volatility in our stock price.

We are making significant investments in development and engineering and a process management system. These investments will negatively affect our short-term operating results, and may achieve delayed, or lower than expected, benefits which could harm our long-term operating results.
While we intend to focus on managing our costs and expenses, the investments in development and engineering and a process management system will impact our short-term operating results, as we are likely to recognize the costs associated with these investments earlier than some of the anticipated benefits, and the return on these investments may be lower, or may develop more slowly, than we expect. If we do not achieve the benefits anticipated from these investments, or if the achievement of these benefits is delayed, our long-term operating results may be adversely affected.

Competition is ever increasing, and we face additional challenges when entering into new markets which could reduce our revenue and gross margins or cause us to lose market share.
The network equipment and network integration industries are intensely competitive, and we must continually provide new products while dealing with increased price competition from low-cost producers in Asia or elsewhere. We are further looking to expand our provision of services, and the markets in which we currently offer our products and services. These efforts expose us to additional competition and will likely increase demands on our service and support operations.
Many of our competitors have significantly greater financial, technical, marketing, distribution, sales and customer support organizations and other resources and larger installed customer bases than we have. Our competitors continually introduce new competitive products, and may be able to devote greater resources to the development, promotion, sale and support of their products. They may also be able to leverage their buying power with vendors to give them preferential treatment in delivery of high-demand products in times of supply constraint. Many of our larger competitors offer customers broader product lines, which provide a more comprehensive networking solution than we provide. These companies can leverage their customer bases and broader product offerings and adopt aggressive pricing policies to gain market share. In addition, several of our competitors have large market capitalizations, have substantially larger 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 and give them a strategic advantage. Accordingly, in certain regional markets we have collaborated with other vendors in an effort to enhance our overall capability in providing products and services, and we focus on consolidating our purchasing programs globally to improve purchasing power with vendors.
Additional competitors may enter the market, and we are likely to compete with new companies in the future, especially from the People's Republic of China ("PRC"). Companies competing with us may introduce products that are more competitively priced, have increased performance or functionality, or incorporate technological advances that we have not yet developed or implemented, and may be able to react more quickly to changing customer requirements and expectations. There is also the risk that other network system vendors may enter or re-enter the subsystem market and begin to manufacture in-house the networking subsystems incorporated into their network systems. We also expect to encounter potential customers that, because of existing relationships with our competitors, are committed to the products offered by these competitors. As a result of the foregoing factors, we expect that competitive pressures may result in price reductions, reduced or negative margins or loss of market share in our markets.

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Our markets are subject to rapid technological change, and to compete effectively, we must continually introduce new products that achieve market acceptance.

The markets for our products are characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. We expect that new technologies will emerge as competition and the need for higher and more cost effective transmission capacity, or bandwidth, increases. Our future performance will depend on the successful development of new and enhanced products that address these changes and other customer requirements. The introduction of new and enhanced products may cause our customers to defer or cancel orders for existing products. We have in the past experienced delays in product development and these delays may occur in the future. Therefore, to the extent that customers defer or cancel orders in the expectation of a new product release or there is any delay in development or introduction of our new products or enhancements of our products, our operating results would suffer.

During the years ended December 31, 2014 and 2013, product development and engineering expenses accounted for 12% of revenue. In 2015, we are investing further in our engineering staff and the development of our product lines, and expect this expense to increase. Introduction of new products and product enhancements will require that we effectively transfer production processes from development to manufacturing and coordinate our efforts with those of our manufacturers and suppliers to achieve volume production rapidly. If we fail to transfer production processes effectively, develop product enhancements or introduce new products in sufficient quantities to meet the needs of our customers as scheduled, our net sales may be reduced and our business may be harmed. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements, or to license these technologies from third parties. Product development delays may result from numerous factors, including:

changing product specifications and customer requirements;
difficulties in hiring and retaining necessary technical personnel;
difficulties in reallocating engineering resources and overcoming resource limitations;
difficulties with contract manufacturers;
changing market or competitive product requirements; and
unanticipated engineering complexities.
The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. In order to compete, we must be able to deliver to customers products that are highly reliable, operate with their existing equipment, lower their costs of acquisition, installation and maintenance, and provide an overall cost-effective solution. We may not be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, our new products may not gain market acceptance or we may not be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Our failure to respond effectively to technological changes would significantly harm our business.
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 may cause us to incur significant costs, divert our attention from product development efforts, or damage our reputation and cause us to lose customers.
Our products are complex and undergo internal quality testing and qualification as well as formal qualification by our customers. However, defects may be found from time to time. Our customers' testing procedures are limited to evaluating our products under likely and foreseeable failure scenarios and over varying amounts of time. For various reasons, including among others, the occurrence of performance problems that are unforeseeable in testing or that are detected only when products age or are operated under peak stress conditions, our products may fail to perform as expected long after customer acceptance. Failures could result from faulty components or design, problems in manufacturing or other unforeseen reasons. As a result, we could incur significant costs to repair and/or replace defective products under warranty, particularly when such failures occur in installed systems. We have experienced such failures in the past and will continue to face this risk going forward, as our products are widely deployed throughout the world in multiple demanding environments and applications. In addition, we may in certain circumstances honor warranty claims after the warranty period has expired or for problems not covered by warranty in order to maintain customer relationships. We believe that our warranty reserves adequately address our potential exposure to liability for warranty claims. Our warranty reserves are based on historical return rates, and our average material costs incurred to repair items, including labor costs. The warranty reserves are evaluated and adjusted based on updated actual experience.


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In addition, certain of our networking products are typically embedded in, or deployed in conjunction with, our customers' products, which incorporate a variety of components and may be expected to interoperate with modules produced by third parties. As a result, not all defects are immediately detectable and when problems occur, it may be difficult to identify the source of the problem. These problems may cause us to incur significant damages or warranty and repair costs, divert the attention of our engineering personnel from our product development efforts, cause significant customer relation problems or loss of customers, and harm our reputation and brand, any of which could materially and adversely affect our business.

Our customers may adopt alternate technologies for which we do not produce products or for which our products are not adaptable.

The market for our products is characterized by rapidly changing technology, evolving industry standards and new product introductions, which may minimize the demand for our existing products or render them obsolete. Our future success will depend in part upon our ability to enhance existing products and to develop and introduce new products that address such changes in technology and standards and respond to our customers' potential desire to adopt such technologies in place of those supported by our current product offerings. The development of new or enhanced products is a complex and uncertain process requiring the accurate anticipation of technological and market trends as well as precise technological execution. Further, the development cycle for products integrating new technologies or technologies with which we are not as familiar may be longer and more costly than our current product development process. We may experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products, and the new products may not be successfully commercialized. These costs and delays may prevent us from being able to establish a market position with respect to such new technologies and industry standards or be as responsive as we would like to be in meeting our customers' demands for such products, thus adversely affecting our results of operations and our customer relationships.

We do not have many long-term volume purchase contracts with our customers, so our customers may increase, decrease, cancel or delay their purchasing levels at any time with minimal advance notice to us, which may significantly harm our business.

Our customers typically purchase our products pursuant to individual purchase orders. While our customers generally provide us with their demand forecasts, in most cases they are not contractually committed to buy any quantity of products beyond firm purchase orders. Our customers may increase, decrease, cancel or delay purchase orders already in place. If any of our major customers decrease, stop or delay purchasing our products for any reason, our business and results of operations would be harmed. Cancellation or delays of such orders may cause us to fail to achieve our short- and long-term financial and operating goals. Lead times for components and materials that we order vary significantly and depend on factors including the specific supplier requirements, the size of the order, contract terms and current market demand for components. For substantial increases in our sales levels, some of our suppliers may need significant lead time. In the past, during periods of market downturns, certain of our largest customers canceled or delayed significant orders with us and with our competitors, which resulted in losses of sales and excess and obsolete inventory. Similarly, decreases or deferrals of purchases by our customers may significantly harm our industry and specifically our business in these and in additional unforeseen ways, particularly if they are not anticipated.

We may suffer losses as a result of entering into fixed price contracts.

From time to time we enter into contracts with certain customers in which the price we charge for particular products is fixed. Although our estimated production costs for these products are used to compute fixed sales prices, if actual production costs exceed the estimated production costs because of our inability to obtain needed components timely, or at all, or we cannot continue to cut costs in production and have incrementally decreased future fixed prices, we may incur a loss on the sale. Sales of material amounts of products on a fixed price basis, for which we have not accurately forecast the production costs, could have a material adverse effect on our results of operations.


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We face risks in reselling the products of other companies.

We distribute products manufactured by other companies. To the extent we succeed in reselling the products of these companies, or products of other vendors with which we may enter into similar arrangements, we may be required by customers to assume warranty and service obligations and to make intellectual property representations. While these suppliers have agreed to support us with respect to those obligations and indemnify us against third party claims of intellectual property infringement, if they should be unable, for any reason, to provide the required support or indemnification, we may have to expend our own resources on doing so. We are unable to evaluate fully the potential magnitude of these claims as the equipment has been designed and manufactured by others.

There are a limited number of potential source suppliers for certain components, which makes us susceptible to supply shortages.

We currently purchase several key components from single or limited sources. Moreover, we depend on the quality of the products supplied to us, over which we have limited control. We have encountered shortages and delays in obtaining components in the past and expect to encounter shortages and delays in the future. Sudden significant increases in demand for products that we purchase may cause delays in delivery of subcomponents, which may cause delay in delivery of our products. Larger competitors may be able to demand more rapid delivery of components parts in comparison to us. If we cannot supply products due to a lack of certain components or are unable to redesign products with other components in a timely manner, our business will be significantly harmed.

We typically have not entered into long-term agreements with our suppliers and, therefore, our suppliers could stop supplying materials and equipment at any time or fail to supply adequate quantities of component parts on a timely basis. It is difficult, costly, time consuming and, on short notice, sometimes impossible for us to identify and qualify new component suppliers. The reliance on a sole supplier, single qualified vendor or limited number of suppliers could result in delivery and quality problems, reduced control over product pricing, reliability and performance. We may have difficulty in identifying and qualifying another supplier in a timely manner. We have in the past had to change suppliers, which, in some instances, resulted in delays in product development and manufacturing until another supplier was found and qualified. Any such delays in the future may limit our ability to respond to changes in customer and market demands. During the last several years, the number of suppliers of components has decreased significantly and, more recently, demand for components has increased. Any supply deficiencies relating to the quality or quantities of components we use to manufacture our products could adversely affect our ability to fulfill customer orders and our results of operations.

We rely substantially upon a limited number of contract manufacturing partners, and if these contract manufacturers fail to meet our short- and long-term needs and contractual obligations, our business may be negatively impacted.

We rely to a significant extent on a limited number of contract manufacturers to, manufacture, assemble and test our products. The qualification and set up of these independent manufacturers under quality assurance standards is an expensive and time-consuming process. Our reliance upon third party manufacturers could expose us to increased risks related to lead times, continuity of supply, on-time delivery, quality assurance, and compliance with environmental standards and other regulations. Reliance upon third party manufacturers also exposes us to significant risks related to their operations, financial position, business continuity, sourcing relationships and labor relationships that may affect their manufacturing of our products including their continued viability. Product manufacturing with our contract manufacturing partners principally takes place in the United States, Israel and Canada. Significant disruptions in these and other countries where our products or key components are manufactured, including natural disasters, epidemics, acts of war or terrorism, social or political unrest or work stoppages, could affect the cost, availability or allocation of supply and manufacturing capacity and negatively affect our business and results of operations. As a result, we may lose existing or potential customers or orders and our business may be negatively impacted.


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If we fail to forecast component and material requirements accurately, we could incur additional costs or experience manufacturing delays.

We use rolling forecasts based on anticipated product orders to determine our component and material 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 or obsolete inventory, which may not get used or have to be discounted to eliminate. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively impact our revenue.

Changes in key management and loss of highly qualified personnel could negatively affect our business.

Our ability to run our operations, develop, manufacture and market our products, and compete with our current and future competitors depends in large part on our ability to attract and retain qualified personnel. The loss or unavailability of any of our key personnel, which includes our executive officers, could have an adverse effect on the Company’s financial condition and results of operations. We have had a succession of chief executive officers and other executive management in the recent past, and maintaining consistency and providing structure and reliability to the Company's employees and our customers and vendors will be important for the Company's ability to produce reliable financial results. We are dependent upon our management team, especially in places where personal relationships are a significant part of a business transaction. We do not have succession plans in every key position, and the loss of the services of these officers could have a material adverse effect on our operations. Further, competition for highly-qualified engineers in the network equipment and integration industries is intense, and we will be required to compete for those personnel with companies having substantially greater financial and other resources than we do. If we do not attract and retain necessary team members to operate our business and build our products, our business could be materially adversely affected.

Our business and future operating results are subject to a wide range of uncertainties arising out of the international nature of our operations and facilities that could adversely affect our results of operations.

External revenues from foreign subsidiaries accounted for 63.0%, 61.0% and 62.0% of revenue for the years ended December 31, 2014, 2013, and 2012, respectively.


