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MRV COMMUNICATIONS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Financial Statements and Notes thereto included elsewhere in this Form 10-Q, and Items 6, 7 and 8 of our 2013 Form 10-K. The discussion in this Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and may qualify for the safe harbor provided for in Section 21E of the Exchange Act. Forward-looking statements are statements other than statements of historical fact and may be identified by use of such terms as "expects," "anticipates," "intends," "potential," "estimates," "believes," "may," "should," "could," "will," "would," and words of similar import. Forward-looking statements involve known and unknown risks and uncertainties that could cause actual results to differ materially from those projected. In addition, the statements in this Form 10-Q may involve certain risks, uncertainties and assumptions, the likelihood of which are difficult to assess and may not occur, including risks that each of its business segments may not make the expected progress in its respective market, or that management's long-term strategy may not achieve the expected results. Other risks and uncertainties relate to delayed lead times in receiving components and delayed delivery times to customers due to short-term capacity constraints, potential changes in relationships with MRV's customers and suppliers and their financial condition, MRV's success in developing, introducing and shipping product enhancements and new products, competition in our market segments, market acceptance of new products and our ability to succeed in entering new markets, continued market acceptance of existing products and continued success in selling the products of other companies, product price discounts and general pricing pressure in certain of our markets, the timing and amount of significant orders from customers, obsolete inventory or product returns, warranty and other claims on products, the continued ability of MRV to protect its intellectual property rights and avoid onerous licensing fees, changes in product mix, maturing product life cycles, implementation of operating cost structures that align with revenue growth, political instability in areas of the world in which MRV operates or sells its products and services, currency fluctuations, changes in accounting rules, general economic conditions, as well as changes in such conditions specific to our market segments, maintenance of our inventory and production backlog, supply constraints directly or indirectly caused by natural disasters, litigation, including but not limited to patent infringement claims and litigation related to MRV's historical stock option granting practices. In light of the risks and uncertainties inherent whenever matters or events expected to occur or not occur in the future are discussed, there can be no assurance that the forward-looking information contained in this Form 10-Q will in fact transpire or prove to be accurate. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on our behalf are expressly qualified in their entirety by this introduction. In light of the risks and uncertainties in all such projected operational matters, the inclusion of forward-looking statements in this Form 10-Q should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved or that any of the Company's operating expectations will be realized. Revenue and results of operations are difficult to forecast and could differ materially from those projected in the forward-looking statements contained in this Form 10-Q for the reasons detailed in Item 1A "Risk Factors" of Part I on the Company's 2013 Form 10-K and as set forth in item 1A of Part II of this Form 10-Q. Readers should not place undue reliance on forward-looking statements, which reflect management's view only as of the date of this Form 10-Q. The Company undertakes no obligation to amend this Form 10-Q or revise publicly these forward-looking statements (other than pursuant to requirements imposed on registrants pursuant to Item 1A under Part II of Form 10-Q) to reflect subsequent events or circumstances. Readers should also carefully review the risk factors described in other documents the Company files from time to time with the SEC and the cautionary statements contained in our press releases when we provide forward-looking information. 18-------------------------------------------------------------------------------- Table of Contents 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. We continue to encounter a highly competitive global marketplace for our products and services. Our recent introduction of the OptiDriver and OptiPacket product lines and the enhancement of existing products are positioning us to aggressively seek to retain current customers and capture additional market share. We expect the competitive landscape to remain dynamic. As technologies migrate toward being software-driven and the network layers converge, we expect to see competition for our products and services to increase. As we seek opportunities for our OptiDriver and OptiPacket systems, additional investment in demonstration equipment, inventory, and deployment activities will be required. These investments may burden our results before we begin to see revenues as the sales cycle for these products can extend over several months. In the Italian market, securing new opportunities on the Network Integration side of our business often requires less favorable pricing on the third party products that we sell to Tier One service providers. This less favorable pricing, combined with the protracted cash conversion cycle inherent in Italy, places working capital resources at risk. These market conditions can adversely affect our operations and cause fluctuations in our results. Our business involves reliance on foreign-based offices. Some 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 nine months ended September 30, 2014 and 2013, foreign revenue constituted 62% and 59% of our total revenue, respectively. The majority of our foreign sales are to customers located in the European region, with the remaining foreign sales primarily to customers in the Asia Pacific region. As of September 30, 2014, the Company had $24.5 million in cash and cash equivalents, $0.4 million in restricted time deposits, and $5.2 million in short-term debt. 