<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-27764
______________________________
XYLAN CORPORATION
(Exact name of registrant as specified in its charter)
California 95-4433911
---------------- ---------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
26679 WEST AGOURA ROAD
CALABASAS, CALIFORNIA 91302
(Address of principal executive offices)
TELEPHONE: (818) 880-3500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filled by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X]* No [_]
The number of shares outstanding of the registrant's Common Stock as of June 30,
1996, was 41,607,340.
This quarterly report on Form 10-Q contains a total of 25 pages, of which this
page is page 1.
* The Registrant has been subject to such filing requirements since March 11,
1996, the effective date of its Registration Statement on Form 8-A.
1
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XYLAN CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 1996
<TABLE>
<CAPTION>
INDEX
PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets -- June 30, 1996 and
December 31, 1995 3
Condensed Consolidated Statements of Operations --
Three Months Ended June 30, 1996, March 31, 1996, and
June 30, 1995 4
Six Months Ended June 30, 1996 and June 30, 1995 5
Condensed Consolidated Statements of Cash Flows --
Six Months Ended June 30, 1996, and June 30, 1995 6
Notes to Condensed Consolidated Financial Statements 7-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-23
PART II OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities 24
Item 3. Defaults in Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signature 25
Exhibit Index 26
</TABLE>
2
<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
XYLAN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1995
--------- -------------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents............................. $ 68,554 $ 6,034
Short-term investments................................ 58,066 --
Accounts receivable, net.............................. 14,722 13,142
Inventories........................................... 6,634 2,128
Note receivable....................................... 6,000 --
Prepaid expenses and other current assets............. 1,480 383
-------- --------
Total current assets................................. 155,456 21,687
Investments 15,429 --
Property and equipment, net 9,333 5,073
Other assets 382 488
-------- --------
$180,600 $ 27,248
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of capital lease obligations..... $ 340 $ 329
Accounts payable...................................... 4,675 7,371
Accrued expenses...................................... 5,107 2,258
Deferred revenue...................................... 1,603 599
-------- --------
Total current liabilities............................ 11,725 10,557
Capital lease obligations, less current installments... 338 509
Deferred revenue....................................... 905 77
-------- --------
Total liabilities.................................... 12,968 11,143
-------- --------
Shareholders' equity:
Convertible preferred stock........................... -- 26
Common stock and additional paid-in capital........... 178,105 31,012
Unearned compensation................................. (2,011) (887)
Accumulated deficit................................... (8,462) (14,046)
-------- --------
Net shareholders' equity............................. 167,632 16,105
-------- --------
$180,600 $ 27,248
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
XYLAN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------
JUNE 30, MARCH 31, JUNE 30,
1996 1996 1995
------- ------- -------
<S> <C> <C> <C>
Revenue.............................. $28,187 $23,392 $ 4,503
Cost of revenue...................... 13,225 10,823 2,659
------- ------- -------
Gross profit....................... 14,962 12,569 1,844
------- ------- -------
Operating expenses:
Research and development........... 3,484 3,194 1,646
Sales and marketing................ 7,039 5,800 3,336
General and administrative......... 1,081 989 605
------- ------- -------
Total operating expenses........... 11,604 9,983 5,587
------- ------- -------
Operating income (loss)........... 3,358 2,586 (3,743)
Interest income...................... 1,321 177 30
------- ------- -------
Income (loss) before income taxes.... 4,679 2,763 (3,713)
Income tax expense................... 1,778 80 --
------- ------- -------
Net income (loss).................. $ 2,901 $ 2,683 $(3,713)
======= ======= =======
Net income (loss) per share.......... $ 0.06 $ 0.06 $ (0.18)
======= ======= =======
Weighted average common and common
equivalent shares outstanding....... 46,996 43,957 21,151
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
XYLAN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-------------------
JUNE 30, JUNE 30,
1996 1995
------- -------
<S> <C> <C>
Revenue.............................. $51,579 $ 5,900
Cost of revenue...................... 24,048 3,620
------- -------
Gross profit....................... 27,531 2,280
------- -------
Operating expenses:
Research and development........... 6,678 2,685
Sales and marketing................ 12,839 5,424
General and administrative......... 2,070 955
------- -------
Total operating expenses........... 21,587 9,064
------- -------
Operating income (loss)............ 5,944 (6,784)
Interest income...................... 1,498 101
------- -------
Income (loss) before income taxes.... 7,442 (6,683)
Income tax expense 1,858 -
------- -------
Net income (loss).................. $ 5,584 $(6,683)
======= =======
Net income (loss) per share.......... $ 0.12 $ (0.32)
======= =======
Weighted average common and common
equivalent shares outstanding....... 45,528 21,151
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
XYLAN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------
JUNE 30, JUNE 30,
1996 1995
----------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)............................................. $ 5,584 $(6,683)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization................................ 1,298 293
Income tax expense........................................... 1,778 -
Consulting expense paid in common stock...................... - 6
Unearned compensation amortization........................... 271 -
Changes in operating assets and liabilities:
Accounts receivable........................................ (1,580) (4,130)
Inventories................................................ (4,506) 340
Prepaid expenses and other current assets.................. (1,097) (1,491)
Other assets............................................... 106 (232)
Accounts payable........................................... (2,696) 973
Accrued expenses........................................... 2,849 1,360
Deferred revenue........................................... 1,832 62
-------- -------
Net cash provided by (used) in operating
activities........................................ 3,839 (9,502)
-------- -------
Cash flows from investing activities:
Purchases of property and equipment.......................... (5,558) (1,497)
Note receivable.............................................. (6,000) -
Sales (purchases) of investments............................. (73,495) 335
-------- -------
Net cash used in investing activities................ (85,053) (1,162)
-------- -------
Cash flows from financing activities:
Proceeds from issuances of common stock and
common stock warrants....................................... 143,894 -
Proceeds from issuances of convertible preferred stock...... - 9,986
Repayments of debt.......................................... (160) -
-------- -------
Net cash provided by financing activities............ 143,734 9,986
-------- -------
Net increase (decrease) in cash and cash
equivalents....................................... 62,520 (678)
Cash and cash equivalents at beginning of period............... 6,034 731
-------- -------
Cash and cash equivalents at end of period..................... $ 68,554 $ 53
======== =======
Supplemental disclosure of cash flow information--
cash paid during the period for interest..................... $ 21 $ 24
======== =======
Supplemental disclosure of non-cash investing and financing
activities - financed capital expenditures................... $ - $ 644
======== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
XYLAN CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. Basis Of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, these statements include all
adjustments, consisting of normal and recurring adjustments, considered
necessary for a fair presentation of results for such periods. The results of
operations for the three and six month periods ending June 30, 1996 are not
necessarily indicative of results which may be achieved for the full fiscal year
or for any future period. The unaudited consolidated interim financial
statements should be read in conjunction with the financial statements and notes
thereto contained in Xylan Corporation's ("Xylan" or the "Company") Registration
Statement on Form S-1, File No. 333-03623, declared effective by the Securities
and Exchange Commission on May 29, 1996.
NOTE 2. Investments
Investments at June 30, 1996 consist of corporate and government debt
securities. In accordance with the provisions of Statement of Financial
Accounting Standards Board No. 115, "Accounting for Certain Investments in Debt
and Equity Securities," the Company classifies its investments as held-to-
maturity securities. The market value of these securities at June 30, 1996,
approximated cost.
NOTE 3. Accounts Receivable
During the three months ended June 30, 1996, the Company completed the
earnings process for products that were shipped during three months ended March
31, 1996. Accordingly, during the three months ended June 30, 1996 the Company
recognized the related revenue and cost of revenue, which had a net value of
$2.4 million.
NOTE 4. Inventories
Inventories are stated at the lower of cost or market, cost being
determined using the first-in, first-out method. At December 31, 1995,
inventories were primarily components parts. At June 30, 1996, inventories
consisted of the following:
Component parts $5,585,000
Finished Goods 1,049,000
----------
Total inventories $6,634,000
==========
7
<PAGE>
NOTE 5. Note Receivable
To increase the additional production of product from the Company's
contract manufacturer during the three months ended June 30, 1996, the Company
loaned its contract manufacturer $6 million. The loan is classified as a current
asset and is secured by raw materials and electronic components purchased by the
contract manufacturer. In July, the Company also guaranteed up to $5 million of
the contract manufacturers debt for inventory purchases.
