Vixel (VIXL) 10-Q 2001 Q2 Quarterly report

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 July 1, 2001   OR
[   ]	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File No. 000-27221
 

 
VIXEL CORPORATION
(Exact name of registrant as specified in its charter)

Delaware	84-1176506
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

11911 North Creek Parkway South
Bothell, Washington 98011
(425) 806-5509
 
(Address, including zip code, of Registrant’s principal executive offices and
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 Registrant’s common stock, $.0015 par value, as of August 8, 2001 was 24,094,474.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS
		CONDENSED BALANCE SHEET
		CONDENSED STATEMENT OF OPERATIONS
		CONDENSED STATEMENT OF CASH FLOWS
		Notes to Condensed Financial Statements
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
PART II — OTHER INFORMATION
	ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
EXHIBIT INDEX
EXHIBIT 10.1

VIXEL CORPORATION
 
INDEX TO FORM 10-Q FOR QUARTER ENDED JULY 1, 2001

			Page
Part I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		Condensed Balance Sheet as of July 1, 2001 (unaudited) and December 31, 2000 (unaudited)		3
		Condensed Statement of Operations for the three and six month periods ended July 1, 2001 (unaudited) and July 2, 2000 (unaudited)		4
		Condensed Statement of Cash Flows for the three and six month periods ended July 1, 2001 (unaudited) and July 2, 2000 (unaudited)		5
		Notes to Condensed Financial Statements		6
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			7
	Item 3. Quantitative and Qualitative Disclosures About Market Risk			21
Part II OTHER INFORMATION
	Item 2. Changes in Securities and Use of Proceeds			21
	Item 4. Submission of Matters to a Vote of Security Holders			21
	Item 6. Exhibits and Reports on Form 8-K			22
Signature				23
Exhibit Index				24

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VIXEL CORPORATION
CONDENSED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)

				July 1,			December 31,
				2001			2000
Assets
	Current assets
		Cash and cash equivalents		$	20,291		$	17,066
		Short-term investments			17,603			25,636
		Accounts receivable, net of allowance for doubtful accounts of $521 and $850, respectively			2,736			7,344
		Inventories			2,318			1,415
		Prepaid expenses and other current assets			1,415			2,129
			Total current assets		44,363			53,590
	Property and equipment, net				6,142			7,307
	Goodwill and other intangibles, net				1,348			1,680
	Other assets				340			354
			Total assets	$	52,193		$	62,931
Liabilities and stockholders’ equity
	Current liabilities
		Current portion of long-term debt and capital leases		$	1,912		$	2,466
		Accounts payable			5,033			5,083
		Accrued liabilities			7,119			6,927
			Total current liabilities		14,064			14,476
	Long-term debt and capital leases				619			1,510
			Total liabilities		14,683			15,986
	Commitments and contingencies
	Stockholders’ equity
		Common stock, $.0015 par value; 60,000,000 shares authorized; 24,092,252 and 23,845,041 shares issued and outstanding, respectively			36			36
		Additional paid-in capital			156,681			156,387
		Stock-based compensation			(1,332	)		(2,160	)
		Notes receivable from stockholders			(3,745	)		(5,122	)
		Treasury stock, at cost; 66,666 shares			(50	)		(50	)
		Accumulated deficit			(114,080	)		(102,146	)
			Total stockholders’ equity		37,510			46,945
			Total liabilities and stockholders’ equity	$	52,193		$	62,931

The accompanying notes are an integral part of these condensed financial statements.

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VIXEL CORPORATION
CONDENSED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

			THREE MONTHS ENDED						SIX MONTHS ENDED
			July 1,			July 2,			July 1,			July 2,
			2001			2000			2001			2000
Revenue
	SAN systems		$	3,971		$	7,726		$	7,511		$	14,696
	Components			2,520			55			5,034			862
		Total revenue		6,491			7,781			12,545			15,558
Cost of revenue (1)				3,997			5,300			7,836			10,881
Gross profit				2,494			2,481			4,709			4,677
Operating expenses
	Research and development (2)			3,676			3,845			7,669			7,289
	Selling, general and administrative (3)			3,940			4,531			8,757			8,637
	Amortization of goodwill and other intangibles			191			540			438			1,079
	Amortization of stock-based compensation			282			631			798			1,773
		Total operating expenses		8,089			9,547			17,662			18,778
Loss from operations				(5,595	)		(7,066	)		(12,953	)		(14,101	)
Other income, net				451			741			1,019			1,509
Net loss			$	(5,144	)	$	(6,325	)	$	(11,934	)	$	(12,592	)
Basic and diluted net loss per share			$	(0.22	)	$	(0.28	)	$	(0.51	)	$	(0.56	)
Weighted-average shares outstanding				23,502			22,663			23,383			22,383

(1)	Includes amortization of stock-based compensation of $7 and $16 for the three months ended July 1, 2001 and July 2, 2000, respectively, and $18 and $42 for the six months ended July 1, 2001 and July 2, 2000, respectively.
(2)	Excludes amortization of stock-based compensation of $8 and $31 for the three months ended July 1, 2001 and July 2, 2000, respectively, and $18 and $81 for the six months ended July 1, 2001 and July 2, 2000, respectively.
(3)	Excludes amortization of stock-based compensation of $274 and $600 for the three months ended July 1, 2001 and July 2, 2000, respectively, and $780 and $1,692 for the six months ended July 1, 2001 and July 2, 2000, respectively.

The accompanying notes are an integral part of these condensed financial statements.

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VIXEL CORPORATION
CONDENSED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

					SIX MONTHS ENDED
					July 1,			July 2,
					2001			2000
Cash flows from operating activities
	Net loss				$	(11,934	)	$	(12,592	)
	Adjustments to reconcile net loss to net cash used in operating activities
		Depreciation				2,066			1,517
		Amortization of goodwill and other intangibles				332			1,079
		Stock-based compensation				816			1,815
		Changes in
			Accounts receivable, net			4,608			(705	)
			Inventories			(903	)		1,573
			Prepaid expenses and other assets			728			303
			Accounts payable and accrued liabilities			142			(258	)
				Net cash used in operating activities		(4,145	)		(7,268	)
Cash flows from investing activities
	Purchase of short-term investments					(19,481	)		(12,117	)
	Sale of short-term investments					27,513			48,979
	Purchase of property and equipment					(866	)		(1,599	)
				Net cash provided by investing activities		7,166			35,263
Cash flows from financing activities
	Receipt of payment on stockholder notes receivable					1,377			24
	Principal payments on long-term debt and capital leases					(1,481	)		(1,473	)
	Amortization of debt issuance costs					1			8
	Proceeds from exercise of stock options					307			1,321
				Net cash provided by (used in) financing activities		204			(120	)
Net increase in cash and cash equivalents						3,225			27,875
Cash and cash equivalents, beginning of period						17,066			16,706
Cash and cash equivalents, end of period					$	20,291		$	44,581
Cash paid for interest					$	178		$	455
Equipment purchased under capital leases					$	35		$	698

The accompanying notes are an integral part of these condensed financial statements.

