<PAGE>
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ---------------
 
                                   FORM 10-K
 
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                    OF THE SECURITIES EXCHANGE ACT OF 1934
 
                 FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1997
 
                        COMMISSION FILE NUMBER: 0-23023
 
                               ---------------
 
                              MMC NETWORKS, INC.
            (Exact name of registrant as specified in its charter)
 
<TABLE>
<S>                                                    <C>
                    DELAWARE                                        77-0319809
(STATE OR OTHER JURISDICTION OF INCORPORATION OR       (I.R.S. EMPLOYER IDENTIFICATION NO.)
                 ORGANIZATION)
     1134 EAST ARQUES AVENUE, SUNNYVALE, CA                           94086
    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)                         (ZIP CODE)
 
      Registrant's telephone number, including area code: (408) 731-1600
 
                                ---------------
 
          Securities registered pursuant to Section 12(b) of the Act:
 
<CAPTION>
              TITLE OF EACH CLASS                   NAME OF EACH EXCHANGE ON WHICH REGISTERED
              -------------------                   -----------------------------------------
<S>                                                 <C>
                      NONE                                             NONE
</TABLE>
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                        Common Stock, $0.001 par value
                               (TITLE OF CLASS)
 
                               ---------------
 
  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
 
                                Yes [X] No [_]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
  The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on March 13,
1998, as reported on the National Market of The Nasdaq Stock Market, was
approximately $213,012,972. Shares of Common Stock held by each officer and
director and by each person who owns 5% or more of the outstanding Common
Stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes. As of March 13, 1998, the registrant had
outstanding 29,274,597 shares of Common Stock.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  The registrant has incorporated by reference into Part III of this Form 10-K
portions of its Proxy Statement for registrant's Annual Meeting of
Stockholders to be held May 28, 1998.
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<PAGE>
 
  The Business section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those detailed in the Company's S-1 registration statement and
those discussed in the section entitled "Management's Discussion and Analysis
of Financial Condition and Results of Operation -- Factors Affecting Future
Results" commencing on page 21 of this Report.
 
                                    PART I
 
                               ITEM 1. BUSINESS
 
THE COMPANY
 
  MMC Networks, Inc. (the "Company" or "MMC Networks") is a leading developer
and supplier of network processors--high-performance, open-architecture,
software-programmable processors optimized for network applications. The
Company's network processors form the core silicon "engines" of LAN and WAN
switches and routers and are designed to allow network equipment vendors to
rapidly develop high-performance, feature-rich, cost-effective products
supporting a broad range of networking functions. MMC networks' customers
employ the Company's network processors to develop and market multi-gigabit,
wire-speed switches and routers with advanced features such as Layer 3
switching, internetworking of LANs and WANs, security, class of service,
quality of service and network management.
 
  The Company's current products, the PS1000, ATMS2000 and AF5000 families of
network processors, provide the core functionality of high-performance Fast
Ethernet and Asynchronous Transfer Mode ("ATM") networking equipment,
respectively. 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. All
of the Company's products are based on the Company's proprietary VIX/TM/
architecture, which enables network equipment vendors to easily and cost-
effectively implement high-performance, value-added features in their switch
and router products.
 
  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 1134 East Arques Avenue, Sunnyvale, California 94086,
and its telephone number is (408) 731-1600.
 
INDUSTRY BACKGROUND
 
  The proliferation of high-performance personal computers, workstations and
servers along with the growing reliance on increasingly data-intensive
networked applications has resulted in dramatic growth in traffic over data
networks. In addition, as organizations and individuals increasingly rely on
intranets and the Internet, networks have been extended to connect branch
offices, home offices, mobile users and, more recently, customers and
suppliers. The rise in data traffic has been accompanied by substantial growth
in the number of protocols employed in LAN and WAN networking, including
Ethernet, Token Ring, Fiber-Distributed Data Interface ("FDDI"), WAN serial
lines, X.25, Frame Relay and dial-up access. More recently, Fast Ethernet,
Gigabit Ethernet, higher-speed Frame Relay and ATM networks are beginning to
be deployed. These trends continue to drive demand for high-performance
networking equipment that supports internetworking a variety of types of LANs
and WANs.
 
  As the size and performance requirements of networks have grown, network
equipment vendors have increasingly focused on advanced switching and routing
devices to enable large-scale, high-performance networks. Known as Layer 3
switches, IP switches, high-speed routers or switching routers, these devices
are designed to enable a network hierarchy that facilitates the implementation
of such networks. In addition to improved performance and multiprotocol
connectivity, enterprises and network service providers are increasingly
demanding networking equipment that supports a broad variety of advanced
features, without compromising
 
                                       2
<PAGE>
 
performance. For example, as the reach of enterprise data networks has spread
to WANs and the Internet, network administrators need security at multiple
points in the network. As businesses become more dependent on intranets and
the Internet, they are increasingly focused on differentiated classes or
priorities of service for certain of their applications and users to make more
efficient use of networking resources. Similarly, new applications such as
video conferencing, multimedia training and Internet telephony require end-to-
end quality of service guaranteed across entire networks. Finally, in order to
implement advanced features and functionality across complex, high speed
networks, network administrators also need better network management
capabilities to help them analyze the traffic flowing through the network, to
anticipate traffic growth and to quickly isolate and solve network problems.
 
  While attempting to respond to customer demands for more performance, new
capabilities, greater security and better management, network equipment
vendors face growing competition, evolving networking standards and increasing
market segmentation. Rapid growth in the data networking industry has
attracted a multitude of new entrants who are competing with or, in many
instances, are being acquired by major network equipment vendors. To compete
effectively, network equipment vendors must improve their time-to-market and
lower their costs while continuing to increase performance and add advanced
features and differentiated functionality. At the same time, network equipment
vendors must support multiple evolving industry standards and protocols and
must address the diverse needs of customers in an increasingly segmented
networking market. For example, a small office may require a simple network
built with one Ethernet LAN switch, a large corporation may require multiple
Fast Ethernet high-speed routers connected to an ATM campus backbone switch,
and an Internet service provider may require a dedicated OC-3 or SDH-1
backbone switch with downlinks that support dedicated and dial-up
connectivity.
 
  In order to address the needs of their increasingly diverse customer base
and provide support for a broad array of networking protocols and
functionalities without substantially degrading performance, network equipment
vendors have employed increasingly capable semiconductor devices in their
networking equipment, the most important being those used as the switching or
routing "engines." Network equipment vendors have traditionally relied on two
general approaches for these semiconductor engines: general purpose processors
which are software-programmable or custom-developed ASICs. Each of these
approaches has advantages but involves significant trade-offs with respect to
performance, feature implementation, time-to-market and cost. Switches and
routers utilizing general purpose processors can be brought to market
relatively rapidly, can be easily adapted to changes in industry protocols and
standards and can be programmed in software to add additional features, but
these benefits are usually not achievable without significant performance
degradation or unacceptably high unit production cost. Alternatively, switches
and routers based on ASICs can be designed to achieve high performance and
produced at relatively low unit cost, but the ASIC development cycle is
usually too time consuming to permit the development of high-performance ASICs
with advanced feature sets while meeting network equipment vendors' time-to-
market constraints. In addition, ASICs involve the risk of additional delays
associated with multiple iterations that may be required in the ASIC
development cycle, provide little flexibility to conform to rapidly evolving
standards and protocols and lack the full feature support that would allow
them to address multiple segments of the networking market. Consequently,
neither approach achieves network equipment vendors' requirements for high
performance and advanced features without imposing an unacceptable time-to-
market and/or cost burden.
 
MARKET OPPORTUNITY FOR NETWORK PROCESSORS
 
  The Company believes that these market trends have created a significant
opportunity for network processors--high-performance, open-architecture,
software-programmable processors optimized for networking applications. These
network processors enable the design and development of switching and routing
solutions that incorporate advanced features, operate without significant
performance degradation, address evolving standards and multiple market
segments through software programmability, and can be produced in a cost-
efficient manner and within the time-to-market constraints of the competitive
networking equipment market. The Company believes that network processors
offer network equipment vendors the ability to reduce the time and
 
                                       3
<PAGE>
 
expense involved in developing customized chip sets for individual network
switching products, while allowing vendors to focus on developing networking
systems which are powerful, cost-effective, differentiated and feature-rich to
satisfy the needs of their increasingly diverse customer bases.
 
MMC NETWORKS' SOLUTION
 
  MMC Networks is a leading developer and supplier of network processors
enabling a new generation of high-performance networking equipment. These
network processors are designed to allow network equipment vendors to rapidly
develop high-performance, feature-rich, cost-effective, scalable LAN and WAN
switches and routers targeting the specific needs of distinct customer
segments. The Company believes that, by designing-in the Company's network
processors, network equipment vendors can simultaneously reduce development
costs, accelerate time-to-market and focus on enhancing system differentiation
with advanced features and functionality. Using the Company's network
processors as building blocks, MMC Networks' customers are offering or
designing multi-gigabit, wire-speed switches and routers with enhanced
features including internetworking among multiple types of LANs and WANs,
security, class of service, quality of service and network management without
significant performance degradation.
 
  The Company currently offers the PS1000 Fast Ethernet, ATMS2000 ATM and
AF5000 multiservice families of network processors. All of the Company's
products are based on the Company's ViX architecture, which is designed to
enable network equipment vendors to construct cost-effective, high-bandwidth,
high-port-count, feature-rich, modular and stand-alone switches and routers.
The Company's proprietary Per Flow Queuing ("PFQ") technology extends the ViX
architecture to support class of service and quality of service for network
switches.
 
MMC NETWORKS' STRATEGY
 
  MMC Networks' strategy is to enable network equipment vendors to rapidly
develop and introduce differentiated products by leveraging the high-
performance, feature-rich, software-programmable and cost-effective network
processors offered by the Company. Key elements of the Company's strategy
include the following:
 
  Target High-Growth Markets. MMC Networks' network processors target the
rapidly growing enterprise and service provider markets. These markets require
high-performance, feature-rich, mid- to high-end LAN and WAN networking
equipment solutions. The Company believes that as these markets continue to
grow, they will become increasingly specialized. Consequently, network
equipment vendors will need to deliver a broader mix of products in order to
satisfy increasingly sophisticated and diverse customer performance and
feature requirements. The Company focuses on the design and development of
network processors that enable network equipment vendors to rapidly design and
bring to market a broad variety of differentiated networking solutions meeting
the performance and feature requirements of this evolving market.
 
  Facilitate Customer Success. Increasing competition and evolving networking
standards have exerted and will continue to exert pressure on network
equipment vendors to introduce new products rapidly and cost-effectively. MMC
Networks' network processors are designed to improve network equipment
vendors' time-to-market and lower their development costs by providing them
with software programmable processing functionality to enable them to address
evolving standards and multiple market segments. The Company works closely
with its customers to design network processors that enable performance and
functionality compatible with such customers' current and future needs and
that complement network equipment vendors' product development efforts.
 
  Extend Technology Leadership. MMC Networks has made substantial investments
in the technologies that underlie its network processors, with the goal of
setting new price/performance benchmarks and enabling the widespread use of
sophisticated networking functionality. For example, the Company's ViX
architecture, which forms the basis of all of its products, is designed to
enable network equipment vendors to implement value-added
 
                                       4
<PAGE>
 
features without significant performance degradation. MMC Networks is
continually developing new technologies for its network processors, such as
the Company's AF5000 family network processors, which were designed to
integrate the processing of data from different protocols.
 
  Leverage Fabless Semiconductor Model. MMC Networks seeks to leverage the
flexibility of its fabless semiconductor business model to lower technology
and production risks, increase profitability and reduce time-to-market. The
Company's fabless model allows it to focus on its core network processor
design competencies, while minimizing the capital and operating infrastructure
requirements. In addition, the Company's reliance on mainstream semiconductor
design and manufacturing technologies rather than newer, more expensive
manufacturing processes reduces the risks inherent in newer, less proven
process technologies.
 
TECHNOLOGY
 
  MMC Networks' network processors are high-performance, multi-gigabit, open-
architecture, software-programmable processors with instruction sets that have
been optimized for processing and switching data, voice and video packets and
cells. The Company believes that the key underlying technologies employed in
its network processors give it a substantial competitive advantage. The core
technologies employed in current products include the Company's ViX
architecture, Per-Flow Queuing technology, Direct Replication Engine
technology, Virtual SAR technology and Programmable BitStream Processor
technology.
 
  ViX Architecture. The ViX architecture is a switch fabric architecture that
uses a patented point-to-point connection matrix that permits the use of a
wide, centralized, shared-memory structure, while separating control
information from user data. The ViX architecture's use of "point-to-point
connections" is designed to enable network equipment vendors to easily scale
the number of ports in their switches and routers, unlike shared-bus
architectures that run into clock frequency, bus capacitance and pin count
limitations. The use of a "wide, centralized shared-memory structure" enables
network equipment vendors to scale the bandwidth and amount of buffer memory,
unlike crossbar architectures which become increasingly expensive as bandwidth
and buffer requirements increase. The "separation of control information from
user data" enables network equipment vendors to more easily implement high-
performance processing, queuing, replication and switching functions for
networking applications, unlike shared-bus and crossbar architectures, which
may require complex processors to coordinate multiple functions across
multiple ports and the replication of user data within their buffers. In
addition, the ViX architecture is designed as an open architecture, providing
external access to the appropriate timing and control signals, which enables
network equipment vendors to more easily implement differentiated features and
functionality.
 
  Per-Flow Queuing Technology. All networking switches and routers must buffer
data when networks become congested. Networks that use conventional switches
and routers usually buffer data on a linear, first-in-first-out ("FIFO")
basis. As data accumulates in the buffer, new data sits "behind" all of the
information that previously arrived at the switch/router. High-priority
information sent to that switch or router is not distinguished from other data
and is therefore "stuck" in the back of the buffer until such other data is
sent. MMC Networks' PFQ technology is designed to alleviate the limitations of
FIFO queuing by assigning each piece of data to its own unique queue and then
scheduling the sending of the data according to software-programmable
algorithms developed by the network equipment vendor, thus allowing the switch
or router to implement class of service or quality of service functionality.
Switches and routers incorporating PFQ technology can be designed to support
up to 500,000 queues, providing enough queues for large-scale networks.
 
  Direct Replication Engine Technology. When data must be broadcast to all
ports on a switch or router or "multicast" to select ports, routers and
switches must replicate data packets for each port connection. This process
may significantly degrade performance. MMC Networks' Direct Replication Engine
technology is designed to provide wire-speed multicast and broadcast
capability by leveraging the separation of control information from user data
enabled by the ViX architecture. This capability allows the switch or router
to store a single copy of the data to be transmitted and replicate it to
multiple ports in a single instruction cycle.
 
                                       5
<PAGE>
 
  Virtual SAR Technology. Conventional switches and routers use expensive
segmentation and reassembly ("SAR") chips to convert frames to cells and vice
versa, thus enabling the internetworking of ATM with Ethernet, frame relay and
other packet-based protocols. The Company's Virtual SAR technology provides
the ability to convert frames to cells and vice versa, thus eliminating the
need for expensive external SAR chips.
 
  Programmable BitStream Processor Technology. MMC Networks' Programmable
BitStream Processor technology performs the processing of packet and cell
headers including such functions as real-time parsing, matching and table
look-up, as well as bit stream manipulations such as adding, deleting,
substituting, appending and pre-pending. This functionality enables network
equipment vendors to build high-performance switches and routers with
additional services that address network security, class of service and
quality of service and improve management throughout the network.
 
TARGET MARKETS AND PRODUCTS
 
  MMC Networks' products serve two primary markets: the enterprise network
market and the service provider market. The Company's Fast Ethernet and ATM
products are being designed into networking equipment intended for both of
these markets. The following table summarizes selected product and service
applications within each of these markets:
 
<TABLE>
<CAPTION>
              ENTERPRISE NETWORK                    SERVICE PROVIDER SERVICES
-----------------------------------------------------------------------------
  <S>                    <C>                 <C>                 <C>
  Wiring Closet          Remote Access       Internet            Voice
  Power Workgroup        WAN Backbone        Frame Relay         Cable
  Campus Backbone                            ATM                 Dial
                                             xDSL
</TABLE>
 
 
  The Company's PS1000, ATMS2000 and AnyFlow 5000 product families provide the
core functionality for Fast Ethernet and ATM switches and routers developed by
network equipment vendors targeting both the enterprise network and service
provider markets. The Company also offers reference design kits, which assist
customers in their technical evaluation of the Company's products.
 
