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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
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 March
31, 1997, was 42,277,102.
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XYLAN CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 1997
INDEX
Page
----
PART I Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets - March 31,
1997 and December 31, 1996 3
Condensed Consolidated Income Statements --
Three Months Ended March 31, 1997, December 31,
1996 and March 31, 1996 4
Condensed Consolidated Statements of Cash Flows --
Three Months Ended March 31, 1997, December 31,
1996 and March 31, 1996 5
Notes to Condensed Consolidated Financial
Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risks N/A
PART II Other Information
Item 1. Legal Proceedings 22
Item 2. Changes in Securities 22
Item 3. Defaults in Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
Signature 24
Exhibit Index 25
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PART I -- FINANCIAL INFORMATION
ITEM 1. Financial Statements
XYLAN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
----------- ------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 45,630 $ 62,483
Short-term investments 56,721 50,498
Accounts receivable, net 37,020 26,956
Inventories 8,299 11,578
Prepaid expenses and other current assets 4,614 4,013
-------- --------
Total current assets 152,284 155,528
Investments 41,263 27,785
Note receivable 6,000 6,000
Property and equipment, net 17,426 16,665
Other assets 3,355 1,273
-------- --------
Total assets $220,328 $207,251
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 20,691 $ 17,760
Current installments of capital lease obligations 278 303
Deferred revenue 3,595 2,838
Income taxes payable 1,253 12
-------- --------
Total current liabilities 25,817 20,913
Capital lease obligations, less current installments 145 206
Deferred revenue 581 494
-------- --------
Total liabilities 26,543 21,613
-------- --------
Shareholders' equity:
Common stock and additional paid-in capital 186,718 184,439
Retained earnings 7,067 1,199
-------- --------
Shareholders' equity 193,785 185,638
-------- --------
Total shareholders' equity $220,328 $207,251
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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XYLAN CORPORATION
CONDENSED CONSOLIDATED INCOME STATEMENTS
(Unaudited)
(in thousands, except per share data)
Three Months Ended
----------------------------------------
March 31, December 31, March 31,
1997 1996 1996
-------- ------------ ---------
Revenue $48,008 $41,452 $23,392
Cost of revenue 20,663 17,878 10,823
------- ------- -------
Gross profit 27,345 23,574 12,569
------- ------- -------
Operating expenses:
Research and development 5,506 4,890 3,194
Sales and marketing 12,621 11,157 5,800
General and administrative 1,577 1,310 989
------- ------- -------
Total operating expenses 19,704 17,357 9,983
------- ------- -------
Operating income 7,641 6,217 2,586
Interest income, net 1,828 1,881 177
------- ------- -------
Income before income taxes 9,469 8,098 2,763
Income tax expense 3,601 3,067 80
------- ------- -------
Net income $ 5,868 $ 5,031 $ 2,683
======= ======= =======
Net income per share $.13 $.11 $.06
======= ======= =======
Weighted average common and common
equivalent shares outstanding 46,594 47,286 43,957
======= ======= =======
The accompanying notes are an integral part of these financial statements.
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XYLAN CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31, December 31, March 31,
1997 1996 1996
--------- ------------ ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income..................................................... $ 5,868 $ 5,031 $ 2,683
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization.............................. 1,540 1,298 524
Deferred income taxes...................................... -- (1,794) --
Expense related to warrants................................ 190 174 --
Unearned compensation amortization......................... 114 114 157
Change in:
Accounts receivable...................................... (10,064) (3,256) (6,589)
Inventories.............................................. 3,279 (804) (2,518)
Prepaid expenses and other current assets................ (601) (219) (1,057)
Other assets............................................. (2,081) (2) 48
Accounts payable and accrued expenses.................... 2,931 5,484 4,403
Deferred revenue......................................... 844 (696) 388
Income taxes payable..................................... 1,841 4,843 --
-------- ------- --------
Net cash provided by (used in) operating activities.... 3,861 10,173 (1,961)
-------- ------- --------
Cash flows from investing activities:
Purchases of property and equipment........................ (2,302) (5,222) (2,765)
Sales (purchases) of investments........................... (19,701) 2,929 (32,495)
-------- ------- --------
Net cash used in investing activities.................. (22,003) (2,293) (35,260)
-------- ------- --------
Cash flows from financing activities:
Proceeds from issuances of common stock.................... 1,375 55 87,446
Principal payments under capital lease obligations......... (86) (86) (79)
-------- ------- --------
Net cash provided by (used in) financing activities.... 1,289 (31) 87,367
-------- ------- --------
Net increase (decrease) in cash and cash equivalents. (16,853) 7,849 50,146
Cash and cash equivalents at beginning of period............... 62,483 54,634 6,034
-------- ------- --------
Cash and cash equivalents at end of period..................... $ 45,630 $62,483 $ 56,180
======== ======= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest............... $ 11 $ 13 $ 58
Cash paid during the period for taxes.................. $ 735 $ 228 $ --
======== ======= ========
Supplemental disclosure of noncash investing and
financing activities:
Income tax benefit resulting from exercise of
employee stock options............................... $ 600 $ 4,843 $ --
======== ======= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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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 month period ending March 31, 1997 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") Form 10-K.