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"). 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. 19-------------------------------------------------------------------------------- Table of Contents 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. 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 fair value of each deliverable. 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. 20-------------------------------------------------------------------------------- Table of Contents 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. 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. Income Taxes. As part of the process of preparing our interim 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 Condensed 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 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 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 9 "Share-Based Compensation" to the Financial Statements in Item 1, Part 1 of this Form 10-Q for further discussion.) Correction of an Immaterial Error During the three months ended September 30, 2014, the Company recorded an out-of-period adjustment to eliminate intercompany profit in inventory of $0.2 million, which resulted in an increase to net loss of $0.2 million for the three and nine months ended September 30, 2014. The Company reduced inventory by $0.2 million, and increased cost of sales by $0.2 million related to prior periods to remove the effect of profit in inventory not previously eliminated. 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. These out-of-period adjustments did not have a material impact on the Company's consolidated financial statements for the three and nine months ended September 30, 2014. 21-------------------------------------------------------------------------------- Table of Contents During the three 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 nine months ended September 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. 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. The impact on accumulated deficit and stockholder's equity was a reduction by $0.1 million. 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. These out-of-period adjustments did not have a material impact on the Company's consolidated financial statements for the nine months ended September 30, 2014. 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 nine months ended September 30, 2014 and 2013, 62% and 59% of revenue and 43% and 39% of operating expenses, respectively, were incurred at subsidiaries with a reporting currency other than the U.S. dollar. For the nine months ended September 30, 2014, these currencies strengthened against the U.S. dollar compared to the nine months ended September 30, 2013, so revenue and expenses in these currencies translated into slightly more dollars than they would have in the prior period. The Euro and Israeli new shekel strengthened 3% and 4% respectively against the U.S. dollar in nine months ended September 30, 2014, compared to nine months ended September 30, 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 three and nine months ended September 30, 2014, compared to the three and nine months ended September 30, 2013. Additional discussion of foreign currency risk and other market risk is included in Part I, Item 3 "Quantitative and Qualitative Disclosures About Market Risk" of this Form 10-Q. 22-------------------------------------------------------------------------------- Table of Contents Management Discussion Snapshot The following table sets forth, for the periods indicated, certain consolidated Statements of Operations data (dollars in thousands): Three months ended September 30, Nine months ended September 30, 2014 2013 2014 2013 $ % (1) $ % (1) $ % (1) $ % (1) Revenue (1) (2) $ 43,170 100 % $ 38,385 100 % $ 128,612 100 % $ 115,465 100 % Network Equipment 21,979 51 22,806 59 66,131 51 64,852 56 Network Integration 21,237 49 15,585 41 62,644 49 50,701 44 Gross profit (3) $ 14,716 34 $ 14,974 39 $ 42,749 33 $ 41,373 36 Network Equipment 11,062 50 12,041 53 33,007 50 33,990 52 Network Integration 3,654 17 2,934 19 9,742 16 7,378 15 Operating $ 48,148 expenses (4) $ 15,140 35 $ 14,935 39 37 $ 45,882 40Network Equipment 12,016 55 11,954 52 38,302 58 35,318 54 Network Integration 1,892 9 1,408 9 5,431 9 4,486 9 Operating income $ (5,399 ) (loss) (3) (4) $ (424 ) (1 ) $ 39 - (4 ) $ (4,509 ) (4 ) Network Equipment (953 ) (4 ) 87 - (5,296 ) (8 ) (1,328 ) (2 ) Network Integration 1,762 8 1,525 10 4,311 7 2,891 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 Network Integration. (3) Consolidated gross profit data reflects adjustments for intersegment eliminations. (4) Consolidated operating expenses include corporate unallocated operating expenses. Three months ended September 30, 2014 Compared to the Three months ended September 30, 2013 Revenue The following table summarizes revenue by segment, including intersegment sales (dollars in thousands): Favorable/(Unfavorable) Three months ended $ % % Change constant September 30: 2014 2013 Change Change currency (1) Network Equipment $ 21,979 $ 22,806 $ (827 ) (4 )% (4 )% Network Integration 21,237 15,585 5,652 36 36 Before intersegment adjustments 43,216 38,391 4,825 13 12 Intersegment adjustments (2) (46 ) (6 ) (40 ) 667 820 Total $ 43,170 $ 38,385 $ 4,785 12 % 12 % ___________________________________ (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. 