  The PS1000 Family. The PS1000 network processor family implements the core
functionality of a high-performance Fast Ethernet switch, provides extensions
for layer 3 routing and is optimized for power workgroup, wiring closet and
LAN backbone applications. The PS1000 network processor family enables network
equipment vendors to build low-cost, highly-integrated solutions supporting
scalable port densities from eight to 128 10-Mbps Ethernet ports and up to 32
100-Mbps Fast Ethernet ports with the option of one or two ATM uplinks. The
flexible PS1000 ViX-based architecture allows a high degree of customer
product differentiation in terms of bandwidth segmentation, port type
implementations, support for external frame forwarding, prioritization and
uplinks.
 
  The following table sets forth MMC Networks' PS1000 product family:
 
<TABLE>
<CAPTION>
    PRODUCT                               DESCRIPTION
-------------------------------------------------------------------------------
  <C>          <S>
  PS1001 PSP   Packet switch processor which provides the central core of the
               switching operation
  PS1002 FEIU  Fast Ethernet interface unit comprised of four 10/100-Mbps full-
               duplex Fast Ethernet MAC ports
  PS1003 EIU   Ethernet interface unit comprised of six 10-Mbps MAC ports and
               two 10/100-Mbps MAC ports
  PS1004 AIU   ATM interface unit that provides an ATM uplink for Ethernet
               switches
  PS1005 ARL   Address resolution logic device that provides full frame
               forwarding and filtering logic
  PS1007 NCB   Network component interconnect ("NCI") bus to CPU bridge
  PS1008 NPB   NCI bus to PCI bus bridge
</TABLE>
 
 
                                       6
<PAGE>
 
  A 16-port full-duplex Fast Ethernet switch can be constructed using a set of
four PS1001s, four PS1002s, four PS 1005s, and either a PS1007 or PS1008. This
chip set is priced at approximately $480 per set in quantities of 1,000 per
year. PS1004 processors may be used to add optional ATM uplinks to the switch.
 
  The ATMS2000 Family. The ATMS2000 network processor family provides the core
functionality of a high-performance ATM switch and the capabilities for layer
3 routing. The ATMS2000 network processor family is optimized for feature-rich
building or campus backbones, power workgroups and WAN access. The ATMS2000
network processor family provides a cost-effective solution for 2.5- or 5-Gbps
switches and routers with port densities of up to 32 OC-3 ports or eight OC-12
ports. The flexible ViX-based architecture enables the centralized
implementation of value-added features such as PFQ, as well as customer-
defined features, without the need to change any of the linecards in the
network.
 
  The following table sets forth MMC Networks' ATMS2000 product family:
 
<TABLE>
<CAPTION>
  PRODUCT                               DESCRIPTION
-------------------------------------------------------------------------------
  <C>      <S>
  ATMS2001 Memory access buffer which acts as an interface between the ATMS2002
  MBUF     PIF and a common memory bank
  ATMS2002 Port interface which interfaces the ATMS2000 switch core with ATM
  PIF      Physical Layer Devices
  ATMS2003 Switch controller which manages data queues and provides an
  SWC1     interface to the CPU
  ATMS2004 Switch controller which manages the reading and writing of data to
  SWC2     various external data structures and performs pipeline control
  ATMS2101 Optional feature chip set that monitors and polices cell traffic,
  Xchecker providing statistics, usage parameter control and/or packet discard
  ATMS2110 Optional feature chip set that offloads cell reception and
  Xport    transmission from the CPU
  ATMS2200 Co-processor that implements PFQ
  Xstream
</TABLE>
 
 
  A 32-port OC-3 5-Gbps switch utilizing the Company's ATMS2000 network
processor requires six ATMS2001s, eight ATMS2002s and one each of the ATMS2003
and ATMS2004. This chip set is priced at approximately $2,000 per set in
quantities of 1,000 per year. The ATMS2101, ATMS2110 and ATMS2200 may be used
to add additional features to the network processor.
 
  The AnyFlow 5000 Family. MMC Networks' AnyFlow 5000 network processor family
implements the Company's new Virtual SAR and Programmable BitStream Processor
technologies. The AnyFlow 5000 family employs a modular design which enables a
wide range of networking equipment, including both Ethernet and ATM switches
and routers. The AnyFlow 5000 network processors are designed to provide Layer
3 switching and routing with quality of service and packet/cell
internetworking at a bandwidth of 20 Gbps and with throughput of up to 20
million packets-per-second. AnyFlow network processors scale up to 128 Fast
Ethernet or ATM OC-3 ports, 16 Gigabit Ethernet ports or 32 ATM OC-12 ports.
The AF5000 is MMC Network's newest family of network processors. Samples of
the AnyFlow 5000 products have been available since the fourth quarter of
1997, and the Company anticipates that the products will be shipped in volume
production during the second half of 1998. No assurance can be given that the
AnyFlow product line will become commercially available on a timely basis,
will provide the functional and performance advantages expected by customers,
or will find market acceptance. The success of the Company's products may also
be adversely affected if the Company's customers face any problems related to
such products.
 
                                       7
<PAGE>
 
  Reference Design Kits. To facilitate the adoption by network equipment
vendors and speed the design cycle for its network processors, MMC Networks
designs and makes available system-level reference design kits. The Company's
reference design kits include a reference machine, schematics, layout details,
documentation and firmware, including device drivers and diagnostic software.
Source code for the reference machines can be licensed from the Company, as
can the bus models for those companies who design their own interfaces to the
network processors.
 
  Products Under Development. The Company expects to continue to enhance and
refine its network processors, while adding additional operational features
designed to make the Company's products more attractive to a wide range of
network equipment vendors.
 
CUSTOMERS
 
  MMC Networks sells its products to a variety of network equipment vendors.
As of December 31, 1997, the Company had achieved more than 40 design wins
with in excess of 30 network equipment vendors, of which 10 (Cisco, D-link,
Fujitsu, Hitachi, NBase, NEC, Olicom, SNT, Sumitomo and Toshiba) are shipping
networking products that incorporate the Company's network processors. To
qualify as a design win, a network equipment vendor must have (i) purchased
network processor prototypes, a reference design kit or software drivers from
the Company and (ii) commenced development of a product incorporating the
Company's network processors. During the design-in process, the Company works
closely with each customer to assist in resolving technical questions and to
help the customer achieve volume production of its products. Achieving a
design win with a network equipment vendor provides no assurance that such
network equipment vendor will ultimately ship products incorporating the
Company's network processors.
 
  Cisco, Mitsui Comtek Corp., a non-stocking sales representative for Japan,
and the U. S. Computer Division of Hitachi accounted for 28%, 28% and 12%,
respectively, of total revenues for the year ended December 31, 1997 and 51%,
15% and 10%, respectively, of total revenues for the year ended December 31,
1996. Cisco, Ipsilon, Toshiba, and Agile represented 48%, 12%, 11% and 11%,
respectively, of total revenues for the year ended 1995. None of the Company's
customer purchase agreements contains a minimum purchase requirement.
Customers typically purchase the Company's products pursuant to short-term
purchase orders that may be canceled without charge if notice is given within
an agreed-upon period.
 
SALES, MARKETING AND TECHNICAL SUPPORT
 
  The Company targets customers based on industry leadership, technology
leadership and target applications. The Company maintains close working
relationships with its customers in order to design and develop solutions
which specifically address their needs. The Company markets its products
through a direct sales and marketing organization, headquartered in Sunnyvale,
California, with a sales office in Massachusetts, and through sales
representatives in the United States, Canada, Japan, Taiwan and the United
Kingdom. Sales representatives are selected for their understanding of the
networking marketplace and their ability to provide effective field sales
support for MMC Networks' products. The Company's relationships with many of
its representatives have been established within the last year, and the
Company is unable to predict the extent to which some of these representatives
will be successful in marketing and selling the Company's products.
 
  Sales to U.S. customers account for the substantial majority of MMC
Networks' revenues. Although the Company has a number of international
customers, substantially all of these customers currently order through, and
receive shipments at, their U.S. operations.
 
  The Company has a number of marketing programs designed to inform network
equipment vendors about the capabilities and benefits of the Company's
products. The Company's marketing efforts include participation in industry
trade shows, technical conferences and technology seminars, preparation of
competitive analyses, sales training, publication of technical and educational
articles in industry journals, maintenance of MMC Networks' World Wide Web
site, advertising and direct mail distribution of Company literature.
 
                                       8
<PAGE>
 
  Technical support to customers is provided through factory system engineers
and, if necessary, product designers and architects. Local field support is
provided in person or by telephone. The Company plans to hire additional
support staff for remote offices, as the need arises. The Company believes
that providing network equipment vendors with comprehensive product service
and support is critical to maintaining a competitive position in the
networking market and is critical to shortening customers' design-in cycles.
The Company works closely with its customers to monitor the performance of its
product designs and to provide support at each stage of customer product
development.
 
RESEARCH AND DEVELOPMENT
 
  The Company's success will depend to a substantial degree upon its ability
to develop and introduce in a timely fashion new products and enhancements to
its existing products that meet changing customer requirements and emerging
industry standards. MMC Networks has made and plans to continue to make
substantial investments in research and development and to participate in the
development of industry standards.
 
  The Company focuses its development efforts on network processor product
development. Before a new product is developed, the Company's research and
development engineers work with marketing managers and customers to develop a
comprehensive requirements specification. After the product is designed and
commercially released, Company engineers continue to work with customers on
early design-in efforts to understand requirements for future generations and
upgrades. Most of the Company's engineers are involved in algorithm and chip
design and verification. In addition, the Company also has a group of software
engineers and reference machine designers.
 
  The Company's research and development expenditures, net of nonrecurring
engineering funding received from customers, totaled $8.3, $3.3, and $1.8
million in the years ended December 31, 1997, 1996 and 1995, respectively,
representing 38%, 31% and 312% of revenues for such periods, respectively.
Research and development expenses primarily consist of salaries and related
costs of employees engaged in ongoing research, design and development
activities and subcontracting costs. These expenses are reduced by non-
recurring engineering fees paid by the Company's customers to facilitate
product development projects. As of December 31, 1997, there were 45 employees
engaged in research and development. The Company performs its research and
product development activities at its headquarters in Sunnyvale, California.
 
MANUFACTURING
 
  Currently, the Company outsources all of its semiconductor manufacturing,
assembly and test. The Company's suppliers currently deliver fully assembled
and tested products on a turnkey basis. This "fabless" semiconductor
manufacturing model allows the Company to focus substantially all of its
resources on the design, development and marketing of products and
significantly reduces the capital requirements of the Company.
 
  In 1995 and 1996, MMC Networks subcontracted its semiconductor manufacturing
to Oki Semiconductor and NEC in Japan and Motorola, Inc. in the United States.
In 1997, the Company added TSMC in Taiwan. In 1998, it is expected that a
growing percentage of the Company's production will be contracted to TSMC and
potentially other new suppliers as new products reach volume production. The
Company chose these four manufacturers in large part due to their conformance
with international standards of technology, their capacity, their quality and
their support for the state-of-the-art design tools used by MMC Networks. Only
one of the Company's products is currently manufactured by more than one
supplier.
 
  MMC Networks uses mainstream CMOS processes for the manufacturing of its
products instead of depending on leading edge processes in order to help
reduce technical risks and production capacity constraints. The Company's main
products currently are fabricated in .35, .5 and .8 micron CMOS. The Company
continuously evaluates the benefits, on a product-by-product basis, of
migrating to a smaller geometry process in order to reduce costs, and has
commenced migration of certain products to smaller geometries. The Company
believes that transitioning its products to increasingly smaller geometries
will be important for the Company to remain competitive. No assurance can be
given that future process migration will be achieved without difficulty.
 
                                       9
<PAGE>
 
  The Company must place orders approximately 12 to 14 weeks in advance of
expected delivery. As a result, the Company has only a limited ability to
react to fluctuations in demand for its products, which could cause the
Company to have an excess or a shortage of inventory of a particular product.
In the future, the Company expects to change its supply arrangements to assume
more of the product manufacturing responsibilities. Such changes will include
contracting for wafer manufacturing and subcontracting for assembly and test
rather than purchasing finished product. The Company has begun investing in
design tools, libraries and personnel with the expectation of assuming greater
manufacturing responsibilities by mid 1998.
 
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 PS1000, ATMS2000 and AF5000
product families compete with products from companies such as Texas
Instruments, Lucent Technologies, PMC-Sierra, Galileo Technology, Integrated
Telecom and I-Cube. In addition, the Company expects significant competition
in the future from major domestic and international semiconductor suppliers.
The Company also may face competition from suppliers of products based on new
or emerging technologies. Moreover, several established electronics and
semiconductor suppliers have recently entered or indicated an intent to enter
the switching and routing equipment market. In addition, many of the Company's
existing and potential customers, including Cisco, internally develop ASICs,
general purpose processors, network processors and other devices which attempt
to perform all or a portion of the functions performed by the Company's
products.
 
INTELLECTUAL PROPERTY
 
  The Company's future success and ability to compete are dependent, in part,
upon its proprietary technology. The Company has been granted one patent in
the United States, the claims of which cover certain aspects of its ViX
architecture, and has received notice that two additional patents will issue.
In addition, the Company has filed 24 other patent applications, 13 in the
United States and 11 outside the United States, relating to other aspects of
systems employing the ViX architecture. None of the Company's patent
applications relate to specific products of the Company, such as the ATMS2000
and PS1000 lines of network processors, as the Company believes that it may be
more effective to seek patent protection with respect to its key underlying
technologies, such as aspects of its ViX Architecture.
 
  In addition, the Company claims copyright protection for certain proprietary
software and documentation. The Company also attempts to protect its trade
secrets and other proprietary information through agreements with its
customers, suppliers, employees and consultants, and through other security
measures. Although the Company intends to protect its rights vigorously, there
can be no assurance that these measures will be successful. In addition, the
laws of certain countries in which the Company's products are or may be
manufactured or sold, including Japan and Taiwan, may not protect the
Company's products and intellectual property rights to the same extent as the
laws of the United States.
 
  While the Company's ability to compete may be affected by its ability to
protect its intellectual property, the Company believes that, because of the
rapid pace of technological change in the networking industry, its technical
expertise and ability to introduce new products on a timely basis will be more
important in maintaining its competitive position than protection of its
intellectual property and that patent, trade secret and copyright protection
are important but must be supported by expanding the knowledge, ability and
experience of the Company's personnel and introducing and enhancing products.
Although the Company continues to implement protective measures and intends to
defend vigorously its intellectual property rights, there can be no assurance
that these measures will be successful. See Item 3--Legal Proceedings.
 
EMPLOYEES
 
  As of December 31, 1997, the Company had a total of 88 full-time employees
and 3 full-time contractors. Of the total number of employees, 45 were in
research and development, 17 in marketing and technical support,
 
                                      10
<PAGE>
 
nine in sales and 17 in operations and administration. The Company's employees
are not represented by any collective bargaining agreement, and the Company
has never experienced a work stoppage. The Company believes its employee
relations are good.
 
                EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY
 
  The following table sets forth certain information regarding the executive
officers and directors of the Company as of December 31, 1997.
 
<TABLE>
<CAPTION>
          NAME           AGE POSITION
          ----           --- --------
<S>                      <C> <C>
Prabhat K. Dubey........ 47  President, Chief Executive Officer and Director
Amos Wilnai............. 58  Chairman of the Board, Executive Vice President, Business Development
Sena C. Reddy........... 49  Executive Vice President, Operations
Uday Bellary............ 43  Vice President, Finance, Chief Financial Officer and Assistant Secretary
Alexander Joffe......... 40  Vice President, Engineering
Brent R. Bilger......... 40  Vice President, Marketing
John A. Teegen.......... 39  Vice President, Sales
John G. Adler(1)........ 60  Director
Irwin Federman(2)....... 62  Director
Andrew S. Rappaport(2).. 40  Director
Geoffrey Y. Yang(1)..... 38  Director
</TABLE>
--------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
 
  Prabhat K. Dubey has served as the Company's President and Chief Executive
Officer, and as a director, since he joined the Company in October 1994. From
March 1994 to August 1994, Mr. Dubey was the Chief Operating Officer of
Wireless Access, Inc., a supplier of communications devices and chip sets.
From August 1989 to March 1994, he served as Vice President and General
Manager of the Wireless & Messaging DSP IC Group at Lucent Technologies, a
communications products company and former subsidiary of AT&T Corporation. Mr.
Dubey holds a Ph.D. in Physics from the Indian Institute of Technology and an
M.B.A. from the University of Western Ontario.
 