NOTE 2. Investments
Investments at March 31, 1997 and December 31, 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 March 31, 1997, approximated cost.
NOTE 3. Inventories
Inventories, primarily component parts, are stated at the lower of cost
or market, cost being determined using the first-in, first-out method.
NOTE 4. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following:
March 31, December 31,
1997 1996
----------- ------------
(Unaudited)
Accounts payable................................ $10,488 $ 9,336
Accrued payroll and related costs............... 4,328 4,281
Accrued warranty................................ 2,091 1,535
Other accrued expenses.......................... 3,784 2,608
------- -------
Total accounts payable and accrued
expenses.............................. $20,691 $17,760
======= =======
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NOTE 5. Shareholder's Equity
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 March 31, 1997,
the Company has issued 1,666,967 shares of common stock under the 1993 Plan and
options to purchase 5,886,506 shares of common stock are 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 representing 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 March 31, 1997,
December 31, 1996 and March 31, 1996, the Company recorded $114,000, $114,000
and $157,000 of compensation expense, respectively.
The Company has a 1996 Stock Option Plan. Under the 1996 Stock Option
Plan, 3,000,000 shares of the Company's authorized but unissued common stock are
reserved for option grants. As of March 31, 1997 the Company has not issued any
shares of common stock under this plan and options to purchase 2,375,369 shares
of common stock are outstanding.
The Company has a 1996 Directors' Stock Option Plan. Under the 1996
Directors' Stock Option Plan, 150,000 shares of the Company's authorized but
unissued common stock are reserved for option grants. As of March 31, 1997 the
Company has not issued any shares of common stock under this plan and options to
purchase 25,000 shares of common stock are outstanding.
The Company has a 1996 Employee Stock Purchase Plan which reserves
1,500,000 shares of common stock for issuance under the plan. As of March 31,
1997, the Company issued 46,734 shares under this plan.
In July 1996 the Company and IBM entered into an alliance in the field
of campus networking switching products. The Company has committed 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 6. Income Taxes
The Company's provision for income taxes for the three months ended
March 31, 1997, December 31, 1996 and March 31, 1996 is based upon the Company's
estimate of the effective tax rate for the respective fiscal year. For the
quarter ended March 31, 1997 and December 31, 1996, the Company realized an
income tax benefit of $600,000 and $4.8 million, respectively, 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, for the quarter ended March 31, 1997, the Company recorded an
income tax provision equal to approximately 38% of pretax income and reduced the
income tax liability by the $600,000 benefit for certain stock option
transactions. For the quarter ended December 31, 1996, the Company recorded an
income tax provision equal to approximately 38% of pretax income but did not
incur an income tax liability due to the $4.8 million benefit for certain stock
option transactions. 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. For the remainder of 1997, the
Company expects to record a 38% provision for income taxes, although such
percentage may vary depending on several factors, including the assessment of
the deferred tax asset realization probability and the international component
of the Company's business.
As of December 31, 1996, the Company had net operating loss
carryforwards for Federal income tax purposes of approximately $7,700,000, which
are available to offset future taxable income, if any, through 2010.
Additionally, the Company had research and development tax credit carryforwards
for
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Federal and state income tax purposes of $936,000 and $421,000, respectively,
which are available to offset future income taxes, if any, through 2011.
NOTE 7. Computation Of Net Income Per Share
Net income per 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. The difference between fully
diluted and primary net income per share is immaterial for all periods
presented. Shares used in the net income per share calculation are summarized as
follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------
March 31, December 31, March 31,
1997 1996 1996
--------- ------------ ---------
<S> <C> <C> <C>
Weighted average common stock outstanding 42,147 41,892 37,364
Weighted average common stock equivalents 4,447 5,394 6,593
------ ------ ------
Shares used in net income per share
calculation 46,594 47,286 43,957
====== ====== ======
</TABLE>
NOTE 8. Segment Information
For the quarter ended March 31, 1997, IBM accounted for 26% of
revenue. For the quarter ended December 31, 1996, IBM and Alcatel accounted for
23% and 14.1%, respectively, of revenue. For the quarter ended March 31, 1996,
NTT PC Communications, Inc., Hitachi Computer Products and Digital Equipment
Corp. accounted for 34.4%, 12.8% and 11.9%, respectively, of revenue.
