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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1998
COMMISSION FILE NUMBER: 0-23023
MMC NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 77-0319809
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1134 EAST ARQUES AVENUE, SUNNYVALE, CA 94086
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 731-1600
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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None None
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $0.001 par value
(TITLE OF CLASS)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of the Common Stock on March
12, 1999, as reported on the National Market of The Nasdaq Stock Market, was
approximately $264,235,989. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common Stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes. As of March 12, 1999, the registrant had outstanding
30,395,533 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant has incorporated by reference into Part III of this Form
10-K portions of its Proxy Statement for registrant's Annual Meeting of
Stockholders to be held May 18, 1999.
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The Business section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operation -- Factors Affecting
Future Results" commencing on page 20 of this Report.
PART I
ITEM 1. BUSINESS
THE COMPANY
MMC Networks, Inc. (the "Company" or "MMC Networks") is a leading developer
and supplier of Network Processors, which are high-performance,
open-architecture, software-programmable processors optimized for network
applications. The Company's Network Processors form the core silicon "engines"
of LAN and WAN switches and routers and are designed to allow network equipment
vendors to rapidly develop high-performance, feature-rich, cost-effective
products supporting a broad range of networking functions.
The Company's current products, the AF5400, AF5500, ATMS2000 and PS1000
Network Processors, provide the core functionality of high-performance Gigabit
Ethernet, Fast Ethernet and Asynchronous Transfer Mode ("ATM") networking
equipment. The Company believes that network equipment vendors are able to
reduce design and development costs and accelerate product development cycles
for high-performance routers and switches by using the Company's products. All
of the Company's products are based on the Company's proprietary ViX(TM)
architecture, which enables network equipment vendors to easily and cost-
effectively implement high-performance, value-added features in their switch and
router products. MMC Networks' customers employ the Company's Network Processors
to develop and market multi-gigabit, wire-speed switches, routers, access
concentrators, firewalls and gateways with advanced features such as Layer 3
switching, internetworking of LANs and WANs, security, class of service, quality
of service and network management.
The Company was incorporated in California in September 1992 and
reincorporated in Delaware in October 1997. The Company's principal executive
offices are located at 1134 East Arques Avenue, Sunnyvale, California 94086, and
its telephone number is (408) 731-1600.
INDUSTRY BACKGROUND
The proliferation of high-performance personal computers, workstations and
servers along with the growing reliance on increasingly data-intensive networked
applications has resulted in dramatic growth in traffic over data networks. In
addition, as organizations and individuals increasingly rely on intranets and
the Internet, networks have been extended to connect branch offices, home
offices, mobile users and, more recently, customers and suppliers. The rise in
data traffic has been accompanied by substantial growth in the number of
protocols employed in LAN and WAN networking, including Ethernet, Token Ring,
Fiber-Distributed Data Interface ("FDDI"), WAN serial lines, X.25, Frame Relay
and dial-up access. More recently, Fast Ethernet, Gigabit Ethernet, higher-speed
Frame Relay and ATM networks are beginning to be deployed. These trends continue
to drive demand for high-performance networking equipment that supports
internetworking among a variety of types of LANs and WANs.
As the size and performance requirements of networks have grown, network
equipment vendors have increasingly focused on advanced switching and routing
devices to enable large-scale, high-performance networks. Known as Layer 3
switches, IP switches, high-speed routers or switching routers, these devices
are designed to enable a network hierarchy that facilitates the implementation
of such networks. In addition to improved performance and multiprotocol
connectivity, enterprises and network service providers are increasingly
demanding networking equipment that supports a broad variety of advanced
features, without compromising performance. For example, as the reach of
enterprise data networks has spread to WANs and the Internet, network
administrators need security at multiple points in the network. As businesses
become more
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dependent on intranets and the Internet, they are increasingly focused on
differentiated classes or priorities of service for certain of their
applications and users to make more efficient use of networking resources.
Similarly, new applications such as video conferencing, multimedia training and
Internet telephony require end-to-end quality of service guaranteed across
entire networks. Finally, in order to implement advanced features and
functionality across complex, high-speed networks, network administrators also
need better network management capabilities to help them analyze the traffic
flowing through the network, to anticipate traffic growth and to quickly isolate
and solve network problems.
While attempting to respond to customer demands for more performance, new
capabilities, greater security and better management, network equipment vendors
face growing competition, evolving networking standards and increasing market
segmentation. Rapid growth in the data networking industry has attracted a
multitude of new entrants who are competing with or, in many instances, are
being acquired by major network equipment vendors. To compete effectively,
network equipment vendors must improve their time-to-market and lower their
costs while continuing to increase performance and add advanced features and
differentiated functionality. At the same time, network equipment vendors must
support multiple evolving industry standards and protocols and must address the
diverse needs of customers in an increasingly segmented networking market. For
example, a small office may require a simple network built with one Ethernet LAN
switch, a large corporation may require multiple Fast Ethernet high-speed
routers connected to an ATM campus backbone switch, and an Internet service
provider may require a dedicated OC-3 or SDH-1 backbone switch with downlinks
that support dedicated and dial-up connectivity.
In order to address the needs of their increasingly diverse customer base
and provide support for a broad array of networking protocols and
functionalities without substantially degrading performance, network equipment
vendors have employed increasingly capable semiconductor devices in their
networking equipment, the most important being those used as the switching or
routing "engines." Network equipment vendors have traditionally relied on two
general approaches for these semiconductor engines: general purpose processors,
which are software-programmable, or custom-developed ASICs. Each of these
approaches has advantages but involves significant trade-offs with respect to
performance, feature implementation, time-to-market and cost. Switches and
routers utilizing general purpose processors can be brought to market relatively
rapidly, can be easily adapted to changes in industry protocols and standards
and can be programmed in software to add additional features, but these benefits
are usually not achievable without significant performance degradation or
unacceptably high unit production cost. Alternatively, switches and routers
based on ASICs can be designed to achieve high performance and produced at
relatively low unit cost, but the ASIC development cycle is usually too time
consuming to permit the development of high-performance ASICs with advanced
feature sets while meeting network equipment vendors' time-to-market
constraints. In addition, ASICs involve the risk of additional delays associated
with multiple iterations that may be required in the ASIC development cycle,
provide little flexibility to conform to rapidly evolving standards and
protocols and lack the full feature support that would allow them to address
multiple segments of the networking market. Consequently, neither approach
achieves network equipment vendors' requirements for high performance and
advanced features without imposing an unacceptable time-to-market and/or cost
burden.
MARKET OPPORTUNITY FOR NETWORK PROCESSORS
The Company believes that these market trends have created a significant
opportunity for Network Processors, which are high-performance,
open-architecture, software-programmable processors optimized for networking
applications. These Network Processors enable the design and development of
switching and routing solutions that incorporate advanced features, operate
without significant performance degradation, address evolving standards and
multiple market segments through software programmability, and can be produced
in a cost-efficient manner and within the time-to-market constraints of the
competitive networking equipment market. The Company believes that Network
Processors offer network equipment vendors the ability to reduce the time and
expense involved in developing customized chip sets for individual network
switching products, while allowing vendors to focus on developing networking
systems which are powerful, cost-effective, differentiated and feature-rich to
satisfy the needs of their increasingly diverse customer bases.
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MMC NETWORKS' SOLUTION
MMC Networks is a leading developer and supplier of Network Processors
enabling a new generation of high-performance networking equipment. These
Network Processors are designed to allow network equipment vendors to rapidly
develop high-performance, feature-rich, cost-effective, scalable LAN and WAN
switches and routers targeting the specific needs of distinct customer segments.
The Company believes that, by designing-in the Company's Network Processors,
network equipment vendors can simultaneously reduce development costs,
accelerate time-to-market and focus on enhancing system differentiation with
advanced features and functionality. Using the Company's Network Processors as
building blocks, MMC Networks' customers are offering or designing
multi-gigabit, wire-speed switches, routers, access concentrators, firewalls and
gateways with enhanced features including internetworking among multiple types
of LANs and WANs, security, class of service, quality of service and network
management without significant performance degradation.
The Company currently offers the AF5400 Gigabit and Fast Ethernet, AF5500
multiservice, ATMS2000 ATM and PS1000 Fast Ethernet Network Processors. All of
the Company's products are based on the Company's ViX architecture, which is
designed to enable network equipment vendors to construct cost-effective,
high-bandwidth, high-port-count, feature-rich, modular and stand-alone switches
and routers. The Company's proprietary Per Flow Queuing ("PFQ") technology
extends the ViX architecture to support class of service and quality of service
for network switches.
MMC NETWORKS' STRATEGY
MMC Networks' strategy is to enable network equipment vendors to rapidly
develop and introduce differentiated products by leveraging the
high-performance, feature-rich, software-programmable and cost-effective Network
Processors offered by the Company. Key elements of the Company's strategy
include the following:
Target High-Growth Markets. MMC Networks' Network Processors target the
rapidly growing enterprise and service provider markets. These markets require
high-performance, feature-rich, mid- to high-end LAN and WAN networking
equipment solutions. The Company believes that as these markets continue to
grow, they will become increasingly specialized. Consequently, network equipment
vendors will need to deliver a broader mix of products in order to satisfy
increasingly sophisticated and diverse customer performance and feature
requirements. The Company focuses on the design and development of Network
Processors that enable network equipment vendors to rapidly design and bring to
market a broad variety of differentiated networking solutions meeting the
performance and feature requirements of this evolving market.
Facilitate Customer Success. Increasing competition and evolving networking
standards have exerted and will continue to exert pressure on network equipment
vendors to introduce new products rapidly and cost-effectively. MMC Networks'
Network Processors are designed to improve network equipment vendors'
time-to-market and lower their development costs by providing them with
software-programmable processing functionality to enable them to address
evolving standards and multiple market segments. The Company works closely with
its customers to design Network Processors that enable performance and
functionality compatible with such customers' current and future needs and that
complement network equipment vendors' product development efforts.
Extend Technology Leadership. MMC Networks has made substantial investments
in the technologies that underlie its Network Processors, with the goal of
setting new price/performance benchmarks and enabling the widespread use of
sophisticated networking functionality. For example, the Company's ViX
architecture, which forms the basis of all of its products, is designed to
enable network equipment vendors to implement value-added features without
significant performance degradation. MMC Networks is continually developing new
technologies for its Network Processors, such as the Company's AF5500 Network
Processor, which was designed to integrate the processing of data from different
protocols.
Leverage Fabless Semiconductor Model. MMC Networks seeks to leverage the
flexibility of its fabless semiconductor business model to lower technology and
production risks, increase profitability and reduce
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time-to-market. The Company's fabless model allows it to focus on its core
Network Processor design competencies, while minimizing the capital and
operating infrastructure requirements.
TECHNOLOGY
MMC Networks' Network Processors are high-performance, multi-gigabit,
open-architecture, software-programmable processors with instruction sets that
have been optimized for processing and switching data, voice and video packets
and cells. The Company believes that the key underlying technologies employed in
its Network Processors give it a substantial competitive advantage. The core
technologies employed in current products include the Company's ViX
architecture, Per-Flow and Per-Stream Queuing technology, Direct Replication
Engine technology, Virtual SAR technology and Programmable BitStream Processor
technology.
ViX Architecture. The ViX architecture is a switch fabric architecture that
uses a patented point-to-point connection matrix that permits the use of a wide,
centralized, shared-memory structure, while separating control information from
user data. The ViX architecture's use of "point-to-point connections" is
designed to enable network equipment vendors to easily scale the number of ports
in their switches and routers, unlike shared-bus architectures that run into
clock frequency, bus capacitance and pin count limitations. The use of a "wide,
centralized shared-memory structure" enables network equipment vendors to scale
the bandwidth and amount of buffer memory, unlike crossbar architectures which
become increasingly expensive as bandwidth and buffer requirements increase. The
"separation of control information from user data" enables network equipment
vendors to more easily implement high-performance processing, queuing,
replication and switching functions for networking applications, unlike
shared-bus and crossbar architectures, which may require complex processors to
coordinate multiple functions across multiple ports and the replication of user
data within their buffers. In addition, the ViX architecture is designed as an
open architecture, providing external access to the appropriate timing and
control signals, which enables network equipment vendors to more easily
implement differentiated features and functionality.
Per-Flow and Per-Stream Queuing (PFQ and PSQ) Technology. All networking
switches and routers must buffer data when networks become congested. Networks
that use conventional switches and routers usually buffer data on a linear,
first-in-first-out ("FIFO") basis. As data accumulates in the buffer, new data
sits "behind" all of the information that previously arrived at the
switch/router. High-priority information sent to that switch or router is not
distinguished from other data and is therefore "stuck" in the back of the buffer
until such other data is sent. MMC Networks' PFQ and PSQ technology is designed
to alleviate the limitations of FIFO queuing by assigning each piece of data to
its own unique queue and then scheduling the sending of the data according to
software-programmable algorithms developed by the network equipment vendor, thus
allowing the switch or router to implement class of service or quality of
service functionality. Switches and routers incorporating PFQ technology can be
designed to support up to 500,000 queues, providing enough queues for
large-scale networks.
Direct Replication Engine Technology. When data must be broadcast to all
ports on a switch or router or "multicast" to select ports, routers and switches
must replicate data packets for each port connection. This process may
significantly degrade performance. MMC Networks' Direct Replication Engine
technology is designed to provide wire-speed multicast and broadcast capability
by leveraging the separation of control information from user data enabled by
the ViX architecture. This capability allows the switch or router to store a
single copy of the data to be transmitted and replicate it to multiple ports in
a single instruction cycle.
Virtual SAR Technology. Conventional switches and routers use expensive
segmentation and reassembly ("SAR") chips to convert frames to cells and vice
versa, thus enabling the internetworking of ATM with Ethernet, frame relay and
other packet-based protocols. The Company's Virtual SAR technology provides the
ability to convert frames to cells and vice versa, thus eliminating the need for
expensive external SAR chips.
Programmable BitStream Processor Technology. MMC Networks' Programmable
BitStream Processor technology performs the processing of packet and cell
headers including such functions as real-time parsing, matching and table
look-up, as well as bit stream manipulations such as adding, deleting,
substituting, appending and pre-pending. This functionality enables network
equipment vendors to build high-performance
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switches and routers with additional services that address network security,
class of service and quality of service and improve management throughout the
network.
TARGET MARKETS AND PRODUCTS
MMC Networks' products serve two primary markets: the enterprise network
market and the service provider market. The Company's Gigabit Ethernet, Fast
Ethernet and ATM products are being designed into networking equipment intended
for both of these markets. The following table summarizes selected product and
service applications within each of these markets:
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ENTERPRISE NETWORK SERVICE PROVIDER SERVICES
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Wiring Closet Campus Backbone ATM Voice
Power Workgroup Access Remote Frame Relay Cable
Firewalls Internet Routers Web Switch Dial
xDSL Wireless
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The Company's AF5400, AF5500, ATMS2000 and PS1000 Network Processors
provide the core functionality for Gigabit Ethernet, Fast Ethernet and ATM
switches and routers developed by network equipment vendors targeting both the
enterprise network and service provider markets. The Company also offers
reference design kits, which assist customers in their technical evaluation of
the Company's products.
The AnyFlow 5400 Network Processor. The AnyFlow 5400 Network Processor is
the newest member of the AnyFlow 5000 family. The instruction set of the AnyFlow
5400 contains the base-level functionality to examine, modify and make
wire-speed switching decisions at Layers 2 through 7 of the OSI model, while
simultaneously providing IP multicast operations and Per-Stream Queuing (PSQ).
