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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER : 0-23023
MMC NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0319809
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1134 E. ARQUES AVENUE
SUNNYVALE, CA 94086
(ADDRESS OF PRINCIPAL OFFICES)
(ZIP CODE)
(408) 731-1600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES [X] NO [ ]
THE NUMBER OF SHARES OUTSTANDING OF THE ISSUER'S COMMON STOCK AS OF JULY 31,
1999 WAS 31,119,511.
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MMC NETWORKS, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at June 30, 1999 and December 31, 1998 .... 3
Condensed Consolidated Statements of Operations for the three and six months
ended June 30, 1999 and 1998 ................................................. 4
Condensed Consolidated Statements of Cash Flows for the six months
months ended June 30, 1999 and 1998 .......................................... 5
Notes to the Condensed Consolidated Financial Statements ........................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations ................................................................... 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .............................................................. 19
Item 2. Changes in Securities .......................................................... 19
Item 3. Defaults Upon Senior Notes ..................................................... 19
Item 4. Submission of Matters to a Vote of Security Holders ............................ 19
Item 5. Other Information .............................................................. 20
Item 6. Exhibits and Reports on Form 8-K ............................................... 20
SIGNATURES ....................................................................................... 21
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MMC NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ....................................... $ 43,578 $ 31,452
Short-term investments .......................................... 18,530 21,726
Accounts receivable, net of allowance of $272 and $172 .......... 10,573 10,582
Inventories ..................................................... 1,486 630
Prepaid expenses and other current assets ....................... 3,064 3,372
-------- --------
Total current assets ......................................... 77,231 67,762
Property and equipment, net .......................................... 5,853 5,487
Other assets ......................................................... 234 135
-------- --------
$ 83,318 $ 73,384
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................ $ 5,494 $ 4,400
Accrued expenses ................................................ 5,194 5,753
Capital lease obligations ....................................... 130 286
-------- --------
Total current liabilities .................................... 10,818 10,439
-------- --------
Stockholders' equity:
Preferred Stock: $0.001 par value; 10,000 shares authorized; no
shares issued or outstanding ............................... -- --
Common Stock: $0.001 par value; 100,000 shares authorized; 30,925
and 30,135 shares issued and outstanding ................... 27 26
Additional paid-in capital ...................................... 57,694 55,520
Notes receivable from stockholders .............................. (107) (107)
Retained earnings ............................................... 14,886 7,506
-------- --------
Total stockholders' equity ................................... 72,500 62,945
-------- --------
$ 83,318 $ 73,384
======== ========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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MMC NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues .............................................. $ 19,323 $ 12,017 $ 35,433 $ 21,640
Cost of revenues ...................................... 5,667 3,490 10,468 6,426
-------- -------- -------- --------
Gross profit ................................ 13,656 8,527 24,965 15,214
-------- -------- -------- --------
Operating expenses:
Research and development, net .................... 5,256 3,654 9,710 6,798
Selling, general and administrative .............. 2,683 2,255 5,075 4,352
Litigation settlement ............................ -- 1,250 -- 1,250
-------- -------- -------- --------
Total operating expenses .................... 7,939 7,159 14,785 12,400
-------- -------- -------- --------
Operating income ...................................... 5,717 1,368 10,180 2,814
-------- -------- -------- --------
Other income (expense):
Interest income .................................. 701 495 1,366 1,024
Interest expense ................................. (10) (16) (21) (35)
-------- -------- -------- --------
Total other income .......................... 691 479 1,345 989
-------- -------- -------- --------
Income before income taxes ............................ 6,408 1,847 11,525 3,803
Provision for income taxes ............................ 2,305 555 4,145 1,255
-------- -------- -------- --------
Net income ............................................ $ 4,103 $ 1,292 $ 7,380 $ 2,548
======== ======== ======== ========
Basic income per share ................................ $ 0.13 $ 0.04 $ 0.24 $ 0.09
======== ======== ======== ========
Shares used to compute basic income per share ......... 30,716 29,553 30,523 29,414
======== ======== ======== ========
Diluted income per share .............................. $ 0.12 $ 0.04 $ 0.22 $ 0.08
======== ======== ======== ========
Shares used to compute diluted income per share ....... 34,587 33,794 34,043 33,756
======== ======== ======== ========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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MMC NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
------------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................................ $ 7,380 $ 2,548
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ...................................... 1,448 970
Changes in assets and liabilities:
Accounts receivable ............................................. 9 (2,010)
Inventories ..................................................... (856) (134)
Prepaid expenses and other assets ............................... 209 (483)
Accounts payable ................................................ 1,094 (178)
Accrued expenses ................................................ (559) 1,501
-------- --------
Net cash provided by operating activities ..................... 8,725 2,214
-------- --------
Cash flows from investing activities:
Sale (purchase) of short-term investments ............................. 3,196 (28,166)
Acquisition of property and equipment ................................. (1,814) (1,413)
-------- --------
Net cash provided by (used in) investing activities ........... 1,382 (29,579)
-------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options and other ..................... 2,175 794
Proceeds from the repayment of notes receivable from stockholders ..... -- 65
Principal payments on capital lease obligations ....................... (156) (197)
-------- --------
Net cash provided by financing activities ..................... 2,019 662
-------- --------
Net increase (decrease) in cash and cash equivalents ...................... 12,126 (26,703)
Cash and cash equivalents at beginning of period .......................... 31,452 45,401
-------- --------
Cash and cash equivalents at end of period ................................ $ 43,578 $ 18,698
======== ========
SUPPLEMENTAL DISCLOSURE:
Cash paid for interest ................................................ $ 21 $ 35
Cash paid for income taxes ............................................ $ 3,377 $ 1,333
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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MMC NETWORKS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements and notes to the
condensed consolidated financial statements of MMC Networks, Inc. ("MMC") are
unaudited. In the opinion of management, these statements and notes have been
prepared on the same basis as the audited consolidated financial statements and
include all adjustments, consisting only of normal recurring adjustments,
necessary for the fair presentation of the financial position, results of
operations and cash flows for MMC for the periods presented. Results for the
interim periods presented are not necessarily indicative of results for the
entire year. The words "we", "us" and "our" used in this report refer to MMC
Networks, Inc.
