10-Q 1 e10-q.txt FORM 10-Q 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission file number : 000-23023 MMC NETWORKS, INC. (Exact name of registrant as specified in its charter) ~~Delaware 77-0319809 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization)~~

1144 E. Arques Avenue Sunnyvale, CA 94085 (Address of principal offices) (zip code) (408) 731-1600 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The number of shares outstanding of the issuer's common stock as of June 30, 2000 was 32,848,357. ================================================================================ 2 MMC NETWORKS, INC. QUARTERLY REPORT ON FORM 10-Q INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets at June 30, 2000 and December 31, 1999 ........................................... 3 Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2000 and 1999 ..................... 4 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2000 and 1999 ......................... 5 Notes to the Condensed Consolidated Financial Statements ........ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ....................................... 9 Item 3. Quantitative and Qualitative Disclosures About Market Risk ...... 17 PART II. OTHER INFORMATION Item 1. Legal Proceedings ............................................... 19 Item 2. Changes in Securities and Use of Proceeds ....................... 19 Item 3. Defaults Upon Senior Notes ...................................... 19 Item 4. Submission of Matters to a Vote of Security Holders ............. 19 Item 5. Other Information ............................................... 19 Item 6. Exhibits and Reports on Form 8-K ................................ 19 SIGNATURES ..................................................................... 20

2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MMC NETWORKS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated financial statements. 3 4 MMC NETWORKS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated financial statements. 4 5 MMC NETWORKS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (IN THOUSANDS) (UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated financial statements. 5 6 MMC NETWORKS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The accompanying condensed consolidated financial statements and notes to the condensed consolidated financial statements of MMC Networks, Inc. ("MMC") are unaudited. In the opinion of management, these statements and notes have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial position, results of operations and cash flows for MMC for the periods presented. Results for the interim periods presented are not necessarily indicative of results for the entire year. The words "we", "us" and "our" used in this report refer to MMC Networks, Inc. The accompanying condensed consolidated financial statements and notes do not include certain information and footnote disclosures normally required under generally accepted accounting principles. Therefore, these condensed consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1999. NOTE 2 - EARNINGS PER SHARE The computations of basic and diluted earnings per share for the periods presented are as follows:

6 7 MMC NETWORKS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 3 - COMPOSITION OF INVENTORIES

NOTE 4 - FINANCING AGREEMENTS AND OTHER COMMITMENTS The Company maintains a loan agreement with a bank that allows the Company to borrow up to $10.0 million. Borrowings bear interest at the bank's prime interest rate, which was 9.5% at June 30, 2000. The agreement requires that we comply with certain financial covenants. In the event of default, all outstanding borrowings will accrue interest at a rate of five percentage points above the rate effective immediately prior to a default. There have been no borrowings against the loan agreement since its inception in 1998. The loan agreement expires in May 2001. During 1999, the Company entered into an agreement with a software vendor. Under this agreement, the Company committed to pay $3.8 million over 3 years beginning April 1999 in exchange for the use of certain design software. As of June 30, 2000, $2.4 million remains outstanding under this commitment. NOTE 5 - RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS 133,"Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes new standards of accounting and reporting for derivative instruments and hedging activities. It requires that all derivatives be recognized at fair value in the statement of financial position, and that the corresponding gains and losses be reported either in the statement of operations or as a component of comprehensive income (loss), depending on the type of hedging relationship that exists. In July 1999, the FASB issued SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133." SFAS 137 deferred the effective date of SFAS 133 until fiscal years beginning after June 15, 2000. Management does not believe that the adoption of SFAS 133 will have a material impact on its reported operations or financial position. