MRV Buys Fiberxon, Along With A Heap Of Troubles

| About: MRV Communications, (MRVC)

MRV Communications (NASDAQ:MRVC) Monday announced that it has closed its previously disclosed acquisition of Fiberxon, a venture-backed company based in Santa Clara, but with all of its operations in China (venture investors in the company include Greylock and Apax Partners). That is not very interesting, and I would not have bothered to mention it here at all were it not for some rather extraordinary details in the announcement and a related SEC filing that MRV made Monday.

So, MRV has previously agreed to buy Fiberxon for $131 million in cash and stock; the plan is to merger the company with MRV’s Luminent Inc. unit; both companies provide optical transceivers used in telecommunications networks. The theory was that the combined companies could before long be taken public, and that may still be the plan. Fair enough. But as MRV announced Monday, it has now amended the merger agreement in a variety of ways. The most significant change is to drop the requirement that before closing of the deal Fiberxon provide audited financial statements for 2004, 2005 and 2006.

MRV says it has determined that Fiberxon could not be delivered in time for the closing, but that its board decided to go ahead and complete the deal anyway. This despite the fact that not having current financial data on Fiberxon puts MRV’s listing on NASDAQ in jeopardy; and that loss of that listing could trigger a default on its outstanding debt.

But to really get any sense of how weird this story is, you have to read the 8-K.

In the 8-K, MRV discloses that during the due diligence process for the deal, it learned of allegations of financial and accounting irregularities at Fiberxon that were serious enough that they “called into question the reliability of Fiberxon’s consolidated financial statements” for 2004 and 2005 and “raised serious concerns regarding Fiberxon’s financial and reporting processes.”

MRV said that these irregularities lead to “termination” of the company’s CEO, apparently a man named Li Hsu, as well as its VP of Finance, in the first half of 2007, and to the triggering of an investigation by the Fiberxon audit committee.

MRV said that in June, the independent auditor hired by Fiberxon in April reported that in addition to the irregularities identified by the audit committee, the auditors had found “a number of serious issues and encountered significant difficulties in the performance of the audit that…called into question the commitment of Fiberxon’s management to maintain reliable financial reporting systems, including accounting books and records, in conformity with accounting principles generally accepted in the U.S. and China.”

The auditors also questioned whether Fiberxon’s management was committed to “ensure that Fiberxon complies with the laws and relations applicable to its activities and to inform Fiberxon’s auditors of any known material violations of such laws or regulations.” They also questioned whether management was committed “to adjust Fiberxon’s financial statements to correct material misstatements, and to make all financial records and related information available to the auditors.”

MRV said the auditors “determined to suspend its audit.”

Did MRV decide to walk? No! It decided to keep going. More specifically, MRV decided to take control of the audit process, as long as compensation to Fiberxon’s holders was deferred until the required financial information could be filed under SEC rules, and as long as Fiberxon’s holders absorbed the costs involved. This is not going to be an easy task; as MRV notes in the filing, it will involve “potential reconstruction and reconciliation of erroneous or falsified business and financial records,” among other issues.

Oh, and MRV Monday also said that while it still sees second quarter revenue of $95 million to $99 million, it now sees non-GAAP net income of a loss of 1 cents a share to break even, rather than previous expectations for break even to a penny a share profit.

All I can say is, Fiberxon better have some truly remarkable products. Because this deal is providing MRV with some truly astonishing complications.

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