The accompanying condensed consolidated financial statements and notes do not
include certain information and footnote disclosures normally required under
generally accepted accounting principles. Therefore, these condensed
consolidated financial statements and notes should be read in conjunction with
the audited consolidated financial statements and notes included in our Annual
Report on Form 10-K filed with the Securities and Exchange Commission for the
year ended December 31, 1998.
NOTE 2 - EARNINGS PER SHARE
The computations of basic and diluted earnings per share for the periods
presented are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net income available to
common stockholders .................. $ 4,103 $ 1,292 $ 7,380 $ 2,548
======= ======= ======= =======
Shares used to compute basic income
per share ............................ 30,716 29,553 30,523 29,414
Effect of dilutive securities:
Warrants ............................. -- 31 2 31
Stock options ........................ 3,871 4,210 3,518 4,311
------- ------- ------- -------
Shares used to compute diluted income
per share ............................ 34,587 33,794 34,043 33,756
======= ======= ======= =======
Basic income per share .................... $ 0.13 $ 0.04 $ 0.24 $ 0.09
======= ======= ======= =======
Diluted income per share .................. $ 0.12 $ 0.04 $ 0.22 $ 0.08
======= ======= ======= =======
</TABLE>
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MMC NETWORKS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - COMPOSITION OF INVENTORIES
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
(IN THOUSANDS)
<S> <C> <C>
Inventories:
Work in process ................... $ 322 $ --
Finished goods .................... 1,164 630
------ ------
$1,486 $ 630
====== ======
</TABLE>
NOTE 4 - EQUITY
On January 15, 1999 a warrant to purchase 33,963 shares of Common Stock at an
exercise price of $1.77 was exercised. As payment for the exercise, 3,277 shares
of the 33,963 shares available for exercise under the warrant were surrendered
to MMC. On the date of the transaction, the value of the shares surrendered was
$60,000. The transaction resulted in no net proceeds to MMC.
NOTE 5 - FINANCING AGREEMENTS AND OTHER COMMITMENTS
During the first half of 1998, MMC established two credit facilities with a
bank: (1) a loan agreement and (2) a non-recourse receivables purchase
agreement. The loan agreement allows the Company to borrow up to $8.0 million.
Borrowings bear interest at the bank's prime rate. The agreement requires that
MMC comply with certain financial covenants. In the event of default, all
outstanding borrowings will accrue interest at a rate of five percentage points
above the rate effective immediately prior to a default. The loan agreement
expired in May 1999 and was renewed for one year on the same terms. The
non-recourse receivables purchase agreement expired in February 1999 and was not
renewed. To date, MMC has not utilized either credit facility.
In the second quarter of 1999, MMC entered into an agreement with a software
vendor. Under this agreement, MMC is committed to pay $2.9 million over 3 years
beginning April 1999 in exchange for the use of certain design software. As of
June 30, 1999, approximately $2.7 million remains outstanding under this
commitment.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with: (1) the interim
condensed consolidated financial statements and the notes included in Part I,
Item 1 of this Quarterly Report on Form 10-Q and (2) the consolidated financial
statements and notes contained in our Annual Report on Form 10-K for the year
ended December 31, 1998.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements which reflect our current views
with respect to future events which may impact our results of operations and
financial condition. In this report, the words "anticipates", "believes",
"expects", "intends" and similar expressions identify forward-looking
statements. These forward-looking statements are subject to risks and
uncertainties and other factors, including those described below under the
caption "Factors Affecting Future Results", which could cause our actual future
results to differ materially from historical results or from those described in
the forward-looking statements. Readers are urged not to place undue reliance on
these forward-looking statements, which reflect our outlook only as of the date
of this report.
BACKGROUND
MMC Networks, Inc. ("MMC") is a leading developer and supplier of Network
Processors, which are high-performance, open-architecture, software-programmable
processors optimized for network applications. MMC'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.