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB) No. 101, "Revenue Recognition in Financial Statements," which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. On June 26, 2000, the SEC issued SAB 101B to provide registrants with additional time to implement guidance contained in SAB 101. SAB 101B delays the implementation date of SAB 101 until no later than the Company's fourth fiscal quarter of fiscal 2000. In various areas, 7 8 MMC NETWORKS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 - RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED) including revenue recognition, accounting standards and practices continue to evolve. Additionally, the SEC is preparing to issue interpretative guidance relating to SAB 101, and the FASB's Emerging Issues Task Force continues to address revenue related accounting issues. The management of the Company believes it is in compliance with all of the rules and related guidance as they currently exist. However, any changes to generally accepted accounting principles in these areas could impact the Company's future accounting for its operations. In March 2000, the Financial Accounting Standard Board issued Interpretation No. 44 ("FIN 44") "Accounting for Certain Transactions Involving Stock Compensation", an interpretation of APB Opinion No. 25 ("APB 25"). FIN 44 clarifies the application of APB 25 for: a) the definition of "employee" for the purposes of applying APB 25, b) the criteria for determining whether a plan qualifies as a non-compensatory plan, c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998 or January 12, 2000. We believe that the impact of FIN 44 will not have a material effect on our financial position or results of operations of the Company. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with: (1) the interim condensed consolidated financial statements and the notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q and (2) the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 1999. This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements which reflect our current views with respect to future events which may impact our results of operations and financial condition. In this report, the words "anticipate", "believe", "expect", "intend" and similar expressions identify forward-looking statements. These forward-looking statements are subject to risks and uncertainties and other factors, including those described below under the caption "Factors Affecting Future Results", which could cause our actual future results to differ materially from historical results or from those described in the forward-looking statements. We urge readers not to place undue reliance on these forward-looking statements, which reflect our outlook only as of the date of this report. BACKGROUND MMC Networks, Inc. (the "Company" or "MMC ") is a leading developer and supplier of Network Processing Platforms, including both Network Processors and Switch Fabrics, that allow network equipment vendors to more rapidly develop high-performance, feature-rich, cost-effective products supporting a broad range of networking functions. Network Processors are high-performance, software-programmable processors optimized for networking and communications applications. Switch Fabrics are high-capacity, software-configurable devices that provide central, high-speed interconnections among multiple processors or other devices. MMC's Network Processors and Switch Fabrics form the core silicon "engines" of WAN and LAN products for both Service Provider and Enterprise networks. The Company's AnyFlow(TM) family of products includes the MMC nP(TM) family of Network Processors, the nPX(TM) family of Switch Fabrics, and the nPC family of Coprocessors and Connectivity Components. MMC Networks also offers and markets nP Design Services(TM), which include hardware and software design consulting in addition to training and traditional support services. The Company believes that network equipment vendors are able to reduce design and development costs and accelerate product development cycles for high-performance routers and switches by using the Company's products and services. The Company's products employ its proprietary nPcore(TM) network-optimized RISC processor core and its ViX(TM) interconnect architecture. These enable network equipment vendors to implement high-performance, value-added features in their switch and router products. MMC Networks' customers use the Company's Network Processor Platforms to develop and market multi-gigabit, wire-speed, policy-enabled, Layer 2-7 WAN and LAN switches and routers; wireless, cable, and dial-up access and aggregation platforms; Web switching; optical switching; security and firewall devices; Virtual Private Network (VPN) systems; Voice Over IP (VoIP) switching; ATM switches; and other communications platforms. The Company was incorporated in California in September 1992 and reincorporated in Delaware in October 1997. The Company's principal executive offices are located at 1144 East Arques Avenue, Sunnyvale, California 94085, and its telephone number is (408) 731-1600. 9 10 RESULTS OF OPERATIONS The following table shows certain statement of operations data expressed as a percentage of our revenues.

