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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For the Fiscal Year Ended December 31, 1997
Commission file number: 0-27764
XYLAN CORPORATION
(Exact name of Registrant as specified in its Articles of Incorporation)
CALIFORNIA 95-4433911
(State of Incorporation) (I.R.S. Employer Identification No)
26707 WEST AGOURA ROAD, CALABASAS, CA 91302
(Address of principal executive offices)
(818) 880-3500
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
PREFERRED STOCK PURCHASE RIGHTS
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $599,037,019 as of February 27, 1998, based upon
the closing sale price on the Nasdaq National Market reported for such date.
Shares of Common Stock held by each officer and director and by each person who
owns 5% of more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
There were 43,375,547 shares of Registrant's Common Stock issued and
outstanding as of February 27, 1998.
_________________________
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 1998 Annual Meeting of
Shareholders are incorporated in Part III of this Annual Report on Form 10-K.
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XYLAN CORPORATION
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PART I
ITEM 1. BUSINESS................................................ 3
ITEM 2. PROPERTIES.............................................. 10
ITEM 3. LEGAL PROCEEDINGS....................................... 10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS................................................. 10
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK
AND RELATED SHAREHOLDERS MATTERS........................ 11
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.................... 21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................... 22
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............. 27
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..................... 27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT.............................................. 28
ITEM 11. EXECUTIVE COMPENSATION.................................. 29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT................................... 29
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......... 29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K................................. 30
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INTRODUCTORY STATEMENT
Except for the historical information contained in this Annual Report on Form
10-K, the matters discussed herein may include forward-looking statements that
are subject to certain risks and uncertainties that could cause the actual
results to differ materially from those projected. Factors that could cause
actual results to differ materially include, but are not limited to, the timing
of orders and shipments, the timely development and market acceptance of new
products, the impact of competitive products and pricing, the quality of the
Company's products, the Company's ability to further expand into domestic and
international markets and other risks detailed below in the "Certain Risk
Factors" section and included from time to time in the Company's other SEC
reports and press releases, copies of which are available from the Company upon
request. The Company assumes no obligation to update any forward-looking
statements contained herein.
Xylan was incorporated in California in July 1993. The Company's executive
offices are located at 26707 West Agoura Road, Calabasas, California 91302, and
its telephone number at that location is (818) 880-3500.
References made in this Annual Report on Form 10-K to "Xylan Corporation" or
the "Company" refer to Xylan Corporation and its subsidiaries. The following
Xylan Corporation trademarks are mentioned in this Annual Report: Xylan(R),
PizzaSwitch(R) and OmniSwitch(R) are registered trademarks of the Company, and
AutoTracker(TM), X-Vision(TM), OmniStack(TM) and X-Cell(TM) are trademarks of
the Company.
PART I
Item 1. BUSINESS
OVERVIEW
Xylan Corporation ("Xylan" or the "Company") is a leading provider of high-
bandwidth switching systems that enhance the performance of existing local area
networks ("LAN") and facilitate migration to next-generation networking
technologies such as Asynchronous Transfer Mode ("ATM"). Current hub and router-
based networks are facing performance degradation due to the continued growth in
the size of networks, increasing demands of high-performance personal computers
and workstations, and emergence of graphical applications, such as Intranet/Java
applications, document image processing, desktop video, medical imaging,
modeling and simulation, and the World Wide Web. To address these issues, a new
generation of switched technologies has emerged, including LAN switching, ATM
switching, and layer-three switching.
Xylan offers the OmniSwitch, OmniStack and PizzaSwitch product families, which
support all popular LAN types with "any-to-any" MAC-layer translation, and allow
the use of LAN switches in place of shared-media hubs. The Company's switches
are based on a distributed, modular, multiprocessor architecture that currently
combines LAN switching, virtual LANs, ATM switching, wide area access, security,
and layer-three switching in a single product, and which allows switching
performance to increase in linear proportion to the number of ports. The Company
has developed and continues to develop custom chips (ASICs, or application-
specific integrated circuits) providing important feature differentiation for
integration into its product line.
Xylan has strategic OEM partnerships with leading communications and
networking companies, including Alcatel and IBM that have significant customer
relationships already in place. Xylan pursues direct sales to organizations in
North America with large networking requirements and employs network integrators
to target customers worldwide. The Company's products have been deployed by a
broad range of organizations, ranging from companies in the telecommunications,
manufacturing, medical, computer services, media and finance/insurance
industries to educational institutions and the federal government.
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XYLAN SOLUTION
Xylan was founded to provide high-bandwidth switching systems that enhance the
performance of existing LANs and facilitate migration to next generation
networking technologies such as ATM. The Company's products accomplish these
goals by: providing "any-to-any" MAC-layer translation; supporting widely used
LAN types such as Ethernet, Fast Ethernet, token ring, ATM, and Fiber
Distributed Data Interface ("FDDI"); and enabling the customer to replace
shared-media hubs with LAN switches. Xylan's AutoTracker product is designed to
support powerful, flexible virtual LANs and to simplify network management.
Xylan has designed its product architecture specifically to support LAN
switching, ATM switching, virtual LANs, security, and routing. The Company's
switches are based on a distributed, modular, multiprocessor architecture. This
architecture allows switching performance to increase in linear proportion to
the number of ports, unlike many other switches based on a central switching
engine, which generally cannot increase performance as ports are added. The
Company's virtual LAN capability is integrated directly into its hardware
architecture and controlled by distributed reduced instruction set computing
("RISC") processors and ASICs to achieve high throughput and flexibility.
Xylan's products can switch within virtual LANs and route between them, and can
establish security firewalls between them. The Company has also developed a
substantial number of LAN interface modules, enabling the customer to tailor the
product to a particular application. The Company continues to develop ASICs to
provide unique functionality, increase system performance and reduce costs.
PRODUCTS AND TECHNOLOGY
Xylan offers a family of products that are designed to serve as a complete
switching system for a building or campus. The Company's OmniSwitch, OmniStack,
and PizzaSwitch products provide flexible high-end LAN switching, virtual LANs,
high-speed routing, ATM switching, layer-three switching, wide-area access and
comprehensive network management capabilities. The Company's OmniVision software
provides a graphical network management capability designed to be compatible
with the user's network environment.
OmniSwitch
The OmniSwitch is a modular, chassis-based switch that provides high
performance LAN switching, routing, layer-three switching, and ATM switching.
The OmniSwitch supports a variety of LAN types, interconnecting Ethernet, Fast
Ethernet, token ring, FDDI, frame relay, and ATM with any-to-any MAC-layer
protocol translation. The Company offers the OmniSwitch in three-slot, five-
slot, and nine-slot enclosures, which can be configured with a mix of switching
modules to meet a customer's specific needs. All three enclosures use the same
hardware and software and offer redundant, load-sharing power supplies with
separate AC or DC inputs. The OmniSwitch is designed to be located either in the
customer's wiring closet or in the computer room. The list price for a fully
configured OmniSwitch typically ranges from $10,000 to $100,000, depending on
the configuration necessary to meet the needs of a specific customer. A network
could use one OmniSwitch or could use hundreds, depending on network size and
the extent to which switching is deployed.
The Xylan OmniSwitch family of products is based on a distributed, modular,
multiprocessor, and multi-ASIC switching architecture. This distributed
architecture eliminates the traditional central switching engine, enabling data
to move more quickly through the Company's switching modules. In addition, users
can increase the processing capacity of an OmniSwitch by simply adding switching
modules.
The OmniSwitch serves as a platform for a broad array of LAN, ATM, and wide
area switching modules. Each module not only provides connections for user
equipment, but also acts as an independent switching engine, communicating
directly with other modules in the OmniSwitch.
OmniStack
The Company announced its OmniStack series of products in March of 1998. The
OmniStack is designed to be more cost effective in smaller configurations. The
OmniStack is based on the same system architecture and incorporates many of the
same LAN switching and software capabilities as the OmniSwitch. Consequently,
the OmniStack units incorporate many of the features and functionality of the
OmniSwitch that are lacking in traditional small switches, making the OmniStack
suitable for a wider range of customers and applications. The OmniStack
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units may be used alone in a small network or in combination with multiple
OmniSwitch and/or OmniStack devices in a larger network. While the OmniSwitch is
fully modular, the OmniStack units combine a number of Ethernet or 10/100
(Ethernet / Fast Ethernet) ports with a small number of modular high-speed
ports, which are scheduled to be Fast Ethernet, Gigabit Ethernet, ATM or various
wide area interfaces. The OmniStack is designed to be located either in the
customer's wiring closet or in the computer room. The list price for a fully
configured OmniStack typically ranges from $3,350 to $37,000, depending on the
configuration necessary to meet the needs of a specific customer.
PizzaSwitch
The Company's PizzaSwitch product, which was introduced during the first
quarter of 1996, is based on the same system architecture and incorporates many
of the same LAN switching and software capabilities as the OmniSwitch. The
PizzaSwitch will be used in applications which require a small access switch
with FDDI uplinks.
AutoTracker-Virtual LANs
The OmniSwitch and OmniStack hardware and software architectures were designed
to support flexible virtual LANs. The Company's AutoTracker capability allows a
network manager to group devices logically, rather than physically, using
policy-based management. Workstation movements can be automatically tracked for
the network manager through the network. Virtual LAN processing is integrated
into the OmniSwitch and OmniStack hardware and software architecture in order to
maintain switching performance. A virtual LAN supported by AutoTracker can
include any combination of LAN types supported by the OmniSwitch and the
OmniStack. For example, a single virtual LAN could include Ethernet and token
ring workstations as well as FDDI and ATM servers. Virtual LANs supported by
AutoTracker can span multiple switches, across FDDI, Fast Ethernet, Gigabit
Ethernet, and/or ATM backbones. Any given workstation or server can belong to as
many as 31 virtual LANs. AutoTracker also allows workstations attached to a
single hub to be assigned to different virtual LANs.
Vision Network Management
Xylan's X-Vision network management software operates within a customer's
existing network management environment. It supports the OmniSwitch, OmniStack
and PizzaSwitch products with a graphical interface which operates on industry-
standard applications for both Windows (Hewlett-Packard's OpenView) and UNIX
(OpenView, SunSoft's SunNet Manager and IBM's NetView for AIX). Network managers
can also control the OmniSwitch, OmniStack and PizzaSwitch with an ASCII menu-
driven interface.
ATM Switching Technology
Xylan has incorporated ATM switching capability into the OmniSwitch. The
Company believes that its ATM switching architecture, Distributed Input
Buffering with Output Control, allows both data-based and real-time traffic to
be handled with minimal cell loss even under heavy loads. Video streams and
other real-time traffic are also supported. The ATM switching capability, known
as X-Cell, supports large cell buffers, offers intelligent cell discard
mechanisms, and supports a number of important ATM Forum standards.
PRODUCT DEVELOPMENT
The Company's success will depend to a substantial degree upon its ability to
develop and introduce in a timely fashion new products and enhancements to its
existing products that meet changing customer requirements and emerging industry
standards. Xylan intends to make substantial investments in product development
and to participate in the development of industry standards. The Company
monitors changing customer needs and works closely with its OEM partners,
network integrators, end-user customers and market research organizations to
track changes in the marketplace, including emerging industry standards and
local area networking protocols.
The Company's products are developed using a distributed architecture that
allows multiple development teams to work in parallel. The Company believes that
this accelerates the product development cycle and reduces the time to bring new
products and features to market. Xylan intends to continue to use this approach
to develop and introduce additional products and enhancements in the future.
The Company is focusing development efforts on expanding the LAN and ATM
interfaces and routing protocol capabilities of its products, supporting carrier
services and additional industry standards, adding higher capacity
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platforms and expanding the Company's network management capabilities. In
addition, Xylan has devoted and continues to devote significant resources to the
design, simulation and fabrication of ASICs to provide differentiated
functionality, reduce costs and increase the performance of its products. No
assurances can be given that the Company will be able to introduce any or all of
these products, or any future products, on a timely basis, if at all.
Furthermore, there can be no assurance that the Company will be able to
identify, develop, manufacture, market, or support new products, or enhancements
to its existing 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.
The Company's research and development expenditures totaled $25.9 million,
$15.8 million and $7.2 million for the years ended December 31, 1997, 1996, and
1995, respectively. At December 31, 1997, the Company employed 187 employees in
research and product development. The Company performs its research and product
development activities at its headquarters and in offices located in Irvine, CA;
San Diego, CA; San Jose, CA; Acton MA; Raleigh, NC; Minneapolis, MN; and Salt
Lake City, UT. The Company is seeking to hire additional skilled development
engineers, who are currently in short supply. The Company's business, operating
results and financial condition could be adversely affected if it encounters
delays in hiring required engineers.
SALES AND MARKETING
The Company's sales and marketing strategy is focused on three channels of
distribution: worldwide OEM partners, network integrators in North America and
overseas, and direct sales. In general, the Company's resale agreements with its
OEM partners and system integrators are not exclusive and each of the Company's
OEM partners and system integrators can cease marketing the Company's products
at their option with limited notice and with little or no penalty. In addition,
these agreements generally provide for discounts based on expected or actual
volumes of products purchased or resold by the reseller and OEM 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.
OEM Partners
The Company has established OEM partnerships with leading communications and
networking companies, including Alcatel and IBM. For the year ended December 31,
1997, IBM and Alcatel accounted for 21.5% and 11.6% of revenue, respectively.
Each of the Company's OEM partners resells the Company's products under its own
name. Certain of them have also agreed to supply Xylan with technology to be
incorporated into the OmniSwitch. Each of Xylan's OEM partners is a major system
integrator, as well as a manufacturer. The Company believes that its OEM
partnerships enhance its ability to sell to large organizations because these
resellers have long-term supplier relationships with these potential customers,
and because certain end user organizations prefer to do business with very large
suppliers. Since OEM partners provide support to their customers, Xylan is also
able to focus its support efforts on its direct customers, and on training and
high-level backup support to OEM partners and system integrators.
System Integrators
The Company also currently sells its products through more than 100 system
integrators worldwide. The Company's system integrators supplement the direct
and OEM channels. System integrators generally are responsible for system
installation, technical support, and follow-on services to customers in their
respective territories. System integrators accounted for approximately 38% of
revenue for the year ended December 31, 1997. No individual network integrator
accounted for more than 10% of the Company's revenue in 1997.
Direct Sales in North America
Xylan conducts direct sales to end users in North America to focus on major
account sales, promote the Company's products, and ensure direct contact with
the Company's current and potential customers. Xylan's sales organization also
provides support to OEM partners and system integrators, assists end user
customers in addressing complex switching problems, and promotes the features
and capabilities of the Company's products. In addition, the Company believes
that direct sales help the Company to monitor changing customer requirements.
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Xylan's International Sales Organization
The Company has designed its products and established its marketing and sales
channels to address the global market opportunities for switching products. The
Company's international sales are conducted primarily through its OEM partners,
worldwide network integrators and territory-specific network integrators. The
Company believes that there is a strong international market for its products.
Sales to customers outside of North America accounted for approximately 53% of
the Company's revenue for the year ended December 31, 1997, with approximately
22% and 28% of 1997 revenue being attributable to sales to customers in Asia-
Pacific and Europe, 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 organization provides support to OEM partners and
system integrators and promotes the features and capabilities of the Company's
products.
End Users
The Company's products have been deployed by a broad range of organizations,
ranging from companies in the telecommunications, manufacturing, medical,
computer services, media and finance/insurance industries to educational
institutions and the federal government.
Marketing
The Company has a number of marketing programs to support the sale and
distribution of its products. The objective of these programs is to inform OEM
partners, system integrators, and prospective end user customers about the
capabilities and benefits of the Company's products. Marketing programs include
participation in industry tradeshows, technical conferences and technology
seminars; preparation of competitive analyses; sales training; publication of
technical and educational articles in industry journals; presentation of Xylan-
specific seminars; maintenance of Xylan's World Wide Web site; advertising;
public relations; and direct mail distribution of Company literature.
CUSTOMER SERVICE AND SUPPORT ENGINEERING
Xylan's customer service and support organization installs, maintains and
supports products sold in North America directly to end users by the Company,
and provides technical support to the Company's OEM partners and network
integrators. The Company's OEM partners and system integrators generally provide
installation, maintenance and support services to their customers, with the
Company providing backup support.
The Company offers maintenance programs in North America that provide seven
days a week and 24 hours a day technical phone support; software updates; and
on-site hardware replacement through a network of service delivery partners.
Xylan employs systems engineers who work closely with the Company's OEM
partners, system integrators, and sales personnel to assist end users with pre-
and post-sales support. These systems engineers provide input to the product
development process based on their experiences in the field.
Xylan typically provides its system integrators with a one-year hardware
warranty and a three-month software warranty, commencing on product shipment.
Warranty terms for OEM partners are negotiated individually.
MANUFACTURING
Xylan's manufacturing operations consist primarily of material planning and
procurement, final assembly, software loading, test and quality assurance.
Xylan's operational strategy relies on outsourcing of manufacturing to reduce
fixed costs and to provide flexibility in meeting market demand. The Company
currently subcontracts component procurement and kitting and printed circuit
board assembly to two companies that specialize in these services. The printed
circuit board-based modules produced by its contract manufacturers are inserted
into product enclosures in combination with Xylan's software to meet the needs
of individual customers.
In connection with its outsourcing 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 quality, quantity and on-time delivery.
In addition, the
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Company may in the future experience pricing pressures 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 contract
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 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 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 on the Company's business, operating results and
financial condition.
The Company uses a rolling six-month forecast based on anticipated product
orders to determine its general materials and component 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. Currently, the Company acquires materials and
completes certain standard subassemblies based on the Company's forecast. Upon
receipt of firm orders from customers, the Company assembles fully-configured
systems and subjects them to a number of tests before shipment. If orders do not
match forecasts, the Company may have excess or inadequate inventory of certain
materials and components. The Company continues to implement new and enhanced
financial and management information systems and controls and to train its
personnel to operate such systems. Any difficulty in the operation of such new
and enhanced systems and controls or the training of personnel, or any
disruptions in the transition to such new and 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 and
to accurately record and control inventory levels and to record and report
financial and management information on a timely and accurate basis.
Although the Company generally uses standard parts and components for its
products, many 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 ASIC's, certain processors, programmable integrated
circuits, selected other integrated circuits, cables, and custom-tooled sheet
metal; and limited-sourced components include flash 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 additional ASICs in many of its products. 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 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. From time to time the
Company has experienced shortages and allocations of certain components and has
experienced delays in fulfilling orders while waiting to receive the necessary
components. Given current worldwide demand for integrated circuits and certain
other components used by the Company, such shortages and allocations are likely
to occur again in the future and could have a material adverse effect on the
Company's business, operating results, and financial condition.
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. 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
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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. 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.
Xylan believes that the principal competitive factors in its market are: (i)
expertise and familiarity with LAN and ATM protocols, LAN and ATM switching, and
network management; (ii) product performance, features, functionality, and
reliability; (iii) price/performance; (iv) timeliness of new product
introductions; (v) adoption of emerging industry standards; (vi) customer
service and support; (vii) size and scope of distribution network; (viii) access
to customers; (ix) size of installed customer base; and (x) corporate operating
history and financial resources. The Company believes that it is competitive
with respect to the first seven of these factors and intends to become
competitive with respect to the remaining factors.
The Company's international business is subject to risks customarily
encountered in foreign operations, including changes in a specific country's or
region's political or economic conditions, trade protection measures, import or
export licensing requirements, the overlap of different tax structures,
unexpected changes in regulatory requirements and natural disasters. For
example, due to the recent financial turmoil in Asia, the Company's revenues
from Asia declined from 25% in the third quarter of 1997 to 18% in the fourth
quarter.
EMPLOYEES
As of December 31, 1997, the Company employed 721 persons, including 187 in
research and product development, 361 in sales and marketing, 116 in operations
and 57 in finance and administration. None of the Company's employees is
represented by a labor union. The Company has experienced no work stoppages and
believes that its relationship with its employees is good.
Competition for qualified personnel in the computer networking and
communications industry is intense. There can be no assurance that the Company
will be successful in retaining its key employees or that it can attract the
additional skilled personnel required for the Company's future growth. 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.
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ITEM 2. PROPERTIES
The Company leases approximately 94,500 square feet of office, development and
manufacturing space in three adjacent facilities in Calabasas, California. The
current leases on this space expire through October 2002. The Company also has
approximately 97 sales and support offices worldwide. For additional information
regarding the Company's obligations under such leases, see the notes to
Consolidated Financial Statements. Xylan needs to obtain additional office,
development and manufacturing space to accommodate expected business growth
during 1998. There can be no assurance that such additional facilities will be
available in a timely manner or on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
The Company may in the future be, party to litigation arising in the course of
its business. There can be no assurance that the Company's insurance coverage
will be adequate to cover all liabilities arising out of any such claims or that
any claim will be covered by the Company's insurance.
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 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.
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 Company infringe third party
intellectual property rights. Xylan has, from time to time, received claims,
directly or indirectly, 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 any 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this Report.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS
The Company's Common Stock is traded on the NASDAQ National Market under the
symbol "XYLN". As of February 27, 1998, the Company had approximately 421
shareholders of record. Since many shareholders are listed under their brokerage
firm's name, the actual number of shareholders is higher. On February 27, 1998,
the last reported sale price for the Common Stock on the NASDAQ National Market
was $24.13 per share.
The following table shows the Company's high and low closing bid prices for
the periods indicated as reported by NASDAQ National Market:
<TABLE>
<CAPTION>
1997 1996
------------------ ------------------
HIGH BID LOW BID HIGH BID LOW BID
-------- ------- -------- -------
<S> <C> <C> <C> <C>
First Quarter $36.13 $17.13 $58.38 $51.25
Second Quarter $22.63 $13.63 $74.31 $46.50
Third Quarter $24.56 $15.50 $56.75 $34.75
Fourth Quarter $23.38 $14.50 $58.25 $24.00
</TABLE>
Future stock prices may be subject to volatility particularly on a quarterly
basis. Any shortfall in revenues or net income from amounts expected by
securities analysts could have an immediate and significant adverse effect on
the trading price of the Company's stock.
DIVIDEND POLICY
The Company has not paid dividends on its common stock and has no present
plans to do so.