NOTE 6. Shareholders' Equity
On March 12, 1996, the Company completed its initial public offering
of a total of 4,830,000 shares of common, of which 3,680,000 shares of common
stock were sold by the Company, and 1,150,000 shares were sold by a selling
shareholder. Aggregate net proceeds to the Company were approximately $87.4
million.
Upon the effectiveness of the initial public offering, all of the
25,698,676 outstanding shares of preferred stock were converted into the same
number of shares of common stock. Additionally, a warrant containing an
automatic net exercise provision was converted into 185,725 shares of common
stock.
On May 30, 1996, the Company completed a secondary public offering of
4,600,000 shares of common stock, of which 1,000,000 shares of common stock were
sold by the Company, and 3,600,000 shares were sold by certain selling
shareholders. Aggregate net proceeds to the Company were approximately $56.2
million.
The Company has a 1993 Stock Incentive Plan (the "1993 Plan"). Under
the 1993 Plan, 8,000,000 shares of the Company's authorized but unissued common
stock are reserved for options or stock purchase grants. As of June 30, 1996,
the Company has issued 1,042,849 shares of common stock and 6,622,477 granted
options are still outstanding. In connection with the grant of stock options,
for financial statement presentation purposes, the Company has recorded unearned
compensation, net of cancellations, of $2,336,000 for the difference between the
grant price and the deemed fair market value. This amount will be recorded as
compensation expense ratably over the vesting period for each option. For the
quarters ended June 30, 1996,and March 31, 1996, the Company recorded $114,000
and $157,000 of compensation expense, respectively. For the six months ended
June 30, 1996 the Company recorded $271,000 of compensation expense.
In January 1996, the Board of Directors adopted the 1996 Stock Option
Plan, the 1996 Employee Stock Purchase Plan and the 1996 Directors Stock Option
Plan. As of June 30, 1996 no options or shares have been granted under these
plans.
In July 1996 the Company and IBM entered into an alliance in the field
of campus networking switching products. The Company has commited to grant IBM
warrants to purchase up to 2,350,000 shares of Xylan common stock based on the
achievement of specific business goals. The exercise price of the warrants will
be at a 25% premium over the Xylan closing stock price when earned.
NOTE 7. Income Taxes
The Company's provision for income taxes for the three months ended
June 30, 1996 and March 31, 1996 and the six months ended June 30, 1996 is based
upon the Company's estimate of the effective tax rate for fiscal 1996. For the
quarter ended June 30, 1996, the Company realized an income tax benefit for
certain stock option transactions. This benefit is used to reduce taxable income
prior to the utilization of net operating loss carryforwards, and results in a
decrease in current income taxes payable and an increase in additional paid in
capital. Accordingly, the Company recorded an income tax provision equal to 38%
of pretax income but did not incur an income tax liability. For the quarter
ended March 31, 1996, the Company reduced the income tax provision and income
tax liability to 3% of pretax income by utilizing net operating loss
carryforwards. As a result of net operating losses, no provision for income
taxes was recorded for 1995. For the remainder of 1996, the Company expects to
record a 38% provision for income taxes, although such percentage may vary
depending on several factors, including tax benefits associated with certain
stock option transactions, the assessment of the deferred tax asset realization
probability and the international component of the Company's business. As of
December 31, 1995, the Company had available net operating loss carryforwards
for federal and state tax purposes of approximately $12.4 million and $6.2
million, respectively, to offset future United States tax obligations.
8
<PAGE>
NOTE 8. Computation Of Net Income (Loss) Per Share
Net income (loss) per common and common equivalent share has been
computed using the weighted average number of common and common equivalent
shares outstanding using the treasury stock method, as adjusted for the two-for-
one common stock split, effective as of February 28, 1996, for all periods
presented. Shares used in the net income (loss) per share calculation are
summarized as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
--------------------------------- --------------------
JUNE 30, MARCH 31, JUNE 30, JUNE 30, JUNE 30,
1996 1996 1995 1996 1995
---------- --------- --------- --------- --------
<S> <C> <C> <C> <C> <C>
Weighted average common
stock outstanding 40,963 37,364 10,320 39,350 10,320
Weighted average common
stock equivalents outstanding 6,033 6,593 10,831 6,178 10,831
------ ------ ------ ------ --------
Shares used in net income
(loss) per share calculation 46,996 43,957 21,151 45,528 21,151
====== ====== ====== ====== ========
</TABLE>
Pursuant to the requirements of the Securities and Exchange
Commission, common stock, stock options, warrants and convertible preferred
stock issued by the Company during the twelve months immediately preceding the
initial public offering date have been included in the calculation of the
weighted average shares outstanding for all periods presented using the treasury
stock method. Stock options, warrants and convertible preferred stock issued
prior to 1995 are excluded from the computation for the three and six months
ended June 30, 1995, as their inclusion would be antidilutive.
NOTE 9. Newly Adopted Financial Accounting Standards
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of". This statement provides
guidelines for recognition of impairment losses related to long-term assets. The
adoption of this new standard did not have a material effect on the Company's
consolidated financial statements.
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation"
("Statement No. 123"). This statement encourages, but does not require, a fair
value based method of accounting for employee stock options. The Company
elected to continue to measure compensation costs under APB Opinion No. 25,
"Accounting for Stock Issued to Employees" and to comply with the pro forma
disclosure requirements of Statement No. 123. The adoption of this standard had
no impact on the Company's consolidated financial statements.
9
<PAGE>
NOTE 10. Segment Information
<TABLE>
<CAPTION>
Customers comprising 10% or more of sales are as follows:
Three months ended Six months ended
---------------------------------------------------------------
June 30, March 31, June 30, June 30, June 30,
1996 1996 1995 1996 1995
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Customer A 27% 13% * 21% *
Customer B * 34% * 18% *
Customer C * 12% 21% * 16%
</TABLE>
_________________________
* Sales to these customers comprised less than 10% of sales for the respective
period.
Sales to customers outside of North America accounted for
approximately 65%, 67% and 37% of the Company's revenue in the three months
ended June 30, 1996, March 31, 1996 and June 30, 1995, respectively. Sales to
customers outside of North America accounted for approximately 66% and 41% of
the Company's revenue in the six months ended June 30, 1996 and 1995,
respectively. However, these percentages may understate sales of the Company's
products to international end users because certain of the Company's U.S.-based
OEM partners sell the Company's products abroad.
10
<PAGE>
ITEM 2. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations
Except for the historical information contained herein, the matters
discussed in this report are forward looking statements that involve certain
risks and uncertainties that could cause actual results to differ materially
from those in the forward-looking statements. Potential risks and uncertainties
include, without limitation, those mentioned in this report and, in particular
the factors described below under the heading "Factors Affecting Future
Results," and those mentioned in the Company's prospectus dated May 29, 1996,
under the heading "Risk Factors."
Overview
Xylan is a leading provider of high-bandwidth switching systems that
enhance the performance of existing local area networks ("LANs") and facilitate
migration to next-generation networking technologies such as asynchronous
transfer mode ("ATM"). From inception (July 9, 1993) to December 31, 1994, the
Company was primarily engaged in product research and development and in the
development of systems and operations. The Company began commercial shipments of
its initial OmniSwitch products in January 1995 and introduced the PizzaSwitch
product family in March 1996. The Company first achieved profitability in the
fourth quarter of 1995. As of June 30, 1996, the Company had an accumulated
deficit of $8.5 million.
The Company markets its products worldwide through OEM partners,
network integrators and its own sales force. As a percentage of revenue
aggregate sales to OEM partners and network integrators accounted for 47% and
48%, respectively, for the quarter ended June 30, 1996, 42% and 56%,
respectively, for the quarter ended March 31, 1996, 48% and 44%, respectively,
for the quarter ended June 30, 1995, 44% and 51%, respectively, for the six
months ended June 30, 1996 and 43% and 50%, respectively, for the six months
ended June 30, 1995.
The Company intends to continue to significantly increase its
investments in research and development, sales and marketing and related
infrastructure. Any such increases will be highly dependent on factors including
the continued growth of the Company's revenues and the rate thereof, success in
hiring the appropriate personnel and market acceptance of the Company's
products. Due to the anticipated increases in the Company's operating expenses,
the Company's operating results will be materially and adversely affected if
revenue does not increase. Xylan's limited operating history makes the
prediction of future annual or quarterly operating results difficult or
impossible. Although the Company has experienced revenue growth in all quarters
since revenue was first recognized, such growth rates will not be sustainable
and are not indicative of future operating results. There can be no assurance
that the Company will sustain profitability.