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We have offices and facilities in, and conduct a significant portion of our operations in and from, Israel and Italy. We are, therefore, influenced by the political and economic conditions affecting these countries. Risks we face from international sales and our use of facilities and suppliers overseas for manufacturing include:

ensuring compliance with local regulations and laws in each country and locality in which we do business;
greater difficulty in accounts receivable collection and longer collection periods;
the impact of recessions in economies outside the United States;
changes in regulatory requirements;
seasonal reductions in business activities in some parts of the world, such as during the summer months in Europe;
difficulties in managing operations across disparate geographic areas;
difficulties associated with enforcing agreements through foreign legal systems;
the payment of operating expenses in local currencies, which exposes us to risks of currency exchange rate fluctuations;
higher credit risks requiring cash in advance or letters of credit;
potentially adverse tax consequences, increasing taxes, and heightened efforts by officials of foreign countries to increase revenue from tax collection;
unavailability or delays in delivery of equipment, raw materials or key components;
trade restrictions, tariff increases and increasing import-export duties;
shipping delays;
limited protection of intellectual property rights;
tightening immigration controls that may adversely affect our ability to hire new non-U.S. employees in our U.S. facilities; and
increasing foreign environmental regulation or unforeseen environmental problems.

Our business and operations are also subject to general geopolitical conditions, such as terrorism, political and economic instability, changes in the costs of key resources such as crude oil and changes in diplomatic or trade relationships. Economic conditions in several countries and markets outside the United States in which we have offices, personnel, facilities or sales represent significant risks to us. Instability in the Middle East, PRC or European Union could have a negative impact on our sales and operations in these regions, and unstable conditions could have a material adverse effect on our business and results of operations. In addition to the effect of global economic instability on our operations or facilities on sales to customers outside the United States, sales to domestic customers could be negatively impacted by these conditions.

Our operating results are impacted by foreign exchange rates and interest rate fluctuations.

Our interest income and expense is impacted by fluctuations in interest rates. Changes in foreign exchange rates impact us in four ways. Several of our foreign business units have a functional currency other than the U.S. dollar. The amount of revenue, expenses, assets and liabilities measured in U.S. dollars is impacted by changes in exchange rates. Our revenue and profits were not materially impacted by fluctuations in exchange rates during the year ended December 31, 2014 when compared to the prior year period. Conversely, our revenue and profits were positively impacted in 2013 and negatively impacted in 2012 because of the fluctuations of the U.S. dollar relative to the currencies in which these business units report their results. Further, fluctuations in currency exchange rates can and do cause our products to become relatively more expensive in particular countries, leading to a reduction in sales in that country. The proportion of our costs incurred in various currencies varies from the proportion of revenue denominated in that currency which may materially impact our gross margins. Some of our accounts receivable, cash balances, accounts payable, credit lines, and other assets and liabilities are denominated in currencies other than the related business unit's functional currency. Increases or decreases in the expected amount of cash flow result in foreign exchange gains or losses which impact our profitability. We currently do not have any hedging or swap agreements in place. Where possible, we attempt to denominate sales in countries in which we do business in the local currency, to match the proportion of cost and revenue transacted in each currency, and to match the assets and liabilities held in each currency which helps to reduce foreign exchange rate exposure to some degree. We could incur losses from the lack of hedging activities in the future. In addition, inflation or fluctuations in currency exchange or interest rates in any of the countries that we do business could increase our operating expenses and thereby adversely affect our results of operations.


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Our ability to utilize our NOLs and certain other tax attributes may be limited.

As of December 31, 2014, MRV had net operating losses ("NOLs") of $179.7 million, $100.7 million and $97.3 million, for federal, state and foreign income tax purposes, respectively. Additionally, the Company had capital loss carry-forwards of $110.5 million and $24.0 million for federal and state tax purposes, respectively. The capital loss carry-forwards, which were generated by the sale of Source Photonics, expire in 2015. Under the Internal Revenue Code, if a corporation undergoes an "ownership change," the corporation's ability to use its pre-change NOLs, capital loss carry-forwards and other pre-change tax attributes to offset its post-change income may be limited. An ownership change is generally defined as a greater than 50% change in its equity ownership by value over a three-year period. We may experience an ownership change in the future as a result of subsequent shifts in our stock ownership. If we were to trigger an ownership change in the future, our ability to use any NOLs and capital loss carry-forwards existing at that time could be limited. As of December 31, 2014, the US federal and state NOLs had a full valuation allowance.

Our business and future operating results may be adversely affected by events outside of our control.

We use our facilities in California, Massachusetts and Israel for major product design and development and customer support, and we manufacture products at our facilities and through third-party manufacturers in California, Israel, Taiwan and Canada. The risk of earthquakes in Southern California is significant because of the proximity of these manufacturing facilities to major earthquake fault lines. In January 1994, major earthquakes near Chatsworth, California affected our facilities, causing power and communications outages and disruptions that impaired production capacity. While our facility did not suffer material damage and our business was not materially disrupted by this earthquake, 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 earthquakes, other natural disasters or other catastrophic events including fire, excessive rain, terrorist attacks and wars, could disrupt our manufacturing ability, which could harm our operations and financial results, and 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. The location of our manufacturing facilities subjects us to increased risk that a natural disaster could disrupt our operations.

Although we believe our insurance coverage is adequate to address the variety of potential liabilities we face, our insurance coverage is subject to deductibles and coverage limits. Upon an occurrence of a significant natural disaster, or manmade problems such as computer viruses, civil war, terrorism, blackout or disruptions to the economies of the United States and other countries, such coverage may not be adequate or continue to be available at commercially reasonable rates and terms. In the event of a major earthquake or other disaster affecting one or more of our facilities, our operations could be significantly disrupted, delayed or prevented for the time required to transfer production, repair, rebuild or replace the affected manufacturing facilities. This time frame could be lengthy, and result in significant expenses for repair and related costs. In addition, concerns about an outbreak of epidemic diseases such as avian or swine influenza or severe acute respiratory syndrome, could have a negative effect on travel and our business operations, and result in adverse consequences to our business and results of operations.

Environmental regulations applicable to our manufacturing operations could limit our ability to expand or subject us to substantial costs. Compliance with current and future environmental regulations may be costly which could impact our future operating results.

We are subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during our development and manufacturing processes, as are the third parties who manufacture our products. Further, we are subject to other safety, labeling and training regulations as required by foreign, local, state and federal law. We believe we are compliant in all material respects with applicable environmental regulations in the United States, Taiwan and Israel. However, any failure by us or our contract manufacturers 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 and we may need to acquire costly equipment or incur other significant expenses to comply with environmental regulations. We cannot provide assurance that legal requirements will not be imposed on us that would require additional capital expenditures or the satisfaction of other requirements. If we fail to obtain required permits or make adequate reporting submissions, or otherwise fail to operate within current or future legal requirements, including those applicable to us in the countries in which we manufacture our products, we may be required to pay substantial penalties, suspend our operations, or make costly changes to our development and manufacturing processes or facilities.


19


In addition, we could face significant costs and liabilities in connection with legislation which enables customers to return a product at the end of its useful life and charges us with financial and other responsibility for environmentally safe collection, recycling, treatment and disposal. We also face increasing complexity in our product design and procurement operations as we adjust to new and upcoming requirements relating to the materials composition of our products, and disclosure related to the origin of certain raw materials used in our products. This includes the restrictions on lead and certain other substances in electronics that apply to specified electronics products put on the market in the European Union and the PRC. Many of our customers have adopted this approach and have required our full compliance. Even though we have devoted a significant amount of resources and effort planning and executing our compliance program and believe that we are in compliance with such legislation, it is possible that some of our products might be incompatible with such regulations. In such event, we could experience loss of revenue, damaged reputation, diversion of resources, monetary penalties and legal action. Other environmental regulations may require us to re-engineer our products to utilize components that are more environmentally compatible. Such re-engineering and component substitution may result in additional costs to us. Although we currently do not anticipate any material adverse effects based on the nature of our operations and the effect of such laws, there is no assurance that such existing laws or future laws will not have a material adverse effect on us.

Changes in accounting standards issued by the Financial Accounting Standards Board (“FASB”) or other standard-setting bodies may adversely affect the Company’s consolidated financial statements.

The Company’s consolidated financial statements are subject to the application of generally accepted accounting principles ("GAAP"), which is periodically revised and/or expanded. Accordingly, the Company is required to adopt new or revised accounting standards from time to time issued by recognized authoritative bodies, including the FASB. It is possible that future changes the Company is required to adopt could change the current accounting treatment that the Company applies to its consolidated financial statements and that such changes could have a material effect on the Company’s financial condition and results of operations.

New regulations related to conflict-free minerals may force us to incur additional expenses.

The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions to improve transparency and accountability concerning the supply of minerals originating from the conflict zones of the Democratic Republic of Congo (DRC) and adjoining countries. As a result, in August 2012, the Securities and Exchange Commission adopted disclosure rules regarding a companys use of conflict minerals in their products, with substantial supply chain verification requirements in the event that the conflict minerals come from, or could have come from the DRC or adjoining countries. These new rules and verification requirements will impose additional costs on us and on our suppliers, and may limit the sources or increase the prices of materials used in our products. Further, if we are unable to certify that our products are conflict-free, we may face challenges with customers, which could place us at a competitive disadvantage and could harm our reputation.

Our business is dependent upon the proper functioning of our internal business processes and information systems and modification or interruption of such systems may disrupt our business, processes and internal controls.

We rely upon a number of internal business processes and information systems to support key business functions and the efficient operation of these processes and systems is critical to our business. We implemented an enterprise resource planning (ERP) system in 2013 that allows the financial and other business functions to interact and scale to support the growth of our business. The continued integration of the ERP system into our business can be costly and imposes substantial demands on management's time, and may be disruptive to our operations. Further, it may require changes in our other information systems, modification of internal control procedures and training of employees or third party resources. Our information technology systems, and those of third party providers, may also be vulnerable to damage or disruption caused by circumstances beyond our control. These include catastrophic events, power anomalies or outages, natural disasters, computer system or network failures, viruses or malware, physical or electronic break-ins, unauthorized access and cyber-attacks affecting our systems or those of third party business partners. Any material disruption, malfunction or similar challenges with our business processes or information systems, or disruptions or challenges relating to the transition to new processes, systems or providers, could have a material adverse effect on the operation of our business and our results of operations.


20


If we fail to protect our intellectual property, we may not be able to compete.

We rely on a combination of trade secret laws and restrictions on disclosure and patents, copyrights and trademarks to protect our intellectual property rights. We cannot be sure that our pending patent and trademark applications will be approved, that any patents or trademarks that may be issued will protect our intellectual property or that third parties will not challenge any issued patents. Other parties may independently develop similar or competing technology or design around any patents that may be issued to us. We cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Specifically there is a risk of poor enforcement of intellectual property rights in the PRC, where the validity, enforceability and scope of protection of intellectual property is uncertain and still evolving. Policing unauthorized use of proprietary technology is difficult and expensive. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable competitors, especially in the PRC, to benefit from our technologies without paying us any royalties. Enforcing our intellectual property rights or resolving intellectual property disputes may involve litigation. Any of this kind of litigation, regardless of outcome, could be expensive and time consuming, and adverse determinations in any of this kind of litigation could seriously harm our business.

We are involved in intellectual property disputes from time to time as part of doing business in the network equipment industry, which could divert management's attention, cause us to incur significant costs, and prevent us from selling or using the challenged technology.

Participants in the network equipment markets in which we sell our products have experienced litigation regarding patent and other intellectual property rights. Numerous patents in these industries are held by others, including our competitors. From time to time, we have become aware of the possibility or have been notified that we may be infringing certain patents or other intellectual property rights of others, and we have been involved in litigation matters regarding intellectual property right claims of others in the past. In addition, we may be a party to litigation to protect our intellectual property. These claims and any resulting lawsuits, if successful, could subject us to significant liability for damages or invalidation of our proprietary rights, and there can be no assurance that we will be successful in our defense and, even if we are successful, we may incur substantial legal fees and other costs in defending such lawsuits. Any lawsuit that we may become party to, regardless of its success, may be time-consuming and expensive to resolve and divert technical and management time and attention. Accordingly, any infringement claim or litigation against us could significantly harm our business, operating results and financial condition. In the event of an adverse result in any litigation with respect to intellectual property rights relevant to our products, we could be required to obtain licenses to the infringing technology, to pay substantial damages under applicable law, to cease the manufacture, use and sale of infringing products, or to expend significant resources to develop non-infringing technology. Licenses may not be available from third parties either on commercially reasonable terms or at all.

Data breaches and cyber-attacks could compromise our intellectual property or other sensitive information and cause significant damage to our business and reputation.
 
In the ordinary course of our business, we maintain sensitive data on our networks, including our intellectual property and proprietary or confidential business information relating to our business and that of our customers and business partners. The secure maintenance of this information is critical to our business and reputation. We believe that companies in the technology industry have been increasingly subject to a wide variety of security incidents, cyber-attacks and other attempts to gain unauthorized access. Our network and storage applications may be subject to unauthorized access by hackers or breached due to operator error, malfeasance or other system disruptions. In some cases, it is difficult to anticipate or immediately detect such incidents and the damage caused thereby. These data breaches and any unauthorized access or disclosure of our information, could compromise our intellectual property and expose sensitive business information. Cyber-attacks could also cause us to incur significant remediation costs, disrupt key business operations and divert attention of management and key information technology resources. These incidents could also subject us to liability, expose us to significant expense, or cause significant harm to our reputation.