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VIXEL CORPORATION
 
Notes to Condensed Financial Statements
(Information for the three months ended
July 1, 2001 and July 2, 2000)
(Unaudited)

NOTE 1. BASIS OF PRESENTATION

     The accompanying condensed financial statements as of July 1, 2001 and for the three and six month periods ended July 1, 2001 and July 2, 2000 are unaudited; however, in the opinion of management, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results and financial position for the interim periods. Certain information and note disclosures normally included in financial statements, prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Results of operations for the three and six month periods ended July 1, 2001 are not necessarily indicative of future financial results.

     Investors should read these interim statements in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and notes thereto for the fiscal year ended December 31, 2000 (audited) included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 29, 2001.

     Certain items in the July 2, 2000 financial statements have been reclassified to conform to the July 1, 2001 presentation. These reclassifications have no impact on stockholders’ equity, net loss or cash flows as previously reported.

NOTE 2. INVENTORIES

     Inventories consist of the following (in thousands):

	July 1,			December 31,
	2001			2000
Raw materials	$	2,849		$	1,177
Finished goods		1,763			1,266
Less: write-down to expected realizable value		(2,294	)		(1,028	)
	$	2,318		$	1,415

NOTE 3. NET LOSS PER SHARE

     Basic net loss per share represents the net loss divided by the weighted-average number of common shares outstanding during the period, excluding shares of restricted stock subject to repurchase. Diluted net loss per share represents net loss divided by the weighted-average number of common shares outstanding including the potentially dilutive impact of common stock options and warrants and shares of restricted stock subject to repurchase. Common stock options and warrants are converted using the treasury stock method. Basic and diluted net loss per share are equal for the periods presented because the impact of common stock equivalents is anti-dilutive. Potentially dilutive securities totaling 5,448,744 and 4,467,479 shares for the quarters ended July 1, 2001 and July 2, 2000, respectively, were excluded from diluted net loss per share calculations due to their anti-dilutive effect.

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion should be read in conjunction with the condensed financial statements in Item 1 of this Quarterly Report and with the Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 29, 2001.

     This document contains forward-looking statements that involve risk and uncertainties. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.

     Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We are under no duty to update any of the forward-looking statements after the date hereof to conform such statements to actual results or to changes in our expectations.

     References to dollar amounts are in thousands unless otherwise specified.

COMPANY OVERVIEW

     We are a provider of comprehensive solutions in storage area networks, or SANs. SANs are networks that are specifically designed to interconnect computer systems and data storage devices. Our portfolio of Fibre Channel products, including our SAN management software, switches, hubs and transceivers, is fully interoperable and designed to perform in concert to address a wide variety of data and storage needs.

     We derive substantially all of our revenue from the sale of SAN interconnect products, including switches, hubs and transceivers. We currently include our SAN InSite software with our switches and managed hubs and do not sell this software separately from our other products. We have, however, developed a version of our SAN InSite software, SAN InSite™ Professional, that we will license for a fee. We introduced SAN InSite™ Professional during the second quarter of 2001, but to date have not recognized any revenue from this new product. SAN systems revenue consists of revenue generated from our SAN switches, hubs and transceiver products sold as a result of selling our switches and hubs. Component revenue consists primarily of revenue generated from the sale of our transceiver products to original equipment manufacturers, or OEMs, for use in their products. During the second quarter of 2001, we discontinued the manufacturing and selling of our transceiver products.

     We sell our products primarily to a limited number of customers. Sun Microsystems, Compaq Computer and Avid Technology represented 45.9%, 23.0% and 11.0% of revenue, respectively for the three months ended July 1, 2001. Compaq Computer, Sun Microsystems and Bell Microproducts represented 22.6%, 21.2% and 11.6% of revenue, respectively for the three months ended July 2, 2000. No other individual customer represented more than 10.0% of our total revenue in those periods. During the three months ended July 1, 2001 and July 2, 2000, 8.3% and 21.3%, respectively, of our total revenue was derived from sales to distribution channel customers. We plan to continue to expand our sales channels to include systems integrators, VARs and additional distributors in the United States and internationally.

     We recently developed a Fibre Channel loop switch application specific integrated circuit, or ASIC, for use in various storage devices. We have licensed the manufacturing and selling of this ASIC to a third party and will generally derive royalty revenue from its sales.

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     We generally recognize revenue at the time of product shipment, unless we have future obligations for installation or when we ship product demonstration units. Revenue from products shipped with future installation obligations is recognized when we meet our future obligation. Revenue is not recognized on demonstration units unless the customer ultimately purchases the unit, and the related revenue is recognized at that time. Our agreements with our North American distributors provide for price protection and for stock rotation based on a percentage of shipments for the preceding quarter when an offsetting order is requested. Revenue for these stock rotation rights is deferred until the stock rotation period has passed. We provide an allowance for price protection rights. We also maintain a reserve for product warranty costs based on a combination of historical experience and specifically identified potential warranty liabilities.

     Our gross profit as a percentage of total revenue is affected by the mix of products sold, sales channels and customers to which our products are sold. Our gross profit as a percentage of total revenue also is affected by fluctuations in manufacturing volumes and component costs, manufacturing costs charged by our contract manufacturer, new product introductions, changes in our product pricing and estimated warranty costs. We expect that average unit selling prices for our products will decline over time in response to competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors and other factors. We seek to maintain gross profit as a percentage of total revenue by selling a higher percentage of higher margin products and reducing the cost of our products through manufacturing efficiencies, design improvements and cost reductions for components.

RESULTS OF OPERATIONS

     The following table sets forth the percentage of total revenue represented by selected items from the unaudited Condensed Statement of Operations. This table should be read in conjunction with the unaudited Condensed Financial Statements included elsewhere herein.