Revenues. Revenues increased during the second quarter of 2000 by $4.4 million in comparison to revenues for the first quarter of 2000 of $12.6 million. Revenues decreased to $17.0 million for the three months ended June 30, 2000 from $19.3 million for the three months ended June 30, 1999. Revenues decreased to $29.7 million for the six months ended June 30, 2000 from $35.4 million for the same period in 1999. The decreases in second quarter revenues and first half revenues in 2000 compared to the same periods in 1999 are primarily due to two events. First, IBM, which accounted for 23% of revenues in the second quarter of 1999, announced during the third quarter of 1999 that it was closing down most of its network equipment business and informed MMC that it was ceasing the manufacture and sale of its network equipment products, which use MMC products. Revenues to IBM were zero in the first and second quarters of 2000. Second, Cisco Systems, our largest customer in the six months ended June 30, 1999 at 52% of revenues, decreased its purchases from MMC during the fourth quarter of 1999 and the first half of 2000, as it terminated a large program and decreased purchases while it consumed inventory already purchased. Revenues from Cisco were 45% of total revenues in the fourth quarter of 1999, 35% in the first quarter of 2000 and 25% in the second quarter of 2000. These revenues from Cisco exclude revenues from ArrowPoint Communications, which Cisco acquired on June 23, 2000. Decreases in revenues from IBM and Cisco were partially offset by increases in revenues from other customers. Revenues from ArrowPoint Communications increased to 8% of revenues in the first quarter of 2000 and 20% in the second quarter of 2000, up from under 5% in the fourth quarter of 1999. Revenues from Nortel Networks increased to 24% of revenues in the first quarter of 2000 and 23% of revenues in the second quarter of 2000, up from 18% in the fourth quarter of 1999. Revenues from Fujitsu increased to 11% of revenues in the first quarter of 2000 and 13% in the second quarter of 2000, up from under 5% in the fourth quarter of 1999. The Company may experience substantial period-to-period fluctuations in future operating results due to changes in demand for its products or due to the continued average sales price erosion that characterizes the data networking and semiconductor industries. 10 11 Cost of Revenues; Gross Profit. Cost of revenues decreased to $5.0 million for the three months ended June 30, 2000 from $5.7 million for the three months ended June 30, 1999. Cost of revenues also decreased to $8.9 million for the first half of 2000 from $10.5 million for the same period in 1999. Decreased cost of revenues in both periods resulted from decreased unit shipments. Gross margin was 70.6% for the three months ended June 30, 2000, compared to 70.7% for the three months ended June 30, 1999. Gross margin for the six months ended June 30, 2000 was 70.1%, compared to 70.4% for the same period in 1999. We anticipate that gross margins will remain in the same range during the remainder of 2000. Research and Development Expense. Research and development expenses increased to $7.9 million for the three months ended June 30, 2000 from $5.3 million for the three months ended June 30, 1999. These expenses also increased to $15.1 million for the six months ended June 30, 2000 from $9.7 million during the same period in 1999. The increases in both 2000 periods are due primarily to increased new product development activity. As a percentage of total revenues, research and development expenses increased to 46.5% during the second quarter of 2000 from 27.2% during the same period in 1999, increased to 50.8% during the first half of 2000 from 27.4% in the same period in 1999 due to the continued increase in research and development activity and the decrease in revenue from period to period. In 2000, we expect research and development expenses to continue to increase in absolute dollars, but to increase at a lower percentage rate than the expected rate of increase in revenues. Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $3.7 million for the three months ended June 30, 2000 from $2.7 million for the three months ended June 30, 1999. These expenses also increased to $6.9 million for the six months ended June 30, 2000 from $5.1 million during the same period in 1999. The increases in both 2000 periods are due to increased headcount in selling, general and administrative functions and increased sales support functions. As a percentage of total revenues, selling, general and administrative expenses increased to 21.9% for the three months ended June 30, 2000 from 13.9% for the three months ended June 30, 1999. They also increased to 23.4% during the first half of 2000 from 14.3% in the same period in 1999. The increases in both 2000 periods are due to increased headcount in selling, general and administrative functions and increased sales support functions, and the decrease in revenue from period to period. In 2000, we expect selling, general and administrative expenses to continue to increase in absolute dollars, but to increase at a lower percentage rate than the expected rate of increase in revenues. Interest income, net. Interest income, net increased to $1.1 million for the three months ended June 30, 2000 from $691,000 for the three months ended June 30, 1999. Interest income, net increased to $2.1 million for the six months ended June 30, 2000 from $1.3 million during the same period in 1999. Interest income, net consists of interest income, which is interest earned on average cash, cash equivalents and short-term investments, offset by interest expense. Interest income, net consisted primarily of interest income for the periods presented. The increases in interest income, net are due to increased cash and investment balances provided by cash flow from operations and the exercise of stock options. Provision for Income Taxes. The provision for income taxes decreased to $453,000 for the three months ended June 30, 2000 from $2.3 million for the three months ended June 30, 1999, reflecting effective tax rates of 32% and 36%, respectively. The provision for income taxes decreased to $264,000 for the first half of 2000 from $4.1 million during the same period in 1999. The decrease in the provision for income taxes during both periods is due to the decrease in income before taxes and the decrease in the effective tax rate. The decrease in the effective tax rate is due to increased research and development tax credits and an anticipated increase in operations in Israel, where we have qualified for certain low rates of taxation. The Company expects its effective tax rate to remain at about 32% during 2000. 