  Amos Wilnai has served as the Chairman of the Board of Directors since he
founded the Company in September 1992. Since September 1994, Mr. Wilnai has
also served as the Company's Executive Vice President of Business Development.
From September 1992 to October 1994, he was the President of the Company. Mr.
Wilnai has a B.S.E.E. degree from the Technion Institute of Technology in
Israel and an M.S.E.E. degree from the Polytechnic Institute in Brooklyn.
 
  Sena C. Reddy has served as the Company's Executive Vice President of
Operations since he joined the Company in January 1997. Prior to joining the
Company, Mr. Reddy spent more than 11 years at Cirrus Logic Inc., a
semiconductor company, where he served as the Senior Vice President of
Operations from April 1994 to January 1997, Vice President of Manufacturing
from July 1991 to April 1994 and the Director of Wafer Fabrication and
Technology from September 1985 to June 1991. Mr. Reddy holds an M.S.E.E.
degree from Oklahoma State University.
 
  Uday Bellary joined the Company as its Vice President and Chief Financial
Officer in September 1997. From February 1997 until joining the Company, Mr.
Bellary served as Vice President, Finance & Administration and Chief Financial
Officer of DTM Corporation, a manufacturer of computer-driven laser systems
for industrial prototyping. From May 1990 to December 1996, Mr. Bellary served
in various positions at Cirrus Logic Inc., a semiconductor company, most
recently as Director of Finance. Mr. Bellary holds a B.S. degree from Karnatak
University and a DMA from the University of Bombay. He is also a chartered
accountant and a certified public accountant.
 
                                      11
<PAGE>
 
  Alexander Joffe has served as the Company's Vice President of Engineering
since July 1994. From March 1993 to July 1994, Mr. Joffe was the Company's
Director of Engineering. Prior to joining the Company, Mr. Joffe spent more
than eight years with Motorola Semiconductor Products, a semiconductor
manufacturing subsidiary of Motorola, Inc., where he served most recently as
an engineering manager. Mr. Joffe holds a B.S.E.E. degree from the Technion
Institute of Technology in Israel.
 
  Brent R. Bilger has served as the Company's Vice President of Marketing
since joining the Company in April 1997. Prior to joining the Company, Mr.
Bilger spent more than seven years with Cisco, a network equipment vendor,
where he served most recently as the Director of Marketing for service
providers. Mr. Bilger also served as the Director of Marketing of high-end
routers and ATM products during part of his tenure at Cisco. Mr. Bilger
received a B.A. degree from Dartmouth College, a B.E. degree from Thayer
School of Engineering, Dartmouth College, and an M.S.E.E. degree from Cornell
University.
 
  John A. Teegen has served as the Company's Vice President of Sales since
joining the Company in January 1997. From August 1994 to January 1997, Mr.
Teegen was the Vice President of Worldwide Sales for Intellon Corporation, a
semiconductor company. From August 1987 to August 1994, Mr. Teegen was
employed by VLSI Technology, Inc., also a semiconductor company, where he
served in a variety of sales management positions, most recently as the Vice
President of Consumer and Industrial Sales. Mr. Teegen holds a B.S.E.E. degree
from the University of Florida.
 
  John G. Adler has served as a director of the Company since March 1997. Mr.
Adler served as the Chairman of the Board of Directors of Adaptec, Inc., an
electronic equipment manufacturing company, from May 1990 through August 1997.
Mr. Adler also served as the President of Adaptec, Inc. from May 1985 to
August 1992 and as its Chief Executive Officer from December 1986 to July
1995. Mr. Adler holds a B.S.E.E. degree from University of Mississippi and was
a Sloan Executive Fellow at Stanford University in 1971.
 
  Irwin Federman has served as a director of the Company since July 1994. Mr.
Federman has been a general partner of U.S. Venture Partners, a venture
capital firm, since April 1990. From 1988 to 1990 he was a Managing Director
of Dillon Read & Co., an investment banking firm, and a general partner in its
venture capital affiliate, Concord Partners. Mr. Federman also serves on the
boards of directors of SanDisk Corporation, a memory systems company, Western
Digital Corporation, a disk drive manufacturer, Komag Incorporated, a thin
film media manufacturer, NeoMagic Corporation, a developer of multimedia
accelerators, Checkpoint Software Technology, Ltd., a network security
software company and several privately-held companies. Mr. Federman received a
B.S. degree in Economics from Brooklyn College and was awarded an honorary
Doctorate of Engineering Science from Santa Clara University.
 
  Andrew S. Rappaport has served as a director of the Company since July 1994.
Mr. Rappaport has been a partner of August Capital, LLC, a venture capital
firm, since July 1996. Prior to that time, Mr. Rappaport was the President of
The Technology Research Group, Inc., a Boston-based strategic management
consulting firm which he founded in August 1984. Mr. Rappaport attended
Princeton University.
 
  Geoffrey Y. Yang has served as a director of the Company since July 1994.
Mr. Yang has been a general partner of Institutional Venture Partners, a
venture capital firm, since June 1989. He also serves on the Board of
Directors of Excite, Inc., an Internet navigation service, and numerous
private companies. Mr. Yang holds a B.A. in Economics from Princeton
University, a B.S.E. in Engineering and Management Systems from Princeton
University, as well as an M.B.A. from Stanford University.
 
  There are no family relationships among any of the Company's directors or
executive officers.
 
                              ITEM 2. PROPERTIES
 
  The Company's main executive, administrative and technical offices occupy
approximately 35,000 square feet in Sunnyvale, California, under a lease that
expires in March 1999. Effective December 1, 1997, the
 
                                      12
<PAGE>
 
Company entered into a lease in Chelmsford, Massachusetts for approximately
4,000 square feet that expires in November 2002, which houses sales and
customer support personnel. The Company believes that its existing facilities
are adequate to meet its requirements through 1998.
 
                           ITEM 3. LEGAL PROCEEDINGS
 
  On October 27, 1997, FORE Systems, Inc. filed a complaint in the United
States District Court for the Western District of Pennsylvania alleging that
the Company willfully infringed two of FORE's patents. The complaint seeks
both a preliminary and a permanent injunction against the Company, as well as
recovery of damages. On December 17, 1997, FORE filed an amended complaint
alleging patent infringement of an additional patent, seeking identical relief
on all three patents and, in addition, FORE alleged trade secret
misappropriation against MMC seeking preliminary and permanent injunctive
relief as well as recovery of damages. On January 9, 1998, MMC filed a motion
to dismiss or transfer the Pennsylvania action and to transfer the case to the
Northern District of California. This motion is currently pending. The results
of litigation are inherently uncertain, and there can be no assurance that the
Company will prevail in any litigation with FORE. An adverse result in the
FORE litigation could have a material adverse effect on the Company's
business, financial condition and results of operations.
 
  In the normal course of business, the Company has been named as defendant in
certain actions and could incur liability from such actions; however, any such
liability is not determinable or estimable and in the opinion of management,
the outcome of such litigation is not expected to have a material adverse
effect on the results of operations and financial condition of the Company.
 
          ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  Not applicable.
 
                                      13
<PAGE>
 
                                    PART II
 
                 ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
                        AND RELATED STOCKHOLDER MATTERS
 
  The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "MMCN." The following table sets forth the range of the high and low
sale prices by quarter as reported on the Nasdaq National Market since October
29, 1997, the date the Common Stock commenced trading.
 
<TABLE>
<CAPTION>
   QUARTER                                                       HIGH    LOW
   -------                                                       ----  --------
   <S>                                                           <C>   <C>
   1997: Fourth Quarter (from October 29, 1997).................  $28   $12 5/8
</TABLE>
 
  As of March 13, 1998, the number of common stockholders of record was 166.
The Company currently intends to retain any earnings for use in its business
and does not anticipate paying any cash dividends in the foreseeable future.
 
  On October 28, 1997, the Company commenced and completed its initial public
offering (the "IPO") of 4,025,000 shares (including the exercise of the
underwriters' over-allotment option consisting of 525,000 shares) of its
Common Stock, $0.001 par value per share, at a public offering price of $11.00
per share pursuant to a registration statement on Form S-1 (file no. 333-
34005) filed with the Securities and Exchange Commission. All of the shares
registered were sold. Morgan Stanley Dean Witter, Deutsche Morgan Grenfell and
Wessels, Arnold & Henderson were the managing underwriters of the IPO.
 
  The following table indicates the amount and aggregate offering price of the
Common Stock registered and sold in the IPO for the account of the Company.
There were no selling stockholders in the IPO.
 
<TABLE>
<CAPTION>
                                        AGGREGATE PRICE OF                      AGGREGATE
                            AMOUNT       OFFERING AMOUNT                    OFFERING PRICE OF
   TITLE OF SECURITY      REGISTERED        REGISTERED       AMOUNT  SOLD      AMOUNT SOLD
   -----------------      ----------    ------------------   ------------   -----------------
   <S>                 <C>              <C>                <C>              <C>
   Common Stock,
    $0.001 par value   4,025,000 shares    $44,275,000     4,025,000 shares    $44,275,000
</TABLE>
 
  The following table lists the amount of expenses incurred for the Company's
account in connection with the issuance and distribution of the Common Stock
issued in the IPO.
 
<TABLE>
<CAPTION>
                            DIRECT OR INDIRECT PAYMENTS TO DIRECTORS
                            OR OFFICERS OF THE COMPANY OR THEIR
                            ASSOCIATES; TO PERSONS OWNING TEN PERCENT
                            OR MORE OF ANY CLASS OF EQUITY SECURITIES
                            OF THE COMPANY; AND TO AFFILIATES OF THE  DIRECT OR INDIRECT
                            COMPANY                                   PAYMENTS TO OTHERS
                            ----------------------------------------- ------------------
   <S>                      <C>                                       <C>
   Underwriting discounts
    and commissions........                     $0                       $ 3,099,250
   Finders' fees...........                     $0                       $         0
   Expenses paid to or for
    underwriters...........                     $0                       $         0
   Other expenses through
    December 31, 1997......                     $0                       $ 1,103,533
                                               ---                       -----------
   Total expenses..........                     $0                       $ 4,202,783
   Net Proceeds of IPO.....                                              $40,072,217
                                                                         ===========
</TABLE>
 
                                      14
<PAGE>
 
  The following table lists the amount of net offering proceeds to the Company
used for each of the purposes listed below for the period from October 28,
1997, the effective date of the registration statement, through December 31,
1997.
<TABLE>
<CAPTION>
                             DIRECT OR INDIRECT PAYMENTS TO DIRECTORS
                             OR OFFICERS OF THE COMPANY OR THEIR
                             ASSOCIATES; TO PERSONS OWNING TEN
                             PERCENT OR MORE OF ANY CLASS OF EQUITY
                             SECURITIES OF THE COMPANY; AND TO        DIRECT OR INDIRECT
                             AFFILIATES OF THE COMPANY                PAYMENTS TO OTHERS
                             ---------------------------------------- ------------------
   <S>                       <C>                                      <C>
   Construction of plant,
    building and
    facilities.............                    $ 0                       $         0
   Purchase and
    installation of
    machinery and
    equipment..............                     $0                       $         0
   Purchase of real estate.                     $0                       $         0
   Acquisition of other
    business(es)...........                     $0                       $         0
   Repayment of
    indebtedness...........                     $0                       $         0
   Working capital.........                     $0                       $   500,000
   TEMPORARY INVESTMENT
    (SPECIFY)
   Asset-backed securities.                    $ 0                       $ 2,000,000
   Municipal bonds.........                    $ 0                       $ 8,601,296
   Commercial paper........                    $ 0                       $28,970,921
   OTHER PURPOSES (SPECIFY)
   Acquisition of minority
    equity interests in
    other corporations.....                     $0                       $         0
</TABLE>
 
                                      15
<PAGE>
 
                        ITEM 6. SELECTED FINANCIAL DATA
 
  The selected financial data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Financial Statements and notes thereto included
elsewhere in this Report.
 
<TABLE>
<CAPTION>
                                             YEAR ENDED DECEMBER 31,
                                    --------------------------------------------
                                      1997     1996     1995     1994     1993
                                    -------- -------- --------  -------  -------
STATEMENT OF OPERATIONS DATA:         (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                 <C>      <C>      <C>       <C>      <C>
Revenues..........................  $ 21,930 $ 10,515 $    577  $   165  $   --
Cost of revenues..................     6,542    3,576      304       23      --
                                    -------- -------- --------  -------  ------
    Gross profit..................    15,388    6,939      273      142      --
                                    -------- -------- --------  -------  ------
Operating expenses:
  Research and development, net...     8,318    3,312    1,802      132    (186)
  Selling, general and
   administrative.................     6,240    3,225    1,151      298     184
                                    -------- -------- --------  -------  ------
    Total operating expenses......    14,558    6,537    2,953      430      (2)
                                    -------- -------- --------  -------  ------
Operating income (loss)...........       830      402   (2,680)    (288)      2
  Interest income, net............       504      317      104       62       5
                                    -------- -------- --------  -------  ------
Income (loss) before income taxes.     1,334      719   (2,576)    (226)      7
Provision for income taxes........       138       17       --       --      --
                                    -------- -------- --------  -------  ------
Net income (loss).................  $  1,196 $    702 $ (2,576) $  (226) $    7
                                    ======== ======== ========  =======  ======
Basic income per share(1).........  $   0.08 $   0.07 $  (0.38) $ (0.04) $ 0.00
                                    ======== ======== ========  =======  ======
Shares used to compute basic
 income per share(1)..............    14,432   10,652    6,808    6,081   6,075
                                    ======== ======== ========  =======  ======
Diluted income per share(1).......  $   0.04 $   0.03 $  (0.38) $ (0.04) $ 0.00
                                    ======== ======== ========  =======  ======
Shares used to compute diluted
 income per share(1)..............    29,113   25,745    6,808    6,081   6,075
                                    ======== ======== ========  =======  ======
</TABLE>
 
 
<TABLE>
<CAPTION>
                                                        DECEMBER 31,
                                              ---------------------------------
                                               1997    1996   1995   1994  1993
                                              ------- ------ ------ ------ ----
BALANCE SHEET DATA:                                     (IN THOUSANDS)
<S>                                           <C>     <C>    <C>    <C>    <C>
Cash, cash equivalents and short-term
 investments................................. $45,401 $6,318 $8,102 $2,920 $23
Working capital..............................  46,159  7,113  7,177  2,777  19
Total assets.................................  54,723 10,676  9,527  3,322  33
Long-term obligations........................     286    636    301    100  --
Total stockholders' equity...................  49,717  8,177  7,446  2,830  19
</TABLE>
--------
(1) For an explanation of the number of shares used to compute basic and
    diluted net income per share, see Note 2 of Notes to Financial Statements.
 
                                      16
<PAGE>
 
           ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
 
                      CONDITION AND RESULTS OF OPERATIONS
 
  This section and other parts of this Report contain forward-looking
statements that involve risks and uncertainties. The Company's actual results
may differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed in the subsection entitled "Factors Affecting
Future Results" commencing on page 21. The following discussion of the
financial condition and results of operations of the Company should be read in
conjunction with the Financial Statements and the Notes thereto included
elsewhere in this Report.
 
OVERVIEW
 
  MMC Networks is a leading developer and supplier of network processors--
high-performance, open-architecture, software-programmable processors
optimized for networking applications. From its inception in September 1992
through late 1995, the Company was engaged principally in research and
development, and a substantial portion of the Company's operating expenses
during such period was related to such research and development activities.
The Company commenced volume shipments of its ATMS2000 products in late 1995
and of its PS1000 products in 1996. The Company's operating results in 1997
reflect increased market acceptance and sales of the Company's products. The
Company recognizes revenue at the time of product shipment to its customers.
Product returns and sales allowances, which have not been significant through
December 31, 1997, are estimated and provided for at the time of sale.
 