			Three Months Ended						Six Months Ended
			July 1,			July 2,			July 1,			July 2,
			2001			2000			2001			2000
Revenue
	SAN systems			61.2	%		99.3	%		59.9	%		94.5	%
	Components			38.8			0.7			40.1			5.5
		Total revenue		100.0			100.0			100.0			100.0
Cost of revenue				61.6			68.1			62.5			69.9
Gross profit				38.4			31.9			37.5			30.1
Operating expenses
	Research and development			56.6			49.4			61.1			46.9
	Selling, general and administrative			60.8			58.3			69.8			55.5
	Amortization of goodwill and other intangibles			2.9			6.9			3.5			6.9
	Amortization of stock-based compensation			4.3			8.1			6.4			11.4
		Total operating expenses		124.6			122.7			140.8			120.7
Loss from operations				(86.2	)		(90.8	)		(103.3	)		(90.6	)
Other income, net				6.9			9.5			8.1			9.7
Net loss				(79.2	)%		(81.3	)%		(95.1	)%		(80.9	)%

THREE AND SIX MONTHS ENDED JULY 1, 2001 COMPARED WITH THREE AND SIX MONTHS ENDED JULY 2, 2000

     Revenue.Total revenue in the second quarter of fiscal 2001 was $6,491, a decrease of $1,290, or 16.5%, compared with $7,781 for the second quarter of fiscal 2000. Total revenue for the first six months of fiscal 2001, was $12,545, a decrease of $3,013, or 19.4%, from $15,558 for the first six months of fiscal 2000.

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     Revenue generated from our SAN systems was $3,971, or 61.2%, of total revenue, for the second quarter of fiscal 2001. This represents a decrease of $3,755, or 48.6%, from the comparable quarter of fiscal 2000. SAN systems revenue was $7,511, or 59.9%, of total revenue, for the first six months of fiscal 2001. This represents a decrease of $7,185, or 48.9%, from the first six months of fiscal 2000. We believe the decreases in SAN systems revenue in 2001 compared with 2000 are primarily a result of a slowdown in the United States economy.

     Component revenue was $2,520, or 38.8%, of total revenue for the second quarter of fiscal 2001. This represents an increase of $2,465 from the comparable quarter of fiscal 2000. Component revenue was $5,034 or 40.1%, of total revenue for the first six months of fiscal 2001. This represents an increase of $4,172 from the first half of fiscal 2000. The increase in our component revenue is a result of a one-time order of a transceiver product from one of our OEM customers. This order was received during the fourth quarter of 2000 and shipments against the order took place during the fourth quarter of 2000 and the first and second quarters of 2001. We have transitioned away from the component business, and component revenue during the second quarter is anticipated to represent the final revenue from our gigabit interface converter, or GBIC, products. As a result, we expect our third quarter 2001 component revenue will decrease compared with the second quarter of 2001.

     Gross profit. Cost of revenue includes the cost to acquire finished products from a third party manufacturer of our products, expenses we incur related to inventory management, product quality testing, customer order fulfillment, and provisions for warranty expenses and inventory obsolescence. Gross profit in the second quarter of fiscal 2001 was $2,494, or 38.4%, of total revenue compared with $2,481, or 31.9%, for the second quarter of fiscal 2000. Gross profit in the first six months of fiscal 2001 was $4,709, or 37.5%, of total revenue, compared with $4,677, or 30.1%, of total revenue in the first six months of fiscal 2000. The increase in gross profit percentage in 2001 compared with 2000 reflects the shift to higher-margin switch revenue and increased gross margins on the 2001 component revenue.

     Cost of revenue for the second quarter of fiscal 2001 was reduced by $2,200 as a result of the settlement of claims against a third party vendor. Also, included in cost of revenue for the second quarter of fiscal 2001 were provisions for excess and obsolete inventory and purchase commitments totaling approximately $3.1 million, reduced by $800 resulting from the settlement of a patent infringement claim related to our GBIC transceivers for less than previously estimated. These provisions resulted primarily from transitioning out of the GBIC and gigabaud link modules, or GLM, transceiver products and a reduction in future revenue forecasts. Inventory purchases and commitments are based upon future sales forecasts. To mitigate the component supply constraints that have existed in the past, our contract manufacturer built inventory levels for certain components with long lead times and entered into certain longer-term commitments for certain components. Due to the sudden and significant decrease in demand for certain of our products, inventory levels exceeded our requirements based on sales forecasts through the end of fiscal 2001. This excess inventory charge was calculated based on the inventory levels in excess of demand for each specific product. We do not anticipate that the excess inventory subject to this charge will be used at a later date.

     We expect gross profit as a percentage of revenue to decrease in the third quarter of 2001 as a result of the initial sales of our new ASIC product being made from inventory that we will have purchased at higher pre-production prices. Also, lower anticipated volumes of total product sales, primarily as a result of transitioning out of the transceiver products, will result in higher overhead burden on remaining product sales.

     Research and development expenses.Research and development (“R&D”) expenses consist primarily of salaries and related expenses for personnel engaged in the design, development and sustaining engineering of our products, consulting and outside service fees, costs for prototype and test units and other expenses related to the design, development, testing and enhancement of our products. R&D expenses in the second quarter of fiscal 2001 were $3,676, compared with $3,845 in the second quarter of fiscal 2000, a decrease of 4.5%. R&D expenses, as a percentage of revenue, increased to 56.6% in the second quarter of

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fiscal 2001, compared with 49.4% in the second quarter of fiscal 2000. The decrease in R&D expenses was primarily attributable to capitalization of $106 of software development costs in the second quarter of 2001 relating to SAN InSite™ Professional. R&D expenses in the first six months of fiscal 2001 were $7,669, compared with $7,289 in the first six months of fiscal 2000, an increase of 5.2%. R&D expenses, as a percentage of revenue, increased to 61.1% in the first six months of fiscal 2001, compared with 46.9% in the first six months of fiscal 2000. The increase in R&D expenses was primarily attributable to increased costs for prototypes and test units related to our new 9000 series switches.

     In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” costs incurred for the research and development of new software products are expensed as incurred until such time that technological feasibility, in the form of a working model, is established, after which time such costs are capitalized. During the second quarter of 2001, we capitalized $106 of development costs related to SAN InSite Professional software. The capitalized software costs will be amortized to cost of revenue over a period of 36 months or in proportion to revenues realized as a percentage of expected revenues if the resulting amortization is greater.

     We believe that continued investment in research and development is an essential element of our strategic objectives to design quality products while reducing costs. We anticipate that research and development expenses will increase in the future.