As Xylan only began commercial shipments of its OmniSwitch products in
January 1995, and due to the significant growth in both revenues and operating
expenses for the quarter ended June 30, 1996, versus the same quarter in 1995,
the Company believes that the comparison of the operating results for the
quarter ended June 30, 1996, versus the quarter ended March 31, 1996, is more
meaningful than the comparison of the quarter and six months ended June 30,
1996, versus the quarter and six months ended June 30, 1995, respectively.
Results Of Operations
Revenue
Revenue for the quarter ended June 30, 1996 was $28.2 million compared
to $23.4 million for the quarter ended March 31, 1996, an increase of 21%.
Revenue for the quarter ended June 30, 1995 was $4.5 million.
11
<PAGE>
Revenue for the six months ended June 30, 1996 was $51.6 million compared to
$5.9 million for the six months ended June 30, 1995. The increase in revenue was
due to a number of factors, including substantial growth of the LAN switching
market, continued introduction by the Company of additional features and
functions to its OmniSwitch product family and the introduction of the
PizzaSwitch product family in March 1996, significant shipments to customers in
Asia, market acceptance of the Company's LAN switching products, and the
Company's investment in sales and marketing efforts. The relative contribution
of most of these factors cannot be quantified, and future changes in an
individual factor therefore cannot be used to predict future revenue growth.
While the Company has achieved quarter-to-quarter revenue growth in previous
quarters, there can be no assurances that the Company will be able to sustain
this rate of sequential quarterly revenue growth in future periods.
<TABLE>
<CAPTION>
Customers comprising 10% or more of sales are as follows:
Three months ended Six months ended
----------------------------------------------------------------
June 30, March 31, June 30, June 30, June 30,
1996 1996 1995 1996 1995
----------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Customer A 27% 13% * 21% *
Customer B * 34% * 18% *
Customer C * 12% 21% * 16%
</TABLE>
_____________________________
* Sales to these customers comprised less than 10% of sales for the respective
period.
Sales to customers outside of North America accounted for
approximately 65%, 67% and 37% of the Company's revenue in the three months
ended June 30, 1996, March 31, 1996 and June 30, 1995, respectively. Sales to
customers outside of North America accounted for approximately 66% and 41% of
the Company's revenue in the six months ended June 30, 1996 and 1995,
respectively. However, these percentages may understate sales of the Company's
products to international end users because certain of the Company's U.S.-based
OEM partners sell the Company's products abroad.
Gross Profit
Gross margins were approximately 53.1%, 53.7% and 41.0% for the
quarters ended June 30, 1996, March 31, 1996 and June 30, 1995, respectively.
Gross margins were approximately 53.4% and 38.6% for the six months ended June
30, 1996 and 1995, respectively. The lower gross margins in the three and six
months ended June 30, 1995 as compared to the respective periods in 1996
resulted from allocating fixed costs over a smaller revenue base, costs
associated with tooling charges and smaller lot sizes during the early months of
the Company's initial product introduction. The decrease in gross margins from
the first quarter of 1996 to the second quarter of 1996 resulted primarily from
the increased sales mix to OEM partners, relative to sales to the Company's
network integrators which are typically made at higher margins.
The Company's gross margins in the future will be affected by a number
of factors, including product mix, competitive market pricing and discount
levels, manufacturing volumes and fluctuations in component costs. After
initial product introduction, the Company's strategy is to seek to reduce
component costs, particularly by integrating newly-developed ASICs into such
products. In addition, the timing and execution of new product introductions may
impact gross margins and result in excess or obsolete inventories. The Company's
gross margins may also fluctuate due to the mix of distribution channels
employed. The Company expects to realize higher gross margins on direct sales
than on sales through its OEM partners and network integrators. The Company has
recently entered into an agreement with IBM and may in the future enter into
additional OEM agreements, which could adversely affect gross margins. Although
gross margins may vary from quarter to quarter, the Company does not anticipate
significant improvements in gross margins during the remainder of 1996.
12
<PAGE>
Research and Development Expenses
Research and development expenses were $3.5 million, $3.2 million and
$1.6 million for the quarters ended June 30, 1996, March 31, 1996 and June 30,
1995, respectively. Research and development expenses were $6.7 million and $2.7
million for the six months ended June 30, 1996 and 1995, respectively. The
significant increases when comparing the three and six months ended June 30,
1996 with comparable periods of 1995 were primarily due to a significant
increase in the number of development personnel, additional product development
expenses incurred in connection with ongoing development of new products and
enhancements to the OmniSwitch and PizzaSwitch product family as well as
significant prototyping and tooling costs related to the final development and
test phases of new products. Research and development expenses increased 9.1%
from the first quarter of 1996 to the second quarter of 1996. This resulted from
significant expenditures in the first quarter of 1996 related to final
development and testing of the PizzaSwitch and enhancements to OmniSwitch
modules which were completed in the first quarter of 1996.
As a percentage of revenue, research and development expenses were
12%, 14% and 37% for the quarters ended June 30, 1996, March 31, 1996 and June
30, 1995, respectively. For the six months ended June 30, 1996 and 1995,
research and development expenses as a percentage of revenues were 13% and 46%,
respectively. These declines were primarily due to the increases in revenue.
The market for the Company's products is characterized by frequent new
product introductions and rapidly changing technology and industry standards,
any of which can render Xylan's existing products obsolete. As a result, the
Company's success will depend to a substantial degree upon its ability to
develop and introduce in a timely fashion new products and enhancements to its
existing products that meet changing customer requirements and emerging industry
standards. Accordingly, the Company expects to continue to make substantial
investments in research and development and anticipates that research and
development expenses will continue to increase in 1996 in absolute dollars.
Sales And Marketing Expenses
Sales and marketing expenses were $7.0 million, $5.8 million and $3.3
million for the quarters ended June 30, 1996, March 31, 1996 and June 30, 1995,
respectively. Sales and marketing expenses were $12.8 million and $5.4 million
for the six months ended June 30, 1996 and 1995, respectively. This represents
an increase of 21% from the first quarter of 1996 to the second quarter of 1996,
an increase of 111% from the second quarter of 1995 to the second quarter of
1996 and an increase of 137% from the six months ended June 30, 1995 as compared
to the six months ended June 30, 1996. These increases were primarily due to
expenses related to the addition of Xylan sales personnel throughout the United
States, Europe and Asia, increased commission expenses resulting from higher
sales, and advertising and promotional campaigns in support of the Company's
direct sales and network integrator channels. The Company incurred additional
sales and marketing expenses in connection with the launch of the PizzaSwitch
product in March 1996, the introduction of additional features and enhancements
to the OmniSwitch product family and demonstration equipment used for customer
trials.
As a percentage of revenue, sales and marketing expenses were 25%, 25%
and 74% for the quarters ended June 30, 1996, March 31, 1996 and June 30, 1995,
respectively. For the six months ended June 30, 1996 and 1995 sales and
marketing expenses as a percentage of revenues were 25% and 92%, respectively.
These declines were again primarily due to the increases in revenue.
As the Company continues to expand its sales force, adding
personnel and offices worldwide, and to introduce new products and enhancements
to its existing products, it expects that sales and marketing expenses will
continue to increase in 1996 in absolute dollars.
13
<PAGE>
General And Administrative Expenses
General and administrative expenses were $1.1 million, $1.0 million
and $0.6 million for the quarters ended June 30, 1996, March 31, 1996 and June
30, 1995, respectively. General and administrative expenses were $2.1 million
and $1.0 million for the six months ended June 30, 1996 and 1995, respectively.
This represents an increase of 9% from the first quarter of 1996 to the second
quarter of 1996, an increase of 79% from the second quarter of 1995 to the
second quarter of 1996 and an increase of 117% from the six months ended June
30, 1995 as compared to the six months ended June 30, 1996. The increases for
the three and six months ended June 30, 1996 as compared to the same periods in
1995 reflect the addition of personnel and systems to support the growth of
Xylan's business.