21


We were involved in various derivative litigation suits due to past stock option granting practices, and the related restatement of our prior financial results that negatively affected our financial results and diverted management and Board attention from the management of our business.

In connection with our past stock option grant practices, we, and a number of our former directors and officers, were subjected to a number of lawsuits. A description of the litigation is set forth in Item 3. "Legal Proceedings" of this Form 10-K. Although we entered into a Stipulation of Settlement with the other parties to the litigation which was approved by the courts, we have been and remain subject to a number of risks, including the following, each of which could result in a material adverse effect to our business, financial condition and results of operations and/or a negative effect on the market for our stock: (i) potential indemnification obligations for our former directors and officers related to the litigation; (ii) costs in effectuating on-going or additional remediation actions; and (iii) diversion of the time and attention of members of our management and Board of Directors from the management of our business.

We are involved in other lawsuits and legal proceedings, which, if determined against us, could require us to pay substantial damages, fines and/or penalties.

We are involved in various lawsuits, disputes and claims, arising in the ordinary course of business. These suits or actions may raise complex factual and legal issues and are subject to uncertainties. Actions filed against us could include product liability, commercial, intellectual property, customer, employment and securities related claims, including class action lawsuits. Plaintiffs (or defendants who counterclaim) may seek unspecified damages or injunctive relief, or both. Although we carry product liability and other insurance, and believe such coverage is adequate based on the historical rate and nature of customer product quality claims or complaints, we cannot provide assurance that this insurance would adequately cover our costs arising from any significant defects in our products. Adverse results to any lawsuits, disputes or claims may harm our business and have material adverse effects on our results of operations, liquidity or financial position, any or all of which could adversely affect our stock price.

Failure to achieve and maintain internal controls in accordance with Sections 302 and 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse effect on our business and stock price.

We have examined and evaluated our internal control procedures to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, and identified two material weaknesses for the year ended December 31, 2014. We previously identified a material weakness in the year ended December 31, 2013, which was remediated in the subsequent year. For the year ended December 31, 2012, we had no material weaknesses.

We cannot assure you that we will not discover other material weaknesses in the future. If we fail to maintain the internal controls we implemented, or fail to implement required new or improved controls, as such control standards are modified, supplemented or amended from time to time, or as our business changes, we may fail to meet our annual or periodic reporting obligations and there may be material misstatements in our financial statements, and substantial costs and resources may be required to rectify these or other internal control deficiencies. Effective internal controls are necessary for us to produce reliable financial reports and are important in the prevention of financial fraud. If we cannot produce reliable financial reports or prevent fraud, our business and operating results could be harmed, investors may lose further confidence in our reported financial information, there could be investigations or sanctions by regulatory authorities or litigation and there could be a material adverse effect on our stock price.


22


The Company's disclosure controls and procedures may not prevent or detect all acts of fraud.

The Company’s disclosure controls and procedures are designed to reasonably ensure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act is accumulated and communicated to management and is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. The Company’s management believes that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, they cannot provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been prevented or detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by an unauthorized override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and the Company cannot ensure that any design will succeed in achieving its stated goals under all potential future conditions. Accordingly, because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and may not be detected.

Failure to comply with the U.S. Foreign Corrupt Practices Act or the U.K. Bribery Act could subject us to penalties and other adverse consequences. We could suffer losses from corrupt or fraudulent business practices.

We are subject to the U.S. Foreign Corrupt Practices Act ("FCPA"), and potentially the U.K. Bribery Act, each of which generally prohibits companies from engaging in bribery or making other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some that may compete with us, are not subject to these prohibitions, and therefore may have a competitive advantage over us. We have implemented and maintained preventative measures and policies, but cannot assure that our employees or other agents will not engage in such conduct and render us responsible under the FCPA. If our employees or other agents are found to have engaged in these practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.

Delaware law and our ability to issue preferred stock may have anti-takeover effects that could prevent a change in control, which may cause our stock price to decline.

We are authorized to issue up to 1,000,000 shares of Preferred Stock. This Preferred Stock may be issued in one or more series, the terms of which may be determined at the time of issuance by our Board of Directors without further action by stockholders. The terms of any series of preferred stock may include voting rights (including the right to vote as a series on particular matters), preferences as to dividend, liquidation, conversion and redemption rights and sinking fund provisions. No preferred stock is currently outstanding. The issuance of any preferred stock could materially adversely affect the rights of the holders of our Common Stock, and therefore reduce the value of our Common Stock. In particular, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell our assets to, a third party and thereby preserve control by the present management. We are also subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibit us from engaging in a business combination with an interested stockholder for a period of three years after the date of the transaction in which the person became an interested stockholder unless the business combination is approved in the manner prescribed under Section 203. These provisions of Delaware law also may discourage, delay or prevent someone from acquiring or merging with us, which may cause the market price of our Common Stock to decline.

Because this Form 10-K contains forward-looking statements, it may not prove to be accurate.

This Form 10-K and other Company releases and filings with the SEC may contain forward-looking statements. We generally identify forward-looking statements using words like "anticipate," "appear," "believe," "estimate," "expect," "intend," "may," "should," "plan," "project," "contemplate," "target," "foresee," "goal," "likely," "will," and "would" or similar statements. Because these statements reflect our current views concerning future events, they involve risks, uncertainties and assumptions, including the risks and uncertainties identified in this report. Actual results may differ significantly from the results discussed in these forward-looking statements. We do not undertake to update any forward-looking statements or risk factors to reflect future events or circumstances.


23


Item 1B.    Unresolved Staff Comments.
None.

Item 2.    Properties.
Our properties consist of leased facilities for product development, manufacturing, sales, support, and administrative operations. Our largest offices are located in Chatsworth, CA and Chelmsford, MA in the United States, in Rome, Italy and in Yokneam, Israel. The Rome office is for Tecnonet in our Network Integration segment, and the other facilities are for our Network Equipment business. We believe that our existing properties are in good condition and suitable for the conduct of our business. Should the need arise, we believe that suitable replacement and additional space will be available in the future on commercially reasonable terms subject to force majeure conditions. The Company is currently seeking space to consolidate its two Chatsworth buildings. For additional information regarding obligations under operating leases, see Note 10 to the Consolidated Financial Statements located in Item 8 of this Form 10-K.

Item 3.    Legal Proceedings.
We are subject to legal claims and litigation in the ordinary course of business, including but not limited to product liability, employment and intellectual property claims. The outcome of any such matters is currently not determinable. In addition, we were party to the litigation set forth below.
From June to August 2008, five purported stockholder derivative and securities class action lawsuits were filed in the U.S. District Court in the Central District of California and one derivative lawsuit was filed in the Superior Court of the State of California against the Company and certain of our former officers and directors. The five lawsuits filed in the Central District of California were consolidated. Claims were asserted under Section 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 promulgated thereunder. In November 2010, the judge overseeing the securities class action lawsuits gave final approval to a stipulated $10.0 million settlement agreement, which was covered by our director and officer insurance policies.
On April 8, 2013 the Federal Court preliminarily approved a Stipulation of Settlement (the "Settlement Stipulation"), which included, among other things, (a) a release of all claims relating to the derivative litigation for the Company, the individual defendants and the plaintiffs; (b) a provision that $2.5 million in cash be paid to the Company by the Company's insurance carriers; (c) payment of attorneys' fees to plaintiffs' counsel including $500,000 in cash and 250,000 warrants to purchase the Company's Common Stock, with a five-year term and strike price of the closing price of the Company's Common Stock on the date an order of the federal District Court approving the settlement becomes final; (d) the continued payment by the Company of applicable reasonable attorneys' fees for the individual defendants. On June 6, 2013, the Federal Court granted final approval of the Settlement Stipulation and on June 13, 2013 entered Judgment dismissing the federal derivative action with prejudice. On June 24, 2013, the State Court entered a dismissal with prejudice of the state derivative action. The Company was also required to undertake certain corporate governance reform actions, all of which have been implemented.
A majority of the costs related to the Company's and defendants' defense of these actions was paid by the Company's insurance carriers under its director and officer insurance policies, including the securities class action settlement. Insurance proceeds paid to the Company upon settlement of the derivative litigation were $1.0 million. However, MRV paid $1.9 million for services of defense counsel and other parties through December 31, 2013 above the insured amount.
In May 2014, a former customer of Tecnonet S.p.A.(Tecnonet), the Company's Italian subsidiary, filed a claim in an Italian civil court alleging that Tecnonet, and two of its third-party subcontractors, breached certain supply agreements with the customer, entered into between 2009 and 2011, by failing to have performed the contracted services. The plaintiff further alleges that Tecnonet was aware, at the time of entering into the supply agreements, that the customer’s managing director had a conflict of interest involving the subcontractors. The plaintiff is claiming damages and restitution from Tecnonet and the subcontractors, jointly and severally, of approximately $3.0 million in the aggregate, plus costs. As of December 31, 2014, the Company has not accrued any liabilities related to this matter. While we believe that Tecnonet has valid defenses to the plaintiff's claims, we cannot provide assurance that such claims will not result in any liability to Tecnonet.

24


Nhan T. Vo, individually and on behalf of other aggrieved employees vs. the Company, Superior Court of California, County of Los Angeles. On June 27, 2013, the plaintiff in this matter filed a lawsuit against the Company alleging claims for failure to properly pay overtime or provide meal and rest breaks to its non-exempt employees in California, among other things. The complaint seeks an unspecified amount of damages and penalties under provisions of the Labor Code, including the Labor Code Private Attorneys General Act. The Company has filed an answer denying all allegations regarding the plaintiff’s claims and asserting various defenses. The Company is currently in the discovery phase of this case. The Company believes it has accrued adequate reserves for this matter and does not expect the matter to have a material adverse effect on its business or financial condition. However, depending on the actual outcome of this case, further provisions could be recorded in the future which may have a material adverse effect on the Company’s operating results.
From time to time, MRV has received notices from third parties alleging possible infringement of patents with respect to product features or manufacturing processes. Management believes such notices are common in the communications industry because of the large number of patents that have been filed on these subjects. The Company's policy is to discuss these notices with the parties in an effort to demonstrate that MRV's products and/or processes do not violate any patents. The Company has been involved in such discussions in the past with Alcatel-Lucent SA, Apcon, Inc., Finisar Corporation, International Business Machines, Mediacom Broadband LLC, Ortel Communications, Ltd., Nortel Networks Corporation, Rockwell Automation, Inc. and The Lemelson Foundation. Management does not believe that any of these matters will result in a material adverse outcome.
MRV and its subsidiaries have been named as a defendant in other lawsuits involving matters that management considers routine to the nature of its business. Management is of the opinion that the ultimate resolution of such matters will not have a material adverse effect on our business, operating results and financial condition.

Item 4.    Mine Safety Disclosures.
Not applicable.

PART II
Item 5.    Market for the Company's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information and Holders
Our Common Stock is traded on the NASDAQ Global Market under the symbol "MRVC". The high and low sales prices (by quarter) during the last two comparable twelve month periods are as follows:
 
 
High
 
Low
Year Ended December 31, 2014
 
 
 
 
First quarter ending March 31
 
$
15.98

 
$
10.80

Second quarter ending June 30
 
$
15.31

 
$
10.51

Third quarter ending September 30
 
$
14.55

 
$
11.76

Fourth quarter ending December 31
 
$
12.80

 
$
9.11

Year Ended December 31, 2013
 
 
 
 
First quarter ending March 31
 
$
11.32

 
$
8.91

Second quarter ending June 30
 
$
10.90

 
$
8.30

Third quarter ending September 30
 
$
10.85

 
$
8.40

Fourth quarter ending December 31
 
$
12.00

 
$
9.40

As of March 6, 2015 the closing price of our Common Stock was $9.87 per share, and there were approximately 1,233 stockholders of record.

25


Dividends
The payment of dividends on the Company's Common Stock is within the discretion of the Company's Board of Directors. The Board of Directors did not declare cash dividends during the years ended December 31, 2014 and 2013. The Board of Directors regularly evaluates its capital position to consider the return of cash to stockholders. The Board of Directors does not currently have plans to begin paying a regular dividend.

On May 1, 2012, the Company's Board of Directors declared a special dividend totaling approximately $47.3 million, or $6.00 per share of the Company's Common Stock. The dividend was paid on May 25, 2012 to holders of record as of the close of business on May 16, 2012.