23-------------------------------------------------------------------------------- Table of Contents Consolidated revenue for the three months ended September 30, 2014, increased $4.8 million, or 12%, compared to the three months ended September 30, 2013, due to a $5.7 million, or 36%, increase in Network Integration revenue, offset by a $0.8 million, or 4%, decrease in Network Equipment revenue. Network Equipment. Revenue generated from Network Equipment decreased $0.8 million, or 4%, for the three months ended September 30, 2014, compared to the three months ended September 30, 2013. The decrease is primarily due to lower product revenues that were partially offset by higher service revenue volume. Revenues for our optical transport and out of band products increased in the third quarter of 2014 compared to same period in the prior year, which was offset by a decrease in network infrastructure management and carrier Ethernet networking. Geographically, the decrease in revenues was attributable to lower sales in the United States, Latin America and Europe. In Asia Pacific, there was increased order volume over the same period in the prior year from a Tier One carrier. Our Americas region was primarily down due to delays on some orders from some of our larger South American customers. The foreign exchange impact to Network Equipment revenue was not material. The following table summarizes Network Equipment revenue by geographic region (dollars in thousands): Favorable/(Unfavorable)Three months ended September 30: 2014 2013 $ Change % Change Revenue, excluding intersegment sales: United States $ 13,253 $ 15,010 $ (1,757 ) (12 )% Americas (Excluding the U.S.) 197 972 (775 ) (80 ) Europe 4,316 5,691 (1,375 ) (24 ) Asia Pacific 4,167 1,127 3,040 270 Total external sales 21,933 22,800 (867 ) (4 ) Sales to Network Integration: Europe 46 6 40 667 Total intersegment sales 46 6 40 667 Total Network Equipment revenue $ 21,979 $ 22,806 $ (827 ) (4 )% Network Integration. Revenue generated from Network Integration increased $5.7 million, or 36%, for the three months ended September 30, 2014, compared to the three months ended September 30, 2013. The $5.7 million increase in revenue was due to a $5.3 million, or 81%, increase in product revenue and a $0.4 million, or 4%, increase in service revenues at Tecnonet. Tecnonet has seen an increase in product revenue order volume arising from large orders from the two largest telecommunication carriers in Italy. The increase in service revenue was the result of our continued focus on this aspect of the business that has higher margins. The foreign exchange impact to Network Integration revenue was not material. Gross Profit The following table summarizes gross profit by segment (dollars in thousands): Favorable/(Unfavorable) $ % % Change constant Three months ended September 30: 2014 2013 Change Change currency (1) Network Equipment $ 11,062 $ 12,041 $ (979 ) (8 )% (8 )% Network Integration 3,654 2,934 720 25 24 Before intersegment adjustments 14,716 14,975 (259 ) (2 ) - Adjustments (2) - (1 ) 1 (100 ) (2 ) Total $ 14,716 $ 14,974 $ (258 ) (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) Adjustments represent the change in the elimination of intersegment profit in ending inventory in order to reconcile to consolidated gross profit. 24-------------------------------------------------------------------------------- Table of Contents Consolidated gross profit decreased $0.3 million in the three months ended September 30, 2014, compared to the three months ended September 30, 2013, principally due to variances in material costs from standard costs and the effect of adjustments in the valuation of service inventory partially offset by the 12% increase in revenue. Gross margin for the third quarter of 2014 was 34.1%, as compared to 39.0% in the third quarter of 2013. The 4.9 percentage point decrease was due to the variances in material costs and costs adjustments in Network Equipment. These decreases in gross margin were partially offset by a more favorable consolidated product to service revenue mix in the third quarter of 2014 as compared to the third quarter of 2013. In the third quarter of 2014, the consolidated effect of the change in constant currency did not materially impact gross profit. The above discussion 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 current period and impacted consolidated gross margin by 0.5 percentage points. Network Equipment. Gross profit for Network Equipment decreased $1.0 million in the three months ended September 30, 2014, compared to the three months ended September 30, 2013, principally due to cost variances due to lower production volumes and adjustments to the valuation of service inventory. These effects were partially offset by the lower production labor and overhead costs arising from cost saving initiatives implemented during the fourth quarter of 2013. Gross margin for the three months ended September 30, 2014, was 50.3%, a decline of 2.5% percentage points from 52.8% for the three