  Substantially all of the Company's revenues have been derived from sales of
its ATMS2000 and PS1000 product families to a small number of customers. Sales
to the Company's three largest customers in 1997, 1996 and 1995 accounted for
68%, 76% and 71% of total revenues, respectively. The largest of these
customers is Cisco, which accounted for approximately 28%, 51% and 48% of
total revenues in 1997, 1996 and 1995, respectively. The decrease in the
percentage of revenues attributable to Cisco is primarily the result of the
significant increase in revenues from other customers. The level of sales to
any customer can vary substantially from period to period based on the
customer's product development cycle. The Company expects that significant
customer concentration will continue for the foreseeable future. As a result,
the Company's business, financial condition and operating results may be
materially adversely affected by any cancellation, delay or deferral of orders
by any of its significant customers. See "Factors Affecting Future Results--
Customer Concentration."
 
  The Company markets and sells its products primarily through a direct sales
and marketing organization. Substantially all of the Company's sales to date
have been to customers located in the United States, including sales to U.S.-
based affiliates of non-U.S. network equipment vendors. The Company has sales
representatives in the United States, Canada, Israel, Japan, Taiwan and the
United Kingdom.
 
                                      17
<PAGE>
 
RESULTS OF OPERATIONS
 
  The following table sets forth certain financial data for the years ended
December 31, 1997, 1996 and 1995 expressed as a percentage of the Company's
revenues.
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                                                    --------------------------
                                                     1997     1996      1995
                                                    -------  -------  --------
   <S>                                              <C>      <C>      <C>
   STATEMENT OF OPERATIONS DATA:
   Revenues........................................   100.0%   100.0%    100.0%
   Cost of revenues................................    29.8%    34.0%     52.7%
                                                    -------  -------  --------
       Gross profit................................    70.2%    66.0%     47.3%
                                                    -------  -------  --------
   Operating expenses:
     Research and development, net.................    37.9%    31.5%    312.3%
     Selling, general and administrative...........    28.5%    30.7%    199.5%
                                                    -------  -------  --------
       Total operating expenses....................    66.4%    62.2%    511.8%
                                                    -------  -------  --------
   Operating income (loss).........................     3.8%     3.8%   (464.5%)
     Interest income, net..........................     2.3%     3.0%     18.1%
                                                    -------  -------  --------
   Income (loss) before income taxes...............     6.1%     6.8%   (446.4%)
   Provision for income taxes......................     0.6%     0.1%      0.0%
                                                    -------  -------  --------
   Net income (loss)...............................     5.5%     6.7%   (446.4%)
                                                    =======  =======  ========
</TABLE>
 
YEARS ENDED DECEMBER 31, 1997 AND 1996
 
  Revenues. Revenues increased to $21.9 million for the year ended December
31, 1997 from $10.5 million for the year ended December 31, 1996. This
increase in revenues reflects the increased acceptance of the Company's
ATMS2000 and PS1000 families of network processors by new and existing
customers.
 
  Cost of Revenues; Gross Profit. Cost of revenues increased to $6.5 million
for the year ended December 31, 1997 from $3.6 million for the year ended
December 31, 1996 as a result of manufacturing costs associated with increased
sales of the Company's network processors to new and existing customers,
including volume shipments of the Company's PS1000 product family. Gross
margin increased to 70.2% for the year ended December 31, 1997 from 66.0% for
the year ended December 31, 1996. Gross margin was lower in 1996 as a result
of higher costs associated with the commencement of volume production during
this period. The Company anticipates that gross margins will decrease slightly
in 1998 as changes in product mix and increased competition, especially with
regards to the more price-sensitive products such as the PS1000 family, exert
pressure on the Company's gross margins.
 
  Research and Development Expenses, Net. Net research and development
expenses increased to $8.3 million for the year ended December 31, 1997 from
$3.3 million for the year ended December 31, 1996 due to the addition of
research and development personnel and associated costs. As a percentage of
total revenues, research and development expenses were 37.9% and 31.5% for the
years ended December 31, 1997 and 1996, respectively, reflecting a substantial
increase in the Company's investment in research and new product development
in 1997. In 1998, the Company expects research and development expenses to
continue to increase in absolute dollars.
 
  Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $6.2 million for the year ended December
31, 1997 from $3.2 million for the year ended December 31, 1996 due to several
factors: increased sales commissions on higher sales, increased product
marketing costs associated with new products, additional personnel, higher
costs associated with the Company's new headquarters facility, the
establishment of a sales office in Massachusetts and additional costs
associated with being a public company.
 
                                      18
<PAGE>
 
In 1998, the Company expects selling, general and administrative expenses to
continue to increase in absolute dollars.
 
  Interest Income, net. Interest income reflects interest earned on average
cash, cash equivalents and short-term investment balances. Interest income was
$630,000 and $427,000 for the years ended December 31, 1997 and 1996,
respectively, reflecting an increase in cash balances and investments from
period to period, due primarily to receipt of net proceeds from the Company's
IPO. Interest expense reflects interest on borrowings against lease lines to
finance the acquisition of capital equipment. Interest expense was $126,000
and $110,000 for the years ended December 31, 1997 and 1996, respectively.
 
  Provision for Income Taxes. The provision for income taxes in 1997 reflects
an effective rate of 10.3%, up from 2.4% in 1996. The federal and state income
taxes payable in 1997 and 1996 relate to federal and state alternative minimum
taxes and certain other permanent tax adjustments. Management expects the
effective tax rate for 1998 to increase as compared to the current year.
 
YEARS ENDED DECEMBER 31, 1996 AND 1995
 
  Revenues. Revenues for 1996 and 1995 were $10.5 million and $577,000,
respectively. The Company commenced sales of its network processors in late
1995 and substantially increased shipments to its customers in 1996.
 
  Cost of Revenues; Gross Profit. Cost of revenues was $3.6 million and
$304,000 in 1996 and 1995, respectively, reflecting increased sales in these
periods. Gross margin was 66.0% and 47.3% for 1996 and 1995, respectively. In
1995, the Company commenced shipments of its first ATMS2000 products, and the
cost of revenues reflected the related start-up manufacturing costs during
this period. In 1996, increased gross margin reflected increased production
volumes resulting in lower unit prices paid to the Company's contract
manufacturers.
 
  Research and Development Expenses, Net. Net research and development
expenses were $3.3 million and $1.8 million in 1996 and 1995, respectively.
Research and development expenses as a percentage of revenues were 31.5% and
312.3% in 1996 and 1995, respectively. The increase in research and
development expenses in absolute dollars primarily reflected the addition of
personnel and related costs during these periods. The decrease in research and
development expenses as a percentage of revenues in 1996 reflected the
substantial increase in product shipments in 1996.
 
  Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $3.2 million and $1.2 million in 1996 and 1995,
respectively. The increase in absolute dollars was due to several factors;
increased commissions on higher sales, increased product marketing costs
associated with new products, additional personnel, costs associated with the
Company's new facility commencing in September 1996 and the establishment of a
sales office in Boston. Selling, general and administrative expenses as a
percentage of total revenues were 30.7% and 199.5% in 1996 and 1995,
respectively. The decrease in selling, general and administrative expenses as
a percentage of revenues reflected the substantial increase in product
shipments in 1996.
 
  Interest Income, net. Interest income totaled $427,000 and $146,000 in 1996
and 1995, respectively. The increase reflects interest earned on higher
balances of cash, cash equivalents and short-term investments resulting from
sales of Preferred Stock in November 1995. Interest expense totaled $110,000
and $42,000 in 1996 and 1995, respectively. The increase in interest expense
resulted from increased borrowing against established lease lines to finance
the acquisition of capital equipment.
 
  Provision for Income Taxes. The provision for income taxes of $17,000 in
1996 represents federal and state alternative minimum taxes. No current
provisions for income taxes were recorded in 1995 as the Company incurred net
operating losses for income tax purposes from July 12, 1994, the date on which
the Company elected
 
                                      19
<PAGE>
 
to be taxed as a Subchapter C corporation, through December 31, 1995. In
addition, no deferred benefit for income taxes was recorded in 1995 as the
Company was in a net deferred tax asset position for which a full valuation
allowance was provided.
 
RECENT ACCOUNTING PRONOUNCEMENTS
 
  In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes
standards for the reporting of comprehensive income and its components in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income, as defined, includes all changes
in equity (net assets) during a period from nonowner sources. Examples of
items to be included in comprehensive income, which are excluded from net
income, include foreign currency translation adjustments and unrealized
gain/loss on available-for-sale securities. The disclosures prescribed by SFAS
130 are effective beginning with the first quarter of calendar 1998. The
adoption of SFAS 130 in 1998 is not expected to have a material impact on the
Company's financial statements.
 
  In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures About Segments of an Enterprise and Related Information"
("SFAS 131"). This statement establishes standards for the way companies
report information about operating segments in annual financial statements. It
also establishes standards for related disclosures about products and
services, geographic areas and major customers. The disclosures prescribed by
SFAS 131 are effective for calendar 1998. The adoption of SFAS 131 in 1998 is
not expected to have a material impact on the Company's financial statements.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  The Company's cash and cash equivalents increased during 1997 by $40.6
million due primarily to receipt of net proceeds from the IPO of $40.1
million. Net cash provided by operating activities in 1997 of $2.4 million was
the result of net income from operations adjusted for depreciation and
amortization and an increase of accounts payable year over year for a total of
approximately $4.4 million which was partially offset by an increase in
accounts receivable of $2.5 million. Net cash used in investing activities in
1997 was $1.7 million and was due to the sale of short-term investments of
$1.5 million offset by the purchase of capital equipment of $3.2 million. The
net increase in cash and cash equivalents during 1996 of $4.6 million was
primarily attributable to the sale of short-term investments of $6.3 million
partially offset by an increase in accounts receivable of $1.4 million. The
net decrease in cash and cash equivalents during 1995 of $338,000 primarily
resulted from the net loss from operations of $2.6 million and the purchase of
short-term investments of $5.5 million offset by the proceeds from the
issuance of Preferred Stock of $7.2 million.
 
  The Company had working capital of $46.1 million at December 31, 1997 as
compared to $7.1 million at December 31, 1996, and the Company's current ratio
improved to 10.8 to 1 as of December 31, 1997 from 4.8 to 1 as of December 31,
1996.
 
  In April 1997, the Company entered into a $5.0 million revolving bank credit
facility, which bears interest at the bank's prime rate, and a $3.0 million
bank lease line, which bears interest at the bank's prime rate plus .5%. Both
facilities expire in April 1998. At December 31, 1997, there were no
borrowings outstanding under either facility. As of that date, however, the
Company had $636,000 in borrowings under two prior lease facilities. See Notes
4 and 10 of Notes to Financial Statements.
 
  Through December 31, 1997, the Company had acquired approximately $5.4
million in capital assets. A portion of the Company's future capital
expenditures will be devoted to enhancing and expanding the Company's
operational, financial and management information systems. Capital
expenditures through 1998 are expected to be funded in part out of working
capital, and in part through existing and future credit and lease facilities.
 
  The Company uses a number of independent suppliers to manufacture
substantially all of its products. As a result, the Company relies on these
suppliers to allocate to the Company a sufficient portion of foundry capacity
 
                                      20
<PAGE>
 
to meet the Company's needs and deliver sufficient quantities of the Company's
products on a timely basis. See "Factors Affecting Future Results --Dependence
on Independent Manufacturers." These arrangements allow the Company to avoid
utilizing its capital resources for manufacturing facilities and work-in-
process inventory and focus substantially all of its resources on the design,
development and marketing of its products. The Company expects to assume more
responsibility for managing product manufacturing in the future, which may
entail additional expenditures. The Company anticipates that any such
expenditures will be funded by working capital.
 
  The Company believes that the net proceeds of the IPO, together with its
existing cash balances and available line of credit and cash flow expected to
be generated from future operations, will be sufficient to meet the Company's
capital requirements through the next twelve months, although the Company
could be required, or could elect, to seek to raise additional capital before
such time. This estimate is a forward-looking statement and the actual period
of time for which the Company's 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 and 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 and market acceptance of the Company's products. There can
be no assurance that additional equity or debt financing, if required, will be
available on acceptable terms or at all.
 
IMPACT OF THE YEAR 2000 ISSUE
 
  The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including among other
things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
 
  During the first quarter of 1998, initial contact with both the Company's
accounting system representatives and its significant outside suppliers
indicates Year 2000 compliance and, as such, the Company does not expect to be
required to modify or replace significant portions of its software to properly
utilize dates beyond December 31, 1999. The Company has adopted a Year 2000
plan which includes comprehensive testing of all critical systems for Year
2000 compliance by June 1999. In addition, the plan provides for a full
assessment of any potential Year 2000 issues, if any, related to software
embedded in the Company's products. This assessment is expected to be
completed prior to the release of the Company's Year 2000 Statement covering
the compliance of its products with respect to Year 2000 issues, which is
scheduled for June 1998.
 
  Costs related to the Company's Year 2000 plan will be expensed as incurred
and are not currently expected to have a material effect on the results of
operations of the Company. The Company's estimate of costs related to Year
2000 compliance is a forward-looking statement that is subject to risks and
uncertainties that could cause actual costs to be higher, including whether
management's assumptions of future events prove to be correct.
 
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.
 
  Limited Operating History; No Assurance of Future Profitability. Although
the Company has experienced significant revenue growth in recent periods and
first achieved profitability in the first quarter of 1996, these results
should not be considered indicative of future revenue growth, if any, nor is
there any assurance that the Company will be profitable in any future period.
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, with an
 
                                      21
<PAGE>
 
additional nine to 18 months or more before a network equipment vendor
customer commences volume production of equipment which incorporates the
Company's products. As a result, there may be a significant delay between the
Company increasing its research and development and sales and marketing
expenses and its 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 and
continue to commercialize products incorporating innovative technologies.
There can be no assurance that the Company will be successful in doing so.
 
  Fluctuations in Operating Results. Fluctuations in the Company's operating
results have occurred in the past and are likely to occur in the future due to
a variety of factors, any of which may have a material adverse effect on the
Company's operating results. In particular, the Company's quarterly results of
operations may vary significantly due to general business conditions in the
networking equipment and semiconductor industries, changes in demand for the
network equipment products of the Company's customers, the timing and amount
of orders from the Company's network equipment vendor customers, cancellations
or delays of customer product orders, new product introductions by the Company
or its competitors, cancellations, changes or delays of deliveries of products
to the Company by its suppliers, increases in the costs of products from the
Company's suppliers, fluctuations in product life cycles, price erosion,
competition, changes in the mix of products sold by the Company, availability
of semiconductor foundry capacity, variances in the timing and amount of
nonrecurring engineering funding and operating expenses, seasonal fluctuations
in demand, intellectual property disputes and general economic conditions. The
Company has at times recognized a substantial portion of its revenues in the
last month of a quarter. Since a large portion of the Company's operating
expenses, including rent, salaries and capital lease expenses, is fixed and
difficult to reduce or modify, if revenue does not meet the Company's
expectations, the material adverse effect of any revenue shortfall will be
magnified by the fixed nature of these operating expenses. All of the above
factors are difficult for the Company to forecast, and these and other factors
could have a material adverse effect on the Company's business, financial
condition and results of operations.
 
  Dependence Upon Development of the Market for Network Processors. The
Company's future prospects are dependent upon the acceptance of network
processors as an alternative to the Application-Specific Integrated Circuit
("ASIC") components and general purpose processors traditionally utilized by
network equipment vendors. The Company's future prospects are also dependent
upon acceptance by the Company's customers of third party sourcing for network
processors as an alternative to in-house development. Many of the Company's
current and potential customers have substantial technological capabilities
and financial resources and currently develop internally the ASIC components
and program the general purpose processors utilized in their products. These
customers may in the future continue to utilize internally-developed ASIC
components and general purpose processors or may determine 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 such network equipment vendors and must successfully develop
and manufacture products that meet these requirements. In addition, the
Company must make products available to such 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.
 