CERTAIN RISK FACTORS
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 generally experienced 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. In fiscal 1998, the Company intends to continue 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
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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 Company's ability to support its current and new products,
(iv) the ability to obtain sufficient supplies of sole or limited source
components for the Company's products, (v) the ability to attain and maintain
production volumes and quality levels for its products (including ASICs), (vi)
the mix of distribution channels and products, (vii) new product introductions
by the Company's competitors, (viii) pricing actions by the Company or its
competitors, (ix) changes in material costs (x) mix of products manufactured or
purchased by IBM and (xi) general economic conditions. See "--Dependence on OEM
Partners and System Integrators; IBM and Alcatel; 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." For example, the
Company's revenue in the quarter ended June 30, 1997 declined as compared to the
immediately preceding quarter primarily due to lower than expected orders from a
large OEM customer, material availability for the Company's ATM switch product,
and lower than expected shipments of the Company's new Ethernet/Fast Ethernet
products.
The Company's revenue in any period is highly dependent upon the sales efforts
and success of Xylan's OEM partners (including IBM and Alcatel) 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
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, the Company's operating results has and
may in the future 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.
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<PAGE>
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 may 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. As demand for the Company's products grow, the Company will
increase its flow of materials, contract manufacturing capacity and internal
test and quality functions to respond to such customer demand and to reduce its
order lead times. Any inability or delay in 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. During 1996, the Company leased 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 financial condition. The Company also requires
additional manufacturing space and 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 printed circuit board
assembly to two companies. The Company also subcontracts assembly of chassis to
a number of companies, 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 one of its contract manufacturers
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, 1997, the note had an outstanding balance of $7.5 million. Also,
during 1996 and 1997, the Company guaranteed up to $5.0 million of such contract
manufacturer's debt for certain raw material and electronic component purchases.
Any additional loans or guaranties to contract manufacturer, or defaults or
financial insolvency of such 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
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<PAGE>
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 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, certain 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, many of these ASICs are initially being
manufactured 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 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.
DEPENDENCE ON OEM PARTNERS AND SYSTEM INTEGRATORS; IBM AND ALCATEL; CUSTOMER
CONCENTRATION. The Company pursues a sales and marketing strategy focused on
developing three channels of distribution for its products: worldwide OEM
partners, system integrators 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 year ended
December 31, 1997, sales to IBM comprised 21.5% 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 December 31, 1997, no royalties have
been earned by either company. However, sales by IBM of IBM manufactured or
other 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
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<PAGE>
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 37% and 38%, respectively, for the year ended December
31, 1997, and 46% and 42% for the year ended December 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.
Certain of the Company's OEM agreements provide for limited exclusivity.
Certain of the Company's OEM partners have developed 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. For example, in July 1997, IBM
announced that it had also formed an alliance with 3Com, a competitor of the
Company. 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 or acquisition 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, support or acquire 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. Such delays have, and any future delays
could have, a material adverse effect on the Company's business, operating
results and financial condition. 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
15
<PAGE>
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 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.
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. The Company introduced its OmniStack series
of products in March of 1998. The Company expects that revenue from these
products will account for a substantial portion of the Company's revenue through
1998. 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 and support 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 AND SYSTEM 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. In addition, end
users use the Company's products in complex systems or networks with products
from multiple vendors. As a result, the Company's products must successfully
interoperate with products from other vendors and at times, a system problem (if
one exists) may be difficult to identify the source of the problem. 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.
MANAGEMENT OF GROWTH. The Company's growth has resulted in a continuing
increase in the level of responsibility for both existing and new management
personnel. The Company recently has implemented and continues to implement 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 the
Company's 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 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
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<PAGE>
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.
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
17
<PAGE>
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 53% and 51% of the Company's revenue for the fiscal
years ended 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-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. The Company's international business is subject to risks
customarily encountered in foreign operations, including changes in a specific
country's or region's political or economic conditions, trade protection
measures, import or export licensing requirements, the overlap of different tax
structures, unexpected changes in regulatory requirements and natural disasters.
For example, due to the recent financial turmoil in Asia, the Company's
revenues from Asia declined from 25% of total revenues in the third quarter of
1997 to 18% in the fourth quarter. 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. 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.
YEAR 2000
Many computer systems experience problems handling dates beyond the year 1999.
Therefore, some computer hardware and software will need to be modified prior to
the Year 2000 in order to remain functional. The Company is assessing both the
internal readiness of its computer systems and the compliance of its computer
products and software sold to customers for handling the Year 2000. The Company
expects to implement successfully the systems and programming changes necessary
to address Year 2000 issues, and does not believe that the cost of such actions
will have a material effect on the Company's results of operations or financial
condition. There can be no assurance, however, that there will not be a delay
in, or increased costs associated with, the implementation of such changes, and
the Company's inability to implement such changes could have an adverse effect
on future results of operations.
The Company is also assessing the possible effects on the Company's operations
of the Year 2000 readiness of key suppliers and subcontractors. The Company's
reliance on suppliers and subcontractors, and, therefore, on the proper
functioning of their information systems and software, means that failure to
address Year 2000 issues could have a material impact on the Company's
operations and financial results; however, the potential impact and related
costs are not known at this time.
18
<PAGE>
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 next twelve months, 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, the Company's Board of Directors are divided between
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. In October of 1997, the Company's Board of Directors approved
acceleration of vesting of stock options held by the Company's Executive
Officers and certain key employees in the event of a change of control, which
could also make a change in control or management of the Company more difficult.
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. 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 existence of 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
19
<PAGE>
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 affect 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, provided, however, the amount
of shares to be delivered by Mr. Kim will be reduced to 80,000 shares commencing
with the second quarter of 1998. Furthermore, the trust for Steve Kim's children
will sell 25,000 shares and Yuri Pikover's trusts will sell 20,000 shares within
each 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.
20
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial information has been derived from the
audited Consolidated Financial Statements. The information set forth below is
not necessarily indicative of results of future operations, and should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and related
notes thereto included elsewhere in the Form 10-K.
<TABLE>
<CAPTION>
PERIOD
ENDED
YEAR ENDED DECEMBER 31, DECEMBER 31,
---------------------------------------------- ------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenue............................................................ $210,849 $128,456 $29,662 $ 443 $ --
Cost of revenue.................................................... 92,551 57,830 15,418 327
-------- -------- ------- -------
Gross profit..................................................... 118,298 70,626 14,244 116 --
-------- -------- ------- ------- -------
Operating expenses:
Research and development.......................................... 25,875 15,823 7,154 2,404 343
Sales and marketing.............................................. 60,356 32,590 13,011 695 --
General and administrative....................................... 7,013 4,397 3,593 1,168 188
-------- -------- ------- ------- -------
Total operating expenses....................................... 93,244 52,810 23,758 4,267 531
-------- -------- ------- ------- -------
Operating income (loss)............................................ 25,054 17,816 (9,514) (4,151) (531)
Interest income, net............................................ 6,694 5,240 73 68 9
-------- -------- ------- ------- -------
Income (loss) before income taxes.................................. 31,748 23,056 (9,441) (4,083) (522)
Income tax expense............................................... 7,621 7,811 -- -- --
-------- -------- ------- ------- -------
Net income (loss).................................................. $ 24,127 $ 15,245 $(9,441) $(4,083) $ (522)
======== ======== ======= ======= =======
Net income (loss) per share (1):
Basic............................................................ $ 0.57 $ 0.43 $ (0.91) $ (0.41) $ (0.05)
Diluted.......................................................... $ 0.52 $ 0.33 $ (0.91) $ (0.41) $ (0.05)
======== ======== ======= ======= =======
Shares used in per share computation (1):
Basic............................................................ 42,550 35,870 10,320 10,025 9,983
Diluted.......................................................... 46,796 46,381 10,320 10,025 9,983
======== ======== ======= ======= =======
<CAPTION>
DECEMBER 31,
------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments.................. $ 79,088 $112,981 $ 6,034 $ 4,584 $ 1,306
Investments........................................................ 59,382 27,785 -- -- --
Working capital.................................................... 124,934 134,615 11,130 4,186 1,216
Total assets....................................................... 250,906 207,251 27,248 6,613 1,411
Capital lease obligations, long-term............................... 17 206 509 239 --
Net shareholders' equity........................................... 216,100 185,638 16,105 5,367 1,269
</TABLE>
- ----------
21
<PAGE>
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of shares used to compute net income
(loss) per share.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Annual Report on Form 10-K 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 "Certain Risk
Factors" section of this Form 10-K, which identify important risk factors that
could cause actual results to differ from those contained in the forward-looking
statements.
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 to an aggregate of $210.8 million in fiscal year 1997
from $29.7 million in fiscal year 1995. The increase in 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 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 December 31, 1997 and 1996,
the Company had retained earnings of $25.3 million and $1.2 million,
respectively.
The Company intends to continue 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 but one quarter 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.
YEARS ENDED DECEMBER 31, 1997 AND 1996
Revenue
Revenue for the year ended December 31, 1997 was $210.8 million compared to
$128.5 million for the year ended December 31, 1996, an increase of 64%. The
increases in revenue were 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, market
acceptance of the Company's LAN switching products, the continued strategic
relationships with IBM and Alcatel and the Company's investment in sales and
marketing resources. 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 December 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. While the Company achieved revenue growth
of 64% from 1996 to 1997, the Company cannot insure this rate of sequential
revenue growth if at all in future periods.
22
<PAGE>
For the year ended December 31, 1997, IBM and Alcatel accounted for 21.5%, and
11.6% of revenue, respectively. For the year ended December 31, 1996, Hitachi
Computer Products, NTT PC Communications and IBM accounted for 13.5%, 12.3% and
11.7% of revenue, respectively. 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 years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996
---- ----
<S> <C> <C>
Channel:
OEM 37% 46%
Network Integrator 38% 42%
Direct Sales 25% 12%
=== ===
Region(1):
North America 47% 49%
International 53% 51%
=== ===
- --------
</TABLE>
(1) 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 56.1% and 55.0% for the years ended December 31, 1997 and
1996, respectively. The increase in gross margins resulted from component cost
reductions due to increased volume, the use of application specific integrated
circuits ("ASICs") and design improvements along with the allocation of fixed
costs over a larger revenue base. 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 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.
Research and Development Expenses
Research and development expenses increased to $25.9 million in 1997 from
$15.8 million in 1996, or 12.3% as a percentage of sales for 1997 and 1996. The
increase in absolute spending was primarily due to the hiring of additional
engineers for new product development. At December 31, 1997, the Company
employed 187 employees in research and development compared to 122 employees at
December 31, 1996.
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 in absolute dollars will continue to increase in 1998. 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 increased to $60.4 million or 28.6% of sales in
1997 from $32.6 million or 25% of sales in 1996. During 1997 the Company
continued to expand its infrastructure, including the addition of Xylan sales
personnel and sales offices throughout North America, Europe and Asia, increased
commission expenses resulting from higher revenue, and increased spending in
advertising and promotional campaigns in support of the
23
<PAGE>
Company's direct sales and system integrator channels. At December 31, 1997, the
Company employed 361 employees in sales and marketing compared to 216 employees
at December 31, 1996. 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 spending in
absolute dollars will continue to increase in 1998.
General and Administrative Expenses
General and administrative expenses increased to $7.0 million or 3.3% of sales
in 1997 from $4.4 million or 3.4% of sales in 1996. The increase in absolute
dollars reflects the addition of personnel and systems to support the growth of
Xylan's business. As the Company continues to add personnel and offices
worldwide, and introduce new products and enhancements to its existing products,
it expects that general and administrative expenses will increase in 1998 in
absolute dollars.
Interest Income
Interest income was $6.7 million and $5.2 million for the years ended December
31, 1997 and 1996, respectively. This increase is the result of interest income
earned on higher average cash, cash equivalents and investments for all 1997
versus 1996.
Provision for Income Taxes
During 1997, the Company recorded an effective tax rate of 24%, which included
the recognition of $5.6 million of certain deferred tax assets. This resulted in
an income tax provision of $7.6 million in 1997 versus $7.8 million in 1996. The
recognition of the deferred tax assets resulted from the reversal of the
valuation allowance based on management's assessment that it is more likely than
not that the net deferred tax assets will be realized based upon existing
temporary differences and expectations of future taxable income levels. During
1996, the Company recorded an effective tax rate of 34%, which included the
recognition of $400,000 of certain deferred tax assets. Also, during 1997 and
1996, the Company realized an income tax benefit of $2.7 million and $9.5
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 resulted in a decrease in current income taxes payable and an
increase in additional paid in capital.
YEARS ENDED DECEMBER 31, 1996 AND 1995
Revenue
Revenue for the year ended December 31, 1996 was $128.5 million compared to
$29.7 million for the year ended December 31, 1995, an increase of 333%. The
increases in revenue were 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, the
introduction of the PizzaSwitch product family, market acceptance of the
Company's LAN switching products, the addition of IBM as a strategic partner in
July 1996, and the Company's investment in sales and marketing resources. 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 December 31, 1996, no royalties have been earned by the Company. Product
revenue could be adversely impacted if IBM elects to manufacture the Company's
products. While the Company achieved revenue growth of 333% from 1995 to 1996,
the Company does not expect to sustain this rate of sequential revenue growth if
at all in future periods.
For the year ended December 31, 1996, Hitachi Computer Products, NTT PC
Communications, Inc. and IBM accounted for 13.5%, 12.3% and 11.7% of revenue,
respectively. For the year ended December 31, 1995, Hitachi Computer Products,
Digital Equipment Corp. and Alcatel accounted for 17.6%, 17.2% and 10.5% of
revenue, respectively. For the year ended December 31, 1994, substantially all
of the Company's revenue was derived from network integration services, and one
customer accounted for 13.8% revenue.
24
<PAGE>
Gross Profit
Gross margins were 55.0% and 48.0% for the years ended December 31, 1996 and
1995, respectively. The increase in gross margins resulted from component cost
reductions due to increased volume, the use of application specific integrated
circuits ("ASICs") and design improvements along with the allocation of fixed
costs over a larger revenue base. 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
components 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 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 gross
margins.
Research and Development Expenses
Research and development expenses increased to $15.8 million in 1996 from $7.2
million in 1995, while declining as a percentage of revenue to 12% in 1996 from
24% in 1995. The increase in spending was primarily due to the hiring of
additional engineers and increased in prototype material costs for new product
development. At December 31, 1996, the Company employed 122 employees in
research and development compared to 64 employees at December 31, 1996. The
decline in research and development expenses as a percentage of revenue is
primarily due to the increase 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 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 in 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 increased to $32.6 million in 1996 from $13.0
million in 1995, while declining as a percentage of revenue to 25% in 1996 from
44% in 1995. During 1996 the Company established an expanded infrastructure,
including the addition of Xylan sales personnel and sales offices throughout
North America, Europe and Asia, increased commission expenses resulting from
higher revenue, and advertising and promotional campaigns in support of the
Company's direct sales and system integrator channels. At December 31, 1996, the
Company employed 216 employees in sales and marketing compared to 88 employees
at December 31, 1995. The decline in sales and marketing expenses as a
percentage of revenue is primarily due to the increase in revenue. As the
Company continues to expand its sales force, adding personnel and offices
worldwide, and to introduce new products and enhancements of its existing
products, it expects that sales and marketing spending will continue to increase
in 1997.
General and Administrative Expenses
General and administrative expenses increased to $4.4 million in 1996 from
$3.6 million in 1995, while declining as a percentage of revenue. The increase
in absolute dollars reflects the addition of personnel and systems to support
growth of Xylan's business. The decline in general and administrative expenses
as a percentage of revenue is primarily due to the increase 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 increase in 1997 in
absolute dollars.
25
<PAGE>
Interest Income
Interest income was $5.2 million and $73,000 for the years ended December 31,
1996 and 1995, respectively. This increase 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.
Provision for Income Taxes
The Company recorded a provision for income taxes of $7.8 million for the year
ended December 31, 1996 and recorded a deferred tax asset at December 31, 1996
of $1.8 million. The net deferred tax asset is included in prepaids and other
current assets in the accompanying consolidated financial statements. Also,
during 1996, the Company realized an income tax benefit of $9.5 million for
certain stock option transactions. This benefit is used to reduce taxable income
prior to the utilization of net operating loss carryforwards, and resulted in a
decrease in current income taxes payable and an increase in additional paid in
capital. As a result of net operating losses, no provision for income taxes was
recorded for 1995.
As of December 31, 1996, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $7.7 million, 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 $1 million and $421,000, respectively, which are
available to offset future income taxes, if any, through 2011.
LIQUIDITY AND CAPITAL RESOURCES
In March 1996, the Company completed its initial public offering and raised
$87.4 million, net of issuance costs and in May 1996 the Company completed a
secondary offering which raised $56.2 million, net of issuance costs.
Additionally, during 1997, cash provided by operating activities aggregated
$11.2 million.
From inception to December 31, 1995, the Company financed its operations and
capital expenditures through the sale of Common and Preferred Stock, for
aggregate proceeds of $30.0 million, and capital lease and other debt financing.
During 1995, cash utilized by operating activities was $14.3 million, compared
to $4.0 million in 1994. The increase in cash utilized during 1995 reflected the
increased working capital necessary to fund significantly expanded operations
and the resulting inventory and accounts receivable.
The Company requires substantial working capital to fund its business,
particularly to finance inventories and accounts receivable and for capital
expenditures. Capital expenditures aggregated $12.1 million and $15.2 million in
1997 and 1996, respectively. The Company has also agreed to loan a contract
manufacturer up to $10 million, of which $7.5 million was outstanding as of
December 31, 1997. Additionally, the Company has guaranteed up to $5 million of
this contract manufacturer's debt for raw material and electronic components
purchases. 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, 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 announced in January 1998, a stock repurchase program in which up
to 2 million shares of its common stock may be repurchased in the open market or
private transactions.
The Company's principal source of liquidity as of December 31, 1997, consisted
of $35.9 million in cash and cash equivalents, $43.2 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 12 months.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings per Share." Statement No. 128 replaced the previously
reported primary and fully diluted earnings per share with basic and diluted
earnings per share and became effective for both interim and annual periods
ending after December 15,
26
<PAGE>
1997. Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options and convertible securities. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented, and
where necessary, restated to conform to the Statement No. 128 requirements.
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income" effective for fiscal years beginning after
December 15, 1997. Statement No. 130 established standards for the reporting and
display of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general-purpose financial statements. The Statement
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. The Company will adopt Statement No. 130 effective January 1, 1998.
In June 1997, the Financial Accounting Standards Board issued Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information"
effective for financial statements for periods beginning after December 15,
1997. Statement No. 131 establishes standards for the way that public business
enterprises report financial and descriptive information about reportable
operating segments in annual financial statements and interim financial reports
issued to shareholders. Statement No. 131 supersedes Statement No. 14,
"Financial Reporting for Segments of a Business Enterprise," but retains the
requirement to report information about major customers. The Company will adopt
Statement No. 131 effective January 1, 1998.
YEAR 2000
The majority of the Company's internally used management information systems
were installed in the last two years and are warranted to comply with the Year
2000 requirement. The Company is in the process of conducting a comprehensive
review of its other internal computer systems to identify the systems that could
be affected by the Year 2000 issue. To date, costs incurred related to the Year
2000 issue have been minimal. Furthermore, mangement believes that, additional
costs associated with addressing the Year 2000 issue for the Company's internal
information systems, and current and future products, will not have a material
impact on operations or financial results.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements are included in this Form 10-K
starting at page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
27
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding Registrant's directors will be set forth under the
caption "Election of Directors - Nominees" in Registrant's proxy statement for
use in connection with the Annual Meeting of Shareholders to be held May 8,
1998, (the "1998 Proxy Statement") and is incorporated herein by reference. The
1998 Proxy Statement will be filed with the Securities and Exchange Commission
within 120 days after the end of the Registrant's fiscal year.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company and their ages as of February 28, 1998
are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Steve Y. Kim..... 48 President, Chief Executive Officer and Chairman
John Bailey...... 40 Vice President of Product Development
Dale J. Bartos... 47 Vice President of Finance and Chief Financial Officer
Douglas Hill..... 45 Vice President of Corporate Communications
Yuri Pikover..... 36 Executive Vice President and Director
Kevin T. Walsh... 40 Vice President of Marketing
Rene Arvin....... 38 Vice President of Worldwide Sales
</TABLE>
The officers of the Company are appointed annually by the Board of Directors
and serve at the discretion of the Board. There are no family relationships
among the directors or officers of Xylan.
Mr. Kim, a co-founder of the Company, has served as the Company's President
and Chief Executive Officer and Chairman of the Board of Directors since the
Company's inception in July 1993. Prior to co-founding the Company, Mr. Kim
founded and served as President and Chief Executive Officer of Fibermux
Corporation ("Fibermux"), a networking company, from November 1984 to June 1993.
Prior to founding Fibermux, Mr. Kim held management and design positions with a
number of companies, including Phalo Optical Systems Division, Litton Data
Systems, and Burroughs Corporation.
Mr. Bailey joined the Company in January 1994 and has served in various
engineering management positions, most recently as Vice President of Product
Development. Prior to joining the Company, Mr. Bailey was an Assistant Vice
President for LAN Internetworking Technology at Ascom Timplex, a networking
company, from September 1992 to January 1994. From January 1990 to September
1992, Mr. Bailey served in various engineering management and design positions
at Unisys Corporation, a computer manufacturer.
Mr. Bartos joined the Company in January 1997 as the Company's Vice President
of Finance and Chief Financial Officer. Prior to joining the Company, Mr. Bartos
was the Chief Financial Officer at ADFlex Solutions, Inc. from May 1996 to
January 1997. Prior to that, Mr. Bartos served as the Chief Financial Officer at
Integral Peripherals, Inc. from March 1995 to May 1996, and Micropolis
Corporation from December 1989 to March 1995. Mr. Bartos has also held senior
financial positions at DataProducts Corporation and Harris Corporation. Mr.
Bartos is a certified public accountant.
Mr. Hill joined the Company in January 1994 and has served in various
marketing management positions, most recently as Vice President of Corporate
Communications. Prior to joining the Company, Mr. Hill was Senior Consultant at
Western Data Group, a network integration company, from October 1989 to January
1994. Mr. Hill has also served as Vice President, Marketing and Sales at ACT
Networks, Inc., a networking company, and as Assistant Vice President at MICOM
Systems, Inc. ("MICOM Systems"), a networking company.
28
<PAGE>
Mr. Pikover, a co-founder of the Company, has served in various sales and
management positions and as a member of the Board of Directors since the
Company's inception in July 1993, most recently as Vice President of Worldwide
Sales. From August 1988 to June 1993, Mr. Pikover served as Regional Sales
Manager at Fibermux. Mr. Pikover served in various sales, marketing and
technical positions at MICOM Systems from September 1982 to August 1988.