months ended September 30, 2013, principally caused by the cost variances along with an out-of-period adjustment of $0.2 million related to the elimination of intercompany profit in inventory and impacted Network Equipment gross margin by 1.0 percentage points. The foreign exchange impact to Network Equipment gross profit was not material. Network Integration. Gross profit for Network Integration increased $0.7 million, or 25% in the three months ended September 30, 2014, as compared to the three months ended September 30, 2013. The increase was essentially the result of the volume impact of the $5.7 million increase in revenue, $5.3 million of which was product related at substantially lower margins than our service revenue generates. Our gross margin was 17.2% and 18.8% for the quarter ended September 30, 2014 and 2013, respectively. The 1.6% percentage point decline was the result of the significant increase in product revenues in the quarter compared to the comparable prior year quarter. The foreign exchange impact to Network Integration gross profit was not material. Operating Expenses The following table summarizes operating expenses by segment (dollars in thousands): (Favorable)/Unfavorable $ % % Change constant Three months ended September 30: 2014 2013 Change Change currency (1) Network Equipment $ 12,016 $ 11,954 $ 62 1 % 1 % Network Integration 1,892 1,408 484 34 % 34 % Total segment operating expenses 13,908 13,362 546 4 % 4 % Corporate unallocated operating expenses and adjustments (2) 1,232 1,573 (341 ) (22 )% (22 )% Total $ 15,140 $ 14,935 $ 205 1 % 1 % (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 for the three months ended September 30, 2014, were $15.1 million, or 35% of revenue, compared to $14.9 million, or 39% of revenue, for the three months ended September 30, 2013, an increase of $0.2 million. The increase was primarily due to an increase in Network Integration expenses of $0.5 million and an increase of $0.1 million in expenses at Network Equipment offset by a $0.3 million decrease of Corporate unallocated operating expenses as discussed below. In the third quarter of 2014, the consolidated effect of the change in constant currency was not material. 25-------------------------------------------------------------------------------- Table of Contents Network Equipment. Operating expenses in Network Equipment for the three months ended September 30, 2014, were $12.0 million, or 55% of revenue, compared to $12.0 million, or 52% of revenue in three months ended September 30, 2013. The $0.1 million, or 1%, increase was due to a $0.4 million increase in salary costs for engineers supporting our product development initiatives and $0.5 million increase in salaries to enhance the U.S. sales organization, partially offset by $0.5 million decrease in external labor related to the ERP system implementation in 2013 and a $0.3 million decrease in general administrative charges related to bad debt and facility maintenance. The foreign exchange impact to Network Equipment operating expenses was not material. Network Integration. Operating expenses in Network Integration for the three months ended September 30, 2014, were $1.9 million, or 9% of revenue, compared to $1.4 million, or 9% of revenue, for the three months ended September 30, 2013. The $0.5 million increase was mainly due to $0.3 million of sales labor support costs to support increased revenue volume and an increase of $0.2 million in general and administrative charges related to accounting fees. In the third quarter of 2014, the foreign exchange impact to Network Integration operating expenses was not material. Corporate. Corporate expenses decreased by $0.3 million for the three months ended September 30, 2014, compared to the three months ended September 30, 2013. The decrease was primarily related to a decrease in salaries and wages of $0.2 million and a decrease of $0.4 million in administrative overhead charges, as the prior year period was burdened by $0.2 million in warrant revaluation charges and $0.2 million in professional fees for financial advisory services that were not incurred in the current year to date periods. These amounts were offset by an increase in accounting fees of $0.3 million incurred during the period. The foreign exchange impact to corporate operating expenses was not material. Operating Income (Loss) The following table summarizes operating income (loss) by segment (dollars in thousands): Favorable/(Unfavorable) Three months ended September $ % % Change constant 30: 2014 2013 Change Change currency(1) Network Equipment $ (953 ) $ 87 $ (1,040 ) (1,195 )% (1,195 )% Network Integration 1,762 1,525 237 16 15 Total segment operating income (loss) 809 1,612 (803 ) (50 ) (51 ) Corporate unallocated and adjustments (2) (1,233 ) (1,573 ) 340 22 (22 ) Total $ (424 ) $ 39 $ (463 ) (1,187 )% (1,217 )% (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). Network Equipment. Network Equipment reported an operating loss of $1.0 million for three months ended September 30, 2014, compared to operating income of $0.1 million for the three months ended September 30, 2013. The $1.0 million change in operating results was primarily due to the $1.0 million decrease in gross profit, offset by the $0.1 million increase in operating expenses. Operating margin was (4)% in 2014 and 0.4% in 2013. Network Integration. Network Integration reported operating income of $1.8 million for the three months ended September 30, 2014, compared to $1.5 million for three months ended September 30, 2013. The increase was primarily due to the $0.7 million increase in gross profit that was partially offset by a $0.5 million increase in operating costs. Network Integration operating margin was 8% and 10% for the three months ended September 30, 2014 and 2013, respectively. 