  Customer Concentration. The Company's customer base is highly concentrated.
A relatively small number of customers has accounted for a significant portion
of the Company's revenues to date, and the Company expects that this trend
will continue for the foreseeable future. Each of the Company's network
equipment vendor customers, including Cisco and Hitachi, can cease
incorporating the Company's products with limited notice to the Company and
with little or no penalty. The Company's agreements with network equipment
vendor customers do not require minimum purchases. Pursuant to the Company's
agreements with Cisco and certain of its other customers, under certain
circumstances, such customers have the right to manufacture the Company's
 
                                      22
<PAGE>
 
network processors for resale as part of their products or to otherwise use
proprietary technology of the Company in their products. The circumstances in
which customers have such rights include certain defaults by the Company, a
change of control of the Company and certain other events relating to the
Company's inability, or potential inability, to supply products to such
customers. In any such event, the Company will not necessarily be entitled to
royalty payments or fees for use of its technology. The obligation of
customers to pay royalties, if any, may be dependent upon the customer's
ability to obtain products at a price lower than that previously charged by
the Company to the customer.
 
  The Company's longstanding relationship with Cisco may inhibit other leading
network equipment vendors from adopting the Company's network processors.
Cisco faces intense competition from vendors such as Bay Networks, Inc., 3Com
Corporation and FORE, none of which currently uses the Company's network
processors. Accordingly, the Company's future operating results may be
substantially dependent on Cisco's competitive position in the networking
equipment market. Any reduction or delay in sales of the Company's products to
its network equipment vendor customers could have a material adverse effect on
the Company's business, operating results and financial condition. There can
be no assurance that the Company will retain its current network equipment
vendor customers or that it will be able to recruit additional customers. The
loss of one or more of the Company's customers or the inability of the Company
to successfully develop relationships with additional significant network
equipment vendors could have a material adverse effect on the Company's
business, financial condition and results of operations.
 
  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 ASP erosion. The Company anticipates that ASPs will decrease in
the future in response to product introductions by competitors or the Company
or other factors, including 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 which incorporate features that can be sold at higher ASPs.
Failure to achieve any or all of the foregoing 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. Accordingly,
the Company's future performance depends on a number of factors, including the
Company's ability to identify emerging technological trends in its target
markets, develop and maintain competitive products, enhance its products by
adding innovative features that differentiate its products from those of
competitors, bring products to market on a timely basis at competitive prices,
properly identify target markets and respond effectively to new technological
changes or new product announcements by others. No assurance can be given that
the Company's design and introduction schedules for any additions and
enhancements to its existing and future products will be met, that these
products will achieve market acceptance, or that the Company will be able to
sell these products at ASPs that are favorable to the Company. In evaluating
new product decisions, the Company must anticipate well in advance future
demand for product features and performance characteristics, as well as
available supporting technologies, manufacturing capacity, industry standards
and competitive product offerings. The technical innovations required for the
Company to remain competitive must be completed before developments in
networking technologies or standards render them obsolete and must be
sufficiently compelling to induce network equipment vendors to favor them over
alternative technologies. Moreover, the Company must generally incur
substantial research and development costs before the technical feasibility
and commercial viability of a product line can be ascertained. There can be no
assurance that revenues from future products or product enhancements will be
sufficient to recover the development costs associated with such products or
enhancements, or that the Company will be able to secure the financial
resources necessary to fund future development. In particular, no assurance
can be given that the Company's AnyFlow product line
 
                                      23
<PAGE>
 
will become commercially available on a timely basis, will provide the
functional and performance advantages expected by customers, or will find
market acceptance. The failure to successfully develop new products on a
timely basis could have a material adverse effect on the Company's business,
financial condition and results of operations.
 
  Dependence on Independent Manufacturers. The Company outsources all
manufacturing, assembly and test of its network processors. The Company's
suppliers currently deliver fully assembled and tested products on a turnkey
basis. The semiconductor industry is highly cyclical and, in the past, foundry
capacity has been very limited at times and may become limited in the future.
Currently, only one of the Company's products is manufactured by more than one
supplier. The Company depends on its suppliers to deliver sufficient
quantities of finished product to the Company in a timely manner. Since the
Company places its orders on a purchase order basis and does not have a long-
term volume purchase agreement with any of its existing suppliers, these
suppliers may allocate, and in the past have allocated, capacity to the
production of other products while reducing deliveries to the Company on short
notice. The Company has recently experienced delays in obtaining an adequate
supply of certain of its products from one supplier, as well as certain
problems regarding the quality of the products delivered by that supplier, and
as a result has begun obtaining such products from an alternative supplier.
There can be no assurance that the Company will not have similar or more
protracted problems in the future with existing or new suppliers. In the event
of a loss of, or a decision by the Company to change, a key supplier or
foundry, qualifying a new supplier or foundry and commencing volume production
could involve delay and expense, resulting in lost revenues, reduced operating
margins and possible detriment to customer relationships and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
 
  Given that the Company must place orders approximately 12 to 14 weeks in
advance of expected delivery, any failure of global semiconductor
manufacturing capacity to increase in line with demand could cause foundries
to allocate available capacity to larger customers or customers with long-term
supply contracts. The inability of the Company to obtain adequate foundry
capacity at acceptable prices, or any delay or interruption in supply, could
reduce the Company's product revenues or increase the Company's cost of
revenues and could have a material adverse effect on the Company's business,
financial condition and results of operations.
 
  In the future, the Company expects to change its supply arrangements to
assume more of the product manufacturing responsibilities. The assumption of
greater manufacturing responsibilities involves additional risks including not
only the risks discussed above, but also risks associated with variances in
production yields, obtaining adequate test and assembly capacity at reasonable
cost and other general risks associated with the manufacture of
semiconductors. In addition, the Company also expects that it may enter into
volume purchase agreements pursuant to which the Company must commit to
minimum levels of purchases and which may require up-front investments. The
inability of the Company to effectively assume greater manufacturing
responsibilities or manage volume purchase arrangements could have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
  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 PS1000,
ATMS2000 and AF5000 product families compete with products from companies such
as Texas Instruments Incorporated, Lucent Technologies, Inc., PMC-Sierra Inc.,
Galileo Technology Ltd., Integrated Telecom Technology, Inc. and I-Cube, Inc.
In addition, the Company expects significant competition in the future from
major domestic and international semiconductor suppliers. The Company also may
face competition from suppliers of products based on new or emerging
technologies. Moreover, several established electronics and semiconductor
suppliers have recently entered or indicated an intent to enter the switching
and routing equipment market. In addition, many of the Company's existing and
potential customers internally develop ASICs, general purpose processors,
network processors and other devices which attempt to perform all or a portion
of the functions performed by the Company's products. Many of the Company's
current and prospective competitors offer broader product lines and have
significantly greater financial, technical,
 
                                      24
<PAGE>
 
manufacturing and marketing resources than the Company. Failure of the Company
to compete successfully could have a material adverse effect on its operating
results.
 
  Product Complexity. Products as complex as those offered by the Company
frequently contain errors, defects and bugs when first introduced or as new
versions are released. The Company has in the past experienced such errors,
defects and bugs. Delivery of products with production defects or reliability,
quality or compatibility problems could significantly delay or hinder market
acceptance of such products, which could damage the Company's reputation and
adversely affect the Company's ability to retain its existing customers and to
attract new customers. Moreover, such errors, defects or bugs could cause
problems, interruptions, delays or a cessation of sales to the Company's
customers. Alleviating such problems may require significant expenditures of
capital and resources by the Company. There can be no assurance that, despite
testing by the Company, its suppliers or its customers, errors, defects or
bugs will not be found in new products after commencement of commercial
production, resulting in additional development costs, loss of, or delays in,
market acceptance, diversion of technical and other resources from the
Company's other development efforts, claims by the Company's customers or
others against the Company, or the loss of credibility with the Company's
current and prospective customers. Any such event would have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
  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 and general economic conditions. There can be no assurance with respect
to the rate or extent to which the networking equipment market will grow, if
at all, nor can there be any assurance that the Company will not 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.
 
  Protection of Intellectual Property. The Company relies primarily on a
combination of nondisclosure agreements and other contractual provisions as
well as patent, trademark, trade secret and copyright law to protect its
proprietary rights. There can be no assurance that any patents will issue
pursuant to the Company's current or future patent applications or that
patents issued pursuant to such applications will not be invalidated,
circumvented, challenged or licensed to others. In addition, there can be no
assurance that the rights granted under any such patents will provide
competitive advantages to the Company or be adequate to safeguard and maintain
the Company's proprietary rights. Failure of the Company to enforce and
protect its intellectual property rights could have a material adverse effect
on the Company's business, financial condition and results of operations.
There can be no assurance that such intellectual property rights can be
successfully asserted in the future or will not be invalidated, circumvented
or challenged. From time to time, third parties, including competitors of the
Company, may assert patent, copyright and other intellectual property rights
to technologies that are important to the Company. There can be no assurance
that third parties will not assert infringement claims against the Company in
the future, that assertions by third parties will not result in costly
litigation or that the Company would prevail in any such litigation or be able
to license any valid and infringed patents from third parties on commercially
reasonable terms, if at all.
 
  On October 27, 1997, FORE filed a complaint in the United States District
Court for the Western District of Pennsylvania alleging that the Company
willfully infringed two of FORE's patents. The complaint seeks both a
preliminary and a permanent injunction against the Company, as well as
recovery of damages. On December 17, 1997, FORE filed an amended complaint
alleging patent infringement of an additional patent, seeking identical relief
on all three patents and, in addition, FORE alleged trade secret
misappropriation against MMC seeking preliminary and permanent injunctive
relief as well as recovery of damages. On January 9, 1998, MMC filed a motion
to dismiss or transfer the Pennsylvania action and to transfer the case to the
Northern District of California. This motion is currently pending. The results
of litigation are inherently uncertain, and
 
                                      25
<PAGE>
 
there can be no assurance that the Company will prevail in any litigation with
FORE. An adverse result in the FORE litigation could have a material adverse
effect on the Company's business, financial condition and results of
operations.
 
  Furthermore, there can be no assurance that the Company will not in the
future become subject to other patent infringement claims and litigation or
interference proceedings to determine the priority of inventions. The defense
and prosecution of intellectual property suits, interference proceedings and
related legal and administrative proceedings are both costly and time
consuming. Any such suit or proceeding involving the Company could have a
material adverse effect on the Company's business, financial condition and
results of operations. Litigation, regardless of the outcome, is likely to
result in substantial cost and diversion of resources of the Company. Any
infringement claim or other litigation against or by the Company could
materially adversely affect the Company's business, financial condition and
results of operations.
 
  Dependence on Key Personnel and Hiring of Additional Personnel. The
Company's success depends to a significant degree upon the continued
contributions of its key management, engineering and other personnel, many of
whom would be difficult to replace. The Company does not have employment
contracts with any of its key personnel and only maintains limited key man
life insurance on two of its officers. In addition, the Company believes that
its success depends to a significant extent on the ability of its management
to operate effectively, both individually and as a group. The Company must
continue to attract and retain highly skilled managerial, engineering and
other personnel. Competition for such personnel is intense, and there can be
no assurance that the Company will be successful in attracting and retaining
such personnel. The loss of the services of any of the key personnel, the
inability to attract or retain qualified personnel in the future or delays in
hiring required personnel, particularly engineers, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
  Management of Growth. The Company has experienced a period of rapid growth
and expansion which has placed, and continues to place, a significant strain
on its resources. To accommodate this growth, the Company will be required to
implement a variety of new and upgraded operational and financial systems,
procedures and controls, including the improvement of its accounting and other
internal management systems, all of which may require substantial management
effort. There can be no assurance that such efforts can be accomplished
successfully. Any failure to improve the Company's operational, financial and
management information systems in response to growth, or to hire, train,
motivate or manage its employees could have a material adverse effect on the
Company's business, financial condition and results of operations.
 
  Risks Associated with Expansion of International Business
Activities. Substantially all of the Company's sales to date have been to
customers located in the United States, including sales to U.S.-based
affiliates of non-U.S. network equipment vendors. If the Company's
international sales increase, the Company will be subject to additional risks
inherent in international operations. All of the Company's international sales
to date are U.S. dollar-denominated. As a result, an increase in the value of
the U.S. dollar relative to foreign currencies could make the Company's
products less competitive in international markets. In addition, the Company
procures a portion of its manufacturing, assembly and test services from
suppliers located outside the United States. International business activities
may be limited or disrupted by the imposition of governmental controls, export
license requirements, restrictions on the export of critical technology,
currency exchange fluctuations, political instability, trade restrictions and
changes in tariffs. Demand for the Company's products could also be adversely
affected by seasonality of international sales and economic conditions in the
Company's primary overseas markets. These international factors could have a
material adverse effect on future sales of the Company's products to
international customers and, consequently, on the Company's business,
financial condition and results of operations. While the Company has not
experienced any revenue shortfall to date as a result of recent financial
difficulties of Asian economies, any decrease in demand by Company customers
for the Company's products caused by decreased sales by such customers in Asia
could have an adverse effect on the Company's revenues in the future.
 
 
                                      26
<PAGE>
 
  Need for Additional Capital. The Company may require substantial additional
working capital to fund its business, particularly to finance inventories and
accounts receivable and for product development. Any such additional financing
may result in significant dilution to the Company's then existing investors.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources."
 
  Risks Associated with Potential Acquisitions. As part of its business
strategy, the Company expects to review acquisition prospects that would
complement its existing product offerings, augment its market coverage or
enhance its technological capabilities, or that may otherwise offer growth
opportunities. Future acquisitions by the Company could result in potentially
dilutive issuances of equity securities, the incurrence of debt and contingent
liabilities and amortization expenses related to goodwill and other intangible
assets, any of which could materially adversely affect the Company's operating
results and/or the price of the Company's Common Stock. Acquisitions entail
numerous risks, including difficulties in the assimilation of acquired
operations, technologies and products, diversion of management's attention to
other business concerns, risks of entering markets in which the Company has no
or limited prior experience and potential loss of key employees of acquired
organizations. No assurance can be given as to the ability of the Company to
successfully integrate any businesses, products, technologies or personnel
that might be acquired in the future, and the failure of the Company to do so
could have a material adverse effect on the Company's business, financial
condition and results of operations.
 
  Expected Volatility of Stock Price. In recent years the stock market in
general, and the market for shares of high technology, data networking and
semiconductor companies in particular, have experienced extreme price
fluctuations, which have often been unrelated to the operating performance of
affected companies. The trading price of the Company's Common Stock is
expected to be subject to extreme fluctuations in response to both business-
related issues, such as quarterly variations in operating results,
announcements of new products by the Company or its competitors, the gain or
loss of significant network equipment vendor customers, and stock market-
related influences, such as changes in analysts' estimates, the presence or
absence of short-selling of the Company's Common Stock and events affecting
other companies that the market deems to be comparable to the Company. In
addition, technology stocks have from time to time experienced extreme price
and volume fluctuations that often have been unrelated or disproportionate to
the operating performance of these companies. These broad market fluctuations
may adversely affect the market price of the Company's Common Stock. Moreover,
the trading prices of many high technology, data networking and semiconductor
stocks are at or near their historical highs and reflect price/earnings ratios
substantially above historical norms.
 
              ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
  Reference is made to the financial statements and supplemental data required
by this item and set forth at the pages indicated in item 14(a) of this
Report.
 
    ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
                             FINANCIAL DISCLOSURE
 
  Not applicable.
 
                                      27
<PAGE>
 
                                   PART III
 
  Certain information required by Part III is omitted from this Report in that
the registrant will file a definitive Proxy Statement pursuant to Regulation
14A (the "Proxy Statement") no later than 120 days after the end of the fiscal
year covered by this Report, and certain information included therein is
incorporated herein by reference.
 
                ITEM 10. DIRECTORS AND OFFICERS OF THE COMPANY
 
  Certain information regarding the directors and officers of the Company is
contained herein under Item 1, "Executive Officers and Directors of the
Company."
 
  Information regarding directors appearing under the caption "Election of
Directors--Directors and Nominees for Director" in the Proxy Statement is
hereby incorporated by reference.
 
  Information regarding compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, is hereby incorporated herein by reference
from the section entitled "Election of Directors--Section 16(a) Beneficial
Ownership Reporting Compliance" in the Proxy Statement.
 
                        ITEM 11. EXECUTIVE COMPENSATION
 
  The information required by Item 11 is set forth under the caption,
"Additional Information Relating to Directors and Officers of the Company -
Executive Compensation" in the Company's Proxy Statement, which information is
incorporated herein by reference.
 
    ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The information required by Item 12 is set forth under the caption "Security
Ownership" in the Company's Proxy Statement, which information is incorporated
herein by reference.
 
            ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  The information required by Item 13 is set forth under the captions
"Election of Directors--Compensation Committee Interlocks and Insider
Participation" and "Certain Transactions" in the Company's Proxy Statement,
which information is incorporated herein by reference.
 
                                      28
<PAGE>
 
                                    PART IV
 
    ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
 
  (a) The following documents are filed as part of this Report:
 
    1. FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
       <S>                                                                  <C>
       Report of Independent Accountants..................................   30
       Balance Sheets at December 31, 1997 and 1996.......................   31
       Statements of Operations for each of the three years ended December
        31, 1997..........................................................   32
       Statements of Stockholders' Equity for each of the three years
        ended December 31, 1997...........................................   33
       Statements of Cash Flows for each of the three years ended December
        31, 1997..........................................................   34
       Notes to Financial Statements......................................   35
 
    2. FINANCIAL STATEMENTS SCHEDULE
 
       Schedule II--Valuation and Qualifying Accounts.....................   49
</TABLE>
 
  All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
 
                                      29
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and Stockholders of
MMC Networks, Inc.
 
  In our opinion, the financial statements listed in the index appearing under
Item 14(a)(1) and (2) on page 29 present fairly, in all material respects, the
financial position of MMC Networks, Inc. at December 31, 1997 and 1996, and
the results of its operations and its cash flows for each of the three years
in the period ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
 
PRICE WATERHOUSE LLP
San Jose, California
January 16, 1998
 
                                      30
<PAGE>
 
                               MMC NETWORKS, INC.
 
                                 BALANCE SHEETS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                              ----------------
                                                               1997     1996
                                                              -------  -------
<S>                                                           <C>      <C>
ASSETS
Current assets:
  Cash and cash equivalents.................................. $45,401  $ 4,809
  Short-term investments.....................................      --    1,509
  Accounts receivable, net of allowances of $181 and $133....   4,526    2,025
  Inventories................................................     570      511
  Prepaid expenses and other current assets..................     382      122
                                                              -------  -------
    Total current assets.....................................  50,879    8,976
Property and equipment, net..................................   3,631    1,616
Other assets.................................................     213       84
                                                              -------  -------
                                                              $54,723  $10,676
                                                              =======  =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable........................................... $ 2,626  $   586
  Accrued expenses...........................................   1,744      789
  Deferred revenue and customer deposits.....................      --      100
  Current portion of capital lease obligations...............     350      388
                                                              -------  -------
    Total current liabilites.................................   4,720    1,863
                                                              -------  -------
Capital lease obligations, net of current portion............     286      636
                                                              -------  -------
Commitments and contingencies (Note 10)
Stockholders' equity:
  Series A Convertible Preferred Stock: $0.001 par value;
   9,378 shares authorized; 0 and 9,255 shares issued and
   outstanding...............................................      --    3,055
  Series B Convertible Preferred Stock: $0.001 par value;
   4,121 shares authorized; 0 and 4,087 shares issued and
   outstanding...............................................      --    7,192
  Common Stock: $0.001 par value; 100,000 and 60,000 shares
   authorized; 29,198 and 11,121 shares issued and
   outstanding...............................................      25        7
  Additional paid-in capital.................................  50,778      249
  Notes receivable from stockholders.........................    (181)    (225)
  Accumulated deficit........................................    (905)  (2,101)
                                                              -------  -------
    Total stockholders' equity...............................  49,717    8,177
                                                              -------  -------
                                                              $54,723  $10,676
                                                              =======  =======
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       31
<PAGE>
 
                               MMC NETWORKS, INC.
 
                            STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
 
<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                                     -------------------------
                                                      1997     1996     1995
                                                     -------  -------  -------
<S>                                                  <C>      <C>      <C>
Revenues............................................ $21,930  $10,515  $   577
Cost of revenues....................................   6,542    3,576      304
                                                     -------  -------  -------
    Gross profit....................................  15,388    6,939      273
                                                     -------  -------  -------
Operating expenses:
  Research and development, net.....................   8,318    3,312    1,802
  Selling, general and administrative...............   6,240    3,225    1,151
                                                     -------  -------  -------
    Total operating expenses........................  14,558    6,537    2,953
                                                     -------  -------  -------
Operating income (loss).............................     830      402   (2,680)
                                                     -------  -------  -------
Other income (expense):
  Interest income...................................     630      427      146
  Interest expense..................................    (126)    (110)     (42)
                                                     -------  -------  -------
    Total other income..............................     504      317      104
                                                     -------  -------  -------
Income (loss) before income taxes...................   1,334      719   (2,576)
Provision for income taxes..........................     138       17       --
                                                     -------  -------  -------
Net income (loss)................................... $ 1,196  $   702  $(2,576)
                                                     =======  =======  =======
Basic income (loss) per share....................... $  0.08  $  0.07  $ (0.38)
                                                     =======  =======  =======
Shares used to compute basic income (loss) per
 share..............................................  14,432   10,652    6,808
                                                     =======  =======  =======
Diluted income (loss) per share..................... $  0.04  $  0.03  $ (0.38)
                                                     =======  =======  =======
Shares used to compute diluted income (loss) per
 share..............................................  29,113   25,745    6,808
                                                     =======  =======  =======
</TABLE>
 
 
   The accompanying notes are an integral part of these financial statements.
 
                                       32
<PAGE>
 
                               MMC NETWORKS, INC.
 
                       STATEMENTS OF STOCKHOLDERS' EQUITY
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                            CONVERTIBLE                                  NOTES       RETAINED
                          PREFERRED STOCK    COMMON STOCK  ADDITIONAL RECEIVABLES    EARNINGS
                          ----------------  --------------  PAID-IN       FROM     (ACCUMULATED
                          SHARES   AMOUNT   SHARES  AMOUNT  CAPITAL   STOCKHOLDERS   DEFICIT)    TOTAL
                          -------  -------  ------  ------ ---------- ------------ ------------ -------
<S>                       <C>      <C>      <C>     <C>    <C>        <C>          <C>          <C>
Balance at December 31,
 1994...................    9,255  $ 3,055   6,097   $ 2    $    --      $  --        $ (227)   $ 2,830
Issuance of Series B
 Convertible Preferred
 Stock, net of issue
 costs of $28...........    4,087    7,192      --    --         --         --            --      7,192
Exercise of stock
 options................       --       --   4,268     4        121       (125)           --         --
Net loss................       --       --      --    --         --         --        (2,576)    (2,576)
                          -------  -------  ------   ---    -------      -----        ------    -------
Balance at December 31,
 1995...................   13,342   10,247  10,365     6        121       (125)       (2,803)     7,446
Exercise of stock
 options................       --       --     741     1        122       (100)           --         23
Issuance of Common Stock
 in exchange for
 services...............       --       --      15    --          6         --            --          6
Net income..............       --       --      --    --         --         --           702        702
                          -------  -------  ------   ---    -------      -----        ------    -------
Balance at December 31,
 1996...................   13,342   10,247  11,121     7        249       (225)       (2,101)     8,177
Conversion of Preferred
 Stock upon the
 completion of the
 initial public
 offering...............  (13,342) (10,247) 13,342    13     10,234         --            --         --
Issuance of Common
 Stock, net of issue
 costs of $1,104........       --       --   4,025     4     40,068         --            --     40,072
Repurchase of Common
 Stock and reduction of
 loan receivable from
 stockholder............       --       --    (170)   --       (114)       114            --         --
Exercise of warrant.....       --       --     121    --         --         --            --         --
Exercise of stock
 options and other......       --       --     744     1        311        (70)           --        242
Issuance of Common Stock
 in exchange for
 services...............       --       --      15    --         30         --            --         30
Net income..............       --       --      --    --         --         --         1,196      1,196
                          -------  -------  ------   ---    -------      -----        ------    -------
Balance at December 31,
 1997...................       --  $    --  29,198   $25    $50,778      $(181)       $ (905)   $49,717
                          =======  =======  ======   ===    =======      =====        ======    =======
</TABLE>
 
 
   The accompanying notes are an integral part of these financial statements.
 
                                       33
<PAGE>
 
                               MMC NETWORKS, INC.
 
                            STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                                       ------------------------
                                                        1997     1996    1995
                                                       -------  ------  -------
<S>                                                    <C>      <C>     <C>
Cash flows from operating activities:
  Net income (loss)................................... $ 1,196  $  702  $(2,576)
  Adjustments to reconcile net income (loss) to net
   cash provided by (used in) operating activities:
    Depreciation and amortization.....................   1,186     479       97
    Issuance of Common Stock in exchange for services.      30       6       --
    Changes in assets and liabilities:
      Accounts receivable.............................  (2,501) (1,388)    (427)
      Inventories.....................................     (59)   (357)    (154)
      Prepaid expenses and other assets...............    (389)   (114)     (26)
      Accounts payable................................   2,040     (31)     598
      Accrued expenses................................     955     594      128
      Deferred revenue and customer deposits..........    (100)   (750)     575
                                                       -------  ------  -------
        Net cash provided by (used in) operating
         activites....................................   2,358    (859)  (1,785)
                                                       -------  ------  -------
Cash flows from investing activities:
  Sale (purchase) of short-term investments...........   1,509   6,343   (5,520)
  Acquisition of property and equipment...............  (3,201)   (673)    (162)
                                                       -------  ------  -------
        Net cash provided by (used in) investing
         activities...................................  (1,692)  5,670   (5,682)
                                                       -------  ------  -------
Cash flows from financing activities:
  Proceeds from issuance of Convertible Preferred
   Stock, net.........................................      --      --    7,192
  Proceeds form issuance of Common Stock, net.........  40,072      --       --
  Proceeds from exercise of stock options.............     242      23       --
  Principal payments on capital lease obligations.....    (388)   (275)     (63)
                                                       -------  ------  -------
        Net cash provided by (used in) financing
         activites....................................  39,926    (252)   7,129
                                                       -------  ------  -------
Net increase (decrease) in cash and cash equivalents..  40,592   4,559     (338)
Cash and cash equivalents at beginning of period......   4,809     250      588
                                                       -------  ------  -------
Cash and cash equivalents at end of period............ $45,401  $4,809  $   250
                                                       =======  ======  =======
SUPPLEMENTAL DISCLOSURE:
  Cash paid for interest.............................. $   126  $  110  $    42
  Cash paid for income taxes.......................... $    13  $   --  $    --
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
 FINANCING ACTIVITIES
  Acquisition of property and equipment through
   capital leases..................................... $    --  $  880  $   352
</TABLE>
 
 
   The accompanying notes are an integral part of these financial statements.
 
                                       34
<PAGE>
 
                              MMC NETWORKS, INC.
 
                         NOTES TO FINANCIAL STATEMENTS
 
NOTE 1 -- THE COMPANY
 
  MMC Networks, Inc. (the "Company") was incorporated in California on
September 25, 1992 as a Subchapter S corporation and became a Subchapter C
corporation effective July 12, 1994. The Company is a leading developer and
supplier of network processors--high-performance, open-architecture, software-
programmable processors optimized for networking applications. The Company
sells its products primarily in the United States.
 
 Certain equity transactions
 
  In August 1997, the Company's Board of Directors authorized, and the
stockholders subsequently approved, the reincorporation of the Company in
Delaware and the associated exchange of one share of each class and series of
stock of the predecessor Company for one share of each corresponding class and
series of stock of the Delaware successor. As a result of the reincorporation,
the Company is authorized to issue 100,000,000 shares of Common Stock. On
January 13, 1998, the Company amended its Certificate of Incorporation to
authorize 10,000,000 shares of undesignated Preferred Stock. The Board of
Directors will have the authority to issue the undesignated Preferred Stock in
one or more series and to fix the rights, preferences, privileges and
restrictions thereof.
 
 Initial public offering
 
  In October 1997, the Company completed its initial public offering and sold
4,025,000 shares of its Common Stock to the public at a price of $11.00 per
share. The Company received approximately $40.1 million of cash, net of
underwriting discounts, commissions and other offering costs. Simultaneously
each outstanding share of Convertible Preferred Stock was automatically
converted into one share of Common Stock. (See Note 6.)
 
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Use of estimates
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
 Cash, cash equivalents and short-term investments
 
  The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. Short-term investments
consist primarily of commercial paper and U.S. Treasury securities with
maturities of more than three months when purchased. The Company has
categorized its short-term investments as available-for-sale. At December 31,
1996, the fair market value of the Company's short-term investments
approximated cost.
 
 Inventories
 
  Inventories are stated at the lower of cost, determined using the first-in,
first-out method, or market.
 
 
                                      35
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 Property and equipment
 
  Property and equipment are stated at cost. Depreciation and amortization are
computed using the straight-line method over the estimated useful lives of the
assets, generally three years.
 
 Long-lived assets
 
  The Company periodically evaluates the recoverability of its long-lived
assets and recognizes impairment of long-lived assets in the event the net
book value of such assets exceeds the future undiscounted cash flows
attributable to such assets. No such impairments have been identified to date.
 
 Revenue recognition; customer concentration
 
  Revenues are recognized upon shipment of product to customers. Funds
received in advance of product shipment are deferred and recognized upon
shipment of the product. The Company's normal policy is to not accept returns
except for defective products. Anticipated costs related to product warranties
are charged to operations as revenues are recognized. The Company has not
experienced significant warranty claims to date.
 
  The percentage of total revenues accounted for by the Company's significant
customers (significant customers are those customers accounting for more than
10% of the Company's total revenues) are as follows: Cisco, Mitsui Comtek
Corp., a non-stocking sales representative for Japan, and the U. S. Computer
Division of Hitachi accounted for 28%, 28% and 12%, respectively, of total
revenues for the year ended December 31, 1997 and 51%, 15% and 10%,
respectively, of total revenues for the year ended December 31, 1996. For the
year ended December 31, 1995, Cisco, Ipsilon, Toshiba, and Agile represented
48%, 12%, 11% and 11% of total revenues, respectively.
 
 Research and development
 
  Research and development expenses are charged to operations as incurred. The
Company on occasion receives non-recurring engineering funding for development
projects to apply or enhance the Company's technology to a particular
customer's needs. Such funding is recognized over the term of the respective
contract using the percentage-of-completion method. At the time of
recognition, amounts received under research and development contracts are
offset against research and development expenses. (See Note 9.)
 
 Software development expenses
 
  Software development expenses are included in research and development and
are expensed as incurred. The Company capitalizes certain software development
expenses once technological feasibility is established, which the Company
defines as the completion of a working model. The capitalized expense is then
amortized on a straight-line basis over the estimated product life, or on the
ratio of current sales to total projected product sales, whichever is greater.
To date, the period between achieving technological feasibility and the
general availability of such software has been short, and software development
expenses qualifying for capitalization have been insignificant. Accordingly,
the Company has not capitalized any software development expenses.
 
 Income taxes
 
  The Company accounts for income taxes using an asset and liability approach,
which requires the recognition of taxes payable or refundable for the current
year and deferred tax liabilities and assets for the future tax consequences
of events that have been recognized in the Company's financial statements or
tax returns. The measurement of current and deferred tax liabilities and
assets are based on the provisions of the enacted tax law;
 
                                      36
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
the effects of future changes in tax laws or rates are not anticipated. The
measurement of deferred tax assets is reduced, if necessary, by the amount of
any tax benefits that, based on available evidence, are not expected to be
realized.
 
 Stock-based compensation
 
  The Company accounts for stock based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. The
Company provides additional pro forma disclosures as required under Statement
of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-
Based Compensation." (See Note 6.)
 
 Concentrations of credit risk
 
  Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, cash equivalents,
short-term investments and accounts receivable. The Company places its cash,
cash equivalents and short-term investments primarily in market rate accounts,
commercial paper, state and municipal securities and U.S. Treasury bills. The
Company performs ongoing credit evaluations of its customers' financial
condition and generally requires no collateral from its customers. The Company
provides an allowance for doubtful accounts receivable based upon the expected
collectibility of such receivables and to date has not experienced any
material losses.
 
