<PAGE>
SECURITIES AND EXCHANGE COMMISSION WASHINGTON DC 20549
FORM 10-K
(Mark One)
|X| Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended September 30, 1998
|_| Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File No. 0-19856
XIRCOM, INC.
2300 Corporate Center Drive
Thousand Oaks, California 91320
Telephone: (805) 376-9300
CALIFORNIA (State of Incorporation)
95-4221884 (IRS Employer Identification No.)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of Class: Common Stock, $.001 Par Value
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. |_|
Based on the closing sale price of the Common Stock on the Nasdaq Stock Market
on November 13, 1998, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was approximately $773,143,562. 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.
The number of shares outstanding of Registrant's Common Stock, $.001 par value,
was 23,607,437 as of November 13, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the Registrant's Proxy
Statement for its Annual Meeting of Shareholders to be held on January 22, 1999.
1 XIRCOM, INC.
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Part 1
ITEM 1. BUSINESS
This Annual Report contains trend analysis and other forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Actual results
could differ materially from those projected in the trend analysis and other
forward-looking statements contained herein, as a result of the risk factors set
forth elsewhere in this report.
Xircom, Inc. ("Xircom" or the "Company") develops, manufactures, sells and
supports a comprehensive set of communications solutions for mobile and remote
portable computer ("PC") users. These products represent a market category
recognized as mobile networking. Xircom's principal products enable users to
connect mobile and remote notebook computers to corporate networks, the Internet
and other online services from a wide variety of locations. The Company is
focused on one industry segment: the design, development, manufacture, marketing
and support of mobile communications products for notebook PCs. Xircom products
are recognized for innovative technology, high reliability and broad
compatibility.
Xircom was founded in 1988 and pioneered the use of the universal PC parallel
port to connect notebook PCs to local area networks ("LANs"). Xircom's Pocket
LAN Adapter/TM/ product established the mobile networking market and by 1992 had
become the leading solution for notebook PC-to-LAN connectivity. In 1992, Xircom
became the first company in the industry to ship a LAN adapter compliant with
the standards set by the Personal Computer Memory Card International Association
("PCMCIA" or "PC Card"). In 1994 and 1995 Xircom expanded its offerings to
include multi-function LAN+Modem and modem-only PC Cards.
In 1998, Xircom introduced its family of RealPort Integrated PC Cards featuring
built-in connectors. The patented RealPort Integrated PC Card's built-in
connector system eliminates external cables and solves the number one problem
faced by mobile users of PC Cards--broken, lost or forgotten cables and broken
pop-out jacks.
Market Background
Growth in Client/Server Computing. Local area networks offer greater
productivity and lower systems costs by enabling workgroups and geographically
dispersed organizations to share information, applications and resources such as
printers, file servers and communication devices. LANs have enabled the
widespread use of personal computers and servers in a client/server network
configuration, and wide area networking has created "enterprise networks" of
broadly interconnected LANs offering client PCs access to LANs from almost any
location.
Trends Toward Smaller, Mobile Computers. Simultaneous with the growth in LANs,
continuing technological advances have been made in portable PCs, often referred
to as laptop or notebook computers. An increasingly mobile workforce requiring a
higher level of productivity is driving the growing use of notebook PCs. Today's
mobile professionals travel constantly among a variety of locations including
office, home, airport, automobile, hotel, branch office or customer sites.
Gartner Group, an IT consulting firm, estimates that as many as 55 million
users, including salespeople, consultants, traveling executives, telecommuters,
field personnel and "day extenders," who work at home in the evening or on
weekends, will work outside the boundaries of the enterprise network by the year
2000. Within a few years, more than 75 percent of so-called "knowledge workers"
will be location-independent, according to Gartner. Their requirements demand
the flexibility and convenience that only mobile computing can deliver. In
addition, an increasing number of workers are now utilizing notebook computers
as their primary PCs and more business applications are being developed
specifically for notebook PCs.
As a result, the notebook PC has become the preferred computing platform and is
now an integral part of corporate cultures throughout the world. International
Data Corporation ("IDC") estimates that 15 million
2 XIRCOM, INC.
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notebook PCs will be shipped worldwide this year alone. IDC also estimates that
by the year 2000, the number of PC Cards shipped worldwide is expected to reach
over 24 million. Like cellular telephones, pagers, and other handheld electronic
devices, the notebook PC has become a strategic business tool for mobile
workers.
Remote Access. Over the last several years, there has been a significant
increase in the number of PC users accessing a corporate network, the Internet
or an online service from a "remote" location. To do so requires a modem on the
client PC and a modem "on the LAN" that serves as a communication gateway to the
network (often referred to as a remote access server or communications server).
The modem market has grown substantially over the last several years and today
nearly all notebook PCs are equipped with a modem.
Products
The Company's products include Integrated PC Card, PC Card and CardBus products
with Ethernet and Token Ring LAN, modem, and combination LAN and modem
functionality.
PC Card LAN Adapter
Xircom offers the industry's broadest family of PC Card LAN adapters that
operate on Ethernet and Token Ring topologies and are compatible with all widely
used wiring. Xircom LAN adapters incorporate pre-configured software drivers
that support over 50 different network operating systems and communication
protocols. Most Xircom adapters include DOS-, Windows-, Windows 95- and Windows
98-based menu-driven software for simple, fast installation.
Xircom shipped the industry's first external parallel port LAN adapter, the
Pocket Ethernet Adapter/TM/, in May 1989, and is currently shipping its
third-generation product. Xircom also shipped the first commercially available
parallel port adapter for Token Ring networks, the Xircom Pocket Token Ring
Adapter/TM/, in December 1989. BYTE magazine's 20th anniversary issue named
Xircom's original Pocket LAN Adapter as one of the Most Important Networking
Products of all time. Net sales from Pocket LAN Adapter products have declined
to 1% of Xircom's total net sales in fiscal 1998, compared to 4% in 1997. The
percentage of net sales is expected to continue to decline in 1999 as the
Integrated PC Card and PC Card become the preferred form factors for connecting
peripheral devices to notebook PCs.
During 1991, the PCMCIA made possible the development of PC Cards by defining
certain dimensional interface standards for use by a variety of PC peripherals,
including memory cards, fax/modems, LAN adapters and disk drives. The PC Card
interface, or slot, is now incorporated into nearly all notebook computers,
allowing the PC Card peripheral device, which is the size of a thick credit
card, to be inserted. Xircom was first to ship an Ethernet LAN adapter card
compliant with the PCMCIA standard in late 1992. Other first customer shipment
dates of key LAN adapter products are as follows.
<TABLE>
<S> <C>
CreditCard Ethernet Adapter/TM/ February 1993
CreditCard Token Ring Adapter/TM/ December 1993
CreditCard Ethernet Adapter 10/100/TM/ June 1996
CardBus Ethernet Adapter 10/100/TM/ 32-bit October 1996
CreditCard Ethernet Adapter 10/100 (Second-generation) November 1996
RealPort/TM/ Ethernet 10/100-- August 1998
Features a built-in Ethernet connector for cable-free Ethernet connections
RealPort/TM/ CardBuS Ethernet 10/100 August 1998
</TABLE>
Net sales from PC Card LAN adapters were 30% of total net sales in fiscal 1998
compared to 42% in fiscal 1997.
3 XIRCOM, INC.
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PC Card Modem
Xircom commenced shipment of the Company's first modem-only PC Card in September
1995. The original CreditCard Modem 28.8/TM/ adapter incorporated the latest
V.34 standard and broadened Xircom's remote access solutions by adding a
modem-only option for notebook PC users who require high-speed remote access to
corporate networks, commercial online service, or the Internet. Other first
customer shipment dates of key modem-only adapters are as follows.
<TABLE>
<S> <C>
CreditCard Modem 33.6/TM/ adapter-- October 1996
Features the V.34-1996 standard
GlobalACCESS/TM/ CreditCard Modem 56/TM/ adapter-- July 1997
Allows users to connect in over 160 countries
CreditCard GSM/TM/PC Card-- September 1997
Provides wireless data, fax and Short Message Service (SMS) communications
over GSM cellular phones
RealPort Modem 56-GlobalACCESS/TM/-- August 1998
Features built-in modem and telephone pass-through connectors for
cable-free modem connections
RealPort Modem 56/TM/ October 1998
RealPort CardBus Modem 56-GlobalACCESS/TM/ October 1998
</TABLE>
Net sales from PC Card Modem products were 21% of total net sales in fiscal 1998
compared to 11% in fiscal 1997.
Multifunction PC Card LAN Adapter+Modem
In February 1994, the Company began shipping the first PC Card offering both a
LAN adapter and a modem in a single PCMCIA card (a "Combo card"). The CreditCard
Ethernet+Modem/TM/ adapter quickly achieved market acceptance and received a
number of industry awards for technical excellence, including PC Magazine's
"1994 Technical Excellence Award" in the Networking Hardware category. The
Company commenced shipments of the second-generation CreditCard Ethernet+Modem
II/TM/ adapter in September 1994 and in July 1995 was the first to ship in
volume a combination PC Card product incorporating a V.34 modem with a LAN
adapter. Other more recent first customer shipment dates of key Combo card
products are as follows.
<TABLE>
<S> <C>
GlobalACCESS/TM/ CreditCard Ethernet 10/100+Modem 33.6/TM/ adapter-- January 1997
Allows users to connect in over 160 countries
CreditCard Ethernet 10/100+Modem 56/TM/adapter-- July 1997
Incorporates a 56Kbps modem and 10/100Mbps Ethernet adapter
in a single PC Card
RealPort Ethernet 10/100+Modem 56/TM/-- May 1998
Features built-in modem, Ethernet and telephone pass-through connectors
for cable-free Ethernet and modem connections
RealPort CardBus Ethernet 10/100+Modem 56/TM/ August 1998
</TABLE>
Net sales from Combo card products were 48% of total net sales in fiscal 1998
compared to 43% in fiscal 1997.
Xircom expects customers for its PC Card products to continue to demand higher
speeds and bandwidth. The Company is focusing its development efforts on new
versions of its Integrated PC Card and PC Card LAN adapters (both 16-bit PC Card
and 32-bit CardBus buses), modem-only cards, and multifunction cards that
combine LAN, modem and ISDN technologies for use with high-bandwidth
applications.
4 XIRCOM, INC.
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Form Factor Evolution
Xircom integrates the latest global communications technologies into more
reliable and convenient form factors. The Company's first product, the Pocket
Ethernet Adapter, made it possible for notebook PC users to access their
corporate networks. As the mobile computing revolution began to take hold,
smaller, less cumbersome internal adapters, rather than external solutions were
needed. Xircom migrated its products to the PC Card form factor, an internal
adapter that requires custom cable connectors. Today, PC Card users cite cables
as their number one problem, as they are prone to breakage or loss when moving
from place to place. Xircom solved this problem for mobile users with the
patented RealPort Integrated PC Card. It allows users to plug standard RJ-45
Ethernet and RJ-11 telephone cords directly into the Integrated PC Card's
built-in connectors, eliminating the need for proprietary cables.
<TABLE>
<S> <C> <C>
- -------------------------------- ------------------------------------------- ----------------------------------
1990 1994 1998
- -------------------------------- ------------------------------------------- ----------------------------------
Pocket Adapter PC Card Integrated PC Card
(Fully External) (Internal Card, External Cable Connectors) (Fully Internal)
- -------------------------------- ------------------------------------------- ----------------------------------
</TABLE>
Industry Leadership
Xircom is a worldwide leader in simplifying the installation and configuration
of PC Card connectivity products by incorporating certain proprietary software
coding in its installation routines. The Company has developed an intelligent
Windows-based installation utility now shipping with most Xircom adapters.
Although the Windows 95 operating system improved the installation process for
PC Card adapters and other peripherals, add-on hardware often requires driver
updates to enhance features or performance. Therefore, installation utilities
and related driver software remain an important feature of the products.
The Company ships its products worldwide and has developed expertise in
obtaining worldwide homologation including local telephone approvals in over 25
countries including: France, Germany, UK, Japan, Australia, Holland, Denmark,
Belgium and Austria. Xircom has developed a modem design, which is a single,
worldwide solution and has a programmable Data Access Arrangement ("DAA").
Xircom GlobalACCESS/TM/ modem products offer notebook users one card for
worldwide use. Unique features include local approvals in the major business
centers around the world and CountrySelect/TM/ software, which automatically
configures the modem DAA to local dialing conventions when traveling from
country to country.
Device driver software is also a key component of the Company's products. Device
drivers allow the hardware and firmware (the software code which provides
operating instructions to the hardware) to interact with the communications port
on the PC in which the LAN adapter or modem is being installed (e.g., the
parallel port, PCMCIA, or CardBus slot). While the Company's leading products
are designed to operate with the major operating systems, including Microsoft
Windows 98, Windows 95, Windows NT and Windows 3.1, the Company has also
developed Driver Development Kits that include a library of software interfaces
and source code examples to substantially reduce the time required for other
network operating system vendors to develop drivers for Xircom products. The
Company believes that its family of products incorporates software drivers for a
broader range of computers and network operating systems than any other family
of external LAN adapters commercially available.