26-------------------------------------------------------------------------------- Table of Contents Interest Expense and Other Expense, Net Interest expense was $0.1 million for the three months ended September 30, 2014, compared to $0.04 million for the three months ended September 30, 2013. Other expense, net, principally includes interest income on cash, cash equivalents and investments and gains and losses on foreign currency transactions. Provision for Income Taxes The tax provision for the three months ended September 30, 2014, and 2013, was $0.7 million and $0.01 million, respectively. Our income tax provision fluctuates based on the amount of pre-tax income or loss generated in the various jurisdictions where we conduct operations and pay income tax. The income tax expense of $0.7 million on the loss before provision for income taxes of $0.3 million for the three months ended September 30, 2014, is due to income tax associated with our foreign subsidiaries that do not benefit from our federal net operating loss carryforwards. Tax Loss Carryforwards As of December 31, 2013, we had net operating losses ("NOLs") of $172.3 million, $93.1 million, and $95.8 million for federal, state, and foreign income tax purposes, respectively. Additionally, the Company has capital loss carryforwards 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 September 30, 2014, the US federal and state NOLs had a full valuation allowance. Nine months ended September 30, 2014 Compared To Nine months ended September 30, 2013 Revenue The following table summarizes revenue by segment, including intersegment sales (dollars in thousands): Favorable/(Unfavorable) Nine months ended $ % % Change constant September 30: 2014 2013 Change Change currency (1) Network Equipment group $ 66,131 $ 64,852 $ 1,279 2 % 2 % Network Integration group 62,644 50,701 11,943 24 20 Before intersegment adjustments 128,775 115,553 13,222 11 10 Intersegment adjustments (2) (163 ) (88 ) (75 ) 85 85 Total $ 128,612 $ 115,465 $ 13,147 11 % 10 % ___________________________________ (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 nine months ended September 30, 2014, increased $13.1 million, or 11%, compared to the nine months ended September 30, 2013. This increase was due to an $11.9 million increase in Network Integration revenue, a $1.3 million increase in Network Equipment revenue, offset by the $0.1 million increase in Intersegment adjustments, which are eliminated in consolidation. Consolidated revenue would have been $1.8 million lower if foreign currency exchange rates had remained the same as they were in the first nine months of 2013. 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 $1.2 million during the three months ended September 30, 2014, reducing the impact on deferred revenues for the out-of-period adjustment recorded in the prior quarter to $0.8 million as of September 30, 2014. 27-------------------------------------------------------------------------------- Table of Contents Network Equipment Group. Revenue generated from the Network Equipment group increased $1.3 million in the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013. Revenues increased primarily due to a $1.7 million increase in product revenue offset by a $0.4 million decrease in service revenue. Revenues for our optical transport products increased during the nine months ended September 30, 2014, compared to the prior year period, offset by a decrease in carrier Ethernet networking and out of band products. Service revenues were down 5% as compared to same period last year primarily due to the roll off of older deferred service contracts that related to revenues scheduled for recognition prior to the effective date of ASU 2009-13. Geographically, Asia Pacific and Europe revenues increased $4.9 million that was partially offset by a $3.7 million decrease in OCS Americas. The decrease in OCS Americas was primarily due to a revenue decline in the South American portion of the region that was partially offset by modest revenue growth in the North American portion of the region. The following table summarizes Network Equipment revenue by geographic region (dollars in thousands): Favorable/(Unfavorable) Nine months ended September 30: 2014 2013 $ Change % Change Revenue, excluding intersegment sales: United States $ 39,665 $ 40,811 $ (1,146 ) (3 )% Americas (Excluding the U.S.) 879 3,452 (2,573 ) (75 )% Europe 16,009 15,864 145 1 Asia Pacific 9,416 4,637 4,779 103 Total external sales 65,969 64,764 1,205 2 Sales to Network Integration group: Europe 163 88 75 85 Total intersegment sales 163 88 75 85 Total Network Equipment revenue $ 66,132 $ 64,852 $ 1,280 2 % Network Integration Group. Revenue generated from the Network Integration group was $11.9 million, or 24% higher for the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013. This increase was due to a $10.2 million, or 42% increase in product revenue and $1.7 million, or 6% increase in service revenues at Tecnonet. Tecnonet has seen an increase in product revenue order volume primarily 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. Revenue would have been $1.9 million lower for the nine months ended September 30, 2014 had foreign currency exchange rates remained the same as they were in the nine months ended September 30, 2013. All revenue in the Network Integration group was generated in Italy. 