PSQ is a new technology developed by MMC Networks that provides ATM-like quality
of service (QoS) and bandwidth shaping capabilities for packet-oriented
switching, routing and firewall applications. These base level instructions can
be combined in a number of ways by the higher level software of network
equipment vendors to build highly differentiated switches and routers. The
single chip AF5400 can be cascaded to provide a throughput of up to 20 Gbps. The
Company shipped some samples of the AF5400 in late 1998 and anticipates it will
ship the product in volume in 1999. The development and introduction of new
product classes like the AF5000 is subject to numerous risks and uncertainties
including delays in the design and engineering process, uncertain manufacturing
and assembly lead times, yield uncertainties and product defects. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Factors Affecting Future Results -- New Product Development and
Technological Change", "-- Dependence on Independent Manufacturers" and
"-- Product Complexity."
The AnyFlow 5500 Network Processor. MMC Networks' AnyFlow 5500 Network
Processor chip set was the first member of the AnyFlow 5000 family to be
introduced and implements the Company's Virtual SAR, PFQ and Programmable
BitStream Processor technologies. The AF5500 employs a modular design which
enables deployment in a wide range of networking equipment, including both
Ethernet and ATM switches and routers. The AF5500 is designed to provide
wire-speed switching and routing with quality of service and packet/cell
internetworking at a bandwidth of 20 Gbps and with a throughput of up to 20
million packets-per-second. The AF5500 scales up to 128 Fast Ethernet or ATM
OC-3 ports. The Company shipped samples of the AF5500 in 1997 and began volume
shipment of the product during 1998.
The ATMS2000 Family. The ATMS2000 Network Processor chip set provides the
core functionality of a high-performance ATM switch and the capabilities for
Layer 3 routing. The ATMS2000 is optimized for feature-rich building or campus
backbones, power workgroups and WAN access. The ATMS2000 provides a
cost-effective solution for 2.5- or 5-Gbps switches and routers with port
densities of up to 32 OC-3 ports or eight OC-12 ports. The flexible ViX-based
architecture enables the centralized implementation of value-added features such
as Per-Flow Queuing, as well as customer-defined features, without the need to
change any of the linecards in the network.
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The PS1000 Family. The PS1000 Network Processor chip set implements the
core functionality of a high-performance Fast Ethernet switch, provides
extensions for Layer 3 routing and is optimized for power workgroup, wiring
closet and LAN backbone applications. The PS1000 enables network equipment
vendors to build low-cost, highly-integrated solutions supporting scalable port
densities from eight to 128 10-Mbps Ethernet ports and up to 32 100-Mbps Fast
Ethernet ports with the option of one or two ATM uplinks. The flexible PS1000
ViX-based architecture allows a high degree of customer product differentiation
in terms of bandwidth segmentation, port type implementations, support for
external frame forwarding, prioritization and uplinks.
Reference Design Kits. To facilitate the adoption by network equipment
vendors and speed the design cycle for its Network Processors, MMC Networks
designs and makes available system-level reference design kits. The Company's
reference design kits include a reference machine, schematics, layout details,
documentation and firmware, including device drivers and diagnostic software.
Source code for the reference machines can be licensed from the Company, as can
the bus models for those companies who design their own interfaces to the
Network Processors.
Products Under Development. The Company expects to continue to enhance and
refine its Network Processors, while adding additional operational features
designed to make the Company's products more attractive to a wide range of
network equipment vendors.
CUSTOMERS
MMC Networks sells its products to a variety of network equipment vendors.
As of December 31, 1998, the Company had achieved more than 60 design wins among
more than 30 network equipment vendors. To qualify as a design win, a network
equipment vendor must have (i) purchased network processor prototypes, a
reference design kit or software drivers from the Company and (ii) commenced
development of a product incorporating the Company's network processors. During
the design-in process, the Company works closely with each customer to assist in
resolving technical questions and to help the customer achieve volume production
of its products. Achieving a design win with a network equipment vendor provides
no assurance that such network equipment vendor will ultimately ship products
incorporating the Company's network processors.
Cisco, Mitsui Comtek Corp., a non-stocking sales representative for Japan,
and the U.S. Computer Division of Hitachi accounted for 50%, 12% and less than
10%, respectively, of total revenues for the year ended December 31, 1998; 28%,
28% and 12%, respectively, of total revenues for the year ended December 31,
1997 and 51%, 15% and 10%, respectively, of total revenues for the year ended
December 31, 1996. None of the Company's customer purchase agreements contains a
minimum purchase requirement. Customers typically purchase the Company's
products pursuant to short-term purchase orders that may be canceled without
charge if notice is given within an agreed-upon period.
SALES, MARKETING AND TECHNICAL SUPPORT
The Company targets customers based on industry leadership, technology
leadership and target applications. The Company maintains close working
relationships with its customers in order to design and develop solutions which
specifically address their needs. The Company markets its products through a
direct sales and marketing organization, headquartered in Sunnyvale, California,
with a major sales office in Massachusetts and through sales representatives in
the United States, the United Kingdom and several Pacific Rim countries. Sales
representatives are selected for their understanding of the networking
marketplace and their ability to provide effective field sales support for MMC
Networks' products. The Company's relationships with some of its representatives
have been established within the last year, and the Company is unable to predict
the extent to which some of these representatives will be successful in
marketing and selling the Company's products.
The Company has a number of marketing programs designed to inform network
equipment vendors about the capabilities and benefits of the Company's products.
The Company's marketing efforts include participation in industry trade shows,
technical conferences and technology seminars, preparation of competitive
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analyses, sales training, publication of technical and educational articles in
industry journals, maintenance of MMC Networks' World Wide Web site, advertising
and direct mail distribution of Company literature.
Technical support to customers is provided through factory system engineers
and, if necessary, product designers and architects. Local field support is
provided in person or by telephone. The Company plans to hire additional support
staff for remote offices, as the need arises. The Company believes that
providing network equipment vendors with comprehensive product service and
support is critical to maintaining a competitive position in the networking
market and is critical to shortening customers' design-in cycles. The Company
works closely with its customers to monitor the performance of its product
designs and to provide support at each stage of customer product development.
RESEARCH AND DEVELOPMENT
The Company's success will depend to a substantial degree upon its ability
to develop and introduce in a timely fashion new products and enhancements to
its existing products that meet changing customer requirements and emerging
industry standards. MMC Networks has made and plans to continue to make
substantial investments in research and development and to participate in the
development of industry standards.
The Company focuses its development efforts on network processor product
development. Before a new product is developed, the Company's research and
development engineers work with marketing managers and customers to develop a
comprehensive requirements specification. After the product is designed and
commercially released, Company engineers continue to work with customers on
early design-in efforts to understand requirements for future generations and
upgrades. The Company employs engineers working on many stages of chip
architecture, design, verification and test. In addition, the Company also
employs hardware and software engineers to develop its reference design kits and
related software.
The Company's research and development expenditures, net of non-recurring
engineering funding received from customers, totaled $14.6, $8.3 and $3.3
million in the years ended December 31, 1998, 1997 and 1996, respectively,
representing 30%, 38% and 31% of revenues for such periods, respectively.
Research and development expenses primarily consist of salaries and related
costs of employees engaged in ongoing research, design and development
activities and subcontracting costs. These expenses are reduced by non-recurring
engineering fees paid by the Company's customers to facilitate product
development projects. As of December 31, 1998, there were 65 employees and 1
contractor engaged in research and development. During the second quarter of
1998, the Company established a wholly owned subsidiary in Israel, MMC Networks
Israel, Ltd. ("MMCIL"). The Company performs research and development activities
at its Israeli location in addition to its U.S. locations.
MANUFACTURING
Currently, the Company outsources all of its semiconductor manufacturing,
including wafer fabrication, unit assembly and test. This "fabless"
semiconductor manufacturing model allows the Company to focus substantially all
of its resources on the design, development and marketing of products. "Fabless"
manufacturing also significantly reduces the capital requirements of the
Company.
The Company purchases certain of its products fully assembled and tested,
on a "turnkey" basis. The Company obtains other products by purchasing processed
wafers and then subcontracting the assembly and test of finished units.
The Company currently purchases turnkey products from Oki Semiconductor and
NEC in Japan. The Company purchases wafers from Taiwan Semiconductor
Manufacturing Corporation (TSMC) and United Microelectronics Corporation (UMC)
in Taiwan. The Company anticipates that the portion of its production purchased
as wafers rather than turnkey units will increase in future periods. The Company
chose these four manufacturers in large part due to their conformance with
international standards of technology, their capacity, their quality and their
support for the state-of-the-art design tools used by MMC Networks. Only one of
the Company's products is currently manufactured by more than one supplier.
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MMC Networks uses mainstream Complementary Metal Oxide Silicon (CMOS)
processes for the manufacturing of its products. The Company's main products
currently are fabricated in .35, .5 and .8 micron CMOS. The Company plans to
build certain new products on .25 micron CMOS. The Company continuously
evaluates the benefits, on a product-by-product basis, of migrating to a smaller
geometry process in order to reduce costs and has commenced migration of certain
products to smaller geometries. The Company believes that transitioning its
products to increasingly smaller geometries will be important for the Company to
remain competitive. No assurance can be given that future process migration will
be achieved without difficulty. See risks and uncertainties described in the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Factors Affecting Future Results -- New Product
Development and Technological Change" and "-- Dependence on Independent
Manufacturers".
The Company must place orders approximately eight to 10 weeks in advance of
expected delivery. As a result, the Company has only a limited ability to react
to fluctuations in demand for its products, which could cause the Company to
have an excess or a shortage of inventory of a particular product. If capacity
becomes less available in the future, the Company may be required to place
orders earlier than eight to 10 weeks in advance of expected delivery.
The success of the Company's manufacturing approach is subject to the risks
and uncertainties described in Factors Affecting Future Results -- Dependence on
Independent Manufacturers.
COMPETITION
The data networking and semiconductor industries are intensely competitive
and are characterized by constant technological change, rapid rates of product
obsolescence and price erosion. The Company's AF5400, AF5500, ATM2000 and PS1000
Network Processors compete with products from companies such as Texas
Instruments, Lucent Technologies, PMC-Sierra, Galileo Technology and Broadcom.
In addition, the Company expects significant competition in the future from
major domestic and international semiconductor suppliers. The Company also may
face competition from suppliers of products based on new or emerging
technologies. Moreover, several established electronics and semiconductor
suppliers have recently entered or indicated an intent to enter the switching
and routing equipment market. In addition, many of the Company's existing and
potential customers, including Cisco, internally develop ASICs, general purpose
processors, Network Processors and other devices which attempt to perform all or
a portion of the functions performed by the Company's products.
INTELLECTUAL PROPERTY
The Company's future success and ability to compete are dependent, in part,
upon its proprietary technology. The Company has been granted three patents in
the United States and has received notice that two additional patents will
issue. In addition, the Company has filed 10 other patent applications in the
United States. Internationally the Company has been granted one patent, has
received notice that one additional patent will issue and has filed 17 other
patent applications. None of the Company's patent applications relate to
specific products of the Company, as the Company believes that it may be more
effective to seek patent protection with respect to its key underlying
technologies, such as aspects of its ViX Architecture.
In addition, the Company claims copyright protection for certain
proprietary software and documentation. The Company also attempts to protect its
trade secrets and other proprietary information through agreements with its
customers, suppliers, employees and consultants, and through other security
measures. Although the Company intends to protect its rights vigorously, there
can be no assurance that these measures will be successful. In addition, the
laws of certain countries in which the Company's products are or may be
manufactured or sold, including Japan and Taiwan, may not protect the Company's
products and intellectual property rights to the same extent as the laws of the
United States.
While the Company's ability to compete may be affected by its ability to
protect its intellectual property, the Company believes that, because of the
rapid pace of technological change in the networking industry, its technical
expertise and ability to introduce new products on a timely basis will be more
important in maintaining its competitive position than protection of its
intellectual property and that patent, trade secret
9
<PAGE> 10
and copyright protection are important but must be supported by expanding the
knowledge, ability and experience of the Company's personnel and introducing and
enhancing products. Although the Company continues to implement protective
measures and intends to defend vigorously its intellectual property rights,
there can be no assurance that these measures will be successful. See Item
3 -- Legal Proceedings.
EMPLOYEES
As of December 31, 1998, the Company had a total of 127 full-time employees
and 4 contractors. Of the total number of employees, 65 were in research and
development, 24 in marketing and technical support, 13 in sales and 25 in
operations and administration. The Company's employees are not represented by
any collective bargaining agreement, and the Company has never experienced a
work stoppage. The Company believes its employee relations are good.
EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY
The following table sets forth the current executive officers and directors
of the Company and their respective positions. The ages set forth below are as
of December 31, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Amos Wilnai.......................... 59 Chairman of the Board, Interim Chief Executive Officer
Alexander Joffe...................... 41 Executive Vice President and Chief Technology Officer
Sena C. Reddy........................ 50 Executive Vice President, Operations
Uday Bellary......................... 44 Vice President, Finance, Chief Financial Officer and
Assistant Secretary
Frederick J. Berkowitz............... 41 Vice President, Engineering
Brent R. Bilger...................... 41 Vice President, Marketing
John A. Teegen....................... 40 Vice President, Sales
John G. Adler(1)..................... 61 Director
Irwin Federman(2).................... 63 Director
Andrew S. Rappaport(2)............... 41 Director
Geoffrey Y. Yang(1).................. 39 Director
</TABLE>
- ---------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
AMOS WILNAI has served as the Chairman of the Board of Directors since he
founded the Company in September 1992 and was appointed Interim Chief Executive
Officer in November 1998. From September 1994 to June 1998, Mr. Wilnai served as
the Company's Executive Vice President of Business Development and from
September 1992 to October 1994, he was the President of the Company. Mr. Wilnai
has a B.S.E.E. degree from the Technion Institute of Technology in Israel and an
M.S.E.E. degree from the Polytechnic Institute in Brooklyn.
ALEXANDER JOFFE was named Executive Vice President and Chief Technology
Officer in January 1999. Mr. Joffe served as the Company's Vice President of
Engineering since July 1994. From March 1993 to July 1994, Mr. Joffe was the
Company's Director of Engineering. Prior to joining the Company, Mr. Joffe spent
more than eight years with Motorola Semiconductor Products, a semiconductor
manufacturing subsidiary of Motorola, Inc., where he served most recently as an
engineering manager. Mr. Joffe holds a B.S.E.E. degree from the Technion
Institute of Technology in Israel.
SENA C. REDDY has served as the Company's Executive Vice President of
Operations since he joined the Company in January 1997. Prior to joining the
Company, Mr. Reddy spent more than 11 years at Cirrus Logic Inc., a
semiconductor company, where he served as the Senior Vice President of
Operations from April 1994 to January 1997, Vice President of Manufacturing from
July 1991 to April 1994 and the Director of Wafer
10
<PAGE> 11
Fabrication and Technology from September 1985 to June 1991. Mr. Reddy holds an
M.S.E.E. degree from Oklahoma State University.
UDAY BELLARY joined the Company as its Vice President and Chief Financial
Officer in September 1997. From February 1997 until joining the Company, Mr.
Bellary served as Vice President, Finance & Administration and Chief Financial
Officer of DTM Corporation, a manufacturer of computer-driven laser systems for
industrial prototyping. From May 1990 to December 1996, Mr. Bellary served in
various positions at Cirrus Logic Inc., a semiconductor company, most recently
as Director of Finance. Mr. Bellary holds a B.S. degree from Karnatak University
and a DMA from the University of Bombay. He is also a chartered accountant and a
certified public accountant.