11 12 LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2000, the Company had cash, cash equivalents and short-term investments of $74.2 million compared to $72.0 million at December 31, 1999, an increase of $2.2 million. As of June 30, 2000, the Company had cash and cash equivalents of $40.7 million, up from $13.5 million at December 31, 1999. This $27.3 million increase in cash and cash equivalents was due to cash flows from operating activities of $2.1 million, $19.6 million in investing activities primarily from the sale of short-term investments and $5.6 million in financing activities from the exercise of stock options. Cash was used to acquire property and equipment of $4.2 million during the first half of 2000. During April 2000, we invested $1.0 million in a software development company in exchange for a debenture, convertible into common stock of the company. The Company maintains a $10.0 million credit facility with a bank, which expires in May 2001. Borrowings bear interest at the bank's prime rate. Our agreement with the bank requires compliance with certain financial covenants. In the event of default, all outstanding borrowings will accrue interest at a rate of five percentage points above the rate effective immediately prior to the default. The credit facility has not been used since its inception in 1998. We anticipate that a significant portion of future capital expenditures will be devoted to investment in design tool software and computer equipment on which the design software tools run. We believe that our existing cash balances together with the borrowing capacity under our credit facility and cash flow from future operations will be sufficient to meet our capital requirements through the next twelve months. It is possible that the Company could be required, or could elect, to seek to raise additional capital before such time. This is a forward-looking statement, and the actual period of time for which our resources will be sufficient will depend on many factors, including: - the rate of revenue growth, if any - the timing and extent of spending to support product development efforts - the expansion of sales and marketing efforts - the timing and size of business or technology acquisitions - the timing of introductions of new products and enhancements to existing products - 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. FACTORS AFFECTING FUTURE RESULTS As described by the following factors, past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. FLUCTUATIONS IN OPERATING RESULTS. The Company's revenues and expenses have fluctuated significantly in the past and may continue to do so in the future. For example, revenues in the fourth quarter of 1999 fell to $11.6 million from $23.1 million in the previous quarter, resulting in a decrease in net income from $4.9 million to a loss of $427,000. Two events caused this decrease. First, IBM, one of our major customers, announced it was closing down most of its network equipment business and informed MMC that it was ceasing the manufacture and sale of its network equipment products that use MMC products. Second, Cisco, our largest customer in the first three quarters of 1999, decreased its 12 13 purchases from MMC in the fourth quarter of 1999 and the first half of 2000 as it terminated a large program and decreased purchases while it consumed inventory already purchased. Such fluctuations in operating results can be caused by a variety of factors, many of which are outside our control. Factors that could affect our future operating results include: - the loss of or a reduction in sales to major customers - changes in demand for the network equipment products of our customers - variations, delays or cancellations of orders and/or shipments of our products - reduction in the selling prices of our products - changes in the mix of products being sold - fluctuations in our manufacturing yields and other potential problems or delays in the fabrication, assembly, testing or delivery of our products - failure to manufacture and ship our products on time - increases in the costs of products from our suppliers - availability of semiconductor foundry capacity - external events causing disruption of fabrication activities - fluctuations in product life cycles - delays in introducing new products - introduction of new products by our competitors - variances in the timing and amount of non-recurring engineering funding and operating expenses - intellectual property disputes A large portion of our operating expenses, including salaries, rent and software time license expenses, is fixed and difficult to reduce or change on short notice. Accordingly, if our total revenues do not meet our expectations, we may not be able to adjust our expenses quickly enough to compensate for the shortfall in revenues. This situation could have a negative effect on our business, financial condition and results of operations. CUSTOMER CONCENTRATION. A relatively small number of major network equipment vendors dominate the network equipment market. Accordingly, a small number of customers has accounted for a large portion of our revenues to date. We expect the Company to continue to be dependent on a small number of customers for