Our 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. We
believe 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 our products. All of MMC's products are based on our
proprietary ViXTM architecture, which enables network equipment vendors to
easily and cost-effectively implement high-performance, value-added features in
their switch and router products. Our customers employ MMC'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.
MMC was incorporated in California in September 1992 and reincorporated in
Delaware in October 1997. Our principal executive offices are located at 1134
East Arques Avenue, Sunnyvale, California 94086, and our telephone number is
(408) 731-1600.
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RESULTS OF OPERATIONS
The following table shows certain statement of operations data expressed as a
percentage of our revenues.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues .................................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues ............................ 29.3% 29.0% 29.6% 29.7%
------- ------- ------- -------
Gross profit ........................ 70.7% 71.0% 70.4% 70.3%
------- ------- ------- -------
Operating expenses:
Research and development, net .......... 27.2% 30.4% 27.4% 31.4%
Selling, general and administrative .... 13.9% 18.8% 14.3% 20.1%
Litigation settlement .................. 0.0% 10.4% 0.0% 5.8%
------- ------- ------- -------
Total operating expenses ............ 41.1% 59.6% 41.7% 57.3%
------- ------- ------- -------
Operating income ............................ 29.6% 11.4% 28.7% 13.0%
Interest income, net ................... 3.5% 4.0% 3.8% 4.6%
------- ------- ------- -------
Income before income taxes .................. 33.1% 15.4% 32.5% 17.6%
Provision for income taxes .................. 11.9% 4.6% 11.7% 5.8%
------- ------- ------- -------
Net income .................................. 21.2% 10.8% 20.8% 11.8%
======= ======= ======= =======
</TABLE>
REVENUES
Revenues primarily consist of sales of our Network Processors, the AF5400,
AF5500, ATMS2000 and PS1000. Revenues increased by 19.9% to $19.3 million in the
second quarter of 1999 from $16.1 million in the first quarter of 1999 and
increased by 60.8% from $12.0 million for the same quarter of the previous year.
The revenue growth from the first quarter to the second quarter of 1999 was due
to increased unit shipments across all of our products as the number and run
rate of our customer design wins in production increased from period to period.
Revenues for the six months ended June 30, 1999 increased by 63.7% to $35.4
million as compared to $21.6 million for the same period in the previous year.
This increase in revenues from period to period is primarily due to increased
sales resulting from the shift into volume production of the AF5500 product.
COST OF REVENUES; GROSS PROFIT
Cost of revenues primarily includes the cost of our Network Processors and the
costs of personnel and equipment associated with manufacturing support. The cost
of our Network Processors consists of either (1) the cost of fully assembled and
tested units which we buy and immediately resell to our customers, or (2) the
cost of purchasing finished silicon wafers and subcontracting the assembly and
test of finished units. Gross profit represents revenues less the cost of
revenues.
Cost of revenues increased to $5.7 million in the second quarter of 1999 from
$4.8 million in the first quarter of 1999 and from $3.5 million in the same
quarter of the previous year. The increase in cost of revenues compared to prior
periods reflects the increase in unit shipments from period to period. Gross
profit as a percentage of total revenues stayed relatively constant: 70.7% for
the second quarter of 1999, 70.2% for the first quarter of 1999 and 71.0% for
the first quarter of 1998.
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The cost of revenues for the six months ended June 30, 1999 was $10.5 million as
compared to $6.4 million for the same period in the previous year. Gross margins
remained relatively constant from period to period: 70.4% for the six months
ended June 30, 1999 and 70.3% for the same period in the previous year.
RESEARCH AND DEVELOPMENT EXPENSES, NET
Research and development expenses, net, consist primarily of salaries and
related expenses of employees engaged in research, design and development
activities, depreciation and amortization of computing equipment and software
design tools and subcontracted engineering. On occasion, we receive partial or
complete reimbursement for expenses incurred under certain contracts with
customers. These reimbursements are recorded as an offset against research and
development expenses. Research and development expenses, net increased by 18.0%
to $5.3 million in the second quarter of 1999 from $4.5 million in the first
quarter of 1999 and increased by 43.8% from $3.7 million for the same quarter of
the previous year. The increase in research and development expenses, net from
period to period was due to the addition of personnel, increased subcontracting
expenses and investment in design tools for the development of new products and
enhancement of existing products. Research and development expenses as a
percentage of total revenues remained relatively constant: 27.2% for the second
quarter of 1999 from 27.6% for the first quarter of 1999 and 30.4% for the
second quarter of 1998.