Sales to customers outside of North America accounted for approximately
55%, 50% and 67% of the Company's revenue in the quarters ended March 31, 1997,
December 31, 1996, and March 31, 1996, 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.
8
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ITEM 2. Management's Discussion And Analysis Of Financial Condition And
Results Of Operations
This quarterly report on Form 10-Q may consist of forward looking
statements that involve risks and uncertainties. These statements may differ
materially from actual future events or results. Readers are referred to the
"Factors Affecting Future Results" section of this Management's Discussion and
Analysis of Financial Condition and Results of Operations which identify
important risk factors that could cause actual results to differ from those
contained in the forward looking statements. The Company undertakes no
obligation to update the information, including the forward looking Statements,
in this Form 10-Q.
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. Since then, revenue has
increased significantly on a quarterly basis to an aggregate of $128.5 million
in fiscal year 1996 from $29.7 million in fiscal year 1995. Revenues increased
to $48.0 million in the quarter ended March 31, 1997 from $23.4 million in the
quarter ended March 31, 1996. The increase in quarterly revenue reflects
substantial growth of the LAN switching market, the continued introduction by
the Company of additional features and enhancements to its OmniSwitch product
family and the introduction of the PizzaSwitch product in March 1996, all of
which expanded the portion of the market addressed by Xylan's products. The
increase in quarterly revenue was also the result of continued market acceptance
of the Company's LAN switching products, and investment in sales and marketing
efforts, including significant expansion of the Company's domestic and
international product distribution network. The Company markets its products
worldwide through OEM partners, system integrators and its own sales force and
first achieved profitability in the fourth quarter of 1995. As of March 31,
1997, the Company had retained earnings of $7.1 million.
The Company intends to increase significantly its investments in
research and development, sales and marketing and related infrastructure. Such
increases will be 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.
Results Of Operations
Revenue
Revenue for the quarter ended March 31, 1997 was $48.0 million compared
to $41.5 million for the quarter ended December 31, 1996, an increase of 16%.
Revenue for the quarter ended March 31, 1996 was $23.4 million. Comparing
revenue for the quarter ended March 31, 1997 to the quarter ended March 31,
1996, revenue increased 105%. The increases in revenue were due to a number of
factors, including, substantial growth of the LAN switching market, the
integration of a new ATM switch, called X-Cell, into the OmniSwitch during the
quarter ended March 31, 1997, continued introduction by the Company of
additional features and functions to its OmniSwitch product family, the
introduction of the PizzaSwitch product family, market acceptance of the
Company's LAN switching products, the addition of IBM in July 1996 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
9
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predict future revenue growth. While the Company has achieved quarter-to-quarter
revenue growth in previous quarters, the Company does not expect to sustain this
rate of sequential quarterly revenue growth in future periods. Under an
agreement with IBM and the Company, IBM has the right to manufacture certain
Company products after a specified period of time and pay a royalty to Xylan. As
of March 31, 1997, no royalties have been earned by the Company. Product revenue
could be adversely impacted if IBM elects to manufacture the Company's products.
The Company markets its products worldwide through OEM partners, system
integrators and a direct sales force. The following table sets forth the
Company's revenue by sales channel and geographic region as a percentage of
total revenue for the three months ended March 31, 1997, December 31, 1996 and
March 31, 1996:
Three months ended
----------------------------------
March 31, Dec. 31, March 31,
1997 1996 1996
--------- -------- ---------
Channel:
OEM partners 43% 48% 42%
System Integrators 38% 35% 56%
Direct Sales(1) 19% 17% 2%
== == ==
Region(2):
North America 45% 50% 33%
International 55% 50% 67%
== == ==
________
(1) Direct sales also include sales to the government and carriers.
(2) 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.
For the quarter ended March 31, 1997, IBM, accounted for 26% of
revenue. For the quarter ended December 31, 1996, IBM and Alcatel accounted for
23% and 14.1%, respectively, of revenue. For the quarter ended March 31, 1996,
NTT PC Communications, Inc., Hitachi Computer Products and Digital Equipment
Corp. accounted for 34.4%, 12.8% and 11.9%, respectively, of revenue.
Gross Profit
Gross margins were approximately 57.0%, 56.9% and 53.7% for the quarters
ended March 31, 1997, December 31, 1996 and March 31, 1996, respectively. The
Company's gross margins in the future will be affected by a number of factors,
including competitive market pricing and discount levels, product mix,
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 and ASICs 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 system integrators. The Company has
entered into an agreement with IBM and may in the future enter into additional
OEM agreements, which could adversely affect its gross margins.
