<PAGE>
 
         The following items were the subject of a Form 12b-25 and are
                      included herein; 5,6,7,7A, 8 and 14
================================================================================

               UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                                        
                            WASHINGTON, D.C. 20549
                               ________________
                                  FORM 10-K/A
                                        
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
                                     1934

                  For the Fiscal Year Ended December 31, 1998

                       Commission file number:   0-27764

                               XYLAN CORPORATION
   (Exact name of Registrant as specified in its Articles of Incorporation)

  
       CALIFORNIA                                   95-4433911
 (State of Incorporation)              (I.R.S. Employer Identification No)


                  26801 WEST AGOURA ROAD, CALABASAS, CA 91301
                   (Address of principal executive offices)

                                (818) 880-3500
             (Registrant's telephone number, including area code)

       Securities registered pursuant to Section 12(b) of the Act: None

          Securities registered pursuant to Section 12(g) of the Act:

                         Common Stock, $.001 par value

                        Preferred Stock Purchase Rights

  Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X]  NO [_]

  Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.

  The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $588,584,194 as of February 23, 1999, based upon
the closing sale price on the Nasdaq National Market reported for such date.
Shares of Common Stock held by each officer and director and by each person who
owns 5% of more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates.  This determination of affiliate status
is not necessarily a conclusive determination for other purposes.

  There were 42,486,382 shares of Registrant's Common Stock issued and
outstanding as of February 23, 1999.
<PAGE>
 
                               XYLAN CORPORATION

                        1998 FORM 10-K/A ANNUAL REPORT

                               TABLE OF CONTENTS

Explanatory Note:  In this Form 10-K/A, the Registrant has included the
information omitted from items 5, 6, 7, 7A, 8 and 14 of the Form 10-K,
originally filed by the Registrant on March 31, 1999.

<TABLE>
<CAPTION>
PART I
 
<S>                                                                                                         <C>
ITEM 1.  BUSINESS........................................................................................        3
 
ITEM 2.  PROPERTIES......................................................................................       10
 
ITEM 3.  LEGAL PROCEEDINGS...............................................................................       10
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................................       11
 
PART II
 
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY
         AND RELATED STOCKHOLDERS MATTERS................................................................       11
 
ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA............................................................       12
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
         CONDITION AND RESULTS OF OPERATIONS.............................................................       13
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......................................       19
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.....................................................       19
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
         ACCOUNTING AND FINANCIAL DISCLOSURE.............................................................       19
 
PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT..............................................       20
 
ITEM 11. EXECUTIVE COMPENSATION..........................................................................       22
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
         OWNERS AND MANAGEMENT...........................................................................       24
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................................................       26
 
PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
         AND REPORTS ON FORM 8-K.........................................................................       27
</TABLE>

                                       2
<PAGE>
 
                             INTRODUCTORY STATEMENT
                                        
     Except for the historical information contained in this Annual Report on
Form 10-K, the matters discussed herein may include forward-looking statements
that are subject to certain risks and uncertainties that could cause the actual
results to differ materially from those projected.  Readers are referred to
"Item 1. Business", which identifies important risk factors that could cause
actual results to differ from those contained in the forward-looking statements.
Xylan Corporation ("Xylan" or the "Company") assumes no obligation to update any
forward-looking statements contained herein.

     Xylan was incorporated in California in July 1993.  The Company's executive
offices are located at 26801 West Agoura Road, Calabasas, California 91301, and
its telephone number at that location is (818) 880-3500.

     References made in this Annual Report on Form 10-K to "Xylan Corporation"
or the "Company" refer to Xylan Corporation and its subsidiaries.  The following
Xylan Corporation trademarks are mentioned in this Annual Report: Xylan(R),
PizzaSwitch(R), OmniSwitch(R) and OmniStack(R) are registered trademarks of the
Company, and AutoTracker(TM), X-Vision(TM), OmniSwitch/Router(TM),OmniS/R(TM),
and X-Cell(TM) are trademarks of the Company.


                                    PART I


Item 1.  BUSINESS

Overview

     The Company is a leading provider of high- bandwidth switching systems that
enhance the performance of existing local area networks ("LAN") and facilitate
migration to next-generation networking technologies such as Asynchronous
Transfer Mode ("ATM").  Current hub and router- based networks are facing
performance degradation due to the continued growth in the size of networks,
increasing demands of high-performance personal computers and workstations, and
emergence of graphical applications, such as Intranet/Java applications,
document image processing, desktop video, medical imaging, modeling and
simulation, and the World Wide Web.  To address these issues, a new generation
of switched technologies has emerged, including LAN switching, ATM switching,
and layer-three switching.

     The Company offers the OmniSwitch, OmniStack, OmniSwitch/Router and
PizzaSwitch product families, which support all popular LAN types with "any-to-
any" MAC-layer translation, and allow the use of LAN switches in place of
shared-media hubs.  The Company's switches are based on a distributed, modular,
multiprocessor architecture that currently combines LAN switching, virtual LANs,
ATM switching, wide area access, security, and layer-three switching in a single
product, and which allows switching performance to increase in linear proportion
to the number of ports.  The Company has developed and continues to develop
custom chips (ASICs, or application-specific integrated circuits) providing
important feature differentiation for integration into its product line.

     The Company has strategic OEM partnerships with leading communications and
networking companies, including Alcatel and IBM that have significant customer
relationships already in place.  Xylan pursues direct sales to organizations in
North America with large networking requirements and employs network integrators
to target customers worldwide.  The Company's products have been deployed by a
broad range of organizations, ranging from companies in the telecommunications,
manufacturing, medical, computer services, media and finance/insurance
industries to educational institutions and the federal government.

Merger

     Xylan and Alcatel, a French corporation ("Alcatel"), and Zeus Acquisition
Corp., a California corporation and a wholly owned subsidiary of Alcatel
("Sub"), entered into an Agreement and Plan of Merger dated as of March 1, 1999
(the "Merger Agreement"), pursuant to which and subject to the conditions
thereof, Xylan will become a wholly-owned indirect subsidiary of Alcatel through
the merger of Sub with and into Xylan (the "Merger").

                                       3
<PAGE>
 
     On April 5, 1999, Alcatel announced that it successfully completed its
tender offer (the "the Offer") to purchase the outstanding shares of Xylan for
$37 per share.  The tender offer expired at 12:00 midnight, New York City time,
on Friday, April 2, 1999.  Based on a preliminary count, approximately 97% of
the outstanding shares of Xylan (together with shares already owned by Alcatel)
were tendered.  Alcatel has accepted for purchase all of these shares.
Following the closing of the Offer, Alcatel appointed a majority of the
directors of Xylan.

     Under California Law, since Sub has acquired pursuant to the Offer at least
90% of the outstanding Xylan shares, it will be able to approve the Merger
Agreement and the transactions contemplated thereby, including the Merger,
without a vote of the shareholders of Xylan.  Alcatel, Sub and Xylan have agreed
in the Merger Agreement to take, subject to the satisfaction or waiver of the
conditions set forth in the Merger Agreement, all necessary and appropriate
action to cause the Merger to become effective as soon as practicable after the
acceptance of the payment for Xylan shares by Sub pursuant to the Offer, without
a meeting of shareholders of Xylan, in accordance with Section 1110 of the
California General Corporation Law.

     Alcatel expects the Merger to be completed by the end of April.  As a
result of the Merger, the shares of Xylan that were not tendered in the tender
offer will be converted into the right to receive $37 per share in cash and
Xylan will become a wholly-owned indirect subsidiary of Alcatel.

Xylan Solution

     Xylan was founded to provide high-bandwidth switching systems that enhance
the performance of existing LANs and facilitate migration to next generation
networking technologies such as ATM. The Company's products accomplish these
goals by: providing "any-to-any" MAC-layer translation; supporting widely used
LAN types such as Ethernet, Fast Ethernet, token ring, ATM, and Fiber
Distributed Data Interface ("FDDI"); and enabling the customer to replace
shared-media hubs with LAN switches. Xylan's AutoTracker product is designed to
support powerful, flexible virtual LANs and to simplify network management.

     Xylan has designed its product architecture specifically to support LAN
switching, ATM switching, virtual LANs, security, and routing.  The Company's
switches are based on a distributed, modular, multiprocessor architecture.  This
architecture allows switching performance to increase in linear proportion to
the number of ports, unlike many other switches based on a central switching
engine, which generally cannot increase performance as ports are added.  The
Company's virtual LAN capability is integrated directly into its hardware
architecture and controlled by distributed reduced instruction set computing
("RISC") processors and ASICs to achieve high throughput and flexibility.
Xylan's products can switch within virtual LANs and route between them, and can
establish security firewalls between them.  The Company has also developed a
substantial number of LAN interface modules, enabling the customer to tailor the
product to a particular application.  The Company continues to develop ASICs to
provide unique functionality, increase system performance and reduce costs.

Products And Technology

     Xylan offers a family of products that are designed to serve as a complete
switching system for a building or campus.  The Company's OmniSwitch, OmniStack,
OmniSwitch/Router, and PizzaSwitch products provide flexible high-end LAN
switching, virtual LANs, high-speed routing, ATM switching, layer-three
switching, wide-area access and comprehensive network management capabilities.
The Company's X-Vision software provides a graphical network management
capability designed to be compatible with the user's network environment.

  OmniSwitch

     The OmniSwitch is a modular, chassis-based switch that provides high
performance LAN switching, routing, layer-three switching, and ATM switching.
The OmniSwitch supports a variety of LAN types, interconnecting Ethernet, Fast
Ethernet, Gigabit Ethernet, token ring, FDDI, frame relay, and ATM with any-to-
any MAC-layer protocol translation.  The Company offers the OmniSwitch in three-
slot, five- slot, and nine-slot enclosures, which can be configured with a mix
of switching modules to meet a customer's specific needs.  All three enclosures
use the same hardware and software and offer

                                       4
<PAGE>
 
redundant, load-sharing power supplies with separate AC or DC inputs. The
OmniSwitch is designed to be located either in the customer's wiring closet or
in the computer room. The list price for a fully configured OmniSwitch typically
ranges from $10,000 to $100,000, depending on the configuration necessary to
meet the needs of a specific customer. A network could use one OmniSwitch or
could use hundreds, depending on network size and the extent to which switching
is deployed.

     The Xylan OmniSwitch family of products is based on a distributed, modular,
multiprocessor, and multi-ASIC switching architecture.  This distributed
architecture eliminates the traditional central switching engine, enabling data
to move more quickly through the Company's switching modules.  In addition,
users can increase the processing capacity of an OmniSwitch by simply adding
switching modules.

     The OmniSwitch serves as a platform for a broad array of LAN, ATM, and wide
area switching modules. Each module not only provides connections for user
equipment, but also acts as an independent switching engine, communicating
directly with other modules in the OmniSwitch.

  OmniStack

     The Company announced its OmniStack series of products in March of 1998.
The OmniStack is designed to be more cost effective in smaller configurations.
The OmniStack is based on the same system architecture and incorporates many of
the same LAN switching and software capabilities as the OmniSwitch.
Consequently, the OmniStack units incorporate many of the features and
functionality of the OmniSwitch that are lacking in traditional small switches,
making the OmniStack suitable for a wider range of customers and applications.
The OmniStack units may be used alone in a small network or in combination with
multiple OmniSwitch and/or OmniStack devices in a larger network. While the
OmniSwitch is fully modular, the OmniStack units combine a number of Ethernet or
10/100 (Ethernet / Fast Ethernet) ports with a small number of modular high-
speed ports, which are scheduled to be Fast Ethernet, Gigabit Ethernet, ATM or
various wide area interfaces.  The OmniStack is designed to be located either in
the customer's wiring closet or in the computer room.  The list price for a
fully configured OmniStack typically ranges from $3,350 to $37,000, depending on
the configuration necessary to meet the needs of a specific customer.

  PizzaSwitch

     The Company's PizzaSwitch product, which was introduced during the first
quarter of 1996, is based on the same system architecture and incorporates many
of the same LAN switching and software capabilities as the OmniSwitch.  The
PizzaSwitch will be used in applications which require a small access switch
with FDDI uplinks.