As a percentage of revenue, general and administrative expenses were
4%, 4% and 13% for the quarters ended June 30, 1996, March 31, 1996 and June 30,
1995, respectively. For the six months ended June 30, 1996 and 1995 general and
administrative expenses as a percentage of revenues were 4% and 16%,
respectively. The decreases for the three and six months ended June 30, 1996 as
compared to the same periods in 1995 reflect the increases in revenue.
As the Company continues to expand its sales force, add personnel and
offices worldwide, and introduce new products and enhancements to its existing
products, it expects that general and administrative expenses will continue to
increase in 1996 in absolute dollars.
Interest Income
Interest income was $1.3 million, $177,000 and $30,000 for the
quarters ended June 30, 1996, March 31, 1996 and June 30, 1995, respectively.
Interest income was $1.5 million and $101,000 for the six months ended June 30,
1996 and 1995, respectively. The increase in interest income for the second
quarter of 1996 over the first quarter of 1996 and the second quarter of 1995 is
the result of interest income earned on the net proceeds of $87.4 million and
$56.2 million from the Company's initial public offering in March 1996 and the
Company's secondary public offering in May 1996, respectively. This was also the
reason for the increase in interest income for the six months ended June 30,
1996 over the six months ended June 30, 1995.
Provision For Income Taxes
The Company's provision for income taxes for the three months ended
June 30, 1996 and March 31, 1996 and the six months ended June 30, 1996 is based
upon the Company's estimate of the effective tax rate for fiscal 1996. For the
quarter ended June 30, 1996, the Company realized an income tax benefit for
certain stock option transactions. This benefit is used to reduce taxable
income prior to the utilization of net operating loss carryforwards, and results
in a decrease in current income taxes payable and an increase in additional paid
in capital. Accordingly, the Company recorded an income tax provision equal to
38% of pretax income but did not incur an income tax liability. For the quarter
ended March 31, 1996, the Company reduced the income tax provision and income
tax liability to 3% of pretax income by utilizing net operating loss
carryforwards. As a result of net operating losses, no provision for income
taxes was recorded for 1995. For the remainder of 1996, the Company expects to
record a 38% provision for income taxes, although such percentage may vary
depending on several factors, including tax benefits associated with certain
stock option transactions, the availability of research and development tax
credits and the international component of the Company's business. As of
December 31, 1995, the Company had available net operating loss carryforwards
for federal and state tax purposes of approximately $12.4 million and $6.2
million, respectively, to offset future United States tax obligations.
Liquidity And Capital Resources
Since inception, the Company has financed its operations and capital
expenditures principally through the sale of Common Stock and Preferred Stock,
for aggregate proceeds of approximately $178 million, and capital lease and
other debt financing. For the six months ended June 30, 1996 and 1995 cash
provided by (utilized in) operating activities was $3.8 million and ($9.5
million), respectively. The increase in cash provided by operations is primarily
the result of the increase in net income partially offset by increased
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working capital necessary to fund the significantly expanded operations and the
resulting inventories and accounts receivable.
For the six months ended June 30, 1996 and 1995 capital expenditures
aggregated $5.6 million and $1.5 million, respectively. To increase the
additional production of product from the Company's contract manufacturer during
the three months ended June 30, 1996, the Company loaned its contract
manufacturer $6 million. The loan is classified as a current asset and is
secured by raw materials and electronic components purchased by the contract
manufacturer. In July, the Company also guaranteed up to $5 million of the
contract manufacturer's debt for inventory purchases.
The Company requires substantial working capital to fund its business,
particularly to finance inventories and accounts receivables and for capital
expenditures. The Company's future capital requirements will depend on many
factors, including the rate of revenue growth, the timing and extent of spending
to support product development efforts and expansion of sales and marketing, the
timing of introductions of new products and enhancements to existing products,
and market acceptance of the Company's products. There can be no assurance that
additional equity or debt financing, if required, will be available on
acceptable terms or at all.
The Company's principal sources of liquidity as of June 30, 1996
consisted of $69 million in cash and cash equivalents, $58 million in short-term
investments and a $7.5 million bank credit facility. The Company believes that
existing cash and investment balances and cash flow expected to be generated
from future operations, will be sufficient to meet the Company's requirements
for at least the next 12 months.
Factors Affecting Future Results
LIMITED OPERATING HISTORY; RECENT PROFITABILITY; UNCERTAIN FUTURE
PROFITABILITY. The Company was organized in July 1993 and began shipping its
first LAN switching products in volume in the first quarter of 1995. The
Company's initial products offered limited interfaces and, in September 1995,
the Company began offering fully-featured products. Accordingly, the Company has
only a limited operating history upon which an evaluation of the Company and its
prospects can be based. As of June 30, 1996, the Company had an accumulated
deficit of $8.5 million. The Company has experienced substantial revenue growth
since January 1995, and first achieved profitability in the fourth quarter of
1995. Due to the Company's limited operating history, there can be no assurance
of revenue growth and profitability on a quarterly or annual basis in the
future. While the Company achieved significant quarter-to-quarter revenue growth
since it introduced its products in 1995, there can be no assurance that the
Company will be able to sustain the same rate of sequential quarterly revenue
growth in future periods. The Company intends to increase significantly its
investments in 1996 in research and development, sales and marketing and related
infrastructure. Any such increases will be highly dependent on factors including
the continued growth of the Company's revenues and the rate thereof, success in
hiring the appropriate personnel and market acceptance of the Company's
products. Due to the anticipated increases in the Company's operating expenses,
the Company's operating results will be adversely affected if revenue does not
increase. The Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development, particularly companies in rapidly evolving markets. To
address these risks, the Company must, among other things, successfully increase
the scope of its operations, respond to competitive developments, continue to
attract, retain and motivate qualified personnel and continue to commercialize
products incorporating advanced technologies. There can be no assurance that the
Company will be successful in addressing such risks.
FLUCTUATIONS IN OPERATING RESULTS. The Company's revenue and operating
results may fluctuate from quarter to quarter and from year to year due to a
combination of factors, including (i) the timing and amount of significant
orders from the Company's OEM partners and network integrators, (ii) the
Company's success in developing, introducing and shipping product enhancements
and new products, (iii) the ability to obtain sufficient supplies of sole or
limited source components for the Company's products, (iv) the ability to attain
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and maintain production volumes and quality levels for its products, (v) the mix
of distribution channels and products, (vi) new product introductions by the
Company's competitors, (vii) pricing actions by the Company or its competitors,
(viii) changes in material costs and (ix) general economic conditions. See
"Factors Affecting Future Results--Dependence on OEM Partners and Network
Integrators; Customer Concentration," "--Dependence on Sole and Limited Source
Suppliers and Availability of Components," "--Substantial Increase in
Manufacturing Operations; Dependence on Contract Manufacturing," "--
Competition," "--Rapid Technological Change; New Products and Evolving Markets,"
"--Uncertain Market Acceptance of the Company's Products; Product Concentration"
and "--Product Complexity."
The Company's revenue in any period is highly dependent upon the sales
efforts and success of Xylan's OEM partners and network integrators, which are
not within the control of the Company. The Company generally realizes a higher
gross margin on direct sales than on sales through its OEM partners and network
integrators. Accordingly, if the Company's OEM partners and network integrators
were to account for an increased portion of the Company's revenue, gross margins
would decline. In addition, new products may have different gross margins than
existing products. In particular, the Company's PizzaSwitch product, introduced
in the first quarter of 1996, currently has a lower gross margin than the
OmniSwitch product. A significant portion of the Company's expenses, such as
rent, headcount and capital lease expenses, are relatively fixed in advance,
based in large part on the Company's forecasts of future sales. If sales are
below expectations in any given period, the adverse effect of a shortfall in
sales on the Company's operating results may be magnified by the Company's
inability to adjust spending to compensate for such shortfall. The Company's
backlog at the beginning of each quarter typically is not sufficient to achieve
expected revenue for that quarter. To achieve its revenue objectives, the
Company is dependent upon obtaining orders in a quarter for shipment in that
quarter. Furthermore, the Company's agreements with its customers typically
provide that they may change delivery schedules and cancel orders within
specified timeframes without significant penalty. The Company's industry is
characterized by short product life cycles and declining prices of existing
products, which requires continual improvement of manufacturing efficiencies and
introduction of new products and enhancements to existing products to maintain
gross margins. Moreover, in response to competitive pressures or to pursue new
product or market opportunities, the Company may take certain pricing or
marketing actions that could materially and adversely affect the Company's
operating results. For example, a reduction in prices of the Company's products
could result in lower revenues, an increase in discounts offered to the
Company's OEM partners or network integrators would adversely affect the
Company's operating margins, and a substantial targeted marketing campaign could
significantly increase marketing expense and result in decreased profitability.