Research And Development Expenses
Research and development expenses were $5.5 million, $4.9 million and
$3.2 million for the quarters ended March 31, 1997, December 31, 1996 and March
31, 1996, respectively. This represents an increase of 72% from the first
quarter of 1996 to the first quarter of 1997 and an increase of 12% from the
fourth
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quarter of 1996 to the first quarter of 1997. These increases from
spending were primarily due to the hiring of additional engineers and an
increase in prototype material costs for new product development. As a
percentage of revenue, research and development expenses were 12%, 12% and 14%
for the quarters ended March 31, 1997, December 31, 1996 and March 31, 1996,
respectively. The decline of research and development expenses as a percent of
revenue from March 31, 1996 to March 31, 1997 was 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 impact Xylan's existing product offerings. 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 spending will continue to increase throughout 1997. To date, the
Company has not capitalized any development costs and does not anticipate
capitalizing any such costs in the foreseeable future.
Sales And Marketing Expenses
Sales and marketing expenses were $12.6 million, $11.2 million and $5.8
million for the quarters ended March 31, 1997, December 31, 1996 and March 31,
1996, respectively. This represents an increase of 117% from the first quarter
of 1996 to the first quarter of 1997, and an increase of 13% from the fourth
quarter of 1996 to the first quarter of 1997. These increases were primarily due
to expenses related to the addition of direct sales personnel throughout the
United States, Europe and Asia, increased commission expenses resulting from
higher revenues, and advertising and promotional campaigns in support of the
Company's direct sales and system integrator channels. From December 31, 1996 to
March 31, 1997, the number of sales and marketing personnel increased by
approximately 16%. As the Company continues to expand its direct 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 1997 in absolute dollars.
As a percentage of revenue, sales and marketing expenses were 26%, 27%
and 25% for the quarters ended March 31, 1997, December 31, 1996 and March 31,
1996, respectively.
General And Administrative Expenses
General and administrative expenses were $1.6 million, $1.3 million and
$1.0 million for the quarters ended March 31, 1997, December 31, 1996 and March
31, 1996, respectively. As a percentage of revenue, general and administrative
expenses were 3%, 3% and 4% for the quarters ended March 31, 1997, December 31,
1996 and March 31, 1996, respectively. As the Company continues to expand its
direct 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 1997 in absolute dollars.
Interest Income
Interest income, net, was $1.8 million, $1.9 million and $177,000, for
the quarters ended March 31, 1997, December 31, 1996 and March 31, 1996,
respectively. The increases from the first quarter of 1996 is primarily 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.
Provision For Income Taxes
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The Company's provision for income taxes for the three months ended
March 31, 1997, December 31, 1996 and March 31, 1996 is based upon the Company's
estimate of the effective tax rate for the respective fiscal year. For the
quarter ended March 31, 1997 and December 31, 1996, the Company realized an
income tax benefit of $600,000 and $4.8 million, respectively, 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, for the quarter ended March 31, 1997, the Company recorded an
income tax provision equal to approximately 38% of pretax income and reduced the
income tax liability by the $600,000 benefit for certain stock option
transactions. For the quarter ended December 31, 1996, the Company recorded an
income tax provision equal to approximately 38% of pretax income but did not
incur an income tax liability due to the $4.8 million benefit for certain stock
option transactions. 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. For the remainder of 1997, the
Company expects to record a 38% provision for income taxes, although such
percentage may vary depending on several factors, including the assessment of
the deferred tax asset realization probability and the international component
of the Company's business.
As of December 31, 1996, the Company had net operating loss
carryforwards for Federal income tax purposes of approximately $7,700,000, which
are available to offset future taxable income, if any, through 2010.
Additionally, the Company had research and development tax credit carryforwards
for Federal and state income tax purposes of $936,000 and $421,000,
respectively, which are available to offset future income taxes, if any, through
2011.
Liquidity And Capital Resources
The Company's principal source of liquidity as of March 31, 1997,
consisted of $45.6 million in cash and cash equivalents, $56.7 million in short-
term investments and a $6.0 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 twelve months.
For the three months ended March 31, 1997, December 31, 1996 and March
31, 1996 cash provided by (utilized in) operating activities was $3.9 million,
$10.2 million and ($2.0 million), respectively. The increase in cash provided by
operations is primarily the result of the increase in net income partially
offset by increased working capital necessary to fund the significantly expanded
operations and the resulting inventories and accounts receivable.
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.