 Omni Switch/Router

     The Omni Switch/Router, or OmniS/R, is a modular, chassis-based switch that
provides high performance LAN switching, routing, layer-three switching, and ATM
uplinks.  The OmniSwitch/Router supports a variety of LAN types, interconnecting
Ethernet, Fast Ethernet, Gigabit Ethernet, token ring, FDDI, frame relay, and
ATM with any-to-any MAC-layer protocol translation.  The Company offers the
OmniSwitch/Router in five-slot and nine-slot enclosures, which can be configured
with a mix of switching modules to meet a customer's specific needs.  Both
enclosures use the same hardware and software and offer redundant, load-sharing
power supplies with separate AC or DC inputs. The OmniSwitch/Router is designed
to be located either in the customer's wiring closet or in the computer room.
The list price for a fully configured OmniSwitch/Router typically ranges from
$10,000 to $100,000, depending on the configuration necessary to meet the needs
of a specific customer.  A network could use one OmniSwitch/Router or could use
hundreds, depending on network size and the extent to which switching is
deployed.

  AutoTracker-Virtual LANs

     The OmniSwitch and OmniStack hardware and software architectures were
designed to support flexible virtual LANs.  The Company's AutoTracker capability
allows a network manager to group devices logically, rather than physically,
using policy-based management. Workstation movements can be automatically
tracked for the network manager through the network.  Virtual LAN processing is
integrated into the OmniSwitch and OmniStack hardware and software architecture
in order to maintain switching performance.  A virtual LAN supported by
AutoTracker can include any combination of LAN

                                       5
<PAGE>
 
types supported by the OmniSwitch and the OmniStack. For example, a single
virtual LAN could include Ethernet and token ring workstations as well as FDDI
and ATM servers. Virtual LANs supported by AutoTracker can span multiple
switches, across FDDI, Fast Ethernet, Gigabit Ethernet, and/or ATM backbones.
Any given workstation or server can belong to as many as 31 virtual LANs.
AutoTracker also allows workstations attached to a single hub to be assigned to
different virtual LANs.

  Vision Network Management

     Xylan's X-Vision network management software operates within a customer's
existing network management environment.  It supports the OmniSwitch, OmniStack
and PizzaSwitch products with a graphical interface which operates on industry-
standard applications for both Windows (Hewlett-Packard's OpenView) and UNIX
(OpenView, SunSoft's SunNet Manager and IBM's NetView for AIX). Network managers
can also control the OmniSwitch, OmniStack and PizzaSwitch with an ASCII menu-
driven interface.

  ATM Switching Technology

     Xylan has incorporated ATM switching capability into the OmniSwitch.  The
Company believes that its ATM switching architecture, Distributed Input
Buffering with Output Control, allows both data-based and real-time traffic to
be handled with minimal cell loss even under heavy loads. Video streams and
other real-time traffic are also supported.  The ATM switching capability, known
as X-Cell, supports large cell buffers, offers intelligent cell discard
mechanisms, and supports a number of important ATM Forum standards.

Product Development

     The Company's business depends to a substantial degree upon its ability to
develop and introduce in a timely fashion new products and enhancements to it's
existing products that meet changing customer requirements and emerging industry
standards.  Xylan intends to make substantial investments in product development
and to participate in the development of industry standards.  The Company
monitors changing customer needs and works closely with its OEM partners,
network integrators, end-user customers and market research organizations to
track changes in the marketplace, including emerging industry standards and
local area networking protocols.

     The Company's products are developed using a distributed architecture that
allows multiple development teams to work in parallel.  The Company believes
that this accelerates the product development cycle and reduces the time to
bring new products and features to market. Xylan intends to continue to use this
approach to develop and introduce additional products and enhancements in the
future.

     The Company is focusing development efforts on expanding the LAN and ATM
interfaces and routing protocol capabilities of its products, supporting carrier
services and additional industry standards, adding higher capacity platforms and
expanding the Company's network management capabilities.  In addition, Xylan has
devoted and continues to devote significant resources to the design, simulation
and fabrication of ASICs to provide differentiated functionality, reduce costs
and increase the performance of its products. No assurances can be given that
the Company will be able to introduce any or all of these products, or any
future products, on a timely basis, if at all.  Furthermore, there can be no
assurance that the Company will be able to identify, develop, manufacture,
market, or support new products, or enhancements to its existing products
successfully or on a timely basis, that new Company products will gain market
acceptance or that the Company will be able to respond effectively to product
announcements by competitors, technological changes or emerging industry
standards.

     The Company's research and development expenditures totaled $41.3 million,
$25.9 million and $15.8 million for the years ended December 31, 1998, 1997, and
1996, respectively.  At December 31, 1998, the Company employed 292 employees in
research and product development.  The Company performs its research and product
development activities at its headquarters and in offices located in Irvine, CA;
San Diego, CA; San Jose, CA; Acton MA; Raleigh, NC; Minneapolis, MN; and Salt
Lake City, UT.  The Company is seeking to hire additional skilled development
engineers.  The Company's business, operating results and financial condition
could be adversely affected if it encounters delays in hiring required
engineers.

                                       6
<PAGE>
 
Sales And Marketing

     The Company's sales and marketing strategy is focused on three channels of
distribution: worldwide OEM partners, network integrators in North America and
overseas and direct sales.  In general, the Company's resale agreements with its
OEM partners and system integrators are not exclusive and each of the Company's
OEM partners and system integrators can cease marketing the Company's products
at their option with limited notice and with little or no penalty. In addition,
these agreements generally provide for discounts based on expected or actual
volumes of products purchased or resold by the reseller and OEM in a given
period and do not require minimum purchases.  Certain of these agreements
provide manufacturing rights and access to source code upon the occurrence of
specified conditions or defaults.

  OEM Partners

     The Company has established OEM partnerships with leading communications
and networking companies, including Alcatel and IBM.  For the year ended
December 31, 1998, IBM and Alcatel accounted for 18% and 16% of revenue,
respectively. Each of the Company's OEM partners resells the Company's products
under its own name. Certain of them have also agreed to supply Xylan with
technology to be incorporated into the OmniSwitch.  Each of Xylan's OEM partners
is a major system integrator, as well as a manufacturer.  The Company believes
that its OEM partnerships enhance its ability to sell to large organizations
because these resellers have long-term supplier relationships with these
potential customers, and because certain end user organizations prefer to do
business with very large suppliers.  Since OEM partners provide support to their
customers, Xylan is also able to focus its support efforts on its direct
customers, and on training and high-level backup support to OEM partners and
system integrators.

  System Integrators

     The Company also currently sells its products through more than 200 system
integrators worldwide.  The Company's system integrators supplement the direct
and OEM channels.  System integrators generally are responsible for system
installation, technical support, and follow-on services to customers in their
respective territories.  No individual network integrator accounted for more
than 10% of the Company's revenue in 1998.

  Direct Sales in North America

     Xylan conducts direct sales to end users in North America to focus on major
account sales, promote the Company's products, and ensure direct contact with
the Company's current and potential customers.  Xylan's sales organization also
provides support to OEM partners and system integrators, assists end user
customers in addressing complex switching problems, and promotes the features
and capabilities of the Company's products.  In addition, the Company believes
that direct sales help the Company to monitor changing customer requirements.

  Xylan's International Sales Organization

     The Company has designed its products and established its marketing and
sales channels to address the global market opportunities for switching
products.  The Company's international sales are conducted primarily through its
OEM partners, worldwide network integrators and territory-specific network
integrators.  The Company believes that there is a strong international market
for its products. Sales to customers outside of North America accounted for
approximately 50% of the Company's revenue for the year ended December 31, 1998,
with approximately 14%, 33% and 3% of 1998 revenue being attributable to sales
to customers in Asia-Pacific, Europe and Latin America, respectively.  However,
these percentages may understate sales of the Company's products to
international end users because certain of the Company's U.S.-based OEM partners
market the Company's products abroad.  The Company's international sales
organization provides support to OEM partners and system integrators and
promotes the features and capabilities of the Company's products.

                                       7
<PAGE>
 
  End Users

     The Company's products have been deployed by a broad range of
organizations, ranging from companies in the telecommunications, manufacturing,
medical, computer services, media and finance/insurance industries to
educational institutions and the federal government.

  Marketing

     The Company has a number of marketing programs to support the sale and
distribution of its products.  The objective of these programs is to inform OEM
partners, system integrators, and prospective end user customers about the
capabilities and benefits of the Company's products.  Marketing programs include
participation in industry tradeshows, technical conferences and technology
seminars; preparation of competitive analyses; sales training; publication of
technical and educational articles in industry journals; presentation of Xylan-
specific seminars; maintenance of Xylan's World Wide Web site; advertising;
public relations; and direct mail distribution of Company literature.

Customer Service And Support Engineering

     Xylan's customer service and support organization installs, maintains and
supports products sold in North America directly to end users by the Company,
and provides technical support to the Company's OEM partners and network
integrators.  The Company's OEM partners and system integrators generally
provide installation, maintenance and support services to their customers, with
the Company providing backup support.

     The Company offers maintenance programs in North America that provide seven
days a week and 24 hours a day technical phone support; software updates; and
on-site hardware replacement through a network of service delivery partners.
Xylan employs systems engineers who work closely with the Company's OEM
partners, system integrators, and sales personnel to assist end users with pre-
sales and post-sales support.  These systems engineers provide input to the
product development process based on their experiences in the field.

     Xylan typically provides its system integrators with a one-year hardware
warranty and a three-month software warranty, commencing on product shipment.
Warranty terms for OEM partners are negotiated individually.

Manufacturing

     Xylan's manufacturing operations consist primarily of material planning and
procurement, final assembly, software loading, test and quality assurance.
Xylan's operational strategy relies on outsourcing of manufacturing to reduce
fixed costs and to provide flexibility in meeting market demand.  The Company
currently subcontracts component procurement and kitting and printed circuit
board assembly to three companies that specialize in these services.  The
printed circuit board-based modules produced by its contract manufacturers are
inserted into product enclosures in combination with Xylan's software to meet
the needs of individual customers.

     In connection with its outsourcing strategy, the Company is seeking to
secure additional sources of supply, including additional contract
manufacturers.  The Company has experienced in the past, and may in the future
experience, problems with its contract manufacturers, such as quality, quantity
and on-time delivery.  In addition, the Company may in the future experience
pricing pressures from its contract manufacturers.  To date, the Company has had
only limited experience with the use of contract manufacturers.  There can be no
assurance that the Company will effectively manage its contract manufacturers or
that these contract manufacturers will meet the Company's future requirements
for timely delivery of products of sufficient quality and quantity.  The Company
intends to introduce a number of new products and product enhancements in 1999,
which will require that the Company rapidly achieve volume production by
coordinating its efforts with those of its suppliers and contract manufacturers.
Certain of the Company's products in development will require contract
manufacturers to adopt or develop advanced manufacturing techniques, which could
inhibit volume manufacturing of those products.  The inability of Xylan's
contract manufacturers to provide it with adequate supplies of high-quality
products or the loss of any of the Company's contract manufacturers could cause
a delay in Xylan's ability to fulfill orders while the Company identifies a
replacement manufacturer and could have a material adverse effect on the
Company's business, operating results and financial condition.

                                       8
<PAGE>
 
     The Company uses a rolling six-month forecast based on anticipated product
orders to determine its general materials and component requirements. Lead times
for materials and components ordered by the Company vary significantly, and
depend on factors such as the specific supplier, contract terms, and demand for
a component at a given time.  Currently, the Company acquires materials and
completes certain standard subassemblies based on the Company's forecast. Upon
receipt of firm orders from customers, the Company assembles fully-configured
systems and subjects them to a number of tests before shipment.  If orders do
not match forecasts, the Company may have excess or inadequate inventory of
certain materials and components.  The Company continues to implement new and
enhanced financial and management information systems and controls and to train
its personnel to operate such systems. Any difficulty in the operation of such
new and enhanced systems and controls or the training of personnel, or any
disruptions in the transition to such new and enhanced systems and controls,
could adversely affect the Company's ability to accurately forecast sales demand
and calibrate manufacturing to such demand, to calibrate purchasing levels and
to accurately record and control inventory levels and to record and report
financial and management information on a timely and accurate basis.