As a result of all of the foregoing, there can be no assurance that the Company
will be able to achieve or sustain profitability on a quarterly or annual basis.
In addition, it is possible that in some future quarter the Company's operating
results may be below the expectations of public market analysts and investors.
In such event, the price of the Company's Common Stock would likely be
materially and adversely affected.
COMPETITION. The market for network switching products is intensely
competitive and subject to frequent product introductions with improved
price/performance characteristics, rapid technological change and continued
emergence of new industry standards. Many networking companies, including Bay
Networks, Inc., Cabletron Systems, Inc., Cisco Systems, Inc., FORE Systems, Inc.
and 3Com Corporation, have introduced, or have announced their intention to
develop, network switching products that are or will be competitive with the
Company's products. In addition, many of the Company's large competitors offer
customers a broader product line which provides a more comprehensive networking
solution than the Company currently offers. Xylan expects that other companies
will also enter markets in which the Company competes. In addition to
competition from providers of network switching products, the Company expects to
face competition from other vendors in the networking market who may incorporate
switching functionality into their products or provide alternative network
solutions. Furthermore, the Company's OEM partners may in the future develop
competitive products and may then decide to terminate their relationships with
the Company. In addition, certain of the Company's OEMs could sell competitive
products using the Company's technology. Many of the Company's current and
potential competitors have longer operating histories and substantially greater
financial, technical, sales, marketing and other resources, as well as greater
name recognition and a larger installed customer base, than the Company. As a
result, these competitors may be able to devote greater resources to the
development, promotion, sale and
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support of their products than the Company. In addition, competitors with a
larger installed customer base may have a competitive advantage over the Company
when selling similar products or alternative networking solutions to such
customers. Increased competition could result in significant price competition,
reduced profit margins or loss of market share, any of which could have a
material adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that the Company will be able to
compete successfully against either current or potential competitors in the
future. See "Factors Affecting Future Results--Dependence on Proprietary
Technology; Intellectual Property Litigation."
SUBSTANTIAL INCREASE IN MANUFACTURING OPERATIONS; DEPENDENCE ON
CONTRACT MANUFACTURING. The Company is in the process of substantially
increasing its flow of materials, contract manufacturing capacity and internal
test and quality functions to respond to customer demand and reduce its order
lead times. Any inability or delay in increasing product flow would limit the
Company's revenue, could adversely affect the Company's competitive position and
could result in late fees or cancellation of orders under agreements with the
Company's OEM partners, although these have not occurred to date. The Company
currently requires additional manufacturing space and is in the process of
leasing an additional 40,000 square feet of space (a portion of which will be
used for manufacturing) that is scheduled to be occupied during September 1996.
Any delay in leasing or occupying this additional space, or interruption in the
normal flow of production as the Company expands manufacturing activities to
this new facility, could have a material adverse effect on the Company's
business, operating results and financial condition. The Company may also
require manufacturing space beyond this additional 40,000 square foot facility
in 1996 or thereafter. There can be no assurance that such additional space, if
required, will be available in a timely manner or on commercially reasonable
terms.
Xylan's operational strategy relies on outsourcing of manufacturing.
The Company currently subcontracts component procurement and assembly of chassis
to a single company, and printed circuit board assembly to a single company each
of which specializes in the particular services provided. In connection with its
operational strategy, the Company is seeking to secure additional sources of
supply, including additional contract manufacturers. The Company has experienced
in the past, and may in the future experience, problems with its contract
manufacturers, such as inferior quality, insufficient quantities and late
delivery of product. While such problems have not resulted in any material
liabilities from the Company to its customers or end-users to date, there can be
no assurance that such problems will not generate material liabilities for the
Company or adversely impact the Company's relations with its customers and end-
users in the future. To increase the additional production of product from the
Company's contract manufacturer during the three months ended June 30, 1996, the
Company loaned its contract manufacturer $6 million. The loan is classified as
a current asset and is secured by raw materials and electronic components
purchased by the contract manufacturer. In July, the Company also guaranteed up
to $5 million of the contract manufacturers debt for inventory purchases. Any
additional loans or guaranties to the Company's contract adverse affect upon the
Company's business, operating results and financial condition. In addition, the
Company may in the future experience pricing pressure from its contract
manufacturers. To date, the Company has had only limited experience with the use
of contract manufacturers. There can be no assurance that the Company will
effectively manage its contract manufacturers or that these manufacturers will
meet the Company's future requirements for timely delivery of products of
sufficient quality and quantity. The Company intends to introduce a number of
new products and product enhancements in 1996 and 1997, which will require that
the Company rapidly achieve volume production by coordinating its efforts with
those of its suppliers and contract manufacturers. Certain of the Company's
products in development will require contract manufacturers to adopt or develop
advanced manufacturing techniques, which could inhibit volume manufacturing of
those products. The inability of Xylan's contract manufacturers to provide it
with adequate supplies of high-quality products or the loss of any of the
Company's contract manufacturers could cause a delay in Xylan's ability to
fulfill orders while the Company identifies a replacement manufacturer and could
have a material adverse effect upon the Company's business, operating results
and financial condition.
DEPENDENCE ON SOLE AND LIMITED SOURCE SUPPLIERS AND AVAILABILITY OF
COMPONENTS. Several key components used in the manufacture of the Company's
products are currently purchased only from single or limited sources. At
present, single-sourced components include ASICs, processors, selected
integrated circuits, programmable integrated circuits, cables and custom-tooled
sheet metal; and limited-sourced components include flash memories, dynamic
random access memories ("DRAMs"), and printed circuit boards. The Company
generally does not have long-term agreements with any of these single or limited
sources of supply. The Company is in the process of incorporating ASICs in many
of its products. As stated above, each of these ASICs is initially being
manufactured only by a single source, particularly LSI Logic Corporation, and
accordingly the risks of relying on sole sources is expected to increase. Any
interruption in the supply of any of these components, or the inability of the
Company to procure these components from alternate sources at acceptable
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prices and within a reasonable time, could have a material adverse effect upon
the Company's business, operating results and financial condition. Qualifying
additional suppliers is time consuming and expensive and the likelihood of
errors is greater with new suppliers. The Company uses a rolling six-month
forecast based on anticipated product orders to determine its general materials
and components requirements. Lead times for materials and components ordered by
the Company vary significantly, and depend on factors such as the specific
supplier, contract terms and demand for a component at a given time. If orders
do not match forecasts, the Company may have excess or inadequate inventory of
certain materials and components. From time to time the Company has experienced
shortages and allocations of certain components and has experienced delays in
filling orders while waiting to obtain the necessary components. Given current
worldwide demand for integrated circuits and certain other components used by
the Company and the complexity and yield problems in manufacturing such
integrated circuits and components, such shortages and allocations are likely to
occur in the future and could have a material adverse effect on the Company's
business, operating results and financial condition.
MANAGEMENT OF GROWTH. The Company's recent growth has placed a
significant strain on the Company's financial and management personnel and
information systems and controls. This growth has resulted in a continuing
increase in the level of responsibility for both existing and new management
personnel. The Company recently implemented new and enhanced financial and
management information systems and controls and is training its personnel to
operate such systems. Any difficulty in the operation of such new and enhanced
systems or the training of personnel, or any disruptions in the transition to
such new or enhanced systems and controls, could adversely affect the Company's
ability to accurately forecast sales demand and calibrate manufacturing to such
demand, to calibrate purchasing levels, to accurately record and control
inventory levels, and to record and report financial and management information
on a timely and accurate basis. Due to its rapid growth and the fact that such
systems and controls had not been implemented, the Company experienced each of
these problems in 1995. The occurrence of the Company's problems with
forecasting sales demands did not result in shortfalls in projected revenues in
1995. However, the occurrence of any of these events in the future could have a
material adverse effect on the Company's business, financial condition and
results of operations.
DEPENDENCE ON OEM PARTNERS AND NETWORK INTEGRATORS; CUSTOMER
CONCENTRATION. The Company is pursuing a sales and marketing strategy focused on
developing three channels of distribution for its products: worldwide OEM
partners, network integrators in North America and overseas and direct sales.