Mr. Walsh joined the Company in May 1995 and has served in various marketing
management positions, most recently as Vice President of Marketing. Prior to
joining the Company, Mr. Walsh served in various management positions at Ascom
Timeplex from August 1990 to May 1995, most recently as Director, Technical
Marketing.
Mr. Arvin joined the Company in February 1996 and has served in various sales
and mangement positions, most recently as Vice President of Worldwide Sales.
Prior to joining the Company, Mr Arvin was Director of Worldwide Sales for
NetEdge Corporation, a data communications company, from September 1994 to
February 1996. Mr. Arvin also served as Area Director, Northern Europe for
Synoptics Corporation, a networking company, from December 1989 to September
1994.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference into this
Form 10-K from the information set forth under the caption "Compensation of
Executive Officers" in the Company's 1998 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference into this
Form 10-K from the information set forth under the caption "Common Stock
Ownership of Certain Beneficial Owners and Management" in the Company's 1998
Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference into this
Form 10-K from the information set forth under the caption "Certain
Relationships and Related Transactions" in the Company's 1998 Proxy Statement.
29
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
(a)(1) CONSOLIDATED FINANCIAL STATEMENTS:
Independent Auditors' Report.................................................. F-1
Consolidated Balance Sheets at December 31, 1997 and 1996..................... F-2
Consolidated Statements of Operations for the Years ended
December 31, 1997, 1996, and 1995.......................................... F-4
Consolidated Statements of Shareholders' Equity for the
Years ended December 31, 1997, 1996, and 1995.............................. F-5
Consolidated Statements of Cash Flows for the Years ended
December 31, 1997, 1996, and 1995.......................................... F-6
Notes to Consolidated Financial Statements.................................... F-7
(2) CONSOLIDATED FINANCIAL STATEMENT SCHEDULE:
II-Valuation and Qualifying Accounts.......................................... S-1
</TABLE>
All other schedules are omitted because they are not applicable or the
required information is included in the consolidated financial statements or
notes thereto.
(3) EXHIBITS included herein (numbered in accordance with Item 601 of
Regulation S-K):
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
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)
4.2 Preferred Shares Rights Agreement dated as of April 17, 1997 between
the Registrant and the First National Bank of Boston, including
Certificate of Determination of Rights, Preferences and Privileges of
Series A Participating Preferred Stock, the Form of Rights Certificate
and the Summary of Rights attached thereto as Exhibits A, B and C,
respectively.(2)
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 amended 1996 Stock Plan.(4)
10.6 Fourth Restated Registration Rights Agreement among the Registrant and
certain security holders 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)
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
- -------- -----------
<S> <C>
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.(1)
10.19 Amendment to Manufacturing and Purchase Agreement between Xylan
and Victron, Inc. dated as of December 30, 1996.(3)
10.20 Dale Bartos Employment Agreement dated as of January 4, 1997.(3)
10.21 Form of 1998 Employee Stock Option Plan and related Agreements.(4)
10.22 Form of Change of Control Agreement.(4)
23.1 Consent of KPMG Peat Marwick LLP.(4)
24.1 Power of Attorney (see page 33).(4)
27.1 Financial Data Schedule for (current) fiscal year ended December
31, 1997.
27.2 Restated FDS for fiscal year ended December 31, 1996.
27.3 Restated FDS for fiscal year ended December 31, 1995.
27.4 Restated Financial Data Schedule 3 Months Ended Mar-31-1997.(4)
27.5 Restated Financial Data Schedule Fiscal Year Ended Dec-31-1996.(4)
27.6 Restated Financial Data Schedule 9 Months Ended Sep-30-1996.(4)
27.7 Restated Financial Data Schedule 6 Months Ended Jun-30-1996.(4)
27.8 Restated Financial Data Schedule 3 Months Ended Mar-31-1996.(4)
27.9 Restated Financial Data Schedule for Fiscal Year Ended
Dec-31-1995.(4)
________
</TABLE>
(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 Exhibit 1 of the Registrant's Registration
Statement on Form 8-A filed with the Commission in August 24, 1997.
(3) Incorporated by reference to identically numbered exhibits filed in the
Company's Annual Report on Form 10-K filed in March 31, 1997.
(4) Filed herewith.
(b) REPORTS ON FORM 8-K:
None.
31
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
XYLAN CORPORATION
Date: March 28, 1998 By /S/ Dale J. Bartos
_____________________________________
DALE J. BARTOS
VICE PRESIDENT OF FINANCE AND
ADMINISTRATION
AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
By: /S/ Thomas S. Burns
____________________________________
THOMAS S. BURNS
VICE PRESIDENT OF FINANCE
(CHIEF ACCOUNTING OFFICER)
32
<PAGE>
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Steve Y. Kim and Dale J. Bartos, his attorneys-
in-fact, each with the power of substitution, for him in any and all capacities,
to sign any amendments to this Report on Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith with the Securities
and Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
/s/ Steve Y. Kim President, Chief Executive Officer and Chairman March 26, 1998
- -----------------------------
(STEVE Y. KIM)
/s/ Dale J. Bartos Vice President of Finance and Administration March 26, 1998
- ----------------------------- and Chief Financial Officer (Principal Financial
(DALE J. BARTOS) Officer)
/s/ Thomas S. Burns Vice President of Finance (Chief Accounting Officer) March 26, 1998
- -----------------------------
(THOMAS S. BURNS)
/s/ Yuri Pikover Executive Vice President and Director March 26, 1998
- -----------------------------
(YURI PIKOVER)
/s/ Robert S. Cecil Director March 26, 1998
- -----------------------------
(ROBERT S. CECIL)
/s/ Robert C. Hawk Director March 26, 1998
- -----------------------------
(ROBERT C. HAWK)
/s/ Trude C. Taylor Director March 26, 1998
- -----------------------------
(TRUDE C. TAYLOR)
/s/ John L. Walecka Director March 26, 1998
- -----------------------------
(JOHN L. WALECKA)
</TABLE>
33
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Xylan Corporation:
We have audited the accompanying consolidated balance sheets of Xylan
Corporation and subsidiaries as of December 31, 1997 and 1996 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1997. In
connection with our audits of the consolidated financial statements, we also
have audited the related consolidated financial statement schedule. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Xylan Corporation
and subsidiaries at December 31, 1997 and 1996 and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997 in conformity with generally accepted accounting
principles. Also in our opinion, the related consolidated financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
/s/ KPMG Peat Marwick LLP
Los Angeles, California
January 21, 1998
F-1
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
XYLAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
ASSETS 1997 1996
---- ----
<S> <C> <C>
Current assets:
Cash and cash equivalents................... $ 35,917 $ 62,483
Short-term investments...................... 43,171 50,498
Accounts receivable, net.................... 53,013 26,956
Inventories, net............................ 17,731 11,578
Deferred income taxes, net.................. 6,100 1,766
Prepaid expenses and other current assets... 2,892 2,247
-------- --------
Total current assets..................... 158,824 155,528
Investments.................................... 59,382 27,785
Note receivable................................ 7,500 6,000
Property and equipment, net.................... 20,894 16,665
Other assets................................... 4,306 1,273
-------- --------
Total assets............................ $250,906 $207,251
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
XYLAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996
---- ----
<S> <C> <C>
Current liabilities:
Current installments of capital lease obligations............. $ 189 $ 303
Accounts payable and accrued expenses......................... 26,382 17,760
Deferred revenue.............................................. 4,317 2,838
Income taxes payable.......................................... 3,002 12
-------- --------
Total current liabilities................................. 33,890 20,913
Capital lease obligations, less current installments.......... 17 206
Deferred revenue.............................................. 899 494
-------- --------
Total liabilities......................................... 34,806 21,613
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value. Authorized 5,000,000 shares... -- --
Common stock, $0.001 par value. Authorized 200,000,000
shares; issued and outstanding 42,992,600
and 41,947,025 shares, respectively........................ 43 42
Additional paid-in capital................................... 190,731 184,397
Retained earnings............................................ 25,326 1,199
-------- --------
Shareholders' equity.................................... 216,100 185,638
-------- --------
Total liabilities and shareholders' equity............. $250,906 $207,251
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
XYLAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Revenue.............................................. $210,849 $128,456 $29,662
Cost of revenue...................................... 92,551 57,830 15,418
-------- -------- -------
Gross profit.................................. 118,298 70,626 14,244
-------- -------- -------
Operating expenses:
Research and development...................... 25,875 15,823 7,154
Sales and marketing........................... 60,356 32,590 13,011
General and administrative.................... 7,013 4,397 3,593
-------- -------- -------
Total operating expenses............................. 93,244 52,810 23,758
-------- -------- -------
Operating income (loss)....................... 25,054 17,816 (9,514)
Interest income, net................................. 6,694 5,240 73
-------- -------- -------
Income (loss) before income taxes.................... 31,748 23,056 (9,441)
Income tax expense................................... 7,621 7,811 --
-------- -------- -------
Net income (loss)............................. $ 24,127 $ 15,245 $ (9,441)
======== ======== ========
Net income (loss) per share:
Basic............................................. $ 0.57 $ 0.43 $ (0.91)
Diluted........................................... $ 0.52 $ 0.33 $ (0.91)
========= ======== ========
Shares used in per share computations:
Basic............................................. 42,550 35,870 10,320
Diluted........................................... 46,796 46,381 10,320
========= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
XYLAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
RETAINED NET
CONVERTIBLE PREFERRED STOCK ADDITIONAL EARNINGS SHARE-
----------------------------------------------- COMMON PAID-IN (ACCUMULATED HOLDERS'
SERIES A SERIES B SERIES C SERIES D SERIES E STOCK CAPITAL DEFICIT) EQUITY
-------- -------- -------- -------- -------- ------- ---------- ------------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994....... $ 12 $ 8 $-- $-- $-- $10 $ 9,942 $(4,605) $ 5,367
Issuances of preferred stock...... -- -- 4 1 1 -- 20,008 -- 20,014
Issuances of common stock for
promissory notes or services... -- -- -- -- -- -- 108 -- 108
Issuances of common stock
warrants....................... -- -- -- -- -- -- 3 -- 3
Unearned compensation
amortization................... -- -- -- -- -- -- 54 -- 54
Net loss.......................... -- -- -- -- -- -- -- (9,441) (9,441)
---- --- --- --- --- --- -------- -------- --------
Balance at December 31, 1995....... 12 8 4 1 1 10 30,115 (14,046) 16,105
Conversion of preferred
stock to common stock.......... (12) (8) (4) (1) (1) 26 -- -- --
Issuances of common stock in
conjunction with offerings..... -- -- -- -- -- 5 143,653 -- 143,658
Issuances of common stock
under stock option plans....... -- -- -- -- -- 1 349 -- 350
Issuance of common stock
warrants....................... -- -- -- -- -- -- 274 -- 274
Tax benefit attributable to
stock option plan.............. -- -- -- -- -- -- 9,507 -- 9,507
Unearned compensation
amortization................... -- -- -- -- -- -- 499 -- 499
Net income........................ -- -- -- -- -- -- -- 15,245 15,245
---- --- --- --- --- --- -------- -------- --------
Balance at December 31, 1996....... -- -- -- -- -- 42 184,397 1,199 185,638
Issuances of common stock
under stock option plans........ -- -- -- -- -- 1 1,772 -- 1,773
Issuances of common stock
under stock purchase plans...... -- -- -- -- -- -- 1,690 -- 1,690
Cancellation of common
stock warrants.................. -- -- -- -- -- -- (274) -- (274)
Tax benefit attributable to
stock option plan............... -- -- -- -- -- -- 2,689 -- 2,689
Unearned compensation
amortization.................... -- -- -- -- -- -- 457 -- 457
Net income........................ -- -- -- -- -- -- -- 24,127 24,127
---- --- --- --- --- --- -------- -------- --------
Balance at December 31, 1997 $ -- $-- $-- $-- $-- $43 $190,731 $ 25,326 $216,100
==== === === === === === ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
XYLAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)....................................................... $ 24,127 $ 15,245 $ (9,441)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization.......................................... 7,877 3,581 928
Deferred income taxes.................................................. (4,334) (1,766) --
Consulting expense paid in common stock................................ -- -- 82
Expense (benefit) related to warrants.................................. (274) 274 --
Unearned compensation amortization..................................... 457 499 54
Change in:
Accounts receivable................................................... (26,057) (13,814) (13,020)
Inventories........................................................... (6,153) (9,450) (1,846)
Prepaid expenses and other current assets............................. (645) (1,864) (178)
Other assets.......................................................... (33) (785) (268)
Accounts payable and accrued expenses................................. 8,622 8,131 8,741
Deferred revenue...................................................... 1,884 2,656 676
Income taxes payable.................................................. 5,679 9,519 --
--------- --------- --------
Net cash provided by (used in) operating activities.................. 11,150 12,226 (14,272)
--------- --------- --------
Cash flows from investing activities:
Purchases of property and equipment..................................... (12,106) (15,173) (4,295)
Advances on note receivable............................................. (1,500) (6,000) --
Purchases of investments................................................ (192,745) (147,125) --
Maturities of investments............................................... 165,475 68,842 3,890
--------- --------- --------
Net cash used in investing activities................................ (40,876) (99,456) (405)
--------- --------- --------
Cash flows from financing activities:
Proceeds from issuances of common stock and common stock warrants....... 3,463 144,008 3
Proceeds from issuances of convertible preferred stock.................. -- -- 20,014
Principal payments under capital lease obligations...................... (303) (329) --
--------- --------- --------
Net cash provided by financing activities............................ 3,160 143,679 20,017
--------- --------- --------
Net increase (decrease) in cash and cash equivalents................. (26,566) 56,449 5,340
Cash and cash equivalents at beginning of year....................... 62,483 6,034 694
--------- --------- --------
Cash and cash equivalents at end of year................................. $ 35,917 $ 62,483 $ 6,034
========= ========= ========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest................................... $ 33 $ 97 $ 101
Cash paid during the year for income taxes............................... $ 6,177 $ 222 $ -
========= ========= ========
Supplemental disclosure of noncash investing and financing activities:
Financed capital expenditures............................................ $ - $ - $ 480
Common stock issued for promissory notes................................. $ - $ - $ 26
Income tax benefit resulting from exercise of employee stock options..... $ 2,689 $ 9,507 $ -
========= ========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Since its incorporation in July 1993, Xylan Corporation has focused on the
development, marketing and sale of dedicated, high-bandwidth switching systems
that easily integrate with and enhance the performance of customers' existing
LANs, as well as facilitate migration to new networking technologies.
Principles of Consolidation
The consolidated financial statements include the accounts of Xylan
Corporation and its wholly and majority-owned subsidiaries (collectively, the
Company). All significant intercompany accounts and transactions have been
eliminated in consolidation. The minority interest is not considered material.
Cash Equivalents
The Company considers all highly liquid investments with an original maturity
of three months or less to be cash equivalents.
Investment Securities
The Company's investments consist of corporate and municipal debt, U.S.
Treasuries and Federal Government Agency debt. The Company accounts for its
investments in accordance with Statement of Financial Accounting Standards
(SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," which requires investments to be classified based on management's
intent in one of three categories: held-to-maturity securities, available-for-
sale securities and trading securities. The Company has the intent and ability
to hold its investments to maturity and, accordingly, classifies both long-term
and short-term investments as held-to-maturity securities which are carried at
amortized cost.
Accounts Receivable
Accounts receivable are shown net of an allowance for doubtful accounts of
$1,563,000 and $270,000 at December 31, 1997 and 1996, respectively.
Inventories
Inventories, consisting principally of component parts, are stated at the
lower of cost or market being determined using the first-in, first-out method.
Inventories are shown net of valuation reserves of $2,635,000 and $458,000 at
December 31, 1997 and 1996, respectively.
Note Receivable
The Company accounts for its note receivable in accordance with the provisions
of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended
by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan Income
Recognition and Disclosure." Management, considering current information and
events regarding the borrowers' ability to repay their obligations, considers a
note to be impaired when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the note
agreement. The note receivable is recorded at cost.
F-7
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Long-Lived Assets
The Company adopted the provisions SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," on
January 1, 1996. This Statement requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of the asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to the undiscounted operating cash flows expected to be generated by the asset.
If such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Adoption of this Statement did not have a material
impact on the Company's financial position, results of operations or liquidity.
Financial Instruments
The estimated fair values of cash and cash equivalents, accounts receivable,
note receivable, capital lease obligations, accounts payable and accrued
expenses, deferred revenue and income taxes payable approximate their carrying
values due to the short-term maturity of these instruments or because the stated
interest rates are indicative of market interest rates.
The fair values of short-term and long-term investment securities are based on
quoted market prices at the reporting date for those investments. The carrying
values of investments are described in note 3.
Revenue Recognition
The Company generally recognizes product revenue at the time of shipment,
unless the Company has future obligations for installation or has to obtain
customer acceptance in which case revenue is deferred until earned. Revenue
from service obligations is deferred and recognized on a straight-line basis
over the contractual period. Amounts billed in excess of revenue recognized are
included as deferred revenue in the accompanying consolidated balance sheets.
Allowances for sales returns are established based upon historical experience
and management's estimates as shipments are made.
Warranty and Technical Support Obligations
The Company accrues the estimated costs to fulfill customer warranty and
technical support obligations upon the recognition of the related revenue.
Depreciation and Amortization
Depreciation of property and equipment is calculated on the straight-line
method over estimated useful lives ranging from three to five years, or in the
case of capital lease assets over the shorter of the lease term or the estimated
useful life of the asset.
Research and Development Costs
The Company charges all research and development costs to expense as incurred.
Income Taxes
The Company accounts for income taxes under SFAS No. 109, "Accounting for
Income Taxes." Under the asset and liability method of SFAS No. 109, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Under SFAS No. 109, the effect on deferred tax
F-8
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Net Income (Loss) Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings per Share." SFAS No. 128 replaced the previously reported primary
and fully diluted earnings per share with basic and diluted earnings per share
and became effective for both interim and annual periods ending after December
15, 1997. Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options and convertible securities. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been restated to
conform to the SFAS No. 128 requirements.
In February 1998, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 98 which changes the calculation of earnings per
share in periods prior to initial public offerings as previously applied under
SAB No. 83. When a registrant issued common stock, warrants, options, or other
potentially dilutive instruments for consideration or with exercise prices below
the initial public offering price within a one year period prior to the initial
filing of a registration statement relating to an initial public offering, SAB
No. 83 required such equity instruments to be treated as outstanding for all
periods presented in the filing using the anticipated initial public offering
price and the treasury stock method. Under SAB No. 98, when common stock,
options, warrants, or other potentially dilutive instruments have been issued
for nominal consideration during the periods covered by income statements in the
filing, those nominal issuances are to be reflected in earnings per share
calculations for all periods presented. Based on the Company's current
understanding of the definition of "nominal consideration", the Company has
concluded that during all periods prior to the Company's initial public
offering, no equity instruments were issued for nominal consolidation. Per share
results for periods prior to or including the Company's initial public offering
have been restated in accordance with SAB No. 98
For the periods in which the Company had net income, basic net income per
share was based on the weighted average number of shares of common stock
outstanding during the period. For the same periods diluted net income per share
further included the effect of stock options outstanding during the period. For
the periods in which the Company had a net loss, the net loss per share was
computed using only the weighted average number of shares of common stock
outstanding during the period.
F-9
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The following table sets forth the computation of basic and diluted net income
(loss) per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Numerator for basic and diluted
per share computations:
Net income (loss) available to common shareholders..... $24,127 $15,245 $(9,441)
======= ======= =======
Denominator:
Shares used for basic per share computations -
weighted average shares outstanding................... 42,550 35,870 10,320
Effect of dilutive securities:
Stock options and warrants............................. 4,246 5,582 --
Preferred stock........................................ -- 4,929 --
------- ------- -------
Shares used for diluted per share computations........... 46,796 46,381 10,320
======= ======= =======
Net income (loss) per share:
Basic................................................... $ 0.57 $ 0.43 $ (0.91)
Diluted................................................. $ 0.52 $ 0.33 $ (0.91)
======= ======= =======
</TABLE>
Options to purchase 637,000 and 968,000 shares at a weighted average exercise
price of $21.64 and $48.87 were outstanding at December 31, 1997 and 1996,
respectively, but were not included in the computation of diluted net income per
share because the exercise price of the options was greater than the average
market price of the common shares and therefore, the effect would be
antidilutive.
Accounting for Stock Options
Prior to January 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations. As
such, compensation expense would be recorded only if the current market price of
the underlying stock on the date of grant exceeded the exercise price. On
January 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," which permits entities to recognize as expense over the vesting
period the fair value of all stock based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
net income per share disclosures for employee stock option grants made in 1995
and future years as if the fair-value-based method defined in SFAS No. 123 had
been applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.
Use of Estimates
Company management has made a number of estimates and assumptions relating to
the reporting of assets and liabilities in conformity with generally accepted
accounting principles. Actual results could differ from these estimates.
F-10
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" effective for fiscal years beginning after
December 15, 1997. SFAS No. 130 established standards for the reporting and
display of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general-purpose financial statements. The Statement
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. The Company will adopt SFAS No. 130 effective January 1, 1998.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" effective
for financial statements for periods beginning after December 15, 1997. SFAS No.
131 establishes standards for the way that public business enterprises report
financial and descriptive information about reportable operating segments in
annual financial statements and interim financial reports issued to
shareholders. SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for
Segments of a Business Enterprise," but retains the requirement to report
information about major customers. The Company will adopt SFAS No. 131 effective
January 1, 1998.
Reclassifications
Certain amounts in the prior period financial statements have been
reclassified to conform with current period presentation.
(2) PROPERTY AND EQUIPMENT
Property and equipment, stated at cost, at December 31, 1997 and 1996 are
summarized as follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
(In thousands)
<S> <C> <C>
Furniture and fixtures........................... $ 2,969 $ 1,825
Manufacture and test equipment................... 6,860 4,870
Computer equipment and purchased software........ 21,959 13,636
Leasehold improvements........................... 1,615 966
------- -------
Total property and equipment................... 33,403 21,297
Less accumulated depreciation and amortization... 12,509 4,632
------- -------
Net property and equipment...................... $20,894 $16,665
======= =======
</TABLE>
Assets acquired through capitalized leases, which are included in property and
equipment, aggregated $1,176,000 at December 31, 1997 and 1996. Accumulated
depreciation related to these assets aggregated $841,000 and $654,000 at
December 31, 1997 and 1996, respectively.