On December 3, 2012, the Company's Board of Directors declared a special dividend totaling approximately $10.6 million, or $1.40 per share of the Company's Common Stock. The dividend was paid on December 21, 2012 to holders of record as of the close of business on December 14, 2012.
Equity Compensation Plans
The table below sets forth information with respect to shares of Common Stock that may be issued under our stock option plans as of December 31, 2014.
Plan Category
 
Number of securities
issuable upon
exercise of
outstanding options
 
Weighted
average
exercise price
of outstanding
options
 
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
 
 
(a)
 
(b)
 
(c)
Equity compensation plans approved by security holders (1)
 
291,639

 
$
18.83

 
103,914

Equity compensation plans not approved by security holders (2)
 
116,311

 
$
30.39

 

Total 
 
407,950

 
$
22.12

 
103,914

 
 
 
 
 
 
 
_____________________________
(1)
Includes shares underlying options granted or available for grant under the 2007 Omnibus Incentive Plan, as amended, (the "Omnibus Plan") and one of its predecessors, the 1997 Incentive and Nonstatutory Stock Option Plan.
(2)
Includes (a) a grant of 87,500 to Dilip Singh, a former chief executive officer, on his July 1, 2010 hire date, and (b) shares underlying options or awards granted under the 2003 Non-Director and Non-Executive Officer Consolidated Long-Term Stock Incentive Plan (the "Consolidated Plan"). These options expire in accordance with their terms on December 5, 2015.
In 2007, MRV's stockholders approved the Omnibus Plan to consolidate MRV's two outstanding equity compensation plans including (a) MRV's expiring 1997 Incentive and Nonstatutory Stock Option Plan, under which all employees, officers, directors and consultants were eligible to participate, which was submitted to and approved by stockholders, and (b) the Consolidated Plan which was not submitted to or approved by stockholders as neither the NASDAQ qualification standards nor federal law or regulation required such approval at the time the Consolidated Plan was adopted. On October 11, 2012, MRV's stockholders approved an amendment to the Omnibus Plan to eliminate the sub-limit of the number of shares of restricted shares and performance and other stock-based awards that have otherwise previously been authorized for issuance under the plan and to incorporate additional stockholder-friendly revisions to the plan. They also re-approved the material terms of the plan relating to the performance-based awards in order to enable the Company to satisfy applicable tax law requirements.
Upon adoption of the Omnibus Plan, no further shares were available for future grants of options or warrants under its predecessor plans including shares that became and become available as a consequence of the cancellation or forfeiture of outstanding options granted under such plans.

26


Performance Graph
The chart below compares the five-year cumulative total return, assuming the reinvestment of dividends, on MRV's Common Stock with that of the NASDAQ Composite Index, and the RDG SmallCap Technology Index. The graph assumes $100 was invested on December 31, 2009, in our Common Stock and the companies in each of the NASDAQ Composite Index, and the RDG SmallCap Technology Index. It should be noted that this graph represents historical stock price performance and should not be considered indicative of potential future stock price performance.
 
 
Cumulative Total Return
 
 
2009
 
2010
 
2011
 
2012
 
2013
 
2014
MRV Communications, Inc. 
 
100.00

 
252.11

 
185.15

 
180.89

 
188.27

 
174.40

NASDAQ Composite
 
100.00

 
117.61

 
118.70

 
139.00

 
196.83

 
223.74

RDG SmallCap Technology
 
100.00

 
124.53

 
97.01

 
94.60

 
116.41

 
101.03


Item 6.    Selected Financial Data.
The following data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto, in Items 7 and 8, respectively, of this Form 10-K in order to fully understand factors that may affect the comparability of the financial data.

27


The following selected balance sheet data as of December 31, 2014 and 2013 and selected statement of operations data for each of the three years in the period ended December 31, 2014, 2013 and 2012 are derived from our audited financial statements included in Item 8 of this Form 10-K. The selected balance sheet data as of December 31, 2012, 2011 and 2010 and selected statement of operations data for the years ended December 31, 2011 and 2010 are derived from the selected financial data contained in Item 6 of MRV's 2013 Annual Report on Form 10-K, adjusted for discontinued operations.
On October 26, 2010, the Company sold all of the issued and outstanding capital stock of its wholly-owned subsidiaries Source Photonics, Inc. and Source Photonics Santa Clara, Inc. (together “Source Photonics"). We recognized a gain of $37.5 million in 2010 on the sale of Source Photonics.

On May 6, 2011, we sold all of the issued and outstanding capital stock of three wholly-owned operating subsidiaries, TurnKey Communications AG, TurnKey Services AG, and Elcoma AG (together “TurnKey"). We recognized a loss of $3.4 million in 2011 on the sale of TurnKey.
On March 29, 2012, we sold all of the issued and outstanding capital stock of CES, which was part of our Network Equipment segment. We have reclassified the historical financial results of CES as discontinued operations in all periods presented prior to 2013. The historical results do not necessarily indicate results expected for any future period.
On October 12, 2012, we sold all of the issued and outstanding capital stock of Alcadon, which was part of our Network Integration segment. We have reclassified the historical financial results of Alcadon as discontinued operations in all periods presented prior to 2013. The historical results do not necessarily indicate results expected for any future period.

On October 16, 2012, we sold all of the issued and outstanding capital stock of Pedrena, which was part of our Network Integration segment. We have reclassified the historical financial results of Pedrena as discontinued operations in all periods presented prior to 2013. The historical results do not necessarily indicate results expected for any future period.

28



 
 
Year ended December 31,
(in thousands, except per share amounts)
 
2014
 
2013
 
2012
 
2011
 
2010
Statements of Operations Data:
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
172,056

 
$
166,201

 
$
151,661

 
$
157,068

 
$
163,461

Cost of sales
 
116,278

 
108,208

 
96,509

 
95,394

 
95,720

Gross profit
 
55,778

 
57,993


55,152


61,674


67,741

Operating expenses:
 
 
 
 
 
 
 
 
 
 
Product development and engineering
 
20,833

 
19,381

 
15,344

 
14,486

 
15,462

Selling, general and administrative
 
42,695

 
42,993

 
48,599

 
50,905

 
50,664

Impairment of goodwill
 

 

 
1,056

 

 

Total operating expenses
 
63,528

 
62,374


64,999


65,391


66,126

Operating income (loss)
 
(7,750
)
 
(4,381
)

(9,847
)

(3,717
)

1,615

Interest and other income (expense), net
 
(102
)
 
(933
)
 
1,659

 
(826
)
 
(1,238
)
Income (loss) from continuing operations before income taxes
 
(7,852
)
 
(5,314
)
 
(8,188
)
 
(4,543
)
 
377

Provision for income taxes
 
4,303

 
1,508

 
(1,013
)
 
(1,191
)
 
(468
)
Income (loss) from continuing operations
 
(12,155
)
 
(6,822
)
 
(7,175
)
 
(3,352
)
 
845

Income (loss) from discontinued operations, net
 

 

 
12,839

 
(3,474
)
 
49,935

Net income (loss)
 
(12,155
)
 
(6,822
)
 
5,664

 
(6,826
)
 
50,780

Less:
 
 
 
 
 
 
 
 
 
 
Net income (loss) attributable to non-controlling interests, continuing operations
 

 

 

 

 
2,089

Net income (loss) attributable to MRV
 
$
(12,155
)
 
$
(6,822
)
 
$
5,664

 
$
(6,826
)
 
$
48,691

Net income (loss) from continuing operations attributable to MRV
 
$
(12,155
)
 
$
(6,822
)
 
$
(7,175
)
 
$
(3,352
)
 
$
(1,244
)
Net income (loss) from discontinued operations attributable to MRV
 
$

 
$

 
$
12,839

 
$
(3,474
)
 
$
49,935

Net income (loss) attributable to MRV per share — basic:
 
 
 
 
 
 
 
 
 
 
From continuing operations
 
$
(1.66
)
 
$
(0.91
)
 
$
(0.92
)
 
$
(0.43
)
 
$
(0.16
)
From discontinued operations
 

 

 
1.64

 
(0.44
)
 
6.34

Net income (loss) attributable to MRV per share — basic
 
$
(1.66
)
 
$
(0.91
)
 
$
0.72

 
$
(0.87
)
 
$
6.18

Net income (loss) attributable to MRV per share — diluted:
 
 
 
 
 
 
 
 
 
 
From continuing operations
 
$
(1.66
)
 
$
(0.91
)
 
$
(0.92
)
 
$
(0.43
)
 
$
(0.16
)
From discontinued operations
 

 

 
1.64

 
(0.44
)
 
6.30

Net income (loss) attributable to MRV per share — diluted
 
$
(1.66
)
 
$
(0.91
)
 
$
0.72

 
$
(0.87
)
 
$
6.14

Basic weighted average shares
 
7,344

 
7,484

 
7,813

 
7,878

 
7,878

Diluted weighted average shares
 
7,344

 
7,484

 
7,817

 
7,878

 
7,921

 
 
 
 
 
 
 
 
 
 
 
Cash dividend declared per share
 
$

 
$

 
$
7.40

 
$
9.60

 
$




29


 
 
December 31,
(in thousands)
 
2014
 
2013
 
2012
 
2011
 
2010
Selected Balance Sheet Data:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
22,422

 
$
27,591

 
$
40,609

 
$
58,590

 
$
125,598

Working capital
 
47,081

 
58,249

 
69,111

 
116,420

 
192,756

Total assets
 
114,572

 
127,947

 
128,565

 
230,689

 
326,866

Total long-term liabilities
 
5,271

 
5,236

 
5,184

 
6,676

 
9,393

Additional paid-in capital
 
1,284,483

 
1,281,883

 
1,281,170

 
1,337,935

 
1,410,234

Accumulated deficit
 
(1,220,492
)
 
(1,208,337
)
 
(1,201,515
)
 
(1,207,178
)
 
(1,200,352
)
Total stockholders' equity
 
$
50,970

 
$
63,790

 
$
72,901

 
$
142,214

 
$
221,101


Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Item 8 of this Form 10-K. In addition to historical information, the discussion in this Form 10-K contains certain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated by these forward-looking statements. We assume no obligation to update any of the forward-looking statements after the date of this Form 10-K. The following discussion and analysis is organized as follows:
Overview
Critical Accounting Policies
Recently Issued Accounting Standards
Currency Rate Fluctuations
Results of Operations
Liquidity and Capital Resources
Off Balance Sheet Arrangements
Overview
We supply communications equipment and services to carriers, governments and enterprise customers worldwide. We conduct our business along two principal segments: Network Equipment and Network Integration. We evaluate segment performance based on the revenues, gross profit and operating expenses of each segment. We do not evaluate segment performance on additional financial information. As such, there are no separately identifiable Statements of Operations data below operating income. Our Network Equipment segment primarily provides communications equipment that facilitates access, transport, aggregation and management of voice, data and video traffic in communication networks and data centers used by telecommunications service providers, cable operators, enterprise customers and governments worldwide. Our Network Integration segment operates primarily in Italy, servicing Tier One service providers, regional carriers, large enterprises, and government institutions. Network Integration is a supplier of a wide range of communications equipment from leading global manufacturers, as well as telecommunications solutions and services, including network infrastructure, unified communications, mobility and wireless, network security, cloud computing services, managed call center services, network integration, and optimization. We market and sell our products worldwide, through a variety of channels, which include a dedicated direct sales force, manufacturers' representatives, value-added-resellers, distributors and systems integrators. Sales of our products can be subject to seasonality.

On March 29, 2012, the Company completed the sale of all of the issued and outstanding capital stock of its wholly-owned subsidiary CES. The sale was completed pursuant to a Stock Purchase Agreement, dated as of December 2, 2011, with CES Holding SA, as purchaser, represented for purpose of the Agreement by Vinci Capital Switzerland SA. The purchase agreement and sale of CES were approved by the Company's stockholders at the Company's annual meeting of stockholders held on January 9, 2012. We recognized a gain of $5.8 million in 2012 on the sale of CES.


30


On October 12, 2012, the Company completed the sale of all of the shares of its wholly-owned subsidiary Alcadon pursuant to a Stock Purchase Agreement, dated as of September 11, 2012 with Deltaco Aktiebolag, a public corporation organized under the laws of Sweden. The Alcadon Purchase Agreement and sale of Alcadon were approved by the Company's stockholders at the Company's annual meeting of stockholders held on October 11, 2012. We recognized a gain of $4.5 million in 2012 on the sale of Alcadon.

On October 16, 2012, the Company completed the sale of its subsidiary Pedrena Enterprises B.V., a Dutch company ("Pedrena"). Pedrena is the parent company of Interdata, which is in turn, the parent company of J3TEL. The sale was completed pursuant to a Share Purchase Agreement, dated as of August 1, 2012 with IJ Next, a French "société par actions simplifiée," as purchaser, a subsidiary of the French company, Holding Baelen Gaillard. We recognized a gain of $2.6 million in 2012 on the sale of Pedrena.

We have reclassified the historical results of TurnKey, CES, Alcadon, and Pedrena as discontinued operations in this Form 10-K for all periods presented. Accordingly, the related assets and liabilities of TurnKey, CES, Alcadon and Pedrena have been classified as assets and liabilities from discontinued operations in the December 31, 2011 Balance Sheet and the net income or loss of TurnKey, CES, Alcadon, and Pedrena prior to their dispositions has been classified as income or loss from discontinued operations. Cash flows from discontinued operations are presented combined with the cash flows from continuing operations in the accompanying Statement of Cash Flows. See Note 3 "Discontinued Operations" to the Financial Statements in Item 8 of this Form 10-K for further discussion.

Our business involves reliance on foreign-based offices. Several of our divisions, outside subcontractors and suppliers are located in foreign countries, including Argentina, Australia, Canada, Denmark, Germany, Israel, Italy, Netherlands, Philippines, Poland, Russia, Taiwan, Thailand, and the United Kingdom. For the years ended December 31, 2014, 2013 and 2012, external revenues from foreign subsidiaries accounted for 63%, 61% and 62%, respectively, of our total revenue. The majority of our foreign sales are to customers located in the European region, with remaining foreign sales primarily to customers in the Asia Pacific region.