The Company has established OEM partnerships with leading communications and
networking companies, including Alcatel N.V. ("Alcatel"), Digital Equipment
Corporation ("Digital"), Hitachi Computer Products (America), Inc. ("Hitachi"),
and Network Systems Corporation. In July 1996 the Company entered into an
alliance with IBM in the field of campus network switching products. Under this
alliance, IBM and Xylan will be able to offer the other company's LAN products
for resale. In addition, the parties will form a joint development organization
using certain of the other company's LAN technology. Both companies will have
the right to manufacture and sell each other's campus switching products in
exchange for a royalty. Although there is a large number of end-users of Xylan's
products, the Company's customer base is highly concentrated and a relatively
small number of customers have accounted for a significant portion of the
Company's revenue to date. The Company's OEM partners and network integrators
account, and are expected to continue to account, for a substantial portion of
the Company's net revenue. As a percentage of revenue aggregate sales to OEM
partners and network integrators accounted for 47% and 48%, respectively, for
the quarter ended June 30, 1996, 42% and 56% respectively, for the quarter ended
March 31, 1996, 48% and 44%, respectively, for the quarter ended June 30, 1995,
44% and 51%, respectively, for the six months ended June 30, 1996 and 43% and
50%, respectively, for the six months ended June 30, 1995. Each of the Company's
OEM partners and network integrators can cease marketing the Company's products
with limited notice to Xylan and with little or no penalty. In addition, the
Company's agreements with its OEM partners and network integrators generally
provide for discounts based on expected or actual volumes of products purchased
or resold by the reseller in a given period and do not require minimum
purchases. Certain of these agreements provide manufacturing rights and access
to source code upon the occurrence of specified conditions or defaults.
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Certain of the Company's OEM agreements provide for limited exclusivity. The
Company expects that certain of its OEM partners will in the future develop
competitive products and, if they do so, they may decide to terminate their
relationship with the Company. In addition, many of the Company's resellers
offer competitive products manufactured either by third parties or by
themselves. Furthermore, certain of the Company's OEM partners and network
integrators offer alternative networking solutions, designed by themselves or
third parties, or have pre-existing relationships with current or potential
competitors of the Company. There can be no assurance that the Company's OEM
partners and network integrators will give a high priority to the marketing of
the Company's products as compared to competitive products or alternative
networking solutions or that Xylan's OEM partners and network integrators will
continue to offer the Company's products. Any reduction or delay in sales of the
Company's products by its OEM partners and network integrators could have a
material adverse effect on the Company's business, operating results and
financial condition. There can be no assurance that the Company will retain its
current OEM partners or network integrators or that it will be able to recruit
additional or replacement OEM partners or network integrators. The loss of one
or more of the Company's OEM partners or network integrators could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company generally realizes a higher gross margin on
direct sales than on sales through its OEM partners and network integrators.
Accordingly, if the Company's OEM partners and network integrators were to
account for an increased portion of the Company's revenue, its gross margin
would decline.
RAPID TECHNOLOGICAL CHANGE; NEW PRODUCTS AND EVOLVING MARKETS. The
market for the Company's products is characterized by frequent new product
introductions, rapidly changing technology and continued emergence of new
industry standards, any of which could render Xylan's existing products
obsolete. The Company's success will depend to a substantial degree upon its
ability to develop and introduce in a timely fashion new products and
enhancements to its existing products that meet changing customer requirements
and emerging industry standards. The development of new, technologically
advanced products is a complex and uncertain process requiring high levels of
innovation, as well as the accurate anticipation of technological and market
trends. There can be no assurance that the Company will be able to identify,
develop, manufacture, market or support new or enhanced products successfully or
on a timely basis, that new Company products will gain market acceptance or that
the Company will be able to respond effectively to product announcements by
competitors, technological changes or emerging industry standards. In addition,
the Company has on occasion experienced delays in the introduction of new
products and product enhancements. Furthermore, from time to time, the Company
may announce new products or product enhancements, capabilities or technologies
that have the potential to replace or shorten the life cycle of the Company's
existing product offerings and that may cause customers to defer purchasing
existing Company products or cause resellers to return products to the Company.
The market for LAN switch products is evolving and the Company believes its
ability to compete successfully in this market is dependent upon the continued
compatibility and interoperability of its products with products and
architectures offered by various vendors, including workstation and personal
computer architectures and computer and network operating systems. There can be
no assurance that the Company will be able to effectively address the
compatibility and interoperability issues raised by technological changes or
evolving industry standards. A key element of the Company's strategy is the
development of multiple ASICs to increase system performance and reduce
manufacturing costs, thereby enhancing the price/performance of the Company's
products. Any failure to continue to introduce new products or product
enhancements and develop and incorporate ASICs effectively and on a timely
basis, customer delays in purchasing products in anticipation of new product
introductions or any inability of the Company to respond effectively to product
announcements by competitors, technological changes or emerging industry
standards could have a material adverse effect on the Company's business,
operating results and financial condition.
UNCERTAIN MARKET ACCEPTANCE OF THE COMPANY'S PRODUCTS; PRODUCT
CONCENTRATION. The Company currently derives substantially all of its revenue
from its OmniSwitch and PizzaSwitch products and the Company expects that
revenue from these products will continue to account for a substantial portion
of the Company's revenue at least through 1997. Broad market acceptance of these
products is, therefore, critical to the Company's future success. Factors that
may affect the market acceptance of the Company's products
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include market acceptance of network switching products, the availability and
price of competing products and technologies and the success of the sales
efforts of the Company and its OEM partners and network integrators. Moreover,
the Company's operating history in the network switching market and its
resources are limited relative to those of certain of its current and potential
competitors. The Company's future performance will also depend in part on the
successful development, introduction and market acceptance of new and enhanced
products. Failure of the Company's products to achieve market acceptance would
have a material adverse effect on the Company's business, operating results and
financial condition.
PRODUCT COMPLEXITY. Products as complex as those offered by the
Company frequently contain undetected software or hardware errors when first
introduced or as new versions are released. As is common among participants in
the Company's industry, the Company has experienced such errors in the past in
connection with product upgrades and new products. Despite testing by the
Company and by current and potential customers, Xylan expects that such errors
will be found from time to time in new or enhanced products after commencement
of commercial shipments. The Company believes it has addressed these errors when
they have occurred through software and hardware revisions. However, the
occurrence of such errors could, and the inability to correct such errors would,
result in the delay or loss of market acceptance of the Company's products,
additional expense, diversion of engineering and other resources from the
Company's product development efforts and the loss of credibility with Xylan's
OEM partners, network integrators and end users, any of which would have a
material adverse effect on the Company's business, operating results and
financial condition.
DEPENDENCE ON PROPRIETARY TECHNOLOGY; INTELLECTUAL PROPERTY
LITIGATION. The Company's success and its ability to compete is dependent, in
part, upon its proprietary technology. The Company does not hold any issued
patents and currently relies on a combination of contractual rights, trade
secrets and copyright laws to establish and protect its proprietary rights in
its products. There can be no assurance that the steps taken by the Company to
protect its intellectual property will be adequate to prevent misappropriation
of its technology or that the Company's competitors will not independently
develop technologies that are substantially equivalent or superior to the
Company's technology. In the event that protective measures are not successful,
the Company's business, operating results and financial condition could be
materially and adversely affected. In addition, the laws of some foreign
countries do not protect the Company's proprietary rights to the same extent as
do the laws of the United States.
The Company is also subject to the risk of adverse claims and
litigation alleging infringement of intellectual property rights of others. On
June 8, 1995, a suit alleging misappropriation of trade secrets, infringement of
U.S. Patent No. 5,394,402 and improper hiring of employees was brought against
Xylan by Ascom Timeplex Inc. ("Ascom Timeplex") in the U.S. District Court for
the Central District of California in Los Angeles, California, seeking
injunctive relief and unspecified monetary damages. The Company and Ascom
Timeplex have signed a binding memorandum of understanding to settle this
litigation and dismiss all of Ascom Timeplex's charges against the Company and
against Steve Y. Kim, John Bailey and another employee named in Ascom Timeplex's
complaint, and otherwise release the parties from all claims. The settlement
also involves a royalty-free license to the Company of Ascom Timeplex's virtual
LAN technology covered by the patent and a royalty-free license to Ascom
Timeplex of certain technology embodied in the Company's currently available
products for use in and in connection with Ascom Timeplex's Synchrony product
family. These licenses are not assignable other than to a successor-in-interest
to Ascom Timeplex. The Company also undertakes to transfer a copy of the
licensed technology to Ascom Timeplex and for a specified time not to hire Ascom
Timeplex employees. The release by Ascom Timeplex is conditioned on transfer of
this technology. While the court recently dismissed Ascom Timeplex's charges
with prejudice in connection with the settlement, there can be no assurance that
future disputes will not arise between the parties with respect to the
settlement or otherwise.