F-11
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(3) INVESTMENT SECURITIES
The Company's held-to-maturity investments at December 31, 1997 and 1996
consist of corporate and municipal debt, U.S. Treasuries and Federal Government
Agency debt. The investments which are carried at amortized cost and approximate
market are summarized as follows:
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
(In thousands)
Corporate debt.......................................... $ 10,319 $32,821
Municipal debt.......................................... 85,135 2,235
U.S. Treasuries......................................... -- 7,910
Federal Government Agency debt.......................... 7,099 35,317
-------- -------
Total investments...................................... 102,553 78,283
Due within one year..................................... 43,171 50,498
-------- -------
Due after one year...................................... $ 59,382 $27,785
======== =======
</TABLE>
At December 31, 1997, total net unrealized holding gains and losses were
immaterial.
(4) NOTE RECEIVABLE
The Company agreed to loan up to $10 million to a contract manufacturer that
the Company has subcontracted component procurement, kitting and printed circuit
board assembly. The Company entered into the agreement to assist the contract
manufacturer in meeting the Company's increasing production requirements. The
Company purchases a majority of its inventory components from this contract
manufacturer. The loan 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, 1997 and 1996, the note had an
outstanding balance of $7.5 million and $6 million, respectively, and is
classified as a noncurrent asset on the accompanying consolidated balance sheet.
Additionally, the Company has guaranteed up to $5,000,000 of this contract
manufacturer's debt for raw material and electronic component purchases.
(5) NOTE PAYABLE
The Company has a revolving line of credit agreement providing for borrowings
up to the lesser of $6,000,000 or 80% of eligible accounts receivable, as
defined. Interest is payable monthly at the bank's prime rate (8.5% at December
31, 1997) or at the bank's libor rate (5.8% at December 31, 1997) plus 1.75% and
expires January 28, 1999. The Company had available borrowings of $6,000,000 at
December 31, 1997.
As of December 31, 1997 and 1996, the Company had no outstanding borrowings on
the aforementioned note payable. Additionally, the note is secured by all
Company personal property and contains certain financial covenants and
restrictions. As of December 31, 1997, the Company was in compliance with such
covenants and restrictions.
F-12
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(6) ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 1997 and 1996 consist of
the following:
<TABLE>
<CAPTION>
1997 1996
---- ----
(In thousands)
<S> <C> <C>
Accounts payable....................................... $10,926 $ 9,336
Accrued payroll and related costs...................... 7,890 4,281
Accrued warranty....................................... 1,256 1,535
Other accrued expenses................................. 6,310 2,608
------- -------
Total accounts payable and accrued expenses........ $26,382 $17,760
======= =======
</TABLE>
(7) CAPITAL LEASE OBLIGATIONS
Capital lease obligations at December 31, 1997 and 1996 are summarized as
follows:
<TABLE>
<CAPTION>
1997 1996
------- -------
(In thousands)
<S> <C> <C>
Capital lease obligations, secured by related assets, payable in
monthly installments including interest ranging from 4% to 21%
through January 1999............................................... $ 206 $ 509
Less current installments............................................. 189 303
------- -------
$ 17 $ 206
======= =======
</TABLE>
Future minimum capital lease payments at December 31, 1997 are as follows (in
thousands):
<TABLE>
<S> <C>
Year ending December 31:
1998.................................................... $ 207
1999.................................................... 19
-------
226
Less amounts representing interest..................... 20
-------
$ 206
=======
</TABLE>
(8) SHAREHOLDERS' EQUITY
Convertible Preferred Stock
During 1995, the Company issued 3,964,244 shares of series C convertible
preferred stock for cash consideration of $10,000,004, 1,262,120 shares of
series D convertible preferred stock for cash consideration of $5,048,480 and
952,382 shares of series E convertible preferred stock for cash consideration of
$5,000,006. Legal expenses of approximately $34,000 were netted against the
proceeds of the 1995 convertible preferred stock issuances.
Upon the effectiveness of the Company's initial public offering in March 1996,
all of the Company's 25,698,676 outstanding shares of convertible preferred
stock which had certain liquidation preferences, voting rights, and cumulative
dividend provisions were converted into the same number of shares of common
stock upon the effectiveness of the Company's initial public offering.
Preferred Stock
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. 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.
F-13
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Common Stock
During March 1996, the Company completed its initial public offering of a
total of 4,830,000 shares of common stock, of which 3,680,000 shares were sold
by the Company and 1,150,000 shares were sold by selling shareholders. Aggregate
net proceeds to the Company were $87.4 million.
During May 1996, the Company completed a secondary public offering of
4,600,000 shares of common stock, of which 1,000,000 shares were sold by the
Company and 3,600,000 shares were sold by selling shareholders. Aggregate net
proceeds to the Company were $56.2 million.
Stock Warrants
During 1994, the Company granted to an equipment lessor a warrant to purchase
188,076 shares of series A convertible preferred stock of the Company at a price
per share of $.325. This warrant was exercisable at grant date and on the
effectiveness of the Company's initial public offering was converted into
185,725 shares of common stock.
During 1995, in connection with the issuance of series D convertible preferred
stock, the Company sold warrants, at $0.005 per share, to purchase 315,528
shares of common stock of the Company at an exercise price per share of $3.50,
and in connection with the issuance of series E convertible preferred stock, the
Company sold warrants, at $0.005 per share, to purchase 238,096 shares of common
stock of the Company at a price per share of $4.60. These warrants expired upon
the closing of the Company's initial public offering.
In 1996, Xylan and IBM entered into an agreement whereby Xylan committed to
grant IBM warrants to purchase up to a maximum of 2,350,000 shares of Xylan
common stock based on the achievement of specific business goals. During 1996,
the Company recognized $274,000 of expense related to these warrants. In 1997,
the commitment to grant warrants to IBM was cancelled and the $274,000 of
expense was reversed.
(9) STOCK OPTION PLANS
1993 Stock Incentive Plan
The Company has a 1993 Stock Incentive Plan (the 1993 Plan) which reserves
8,000,000 shares of the Company's authorized but unissued common stock for
options or stock purchase grants issuable to officers, employees, consultants
and the members of the Board of Directors of the Company.
The Board of Directors or committees named by the Board of Directors (Plan
Administrator) have sole discretion and authority to promulgate, amend and
rescind rules and regulations relating to the administration of the 1993 Plan
and to select the eligible participants to whom options will be granted or
shares sold, the number of shares covered by the option or to be sold, the
exercise or purchase price and the form and terms of agreement to be used.
Outstanding options under the 1993 Plan vest in varying increments and expire
five to ten years after grant or upon earlier termination. Stock options shall
be exercisable over the exercise period as determined by the Plan Administrator,
not to exceed five years from the date the option is granted in the case of
optionees who own at least 10% of the total combined voting power of all classes
of stock of the Company.
The Company determined subsequent to the grant of certain options, based in
part on an independent appraisal of the common stock at September 30, 1995, to
record for financial statement presentation purposes unearned compensation of
$941,000 for the difference between the exercise price and the deemed fair
market value. The methods of valuation used by the independent appraiser to
determine fair market value (based on an armslength transaction) were primarily
estimates of future cash flows, and also a comparison to similar publicly traded
companies, with a discount applied for the lack of a public market for the
Company's stock.
During 1996, the Company recorded additional unearned compensation of
$1,395,000, for the difference between the grant price and the deemed fair
market value for options issued during the period from January 1, 1996 through
March 4, 1996.
F-14
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The unearned compensation is recorded as an offset to additional paid-in
capital and will be recorded as compensation expense ratably over the related
vesting periods. During 1997, 1996 and 1995, the Company recorded $457,000,
499,000 and $54,000 of compensation expense, respectively.
During 1995, the Company issued 68,080 shares of common stock to a director
for promissory notes of $25,530 pursuant to stock purchase grants under the 1993
Plan. Such notes were repaid subsequent to December 31, 1995. The Company
determined subsequent to the grant of such stock, based in part on an
independent appraisal of the common stock as of September 30, 1995, to record
for financial statement reporting purposes compensation expense of $5,050 for
the difference between the grant price and the deemed fair market value.
Additionally during 1995, the Company issued 167,080 shares of common stock for
services with a fair value of $77,161 pursuant to stock purchase grants under
the 1993 Plan.
In July 1997, the Board of Directors approved the repricing of options granted
with an exercise price in excess of $15.81 for all employees. In June and July
1996, the Board of Directors approved the repricing of options with an exercise
price in excess of $50.75 and $34.75, respectively, for all employees excluding
executive officers.
1996 Stock Option Plan
The Company has a 1996 Stock Option Plan (the 1996 Plan) which reserves
5,000,000 shares of the Company's authorized but unissued common stock for
option grants. The 1996 Plan provides for the grant to Company employees of
incentive stock options and for the grant of nonstatutory stock options to
employees and consultants of the Company. Incentive stock options are granted
at 100% of fair market value. Nonstatutory stock options granted to certain of
the Company's executive officers must be at fair market value and grants to all
other persons must be at least 85% of fair market value at grant date.
Outstanding options under the 1996 Plan vest in varying increments and expire
five to ten years after grant or upon earlier termination.
In July 1997, the Board of Directors approved the repricing of options with an
exercise price in excess of $15.81 for all employees. In June and July 1996,
the Board of Directors approved the repricing of options with an exercise price
in excess of $50.75 and $34.75, respectively, for all employees excluding
executive officers.
1996 Stock Purchase Plan
The Company has a 1996 Employee Stock Purchase Plan (the Purchase Plan) which
reserves 1,500,000 shares of common stock for issuance. The Purchase Plan
permits eligible employees to purchase common stock through payroll deductions,
which may not exceed 10% of an employee's salary, at a price equal to the lower
of 95% of the fair market value of the Company's common stock at the beginning
of the offering period or the purchase date. The Purchase Plan expires in 20
years.
For the years ended December 31, 1997 and 1996, the Company recorded $492,000
and $1,023,000 in employee payroll deductions which have been included in
accounts payable and accrued expenses on the accompanying consolidated balance
sheet. At December 31, 1997, 81,051 shares had been issued pursuant to the
Purchase Plan for aggregate proceeds of $1,690,000. At December 31, 1996, no
shares has been issued pursuant to the Purchase Plan.
1996 Directors' Stock Option Plan
The Company has a 1996 Directors' Stock Option Plan (the Directors' Plan)
which reserves 150,000 shares of common stock for issuance related to
nonstatutory stock options to nonemployee directors of the Company. Options are
exercisable at the fair market value of common stock on the grant date and have
a term of ten years.
F-15
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
1998 Employee Stock Option Plan
In January 1998, the Company adopted the 1998 Employee Stock Option Plan (the
1998 Plan) which reserves 1,000,000 shares of the Company's authorized but
unissued common stock for option grants. The 1998 Plan provides for the grant of
nonstatutory stock options to Company employees, excluding named executive
officers.
Summary Stock Option Activity
As of December 31, 1997, 2,347,000 options were exercisable. In October 1997,
the Company's Board of Directors approved acceleration of vesting of stock
options held by the Company's Executive Officers and certain key employees in
the event of a change of control. Summary stock option activity during the years
ended December 31, 1996, 1995 and 1994 is as follows:
<TABLE>
<CAPTION>
WEIGHTED NUMBER OF OPTIONS
---------------------------------------------- AVERAGE
DIRECTORS EXERCISE
1993 PLAN 1996 PLAN PLAN TOTAL PRICE
--------- --------- ---- ----- --------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994....... 2,650,000 -- -- 2,650,000 $ .08
Granted............................ 4,719,000 -- -- 4,719,000 .67
Canceled........................... (994,000) -- -- (994,000) .26
---------- ---------- ------- ---------- ------
Balance at December 31, 1995....... 6,375,000 -- -- 6,375,000 .48
Granted............................ 2,262,000 1,968,000 20,000 4,250,000 35.98
Exercised.......................... (1,062,000) -- -- (1,062,000) .33
Canceled........................... (1,238,000) (37,000) -- (1,275,000) 27.19
---------- ---------- ------- ---------- ------
Balance at December 31, 1996....... 6,337,000 1,931,000 20,000 8,288,000 14.75
Granted............................ 114,000 4,222,000 30,000 4,366,000 18.37
Exercised.......................... (935,000) (30,000) -- (965,000) 1.84
Canceled........................... (679,000) (1,265,000) (5,000) (1,949,000) 19.74
---------- ---------- ------- ---------- ------
Balance at December 31, 1997....... 4,837,000 4,858,000 45,000 9,740,000 $10.48
========== ========== ======= ========== ======
Reserved for future issuance....... 845,000 112,000 105,000 1,062,000
========== ========== ======= ==========
</TABLE>
F-16
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(10) ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement 123,
"Accounting for Stock-Based Compensation," but applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its plans and
warrants. If the Company had elected to recognize compensation cost based on the
fair value at the date of grant for awards under the plans and warrants
(including modified awards), consistent with the method as prescribed by
Statement No. 123, net income (loss) and net income (loss) per share for the
years ended December 31, 1997, 1996 and 1995 would have changed to the pro forma
amounts indicated below (in thousands, except per share data):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net income (loss):
As reported.............. $24,127 $15,245 $(9,441)
Pro forma................ $(1,672) $ 7,690 $(9,562)
======= ======= =======
Net income (loss) per share:
As reported
Basic................... $ 0.57 $ 0.43 $ (0.91)
Diluted ................ $ 0.52 $ 0.33 $ (0.91)
Pro forma:
Basic................... $ (0.04) $ 0.21 $ (0.93)
Diluted ................ $ (0.04) $ 0.17 $ (0.93)
======= ======= =======
</TABLE>
The pro forma disclosure of compensation cost under this pronouncement was
based on the Black-Scholes single-option pricing model with the following
weighted average assumptions for 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Expected volatility............... 45% 55% 55%
Expected risk-free interest rate.. 6.1% 6.2% 6.2%
Expected dividend yield........... 0.0% 0.0% 0.0%
Expected option life (in years)... 5.5 5.5 5.5
=== === ===
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion the existing models do not necessarily provide a reliable single measure
of the fair value of the Company's options.
Pro forma net income (loss) reflects only options granted in 1997, 1996 and
1995. Therefore the full amount of calculating compensation cost for stock
options under Statement No. 123 is not reflected in the pro forma net income
(loss) amounts presented above because compensation cost is reflected over the
options' vesting period of five years and compensation cost for options granted
prior to January 1, 1995 is not considered. The disclosure of compensation cost
under this pronouncement may not be representative of the effects on net income
(loss) for future years.
F-17
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
The weighted average fair value of options granted in 1997, 1996 and 1995 was
$17.20, $35.98 and $0.67, respectively. The following table summarizes
information regarding options outstanding and options exercisable at December
31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------------- ----------------------
WEIGHTED WEIGHTED
RANGE OF OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE AT DECEMBER EXERCISE
Prices 1997 LIFE PRICE 31, 1997 PRICE
------- ---- ---- ----- -------- -----
<S> <C> <C> <C> <C> <C>
$ 0.06 - 0.38 2,459,000 7.0 years $ 0.20 963,000 $ 0.16
1.00 - 15.50 1,986,000 8.5 6.73 493,000 2.68
15.56 - 15.81 3,967,000 9.6 15.81 886,000 15.81
15.88 - 24.56 1,328,000 10.1 19.23 5,000 16.13
--------- ---------
$ 0.06 - 24.56 9,740,000 8.8 years $10.48 2,347,000 $ 6.63
============== ========= ========= ====== ========= ======
</TABLE>
(11) INCOME TAXES
The components of income tax expense for the years ended December 31, 1997 and
1996 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Current:
Federal............................................ $ 9,381 $ 7,454
State.............................................. 2,480 2,123
Foreign............................................ 1,450 --
------- -------
Total current.................................... 13,311 9,577
------- -------
Deferred:
Federal............................................ (4,712) (823)
State.............................................. (978) (943)
------- -------
Total deferred................................... (5,690) (1,766)
------- -------
Total income taxes............................... $ 7,621 $ 7,811
======= =======
</TABLE>
The provision for income taxes, all current, for the year ended December 31,
1995 consists solely of the annual minimum California franchise tax of $800.
Such amount is included in general and administrative expense in the
accompanying consolidated statements of operations.
F-18
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Total income tax expense differs from expected income tax expense (computed by
applying the U.S. Federal corporate tax rate of 35%) for the years ended
December 31, 1997 and 1996 as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Computed U.S. Federal income taxes................................ $11,112 $8,070
Computed state income taxes, net of Federal benefit............... 1,765 1,401
Computed foreign taxes............................................ 1,450 --
Benefit from foreign sales corporation............................ (405) (867)
Nondeductible travel and entertainment expense.................... 587 86
Tax exempt interest income........................................ (831) --
Federal alternative minimum tax................................... -- 71
Research and experimentation credits.............................. (796) (598)
Net change in valuation allowance................................. (5,618) (443)
Other............................................................. 357 91
------- ------
Income tax expense.............................................. $ 7,621 $7,811
======= ======
</TABLE>
The net change in the valuation allowance for the year ended December 31, 1995
was an increase of $4,085,000.
For the years ended December 31, 1997 and 1996, the Company realized income
tax benefits totaling $2,689,000 and $9,507,000, respectively, related to
exercised stock options. The total income tax benefit related to these
deductions is recorded as an addition to additional paid-in capital in the
accompanying consolidated balance sheet.
Under FAS 109, deferred tax assets and liabilities are recognized for the
expected future tax consequences of differences between the carrying amount of
assets and liabilities and their respective tax bases using enacted tax rates in
effect for the year in which the differences are expected to reverse. The
deferred tax assets (liabilities) at December 31, 1997 and 1996 consist of the
following:
<TABLE>
<CAPTION>
1997 1996
-------- --------
(In thousands)
<S> <C> <C>
Deferred tax assets:
Allowances and reserves............................. $ 6,834 $ 1,394
Accrued expenses.................................... $ 1,749 1,578
Net operating loss carryforwards.................... -- 2,387
Research and development tax credit carryforwards... -- 1,357
Other............................................... 393 668
------- -------
Total gross deferred tax assets................. 8,976 7,384
------- -------
Deferred tax liabilities:
Depreciation and amortization.......... (1,076) --
Foreign taxes.......................... (1,357) --
State taxes............................ (443) --
------- -------
Total gross deferred tax liabilities............ (2,876) --
------- -------
Valuation allowance................................. -- (5,618)
------- -------
Net deferred tax assets......................... $ 6,100 $ 1,766
======= =======
</TABLE>
F-19
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
In assessing the realizability of deferred tax assets, the Company considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
projected future taxable income and tax planning strategies in making this
assessment.
During the year ended December 31, 1997, the Company recognized a deferred tax
benefit of $5,618,000 through a reduction of the Company's deferred tax asset
valuation allowance. The reduction was determined based on the Company's
assessment of the realizability of its deferred tax assets giving consideration
to the Company's recent operating history, utilization of its remaining net
operating loss and research and development tax credit carryforwards to reduce
its 1997 tax liability, and its expectation that operations will continue to
generate taxable income. Although realization is not assured, the Company
believes it is more likely than not that the net deferred tax asset of
$6,100,000 at December 31, 1997 will be realized.
(12) SIGNIFICANT CUSTOMERS, CONCENTRATION OF CREDIT RISK AND EXPORT SALES
The Company operates in a single industry segment encompassing the design,
development, manufacture, marketing and technical support of internetworking
products and services.
Significant Customers
For years ended December 31, 1997, 1996 and 1995 customers comprising 10% or
more of revenue are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
IBM.................................................... 21.5% 11.7% *
Alcatel................................................ 11.6% * 10.5%
Hitachi Computer Products.............................. * 13.5% 17.6%
NTT PC Communications.................................. * 12.3% *
Digital Equipment Corp................................. * * 17.2%
</TABLE>
* Percentage is less than 10%
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentration
of credit risk consist primarily of accounts receivable. The credit risk
associated with accounts receivable is mitigated by the Company's credit
evaluation process, reasonably short collection terms and the geographical
dispersion of sales transactions.
The Company's two major customers in 1997, each of whom accounted for more
than 10% of revenue, aggregated 23% and 17%, respectively, of accounts
receivable at December 31, 1997.
One of the Company's major customers in 1996, who accounted for more than 10%
of revenue, aggregated 18% of gross accounts receivable at December 31, 1996.
F-20
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Revenues by Geographic Area
Revenues by geographic area for the years ended December 31, 1997, 1996 and
1995 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- -------
(In Thousands)
<S> <C> <C> <C>
Revenue:
North America..... $ 98,823 $ 62,767 $15,267
Asia.............. 45,864 48,092 9,780
Europe............ 60,069 16,359 4,508
Other............. 6,093 1,238 107
-------- -------- -------
Total revenue... $210,849 $128,456 $29,662
======== ======== =======
</TABLE>
(13) EMPLOYEE BENEFIT PLAN
The Company has a defined contribution 401(k) plan. The plan covers all full-
time employees who are at least 21 years of age and have completed 30 days of
service. Participants may contribute 1% to 12% of their pretax compensation. The
plan permits the Company to make matching contributions up to 25% of the
participant's contribution and the matching contributions vest over five years.
The Company's matching contribution for 1997, 1996 and 1995 was $459,000,
$265,000 and $60,000, respectively.
(14) COMMITMENTS AND CONTINGENCIES
The Company is obligated under noncancelable operating lease agreements for
equipment and facilities expiring on various dates through 2002. Rental expense
for the years ended December 31, 1997, 1996 and 1995 aggregated $3,096,000,
$1,482,000 and $718,000, respectively.
Future annual minimum rental commitments under noncancelable operating leases
at December 31, 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
Year ended December 31:
<S> <C>
1998........................................... $2,458
1999........................................... 2,004
2000........................................... 1,839
2001........................................... 1,461
2002........................................... 857
------
$8,619
======
</TABLE>
The Company is involved in various investigations, lawsuits and claims arising
in the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations or liquidity.
The Company has guaranteed up to $5,000,000 of its contract manufacturer's
debt for raw material and electronic components purchases, in addition to the
note agreement as disclosed in note 4.