Some of the Company's technical advancements and accomplishments since 1989
include:
. Pioneered the use of the PC parallel port for LAN connectivity;
. Participated with Zenith Data Systems and Intel Corp. in the development of
Enhanced Parallel Port ("EPP") technology;
. Was first to ship an Ethernet PC Card LAN adapter;
. Was first to ship a parallel port modem, which offers higher throughput
than a serial port modem;
5 XIRCOM, INC.
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. Was first to ship a PC Card combining a LAN adapter and a modem;
. Was first to incorporate full-duplex Ethernet technology in its PC Card LAN
adapters, which offers up to twice the data throughput on an Ethernet
network;
. Developed the first wireless LAN adapter fully contained in a PC Card (with
no external circuitry);
. Was first to incorporate and ship 100 Mbps Ethernet technology in a PC
Card;
. Was first to ship a 32-bit CardBus adapter for connecting CardBus-equipped
notebook computers to 10 Mbps and 100 Mbps networks;
. Was first to ship a 56 Kbps modem and a 100 Mbps Ethernet adapter on a
single PC Card;
. Was first to ship an Integrated PC Card featuring built-in connectors and
a 56 Kbps modem and a 10/100 Mbps Ethernet on a single PC Card.
Xircom has adopted a Distributed Development Environment ("DDE") to facilitate
the remote physical location of some of its engineers. DDE provides structured
development methodologies and high-speed network links into Xircom's corporate
development network. A key component of DDE is the use of Xircom's products by
the engineers that develop and support them. It is believed that DDE results in
increased productivity and retention of key employees. Currently, program
participants include engineers located in Austin, Texas; Provo and Alpine, Utah;
and Kontich, Belgium.
Research and Development
The market for the Company's products is characterized by rapidly changing
technology, short product life cycles and evolving industry standards. The
Company believes that technical innovation in its products is required to make
them more desirable than other notebook connectivity solutions. Xircom's
expertise lies in developing small form factor products, which require a high
degree of electronic component integration and careful circuitry design. In
addition, use of Application Specific Integrated Circuits ("ASIC") reduces the
number of semiconductor devices required in the Company's products resulting in
lower manufacturing cost and higher product reliability. Because of the many
variations of notebook PCs in which Xircom's products are installed, the
Company's ASIC devices are designed so that they can be automatically
reconfigured upon initialization by the Company's proprietary software.
The Company uses flash memory in its products to allow implementation of
enhancements or other changes through a software download by the user.
Xircom's current research and development efforts include ongoing feature
enhancement and cost reduction of current products, continued development of
higher-speed and higher bandwidth Integrated PC Cards and PC Cards, development
of Compact Flash communications adapters, and support for the Company's OEM
customers, including development of Mini-PCI adapters.
Xircom has participated and continues to participate in leading organizations
that drive industry standards. As an active industry participant, the Company
has been able to ensure interoperability of its products with standard hardware
platforms and operating systems. These organizations include:
. PCMCIA, executive membership;
. Gigabit Ethernet Alliance, steering committee membership;
. Mobile Data Initiative ("MDI");
. IEEE 802.3u Committee for 100Mb Ethernet;
. IEEE 802.3z Committee for 1Gb Ethernet LANs;
. Portable Computer and Communications Association ("PCCA");
. International Telecommunications Standards Users Group ("ITSUG") GSM working
party;
. European Telecommunications Standards Institute ("ETSI"), voting member;
. Bluetooth Special Interest Group;
. PCI Special Interest Group, Mini-PCI Working Group;
6 XIRCOM, INC.
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. Mobile Advisory Council ("MAC"); and
. Compact Flash Association.
Approximately 10% of Xircom's 1,000 employees were engaged in research and
development activities as of September 30, 1998. During fiscal years 1998, 1997
and 1996, the Company incurred research and development expenditures of
$15,968,000, $12,799,000 and $9,537,000, respectively.
Marketing
Xircom sells its products primarily through domestic and international
distributors. U.S. distributors include major national distributors of computers
and networking equipment such as Ingram Micro Inc., Tech Data Corporation and
Merisel, Inc., and national reseller organizations such as MicroAge, Inc. and
Inacom Corp. The Company also sells to a number of OEM customers including
notebook computer manufacturers like Toshiba Corporation ("Toshiba"), Compaq
Computer Corporation ("Compaq"), and International Business Machines ("IBM"),
and to Intel Corporation ("Intel").
Internationally Xircom sells products through a worldwide network of
distributors. International sales (sales to customers outside the U.S.)
comprised 52%, 52% and 46% of total net sales in fiscal 1998, 1997 and 1996,
respectively, (see Note Eleven of the accompanying Consolidated Financial
Statements). All international sales are denominated in U.S. dollars and may be
subject to government controls and other risks, including, in some cases, export
licenses, federal restrictions on export, currency fluctuations, political
instability, trade restrictions, and changes in tariffs and freight rates. The
Company has experienced no material difficulties to date as a result of these
factors.
Xircom generally seeks to develop the markets for its products through marketing
programs that promote end-user demand. The Company generates brand recognition
through trade advertising, participation in trade shows and public relations
activities. Xircom has a field sales organization and has expanded its inside
sales/telemarketing function to create demand by calling directly on resellers,
VARs and end-users, but fulfills demand through its distributors. The Company
also has field sales persons and support engineers to sell its products to OEMs.
Backlog
Xircom manufactures its products to its forecast of near-term demand and
maintains inventories of finished goods and top-level subassemblies to satisfy
customer orders. Product shipments are generally made within four weeks after
receipt of orders although some OEM customers submit orders for scheduled
deliveries over a longer period. Orders from distribution customers may be
cancelable without penalty and OEM customers may reschedule or cancel orders
outside a certain minimum time period. Accordingly, the Company generally does
not seek to maintain any significant backlog, and backlog was not significant at
September 30, 1998 or 1997.
Competition
Xircom believes that the principal competitive factors in the market for PC Card
LAN adapters and indirectly competitive products are:
. brand name recognition;
. compatibility with many brands of notebook computers;
. quality and reliability;
. support of commonly used topologies, network wiring systems and network
operating systems;
. performance (including data transfer speeds);
. ease of use;
. size, especially with respect to the latest subnotebook and handheld
notebook PCs;
. price; and
. customer support and service.
7 XIRCOM, INC.
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The principal competitive factors for PC Card modems are:
. brand name recognition;
. compatibility with many brands of notebook computers and software
applications;
. support of industry standards;
. quality and reliability;
. performance (primarily throughput, but also error control, connection
maintenance and compression);
. ease of use;
. price; and
. customer support and service.
The PC Card LAN adapter market has become significantly more competitive, and
the Company has a number of competitors that have substantially greater
financial, development, manufacturing and marketing resources and market
presence than Xircom, including:
. 3Com Corporation, including its U.S. Robotics and Megahertz brands
(collectively "3Com");
. Intel, which purchases its products through an OEM relationship with Xircom;
. IBM; and
. Fujitsu Microelectronics, Inc.
Other manufacturers of desktop LAN adapters offering PC Card adapters include
Standard Microsystems Corporation, Madge Networks Limited and Olicom A/S. In the
multifunction PC Card market (Ethernet+Modem), the Company's most significant
competitor is 3Com, although other companies, including TDK Systems ("TDK"),
Ositech Communications Inc. and New Media, also offer Ethernet+Modem PC Cards.
Intel is also considered a competitor in this market, although they purchase
product through an OEM relationship with Xircom. The Company is also likely to
experience additional competition from large companies that address other
segments of the PC Card market.
Xircom competes indirectly with companies that provide alternative means to
connect notebook computers to LANs, such as docking stations or port replicators
with built-in networking capabilities. Compaq, Toshiba, IBM, NEC Corporation and
others offer docking stations for some of their notebook PCs. Although docking
stations historically enjoyed some competitive advantage because they provide a
broader range of functionality than just a LAN connection, the standardization
provided by PC Card slots reduce the demand for this additional functionality.
In addition, the use of peripheral devices provides the PC user an upgrade path
as speed or other enhancements to the network are developed.
Ethernet interface chipsets on PC system boards which eliminate the need for a
LAN adapter have been offered only in a limited number of notebook PCs to-date,
generally because the chipset solution adds cost and complexity to the base PC
and requires the PC manufacturer to provide networking technical support. As a
result, the Company believes that PC Card solutions for networking notebook
computers will continue to dominate the market because of the performance,
flexibility and range of choices they offer to both users and PC manufacturers.
In the modem-only PC Card market, competition is significant. 3Com holds a
significant market share for PC Card modems and offers a proprietary feature
called X-Jack, which incorporates a pop out RJ-11 telephone jack into the PC
Card case. Other competitors in this market include Boca Research, Hayes
Microcomputer Products, Psion Dacom, Ltd., TDK, and many others, including
manufacturers who may hold leading or significant market shares within specific
countries. Xircom believes that it can continue to leverage its engineering,
sales and manufacturing resources with its RealPort Integrated PC Card 56K
modems because of its patented built-in connector system, as well as market
recognition with its Ethernet+Modem solutions. As with LAN adapters, some
8 XIRCOM, INC.
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PC vendors are opting to include modems with their notebook PCs, however, the
Company believes that expansion slots like PCMCIA will continue to prevail, as
they allow mobile users more flexibility.
Manufacturing
The Company believes that high-volume, low-cost manufacturing has become an
important capability to compete effectively in the PC Card market. As a result,
Xircom builds all of its PC Card adapters at its manufacturing facility in
Penang, Malaysia. The Company purchases most key components in Penang directly
from third-party suppliers with local representation. The Company inspects these
components for quality and performs final assembly, test, packaging and shipping
in Penang.
Although Xircom generally uses standard parts and components for its products,
certain key components used in its products are currently available from only
one source, and others are available from a limited number of sources.
Components currently available from one source include proprietary Ethernet
chipsets (used in the CreditCard Ethernet Adapter) fabricated by Symbios Logic
and Atmel Corp., a Token Ring chipset from Texas Instruments, and modem chipsets
(used in modem and Combo products) from Lucent Technologies. In addition, other
components, including other semiconductor devices, transceivers, transformers
and plastic and metal product housings, are available or acquired from a single
source or a limited number of sources.
Proprietary Rights and Licenses
The Company seeks to protect its intellectual property rights in certain of its
products and technologies through patents, copyrights, trade secrets, and
trademarks. Xircom holds several United States patents relating to the RealPort
Integrated PC Card, parallel port and PC Card networking and data transfer
technologies. Other U.S. patent applications relating to current research and
development efforts of the Company are in progress. The Company regularly
evaluates the applicability of its patents to other products of third parties.
Xircom has several license agreements with third parties granting rights related
to the Company's parallel port data transfer technology in return for license
fee payments or cross-licensing of technology of the licensee. The Company also
seeks to protect its proprietary rights through a combination of employee and
third party nondisclosure agreements.
Employees
As of September 30, 1998, Xircom employed 1,000 persons, including 250 in sales,
marketing and customer support; 100 in engineering and product development; 600
in operations; and 50 in finance and other administrative areas.
Xircom's success depends on its continued ability to attract and retain
qualified personnel. Competition for such personnel in the computer networking
industry is intense and the Company must provide competitive salary, stock
incentive and benefit packages to attract such personnel. Xircom has development
activities in Thousand Oaks, California; Austin, Texas; Provo and Alpine, Utah;
and, Kontich, Belgium. None of the Company's employees is represented by a
collective bargaining arrangement. The Company believes that its relations with
its employees are good.
Factors Affecting Stock Price
As discussed in Management's Discussion and Analysis of Financial Condition and
Results of Operations on pages 13 to 20 of this document, the market price of
Xircom's common stock may fluctuate substantially over short time periods due to
a number of factors, including factors that could affect Xircom's future
financial performance. The price may also be affected by factors that influence
the overall market for stocks or the market for stocks of high technology
companies in particular.
9 XIRCOM, INC.
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Executive Officers of the Registrant
The following presents certain information with respect to the executive
officers of the Company and their ages as of December 1, 1998.
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Dirk I. Gates 37 Chairman of the Board, President and Chief Executive Officer
Steven F. DeGennaro 35 Vice President, Finance and Chief Financial Officer
Robert W. (Sam) Bass 52 Senior Vice President, Worldwide Operations
Marc M. Devis 38 Senior Vice President, Worldwide Sales
Randall H. Holliday 49 General Counsel and Secretary
</TABLE>
Mr. Gates has served as Chairman of the Board of Xircom since January 1995 and
as President and a Director of Xircom since its incorporation in November 1988.
He has also served as Chief Executive Officer since October 1991.
Mr. DeGennaro has served as Vice President, Finance and Chief Financial Officer
of Xircom since June 1996. He had previously served from May 1995 to June 1996
as Vice President, Finance and Chief Accounting Officer and previously since
January 1994 as Corporate Controller and Chief Accounting Officer. Prior to
joining the Company in 1993, Mr. DeGennaro was a senior manager at KPMG Peat
Marwick, a big-six accounting firm. Mr. DeGennaro is a CPA.
Mr. Bass has served as Senior Vice President, Worldwide Operations since August
1997, Vice President, Operations since January 1992. From September 1990 until
joining Xircom, Mr. Bass served as Vice President of Operations for Fibermux
Corporation, a provider of intelligent hubs to the LAN market.
Mr. Devis has served as Senior Vice President, Worldwide Sales since July 1997,
Senior Vice President, Europe and Asia-Pacific Sales and Marketing since August
1996 and Vice President, Europe and Asia-Pacific Sales and Marketing since
January 1995. He had previously served, since June 1991, as Managing Director of
Xircom Europe NV
Mr. Holliday has served as General Counsel of Xircom since January 1995. In
December 1993, Mr. Holliday joined Xircom as Corporate Counsel. From March 1990
to December 1993, Mr. Holliday was Division Counsel of Abex Aerospace Division,
Pneumo Abex Corporation, a manufacturer of aircraft hydraulic components.