the majority of its sales. For example, in the second quarter of 2000 Cisco Systems accounted for 25%, ArrowPoint Communications (which Cisco acquired on June 23, 2000) accounted for 20% and Nortel Networks accounted for 23% of our revenues. This subjects the Company and its financial results to particular risks, including the loss of or reduction in sales to these customers, as occurred in the fourth quarter of 1999 when IBM informed the Company that it was ceasing the manufacture and sale of its network equipment products that use our products. If MMC loses other significant customers or if sales to these customers decrease, future financial results would suffer. It is important to note that our ability to maintain or increase sales to key customers and/or attract new significant customers is subject to a variety of factors, including: 13 14 - our network equipment vendor customers may stop incorporating our products into their own products with limited notice to us and suffer little or no penalty - the introduction of one of our customer's significant new products may be late or less successful in the market than planned - a significant customer's product line using our products may rapidly decline or be phased out - our significant customers may not incorporate our Network Processors in their future product designs - design wins with customers may not result in significant sales to such customers - our agreements with our customers typically do not require them to purchase a minimum amount of our products - many of our customers have pre-existing relationships with our current or potential competitors that may cause them to switch from our products to competing products - we may not be able to successfully develop relationships with additional significant network equipment vendors - our relationship with some of our larger customers may deter other potential customers (who compete with these customers) from buying our products Any one of the factors above could have a material adverse effect on our business, financial condition and results of operation. DEPENDENCE UPON DEVELOPMENT OF THE MARKET FOR NETWORK PROCESSORS. Many of the Company's current and potential customers have substantial technological capabilities and financial resources. They traditionally use these resources to internally develop the Application-Specific Integrated Circuit ("ASIC") components and program the general purpose processors utilized in their products. The Company's future prospects are dependent upon our customers acceptance of network processors as an alternative to ASIC components and general-purpose processors. Future prospects are also dependent upon acceptance of third party sourcing for network processors as an alternative to in-house development. Network equipment vendors may in the future continue to use internally-developed ASIC components and general-purpose processors. They may also decide to develop or acquire components, technologies or network processors that are similar to, or that may be substituted for, the Company's products. The Company must anticipate market trends and the price, performance and functionality requirements of its customers. It must also successfully develop and manufacture products that meet these requirements. The products must be available to customers on a timely basis and at competitive prices. If the Company's network equipment vendor customers fail to accept network processors as an alternative, if they develop or acquire the technology to develop such components internally rather than purchase the Company's products, or if the Company is otherwise unable to develop strong relationships with network equipment vendors, the Company's business, financial condition and results of operations would be materially and adversely affected. LIMITED OPERATING HISTORY AS A PUBLIC COMPANY; NO ASSURANCE OF FUTURE Profitability. Although the Company experienced significant revenue growth in recent years and achieved profitability in each of the last four years through December 31, 1999, these results do not presume profitability and should not be considered indicative of future performance. For example, we recorded a net loss of $400,000 during the three month period ended March 31, 2000. There also is no assurance that the Company will be profitable in any future period. 14 15 Due to anticipated increases in the Company's operating expenses, the Company's operating results will be adversely affected if the Company's revenues do not continue to increase. The sales cycle for the Company's products can range from three to six months or more. There is also an additional nine to 24 months or more before a network equipment vendor customer commences volume production of equipment that incorporates the Company's products. As a result, there may be a significant delay between an increase in research and development and sales and marketing expenses and the generation of higher revenues, if any, from such expenditures. To remain profitable, 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 - continue to commercialize products incorporating innovative technologies. There can be no assurance that the Company will be successful in doing so. EROSION OF AVERAGE SELLING PRICES. The data networking and semiconductor industries have experienced rapid erosion of average selling prices ("ASPs") due to a number of factors, including rapid technological change, price/performance enhancements and product obsolescence. The Company may experience substantial period-to-period fluctuations in future operating results due to continued ASP erosion. The Company anticipates that ASPs will decrease in the future in response to product introductions by competitors or new product introductions by MMC. Other factors impacting ASPs also include price pressures from significant customers. In particular, the market for Ethernet switching and routing components has experienced, and is expected to continue to experience, significant ASP