F-21
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
(15) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected quarterly financial data for 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------
December 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------ -------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
1997:
Revenue........................................................ $64,202 $53,517 $45,122 $48,008
Gross profit................................................... 36,287 29,799 24,867 27,345
Operating income............................................... 8,609 5,542 3,262 7,641
Net income..................................................... 6,562 4,607 7,090 5,868
Net income per share - basic................................... 0.15 0.11 0.17 0.14
Net income per share - diluted................................. 0.14 0.10 0.15 0.13
1996:
Revenue........................................................ 41,452 35,425 28,187 23,392
Gross profit................................................... 23,574 19,521 14,962 12,569
Operating income............................................... 6,217 5,655 3,358 2,586
Net income..................................................... 5,031 4,630 2,901 2,683
Net income per share - basic................................... 0.12 0.11 0.07 0.15
Net income per share - diluted................................. $ 0.11 $ 0.10 $ 0.06 $ 0.06
</TABLE>
F-22
<PAGE>
XYLAN CORPORATION AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING CHARGED TO END
OF YEAR EXPENSE DEDUCTIONS OF YEAR
------- ------- ---------- -------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Allowance for doubtful accounts........................... $270,000 1,293,000 -- $1,563,000
Allowance for excess and obsolete inventory............... 458,000 2,177,000 -- 2,635,000
Year ended December 31, 1996:
Allowance for doubtful accounts........................... 376,644 35,056 141,700 270,000
Allowance for excess and obsolete inventory............... 132,400 355,423 29,823 458,000
Year ended December 31, 1995:
Allowance for doubtful accounts........................... -- 376,644 -- 376,644
Allowance for excess and obsolete inventory............... -- $132,400 -- $132,400
</TABLE>
S-1
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description Page Number
------- ----------- -----------
<S> <C> <C>
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)
4.2 Preferred Shares Rights Agreement dated as of April 17, 1997 between the Registrant
and the First National Bank of Boston, including Certificate of Determination of Rights,
Preferences and Privileges of Series A Participating Preferred Stock, the Form of Rights
Certificate and the Summary of Rights attached thereto as Exhibits A, B and C, respectively. (2)
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 amended 1996 Stock Plan. (4)
10.6 Fourth Restated Registration Rights Agreement among the Registrant and certain
security holders 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)
10.12 Series C Preferred Stock Agreement dated as of March 13, 1995 between
the Registrant and Alcatel Data Networks S.A. (1)
10.13 International Distributor Agreement between the Registrant and Alcatel
N.V., dated as of March 13, 1995. (1)
10.14 Product and Technology Agreement between the Registrant and Alcatel
N.V. dated as of March 13, 1995. (1)
10.15 Original Equipment Manufacturer Agreement dated as of June 14, 1995
between the Registrant and Hitachi Computer Products (America), Inc. (1)
10.16 Original Equipment Manufacturer Agreement dated as of April 12, 1995
between the Registrant and Digital Equipment Corporation. (1)
10.17 Manufacturing and Purchase Agreement dated as of March 28, 1996
between the Registrant and Victron, Inc. (1)
</TABLE>
E-1
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description Page Number
- ------- ------------ -----------
<S> <C> <C>
10.18 Amendment to Manufacturing and Purchase Agreement between
Xylan and Victron, Inc. dated as of December 30, 1996. (3)
10.20 Dale Bartos Employment Agreement dated as of January 4, 1997. (3)
10.21 Form of 1998 Employee Stock Option Plan and related Agreements. (4)
10.22 Form of Change of Control Agreement. (4)
23.1 Consent of KPMG Peat Marwick LLP. (4)
24.1 Power of Attorney (see page 33). (4)
27.1 Financial Data Schedule (Current) Fiscal Year Ended Dec-31-1997. (4)
27.2 Restated Financial Data Schedule 9 Months Ended Sep-30-1997. (4)
27.3 Restated Financial Data Schedule 6 Months Ended Jun-30-1997. (4)
27.4 Restated Financial Data Schedule 3 Months Ended Mar-31-1997. (4)
27.5 Restated Financial Data Schedule Fiscal Year Ended Dec-31-1996. (4)
27.6 Restated Financial Data Schedule 9 Months Ended Sep-30-1996. (4)
27.7 Restated Financial Data Schedule 6 Months Ended Jun-30-1996. (4)
27.8 Restated Financial Data Schedule 3 Months Ended Mar-31-1996. (4)
27.9 Restated Financial Data Schedule for Fiscal Year Ended Dec-31-1995. (4)
</TABLE>
- --------
(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 Exhibit 1 of the Registrant's Registration
Statement on Form 8-A filed with the Commission on August 24, 1997.
(3) Incorporated by reference to identically numbered exhibits filed in the
Company's Annual Report on Form 10-K filed in March 31, 1997.
(4) Filed herewith.
E-2
<PAGE>
EXHIBIT 10.5
XYLAN CORPORATION
1996 STOCK PLAN
(as amended March 28, 1997)
1. Purposes of the Plan. The purposes of this Stock Plan are to attract
--------------------
and retain the best available personnel for positions of substantial
responsibility, to provide additional incentive to the Employees and Consultants
of the Company and to promote the success of the Company's business.
Options granted hereunder may be either Incentive Stock Options (as defined
under Section 422 of the Code) or Nonstatutory Stock Options, at the discretion
of the Board and as reflected in the terms of the written option agreement.
Stock purchase rights may also be granted under the Plan.
2. Definitions. As used herein, the following definitions shall apply:
-----------
(a) "Administrator" shall mean the Board or any of its Committees
-------------
appointed pursuant to Section 4 of the Plan.
(b) "Affiliate" shall mean an entity in which the Company owns an equity
---------
interest.
(c) "Applicable Laws" shall have the meaning set forth in Section 4(a)
---------------
below.
(d) "Board" shall mean the Board of Directors of the Company.
-----
(e) "Code" shall mean the Internal Revenue Code of 1986, as amended.
----
(f) "Committee" shall mean the Committee appointed by the Board of
---------
Directors in accordance with Section 4(a) of the Plan, if one is appointed.
(g) "Common Stock" shall mean the Common Stock of the Company.
------------
(h) "Company" shall mean Xylan Corporation, a California corporation.
-------
(i) "Consultant" shall mean any person who is engaged by the Company or
----------
any Parent, Subsidiary or Affiliate to render consulting services and is
compensated for such consulting services, and any director of the Company
whether compensated for such services or not; provided that if and in the event
the Company registers any class of any equity security pursuant to Section 12 of
the Exchange Act, the term Consultant shall thereafter not include directors who
are not compensated for their services or are paid only a director's fee by the
Company.
<PAGE>
(j) "Continuous Status as an Employee or Consultant" shall mean the
----------------------------------------------
absence of any interruption or termination of service as an Employee or
Consultant. Continuous Status as an Employee or Consultant shall not be
considered interrupted in the case of sick leave, military leave, or any other
leave of absence approved by the Administrator; provided that such leave is for
a period of not more than 90 days or reemployment upon the expiration of such
leave is guaranteed by contract or statute. For purposes of this Plan, a change
in status from an Employee to a Consultant or from a Consultant to an Employee
will not constitute a termination of employment.
(k) "Director" shall mean a member of the Board.
--------
(l) "Employee" shall mean any person, including Named Executives,
--------
Officers and Directors employed by the Company or any Parent, Subsidiary or
Affiliate of the Company. The payment by the Company of a director's fee to a
Director shall not be sufficient to constitute "employment" of such Director by
the Company.
(m) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
------------
amended.
(n) "Fair Market Value" means, as of any date, the value of Common Stock
-----------------
determined as follows:
(i) If the Common Stock is listed on any established stock
exchange or a national market system including without limitation the National
Market of the National Association of Securities Dealers, Inc. Automated
Quotation ("Nasdaq") System, its Fair Market Value shall be the closing sales
price for such stock as quoted on such system on the date of determination (if
for a given day no sales were reported, the closing bid on that day shall be
used), as such price is reported in The Wall Street Journal or such other source
------------------------
as the Administrator deems reliable;
(ii) If the Common Stock is quoted on the Nasdaq System (but not
on the National Market thereof) or regularly quoted by a recognized securities
dealer but selling prices are not reported, its Fair Market Value shall be the
mean between the bid and asked prices for the Common Stock or;
(iii) In the absence of an established market for the Common
Stock, the Fair Market Value thereof shall be determined in good faith by the
Administrator.
(o) "Incentive Stock Option" shall mean an Option intended to qualify as
----------------------
an incentive stock option within the meaning of Section 422 of the Code, as
designated in the applicable written option agreement.
(p) "Named Executive" shall mean any individual who, on the last day of
---------------
the Company's fiscal year, is the chief executive officer of the Company (or is
acting in such
<PAGE>
capacity) or among the four highest compensated officers of the Company (other
than the chief executive officer). Such officer status shall be determined
pursuant to the executive compensation disclosure rules under the Exchange Act.
(q) "Nonstatutory Stock Option" shall mean an Option not intended to
-------------------------
qualify as an Incentive Stock Option, as designated in the applicable written
option agreement.
(r) "Officer" shall mean a person who is an officer of the Company
---------
within the meaning of Section 16 of the Exchange Act and the rules and
regulations promulgated thereunder.
(s) "Option" shall mean a stock option granted pursuant to the Plan.
------
(t) "Optioned Stock" shall mean the Common Stock subject to an Option.
--------------
(u) "Optionee" shall mean an Employee or Consultant who receives an
--------
Option.
(v) "Parent" shall mean a "parent corporation," whether now or hereafter
------
existing, as defined in Section 424(e) of the Code.
(w) "Plan" shall mean this 1996 Stock Plan.
----
(x) "Restricted Stock" shall mean shares of Common Stock acquired
----------------
pursuant to a grant of a Stock Purchase Right under Section 11 below.
(y) "Rule 16b-3" shall mean Rule 16b-3 promulgated under the Exchange
------------
Act as the same may be amended from time to time, or any successor provision.
(z) "Share" shall mean a share of the Common Stock, as adjusted in
-----
accordance with Section 15 of the Plan.
(aa) "Stock Purchase Right" shall mean the right to purchase Common
--------------------
Stock pursuant to Section 11 below.
(bb) "Subsidiary" shall mean a "subsidiary corporation," whether now or
----------
hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to the provisions of Section 15 of
-------------------------
the Plan, the maximum aggregate number of shares that may be optioned and sold
under the Plan is 5,000,000 shares of Common Stock (after a 2-for-1 stock
split). The Shares may be authorized, but unissued, or reacquired Common Stock.
If an Option or Stock Purchase Right should expire or become unexercisable
for any reason without having been exercised in full, the unpurchased Shares
that were subject thereto shall, unless the Plan shall have been terminated,
become available for future grant under the
<PAGE>
Plan. Notwithstanding any other provision of the Plan, shares issued under the
Plan and later repurchased by the Company shall not become available for future
grant or sale under the Plan.
4. Administration of the Plan.
---------------------------
(a) Composition of Administrator.
----------------------------
(i) Multiple Administrative Bodies. If permitted by Rule 16b-3,
------------------------------
and by the legal requirements relating to the administration of incentive stock
option plans, if any, of applicable securities laws and the Code (collectively,
the "Applicable Laws"), the Plan may (but need not) be administered by different
administrative bodies with respect to Directors, Officers who are not directors
and Employees who are neither Directors nor Officers.
(ii) Administration with respect to Directors and Officers. With
-----------------------------------------------------
respect to grants of Options or Stock Purchase Rights to Employees or
Consultants who are also Officers or Directors of the Company, the Plan shall be
administered by (A) the Board, if the Board may administer the Plan in
compliance with Rule 16b-3 as it applies to a plan intended to qualify
thereunder as a discretionary plan and Section 162(m) of the Code as it applies
so as to qualify grants of Options to Named Executives as performance-based
compensation, or (B) a Committee designated by the Board to administer the Plan,
which Committee shall be constituted in such a manner as to permit the Plan to
comply with Rule 16b-3 as it applies to a plan intended to qualify thereunder as
a discretionary plan, to qualify grants of Options to Named Executives as
performance-based compensation under Section 162(m) of the Code and otherwise so
as to satisfy the Applicable Laws.
(iii) Administration with respect to Other Persons. With respect
--------------------------------------------
to grants of Options to Employees or Consultants who are neither Directors nor
Officers of the Company, the Plan shall be administered by (A) the Board or (B)
a Committee designated by the Board, which Committee shall be constituted in
such a manner as to satisfy the Applicable Laws.
(iv) General. If a Committee has been appointed pursuant to
------
subsection (ii) or (iii) of this Section 4(a), such Committee shall continue to
serve in its designated capacity until otherwise directed by the Board. From
time to time the Board may increase the size of any Committee and appoint
additional members thereof, remove members (with or without cause) and appoint
new members in substitution therefor, fill vacancies (however caused) and remove
all members of a Committee and thereafter directly administer the Plan, all to
the extent permitted by the Applicable Laws and, in the case of a Committee
appointed under subsection (ii), to the extent permitted by Rule 16b-3 as it
applies to a plan intended to qualify thereunder as a discretionary plan, and to
the extent required under Section 162(m) of the Code to qualify grants of
Options to Named Executives as performance-based compensation.
(b) Powers of the Administrator. Subject to the provisions of the Plan
---------------------------
and in the case of a Committee, the specific duties delegated by the Board to
such Committee, the Administrator shall have the authority, in its discretion:
<PAGE>
(i) to determine the Fair Market Value of the Common Stock, in
accordance with Section 2(m) of the Plan;
(ii) to select the Employees and Consultants to whom Options may
from time to time be granted hereunder;
(iii) to determine whether and to what extent Options are granted
hereunder;
(iv) to determine the number of shares of Common Stock to be
covered by each such award granted hereunder;
(v) to approve forms of agreement for use under the Plan;
(vi) to determine the terms and conditions, not inconsistent with
the terms of the Plan, of any award granted hereunder (including, but not
limited to, the share price and any restriction or limitation, or any vesting
acceleration or waiver of forfeiture restrictions regarding any Option and/or
the shares of Common Stock relating thereto, based in each case on such factors
as the Administrator shall determine, in its sole discretion);
(vii) to determine whether, to what extent and under what
circumstances Common Stock and other amounts payable with respect to an award
under this Plan shall be deferred either automatically or at the election of the
participant (including providing for and determining the amount, if any, of any
deemed earnings on any deferred amount during any deferral period); and
(viii) to reduce the exercise price of any Option to the then
current Fair Market Value if the Fair Market Value of the Common Stock covered
by such Option shall have declined since the date the Option was granted;
(c) Effect of Administrator's Decision. All decisions, determinations and
----------------------------------
interpretations of the Administrator shall be final and binding on all Optionees
and any other holders of any Options.
5. Eligibility.
-----------
(a) Recipients of Grants. Nonstatutory Stock Options may be granted to
--------------------
Employees and Consultants. Incentive Stock Options may be granted only to
Employees, provided, however, that Employees of an Affiliate shall not be
eligible to receive Incentive Stock Options. An Employee or Consultant who has
been granted an Option may, if he or she is otherwise eligible, be granted an
additional Option or Options.
(b) Type of Option. Each Option shall be designated in the written
--------------
option agreement as either an Incentive Stock Option or a Nonstatutory Stock
Option. However, notwithstanding such designations, to the extent that the
aggregate Fair Market Value of Shares
<PAGE>
with respect to which Incentive Stock Options are exercisable for the first time
by an Optionee during any calendar year (under all plans of the Company or any
Parent or Subsidiary) exceeds $100,000, such excess Options shall be treated as
Nonstatutory Stock Options. For purposes of this Section 5(b), Incentive Stock
Options shall be taken into account in the order in which they were granted, and
the Fair Market Value of the Shares shall be determined as of the time the
Option with respect to such Shares is granted.
(c) No Employment Rights. The Plan shall not confer upon any
--------------------
Optionee any right with respect to continuation of employment or consulting
relationship with the Company, nor shall it interfere in any way with his or her
right or the Company's right to terminate his or her employment or consulting
relationship at any time, with or without cause.
6. Term of Plan. The Plan shall become effective upon the earlier to
------------
occur of its adoption by the Board or its approval by the shareholders of the
Company as described in Section 21 of the Plan. It shall continue in effect for
a term of ten (10) years unless sooner terminated under Section 17 of the Plan.
7. Term of Option. The term of each Option shall be the term stated in
--------------
the Option Agreement; provided, however, that in the case of an Incentive Stock
Option, the term shall be no more than ten (10) years from the date of grant
thereof or such shorter term as may be provided in the Option Agreement.
However, in the case of an Option granted to an Optionee who, at the time the
Option is granted, owns stock representing more than ten percent (10%) of the
voting power of all classes of stock of the Company or any Parent or Subsidiary,
the term of the Option shall be five (5) years from the date of grant thereof or
such shorter term as may be provided in the Option Agreement.
8. Limitation on Grants to Employees. Subject to adjustment as provided
---------------------------------
in this Plan, the maximum number of Shares which may be subject to options or
stock purchase rights granted to any one Employee under this Plan for any fiscal
year of the Company shall be 300,000.
9. Option Exercise Price and Consideration.
---------------------------------------
(a) Exercise Price. The per Share exercise price for the Shares to be
--------------
issued pursuant to exercise of an Option shall be such price as is determined by
the Administrator, but shall be subject to the following:
(i) In the case of an Incentive Stock Option
(A) granted to an Employee who, at the time of the grant of such
Incentive Stock Option, owns stock representing more than ten percent (10%) of
the voting power of all classes of stock of the Company or any Parent or
Subsidiary, the per Share exercise price shall be no less than 110% of the Fair
Market Value per Share on the date of grant;
<PAGE>
(B) granted to any other Employee, the per Share exercise price
shall be no less than 100% of the Fair Market Value per Share on the date of
grant.
(ii) In the case of a Nonstatutory Stock Option
(A) granted to a person who, at the time of the grant of such
Option, owns stock representing more than ten percent (10%) of the voting power
of all classes of stock of the Company or any Parent or Subsidiary, the per
Share exercise price shall be no less than 110% of the Fair Market Value per
Share on the date of the grant;
(B) granted to a person who, at the time of the grant of such
Option, is a Named Executive of the Company, the per share Exercise Price shall
be no less than 100% of the Fair Market Value on the date of grant;
(iii) In the case of an Option granted on or after the effective date
of registration of any class of equity security of the Company pursuant to
Section 12 of the Exchange Act and prior to six months after the termination of
such registration, the per Share exercise price shall be no less than 100% of
the Fair Market Value per Share on the date of grant.
(b) Permissible Consideration. The consideration to be paid for the
-------------------------
Shares to be issued upon exercise of an Option, including the method of payment,
shall be determined by the Administrator (and, in the case of an Incentive Stock
Option, shall be determined at the time of grant) and may consist entirely of
(1) cash, (2) check, (3) promissory note, (4) other Shares that (x) in the case
of Shares acquired upon exercise of an Option either have been owned by the
Optionee for more than six months on the date of surrender or were not acquired,
directly or indirectly, from the Company, and (y) have a Fair Market Value on
the date of surrender equal to the aggregate exercise price of the Shares as to
which said Option shall be exercised, (5) authorization from the Company to
retain from the total number of Shares as to which the Option is exercised that
number of Shares having a Fair Market Value on the date of exercise equal to the
exercise price for the total number of Shares as to which the Option is
exercised, (6) delivery of a properly executed exercise notice together with
irrevocable instructions to a broker to deliver promptly to the Company the
amount of sale or loan proceeds required to pay the exercise price, (7) delivery
of an irrevocable subscription agreement for the Shares that irrevocably
obligates the option holder to take and pay for the Shares not more than twelve
months after the date of delivery of the subscription agreement, (8) any
combination of the foregoing methods of payment, or (9) such other consideration
and method of payment for the issuance of Shares to the extent permitted under
Applicable Laws. In making its determination as to the type of consideration to
accept, the Administrator shall consider if acceptance of such consideration may
be reasonably expected to benefit the Company.
<PAGE>
10. Exercise of Option.
------------------
(a) Procedure for Exercise; Rights as a Shareholder. Any Option granted
-----------------------------------------------
hereunder shall be exercisable at such times and under such conditions as
determined by the Administrator, including performance criteria with respect to
the Company and/or the Optionee, and as shall be permissible under the terms of
the Plan.
An Option may not be exercised for a fraction of a Share.
An Option shall be deemed to be exercised when written notice of such
exercise has been given to the Company in accordance with the terms of the
Option by the person entitled to exercise the Option and full payment for the
Shares with respect to which the Option is exercised has been received by the
Company. Full payment may, as authorized by the Administrator, consist of any
consideration and method of payment allowable under Section 9(b) of the Plan.
Until the issuance (as evidenced by the appropriate entry on the books of the
Company or of a duly authorized transfer agent of the Company) of the stock
certificate evidencing such Shares, no right to vote or receive dividends or any
other rights as a shareholder shall exist with respect to the Optioned Stock,
notwithstanding the exercise of the Option. The Company shall issue (or cause
to be issued) such stock certificate promptly upon exercise of the Option. No
adjustment will be made for a dividend or other right for which the record date
is prior to the date the stock certificate is issued, except as provided in
Section 15 of the Plan.
Exercise of an Option in any manner shall result in a decrease in the
number of Shares which thereafter may be available, both for purposes of the
Plan and for sale under the Option, by the number of Shares as to which the
Option is exercised.
(b) Termination of Status as an Employee or Consultant. In the event of
---------------------------------------------------
termination of an Optionee's Continuous Status as an Employee or Consultant,
such Optionee may, but only within thirty (30) days (or such other period of
time, not exceeding three (3) months in the case of an Incentive Stock Option or
six (6) months in the case of a Nonstatutory Stock Option, as is determined by
the Administrator, with such determination in the case of an Incentive Stock
Option being made at the time of grant of the Option) after the date of such
termination (but in no event later than the date of expiration of the term of
such Option as set forth in the Option Agreement), exercise his or her Option to
the extent that he or she was entitled to exercise it at the date of such
termination. To the extent that the Optionee was not entitled to exercise the
Option at the date of such termination, or if the optionee does not exercise
such Option (which he or she was entitled to exercise) within the time specified
herein, the Option shall terminate.
(c) Disability of Optionee. Notwithstanding Section 10(b) above, in the
----------------------
event of termination of an Optionee's Continuous Status as an Employee or
Consultant as a result of his or her total and permanent disability (as defined
in Section 22(e)(3) of the Code), he or she may, but only within six (6) months
(or such other period of time not exceeding twelve (12) months as is determined
by the Administrator, with such determination in the case of an Incentive Stock
Option being made at the time of grant of the Option) from the date of such
termination (but in
<PAGE>
no event later than the date of expiration of the term of such Option as set
forth in the Option Agreement), exercise his or her Option to the extent he or
she was entitled to exercise it at the date of such termination. To the extent
that he or she was not entitled to exercise the Option at the date of
termination, or if he does not exercise such Option (which he was entitled to
exercise) within the time specified herein, the Option shall terminate.