ITEM 2. PROPERTIES
Xircom's headquarters are located in 87,000 square feet of a leased facility in
Thousand Oaks, California. This facility accommodates corporate administration,
engineering, marketing, sales and customer support. Distribution is conducted in
a portion of an adjacent 50,000 square-foot leased facility. Xircom owns a
manufacturing and distribution facility in Penang, Malaysia and leases
facilities for its European subsidiaries in Kontich, Belgium; Paris, France;
Basingstoke, England; Grassbrunn, Germany; and Stockholm, Sweden; and facilities
for its Asia-Pacific sales and marketing operations in Singapore; Hong Kong;
Tokyo, Japan; and Sydney, Australia. The Company believes its existing
facilities are adequate for its current needs and additional facilities
proximate to its existing facilities are available for lease to meet future
needs.
Financial information regarding leases and lease commitments are contained in
Note Ten of Notes to Consolidated Financial Statements on pages 34 to 35 of this
document.
ITEM 3. LEGAL PROCEEDINGS
No material legal proceedings.
10 XIRCOM, INC.
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Xircom Common Stock began trading on The Nasdaq Stock Market/SM/ on March 31,
1992 under the symbol XIRC. The Company has not paid cash dividends on its
Common Stock and does not plan to pay cash dividends for the foreseeable future.
Under the terms of the Company's credit agreement, it is prohibited from
declaring or paying dividends without the prior consent of the lender. As of
November 25, 1998, there were 278 holders of record and approximately 9,400
beneficial holders of the Company's Common Stock. The following table presents
the high and low closing stock price for Xircom's Common Stock as quoted on The
Nasdaq Stock Market/SM/ National Market System.
<TABLE>
<CAPTION>
Fiscal 1998 High Low
- ----------------------------------------------------------------------------
<S> <C> <C>
First quarter $ 12-3/8 $ 9
Second quarter 14-1/4 9-9/16
Third quarter 17-5/16 13-3/8
Fourth quarter $ 27-1/16 $ 14-3/4
<CAPTION>
Fiscal 1997 High Low
- ----------------------------------------------------------------------------
<S> <C> <C>
First quarter $ 23-3/4 $ 15-5/8
Second quarter 31-1/8 13-7/8
Third quarter 18-3/4 7-1/2
Fourth quarter $ 16-3/8 $ 11-1/2
</TABLE>
11 XIRCOM, INC.
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected balance sheet and statement of operations
data as of and for the fiscal years ended September 30, 1994 through 1998.
<TABLE>
<CAPTION>
(In thousands, except per share amounts) 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net sales $276,056 $ 184,575 $166,757 $119,528 $131,580
Cost of sales 178,426 126,300 107,437 79,048 63,964
- ---------------------------------------------------------------------------------------------------------------
Gross profit 97,630 58,275 59,320 40,480 67,616
Research and development expenses 15,968 12,799 9,537 13,085 11,613
Sales and marketing expenses 49,882 43,012 32,723 37,086 25,194
General and administrative expenses 9,857 8,259 6,543 7,031 5,491
In-process research and development and
other nonrecurring charges/(1)/ - 2,163 1,505 5,745 -
- ---------------------------------------------------------------------------------------------------------------
Operating income (loss) from continuing
operations 21,923 ( 7,958) 9,012 (22,467) 25,318
Other income (expense), net 4,250 3,172 ( 1,338) 435 ( 175)
- ---------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations
before income taxes 26,173 ( 4,786) 7,674 (22,032) 25,143
Income tax provision (benefit) 7,852 ( 1,437) 2,506 ( 7,000) 9,231
- ---------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations/(1)/ 18,321 ( 3,349) 5,168 (15,032) 15,912
Discontinued operations:
Operating income (loss), net of income taxes - ( 226) 784 (43,772) -
Loss on disposal, net of income taxes - ( 6,275) - - -
- ---------------------------------------------------------------------------------------------------------------
Net income (loss) $ 18,321 $( 9,850) $ 5,952 $(58,804) $ 15,912
- ---------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share/(1)/:
Continuing operations $ .78 $( .16) $ .26 $( .88) $ .95
Net income (loss) $ .78 $( .46) $ .30 $( 3.44) $ .95
Balance sheet data
Working capital $118,625 $ 95,501 $ 34,711 $ 25,909 $ 72,590
Total assets $195,224 $ 147,930 $107,201 $ 85,649 $101,015
Long-term obligations, net of current
portion $ - $ - $ 1,860 $ 597 $ 134
Shareholders' equity $136,718 $ 113,427 $ 65,603 $ 53,095 $ 82,115
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Fiscal 1997 includes $2,163 ($1,514, net of tax benefit) or $.07 per share
for write-off of in-process research and development. Fiscal 1996 includes
$1,505 ($1,023 net of tax benefit) or $.05 per share for loss on sale of Netwave
product line. Fiscal 1995 includes $5,745 ($3,561 net of tax benefit) or $.21
per share for other nonrecurring charges.
12 XIRCOM, INC.
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Annual Report contains trend analysis and other forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Actual results
could differ materially from those projected in the trend analysis and other
forward-looking statements contained herein, as a result of the risk factors set
forth below and other cautionary language contained elsewhere in this report.
Results of Operations
- ---------------------
<TABLE>
<CAPTION>
(in thousands) 1998 Change 1997 Change 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net sales $276,056 50% $184,575 11% $166,757
</TABLE>
Net sales -- 1998 versus 1997
Net sales increased 50% to $276.1 million in fiscal 1998 from $184.6 million in
fiscal 1997 due to increased net sales of LAN adapters, modems and multifunction
LAN and modem cards ("Combo cards") (collectively "adapter products"), which
connect notebook PCs to networks, the Internet and online services. The increase
in net sales of adapter products was primarily due to growth in overall market
demand for local and wide area network connectivity products and an increase in
unit sales of the Company's adapter products by its distribution and OEM
customers. The growth in channel sell-through may be indicative of several
factors: an increased growth rate in shipments of notebook PCs, which in turn
require network connections; increased sales of the Company's modem-only PC Card
products; continuing increased market acceptance of the Company's Combo cards
and Fast Ethernet cards; the introduction of the Company's RealPort Integrated
PC Card family of products; and the Company's competitive pricing strategy. In
addition, during the fourth quarter of fiscal 1997, the Company reduced
shipments to its distributors in order to reduce the levels of inventories held
by its distributors and enable the Company to quickly react to market changes.
Unit shipments of adapter products increased 54% in 1998 over 1997 but average
selling prices declined due to increased competition in the PC Card LAN adapter
market. Revenues from the Company's PC Card products as a percentage of total
revenues were as follows:
<TABLE>
<CAPTION>
(percentage of total revenue) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
LAN Adapters 30% 42% 37%
LAN+Modem 48% 43% 44%
Modem 21% 11% 7%
</TABLE>
International sales. Total international sales (shipments to customers located
outside the U.S.) as a percentage of total sales was 52% in both 1998 and 1997.
PC Card sales in the U.S. and Europe grew at a faster rate than in Asia-Pacific
largely due to the economic turmoil in the Asian markets.
Net sales -- 1997 versus 1996
Net sales increased in 1997 as compared to 1996 primarily due to growth in
overall market demand for local and wide area network connectivity products and
an increase in unit sales of the Company's adapter products by its distribution
and OEM customers. Unit shipments of adapter products increased 41% in 1997 over
1996 but average selling prices and gross profit declined due to increased
competition in the PC Card LAN adapter market and to the continued shift in
product mix to PC Card versions from higher-margin parallel port versions. The
increase in net sales was offset partially by a reduction in shipments by the
Company to its distributors during the fourth quarter of fiscal 1997 in order to
reduce the levels of inventories held by its distributors and enable the Company
to quickly react to market changes.
13 XIRCOM, INC.
<PAGE>
<TABLE>
<CAPTION>
(in thousands) 1998 Change 1997 Change 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Gross profit $ 97,630 68% $ 58,275 (2%) $ 59,320
Percentage of net sales 35.4% 31.6% 35.6%
</TABLE>
Gross profit -- 1998 versus 1997
Gross profit consists of net sales less cost of sales, which includes product
costs (materials, labor, manufacturing overhead and royalty payments to
licensers of software incorporated into the Company's products) and other costs
of sales, including provisions for excess and obsolete inventory and warranty
expense. The increase in gross profit as a percent of net sales in 1998 compared
to 1997 was primarily attributable to a decrease in fixed manufacturing costs as
a percentage of sales. In addition, the RealPort Integrated PC Card family of
products, which began shipping in the last half of fiscal 1998, has higher gross
margins than the comparably featured Type II PC Card products. This increase in
the gross profit percentage was partially offset by the increase in modem
product sales to the Company's OEM customers at lower gross profit margins than
sales made through the Company's distribution partners, and by lower average
selling prices on adapter products.
Gross profit -- 1997 versus 1996
The decrease in gross profit as a percent of net sales in 1997 compared to 1996
was primarily attributable to lower average selling prices on adapter products;
the increased portion of sales represented by PC Card products, which have lower
gross profit margins than the Company's parallel port products; the increased
portion of sales made to OEM customers, which generally have lower gross profit
margins than sales made through the Company's distribution partners; and
increased inventory reserves charged to cost of sales, related primarily to
excess parallel port products. These negative gross profit impacts were
partially offset by increased shipments and the resulting decrease in fixed
costs as a percentage of total cost of sales, a change in the discount structure
on products sold into the distribution channel beginning in the September 1996
quarter, and the favorable impact of cost reduction efforts including the
successful transition of all the Company's PC Card production to its own
manufacturing facility in Penang, Malaysia. Start-up expenses related to the
Malaysian manufacturing facility had a negative impact on gross profit in the
first half of fiscal 1996.
<TABLE>
<CAPTION>
(in thousands) 1998 Change 1997 Change 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Research and development $ 15,968 25% $ 12,799 34% $ 9,537
Percentage of net sales 5.8% 6.9% 5.7%
</TABLE>
Research and development expenses increased in 1998 in absolute dollars compared
to 1997 as a result of additional staffing and expenditures to support expanded
branded and OEM product offerings, including the Company's RealPort Integrated
PC Card family of products. Research and development expenses increased in 1997
in absolute dollars and as a percentage of sales compared to 1996 as a result of
additional staffing to support expanded product offerings, offset partially by
reduced spending on Netwave products. Total expenditures for research and
development expenses are expected to increase in 1999 as compared to 1998 in
absolute dollars due to planned expenditures on product enhancements and new
product introductions, and may vary as a percentage of sales.
14 XIRCOM, INC.
<PAGE>
<TABLE>
<CAPTION>
(in thousands) 1998 Change 1997 Change 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Sales and marketing $ 49,882 16% $ 43,012 31% $ 32,723
Percentage of net sales 18.1% 23.3% 19.7%
</TABLE>
Sales and marketing expenses increased in 1998 and decreased as a percentage of
sales as compared to 1997. The increase in expenses were due to additional
staffing and sales and marketing activities required to support expanded branded
markets and increased OEM sales levels. Partially offsetting these increases
were the lower sales and marketing expenditures that generally are associated
with OEM sales versus branded business sales, reduced expenses associated with
lower levels of inventories maintained by distributors, and cooperative
advertising reimbursements. Sales and marketing expenses were higher as a
percentage of net sales in 1997 due to a reduction in shipments by the Company
to its distributors during the fourth quarter of fiscal 1997 in order to reduce
the levels of inventories held by its distributors. Sales and marketing expenses
increased in 1997 from 1996 due to additional headcount, marketing activities to
support the increased sales levels and expanding markets, and increased
distributor-related sales and marketing expenses. As discussed in "Gross profit"
above, the Company changed its discount structure on products sold into the
distribution channel beginning in the September 1996 quarter and, as a result,
improved its gross profit margins in that quarter. However, the additional gross
profit dollars were applied to product and marketing programs, which increased
the amount of sales and marketing expenses. As further product and market
expansion activities are pursued, sales and marketing expenses for fiscal 1999
are expected to increase in absolute dollars but may vary as a percentage of
sales.
<TABLE>
<CAPTION>
(in thousands) 1998 Change 1997 Change 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
General and administrative $ 9,857 19% $ 8,259 26% $ 6,543
Percentage of net sales 3.6% 4.5% 3.9%
</TABLE>
General and administrative expenses increased in 1998 as compared to 1997 to
support growth in the organization and, to a lesser extent, continued
expenditures on information systems hardware and software, including Year 2000
upgrades. During 1998, the Company initiated modification efforts of computer
software issues associated with the Year 2000 project. Costs of the Company's
Year 2000 efforts are expensed as incurred. General and administrative expenses
are expected to increase modestly during fiscal 1999 due to the need to support
growth in the organization and, to a lesser extent, continued expansion of
information systems hardware and software including Year 2000 upgrades, but may
decrease as a percentage of net sales. See Risk Factors for a further discussion
of the Company's Year 2000 project.