FREDERICK J. BERKOWITZ joined the Company as Vice President of Engineering
in January 1999. From January 1998 to January 1999, Mr. Berkowitz was a Director
of Engineering at Silicon Graphics, Inc., a computing workstation vendor. From
November 1996 to October 1997, Mr. Berkowitz served as Vice President of Systems
Engineering for Storage Dimensions, Inc., a storage subsystems vendor. From
November 1990 to October 1996, Mr. Berkowitz was employed at Fujitsu/HAL
Computer Systems, a computing workstation vendor, as Director of Platform
Development. Mr. Berkowitz holds a B.S.E.E. degree from Union College and an
M.S.E. degree from the University of Michigan.
BRENT R. BILGER has served as the Company's Vice President of Marketing
since joining the Company in April 1997. Prior to joining the Company, Mr.
Bilger spent more than seven years with Cisco, a network equipment vendor, where
he served most recently as the Director of Marketing for service providers. Mr.
Bilger also served as the Director of Marketing of high-end routers and ATM
products during part of his tenure at Cisco. Mr. Bilger received a B.A. degree
from Dartmouth College, a B.E. degree from Thayer School of Engineering,
Dartmouth College, and an M.S.E.E. degree from Cornell University.
JOHN A. TEEGEN has served as the Company's Vice President of Sales since
joining the Company in January 1997. From August 1994 to January 1997, Mr.
Teegen was the Vice President of Worldwide Sales for Intellon Corporation, a
semiconductor company. From August 1987 to August 1994, Mr. Teegen was employed
by VLSI Technology, Inc., also a semiconductor company, where he served in a
variety of sales management positions, most recently as the Vice President of
Consumer and Industrial Sales. Mr. Teegen holds a B.S.E.E. degree from the
University of Florida.
JOHN G. ADLER has served as a director of the Company since March 1997. Mr.
Adler has served as director of Adaptec, Inc., an electronic equipment
manufacturing company, since June 1998. Mr. Adler served as the Chairman of the
Board of Directors of Adaptec, Inc. from May 1990 through August 1997, as the
President from May 1985 to August 1992 and as Chief Executive Officer from
December 1986 to July 1995. Mr. Adler holds a B.S.E.E. degree from University of
Mississippi and was a Sloan Executive Fellow at Stanford University in 1971.
IRWIN FEDERMAN has served as a director of the Company since July 1994. Mr.
Federman has been a general partner of U.S. Venture Partners, a venture capital
firm, since April 1990. From 1988 to 1990 he was a Managing Director of Dillon
Read & Co., an investment banking firm, and a general partner in its venture
capital affiliate, Concord Partners. Mr. Federman also serves on the boards of
directors of SanDisk Corporation, a memory systems company, Western Digital
Corporation, a disk drive manufacturer, Komag Incorporated, a thin film media
manufacturer, NeoMagic Corporation, a developer of multimedia accelerators,
Checkpoint Software Technology, Ltd., a network security software company and
several privately-held companies. Mr. Federman received a B.S. degree in
Economics from Brooklyn College and was awarded an honorary Doctorate of
Engineering Science from Santa Clara University.
ANDREW S. RAPPAPORT has served as a director of the Company since July
1994. Mr. Rappaport has been a partner of August Capital, LLC, a venture capital
firm, since July 1996. Prior to that time, Mr. Rappaport was the President of
The Technology Research Group, Inc., a Boston-based strategic management
consulting firm which he founded in August 1984. He is also a director of
numerous private companies. Mr. Rappaport attended Princeton University.
11
<PAGE> 12
GEOFFREY Y. YANG has served as a director of the Company since July 1994.
Mr. Yang has been a general partner of Institutional Venture Partners, a venture
capital firm, since June 1989. He also serves on the Board of Directors of
Excite, Inc., an Internet navigation service, and numerous private companies.
Mr. Yang holds a B.A. in Economics from Princeton University, a B.S.E. in
Engineering and Management Systems from Princeton University, as well as an
M.B.A. from Stanford University.
There are no family relationships among any of the Company's directors or
executive officers.
ITEM 2. PROPERTIES
The Company's main executive, administrative and technical offices occupy
approximately 35,000 square feet in Sunnyvale, California, under a lease that
expires in April 2000. The Company also has a lease in Chelmsford, Massachusetts
for approximately 4,000 square feet that expires in November 2002, which houses
sales and customer support personnel.
The Company's wholly owned subsidiary, MMCIL, entered into a lease
effective October 1998 in Netanya, Israel for approximately 7,200 square feet
that expires in September 2000.
The Company believes that its existing facilities are adequate to meet its
requirements through 1999.
ITEM 3. LEGAL PROCEEDINGS
During the fourth quarter of 1997, FORE Systems, Inc. ("FORE") filed
complaints alleging patent infringement and trade secret misappropriation
against the Company. The Company entered into a settlement agreement with FORE
in June 1998. In accordance with the settlement, the Company agreed to pay a
settlement fee and entered into a patent cross-licensing agreement pursuant to
which the Company and FORE granted each other perpetual, with certain
exceptions, and fully-paid licenses to certain patents held by them. The
settlement fee and related legal expenses totaling approximately $1.3 million
were charged to operating income in the quarter ended June 30, 1998.
Currently, the Company is not aware of any pending legal matters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
12
<PAGE> 13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "MMCN." The following table sets forth the range of the high and low
sale prices by quarter as reported on the Nasdaq National Market since October
29, 1997, the date the Common Stock commenced trading.
<TABLE>
<CAPTION>
QUARTER HIGH LOW
------- ---- ----
<S> <C> <C>
1997 : Fourth Quarter (from October 29, 1997)............... $ 28 1/4 $ 12 5/8
1998 : First Quarter........................................ $ 23 3/8 $ 14
1998 : Second Quarter....................................... $ 34 1/4 $ 19 3/8
1998 : Third Quarter........................................ $ 33 7/8 $ 10
1998 : Fourth Quarter....................................... $ 16 3/8 $ 7 3/4
</TABLE>
As of March 12, 1999, the number of holders of record of the Company's
Common Stock was 30,395,533. The Company currently intends to retain any
earnings for use in its business and does not anticipate paying any cash
dividends in the foreseeable future.
The effective date of the Company's first registration statement, filed on
Form S-1 under the Securities Act of 1933 (No. 333-34005), was October 29, 1997
(the "Registration Statement"). The class of securities registered was Common
Stock. The offering commenced on October 29, 1997 and all securities were sold
in the offering. The managing underwriters for the offering were Morgan Stanley
Dean Witter Discover & Co., Deutsche Morgan Grenfell and Wessels, Arnold &
Henderson.
A total of 4,025,000 shares were registered pursuant to the Registration
Statement, all of which the Company sold for its own account, for an aggregate
offering price of $44,275,000.
The Company incurred expenses of approximately $4,202,783 for the offering,
of which $3,099,250 represented underwriting discounts and commissions and
$1,103,533 represented other expenses. All such expenses were direct or indirect
payments to others. The net offering proceeds to the Company after total
expenses were approximately $40,072,217.
As of December 31, 1998, the Company had used the net proceeds from the
offering as follows: $114,000 for plants, buildings and facilities, $3,882,000
for the purchase and installation of machinery, equipment and purchased
software, $350,000 for the repayment of indebtedness and lease obligations,
$14,000,217 for working capital, and $21,726,000 for temporary investments. The
remaining net proceeds remain in cash and cash equivalents. None of the proceeds
were used for direct or indirect payments to directors, officers, general
partners of the Company or their associates or to persons owning ten (10)
percent or more of any class of equity securities of the Company; or to
affiliates of the Company. The use of the proceeds from the offering does not
represent a material change in the use of proceeds described in the prospectus.
13
<PAGE> 14
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements and notes thereto included elsewhere in
this Report.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- ------
STATEMENT OF OPERATIONS DATA: (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenues.................................. $49,279 $21,930 $10,515 $ 577 $ 165
Cost of revenues.......................... 14,353 6,542 3,576 304 23
------- ------- ------- ------- ------
Gross profit......................... 34,926 15,388 6,939 273 142
------- ------- ------- ------- ------
Operating expenses:
Research and development, net........... 14,552 8,318 3,312 1,802 132
Selling, general and administrative..... 9,162 6,240 3,225 1,151 298
Litigation settlement................... 1,250 -- -- -- --
------- ------- ------- ------- ------
Total operating expenses........ 24,964 14,558 6,537 2,953 430
------- ------- ------- ------- ------
Operating income (loss)................... 9,962 830 402 (2,680) (288)
Interest income, net.................... 2,179 504 317 104 62
------- ------- ------- ------- ------
Income (loss) before income taxes......... 12,141 1,334 719 (2,576) (226)
Provision for income taxes................ 3,730 138 17 -- --
------- ------- ------- ------- ------
Net income (loss)......................... $ 8,411 $ 1,196 $ 702 $(2,576) $ (226)
======= ======= ======= ======= ======
Basic income (loss) per share(1).......... $ 0.28 $ 0.08 $ 0.07 $ (0.38) $(0.04)
======= ======= ======= ======= ======
Shares used to compute basic income (loss)
per share(1)............................ 29,693 14,432 10,652 6,808 6,081
======= ======= ======= ======= ======
Diluted income (loss) per share(1)........ $ 0.25 $ 0.04 $ 0.03 $ (0.38) $(0.04)
======= ======= ======= ======= ======
Shares used to compute diluted income
(loss)
per share(1)............................ 33,611 29,113 25,745 6,808 6,081
======= ======= ======= ======= ======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------
1998 1997 1996 1995 1994
BALANCE SHEET DATA: ------- ------- ------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and short-term
investments.............................. $53,178 $45,401 $ 6,318 $8,102 $2,920
Working capital............................ 57,337 46,159 7,113 7,177 2,777
Total assets............................... 73,384 54,723 10,676 9,527 3,322
Long-term obligations...................... 14 286 636 301 100
Total stockholders' equity................. 62,945 49,717 8,177 7,446 2,830
</TABLE>
- ---------------
(1) For an explanation of the number of shares used to compute basic and diluted
net income per share, see Note 2 of Notes to the Consolidated Financial
Statements.
14
<PAGE> 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the subsection entitled "Factors Affecting Future
Results" commencing on page 19. The following discussion of the financial
condition and results of operations of the Company should be read in conjunction
with the Financial Statements and the Notes thereto included elsewhere in this
Report.
OVERVIEW
MMC Networks is a leading developer and supplier of Network Processors,
which are high-performance, open-architecture, software-programmable processors
optimized for network applications. From its inception in September 1992 through
late 1995, the Company was engaged principally in research and development, and
a substantial portion of the Company's operating expenses during such period was
related to such research and development activities.
The Company commenced volume shipments of the ATMS2000 Network Processor
chip set in 1995. This chip set provides the core functionality of a
high-performance ATM switch and the capabilities for Layer 3 routing. In 1996,
the Company commenced volume shipments of the PS1000 Network Processor chip set
which implements the core functionality of a high-performance Fast Ethernet
switch, provides extensions for Layer 3 routing and is optimized for power work
group, wiring closet and LAN backbone applications. In the second half of 1998,
the Company commenced volume shipments of the AnyFlow 5500 Network Processor
chip set, the first member of the AF5000 product family which implements the
Company's Virtual SAR, PFQ and Programmable BitStream Processor technologies.
The newest member of the AF5000 product family, the AnyFlow 5400 Network
Processor, contains the base-level functionality to examine, modify and make
wire-speed switching decisions at Layers 2 through 7 of the OSI model, while
simultaneously providing IP multicast operations and Per-Stream Queuing (PSQ).
The Company shipped some samples of this product in late 1998 and anticipates
volume shipments of this product to commence in 1999. The development and
introduction of new product classes like the AF5000 is subject to numerous risks
and uncertainties including delays in the design and engineering process,
uncertain manufacturing and assembly lead times, yield uncertainties and product
defects. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Factors Affecting Future Results -- New Product
Development and Technological Change," "-- Dependence on Independent
Manufacturers" and "-- Product Complexity."
15
<PAGE> 16
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the years ended
December 31, 1998, 1997 and 1996 expressed as a percentage of the Company's
total revenues.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
STATEMENT OF OPERATIONS DATA: ----- ----- -----
<S> <C> <C> <C>
Revenues............................................ 100.0% 100.0% 100.0%
Cost of revenues.................................... 29.1% 29.8% 34.0%
----- ----- -----
Gross profit................................... 70.9% 70.2% 66.0%
----- ----- -----
Operating expenses:
Research and development, net..................... 29.5% 37.9% 31.5%
Selling, general and administrative............... 18.6% 28.5% 30.7%
Litigation settlement............................. 2.5% 0.0% 0.0%
----- ----- -----
Total operating expenses.................. 50.6% 66.4% 62.2%
----- ----- -----
Operating income.................................... 20.3% 3.8% 3.8%
Interest income, net.............................. 4.4% 2.3% 3.0%
----- ----- -----
Income before income taxes.......................... 24.7% 6.1% 6.8%
Provision for income taxes.......................... 7.6% 0.6% 0.1%
----- ----- -----
Net income.......................................... 17.1% 5.5% 6.7%
===== ===== =====
</TABLE>
YEARS ENDED DECEMBER 31, 1998 AND 1997
Revenues. Revenues increased to $49.3 million for the year ended December
31, 1998 from $21.9 million for the year ended December 31, 1997. Despite a
decline in average sales prices during 1998, increased unit shipments in 1998 as
compared to 1997 resulted in increased revenues across all the Company's
products. The increase in unit shipments was primarily due to the shift of the
AF5500 into volume production and the continued success of the ATMS2000.
Although PS1000 revenue grew year over year, PS1000 revenue as a percent of
total revenue decreased year over year. This decline was due to the economic
downturn in Japan and Asia and poor acceptance in the marketplace of the end
products of equipment vendors using the PS1000. In future periods, the Company
anticipates that sales of the AF5500 and the newly introduced AF5400 will
increase as a percent of total revenue, that sales of the ATMS2000 will remain
flat or decline as a percent of total revenue and that sales of the PS1000 will
decline rapidly as a percent of total revenue.
Cost of Revenues; Gross Profit. Cost of revenues increased to $14.4 million
for the year ended December 31, 1998 from $6.5 million for the year ended
December 31, 1997 as a result of increased unit shipments associated with
increased sales of the Company's network processors to new and existing
customers. Gross margins remained relatively constant at 70.9% and 70.2% for the
years ended December 31, 1998 and 1997, respectively. Higher margins from newer
products offset declining margins from older products. The Company anticipates
that gross margins will decrease in future periods due to a shift in product mix
from products selling into the high end WAN market to products selling into the
more price-competitive Fast-Ethernet LAN market.
Research and Development Expenses, Net. Net research and development
expenses increased to $14.6 million for the year ended December 31, 1998 from
$8.3 million for the year ended December 31, 1997. The increase is due primarily
to increased new product development activity. As part of a plan to increase the
number of new products under development, during the second quarter of 1998 the
Company established a wholly owned subsidiary in Israel, MMC Networks Israel
Ltd., which functions as a design center. Research and development expenses,
net, include expenses incurred under a number of contracts with customers
whereby the Company receives partial or complete reimbursement for expenses
incurred. These reimbursements are recorded as an offset against research and
development expenses. For further discussion of funding received under the
Company's research and development contracts see Note 9 of Notes to the
Consolidated Financial Statements -- Research and Development Contracts.