  At December 31, 1997, Cisco and Mitsui Comtek Corp., a non-stocking sales
representative for Japan, each represented 27% of trade receivables. At
December 31, 1996, Cisco, the U.S. Computer Division of Hitachi, and Mistsui
Comtek Corp., represented 32%, 34% and 16% of trade receivables, respectively.
 
 Stock splits
 
  In July 1997 and December 1996 the Company effected a 3-for-2 and 2-for-1
stock split, respectively, of its Common Stock and Convertible Preferred
Stock. The accompanying financial statements have been retroactively adjusted
to reflect these splits.
 
 Net income (loss) per share
 
  The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") in the fourth quarter of 1997. All
calculations are in accordance with SFAS 128 and the guidance contained in
Staff Accounting Bulletin 98 ("SAB 98") issued in February 1998. All prior
period net income (loss) presented has been restated in accordance with SFAS
128 and SAB 98. SFAS 128 requires presentation of both basic and diluted EPS
on the face of the income statement. Basic EPS is computed by dividing net
income available to common stockholders (numerator) by the weighted average
shares of common stock outstanding (denominator) during the period. Basic EPS
excludes the dilutive effect of potential common stock. Diluted EPS gives
effect to all dilutive potential common stock outstanding during the period.
In computing diluted EPS, the average stock price for the period is used in
determining the number of shares assumed to be purchased from the exercise of
potential common stock.
 
                                      37
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following table reconciles the numerators and denominators of the basic
and diluted EPS computations for the years ended December 31, 1997 and 1996.
For the year ended December 31, 1995, basic and diluted EPS were the same.
 
<TABLE>
<CAPTION>
                                              1997                 1996
                                      -------------------- --------------------
                                                     PER                  PER
                                                    SHARE                SHARE
                                      INCOME SHARES AMOUNT INCOME SHARES AMOUNT
                                      ------ ------ ------ ------ ------ ------
                                        (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                   <C>    <C>    <C>    <C>    <C>    <C>
BASIC INCOME PER SHARE:
Net income available to common
 stockholders........................ $1,196 14,432 $0.08   $702  10,652 $0.07
                                                    =====                =====
EFFECT OF DILUTIVE SECURITIES:
Convertible Preferred Stock..........     -- 11,118           --  13,342
Warrants.............................     --    114           --      50
Stock options........................     --  3,449           --   1,701
                                      ------ ------         ----  ------
DILUTED INCOME PER SHARE:
Net income available to common
 stockholders and assumed
 conversions......................... $1,196 29,113 $0.04   $702  25,745 $0.03
                                      ====== ====== =====   ====  ====== =====
</TABLE>
 
  At December 31, 1997 and 1996, options to purchase a total of 29,500 shares
of common stock with an average exercise price of $15.94 and 877,500 shares of
common stock with an average exercise price of $1.74, respectively, are
considered anti-dilutive because the options' exercise price was greater than
the average fair market value of the Company's common stock for the years then
ended and, as such, are excluded from the calculation of diluted net income
per share.
 
  Due to the net loss in 1995, all potential common stock outstanding is
considered anti-dilutive and is excluded from the calculation of diluted net
income (loss) per share. Potential common stock outstanding as of December 31,
1995 includes options to purchase 1,479,939 shares of common stock at an
average exercise price of $0.03, warrants to purchase 123,000 shares of common
stock at an exercise price of $0.33 outstanding the entire year, Series A
Convertible Preferred Stock outstanding the entire year convertible into
9,255,000 shares of common stock and Series B Convertible Preferred Stock
issued in November 1995 convertible into 4,086,780 shares of common stock.
(See Note 6.)
 
 Dependence on independent manufacturers
 
  The Company outsources all manufacturing, assembly and test of its network
processors. The Company's suppliers currently deliver fully assembled and
tested products on a turnkey basis. The semiconductor industry is highly
cyclical and, in the past, foundry capacity has been very limited at times and
may become limited in the future. Currently, only one of the Company's
products is manufactured by more than one supplier. The Company depends on its
suppliers to deliver sufficient quantities of finished product to the Company
in a timely manner. Since the Company places its orders on a purchase order
basis and does not have a long-term volume purchase agreement with any of its
existing suppliers, these suppliers may allocate, and in the past have
allocated, capacity to the production of other products while reducing
deliveries to the Company on short notice. During 1997, the Company
experienced delays in obtaining an adequate supply of certain of its products
from one supplier, as well as certain problems regarding the quality of the
products delivered by that supplier, and as a result has begun obtaining such
products from an alternative supplier. There can be no assurance that the
Company will not have similar or more protracted problems in the future with
existing or new suppliers. In the event of a loss of, or a decision by the
Company to change, a key supplier or foundry, qualifying a new supplier or
foundry and
 
                                      38
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
commencing volume production could involve delay and expense, resulting in
lost revenues, reduced operating margins and possible detriment to customer
relationships.
 
 Recent accounting pronouncements
 
  In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes
standards for the reporting of comprehensive income and its components in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income, as defined, includes all changes
in equity (net assets) during a period from nonowner sources. Examples of
items to be included in comprehensive income, which are excluded from net
income, include foreign currency translation adjustments and unrealized
gain/loss on available-for-sale securities. The disclosures prescribed by SFAS
130 are effective beginning with the first quarter of calendar 1998. The
adoption of SFAS 130 in 1998 is not expected to have a material impact on the
Company's financial statements.
 
  In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures About Segments of an Enterprise and Related Information"
("SFAS 131"). This statement establishes standards for the way companies
report information about operating segments in annual financial statements. It
also establishes standards for related disclosures about products and
services, geographic areas and major customers. The disclosures prescribed by
SFAS 131 are effective for calendar 1998. The adoption of SFAS 131 in 1998 is
not expected to have a material impact on the Company's financial statements.
 
NOTE 3 -- COMPOSITION OF CERTAIN BALANCE SHEET COMPONENTS
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                                ---------------
                                                                 1997     1996
                                                                -------  ------
                                                                (IN THOUSANDS)
<S>                                                             <C>      <C>
Inventories:
  Raw materials................................................ $    --  $   99
  Finished goods...............................................     570     412
                                                                -------  ------
                                                                  $ 570  $  511
                                                                =======  ======
Property and equipment:
  Computers and equipment...................................... $ 1,935  $1,397
  Purchased software...........................................   3,157     751
  Furniture and fixtures.......................................     316      59
                                                                -------  ------
                                                                  5,408   2,207
Less accumulated depreciation and amortization.................  (1,777)   (591)
                                                                -------  ------
                                                                $ 3,631  $1,616
                                                                =======  ======
Accrued liabilities:
  Accrued compensation and benefits............................ $   807  $  293
  Other accrued liabilities....................................     937     496
                                                                -------  ------
                                                                $ 1,744  $  789
                                                                =======  ======
</TABLE>
 
NOTE 4 -- BANK LINES OF CREDIT
 
  In April 1997, the Company entered into a revolving credit facility
agreement and lease line agreement with a bank. The revolving line of credit
provides for working capital advances of up to $5 million, and borrowings
 
                                      39
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
bear interest at the bank's prime rate. The lease line allows for advances of
up to $3 million, and borrowings bear interest at the bank's prime rate plus
0.5%. The lines expire in April 1998. Borrowings under the lines are secured
by the assets of the Company. Among other provisions, the Company is required
to maintain certain financial covenants. In addition, payment of dividends is
prohibited without the bank's prior consent. At December 31, 1997, there were
no amounts outstanding under either facility.
 
NOTE 5 -- INCOME TAXES
 
  The provision for income taxes of $138,000 and $17,000 for the years ended
December 31, 1997 and 1996, respectively, represents current federal and state
income taxes payable.
 
  No current provision for income taxes was recorded in 1995 as the Company
incurred net operating losses for income tax purposes.
 
  The effective tax rate for the year ended December 31, 1997 reconciles to
the statutory tax rates as follows:
 
<TABLE>
     <S>                                                                    <C>
     Federal statutory rate................................................  34%
     State taxes, net of federal benefit...................................   6
     Permanent differences.................................................   2
     Utilization of net operating loss carryforwards....................... (32)
                                                                            ---
     Effective tax rate....................................................  10%
                                                                            ===
</TABLE>
 
  Deferred tax assets consist of the following:
 
<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                         ----------------------
                                                          1997    1996    1995
                                                         ------  ------  ------
                                                            (IN THOUSANDS)
     <S>                                                 <C>     <C>     <C>
     Net operating loss carryforwards................... $   --  $  737  $  994
     Research and development credit carryforwards......    500     314     111
     Inventory reserves and basis differences...........    505     129       4
     Accrued expenses...................................    197     187      64
     Deferred revenue and customer deposits.............     --      --     341
     Other..............................................    179     126      71
                                                         ------  ------  ------
       Total deferred tax assets........................  1,381   1,493   1,585
     Valuation allowance................................ (1,381) (1,493) (1,585)
                                                         ------  ------  ------
       Net deferred tax assets.......................... $   --  $   --  $   --
                                                         ======  ======  ======
</TABLE>
 
  Because the Company emerged from the development stage in 1996 and,
consequently, does not have an extensive history of profitability, management
believes that the available objective evidence creates sufficient uncertainty
regarding the realizability of deferred tax assets such that a full valuation
allowance is required at December 31, 1997, 1996 and 1995.
 
  At December 31, 1997, the Company had research and development tax credit
carryforwards for federal and state income tax purposes of $350,000 and
$150,000, respectively. The federal research and development credit
carryforwards expire from 2009 through 2012. The state research and
development credit carryforwards expire from 1999 through 2002.
 
                                      40
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 6 -- CAPITAL STOCK
 
 Convertible Preferred Stock
 
  The Company has authorized 13,498,737 shares of Convertible Preferred Stock,
of which 9,378,000 shares have been designated Series A Convertible Preferred
Stock ("Series A") and 4,120,737 shares have been designated Series B
Convertible Preferred Stock ("Series B"). In November 1995 and July 1994, the
Company issued 4,086,780 shares of Series B at $1.77 per share and 9,255,000
shares of Series A at $0.33 per share, respectively. Each outstanding share of
Preferred Stock was converted into one share of Common Stock upon the
completion of the Company's initial public offering. (See Note 1.)
 
 1997 Stock Plan
 
  In August 1997, the Company's Board of Directors adopted, and the
stockholders subsequently approved, the 1997 Stock Plan (the "1997 Plan"). The
1997 Plan is intended to serve as the successor equity incentive program to
the Company's 1993 Plan (the "Predecessor Plan"). Outstanding options under
the Predecessor Plan were incorporated into the 1997 Plan upon the
effectiveness of the Company's initial public offering. No further option
grants were made under the Predecessor Plan. The incorporated options will
continue to be governed by their existing terms which are essentially the same
as options granted under the 1997 Plan described below. The following shares
have been reserved for issuance under the 1997 Plan: (a) 1,500,000 shares of
Common Stock plus any shares which have been reserved but unissued under the
Predecessor Plan; (b) any shares returned to the Predecessor Plan as a result
of termination of options under such plan; and (c) shares added to the 1997
Plan pursuant to automatic annual increases on the date of each annual meeting
of the stockholders beginning with the 1999 annual meeting equal to the lesser
of (i) 1,000,000 shares, (ii) 5% of all then outstanding shares of Common
Stock of the Company, or (iii) a lesser amount determined by the Board. Unless
terminated sooner, the 1997 Plan will terminate automatically in August 2007.
 
  The 1997 Plan provides for the grant of incentive stock options ("ISOs") to
employees, officers and employee directors and nonstatutory stock options
("NSOs") and stock purchase rights ("SPRs") to employees, directors and
consultants. ISOs granted to participants owning stock possessing more than
10% of the voting power of all classes of stock must have an exercise price at
least equal to 110% of the fair market value on the date of grant and are for
periods not to exceed five years. All other options granted under the plan
must have an exercise price at least equal to the fair market value on the
date of grant and are for periods not to exceed ten years. Options granted
under the 1997 Plan generally shall vest at a rate of 25% on the first
anniversary of the date of grant and as to 1/48 of the underlying shares per
month thereafter.
 
  Stock purchase rights are for periods and prices determined by the Board.
Shares purchased through the exercise of SPRs are subject to repurchase by the
Company at the original price paid by the purchaser in the event that the
purchaser's employment with the Company terminates. The repurchase right
lapses at a rate determined by the Board. No stock purchase rights have been
granted to date under either the 1997 Plan or the Predecessor Plan.
 
 1997 Director Option Plan
 
  In August 1997, the Company's Board of Directors adopted, and the
stockholders subsequently approved, the 1997 Director Option Plan (the
"Director Plan"). The Director Plan provides for the grant of nonstatutory
stock options to non-employee directors. Options granted under the Director
Plan are for periods not to exceed ten years and are granted at exercise
prices not less than the fair market value on the date of grant. The Director
Plan provides that each non-employee director will automatically be granted a
nonstatutory option to purchase 40,000 shares of Common Stock (the "First
Option") on the date which such person first becomes a non-
 
                                      41
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
employee director, unless immediately prior to becoming a non-employee
director, such person was an employee director of the Company. In addition to
the First Option, each non-employee director will automatically be granted an
option to purchase 10,000 shares (a "Subsequent Option") on the date two days
after the announcement of the Company's fiscal year-end earnings of each year,
if on such date he or she will have served on the Board of Directors for at
least the preceding six months.
 
  Each First Option and each Subsequent Option will have a term of 10 years.
Each First Option will vest as to 25% of the optioned stock one year from the
date of grant, and as to an additional 1/48 of the optioned stock each full
month thereafter, provided the person continues to serve as a Director on such
dates. Each Subsequent Option will vest as to 1/12 of the optioned stock each
full month after the date of grant. A total of 150,000 shares of Common Stock
have been reserved for issuance under the Director Plan, plus annual increases
equal to (i) the number of shares of stock underlying options granted under
the Director Plan in the immediately preceding year, or (ii) a lesser amount
determined by the Board.
 
  As of December 31, 1997, a total of 18,375,000 shares have been reserved for
issuance under the plans. A summary of activity under such plans is as
follows:
 
<TABLE>
<CAPTION>
                                                                       WEIGHTED-
                                                SHARES                  AVERAGE
                                              AVAILABLE     OPTIONS    EXERCISE
                                              FOR GRANT   OUTSTANDING    PRICE
                                              ----------  -----------  ---------
   <S>                                        <C>         <C>          <C>
   Balance at December 31, 1994..............  2,351,811   5,073,189     0.03
   Granted...................................   (846,000)    846,000     0.03
   Exercised.................................         --  (4,268,250)    0.03
   Canceled..................................    171,000    (171,000)    0.03
                                              ----------  ----------
   Balance at December 31, 1995..............  1,676,811   1,479,939     0.03
   Authorized................................  3,300,000          --       --
   Granted................................... (3,265,500)  3,265,500     0.79
   Exercised.................................         --    (741,534)    0.17
   Canceled..................................    810,000    (810,000)    0.29
                                              ----------  ----------
   Balance at December 31, 1996..............  2,521,311   3,193,905     0.71
   Authorized................................  7,650,000          --       --
   Granted................................... (3,213,500)  3,213,500     3.53
   Exercised.................................         --    (743,830)    0.36
   Canceled..................................    431,688    (431,688)    0.97
                                              ----------  ----------
   Balance at December 31, 1997..............  7,389,499   5,231,887     2.47
                                              ==========  ==========
</TABLE>
 
  The weighted-average estimated grant-date fair values of options granted
under the plans during the years ended December 31, 1997, 1996 and 1995,
determined using either the minimum value model or the Black-Scholes model as
prescribed by SFAS 123, were $1.16, $0.20, and $0.01 respectively.
 
  For options granted during the years ended December 31, 1996 and for the
period from January 1, 1997 to August 19, 1997 (the day prior to the filing of
the Company's initial registration statement), the Company calculated the fair
value of its stock options using the minimum value model and the following
assumptions: annual dividend yield of 0.0%; risk-free interest rates of 5.63%
to 7.31% in 1995, 5.28% to 6.55% in 1996 and 5.86% to 6.66% for the period
from January 1, 1997 to August 19, 1997; and an expected option term of 4
years. For options granted during the period from August 20, 1997 to December
31, 1997, the Company calculated the fair value of its stock options using the
Black-Scholes model and the following assumptions: annual dividend yield of
0.0%; expected stock price volatility of 70%; risk-free interest rates of
5.69% to 6.16%; and an expected option term of 4 years.
 