Research and development expenses for the six months ended June 30, 1999 were
$9.7 million or 27.4% of revenues, as compared to $6.8 million or 31.4% of
revenues for the six months ended June 30, 1998. The increase in research and
development expenses, net from period to period was due to the addition of
personnel, increased subcontracting expenses and investment in design tools for
the development of new products and enhancement of existing products. We expect
research and development expenses to continue to increase in absolute dollars
for the foreseeable future.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses consist primarily of salaries and
related expenses of employees performing sales, marketing and administrative
functions and various professional fees. Selling, general and administrative
expenses increased by 12.2% to $2.7 million in the second quarter of 1999 from
$2.4 million in the first quarter of 1999 and increased by 19.0% from $2.3
million for the same quarter of the previous year. The increase in selling,
general and administrative expenses was due to additional personnel hired to
support new customer design wins and the increased level of activity across all
MMC functions. Selling, general and administrative expenses decreased as a
percentage of revenues to 13.9% in the second quarter of 1999 compared to 14.9%
in the first quarter of 1999 and 18.8% in the same quarter of the previous year
as revenue growth surpassed the increase in selling, general and administrative
expenses.
Selling, general and administrative expenses for the six months ended June 30,
1999 were $5.1 million or 14.3% of revenues as compared to $4.4 million or 20.1%
of revenues for the six months ended June 30, 1998. Selling, general and
administrative expenses decreased as a percentage of revenue from period to
period as revenue growth outpaced the increase in selling, general and
administrative expenses required to support that growth. We expect selling,
general and administrative expenses to increase in absolute dollars for the
foreseeable future.
INTEREST INCOME, NET
Interest income, net reflects interest earned on average cash, cash equivalents
and short-term investment balances, less interest expense on our capital lease
obligations. Interest income, net increased for the three and six months ended
June 30, 1999 as compared to the same periods of the previous year due to
increased cash balances available to invest resulting primarily from the cash
flow from operations.
PROVISION FOR INCOME TAXES
The provision for income taxes increased to $2.3 million in the second quarter
of 1999 from $1.8 million in the first quarter of 1999 due to the increase in
pre-tax income from period to period. The effective tax rate for the second and
first quarter of 1999 was 36.0%. We expect the effective tax rate to stay at
this rate for the remainder of 1999.
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LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1999, our cash, cash equivalents and short-term investments
totaled $62.1 million, and our working capital was $66.4 million. Cash and cash
equivalents totaled $43.6 million at June 30, 1999, up $12.1 million from $31.5
million at December 31, 1998. Operating activities for the six months ended June
30, 1999 accounted for the majority of the net increase in cash and cash
equivalents for the period. Net cash provided by operating activities of $8.7
million consisted primarily of net income of $7.4 million adjusted for
depreciation and amortization of $1.4 million.
Investing activities provided $1.4 million of cash flows for the six months
ended June 30, 1999. This amount consisted of the net sale of short-term
investments of $3.2 million offset by the purchase of capital equipment of $1.8
million. Financing activities contributed $2.0 million in cash flows primarily
from the proceeds from the exercise of stock options of $2.2 million.
During the first half of 1998, MMC established two credit facilities with a
bank: (1) a loan agreement and (2) a non-recourse receivables purchase
agreement. The loan agreement allows the Company to borrow up to $8.0 million.
Borrowings bear interest at the bank's prime rate. The agreement requires that
MMC comply with certain financial covenants. In the event of default, all
outstanding borrowings will accrue interest at a rate of five percentage points
above the rate effective immediately prior to a default. The loan agreement
expired in May 1999 and was renewed for one year on the same terms. The
non-recourse receivables purchase agreement expired in February 1999 and was not
renewed. To date, MMC has not utilized either credit facility.
We believe that our existing cash, cash equivalents and investment balances,
together with the borrowing capacity under our loan agreement and the cash flow
we expect to generate from future operations, will be sufficient to meet our
capital needs through the next twelve months. However, our future capital
requirements may vary materially from those now planned. We may decide to raise
additional funds in future periods. The amount of capital that we will need in
the future will depend on many factors, including:
- our future revenues
- the timing and extent of spending to support product development
efforts and the expansion of sales and marketing efforts
- the timing and size of any business or technology acquisitions
- the timing of introductions of new products and enhancements to
existing products
- the market acceptance of our products
If we need to raise additional funds, we may not be able to obtain additional
equity or debt financing on favorable 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.
YEAR 2000 PLAN
We have largely completed our business risk assessment of the impact that the
Year 2000 Issue may have on our operations. As business conditions warrant, we
may revise our assessment as new information is made available to us. To date,
we have identified and continue to assess four key areas of our business that
the Year 2000 Issue may affect. These four areas are our products, internal
information systems, third party suppliers and non-information technology
systems. MMC's Year 2000 plan aims at identifying and
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addressing Year 2000 issues based on a four phase approach applied to each of
the key areas mentioned above, as applicable.
Phase 1: Identify potential business disruption problems, including those
with products and systems, as well as potential disruption from suppliers
and other third parties.
Phase 2: Prioritize potential problems and allocate resources at the
appropriate level to implement specific programs aimed at solving or
mitigating any potential Year 2000 Issues identified.
Phase 3: Test systems considered to be Year 2000 ready, if applicable.
Phase 4: Develop contingency plans to address those Year 2000 issues that
may pose a significant risk to our on-going operations, if applicable.
MMC PRODUCTS
We have completed testing our products, including semiconductors, software, and
reference design systems, and we believe them to be Year 2000 compliant.