     Although the Company generally uses standard parts and components for its
products, many key components used in the manufacture of the Company's products
are currently purchased only from single or limited sources. At present, single-
sourced components include ASIC's, certain processors, programmable integrated
circuits, selected other integrated circuits, cables, and custom-tooled sheet
metal; and limited-sourced components include flash memories, DRAMs and printed
circuit boards.  The Company generally does not have long-term agreements with
any of these single or limited sources of supply.  The Company is in the process
of incorporating additional ASICs in many of its products.  Each of these ASICs
is initially being manufactured only by a single source, particularly LSI Logic
Corporation and, accordingly, the risks of relying on sole sources is expected
to increase. Any interruption in the supply of any of these components, or the
inability of the Company to procure these components from alternate sources at
acceptable prices and within a reasonable time, could have a material adverse
effect upon the Company's business, operating results, and financial condition.
Qualifying additional suppliers is time-consuming and expensive and the
likelihood of errors is greater with new suppliers. From time to time the
Company has experienced shortages and allocations of certain components and has
experienced delays in fulfilling orders while waiting to receive the necessary
components.  Given current worldwide demand for integrated circuits and certain
other components used by the Company, such shortages and allocations are likely
to occur again in the future and could have a material adverse effect on the
Company's business, operating results, and financial condition.

Competition

  The market for network switching products is intensely competitive and subject
to frequent product introductions with improved price/performance
characteristics, rapid technological change and continued emergence of new
industry standards.  Many networking companies, including Cabletron Systems,
Inc., Cisco Systems, Inc., FORE Systems, Inc. and 3Com Corporation have
introduced, or have announced their intention to develop, network switching
products that are or will be competitive with the Company's products. In
addition, many of the Company's large competitors offer customers a broader
product line which provides a more comprehensive networking solution than the
Company currently offers.  Recent consolidations in the industry have resulted
in competitors that may have broader product lines, greater access to capital,
or greater research and development resources which could adversely affect the
ability of the Company to compete.  Xylan expects that other companies will also
enter markets in which the Company competes.  In addition to competition from
providers of network switching products, the Company expects to face competition
from other vendors in the networking market who may incorporate switching
functionality into their products or provide alternative network solutions.
Furthermore, the Company's OEM partners may in the future develop competitive
products and may then decide to terminate their relationships with the Company.
In addition, certain of the Company's OEMs may sell competitive products using
the Company's technology.  Many of the Company's current and potential
competitors have longer operating histories and substantially greater financial,
technical, sales, marketing and other resources, as well as greater name
recognition and a larger installed customer base, than the Company.  As a
result, these competitors may be able to devote greater resources to the
development, promotion, sale and support of their products than the Company. In
addition, competitors with a larger installed customer base may have a
competitive advantage over the Company when selling similar products or
alternative networking solutions to such customers.  Increased competition could
result in significant price competition, reduced profit margins or loss of
market share, any of which could have a material adverse effect on the Company's
business, operating results and financial condition.  There can be no assurance
that the Company will be able to compete successfully against either current or
potential competitors in the future.

                                       9
<PAGE>
 
     The Company believes that the principal competitive factors in its market
are: (i) expertise and familiarity with LAN and ATM protocols, LAN and ATM
switching, and network management; (ii) product performance, features,
functionality, and reliability; (iii) price/performance; (iv) timeliness of new
product introductions; (v) adoption of emerging industry standards; (vi)
customer service and support; (vii) size and scope of distribution network;
(viii) access to customers; (ix) size of installed customer base; and (x)
corporate operating history and financial resources.  The Company believes that
it is competitive with respect to the first seven of these factors and intends
to become competitive with respect to the remaining factors.

     The Company's international business is subject to risks customarily
encountered in foreign operations, including changes in a specific country's or
region's political or economic conditions, trade protection measures, import or
export licensing requirements, the overlap of different tax structures,
unexpected changes in regulatory requirements and natural disasters.

Employees

     As of December 31, 1998, the Company employed 1,044 persons, including 292
in research and product development, 525 in sales and marketing, 163 in
operations and 64 in finance and administration.  None of the Company's
employees is represented by a labor union.  The Company has experienced no work
stoppages and believes that its relationship with its employees is good.

Item 2.  PROPERTIES

     During 1998, the Company entered into a ten (10) year lease agreement for a
129,000 square foot facility located in Calabasas, California.  The facility was
completed in January 1999 and the Company has relocated its corporate
headquarters.  The Company leases a total of approximately 224,000 square feet
of office, development and manufacturing space (including the above described
facility), all in Calabasas.  The Company is currently in the process of
subleasing some portion of the space.  The Company also has approximately 100
sales and support offices worldwide.  The Company believes that the current
space is sufficient to meet its requirements for 1999.

Item 3.  LEGAL PROCEEDINGS

     On March 2, 1999, an action entitled Daniel W. Krasner v. Xylan Corporation
et. al. was filed, on March 5, 1999, an action entitled Jay Gentile v. Xylan
Corporation et. al. was filed, and on March 9, 1999, an action entitled Marilyn
Mandel v. Xylan Corporation et. al. was filed, each in the Superior Court of the
State of California, for the County of Los Angeles, in which the respective
plaintiffs named as defendants the Company, the directors of the Company and
Alcatel.  The complaints purport to assert claims on behalf of all public
shareholders of the Company.  The complaints allege that Alcatel and the members
of the Company Board have breached their fiduciary duties to the Company and
that Alcatel used its relationship with the Company and the Company Board to
force the Company Board to accept an inadequate proposal.  The complaints seek
class certification and other equitable and monetary relief, including enjoining
the Offer and the Merger or awarding damages.  Alcatel and the Company believe
that the allegations are without merit and intend to vigorously contest these
actions.  There can be no assurance that the defendants will be successful.

     Xylan has, from time to time, received claims, directly or indirectly, from
third parties alleging infringement of such third parties' intellectual property
rights.  Lucent Technologies, Inc. ("Lucent") has notified Xylan of the
existence of certain data networking patents that it holds and that Xylan's
activities may infringe such patents.  Lucent has proposed that Xylan accept a
royalty-based license under such patents.  Although Lucent's claim has not
resulted in litigation to date, there can be no assurance that this claim will
not generate material litigation or that any material litigation would be
resolved favorably to Xylan.

     The Company believes that no other current claim against the Company would
result in material liability if successful, although there can be no assurance
to that effect.

                                       10
<PAGE>
 
Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this Report.

                                    PART II
                                        

Item 5.  MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
       MATTERS

       The Company's Common Stock is traded on the NASDAQ National Market under
the symbol "XYLN".  As of March 1, 1999, the Company had approximately 381
shareholders of record.  Since many shareholders are listed under their
brokerage firms' names, the actual number of shareholders is higher.  On March
1, 1999, the last full trading date prior to the announcement of the execution
of the Merger Agreement, the last reported sale price for the Common Stock on
the NASDAQ National Market was $26.94 per share.

       The following table shows the Company's high and low closing bid prices
for the periods indicated as reported by NASDAQ National Market:

<TABLE>
<CAPTION>
                                                                      1998                                 1997
                                                                      ----                                 ----                
                                                           High Bid           Low Bid           High Bid            Low Bid
                                                           --------           -------           --------            -------     
<S>                                                       <C>               <C>                <C>               <C>
 First Quarter                                              $26.13             $14.00            $36.13              $17.13
 Second Quarter                                             $30.25             $21.38            $22.63              $13.63
 Third Quarter                                              $31.06             $10.50            $24.56              $15.50
 Fourth Quarter                                             $21.63             $10.69            $23.38              $14.50
</TABLE>

     Pursuant to the Merger Agreement, Xylan will become a wholly-owned indirect
subsidiary of Alcatel.  On April 2, 1999, Alcatel accepted for payment
approximately 97% of the Company's common stock, which was tendered to Alcatel
in connection with the Offer.  The remaining shares of Xylan are expected to be
converted into which the right to receive cash on or around April 27, 1999, and
at such time all of the Company's common stock will be delisted from the NASDAQ
National Market.  Readers are referred to "Item 1. Business", which describes in
greater detail the Offer and the Merger.

Dividend Policy

       The Company has not paid dividends on its common stock and has no present
plans to do so.

                                       11
<PAGE>
 
Item 6.   SELECTED CONSOLIDATED FINANCIAL DATA

    The following selected financial information has been derived from the
audited Consolidated Financial Statements.  The information set forth below is
not necessarily indicative of results of future operations, and should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and related
notes thereto included elsewhere in the Form 10-K.
<TABLE>
<CAPTION>
                                                                                         Year ended December 31,
                                                                   -----------------------------------------------------------------

                                                                         1998            1997        1996        1995         1994
                                                                         ----            ----        ----         ----        ----
                                                                                                (In thousands)
<S>                                                                 <C>               <C>          <C>        <C>          <C>

Consolidated Statements of Operations Data:
Revenue...........................................................        $347,580     $210,849   $128,456     $29,662      $   443
Cost of revenue...................................................         150,567       92,551     57,830      15,418          327
                                                                          --------     --------   --------     -------      -------
  Gross profit....................................................         197,013      118,298     70,626      14,244          116
                                                                          --------     --------   --------     -------      -------

Operating expenses:
 Research and development.........................................          41,342       25,875     15,823       7,154        2,404
  Sales and marketing.............................................          91,081       60,356     32,590      13,011          695
  General and administrative......................................           9,580        7,013      4,397       3,593        1,168
                                                                          --------     --------   --------     -------      -------
    Total operating expenses......................................         142,003       93,244     52,810      23,758        4,267
                                                                          --------     --------   --------     -------      -------

Operating income (loss)...........................................          55,010       25,054     17,816      (9,514)      (4,151)

   Interest income, net...........................................           5,183        6,694      5,240          73           68
                                                                          --------     --------   --------     -------      -------

Income (loss) before income taxes.................................          60,193       31,748     23,056      (9,441)      (4,083)

  Income tax expense..............................................          20,800        7,621      7,811          --           --
                                                                          --------     --------   --------     -------      -------

Net income (loss).................................................        $ 39,393     $ 24,127   $ 15,245     $(9,441)     $(4,083)

                                                                          ========     ========   ========     =======      =======

Net income (loss) per share (1):
  Basic...........................................................           $0.92        $0.57      $0.43      $(0.91)      $(0.41)

  Diluted.........................................................           $0.83        $0.52      $0.33      $(0.91)      $(0.41)

                                                                          ========     ========   ========     =======      =======

Shares used in per share computation (1):
  Basic...........................................................          42,840       42,550     35,870      10,320       10,025
  Diluted.........................................................          47,485       46,796     46,381      10,320       10,025
                                                                          ========     ========   ========     =======      =======


                                                                                                  December 31,
                                                                          ---------------------------------------------------------
                                                                           1998          1997        1996        1995         1994
                                                                           ----          ----        ----        ----         ----
                                                                                                 (In Thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments.................        $ 59,230     $ 79,088   $112,981     $ 6,034      $ 4,584
Investments.......................................................          70,671       59,382     27,785          --           --
Working capital...................................................         120,180      124,934    134,615      11,130        4,186
Total assets......................................................         282,046      250,906    207,251      27,248        6,613
Capital lease obligations, long-term..............................              --           17        206         509          239
Net shareholders' equity..........................................         224,045      216,100    185,638      16,105        5,367
</TABLE>
----------
(1)  See Note 1 of Notes to Consolidated Financial Statements for an explanation
     of the determination of the number of shares used to compute net income
     (loss) per share.

                                       12
<PAGE>
 
Item 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

      This Annual Report on Form 10-K may consist of forward-looking statements
that involve risks and uncertainties. These statements may differ materially
from actual future events or results.  Readers are referred to "Item 1.
Business, which identifies important risk factors that could cause actual
results to differ from those contained in the forward-looking statements.

     On April 5, 1999, Alcatel announced that it had successfully completed its
tender offer to purchase all of the outstanding shares of Xylan.  As a result of
the Offer and the Merger, Xylan will become a wholly-owned indirect subsidiary
of Alcatel.  Readers are referred to "Item 1. Business", which describes in
greater detail the Offer and the Merger.