16
<PAGE> 17
As a percentage of total revenues, research and development expenses, net
decreased to 29.5% for the year ended December 31, 1998 from 37.9% for the year
ended December 31, 1997. This percentage decrease resulted from revenues growing
faster than research and development expenses, net. In 1999, the Company expects
research and development expenses to continue to increase in absolute dollars.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $9.2 million for the year ended December
31, 1998 from $6.2 million for the year ended December 31, 1997 due to several
factors: increased sales commissions resulting from higher revenues, increased
selling and marketing costs associated with new products, additional personnel,
additional costs incurred to provide customer support for new designs and
additional costs associated with being a public company. As a percentage of
total revenues, selling, general and administrative expenses decreased to 18.6%
for the year ended December 31, 1998 from 28.5% for the year ended December 31,
1997 as revenue growth outpaced the increase in selling, general and
administrative expenses required to support that growth. In 1999, the Company
expects selling, general and administrative expenses to continue to increase in
absolute dollars.
Litigation settlement. During the fourth quarter of 1997, FORE filed
complaints alleging patent infringement and trade secret misappropriation
against the Company. The Company entered into a settlement agreement with FORE
in June 1998. In accordance with the settlement, the Company agreed to pay a
settlement fee and entered into a patent cross-licensing agreement pursuant to
which the Company and FORE granted each other perpetual, with certain
exceptions, and fully-paid licenses to certain patents held by them. The
settlement fee and related legal expenses totaling approximately $1.3 million
were charged to operating income in the quarter ended June 30, 1998.
Interest Income, net. Interest income, net consists of the difference
between interest income and interest expense. Interest income reflects interest
earned on average cash, cash equivalents and short-term investment balances.
Interest income increased to $2.2 million for the year ended December 31, 1998
from $630,000 for the year ended December 31, 1997. This increase is due to
increased cash and investment balances from period to period due to the receipt
of net proceeds from the Company's initial public offering in October 1997 and
cash flow from operations. Interest expense reflects interest on borrowings
against lease lines to finance the acquisition of capital equipment. Interest
expense was $55,000 and $126,000 for the years ended December 31, 1998 and 1997,
respectively.
Provision for Income Taxes. The provision for income taxes increased to
$3.7 million for the year ended December 31, 1998 from $138,000 for the year
ended December 31, 1997 reflecting effective rates of 30.7% and 10.3%,
respectively. The increase in the provision is due to a significant increase in
operating income from period to period coupled with an increase in the Company's
effective tax rate as compared to the prior year. The effective tax rate for
1998 is considerably higher than the effective tax rate for 1997 because the
Company utilized all of its net operating loss carryforwards during 1997 and all
of its research and development credit carryforwards in 1998. The Company
expects its effective tax rate to increase in 1999.
YEARS ENDED DECEMBER 31, 1997 AND 1996
Revenues. Revenues increased to $21.9 million for the year ended December
31, 1997 from $10.5 million for the year ended December 31, 1996. This increase
in revenues reflected the increased acceptance of the Company's ATMS2000 and
PS1000 families of network processors by new and existing customers.
Cost of Revenues; Gross Profit. Cost of revenues increased to $6.5 million
for the year ended December 31, 1997 from $3.6 million for the year ended
December 31, 1996 as a result of manufacturing costs associated with increased
sales of the Company's network processors to new and existing customers,
including volume shipments of the Company's PS1000 product family. Gross margin
increased to 70.2% for the year ended December 31, 1997 from 66.0% for the year
ended December 31, 1996. Gross margin was lower in 1996 as a result of higher
costs associated with the commencement of volume production during this period.
Research and Development Expenses, Net. Net research and development
expenses increased to $8.3 million for the year ended December 31, 1997 from
$3.3 million for the year ended December 31, 1996 due to the addition of
research and development personnel and associated costs. As a percentage of
total
17
<PAGE> 18
revenues, research and development expenses were 37.9% and 31.5% for the years
ended December 31, 1997 and 1996, respectively, reflecting a substantial
increase in the Company's investment in research and new product development in
1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $6.2 million for the year ended December
31, 1997 from $3.2 million for the year ended December 31, 1996 due to several
factors: increased sales commissions on higher sales, increased product
marketing costs associated with new products, additional personnel, higher costs
associated with the Company's new headquarters facility, the establishment of a
sales office in Massachusetts and costs incurred in connection with the
Company's initial public offering.
Interest Income, net. Interest income was $630,000 and $427,000 for the
years ended December 31, 1997 and 1996, respectively, reflecting an increase in
cash balances and investments from period to period, due primarily to receipt of
net proceeds from the Company's initial public offering. Interest expense
reflects interest on borrowings against lease lines to finance the acquisition
of capital equipment. Interest expense was $126,000 and $110,000 for the years
ended December 31, 1997 and 1996, respectively.
Provision for Income Taxes. The provision for income taxes in 1997 reflects
an effective rate of 10.3%, up from 2.4% in 1996. The federal and state income
taxes payable in 1997 and 1996 relate to federal and state alternative minimum
taxes and certain other permanent tax adjustments.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1998, the Company had cash, cash equivalents and
short-term investments of $53.2 million, up from $45.4 million at the end of the
prior year. Operating activities in 1998 provided net cash of $10.2 million,
which mainly consisted of two components. The first component was cash provided
from net income, adjusted for depreciation and amortization and the tax benefit
from the exercise of stock options, totalling $13.4 million. The second
component was an increase in accrued expenses of $4.0 million offset by an
increase in accounts receivables of $6.1 million. During 1998, cash and cash
equivalents decreased $13.9 million as the Company used cash in investing
activities to make short-term investments of $21.7 million and acquire property
and equipment of $4.1 million. In 1998, $1.7 million in cash was provided by
financing activities primarily from the exercise of stock options. During 1997,
cash and cash equivalents increased by $40.6 million, primarily due to the
Company's initial public offering which provided net cash proceeds of $40.1
million. In 1996, cash and cash equivalents increased by $4.6 million primarily
due to the liquidation of short-term investments.
During the first half of 1998, the Company established two credit
facilities with a bank pursuant to a loan agreement and a non-recourse
receivables purchase agreement. The loan agreement, which expires in May 1999,
allows the Company to borrow up to $8.0 million. The non-recourse receivables
purchase agreement expires in February 1999 and allows the Company to sell up to
$2.0 million of its accounts receivable to the bank. The Company does not intend
to renew the non-recourse receivables purchase agreement. To date, the Company
has not utilized either credit facility. See Note 4 of Notes to the Consolidated
Financial Statements -- Financing Agreements.
Through December 31, 1998, the Company had acquired approximately $9.4
million in capital assets. A portion of the Company's future capital
expenditures will be devoted to enhancing and expanding the Company's
operational, financial and management information systems.
The Company believes that its existing cash balances together with the
borrowing capacity under its credit facilities and cash flow from future
operations will be sufficient to meet the Company's capital requirements through
the next twelve months, although the Company could be required, or could elect,
to seek to raise additional capital before such time. This is a forward-looking
statement and the actual period of time for which the Company's resources will
be sufficient will depend on many factors, including the rate of revenue growth,
if any, the timing and extent of spending to support product development efforts
and the expansion of sales and marketing efforts, the timing and size of
business or technology acquisitions, the timing of introductions of new products
and enhancements to existing products and market acceptance of the
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Company's products. There can be no assurance that additional equity or debt
financing, if required, will be available on acceptable terms or at all.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any computer programs
that have date-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including among other things
a temporary inability to process transactions, send invoices or engage in
similar normal business activities.
The Company is pursuing a plan to identify and address Year 2000 issues
(the "Plan"). One component of the Plan is designed to identify and assess the
risks associated with the Company's information technology ("IT") systems,
non-IT systems and products. This component of the Plan is composed of three
phases: (1) identification and assessment of risks, (2) implementation and (3)
testing. Based on documentation supplied by the Company's computer hardware and
software vendors, phase 1 and 2 have been completed with respect to the
Company's critical IT systems and phase 3 is expected to be completed by June
1999. With respect to non-critical IT systems, phase 1 has been completed and
phases 2 and 3 are expected to be completed by April and June of 1999,
respectively. For non-IT systems such as facilities and laboratory test
equipment, phase 1 has been completed and phases 2 and 3 are expected to be
completed by April and June of 1999, respectively. The Company has completed
testing its products, including semiconductors, software, and reference design
systems, and believes them to be Year 2000 compliant. However, the Company can
not be sure that errors will not be discovered in the future. The Company does
not intend to create a contingency plan but will reassess the need for a
contingency plan as each major phase of the Plan is completed.
The second component of the Plan is to identify and assess the risks
associated with the Year 2000 readiness of the Company's suppliers, including
critical service suppliers such as banks. The Company believes that these risks
are the greater risks associated with preparing for the Year 2000 given the
Company's reliance upon its suppliers' ability to adequately resolve potential
Year 2000 issues on a timely basis. This component of the Plan is composed of
three phases: (1) identification and assessment of risks, (2) survey of
significant or critical suppliers regarding their Year 2000 preparedness and (3)
contingency planning. The Company has completed phase 1, and phases 2 and 3 are
expected to be completed by April and June of 1999, respectively. As part of the
contingency planning, the Company may be required to find alternative suppliers
to replace suppliers identified as having Year 2000 compliance issues or
suppliers whose published reports and or response to the Company's survey are
not timely, accurate or complete. There can be no assurance that the Company
will be able to adequately address Year 2000 compliance of its vendors, to find
suitable alternate suppliers and contract with them on terms reasonable to the
Company, or at all, and that such inability will not have a material adverse
effect on the Company's business, financial condition and results of operations.
Based on the status of the Company's Year 2000 efforts to date, the Company
does not anticipate total expenses for implementing the Plan to exceed $50,000,
excluding expenses related to internal IT staff. All expenses in this effort are
expensed as incurred. However, the Company may discover additional Year 2000
problems, may not be able to develop, implement, or test contingency plans, or
may find that the expenses associated with these activities exceed current
expectations. In many cases, the Company is relying on assurances from suppliers
and vendors that new and upgraded IT systems and other products will be Year
2000 compliant. The Company can not be sure that its tests of third-party
products will be adequate or that, if problems are identified, they will be
adequately addressed by the third party on a timely basis. Because the Company
uses a variety of IT systems and has additional systems embedded in its
infrastructure, it can not be sure that all of its systems will work together in
a Year 2000-compliant fashion. Furthermore, the Company can not be sure that it
will not suffer business interruptions, either because of its own Year 2000
problems or those of its customers or suppliers whose Year 2000 problems may
make it difficult or impossible for them to fulfill their commitments to the
Company. If the Company fails to satisfactorily resolve Year 2000 issues in a
timely manner, it could also be exposed to liability to third parties.
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FACTORS AFFECTING FUTURE RESULTS
As described by the following factors, past financial performance should
not be considered a reliable indicator of future performance, and investors
should not use historical trends to anticipate results or trends in future
periods.
Limited Operating History as a Public Company; No Assurance of Future
Profitability. Although the Company has experienced significant revenue growth
in recent periods and has achieved profitability in each of the last three
years, these results should not be considered indicative of future revenue
growth, if any, nor is there any assurance that the Company will be profitable
in any future period. Due to anticipated increases in the Company's operating
expenses, the Company's operating results will be adversely affected if the
Company's revenues do not continue to increase. The sales cycle for the
Company's products can range from three to six months or more, with an
additional nine to 18 months or more before a network equipment vendor customer
commences volume production of equipment which incorporates the Company's
products. As a result, there may be a significant delay between an increase in
research and development and sales and marketing expenses and the generation of
higher revenues, if any, from such expenditures. To remain profitable, the
Company must, among other things, successfully increase the scope of its
operations, respond to competitive developments, continue to attract, retain and
motivate qualified personnel and continue to commercialize products
incorporating innovative technologies. There can be no assurance that the
Company will be successful in doing so.
Fluctuations in Operating Results. Fluctuations in the Company's operating
results have occurred in the past and are likely to occur in the future due to a
variety of factors, any of which may have a material adverse effect on the
Company's operating results. In particular, the Company's quarterly results of
operations may vary significantly due to general business conditions in the
networking equipment and semiconductor industries, changes in demand for the
network equipment products of the Company's customers, the timing and amount of
orders from the Company's network equipment vendor customers, cancellations or
delays of customer product orders, new product introductions by the Company or
its competitors, cancellations, changes or delays of deliveries of products to
the Company by its suppliers, increases in the costs of products from the
Company's suppliers, fluctuations in product life cycles, price erosion,
competition, changes in the mix of products sold by the Company, availability of
semiconductor foundry capacity, variances in the timing and amount of
non-recurring engineering funding and operating expenses, seasonal fluctuations
in demand, intellectual property disputes and general economic conditions. The
Company has at times recognized a substantial portion of its revenues in the
last month of a quarter. Since a large portion of the Company's operating
expenses, including rent, salaries and capital lease expenses, is fixed and
difficult to reduce or modify, if revenue does not meet the Company's
expectations, the material adverse effect of any revenue shortfall will be
magnified by the fixed nature of these operating expenses. All of the above
factors are difficult for the Company to forecast, and these and other factors
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence Upon Development of the Market for Network Processors. The
Company's future prospects are dependent upon the acceptance of network
processors as an alternative to the Application-Specific Integrated Circuit
("ASIC") components and general purpose processors traditionally utilized by
network equipment vendors. The Company's future prospects are also dependent
upon acceptance by the Company's customers of third party sourcing for network
processors as an alternative to in-house development. Many of the Company's
current and potential customers have substantial technological capabilities and
financial resources and currently develop internally the ASIC components and
program the general purpose processors utilized in their products. These
customers may in the future continue to utilize internally-developed ASIC
components and general purpose processors or may determine to develop or acquire
components, technologies or network processors that are similar to, or that may
be substituted for, the Company's products. The Company must anticipate market
trends and the price, performance and functionality requirements of such network
equipment vendors and must successfully develop and manufacture products that
meet these requirements. In addition, the Company must make products available
to such customers on a timely basis and at competitive prices. If the Company's
network equipment vendor customers fail to accept network processors as an
alternative, if they develop or acquire the technology to develop such
components internally
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rather than purchase the Company's products, or if the Company is otherwise
unable to develop strong relationships with network equipment vendors, the
Company's business, financial condition and results of operations would be
materially and adversely affected.
Customer Concentration. The Company's customer base is highly concentrated.
A relatively small number of customers has accounted for a significant portion
of the Company's revenues to date, and the Company expects that this trend will
continue for the foreseeable future. Each of the Company's network equipment
vendor customers, including Cisco, IBM Corporation, Lucent Technologies, Mitsui
and Hitachi, can cease incorporating the Company's products with limited notice
to the Company and with little or no penalty. The Company's agreements with
network equipment vendor customers do not require minimum purchases. Pursuant to
the Company's agreements with Cisco and certain of its other customers, under
certain circumstances, such customers have the right to manufacture the
Company's network processors for resale as part of their products or to
otherwise use proprietary technology of the Company in their products. The
circumstances in which customers have such rights include certain defaults by
the Company, a change of control of the Company and certain other events
relating to the Company's inability, or potential inability, to supply products
to such customers. In any such event, the Company will not necessarily be
entitled to royalty payments or fees for use of its technology. The obligation
of customers to pay royalties, if any, may be dependent upon the customer's
ability to obtain products at a price lower than that previously charged by the
Company to the customer.
The Company's future operating results are currently substantially
dependent on Cisco's competitive position in the networking equipment market.