     Selling, general and administrative expenses.Selling, general and administrative (“SG&A”) expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales, finance and information technology support functions, as well as professional fees, allowance for doubtful accounts receivable, trade shows and other marketing activities. SG&A expenses in the second quarter of fiscal 2001 were $3,940 compared with $4,531 in the second quarter of fiscal 2000, a decrease of 13.0%. SG&A expenses, as a percentage of revenue, increased to 60.7% in the second quarter of fiscal 2001, compared with 58.2% in the second quarter of fiscal 2000. The decrease in expenses was primarily due to a decrease in allowance for doubtful accounts receivable, reduced recruiting and relocation expenses and a reduction in travel expenses in the second quarter of fiscal 2001. SG&A expenses in the first six months of fiscal 2001 were $8,757, compared with $8,637 in the first six months of fiscal 2000, an increase of 1.4%. SG&A expenses as a percentage of revenue, increased to 69.8% in the first six months of fiscal 2001, compared with 55.5% in the first six months of fiscal 2000. The increase in expense was primarily due to an increase in consulting expenses during the first six months of fiscal 2001 compared to the first six months of fiscal 2000. We expect our selling, general and administrative expenses to decrease for the remainder of 2001. This reduction is anticipated as a result of reducing the number of personnel engaged in marketing, finance and information technology support functions during the second quarter of 2001, and planned reductions of discretionary spending for the remainder of 2001.

     Amortization of goodwill and other intangibles.Amortization of goodwill and other intangibles in the second quarter of fiscal 2001 was $191 compared with $540 in the second quarter of fiscal 2000. Amortization of goodwill and other intangibles in the first six months of fiscal 2001 was $438, compared with $1,079 in the first six months of fiscal 2000. These decreases are the result of certain intangible assets capitalized in conjunction with our purchase of Arcxel Technologies in February 1998, being fully amortized during fiscal 2000.

     Amortization of stock-based compensation.Total amortization of stock-based compensation in the second quarter of fiscal 2001 was $282, compared with $631 in the second quarter of fiscal 2000. Of these amounts, $7 and $16, respectively, were included in cost of revenue. Total amortization of stock-based compensation in the first six months of fiscal 2001 was $798, compared with $1,773 in the first six months of fiscal 2000. Of these amounts, $18 and $42, respectively, were included in cost of revenue. At July 1, 2001, unamortized stock-based compensation was approximately $1.3 million.

     Other income, net.Other income, net consists of interest income, interest expense and other miscellaneous income or expense. Other income in the second quarter of fiscal 2001 was $451, compared

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with $741 in the second quarter of fiscal 2000. As a percentage of revenue, other income decreased from 6.9% in the second quarter of 2001 from 9.5% in the second quarter of 2000. Other income in the first six months of fiscal 2001 was $1,019, compared with $1,509 in the second quarter of fiscal 2000. As a percentage of revenue, other income decreased from 8.1% in the first six months of fiscal 2001 from 9.7% in the first six months of fiscal 2000. Other income in all periods consisted primarily of interest income. The decreases in 2001 compared with 2000 are primarily the result of decreased cash, cash equivalents and short-term investment balances in the first six months of 2001 compared to the same period in 2000.

LIQUIDITY AND CAPITAL RESOURCES

     Since inception, we have financed our operations primarily through the sale of common stock and preferred stock with aggregate proceeds of approximately $114.3 million. Additionally, we have financed our operations through capital equipment lease lines, working capital credit facilities, notes payable and $6.9 million in net cash received from the sale of our laser diode fabrication facility and gigabit Ethernet product line in 1998. Our principal sources of liquidity at July 1, 2001 consisted of $20.3 million in cash and cash equivalents and $17.6 million in short-term investments.

     Cash utilized by operating activities was $4.1 million for the six months ended July 1, 2001, due primarily to net losses, offset by a reduction in working capital required to fund our operations. Cash provided by investing activities was $7.2 million, primarily related to maturities of short-term investments, offset by purchases of short-term investments, and capital expenditures of $866. Cash provided by financing activities was $204, primarily due to proceeds from the exercise of stock options, payments received on stockholder notes receivable, offset by payments on capital lease obligations.

     We believe that our existing cash, cash equivalents and short-term investment balances will be sufficient to meet our cash requirements at least through the next twelve months. However, we may be required, or could elect, to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including our future revenue, the timing and extent of spending to support product development efforts or potential expansion of sales, general and administrative activities, the timing of introductions of new products, and market acceptance of our products. We cannot assure you that additional equity or debt financing, if required, will be available on acceptable terms or at all.

RECENT ACCOUNTING PRONOUNCEMENTS

     The Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 44 (“FIN 44”), “Accounting for Stock Based Compensation” in March 2000. FIN 44 provides guidance and clarification to the application of Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees.” Our adoption of FIN 44, effective July 1, 2000, has not materially impacted our financial position, results of operations or cash flows.

     Effective January 1, 2002, the Company will adopt Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”. This pronouncement will change the accounting for goodwill from an amortization method to an impairment-only approach. Thus, amortization of goodwill, including goodwill recorded in past business combinations, will cease. In addition, initial impairment tests will be required to be completed by the end of the first quarter of 2002 for intangible assets and by the end of 2002 for goodwill. Any losses resulting from these initial impairment tests will be recognized as the effect of a change in accounting principle. Annual impairment tests will be required every year thereafter, with any impairment recognized as losses on impairment of assets. Management has not yet completed an evaluation of the effects this standard will have on the Company’s consolidated financial statements. However, amortization of intangibles will be lower in 2002 than in prior periods, and the Company could incur charges as a result of the impairment tests.

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FACTORS THAT MAY AFFECT RESULTS OF OPERATIONS AND FINANCIAL CONDITION

We have incurred significant losses since our inception, we expect future losses, and we may not become profitable.

     We have incurred significant losses since inception, most recently a net loss of $11.9 million for the six months ended July 1, 2001, and expect to incur losses in the future. As of July 1, 2001, we had an accumulated deficit of $114.1 million. We expect to incur significant product development, sales and marketing and administrative expenses, and we will need to generate significant revenue to achieve and maintain profitability. We cannot be certain that we ever will realize sufficient revenue to achieve profitability and even if we do achieve profitability, we may not be able to sustain or increase profitability.

Our operating results are difficult to forecast, may fluctuate on a quarterly basis and may be adversely affected by many factors, which may result in volatility in our stock price.

     Our revenue and results of operations have varied on a quarterly basis in the past and may vary significantly in the future due to a number of factors, many of which may cause our stock price to fluctuate. Some of the factors that could affect our operating results include:

• the size, terms and fluctuations of customer orders, particularly orders from a limited number of original equipment manufacturers, or OEMs;

• changes in general economic conditions and specific economic conditions in the computer storage and networking industries, such as a change in spending levels for information technology products;

• the timing of customer orders, a large percentage of which are generated in the last month of the quarter;

• our ability to attain and maintain sufficient reliability levels for our products;

• our ability to develop and market new products;

• the timing of the introduction or enhancement of products by us, our OEMs and our competitors;

• decreases in the prices at which we can sell our products;

• the mix of products sold and the mix of distribution channels through which our products are sold; and

• the ability of our contract manufacturer to produce and distribute our products in a timely fashion.