<TABLE>
<CAPTION>
(in thousands) 1998 Change 1997 Change 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Other income (expense), net $ 4,250 34% $ 3,172 N/A $( 1,338)
Percentage of net sales 1.5% 1.7% (0.8%)
</TABLE>
Net other income or expense includes interest income from the investment of
available cash, foreign currency transaction gains or losses, and interest
expense on notes payable and capital leases. Interest income was $4,256,000,
$2,195,000 and $473,000 in 1998, 1997 and 1996, respectively. Foreign currency
transaction gains (losses) were $1,426,000, $2,119,000 and $(8,000) in 1998,
1997 and 1996, respectively. Net other income for 1998 increased as compared to
1997 primarily due to higher interest income and lower interest expense in 1998
as a result of increased cash and cash equivalents and reduced borrowings under
credit facilities. Net other income for 1997 as compared to net other expense
for 1996 was due primarily to increased foreign currency transaction
15 XIRCOM, INC.
<PAGE>
gains, higher interest income as a result of increased cash and cash equivalent
balances and lower interest expense as a result of reduced borrowings under
credit facilities.
<TABLE>
<CAPTION>
(in thousands) 1998 Change 1997 Change 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income tax provision (benefit) $ 7,852 N/A $( 1,437) N/A $ 2,506
Effective tax rate 30.0% 30.0% 32.7%
</TABLE>
The Company's effective tax rate in 1998 and 1997 was 30.0%. The difference
between the effective tax rate during these years and the 35% federal statutory
tax rate was due primarily to research and development credits and the impact on
the deferred tax asset valuation allowance of realization of state deferred
losses that were originally valued. The Company has tax holiday status on its
operations in Malaysia which expires in 2000. The Company intends to seek
renewal of this tax holiday before its expiration. The Company's effective tax
rate in 1996 was comprised of a 32.0% rate for profitable operations in the last
three quarters of 1996 and a 23.6% tax benefit related to a pre-tax loss
recorded in the first quarter of 1996. The Company expects an effective tax rate
of 28% for the 1999 fiscal year.
Discontinued operations includes the financial results of Netaccess, the
Company's subsidiary which included remote access server and multi-port modem
products sold to original equipment manufacturers and through two-tier
distribution channels. On June 30, 1997, the Company completed the sale of
Netaccess resulting in a loss of $6,275,000, net of income tax benefit.
Operating loss from discontinued operations, net of income taxes, for 1997 was
$226,000, compared to a profit of $784,000 for 1996.
Net income and net income per diluted share for 1998 was $18,321,000 and $0.78,
respectively, compared to net loss and net loss per diluted share for 1997 was
$9,850,000 and $0.46, respectively.
Risk Factors
- ------------
Competition. The market for notebook PC Card adapters has grown rapidly since
the Personal Computer Memory Card International Association (PCMCIA) introduced
a standard form factor for PC Card LAN adapters in 1993. Companies in the PC,
desktop LAN adapter and modem industries with greater name recognition and
greater financial resources than Xircom, now have a significant presence in the
PC Card adapter market. As a result, Xircom's net sales and gross profit margins
have been and are expected to continue to remain subject to adverse competitive
pressure. Actions by Xircom's competitors which continue to influence this
competitive environment include price reductions, new product introductions,
promotional efforts, and changes in the level of channel inventory. Competition
is expected to remain intense and the Company could experience fluctuations in
its market share. Moreover, Xircom believes that the market for PC Card LAN
adapters, modems and Combo cards will continue to be price competitive and thus
could continue to result in lower selling prices, lower gross profit margins and
reduced profitability levels than it earned from such products in the past.
Manufacturing. The Company believes that its in-house manufacturing facility is
operating at a greater efficiency level than during prior years. This
manufacturing facility, located in Malaysia, began volume production in early
fiscal 1996 and is now producing all of Xircom's products. While the
manufacturing facility and increased production is expected to have a continuing
positive impact on cost reduction efforts, Xircom may be unable to achieve
significant additional efficiencies from this facility. If Xircom is unable to
achieve additional cost reductions through increased manufacturing efficiency or
through increased production it may be unable to keep pace with competitors'
cost or price reductions to an extent necessary to maintain or increase market
share without adversely affecting gross profit margins. Because all products are
being manufactured at its own facility, if Xircom is unable to accurately
forecast or react to changes in product demand, interruptions in the supply of
products could occur which in turn could adversely affect future sales. Xircom
also faces risks associated with operations
16 XIRCOM, INC.
<PAGE>
overseas, including management of a distant manufacturing facility, currency
fluctuations and potential instability in the local country, particularly in
light of recent economic and political uncertainty in Malaysia and in Asia
generally.
Currency. All of Xircom's international sales are denominated in U.S. dollars
and may be subject to government controls and other risks. These controls and
risks may include federal restrictions on export, export licenses, trade
restrictions, changes in tariff and freight rates, currency fluctuations, and
political instability. Xircom could experience increased credit risks (such as
customer insolvencies or other impairments of customers' ability to repay
existing obligations) and difficulties in accessing new markets in the region as
a result of the recent economic instability, currency fluctuations and other
factors impacting international markets and Asian markets in particular. The
Company has implemented and may continue to implement certain strategies to
limit the impact of foreign currency fluctuations on its Asian distributors. In
doing so, Xircom may assume greater foreign currency risk in the future.
Continued instability or other adverse changes in local economies could affect
the future operations of the Company. In September 1998, the Malaysian
government fixed the exchange rate of the Malaysian ringgit at 3.8 ringgits per
U.S. dollar. The Company believes that the fixing, or any potential reversion to
a floating exchange rate, will not have a significant impact on its results of
operations.
Several European countries will adopt a Single European Currency (the "Euro") as
of January 1, 1999 with a transition period continuing through January 1, 2002.
Xircom is reviewing the anticipated impact the Euro may have on its internal
systems and on its competitive environment. The Company believes its internal
systems will be Euro capable without material modification cost. Further, the
Company does not presently expect the introduction of the Euro currency to have
a material adverse impact on the Company's financial condition or results of
operations.
Product mix. Revenues derived from Xircom's Combo and modem-only PC Cards
typically have lower gross profit margins than LAN PC Cards. In addition,
shipments to OEMs generally result in lower average selling prices and gross
profit margins than sales made through the Company's distribution partners.
Increases in the proportion of modem-only and Combo PC Cards and in shipments to
OEMs have negatively impacted overall gross margins and may continue to offset
any improvements from manufacturing and design efficiencies. This trend may
continue as the Company anticipates an increased mix of OEM revenues as a
percentage of sales. In addition, the increased percentage of revenue from OEM
customers during fiscal 1998 as compared to fiscal 1997 has resulted in an
increased concentration in the Company's customer base. With this increased
customer concentration, the Company has increased its dependency on a limited
number of customers at lower average selling prices and gross profit margins
than sales made through the Company's distribution partners.
Backlog. Xircom generally ships products within one to four weeks after receipt
of orders and therefore its sales backlog is typically minimal. Accordingly, the
Company's expectations of future net sales are based largely on its own estimate
of future demand and not on firm customer orders. If net sales do not meet
expectations, profitability would be adversely affected, as the Company may not
be able to reduce expenses commensurately in the near-term.
Channel inventory. Xircom's net sales may be affected by its distributors'
decisions as to the quantity of the Company's products to be maintained in their
inventories. Since the fourth quarter of fiscal 1997, Xircom has taken steps to
reduce the levels of inventories maintained by its distributors and to enable
the Company to react more quickly to market changes. As a result, Xircom may be
more directly affected by changes in the market, including the impact of any
slowdown or rapid increase in end user demand. Despite the Company's efforts to
reduce channel inventory exposure, distributors may still choose to reduce their
inventories below the already reduced levels, adversely affecting Xircom's net
sales.
New product introductions. Xircom's continued success is dependent on its
ability to continue to introduce new products offering advanced features,
functionality and solutions demanded by end users. The Company
17 XIRCOM, INC.
<PAGE>
cannot assure that it will be able to continue to introduce advanced products in
a timely manner or that new products it introduces will achieve market
acceptance or sell through to end users in sufficient quantities to make them
viable for the long-term. Sales of such new products may negatively impact sales
of Xircom's existing products. In addition, the Company may have difficulty in
establishing its products' presence in markets in which it does not currently
have significant brand recognition.
Component availability. Because of frequent technology changes and rapid
industry growth, the cost and availability of components used to manufacture
Xircom's products may fluctuate. Because some components, including custom
chipsets, are available from only one supplier, they are subject to the risk of
reduced availability due to manufacturing constraints, an excess of demand
versus supply, national political or economic changes, and other risks not
within the Company's control. Although the Company has not experienced any
significant parts shortages over the past year, many of these components require
long-lead purchase orders and flexibility to change order quantities due to
changes in demand is limited. Any supply source interruptions, limitations on
availability, or inability to develop alternative sources as needed could affect
Xircom's ability to deliver its products and, in turn, adversely affect its
future earnings.
Gross margin. In summary, gross profit margins are impacted by a number of
factors including sales growth rates, competitive pricing pressures, product
sales mix, channel sales mix, frequency of product transitions, component cost,
and manufacturing cost. In addition, new products often have lower gross profit
margins until market acceptance when increased volumes may permit component cost
reductions and manufacturing efficiencies.
Technology shifts. A number of additional factors could have an impact on
Xircom's future operating results. Rapid technological change and short product
life cycles characterize the industry in which Xircom operates. The industry
includes competitors with greater financial and technical resources than the
Company. While Xircom has historically been successful in developing or
integrating leading technology into its products, ongoing investment in research
and development is required to maintain its technological position. The Company
may need to increase the rate of such investment depending on competitive
factors. If networking capability is included in extension modules to PCs or in
the PC itself, a reduction in the demand for add-on networking devices could
result. Xircom's operating results and ability to retain its market share are
also dependent on continued growth in the underlying markets for notebook
networking products and notebook computers, and the notebook-to-network
connection rate.
Intellectual property. Xircom cannot assure that its patents, copyrights,
trademarks and other efforts to protect its intellectual property will prevent
duplication of its technology or provide a competitive advantage. The Company
also cannot assure that any patent issued to it would be upheld as valid if
litigation over the patent were initiated. Because of the rapid pace of
technological change in the communications industry, and while Xircom will
aggressively assert its intellectual property rights when necessary, Xircom
believes its success is likely to depend more upon continued innovation,
technical expertise, marketing skills and customer support and service rather
than upon legal protection of the Company's proprietary rights.
With the proliferation of new products and rapidly changing technology in the PC
Card market, there is a significant volume of patents or similar intellectual
property rights held by third parties. Given the nature of the Company's
products and development efforts, there are risks that claims associated with
such patents or intellectual property rights could be asserted by third parties.
These risks include the cost of licensing a given technology. If a claimant
refuses to offer such a license on terms acceptable to Xircom, there is a risk
of incurring a substantial cost of litigation or settlement of such claims
regardless of the merits of the allegations. In the event of litigation, if the
Company does not prevail, it may be required to pay significant damages, and/or
to cease sales and production of infringing products, and only make future sales
of a noninfringing design.
The Company currently uses software licensed from third parties in certain of
its Combo, modem-only and Token Ring products which, in the aggregate, accounted
for 69% of revenues during 1998. Xircom's operating results
18 XIRCOM, INC.
<PAGE>
could be adversely affected by a number of factors relating to this third-party
software. Such factors include: failure by a licensor to accurately develop,
timely introduce, promote or support the software; resultant delays in shipment
of Xircom's products; excess customer support costs or product returns
experienced by Xircom due to errors in licensed software; or termination of
Xircom's relationship with such licensors.
Stock price. The market price of Xircom's common stock has been, and may
continue to be, subject to a high degree of volatility. Certain factors may have
a significant impact on the market price of the Company's common stock. These
factors include general conditions in the networking and computer industries;
announcements of quarterly operating results; acquisitions; pricing; new
products or technological innovations by the Company or its competitors; and
other events. In addition, stock markets have experienced extreme price
volatility in recent years. This volatility has had a substantial effect on the
market price of securities issued by many high technology companies, including
Xircom, in many cases for reasons unrelated to the operating performance of the
specific companies. Xircom's common stock has experienced volatility not
necessarily related to announcements of Company performance. Broad market
fluctuations may also affect the market price of Xircom's common stock.
Year 2000. The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Such computer
programs or hardware may have date-sensitive software or embedded chips that
always assume the century is "19". This could cause miscalculations or failure
in the Company's information systems and/or manufacturing equipment. Such system
miscalculations or failure could cause disruptions of operations including,
among other things, a temporary inability to process transactions or engage in
normal business activities. Disruptions of the Company's operations may also
occur if key suppliers or customers experience disruptions in their ability to
purchase, supply or transact with the Company due to Year 2000 issues. The
Company's global operations rely heavily on the infrastructures within the
countries in which they do business. The Year 2000 readiness within
infrastructure suppliers (utilities, government agencies, and shipping
organizations) will be crucial to the Company's ability to avoid disruption of
its operations.
Xircom has reviewed its own products and believes they do not present any Year
2000 issues. These products are used as accessories to systems which may contain
Year 2000 issues and the Company believes that any such Year 2000 issues in
systems are not to be attributed to the Company's products.
The Company has completed its initial analysis of the major information systems
that could be significantly affected by the Year 2000 issue and has committed
personnel and resources to resolve potential issues. Based on the initial
analysis, the Company determined that it would be required to modify or replace
certain portions of its internal hardware and software so that those systems
will properly use dates beyond December 31, 1999. The Company presently believes
that the Year 2000 issue can be mitigated with respect to its internal
information systems and manufacturing equipment with modifications or
replacements of certain existing software and hardware.