     Xylan is a leading provider of high-bandwidth switching systems that
enhance the performance of existing local area networks ("LANs") and facilitate
migration to next-generation networking technologies such as asynchronous
transfer mode ("ATM").  From inception (July 9, 1993) to December 31, 1994, the
Company was primarily engaged in product research and development and in the
development of systems and operations.  The Company began commercial shipments
of its initial OmniSwitch products in January 1995. Since then, revenue has
increased significantly to an aggregate of $347.6 million in fiscal year 1998
from $29.7 million in fiscal year 1995.  The increase in revenue reflects
substantial growth of the LAN switching market, the continued introduction by
the Company of additional features and enhancements to its OmniSwitch product
family and the introduction of the PizzaSwitch product in March 1996, all of
which expanded the portion of the market addressed by Xylan's products.  The
increase in revenue was also the result of continued market acceptance of the
Company's LAN switching products, and investment in sales and marketing efforts,
including significant expansion of the Company's domestic and international
product distribution network.  The Company markets its products worldwide
through OEM partners, system integrators and its own sales force and first
achieved profitability in the fourth quarter of 1995.  As of December 31, 1998
and 1997, the Company had retained earnings of $64.7 million and $25.3 million,
respectively.

Revenue

     Revenue for the year ended December 31, 1998 was $347.6 million as compared
to $210.8 million for the year ended December 31, 1997, an increase of $136.8
million or 65%.  The increases in revenue were due to a number of factors
including: the introduction of the Company's new OmniStack product family in the
first quarter of 1998, substantial growth of the LAN switching market, continued
introduction of new features and functions to the OmniSwitch product family, the
introduction in the fourth quarter of 1998 of the OmniSwitch/Router product
family and continued investment in sales and marketing resources.  These
increases more then offset the decline in revenues for the Company's
PizzaSwitch.  The Company markets and sells its products world-wide through OEM
partners, system integrators and direct sales force.  The relative contribution
of the factors can be quantified in the table below.

                                       13
<PAGE>
 
     The following table sets forth the Company's revenue by sales channel,
geographic region, product line and significant customers in dollars and as a
percentage of total revenue (dollars in millions):
<TABLE>
<CAPTION>
 
                                             Years ended December 31,     Years ended December 31,
                                             -------------------------   --------------------------
                                              1998             1997           1996           1998      1997    1996
                                              ----             ----           ----           ----      ----    ----
<S>                                          <C>            <C>          <C>             <C>          <C>     <C>
                                                     
Channel:                                             
 OEM                                         $120.1            $ 77.1         $  59.4           35%     37%     46%
 System Integrator and Direct                $227.5            $133.7         $  69.0           65%     63%     54%
                                             ======            ======         =======         ====    ====    ====
                                                     
Region(1):                                           
  North America (2)                          $173.7            $ 98.8         $  62.8           50%     47%     49%
     Europe                                  $112.6            $ 60.1         $  16.4           33%     28%     13%
     Asia Pacific                            $ 50.4            $ 45.9         $  48.1           14%     22%     37%
     Latin America                           $ 10.8            $  6.1         $   1.2            3%      3%      1%
                                             ======            ======         =======         ====    ====    ====
                                                     
Product Line:                                        
  OmniSwitch                                 $275.6            $191.4         $ 116.3           79%     91%     91%
 OmniSwitch Router                           $ 13.4            $   --         $   --             4%      --      --
 OmniStack                                   $ 51.6            $   --         $   --            15%      --      --
 PizzaSwitch                                 $  7.0            $ 19.5         $  12.2            2%      9%      9%
                                             ======            ======         =======         ====    ====    ====
                                                     
Significant Customers:                               
 IBM                                         $ 62.7            $ 45.3         $  15.0           18%     22%     12%
  Alcatel                                    $ 55.0            $ 24.5              (3)          16%     12%     (3)
  Hitachi Computer Products                      (3)               (3)        $  17.3           (3)     (3)     14%
  NTT-PC Communications                          (3)               (3)        $  15.8           (3)     (3)     12%
                                             ======            ======         =======         ====    ====    ====
</TABLE>
     (1) IBM and Alcatel revenues are attributed to regions based on "point of
         sale" information.  All other revenues are attributed to regions based
         on the location of the customer.
     (2) North America primarily consists of the United States.
     (3) Accounted for less than 10% of total revenues

  While the Company achieved record revenue growth of 65% for the year ended
December 31, 1998, (and 64% in 1997), it can not insure that these rates of
growth will continue if at all in future periods.

     Under an agreement with IBM and the Company, IBM has the right to
manufacture certain Company products after a specified period of time and pay a
royalty to Xylan.  As of December 31, 1998, the Company has earned no royalties.
Product revenue could be adversely impacted if IBM elects to manufacture the
Company's products.

Gross Profit

     Gross margins were 56.7% and 56.1% for the years ended December 31, 1998
and 1997 respectively.  The improvements in gross margins were the result of a
number of factors including reductions in component costs, manufacturing
efficiencies and channel mix.  The increases in gross margins were partially
offset by product mix (OmniStack generally have lower gross margins then
OmniSwitch) and competitive market pricing and discount levels.  After initial
product introduction, the Company's strategy is to seek to reduce component
costs, particularly by integrating newly developed ASICS into such products. The
timing and execution of new product introductions and integration of new ASICS
may also impact gross margins negatively through additional excess or obsolete
inventories.  The Company expects gross margins in 1999 to be comparable to
those in 1998.

                                       14
<PAGE>
 
Research and Development Expenses

     Research and development expenses increased to  $41.3 million for the year
ended December 31, 1998 as compared to $25.9 million in 1997.  The increases in
research and development were primarily due to the hiring of additional
engineers and an increase in prototype material costs for new product
development.  As of December 31, 1998, the company employed 292 people in
engineering as compared to 187 employees as of December 31, 1997.  As a
percentage of total revenues, research and development decreased from 12.3% to
11.9%.

     The market for the Company's products is characterized by frequent new
product introductions and rapidly changing technology and industry standards,
any of which can impact Xylan's existing product offerings.  As a result, the
Company's success will depend to a substantial degree upon its ability to
develop and introduce in a timely fashion new products and enhancements to its
existing products that meet changing customer requirements and emerging industry
standards.  Accordingly, the Company expects to continue to make substantial
investments in research and development and anticipates that research and
development expenses will continue to increase in 1999 in absolute dollars.  To
date, the Company has not capitalized any development costs and does not
anticipate capitalizing any such costs in the foreseeable future.

Sales and Marketing Expenses

     Sales and marketing expenses increased to $91.1 million for the year ended
December 31, 1998 as compared to $60.4 million in 1997.  The increase in
spending is attributable to the hiring of additional direct sales personnel
around the world, additional promotional and advertising campaigns to support
the direct sales force and higher commissions as a result of the increased
revenues.  As of December 31, 1998, the Company employed 525 employees in sales
and marketing, as compared to 361 employees as of December 31, 1997.  As the
Company continues to expand its direct sales force, adding personnel and offices
worldwide and to introduce new products and enhancements of existing products,
it expects that sales and marketing expenses will continue to increase in
absolute dollars in 1999.  As a percentage of total revenues, sales and
marketing expenses decreased from 28.6% to 26.2%.

General and administrative expenses

     General and administrative expenses increased to $9.6 million for the year
ended December 31, 1998 as compared to $7.0 million in 1997.  As a percentage of
revenue, general and administrative expense was 2.8% at December 31, 1998, as
compared to 3.3% as of December 31, 1997.  The increase in absolute dollars
represents additions in personnel and systems to support the growth in the
Company's business.  The Company expects general and administrative expenses to
increase in absolute dollars during 1999.

Interest Income

     Interest income was $5.2 million and $6.7 million for the years ended
December 31, 1998 and 1997 respectively.  The decrease in interest income is a
result of lower average cash balances due to the repurchase of the Company's
stock as discussed further below and also from the Company earning less interest
on tax exempt investments, which have lower pre-tax yield but higher after-tax
yield

Provision for Income Taxes

     During 1998, the Company recorded an effective tax rate of 35% resulting in
an income tax provision of $20.8 million for the year ended December 31, 1998.
This compares to an effective tax rate of 24% or a provision of $7.6 million for
the year ended December 31, 1997.  The provision for 1997 benefited from the
recognition of certain deferred tax assets, resulting from the reversal of
certain valuation allowances based upon management assessment that it was more
likely than not that the net deferred tax assets will be realized based upon
carryback potential, existing temporary differences and expectations of future
taxable income levels.

                                       15
<PAGE>
 
Years Ended December 31, 1997 And 1996

  Revenue

     Revenue for the year ended December 31, 1997 was $210.8 million compared to
$128.5 million for the year ended December 31, 1996, an increase of 64%.  The
increases in revenue were due to a number of factors, including substantial
growth of the LAN switching market, continued introduction by the Company of
additional features and functions to its OmniSwitch product family, market
acceptance of the Company's LAN switching products, the continued strategic
relationships with IBM and Alcatel and the Company's investment in sales and
marketing resources.  Under an agreement with IBM and the Company, IBM has the
right to manufacture certain Company products after a specified period of time
and pay a royalty to Xylan. As of December 31, 1997, no royalties have been
earned by the Company. Product revenue could be adversely impacted if IBM elects
to manufacture the Company's products.  While the Company achieved revenue
growth of 64% from 1996 to 1997, the Company cannot insure this rate of
sequential revenue growth if at all in future periods.

  Gross Profit

     Gross margins were 56.1% and 55.0% for the years ended December 31, 1997
and 1996, respectively. The increase in gross margins resulted from component
cost reductions due to increased volume, the use of application specific
integrated circuits ("ASICs") and design improvements along with the allocation
of fixed costs over a larger revenue base. The Company's gross margins in the
future will be affected by a number of factors, including competitive market
pricing and discount levels, product mix, manufacturing volumes and fluctuations
in component costs. After initial product introduction, the Company's strategy
is to seek to reduce component costs, particularly by integrating newly-
developed ASICs into such products. In addition, the timing and execution of new
product introductions may impact gross margins and result in excess or obsolete
inventories. The Company's gross margins may also fluctuate due to the mix of
distribution channels employed. The Company expects to realize higher gross
margins on direct sales than on sales through its OEM partners and system
integrators.

  Research and Development Expenses

     Research and development expenses increased to $25.9 million in 1997 from
$15.8 million in 1996, or 12.3% as a percentage of sales for 1997 and 1996.  The
increase in absolute spending was primarily due to the hiring of additional
engineers for new product development.  At December 31, 1997, the Company
employed 187 employees in research and development compared to 122 employees at
December 31, 1996.

     The market for the Company's products is characterized by frequent new
product introductions and rapidly changing technology and industry standards,
any of which can impact Xylan's existing product offerings. As a result, the
Company's success will depend to a substantial degree upon its ability to
develop and introduce in a timely fashion new products and enhancements to its
existing products that meet changing customer requirements and emerging industry
standards. Accordingly, the Company expects to continue to make substantial
investments in research and development and anticipates that research and
development spending in absolute dollars will continue to increase in 1998. To
date, the Company has not capitalized any development costs and does not
anticipate capitalizing any such costs in the foreseeable future.

  Sales and Marketing Expenses

  Sales and marketing expenses increased to $60.4 million or 28.6% of sales in
1997 from $32.6 million or 25% of sales in 1996.  During 1997 the Company
continued to expand its infrastructure, including the addition of Xylan sales
personnel and sales offices throughout North America, Europe and Asia, increased
commission expenses resulting from higher revenue, and increased spending in
advertising and promotional campaigns in support of the Company's direct sales
and system integrator channels.  At December 31, 1997, the Company employed 361
employees in sales and marketing compared to 216 employees at December 31, 1996.
As the Company continues to expand its sales force, adding personnel and offices
worldwide, and to introduce new products and enhancements to its existing
products, it expects that sales and marketing spending in absolute dollars will
continue to increase in 1998.