     As a result of these and other factors, we believe that period to period comparisons of our operating results should not be relied upon as an indicator of our future performance. It is likely that in some future period our operating results will be below our guidance, your expectations or the expectations of public market analysts.

Our OEMs have unpredictable order patterns, which may cause our revenue to vary significantly from period to period.

     Our OEMs tend to order sporadically, and their purchases can vary significantly from quarter to quarter. Our OEMs generally forecast expected purchases in advance, but frequently do not order as expected and tend to place purchase orders only shortly before the scheduled delivery date. We plan our operating expenses based in part on revenue projections derived from our OEMs’ forecasts. Because most of our expenses are fixed in the short term or incurred in advance of anticipated revenue, we may not be able to decrease our expenses in a timely manner to offset any unexpected shortfall in revenue. These order habits cause our backlog to fluctuate significantly. Moreover, our backlog is not necessarily indicative of actual sales for any succeeding period, as orders are subject to cancellation or delay by our OEMs with limited or no penalty.

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The loss of one or more key customers could significantly reduce our revenue.

     Our success will depend on our continued ability to develop and manage relationships with significant OEMs and resellers, as well as on the sales efforts and success of these customers. Sun Microsystems, Compaq Computer and Avid Technology represented 45.9%, 23.0% and 11.0% of our total revenue, respectively, for the three months ended July 1, 2001. Although we are attempting to expand our base of OEMs and resellers, most of our future revenue may come from a small number of customers.

     Our agreements with our customers do not provide any assurance of future sales to those customers. For example:

• our OEM and reseller agreements are not exclusive and contain no renewal obligation;

• our OEMs and resellers can stop purchasing and marketing our products at any time; and

• our OEM and reseller agreements do not require minimum purchases.

     We cannot be certain that we will retain our current OEMs and resellers or that we will be able to recruit additional or replacement customers. Many of our OEMs and resellers carry or utilize competing product lines. If we were to lose one or more OEMs or resellers to a competitor, our business, results of operations and financial condition could be significantly harmed.

Our success is dependent upon acceptance of Fibre Channel technology and the growth of the emerging SAN market.

     Our SAN InSite management software, switches and hubs are used exclusively in SANs. Accordingly, widespread adoption of SANs is critical to our future success. The market for SANs and related software, switches and hubs is evolving rapidly and it is difficult to predict its potential size or future growth rate. Our success in generating revenue in this emerging SAN market will depend on, among other things, our ability to:

• demonstrate the benefits of SANs and our SAN InSite management software, switch and hub products to OEMs, resellers and end-users;

• enhance our existing products and to introduce new products on a timely basis to meet changes in customer preferences and evolving industry standards;

• develop, maintain and build relationships with leading OEMs and resellers; and

• accurately predict the direction of industry standards and base our products on those industry standards.

Our failure to do any of these activities would adversely affect our ability to successfully compete in the emerging SAN market.

Competing technologies may emerge and we may fail to adopt new technologies on a timely basis. Failure to utilize new technologies may decrease the demand for our products.

     Emerging technologies, such as Ethernet IP, SCSI over IP and Infiniband have been discussed as competing alternatives to SANs. If we are unable to identify new technologies in a timely manner and efficiently utilize such new technologies in our product development efforts, the demand for our current products may decrease significantly and rapidly, which would harm our business.

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We expect that a growing percentage of our future revenue will be derived from our switch products, our SAN management software products, and royalties from technology development agreements with customers, and our success will depend on widespread acceptance of these products and technologies.

     Our future success depends upon our ability to address the rapidly changing needs of our customers by developing and introducing high-quality, cost-effective products as well as product enhancements and services on a timely basis and by keeping pace with technological developments and emerging industry standards. If we do not successfully develop, introduce and market new products, especially our switch products, our revenue may decline. We have announced the first end user shipment of our new 9000 Series 2-gigabit Fibre Channel switches and have launched our SAN InSite management software, SAN InSite™ Professional. Our future revenue growth will depend on the success of our new products and product launches by customers for which we are developing products under technology development agreements and the success of our current switch products. In addition, as we introduce new or enhanced products, we will have to manage successfully the transition from older products in order to minimize disruption in our customers’ ordering patterns, avoid excessive levels of older product inventories and ensure that enough supplies of new products can be delivered to meet our customers’ demands. To the extent customers defer or cancel orders in expectation of new product releases, any delay in development or introduction of new products could cause our operating results to suffer.

Because a significant portion of our revenue is derived from sales of entry-level hubs, we are dependent on continued widespread market acceptance of these products.

     We currently derive a significant portion of our revenue from sales of our entry-level hubs. Although we anticipate our revenue from sales of entry level hubs to decline as management of SAN products becomes more important in larger, more complex SAN implementations, we expect that revenue from our entry-level hubs will continue to account for a substantial portion of our total revenue for the foreseeable future. If the market does not continue to accept our entry-level hubs, our total revenue will decline significantly.

Competition in our markets may lead to reduced prices and sales of our products, increased losses and reduced market share.

     The markets for SAN interconnect products are highly competitive. Our current competitors include a number of domestic and international companies, many of which have substantially greater financial, technical, marketing and distribution resources than we have. We expect that more companies, including our customers, may enter the market for SAN interconnect products. We may not be able to compete successfully against either current or future competitors. Increased competition could result in significant price erosion, reduced revenue, lower margins or loss of market share, any of which would have a material adverse effect on our business, results of operations and financial condition.

     For switch sales, we compete primarily with Brocade Communications, McDATA Corporation and Qlogic Corporation. For hub sales, we compete primarily with Emulex Corporation and Gadzoox Networks. Although we do not believe that any of the above competitors offer comprehensive SAN interconnect management software that directly competes with ours, other vendors, such as Brocade and Gadzoox, provide single point-device managers for either switch or hub products, but not across multiple interconnect devices, including switches, hubs and transceivers. We have launched a version of our SAN InSite management software, SAN InSite™ Professional, to manage third party devices within the SAN interconnect. Other software vendors, such as Veritas Software, SANavigator Inc., and Prisa Networks, have introduced or have under development products that may compete with our product. Our competitors continue to introduce improved products with lower prices, and we will have to do the same to remain competitive. Furthermore, larger companies in other related industries or our customers may develop or acquire technologies and apply their significant resources, including their distribution channels and brand recognition, to capture significant SAN market share. Therefore, we may not be able to compete successfully in the SAN market.

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Our failure to enhance our existing products and introduce new products on a timely basis could cause our revenue to fall.