The Company's plan to resolve the Year 2000 issue involves four phases:
assessment, remediation, testing, and contingency planning. The Company's
assessment plan for both information technology ("IT") and non-IT systems is
currently in process. A communications plan has been initiated to create
awareness, both internally and externally, of the need to identify Year 2000
issues and the risks the issues create. Inventories of systems, equipment, and
processes from Xircom's global locations are in the process of being collected
and analyzed. Thus far, the assessment has indicated that most of the Company's
significant IT systems are Year 2000 compliant. The assessment indicated,
however, that the Company's customer interaction system could be affected. This
system is currently in the process of being replaced, with completion scheduled
for June 1999.
The Company is 10% complete with its remediation phase with respect to its IT
exposures and expects to complete all software reprogramming or replacement no
later than September 30, 1999. Upon completion of software reprogramming or
replacement for a particular system, the Company tests and implements the
modifications.
19 XIRCOM, INC.
<PAGE>
Awareness and assessment of any Year 2000 issues relating to operating equipment
is 90% complete. The initial conclusion of this assessment is that the Company's
operating equipment is Year 2000 compliant. The Company plans to complete the
validation of this preliminary conclusion by March 31, 1999. The Company has
queried its significant suppliers regarding their Year 2000 readiness. To date,
the Company is not aware of any such supplier with a Year 2000 issue that would
materially affect the Company's operating results. The Company has no means of
ensuring that such suppliers will be Year 2000 ready and, accordingly, is
planning to perform a secondary evaluation by March 31, 1999 of its critical
suppliers to obtain further assurances about their readiness. The Company could
be materially impacted if its significant suppliers are unable to complete their
Year 2000 resolution process in a timely fashion. The ultimate effect of
non-compliance by these parties is not determinable.
Xircom is using both internal and external resources to replace, test and
implement software and operating equipment needing Year 2000 modifications. The
total cost of the Year 2000 project is estimated at $1.1 million and is being
funded by cash flows from operations. To date, the Company has incurred
approximately $410,000 ($252,000 expensed and $158,000 capitalized for new
software), related to all phases of the Year 2000 project. Of the total
remaining project costs, approximately $314,000 is attributable to the purchase
of new software and hardware, which will be capitalized.
The remaining $408,000 will be expensed as incurred.
The Company is developing a contingency plan for organizing responses in case of
shutdown of certain critical applications due to Year 2000 issues. This
contingency plan involves, among other things, IT and non-IT systems and
external systems. The Company believes that the most likely worst case of a Year
2000-related failure given its state of readiness today would be a temporary
loss of 20% of its internal IT capability with no material impact on its ability
to conduct normal revenue-generating operations.
Liquidity and Capital Resources
The Company's continuing operating activities provided cash of approximately
$46.8 million in 1998, primarily due to net income and a decrease in working
capital requirements. The decrease in working capital requirements consists of
decreases in inventories and income tax receivable and increases in accounts
payable and accrued liabilities and income taxes payable, offset in part by an
increase in accounts receivable. The decrease in inventories and increase in
accounts receivable are due to a reduction in shipments by the Company to its
distributors during the fourth quarter of fiscal 1997 in order to reduce the
levels of inventories held by its distributors.
Investing activities in 1998 used $17.7 million in cash, primarily for capital
expenditures. The capital expenditures primarily related to the purchase of the
Company's manufacturing facility located in Malaysia, manufacturing equipment
and improvements at the manufacturing facility, equipment for increased
headcount, and information systems hardware and software. The Company has no
material fixed commitments for capital expenditures.
The Company's financing activities provided $1.5 million in cash in 1998,
primarily from the issuance of common stock through its stock option and
employee stock purchase plans.
The Company has a credit facility with a bank for borrowings up to $25.0
million. Loans under the agreement are secured by all U.S.-based assets of the
Company. The agreement expires in December 2000. The Company also has a credit
facility, denominated in Malaysian ringgit, with a bank in Malaysia totaling
$10.8 million. As of September 30, 1998, there were no borrowings outstanding
under either agreement. As of November 30, 1998, the Company had approximately
$35.8 million in borrowings available under these credit facilities. Intel
Corporation holds a warrant to purchase 1,509,903 newly issued shares of
Xircom's common stock. The warrant is exercisable at a price of $27.01 per share
through February 27, 1999 and $31.16 per share from February 28, 1999 through
its expiration on February 27, 2002.
The Company believes that cash on hand, borrowings available under its existing
facilities or from other financing sources and cash provided by operations will
be sufficient to support its working capital and capital expenditure
20 XIRCOM, INC.
<PAGE>
requirements for at least the next twelve months. However, there can be no
assurances that future cash requirements to fund operations will not require the
Company to seek additional capital sooner than the twelve months, or that such
additional capital will be available when required on terms acceptable to the
Company.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Disclosures
The following discussion about the Company's market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. The Company is exposed to market
risk related to changes in interest rates and foreign currency exchange rates.
The Company does not use derivative financial instruments.
Xircom maintains a portfolio of highly liquid cash equivalents maturing in three
months or less as of the date of purchase. Given the short-term nature of these
investments, and that the Company has no borrowings outstanding, the Company is
not subject to significant interest rate risk.
A portion of Xircom's operations consists of manufacturing and sales activities
in foreign locations. The Company manufactures its products in Malaysia and
sells its products worldwide. The Company's financial results, therefore, could
be significantly impacted by factors such as changes in foreign currency
exchange rates or weak economic conditions in foreign markets. Xircom's
operating results are exposed to the impact of weakening economic conditions in
the countries in which it sells its products. Since all of Xircom's sales are
denominated in U.S. dollars, the Company's foreign operations are net payers of
currencies other than the U.S. dollar, particularly the Malaysian ringgit and
the Belgian franc. As such, the Company's operating results may be adversely
affected by the impacts of a stronger Malaysian ringgit or Belgian franc
relative to the U.S. dollar. To mitigate the short-term effect of changes in
currency exchange rates on its foreign currency based expenses, the Company
purchases and holds Malaysian ringgits and Belgian francs in advance of the due
date of their underlying obligations.
21 XIRCOM, INC.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Xircom, Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
(In thousands, except per share amounts)
Fiscal Years Ended September 30 1998 1997 1996
- -------------------------------------------------------------- ---------------- ------------------ ----------------
<S> <C> <C> <C>
Net sales $276,056 $ 184,575 $166,757
Cost of sales 178,426 126,300 107,437
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Gross profit 97,630 58,275 59,320
Research and development expenses 15,968 12,799 9,537
Sales and marketing expenses 49,882 43,012 32,723
General and administrative expenses 9,857 8,259 6,543
In-process research and development and
other nonrecurring charges - 2,163 1,505
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Total operating expenses 75,707 66,233 50,308
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Operating income (loss) from continuing operations 21,923 ( 7,958) 9,012
Other income (expense), net 4,250 3,172 ( 1,338)
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Income (loss) from continuing operations before
income taxes 26,173 ( 4,786) 7,674
Income tax provision (benefit) 7,852 ( 1,437) 2,506
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Income (loss) from continuing operations 18,321 ( 3,349) 5,168
Discontinued operations:
Operating income (loss), net of income taxes - ( 226) 784
Loss on disposal, net of income taxes - ( 6,275) -
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Net income (loss) $ 18,321 $( 9,850) $ 5,952
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Basic earnings (loss) per share:
Continuing operations $ .80 $( .16) $ .27
Discontinued operations - ( .30) .04
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Net income (loss) $ .80 $( .46) $ .31
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Diluted earnings (loss) per share:
Continuing operations $ .78 $( .16) $ .26
Discontinued operations - ( .30) .04
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Net income (loss) $ .78 $( .46) $ .30
- -------------------------------------------------------------- ---------------- ------------------ ----------------
</TABLE>
See accompanying notes
22 XIRCOM, INC.
<PAGE>
Xircom, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
(In thousands, except share and per share information)
September 30 1998 1997
- ------------------------------------------------------------------------------- ------------------ ----------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $105,796 $ 75,109
Accounts receivable, net of allowances for sales returns and
bad debts of $8,492 ($6,254 in 1997) 27,978 9,549
Accounts receivable from related party 1,302 1,348
Income tax receivable 285 5,006
Inventories 16,121 28,962
Deferred income taxes 11,659 7,075
Other current assets 4,874 2,476
- ------------------------------------------------------------------------------- ------------------ ----------------
Total current assets 168,015 129,525
Property and equipment, net 26,730 17,819
Other assets 479 586
- ------------------------------------------------------------------------------- ------------------ ----------------
Total assets $195,224 $147,930
- ------------------------------------------------------------------------------- ------------------ ----------------
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 17,269 $ 10,431
Accrued liabilities 28,813 20,107
Current portion of long-term obligations - 2,541
Accrued income taxes 3,308 945
- ------------------------------------------------------------------------------- ------------------ ----------------
Total current liabilities 49,390 34,024
Deferred income taxes 9,116 479
Commitments and contingencies
Shareholders' equity:
Preferred Stock, 2,000,000 shares authorized, none issued - -
Common Stock, $.001 par value, 50,000,000 shares authorized;
23,081,374 shares outstanding at September 30, 1998
(22,671,822 in 1997) 23 23
Paid-in capital 145,862 140,892
Accumulated deficit ( 9,167) (27,488)
- ------------------------------------------------------------------------------- ------------------ ----------------
Total shareholders' equity 136,718 113,427
- ------------------------------------------------------------------------------- ------------------ ----------------
Total liabilities and shareholders' equity $195,224 $147,930
- ------------------------------------------------------------------------------- ------------------ ----------------
</TABLE>
See accompanying notes 23 XIRCOM, INC.
<PAGE>
Xircom, Inc.
Consolidated Statements of Shareholders' Equity
<TABLE>
<CAPTION>
Common Stock
---------------------- Paid-in Accumulated
(In thousands) Shares Amount Capital Deficit Total
- ------------------------------------------------ ---------- ----------- ------------ ---------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at September 30, 1995 18,926 $19 $ 76,666 $(23,590) $ 53,095
Issuance of Common Stock under Employee
Stock Purchase Plan 116 - 888 - 888
Exercise of stock options 689 1 3,965 - 3,966
Tax benefit related to employee stock options - - 1,702 - 1,702
Net income - - - 5,952 5,952
- ------------------------------------------------ ---------- ----------- ------------ ---------------- -------------
Balance at September 30, 1996 19,731 20 83,221 (17,638) 65,603
Issuance of Common Stock 2,516 3 51,358 - 51,361
Issuance of Common Stock under Employee
Stock Purchase Plan 125 - 1,259 - 1,259
Exercise of stock options 450 - 4,050 - 4,050
Tax benefit related to employee stock options - - 1,062 - 1,062
Repurchase of Common Stock, net ( 150) - ( 58) - (58)
Net loss - - - ( 9,850) ( 9,850)
- ------------------------------------------------ ---------- ----------- ------------ ---------------- -------------
Balance at September 30, 1997 22,672 23 140,892 (27,488) 113,427
Issuance of Common Stock under Employee
Stock Purchase Plan 160 - 1,370 - 1,370
Exercise of stock options 249 - 2,688 - 2,688
Tax benefit related to employee stock options - - 912 - 912
Net income - - - 18,321 18,321
- ------------------------------------------------ ---------- ----------- ------------ ---------------- -------------
Balance at September 30, 1998 23,081 $23 $145,862 $( 9,167) $136,718
- ------------------------------------------------ ---------- ----------- ------------ ---------------- -------------
</TABLE>
See accompanying notes
24 XIRCOM, INC.
<PAGE>
Xircom, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
(In thousands)
Fiscal Years Ended September 30 1998 1997 1996
- -------------------------------------------------------------- ---------------- ------------------ ----------------
<S> <C> <C> <C>
Operating activities
Net income (loss) from continuing operations $ 18,321 $( 3,349) $ 5,168
Adjustments to derive cash flows from continuing operating
activities:
Depreciation and amortization 7,955 6,499 6,135
Deferred income taxes 4,053 2,043 5,187
Foreign currency exchange (gain) loss ( 1,426) ( 2,119) 8
Write-off of in-process research and development - 2,163 -
Loss on sale of Netwave product line - - 1,505
Other 156 - 81
Changes in assets and liabilities, net of the effect of
acquisition and disposition:
Accounts receivable ( 18,383) 14,109 (13,920)
Income tax receivable 4,721 ( 2,354) 5,710
Inventories 12,841 (15,191) 1,026
Prepaid expenses and other current assets ( 2,398) 854 ( 1,684)
Accounts payable and accrued liabilities 17,709 1,996 ( 1,792)
Income taxes payable 3,275 941 1,627
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Net cash provided by continuing operating activities 46,824 5,592 9,051
Net cash used in operating activities of discontinued
operations - ( 5,984) ( 4,569)
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Net cash provided by (used in) operating activities 46,824 ( 392) 4,482
Investing activities
Purchases of property and equipment ( 17,964) ( 6,437) ( 8,309)
Decrease in other assets 310 338 728
Proceeds from sale of Netaccess, Inc. - 11,000 -
Proceeds from sale of Netwave product line - - 1,000
Cash paid for acquisition - ( 1,463) -
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Net cash provided by (used in) continuing investing ( 17,654) 3,438 ( 6,581)
activities
Net cash used in investing activities of discontinued
operations - ( 501) ( 1,288)
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Net cash provided by (used in) investing activities ( 17,654) 2,937 ( 7,869)
Financing activities
Proceeds from issuance of common stock 4,058 56,612 4,854
Proceeds from issuance of debt obligations - 960 8,526
Repayment of debt obligations ( 2,541) ( 6,385) ( 1,659)
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Net cash provided by financing activities 1,517 51,187 11,721
Net increase in cash and cash equivalents 30,687 53,732 8,334
Cash and cash equivalents at beginning of period 75,109 21,377 13,043
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Cash and cash equivalents at end of period $ 105,796 $ 75,109 $ 21,377
- -------------------------------------------------------------- ---------------- ------------------ ----------------
</TABLE>
See accompanying notes 25 XIRCOM, INC.