erosion. Therefore, the Company must continue to develop and introduce, on a timely basis, new products that incorporate features that can be sold at higher ASPs or provide a reduced cost per function. Failure to achieve any or all of the factors that have been mentioned could cause the Company's revenues and gross margins to decline, which would have a material adverse effect on the Company's business, financial condition and results of operations. NEW PRODUCT DEVELOPMENT AND TECHNOLOGICAL CHANGE. The data networking and semiconductor industries are characterized by rapidly changing technology, frequent product introductions and evolving industry standards. The technical innovations required for MMC to remain competitive must be completed before developments in networking technologies or standards make them obsolete. These innovations must also be compelling enough to make network equipment vendors want to use them over other technologies. Accordingly, our future performance depends on a number of factors, including our ability to: - properly identify target markets - identify emerging technological trends in our target markets - develop and maintain competitive products - enhance our products by adding innovative features that differentiate MMC products from competitors' products - bring products to market on a timely basis at competitive prices - respond effectively to new technological changes or new product announcements by others 15 16 It is possible that our design and introduction schedules for future products and additions and enhancements to our existing products will not be met. It is possible that these products will not achieve market acceptance or that we will not be able to sell these products at prices that are favorable to us. We must design new products and sometimes redesign existing products to be manufactured on newer wafer process technologies that provide smaller circuit dimensions. It is possible that either (1) the suppliers of these new manufacturing technologies will not deliver them to us or our vendors on schedule or (2) we will not be able to complete our designs on the new processes on schedule. Our success will also depend on the ability of our customers to develop new products and enhance existing products within our market segment and to successfully introduce and promote those products. To keep pace with the rapid technological changes, we must incur substantial research and development costs before we can determine the likelihood that the technology for a product is sound and that our network equipment vendors will accept the product. It is possible that revenues from future products or product enhancements will not be sufficient to recover the development costs associated with those products or enhancements. It is possible that we may not be able to obtain additional financing necessary to fund future development efforts. Our failure to adequately address any of the factors above could have a negative impact on our business, financial condition and results of operations. DEPENDENCE ON INDEPENDENT MANUFACTURERS. We depend on independent foundries to manufacture all of our products. We purchase both (1) fully assembled and tested products which we can immediately resell to our customers and (2) finished silicon wafers which we then consign to third party subcontractors who perform assembly and test functions. Because we rely on independent foundries and third party subcontractors, we face several significant risks including: - a lack of committed manufacturing, assembly or test capacity - limited control over delivery schedules, quality assurance and control, manufacturing yields and production costs - the unavailability of, or potential delays in, obtaining access to key process technologies Although we work closely with our suppliers to minimize the likelihood of reduced manufacturing yields, in the past our suppliers have occasionally experienced lower than anticipated manufacturing yields. This often occurs during the production of new products or the installation and start-up of new wafer process technologies that use smaller circuit dimensions. We do not have long-term volume purchase agreements or a guaranteed level of production capacity with any of our suppliers. We depend on our suppliers to deliver sufficient quantities of finished product to us in a timely manner. Since we place our orders on a purchase order basis, these suppliers can allocate, and in the past have allocated, capacity to the production of other companies' products while reducing deliveries to us on short notice. None of our products is currently manufactured by more than one supplier. In order to meet our customer demand, currently we must place most orders approximately 10 to 13 weeks in advance of expected delivery. Some orders require that orders be placed up to 18 weeks in advance of expected delivery. If capacity becomes less available in the future, we may be required to place orders earlier than 10 to 18 weeks in advance of expected delivery, making it more difficult to meet customer demand. Any sudden increase in customer demand that we did not anticipate in advance could result in our inability to deliver product on a timely basis. This inability to deliver product may reduce our product revenues or increase our cost of revenues and negatively impact our business, financial condition and results of operations. In addition, we must place orders based on forecast demand to ensure enough lead time to be able to meet anticipated customer orders. Any sudden decrease in customer demand could result in excess inventory that could reduce our profit margins and have a negative effect on our business, financial condition and results of operations. 