                                       16
<PAGE>
 
  General and Administrative Expenses

     General and administrative expenses increased to $7.0 million or 3.3% of
sales in 1997 from $4.4 million or 3.4% of sales in 1996. The increase in
absolute dollars reflects the addition of personnel and systems to support the
growth of Xylan's business. As the Company continues to add personnel and
offices worldwide, and introduce new products and enhancements to its existing
products, it expects that general and administrative expenses will increase in
1998 in absolute dollars.

  Interest Income

     Interest income was $6.7 million and $5.2 million for the years ended
December 31, 1997 and 1996, respectively. This increase is the result of
interest income earned on higher average cash, cash equivalents and investments
for all 1997 versus 1996.

  Provision for Income Taxes

     During 1997, the Company recorded an effective tax rate of 24%, which
included the recognition of $5.6 million of certain deferred tax assets. This
resulted in an income tax provision of $7.6 million in 1997 versus $7.8 million
in 1996. The recognition of the deferred tax assets resulted from the reversal
of the valuation allowance based on management's assessment that it is more
likely than not that the net deferred tax assets will be realized based upon
existing temporary differences and expectations of future taxable income levels.
During 1996, the Company recorded an effective tax rate of 34%, which included
the recognition of $400,000 of certain deferred tax assets. Also, during 1997
and 1996, the Company realized an income tax benefit of $2.7 million and $9.5
million, respectively for certain stock option transactions. This benefit is
used to reduce taxable income prior to the utilization of net operating loss
carryforwards, and resulted in a decrease in current income taxes payable and an
increase in additional paid-in capital.

Liquidity And Capital Resources

     The Company's principal source of liquidity as of December 31, 1998
consisted of $42.3 million in cash and equivalents and $16.9 million in short
term investments. In addition, the Company had $70.7 million in long term
investments. For the year ended December 31, 1998, the Company generated $54.4
million from operating activities. Both inventories and receivables increased as
compared to December 31, 1997; however, days sales outstanding improved from 74
days to 63 days, and days of inventory on hand improved from 57 days to 55 days.

     Cash used in investing activities for the year ended December 31, 1998 was
$5.7 million.  Net maturities of investments of $17.5 million were offset by
purchases of $23.3 million in capital expenditures.  The capital expenditures
were for leasehold improvements, equipment for research and development,
additional manufacturing requirements, equipment to support the additional
headcount and information systems hardware and software.

     Cash used in financing activities during the year ended December 31, 1998
was $42.2 million.  Proceeds from the issuance of stock under the Company's
stock plans was $11.2 million.  During 1998, the Board of Directors of the
Company authorized the Company to repurchase up to 3,000,000 of the Company's
common stock, respectively, to offset the dilutive effect of new issuances of
common stock under the Company's stock option and stock purchase plans.  For the
twelve months ended December 31, 1998, the Company repurchased 2,482,500 shares
of common stock for $53.2 million.  Additional repurchases, if any, of the
Company's common stock will be funded from the Company's existing cash and
investment balances.

     During 1998, the Company entered into a new ten (10) year lease for a
129,000 square foot building near its current headquarters.  The Company is
using this facility for its new headquarters and occupied the building in the
first quarter of 1999.  The Company is in the process of pursuing subleases for
a portion of its current headquarters.  The Company believes that existing cash
and investment balances and cash generated from future operations will be
sufficient to meet the Company's requirements for at least the next twelve (12)
months.

                                       17
<PAGE>
 
     The Company's future capital requirements will depend on many factors,
including: the rate of revenue growth, the timing and extent of spending to
support product development efforts and expansion of sales and marketing, the
timing of introductions of new products and enhancements to existing products
and market acceptance of the Company's products.  There can be no assurance that
additional equity or debt financing, if required, will be available on
acceptable terms or at all.

Year 2000

 Year 2000 Issues

     The Company is currently conducting a company-wide Year 2000 readiness
program ("Y2K Program").  The Y2K Program is addressing the issue of computer
programs and embedded computer chips being unable to distinguish between the
year 1900 and the year 2000.  Therefore, some computer hardware and software
will need to be modified prior to the Year 2000 in order to remain functional.
The Company anticipates that Year 2000 compliance will be substantially complete
by June 1999.

     The Company's Y2K Program is divided into four major sections --Xylan
manufactured equipment and products, internal information ("IT") systems, non-IT
systems, and third-party suppliers and customers.  The general phases common to
all sections are: (1) inventorying Year 2000 items; (2)  assessing the Year 2000
compliance of items determined to be material to the company; and (3) repairing
or replacing material items that are determined not to be Year 2000 compliant.

     The Company has completed the review of all Xylan manufactured equipment
and products for Year 2000 compliance purposes.  The Company believes that its
products are either Year 2000 compliant or at the election of the customer can
be upgraded to be Year 2000 compliant.

     The Company is currently evaluating and addressing Year 2000 issues
associated with its internal IT computer systems.  Most of the Company's IT
computer systems are already Year 2000 compliant.  The Company expects to finish
the evaluation by the second quarter of 1999.  Other internal IT computer
systems that have been identified as non-compliant will be upgraded to be Year
2000 compliant by June 1999.

     The Company is currently evaluating and addressing Year 2000 issues
associated with its non-IT systems.  Most of these systems are already Year 2000
compliant.  Those non-IT systems that are not Year 2000 compliant will be
repaired or replaced by June 1999.

     The Company is currently assessing the possible effects on the Company's
operations of the Year 2000 readiness of its key suppliers and contract
manufacturers.  See "-Substantial Increase in Manufacturing Operations;
Dependence on Contract Manufacturing."  The Company expects this assessment will
be completed no later than April 1999.  The Company's reliance on suppliers and
contract manufacturers and, therefore, on the proper functioning of their
information systems and software, means that failure to address Year 2000 issues
could have a material impact on the Company's operations and financial results.
However, the potential impact and related costs are not known at this time.

     Through December 31, 1998, the Company has spent less than $100,000 to
implement the Year 2000 compliance program.  That amount has been expensed as
incurred.  The Company estimates that it may spend up to an additional $150,000
for other replacements or upgrades and for communicating with key suppliers and
customers.  That amount will also be expensed as incurred.

     The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations.  Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition.  Due to the general
uncertainty inherent in the Year 2000 problem resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition.  The Y2K Program is expected to
significantly reduce the Company's level of uncertainty about the Year 2000
problem and, in particular, about the Year 2000 compliance and readiness of its
material key suppliers and customers.  The Company believes that, with the
implementation of new business systems and completion of the Y2K Program as
scheduled, the possibility of significant interruptions of normal operations
should be reduced.

                                       18
<PAGE>
 
     The Company does not yet have a contingency plan to address the Year 2000
problem, but it is expected to create one by June, 1999 if it appears that the
Company or its key suppliers and customers will not be Year 2000 compliant and
that such non-compliance is expected to have a material adverse impact on the
Company's operations.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

Market Risk Disclosures

     The following discussion about the Company's market risk disclosures
involves forward-looking statements.  Actual results could differ materially
from those projected in the forward-looking statements.

     The Company does not use derivative financial instruments.

     Xylan maintains a portfolio of highly liquid cash equivalents maturing
within three months or less of purchase. Given the short-term nature of these
investments and the fact that the Company has no outstanding debt, the Company
is not subject to significant interest rate risk.

     A large portion of Xylan's sales are outside of the United States and the
Company has operations, primarily sales and marketing, in foreign locations.
The Company's results could be impacted by factors such as changes in exchange
rates or weak economic conditions in foreign markets.  However, all of the
Company's revenues are denominated in U.S. dollars and thus its foreign exchange
risk is limited  to foreign currency denominated expenses, which are minimal.
Therefore the Company believes that sudden and or significant changes in foreign
currency exchange rates would have no significant impact to its results of
operations or financial position.

Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

       The Company's Consolidated Financial Statements are included in this Form
10-K starting at page F-1.

Item 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         Not applicable.

                                       19
<PAGE>
 
                                   PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

<TABLE>
<CAPTION>
Name                              Age         Class                            Positions(1)
----                             ----         -----                            ------------

<S>                             <C>          <C>          <C>
Steve Y. Kim.......................  49         I         President, Chief Executive Officer and Chairman of
                                                          the Board of Directors
Yuri Pikover.......................  37        II         Executive Vice President of Business Development, and
                                                          Director
John L. Walecka....................  38         I         Director
Olivier Houssin....................  45         I         Director
Krish Prabhu.......................  43         I         Director
Martin de Prycker..................  43        II         Director
Hubert de Pesquidoux...............  33        II         Director
John Bailey........................  41                   Vice President of Product Development
Dale J. Bartos.....................  48                   Vice President and Chief Financial Officer
Douglas Hill.......................  46                   Vice President of Corporate Communications
Rene Arvin.........................  39                   Vice President of Worldwide Sales
</TABLE>

________________

(1)  The Company Board is divided into two classes as nearly equal in number as
     possible, and the members of each class are elected for a term of two
     years.  The officers of the Company are appointed annually by the Company
     Board of Directors and serve at the discretion of the Company Board.  There
     are no family relationships among the directors or officers of the Company.

     Mr. Kim, a co-founder of the Company, has served as the Company's President
and Chief Executive Officer and Chairman of the Board of Directors since the
Company's inception in July 1993.  Prior to co-founding the Company, Mr. Kim
founded and served as President and Chief Executive Officer of Fibermux
Corporation ("Fibermux"), a networking company, from November 1984 to June 1993.

     Mr. Pikover, a co-founder of the Company, has served in various sales
and management positions and as a member of the Board of Directors since the
Company's inception in July 1993, most recently as Executive Vice President of
Business Development.  Mr. Pikover served as the Company's Vice President of
Worldwide Sales from July 1993 to September 1997.

     Mr. Walecka has served as a member of the Company Board since February
1994.  Mr. Walecka has been a General Partner of certain venture capital funds
associated with Brentwood Venture Capital since January 1990.  Mr. Walecka also
serves as a director of Documentum, Inc. and several privately held companies.

     Mr. Houssin graduated from the Ecole Polytechnique and
Telecommunications Engineer and started his career in Thomson CGR, where he had
responsibilities in Italy and in the U.S.  In 1988, he became Vice President,
Operations in Thomson Consumer Electronic, then Executive Vice President in
1991.  In 1993, he joined Alcatel to be President of Cables activities in the
North America.  In 1996 he became a President, Telecom Products Division, Cable
and Components sector of Alcatel.  In November 1998, he joined the Executive
Committee as Executive Vice President of Alcatel Telecom in charge of the
Enterprise and Consumer Business Group.

     Mr. Prabhu has been Senior Executive Vice President of the Telecom Sector
of Alcatel since November 1998 and Executive Vice President and Member of the
Executive Committee of Alcatel since July 1998. Since September 1998, he has
been President and Chief Executive Officer of Alcatel USA, located at 1000 Coit
Road, Plano, Texas 75075. Mr. Prabhu joined Alcatel in the United States in
1991, becoming President of its Broadband Division in 1996. He is a U.S.
citizen.

                                       20
<PAGE>
 
     Mr. Prycker joined Alcatel in 1982 after obtaining degrees in electrical
engineering, computer science and business management.  He held various
positions within Alcatel's Research Division.  In 1984, he was appointed
Research Director of Alcatel in Antwerp.  In 1996, he became Vice President of
the Access Division, responsible for Internet and ADSL.  At the end of 1998, he
was appointed Network Strategy Director for Alcatel Telecom.  In March 1999, he
became President of the Internet Division.

     Mr. Hubert de Pesquidoux has a Master in Law, a Master in Business, and PhD
in Finance from the Paris University.  He began his career in banking with
Paribas NY.  He then joined Alcatel CIT in 1991, and became Corporate Treasurer
in 1995.  In September 1998, he was appointed Senior Vice President and CFO of
Alcatel USA.

     Mr. Bailey joined the Company in January 1994 and has served in various
engineering management positions, most recently as Vice President, Chief
Technology Officer and General Manager of Enterprise Division.  Prior to joining
the Company, Mr. Bailey was an Assistant Vice President for LAN Internetworking
Technology at Ascom Timplex, a networking company, from September 1992 to
January 1994..