The loss of one or more of the Company's customers in general and Cisco in
particular, the possibility that new customer products employing the Company's
Network Processors may not be successful, the possibility that design wins with
customers may not result in volume production of new products, and the inability
of the Company to successfully develop relationships with additional significant
network equipment vendors could have a material adverse effect on the Company's
business, financial condition and results of operations.
Erosion of Average Selling Prices. The data networking and semiconductor
industries have experienced rapid erosion of average selling prices ("ASPs") due
to a number of factors, including rapid technological change, price/performance
enhancements and product obsolescence. The Company may experience substantial
period-to-period fluctuations in future operating results due to ASP erosion.
The Company anticipates that ASPs will decrease in the future in response to
product introductions by competitors or the Company or other factors, including
price pressures from significant customers. In particular, the market for
Ethernet switching and routing components has experienced and is expected to
continue to experience significant ASP erosion. During 1998, the Company's
PS1000 product line experienced such erosion. Therefore, the Company must
continue to develop and introduce on a timely basis new products which
incorporate features that can be sold at higher ASPs. Failure to achieve any or
all of the foregoing could cause the Company's revenues and gross margins to
decline, which would have a material adverse effect on the Company's business,
financial condition and results of operations.
New Product Development and Technological Change. The data networking and
semiconductor industries are characterized by rapidly changing technology,
frequent product introductions and evolving industry standards. Accordingly, the
Company's future performance depends on a number of factors, including the
Company's ability to identify emerging technological trends in its target
markets, develop and maintain competitive products, enhance its products by
adding innovative features that differentiate its products from those of
competitors, bring products to market on a timely basis at competitive prices,
properly identify target markets and respond effectively to new technological
changes or new product announcements by others. No assurance can be given that
the Company's design and introduction schedules for any additions and
enhancements to its existing and future products will be met, that these
products will achieve market acceptance, or that the Company will be able to
sell these products at prices that are favorable to the Company. In evaluating
new product decisions, the Company must anticipate well in advance future demand
for product features and performance characteristics, as well as available
supporting technologies, manufacturing capacity, industry standards and
competitive product offerings. The technical innovations required for the
Company to remain competitive must be completed before developments in
networking technologies or
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standards render them obsolete and must be sufficiently compelling to induce
network equipment vendors to favor them over alternative technologies. To remain
competitive, the Company must design new products and sometimes redesign
existing products to be manufactured on newer wafer process technologies that
provide smaller circuit dimensions. There is no assurance that the suppliers of
these new technologies can deliver them on schedule or that the Company can
complete its designs on the new processes on schedule. Moreover, the Company
must generally incur substantial research and development costs before the
technical feasibility and commercial viability of a product line can be
ascertained. There can be no assurance that revenues from future products or
product enhancements will be sufficient to recover the development costs
associated with such products or enhancements, or that the Company will be able
to secure the financial resources necessary to fund future development. The
inability of the Company and its products to achieve market acceptance from
network equipment vendors and to adequately address any of the factors discussed
above could have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence on Independent Manufacturers. Currently, the Company outsources
all manufacturing, assembly and testing of its network processors. The Company
purchases both fully assembled and tested products on a turnkey basis and wafers
which it then consigns to subcontract assembly and test providers. For products
purchased in wafer form, the Company assumes the risk of yield loss in
subsequent manufacturing steps. The Company has not entered into any volume
purchase agreements with its suppliers for the purchase of the wafers. Only one
of the Company's products is currently manufactured by more than one supplier.
The Company depends on its suppliers to deliver sufficient quantities of
finished product to the Company in a timely manner. Since the Company places its
orders on a purchase order basis and does not have a long-term volume purchase
agreement with any of its existing suppliers, these suppliers may allocate, and
in the past have allocated, capacity to the production of other products while
reducing deliveries to the Company on short notice. Given that the Company must
place orders approximately eight to 10 weeks in advance of expected delivery,
any sudden increase in customer demand not anticipated by the Company in advance
could result in the inability to deliver product on a timely basis and, as such,
may reduce the Company's product revenues or increase the Company's cost of
revenues and could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company places
orders based on forecast demand to ensure enough lead time to be able to meet
anticipated customer orders. Any sudden decrease in the anticipated customer
demand could have a material adverse effect on the Company's business, financial
condition and results of operations. If capacity becomes less available in the
future, the Company may be required to place orders earlier than eight to 10
weeks in advance of expected delivery. As the Company increases the volume of
its wafer purchases in place of turnkey purchases, the Company will need to
continue to invest in the capital and engineering resources necessary for
production under this manufacturing flow.
Competition. The data networking and semiconductor industries are intensely
competitive and are characterized by constant technological change, rapid rates
of product obsolescence and price erosion. The Company's AF5400, AF5500, ATM2000
and PS1000 Network Processors compete with products from companies such as Texas
Instruments, Lucent Technologies, PMC-Sierra, Galileo Technology and Broadcom.
In addition, the Company expects significant competition in the future from
major domestic and international semiconductor suppliers. The Company also may
face competition from suppliers of products based on new or emerging
technologies. Moreover, several established electronics and semiconductor
suppliers have recently entered or indicated an intent to enter the switching
and routing equipment market. In addition, many of the Company's existing and
potential customers internally develop ASICs, general purpose processors,
network processors and other devices which attempt to perform all or a portion
of the functions performed by the Company's products. Many of the Company's
current and prospective competitors offer broader product lines and have
significantly greater financial, technical, manufacturing and marketing
resources than the Company. Failure of the Company to compete successfully could
have a material adverse effect on its operating results.
Product Complexity. Products as complex as those offered by the Company
frequently contain errors, defects and bugs when first introduced or as new
versions are released. The Company has in the past experienced such errors,
defects and bugs. Delivery of products with production defects or reliability,
quality or compatibility problems could significantly delay or hinder market
acceptance of such products, which could
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damage the Company's reputation and adversely affect the Company's ability to
retain its existing customers and to attract new customers. Moreover, such
errors, defects or bugs could cause problems, interruptions, delays or a
cessation of sales to the Company's customers. Alleviating such problems may
require significant expenditures of capital and resources by the Company. There
can be no assurance that, despite testing by the Company, its suppliers or its
customers, errors, defects or bugs will not be found in new products after
commencement of commercial production, resulting in additional development
costs, loss of, or delays in, market acceptance, diversion of technical and
other resources from the Company's other development efforts, claims by the
Company's customers or others against the Company, or the loss of credibility
with the Company's current and prospective customers. Any such event could have
a material adverse effect on the Company's business, financial condition and
results of operations.
Dependence on Growth in Demand for Networking Equipment. The Company's
future success is in large measure dependent on continued growth in the market
for networking equipment, in particular the market for mid- to high-end switches
and routers which are manufactured and sold by the Company's customers. The
market for these products has in the past and may in the future fluctuate
significantly based upon numerous factors, including the lack of industry
standards, adoption of alternative technologies, capital spending levels and
general economic conditions. There can be no assurance with respect to the rate
or extent to which the networking equipment market will grow, if at all, nor can
there be any assurance that the Company will not experience a decline in demand
for its products. Any decrease in the growth of the networking equipment market
or decline in demand for the Company's products could have a material adverse
effect on the Company's business, financial condition and results of operations.
Protection of Intellectual Property. The Company relies primarily on a
combination of nondisclosure agreements and other contractual provisions as well
as patent, trademark, trade secret and copyright law to protect its proprietary
rights. There can be no assurance that any patents will issue pursuant to the
Company's current or future patent applications or that patents issued pursuant
to such applications will not be invalidated, circumvented, challenged or
licensed to others. In addition, there can be no assurance that the rights
granted under any such patents will provide competitive advantages to the
Company or be adequate to safeguard and maintain the Company's proprietary
rights. Failure of the Company to enforce and protect its intellectual property
rights could have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance that such
intellectual property rights can be successfully asserted in the future or will
not be invalidated, circumvented or challenged. From time to time, third
parties, including competitors of the Company, may assert patent, copyright and
other intellectual property rights to technologies that are important to the
Company. There can be no assurance that third parties will not assert
infringement claims against the Company in the future, that assertions by third
parties will not result in costly litigation or that the Company would prevail
in any such litigation or be able to license any valid and infringed patents
from third parties on commercially reasonable terms, if at all.
During the fourth quarter of 1997, FORE filed complaints alleging patent
infringement and trade secret misappropriation against the Company. The Company
entered into a settlement agreement with FORE in June 1998. In accordance with
the settlement, the Company agreed to pay a settlement fee and entered into a
patent cross-licensing agreement pursuant to which the Company and FORE granted
each other perpetual, with certain exceptions, and fully-paid licenses to
certain patents held by them. The settlement fee and related legal expenses
totaling approximately $1.3 million were charged to operating income in the
quarter ended June 30, 1998.
There can be no assurance that the Company will not in the future become
subject to other patent infringement claims and litigation or interference
proceedings to determine the priority of inventions. The defense and prosecution
of intellectual property suits, interference proceedings and related legal and
administrative proceedings are both costly and time consuming. Any such suit or
proceeding involving the Company could have a material adverse effect on the
Company's business, financial condition and results of operations. Litigation,
regardless of the outcome, is likely to result in substantial cost and diversion
of resources of the Company. Any infringement claim or other litigation against
or by the Company could materially adversely affect the Company's business,
financial condition and results of operations.
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Dependence on Key Personnel and Hiring of Additional Personnel. The
Company's success depends to a significant degree upon the continued
contributions of its key management, engineering and other personnel, many of
whom would be difficult to replace. The Company does not have employment
contracts with any of its key personnel. In addition, the Company believes that
its success depends to a significant extent on the ability of its management to
operate effectively, both individually and as a group. The Company must continue
to attract and retain highly skilled managerial, engineering and other
personnel, including a permanent Chief Executive Officer. Competition for such
personnel is intense, and there can be no assurance that the Company will be
successful in attracting and retaining such personnel. The loss of the services
of any of the key personnel, the inability to attract or retain qualified
personnel in the future or delays in hiring required personnel, particularly
engineers, could have a material adverse effect on the Company's business,
financial condition and results of operations.
Management of Growth. The Company has experienced a period of rapid growth
and expansion which has placed, and continues to place, a significant strain on
its resources. To accommodate this growth, the Company will be required to
implement a variety of new and upgraded operational and financial systems,
procedures and controls, including the improvement of its accounting and other
internal management systems, all of which may require substantial management
effort. There can be no assurance that such efforts can be accomplished
successfully. Any failure to improve the Company's operational, financial and
management information systems in response to growth, or to hire, train,
motivate or manage its employees could have a material adverse effect on the
Company's business, financial condition and results of operations.
Risks Associated with Expansion of International Business
Activities. Substantially all of the Company's sales to date have been to
customers located in the United States, including sales to U.S.-based affiliates
of non-U.S. network equipment vendors. If the Company's international sales
increase, the Company will be subject to additional risks inherent in
international operations. All of the Company's international sales to date are
U.S. dollar-denominated. As a result, an increase in the value of the U.S.
dollar relative to foreign currencies could make the Company's products less
competitive in international markets. In addition, the Company procures the
majority of its manufacturing, assembly and test services from suppliers located
outside the United States. International business activities may be limited or
disrupted by the imposition of governmental controls, export license
requirements, restrictions on the export of critical technology, currency
exchange fluctuations, political instability, trade restrictions and changes in
tariffs. Demand for the Company's products could also be adversely affected by
seasonality of international sales and economic conditions in the Company's
primary overseas markets. These international factors could have a material
adverse effect on future sales of the Company's products to international
customers and, consequently, on the Company's business, financial condition and
results of operations. As a percentage of total revenues, sales to Mitsui have
declined to 12% for the year ended December 31, 1998 as compared to 28% for the
year ended December 31, 1997. Sales to Mitsui may remain at this lower level or
decline further due to the economic downturn in Japan and Asia in general, and
could have an adverse effect on the Company's revenues in the future.
Need for Additional Capital. The Company may require substantial additional
working capital to fund its business, particularly to finance inventories and
accounts receivable and for product development. Any such additional financing
may result in significant dilution to the Company's then existing investors. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Risks Associated with Potential Acquisitions. As part of its business
strategy, the Company expects to review acquisition prospects that would
complement its existing product offerings, augment its market coverage or
enhance its technological capabilities, or that may otherwise offer growth
opportunities. Future acquisitions by the Company could result in potentially
dilutive issuances of equity securities, the incurrence of debt and contingent
liabilities and amortization expenses related to goodwill and other intangible
assets, any of which could materially adversely affect the Company's operating
results and/or the price of the Company's Common Stock. Acquisitions entail
numerous risks, including difficulties in the assimilation of acquired
operations, technologies and products, diversion of management's attention to
other business concerns, risks of entering markets in which the Company has no
or limited prior experience and potential loss of key employees of acquired
organizations. No assurance can be given as to the ability of the Company to
successfully integrate
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any businesses, products, technologies or personnel that might be acquired in
the future, and the failure of the Company to do so could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Expected Volatility of Stock Price. In recent years the stock market in
general, and the market for shares of high technology, data networking and
semiconductor companies in particular, have experienced extreme price
fluctuations, which have often been unrelated to the operating performance of
affected companies. The trading price of the Company's Common Stock has been,
and is expected to continue to be, subject to extreme fluctuations in response
to both business-related issues, such as quarterly variations in operating
results, announcements of new products by the Company or its competitors, the
gain or loss of significant network equipment vendor customers, and stock
market-related influences, such as changes in analysts' estimates, the presence
or absence of short-selling of the Company's Common Stock and events affecting
other companies that the market deems to be comparable to the Company. In
addition, technology stocks have from time to time experienced extreme price and
volume fluctuations that often have been unrelated or disproportionate to the
operating performance of these companies. These broad market fluctuations have
affected and are expected to continue to adversely affect the market price of
the Company's Common Stock. Moreover, the trading prices of many high
technology, data networking and semiconductor stocks are at or near their
historical highs and reflect price/earnings ratios substantially above
historical norms.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk. As of December 31, 1998, the Company held a total of
$50.7 million in marketable securities. The Company classified $29.0 million of
this amount within the cash and cash equivalents category and classified the
remaining $21.7 million as short-term investments. These securities consisted
primarily of commercial paper and securities issued or guaranteed by the U.S.
government. These securities, like all fixed income instruments, are subject to
interest rate risk and will decline in value if market interest rates increase.
If market interest rates were to increase immediately and uniformly by 10
percent from levels as of December 31, 1998, the decline in the fair value of
the portfolio would not be material. Additionally, the Company has the ability
to hold its fixed income investments until maturity and, therefore, the Company
would not expect to recognize such an adverse impact in income or cash flows.
The Company currently does not use derivative financial instruments in its
investment portfolio. The Company currently has no fixed-rate obligations except
for capitalized leases of approximately $286,000. The Company currently holds no
equity securities. Thus the Company does not face risk of material adverse
impact from market rate changes from these sources.
Foreign currency risk. The Company pays suppliers for its subsidiary in
Israel in local currency. The Company also has a supplier contract that requires
price changes based on currency fluctuations. Therefore, the Company is subject
to foreign currency rate exposure. If the Israeli currency rate fluctuated by 10
percent from the rate at December 31, 1998, the effect on the Company's
financial position and results of operations would not be material. If the
foreign currency of the supplier had increased in value during 1998 by 10
percent from the rate at December 31, 1998, the cost of sales for 1998 would
have been higher by approximately $400,000. The Company can not assure that
there will not be a material impact in the future from foreign currency
fluctuations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements and supplemental data
required by this item and set forth at the pages indicated in item 14(a) of this
Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
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PART III
Certain information required by Part III is omitted from this Report in
that the registrant will file a definitive Proxy Statement pursuant to
Regulation 14A (the "Proxy Statement") no later than 120 days after the end of
the fiscal year covered by this Report, and certain information included therein
is incorporated herein by reference.