Since patent applications in the United States are not publicly
disclosed until the patent issues, applications may have been filed which, if
issued as patents, would relate to the Company's products. In addition, the
Company has not conducted a comprehensive patent search relating to the
technology used in its
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products. The Company is subject to the risk of claims and litigation alleging
infringement of the intellectual property rights of others. In addition to the
claims of Ascom Timeplex, Xylan has, from time to time, received claims from
third parties alleging infringement of such third parties' intellectual property
rights. The Company believes that none of the current claims against the Company
would result in material liability if successful. Although such claims have not
resulted in material litigation to date, there can be no assurances that such
claims will not be successful or generate material litigation in the future.
Furthermore, there can be no assurance that third parties will not assert
infringement claims against the Company in the future based on patents or trade
secrets or that such claims will not be successful. The Company could incur
substantial costs in defending itself and its customers against any such claims,
regardless of the merits of such claims. Parties making such claims may be able
to obtain injunctive or other equitable relief which could effectively block the
Company's ability to sell its products in the United States and abroad, and
could result in an award of substantial damages. In the event of a successful
claim of infringement, the Company, its customers and end-users may be required
to obtain one or more licenses from third parties. There can be no assurance
that the Company or its customers could obtain necessary licenses from third
parties at a reasonable cost or at all. The defense of any lawsuit could result
in time-consuming and expensive litigation, damages, license fees, royalty
payments and restrictions on the Company's ability to sell its products, any of
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON KEY PERSONNEL AND HIRING OF ADDITIONAL PERSONNEL. The
Company's success depends to a significant degree upon the continued
contributions of its key management, engineering, sales and marketing and
manufacturing personnel, many of whom would be difficult to replace. In
particular, the Company believes that its future success is highly dependent on
Steve Y. Kim, Chairman, President and Chief Executive Officer and John Bailey,
Vice President of Development. The Company does not have employment contracts
with, and does not currently maintain key man life insurance covering, its key
personnel. The Company believes its future success will also depend in large
part upon its ability to attract and retain highly skilled managerial,
engineering, sales and marketing, finance and manufacturing personnel.
Competition for such personnel is intense, and there can be no assurance that
the Company will be successful in attracting and retaining such personnel. In
July 1996, the Company announced the resignation of the Company's vice president
and chief financial officer, C. Stephen Cordial. The loss of the services of any
of the key personnel, the inability to attract or retain qualified personnel in
the future or delays in hiring required personnel, particularly the chief
financial officer, engineers and sales personnel, could have a material adverse
effect on the Company's business, operating results or financial condition. In
July 1996, the Company announced the resignation of the Company's vice president
and chief financial officer, C. Stephen Cordial. Mr. Cordial will consult for
the Company and assist in the Company's nationwide search for a new chief
financial officer. In addition, companies in the networking industry whose
employees accept positions with competitive companies frequently claim that
their competitors have engaged in unfair hiring practices. Xylan has, from time
to time, received such claims from other companies and, although claims to date
have not resulted in material litigation other than in connection with Ascom
Timeplex, there can be no assurance that the Company will not receive additional
claims in the future as it seeks to hire qualified personnel or that such claims
will not result in material litigation involving the Company. The Company could
incur substantial costs in defending itself against any such claims, regardless
of the merits of such claims. To date, the Company has not lost any employees as
a result of such claims.
INTERNATIONAL OPERATIONS. The Company's sales to customers outside of
the United States accounted for approximately 65% and 49% of the Company's
revenue in the second quarter of 1996 and fiscal 1995, respectively. However,
these percentages may understate sales of the Company's products to
international end-users because certain of the Company's U.S.-based OEM partners
market the Company's products abroad. The Company's international sales are
conducted primarily through its OEM partners and independent territory-specific
network integrators. Failure of the Company's OEM partners and network
integrators to effectively market the Company's products internationally or the
loss of any of these resellers could have a material adverse effect on the
Company's business, operating results and financial condition. A number of
additional risks are inherent in international operations. The Company's
international sales currently are U.S. dollar-denominated. As a result, an
increase in the value of the U.S. dollar relative to foreign currencies could
make the Company's products less competitive in international markets.
International sales may also be limited or disrupted by the imposition of
governmental controls, export license requirements, restrictions on the export
of critical technology, currency exchange fluctuations, political instability,
trade restrictions and changes in tariffs. The Company's operating results could
also be adversely affected by seasonality of international sales,
21
<PAGE>
for example, industry sales are typically lower in Europe in the third calendar
quarter. These international factors could have a material adverse effect on
future sales of the Company's products to international end-users and,
consequently, the Company's business, operating results and financial condition.
MARKET FOR NETWORK SWITCHES; GENERAL ECONOMIC CONDITIONS. Demand for
the Company's products depends in large part on overall demand for network
switching products, which may in the future fluctuate significantly based on
numerous factors, including adoption of alternative technologies, capital
spending levels and general economic conditions. While certain analysts believe
that there is a significant market for network switches, there can be no
assurance as to the rate or extent of the growth of this market. There can be no
assurance that the Company will not experience a decline in demand for its
products, which would have a material adverse effect on the Company's business,
operating results and financial condition.
NEED FOR ADDITIONAL CAPITAL. The Company requires substantial working
capital to fund its business, particularly to finance inventories and accounts
receivable and for capital expenditures. The Company believes that its existing
cash balances, together with its line of credit and cash flow expected to be
generated from future operations, will be sufficient to meet the Company's
capital requirements through at least the end of 1996, although the Company
could be required, or could elect, to seek to raise additional capital during
1996. The Company's future capital requirements will depend on many factors,
including the rate of revenue growth, the timing and extent of spending to
support product development efforts and expansion of sales and marketing, the
timing of introductions of new products and enhancements to existing products,
and market acceptance of the Company's products. The Company expects that it may
need to raise additional equity or debt financing in the future. There can be no
assurance that additional equity or debt financing, if required, will be
available on acceptable terms or at all.
REGULATORY MATTERS. The Company's products must meet industry
standards and receive certification for connection to certain public
telecommunications networks prior to their sale. In the United States, the
Company's products must comply with various regulations defined by the Federal
Communications Commission and Underwriters Laboratories. Internationally, the
Company's products must comply with standards established by telecommunications
authorities in various countries as well as with recommendations of the
International Telecommunication Union. Although the Company's products have not
been denied any regulatory approvals or certifications to date, any future
inability to obtain on a timely basis or retain domestic or foreign regulatory
approvals or certifications or to comply with existing or evolving industry
standards could have a material adverse effect on the Company's business,
operating results and financial condition.
ANTI-TAKEOVER PROVISIONS. Certain provisions of the Company's charter
documents, including provisions eliminating the ability of shareholders to take
action by written consent and limiting the ability of shareholders to raise
matters at a meeting of shareholders without giving advance notice, may have the
effect of delaying or preventing changes in control or management of the
Company, which could have an adverse effect on the market price of the Company's
Common Stock. In addition, effective upon qualification of the Company as a
"listed corporation," as defined in Section 301.5(d) of the California
Corporations Code (the "California Code"), the Company's charter documents will
eliminate cumulative voting and provide that the Company's Board of Directors
will be divided into two classes, each of which serves for a staggered two-year
term, which may make it more difficult for a third party to gain control of the
Company's Board of Directors. The Board of Directors has authority to issue up
to 5,000,000 shares of Preferred Stock and to fix the rights, preferences,
privileges and restrictions, including voting rights, of these shares without
any further vote or action by the shareholders. The rights of the holders of the
Company's Common Stock will be subject to, and may be adversely affected by, the
rights of the holders of any Preferred Stock that may be issued in the future.