(d) Death of Optionee. In the event of the death of an Optionee:
-----------------
(i) during the term of the Option who is at the time of his death an
Employee or Consultant of the Company and who shall have been in Continuous
Status as an Employee or Consultant since the date of grant of the Option, the
Option may be exercised, at any time within six (6) months (or such other period
of time, not exceeding six (6) months, as is determined by the Administrator,
with such determination in the case of an Incentive Stock Option being made at
the time of grant of the Option) following the date of death (but in no event
later than the date of expiration of the term of such Option as set forth in the
Option Agreement), by the Optionee's estate or by a person who acquired the
right to exercise the Option by bequest or inheritance but only to the extent of
the right to exercise that would have accrued had the Optionee continued living
and remained in Continuous Status as an Employee or Consultant three (3) months
(or such other period of time as is determined by the Administrator as provided
above) after the date of death, subject to the limitation set forth in Section
5(b); or
(ii) within thirty (30) days (or such other period of time not
exceeding three (3) months as is determined by the Administrator, with such
determination in the case of an Incentive Stock Option being made at the time of
grant of the Option) after the termination of Continuous Status as an Employee
or Consultant, the Option or may be exercised, at any time within six (6) months
following the date of death (but in no event later than the date of expiration
of the term of such Option as set forth in the Option Agreement), by the
Optionee's estate or by a person who acquired the right to exercise the Option
by bequest or inheritance, but only to the extent of the right to exercise that
had accrued at the date of termination.
11. Stock Purchase Rights.
---------------------
(a) Rights to Purchase. Stock Purchase Rights may be issued either
------------------
alone, in addition to, or in tandem with other awards granted under the Plan
and/or cash awards made outside of the Plan. After the Administrator determines
that it will offer Stock Purchase Rights under the Plan, it shall advise the
offeree in writing of the terms, conditions and restrictions related to the
offer, including the number of Shares that such person shall be entitled to
purchase, the price to be paid (which price shall not be less than 85% of the
Fair Market Value of the Shares as of the date of the offer), and the time
within which such person must accept such offer, which shall in no event exceed
thirty (30) days from the date upon which the Administrator made the
determination to grant the Stock Purchase Right. The offer shall be accepted by
execution of a Restricted Stock Purchase Agreement in the form determined by the
Administrator. Shares purchased pursuant to the grant of a Stock Purchase Right
shall be referred to herein as "Restricted Stock."
<PAGE>
(b) Repurchase Option. Unless the Administrator determines otherwise,
-----------------
the Restricted Stock Purchase Agreement shall grant the Company a repurchase
option exercisable upon the voluntary or involuntary termination of the
purchaser's employment with the Company for any reason (including death or
disability). The purchase price for Shares repurchased pursuant to the
Restricted Stock Purchase Agreement shall be the higher of either the original
purchase price or the Fair Market Value on the date of the repurchase.
(c) Other Provisions. The Restricted Stock Purchase Agreement shall
----------------
contain such other terms, provisions and conditions not inconsistent with the
Plan as may be determined by the Administrator in its sole discretion. In
addition, the provisions of Restricted Stock Purchase Agreements need not be the
same with respect to each purchaser.
(d) Rights as a Shareholder. Once the Stock Purchase Right is
-----------------------
exercised, the purchaser shall have the rights equivalent to those of a
shareholder, and shall be a shareholder when his or her purchase is entered upon
the records of the duly authorized transfer agent of the Company. No adjustment
will be made for a dividend or other right for which the record date is prior to
the date the Stock Purchase Right is exercised, except as provided in Section 15
of the Plan.
(e) Rule 16b-3. Options granted to persons subject to Section 16(b)
----------
of the Exchange Act must comply with Rule 16b-3 and shall contain such
additional conditions or restrictions as may be required thereunder to qualify
for the maximum exemption from Section 16 of the Exchange Act with respect to
Plan transactions.
12. Withholding Taxes. As a condition to the exercise of Options and
-----------------
Stock Purchase Rights granted hereunder, the Optionee or Stock Purchase Right
holder shall make such arrangements as the Administrator may require for the
satisfaction of any federal, state, local or foreign withholding tax obligations
that may arise in connection with the exercise, receipt or vesting of such
Option or Stock Purchase Right. The Company shall not be required to issue any
Shares under the Plan until such obligations are satisfied.
13. Stock Withholding to Satisfy Withholding Tax Obligations. At the
--------------------------------------------------------
discretion of the Administrator, Optionees and Stock Purchase Right holders may
satisfy withholding obligations as provided in this paragraph. When an Optionee
or Stock Purchase Right holder incurs tax liability in connection with an Option
or Stock Purchase Right which tax liability is subject to tax withholding under
applicable tax laws, and the Optionee or Stock Purchase Right holder is
obligated to pay the Company an amount required to be withheld under applicable
tax laws, the Optionee or Stock Purchase Right holder may satisfy the
withholding tax obligation by one or some combination of the following methods:
(a) by cash payment, or (b) out of the Optionee's or the Stock Purchase Right
holder's current compensation, (c) if permitted by the Administrator, in its
discretion, by surrendering to the Company Shares that (i) in the case of Shares
previously acquired from the Company, have been owned by the Optionee or Stock
Purchase Right holder for more than six months on the date of surrender, and
(ii) have a fair market value on the date of surrender equal to or less than the
Optionee's or the Stock Purchase Right holder's marginal tax rate times the
ordinary income recognized, or (d) by electing to have
<PAGE>
the Company withhold from the Shares to be issued upon exercise of the Option or
Stock Purchase Right that number of Shares having a fair market value equal to
the amount required to be withheld. For this purpose, the fair market value of
the Shares to be withheld shall be determined on the date that the amount of tax
to be withheld is to be determined (the "Tax Date").
Any surrender by an Officer or Director of previously owned Shares to
satisfy tax withholding obligations arising upon exercise of an Option or Stock
Purchase Right must comply with the applicable provisions of Rule 16b-3 and
shall be subject to such additional conditions or restrictions as may be
required thereunder to qualify for the maximum exemption from Section 16 of the
Exchange Act with respect to Plan transactions.
All elections by an Optionee or Stock Purchase Right holder to have Shares
withheld to satisfy tax withholding obligations shall be made in writing in a
form acceptable to the Administrator and shall be subject to the following
restrictions:
(a) the election must be made on or prior to the applicable Tax Date;
(b) once made, the election shall be irrevocable as to the particular
Shares of the Option or Stock Purchase Right as to which the election is made;
(c) all elections shall be subject to the consent or disapproval of the
Administrator;
(d) if the Optionee or Stock Purchase Right holder is an Officer or
Director, the election must comply with the applicable provisions of Rule 16b-3
and shall be subject to such additional conditions or restrictions as may be
required thereunder to qualify for the maximum exemption from Section 16 of the
Exchange Act with respect to Plan transactions.
In the event the election to have Shares withheld is made by an Optionee or
Stock Purchase Right holder and the Tax Date is deferred under Section 83 of the
Code because no election is filed under Section 83(b) of the Code, the Optionee
shall receive the full number of Shares with respect to which the Option or
Stock Purchase Right is exercised but such Optionee or Stock Purchase Right
holder shall be unconditionally obligated to tender back to the Company the
proper number of Shares on the Tax Date.
14. Non-Transferability of Options and Stock Purchase Rights. Options and
--------------------------------------------------------
Stock Purchase Rights may not be sold, pledged, assigned, hypothecated,
transferred, or disposed of in any manner other than by will or by the laws of
descent or distribution. The designation of a beneficiary by an Optionee or
Stock Purchase Right holder will not constitute a transfer. An Option or Stock
Purchase Right may be exercised, during the lifetime of the Optionee or Stock
Purchase Right holder only by the Optionee or Stock Purchase Right holder or a
transferee permitted by this Section 14.
<PAGE>
15. Adjustments Upon Changes in Capitalization; Corporate Transactions.
------------------------------------------------------------------
(a) Adjustment. Subject to any required action by the shareholders
----------
of the Company, the number of shares of Common Stock covered by each outstanding
Option or Stock Purchase Right, the number of shares of Common Stock that have
been authorized for issuance under the Plan but as to which no Options or Stock
Purchase Rights have yet been granted or which have been returned to the Plan
upon cancellation or expiration of an Option or Stock Purchase Right, the
maximum number of shares of Common Stock for which Options or Stock Purchase
Rights may be granted to any employee under Section 8 of the Plan, and the price
per share of Common Stock covered by each such outstanding Option or Stock
Purchase Right, shall be proportionately adjusted for any increase or decrease
in the number of issued shares of Common Stock resulting from a stock split,
reverse stock split, stock dividend, combination or reclassification of the
Common Stock, or any other increase or decrease in the number of issued shares
of Common Stock effected without receipt of consideration by the Company;
provided, however, that conversion of any convertible securities of the Company
shall not be deemed to have been "effected without receipt of consideration."
Such adjustment shall be made by the Administrator, whose determination in that
respect shall be final, binding and conclusive. Except as expressly provided
herein, no issuance by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall affect, and no
adjustment by reason thereof shall be made with respect to, the number or price
of shares of Common Stock subject to an Option or Stock Purchase Right.
(b) Corporate Transactions. In the event of the proposed dissolution
----------------------
or liquidation of the Company, the Option or Stock Purchase Right will terminate
immediately prior to the consummation of such proposed action, unless otherwise
provided by the Administrator. The Administrator may, in the exercise of its
sole discretion in such instances, declare that any Option or Stock Purchase
Right shall terminate as of a date fixed by the Administrator and give each
Optionee or Stock Purchase Right holder the right to exercise his or her Option
or Stock Purchase Right as to all or any part of the Optioned Stock or
Restricted Stock, including Shares as to which the Option or Stock Purchase
Right would not otherwise be exercisable. In the event of a proposed sale of all
or substantially all of the assets of the Company, or the merger of the Company
with or into another corporation, the Option or Stock Purchase Right shall be
assumed or an equivalent option or stock purchase right shall be substituted by
such successor corporation or a parent or subsidiary of such successor
corporation, unless the Administrator determines, in the exercise of its sole
discretion and in lieu of such assumption or substitution, that the Optionee or
Stock Purchase Right holder shall have the right to exercise the Option or Stock
Purchase Right as to some or all of the Optioned Stock or Restricted Stock,
including Shares as to which the Option would not otherwise be exercisable, or
that Restricted Stock held by a purchaser shall be released from the Company's
repurchase option. If the Administrator makes an Option or Stock Purchase Right
exercisable in lieu of assumption or substitution in the event of a merger or
sale of assets, the Administrator shall notify the Optionee or Stock Purchase
Right Holder that the Option or Stock Purchase Right shall be exercisable for a
period of fifteen (15) days from the date of such notice, and the Option or
Stock Purchase Right will terminate upon the expiration of such period.
<PAGE>
16. Time of Granting Options and Stock Purchase Rights. The date of grant
--------------------------------------------------
of an Option or Stock Purchase Right shall, for all purposes, be the date on
which the Administrator makes the determination granting such Option or Stock
Purchase Right or such other date as is determined by the Administrator. Notice
of the determination shall be given to each Employee or Consultant to whom an
Option or Stock Purchase Right is so granted within a reasonable time after the
date of such grant.
17. Amendment and Termination of the Plan.
-------------------------------------
(a) Amendment and Termination. The Board may amend or terminate the
-------------------------
Plan from time to time in such respects as the Board may deem advisable;
provided that, the following revisions or amendments shall require approval of
the shareholders of the Company in the manner described in Section 21 of the
Plan:
(i) any increase in the number of Shares subject to the Plan,
other than an adjustment under Section 15 of the Plan;
(ii) any change in the designation of the class of persons
eligible to be granted Options or Stock Purchase Rights;
(iii) any change in the limitation on grants to employees as
described in Section 8 of the Plan or other changes which would require
shareholder approval to qualify options or stock purchase rights granted
hereunder as performance-based compensation under Section 162(m) of the Code; or
(iv) any revision or amendment requiring shareholder approval in
order to preserve the qualification of the Plan under Rule 16b-3.
(b) Shareholder Approval. If any amendment requiring shareholder
---------------------
approval under Section 17(a) of the Plan is made subsequent to the first
registration of any class of equity securities by the Company under Section 12
of the Exchange Act, such shareholder approval shall be solicited as described
in Section 21 of the Plan.
(c) Effect of Amendment or Termination. Any such amendment or
----------------------------------
termination of the Plan shall not affect Options or Stock Purchase Rights
already granted and such Options or Stock Purchase Rights shall remain in full
force and effect as if this Plan had not been amended or terminated, unless
mutually agreed otherwise between the Optionee or Stock Purchase Right Holder
and the Board, which agreement must be in writing and signed by the Optionee or
Stock Purchase Right Holder and the Company.
18. Conditions Upon Issuance of Shares. Shares shall not be issued
----------------------------------
pursuant to the exercise of an Option or Stock Purchase Right unless the
exercise of such Option or Stock Purchase Right and the issuance and delivery of
such Shares pursuant thereto shall comply with all relevant provisions of law,
including, without limitation, the Securities Act of 1933, as amended, the
Exchange Act, the rules and regulations promulgated thereunder, and the
<PAGE>
requirements of any stock exchange upon which the Shares may then be listed, and
shall be further subject to the approval of counsel for the Company with respect
to such compliance.
As a condition to the exercise of an Option or Stock Purchase Right, the
Company may require the person exercising such Option or Stock Purchase Right to
represent and warrant at the time of any such exercise that the Shares are being
purchased only for investment and without any present intention to sell or
distribute such Shares if, in the opinion of counsel for the Company, such a
representation is required by any of the aforementioned relevant provisions of
law.
19. Reservation of Shares. The Company, during the term of this Plan,
---------------------
will at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan. The inability of the
Company to obtain authority from any regulatory body having jurisdiction, which
authority is deemed by the Company's counsel to be necessary to the lawful
issuance and sale of any Shares hereunder, shall relieve the Company of any
liability in respect of the failure to issue or sell such Shares as to which
such requisite authority shall not have been obtained.
20. Agreements. Options and Stock Purchase Rights shall be evidenced by
----------
written agreements in such form as the Board shall approve.
21. Shareholder Approval.
--------------------
(a) Continuance of the Plan shall be subject to approval by the
shareholders of the Company within twelve (12) months before or after the date
the Plan is adopted. Such shareholder approval shall be obtained in the manner
and to the degree required under applicable federal and state law and the rules
of any stock exchange upon which the Shares are listed.
(b) In the event that the Company registers any class of equity
securities pursuant to Section 12 of the Exchange Act, any required approval of
the shareholders of the Company obtained after such registration shall be
solicited substantially in accordance with Section 14(a) of the Exchange Act and
the rules and regulations promulgated thereunder.
(c) If any required approval by the shareholders of the Plan itself or
of any amendment thereto is solicited at any time otherwise than in the manner
described in Section 21(b) hereof, then the Company shall, at or prior to the
first annual meeting of shareholders held subsequent to the later of (1) the
first registration of any class of equity securities of the Company under
Section 12 of the Exchange Act or (2) the granting of an Option or Stock
Purchase Right hereunder to an officer or director after such registration, do
the following:
(i) furnish in writing to the holders entitled to vote for the
Plan substantially the same information that would be required (if proxies to be
voted with respect to approval or disapproval of the Plan or amendment were then
being solicited) by the rules and regulations in effect under Section 14(a) of
the Exchange Act at the time such information is furnished; and
<PAGE>
(ii) file with, or mail for filing to, the Securities and
Exchange Commission four copies of the written information referred to in
subsection (i) hereof not later than the date on which such information is first
sent or given to shareholders.
22. Information to Optionees and Purchasers. The Company shall provide to
---------------------------------------
each Optionee and Stock Purchase Right holder, during the period for which such
Optionee or holder has one or more Options or Stock Purchase Rights outstanding,
copies of all annual reports and other information which are provided to all
shareholders of the Company.
<PAGE>
EXHIBIT 10.21
XYLAN CORPORATION
1998 EMPLOYEE STOCK OPTION PLAN
1. Purposes of the Plan. The purposes of this 1998 Employee Stock Option
--------------------
Plan are to attract and retain the best available personnel for positions of
substantial responsibility, to provide additional incentive to the Employees and
Consultants of the Company and to promote the success of the Company's business.
Options granted hereunder shall be Nonstatutory Stock Options.
2. Definitions. As used herein, the following definitions shall apply:
-----------
(a) "Administrator" shall mean the Board or any of its Committees
-------------
appointed pursuant to Section 4 of the Plan.
(b) "Board" shall mean the Board of Directors of the Company.
-----
(c) "Code" shall mean the Internal Revenue Code of 1986, as amended.
----
(d) "Committee" shall mean the Committee appointed by the Board of
---------
Directors in accordance with paragraph (a) of Section 4 of the Plan, if one is
appointed. The Committee members shall not be required to be Board members.
(e) "Common Stock" shall mean the Common Stock of the Company.
------------
(f) "Company" shall mean Xylan Corporation, a California corporation.
-------
(g) "Consultant" shall mean any person who is engaged by the Company
----------
or any Parent or Subsidiary to render consulting services and is compensated for
such consulting services, excluding any Officers, Named Executives and
Directors.
(h) "Continuous Status as an Employee or Consultant" shall mean the
----------------------------------------------
absence of any interruption or termination of service as an Employee or
Consultant. Continuous Status as an Employee or Consultant shall not be
considered interrupted in the case of sick leave, military leave, or any other
leave of absence approved by the Board; provided that such leave is for a period
of not more than 90 days or reemployment upon the expiration of such leave is
guaranteed by contract or statute.
(i) "Director" shall mean a member of the Board.
--------
(j) "Employee" shall mean any person who is employed by the Company or
--------
any Parent or Subsidiary of the Company, excluding any Officer, Named Executive
and Director.
(k) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
------------
amended.
(l) "Fair Market Value" shall mean, as of any date, the
-----------------
value of Common Stock determined as follows:
(i) If the Common Stock is listed on any established stock
exchange or a national market system including without limitation the National
Market of the National Association of Securities Dealers, Inc. Automated
Quotation ("Nasdaq") System, its Fair Market Value shall be the closing sales
price for such stock as quoted on such system on the date of determination (if
for a given day no sales were reported, the closing bid on that day shall be
used), as such price is reported in The Wall Street Journal or such other source
-----------------------
as the Administrator deems reliable;
<PAGE>
(ii) If the Common Stock is quoted on the Nasdaq System (but not
on the National Market thereof) or regularly quoted by a recognized securities
dealer but selling prices are not reported, its Fair Market Value shall be the
mean between the bid and asked prices for the Common Stock or;
(iii) In the absence of an established market for the Common
Stock, the Fair Market Value thereof shall be determined in good faith by the
Administrator.
(m) "Named Executive" shall mean any individual who, on the last day
---------------
of the Company's fiscal year, is the chief executive officer of the Company (or
is acting in such capacity) or among the four highest compensated officers of
the Company (other than the chief executive officer). Such officer status shall
be determined pursuant to the executive compensation disclosure rules under the
Exchange Act.
(n) "Nonstatutory Stock Option" shall mean an Option not intended to
-------------------------
qualify as an Incentive Stock Option, as designated in the applicable option
agreement. "Incentive Stock Option" shall mean an Option intended to qualify as
----------------------
an incentive stock option within the meaning of Section 422 of the Code, as
designated in the applicable option agreement.
(o) "Officer" shall mean a person who is an officer of the Company
-------
within the meaning of Section 16 of the Exchange Act and the rules and
regulations promulgated thereunder.
(p) "Option" shall mean a stock option granted pursuant to the Plan.
------
(q) "Optioned Stock" shall mean the Common Stock subject to an Option.
--------------
(r) "Optionee" shall mean an Employee or Consultant who receives an
--------
Option.
(s) "Parent" shall mean a "parent corporation," whether now or
------
hereafter existing, as defined in Section 424(e) of the Code.
(t) "Plan" shall mean this 1998 Employee Stock Option Plan.
----
(u) "Rule 16b-3" shall mean Rule 16b-3 promulgated under the Exchange
----------
Act as the same may be amended from time to time, or any successor provision.
(v) "Share" shall mean a share of the Common Stock, as adjusted in
-----
accordance with Section 11 of the Plan.
(w) "Subsidiary" shall mean a "subsidiary corporation," whether now or
----------
hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to the provisions of Section 11 of
-------------------------
the Plan, the maximum aggregate number of shares which may be optioned and sold
under the Plan is 1,000,000 shares of Common Stock. The Shares may be
authorized, but unissued, or reacquired Common Stock.
If an Option should expire or become unexercisable for any reason without
having been exercised in full, the unpurchased Shares which were subject thereto
shall, unless the Plan shall have been terminated, become available for future
grant under the Plan. Notwithstanding any other provision of the Plan, shares
issued under the Plan and later repurchased by the Company shall not become
available for future grant or sale under the Plan.
4. Administration of the Plan.
---------------------------
<PAGE>
(a) Composition of Administrator. The Plan shall be administered by
----------------------------
(A) the Board or (B) a Committee designated by the Board, which Committee shall
be constituted in such a manner as to satisfy the legal requirements relating to
the administration of nonstatutory stock option plans, if any, of applicable
securities laws and the Code (collectively, the "Applicable Laws"). If a
Committee has been appointed pursuant to this Section 4(a), such Committee shall
continue to serve in its designated capacity until otherwise directed by the
Board. From time to time the Board may increase the size of any Committee and
appoint additional members thereof, remove members (with or without cause) and
appoint new members in substitution therefor, fill vacancies (however caused)
and remove all members of a Committee and thereafter directly administer the
Plan, all to the extent permitted by the Applicable Laws.
(b) Powers of the Administrator. Subject to the provisions of the
---------------------------
Plan, and in the case of a Committee, the specific duties delegated by, or
limitations of authority imposed by, the Board to or on such Committee, the
Administrator shall have the authority, in its discretion:
(i) to grant Options under the Plan;
(ii) to determine, upon review of relevant information and in
accordance with Section 2(l) of the Plan, the fair market value of the Common
Stock;
(iii) to determine the exercise price per share of Options to be
granted, which exercise price shall be determined in accordance with Section
8(a) of the Plan;
(iv) to determine the Employees or Consultants to whom, and the time
or times at which, Options shall be granted and the number of shares to be
represented by each Option;
(v) to interpret the Plan;
(vi) to approve forms of agreement for use under the Plan;
(vii) to determine the terms and provisions of each Option granted
(which need not be identical) and, with the consent of the holder thereof,
modify or amend each Option;
(viii) to accelerate or defer (with the consent of the Optionee) the
exercise date of any Option;
(ix) to reduce the exercise price of any Option to the then current
Fair Market Value if the Fair Market Value of the Common Stock covered by such
Option shall have declined since the date the Option was granted;
(x) to authorize any person to execute on behalf of the Company any
instrument required to effectuate the grant of an Option previously granted by
the Administrator; and
(xi) to make all other determinations deemed necessary or advisable
for the administration of the Plan.