12
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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 LAN switching products. Accordingly, the Company has
only a limited operating history upon which an evaluation of the Company and its
prospects can be based. 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. In fiscal 1997, the Company intends to increase
significantly 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 revenue 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 system integrators, (ii) the
Company's success in developing, introducing and shipping product enhancements,
ASICs 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 and maintain production volumes and quality levels for its products
(including ASICs), (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 (ix) mix of
products manufactured or purchased by IBM and (x) general economic conditions.
See "-Dependence on OEM Partners and System Integrators; IBM; 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 (including IBM) and system
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 system integrators. Accordingly, if the Company's OEM
partners and system integrators were to account for an increased portion of the
Company's revenue, gross margins would decline. In addition, if IBM elects to
manufacture products using technology licensed from the Company, the Company's
product revenue and product gross margin will be adversely affected. New
products may have different gross margins than existing products. A significant
portion of the Company's expenses, such as rent, headcount and lease expenses,
are relatively fixed in advance, based in large part on the Company's forecasts
of future revenue. If revenues are below expectations in any given period, the
adverse effect of a shortfall in revenue 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. In addition, due in part to the timing of product
release dates, purchase orders and product availability, significant volume
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shipments of products have occurred and may continue to occur at the end of the
Company's fiscal quarter. Failure to ship such products by the end of a quarter
may adversely affect the Company's operating results. 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 revenue, an increase in
discounts offered to the Company's OEM partners or system 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, significant price reductions, 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. Recent consolidations in the industry have resulted in competitors that
may have broader product lines, greater access to capital or greater research
and development resources, which could adversely affect the ability of the
Company to compete. 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
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 "-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. During 1996, the Company
leased an additional 40,000 square feet of space, a portion of which is being
used for manufacturing. Any interruption or delay in the normal flow of
production, or defaults or financial insolvency of the contract manufacturer
could have a material adverse effect on the Company's business, operating
results and
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financial condition. The Company may also require manufacturing space beyond
this additional 40,000 square foot facility. There can be no assurance that such
additional space, if required, will be available in a timely manner or on
commercially reasonable terms, if at all.
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 specialize 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. During 1996, the Company agreed to loan up to $10 million
to its contract manufacturer that performs circuit board assembly. The loan,
which assists the contract manufacturer to meet the Company's increasing
production requirements, is non-interest bearing, does not have a defined due
date and is secured by raw materials and electronic components purchased by the
contract manufacturer. At December 31, 1996, the note had an outstanding balance
of $6 million. Also, during 1996, the Company guaranteed up to $5 million of
such contract manufacturer's debt for raw material and electronic component
purchases. Any additional loans or guaranties to the Company's contract
manufacturer, or defaults or financial insolvency of the contract manufacturer,
could have an adverse effect 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 1997 and 1998,
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 on-time 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, LSI Logic Corporation in most cases, and
accordingly the risks of relying on sole sources is expected to increase. Any
interruption or delay in the supply of any of these components, or the inability
of the Company to procure these components from alternate sources at acceptable
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, which could have a material adverse effect on
the Company's financial condition. From time to time the Company has experienced
shortages and
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allocations of certain components, delays in filling orders while waiting to
obtain the necessary components and delays in prototyping of its ASICs. 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 allocations and delays 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 the Company experienced
each of these problems in the past. The occurrence or recurrence of any of these
events could have a material adverse effect on the Company's business, financial
condition and results of operations.
Dependence on OEM Partners and System Integrators; IBM; Customer
Concentration. The Company is pursuing a sales and marketing strategy focused on
developing three channels of distribution for its products: worldwide OEM
partners, system integrators in North America and overseas and direct sales. The
Company has established OEM partnerships with leading communications and
networking companies, including IBM and Alcatel N.V. ("Alcatel"). In November
1996, the Company entered into an OEM agreement with Samsung Electronics
Company Ltd. ("Samsung") and also signed a licensing agreement with Samsung
under which the Company will modify its OmniVision network management software
to control Samsung's ATM switches, in addition to Xylan's LAN switches.
Samsung will also be combining Samsung's ATM switching technology, Xylan's LAN
switching technology and the new integrated network management system to
provide a complete solution to the needs of Samsung's customers.
In the field of campus network switching products, IBM and Xylan are
offering the other company's campus switch products for resale. For the quarter
ended March 31, 1997, sales to IBM comprised 26% of the Company's revenue.
There is no assurance that IBM will continue to purchase the Company's products.