     Given the product life cycles in the markets for our products, any delay or unanticipated difficulty associated with new product introductions or product enhancements could significantly harm our business, results of operations and financial condition. During the second quarter of 2001, we introduced our new 9000 Series 2-gigabit Fibre Channel switches, and a new version of our SAN InSite management software, SAN InSite™ Professional, that will manage third party products in the SAN. During the remainder of 2001, we plan to introduce our “loop switch on a chip” ASIC and a Fibre Channel switch module for Lucent Technology’s OptiStar EdgeSwitch. We may not be able to develop, manufacture and market these new products or other product enhancements in a timely manner or in a manner that will achieve market acceptance. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements, or to license these new technologies from third parties. Product development delays may result from numerous factors, including:

• changing OEM product specifications;

• difficulties in hiring and retaining necessary personnel;

• difficulties in reallocating engineering resources and overcoming resource limitations;

• difficulties with independent contractors or development partners;

• changing market or competitive product requirements; and

• unanticipated engineering complexities.

The sales cycle for our products is long and we may incur substantial non-recoverable expenses and devote significant resources to sales that do not occur when anticipated or at all.

     OEMs and resellers typically conduct significant evaluation, testing, implementation and acceptance procedures before they begin to market and sell new solutions that include our products. This evaluation process is lengthy and may range from six months to one year or more. This process is complex and may require significant sales, marketing and management efforts on our part. This process becomes more complex as we simultaneously qualify our products with multiple customers. As a result, we may expend significant resources to develop customer relationships before we recognize any revenue from these relationships or we may never realize any revenue from these efforts.

Failure to manage our OEM and reseller relationships and expand our distribution channels could significantly reduce our revenue.

     We rely on OEMs and resellers to distribute and sell our products. Our success depends substantially on our ability to initiate, manage and expand our relationships with OEMs, our ability to attract additional resellers and the sales efforts of these OEMs and resellers. Our failure to manage and expand our relationships with OEMs and resellers, or their failure to market our products effectively, could substantially reduce our revenue and seriously harm our business.

Any failure by us to successfully execute our distribution strategy will negatively impact our revenue.

     Our distribution strategy focuses primarily on developing and expanding indirect distribution channels through OEMs and resellers. Our failure to execute this strategy successfully could limit our ability to grow or sustain revenue. Furthermore, as we expand our sales to resellers, we may increase our selling costs, as these parties generally require a higher level of customer support than our OEMs. If we fail to develop and cultivate relationships with significant resellers, or if these resellers are not successful in their sales efforts, sales of our products may decrease and our operating results would suffer. Many of our resellers also sell

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products that compete with our products. We cannot assure you that our resellers will market our products effectively or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. Our failure to successfully develop or manage our reseller relationships or their failure to sell our products could reduce our revenue.

The loss of K*Tec, the failure to forecast accurately demand for our products or to manage successfully our relationship with K*Tec would negatively affect our business.

     We rely on K*Tec Electronics, an outside contract-manufacturing firm, to manufacture, store and ship our products. We share K*Tec’s manufacturing capacity with numerous companies whose manufacturing needs may conflict with ours. If K*Tec is unable or unwilling to complete production runs for us in the future, or experiences any significant delays in completing production runs or shipping our products, the manufacturing and sale of our products would be temporarily suspended. We have in the past experienced delivery problems based on capacity constraints for production, test and material supply. If our product volume requirements increase, we may find it necessary to augment our manufacturing capacity by exploring new subcontract manufacturers. We may not be successful in finding qualified manufacturers that meet our needs. An interruption in supply of our products, or additional costs incurred to qualify and shift production to an alternative manufacturing facility, would significantly harm our business, results of operations and financial condition.

     In October 2000, Kent Electronics announced that it had sold K*Tec Electronics to Thayer-Blum Funding II LLC. K*Tec Electronics has assured us that the sale will not affect its ability to meet our manufacturing needs. However, we cannot be certain that K*Tec will continue to operate in the same manner as before the sale or be able to meet our manufacturing requirements without additional cost, or at all.

     K*Tec is not obligated to supply products for us, except as may be provided in a particular purchase order that K*Tec has accepted. We place purchase orders with K*Tec based on periodic forecasts. While most of the materials used in our products are standard products, some are proprietary and/or sole-source and require extended lead times. Our business will be adversely affected if we are unable to accurately forecast demand for our products and manufacturing capacity or if materials are not available at K*Tec to meet the demand. Lead times for materials and components vary significantly and depend on the specific supplier, contract terms and demand for a component at a given time. We also may experience shortages of components from time to time, which could delay the manufacture of our products.

     During the second quarter of 2001 we launched our new 9000 Series 2-gigabit Fibre Channel switches, and plan to regularly introduce new products and product enhancements, which will require that we coordinate our efforts with K*Tec to rapidly achieve volume production. If we do not effectively manage our relationship with K*Tec, or if K*Tec experiences delays, disruptions, capacity constraints or quality control problems in its manufacturing operations, our ability to ship products to our customers could be delayed and our competitive position and reputation could be harmed. Qualifying a new contract manufacturer and commencing volume production is expensive and time consuming. If we are required to or choose to change contract manufacturers, we may lose revenue and damage our customer relationships.

We may lose sales if our sole source suppliers fail to meet our needs.

     We currently purchase several key components from single sources. We depend on single sources for our card guides, ASICs and our microprocessors. ASICs are custom designed computer chips that perform specific functions very efficiently. In addition, we license software from a third party that is incorporated into our switches and hubs. If we cannot supply products due to a lack of components, or are unable to redesign products with other components in a timely manner, our business, results of operations and financial condition would be materially adversely affected.

     We use rolling forecasts based on anticipated product orders to determine our component requirements. Lead times for materials and components that we order vary significantly and depend on

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factors such as specific supplier requirements, contract terms and current market demand for particular components. As a result, our component requirement forecasts may not be accurate. If we overestimate our component requirements, we may have excess inventory, which would increase our costs. If we underestimate our component requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively impact our business and operating results.

Undetected software or hardware defects could increase our costs and reduce our revenue.

     SAN interconnect products and management software frequently contain undetected software or hardware defects when first introduced or as new versions are released. Our products are complex and problems may be found from time to time in our existing, new or enhanced products. Our products incorporate components manufactured by third parties. We have in the past experienced difficulties with quality and reliability of components obtained from third parties and we could experience similar problems in the future. In addition, our products are integrated with products from other vendors. As a result, when problems occur, it may be difficult to identify the source of the problem. These problems may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems.

A component in our transceivers has experienced an abnormally high failure rate, which has adversely affected and could in the future affect our sales.