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 $1.2 million during the three months ended September 30, 2014, reducing the impact on deferred revenues for the out-of-period adjustment recorded in the prior quarter to $0.8 million as of September 30, 2014. 28-------------------------------------------------------------------------------- Table of Contents Gross Profit The following table summarizes gross profit by segment (dollars in thousands): Favorable/(Unfavorable) $ % % Change constant Nine months ended September 30: 2014 2013 Change Change currency (1) Network Equipment group $ 33,007 $ 33,990 $ (983 ) (3 )% (3 )% Network Integration group 9,742 7,378 2,364 32 28 Before intersegment adjustments 42,749 41,368 1,381 3 3 Adjustments (2) - 5 (5 ) (100 ) (80 ) Total $ 42,749 $ 41,373 $ 1,376 3 % 3 % (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 increased $1.4 million, or 3% for the nine months ended September 30, 2014, from the prior year period, principally due to the 11% increase in revenue offset by the pressure on pricing and revenue mix. Gross margin for the nine months ended September 30, 2014, was 33.2% compared to 35.8% for the nine months ended September 30, 2013. The 2.6 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 nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013. Gross profit would have been $0.3 million lower for the nine months ended September 30, 2014, if foreign currency exchange rates had remained the same as they were in the nine months ended September 30, 2013. 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 three months ended September 30, 2014, reducing the impact on consolidated gross profit for the out-of-period adjustment recorded in the prior quarter to $0.1 million for the nine months ended September 30, 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 current period and impacted consolidated gross margin by 0.2 percentage points. Network Equipment Group. Gross profit for the Network Equipment segment decreased $1.0 million or 3% for the nine months ended September 30, 2014, compared to the nine months ended September 30, 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 nine months ended September 30, 2014, was 49.9% a decline of 2.5% percentage points from 52.4% for the nine months ended September 30, 2013, principally caused by a decrease in sales to our European channel partners, which have a lower gross margin and lower pricing of mature products in advance of new products. 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 current period and impacted Network Equipment gross margin by 0.3 percentage points. Gross profit would have been flat in the nine months ended September 30, 2014, had foreign currency exchange rates remained the same as they were in the nine months ended September 30, 2013. 29-------------------------------------------------------------------------------- Table of Contents Network Integration Group. Gross profit for the Network Integration segment increased $2.4 million, or 32% for the nine months ended September 30, 2014, compared to nine months ended September 30, 2013, primarily due to the $11.9 million increase in revenue for the nine months ended September 30, 2014, compared to the prior year period as discussed above. Gross margin for the nine months ended September 30, 2014, was 15.6% an increase of 1% percentage point from 14.6% for the nine months ended September 30, 2013, principally due to an improvement in product revenue gross margins. Gross profit would have been $0.3 million lower in the nine months ended September 30, 2014, had foreign currency exchange rates remained the same as they were in the nine months ended September 30, 2013. 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 three months ended September 30, 2014, reducing the impact on Network Integration gross profit for the out-of-period adjustment recorded in the prior quarter to $0.1 million for the nine months ended September 30, 2014. Operating Expenses The following table summarizes operating expenses by segment (dollars in thousands): (Favorable)/Unfavorable $ % % Change constant Nine months ended September 30: 2014 2013 Change Change currency (1) Network Equipment group $ 38,302 $ 35,318 $ 2,984 8 % 8 % Network Integration group 5,431 4,486 945 21 % 18 %Total segment operating expenses 43,733 39,804 3,929 10 % 374 % Corporate unallocated operating expenses and adjustments (2) 4,415 6,078 (1,663 ) (27 )% (27 )% Total $ 48,148 $ 45,882 $ 2,266 5 % 5 % (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 $48.1 million, or 37% of revenue, for the nine months ended September 30, 2014, compared to $45.9 million, or 40% of revenue, for the nine months ended September 30, 2013, an increase of $2.3 million, or 5%, including $1.0 million due to insurance proceeds recorded in the second quarter of 2013 in conjunction with a derivative litigation settled that quarter. The remaining increase included a $3.0 million increase in Network Equipment and $0.9 million increase in Network Integration related to investments in the core business offset by a $1.7 million decrease in Corporate, excluding the effect of the insurance proceeds. Network Equipment Group. Operating expenses in the Network Equipment group for the nine months ended September 30, 2014, were $38.3 million, or 58% of revenue, compared to $35.3 million, or 54% of revenue for the nine months ended September 30, 2013. The $3.0 million or 8% increase was due to $2.3 million in additional costs related to the planned higher investment in engineering and product development to drive future product development, an increase in sales and back office support costs of $1.2 million, offset by a decrease in general and administrative overhead of $0.5 million of costs in 2013 related to the implementation of our Oracle ERP system. Network Integration Group. Operating expenses in the Network Integration group for the nine months ended September 30, 2014, were $5.4 million, or 9% of revenue, compared to $4.5 million, or 9% of revenue, for the nine months ended September 30, 2013. The $0.9 million or 21% increase in operating expense was primarily due to additional sales costs for labor and commissions and administrative costs principally for audit related services. Operating expenses would have been $0.2 million lower for the nine months ended September 30, 2014, had foreign currency exchange rates remained the same as they were in the prior year period. 