However, it is possible that errors which we are not aware of at this time will
be discovered in the future. In addition, we cannot determine whether all of our
customers' products into which our products are incorporated will be Year 2000
compliant because we have little or no control over the design, production and
testing of our customers' products.
INTERNAL INFORMATION SYSTEMS
We believe that we have identified substantially all of the major systems,
software applications and related equipment used in connection with our internal
operations and have largely completed the implementation of specific programs
addressing the most critical areas. We are testing our systems for Year 2000
compliance, and we expect to complete this testing in October 1999. Although we
do not anticipate any significant issues to be identified during this testing,
the failure of any of our critical internal information systems to achieve Year
2000 readiness could cause a significant disruption in our operations. We are
currently developing contingency plans to address issues that may pose a
significant risk to our on-going operations. These plans could include temporary
use of back-up software or systems or implementation of manual procedures to
compensate for system deficiencies. We expect to complete these contingency
plans by October 1999.
THIRD PARTY SUPPLIERS
We rely directly and indirectly on external systems utilized by our third party
suppliers for the fabrication, assembly and testing of substantially all of our
products. In addition to our foundries and third party subcontractors, we rely
on systems utilized by other critical third party service providers such as
banks. We have identified critical third party service providers and surveyed
these suppliers regarding their Year 2000 preparedness. We expect to complete
our assessment of the survey and issues by October 1999. Based on our initial
assessment this far, we do not expect to uncover any significant Year 2000
issues. However, we view the risks associated with third party suppliers to be
higher than other risks we face because we have little or no control over the
ability of our third party suppliers to adequately resolve potential Year 2000
issues on a timely basis and adequately test the compliance of their systems. We
are currently developing contingency plans to address critical third party
suppliers to the extent possible. These plans could include the use of back-up
suppliers, buffer inventories for certain products or the implementation of
manual procedures to compensate for system deficiencies. We expect to complete
these plans by October 1999.
NON-INFORMATION TECHNOLOGY SYSTEMS
Non-information technology systems such as heating, security, test equipment and
electricity at our facilities may also be affected by Year 2000 issues. We have
identified and assessed the risks associated with our non-information technology
systems and are in process of making all significant systems Year 2000
compliant. We expect to complete this process as well as related contingency
plans such as temporary use of back-up equipment by October 1999.
12
<PAGE> 13
We presently estimate that the cost of addressing our Year 2000 issues will not
exceed $50,000, excluding expenses related to our own internal information
technology staff. This estimate was derived using numerous assumptions,
including the assumption that we have already identified our most significant
Year 2000 issues and that the plans of our third party suppliers will be
fulfilled in a timely manner without cost to us. However, these assumptions may
not be accurate. Actual results could differ significantly from those
anticipated after completion of all phases of our Year 2000 Plan. In addition,
contingency plans we implement may not succeed or may not be adequate to meet
our needs without significantly impacting our operations. Also, delays and
inefficiencies inherent in conducting operations in an alternative manner could
negatively impact our results of operations.
13
<PAGE> 14
FACTORS AFFECTING FUTURE RESULTS
Past financial performance should not be considered a reliable indicator of
future performance. We operate in a rapidly changing environment that involves a
number of risks and uncertainties, many of which are beyond our control. The
risks and uncertainties described below, in addition to those described
elsewhere in this report and in our Annual Report on Form 10-K for the year
ended December 31, 1998 are not the only ones facing our company. Any of the
following risks could significantly impact our business, financial condition or
results of operations.
FLUCTUATIONS IN OPERATING RESULTS
Our quarterly revenues and expenses have fluctuated significantly in the past
and may continue to fluctuate significantly in the future. These fluctuations
may be due to a variety of factors, many of which are outside of our control.
Factors that could affect our future operating results include:
- the loss of major customers
- changes in demand for the network equipment products of our customers
- variations, delays or cancellations of orders and/or shipments of our
products
- reduction in the selling prices of our products
- changes in the mix of products being sold
- fluctuations in our manufacturing yields and other potential problems
or delays in the fabrication, assembly, testing or delivery of our
products
- our failure to manufacture and ship products on time
- increases in the costs of products from our suppliers
- availability of semiconductor foundry capacity
- fluctuations in product life cycles
- delays in introducing new products
- introduction of new products by our competitors
- variances in the timing and amount of non-recurring engineering
funding and operating expenses
- intellectual property disputes
A large portion of our operating expenses including salaries, rent and capital
lease expenses is fixed and difficult to reduce or change on short notice.
Accordingly, if our total revenues does not meet our expectations, we may not be
able to adjust our expenses quickly enough to compensate for the shortfall in
revenues. This situation could have a negative effect on our business, financial
condition and results of operations.
CUSTOMER CONCENTRATION
Significant customers are those customers accounting for more than 10% of our
total revenues. The following table lists significant customers for the periods
presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Cisco Systems, Inc ("Cisco") ............................... 51% 54% 52% 43%
International Business Machines Corporation ("IBM") ........ 23% * 21% *
Mitsui Comtek Corp, a non-stocking sales representative
for Japan ("Mitsui") .................................. * * * 17%
</TABLE>
* less than 10%
14
<PAGE> 15
A relatively small number of major network equipment vendors dominate the
network equipment market. Accordingly, a small number of customers has accounted
for a significant portion of our revenues to date. We expect this trend will
continue for the foreseeable future.