     Mr. Bartos joined the Company in January 1997 as the Company's Vice
President and Chief Financial Officer.  Prior to joining the Company, Mr. Bartos
was the Chief Financial Officer at ADFlex Solutions, Inc. from May 1996 to
January 1997.  Prior to that, Mr. Bartos served as the Chief Financial Officer
at Integral Peripherals, Inc. from March 1995 to May 1996, and Micropolis
Corporation from December 1989 to March 1995.  Mr. Bartos is a certified public
accountant.

     Mr. Hill joined the Company in January 1994 and has served in various
marketing management positions, most recently as Vice President of Corporate
Marketing.  Prior to joining the Company, Mr. Hill was Senior Consultant at
Western Data Group, a network integration company, from October 1989 to January
1994.

     Mr. Arvin joined the Company in February 1996 and has served in various
sales and management positions, most recently as Vice President of Worldwide
Sales.  Prior to joining the Company, Mr. Arvin was Director of Worldwide Sales
for NetEdge Corporation, a data communications company, from September 1994 to
February 1996.  Mr. Arvin also served as Area Director, Northern Europe for
Synoptics Corporation, a networking company, from December 1989 to September
1994.

                                       21
<PAGE>
 
Item 11. EXECUTIVE COMPENSATION AND OTHER INFORMATION

     The following table illustrates the compensation received by (a) the
individual who served as the Company's Chief Executive Officer during the fiscal
year ended December 31, 1998, (b) the four other most highly compensated
individuals who served as an executive officer of the Company during the fiscal
year ended December 31, 1998 (the "Named Executive Officers"), and (c) the
compensation received by each such individual for the two preceding fiscal
years.

                          SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                                                 Long-Term Compensation
                                               Annual Compensation                                       Awards
                                       -----------------------------------------------          ----------------------------------
                                                                               Other 
                                                                               Annual           Securities        All Other  
Name and Principal                             Salary         Bonus          Compensa           Underlying         Compen         
  Position                             Year    ($)(1)        ($)(2)         tion ($)(3)           Options          sation($)      
  --------                             ----    ------        ------         ----------          -----------       ----------       
<S>                                  <C>      <C>           <C>              <C>               <C>                <C>
Steve Y. Kim.................           1998   236,321       39,325                 --           300,000(4)        30,827(5)   
   Chief Executive Officer,             1997   203,944        1,000             16,002                --           45,753(6)   
    President and Chairman              1996   160,416           --            134,123                --           49,902(7)   
    of the Board                                                                                                               
                                                                                                                               
Yuri Pikover.................           1998   197,000       28,875                 --           150,000(8)            --      
Executive Vice President,               1997   146,251       11,760                 --                --           11,760(9)   
 Business Development                   1996   132,083        9,750                 --                --            7,200(9)   
                                                                                                                               
John Bailey..................           1998   175,896       29,496                 --           200,000(10)           --      
Vice President/CTO and                  1997   143,559       15,735                 --                --               --      
 General Manager, Enterprise            1996   132,083       11,378                 --                --               --      
 Div.                                                                                                                          
                                                                                                                               
Rene Arvin...................           1998   135,759       66,670            131,793           320,000(11)       47,808(12)  
Vice President of Worldwide             1997   128,309       20,175             71,917           300,000(13)           --      
 Sales                                  1996    93,534           --             29,301           110,000               --      
                                                                                                                               
Dale J. Bartos...............           1998   214,984       40,915                 --           158,000(14)           --      
Vice President and Chief                1997   178,496       35,979                 --           120,000(15)       23,594(16)   
 Financial Officer                      1996        --           --                 --               --                --       
</TABLE>

1)   Includes amounts deferred under the Company's 401(k) plan.

2)   Includes bonuses earned in the year indicated and paid in the subsequent
     year. Excludes bonuses paid in the year indicated but
     earned in the preceding year.

3)   Represents amounts paid in commissions.

4)   Mr. Kim was granted 300,000 options on January 13, 1998 at an exercise
     price of $15.25, the closing price of Common Stock on such date. In
     connection with the Company's repricing program, on September 21, 1998,
     such options were repriced at $10.50, the closing price of Common Stock on
     such date.

5)   Includes $19,549 as reimbursement for country club expenses and $11,278 as
     reimbursement for automobile payments.

6)   Includes $20,832 as reimbursement for tax and estate planning expenses,
     $12,321 as reimbursement for country club expenses and $12,600 as
     reimbursement for automobile payments.

                                       22
<PAGE>
 
7)   Includes $18,509 as reimbursement for tax and estate planning expenses and
     $15,242 as reimbursement for country club expenses.

8)   Mr. Pikover was granted 150,000 options on January 13, 1998 at an exercise
     price of $15.25, the closing price of Common Stock on such date. In
     connection with the Company's repricing program, on September 21, 1998,
     such options were repriced at $10.50, the closing price of Common Stock on
     such date.

9)   Represents a reimbursement for tax and estate planning expenses.

10)  Mr. Bailey was granted 150,000 options on January 13, 1998 at an exercise
     price of $15.25, the closing price of Common Stock on such date. In
     connection with the Company's repricing program, on September 21, 1998,
     such options were repriced at $10.50, the closing price of Common Stock on
     such date. Mr. Bailey was also granted 50,000 options on October 13, 1998
     at an exercise price of $10.6875, the closing price of Common Stock on such
     date.

11)  In connection with the Company's repricing program, on September 21, 1998,
     all of Mr. Arvin's 300,000 outstanding options on such date were repriced
     at $10.50, the closing price of Common Stock on such date. Mr. Arvin was
     also granted 20,000 options on October 13, 1998 at an exercise price of
     $10.6875, the closing price of Common Stock on such date.

12)  Includes $45,833 for housing allowance and $1,975 for taxable relocation
     assistance.

13)  Mr. Arvin was granted 110,000 options on February 21, 1996 and 20,500 on
     April 2, 1997 at exercise prices of $20.00 and $16.13, respectively, the
     closing price of the Company's Common Stock on such dates. In connection
     with the Company's repricing program, on July 23, 1997, such options were
     repriced at $15.8125, the closing price of the Company's Common Stock on
     such date. Mr. Arvin was also granted 169,500 options on October 27, 1997
     at an exercise price of $14.50, the closing price of the Company's Common
     Stock on such date.

14)  Mr. Bartos was granted 30,000 options on April 14, 1998 at an exercise
     price of $26.625, the closing price of the Company's Common Stock on such
     date. In connection with the Company's repricing program, on September 21,
     1998, all of Mr. Bartos' 138,000 outstanding options on such date were
     repriced at $10.50, the closing price of the Company's Common Stock on such
     date. Mr. Bartos was also granted 20,000 options on October 13, 1998 at an
     exercise price of $10.6875, the closing price of the Company's Common Stock
     on such date.

15)  Mr. Bartos was granted 100,000 options on January 27, 1997 and 20,000 on
     April 2, 1997 at exercise prices of $28.12 and $16.13, respectively. In
     connection with the Company's repricing program, on July 23, 1997, such
     options were repriced at $15.8125, the closing price of the Company's
     Common Stock on such date.

16)  Includes $12,722 paid as reimbursement for relocation and expenses and
     $10,872 paid as reimbursement for loss of certain benefits.

                                       23
<PAGE>
 
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following table sets forth the beneficial ownership of the Company's
Common Stock as of February 23, 1999 as to (i) each person who is known by the
Company to beneficially own more than five percent of the Company's Common
Stock, (ii) each of the Company's directors, (iii) each of the executive
officers named in the Summary Compensation Table of this Statement and (iv) all
directors and executive officers as a group.



<TABLE>
<CAPTION>
                                                                              
                      Name (1)                                     Common Stock Beneficially Owned
-----------------------------------------------------         -----------------------------------------
                                                               Number                    Percent (2)
                                                              ----------------         ----------------
<S>                                                           <C>                     <C>  
Alcatel Data Networks S.A............................           2,814,244 (3)                 6.6%
    12 rue de la Baume                                                                                  
    Paris, France 75008                                                                                 
                                                                                                        
Amerindo Investment Advisors, Inc....................           2,370,750 (4)                 5.6%      
    One Embarcadero Center, Suite 2300                                                                  
    San Francisco, CA 94111                                                                             
                                                                                                        
Franklin Resources Inc...............................           2,223,700 (5)                 5.2%      
    777 Mariners Island Blvd                                                                            
    San Mateo, CA 94494                                                                                 
                                                                                                        
Pilgrim Baxter & Associates, Ltd.                               2,728,100 (6)                 6.4%      
825 Duportail Road                                                                                      
Wayne, PA  19087                                                                                        
                                                                                                        
Steve Y. Kim.........................................           3,007,000 (7)                 7.0%      
    Chairman of the Board, CEO & President                                                              
                                                                                                        
Yuri Pikover.........................................           2,086,251 (8)                 4.9%      
    Executive VP, Business Development                                                                  
                                                                                                        
Robert C. Hawk, Director as of February 23, 1999.....              60,758 (9)                   *       
                                                                                                        
Trude C. Taylor, Director as of February 23, 1999....            573,264 (10)                 1.4%      
                                                                                                        
John L. Walecka, Director............................            173,205 (11)                   *       
                                                                                                        
John Bailey..........................................            153,081 (12)                   *       
    VP/CTO and General Manager, Enterprise Div.                                                         
                                                                                                        
Rene Arvin...........................................            152,622 (13)                   *       
    VP of Worldwide Sales                                                                               
                                                                                                        
Dale J. Bartos.......................................             54,425 (14)                   *       
    VP and CFO                                                                                          
                                                                                                        
All directors and executive officers as a group                6,438,463 (15)                  15%       
    (10 persons)
</TABLE>
_______________
*  Less than 1%.