In 2012, we continued to experience contraction in the Americas and Europe that were exacerbated by falling exchange rates. These unfavorable results were partially offset with growth in the Asia Pacific. In 2013, we witnessed improvement in the Americas and experienced continued contraction in Europe and Asia Pacific that were partially offset by increasing in exchange rates. In 2014, we saw improvement in Asia Pacific but witnessed continued contraction in the Americas and Europe and were not materially impacted by exchange rate fluctuations.

During 2012, we declared two special dividends to stockholders totaling $58.0 million. Our Board of Directors considered the Company's liquidity and capital needs prior to declaring each of the dividends, and determined the $58.0 million to be excess capital. We believe that after the dividends, the Company continues to have ample capital to meet our expected capital needs. As of December 31, 2014, the Company had $22.4 million in cash and cash equivalents and $5.4 million in short-term debt.

On December 16, 2014, the Company announced that the Board of Directors approved a repurchase of shares of Common Stock of the Company in an amount up to $8.0 million under a Stock Repurchase Program. The program expires on November 13, 2015. The Company did not have any share repurchases settle under this program through December 31, 2014.

Critical Accounting Policies

Our discussion and analysis of the Company's financial condition and results of operations are based upon the financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).


31


The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. Certain of these critical accounting policies affect working capital account balances, including the policies for revenue recognition, allowance for doubtful accounts, inventory reserves and income taxes. These policies require that we make estimates in the preparation of our financial statements as of a given date.

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

Revenue Recognition. Our major revenue-generating products consist of switches and routers, console management, physical layer products, and fiber optic components. We recognize product revenue, net of sales discounts, returns and allowances, when persuasive evidence of an arrangement exists, delivery has occurred and all significant contractual obligations have been satisfied, the fee is fixed or determinable and collection is considered reasonably assured. Products are generally shipped "FOB shipping point," with no right of return and revenue is recognized upon shipment. If revenue is to be recognized upon delivery, such delivery date is tracked through information provided by the third party shipping company we use to deliver the product to the customer. Network Integration resells third party products. We recognize revenue on these sales on a gross basis, as a principal, because we are the primary obligor in the arrangement, we are exposed to inventory and credit risk, we negotiate the selling prices, and we sell the products as part of a solution in which we provide services. Sales of services and system support are deferred and recognized ratably over the contract period. Sales to end customers with contingencies, such as rights of return, rotation rights, conditional acceptance provisions and price protection, are infrequent and insignificant and are deferred until the contingencies have been satisfied or the contingent period has lapsed. For sales to distributors, we generally recognize revenue when product is sold to the distributor rather than when the product is sold by the distributor to the end user. In certain circumstances, distributors have limited rights of return, including stock rotation rights, and/or are entitled to price protection, where a rebate credit may be provided to the customer if we lower our price on products held in the distributor's inventory. We estimate and establish allowances for expected future product returns and credits. We record a reduction in revenue for estimated future product returns and future credits to be issued to the customer in the period in which revenue is recognized, and for future credits to be issued in relation to price protection at the time we make changes to our distributor price book. We monitor product returns and potential price adjustments on an ongoing basis and estimate future returns and credits based on historical sales returns, analysis of credit memo data, and other factors known at the time of revenue recognition.

We generally warrant our products against defects in materials and workmanship for 90 days to three year periods. The estimated cost of warranty obligations and sales returns and other allowances are recognized at the time of revenue recognition based on contract terms and prior claims experience.

Accounting for Multiple-Element Arrangements entered into prior to January 1, 2011. Arrangements with customers may include multiple deliverables involving combinations of equipment, services and software. In accordance with ASC 605-25 Multiple-Element Arrangements, the entire fee from the arrangement is allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element is met. Fair value for each element is established based on the sales price charged when the same element is sold separately. If multiple element arrangements include software or software-related elements, we apply the provisions of ASC 985-605 Software to the software and software-related elements, or to the entire arrangement if the software is essential to the functionality of the non-software elements.

Accounting for Multiple-Element Arrangements entered into or materially altered after January 1, 2011. We allocate arrangement consideration at the inception of the arrangement to all deliverables using the relative selling price method. The selling price we use for each deliverable is based on (a) vendor-specific objective evidence if available; (b) third-party evidence if vendor-specific objective evidence is not available; or (c) estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. We allocate discounts in the arrangement proportionally on the basis of the selling price of each deliverable.


32


Allowance for Doubtful Accounts. We make ongoing estimates relating to the collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability of customers to meet their financial obligations to us. In determining the amount of the reserve, we consider our historical level of credit losses and make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Because we cannot precisely predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates. If the financial condition of our customers deteriorates, resulting in their inability to make payments, a larger reserve may be required. In the event we determine that a change in the allowance is appropriate, we would record a credit or a charge to selling, general and administrative expense in the period in which we make such a determination.

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

Inventory.   We make ongoing estimates relating to the net realizable value of inventories, based upon our assumptions about future demand and market conditions. If we estimate that the net realizable value of our inventory is less than the cost of the inventory recorded on our books, we record an adjustment to the cost basis equal to the difference between the cost of the inventory and the estimated net realizable market value. This adjustment is recorded as a charge to cost of goods sold, and includes estimates for excess quantities and obsolete inventory. If changes in market conditions result in reductions in the estimated net realizable value of our inventory below previous estimates, we would make further adjustments in the period in which we make such a determination and record a charge to cost of goods sold. At the time of recording the adjustment, a new, lower cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration of, or increase in, that newly established cost basis.

Goodwill and Other Intangibles. Goodwill represents the excess purchase price over amounts assigned to tangible or identifiable intangible assets acquired and liabilities assumed from our acquisitions. We do not amortize goodwill and intangible assets with indefinite lives, but instead measure these assets for impairment at least annually or whenever events or changes in circumstances indicate that the asset might be impaired. We also test goodwill for impairment between annual tests if an event occurs or circumstances change that could potentially reduce the fair value of the reporting unit below its carrying value. Due to goodwill impairment charges in 2012, which effectively reduced Goodwill down to zero, there is no reported goodwill or goodwill impairment as of and for the years ended December 31, 2014 and 2013.

Our annual assessment of fair value would first involve a qualitative assessment to determine if it is more likely than not that a reporting unit's fair value is less than its carrying amount. If this qualitative assessment indicates a possible impairment, then a two-step quantitative test is performed. Our annual assessment considers economic conditions and trends, estimated future operating results, and anticipated future economic conditions. We determine the fair value of each reporting unit using a discounted cash flow based valuation methodology. To validate reasonableness of the valuation, we reconcile the sum of the fair values across all reporting units to the Company's market capitalization as of the valuation date. The first step is to compare the fair value of the reporting unit with the unit's carrying amount, including goodwill. If this test indicates that the fair value is less than the carrying value, then step two is required to compare the implied fair value of the reporting unit's goodwill with the carrying amount of the reporting unit's goodwill. A non-cash goodwill impairment charge would have the effect of decreasing our earnings or increasing our losses in such period. See Note 4 "Goodwill and Other Intangibles" to the Consolidated Financial Statements in Item 1 of this Form 10-K for further discussion.

We make judgments about the recoverability of intangible assets with finite lives whenever events or changes in circumstances indicate that impairment may exist. Recoverability of intangible assets with finite lives is measured by comparing the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. Our ongoing consideration of all the factors described previously could result in additional impairment charges in the future, which could adversely affect our net income.
  

33


Software Development Costs. Development costs related to software products are expensed as incurred until the technological feasibility of the product has been established. Technological feasibility occurs when a working model is completed or a detail program design exists. After technological feasibility is established, additional costs are capitalized. We believe that our process for internally developed software is essentially completed concurrent with the establishment of technological feasibility, and, accordingly, no software development costs for internally developed software have been capitalized to date.

Internal Use Software Development. Any software that we acquire, internally develop, or modify solely to meet our internal needs, and for which we have no substantive plan to market the software externally, is capitalized. During the year ended December 31, 2013, we implemented a new enterprise-wide software for which we capitalized the development costs. These costs were capitalized and included in property and equipment on the Consolidated Balance Sheets.

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

We utilize significant management judgment to determine the provision for income taxes, deferred income tax assets and liabilities, including uncertain tax positions, and any valuation allowance recorded against net deferred income tax assets. Management periodically evaluates the deferred income tax assets as to whether it is likely that the deferred income tax assets will be realized. We establish a valuation allowance on the deferred income tax asset at the time we determine the asset is not likely to be realized. If we later determine that it is more-likely-than-not that a deferred tax asset will be realized, we release the valuation allowance and record a credit within the Consolidated Statements of Operations.

Share-Based Compensation.   We determine the fair value of stock options using the Black-Scholes valuation model. The assumptions used in calculating the fair value of share-based payment awards represent our best estimates. Our estimates may be impacted by certain variables including stock price volatility, employee stock option exercise behaviors, additional stock option grants, estimates of forfeitures, and the related income tax impact. (See Note 13 “Share-Based Compensation” to the Consolidated Financial Statements in Item 8 of this Form 10-K for further discussion.)

Correction of an Immaterial Error

During the six months ended June 30, 2014, the Company recorded an out-of-period adjustment to defer previously recognized revenue of $2.0 million, which resulted in an increase to after-tax net loss of $0.1 million for the six months ended June 30, 2014. The Company reduced cost of sales by $1.8 million, gross profit by $0.2 million and the provision for income taxes by $0.1 million related to prior periods to remove the effect of the previously recognized revenue for the six months ended June 30, 2014. These out of period adjustments also resulted in an increase in Inventory of $1.9 million, deferred revenue of $2.0 million and deferred income taxes, net of current portion by $0.1 million at of June 30, 2014. The impact on accumulated deficit and stockholder’s equity was a reduction of $0.1 million as of June 30, 2014. Management evaluated the effects of this adjustment on the Company’s consolidated financial statements and concluded that the error was not material to any prior periods, individually or in the aggregate. During the six months ended December 31, 2014, the Company recognized $1.4 million of revenue and $0.1 million gross profit, reducing the impact on deferred revenue, inventory and gross profit for the out-of-period adjustment to $0.6 million, $0.5 million and $0.1 million, respectively for the year ended December 31, 2014. The impact on accumulated deficit and stockholder’s equity was a reduction of $0.1 million as of December 31, 2014.


34



Currency Rate Fluctuations
Changes in the relative values of non-U.S. currencies to the U.S. dollar affect our results. We conduct a significant portion of our business in foreign currencies, including the Euro, the Taiwan dollar and the Israeli new shekel. For the year ended December 31, 2014 and 2013, 63% and 61% of external revenue, respectively, and 42% of operating expenses, were incurred at foreign subsidiaries. For the year ended December 31, 2014, the exchange rates for these currencies did not materially change against the U.S. dollar compared to the year ended December 31, 2013, so revenue and expenses in these currencies translated into slightly fewer dollars than they would have in the prior period. The Israeli new shekel strengthened 1% respectively against the U.S. dollar for the year ended December 31, 2014, compared to the year ended December 31, 2013. The fluctuation in the Euro against the U.S. dollar was not significant for the year ended December 31, 2014, compared to the year ended December 31, 2013. The Company's Taiwan subsidiary, Appointech, Inc., is included in Network Equipment that also includes our Optical Communications Systems ("OCS") division. Relative to OCS, the revenues and related operating gross profit and operating expenses are not material and the change in foreign currency did not have a material impact on the results for the year ended December 31, 2014 compared to 2013. Additional discussion of foreign currency risk and other market risks is included in Part I, Item 3 “Quantitative and Qualitative Disclosures About Market Risk” of this Form 10-K.

Management Discussion Snapshot

The following table sets forth, for the periods indicated, certain consolidated and segment Statements of Operations data (in thousands):

 
Year ended December 31,
 
2014
 
2013
 
2012
 
 
$
 
% (1)
 
$
 
% (1)
 
$
 
% (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenue (1) (2)
$
172,056

 
100
 %
 
$
166,201

 
100
 %
 
$
151,661

 
100
 %
 
Network Equipment segment
86,705

 
50

 
90,711

 
55

 
87,727

 
58

 
Network Integration segment
85,518

 
50

 
75,636

 
46

 
72,421

 
48

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit (3)
55,778

 
32

 
57,993

 
35

 
55,152

 
36

 
Network Equipment segment
42,601

 
49

 
47,069

 
52

 
43,325

 
49

 
Network Integration segment
13,176

 
15

 
10,917

 
14

 
11,832

 
16

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses (4)
63,528

 
37

 
62,374

 
38

 
64,999

 
43

 
Network Equipment segment
49,674

 
57

 
48,768

 
54

 
42,228

 
48

 
Network Integration segment
7,615

 
9

 
6,297

 
8

 
7,318

 
10

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss) (3) (4)
(7,750
)
 
(5
)
 
(4,381
)
 
(3
)
 
(9,847
)
 
(6
)
 
Network Equipment segment
(7,074
)
 
(8
)
 
(1,699
)
 
(2
)
 
1,096

 
1

 
Network Integration segment
5,562

 
7

 
4,620

 
6

 
4,514

 
6

 
 
 
 
 
 
 
 
 
 
 
 
 
 
___________________________________
(1)
Consolidated Statements of Operations data and segment revenue data express percentages as a percentage of consolidated revenue. Other Statements of Operations data by segment express percentages as a percentage of applicable segment revenue.
(2)
Revenue information by segment includes intersegment revenue reflecting sales of network equipment to the Network Integration segment.
(3)
Consolidated gross profit data reflects adjustments for intersegment eliminations.
(4)
Consolidated operating expenses include corporate unallocated operating expenses.