<PAGE>
Xircom, Inc.
Notes to Consolidated Financial Statements
NOTE ONE: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying consolidated financial statements include the accounts of
Xircom, Inc. (the "Company") and its wholly-owned subsidiaries. All intercompany
balances and transactions have been eliminated.
Business
The Company designs, manufactures, markets and supports products that allow
notebook PCs to connect to a network either locally or remotely.
Cash and cash equivalents
All highly liquid investments with a maturity of three months or less at the
date of purchase are considered to be cash equivalents and are carried at cost
plus accrued interest which approximates market value. Interest income totaled
$4,256,000, $2,195,000 and $473,000 for fiscal 1998, 1997 and 1996,
respectively, and is included in Other income (expense), net in the accompanying
Consolidated Statements of Operations.
Concentration of credit risk
The Company sells its products primarily through two-tier distributors or
original equipment manufacturers. The Company makes periodic evaluations of the
creditworthiness of its customers and generally does not require collateral. To
date, the Company has not experienced any material bad debts or collection
problems. As of September 30, 1998 and 1997, three customers accounted for a
total of 34% and 33%, respectively, of total trade accounts receivable. Accounts
receivable from related party represents amounts due from Intel Corporation. See
Note Eight. The carrying amounts reported in the balance sheets for accounts
receivable and accounts payable approximate their fair value.
Inventories
Inventories are carried at the lower of cost (determined on a first-in,
first-out basis) or market.
Property and equipment
Property and equipment is stated at cost. Depreciation and amortization is
provided using the straight-line method over the estimated useful lives of the
assets, ranging from one to twenty years. Leasehold improvements are amortized
using the straight-line method over the term of the related lease or the useful
life of the asset, whichever is shorter.
Revenue recognition
The Company recognizes revenue from product sales when shipped. The Company
generally provides a lifetime limited warranty against defects in the hardware
component and a two-year limited warranty on the software component of its
network adapters and modem products. In addition, the Company provides telephone
support to purchasers of its products as needed to assist them in installation
or use of the products. The Company makes provisions for these costs in the
period of sale. The Company also has contractual agreements that permit
distributors and dealers to return products or receive price protection credits
under certain circumstances. The Company makes a provision for the estimated
amount of product returns or credits that may occur under these contracts in the
period of sale.
Licensing agreements
The Company has entered into agreements with third parties to license software
and hardware that is incorporated into or sold with certain of the Company's
products. Royalties associated with such licenses are accrued and expensed as
cost of goods sold when the products are shipped.
26 XIRCOM, INC.
<PAGE>
Xircom, Inc.
Notes to Consolidated Financial Statements
Research and development
Research and development costs are expensed as incurred.
Advertising costs
The Company expenses advertising costs as incurred. Advertising expense, net,
totaled $3,860,000, $4,753,000 and $3,094,000 for fiscal 1998, 1997 and 1996,
respectively.
Nonrecurring charges
In fiscal 1997, the Company recorded a charge to operations of $2,163,000
($1,514,000, net of tax benefit) for the write-off of in-process research and
development in connection with the purchase of certain assets from Angia
Communications, Inc., a developer and manufacturer of PC Card products. In
fiscal 1996, the Company recorded a charge to operations of $1,505,000
($1,023,000, net of tax benefit) for the sale of all assets and intellectual
property related to its Netwave wireless LAN product line.
Foreign currency exchange gain (loss)
The functional currency of the Company's foreign subsidiaries is the U.S.
dollar. All of the Company's sales are denominated in U.S. dollars. Gains
(losses) from foreign currency transactions and re-measurement totaled
$1,426,000, $2,119,000 and $(8,000) for fiscal 1998, 1997 and 1996,
respectively, and are recognized currently in the Consolidated Statements of
Operations.
Earnings (loss) per share
During fiscal 1998, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share," ("SFAS 128") which required a change in
the method used to compute earnings per share. SFAS 128 simplifies the
calculation of earnings per share data by replacing primary and fully diluted
earnings per share with basic and diluted earnings per share, respectively.
Basic earnings per share is calculated using the weighted average common shares
outstanding for the period, and excludes dilutive securities. Diluted earnings
per share reflects the dilution to earnings that would occur if securities,
stock options and other dilutive securities resulted in the issuance of common
stock. As required by SFAS 128, all prior period amounts have been restated to
conform to the new presentation. The weighted average number of shares used for
basic and diluted earnings per share were as follows:
<TABLE>
<CAPTION>
Fiscal Years Ended September 30 1998 1997 1996
- --------------------------------------------------------------- ----------------- ---------------- ----------------
<S> <C> <C> <C>
Weighted average number of shares:
Basic 22,834,000 21,560,000 19,289,000
Effect of dilutive securities, employee stock options 508,000 - 456,000
- --------------------------------------------------------------- ----------------- ---------------- ----------------
Diluted 23,342,000 21,560,000 19,745,000
- --------------------------------------------------------------- ----------------- ---------------- ----------------
</TABLE>
Shares issuable under stock options of 610,123, 2,705,124 and 483,302 in fiscal
1998, 1997 and 1996, respectively, and warrants of 1,509,903 in fiscal 1998 and
1997 have been excluded from the computation of diluted earnings per share
because the effect would be antidilutive.
Effects of recent accounting pronouncements
In June 1997, Statement of Financial Accounting Standards No. 131, "Disclosures
About Segments of an Enterprise and Related Information" ("SFAS 131") was
issued. SFAS 131 establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. SFAS 131 is effective for financial
statements for fiscal years beginning after December 15, 1997.
27 XIRCOM, INC.
<PAGE>
Xircom, Inc.
Notes to Consolidated Financial Statements
The adoption of SFAS 131 will have no impact on the Company's consolidated
results of operations, financial position or cash flows.
Use of estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Rapid technological change and short product life cycles
characterize the industry in which the Company operates. As a result, estimates
are required to provide for product returns, price protection, product
obsolescence and warranty returns. Historically, actual amounts recorded under
these programs have not varied significantly from estimated amounts. Actual
results may differ, however, from those estimates, although management does not
believe that any differences would materially affect the Company's financial
position or reported results.
Stock options
Employee stock options are accounted for under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," which requires the
recognition of expense when the option price is less than the fair value of the
stock at the date of grant. The Company awards options for a fixed number of
shares at an option price equal to the fair value at the date of grant.
Accordingly, the financial statements do not include any expense related to
employee stock option awards. The Company has adopted the disclosure-only
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation." See Note Eight.
NOTE TWO: DISCONTINUED OPERATIONS
On March 31, 1997, the Company decided to discontinue its multi-port modem and
remote access server business and on June 30, 1997, completed the sale of
Netaccess, Inc. ("Netaccess"), its remote access server subsidiary. Proceeds of
the sale were $11,000,000. The accompanying financial statements have been
prepared to reflect the historical cash flows and results of operations of
Netaccess as discontinued operations for all periods presented. See Note Nine
for cash flow information for the discontinued operations. Operating income
(loss) from discontinued operations is summarized as follows (in thousands):
<TABLE>
<CAPTION>
Fiscal Years Ended September 30 1998 1997 1996
- -------------------------------------------------------------- ---------------- ------------------ ----------------
<S> <C> <C> <C>
Net sales $ - $ 13,185 $26,549
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Operating income (loss) before income tax provision
(benefit) $ - $( 323) $ 1,174
Income tax provision (benefit) - ( 97) 390
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Operating income (loss), net of tax - ( 226) 784
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Loss on disposal before income tax benefit - ( 8,604) -
Income tax benefit - ( 2,329) -
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Loss on disposal, net of tax benefit - ( 6,275) -
- -------------------------------------------------------------- ---------------- ------------------ ----------------
Total discontinued operations, net of tax $ - $( 6,501) $ 784
- -------------------------------------------------------------- ---------------- ------------------ ----------------
</TABLE>
28 XIRCOM, INC.
<PAGE>
Xircom, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE THREE: INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30 1998 1997
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Finished goods $ 4,165 $ 17,984
Sub-assemblies 1,092 2,441
Work-in-process 5,383 1,253
Component parts 5,481 7,284
- -----------------------------------------------------------------------------------------------------------------
$ 16,121 $ 28,962
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE FOUR: PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
September 30 1998 1997
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Land $ 541 $ -
Building and improvements 3,925 -
Leasehold improvements 6,235 7,135
Equipment 34,082 25,337
Furniture and fixtures 3,676 3,504
- -----------------------------------------------------------------------------------------------------------------
48,459 35,976
Less accumulated depreciation and amortization (21,729) (18,157)
- -----------------------------------------------------------------------------------------------------------------
$ 26,730 $ 17,819
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE FIVE: ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30 1998 1997
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Payroll and related benefits $ 6,828 $ 2,918
Warranty reserve 6,225 4,041
Accrued marketing costs 5,567 4,281
Other 10,193 8,867
- -----------------------------------------------------------------------------------------------------------------
$ 28,813 $ 20,107
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE SIX: BANK BORROWINGS AND LONG-TERM OBLIGATIONS
The Company has a credit facility with a bank for borrowings up to $25,000,000
at the prime rate or at a LIBOR-based rate. Loans under the agreement are
secured by all U.S.-based assets of the Company. The agreement expires in
December 2000. As of September 30, 1998, there were no borrowings outstanding
under the agreement.
The Company has a credit facility with another bank, denominated in Malaysian
ringgit, that permits borrowings up to $10.8 million under a bankers acceptance
agreement at a fixed rate of 7.6%, and on a revolving credit and term loan basis
at the bank's reference rate plus 1.0% (8.5% as of September 30, 1998). As of
September 30, 1997, $2,536,000 was outstanding under both the revolving credit
and term loan provisions of this agreement and there were no amounts outstanding
under the bankers acceptance agreement. All borrowings under this facility were
repaid in fiscal 1998.
29 XIRCOM, INC.
<PAGE>
Xircom, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company had approximately $20,275,000 in borrowings available under its
credit facilities as of September 30, 1998. Interest expense totaled $56,000,
$478,000 and $766,000 for fiscal 1998, 1997 and 1996, respectively, and is
included in Other income (expense), net.
NOTE SEVEN: INCOME TAXES
The income tax provision (benefit) includes the following (in thousands):
<TABLE>
<CAPTION>
Fiscal Years Ended September 30 1998 1997 1996
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Current:
Federal $ 441 $(3,785) $(1,785)
State 351 - 131
Foreign 2,516 945 766
- -----------------------------------------------------------------------------------------------------------------
3,308 (2,840) ( 888)
Deferred:
Federal 4,544 1,403 3,394
State 752 (1,754) 813
Valuation allowance ( 752) 1,754 ( 813)
- -----------------------------------------------------------------------------------------------------------------
4,544 1,403 3,394
- -----------------------------------------------------------------------------------------------------------------
$7,852 $(1,437) $ 2,506
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Significant components of the Company's deferred tax assets and liabilities are
as follows (in thousands):
<TABLE>
<CAPTION>
September 30 1998 1997
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Book reserves not deductible for tax $ 11,302 $ 8,443
Book in excess of tax depreciation 1,246 1,918
Net operating loss carryforward and credit 3,155 5,960
- -----------------------------------------------------------------------------------------------------------------
Total deferred tax asset 15,703 16,321
Valuation allowance ( 2,470) ( 3,263)
- -----------------------------------------------------------------------------------------------------------------
Deferred tax asset, net 13,233 13,058
- -----------------------------------------------------------------------------------------------------------------
Foreign operations ( 9,662) ( 5,252)
Other ( 1,028) ( 1,210)
- -----------------------------------------------------------------------------------------------------------------
Total deferred tax liabilities (10,690) ( 6,462)
- -----------------------------------------------------------------------------------------------------------------
Net deferred tax asset $ 2,543 $ 6,596
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Balance sheet classification of the net deferred tax asset is as follows (in
thousands):
<TABLE>
<CAPTION>
September 30 1998 1997
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Current deferred tax asset $ 11,659 $ 7,075
Noncurrent deferred tax liability ( 9,116) ( 479)
- -----------------------------------------------------------------------------------------------------------------
$ 2,543 $ 6,596
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
At September 30, 1998 the Company has alternative minimum tax (AMT) credit
carryforwards of $613,000, which may be used indefinitely; foreign tax credit
(FTC) carryforwards of $1,170,000, which expire from 2001 to 2003; and research
and development (R&D) credits of $1,372,000, which expire from 2008 to 2012.