The issuance of Preferred Stock, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a majority
of the outstanding voting stock of the Company, thereby delaying, deferring or
preventing a change in control of the Company. Furthermore, such Preferred Stock
may have other rights, including economic rights,
22
<PAGE>
senior to the Common Stock, and as a result, the issuance of such Preferred
Stock could have a material adverse effect on the market value of the Common
Stock. The Company has no present plan to issue shares of Preferred Stock.
POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the shares of
Common Stock has been and is likely to continue to be highly volatile and may be
significantly affected by factors such as actual or anticipated fluctuations in
the Company's operating results, announcement of technological innovations or
new product introductions by the Company or its competitors, changes of
estimates of the Company's future operating results by securities analysts,
developments with respect to copyrights or proprietary rights, general market
conditions and other factors. In addition, the stock market has from time to
time experienced significant price and volume fluctuations that have
particularly affected the market prices for the Common Stocks of technology
companies. These broad market fluctuations may adversely effect the market price
of the Company's Common Stock.
23
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings
On June 8, 1995, a suit alleging misappropriation of trade secrets,
infringement of U.S. Patent No. 5,394,402 and improper hiring of employees was
brought against Xylan by Ascom Timeplex Inc. ("Ascom Timeplex") in the U.S.
District Court for the Central District of California in Los Angeles, California
seeking injunctive relief and unspecified monetary damages. The Company and
Ascom Timeplex have signed a binding memorandum of understanding to settle this
litigation and dismiss all of Ascom Timeplex's charges against the Company and
against Steve Y. Kim, John Bailey and another employee named in Ascom Timeplex's
complaint, and otherwise release the parties from all claims. The settlement
also involves a royalty-free license to the Company of Ascom Timeplex's virtual
LAN technology covered by the patent and a royalty-free license to Ascom
Timeplex of certain technology embodied in the Company's currently available
products for use in connection with Ascom Timeplex's Synchrony product family.
These licenses are not assignable other than to a successor-in-interest to Ascom
Timeplex. The Company also undertakes to transfer a copy of the licensed
technology to Ascom Timeplex and for a specified time not to hire Ascom Timeplex
employees. The release by Ascom Timeplex is conditioned on transfer of this
technology. While the court recently dismissed Ascom Timeplex's charges with
prejudice in connection with the settlement, there can be no assurance that
future disputes will not arise between the parties with respect to the
settlement or otherwise.
ITEM 2. Changes In Securities
None.
ITEM 3. Defaults In Senior Securities
None.
ITEM 4. Submission Of Matters To A Vote Of Security Holders
None.
ITEM 5. Other Information
None.
ITEM 6. Exhibits And Reports On Form 8-K
(a) Exhibits
Exhibit Description
------- -----------
11.1 Statement of Computation of Earnings Per Share.
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed by Xylan during the quarter
ended June 30, 1996.
24
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
XYLAN CORPORATION
Date: August 14, 1996 By: /s/Eugene E. Spies
----------------------------
Eugene E. Spies
Acting Chief Financial Officer
(Principal Financial and Chief
Accounting Officer)
25
<PAGE>
INDEX TO EXHIBITS
Exhibit Description
------- -----------
11.1 Statement of Computation of Earnings Per Share.
27 Financial Data Schedule
26
<PAGE>
EXHIBIT 11.1
STATEMENT REGARDING COMPUTATION OF NET INCOME (LOSS) PER SHARE
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------
JUNE 30, MARCH 31, JUNE 30,
1996 1996 1995
------ ------- -------
<S> <C> <C> <C>
Weighted average common shares outstanding...................... 40,963 37,364 10,320
------ ------ ------
Weighted average common stock equivalents:
Stock options determined using the treasury
stock method............................................ 6,033 6,593 4,652
Convertible preferred stock............................... -- -- 6,179
------ ------ ------
Total weighted average common stock
equivalents outstanding........................... 6,033 6,593 10,831
------ ------ ------
Shares used in net income (loss) per share
calculation....................................... 46,996 43,957 21,151
====== ====== ======
Detailed calculation of shares issuable from the
assumed exercise of stock options:
Calculation of proceeds upon exercise of options:
Number of stock options considered to be
common stock equivalents (1).................. 6,671 7,335 5,376
Weighted average exercise price................. $ 5.75 $ 3.07 $ 3.50
------ ------ ------
Proceeds upon exercise of options............. 38,375 22,540 18,839
====== ====== ======
Calculation of shares that could be repurchased
upon exercise of stock options:
Proceeds upon exercise of options................... 38,375 22,540 18,839
Repurchase price.................................... $60.19 $30.38 $26.00
------ ------ ------
Shares that could be repurchased................ 638 742 724
------ ------ ------
Common stock equivalents for stock options
using the treasury stock method................. 6,033 6,593 4,652
====== ====== ======
Detailed calculation of shares issuable from the assumed
conversion of convertible preferred stock:
Convertible preferred stock considered to be
common stock equivalents (1).................... -- -- 6,179
Conversion ratio.................................... -- -- one for one
------ ------ -----------
Common stock equivalents for convertible
preferred stock............................... -- -- 6,179
====== ====== ======
</TABLE>
(1) Pursuant to the requirements of the Securities and Exchange Commission, only
stock options and convertible preferred stock issued in fiscal 1995 (twelve
months immediately preceding the initial public offering date) are
considered common stock equivalents. All issuances prior to 1995 are
excluded from loss periods as their inclusion would be antidilutive.
<PAGE>
EXHIBIT 11.1 CONTINUED
STATEMENT REGARDING COMPUTATION OF NET INCOME (LOSS) PER SHARE
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
----------------------
JUNE 30, JUNE 30,
1996 1995
------- -------
<S> <C> <C>
Weighted average common shares outstanding............................ 39,350 10,320
------ ------
Weighted average common stock equivalents:
Stock options determined using the treasury
stock method.................................................. 6,178 4,652
Convertible preferred stock..................................... -- 6,179
------- -------
Total weighted average common stock
equivalents outstanding................................. 6,178 10,831
------- -------
Shares used in net income (loss) per share
calculation............................................. 45,528 21,151
======= =======
Detailed calculation of shares issuable from the
assumed exercise of stock options:
Calculation of proceeds upon exercise of options:
Number of stock options considered to be
common stock equivalents (1)........................ 6,611 5,376
Weighted average exercise price....................... $3.04 $3.50
------- -------
Proceeds upon exercise of options................... 20,129 18,839
------- -------
Calculation of shares that could be repurchased
upon exercise of stock options:
Proceeds upon exercise of options......................... 20,129 18,839
Repurchase price.......................................... $46.50 $26.00
------- -------
Shares that could be repurchased.................... 433 724
------- -------
Common stock equivalents for stock options
using the treasury stock method................... 6,178 4,652
======= =======
Detailed calculation of shares issuable from the assumed
conversion of convertible preferred stock:
Convertible preferred stock considered to be
common stock equivalents (1)............................ -- 6,179
Conversion ratio.......................................... -- one for one
------- -----------
Common stock equivalents for convertible
preferred stock................................... -- 6,179
======= =======
</TABLE>
(1) Pursuant to the requirements of the Securities and Exchange Commission, only
stock options and convertible preferred stock issued in fiscal 1995 (twelve
months immediately preceding the initial public offering date) are
considered common stock equivalents. All issuances prior to 1995 are
excluded from loss periods as their inclusion would be antidilutive.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 68,554
<SECURITIES> 58,066
<RECEIVABLES> 21,876
<ALLOWANCES> 394
<INVENTORY> 6,634
<CURRENT-ASSETS> 155,456
<PP&E> 11,682
<DEPRECIATION> 2,349
<TOTAL-ASSETS> 180,600
<CURRENT-LIABILITIES> 11,725
<BONDS> 0
0
0
<COMMON> 40
<OTHER-SE> 167,592
<TOTAL-LIABILITY-AND-EQUITY> 180,600
<SALES> 51,145
<TOTAL-REVENUES> 51,579
<CGS> 24,048
<TOTAL-COSTS> 24,048
<OTHER-EXPENSES> 21,587
<LOSS-PROVISION> 110
<INTEREST-EXPENSE> 21
<INCOME-PRETAX> 7,442
<INCOME-TAX> 1,858
<INCOME-CONTINUING> 5,584
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,584
<EPS-PRIMARY> .12
<EPS-DILUTED> .12
</TABLE>