In addition, the Company has limited information as to the sell-through of its
products by IBM. There is no assurance that even if IBM does purchase such
products, that IBM will sell such products to its customers. Both companies have
the right to manufacture and sell certain of each other's campus switching
products in exchange for a royalty. As of March 31, 1997, no royalties have been
earned by either company. However, sales by IBM of IBM manufactured campus
switch products could have a material adverse effect on the Company's product
revenues. In addition, the parties have formed a joint development organization
to develop new products using certain of the other company's LAN technology. Any
reduction or delay in sales of the Company's products by IBM could have a
material adverse effect on the Company's business, financial condition and
results of operations.
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 system 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 system
integrators accounted for 43% and 38%, respectively, for the quarter ended March
31, 1997, and 42% and 56%, respectively, for the quarter ended March 31, 1996.
Each of the Company's OEM partners and system 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 system
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.
In addition, certain of the Company's OEM partners have and may continue to
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 system
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 system 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 system integrators will
continue to offer the Company's products. In addition, Xylan's OEM partners
and system integrators could sell competitive products to the Company's
existing customers, which could have a material adverse effect on the
Company's business, operating results and financial condition. Any reduction
or delay in sales of the Company's products by its OEM partners and system
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 system integrators or that it
will be able to recruit additional or replacement OEM partners or system
integrators. The loss of one or more of the Company's OEM partners or system
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
system integrators. Accordingly, if the Company's OEM partners and system
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 switching 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. However, ASICs are generally
complex and may contain undetected errors. 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.
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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 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 system 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, system 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 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.
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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 products. The Company is subject to the risk of claims
and litigation alleging infringement of the intellectual property rights of
others. These claims may be asserted against the Company directly in a lawsuit
naming the Company as a defendant, or may be asserted against the Company
indirectly in a lawsuit naming as a defendant one or more customers or resellers
of the Company which the Company is contractually obligated to indemnify in the
event of a lawsuit alleging that products purchased from the Company infringe
third party intellectual property rights. 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 Product 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. The loss of the services of any of the key personnel, the inability
to attract or retain qualified personnel in the future or delays in hiring
required personnel, particularly engineers and sales personnel, could have a
material adverse effect on the Company's business, operating results or
financial condition. 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. Sales to customers outside of North America
accounted for approximately 55% and 67% of the Company's revenue for the
quarters ended March 31, 1997 and 1996, 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. The Company's international sales are conducted primarily
through its OEM partners and independent territory-
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specific system integrators. Failure of the Company's OEM partners and system
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. 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 and investment 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 1997, although the
Company could be required, or could elect, to seek to raise additional capital.
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
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<PAGE>
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. In addition, on April 17, 1997, the Company's Board of
Directors declared a dividend of one right (a "Right") to purchase 1/1000th of a
share of Series A Participating Preferred Stock (the "Series A Preferred") on
each share of Common Stock. The Rights will become exercisable only if a person
or group acquires 15.0% or more of the Company's Common Stock (in the case of
Steve Y. Kim, Yuri Pikover, John L. Walecka or Brentwood Associates VI, L.P.,
this threshold only applies to shares acquired after April 17, 1997 and if such
acquisition is not approved by the Board of Directors) or announces a tender or
exchange offer, the consummation of which would result in ownership by a person
or a group of 15.0% or more of the Company's Common Stock. Each Right has an
exercise price of $75.00 for each 1/1000th of a share of Series A Preferred.
The rights of the holders of the Company's Common Stock will be subject to, and
may be adversely affected by, the Rights and the rights of the holders of any
Preferred Stock that may be issued in the future. The Rights and any future
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, 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.
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.
In October 1996, Steve Kim and Yuri Pikover, executive officers and
members of the Board of Directors of the Company, entered into a program of
periodic sales of shares of their Xylan Common Stock through a blind trust for
the purpose of diversifying their personal holdings. At the beginning of each
calendar quarter, Steve Kim and Yuri Pikover will deliver 125,000 and 55,000
shares, respectively, to their blind trust for sale within the quarter. In
addition, certain of the venture capital partnerships that invested in the
Company have begun to distribute portions of their holdings to their general and
limited partners, who in turn have begun to resell such shares on the open
market. Any such sales by insiders or distributions by large investors may also
have an adverse effect on the market price of the Company's Common Stock. In
addition, recent changes in the rules regarding resales of restricted securities
pursuant to Rule 144 of the Securities Act of 1933, as amended, may result in a
greater number of shares of the Company's Stock becoming available for resale
sooner than anticipated, and could have an adverse effect on the market price of
the Company's Stock.