35


Discontinued Operations

On October 16, 2012, the Company completed the sale of its subsidiary, Pedrena. The sale was completed pursuant to a Share Purchase Agreement, dated as of August 1, 2012 (the "Interdata Purchase Agreement") with IJ Next, a French "société par actions simplifiée," as purchaser. The purchaser was a wholly-owned subsidiary of the French company Holding Baelen Gaillard ("HBG").
 
The purchase price was €14.6 million or $19.0 million and was paid in cash at closing by HBG to the Company. Cash proceeds to the Company were subject to closing costs of approximately $0.8 million. In addition to the Interdata Purchase Agreement, the Company and purchaser entered into a Representations and Warranties Agreement on August 1, 2012 (the "Representation and Warranties Agreement") related to the transaction which included customary representations, warranties, covenants and indemnification obligations. The Interdata Purchase Agreement, Representations and Warranties Agreement and sale of Interdata were approved by the Company's stockholders at the Company's annual meeting of stockholders held on October 11, 2012.

The statements of operations data for the year ended December 31, 2012 that would have been included if Pedrena had not been sold consisted of (in thousands):
Year ended December 31:
2012
Revenue
$
27,602

Income (loss) before income taxes
(3,175
)
Provision for income taxes
(244
)
Income (loss) from operations of discontinued operations
(2,931
)
Gain on sale of Interdata, net of income taxes of $623
5,542

Net income (loss) from discontinued operations, net of income taxes
$
2,611

 
 

On October 12, 2012, the Company completed the sale of all of the shares of its wholly-owned subsidiary Alcadon pursuant to a Stock Purchase Agreement, dated as of September 11, 2012 (the "Alcadon Purchase Agreement") with Deltaco Aktiebolag, a public corporation organized under the laws of Sweden (“Deltaco”). The Alcadon Purchase Agreement and sale of Alcadon were approved by the Company's stockholders at the Company's annual meeting of stockholders held on October 11, 2012.

The purchase price paid at closing to the Company by Deltaco was $6.5 million plus estimated net cash as of September 30, 2012 of $1.2 million for an aggregate of $7.7 million. The cash proceeds received were subject to an escrow amount of $0.8 million and approximately $0.3 million in closing costs. The escrow fund was released on December 28, 2012, subject to a 'true-up' adjustment of $0.7 million. Prior to the closing, Alcadon paid a cash dividend to MRV in the amount of $3.7 million. Total net cash proceeds to the Company were $10.6 million inclusive of the $3.7 million dividend and net of the true-up and other closing costs.

The statements of operations data for the year ended December 31, 2012 that would have been included if Alcadon had not been sold consisted of (in thousands):
Year ended December 31:
2012
Revenue
$
24,320

Income (loss) before income taxes
(1,088
)
Provision for income taxes
643

Income (loss) from operations of discontinued operations
(1,731
)
Gain on sale of Alcadon, net of income taxes of $1,341
6,182

Net income (loss) from discontinued operations, net of income taxes
$
4,451

 
 


36


On March 29, 2012, the Company completed the sale of all of the issued and outstanding capital stock of its wholly-owned subsidiary CES. The sale was completed pursuant to a Stock Purchase Agreement (the "CES Purchase Agreement"), dated as of December 2, 2011, with CES Holding SA, as purchaser, represented for purpose of the Agreement by Vinci Capital Switzerland SA. The CES Purchase Agreement and sale of CES were approved by the Company's stockholders at the Company's annual meeting of stockholders held on January 9, 2012. The purchase price for CES paid on closing to the Company was CHF 25.8 million, or U.S. $28.4 million, with CHF 2.6 million, or U.S. $2.8 million of the proceeds going into an indemnification escrow account to be released in one year to the Company (subject to any indemnification claims that may be brought by the purchaser). Cash proceeds to the Company were $24.2 million upon closing net of the escrowed funds and other closing costs.

The historical financial results of CES prior to its sale have been reclassified as discontinued operations for all periods presented. The Company recorded net income of $5.8 million from discontinued operations, net of income tax expense, for the year ended December 31, 2012. The net income from discontinued operations for the year ended December 31, 2012 include a $6.5 million gain partially offset by a $0.1 million operating loss and $0.4 million in withholding tax expense.

The statements of operations data for the years ended December 31, 2012 that would have been included if CES had not been sold consisted of (in thousands):

Year ended December 31:
2012
Revenue
$
6,829

Income (loss) before income taxes
(135
)
Provision for income taxes
556

Income (loss) from operations of discontinued operations
(691
)
Gain on sale of CES, net of income taxes of $1,668
6,470

Net income (loss) from discontinued operations, net of income taxes
$
5,779

 
 

Year ended December 31, 2014 Compared to the Year ended December 31, 2013

Revenue

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

 
 
 
 
 
Favorable/(Unfavorable)
Years ended December 31:
2014
 
2013
 
$
Change
 
%
Change
 
% Change constant
currency (1)
Network Equipment segment
$
86,705

 
$
90,711

 
$
(4,006
)
 
(4
)%
 
(4
)%
Network Integration segment
85,518

 
75,636

 
9,882

 
13

 
13

Before intersegment adjustments
172,223

 
166,347

 
5,876

 
4

 
4

Intersegment adjustments (2)
(167
)
 
(146
)
 
(21
)
 
14

 
14

Total
$
172,056

 
$
166,201

 
$
5,855

 
4
 %
 
4
 %
 
 
 
 
 
 
 
 
 
 
___________________________________
(1)
Percentage information in constant currencies in the table above and in the text below excludes the effect of foreign currency translation on reported results. Constant currency results were calculated by translating the current year results at prior year average exchange rates.
(2)
Adjustments represent the elimination of intersegment revenue.


37


Consolidated revenue for the year ended December 31, 2014 increased $5.9 million, or 4%, compared to the year ended December 31, 2013, due to a $9.9 million, or 13%, increase in Network Integration revenue, offset by a $4.0 million, or 4%, decrease in Network Equipment revenue. Consolidated revenue would have been $0.3 million, or 0.2% higher for the year ended December 31, 2014 had foreign currency exchange rates remained the same as they were for the year ended December 31, 2013, with the favorable change primarily occurring within in the Network Integration group. The above discussion includes the out-of-period adjustment of $2.0 million recorded during the three months ended June 30, 2014, related to deferred revenue. Of this amount, the Company recognized $1.4 million during the six months ended December 31, 2014, reducing the impact on deferred revenue for the out-of-period adjustment recorded during the three months ended June 30, 2014 to $0.6 million as of December 31, 2014.

Network Equipment Group.    Revenue generated from the Network Equipment group decreased $4.0 million, or 4%, for the year ended December 31, 2014 compared to the year ended December 31, 2013. Revenues decreased primarily due to a $4.0 million, or 5% decrease in product revenues. Revenues for our Optical Transport, Infrastructure Management and Network Management products decreased during the year ended December 31, 2014, compared to the year ended December 31, 2013, primarily due to the end-of-life stage on certain products not yet fully replaced by new products. Decreases were offset in part by an increase in carrier Ethernet networking and out of band products of $2.8 million. Service revenues were down less than 0.5% for the year ended December 31, 2014, compared to the year ended December 31, 2013, primarily due to the roll off of older deferred service contracts that related to revenues scheduled for recognition prior to January 1, 2011. Geographically, Asia Pacific revenues increased $5.4 million, primarily due growth in sales for a Tier 1 customer, partially offset by a $9.4 million decrease in OCS Americas and Europe. The decrease in OCS Americas was primarily due to revenue declines related to end-of-life products, partially offset by modest revenue growth in certain new products. European revenues declined due to overall challenging economic conditions. The foreign exchange impact to the Network Equipment segment is not material due to Appointech, which is a minor part of this segment, being the only business unit subject to foreign exchange fluctuations.

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

 
 
 
 
 
Favorable/(Unfavorable)
Years ended December 31:
2014
 
2013
 
$ Change
 
% Change
Revenue, excluding intersegment sales:
 
 
 
 
 
 
 
United States
$
51,036

 
$
55,071

 
$
(4,035
)
 
(7
)%
Americas (Excluding the U.S.)
1,507

 
4,200

 
(2,693
)
 
(64
)%
Europe
20,478

 
23,207

 
(2,729
)
 
(12
)
Asia Pacific
13,517

 
8,087

 
5,430

 
67

Total external sales
86,538

 
90,565

 
(4,027
)
 
(4
)
Sales to Network Integration segment:
 
 
 
 
 
 
 
Europe
167

 
146

 
21

 
14

Total Network Equipment revenue
$
86,705

 
$
90,711

 
$
(4,006
)
 
(4
)%
 
 
 
 
 
 
 
 

Network Integration Group.    Revenue generated from the Network Integration group increased $9.9 million, or 13%, for the year ended December 31, 2014 compared to the year ended December 31, 2013. This increase was due to $9.6 million, or 25%, increase in product revenue and $0.3 million, or 1%, increase in service revenues at Tecnonet. Tecnonet has seen an increase in product revenue order volume primarily as a result of gains in market share in a difficult market where smaller integrators are decreasing in relevance and as a result of significant projects in 2014 that may not continue in the future. The increase in service revenue was a result of market share gains resulting from our continued focus on this aspect of the business that has higher margins and potential for growth. Total revenue from this segment would have been $0.2 million, or 0.3%, higher for the year ended December 31, 2014 had foreign currency exchange rates remained the same as they were for the year ended December 31, 2013. All revenue in the Network Integration segment was generated in Italy. Revenue from external customers attributed to Italy totaled $86.3 million, $76.6 million, and $73.1 million for the years ended December 31, 2014, 2013 and 2012 respectively. The above discussion includes the out-of-period adjustment of $2.0 million recorded during the three months ended June 30, 2014, related to deferred revenue. Of this amount, the Company recognized $1.4 million during the six months ended December 31, 2014, reducing the impact on deferred revenues for the out-of-period adjustment recorded during the three months ended June 30, 2014 to $0.6 million as of December 31, 2014.


38


Gross Profit

The following table summarizes gross profit by segment (in thousands):
 
 
 
 
 
Favorable/(Unfavorable)
Years ended December 31:
2014
 
2013
 
$
Change
 
%
Change
 
 % Change constant
currency (1)
Network Equipment segment
$
42,601

 
$
47,069

 
$
(4,468
)
 
(9
)%
 
9
 %
Network Integration segment
13,176

 
10,917

 
2,259

 
21

 
(21
)
Before intersegment adjustments
55,777

 
57,986

 
(2,209
)
 
(4
)
 
(4
)
Adjustments (2)
1

 
7

 
(6
)
 
(86
)
 
(86
)
Total
$
55,778

 
$
57,993

 
$
(2,215
)
 
(4
)%
 
(4
)%
 
 
 
 
 
 
 
 
 
 

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

Consolidated gross profit decreased $2.2 million, or 4%, for the year ended December 31, 2014 compared to the year ended December 31, 2013, principally due to the decline in average gross margins offset by the 4% increase in revenue. Gross margin for the year ended December 31, 2014, was 32.4% compared to 34.9% for the year ended December 31, 2013. The 2.5 percentage point decline in gross margins was due to the shift of segment revenue mix toward a higher percentage of total revenue coming from Network Integration, which has lower gross margins than Network Equipment, and due to a decrease in Network Equipment gross margins. These decreases in gross margin were partially offset by a more favorable consolidated product-to-service revenue mix in the year ended December 31, 2014, as compared to the year ended December 31, 2013. The above discussion includes the out-of-period adjustment of $0.2 million recorded during the three month.s ended June 30, 2014, related to deferred revenue. Of this amount, the Company recognized $0.1 million during the six months ended December 31, 2014, reducing the impact on consolidated gross profit for the out-of-period adjustment recorded in the three months ended June 30, 2014 to $0.1 million for the year ended December 31, 2014. The above discussion also includes the out-of-period adjustment of $0.2 million related to the elimination of intercompany profit in inventory, which decreased consolidated gross profit by $0.2 million in the three months ended September 30, 2014 and for the year ended December 31, 2014. In 2014, the effect of foreign currency exchange rates on consolidated gross profit was immaterial.

Network Equipment Group.   Gross profit for the Network Equipment group decreased $4.5 million, or 9% for the year ended December 31, 2014, compared to the year ended December 31, 2013, principally due to a shift in the mix of product revenue toward our lower margin products and a negative effect on costs from lower production volumes. These effects were partially offset by lower production labor and overhead arising from cost saving initiatives implemented during the fourth quarter of 2013. Gross margin for the year ended December 31, 2014, was 49.1%, a decline of 2.8 percentage points from 51.9% for the year ended December 31, 2013, principally caused by variances in material costs due to the under-absorption of material overhead due to lower material purchases than planned and due to the out-of-period adjustment of $0.2 million related to the elimination of intercompany profit in inventory, which resulted in a 3.3 percentage point increase in material costs on product revenues. This was partially offset by strong sales of our new OptiDriver product to a Tier 1 customer in Asia Pacific, which have a higher gross margin. The above discussion includes the out-of-period adjustment of $0.2 million related to the elimination of intercompany profit in inventory, which decreased Network Equipment gross profit by $0.2 million in the three months ended September 30, 2014 and for the year ended December 31, 2014. In 2014, the effect of foreign currency exchange rates on Network Equipment gross profit was immaterial.