ITEM 10. DIRECTORS AND OFFICERS OF THE COMPANY
Certain information regarding the directors and officers of the Company is
contained herein under Item 1, "Executive Officers and Directors of the
Company."
Information regarding directors appearing under the caption "Election of
Directors -- Directors and Nominees for Director" in the Proxy Statement is
hereby incorporated by reference.
Information regarding compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, is hereby incorporated herein by reference
from the section entitled "Election of Directors -- Section 16(a) Beneficial
Ownership Reporting Compliance" in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is set forth under the caption
"Additional Information Relating to Directors and Officers of the
Company -- Executive Compensation" in the Company's Proxy Statement, which
information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is set forth under the caption
"Security Ownership" in the Company's Proxy Statement, which information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is set forth under the captions
"Election of Directors -- Compensation Committee Interlocks and Insider
Participation" and "Certain Transactions" in the Company's Proxy Statement,
which information is incorporated herein by reference.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) The following are filed as part of this Report:
1. FINANCIAL STATEMENTS
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----
<S> <C>
Report of Independent Accountants........................... 28
Consolidated Balance Sheets at December 31, 1998 and 1997... 29
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 1998............... 30
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 1998..... 31
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 1998............... 32
Notes to Consolidated Financial Statements.................. 33
</TABLE>
2. FINANCIAL STATEMENTS SCHEDULE
<TABLE>
<S> <C>
Schedule II -- Valuation and Qualifying Accounts............ 47
</TABLE>
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
27
<PAGE> 28
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
MMC Networks, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) and (2) on page 27 present fairly, in all material
respects, the financial position of MMC Networks, Inc. and its subsidiary at
December 31, 1998 and 1997 and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers, LLP
San Jose, California
January 19, 1999
28
<PAGE> 29
MMC NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $31,452 $45,401
Short-term investments.................................... 21,726 --
Accounts receivable, net of allowances of $172 and $181... 10,582 4,526
Inventories............................................... 630 570
Prepaid expenses and other current assets................. 3,372 382
------- -------
Total current assets.............................. 67,762 50,879
Property and equipment, net................................. 5,487 3,631
Other assets................................................ 135 213
------- -------
$73,384 $54,723
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 4,400 $ 2,626
Accrued expenses.......................................... 5,753 1,744
Current portion of capital lease obligations.............. 272 350
------- -------
Total current liabilities......................... 10,425 4,720
------- -------
Capital lease obligations, net of current portion........... 14 286
------- -------
Commitments and contingencies (Note 10)
Stockholders' equity:
Series A Convertible Preferred Stock: $0.001 par value; 0
and 9,378 shares authorized; no shares issued or
outstanding............................................ -- --
Series B Convertible Preferred Stock: $0.001 par value; 0
and 4,121 shares authorized; no shares issued or
outstanding............................................ -- --
Preferred Stock: $0.001 par value; 10,000 and 0 shares
authorized; no shares issued or outstanding............ -- --
Common Stock: $0.001 par value; 100,000 shares authorized;
30,135 and 29,198 shares issued and outstanding........ 26 25
Additional paid-in capital................................ 55,520 50,778
Notes receivable from stockholders........................ (107) (181)
Retained earnings (Accumulated deficit)................... 7,506 (905)
------- -------
Total stockholders' equity........................ 62,945 49,717
------- -------
$73,384 $54,723
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
29
<PAGE> 30
MMC NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Revenues.................................................... $49,279 $21,930 $10,515
Cost of revenues............................................ 14,353 6,542 3,576
------- ------- -------
Gross profit...................................... 34,926 15,388 6,939
------- ------- -------
Operating expenses:
Research and development, net.......................... 14,552 8,318 3,312
Selling, general and administrative.................... 9,162 6,240 3,225
Litigation settlement.................................. 1,250 -- --
------- ------- -------
Total operating expenses.......................... 24,964 14,558 6,537
------- ------- -------
Operating income............................................ 9,962 830 402
------- ------- -------
Other income (expense):
Interest income........................................ 2,234 630 427
Interest expense....................................... (55) (126) (110)
------- ------- -------
Total other income................................ 2,179 504 317
------- ------- -------
Income before income taxes.................................. 12,141 1,334 719
Provision for income taxes.................................. 3,730 138 17
------- ------- -------
Net income.................................................. $ 8,411 $ 1,196 $ 702
======= ======= =======
Basic income per share...................................... $ 0.28 $ 0.08 $ 0.07
======= ======= =======
Shares used to compute basic income per share............... 29,693 14,432 10,652
======= ======= =======
Diluted income per share.................................... $ 0.25 $ 0.04 $ 0.03
======= ======= =======
Shares used to compute diluted income per share............. 33,611 29,113 25,745
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
30
<PAGE> 31
MMC NETWORKS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE NOTES RETAINED
PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLES EARNINGS
------------------ --------------- PAID-IN FROM (ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCKHOLDERS DEFICIT) TOTAL
------- -------- ------ ------ ---------- ------------ ------------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995.......... 13,342 $ 10,247 10,365 $ 6 $ 121 $(125) $(2,803) $ 7,446
Exercise of stock options............. -- -- 741 1 122 (100) -- 23
Issuance of Common Stock in exchange
for services........................ -- -- 15 -- 6 -- -- 6
Net income............................ -- -- -- -- -- -- 702 702
------- -------- ------ --- ------- ----- ------- -------
Balance at December 31, 1996.......... 13,342 10,247 11,121 7 249 (225) (2,101) 8,177
Conversion of Preferred Stock upon the
completion of the initial public
offering............................ (13,342) (10,247) 13,342 13 10,234 -- -- --
Issuance of Common Stock, net of issue
costs of $1,104..................... -- -- 4,025 4 40,068 -- -- 40,072
Repurchase of Common Stock and
reduction of loan receivable from
stockholder......................... -- -- (170) -- (114) 114 -- --
Exercise of warrant................... -- -- 121 -- -- -- -- --
Exercise of stock options and other... -- -- 744 1 311 (70) -- 242
Issuance of Common Stock in exchange
for services........................ -- -- 15 -- 30 -- -- 30
Net income............................ -- -- -- -- -- -- 1,196 1,196
------- -------- ------ --- ------- ----- ------- -------
Balance at December 31, 1997.......... -- -- 29,198 25 50,778 (181) (905) 49,717
Exercise of stock options and other... -- -- 859 1 1,218 -- -- 1,219
Shares issued under the Employee Stock
Purchase Plan....................... -- -- 78 -- 716 -- -- 716
Repayment of notes receivable from
stockholders........................ -- -- -- -- -- 74 -- 74
Tax benefit from the exercise of stock
options............................. -- -- -- -- 2,808 -- -- 2,808
Net income............................ -- -- -- -- -- -- 8,411 8,411
======= ======== ====== === ======= ===== ======= =======
Balance at December 31, 1998.......... -- $ -- 30,135 $26 $55,520 $(107) $ 7,506 $62,945
======= ======== ====== === ======= ===== ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
31
<PAGE> 32
MMC NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 8,411 $ 1,196 $ 702
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 2,224 1,186 479
Issuance of Common Stock in exchange for services...... -- 30 6
Tax benefit from the exercise of stock options......... 2,808 -- --
Changes in assets and liabilities:
Accounts receivable.................................. (6,056) (2,501) (1,388)
Inventories.......................................... (60) (59) (357)
Prepaid expenses and other assets.................... (2,912) (389) (114)
Accounts payable..................................... 1,774 2,040 (31)
Accrued expenses..................................... 4,009 955 594
Deferred revenue and customer deposits............... -- (100) (750)
-------- ------- -------
Net cash provided by (used in) operating
activities...................................... 10,198 2,358 (859)
-------- ------- -------
Cash flows from investing activities:
Sale (purchase) of short-term investments................. (21,726) 1,509 6,343
Acquisition of property and equipment..................... (4,080) (3,201) (673)
-------- ------- -------
Net cash provided by (used in) investing
activities...................................... (25,806) (1,692) 5,670
-------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net............... 1,935 40,314 23
Proceeds from the repayment of notes receivable from
stockholders........................................... 74 -- --
Principal payments on capital lease obligations........... (350) (388) (275)
-------- ------- -------
Net cash provided by (used in) financing
activities...................................... 1,659 39,926 (252)
-------- ------- -------
Net increase (decrease) in cash and cash equivalents........ (13,949) 40,592 4,559
Cash and cash equivalents at beginning of period............ 45,401 4,809 250
-------- ------- -------
Cash and cash equivalents at end of period.................. $ 31,452 $45,401 $ 4,809
======== ======= =======
SUPPLEMENTAL DISCLOSURE:
Cash paid for interest.................................... $ 55 $ 126 $ 110
Cash paid for income taxes................................ $ 1,517 $ 13 $ --
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Acquisition of property and equipment through capital
leases................................................. $ -- $ -- $ 880
</TABLE>
The accompanying notes are an integral part of these financial statements.
32
<PAGE> 33
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- THE COMPANY
MMC Networks is a leading developer and supplier of Network Processors,
which are high-performance, open-architecture, software-programmable processors
optimized for network applications. The Company was incorporated in California
in September 1992 as a Subchapter S corporation and became a Subchapter C
corporation effective July 1994. The Company was reincorporated in Delaware in
October 1997. In May 1998, the Company established a wholly owned subsidiary in
Israel, MMC Networks Israel, LTD, ("MMCIL"), which functions as an engineering
design center. The Company sells its products primarily in the United States.
Certain equity transactions -- Stock splits. In July 1997 and December
1996, the Company effected a 3-for-2 and a 2-for-1 stock split, respectively, of
its Common Stock and Convertible Preferred Stock. The accompanying financial
statements have been retroactively adjusted to reflect these splits.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiary. All material
intercompany accounts and transactions have been eliminated.
Use of estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the reported amounts of revenues and expenses during the reporting
period and disclosure of contingent assets and liabilities at the date of the
financial statements. Actual results could differ from those estimates.
Cash, cash equivalents and short-term investments. The Company considers
all highly liquid investments with a maturity of three months or less when
purchased to be cash equivalents. Short-term investments consist primarily of
commercial paper and securities issued or guaranteed by the U.S. government with
maturities of more than three months when purchased. The Company has categorized
its short-term investments as available-for-sale. At December 31, 1998 and 1997,
the fair market value of the Company's short-term investments approximated cost.
Inventories. Inventories are stated at the lower of cost, determined using
the first-in, first-out method, or market.
Property and equipment. Property and equipment are stated at cost.
Depreciation and amortization are computed using the straight-line method over
the estimated useful lives of the assets, generally three years.
Long-lived assets. The Company periodically evaluates the recoverability of
its long-lived assets and recognizes impairment of long-lived assets in the
event the net book value of such assets exceeds the future undiscounted cash
flows attributable to such assets. No such impairments have been identified to
date.
Revenue recognition. Revenues are recognized upon shipment of product to
customers. Funds received in advance of product shipment are deferred and
recognized upon shipment of the product. The Company's normal policy is to not
accept returns except for defective products. Anticipated costs related to
product warranties are charged to operations as revenues are recognized. The
Company has not experienced significant warranty claims to date.
Research and development. Research and development expenses are charged to
operations as incurred. The Company on occasion receives non-recurring
engineering funding for development projects to apply or enhance the Company's
technology to a particular customer's needs. Such funding is recognized over the
term of the respective contract using the percentage-of-completion method. At
the time of recognition, amounts received under research and development
contracts are offset against research and development expenses. (See Note 9.)
33
<PAGE> 34
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Software development expenses. Software development expenses are included
in research and development. The Company's policy is to capitalize certain
software development expenses once technological feasibility is established,
which the Company defines as the completion of a working model. The capitalized
expense is then amortized on a straight-line basis over the estimated product
life, or on the ratio of current sales to total projected product sales,
whichever is greater. To date, the period between achieving technological
feasibility and the general availability of such software has been short, and
software development expenses qualifying for capitalization have been
insignificant. Accordingly, the Company has expensed these costs as incurred.
Income taxes. The Company accounts for income taxes using an asset and
liability approach, which requires the recognition of taxes payable or
refundable for the current year and deferred tax liabilities and assets for the
future tax consequences of events that have been recognized in the Company's
financial statements or tax returns. The measurement of current and deferred tax
liabilities and assets are based on the provisions of the enacted tax law; the
effects of future changes in tax laws or rates are not anticipated. The
measurement of deferred tax assets is reduced, if necessary, by the amount of
any tax benefits that, based on available evidence, are not expected to be
realized.
Stock-based compensation. The Company accounts for stock based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations. The Company provides additional pro forma disclosures as
required under Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation." (See Note 6.)
Concentrations of credit risk. Financial instruments that potentially
subject the Company to significant concentrations of credit risk consist
principally of cash, cash equivalents, short-term investments and accounts
receivable. The Company places its cash, cash equivalents and short-term
investments primarily in market rate accounts, commercial paper, state and
municipal securities and securities issued by or guaranteed by the U.S.
government. The Company performs ongoing credit evaluations of its customers'
financial condition and generally requires no collateral from its customers. The
Company provides an allowance for doubtful accounts receivable based upon the
expected collectibility of such receivables and to date has not experienced any
material losses.
Net income (loss) per share. Basic EPS is computed by dividing net income
available to common stockholders (numerator) by the weighted average shares of
common stock outstanding (denominator) during the period. Basic EPS excludes the
dilutive effect of potential common stock. Diluted EPS gives effect to all
dilutive potential common stock outstanding during the period. In computing
diluted EPS, the average stock price for the period is used in determining the
number of shares assumed to be purchased from the exercise of potential common
stock.
34
<PAGE> 35
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table reconciles the numerators and denominators of the basic
and diluted EPS computations for the years ended December 31, 1996 and 1997 and
1998.
<TABLE>
<CAPTION>
PER SHARE
NET INCOME SHARES AMOUNT
------------ -------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
FOR THE YEAR ENDED DECEMBER 31, 1996:
Earning per share of Common Stock -- basic.................. $ 702 10,652 $0.07
=====
Effect of dilutive securities:
Convertible Preferred Stock............................... -- 13,342
Warrants.................................................. -- 50
Stock options............................................. -- 1,701
------ ------
Earnings per share of Common Stock -- diluted............... $ 702 25,745 $0.03
====== ====== =====
FOR THE YEAR ENDED DECEMBER 31, 1997:
Earning per share of Common Stock -- basic.................. $1,196 14,432 $0.08
=====
Effect of dilutive securities:
Convertible Preferred Stock............................... -- 11,118
Warrants.................................................. -- 114
Stock options............................................. -- 3,449
------ ------
Earnings per share of Common Stock -- diluted............... $1,196 29,113 $0.04
====== ====== =====
FOR THE YEAR ENDED DECEMBER 31, 1998:
Earning per share of Common Stock -- basic.................. $8,411 29,693 $0.28
=====
Effect of dilutive securities:
Warrants.................................................. -- 30
Stock options............................................. -- 3,888
------ ------
Earnings per share of Common Stock -- diluted............... $8,411 33,611 $0.25
====== ====== =====
</TABLE>
At December 31, 1996, 1997 and 1998 certain options to purchase Common
Stock are considered anti-dilutive because the options' exercise price was
greater than the average fair market value of the Company's Common Stock for the
years then ended and, as such, are excluded from the calculation of diluted net
income per share. At December 31, 1996, 1997 and 1998 anti-dilutive options were
for the purchase of 877,500 shares of common stock with an average exercise
price of $1.74, 29,500 shares of common stock with an average exercise price of
$15.94 and 354,500 shares of common stock with an average exercise price of
$24.52, respectively.