21
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings
None
ITEM 2. Changes In Securities
On April 17, 1997, the Company's Board of Directors declared a dividend
of one right (a "Right") to purchase 1/1000/th/ of a share of Series A
Participating Preferred Stock (the "Series A Preferred") on each share of Common
Stock. The Rights will become exercisable only if a person or group acquires
15.0% or more of the Company's Common Stock (in the case of Steve Y. Kim, Yuri
Pikover, John L. Walecka or Brentwood Associates VI, L.P., this threshold only
applies to shares acquired after April 17, 1997 and if such acquisition is not
approved by the Board of Directors) or announces a tender or exchange offer, the
consummation of which would result in ownership by a person or a group of 15.0%
or more of the Company's Common Stock. Each Right has an exercise price of
$75.00 for each 1/1000th of a share of Series A Preferred.
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
------- -----------
1.1 Form of Underwriting Agreement.(1)
3.1 Amended and Restated Articles of Incorporation of Registrant.(1)
3.2 Amended and Restated Bylaws of Registrant.(1)
4.1 Form of Common Stock Certificate.(1)
5.1 Opinion of Venture Law Group, A Professional Corporation.(1)
10.1 Form of Indemnification Agreement.(1)
10.2 1993 Stock Incentive Plan.(1)
10.3 Form of 1996 Employee Stock Purchase Plan and related agreements.(1)
10.4 Form of 1996 Directors' Option Plan and related agreements.(1)
10.5 Form of 1996 Stock Plan and related agreements.(1)
10.6 Fourth Restated Registration Rights Agreement among the Registrant and
certain securityholders of the Registrant, dated as of December 11,
1995.(1)
22
<PAGE>
Exhibit
Number Description
- ------- -----------
10.7 Lease Agreement between the Registrant and Malibu Canyon Office
Partners, L.P. dated as of April 14, 1994, as amended November 3, 1994,
January 2, 1995, and April 25, 1995.(1)
10.8 Security and Loan Agreement dated September 1, 1995 between the
Registrant and Imperial Bank.(1)
10.9 Master Lease Agreement dated as of May 31, 1994, as amended between the
Registrant and Dominion Ventures, Inc.(1)
10.10 Master Lease Agreement dated as of June 9, 1995 between the Registrant
and Copelco Capital, Inc.(1)
10.11 Value-Added Product Sales Agreement dated as of July 1, 1995 between the
Registrant and Hamilton Hallmark, a division of Avnet, Inc.(1)
10.12 401(k) Plan.(1)
10.13 Series C Preferred Stock Agreement dated as of March 13, 1995 between
the Registrant and Alcatel Data Networks S.A.(1)
10.14 International Distributor Agreement between the Registrant and Alcatel
N.V., dated as of March 13, 1995.(1)
10.15 Product and Technology Agreement between the Registrant and Alcatel N.V.
dated as of March 13, 1995.(1)
10.16 Original Equipment Manufacturer Agreement dated as of June 14, 1995
between the Registrant and Hitachi Computer Products (America), Inc.(1)
10.17 Original Equipment Manufacturer Agreement dated as of April 12, 1995
between the Registrant and Digital Equipment Corporation.(1)
10.18+ Manufacturing and Purchase Agreement dated as of March 28, 1996 between
the Registrant and Victron, Inc. Incorporated by reference to exhibit
10.18 to the Company's Quarterly Report on Form 10-Q for the period
ended March 31, 1996.
10.19 Amendment to Manufacturing and Purchase Agreement between Xylan and
Victron, Inc. dated as of December 30, 1996. (2)
10.20 Dale Bartos Employment Agreement dated as of January 4, 1997.(2)
11.1 Statement of Computation of Earnings Per Share.
27.1 Financial Data Schedule
________
(1) Incorporated by reference to identically numbered exhibits filed in
response to Item 16(a), "Exhibits," of the Registrant's Registration
Statement on Form S-1 and Amendments thereto (File No. 333-03623), which
became effective on May 29, 1996.
(2) Incorporated by reference to identically numbered exhibits filed in the
Company's Annual Report on Form 10-K for the period ended December 31,
1996.
+ The Company has received confidential treatment for certain portions of
this exhibit filed with the Commission.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by Xylan during the quarter ended
March 31, 1997.