     We observed, and some customers confirmed, that in certain applications our GBIC and GLM transceivers manufactured prior to March 1998 that incorporated a third party CD laser experienced an abnormally high failure rate. We no longer use the CD laser. As a result of this problem, we recorded a warranty reserve of $3.6 million in the fourth quarter of fiscal 1998. Although we have settled claims by customers that purchased the majority of these products, there is a risk that additional claims could occur and that the total amount reserved may be inadequate to cover all potential claims. Claims against us in excess of the amount of our reserves could have a material adverse effect on our business and financial condition. Partially as a result of this problem we have seen our component revenue decrease from $24.2 million in fiscal 1998 to $13.7 million in fiscal 1999 to $3.6 million in fiscal 2000. We discontinued the manufacturing and selling of our GBIC products during the second quarter of 2001.

If we fail to successfully develop the Vixel brand, our revenue may not grow and our stock price may fall.

     We believe that establishing and maintaining the Vixel brand is a critical aspect of our efforts to maintain and develop strategic OEM and reseller relationships, and that the importance of brand recognition will increase due to the growing number of vendors of SAN interconnect products. If we fail to promote our brand successfully, or if we incur excessive expenses in an attempt to promote and maintain the Vixel brand, our business, results of operations and financial condition may be materially adversely affected. In addition, if our OEMs, resellers and end users of our SAN interconnect products do not perceive our products to be of high quality, or if we introduce new products or technologies that are not accepted by the market, the value of the Vixel brand will decline and our business will suffer.

If we lose key personnel or are unable to hire and integrate qualified personnel, we may not be successful.

     Our success depends to a significant degree upon the continued joint contributions of our senior management, including James M. McCluney, President and Chief Executive Officer, Kurtis L. Adams, Chief Financial Officer, Thomas Hughes, Vice President, Product Development and Stuart B. Berman, Chief Technology Officer. The loss of one or more of our senior management personnel could harm our sales or delay our product development efforts.

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     We believe our future success will depend in large part upon our ability to attract and retain highly skilled managerial, technical, sales and marketing, finance and operations personnel. The loss of services of any of our key personnel could have a negative impact on our business. Many of our employees have only recently joined us. If we are unable to integrate new employees in a timely and cost-effective manner, our operating results may suffer. We also need to increase the number of technical staff members with experience in high-speed networking applications, ASIC design and software development as we further develop our product line. Competition for these highly skilled employees in our industry is intense. Our failure to attract and retain these key employees could have a material adverse effect on our business, results of operations and financial condition.

     The loss of the services of any of our key employees, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel could hinder the development and introduction of and negatively impact our ability to sell our products. In addition, employees may leave our company and subsequently compete against us. Moreover, companies in our industry whose employees accept positions with competitors frequently claim that their competitors have engaged in unfair hiring practices. We may be subject to claims of this type in the future as we seek to hire qualified personnel and some of these claims may result in material litigation. We could incur substantial costs in defending ourselves against these claims, regardless of their merits.

We plan to increase our international sales, which will subject us to additional business risks.

     Our revenue from international sales represented 29.9% of our total revenue for the three months ended July 1, 2001. We plan to expand our international sales, especially in Europe and Asia. Our international sales growth will be limited if we are unable to establish relationships with international distributors, establish foreign operations, effectively manage international sales channels and develop relationships with service organizations. We cannot be certain that we will be able to establish, generate and build market demand for our products internationally. Our international operations will be subject to a number of risks, including:

• increased complexity and costs of managing international operations;

• multiple protectionist, conflicting and changing governmental laws and regulations;

• longer sales cycles;

• difficulties in collecting accounts receivables;

• reduced or limited protections of intellectual property rights; and

• political and economic instability.

     These factors and others could harm future sales of our products to international customers, which would negatively impact our business and operating results. To date, none of our international revenue has been denominated in foreign currencies. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and thus less competitive in foreign markets. In the future, a portion of our international revenue may be denominated in foreign currencies, including the Euro, which would subject us to risks associated with foreign currency fluctuations.

     Our SAN interconnect products are subject to U.S. Department of Commerce export control restrictions. Neither our customers nor we may export those products without obtaining an export license. These U.S. export laws also prohibit the export of our SAN interconnect products to a number of countries deemed by the United States to be hostile. These restrictions may make foreign competitors facing less stringent controls on their products more competitive in the global market than are our customers or we. The U.S. government may not approve any pending or future export license requests. In addition, the list of products and countries for which export approval is required, and the regulatory policies with respect thereto, could be revised. The sale of our SAN interconnect products could be harmed by our failure or the failure of our customers to obtain the required government licenses or by the costs of compliance.

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Our products must comply with evolving industry standards and government regulations, and if we cannot develop products that are compatible with these evolving standards, our business will suffer.

     The market for SAN products is characterized by the need to support industry standards as they emerge, evolve and achieve acceptance. To remain competitive, we must continue to introduce new products and product enhancements that meet these industry standards. All components of a SAN must utilize the same standards in order to operate together. Our products comprise only a part of an entire SAN and we depend on the companies that provide other components, many of which are significantly larger than we are, to support industry standards as they evolve. We also depend on our competitors to support these same industry standards. The failure of these providers or our competitors to support these industry standards could negatively impact market acceptance of our products.

     In addition, in the United States, our products must comply with various regulations and standards defined by the Federal Communications Commission and Underwriters Laboratories. Internationally, products that we develop also will be required to comply with standards established by authorities in various countries. Failure to comply with existing or evolving industry standards or to obtain timely domestic or foreign regulatory approvals or certificates could materially harm our business.

Our intellectual property protection may prove to be inadequate which could negatively affect our ability to compete.

     We believe that our continued success depends on protecting our proprietary technology. We currently rely on a combination of patents, copyrights, trademarks, trade secrets and contractual provisions to establish and protect our intellectual property rights. In addition, we also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our software, documentation and other proprietary information. Our failure to protect our intellectual property rights could have a material adverse effect on our business, results of operations and financial condition. Efforts to protect our intellectual property could be time consuming and expensive and could have a material adverse effect on results of operations and financial condition. We cannot be certain that the steps we take to protect our intellectual property will adequately protect our proprietary rights, that others will not independently develop or otherwise acquire equivalent or superior technology or that we can maintain any of our technology as trade secrets. In addition, the laws of some of the countries in which our products are or may be sold may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all.

Third-party claims of infringement of their intellectual property rights could adversely affect our business.

     In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. We occasionally receive communications from third parties alleging patent infringement, and there always is the chance that third parties may assert infringement claims against us. Future patent infringement disputes, with or without merit, could result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. We cannot be certain that the necessary licenses would be available or that they could be obtained on commercially reasonable terms. If we fail to obtain these royalty or licensing agreements in a timely manner and on reasonable terms, our business, results of operations and financial condition would be materially adversely affected.

Our stock price has been and may continue to be volatile.