(c) Effect of Administrator's Decision. All decisions, determinations
----------------------------------
and interpretations of the Administrator shall be final and binding on all
Optionees and any other holders of any Options granted under the Plan.
5. Eligibility.
-----------
<PAGE>
(a) Options may be granted only to Employees and Consultants. An
Employee or Consultant who has been granted an Option may, if he is otherwise
eligible, be granted an additional Option or Options.
(b) Each Option shall be designated in the written option agreement as
a Nonstatutory Stock Option.
(c) The Plan shall not confer upon any Optionee any right with respect
to continuation of employment or consulting relationship with the Company, nor
shall it interfere in any way with his right or the Company's right to terminate
his employment or consulting relationship at any time, with or without cause.
6. Term of Plan. The Plan shall become on January 13, 1998 and it shall
------------
continue in effect for a term of ten (10) years unless sooner terminated under
Section 13 of the Plan.
7. Term of Option. The term of each Nonstatutory Stock Option shall be ten
--------------
(10) years from the date of grant thereof or such shorter term as may be
provided in the Nonstatutory Stock Option Agreement.
8. Exercise Price and Consideration.
--------------------------------
(a) The per Share exercise price for the Shares to be issued pursuant
to exercise of an Option shall be such price as is determined by the
Administrator.
(b) The consideration to be paid for the Shares to be issued upon
exercise of an Option, including the method of payment, shall be determined by
the Administrator and may consist entirely of (1) cash, (2) check, (3)
promissory note, (4) other Shares of Common Stock which (i) either have been
owned by the Optionee for more than six (6) months on the date of surrender or
were not acquired, directly or indirectly, from the Company, and (ii) have a
fair market value on the date of surrender equal to the aggregate exercise price
of the Shares as to which said Option shall be exercised, (5) delivery of a
properly executed exercise notice together with irrevocable instructions to a
broker to deliver promptly to the Company the amount of sale or loan proceeds
required to pay the exercise price, (6) any combination of such methods of
payment, or (7) such other consideration and method of payment for the issuance
of Shares to the extent permitted under Sections 408 and 409 of the California
General Corporation Law. In making its determination as to the type of
consideration to accept, the Administrator shall consider if acceptance of such
consideration may be reasonably expected to benefit the Company (Section 315(b)
of the California General Corporation Law).
9. Exercise of Option.
------------------
(a) Procedure for Exercise; Rights as a Shareholder. Any Option
-----------------------------------------------
granted hereunder shall be exercisable at such times and under such conditions
as determined by the Administrator, including performance criteria with respect
to the Company and/or the Optionee, and as shall be permissible under the terms
of the Plan.
An Option may not be exercised for a fraction of a Share.
An Option shall be deemed to be exercised when written notice of such
exercise has been given to the Company in accordance with the terms of the
Option by the person entitled to exercise the Option and full payment for the
Shares with respect to which the Option is exercised has been received by the
Company. Full payment may, as authorized by the Administrator, consist of any
consideration and method of payment allowable under Section 8(b) of the Plan.
Until the issuance (as evidenced by the appropriate entry on the books of the
Company or of a duly authorized transfer agent of the Company) of the stock
certificate evidencing such Shares, no right to vote or receive dividends or any
other rights as a shareholder shall exist with respect to the Optioned Stock,
notwithstanding the exercise of the Option. The Company shall issue (or cause
to be issued) such stock certificate promptly upon exercise of the Option. No
adjustment will be made for a dividend or other right for which the record date
is prior to the date the stock certificate is issued, except as provided in
Section 11 of the Plan.
<PAGE>
Exercise of an Option in any manner shall result in a decrease in the
number of Shares which thereafter may be available, both for purposes of the
Plan and for sale under the Option, by the number of Shares as to which the
Option is exercised.
(b) Termination of Status as an Employee or Consultant. In the event
--------------------------------------------------
of termination of an Optionee's Continuous Status as an Employee or Consultant,
such Optionee may, but only within thirty (30) days (or such other period of
time, not exceeding six (6) months, as is determined by the Administrator) after
the date of such termination (but in no event later than the date of expiration
of the term of such Option as set forth in the Option Agreement), exercise his
Option to the extent that he was entitled to exercise it at the date of such
termination. To the extent that he was not entitled to exercise the Option at
the date of such termination, or if he does not exercise such Option (which he
was entitled to exercise) within the time specified herein, the Option shall
terminate.
(c) Disability of Optionee. Notwithstanding the provisions of Section
----------------------
9(b) above, in the event of termination of an Optionee's Continuous Status as an
Employee or Consultant as a result of his total and permanent disability (as
defined in Section 22(e)(3) of the Code), he may, but only within six (6) months
(or such other period of time not exceeding twelve (12) months as is determined
by the Administrator) from the date of such termination (but in no event later
than the date of expiration of the term of such Option as set forth in the
Option Agreement), exercise his Option to the extent he was entitled to exercise
it at the date of such termination. To the extent that he was not entitled to
exercise the Option at the date of termination, or if he does not exercise such
Option (which he was entitled to exercise) within the time specified herein, the
Option shall terminate.
(d) Death of Optionee. In the event of the death of an Optionee:
-----------------
(i) during the term of the Option who is at the time of his death
an Employee or Consultant of the Company and who shall have been in Continuous
Status as an Employee or Consultant since the date of grant of the Option, the
Option may be exercised, at any time within six (6) months (or such other period
of time not exceeding six (6) months as is determined by the Administrator)
following the date of death (but in no event later than the date of expiration
of the term of such Option as set forth in the Option Agreement), by the
Optionee's estate or by a person who acquired the right to exercise the Option
by bequest or inheritance, but only to the extent of the right to exercise that
would have accrued had the Optionee continued living and remained in Continuous
Status as an Employee or Consultant six (6) months after the date of death; or
(ii) within thirty (30) days (or such other period of time not
exceeding three (3) months as is determined by the Administrator) after the
termination of Continuous Status as an Employee or Consultant, the Option may be
exercised, at any time within six (6) months following the date of death (but in
no event later than the date of expiration of the term of such Option as set
forth in the Option Agreement), by the Optionee's estate or by a person who
acquired the right to exercise the Option by bequest or inheritance, but only to
the extent of the right to exercise that had accrued at the date of termination.
10. Non-Transferability of Options. The Option may not be sold, pledged,
------------------------------
assigned, hypothecated, transferred, or disposed of in any manner other than by
will or by the laws of descent or distribution. The designation of a
beneficiary by an Optionee will not constitute a transfer. An Option may be
exercised, during the lifetime of the Optionee, only by the Optionee or a
transferee permitted by this Section 10.
11. Adjustments Upon Changes in Capitalization or Merger.
----------------------------------------------------
(a) Adjustments. Subject to any required action by the shareholders
-----------
of the Company, the number of shares of Common Stock covered by each outstanding
Option, and the number of shares of Common Stock which have been authorized for
issuance under the Plan but as to which no Options have yet been granted or
which have been returned to the Plan upon cancellation or expiration of an
Option, and the price per share of Common Stock covered by each such outstanding
Option, shall be proportionately adjusted for any increase or decrease in the
number of issued shares of Common Stock resulting from a stock split, reverse
stock split, stock dividend, combination or reclassification of the Common
Stock, or any other increase or decrease in the number of issued shares of
Common Stock effected without receipt of consideration by the Company; provided,
however, that conversion of any convertible securities of the Company shall not
be deemed to have been "effected without receipt of consideration." Such
adjustment shall be made by the Administrator, whose determination in that
respect shall be
<PAGE>
final, binding and conclusive. Except as expressly provided herein, no issuance
by the Company of shares of stock of any class, or securities convertible into
shares of stock of any class, shall affect, and no adjustment by reason thereof
shall be made with respect to, the number or price of shares of Common Stock
subject to an Option.
(b) Corporate Transactions. In the event of the proposed dissolution
----------------------
or liquidation of the Company, the Option will terminate immediately prior to
the consummation of such proposed action, unless otherwise provided by the
Administrator. The Administrator may, in the exercise of its sole discretion in
such instances, declare that any Option shall terminate as of a date fixed by
the Administrator and give each Optionee the right to exercise his Option as to
all or any part of the Optioned Stock, including Shares as to which the Option
would not otherwise be exercisable. In the event of a proposed sale of all or
substantially all of the assets of the Company, or the merger of the Company
with or into another corporation, the Option shall be assumed or an equivalent
option shall be substituted by such successor corporation or a parent or
subsidiary of such successor corporation, unless the Administrator determines,
in the exercise of its sole discretion and in lieu of such assumption or
substitution, that the Optionee shall have the right to exercise the Option as
to some or all of the Optioned Stock, including Shares as to which the Option
would not otherwise be exercisable. If the Administrator makes an Option fully
exercisable in lieu of assumption or substitution in the event of a merger or
sale of assets, the Administrator shall notify the Optionee that the Option
shall be fully exercisable for a period of fifteen (15) days from the date of
such notice, and the Option will terminate upon the expiration of such period.
12. Time of Granting Options. The date of grant of an Option shall, for
------------------------
all purposes, be the date on which the Administrator makes the determination
granting such Option. Notice of the determination shall be given to each
Employee or Consultant to whom an Option is so granted within a reasonable time
after the date of such grant.
13. Amendment and Termination of the Plan.
-------------------------------------
(a) Amendment and Termination. The Board may amend or terminate the
-------------------------
Plan from time to time in such respects as the Board may deem advisable
(b) Effect of Amendment or Termination. Any such amendment or
----------------------------------
termination of the Plan shall not adversely affect Options already granted
(except to the extent contemplated by such Options) and such Options shall
remain in full force and effect, unless mutually agreed otherwise between the
Optionee and the Board (or other body then administering the Plan), which
agreement must be in writing and signed by the Optionee and the Company.
14. Conditions Upon Issuance of Shares. Shares shall not be issued
----------------------------------
pursuant to the exercise of an Option unless the exercise of such Option and the
issuance and delivery of such Shares pursuant thereto shall comply with all
relevant provisions of law, including, without limitation, the Securities Act of
1933, as amended, the Exchange Act, the rules and regulations promulgated
thereunder, and the requirements of any stock exchange upon which the Shares may
then be listed, and shall be further subject to the approval of counsel for the
Company with respect to such compliance.
As a condition to the exercise of an Option, the Company may require the
person exercising such Option to represent and warrant at the time of any such
exercise that the Shares are being purchased only for investment and without any
present intention to sell or distribute such Shares if, in the opinion of
counsel for the Company, such a representation is required by any of the
aforementioned relevant provisions of law.
15. Reservation of Shares. The Company, during the term of this Plan,
---------------------
will at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan. The inability of the
Company to obtain authority from any regulatory body having jurisdiction, which
authority is deemed by the Company's counsel to be necessary to the lawful
issuance and sale of any Shares hereunder, shall relieve the Company of any
liability in respect of the failure to issue or sell such Shares as to which
such requisite authority shall not have been obtained.
<PAGE>
16. Option Agreement. Options shall be evidenced by written option
----------------
agreements in such form as the Administrator shall approve.
17. Information to Optionees. The Company shall provide to each Optionee
------------------------
upon request, during the period for which such Optionee has one or more Options
outstanding, copies of all annual reports and other information which are
provided to all shareholders of the Company.
18. Withholding Taxes. As a condition to the exercise of Options granted
-----------------
hereunder, the Optionee shall make such arrangements as the Administrator may
require for the satisfaction of any federal, state, local or foreign withholding
tax obligations that may arise in connection with the exercise, receipt or
vesting of such Option. The Company shall not be required to issue any Shares
under the Plan until such obligations are satisfied.
19. Stock Withholding to Satisfy Withholding Tax Obligations. At the
--------------------------------------------------------
discretion of the Administrator, Optionees may satisfy withholding obligations
as provided in this paragraph. When an Optionee incurs tax liability in
connection with an Option which tax liability is subject to tax withholding
under applicable tax laws, and the Optionee is obligated to pay the Company an
amount required to be withheld under applicable tax laws, the Optionee may
satisfy the withholding tax obligation by one or some combination of the
following methods: (a) by cash payment, or (b) out of Optionee's current
compensation, or (c) if permitted by the Administrator, in its discretion, by
surrendering to the Company Shares that (i) in the case of Shares previously
acquired from the Company, have been owned by the Optionee for more than six
months on the date of surrender, and (ii) have a fair market value on the date
of surrender equal to or less than the amount required to be withheld, or (d) by
electing to have the Company withhold from the Shares to be issued upon exercise
of the Option that number of Shares having a fair market value equal to the
amount required to be withheld. For this purpose, the fair market value of the
Shares to be withheld shall be determined on the date that the amount of tax to
be withheld is to be determined (the "Tax Date").
All elections by an Optionee to have Shares withheld to satisfy tax
withholding obligations shall be made in writing in a form acceptable to the
Administrator and shall be subject to the following restrictions:
(a) the election must be made on or prior to the applicable Tax Date;
(b) once made, the election shall be irrevocable as to the particular
Shares of the Option as to which the election is made; and
(c) all elections shall be subject to the consent or disapproval of
the Administrator.
In the event the election to have Shares withheld is made by an
Optionee and the Tax Date is deferred under Section 83 of the Code because no
election is filed under Section 83(b) of the Code, the Optionee shall receive
the full number of Shares with respect to which the Option is exercised but such
Optionee shall be unconditionally obligated to tender back to the Company the
proper number of Shares on the Tax Date.
<PAGE>
EXHIBIT 10.21
XYLAN CORPORATION
1998 EMPLOYEE STOCK OPTION PLAN
NOTICE OF NONSTATUTORY STOCK OPTION GRANT
Optionee's Name and Address:
Name of Optionee
_______________________
_______________________
You have been granted a nonstatutory stock option to purchase Common Stock
of Xylan Corporation, (the "Company") as follows:
Date of Grant: Date of Grant
Option Price Per Share: $ Exercise Price
Total Number of Shares Granted: No Shares
Total Price of Shares Granted: $ Total Exercise Price
Term/Expiration Date: Expiration Date
Vesting Commencement Date: VCD
Vesting Schedule: ___% of the shares shall vest at the
end of _________ after the Vesting
Commencement Date and _____ of the
remainder per month thereafter
Termination Period: This Option may be exercised for a
period of thirty (30) days after
termination of employment or
consulting relationship except as set
out in Sections 7 and 8 of the Stock
Option Agreement (but in no event
later than the Expiration Date).
<PAGE>
By your signature and the signature of the Company's representative below, you
and the Company agree that this option is granted under and governed by the
terms and conditions of the 1998 Employee Stock Option Plan and the Stock Option
Agreement, all of which are attached and made a part of this document.
OPTIONEE: XYLAN CORPORATION
______________________________ By: ___________________________
Signature
______________________________ Title: ________________________
Print Name
<PAGE>
EXHIBIT 10.21
XYLAN CORPORATION
NONSTATUTORY STOCK OPTION AGREEMENT
1. Grant of Option. Xylan Corporation, a California corporation (the
---------------
"Company"), hereby grants to the Optionee named in the Notice of Grant (the
"Optionee"), an option (the "Option") to purchase the total number of shares of
Common Stock (the "Shares") set forth in the Notice of Grant, at the exercise
price per share set forth in the Notice of Grant (the "Exercise Price") subject
to the terms, definitions and provisions of the 1998 Employee Stock Option Plan
(the "Plan") adopted by the Company, which is incorporated in this Agreement by
reference. In the event of a conflict between the terms of the Plan and the
terms of this Agreement, the terms of the Plan shall govern. Unless otherwise
defined in this Agreement, the terms used in this Agreement shall have the
meanings defined in the Plan.
This Option is intended to be a nonstatutory stock option.
2. Exercise of Option. This Option shall be exercisable during its term
------------------
in accordance with the Exercise Schedule set out in the Notice of Grant and with
the provisions of Sections 8 and 9 of the Plan as follows:
(i) Right to Exercise.
(a) This Option may not be exercised for a fraction of a share.
(b) In the event of Optionee's death, disability or other termination
of employment, the exercisability of the Option is governed by Sections 6, 7 and
8 below, subject to the limitation contained in Section 2(i)(c) and (d).
(c) In no event may this Option be exercised after the date of
expiration of the term of this Option as set forth in the Notice of Grant.
(ii) Method of Exercise.
(a) This Option shall be exercisable by delivering to the Company a
written notice of exercise (in the form attached as Exhibit A) which shall state
the election to exercise the Option, the number of Shares in respect of which
the Option is being exercised, and such other representations and agreements as
to the holder's investment intent with respect to such shares of Common Stock as
may be required by the Company pursuant to the provisions of the Plan. Such
written notice shall be signed by the Optionee and shall be delivered in person
or by certified mail to the Secretary of the Company. The written notice shall
be accompanied by payment of the Exercise Price. This Option shall be deemed to
be exercised upon receipt by the Company of such written notice accompanied by
the Exercise Price.
(b) As a condition to the exercise of this Option, the Optionee agrees
to make adequate provision for federal, state or other tax withholding
obligations which arise upon the exercise of the Option or disposition of
Shares, whether by withholding, direct payment to the Company, or otherwise.
(c) No Shares will be issued pursuant to the exercise of an Option
unless such issuance and such exercise shall comply with all relevant provisions
of law and the requirements of any stock exchange upon which the Shares may then
be listed. Assuming such compliance, for income tax purposes the Shares shall
be considered transferred to the Optionee on the date on which the Option is
exercised with respect to such Shares.
(d) In connection with a public offering of the Company's securities
and upon request of the Company or the underwriters managing any underwritten
offering of the Company's securities, Optionee hereby
<PAGE>
agrees not to sell, make any short sale of, loan, grant any option for the
purchase of, or otherwise dispose of any Shares (other than those included in
the registration) without the prior written consent of the Company or such
underwriters, as the case may be, for such period of time (not to exceed 180
days) from the effective date of such registration as may be requested by the
Company or such managing underwriters.
3. Optionee's Representations. In the event the Shares purchasable
--------------------------
pursuant to the exercise of this Option have not been registered under the
Securities Act of 1933, as amended, at the time this Option is exercised,
Optionee shall, if required by the Company, concurrently with the exercise of
all or any portion of this Option, deliver to the Company an investment
representation statement in customary form, a copy of which is available for
Optionee's review from the Company upon request.
4. Method of Payment. Payment of the Exercise Price shall be by any of
-----------------
the following, or a combination of the following, at the election of the
Optionee: (i) cash; (ii) check; (iii) surrender of other shares of Common Stock
of the Company which (a) either have been owned by the Optionee for more than
six (6) months on the date of surrender or were not acquired, directly or
indirectly, from the Company, and (b) have a Fair Market Value on the date of
surrender equal to the aggregate exercise price of the Shares as to which said
Option shall be exercised; or (iv) if there is a public market for the Shares
and they are registered under the Securities Act of 1933, as amended, delivery
of a properly executed exercise notice together with irrevocable instructions to
a broker to deliver promptly to the Company the amount of sale or loan proceeds
required to pay the exercise price.
5. Restrictions on Exercise. This Option may not be exercised until such
------------------------
time as the Plan has been approved by the shareholders of the Company, or if the
issuance of such Shares upon such exercise or the method of payment of
consideration for such shares would constitute a violation of any applicable
federal or state securities or other law or regulation, including any rule under
Part 207 of Title 12 of the Code of Federal Regulations ("Regulation G") as
promulgated by the Federal Reserve Board. As a condition to the exercise of
this Option, the Company may require Optionee to make any representation and
warranty to the Company as may be required by any applicable law or regulation.
6. Termination of Relationship. In the event of termination of Optionee's
---------------------------
Continuous Status as an Employee or Consultant, Optionee may, to the extent
otherwise so entitled at the date of such termination (the "Termination Date"),
exercise this Option during the Termination Period set out in the Notice of
Grant. To the extent that Optionee was not entitled to exercise this Option at
the date of such termination, or if Optionee does not exercise this Option
within the time specified in the Notice of Grant, the Option shall terminate.
7. Disability of Optionee. Notwithstanding the provisions of Section 6
----------------------
above, in the event of termination of Optionee's Continuous Status as an
Employee or Consultant as a result of total and permanent disability (as defined
in Section 22(e)(3) of the Code), Optionee may, but only within six (6) months
from the date of termination of employment (but in no event later than the date
of expiration of the term of this Option as set forth in Section 10 below),
exercise the Option to the extent otherwise so entitled at the date of such
termination. To the extent that Optionee was not entitled to exercise the
Option at the date of termination, or if Optionee does not exercise such Option
(to the extent otherwise so entitled) within the time specified in this
Agreement, the Option shall terminate.
<PAGE>
8. Death of Optionee. In the event of the death of Optionee:
-----------------
(i) during the term of this Option and while an Employee or Consultant
of the Company and having been in Continuous Status as an Employee or Consultant
since the date of grant of the Option, the Option may be exercised, at any time
within six (6) months following the date of death (but in no event later than
the date of expiration of the term of this Option as set forth in Section 10
below), by Optionee's estate or by a person who acquired the right to exercise
the Option by bequest or inheritance, but only to the extent of the right to
exercise that would have accrued had Optionee continued living and remained in
Continuous Status as an Employee or Consultant three (3) months after the date
of death; or
(ii) within thirty (30) days after the termination of Optionee's
Continuous Status as an Employee or Consultant, the Option may be exercised, at
any time within six (6) months following the date of death (but in no event
later than the date of expiration of the term of this Option as set forth in
Section 10 below), by Optionee's estate or by a person who acquired the right to
exercise the Option by bequest or inheritance, but only to the extent of the
right to exercise that had accrued at the date of termination.
9. Non-Transferability of Option. This Option may not be transferred in
-----------------------------
any manner otherwise than by will or by the laws of descent or distribution.
The designation of a beneficiary does not constitute a transfer. An Option may
be exercised during the lifetime of Optionee only by the Optionee or a
transferee permitted by this section. The terms of this Option shall be binding
upon the executors, administrators, heirs, successors and assigns of the
Optionee.
10. Term of Option. This Option may be exercised only within the term set
--------------
out in the Notice of Grant, and may be exercised during such term only in
accordance with the Plan and the terms of this Option.
11. No Additional Employment Rights. Optionee understands and agrees that
-------------------------------
the vesting of Shares pursuant to the Exercise Schedule is earned only by
continuing as an Employee or Consultant at the will of the Company (not through
the act of being hired, being granted this Option or acquiring Shares under this
Agreement). Optionee further acknowledges and agrees that nothing in this
Agreement, nor in the Plan which is incorporated in this Agreement by reference,
shall confer upon Optionee any right with respect to continuation as an Employee
or Consultant with the Company, nor shall it interfere in any way with his or
her right or the Company's right to terminate his or her employment or
consulting relationship at any time, with or without cause.