23
<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
By: Dale J. Bartos
-----------------------------
Date: May 14, 1997 Dale J. Bartos
Vice President and Chief Financial
Officer
(Principal Financial and Chief
Accounting Officer)
24
<PAGE>
INDEX TO EXHIBITS
Exhibit Description
------- -----------
1.1 Form of Underwriting Agreement.(1)
3.1 Amended and Restated Articles of Incorporation of Registrant.(1)
3.2 Amended and Restated Bylaws of Registrant.(1)
4.1 Form of Common Stock Certificate.(1)
5.1 Opinion of Venture Law Group, A Professional Corporation.(1)
10.1 Form of Indemnification Agreement.(1)
10.2 1993 Stock Incentive Plan.(1)
10.3 Form of 1996 Employee Stock Purchase Plan and related agreements.(1)
10.4 Form of 1996 Directors' Option Plan and related agreements.(1)
10.5 Form of 1996 Stock Plan and related agreements.(1)
10.6 Fourth Restated Registration Rights Agreement among the Registrant and
certain securityholders of the Registrant, dated as of December 11,
1995.(1)
10.7 Lease Agreement between the Registrant and Malibu Canyon Office
Partners, L.P. dated as of April 14, 1994, as amended November 3, 1994,
January 2, 1995, and April 25, 1995.(1)
10.8 Security and Loan Agreement dated September 1, 1995 between the
Registrant and Imperial Bank.(1)
10.9 Master Lease Agreement dated as of May 31, 1994, as amended between the
Registrant and Dominion Ventures, Inc.(1)
10.10 Master Lease Agreement dated as of June 9, 1995 between the Registrant
and Copelco Capital, Inc.(1)
10.11 Value-Added Product Sales Agreement dated as of July 1, 1995 between the
Registrant and Hamilton Hallmark, a division of Avnet, Inc.(1)
10.12 401(k) Plan.(1)
10.13 Series C Preferred Stock Agreement dated as of March 13, 1995 between
the Registrant and Alcatel Data Networks S.A.(1)
10.14 International Distributor Agreement between the Registrant and Alcatel
N.V., dated as of March 13, 1995.(1)
10.15 Product and Technology Agreement between the Registrant and Alcatel N.V.
dated as of March 13, 1995.(1)
10.16 Original Equipment Manufacturer Agreement dated as of June 14, 1995
between the Registrant and Hitachi Computer Products (America), Inc.(1)
10.17 Original Equipment Manufacturer Agreement dated as of April 12, 1995
between the Registrant and Digital Equipment Corporation.(1)
10.18+ Manufacturing and Purchase Agreement dated as of March 28, 1996 between
the Registrant and Victron, Inc. Incorporated by reference to exhibit
10.18 to the Company's Quarterly Report on Form 10-Q for the period
ended March 31, 1996.
10.19 Amendment to Manufacturing and Purchase Agreement between Xylan and
Victron, Inc. dated as of December 30, 1996. (2)
10.20 Dale Bartos Employment Agreement dated as of January 4, 1997.(2)
25
<PAGE>
Exhibit
Number Description
- ------- -----------
11.1 Statement of Computation of Earnings Per Share.
27.1 Financial Data Schedule.
________
(1) Incorporated by reference to identically numbered exhibits filed in
response to Item 16(a), "Exhibits," of the Registrant's Registration
Statement on Form S-1 and Amendments thereto (File No. 333-03623), which
became effective on May 29, 1996.
(2) Incorporated by reference to identically numbered exhibits filed in the
Company's Annual Report on Form 10-K for the period ended December 31,
1996.
+ The Company has received confidential treatment for certain portions of
this exhibit filed with the Commission.
26
<PAGE>
EXHIBIT 11.1
STATEMENT REGARDING COMPUTATION OF NET INCOME PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------
March 31, December 31, March 31,
1997 1996 1996
---- ---- ----
<S> <C> <C> <C>
Net income ......................................... $ 5,868 $ 5,031 $ 2,683
======= ======= =======
Weighted average common shares outstanding ......... 42,147 41,892 37,364
Weighted average common stock equivalents - Stock
options determined using the treasury stock
method ........................................... 4,447 5,394 6,593
------- ------- -------
Weighted average common and common
equivalent shares outstanding ..................... 46,594 47,286 43,957
======= ======= =======
Net income per share ............................... $ .13 $ .11 $ .06
======= ======= =======
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 45,630
<SECURITIES> 56,721
<RECEIVABLES> 44,217
<ALLOWANCES> 270
<INVENTORY> 8,299
<CURRENT-ASSETS> 152,283
<PP&E> 23,598
<DEPRECIATION> 6,172
<TOTAL-ASSETS> 220,328
<CURRENT-LIABILITIES> 25,817
<BONDS> 0
0
0
<COMMON> 42
<OTHER-SE> 193,743
<TOTAL-LIABILITY-AND-EQUITY> 220,328
<SALES> 46,326
<TOTAL-REVENUES> 48,008
<CGS> 20,663
<TOTAL-COSTS> 20,663
<OTHER-EXPENSES> 19,704
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11
<INCOME-PRETAX> 9,469
<INCOME-TAX> 3,601
<INCOME-CONTINUING> 5,868
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,868
<EPS-PRIMARY> .13
<EPS-DILUTED> .13
</TABLE>