30-------------------------------------------------------------------------------- Table of Contents Corporate. Operating expenses decreased $1.7 million in the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013. This decrease partially resulted from $1.4 million in lower labor and consulting fees incurred during the 2013 ERP system conversion and $0.1 million in lower auditing fees and accounting support fees. The nine months ended September 30, 2013, were 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. Operating Income (Loss) The following table summarizes operating income (loss) by segment (dollars in thousands): Favorable/(Unfavorable) $ % % Change constant Nine months ended September 30: 2014 2013 Change Change currency(1) Network Equipment group $ (5,296 ) $ (1,328 ) $ (3,968 ) 299 % 299 % Network Integration group 4,311 2,891 1,420 49 45 Total segment operating income (loss) (985 ) 1,563 (2,548 ) (163 ) (171 ) Corporate unallocated and adjustments (2) (4,414 ) (6,072 ) 1,658 27 (27 ) Total $ (5,399 ) $ (4,509 ) $ (890 ) 20 % 23 % (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 $2.3 million, or 5%, increase in operating expenses offset by the $1.4 million, or 3%, increase in gross profit primarily led to a $0.9 million increase in our operating loss. Operating losses included share-based compensation expense of $0.7 million and $0.5 million for the nine months ended September 30, 2014 and 2013, respectively. Our operating loss would have been $0.1 million lower for the nine months ended September 30, 2014, had foreign currency exchange rates remained the same as they were in the prior year period. 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 three months ended September 30, 2014, reducing the impact on deferred revenue for the out-of-period adjustment recorded in the prior quarter to $0.1 million as of September 30, 2014. The above discussion also includes the out-of-period adjustment of $0.2 million recorded in the three months ended September 30, 2014, related to the elimination of intercompany profit in inventory which increased consolidated operating loss by $0.2 million for the nine months ended September 30, 2014. Network Equipment Group. The Network Equipment group reported an operating loss of $5.3 million and $1.3 million for the nine months ended September 30, 2014 and 2013, respectively. The change in operating profit was due to the $3.5 million planned increase in operating expenses. Operating margin was (8)% for the nine months ended September 30, 2014, and (2)% for the nine months ended September 30, 2013. The above discussion includes the out-of-period adjustment of $0.2 million recorded in the three months ended September 30, 2014, related to the elimination of intercompany profit in inventory, which increased Network Equipment operating loss by $0.2 million for the nine months ended September 30, 2014. Network Integration Group. The Network Integration group reported operating income of $4.3 million for the nine months ended September 30, 2014, compared to operating income of $2.9 million for the nine months ended September 30, 2014. The increase in operating profit was primarily due to the 24% increase in Network Integration revenues. The Network Integration group operating margin was 7% for the nine months ended September 30, 2014 compared to 6% for the nine months ended September 30, 2013. The Network Integration group recorded an out-of-period adjustment related to deferred revenue during the three months ended June 30, 2014, that increased its operating loss by $0.2 million for the six months ended June 30, 2014. Of this amount, the Company recognized $0.1 million during the three months ended September 30, 2014, reducing the impact on deferred revenue for the out-of-period adjustment recorded in the prior quarter to $0.1 million as of September 30, 2014. 31-------------------------------------------------------------------------------- Table of Contents Interest Expense and Other Expense, Net Interest expense was $0.3 million in the nine months ended September 30, 2014, and $0.4 million the nine months ended September 30, 2013, respectively. Other expense, net, principally includes interest income on cash, cash equivalents and investments and gains and losses on foreign currency transactions. Provision for Income Taxes The tax provision for the nine months ended September 30, 2014 and 2013 was $1.7 million and $0.4 million, respectively. Our income tax provision fluctuates based on the amount of pre-tax income or loss generated in the various jurisdictions where we conduct operations and pay income tax. The income tax expense of $1.7 million on the loss before provision for income taxes of $5.9 million for the nine months ended September 30, 2014, is due to 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. 