39


Network Integration Group.   Gross profit for the Network Integration group increased $2.3 million, or 21% for the year ended December 31, 2014, compared to the year ended December 31, 2013, principally due to the $9.9 million or 13% increase in revenue for the year ended December 31, 2014, compared to the year ended December 31, 2013. Gross margin for the year ended December 31, 2014 was 15.4% an increase of 1% percentage point from 14.4% for the year ended December 31, 2013, primarily due to an improvement in product revenue gross margins. The above discussion includes the out-of-period adjustment of $0.2 million recorded during the three months ended June 30, 2014, related to deferred revenue. Of this amount, the Company recognized $0.1 million during the six months ended December 31, 2014, reducing the impact on consolidated gross profit for the out-of-period adjustment recorded in the three months ended June 30, 2014 to $0.1 million for the year ended December 31, 2014. In 2014, the effect of foreign currency exchange rates on Network Integration gross profit was immaterial.
 
Operating Expenses

The following table summarizes operating expenses by segment (in thousands):

 
 
 
 
 
(Favorable)/Unfavorable
Years ended December 31:
2014
 
2013
 
$
Change
 
%
Change
 
% Change constant
currency (1)
Network Equipment segment
$
49,674

 
$
48,768

 
$
906

 
2
 %
 
2
 %
Network Integration segment
7,615

 
6,297

 
1,318

 
21
 %
 
22
 %
Total segment operating expenses
57,289

 
55,065

 
2,224

 
4
 %
 
374
 %
Corporate unallocated operating expenses and adjustments (2)
6,239

 
7,309

 
(1,070
)
 
(15
)%
 
(15
)%
Total
$
63,528

 
$
62,374

 
$
1,154

 
2
 %
 
2
 %
 
 
 
 
 
 
 
 
 
 

(1)
Percentage information in constant currencies in the table above and in the text below excludes the effect of foreign currency translation on reported results. Constant currency results were calculated by translating the current year results at prior year average exchange rates.
(2)
Corporate unallocated operating expenses include unallocated product development, and selling, general and administrative expenses.

Consolidated operating expenses were $63.5 million, or 37% of revenue, for the year ended December 31, 2014, compared to $62.4 million, or 38% of revenue, for the year ended December 31, 2013, an increase of $1.2 million, or 2%, offset by $1.0 million from insurance proceeds recorded in the second quarter of 2013 in conjunction with a derivative litigation settled that quarter. The remaining increase included a $0.9 million increase in Network Equipment and $1.3 million increase in Network Integration related to investments in the core business offset by a $1.1 million decrease in Corporate, excluding the effect of the insurance proceeds. Consolidated operating expenses would have been $0.1 million higher for the year ended December 31, 2014 had foreign currency exchange rates remained the same as they were in 2013.

Corporate. Operating expenses decreased $1.1 million for the year ended December 31, 2014 compared to the year ended December 31, 2013. This decrease partially resulted from $1.0 million in lower labor and consulting fees incurred during the 2013 ERP system conversion and $0.8 million in lower auditing fees and accounting support fees, offset by the $0.7 million increase in general and administrative costs. The year ended December 31, 2013 was also burdened by $1.3 million in legal fees arising from the derivative litigation that was settled in June 2013 and costs for an investigation of claims by a former employee that were partially offset by $1.0 million in insurance recovery for legal fees incurred during the derivative litigation that was settled in June 2013.

Network Equipment Group.    Operating expenses in the Network Equipment group for the year ended December 31, 2014 were $49.7 million, or 57% of revenue, compared to $48.8 million, or 54% of revenue for the year ended December 31, 2013. The $0.9 million, or 2%, increase in operating expenses was due to $1.5 million in additional costs related to the planned investment in engineering and product development to drive future new products, and an increase in sales and back office support costs of $0.9 million, offset by a decrease in general and administrative overhead of $1.5 million of costs in 2013 related to the implementation of our Oracle ERP system. In 2014, the effect of foreign currency exchange rates on Network Equipment operating expenses was immaterial.


40


Network Integration Group.    Operating expenses in the Network Integration group for the year ended December 31, 2014 were $7.6 million, or 9% of revenue, compared to $6.3 million, or 8% of revenue for the year ended December 31, 2013. The $1.3 million, or 21%, increase in operating expenses was primarily due to $0.7 million in additional sales costs for labor and commissions and administrative costs of $0.6 million principally for audit related services and legal fees. In 2014, the effect of foreign currency exchange rates on Network Integration operating expenses was immaterial.

Operating Income (Loss)

The following table summarizes operating income (loss) by segment (in thousands):

 
 
 
 
 
Favorable/(Unfavorable)
Years ended December 31:
2014
 
2013
 
$
Change
 
%
Change
 
% Change constant
currency(1)
Network Equipment segment
$
(7,074
)
 
$
(1,699
)
 
$
(5,375
)
 
316
 %
 
317
 %
Network Integration segment
5,562

 
4,620

 
942

 
20

 
20

Total segment operating income (loss)
(1,512
)
 
2,921

 
(4,433
)
 
(152
)
 
(152
)
Corporate unallocated and adjustments (2)
(6,238
)
 
(7,302
)
 
1,064

 
15

 
(15
)
Total  
$
(7,750
)
 
$
(4,381
)
 
$
(3,369
)
 
77
 %
 
77
 %
 
 
 
 
 
 
 
 
 
 

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

(2) Adjustments represent the elimination of intersegment revenue and profit in inventory in order to reconcile to consolidated operating income (loss).

The $2.2 million, or 4%, decrease in gross profit and the $1.2 million, or 2%, increase in operating expenses primarily led to a $3.4 million or 77% increase in operating loss also representing a decline in operating margin to (5)% for the year ended December 31, 2014 compared to (3)% operating margin for the year ended December 31, 2013. Operating loss included share-based compensation expense of $1.0 million and $0.7 million for the years ended December 31, 2014 and 2013, respectively. In 2014, the effect of foreign currency exchange rates on consolidated operating loss was immaterial. The above discussion includes the out-of-period adjustment of $0.2 million recorded during the three months ended June 30, 2014, related to deferred revenue. Of this amount, the Company recognized $0.1 million during the six months ended December 31, 2014, reducing the impact on consolidated gross profit for the out-of-period adjustment recorded in the three months ended June 30, 2014 to $0.1 million for the year ended December 31, 2014. In 2014, the effect of foreign currency exchange rates on consolidated operating loss was immaterial.

Network Equipment Group. The Network Equipment group reported an operating loss of $7.1 million and $1.7 million for the years ended December 31, 2014 and 2013, respectively. The increase in operating loss for the year ended December 31, 2014 when compared to the year ended December 31, 2013, was primarily due to the planned increase in operating expenses and also due to the $4.5 million decrease in gross profit and $0.9 million increase in operating expenses. Operating margin was (8)% for the year ended December 31, 2014, and (2)% for the year ended December 31, 2013. In 2014, the effect of foreign currency exchange rates on Network Equipment operating loss was immaterial.

Network Integration Group. The Network Integration group reported operating income of $5.6 million and $4.6 million for the years ended December 31, 2014 and 2013, respectively. The $0.9 million or 20% increase was due to the $9.9 million or 13% increase in Network Integration revenues along with the $2.3 million increase in gross profit offset by the $1.3 million increase in operating expenses. The Network Integration group operating margin was 6% for the years ended December 31, 2014 and 2013, respectively. The above discussion includes the out-of-period adjustment of $0.2 million recorded during the three months ended June 30, 2014, related to deferred revenue. Of this amount, the Company recognized $0.1 million during the six months ended December 31, 2014, reducing the impact on consolidated gross profit for the out-of-period adjustment recorded in the three months ended June 30, 2014 to $0.1 million for the year ended December 31, 2014. In 2014, the effect of foreign currency exchange rates on Network Integration operating income was immaterial.


41


Interest Expense and Other Income, Net

Interest expense was $0.3 million for the year ended December 31, 2014 compared to $0.5 million for the year ended December 31, 2013. Other income, net, principally includes interest income on cash, cash equivalents and investments and gains and losses on foreign currency transactions. We recognized a net gain of $0.5 million on foreign currency transactions for the year ended December 31, 2014 compared to a $0.3 million net loss on foreign currency transactions for the year ended December 31, 2013.

Provision for Income Taxes

The tax provision for the year ended December 31, 2014 was $4.3 million compared to $1.5 million for the year ended December 31, 2013. Our income tax provision fluctuates based on the amount of per-tax income or loss generated in the various jurisdictions where we conduct operations and pay income tax. The income tax expense of $4.3 million on the loss before provision for income taxes of $7.9 million for the year ended December 31, 2014, is primarily due to recording a $1.9 million increase to the valuation allowance related to net operating losses at MRV's German subsidiary that did not meet the more-likely-than-not threshold, income tax associated with our foreign subsidiaries that do not benefit from our federal net operating loss carryforwards and from the accrual of an income tax liability, including interest and penalties, of $0.3 million on a settlement of a tax audit of Tecnonet.

Tax Loss Carryforwards

As of December 31, 2014, MRV had federal, state, and foreign net operating loss ("NOL") carryforwards available of $179.7 million, $100.7 million and $97.3 million, respectively. Additionally, the Company had capital loss carry-forwards of $110.5 million and $24.0 million for federal and state tax purposes, respectively as December 31, 2014. The capital loss carry-forwards, which were generated by the sale of Source Photonics, expire in 2015. Under the Internal Revenue Code, if a corporation undergoes an "ownership change," the corporation's ability to use its pre-change NOLs, capital loss carryforwards and other pre-change tax attributes to offset its post-change income may be limited. An ownership change is generally defined as a greater than 50% change in its equity ownership by value over a three-year period. We may experience an ownership change in the future as a result of subsequent shifts in our stock ownership. If we were to trigger an ownership change in the future, our ability to use any NOLs and capital loss carry-forwards existing at that time could be limited. As of December 31, 2014, the US federal and state NOLs had a full valuation allowance.

Italy Tax Audit Settlement

In 2013, the Italian Tax Authorities commenced an examination of Tecnonet and proposed a 100% disallowance of the deduction of certain sponsorship and advertising expenses for the years 2006 to 2011. The Company's management felt strongly that the deductions were fully supported by Italian tax law and that we would more-likely-than-not prevail if we litigated the disallowance in the Italian tax courts. Therefore, there was no unrecognized benefit or income tax liability accrued in 2013 and the first quarter of 2014 related to the tax audit. During the three months ended June 30, 2014, the Italian tax authorities offered to reduce the 100% disallowance by 60%. Our local external tax advisers advised management that the 60% offer was a good result and that litigating the matter in Italian courts could be a protracted process despite the strong technical merits of our tax position. In consideration of our tax adviser’s assessment and management's desire to resolve this uncertainty, management accepted the 60% offer and settled with the Italian tax authorities in July 2014.

The Company recorded the interest and penalties of $0.1 million related to the accrued income tax expense of $0.2 million in income tax expense in the accompanying Condensed Consolidated Statement of Operations. Accrued interest and penalties are included in the related income tax liability in the Condensed Consolidated Balance Sheet. The interest and penalties of $0.1 million and accrued VAT expense of $0.1 million related to the settlement are recognized in other expenses in the accompanying Condensed Consolidated Statement of Operations. Accrued interest and penalties are included in the related current accrued liability in the Condensed Consolidated Balance Sheet in June 2014. The accrued income tax liability and accrued VAT liability including interest and penalties of $0.5 million were paid in full on October 3, 2014.


42


Year ended December 31, 2013 Compared To Year ended December 31, 2012

Revenue

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

 
 
 
 
 
Favorable/(Unfavorable)
Years ended December 31:
2013
 
2012
 
$
Change
 
%
Change
 
% Change constant
currency (1)
Network Equipment segment
$
90,711

 
$
87,727

 
$
2,984

 
3
 %
 
3
 %
Network Integration segment
75,636

 
72,421

 
3,215

 
4

 
1

Before intersegment adjustments
166,347

 
160,148

 
6,199

 
4

 
2

Intersegment adjustments (2)
(146
)
 
(8,487
)
 
8,341

 
(98
)
 
(98
)
Total
$
166,201

 
$
151,661

 
$
14,540

 
10
 %
 
8
 %
 
 
 
 
 
 
 
 
 
 
___________________________________
(1)
Percentage information in constant currencies in the table above and in the text below excludes the effect of foreign currency translation on reported results. Constant currency results were calculated by translating the current year results at prior year average exchange rates.
(2)
Adjustments represent the elimination of intersegment revenue.