                                       24
<PAGE>
 
1)   The persons named in this table have sole voting and investment power with
     respect to all shares of Common Stock shown as beneficially owned by them,
     subject to community property laws where applicable and except as indicated
     in the other footnotes to this table. Beneficial ownership is determined in
     accordance with the rules of the Commission. In computing the number of
     shares beneficially owned by a person and the percentage ownership of that
     person, shares of Common Stock subject to options or warrants held by that
     person that are currently exercisable or exercisable within 60 days after
     February 23, 1999 are deemed outstanding. Such shares, however, are not
     deemed outstanding for the purpose of computing the percentage ownership of
     any other person.
2)   As of February 23, 1999, 42,486,382 shares were issued and outstanding.
3)   This information is based on information in Alcatel's Schedule 14D-1 filed
     on March 8, 1999.
4)   This information is based on a Schedule 13G/A filed by Amerindo Investments
     Advisors, Inc. on February 12, 1999. Amerindo Investments Advisors, Inc.
     refers herein to the following persons: Amerindo Investment Advisors, Inc.,
     a California corporation, Amerindo Investment Advisors, Inc., a Panama
     corporation, the Amerindo Investment Advisors Inc. Profit Sharing Trust
     (the "Profit Sharing Trust"), the Amerindo Investment Advisors Inc. Money
     Purchase Plan (together with the Profit Sharing Trust, the "Plans"), the
     Amerindo Advisors (UK) Limited Retirement Benefits Scheme, Alberto W.
     Vilar, Gary A. Tanaka, James P.F. Stableford and Renata Le Port. Messrs.
     Vilar and Tanaka, as the sole shareholders and directors of the entities,
     share with each other investment and dispositive power as to all of the
     shares shown as owned by the entities, who otherwise have sole investment
     and dispositive power with respect thereto, except that each client of the
     entities has the unilateral right to terminate the advisory agreement with
     the entity in question on notice which typically need not exceed 30 days.
     Mr. Vilar is sole trustee of the Plans, and Messrs. Vilar, Tananka,
     Stableford and Ms. Le Port are joint trustees of the Amerindo Advisors (UK)
     Limited Retirement Benefits Scheme.
5)   This information is based on a Schedule 13G filed by Franklin Resources,
     Inc. on February 20, 1999. Franklin Resources, Inc. refers herein to the
     following persons:  Charles B. Johnson, Franklin Advisors, Inc., Franklin
     Resources, Inc., and Rupert H. Johnson, Jr.
6)   This information is based on Schedule 13G filed by Pilgrim Baxter &
     Associates Ltd on February 9, 1999.
7)   Includes 805,000 shares of Common Stock held by the Kim Irrevocable
     Children's Trust dated September 15, 1995, 1,957,500 shares held by Steve
     Y. Kim Living Trust and 244,500 shares of Common Stock issuable upon
     exercise of options exercisable within 60 days of February 23, 1999.
     Excludes 20,000 shares of Common Stock held by The Kim Blind Trust, as to
     which Mr. Kim disclaims voting or investment power. Does not include
     100,000 shares of Common Stock issuable upon exercise of options which
     exercise date will be accelerated to the date immediately prior to the
     Effective Time of the Merger.
8)   Includes 220,000 shares of Common Stock held by the Pikover Irrevocable
     Children's Trust dated September 15, 1995, 10,000 shares of Common Stock
     held by the Pikover 1995 Irrevocable Trust dated September 15, 1995,
     1,825,000 shares held by the Pikover Trust dated May 18, 1996 and 31,251
     shares of Common Stock issuable upon exercise of options exercisable within
     60 days of February 23, 1999. Excludes 15,000 shares of Common Stock held
     by the Pikover Blind Trust, as to which Mr. Pikover disclaims voting or
     investment power. Does not include 50,000 shares of Common Stock issuable
     upon exercise of options which exercise date will be accelerated to the
     date immediately prior to the Effective Time of the Merger.
9)   Includes 5,000 shares of Common Stock issuable uopn exercise of options
     exercisable within 60 days of February 23, 1999. Does not include 10,000
     shares of Common Stock issuable upon exercise of unvested options under the
     Director's Plan which exercise date will be accelerated to the date
     immediately prior to the Effective Time of the Merger. Mr. Hawk resigned as
     a Director effective April 5, 1999.
10)  Includes 90,000 shares of Common Stock issuable upon exercise of options
     exercisable within 60 days of February 23, 1999. Does not include 10,000
     shares of Common Stock issuable upon exercise of unvested options under the
     Director's Plan which exercise date will be accelerated to the date
     immediately prior to the Effective Time of the Merger. Mr. Taylor resigned
     as a Director effective April 5, 1999.
11)  Includes 47,000 shares of Common Stock issuable upon exercise of options
     exercisable within 60 days of February 23, 1999. Does not include 10,000
     shares of Common Stock issuable upon exercise of unvested options under the
     Director's Plan which exercise date will be accelerated to the date
     immediately prior to the Effective Time of the Merger.

                                       25
<PAGE>
 
12)  Includes 150,500 shares of Common Stock issuable upon exercise of options
     exercisable within 60 days of February 23, 1999.
13)  Includes 151,368 shares of Common Stock issuable upon exercise of options
     exercisable within 60 days of February 23, 1999.
14)  Includes 53,834 shares of Common Stock issuable upon exercise of options
     exercisable within 60 days of February 23, 1999.
15)  Includes an aggregate of 842,702 shares of Common Stock held by directors
     and executive officers which are issuable upon exercise of options
     exercisable within 60 days of February 23, 1999.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     In October 1997, the Company Board approved acceleration of vesting of
stock options held by executive officers and certain key employees of the
Company in the event such individuals are terminated in connection with a change
in the Company's control through Change of Control Agreements. In such event,
each stock option to purchase the Company's Common Stock and held by such
individuals on the date of termination becomes immediately vested on the date of
termination as to that number of shares that would have vested in accordance
with the terms of their respective option grants for: (i) two years after the
date of change of control if such individual had been employed by the Company
for at least two years as of the change of control, or (ii) one year after the
date of change of control if such individual had been so employed for less than
two years as of the change of control.

     During fiscal 1997, the Company advanced Dale J. Bartos, the Company's
Vice President and Chief Financial Officer, a total of $350,000 to assist Mr.
Bartos in financing the purchase of a home in California.  Mr. Bartos previously
resided in Arizona, and upon the sale of Mr. Bartos' home in Arizona, the loan
will be repaid to the Company.  The loan was subsequently repaid.

     Except as described above, to date, the Company has made no loans to
officers, directors, principal shareholders or other affiliates or other than
advances of reimbursable expenses.  All future transactions, including loans (if
any), between the Company and its officers, directors and principal shareholders
and their affiliates will be approved by a majority of the Board of Directors,
including a majority of the independent and disinterested outside directors of
the Board of Directors, and will be on terms no less favorable to the Company
than could have been obtained from unaffiliated third parties.

     In January 1997, Brentwood VI Management Partners, L.P., whose general
partners are also general partners of Brentwood VI Ventures, L.P., the general
partner of Brentwood Associates VI, L.P., provided a car to Steve Y. Kim valued
at $139,827.  John Walecka, a general partner of Brentwood VI Ventures, L.P.,
the general partner of Brentwood Associates VI, L.P., is a director of the
Company.

     The Company has entered into indemnification agreements with its officers
and directors containing provisions which may require the Company, among other
things, to indemnify its officers and directors against certain liabilities that
may arise by reason of their status or service as officers or directors (other
than liabilities arising from willful misconduct of a culpable nature) and to
advance their expenses incurred as a result of any proceeding against them as to
which they could be indemnified.

     In connection with the Merger Agreement executed on March 1, 1999,
Messrs. Kim, Pikover and Walecka entered into Shareholder Agreements and Mr. Kim
entered into an Employment Agreement effective as of the closing of the Merger,
as described in the Schedule 14D-9.  As a condition of the Merger and as part of
the Shareholder Agreements, Messrs. Kim and Pikover have agreed to terminate
their Change of Control Agreements and waive the benefits thereof upon the
closing of the Merger.

                                       26
<PAGE>
 
     In February 1999, the Board of Directors of the Company agreed (i) to
accelerate the vesting of certain performance-milestone based option grants to
Messrs. Kim and Pikover for 100,000 and 50,000 shares, respectively, upon the
closing of the Merger, (ii) to accelerate the vesting of all option grants under
the Company's 1995 Directors' Stock Option Plan, and (iii) to have the Company
pay the reasonable legal fees and expenses for Messrs. Kim and Pikover in
connection with the negotiation of their Shareholder Agreements and Mr. Kim's
Employment Agreement.

                                    PART IV

Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>
                                                                                                  Page
                                                                                                --------
(a)(1)  Consolidated Financial Statements:
<S>             <C>                                                                             <C>
                Independent Auditors' Report.................................................     F-1
                Consolidated Balance Sheets at December 31, 1998 and 1997....................     F-2
                Consolidated Statements of Operations for the Years ended
                   December 31, 1998, 1997, and 1996.........................................     F-4
                Consolidated Statements of Shareholders' Equity for the
                   Years ended December 31, 1998, 1997, and 1996.............................     F-5
                Consolidated Statements of Cash Flows for the Years ended
                   December 31, 1998, 1997, and 1996.........................................     F-6
                Notes to Consolidated Financial Statements...................................     F-7
 
 (2)  Consolidated Financial Statement Schedule:
                II-Valuation and Qualifying Accounts.........................................     S-1
</TABLE>

  All other schedules are omitted because they are not applicable or the
  required information is included in the consolidated financial statements or
  notes thereto.

 (3)  Exhibits included herein (numbered in accordance with Item 601 of
      Regulation S-K):

<TABLE>
<CAPTION>
Exhibit
<C>             <S>
Number          Description
------          -----------                                                                                                
   2.1          Form of Offer to Purchase, dated March 8, 1999.(5)
   2.2          Agreement and Plan of Merger, dated as of March 1, 1999, among Registrant, Zeus Acquisition Corp. ("Sub"),
                and Alcatel.(5)
   2.3          Stock Option Agreement, dated as of March 1, 1999, among Registrant, Sub, and Alcatel.(5)
   3.1          Amended and Restated Articles of Incorporation of Registrant.(1)
   3.2          Amended and Restated Bylaws of Registrant.(8)
   4.1          Form of Common Stock Certificate.(1)
   4.2          Preferred Shares Rights Agreement dated as of April 17, 1997 between the Registrant and the First National
                Bank of Boston, including Certificate of Determination of Rights, Preferences and Privileges of Series A
                Participating Preferred Stock, the Form of Rights Certificate and the Summary of Rights attached thereto
                as Exhibits A, B and C, respectively.(2)
   4.3          Amendment No. 1 to Preferred Shares Rights Agreement, dated as of March 2, 1999.(6)
   9.1          Shareholder Agreement between Alcatel, Sub, Yuri Pikover and Pikover 1995 Irrevocable Trust, Pikover
                Trust, and Pikover Irrevocable Children's Trust dated as of March 1, 1999.(5)
   9.2          Shareholder Agreement between Alcatel, Sub, Steve Y. Kim and Steve Y. Kim Living Trust and Kim Irrevocable
                Children's Trust dated as of March 1, 1999.(5)
   9.3          Shareholder Agreement between Alcatel, Sub, and John Walecka dated as of March 1, 1999.(5)
  10.1          Form of Indemnification Agreement.(1)
  10.2          1993 Stock Incentive Plan.(1)
  10.3          Form of 1996 Employee Stock Purchase Plan and related agreements.(1)
  10.4          Form of 1996 Directors' Option Plan and related agreements.(1)
  10.5          Form of amended 1996 Stock Plan.(4)
</TABLE>

                                       27
<PAGE>
 
<TABLE>
<CAPTION>
Exhibit
Number             Description
-------            -----------
<S>             <C> 
  10.6          Fourth Restated Registration Rights Agreement among the Registrant and certain security holders of the
                Registrant, dated as of December 11, 1995.(1)
  10.7          Lease Agreement between the Registrant and Malibu Canyon Office Partners, L.P. dated as of April 14, 1994,
                as amended November 3, 1994, January 2, 1995, and April 25, 1995.(1)
  10.8          Security and Loan Agreement dated September 1, 1995 between the Registrant and Imperial Bank.(1)
  10.9          Master Lease Agreement dated as of May 31, 1994, as amended between the Registrant and Dominion Ventures,
                Inc.(1)
 10.10          Master Lease Agreement dated as of June 9, 1995 between the Registrant and Copelco Capital, Inc.(1)
 10.11          Value-Added Product Sales Agreement dated as of July 1, 1995 between the Registrant and Hamilton Hallmark,
                a division of Avnet, Inc.(1)
 10.12          401(k) Plan.(1)
 10.13          Series C Preferred Stock Agreement dated as of March 13, 1995 between the Registrant and Alcatel Data
                Networks S.A.(1)
 10.14          International Distributor Agreement between the Registrant and Alcatel N.V., dated as of March 13, 1995.(1)
 10.15          Product and Technology Agreement between the Registrant and Alcatel N.V. dated as of March 13, 1995.(1)
 10.16          Original Equipment Manufacturer Agreement dated as of June 14, 1995 between the Registrant and Hitachi
                Computer Products (America), Inc.(1)
 10.17          Original Equipment Manufacturer Agreement dated as of April 12, 1995 between the Registrant and Digital
                Equipment Corporation.(1)
 10.18          Manufacturing and Purchase Agreement dated as of March 28, 1996 between the Registrant and Victron, Inc.(1)
 10.19          Amendment to Manufacturing and Purchase Agreement between Registrant and Victron, Inc. dated as of
                December 30, 1996.(3)
 10.20          Dale Bartos Employment Agreement dated as of January 4, 1997.(3)
 10.21          Form of 1998 Employee Stock Option Plan and related agreements.(4)
 10.22          Form of Change of Control Agreement.(4)
 10.23          Employment Agreement between Sub and Steve Y. Kim, dated as of March 1, 1999.(5)
 10.24          Industrial Real Estate Lease between Cypress Land Company and the Registrant, dated as of June 1, 1998.(7)
 10.25          First Amendment to Industrial Real Estate Lease, dated as of October 19, 1998.(10)
  23.1          Consent of KPMG LLP.(10)
  24.1          Power of Attorney (see page 31).(10)
  27.1          Financial Data Schedule for (current) fiscal year ended December 31, 1998.(10)
  27.2          Restated Financial Data Schedule for fiscal year ended December 31, 1996.(4)
  27.3          Restated Financial Data Schedule three months ended March 31, 1997.(4)
</TABLE>
 
(1)  Incorporated by reference to exhibits filed in response to Item 16(a),
     "Exhibits," of the Registrant's Registration Statement on Form S-1 and
     Amendments thereto, which became effective on May 29, 1996.
(2)  Incorporated by reference to exhibits to the Registrant's Registration
     Statement on Form 8-A filed on August 24, 1997.
(3)  Incorporated by reference to exhibits to the Registrant's Annual Report on
     Form 10-K filed on March 31, 1997.
(4)  Incorporated by reference to exhibits to the Registrant's Annual Report on
     Form 10-K filed on March 31, 1998.
(5)  Incorporated by reference to exhibits to Alcatel and Sub's Tender Offer
     Statement on Schedule 14D-1 filed on March 8, 1999.
(6)  Incorporated by reference to an exhibit to the Registrant's Registration
     Statement on Form8-A/A filed on March 8, 1999.