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. Liquidity and Capital Resources During the nine months ended September 30, 2014, our cash and restricted time deposits decreased from $27.8 million to $25.0 million, a decrease of $2.9 million. Our cash outflows included a net loss of $7.5 million adjusted for non-cash expenses of $4.7 million including depreciation and amortization, share-based compensation, provision for doubtful accounts, and deferred taxes. In addition, there were cash outflows from working capital of $2.4 million, including a $1.4 million increase in inventory due to increased purchases of certain products due to the transition from inside production to contract manufacturing of those products and timing of shipments, a $7.3 million increase in other assets due to increased factoring of receivables at Tecnonet, a $2.3 million decrease in accrued liabilities due to timing of payments of accrued expenses, offset by a $10.2 million decrease in accounts receivable due to increased factoring of receivables at Tecnonet, a $0.2 million increase in accounts payable due to an increase in materials purchased, and a $2.9 million increase in deferred revenue as a result of the timing of shipments. Cash used in investing activities included $1.9 million in purchases of property, plant, and equipment. Cash provided by financing activities included additional borrowings at Tecnonet of $17.5 million, partially offset by payments on short-term debt of $15.8 million at Tecnonet. 32-------------------------------------------------------------------------------- Table of Contents We periodically review our capital position and consider returning capital to stockholders through special dividends or share repurchases when cash on hand exceeds our foreseeable cash needs. We also periodically review the capital needs of our business units. We plan to invest approximately $4.0 million over the next 12 months to upgrade our infrastructure and equipment needed to support the Company's growth objectives in the carrier Ethernet and optical transport markets among others. The nature of the Tecnonet business requires significant levels of working capital to finance the longer term receivables and the extended acceptance periods for its larger customers. The financing for its working capital needs is partially met through the use of factoring certain receivables. Tecnonet has minimal capital requirements and does not conduct research and development. Therefore, we do not anticipate Tecnonet's business to require significant investment to support our strategic objectives in the Italian information technology market. We believe that cash on hand and existing financing will be sufficient to satisfy current operating needs, capital expenditures, and product development and engineering requirements for at least the next 12 months. We may seek to obtain additional debt or equity financing if we believe it appropriate. We may limit our ability to use available NOLs and capital loss carryforwards if we seek financing through issuance of additional equity securities. The following table summarizes MRV's cash position, including cash and cash equivalents, restricted time deposits and our short-term debt position (dollars in thousands): September 30, 2014 December 31, 2013 Cash Cash and cash equivalents $ 24,533 $ 27,591 Restricted time deposits 436 249 24,969 27,840 Short-term debt 5,175 4,320 Cash in excess of debt $ 19,794 $ 23,520 Ratio of cash to debt (1) 4.8 6.4 (1) Determined by dividing total cash by total debt. Short-term Debt Our short-term debt is related to Tecnonet, our Italian Network Integration subsidiary. Customer accounts receivables of Tecnonet have been pledged as collateral on the related borrowings. The following table summarizes our short-term debt (in thousands): September 30, 2014 December 31, 2013 Increase (decrease) Lines of credit secured by accounts receivable $ 5,175 $ 4,320 $ 855 The increase in short-term debt at September 30, 2014, includes additional borrowings of $17.5 million, offset by payments of $15.8 million and the impact of changes in foreign currency exchange rates. 33-------------------------------------------------------------------------------- Table of Contents Working Capital The following table summarizes our working capital position (dollars in thousands). September 30, 2014 December 31, 2013 Current assets $ 107,892 $ 117,170 Current liabilities 56,375 58,921 Working capital $ 51,517 $ 58,249 Current ratio (1) 1.9 2.0 (1) Determined by dividing total current assets by total current liabilities. Off-Balance Sheet Arrangements We do not have transactions, arrangements or other relationships with unconsolidated entities that are reasonably likely to affect our liquidity or capital resources. We have no special purpose or limited purpose entities that provided off-balance sheet financing, liquidity or market or credit risk support, engaged in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected on the face of the financials. Contractual Obligations During the three months ended September 30, 2014, there were no material changes in our contractual obligations. Internet Access to Our Financial Documents We maintain a website at www.mrv.com. We make available, free of charge, either by direct access or hyperlink, our 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 as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Our reports filed with, or furnished to, the SEC are also available directly at the SEC's website at www.sec.gov. 34-------------------------------------------------------------------------------- Table of Contents |