Our future operating results will continue to depend on the success of our
largest customers and on our ability to sell existing and new products to these
customers on a timely basis and in sufficient quantities. We may not be able to
maintain or increase sales to certain of our key customers and/or attract new
significant customers for a variety of factors. These factors include:
- our network equipment vendor customers can stop incorporating our
products into their own products with limited notice to us and suffer
little or no penalty
- our agreements with our customers typically do not require them to
purchase a minimum amount of our products
- many of our customers have pre-existing relationships with our current
or potential competitors that may cause them to switch from our
products to competing products
- we may lose one or more of our significant customers (in particular
Cisco)
- our significant customers may not incorporate our Network Processors
in future product designs
- design wins with customers may not result in significant production
levels
- the introduction of our customers' products may not be successful
- we may not be able to successfully develop relationships with
additional significant network equipment vendors
- our relationship with some of our larger customers may deter other
potential customers who compete with these customers from buying our
products
Any one of the factors above could have a material adverse effect on our
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. The technical innovations required for MMC to remain competitive must
be completed before developments in networking technologies or standards make
them obsolete. These innovations must also be compelling enough to make network
equipment vendors want to use them over other technologies. Accordingly, our
future performance depends on a number of factors, including our ability to:
- properly identify target markets
- identify emerging technological trends in our target markets
- develop and maintain competitive products
- enhance our products by adding innovative features that differentiate
MMC products from competitor products
- bring products to market on a timely basis at competitive prices
- respond effectively to new technological changes or new product
announcements by others
It is possible that our design and introduction schedules for future products
and additions and enhancements to our existing products will not be met. It is
possible that these products will not achieve market acceptance or that we will
not be able to sell these products at prices that are favorable to us. We must
design new products and sometimes redesign existing products to be manufactured
on newer wafer process technologies that provide smaller circuit dimensions. It
is possible that either (1) the suppliers of these new manufacturing
technologies will not deliver them to us or our vendors on schedule or (2) we
will not be able to complete our designs on the new processes on schedule. Our
success will also depend on the ability of our customers to develop new products
and enhance existing products within our market segment and to successfully
introduce and promote those products.
15
<PAGE> 16
To keep pace with the rapid technological changes, we must incur substantial
research and development costs before we can determine the likelihood that the
technology for a product is sound and that our network equipment vendors will
accept the product. It is possible that revenues from future products or product
enhancements will not be sufficient to recover the development costs associated
with those products or enhancements. It is possible that we may not be able to
obtain additional financing necessary to fund future development efforts. Our
failure to adequately address any of the factors above could have a negative
impact on our business, financial condition and results of operations.
DEPENDENCE ON INDEPENDENT MANUFACTURERS
We depend on independent foundries to manufacture all of our products. We
purchase both (1) fully assembled and tested products which we can immediately
resell to our customers and (2) finished silicon wafers which we then consign to
third party subcontractors who perform assembly and test functions. Because we
rely on independent foundries and third party subcontractors, we face several
significant risks including:
- a lack of committed manufacturing, assembly or test capacity
- limited control over delivery schedules, quality assurance and
control, manufacturing yields and production costs
- the unavailability of, or potential delays in, obtaining access to key
process technologies
Although we work closely with our suppliers to minimize the likelihood of
reduced manufacturing yields, in the past our suppliers have occasionally
experienced lower than anticipated manufacturing yields. This often occurs
during the production of new products or the installation and start-up of new
wafer process technologies which provide for smaller circuit dimensions.
We do not have long-term volume purchase agreements or a guaranteed level of
production capacity with any of our suppliers. We depend on our suppliers to
deliver sufficient quantities of finished product to us in a timely manner.
Since we place our orders on a purchase order basis, these suppliers can
allocate, and in the past have allocated, capacity to the production of other
companies' products while reducing deliveries to us on short notice. Only one of
our products is currently manufactured by more than one supplier.
In order to meet our customer demand, currently we must place most orders
approximately 10 to 12 weeks in advance of expected delivery. Some orders
require up to 18 weeks. If capacity becomes less available in the future, we may
be required to place orders earlier than 10 to 18 weeks in advance of expected
delivery, making it more difficult to meet customer demand. Any sudden increase
in customer demand that we did not anticipate in advance could result in our
inability to deliver product on a timely basis. This inability to deliver
product may reduce our product revenues or increase our cost of revenues and
negatively impact our business, financial condition and results of operations.
In addition, we must place orders based on forecast demand to ensure enough lead
time to be able to meet anticipated customer orders. Any sudden decrease in
customer demand could result in excess inventory which could reduce our profit
margins and have a negative effect on our business, financial condition and
results of operations.