     The trading price of our common stock has been and is likely to continue to be volatile. The market price of our common stock may fluctuate significantly in response to several factors, including but not limited to the following factors, some of which are beyond our control:

• actual or anticipated fluctuations in our operating results;

• losses of our key OEMs or reduction in their purchases of our products;

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• changes in financial estimates by securities analysts;

• changes in market valuations of other technology companies;

• announcements by us or our competitors of significant technical innovations, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;

• additions or departures of key personnel; and

• future sales of capital stock.

     In addition, the stock market has experienced extreme volatility that often has been unrelated to the performance of particular companies. These market fluctuations may cause our stock price to fall regardless of our performance.

We may not be able to meet our future capital requirements, limiting our ability to grow.

     We believe that our existing cash, cash equivalents and short-term investment balances will be sufficient to meet our capital requirements at least through the next twelve months. However, we may need, or could elect, to seek additional funding prior to that time. If we need to raise additional funds, we may not be able to do so on favorable terms, or at all. Further, if we issue equity securities, existing stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated funding requirements.

We may engage in future acquisitions that may dilute our stockholders and cause us to incur debt or assume contingent liabilities.

     We may review opportunities to buy other businesses or technologies that would complement our current products, expand the breadth of our markets or enhance our technical capabilities, or that may otherwise offer growth opportunities. While we have no current agreements or negotiations underway, we may buy businesses, products or technologies in the future. If we make any future purchases, we could issue stock that would dilute existing stockholders’ percentage ownership, incur substantial debt or assume contingent liabilities.

     These purchases also involve numerous risks, including:

• problems assimilating the purchased operations, technologies or products;

• unanticipated costs associated with the acquisition;

• diversion of management’s attention from our core business;

• adverse effects on existing business relationships with suppliers and customers;

• incorrect estimates made in the accounting for acquisitions;

• risks associated with entering markets in which we have no or limited prior experience; and

• potential loss of key employees of purchased organizations.

Our corporate offices and principal product development facility are located in regions that are subject to earthquakes and other natural disasters.

     Our corporate offices in Bothell, Washington and research facility in Irvine, California are located near major earthquake faults. We are not specifically insured for earthquakes, or other such natural disasters. Any personal injury or damage to the facilities as a result of such occurrences could have a material adverse effect on our business, results of operations and financial condition.

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Our stockholder rights plan, certificate of incorporation and Delaware law could adversely affect the performance of our stock.

     Our stockholder rights plan and provisions of our certificate of incorporation and the Delaware General Corporation Law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. The stockholder rights plan and these provisions of our certificate of incorporation and Delaware law are intended to encourage potential acquirers to negotiate with us and allow our board of directors the opportunity to consider alternative proposals in the interest of maximizing stockholder value. However, such provisions may also discourage acquisition proposals or delay or prevent a change in control, which could harm our stock price.

ITEM 3.  QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

     We maintain investment portfolio holdings of various issuers, types, and maturities, the majority of which are commercial paper and government securities. These securities are generally classified as available for sale and, consequently, are recorded on the balance sheet at fair value.

     Our investment portfolio, with a fair value of $17.6 million as of July 1, 2001, is invested in commercial paper, government securities and corporate indebtedness that could experience an adverse decline in fair value should an increase in interest rates occur. In addition, declines in interest rates could have an adverse impact on interest earnings for our investment portfolio. We do not currently hedge against this interest rate exposure.

     All of our revenue is realized in U.S. dollars and is from customers primarily headquartered in the United States. Therefore, we do not believe we currently have any significant direct foreign currency exchange risk.

PART II — OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

     The Company’s Registration Statement on Form S-1 (No. 333-81347) for its initial public offering of its common stock become effective September 30, 1999. The initial public offering resulted in net proceeds to the Company of $82.8 million. Expenses related to the offering totaled approximately $1.4 million. Through July 1, 2001, the proceeds were applied to repay $12.3 million in debt and $4.3 million in capital lease obligations, $4.1 million was used to purchase property and equipment and $25.3 million was used for working capital and general purposes.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     The Company’s Annual Meeting of Stockholders was held on May 22, 2001 in Bellevue, Washington. Of the 23,922,706 shares outstanding as of the record date, 17,322,604 were present or represented by proxy at the meeting. The results of the voting on the matters submitted to the stockholders are as follows:

1. To elect two (2) Class Two Directors to serve until the 2004 Annual Meeting of Stockholders and until a successor is duly elected and qualified.

Name	For	Withheld
Charles A. Haggerty	17,164,939	157,665
Werner F. Wolfen	17,239,124	83,480

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2. Appointment of PricewaterhouseCoopers LLP as independent auditors of the Company for its fiscal year ending December 31, 2001.

Votes for:	17,282,359
Votes against:	28,898
Votes abstaining:	11,347

Directors continuing in office until the 2002 Annual Meeting were Messrs. James M. McCluney and Timothy M. Spicer.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits:

EXHIBIT
NUMBER	DESCRIPTION
3.1  (1)	Amended and Restated Certificate of Incorporation of Registrant (Exhibit 3.2)
3.2  (2)	Certificate of Designation of Series A Junior Participating Preferred Stock (Exhibit 3.1)
3.3  (1)	Bylaws of the Registrant (Exhibit 3.4)
4.1  (1)	Form of Registrant’s Common Stock Certificate
10.1	Form of Change in Control Agreement between Registrant and certain of its executive officers

(1)	Incorporated by reference to designated exhibits to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-81347), declared effective on September 30, 1999.
(2)	Incorporated by reference to designated exhibits to Registrant’s current report on Form 8-K filed with the Securities and Exchange Commission on November 17, 2000.

(b)  Reports on Form 8-K:

     None.

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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: August 15, 2001	VIXEL CORPORATION (Registrant)
	/s/  Kurtis L. Adams Kurtis L. Adams Chief Financial Officer, Vice President of Finance, Secretary and Treasurer (Authorized Officer and Principal Financial and Accounting Officer)

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EXHIBIT INDEX

EXHIBIT
NUMBER	DESCRIPTION
3.1  (1)	Amended and Restated Certificate of Incorporation of Registrant (Exhibit 3.2)
3.2  (2)	Certificate of Designation of Series A Junior Participating Preferred Stock (Exhibit 3.1)
3.3  (1)	Bylaws of the Registrant (Exhibit 3.4)
4.1  (1)	Form of Registrant’s Common Stock Certificate
10.1	Form of Change in Control Agreement between Registrant and certain of its executive officers

(1)	Incorporated by reference to designated exhibits to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-81347), declared effective on September 30, 1999.
(2)	Incorporated by reference to designated exhibits to Registrant’s current report on Form 8-K filed with the Securities and Exchange Commission on November 17, 2000.

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