Consolidated revenue for the year ended December 31, 2013 increased $14.5 million, or 10%, compared to the year ended December 31, 2012, due to a $3.0 million, or 3% increase in Network Equipment revenue, a $3.2 million, or 4% increase in Network Integration revenue, and a $8.3 million, or 98% decrease in intersegment sales, which are eliminated in consolidation. Our former subsidiaries, Alcadon and Pedrena, were sold in the fourth quarter of 2012. Since Alcadon and Pedrena were still consolidated subsidiaries for a portion of the fourth quarter of 2012, revenue of $8.1 million from these former subsidiaries was reported in 2012 as intersegment sales that was included in Network Equipment and eliminated in determining consolidated revenue. In the fourth quarter of 2012, after the two subsidiaries were sold, we continued to sell product to these former subsidiaries, and those sales are now reported as trade sales with no adjustment required. Consolidated revenue would have been $2.5 million, or 1%, lower in 2013 if foreign currency exchange remained the same as they were in 2012, with the unfavorable change primarily occurring within in the Network Integration group.

Network Equipment Group.    Revenue generated from the Network Equipment group increased $3.0 million, or 3% for the year ended December 31, 2013, compared to the year ended December 31, 2012. Our OCS division had increased revenue for the year ended December 31, 2013 of $2.4 million due to higher product revenues, excluding the effect of discontinued intersegment sales of $8.1 million, primarily in Europe. Our intersegment sales were our OCS division's sales to Pedrena and Alcadon that were sold in October of 2012. Sales for our Carrier Ethernet and Optical Transport and Infrastructure Management product lines increased for the year ended December 31, 2013, compared to the year ended December 31, 2012, while all other product categories decreased. Service revenue decreased $0.5 million for the year ended December 31, 2013, compared to the year ended December 31, 2012, primarily due to the roll off of older deferred service contracts that related to revenues scheduled for recognition prior to January 1, 2011. Geographically, after adjusting for the $8.1 million of 2012 discontinued subsidiary intersegment revenues included in revenue for Europe, the increase at Network Equipment was in the United States, which was partially offset by a decline in all other regions. The foreign exchange impact to the Network Equipment segment is not material due to Appointech, which is a minor part of this segment, being the only business unit subject to foreign exchange fluctuations.


43


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

 
 
 
 
 
Favorable/(Unfavorable)
Years ended December 31:
2013
 
2012
 
$ Change
 
% Change
Revenue, excluding intersegment sales:
 
 
 
 
 
 
 
United States
$
55,071

 
$
47,250

 
$
7,821

 
17
 %
Americas (Excluding the U.S.)
4,200

 
6,008

 
(1,808
)
 
(30
)%
Europe
23,207

 
16,447

 
6,760

 
41

Asia Pacific
8,087

 
9,521

 
(1,434
)
 
(15
)
Other regions

 
14

 
(14
)
 
(100
)
Total external sales
90,565

 
79,240

 
11,325

 
14

Sales to Network Integration segment:
 
 
 
 
 
 
 
Europe
146

 
8,487

 
(8,341
)
 
(98
)
Total Network Equipment revenue
$
90,711

 
$
87,727

 
$
2,984

 
3
 %
 
 
 
 
 
 
 
 

Network Integration Group.    Revenue generated from the Network Integration group increased $3.2 million, or 4% for the year ended December 31, 2013, compared to the year ended December 31, 2012. This increase is attributable to increased revenue at Tecnonet, the sole business unit in the Network Integration segment. While Tecnonet experienced an increase in order volume in 2013, the Italian public telecommunications market continued to be negatively impacted by the political climate and challenging economic conditions. In addition, the Italian economy had a negative 1.9% decline for 2013. In this environment, new product orders and customer acceptance were being delayed and product pricing remained under pressure, which resulted in very modest growth in product revenues. However, the Company experienced promising growth in service revenues as the result of a continued focus on this aspect of the business that generally has higher margins and greater potential for growth. Total revenue from this segment would have been $2.5 million, or 3%, lower in 2013, compared to the prior year, had foreign currency exchange rates remained the same as they were in 2012. All revenue in the Network Integration segment was generated in Italy. Revenue from external customers attributed to Italy totaled $76.6 million and $73.1 million for the years ended December 31, 2013 and 2012 respectively.

Gross Profit

The following table summarizes gross profit by segment (in thousands):

 
 
 
 
 
Favorable/(Unfavorable)
Years ended December 31:
2013
 
2012
 
$
Change
 
%
Change
 
 % Change constant
currency (1)
Network Equipment segment
$
47,069

 
$
43,325

 
$
3,744

 
9
 %
 
9
 %
Network Integration segment
10,917

 
11,832

 
(915
)
 
(8
)
 
(11
)
Before intersegment adjustments
57,986

 
55,157

 
2,829

 
5

 
4

Adjustments (2)
7

 
(5
)
 
12

 
(240
)
 
(225
)
Total
$
57,993

 
$
55,152

 
$
2,841

 
5
 %
 
4
 %
 
 
 
 
 
 
 
 
 
 

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


44


Consolidated gross profit increased $2.8 million, or 5% for the year ended December 31, 2013, compared to the year ended December 31, 2012, primarily due to the 10% increase in revenue offset by a decline in average gross margins. Average gross margin was 34.9% for the year ended December 31, 2013, compared to 36.4% for the year ended December 31, 2012. Consolidated gross margins were negatively affected by a 1.9 percentage point decrease in Network Integration gross margins offset by the positive effect on 2012 margins due to the elimination of $8.1 million of low margin discontinued operations intersegment revenue and the related cost of sales in consolidation. Gross profit would have been $0.4 million lower if foreign currency exchange rates had remained the same as they were in 2012, which also had an impact on gross margin. Gross profit reflects share-based compensation in cost of sales of $98,000 and $39,000 for the years ended December 31, 2013 and 2012, respectively.

Network Equipment Group.  The $3.7 million, or 9% increase in gross profit for the Network Equipment group was due to $3.0 million, or 3%, increase in revenue, as well as an increase in average gross margin to 51.9% from 49.4% attributable to favorable change in revenue mix resulting in a $1.9 million improvement in gross profit and $0.2 million reduction in overhead costs that were partially offset by $0.1 million increase in labor costs. In 2013, the effect of foreign currency exchange rates on average gross profit was immaterial.

Network Integration Group.  Gross profit for the Network Integration group decreased $0.9 million, or 8% for the year ended December 31, 2013, compared to the year ended December 31, 2012. Although revenues increased $3.2 million, or 4% for the year ended December 31, 2013, compared to the year ended December 31, 2012, the 1.9 percentage point decrease in average gross margin to 14.4% from 16.3% attributed to the decrease in gross profit. Tecnonet gross margins declined mainly due to a decrease in product gross margins primarily caused by competitive pricing pressure arising from the difficult economic conditions in Italy. Tecnonet primarily serves as a reseller of the third party equipment it installs and services, and as a result, it has been experiencing significant gross margin pressure on its product sales to major telecommunication carriers. The decline in product gross margins was partially offset by an increase in service gross margins mainly due to volume efficiency and a favorable shift in revenue mix toward internally supported services. Given the struggles facing the Italian economy, we expect to continue to see pricing pressure on our product revenues. Network integration gross profit would have been $0.4 million lower in 2013 had foreign currency exchange rates remained the same as they were in 2012.

Operating Expenses

The following table summarizes operating expenses by segment (in thousands):

 
 
 
 
 
(Favorable)/Unfavorable
Years ended December 31:
2013
 
2012
 
$
Change
 
%
Change
 
% Change constant
currency (1)
Network Equipment segment
$
48,768

 
$
42,228

 
$
6,540

 
15
 %
 
15
 %
Network Integration segment
6,297

 
7,318

 
(1,021
)
 
(14
)%
 
(17
)%
Total segment operating expenses
55,065

 
49,546

 
5,519

 
11
 %
 
11
 %
Corporate unallocated operating expenses and adjustments (2)
7,309

 
15,453

 
(8,144
)
 
(53
)%
 
(53
)%
Total
$
62,374

 
$
64,999

 
$
(2,625
)
 
(4
)%
 
(4
)%
 
 
 
 
 
 
 
 
 
 

(1)
Percentage information in constant currencies in the table above and in the text below excludes the effect of foreign currency translation on reported results. Constant currency results were calculated by translating the current year results at prior year average exchange rates.
(2)
Corporate unallocated operating expenses include unallocated product development, and selling, general and administrative expenses.


45


Consolidated operating expenses for the year ended December 31, 2013 were $62.4 million, or 38% of revenue, compared to $65.0 million or 43% of revenue for the year ended December 31, 2012, a decrease of $2.6 million, or 4%. The year ended December 31, 2012, included a $1.1 million impairment charge in the third quarter related to Tecnonet goodwill. Excluding this charge, consolidated operating expenses for the year ended December 31, 2012 were $63.9 million, or 42% of revenue, compared to $62.4 million, or 38% of revenue for the year ended December 31, 2013, a decrease of $1.5 million, or 2%. This decrease in consolidated operating expenses was primarily due to an $8.1 reduction in Corporate operating expenses that was partially offset by a $0.1 million increase (adjusted for the goodwill impairment) in Network integration operating expenses and a $6.5 million increase in operating expenses at Network Equipment. Consolidated operating expenses would have been $0.2 million lower in 2013 had foreign currency exchange rates remained the same as they were in 2012.

Corporate expenses decreased $8.1 million for the year ended December 31, 2013, compared to year ended December 31, 2012, primarily due to $2.1 million in reduced labor costs, lower external labor costs of $1.2 million as the restructuring of the corporate offices was completed in the first quarter of 2013, $1.1 million of lower legal and settlement costs accrued for the settlement of the derivative lawsuit as the lawsuit was settled in June 2013, $1.4 million in lower auditing fees arising from improved processes and a change in auditing firms in the fourth quarter of 2013, and $2.3 million in reduced overhead costs.

Network Equipment Group.   Operating expenses in the Network Equipment group for the year ended December 31, 2013, were $48.8 million, or 54% of revenue, compared to $42.2 million, or 48% of revenue for the year ended December 31, 2012. The $6.5 million, or 15%, increase was due to $4.0 million of planned higher investment in engineering and product development to drive future product development, higher sales and marketing expense of $0.5 million, and $1.4 million of increased G&A expense to support the implementation of our ERP system and backfill vacant positions, an increase of $0.5 million in labor to fill vacant full time positions and $0.9 million in higher support costs. These operating cost increases were partially offset by $0.8 million in lower accounting fees primarily due to improved efficiencies and changing auditing firms in fourth quarter of 2013.The costs arising from the implementation of our ERP system and backfilling vacant positions are not expected to continue at the same levels into future periods. In 2013, the effect of foreign currency exchange rates was immaterial.

Network Integration Group.   Operating expenses in the Network Integration group for the year ended December 31, 2013 were $6.3 million, or 8% of revenue, compared to $7.3 million, or 10% of revenue for the year ended December 31, 2012. The $1.0 million decrease is due to the $1.1 million goodwill write off at Tecnonet offset by a $0.1 million increase in sales and marketing costs. Excluding the $1.1 million goodwill charge, Network operating expenses in 2012 were $6.2 million or 9% of revenue compared with $6.3 million, or 8% of revenue, in 2013. Operating expenses would have been $0.2 million lower had foreign currency exchange rates remained the same as they were in 2012.

Operating Income (Loss)

The following table summarizes operating income (loss) by segment (in thousands):
 
 
 
 
 
Favorable/(Unfavorable)
Years ended December 31:
2013
 
2012
 
$
Change
 
%
Change
 
% Change constant
currency(1)
Network Equipment segment
$
(1,699
)
 
$
1,096

 
$
(2,795
)
 
(255
)%
 
(255
)%
Network Integration segment
4,620

 
4,514

 
106

 
2

 
2

Total segment operating income (loss)
2,921

 
5,610

 
(2,689
)
 
(48
)
 
(51
)
Corporate unallocated and adjustments (2)
(7,302
)
 
(15,457
)
 
8,155

 
53

 
(53
)
Total  
$
(4,381
)
 
$
(9,847
)
 
$
5,466

 
(56
)%
 
(54
)%
 
 
 
 
 
 
 
 
 
 

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

(2) Adjustments represent the elimination of intersegment revenue and profit in inventory in order to reconcile to consolidated operating income (loss).

46


The $2.8 million, or 5% increase in gross profit and the $2.6 million, or 4% decrease in operating expenses primarily led to a $5.5 million, or 56% decrease in operating loss, representing a decline in operating margin from (6)% to (3)%. Our operating loss for 2013 would have been approximately $0.2 million higher had foreign currency exchange rates remained the same as they were in 2012. Operating loss included share-based compensation expense of $0.7 million and $1.1 million in 2013 and 2012, respectively.
Network Equipment Group. The Network Equipment group reported an operating loss of $1.7 million for the year ended December 31, 2013, compared to operating income of $1.1 million for the year ended December 31, 2012. The $2.8 million, or 255% decrease was due to an increase in operating expenses of $6.5 million, partially offset by a $3.7 million increase in gross profit. The Network Equipment segment operating margin was (2)% in 2013 and 1% in 2012. Operating income was not impacted by foreign currency exchange rate fluctuations.

Network Integration Group. The Network Integration segment group operating income of $4.6 million for the year ended December 31, 2013, compared to $4.5 million for the year ended December 31, 2012. The $0.1 million, or 2% increase was due to a $0.9 million decrease in gross profit and offset by a $1.0 million decrease in operating expenses. The Network Integration segment operating margin was 6% in 2013 compared to 6% in 2012. Operating income would have been $0.2 million lower in 2013 had foreign currency exchange rates remained the same as they were in 2012.