30 XIRCOM, INC.
<PAGE>
Xircom, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATMENTS
A valuation allowance for deferred tax assets was established in 1995 to reflect
the uncertainty of realizing the loss generated in 1995, applicable to state
income taxes. For 1996 and 1998, the valuation allowance was reduced due to the
realization of these losses that were originally valued. For 1997, an additional
valuation allowance was created due to the uncertainty of the future realization
of the deferred tax asset generated in 1997 applicable to state income taxes. A
reconciliation of the provision (benefit) for income taxes with the tax
(benefit) computed by applying the 35% federal statutory tax rate is as follows
(in thousands):
<TABLE>
<CAPTION>
Fiscal Years Ended September 30 1998 1997 1996
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Computed expected tax (benefit) $ 9,160 $( 1,675) $2,686
State income taxes, net of federal benefit 227 - 163
Research and development credit (1,082) - ( 110)
Foreign operations 280 ( 566) ( 39)
Valuation allowance on deferred tax asset ( 793) 680 -
Tax exempt FSC and interest income - - ( 157)
Other 60 124 ( 37)
- -----------------------------------------------------------------------------------------------------------------
$ 7,852 $( 1,437) $2,506
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
At September 30, 1998, foreign earnings of $25,588,000 have been retained
indefinitely by subsidiary companies for reinvestment, on which no additional
U.S. tax has been paid. If repatriated, additional taxes of approximately
$8,578,000 on these earnings, net of available foreign tax credit carryforwards,
would be due. The Company has tax holiday status on its operations in Malaysia,
which expires in 2000. Income (loss) before income taxes for all foreign
operations was $17,337,000, $12,282,000 and $5,547,000 for fiscal 1998, 1997 and
1996, respectively.
NOTE EIGHT: COMMON STOCK AND RELATED PLANS
On February 28, 1997, the Company sold to Intel Corporation 2,516,405 newly
issued shares of the Company's common stock (representing a 12.5 percent
interest at the date of issuance) and a warrant to purchase an additional
1,509,903 newly issued shares of the Company's common stock. In consideration,
the Company received net cash proceeds of $51,361,000. The warrant is
exercisable at a price of $27.01 per share through February 27, 1999, and $31.16
per share from February 28, 1999 through its expiration on February 27, 2002.
During fiscal 1997, the Company purchased 150,000 shares of Common Stock from a
director of the Company, with substantially all of the proceeds contributed by
the director to the Company as capital.
The Company's Stock Option Plan (1992 Plan), as amended, authorizes a total of
up to 7,500,000 shares of Common Stock for issuance as either incentive stock
options with exercise prices which may not be less than fair market value at the
date of grant, or nonqualified stock options. The options generally vest over
three to four years and have terms of five to seven years. The 1992 Director
Stock Option Plan (Director Plan) provides for the grant of nonqualified options
for a total of up to 425,000 shares of Common Stock to non-employee members of
the Board of Directors. The options are granted at fair market value as of the
date of grant and vest over a four-year period. The 1995 Stock Option Plan
authorizes a total of up to 1,049,857 shares of Common Stock for issuance as
nonqualified stock options with vesting rights similar to the 1992 Plan. The
Patent Award Stock Option Plan authorizes a total of up to 250,000 shares of
Common Stock for issuance as nonqualified stock options with vesting periods
similar to the 1992 Plan. As of September 30, 1998, the Company had 1,693,193
shares of common stock available for future grant under its stock option plans.
31 XIRCOM, INC.
<PAGE>
Xircom, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table is a summary of activity for the Company's stock option
plans:
<TABLE>
<CAPTION>
Option price per share
-------------------------------------------
Number of Weighted-
shares Low High Average
<S> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------
Outstanding at October 1, 1995 2,537,207 $0.33 $19.50 $ 8.83
Granted 1,150,550 $9.00 $17.13 $12.16
Exercised ( 688,963) $0.33 $11.50 $ 5.76
Canceled ( 679,300) $1.29 $19.50 $10.20
- --------------------------------------------------------------------------------------------------------------
Outstanding at September 30, 1996 2,319,494 $1.29 $17.13 $11.04
Granted 1,428,900 $8.63 $29.00 $14.17
Exercised ( 449,493) $1.29 $15.50 $ 9.01
Canceled ( 593,777) $1.86 $29.00 $13.42
- --------------------------------------------------------------------------------------------------------------
Outstanding at September 30, 1997 2,705,124 $7.63 $27.75 $12.48
Granted 1,514,200 $9.00 $26.00 $12.42
Exercised ( 249,516) $7.63 $20.25 $10.78
Canceled ( 380,586) $8.63 $27.75 $12.42
- --------------------------------------------------------------------------------------------------------------
Outstanding at September 30, 1998 3,589,222 $8.63 $27.75 $12.57
- --------------------------------------------------------------------------------------------------------------
</TABLE>
Information regarding stock options outstanding as of September 30, 1998 is as
follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------- ------------------------
Weighted-
Weighted- Average Weighted-
Average Remaining Average
Exercise Contractual Exercise
Shares Price Life Shares Price
<S> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------
Under $11.00 1,292,540 $ 9.96 4.77 years 393,887 $10.16
$11.00-$14.00 1,425,948 $12.25 5.24 years 389,619 $11.74
Over $14.00 870,734 $18.15 5.71 years 218,862 $16.99
</TABLE>
As of September 30, 1998, 1997 and 1996, stock options to purchase 1,002,368,
568,030 and 443,863 shares were exercisable at weighted average exercise prices
of $12.52, $11.32 and $9.47, respectively.
The Company's 1994 Employee Stock Purchase Plan (ESPP) allows employees to
purchase Common Stock of the Company, through payroll deductions, at 85% of the
market value of the shares at the beginning or end of the offering period,
whichever is lower. The plan provides for the grant of rights to employees to
purchase up to a total of 600,000 shares of common stock. As of September 30,
1998, 141,496 shares were available for issuance under this plan. Information
regarding shares issued under the plan is as follows:
<TABLE>
<CAPTION>
Price per share
----------------------
Number of shares
Fiscal years ended issued Low High
<S> <C> <C> <C>
- -------------------------------------------------------------------------------------------------------------
1998 160,036 $8.50 $ 8.61
1997 124,782 $7.86 $14.45
1996 116,149 $7.65 $ 7.65
</TABLE>
32 XIRCOM, INC.
<PAGE>
Xircom, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Subsequent to the end of fiscal 1998, the Board of Directors approved the
authorization of an additional 275,000 shares for issuance under the Director
Plan and 800,000 shares under the ESPP, subject to shareholder approval at the
next Annual Meeting of Shareholders.
If the Company recognized employee stock option-related compensation expense in
accordance with SFAS 123 and used the Black-Scholes option valuation model for
determining the weighted average fair value of options granted after September
30, 1995, its net income (loss) and earnings (loss) per share would have been as
follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Net income (loss) $18,321 $( 9,850) $5,952
Pro forma stock compensation expense, net (3,495) ( 2,056) ( 461)
- -----------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) $14,826 $(11,906) $5,491
- -----------------------------------------------------------------------------------------------------------------
Pro forma diluted earnings (loss) per share $ .65 $( .55) $ .29
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized over the options' vesting periods. The pro forma effect on net
income for fiscal 1998, 1997 and 1996 is not representative of the pro forma
effect on net income in future years because it does not take into consideration
pro forma compensation expense related to grants made prior to fiscal 1996. Pro
forma information in future years will reflect the amortization of a larger
number of stock options granted in succeeding years.
The fair value of the options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996: risk-free interest rates of 5.55%, 6.10%
and 6.00%, respectively; dividend yields of 0%; volatility factors of the
expected market price of the Company's common stock from .60 to .67; and
expected life of the options of 4 years. These assumptions resulted in
weighted-average fair values of $6.85, $7.30 and $6.23 for each stock option
granted in 1998, 1997 and 1996, respectively.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options. The Company's employee stock options have
characteristics significantly different from those of traded options such as
vesting restrictions and extremely limited transferability. In addition, the
assumptions used in option valuation models (see above) are highly subjective,
particularly the expected stock price volatility of the underlying stock.
Because changes in these subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not provide
a reliable single measure of the fair value of its employee stock options.
The Company maintains a defined contribution 401(k) plan under which its U.S.
employees are eligible to participate. Participants may make, within certain
limitations, voluntary contributions based upon a percentage of their
compensation. The Company makes matching contributions based on a participant's
contribution up to a specified maximum percentage of the participant's
contribution. Participants vest in the Company's contributions based on years of
service. Company contributions were $261,000, $174,000 and $65,000 for fiscal
1998, 1997 and 1996, respectively.
33 XIRCOM, INC.
<PAGE>
Xircom, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE NINE: SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
(in thousands) 1998 1997 1996
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Cash paid:
Interest $ 56 $ 491 $ 763
Income taxes $ 807 $ 82 $ 51
Non-cash transactions:
Tax benefit related to employee stock options $ 912 $ 1,062 $ 1,702
- -----------------------------------------------------------------------------------------------------------------
Cash flows from discontinued operating activities:
Income (loss) from discontinued operating activities $ - $(6,501) $ 784
Adjustments to derive cash flows from discontinued operating
activities:
Depreciation and amortization - 1,777 2,028
Deferred income taxes - (2,329) -
Change in net assets of discontinued operations - 1,069 ( 7,381)
- -----------------------------------------------------------------------------------------------------------------
Net cash used in discontinued operating activities $ - $(5,984) $( 4,569)
- -----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities of discontinued operations:
Purchases of equipment and improvements $ - $( 501) $( 1,288)
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Cash paid for acquisition in 1997 of $1,463,000 is comprised of fair value of
assets acquired of $2,463,000 net of liabilities assumed of $1,000,000.
NOTE TEN: COMMITMENTS AND CONTINGENCIES
The Company leases its facilities and certain equipment under operating leases
expiring on various dates through 2005. Rent expense was $1,649,000, $1,512,000
and $1,447,000 for fiscal 1998, 1997 and 1996, respectively. As of September 30,
1998, minimum future rental payments under all noncancelable operating leases
for facilities and equipment were as follows (in thousands):
<TABLE>
<CAPTION>
Operating
Fiscal year leases
<S> <C>
- -----------------------------------------------------------------------------------------------------------------
1999 $ 1,623
2000 1,542
2001 1,578
2002 1,603
2003 1,423
Thereafter 2,907
- -----------------------------------------------------------------------------------------------------------------
$10,676
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Future minimum rentals to be received under noncancelable subleases as of
September 30, 1998 totaled $411,000.
Under certain license agreements (see Note One), the Company is required to pay
specified amounts of per unit royalties based on sales of certain of its
products. Some of these agreements also contain minimum quarterly and annual
volume requirements. Certain of these agreements expire on specific dates,
others continue in effect as long as the technology is incorporated into the
Company's products, and some can be terminated by either party after specified
notice periods. Royalties under these agreements amounted to $640,000, $740,000,
and $1,490,000 for fiscal 1998, 1997 and 1996, respectively.
34 XIRCOM, INC.
<PAGE>
Xircom, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company is involved in certain claims and legal proceedings that arise in
the normal course of business. Management does not believe that the outcome of
any of these matters will have a material adverse effect on the Company's
consolidated financial position, results of operations or cash flows.
NOTE ELEVEN: SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in one industry segment: the design, development,
manufacture, marketing and support of computer network connectivity products.
Information about the Company's operations in the U.S., Europe and Asia is
presented below.
<TABLE>
<CAPTION>
United
(in thousands) States Europe Asia Eliminations Total
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Fiscal 1998
Net sales to unaffiliated
customers $ 144,021 $ 90,017 $ 42,018 $ - $276,056
Intercompany sales 105,350 - 170,890 (276,240) -
- ------------------------------------------------------------------------------------------------------------------
Total sales $ 249,371 $ 90,017 $212,908 $(276,240) $276,056
Operating income from
continuing operations $ 4,872 $ 4,803 $ 11,069 $ 1,179 $ 21,923
Identifiable assets $ 136,385 $ 22,171 $ 43,569 $( 6,901) $195,224
- ------------------------------------------------------------------------------------------------------------------
Fiscal 1997
Net sales to unaffiliated
customers $ 98,677 $ 53,941 $ 31,957 $ - $184,575
Intercompany sales 83,159 - 132,397 (215,556) -
- ------------------------------------------------------------------------------------------------------------------
Total sales $ 181,836 $ 53,941 $164,354 $(215,556) $184,575
Operating income (loss) from
continuing operations $( 17,304) $ 131 $ 10,296 $( 1,081) $( 7,958)
Identifiable assets $ 118,780 $ 15,513 $ 26,149 $( 12,512) $147,930
- ------------------------------------------------------------------------------------------------------------------
Fiscal 1996
Net sales to unaffiliated
customers $ 99,573 $ 45,865 $ 21,319 $ - $166,757
Intercompany sales 59,594 17 64,915 (124,526) -
- ------------------------------------------------------------------------------------------------------------------
Total sales $ 159,167 $ 45,882 $ 86,234 $(124,526) $166,757
Operating income from
continuing operations $ 1,853 $ 572 $ 5,339 $ 1,248 $ 9,012
Identifiable assets/(1)/ $ 80,801 $ 13,980 $ 21,842 $( 9,422) $107,201
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Identifiable assets in the United States includes net assets of
discontinued operations of $17,151,000 as of September 30, 1996.
Total export sales (sales to unaffiliated foreign entities) were $11,019,000,
$10,347,000 and $9,582,000 for fiscal 1998, 1997 and 1996, respectively. Net
sales to one customer in excess of 10% of total net sales was 13%, 17% and 21%
for fiscal 1998, 1997 and 1996, respectively. Net sales to Intel Corporation
were less than 10% of total net sales in fiscal 1998 and 1997. See Note Eight.