COMPETITION
The data networking and semiconductor industries are intensely competitive. This
competition results in constant evolution to better and more complex
technologies and shorter life cycles for our products. In addition, competition
continues to drive down the average selling price of our products. Currently,
our main competition is from ASIC solutions that our customers develop
internally. In the future we expect competition to significantly increase. Some
companies such as Galileo Technology Ltd, Intel Corporation and PMC Sierra, Inc.
have announced new Network Processor products that will directly compete with
our products. In addition to these well established companies, several start-up
companies such as Agere, Inc., C-Port and SiTera have also announced Network
Processors that will compete with our products. Other major semiconductor
suppliers such as Broadcom Corporation and Texas Instruments have expressed an
intent to
16
<PAGE> 17
enter the Network Processor market. We also face competition from suppliers of
products based on new or emerging technologies. Many of our existing and
potential customers also internally develop integrated circuits which attempt to
perform all or a portion of the functions performed by our products. Many of our
current and prospective competitors offer broader product lines and have
significantly greater financial, technical, manufacturing and marketing
resources than we do. To the extent we fail to overcome these challenges, there
would be a negative effect on our business and operating results.
PROTECTION OF INTELLECTUAL PROPERTY
We rely on nondisclosure agreements and other contractual provisions as well as
patent, trademark, trade secret and copyright law to protect our proprietary
rights. We can not be sure that any patents will be issued from our current or
future patent applications. It is possible that patents issued from such
applications may be invalidated, circumvented, challenged or licensed to others.
In addition, we can not be sure that the rights granted under any patents we
receive will provide us with competitive advantages or be adequate to safeguard
and maintain our proprietary rights. Any failure to enforce and protect our
intellectual property rights could have a negative effect on our business,
financial condition and results of operations.
From time to time, third parties, including our competitors, may assert patent,
copyright and other intellectual property rights to technologies that are
important to us. In the future third parties may assert infringement claims
against us, and these assertions may result in costly litigation. We may not
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.
RISKS ASSOCIATED WITH EXPANSION OF INTERNATIONAL BUSINESS ACTIVITIES
Substantially all of our 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. We also ship products to our domestic customers'
international manufacturing divisions and subcontractors. We currently obtain
substantially all of our manufacturing, assembly and testing services from
suppliers located outside of the United States. In 1998 we established a wholly
owned subsidiary in Israel which functions as a design center. In the future, we
intend to expand these international business activities. International
operations are subject to many inherent risks, including:
- political, social and economic instability
- trade restrictions
- changes in tariffs
- the imposition of governmental controls
- import and export license requirements and restrictions
- restrictions on the export of critical technology
- burdens of complying with a variety of foreign laws
- difficulties in staffing and managing international operations
- currency exchange fluctuations
In particular, certain Asian countries have recently experienced significant
economic difficulties. These difficulties include currency devaluation and
instability, business failures and a generally depressed business climate. As a
percentage of total revenues, sales to Mitsui have declined to less than 10% for
the six months ended June 30, 1999 as compared to 17% for the six months ended
June 30, 1998. Sales to Mitsui may remain at this lower level or decline further
due to the economic downturn in Japan and Asia and could have an adverse effect
on our revenues in the future.
General economic or industry-specific conditions in our primary overseas markets
may negatively impact the demand for our products abroad. All of our
international sales to date have been denominated in U.S. dollars. Accordingly,
an increase in the value of the U.S. dollar relative to foreign currencies could
make our products less competitive in international markets. Any one or more of
the factors mentioned above could have a negative effect on our business,
financial condition and results of operations or require us to modify our
current business practices significantly. These factors are anticipated to
impact our business to a
17
<PAGE> 18
greater degree in the event that we expand our international business
activities.
RISKS RELATED TO ACQUISITIONS
The data networking and semiconductor industries are intensely competitive and
MMC's growth is dependent our ability to introduce new products and enhancements
to existing products on a timely basis. It is possible that one way we may
expand our business is through the acquisition of businesses, products or
technologies that complement our existing products, expand our market coverage
or enhance our technological capabilities. Acquisitions involve numerous risks,
including:
- the risk of diverting management's attention from normal daily
operations of the business
- difficulties in integration of the operations, technologies, products
and information systems of the acquired company
- potential difficulties in completing projects associated with
purchased in-process research and development projects
- risks of entering markets in which MMC has limited or no direct prior
experience and where competitors have stronger market positions
- the potential loss of key employees of the acquired company
In addition to the risks above, acquisitions may negatively affect our results
of operations because they may require large one-time write-offs, increased debt
and contingent liabilities, substantial depreciation or deferred compensation
charges or the amortization of expenses related to goodwill and other intangible
assets. We may seek to account for acquisitions under the pooling of interest
method, but that method may not be available. It is possible that any of these
events could cause the price of our stock to decline. In the future we may not
be able to find suitable acquisition opportunities. Even if we do find such
opportunities, it is possible that the acquisitions may be unsuccessful.