                                      42
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The following table summarizes information concerning outstanding and
exercisable options as of December 31, 1997:
 
<TABLE>
<CAPTION>
                               OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                   ------------------------------------------- --------------------------
      RANGE OF                    WEIGHTED-       WEIGHTED-                  WEIGHTED-
      EXERCISE       NUMBER    AVERAGEREMAINING    AVERAGE       NUMBER       AVERAGE
       PRICES      OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE OUTSTANDING EXERCISE PRICE
      --------     ----------- ---------------- -------------- ----------- --------------
  <S>              <C>         <C>              <C>            <C>         <C>
       $ 0.03          442,953        7.13         $  0.03        179,156     $  0.03
    0.18 to 0.42       354,845        8.21            0.24         58,031        0.21
    0.67 to 1.10       733,464        8.45            0.75        180,146        0.71
    2.00 to 2.67     2,302,125        9.10            2.09        137,125        2.01
    3.33 to 5.33       946,500        9.41            4.28             --          --
    6.67 to 7.00       422,500        9.71            7.00             --          --
       15.94            29,500       10.00           15.94             --          --
                     ---------                                    -------
  $ 0.03 to 15.94    5,231,887        8.89         $  2.47        554,458     $  0.76
                     =========                                    =======
</TABLE>
 
 1997 Employee Stock Purchase Plan
 
  In August 1997, the Company's Board of Directors adopted, and the
stockholders subsequently approved, the 1997 Employee Stock Purchase Plan (the
"1997 Purchase Plan"). The 1997 Purchase Plan is intended to qualify under
Section 423 of the Internal Revenue Code and contains 24-month offering
periods, with four six-month purchase periods included in each offering
period. The 1997 Purchase Plan permits employees to purchase Common Stock of
the Company through payroll deductions of up to 10% of the participant's
compensation. The price of stock purchased under the 1997 Purchase Plan shall
be 85% of the lower of the fair market value of the Common Stock at the
beginning of the offering period or at the end of the purchase period. A total
of 300,000 shares of Common Stock has been reserved for issuance under the
1997 Purchase Plan. Shares reserved for issuance under the 1997 Purchase Plan
are subject to automatic annual increases equal to the lesser of (i) 400,000
shares, (ii) 0.8% of all then outstanding shares of Common Stock of the
Company or (iii) a lesser amount determined by the Board.
 
  The fair value of shares granted under the 1997 Purchase Plan was calculated
using the Black-Scholes model as prescribed by SFAS No. 123 assuming the
following weighted-average assumptions: annual dividend yield of 0.0%,
expected stock price volatility of 70%, risk-free interest rate of 5.58%, and
an expected term of 1.3 years. The weighted-average estimated fair value of
shares granted under the 1997 Purchase Plan during 1997 was $4.63 per share.
 
  Had the Company recorded compensation based on the estimated grant-date fair
value, using either the minimum value model or the Black-Scholes model as
discussed above and as prescribed by SFAS 123, for options granted under the
option plans and the 1997 Purchase Plan, the Company's net income (loss) and
basic and diluted income (LOSS) per share would have been reduced to the pro
forma amounts below for the years ended December 31, 1997, 1996 and 1995:
 
<TABLE>
<CAPTION>
                                                                     YEAR ENDED
                                                                     DECEMBER 31,
                                                        -------------------------------------
                                                           1997          1996         1995
                                                        ---------       ------     ----------
                                                         (IN THOUSANDS, EXCEPT PER SHARE DATA)
   <S>                                                  <C>             <C>        <C>     
   Net income (loss) as reported........................  $1,196          $ 702       $(2,576)
   Pro forma net income (loss)..........................     619            662        (2,576)
   Basic income (loss) per share as reported............  $ 0.08          $0.07       $ (0.38)
   Pro forma basic income (loss) per share..............    0.04           0.06         (0.38)
   Diluted income (loss) per share as reported..........  $ 0.04          $0.03       $ (0.38)
   Pro forma diluted income (loss) per share............    0.02           0.03         (0.38)
</TABLE>
 
 
                                      43
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
  Because the determination of the fair value of all options granted after the
Company filed its initial registration statement includes a volatility factor
and because it does not take into consideration pro forma compensation expense
related to grants made prior to 1995, the pro forma effect on net income
(loss) for the years ended December 31, 1997, 1996 and 1995 shown above is not
representative of the pro forma effect on net income (loss) in future years.
 
NOTE 7 -- OTHER EMPLOYEE BENEFITS
 
  Effective January 1994, the Company adopted a 401(k) plan for its employees
whereby eligible employees may contribute up to 20% of their earnings, on a
pre-tax basis, subject to the maximum amount permitted by the Internal Revenue
Code. At the discretion of the Board of Directors, the Company may make
contributions under the 401(k) plan. To date, the Company has not made any
such contributions.
 
NOTE 8 -- NOTES RECEIVABLE FROM STOCKHOLDERS
 
  In October and November 1995, the Company made full recourse loans with
principal amounts totaling $125,000 to certain employees pursuant to the
Company's 1993 Plan. The loans are secured by 4,268,250 shares of the
Company's Common Stock. The loans are non-interest bearing and are due in
October and November 2000 or earlier in the event of the borrower's
termination of employment with the Company.
 
  In December 1996 and January 1997, the Company accepted full recourse
promissory notes with principal amounts of $100,000 and $70,000, respectively,
from an officer upon the exercise of certain stock options pursuant to the
Company's 1993 Plan. The notes bear interest at 5.75% per annum and are due
upon the earlier of three years from the date of the note or six months
following termination of employment with the Company. In the fourth quarter of
1997, after the resignation of the officer, the Company repurchased a portion
of the underlying shares at the original exercise price for a total of
$114,000 which were subsequently retired in exchange for the reduction of a
corresponding portion of the related stockholder receivable. In conjunction
with this repurchase, the Company extended the due date of the remaining
outstanding balance to the earlier of (i) forty days after the expiration of
the 180-day period specified in the Lock-up Agreement entered into by the
former officer in favor of the underwriters of the Company's initial public
offering or (ii) June 30, 1998. The outstanding balance under these notes as
of December 31, 1997 is $56,000.
 
  In March 1997, the Company accepted a full recourse promissory note with a
principal amount of $100,000 from one of its officers. The note bears interest
at 6.07% per annum, is secured by 1,800,000 shares of the Company's Common
Stock and is due upon the earlier of October 31, 1999 or six months following
termination of employment with the Company.
 
NOTE 9 -- RESEARCH AND DEVELOPMENT CONTRACTS
 
  During the years ended December 31, 1997, 1996 and 1995 the Company
performed research and development which was funded under a number of
contracts. The Company recognized $716,000, $863,000 and $280,000,
respectively, as offsets against research and development expenses. These
contracts, which vary in term and are with parties unrelated to the Company,
provide for non-refundable funding (irrespective of the results) of research
and development of certain technologies owned by the Company which will
enhance the Company's products to meet specific customers' needs. To date,
funding received under any of the research and development contracts has not
been individually significant.
 
                                      44
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
 
 Leases
 
  The Company leases its facilities under noncancelable lease agreements which
expire from March 1999 through November 2002. Rent expense under noncancelable
operating leases was $612,000, $245,000 and $112,000 during the years ended
December 31, 1997, 1996 and 1995, respectively.
 
  In 1994, the Company entered into a master lease agreement with a leasing
company for the acquisition of property and equipment. The leasing company's
commitment to fund purchases of capital equipment under this agreement expired
on January 15, 1996. During 1996 the Company leased $54,000 of property and
equipment under this agreement which have been classified as capital leases.
These capital leases terminate at various dates through 1999. In connection
with the master lease agreement the Company issued a warrant to purchase
123,000 shares of Series A at $0.33 per share. The estimated fair value of the
warrant was not material on the date of issuance. The warrant was to expire on
the earlier of October 2003 or upon the fourth anniversary of an initial
public offering of the Company's Common Stock. Upon the completion of the
Company's initial public offering, the warrant to purchase 123,000 shares of
Series A was automatically converted to a warrant to purchase an equal number
of shares of Common Stock at the same exercise price. In November 1997, the
warrant was exercised. As consideration for the exercise, 1,739 shares of the
Company's Common Stock with an in-the-money value of $41,000 were surrendered
resulting in no net proceeds to the Company.
 
  In February 1996, the Company entered into a new master lease agreement with
a leasing company for the acquisition of property and equipment. The agreement
provides for up to $750,000 for equipment purchases made through June 30,
1997, all of which had been utilized as of December 31, 1996. Capital leases
under this agreement terminate at various dates through 1999. In connection
with the master lease agreement the Company issued a warrant to purchase
33,963 shares of Series B at $1.77 per share. The estimated fair value of the
warrant was not material on the date of issuance. The warrant expires in
January 2003. Upon the completion of the Company's initial public offering,
the warrant to purchase 33,963 shares of Series B was automatically converted
to a warrant to purchase an equal number of shares of Common Stock at the same
exercise price. A total of 33,963 shares of Common Stock have been reserved
for issuance upon exercise of the warrant. The warrant had not been exercised
as of December 31, 1997.
 
  As of December 31, 1997 and 1996, property and equipment recorded under
capital leases, consisting primarily of computer equipment and purchased
software, totaled $1,372,000 with related accumulated amortization of $957,000
and $517,000, respectively.
 
  Future minimum lease payments under all noncancelable operating and capital
leases are as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                               OPERATING CAPITAL
   FOR THE YEAR ENDED DECEMBER 31,                              LEASES   LEASES
   -------------------------------                             --------- -------
   <S>                                                         <C>       <C>
   1998.......................................................   $608     $401
   1999.......................................................    188      301
   2000.......................................................     44       --
   2001.......................................................     44       --
   2002.......................................................     40       --
                                                                 ----     ----
     Total minimum payments...................................   $924      702
                                                                 ====
   Less amount representing interest..........................              66
                                                                          ----
     Present value of lease obligations.......................             636
   Less current portion.......................................             350
                                                                          ----
     Lease obligations, net of current portion................            $286
                                                                          ====
</TABLE>
 
 
                                      45
<PAGE>
 
                              MMC NETWORKS, INC.
 
                  NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)
 
 Other
 
  In the fourth quarter of 1997, FORE Systems, Inc. filed a complaint in the
United States District Court for the Western District of Pennsylvania alleging
trade secret misappropriation against the Company and that the Company
willfully infringed three of FORE's patents. The complaint seeks both a
preliminary and a permanent injunction against the Company, as well as
recovery of damages. The results of litigation are inherently uncertain, and
there can be no assurance that the Company will prevail in any litigation with
FORE. An adverse result in the FORE litigation could have a material adverse
effect on the Company's business, financial condition and results of
operations.
 
                                      46
<PAGE>
 
  3.EXHIBITS
 
  The exhibits listed under Item 14(c) hereof are filed as part of this report
on Form 10-K.
 
  (b) Reports on Form 8-K filed in the fourth quarter of 1997.
 
  (c) Exhibits
 
  The following exhibits are filed with this Report:
 
<TABLE>
<CAPTION>
   EXHIBIT
    NUMBER                             EXHIBIT TITLE
   -------                             -------------
   <C>      <S>
     3.1    Amended and Restated Certificate of Incorporation filed on January
             13, 1998.
     3.2*   Bylaws of the Registrant.
     4.1*   Form of Common Stock Certificate.
    10.1*   Form of Indemnification Agreement for directors and executive
             officers of the Company.
   +10.2*   1993 Stock Plan.
   +10.3*   1997 Employee Stock Purchase Plan.
   +10.4*   1997 Stock Plan.
   +10.5*   1997 Director Option Plan.
    10.6*   First Amended and Restated Shareholder Rights Agreement dated
             November 16, 1995, by and among the Registrant and the
             Shareholders named therein.
    10.7*   Sublease, dated June 14, 1996, by and between Olivetti Advanced
             Technology Center, Inc. and the Registrant, and the Lease
             Agreement, dated December 22, 1994, by and between Herman
             Christensen, Jr., Raymond Christensen and Olivetti Advanced
             Technology Center, Inc.
    10.8*++ Development, License and Purchase Agreement, effective as of
             December 19, 1994 (the "Cisco Agreement"), by and between Cisco
             Systems, Inc. and the Registrant, as amended by the First
             Amendment to the Cisco Agreement, effective as of January 30,
             1996, and Amendment Number 2 to the Cisco Agreement, dated July
             7, 1997.
    10.9*   Supplier Escrow Agreement, dated as of April 21, 1997, by and
             between the Registrant, Hitachi Computer Products (America), Inc.
             and SourceFile.
    10.10   Loan and Security Agreement dated April 21, 1997, by and between
             Silicon Valley Bank and the Registrant.
    10.11   Lease dated October 23, 1997, by and between New Boston Mill Road
             Limited Partnership and the Registrant.
    23.1    Consent of Independent Accountants
    24.1    Power of Attorney (see Page 48).
    27.1    Financial Data Schedule.
</TABLE>
--------
 *  Previously filed as exhibits to the Registrant's Registration Statement on
    Form S-1 (File No. 33-34005), filed with Securities Exchange Commission on
    October 27, 1997.
 ++ Confidential treatment granted with respect to certain portions.
 +  Denotes a compensation plan in which an executive officer or director
    participates.
 
(d) Financial Data Schedules. See Item 14(a)(2) above.
 
                                      47
<PAGE>
 
                                  SIGNATURES
 
  Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
 
Dated: March 20, 1998                     MMC NETWORKS, INC.
 
                                                   
                                          By:        /s/ Prabhat K. Dubey
                                            -----------------------------------
                                              Prabhat K. Dubey
                                              President, Chief Executive
                                               Officer and Director
 
  Each person whose signature appears below constitutes and appoints Prabhat
K. Dubey, and Uday Bellary, jointly and severally, his attorneys-in-fact, each
with the power of substitution, for him in any and all capacities, to sign any
amendments to this Annual Report on Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue thereof.
 
  Pursuant to the requirements of the Securities Act of 1934, this Report has
been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated:
 
          SIGNATURE                        TITLE               DATE
          ---------                        -----               ---- 
 
    /s/ Prabhat K. Dubey       President, Chief Executive      March 20, 1998
-----------------------------  Officer and Director
      Prabhat K. Dubey         (Principal Executive
                               Officer)
 
      
 
      /s/ Uday Bellary         Vice President, Finance,        March 20, 1998
-----------------------------  Chief Financial Officer and
        Uday Bellary           Assistant Secretary
                               (Principal Financial and
                               Accounting Officer)
 
 
       /s/ Amos Wilnai         Director                        March 20, 1998
-----------------------------
         Amos Wilnai

 
     /s/ Irwin Federman        Director                        March 20, 1998
-----------------------------
       Irwin Federman
 

   /s/ Andrew S. Rappaport     Director                        March 20, 1998
-----------------------------
     Andrew S. Rappaport

 
    /s/ Geoffrey Y. Yang       Director                        March 20, 1998
-----------------------------
      Geoffrey Y. Yang
 
                                      48
<PAGE>
 
                                                                     SCHEDULE II
 
                               MMC NETWORKS, INC.
 
                       VALUATION AND QUALIFYING ACCOUNTS
 
                  YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                               ADDITIONS   DEDUCTION
                                   BALANCE AT  CHARGED TO     FROM     BALANCE
                                   BEGINNING  STATEMENT OF ALLOWANCE/  AT END
                                   OF PERIOD   OPERATIONS   RESERVE   OF PERIOD
                                   ---------- ------------ ---------- ---------
<S>                                <C>        <C>          <C>        <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Year ended December 31, 1995......    $ --        $ 45        $--       $ 45
                                      ====        ====        ===       ====
Year ended December 31, 1996......    $ 45        $ 88        $--       $133
                                      ====        ====        ===       ====
Year ended December 31, 1997......    $133        $ 48        $--       $181
                                      ====        ====        ===       ====
INVENTORY VALUATION RESERVE
Year ended December 31, 1995......    $ --        $ 24        $--       $ 24
                                      ====        ====        ===       ====
Year ended December 31, 1996......    $ 24        $203        $--       $227
                                      ====        ====        ===       ====
Year ended December 31, 1997......    $227        $620        $33       $814
                                      ====        ====        ===       ====
</TABLE>
 
 
                                       49