12. Tax Consequences. Set forth below is a brief summary as of the date
----------------
of this Option of some of the federal tax consequences of exercise of this
Option and disposition of the Shares. THIS SUMMARY IS NECESSARILY INCOMPLETE,
AND THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. OPTIONEE SHOULD CONSULT
A TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE SHARES.
(i) Exercise of Nonstatutory Stock Option. Optionee may incur a
-------------------------------------
regular federal income tax liability upon the exercise of the Option. Optionee
will be treated as having received compensation income (taxable at ordinary
income tax rates) equal to the excess, if any, of the fair market value of the
Shares on the date of exercise over the Exercise Price. In addition, the
Company will be required to withhold from Optionee's compensation or collect
from Optionee and pay to the applicable taxing authorities an amount equal to a
percentage of this compensation income at the time of exercise.
(ii) Disposition of Shares. Gain realized on disposition of the
---------------------
Shares will be treated as long-term or short-term capital gain for federal
income tax purposes depending on whether or not the disposition occurs more than
one year after the exercise date.
13. Signature. This Stock Option Agreement shall be deemed executed by
---------
the Company and the Optionee upon execution by such parties of the Notice of
Grant attached to this Stock Option Agreement.
<PAGE>
EXHIBIT A
---------
NOTICE OF EXERCISE
To: Xylan Corporation
Attn: Chief Financial Officer
Subject: Notice of Intention to Exercise Nonstatutory Stock Option
---------------------------------------------------------
This is official notice that the undersigned ("Optionee") intends to
exercise Optionee's option to purchase __________ shares of Xylan Corporation
Common Stock, under and pursuant to the Company's 1998 Employee Stock Option
Plan, as amended, and the Stock Option Agreement dated _______________, as
follows:
Grant Number: ________________________________
Number of Shares: ________________________________
Date of Purchase: ________________________________
Purchase Price: ________________________________
Social Security No.: ________________________________
The shares should be issued as follows:
Name: ________________________________
Address: ________________________________
________________________________
________________________________
Optionee agrees to make adequate provision for federal, state or other tax
withholding obligations which arise upon the exercise of this Option, whether by
withholding, direct payment to the Company, or otherwise.
Signed: ____________________________
Date: ____________________________
<PAGE>
EXHIBIT 10.22
CHANGE OF CONTROL AGREEMENT
This Change of Control Agreement (the "Agreement") is made and entered into
effective as of October 16, 1997, by and between Employee (the "Employee") and
Xylan Corporation, a California corporation (the "Company").
RECITALS
A. It is expected that another company or other entity may from time
to time consider the possibility of acquiring the Company or that a change in
control may otherwise occur, with or without the approval of the Company's Board
of Directors (the "Board"). The Board recognizes that such consideration can be
a distraction to the Employee, an executive officer or key employee of the
Company, and can cause the Employee to consider alternative employment
opportunities. The Board has determined that it is in the best interests of the
Company and its shareholders to assure that the Company will have the continued
dedication and objectivity of the Employee, notwithstanding the possibility,
threat or occurrence of a Change of Control (as defined below) of the Company.
B. The Board believes that it is in the best interests of the
Company and its shareholders to provide the Employee with an incentive to
continue his or her employment with the Company, which for purposes of this
Agreement as it relates to Employee's employment shall include a majority-owned
subsidiary of the Company.
C. The Board believes that it is imperative to provide the Employee
with certain benefits upon termination of the Employee's employment in
connection with a Change of Control, which benefits are intended to provide the
Employee with financial security and provide sufficient encouragement to the
Employee to remain with the Company notwithstanding the possibility of a Change
of Control.
D. To accomplish the foregoing objectives, the Board of Directors
has directed the Company, upon execution of this Agreement by the Employee, to
agree to the terms provided in this Agreement.
E. Certain capitalized terms used in the Agreement are defined in
Section 3 below.
In consideration of the mutual covenants contained in this Agreement, and
in consideration of the continuing employment of Employee by the Company, the
parties agree as follows:
1. At-Will Employment. The Company and the Employee acknowledge
------------------
that the Employee's employment is and shall continue to be at-will, as defined
under applicable law. If the Employee's employment terminates for any reason,
including (without limitation) any termination prior to a Change of Control, the
Employee shall not be entitled to any benefits, other than as provided by this
Agreement, or as may otherwise be available in accordance with the terms of the
Company's established employee plans and written policies at the time of
termination. The terms of this Agreement shall terminate upon the earlier of (i)
the date on which Employee ceases to be employed as an executive officer or key
employee of the Company, other than as a result of an involuntary termination by
the Company without Cause (ii) the date that all obligations of the parties
hereunder have been satisfied, or (iii) one (1) year after a Change of Control.
A termination of the terms of this Agreement pursuant to the preceding sentence
shall be effective for all purposes, except that such termination shall not
affect the provision of benefits on account of a termination of employment
occurring prior to the termination of the terms of this Agreement.
<PAGE>
2. Change of Control.
-----------------
(a) Termination Following A Change of Control. Subject to Sections 4
-----------------------------------------
and 5 below, if the Employee's employment with the Company is terminated at any
time within one (1) year after a Change of Control, then the Employee shall be
entitled to receive severance benefits as follows:
(i) Voluntary Resignation. If the Employee voluntarily resigns
---------------------
from the Company (other than as an Involuntary Termination (as defined below) or
if the Company terminates the Employee's employment for Cause (as defined
below)), then the Employee shall not be entitled to receive severance payments.
The Employee's benefits will be terminated under the Company's then existing
benefit plans and policies in accordance with such plans and policies in effect
on the date of termination or as otherwise determined by the Board of Directors
of the Company.
(ii) Involuntary Termination and Certain Voluntary Terminations.
----------------------------------------------------------
If the Employee's employment is terminated as a result of an Involuntary
Termination other than for Cause, each stock option to purchase the Company's
Common Stock granted to Employee over the course of his or her employment with
the Company and held by Employee on the date of termination of employment shall
become immediately vested on such date as to that number of shares that would
have vested in accordance with the terms of such option (assuming that Employee
had remained in Continuous Status as an Employee, as defined in the relevant
plan and option agreement) for:
(x) 2 years after the date of Change of Control if Employee
had been employed by the Company for at least two (2) years as of the Change of
Control, or
(y) one (1) year after the date of Change of Control if
Employee had been so employed for less than two (2) years as of the Change of
Control.
Each such option shall be exercisable in accordance with the provisions of the
option agreement and plan pursuant to which such option was granted.
(iii) Involuntary Termination for Cause. If the Employee's
---------------------------------
employment is terminated for Cause, then the Employee shall not be entitled to
receive severance benefits. The Employee's benefits will be terminated under
the Company's then existing benefit plans and policies in accordance with such
plans and policies in effect on the date of termination.
(b) Termination Apart from A Change of Control. In the event the
------------------------------------------
Employee's employment terminates for any reason, either prior to the occurrence
of a Change of Control or after one year period following the effective date of
a Change of Control, then the Employee shall not be entitled to receive any
severance benefits under this Agreement. The Employee's benefits will be
terminated under the terms of the Company's then existing benefit plans and
policies in accordance with such plans and policies in effect on the date of
termination or as otherwise determined by the Board of Directors of the
Company.
3. Definition of Terms. The following terms referred to in this
-------------------
Agreement shall have the following meanings:
(a) Change of Control. "Change of Control" shall mean the occurrence
-----------------
of any of the following events:
(i) Ownership. Any "Person" (as such term is used in Sections
---------
13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) is or
becomes the "Beneficial Owner" (as defined in Rule 13d-3 under said Act),
directly or indirectly, of securities of the Company representing forty percent
(40%) or more of the total voting power represented by the Company's then
outstanding voting securities without the approval of the Board of Directors of
the Company;
<PAGE>
(ii) Merger/Sale of Assets. A merger or consolidation of the
---------------------
Company whether or not approved by the Board of Directors of the Company, other
than a merger or consolidation which would result in the voting securities of
the Company outstanding immediately prior thereto continuing to represent
(either by remaining outstanding or by being converted into voting securities of
the surviving entity) at least fifty percent (50%) of the total voting power
represented by the voting securities of the Company or such surviving entity
outstanding immediately after such merger or consolidation, or the shareholders
of the Company approve a plan of complete liquidation of the Company or an
agreement for the sale or disposition by the Company of all or substantially all
of the Company's assets; or
(iii) Change in Board Composition. A change in the composition
---------------------------
of the Board of Directors of the Company, as a result of which fewer than a
majority of the directors are Incumbent Directors. "Incumbent Directors" shall
mean directors who either (A) are directors of the Company as of December 31,
1997 or (B) are elected, or nominated for election, to the Board of Directors of
the Company with the affirmative votes of at least a majority of the Incumbent
Directors at the time of such election or nomination (but shall not include an
individual whose election or nomination is in connection with an actual or
threatened proxy contest relating to the election of directors to the Company).
(b) Cause. "Cause" shall mean (i) gross negligence or willful
-----
misconduct in the performance of the Employee's duties to the Company where such
gross negligence or willful misconduct has resulted or is likely to result in
substantial and material damage to the Company or its subsidiaries, (ii)
repeated unexplained or unjustified absence from the Company, (iii) a material
and willful violation of any federal or state law; (iv) commission of any act of
fraud with respect to the Company; or (v) conviction of a felony or a crime
involving moral turpitude causing material harm to the standing and reputation
of the Company, in each case as determined in good faith by the Board of
Directors of the Company.
(c) Involuntary Termination. "Involuntary Termination" shall include
-----------------------
any termination by the Company other than for Cause and the Employee's voluntary
termination, upon 30 days prior written notice to the Company, following (i) a
material reduction or change in job duties, responsibilities and requirements
inconsistent with the Employee's position with the Company and the Employee's
prior duties, responsibilities and requirements, taking into account the
differences in job title and duties that are normally occasioned by reason of an
acquisition of one company by another and that do not actually result in a
material change in duties, responsibilities and requirements inconsistent with
an employee's prior position with the acquired company; (ii) any reduction of
the Employee's base and cash bonus compensation (other than in connection with a
general decrease in base salaries for most similarly situated employees of the
successor corporation); or (iii) the Employee's refusal to relocate to a
location more than 50 miles from the Company's current location.
4. Limitation on Payments.
----------------------
(a) In the event that the severance benefits provided for in this
Agreement to the Employee (i) constitute "parachute payments" within the meaning
of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code")
and (ii) but for this Section, would be subject to the excise tax imposed by
Section 4999 of the Code, then the Employee's benefits under Section 2 shall be
payable either: (i) in full, or (ii) as to such lesser amount which would
result in no portion of such severance benefits being subject to excise tax
under Section 4999 of the Code, whichever of the foregoing amounts, taking into
account the applicable federal, state and local income taxes and the excise tax
imposed by Section 4999, results in the receipt by the Employee on an after-tax
basis, of the greatest amount of benefits under Section 2, notwithstanding that
all or some portion of such benefits may be taxable under Section 4999 of the
Code. Unless the Company and the Employee otherwise agree in writing, any
determination required under this Section 4 shall be made in writing by the
Company's independent public accountants (the "Accountants"), whose
determination shall be conclusive and binding upon the Employee and the Company
for all purposes. For purposes of making the calculations required by this
Section 4, the Accountants may make reasonable assumptions and approximations
concerning applicable taxes and may rely on reasonable, good faith
interpretations concerning the application of Section 280G and 4999 of the Code.
The Company and the Employee shall furnish to the Accountants such information
and documents as the Accountants may reasonably request in order to make a
determination under this Section. The Company shall bear all costs the
Accountants may reasonably incur in connection with any calculations
contemplated by this Section 4.
<PAGE>
(b) The payment of severance benefits provided for in this Agreement
shall be subject to all applicable income, employment and social tax rules and
regulations.
5. Certain Business Combinations. In the event it is determined by the
-----------------------------
Board, upon consultation with Company management and the Company's independent
auditors, that the enforcement of any Section of this Agreement, including, but
not limited to, Section 2 hereof, which allows for the acceleration of vesting
of Option shares upon an involuntary termination of Employee's employment
following the effective date of a Change of Control, would preclude accounting
for any proposed business combination of the Company involving a Change of
Control as a pooling of interests, and the Board otherwise desires to approve
such a proposed business transaction which requires as a condition to the
closing of such transaction that it be accounted for as a pooling of interests,
then any such Section of this Agreement shall be null and void. For purposes of
this Section 5, the Board's determination shall require the unanimous approval
of the non-employee Board members.
6. Successors. Any successor to the Company (whether direct or indirect
----------
and whether by purchase, lease, merger, consolidation, liquidation or otherwise)
to all or substantially all of the Company's business and/or assets shall assume
the obligations under this Agreement and agree expressly to perform the
obligations under this Agreement in the same manner and to the same extent as
the Company would be required to perform such obligations in the absence of a
succession. The terms of this Agreement and all of the Employee's rights
hereunder shall inure to the benefit of, and be enforceable by, the Employee's
personal or legal representatives, executors, administrators, successors, heirs,
distributees, devisees and legatees.
7. Notice. Notices and all other communications contemplated by this
------
Agreement shall be in writing and shall be deemed to have been duly given when
personally delivered or when mailed by U.S. registered or certified mail, return
receipt requested and postage prepaid. Mailed notices to the Employee shall be
addressed to the Employee at the home address which the Employee most recently
communicated to the Company in writing. In the case of the Company, mailed
notices shall be addressed to its corporate headquarters, and all notices shall
be directed to the attention of its Secretary.
8. Miscellaneous Provisions.
------------------------
(a) No Duty to Mitigate. The Employee shall not be required to
-------------------
mitigate the amount of any payment contemplated by this Agreement (whether by
seeking new employment or in any other manner), nor, except as otherwise
provided in this Agreement, shall any such payment be reduced by any earnings
that the Employee may receive from any other source.
(b) Waiver. No provision of this Agreement shall be modified, waived
------
or discharged unless the modification, waiver or discharge is agreed to in
writing and signed by the Employee and by an authorized officer of the Company
(other than the Employee). No waiver by either party of any breach of, or of
compliance with, any condition or provision of this Agreement by the other party
shall be considered a waiver of any other condition or provision or of the same
condition or provision at another time.
(c) Whole Agreement. No agreements, representations or understandings
---------------
(whether oral or written and whether express or implied) which are not expressly
set forth in this Agreement have been made or entered into by either party with
respect to the subject matter hereof. This Agreement supersedes any agreement
of the same title and concerning similar subject matter dated prior to the date
of this Agreement, and by execution of this Agreement both parties agree that
any such predecessor agreement shall be deemed null and void.
(d) Choice of Law. The validity, interpretation, construction and
-------------
performance of this Agreement shall be governed by the laws of the State of
California without reference to conflict of laws provisions.
(e) Severability. If any term or provision of this Agreement or the
------------
application thereof to any circumstance shall, in any jurisdiction and to any
extent, be invalid or unenforceable, such term or provision shall be ineffective
as to such jurisdiction to the extent of such invalidity or unenforceability
without invalidating or rendering unenforceable the remaining terms and
provisions of this Agreement or the application of such terms and provisions to
circumstances other than those as to which it is held invalid or unenforceable,
and a suitable and
<PAGE>
equitable term or provision shall be substituted therefor to carry out, insofar
as may be valid and enforceable, the intent and purpose of the invalid or
unenforceable term or provision.
(f) Arbitration. Any dispute or controversy arising under or in
-----------
connection with this Agreement may be settled at the option of either party by
binding arbitration in the County of Ventura, California, in accordance with the
rules of the American Arbitration Association then in effect. Judgment may be
entered on the arbitrator's award in any court having jurisdiction. Punitive
damages shall not be awarded.
(g) Legal Fees and Expenses. The parties shall each bear their own
-----------------------
expenses, legal fees and other fees incurred in connection with this Agreement.
(h) No Assignment of Benefits. The rights of any person to payments
-------------------------
or benefits under this Agreement shall not be made subject to option or
assignment, either by voluntary or involuntary assignment or by operation of
law, including (without limitation) bankruptcy, garnishment, attachment or other
creditor's process, and any action in violation of this subsection (h) shall be
void.
(i) Employment Taxes. All payments made pursuant to this Agreement
----------------
will be subject to withholding of applicable income and employment taxes.
(j) Assignment by Company. The Company may assign its rights under
---------------------
this Agreement to an affiliate, and an affiliate may assign its rights under
this Agreement to another affiliate of the Company or to the Company; provided,
however, that no assignment shall be made if the net worth of the assignee is
less than the net worth of the Company at the time of assignment. In the case
of any such assignment, the term "Company" when used in a section of this
Agreement shall mean the corporation that actually employs the Employee.
(k) Counterparts. This Agreement may be executed in counterparts,
------------
each of which shall be deemed an original, but all of which together will
constitute one and the same instrument.
<PAGE>
IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the
case of the Company by its duly authorized officer, as of the day and year first
above written.
XYLAN CORPORATION EMPLOYEE
BY: ____________________________ _____________________________
TITLE: _________________________
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Xylan Corporation:
We consent to incorporation by reference in the registration statement (No.
333-3944) on Form S-8 of Xylan Corporation of our report dated January 21, 1998
relating to the consolidated balance sheets of Xylan Corporation and
subsidiaries as of December 31, 1997, and 1996, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
years in the three-year period ended December 31, 1997, and related schedule,
which report appears in the December 31, 1997, annual report on Form 10-K of
Xylan Corporation.
/s/ KPMG PEAT MARWICK LLP
Los Angeles, California
March 27, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 35,917
<SECURITIES> 43,171
<RECEIVABLES> 61,715
<ALLOWANCES> 1,202
<INVENTORY> 17,731
<CURRENT-ASSETS> 158,824
<PP&E> 33,403
<DEPRECIATION> 12,509
<TOTAL-ASSETS> 250,906
<CURRENT-LIABILITIES> 33,890
<BONDS> 0
0
0
<COMMON> 43
<OTHER-SE> 216,057
<TOTAL-LIABILITY-AND-EQUITY> 250,906
<SALES> 210,849
<TOTAL-REVENUES> 210,849
<CGS> 92,551
<TOTAL-COSTS> 92,551
<OTHER-EXPENSES> 93,244
<LOSS-PROVISION> 1,293
<INTEREST-EXPENSE> 33
<INCOME-PRETAX> 31,748
<INCOME-TAX> 7,621
<INCOME-CONTINUING> 24,127
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 24,127
<EPS-PRIMARY> .57
<EPS-DILUTED> .52
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<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 34,572
<SECURITIES> 44,463
<RECEIVABLES> 50,598
<ALLOWANCES> 270
<INVENTORY> 11,371
<CURRENT-ASSETS> 143,218
<PP&E> 30,201
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<TOTAL-ASSETS> 235,581
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0
0
<COMMON> 73
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<TOTAL-LIABILITY-AND-EQUITY> 235,581
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<TOTAL-REVENUES> 146,647
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<TOTAL-COSTS> 64,636
<OTHER-EXPENSES> 65,566
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 26
<INCOME-PRETAX> 21,635
<INCOME-TAX> 4,070
<INCOME-CONTINUING> 17,565
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<NET-INCOME> 17,565
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<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 62,463
<SECURITIES> 34,346
<RECEIVABLES> 45,180
<ALLOWANCES> 270
<INVENTORY> 15,300
<CURRENT-ASSETS> 159,943
<PP&E> 26,826
<DEPRECIATION> 7,957
<TOTAL-ASSETS> 230,433
<CURRENT-LIABILITIES> 27,257
<BONDS> 0
0
0
<COMMON> 43
<OTHER-SE> 201,851
<TOTAL-LIABILITY-AND-EQUITY> 230,433
<SALES> 93,130
<TOTAL-REVENUES> 93,130
<CGS> 40,918
<TOTAL-COSTS> 40,918
<OTHER-EXPENSES> 41,309
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 21
<INCOME-PRETAX> 14,543
<INCOME-TAX> 1,585
<INCOME-CONTINUING> 12,958
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 12,958
<EPS-PRIMARY> 0.31
<EPS-DILUTED> 0.28
</TABLE>
<TABLE> <S> <C>
<PAGE>
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<RESTATED>
<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> 43,290
<ALLOWANCES> 270
<INVENTORY> 8,299
<CURRENT-ASSETS> 152,284
<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> 48,008
<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> .14
<EPS-DILUTED> .13
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 62,483
<SECURITIES> 50,498
<RECEIVABLES> 33,226
<ALLOWANCES> 270
<INVENTORY> 11,578
<CURRENT-ASSETS> 155,528
<PP&E> 21,297
<DEPRECIATION> 4,632
<TOTAL-ASSETS> 207,251
<CURRENT-LIABILITIES> 20,913
<BONDS> 0
0
0
<COMMON> 42
<OTHER-SE> 185,596
<TOTAL-LIABILITY-AND-EQUITY> 207,251
<SALES> 128,456
<TOTAL-REVENUES> 128,456
<CGS> 57,830
<TOTAL-COSTS> 57,830
<OTHER-EXPENSES> 52,810
<LOSS-PROVISION> 35
<INTEREST-EXPENSE> 97
<INCOME-PRETAX> 23,056
<INCOME-TAX> 7,811
<INCOME-CONTINUING> 15,245
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,245
<EPS-PRIMARY> .43
<EPS-DILUTED> .33
</TABLE>
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<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 54,634
<SECURITIES> 60,666
<RECEIVABLES> 30,216
<ALLOWANCES> 516
<INVENTORY> 10,774
<CURRENT-ASSETS> 157,774
<PP&E> 16,074
<DEPRECIATION> 3,334
<TOTAL-ASSETS> 192,332
<CURRENT-LIABILITIES> 16,056
<BONDS> 0
0
0
<COMMON> 41
<OTHER-SE> 175,380
<TOTAL-LIABILITY-AND-EQUITY> 192,332
<SALES> 87,004
<TOTAL-REVENUES> 87,004
<CGS> 39,952
<TOTAL-COSTS> 39,952
<OTHER-EXPENSES> 35,453
<LOSS-PROVISION> 226
<INTEREST-EXPENSE> 96
<INCOME-PRETAX> 14,958
<INCOME-TAX> 4,744
<INCOME-CONTINUING> 10,214
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,214
<EPS-PRIMARY> 0.30
<EPS-DILUTED> 0.22
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<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> 21,116
<ALLOWANCES> 394
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