Unsuccessful acquisitions could have a negative effect on our 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. Our stock price has fluctuated
substantially in the past and is likely to continue to be highly volatile and
subject to wide fluctuations in the future in response to various factors, many
of which we can not control. These factors include:
- quarterly variations in operating results
- announcements of technological innovations or new products by our
competitors, our customers or ourselves
- the gain or loss of significant network equipment vendor customers
- changes in earnings estimates or investment recommendations of
analysts
- the presence or absence of short-selling of our stock
- changes in investor perceptions
- changes in expectations relating to our products, plans and strategic
position or those of our competitors or customers
In addition, market prices of technology stocks have been especially volatile.
This volatility has significantly affected the market prices of securities of
many technology companies for reasons frequently unrelated to the operating
performance of the specific companies. Accordingly, investors may not be able to
resell shares of our Common Stock at or above the price originally paid for the
stock. In the past, companies that have experienced volatility in the market
price of their securities have been the subject of securities class action
litigation. If we were the object of securities class action litigation, it
could result in substantial losses and divert management's attention and
resources from other matters.
18
<PAGE> 19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable.
ITEM 2. CHANGES IN SECURITIES
USE OF PROCEEDS FROM THE SALE OF REGISTERED SECURITIES
The effective date of our first registration statement (the "Registration
Statement") was October 29, 1997. We filed the Registration Statement on Form
S-1 under the Securities Act of 1933, No. 333-34005. The class of securities
registered was Common Stock. The offering commenced on October 29, 1997 and all
securities were sold in the offering.
MMC registered a total of 4,025,000 shares under the Registration Statement. MMC
sold all the shares for its own account, for an aggregate offering price of
$44.3 million. We incurred expenses of approximately $4.2 million for the
offering, of which $3.1 million represented underwriting discounts and
commissions and $1.1 million represented other expenses. All these expenses were
direct or indirect payments to others. The net offering proceeds to MMC after
total expenses were approximately $40.1 million. As of June 30, 1999, MMC had
used the net proceeds from the offering as follows:
<TABLE>
<CAPTION>
Amount Purpose/Use
------ -----------
<S> <C>
$ 5.3 million purchase and installation of capital equipment and purchased software
$ 0.5 million plants, buildings and facilities
$ 0.5 million repayment of indebtedness and lease obligations
$18.5 million temporary investments
$15.3 million working capital
</TABLE>
MMC did not pay any of the proceeds directly or indirectly to any director or
officer of MMC or to their associates, or to any person owning ten percent or
more of any class of equity securities of MMC or to any affiliate of MMC. The
actual use of the proceeds from the offering does not represent a material
change in the use of proceeds as described in the prospectus contained in the
Registration Statement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Stockholders held on May 18, 1999, the stockholders
voted to (1) elect two Class II directors to serve for three-year terms and (2)
ratify the appointment of PricewaterhouseCoopers LLP as the independent
accountants of MMC for the fiscal year ending December 31, 1999.
(1) The Class II directors were elected with the following vote:
<TABLE>
<CAPTION>
Nominee For Withheld
- ------------------- ---------- --------
<S> <C> <C>
Andrew S. Rappaport 25,098,503 15,950
Amos Wilnai 25,099,805 14,648
</TABLE>
(2) The appointment of PricewaterhouseCoopers, LLP as the independent
accountants for the fiscal year ended December 31, 1999 was ratified with the
following vote: For Against Abstentions
25,095,937 12,800 5,716
19
<PAGE> 20
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
----------- ----------------------
<S> <C>
27.1 Financial Data Schedule as of June 30, 1999 and
for the 6 months then ended.
</TABLE>
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the three months
ended June 30, 1999.
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements 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: August 13, 1999 MMC NETWORKS, INC.
By: /s/ Douglas C. Spreng
--------------------------------------
Douglas C. Spreng
President, Chief Executive Officer and
Director (Principal Executive Officer)
By: /s/ Uday Bellary
--------------------------------------
Uday Bellary
Vice President, Finance,
Chief Financial Officer and
Assistant Secretary
(Principal Financial and
Accounting Officer)
21
<PAGE> 22
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
----------- ----------------------
<S> <C>
27.1 Financial Data Schedule as of June 30, 1999 and
for the 6 months then ended.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 43,578
<SECURITIES> 18,530
<RECEIVABLES> 10,845
<ALLOWANCES> 272
<INVENTORY> 1,486
<CURRENT-ASSETS> 77,231
<PP&E> 11,215
<DEPRECIATION> 5,362
<TOTAL-ASSETS> 83,318
<CURRENT-LIABILITIES> 10,818
<BONDS> 130
0
0
<COMMON> 27
<OTHER-SE> 72,473
<TOTAL-LIABILITY-AND-EQUITY> 83,318
<SALES> 35,433
<TOTAL-REVENUES> 35,433
<CGS> 10,468
<TOTAL-COSTS> 25,253
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 50
<INTEREST-EXPENSE> 21
<INCOME-PRETAX> 11,525
<INCOME-TAX> 4,145
<INCOME-CONTINUING> 7,380
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,380
<EPS-BASIC> 0.24
<EPS-DILUTED> 0.22
</TABLE>