16 17 Processes used to manufacture our products are complex, customized to our specification and can only be performed by a limited number of manufacturing facilities. If our current manufacturing suppliers were unable to provide us with adequate manufacturing capacity, we would have to identify and qualify one or more substitute suppliers for a substantial majority of our products. Our manufacturers may experience unanticipated events, like the September 1999 Taiwan earthquake, that could inhibit their abilities to provide us with adequate manufacturing capacity on a timely basis, or at all. All of the Company's manufacturing subcontractors are located in countries outside the United States. Disruptions in the political environment could cause these suppliers to decrease or stop their supply of products to the Company. Introducing new products or transferring existing products to a new third party manufacturer would require significant development time to adapt our designs to their manufacturing processes and could cause product shipment delays. In addition, the costs associated with manufacturing our products may increase if we are required to use a new third party manufacturer. If we fail to satisfy our manufacturing requirements, our business would be materially harmed. COMPETITION. The data networking and semiconductor industries are intensely competitive and are characterized by constant technological change, rapid rates of product obsolescence and price erosion. The Company's Network Processors and Switch Fabrics compete now or are expected to compete in the future with current or future products from companies such as Broadcom, Conexant, Galileo Technology, IBM, Intel, Lucent Technologies, Motorola, PMC-Sierra, Texas Instruments and Vitesse Semiconductors (which acquired SiTera on May 31, 2000), as well as future start-up companies. Additional existing domestic and international semiconductor suppliers could also enter the market in the future. The Company could also face competition from suppliers of products based on new or emerging technologies. In addition, many of the Company's existing and potential customers, including Cisco, internally develop ASICs, general purpose processors, Network Processors, or other devices which attempt to perform some or all of the functions performed by the Company's products. Many of our current and prospective competitors offer broader product lines and have significantly greater financial, technical, manufacturing and marketing resources than we do. To the extent we fail to overcome these challenges, there would be a negative effect on our business and operating results. DEPENDENCE ON GROWTH IN DEMAND FOR NETWORKING EQUIPMENT. The Company's future success is in large measure dependent on continued growth in the market for networking equipment, in particular the market for mid- to high-end switches and routers which are manufactured and sold by the Company's customers. The market for these products has in the past and may in the future fluctuate significantly based upon numerous factors, including: - the lack of industry standards - adoption of alternative technologies - capital spending levels - general economic conditions There can be no assurance of the rate, or extent to which, the networking equipment market will grow. The Company may experience a decline in demand for its products. Any decrease in the growth of the networking equipment market or decline in demand for the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We pay suppliers for expenses incurred by our subsidies in Israel and the United Kingdom in local currency and also have a supplier contract that requires changes based on currency fluctuations. Therefore, the Company is subject to foreign currency rate exposure. Foreign currency rates fluctuate 17 18 frequently and there is always a possibility that fluctuations could have a material impact on the Company's income or cash flows. As of June 30, 2000, the Company held a total of $69.6 million in marketable securities. These securities consisted primarily of commercial paper and securities issued or guaranteed by the U.S. government. These securities, like all fixed income instruments, are subject to interest rate risk and will decline in value if market interest rates increase. The Company has the ability to hold its fixed income investments until maturity and therefore, the Company would not expect to recognize a decline in the fair value of the portfolio and the related adverse impact on income or cash flows. The Company currently does not use derivative financial instruments in its investment portfolio. The Company currently has no fixed-rate obligations and holds no equity securities. Thus the Company does not face risk of material adverse impact from market rate changes from these sources. 18 19 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not Applicable. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not Applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the Annual Meeting of Stockholders held on May 31, 2000, the stockholders voted to (1) elect two Class III directors to serve three-year terms and (2) ratify the appointment of PricewaterhouseCoopers LLP as independent accountants for MMC for the fiscal year ending December 31, 2000. (1) The Class III directors were elected with the following vote:

The terms of office of the following directors continued after the meeting: Douglas C. Spreng, Geoffrey Y. Yang, Andrew S. Rappaport and Amos Wilnai (2) The appointment of PricewaterhouseCoopers LLP as independent accountants for the fiscal year ended December 31, 2000 was ratified with the following vote:

ITEM 5. OTHER INFORMATION Not Applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits

Reports on Form 8-K The Company filed no reports on Form 8-K during the three months ended June 30, 2000. 19 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: July 21, 2000 MMC NETWORKS, INC. By: /s/ DOUGLAS C. SPRENG ------------------------------------------ Douglas C. Spreng President and Chief Executive Officer By: /s/ RICHARD C. YONKER ------------------------------------------ Richard C. Yonker Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer) 20 21 EXHIBIT INDEX

MMC NETWORKS INC 10-Q