Comprehensive Income. The Company reports comprehensive income in
accordance with the standards set forth in the Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). Comprehensive
income, as defined, includes all changes in equity (net assets) during a period
from non-owner sources. Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency translation
adjustments and unrealized gain/loss on available-for-sale securities. For the
years ended December 31, 1998, 1997 and 1996, items of other comprehensive
income were not material.
Segment Information. The Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS 131") in 1998. This statement establishes standards for the
way companies report information about operating segments in financial
statements. It also establishes standards for related disclosures about products
and services, geographic areas and major customers.
35
<PAGE> 36
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Operating Segments -- While the Company has more than one product family,
it operates in one segment, selling all of its products to network equipment
vendors for inclusion in their enterprise and service provider products.
Geographic Areas -- The Company reports its sales in geographic areas
according to the location to which the product is shipped. In the case that a
customer regularly directs product to be shipped to a manufacturing
subcontractor located in a different geographic area, the Company reports the
sale in the geographic area of the customer and not the subcontractor. Revenues
in North America, Asia (including Japan) and Europe represented 84%, 13% and 3%;
69%, 29% and 2% and 83%, 16% and 1% of total revenues for the years ended
December 31, 1998, 1997 and 1996, respectively.
Major Customers -- The percentage of total revenues accounted for by the
Company's significant customers (significant customers are those customers
accounting for more than 10% of the Company's total revenues) are as follows:
Cisco Systems Inc., Mitsui Comtek Corp., a non-stocking sales representative for
Japan, and the U. S. Computer Division of Hitachi accounted for 50%, 12% and
less than 10%, respectively, of total revenues for the year ended December 31,
1998; 28%, 28% and 12%, respectively, of total revenues for the year ended
December 31, 1997 and 51%, 15% and 10%, respectively, of total revenues for the
year ended December 31, 1996. Cisco and Mitsui Comtek Corp. represented 55% and
18% of trade receivables at December 31, 1998 and each represented 27% of trade
receivables at December 31, 1997.
NOTE 3 -- COMPOSITION OF CERTAIN BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Inventories:
Work in process........................................... $ 244 $ --
Finished goods............................................ 386 570
------- -------
$ 630 $ 570
======= =======
Property and equipment:
Computers and equipment................................... $ 2,964 $ 1,935
Purchased software........................................ 6,010 3,157
Furniture and fixtures.................................... 430 316
------- -------
9,404 5,408
Less accumulated depreciation and amortization.............. (3,917) (1,777)
------- -------
$ 5,487 $ 3,631
======= =======
Accrued liabilities:
Accrued compensation and benefits......................... $ 1,844 $ 807
Income taxes payable...................................... 1,802 146
Accrued warranty.......................................... 1,899 219
Other accrued liabilities................................. 208 572
------- -------
$ 5,753 $ 1,744
======= =======
</TABLE>
NOTE 4 -- FINANCING AGREEMENTS
During the first half of 1998, the Company established two credit
facilities with a bank pursuant to a loan agreement and a non-recourse
receivables purchase agreement. The loan agreement, which expires in May 1999,
allows the Company to borrow up to $8.0 million. Borrowings under the loan
agreement bear interest at the bank's prime rate. The agreement requires that
the Company comply with certain financial covenants. In
36
<PAGE> 37
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the event of default, all outstanding borrowings will accrue interest at a rate
of five percentage points above the rate effective immediately prior to any such
default. The non-recourse receivables purchase agreement expires in February
1999. The agreement allows the Company to sell up to $2.0 million of its
accounts receivable to the bank at a discount rate equal to the bank's prime
rate plus 1.0% per annum, less an administrative fee equal to 0.20% of the total
purchased receivables balance and also provided for the Company to grant to the
bank a continuing lien on and security interest in all purchased receivables and
related property. The Company does not intend to renew the non-recourse
receivables purchase agreement. To date, the Company has not utilized either
credit facility.
As of December 31, 1997, the Company had two lines of credit, a $5.0
million revolving bank credit facility under which borrowings accrued interest
at the bank's prime rate and a $3.0 million bank lease line under which
borrowings accrued interest at the bank's prime rate plus 0.5%. The Company
never utilized either of these lines of credit, both of which expired in April
1998.
NOTE 5 -- INCOME TAXES
The Company's income before taxes is primarily composed of domestic income.
The provision for income taxes of $138,000 and $17,000 for the years ended
December 31, 1997 and 1996, respectively, represents current federal and state
income taxes payable. The provision for income taxes of $3.7 million for the
year ended December 31, 1998 consists of:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
-----------------
<S> <C>
Current tax expense (in thousands):
United States............................................. $ 5,212
State..................................................... 760
Foreign................................................... 29
-------
Total current tax expense......................... 6,001
Deferred income taxes....................................... (2,271)
-------
Total provision for income taxes.................. $ 3,730
=======
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1998 1997
------- --------
<S> <C> <C>
Deferred tax assets consist of the following (in thousands):
Research and development credit carryforwards............. $ -- $ 500
Reserves and basis differences............................ 758 505
Accrued expenses.......................................... 1,312 197
Other....................................................... 201 179
------ -------
Total deferred tax assets......................... 2,271 1,381
Valuation allowance......................................... -- (1,381)
------ -------
Net deferred tax assets..................................... $2,271 $ --
====== =======
</TABLE>
Prior to 1998, due to the fact that the Company emerged from the
development stage in 1996 and did not have an extensive history of
profitability, management believed that the available objective evidence created
sufficient uncertainty regarding the realizability of deferred tax assets such
that a full valuation allowance was required.
37
<PAGE> 38
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The effective tax rate for the year ended December 31, 1998 and 1997
reconciles to the statutory tax rates as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1998 1997
---- ----
<S> <C> <C>
Federal statutory rate...................................... 35% 34%
State taxes, net of federal benefit......................... 2% 6%
Foreign income taxes........................................ 2% --
Permanent differences....................................... 2% 2%
Utilization of research and development credit
carryforwards............................................. (3%) --
Utilization of net operating loss carryforwards............. -- (32%)
Release of valuation allowance.............................. (9%) --
Other, net.................................................. 2% --
-- ---
Effective tax rate.......................................... 31% 10%
== ===
</TABLE>
NOTE 6 -- CAPITAL STOCK
Common Stock. The Company is authorized to issue 100,000,000 shares of
Common Stock each with a par value of $0.001 per share and 10,000,000 shares of
undesignated Preferred Stock each with a par value of $0.001 per share. Holders
of Common Stock are entitled to one vote per share on all matters voted on by
the Company's stockholders. The Board of Directors has the authority to issue
the undesignated Preferred Stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof.
In October 1997, the Company completed its initial public offering (the
"IPO") of 4,025,000 shares of Common Stock at a price of $11.00 per share. The
Company received proceeds of approximately $40.1 million of cash, net of issue
costs. In conjunction with the IPO, all outstanding shares of Convertible
Preferred Stock consisting of 9,255,000 shares of Series A Convertible Preferred
Stock and 4,086,780 shares of Series B Convertible Preferred Stock were
converted into shares of Common Stock on a one-for-one basis.
Stock Option Repricing. On September 18, 1998, the Board of Directors
offered to the employees holding outstanding options to purchase Common Stock of
the Company with grant dates subsequent to October 28, 1997 the opportunity to
reprice such options to an exercise price equal to $16.38, the closing sales
price of the Company's Common Stock on the effective date of September 25, 1998.
No other terms or conditions of the original option agreements were changed
except that the repriced option is not exercisable for a period of six months
from the effective date of the repricing, except in the event of a change of
control of the Company or termination of the optionee's employment with the
Company due to involuntary termination, disability, or death. A total of 424,000
options with original exercise prices ranging from $16.75 to $32.13 were
repriced. Members of the Board of Directors and the Company's officers were
excluded from the repricing.
1997 Stock Plan. In August 1997, the Company's Board of Directors adopted,
and the stockholders subsequently approved, the 1997 Stock Plan (the "1997
Plan"). The 1997 Plan is intended to serve as the successor equity incentive
program to the Company's 1993 Plan (the "Predecessor Plan"). Outstanding options
under the Predecessor Plan were incorporated into the 1997 Plan upon the
effectiveness of the Company's IPO. No further option grants were made under the
Predecessor Plan. The incorporated options will continue to be governed by their
existing terms which are essentially the same as options granted under the 1997
Plan described below. The following shares have been reserved for issuance under
the 1997 Plan: (a) 1,500,000 shares of Common Stock plus any shares which were
reserved but unissued under the Predecessor Plan; (b) any shares returned to the
Predecessor Plan as a result of termination of options under such plan; and (c)
shares added to the 1997 Plan pursuant to automatic annual increases on the date
of each annual meeting of the stockholders beginning with the 1999 annual
meeting equal to the lesser of (i) 1,000,000 shares, (ii) 5% of all then
outstanding shares of Common Stock of the Company, or (iii) a
38
<PAGE> 39
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
lesser amount determined by the Board. Unless terminated sooner, the 1997 Plan
will terminate automatically in August 2007.
The 1997 Plan provides for the grant of incentive stock options ("ISOs") to
employees, officers and employee directors and nonstatutory stock options
("NSOs") and stock purchase rights ("SPRs") to employees, directors and
consultants. ISOs granted to participants owning stock possessing more than 10%
of the voting power of all classes of stock must have an exercise price at least
equal to 110% of the fair market value on the date of grant and are for periods
not to exceed five years. All other options granted under the plan must have an
exercise price at least equal to the fair market value on the date of grant and
are for periods not to exceed ten years. Options granted under the 1997 Plan
generally vest at a rate of 25% on the first anniversary of the date of grant
and as to 1/48 of the underlying shares per month thereafter.
Stock purchase rights are for periods and prices determined by the Board.
Shares purchased through the exercise of SPRs are subject to repurchase by the
Company at the original price paid by the purchaser in the event that the
purchaser's employment with the Company terminates. The repurchase right lapses
at a rate determined by the Board. No stock purchase rights have been granted to
date under either the 1997 Plan or the Predecessor Plan.
1997 Director Option Plan. In August 1997, the Company's Board of Directors
adopted, and the stockholders subsequently approved, the 1997 Director Option
Plan (the "Director Plan"). The Director Plan provides for the grant of
nonstatutory stock options to non-employee directors. Options granted under the
Director Plan are for periods not to exceed ten years and are granted at
exercise prices not less than the fair market value on the date of grant. The
Director Plan provides that each non-employee director will automatically be
granted a nonstatutory option to purchase 40,000 shares of Common Stock (the
"First Option") on the date which such person first becomes a non-employee
director, unless immediately prior to becoming a non-employee director, such
person was an employee director of the Company. In addition to the First Option,
each non-employee director will automatically be granted an option to purchase
10,000 shares (a "Subsequent Option") on the date two days after the
announcement of the Company's fiscal year-end earnings of each year, if on such
date he or she will have served on the Board of Directors for at least the
preceding six months.
Each First Option and each Subsequent Option will have a term of 10 years.
Each First Option will vest as to 25% of the optioned stock one year from the
date of grant, and as to an additional 1/48 of the optioned stock each full
month thereafter, provided the person continues to serve as a Director on such
dates. Each Subsequent Option will vest as to 1/12 of the optioned stock each
full month after the date of grant. A total of 150,000 shares of Common Stock
have been reserved for issuance under the Director Plan, plus annual increases
equal to (i) the number of shares of stock underlying options granted under the
Director Plan in the immediately preceding year, or (ii) a lesser amount
determined by the Board.
39
<PAGE> 40
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of December 31, 1998, a total of 18,375,000 shares have been reserved
for issuance under the plans. A summary of activity under such plans is as
follows:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
AVAILABLE OPTIONS EXERCISE
FOR GRANT OUTSTANDING PRICE
---------- ----------- --------
<S> <C> <C> <C>
Balance at December 31, 1995...................... 1,676,811 1,479,939 $ 0.03
Authorized........................................ 3,300,000 -- --
Granted........................................... (3,265,500) 3,265,500 0.79
Exercised......................................... -- (741,534) 0.17
Canceled.......................................... 810,000 (810,000) 0.29
---------- ---------
Balance at December 31, 1996...................... 2,521,311 3,193,905 0.71
Authorized........................................ 7,650,000 -- --
Granted........................................... (3,213,500) 3,213,500 3.53
Exercised......................................... -- (743,830) 0.36
Canceled.......................................... 431,688 (431,688) 0.97
---------- ---------
Balance at December 31, 1997...................... 7,389,499 5,231,887 2.47
Granted........................................... (1,638,000) 1,638,000 17.15
Exercised......................................... -- (859,445) 1.47
Canceled.......................................... 782,783 (782,783) 15.95
---------- ---------
Balance at December 31, 1998...................... 6,534,282 5,227,659 $ 5.22
========== =========
</TABLE>
The weighted-average estimated grant-date fair values of options granted
under the plans during the years ended December 31, 1998, 1997 and 1996,
determined using either the minimum value model or the Black-Scholes model as
prescribed by SFAS 123, were $11.10, $1.16, and $0.20, respectively. The Company
calculated the fair value of its stock options using the minimum value model for
options granted prior to the filing of the Company's initial registration
statement on August 19, 1997 and the Black-Scholes model for options granted
after August 19, 1997 using the following weighted average assumptions:
<TABLE>
<CAPTION>
FROM FROM
FOR THE YEAR AUGUST 20, JANUARY 1, FOR THE YEAR
ENDED 1997 TO 1997 TO ENDED
DECEMBER 31, DECEMBER 31, AUGUST 19, DECEMBER 31,
1998 1997 1997 1996
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
STOCK OPTION PLANS:
Expected dividend yield........... 0 % 0 % 0 % 0 %
Expected stock price volatility... 80 % 70 % 0 % 0 %
Risk free interest rate........... 4.85% 6.03% 6.33% 6.14%
Expected life of the options
(years)......................... 4.53 4.00 4.00 4.00
</TABLE>
40
<PAGE> 41
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information concerning outstanding and
exercisable options as of December 31, 1998 (Remaining Contractual Life is
expressed in years):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- ----------------------------
AVERAGE WEIGHTED- WEIGHTED-
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE OUTSTANDING EXERCISE PRICE
- --------------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$0.03 - 1.10.. 1,114,020 6.99 $ 0.43 596,417 $ 0.34
2.00 - 2.67.. 1,753,845 8.09 2.09 625,646 2.10
3.33 - 5.33.. 897,064 8.39 4.29 315,686 4.28
6.67 - 10.25.. 331,730 8.73 7.07 103,256 7.00
10.50 - 17.16.. 1,123,000 9.42 14.91 9,750 15.76
19.56 - 25.63.. 8,000 9.34 22.59 -- --
--------- ---------
$0.03 - 25.63.. 5,227,659 8.24 $ 5.22 1,650,755 $ 2.27
========= =========
</TABLE>
1997 Employee Stock Purchase Plan. In August 1997, the Company's Board of
Directors adopted, and the stockholders subsequently approved, the 1997 Employee
Stock Purchase Plan (the "1997 Purchase Plan"). The 1997 Purchase Plan is
intended to qualify under Section 423 of the Internal Revenue Code. It contains
24-month offering periods, with four six-month purchase periods included in each
offering period. The 1997 Purchase Plan permits employees to purchase Common
Stock of the Company through payroll deductions of up to 10% of the
participant's compensation. The price of stock purchased under the 1997 Purchase
Plan is 85% of the lower of the fair market value of the Common Stock at the
beginning of the offering period or at the end of the purchase period. A total
of 300,000 shares of Common Stock has been reserved for issuance under the 1997
Purchase Plan. Shares reserved for issuance under the 1997 Purchase Plan are
subject to automatic annual increases equal to the lesser of (i) 400,000 shares,
(ii) 0.8% of all then outstanding shares of Common Stock of the Company or (iii)
a lesser amount determined by the Board.