35 XIRCOM, INC.
<PAGE>
Xircom, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE TWELVE: SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
Quarter ended
------------------------------------------------------------------------------
(in thousands, except per share Dec. 31 Mar. 31 June 30 Sept. 30 Fiscal Year
data)
<S> <C> <C> <C> <C> <C>
- -----------------------------------------------------------------------------------------------------------------
Fiscal 1998
Net sales $52,545 $64,134 $ 71,312 $ 88,065 $ 276,056
Gross profit 18,128 21,629 24,311 33,562 97,630
Net income 2,430 3,277 4,705 7,909 18,321
Diluted earnings per share $ .11 $ .14 $ .20 $ .33 $ .78
- -----------------------------------------------------------------------------------------------------------------
Fiscal 1997
Net sales $56,309 $57,140 $ 50,226 $ 20,900 $ 184,575
Gross profit (loss) 20,816 21,740 16,911 ( 1,192) 58,275
Net income (loss) 4,457 4,341 ( 5,833)/(1)/ (12,815)/(2)/ ( 9,850)
Diluted earnings (loss) per share $ .22 $ .20 $( .25)/(1)/ $( .57)/(2)/ $( .46)
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
(1) In the third quarter of fiscal 1997, net loss includes $6,275,000 or $.29
per share for loss on sale of Netaccess, Inc.
(2) In the fourth quarter of fiscal 1997, net loss includes $1,514,000 or $.07
per share for the write-off of in-process research and development.
36 XIRCOM, INC.
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDERS
XIRCOM, INC.
We have audited the accompanying consolidated balance sheets of Xircom, Inc. as
of September 30, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended September 30, 1998. Our audits also included the financial
statement schedule listed in the Index at Item 14(a). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Xircom, Inc. at
September 30, 1998 and 1997, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended September 30,
1998, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ Ernst & Young LLP
Woodland Hills, California
October 19, 1998
37 XIRCOM, INC.
<PAGE>
ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors of Xircom is incorporated by reference
from the information under the caption "Election of Directors" in the Company's
Proxy Statement for its 1999 Annual Meeting of Shareholders. Information with
respect to executive officers of Xircom is described in Item 1 of this Annual
Report on Form 10-K. Information with respect to delinquent filings under
Section 16(a) of the Securities Exchange Act of 1934 is incorporated by
reference from the information under the caption "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's Proxy Statement for its 1999
Annual Meeting of Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from the information under the caption "Executive
Officer Compensation" in the Company's Proxy Statement for its 1999 Annual
Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the information under the caption "Security
Ownership of Certain Beneficial Owners and Management" in the Company's Proxy
Statement for its 1999 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the information under the caption "Executive
Officer Compensation" in the Company's Proxy Statement for its 1999 Annual
Meeting of Shareholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
Page in Form 10-K
<S> <C>
(a) (1) The following consolidated financial statements of Xircom, Inc. and
the Report of Independent Auditors, are included in Item 8 of this
document:
Consolidated Statements of Operations - Years ended
September 30, 1998, 1997 and 1996 22
Consolidated Balance Sheets at September 30, 1998 and 1997 23
Consolidated Statements of Shareholders' Equity - Years ended
September 30, 1998, 1997 and 1996 24
Consolidated Statements of Cash Flows - Years ended
September 30, 1998, 1997 and 1996 25
Notes to Consolidated Financial Statements 26-36
Report of Ernst & Young LLP, Independent Auditors 37
(2) Consolidated financial statement schedule:
Schedule II - Valuation and Qualifying Accounts 39
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements
or notes thereto.
(3) Exhibits included herein (numbered in accordance with Item 601
of Regulation S-K) 40-41
(b) Reports on Form 8-K: None
</TABLE>
38 XIRCOM, INC.
<PAGE>
SCHEDULE II
Xircom, Inc.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Additions
Balance at Charged to
Beginning of Costs and Balance at End
Description Period Expenses Deductions of Period
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FISCAL 1998
Deducted from asset accounts:
Allowance for sales returns and bad debts $6,254 $16,151 $13,913 $8,492
- -------------------------------------------------------------------------------------------------------------------
Liability reserves:
Warranty $4,041 $ 6,328 $ 4,144 $6,225
- -------------------------------------------------------------------------------------------------------------------
FISCAL 1997
Deducted from asset accounts:
Allowance for sales returns and bad debts $3,434 $28,872 $26,052 $6,254
- -------------------------------------------------------------------------------------------------------------------
Liability reserves:
Warranty $3,204 $ 3,170 $ 2,333 $4,041
- -------------------------------------------------------------------------------------------------------------------
FISCAL 1996
Deducted from asset accounts:
Allowance for sales returns and bad debts $3,425 $15,277 $15,268 $3,434
- -------------------------------------------------------------------------------------------------------------------
Liability reserves:
Warranty $1,800 $ 7,049 $ 5,645 $3,204
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
39 XIRCOM, INC.
<PAGE>
EXHIBITS INCLUDED HEREIN (NUMBERED IN ACCORDANCE WITH ITEM 601 OF
REGULATION S-K)
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
- --------------------------------------------------------------------------------------------------------------------
<S> <C>
2.1 Agreement and Plan of Reorganization By and Among Xircom, Inc., a California Corporation,
Xircom, Inc., a Delaware Corporation, and Primary Rate Incorporated, a Delaware Corporation,
dated April 12, 1995 (incorporated by reference to Exhibit 2.1 of the Company's report on Form 8-K
dated June 22, 1995, No. 0-19856)
3.1 Amended Articles of Incorporation of Xircom, Inc. (incorporated by reference to Exhibit 3.1 of the
Company's report on Form 10-Q for the quarter ended March 31, 1992)
3.2 Bylaws of Xircom, Inc. (incorporated by reference to Exhibit 3.3 of Amendment No. 3 to the
Company's registration statement on Form S-1, No. 33-45667)
4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 of Amendment No. 3 to
the Company's registration statement on Form S-1, No. 33-45667)
10.1 Form of Indemnification Agreement (incorporated by reference to Exhibit 10.3 of the Company's
report on Form 10-Q for the quarter ended March 31, 1992)
10.9 Stock Option Plan of the Company, as amended and restated on January 23, 1998, and forms of
agreement thereunder (incorporated by reference to Exhibit 4.1 of the Company's
registration statement on Form S-8 filed on April 21, 1998, No. 333-50591)
10.10 1992 Director Stock Option Plan of the Company, as amended and restated on January 17, 1997,
and forms of agreement thereunder (incorporated by reference to Exhibit 4.2 of the Company's
registration statement on Form S-8 filed on April 17, 1997, No. 333-25367)
10.15 Form of Distributor Agreement (incorporated by reference to corresponding exhibit number of the
Company's registration statement on Form S-1, No. 33-45667)
10.26 1994 Employee Stock Purchase Plan, as amended and restated as of January 23, 1998, and forms of
agreement thereunder (incorporated by reference to Exhibit 4.2 of the Company's
registration statement on Form S-8 filed on April 21, 1998, No. 333-50591)
10.27 Facility lease agreement, dated as of March 29, 1994, between Metropolitan Life Insurance Company
and the Company (incorporated by reference to Exhibit 10.1 of the Company's report on From 10-Q
for the quarter ended March 31, 1994)
10.28 Facility lease agreement, dated as of March 29, 1994, between Metropolitan Life Insurance Company and
the Company (incorporated by reference to Exhibit 10.2 of the Company's report on From 10-Q for the
quarter ended March 31, 1994)
10.30 Credit Agreement Among Xircom, Inc., Certain Lenders Named Herein and NationsBank of Texas, N.A. as
Administrative Agent, dated as of December 30, 1996 (incorporated by reference to Exhibit 10.30 of the
Company's report on Form 10-Q for the quarter ended December 31, 1996)
</TABLE>
40 XIRCOM, INC.
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
- --------------------------------------------------------------------------------------------------------------------
<S> <C>
10.30a Security Agreement Between Xircom, Inc. as Debtor and NationsBank of Texas, N.A. as Administrative
Agent, dated as of December 30, 1996 (incorporated by reference to Exhibit 10.30 of the Company's
report on Form 10-Q for the quarter ended December 31, 1996)
10.30c Intellectual Property Security Agreement Between Xircom, Inc. as Debtor and NationsBank of Texas,
N.A. as Administrative Agent, dated as of December 30, 1996 (incorporated by reference to Exhibit
10.30 of the Company's report on Form 10-Q for the quarter ended December 31, 1996)
10.31 Xircom, Inc. Common Stock and Warrant Purchase Agreement, of January 13, 1997, between Xircom,
Inc. and Intel Corporation (incorporated by reference to Exhibit 10.31 of the Company's report on
Form 10-Q for the quarter ended March 31, 1997)
10.31a Warrant to Purchase Shares of Common Stock of Xircom, Inc., dated February 28, 1997 (incorporated
by reference to Exhibit 10.31 of the Company's report on Form 10-Q for the quarter ended
March 31, 1997)
10.31b Investor Rights Agreement, dated February 28, 1997, between Xircom, Inc. and Intel Corporation
(incorporated by reference to Exhibit 10.31 of the Company's report on Form 10-Q for the
quarter ended March 31, 1997)
10.32 Asset Purchase Agreement by and among BTINH Operating Company, Inc. as Buyer, Brooktrout
Technology, Inc. as Parent, Netaccess, Inc. as Seller and Xircom, Inc. as Seller's Sole
Stockholder, dated June 30, 1997 (incorporated by reference to Exhibit 10.32 of the Company's
report on Form 10-Q for the quarter ended June 30, 1997)
10.33 1995 Stock Option Plan, as amended and restated on October 24, 1997, and forms of agreement
thereunder (incorporated by reference to Exhibit 4.3 of the Company's registration statement
on Form S-8 filed on April 21, 1998, No. 333-50591)
10.34 1997 Patent Award Stock Option Plan, adopted July 25, 1997, and forms of agreement thereunder
(incorporated by reference to Exhibit 4.4 of the Company's registration statement on Form S-8
filed on April 21, 1998, No. 333-50591)
21.1 Subsidiaries of Xircom, Inc. (see page 42)
23.1 Consent of Ernst & Young LLP, Independent Auditors (see page 43)
24.1 Power of Attorney (see page 44)
27.1 Financial Data Schedule
</TABLE>
41 XIRCOM, INC.
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
Xircom Operations (Malaysia) Sdn. Bhd.
Master-Pack (PG) Sdn. Bhd.
Xircom Europe NV
Xircom U.K., Ltd.
Xircom France, S.A.R.L.
Xircom Deutschland GmbH
Xircom AB
Xircom Asia PTE LTD
Xircom Asia Limited
Xircom Asia Pacific Ltd.
Xircom Australia Pty. Ltd.
Xircom Japan KK
42 XIRCOM, INC.
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
pertaining to the 1992 Director Stock Option Plan, 1992 Stock Option Plan, 1995
Stock Option Plan and 1994 Employee Stock Purchase Plan and in the Registration
Statement (Form S-3 No. 33-93972) and in the related Prospectus of Xircom, Inc.
of our report dated October 19, 1998, with respect to the consolidated financial
statements and schedule of Xircom, Inc., included in this Annual Report (Form
10-K) for the year ended September 30, 1998.
/s/ Ernst & Young LLP
Woodland Hills, California
December 11, 1998
43 XIRCOM, INC.
<PAGE>
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.
XIRCOM, INC.
Date: December 11, 1998 By: /s/ Dirk I. Gates
-----------------------------------------
Dirk I. Gates
Chairman of the Board
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Dirk I. Gates and Steven F. DeGennaro, 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 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 hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ DIRK I. GATES Chairman of the Board, December 11, 1998
- ----------------------------------------
Dirk I. Gates President and Chief Executive Officer
(Principal Executive Officer)
/s/ STEVEN F. DEGENNARO Vice President, Finance and December 11, 1998
- ----------------------------------------
Steven F. DeGennaro Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
/s/ MICHAEL F.G. ASHBY Director December 11, 1998
- ----------------------------------------
Michael F.G. Ashby
/s/ KENNETH J. BIBA Director December 11, 1998
- ----------------------------------------
Kenneth J. Biba
/s/ GARY J. BOWEN Director December 11, 1998
- ----------------------------------------
Gary J. Bowen
/s/ J. KIRK MATHEWS Director December 11, 1998
- ----------------------------------------
J. Kirk Mathews
/s/ WILLIAM J. SCHROEDER Director December 11, 1998
- ----------------------------------------
William J. Schroeder
/s/ DELBERT W. YOCAM Director December 11, 1998
- ----------------------------------------
Delbert W. Yocam
</TABLE>
44 XIRCOM, INC.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAIN SUMMARY FINANCIAL INFORMATION EXTRACTED FROM XIRCOM,
INC.'S FORM 10-K FOR THE YEAR ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN IT'S
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<CASH> 105,796
<SECURITIES> 0
<RECEIVABLES> 37,772
<ALLOWANCES> 8,492
<INVENTORY> 16,121
<CURRENT-ASSETS> 168,015
<PP&E> 48,459
<DEPRECIATION> 21,729
<TOTAL-ASSETS> 195,224
<CURRENT-LIABILITIES> 49,390
<BONDS> 0
0
0
<COMMON> 23
<OTHER-SE> 136,695
<TOTAL-LIABILITY-AND-EQUITY> 195,224
<SALES> 276,056
<TOTAL-REVENUES> 276,056
<CGS> 178,426
<TOTAL-COSTS> 178,426
<OTHER-EXPENSES> 75,707
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 56
<INCOME-PRETAX> 27,173
<INCOME-TAX> 7,852
<INCOME-CONTINUING> 18,321
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 18,321
<EPS-PRIMARY> .80
<EPS-DILUTED> .78
</TABLE>