The weighted-average estimated fair value of shares granted under the 1997
Purchase Plan during 1998 and 1997 was $5.50 and $4.63 per share, respectively.
The fair value of shares granted under the 1997 Purchase Plan was calculated
using the Black-Scholes model as prescribed by SFAS No. 123 assuming the
following weighted-average assumptions:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------
1998 1997
----- -----
<S> <C> <C>
STOCK PURCHASE PLAN:
Expected dividend yield..................................... 0% 0%
Expected stock price volatility............................. 77% 70%
Risk free interest rate..................................... 4.92% 5.58%
Expected life of the options (years)........................ 1.16 1.3
</TABLE>
Had the Company recorded compensation based on the estimated grant-date
fair value, using either the minimum value model or the Black-Scholes model as
discussed above and as prescribed by SFAS 123, for options granted under the
option plans and the 1997 Purchase Plan, the Company's net income and basic and
41
<PAGE> 42
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
diluted income per share would have been reduced to the pro forma amounts below
for the years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ -----
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
Net income as reported.................................... $8,411 $1,196 $ 702
Pro forma net income...................................... 5,741 619 662
Basic income per share as reported........................ $ 0.28 $ 0.08 $0.07
Pro forma basic income per share.......................... 0.19 0.04 0.06
Diluted income per share as reported...................... $ 0.25 $ 0.04 $0.03
Pro forma diluted income per share........................ 0.17 0.02 0.03
</TABLE>
Because the determination of the fair value of all options granted after
the Company filed its initial registration statement includes a volatility
factor and because it does not take into consideration pro forma compensation
expense related to grants made prior to 1995, the pro forma effect on net income
for the years ended December 31, 1998, 1997 and 1996 shown above is not
representative of the pro forma effect on net income in future years.
NOTE 7 -- OTHER EMPLOYEE BENEFITS
Effective January 1994, the Company adopted a 401(k) plan for its employees
whereby eligible employees may contribute up to 20% of their earnings, on a
pre-tax basis, subject to the maximum amount permitted by the Internal Revenue
Code. At the discretion of the Board of Directors, the Company may make
contributions under the 401(k) plan. To date, the Company has not made any such
contributions.
NOTE 8 -- NOTES RECEIVABLE FROM STOCKHOLDERS
In October and November 1995, the Company made full recourse loans with
principal amounts totaling $125,000 to certain employees pursuant to the
Company's 1993 Plan. The loans are non-interest bearing and are due in October
and November 2000 or earlier in the event of the borrower's termination of
employment with the Company. At December 31, 1998 the outstanding balance under
these loans of $107,000 are secured by 586,090 shares of the Company's Common
Stock.
In March 1997, the Company accepted a full recourse promissory note with a
principal amount of $100,000 from one of its officers. The note bears interest
at 6.07% per annum, is secured by 500,590 shares of the Company's Common Stock
and is due upon the earlier of October 31, 1999 or six months following
termination of employment with the Company.
NOTE 9 -- RESEARCH AND DEVELOPMENT CONTRACTS
During the years ended December 31, 1998, 1997 and 1996 the Company
performed research and development which was funded under a number of contracts.
The Company recognized $811,000, $716,000 and $863,000, respectively, as offsets
against research and development expenses. These contracts, which vary in term
and are with parties unrelated to the Company, provide for non-refundable
funding (irrespective of the results) of research and development of certain
technologies owned by the Company which will enhance the Company's products to
meet specific customers' needs. For the year ended December 31, 1998, one
customer represented 77% of the total funding received in 1998. Funding received
under any of the research and development contracts was not individually
significant for the years ended December 31, 1997 and 1996.
42
<PAGE> 43
MMC NETWORKS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
Leases. The Company leases its facilities under noncancelable lease
agreements which expire from April 2000 through November 2002. Rent expense
under noncancelable operating leases was $687,000, $612,000 and $245,000 during
the years ended December 31, 1998, 1997 and 1996, respectively.
In 1994, the Company entered into a master lease agreement with a leasing
company for the acquisition of property and equipment. The leasing company's
commitment to fund purchases of capital equipment under this agreement expired
on January 15, 1996. During 1996 the Company leased $54,000 of property and
equipment under this agreement which have been classified as capital leases.
These capital leases terminate at various dates through 1999.
In February 1996, the Company entered into a new master lease agreement
with a leasing company for the acquisition of property and equipment. The
agreement provided for up to $750,000 for equipment purchases made through June
30, 1997, all of which had been utilized as of December 31, 1996. Capital leases
under this agreement terminate at various dates through 1999. In connection with
the master lease agreement the Company issued a warrant to purchase 33,963
shares of Series B Convertible Preferred Stock at $1.77 per share. The estimated
fair value of the warrant was not material on the date of issuance. The warrant
expires in January 2003. Upon the completion of the Company's IPO, the warrant
to purchase 33,963 shares of Series B Convertible Preferred Stock was
automatically converted to a warrant to purchase an equal number of shares of
Common Stock at the same exercise price. A total of 33,963 shares of Common
Stock have been reserved for issuance upon exercise of the warrant. The warrant
had not been exercised as of December 31, 1998.
As of December 31, 1998 and 1997, property and equipment recorded under
capital leases, consisting primarily of computer equipment and purchased
software, totaled $1.4 million with related accumulated amortization of $1.3
million and $957,000, respectively.
Future minimum lease payments under all non-cancelable operating and
capital leases are as follows (in thousands):
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
--------- -------
<S> <C> <C>
For the Year Ended December 31,
1999...................................................... $ 763 $289
2000...................................................... 308 14
2001...................................................... 44 --
2002...................................................... 40 --
------ ----
Total minimum payments............................ $1,155 303
======
Less amount representing interest........................... 17
----
Present value of lease obligations................ 286
Less current portion........................................ 272
----
Lease obligations, net of current portion......... $ 14
====
</TABLE>
Other. From time to time, third parties, including competitors of the
Company, may assert patent, copyright and other intellectual property rights to
technologies that are important to the Company. Management is not aware of any
such matters that are currently pending.
43
<PAGE> 44
3. EXHIBITS
The exhibits listed under Item 14(c) hereof are filed with this report on
Form 10-K.
(b) No reports were filed on Form 8-K during the three months ended December 31,
1998.
(c) Exhibits
The following exhibits are filed with this Report:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- -------------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation filed on
January 13, 1998.(2)
3.2 Bylaws of the Registrant.(1)
4.1 Form of Common Stock Certificate.(1)
10.1 Form of Indemnification Agreement for directors and
executive officers of the Registrant.(1)
+10.2 1993 Stock Plan.(1)
+10.3 1997 Employee Stock Purchase Plan.(1)
+10.4 1997 Stock Plan.(1)
+10.5 1997 Director Option Plan.(1)
10.6 First Amended and Restated Shareholder Rights Agreement
dated November 16, 1995, by and among the Registrant and the
Shareholders named therein.(1)
10.7 Sublease, dated June 14, 1996, by and between Olivetti
Advanced Technology Center, Inc. and the Registrant, and the
Lease Agreement, dated December 22, 1994, by and between
Herman Christensen, Jr., Raymond Christensen and Olivetti
Advanced Technology Center, Inc.(1)
- --10.8 Development, License and Purchase Agreement, effective as of
December 19, 1994 (the "Cisco Agreement"), by and between
Cisco Systems, Inc. and the Registrant, as amended by the
First Amendment to the Cisco Agreement, effective as of
January 30, 1996, and Amendment Number 2 to the Cisco
Agreement, dated July 7, 1997.(1)
10.9 Supplier Escrow Agreement, dated as of April 21, 1997, by
and between the Registrant, Hitachi Computer Products
(America), Inc. and SourceFile.(1)
10.10 Loan and Security Agreement dated April 21, 1997, by and
between Silicon Valley Bank and the Registrant.(2)
10.11 Lease dated October 23, 1997, by and between New Boston Mill
Road Limited Partnership and the Registrant.(2)
10.12 Non-Recourse Receivables Purchase Agreement dated February
9, 1998, by and between Silicon Valley Financial Services, a
division of Silicon Valley Bank, and the Registrant.(3)
10.13 Loan Agreement dated May 7, 1998 by and between Silicon
Valley Bank and the Registrant.(4)
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (see Page 46).
27.1 Financial Data Schedule.
</TABLE>
- ---------------
-- Confidential treatment granted with respect to certain portions.
+ Denotes a compensation plan in which an executive officer or director
participates.
(1) Previously filed as exhibits to the Registrant's Registration Statement on
Form S-1 (File No. 33-34005), filed with the Securities Exchange Commission
on October 27, 1997.
(2) Previously filed as exhibits to the Registrant's Form 10-K405 (File No.
00-23023), filed with the Securities and Exchange Commission on March 23,
1998.
(3) Previously filed as exhibits to the Registrant's Form 10-Q (File No.
00-23023), filed with the Securities and Exchange Commission on May 1, 1998.
(4) Previously filed as exhibits to the Registrant's Form 10-Q (File No.
00-23023), filed with the Securities and Exchange Commission on August 5,
1998.
(d) Financial Data Schedules. See Item 14(a)(2) above.
44
<PAGE> 45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Dated: March 22, 1999 MMC NETWORKS, INC.
By: /s/ AMOS WILNAI
------------------------------------
Amos Wilnai
Chairman of the Board of Directors
and
Interim Chief Executive Officer
Each person whose signature appears below constitutes and appoints Amos
Wilnai and Uday Bellary, jointly and severally, his attorneys-in-fact, each with
the power of substitution, for him in any and all capacities, to sign any
amendments to this Annual Report on Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Act of 1934, this Report has
been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ AMOS WILNAI Chairman of the Board and Interim March 22, 1999
- ------------------------------------- Chief Executive Officer
Amos Wilnai (Principal Executive Officer)
/s/ UDAY BELLARY Vice President, Finance, Chief March 22, 1999
- ------------------------------------- Financial Officer and Assistant
Uday Bellary Secretary (Principal Financial and
Accounting Officer)
/s/ JOHN G. ADLER Director March 22, 1999
- -------------------------------------
John G. Adler
/s/ IRWIN FEDERMAN Director March 22, 1999
- -------------------------------------
Irwin Federman
/s/ ANDREW S. RAPPAPORT Director March 22, 1999
- -------------------------------------
Andrew S. Rappaport
/s/ GEOFFREY Y. YANG Director March 22, 1999
- -------------------------------------
Geoffrey Y. Yang
</TABLE>
45
<PAGE> 46
SCHEDULE II
MMC NETWORKS, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS DEDUCTION
BALANCE AT CHARGED TO FROM BALANCE
BEGINNING STATEMENT OF ALLOWANCE/ AT END
OF PERIOD OPERATIONS RESERVE OF PERIOD
---------- ------------ ---------- ---------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Year ended December 31, 1996..................... $ 45 $ 88 $ -- $133
==== ==== ==== ====
Year ended December 31, 1997..................... $133 $ 48 $ -- $181
==== ==== ==== ====
Year ended December 31, 1998..................... $181 $ -- $ 9 $172
==== ==== ==== ====
</TABLE>
46
<PAGE> 47
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------- -------------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation filed on
January 13, 1998.(2)
3.2 Bylaws of the Registrant.(1)
4.1 Form of Common Stock Certificate.(1)
10.1 Form of Indemnification Agreement for directors and
executive officers of the Registrant.(1)
+10.2 1993 Stock Plan.(1)
+10.3 1997 Employee Stock Purchase Plan.(1)
+10.4 1997 Stock Plan.(1)
+10.5 1997 Director Option Plan.(1)
10.6 First Amended and Restated Shareholder Rights Agreement
dated November 16, 1995, by and among the Registrant and the
Shareholders named therein.(1)
10.7 Sublease, dated June 14, 1996, by and between Olivetti
Advanced Technology Center, Inc. and the Registrant, and the
Lease Agreement, dated December 22, 1994, by and between
Herman Christensen, Jr., Raymond Christensen and Olivetti
Advanced Technology Center, Inc.(1)
- --10.8 Development, License and Purchase Agreement, effective as of
December 19, 1994 (the "Cisco Agreement"), by and between
Cisco Systems, Inc. and the Registrant, as amended by the
First Amendment to the Cisco Agreement, effective as of
January 30, 1996, and Amendment Number 2 to the Cisco
Agreement, dated July 7, 1997.(1)
10.9 Supplier Escrow Agreement, dated as of April 21, 1997, by
and between the Registrant, Hitachi Computer Products
(America), Inc. and SourceFile.(1)
10.10 Loan and Security Agreement dated April 21, 1997, by and
between Silicon Valley Bank and the Registrant.(2)
10.11 Lease dated October 23, 1997, by and between New Boston Mill
Road Limited Partnership and the Registrant.(2)
10.12 Non-Recourse Receivables Purchase Agreement dated February
9, 1998, by and between Silicon Valley Financial Services, a
division of Silicon Valley Bank, and the Registrant.(3)
10.13 Loan Agreement dated May 7, 1998 by and between Silicon
Valley Bank and the Registrant.(4)
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (see Page 46).
27.1 Financial Data Schedule.
</TABLE>
- ---------------
-- Confidential treatment granted with respect to certain portions.
+ Denotes a compensation plan in which an executive officer or director
participates.
(1) Previously filed as exhibits to the Registrant's Registration Statement on
Form S-1 (File No. 33-34005), filed with the Securities Exchange Commission
on October 27, 1997.
(2) Previously filed as exhibits to the Registrant's Form 10-K405 (File No.
00-23023), filed with the Securities and Exchange Commission on March 23,
1998.
(3) Previously filed as exhibits to the Registrant's Form 10-Q (File No.
00-23023), filed with the Securities and Exchange Commission on May 1, 1998.
(4) Previously filed as exhibits to the Registrant's Form 10-Q (File No.
00-23023), filed with the Securities and Exchange Commission on August 5,
1998.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-40173) of MMC Networks, Inc. of our report dated
January 19, 1999 appearing on page 28 of this Form 10K.
PricewaterhouseCoopers LLP
San Jose, California
March 22, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 31,452
<SECURITIES> 21,726
<RECEIVABLES> 10,754
<ALLOWANCES> 172
<INVENTORY> 630
<CURRENT-ASSETS> 67,762
<PP&E> 9,404
<DEPRECIATION> 3,917
<TOTAL-ASSETS> 73,384
<CURRENT-LIABILITIES> 10,425
<BONDS> 272
0
0
<COMMON> 26
<OTHER-SE> 62,919
<TOTAL-LIABILITY-AND-EQUITY> 73,384
<SALES> 49,279
<TOTAL-REVENUES> 49,279
<CGS> 14,353
<TOTAL-COSTS> 39,317
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 55
<INCOME-PRETAX> 12,141
<INCOME-TAX> 3,730
<INCOME-CONTINUING> 8,411
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,411
<EPS-PRIMARY> 0.28<F1>
<EPS-DILUTED> 0.25
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT, PRIMARY MEANS BASIC.
</FN>
</TABLE>