                                       28
<PAGE>
 
(7)  Incorporated by reference to exhibits to the Registrant's Form 10-Q filed
     on August 12, 1998.
(8)  Incorporated by reference to exhibits to the Registrant's Form 10-Q filed
     on November 13, 1998.
(9)  Incorporated by reference to an exhibit to the Registrant's
     Solicitation/Recommendation Statement on Schedule 14D-9 filed on March 8,
     1999.
(10) Filed herewith.

(b)  Reports on Form 8-K:

     None.

                                       29
<PAGE>
 
                                  SIGNATURES
                                        
    Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.


                                        XYLAN CORPORATION


Date: April14, 1999              By        /S/ Dale J. Bartos
                                     ------------------------------------------
                                                 Dale J. Bartos
                                     Vice President and Chief Financial Officer
                                            (Principal Financial Officer)
                                        


                                 By:       /S/ Thomas S. Burns
                                     ------------------------------------------
                                                 Thomas S. Burns
                                           Vice President of Finance
                                           (Chief Accounting Officer)
                                        

                                       30
<PAGE>
 
                               POWER OF ATTORNEY
                                        
          KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Steve Y. Kim and Dale J. Bartos, his
attorneys- in-fact, each with the power of substitution, for him in any and all
capacities, to sign any amendments to this Report on Form 10-K, and to file the
same, with exhibits thereto and other documents in connection therewith with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes may do or cause
to be done by virtue hereof.

          Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons in the capacities and
on the dates indicated.

<TABLE> 
<CAPTION> 

Signature                                                              Title                                  Date
---------                                                              -----                                  ----      
<S>                                          <C>                                                         <C> 
/s/ STEVE Y. KIM                             President, Chief Executive Officer and Chairman             April 14, 1999
------------------------------------------
(Steve Y. Kim)
 
/s/ DALE J. BARTOS                           Vice President of Finance and Administration                April 14, 1999
------------------------------------------
(Dale J. Bartos)                             and Chief Financial Officer (Principal Financial Officer)
 
/s/ THOMAS S. BURNS                          Vice President of Finance (Chief Accounting Officer)        April 14, 1999
------------------------------------------
(Thomas S. Burns)
 
/s/ YURI PIKOVER                             Executive Vice President and Director                       April 14, 1999
------------------------------------------
(Yuri Pikover)
 
/s/ OLIVIER. HOUSSIN                         Director                                                    April 14, 1999
------------------------------------------
(Olivier Houssin)
 
/s/ KRISH PRABHU                             Director                                                    April 14, 1999
------------------------------------------
(KrishPrabhu)
 
/s/ JOHN L. WALECKA                          Director                                                    April 14, 1999
------------------------------------------
(John L. Walecka)
 
/s/ MARTIN DE PRYCKER                        Director                                                    April 14, 1999
------------------------------------------
(Martin de Prycker)
 
/s/ HUBERT DE PESQUIDOUX                     Director                                                    April 14, 1999
------------------------------------------
(Hubert de Pesquidoux)
</TABLE> 

                                       31
<PAGE>
 
                          INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders
Xylan Corporation:

  We have audited the accompanying consolidated balance sheets of Xylan
Corporation and subsidiaries as of December 31, 1998 and 1997 and the related
consolidated statements of operations, shareholders' equity and cash flows and
the related financial statement schedule for each of the years in the three-year
period ended December 31, 1998. These consolidated financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.

  We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the 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.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Xylan
Corporation and subsidiaries as of December 31, 1998 and 1997 and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998 in conformity with generally accepted accounting
principles. Also in our opinion, the related financial statement schedule, when 
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.


Los Angeles, California
January 21, 1999, except for Note 15,
  which is as of April 5, 1999

                                      F-1
<PAGE>
 
                       XYLAN CORPORATION AND SUBSIDIARIES

                          CONSOLIDATED BALANCE SHEETS
                           December 31, 1998 and 1997
                       (In thousands, except share data)


<TABLE>
<CAPTION>
          ASSETS                                     1998      1997
                                                     ----      ----
 
<S>                                               <C>        <C> 
Current assets:
   Cash and cash equivalents...................   $ 42,343   $ 35,917
   Short-term investments......................     16,887     43,171
   Accounts receivable, net....................     68,642     53,013
   Inventories, net............................     25,911     17,731
   Note receivable.............................      7,500         --
   Deferred income taxes, net..................      9,841      6,100
   Prepaid expenses and other current assets...      3,303      2,892
                                                  --------   --------
  
      Total current assets.....................    174,427    158,824
 
Investments....................................     70,671     59,382
Note receivable................................         --      7,500
Property and equipment, net....................     32,799     20,894
Other assets...................................      4,149      4,306
                                                  --------   --------
       Total assets............................   $282,046   $250,906
                                                  ========   ========
</TABLE>
          See accompanying notes to consolidated financial statements.

                                      F-2
<PAGE>
 
                       XYLAN CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED BALANCE SHEETS, Continued
                           December 31, 1998 and 1997
                       (In thousands, except share data)

<TABLE>
<CAPTION>
 
             LIABILITIES AND SHAREHOLDERS' EQUITY                    1998        1997
                                                                     ----        ----
<S>                                                               <C>          <C>
Current liabilities:
 Current installments of capital lease obligations.............     $     43   $    189
 Accounts payable and accrued expenses.........................       38,762     26,382
 Deferred revenue..............................................        9,767      4,317
 Income taxes payable..........................................        5,675      3,002
                                                                      ------     ------
   Total current liabilities...................................       54,247     33,890
Capital lease obligations, less current installments...........           --         17
Deferred revenue...............................................        3,754        899
                                                                      ------     ------
   Total liabilities...........................................       58,001     34,806
                                                                      ------     ------
 
Commitments and contingencies
Shareholders' equity:
  Preferred stock, no par value. Authorized 5,000,000 shares
       none issued or outstanding..............................           --         --
  Common stock, $0.001 par value. Authorized 200,000,000
  shares; issued and outstanding 42,170,020
  and 42,992,600 shares, respectively..........................           42         43
  Additional paid-in capital...................................      156,758    190,731
  Accumulated other comprehensive income, net..................        2,526         --
  Retained earnings............................................       64,719     25,326
                                                                    --------   --------
     Shareholders' equity......................................      224,045    216,100
                                                                    --------   --------
    Total liabilities and shareholders' equity.................     $282,046   $250,906
                                                                    ========   ========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-3
<PAGE>
 
                       XYLAN CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                  Years ended December 31, 1998, 1997 and 1996
                     (In thousands, except per share data)

<TABLE>
<CAPTION>
 
                                                           1998       1997       1996
                                                           ----       ----       ----    
<S>                                                      <C>        <C>        <C>
 
Revenue.......................................           $347,580   $210,849   $128,456
Cost of revenue...............................            150,567     92,551     57,830
                                                         --------   --------   --------
        Gross profit..................                    197,013    118,298     70,626
                                                         --------   --------   --------
Operating expenses:
        Research and development..........                 41,342     25,875     15,823
        Sales and marketing..................              91,081     60,356     32,590
        General and administrative..........                9,580      7,013      4,397
                                                         --------   --------   --------
 
Total operating expenses.....................             142,003     93,244     52,810
                                                         --------   --------   --------
 
        Operating income..............................     55,010     25,054     17,816
Interest income, net...........................             5,183      6,694      5,240
                                                         --------   --------   --------
 
Income before income taxes............................     60,193     31,748     23,056
Income tax expense...........................              20,800      7,621      7,811
                                                         --------   --------   --------
 
        Net income..........................             $ 39,393   $ 24,127   $ 15,245
                                                         ========   ========   ========
 
Net income per share:
       Basic..........................................      $0.92      $0.57      $0.43
       Diluted....................................          $0.83      $0.52      $0.33
                                                         ========   ========   ========
 
Shares used in per share computations:
       Basic......................................         42,840     42,550     35,870
       Diluted....................................         47,485     46,796     46,381
                                                         ========   ========   ========
 
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>
 
                       XYLAN CORPORATION AND SUBSIDIARIES

                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                  Years ended December 31, 1998, 1997 and 1996
                                 (In thousands)
<TABLE>
<CAPTION>
 
                                                                                          Retained        Accumulated       Net
                                           Preferred                        Additional     earnings          other         share-  
                                             Stock               Common       paid-in    (accumulated    comprehensive    holders'
                                      Series A to Series E        stock       capital       deficit)         income        equity 
                                      --------------------        -----       -------       --------         ------        ------ 

<S>                                        <C>                 <C>           <C>          <C>             <C>           <C>   
Balance at December 31, 1995..........       $  26               $  10        $30,115      $(14,046)        $    --      $  16,105

   Conversion of preferred
     stock to common stock:
       Series A........................        (12)                 12             --            --               --            --
       Series B........................         (8)                  8             --            --               --            --
       Series C........................         (4)                  4             --            --               --            --
       Series D........................         (1)                  1             --            --               --            --
       Series E........................         (1)                  1             --            --               --            --
   Issuances of common stock in
     conjunction with offerings........          --                  5        143,653            --               --       143,658
   Issuances of common stock
     under stock option plans..........          --                  1            349            --               --           350
   Issuance of common stock warrants...          --                 --            274            --               --           274
   Tax benefit attributable to
      stock option plans...............          --                 --          9,507            --               --         9,507
   Unearned compensation amortization..          --                 --            499            --               --           499
   Net income..........................          --                 --             --        15,245               --        15,245
                                               -----             ------       -------        ------            -----       -------
Balance at December 31, 1996...........          --                  42       184,397         1,199               --       185,638

   Issuances of common stock
     under stock option plans..........          --                   1         1,772            --               --         1,773
   Issuances of common stock
     under stock purchase plans........          --                  --         1,690            --               --         1,690
   Cancellation of common
     Stock warrants....................          --                  --         (274)            --               --         (274)
   Tax benefit attributable to
     stock option plan.................          --                  --         2,689            --               --         2,689
   Unearned compensation
     amortization......................          --                  --           457            --               --           457
   Net income..........................          --                  --            --        24,127               --        24,127
                                               -----             ------       -------        ------            -----       -------
Balance at December 31, 1997...........          --                  43       190,731        25,326               --       216,100

   Issuances of common stock
     under stock option plans..........          --                   1         9,704            --               --         9,705
   Issuances of common stock
     under stock purchase plans........          --                   1         1,502            --               --         1,503
   Repurchases of common stock.........          --                 (3)      (53,234)            --               --      (53,237)
   Tax benefit attributable to
     stock option plans................          --                  --         7,702            --               --         7,702
   Unearned compensation amortization..          --                  --           353            --               --           353
Comprehensive Income:
   Net income..........................          --                  --            --        39,393               --        39,393
   Unrealized gain on marketable
     securities, net of tax effect
     of $1,302.........................          --                  --            --            --            2,526         2,526
                                               -----             ------       -------        ------            -----       -------
         Total comprehensive income                                                                                         41,919
                                                                                                                            ------
Balance at December 31, 1998...........     $    --             $    42      $156,758        $64,719          $2,526      $224,045
                                            ========            =======      ========        =======          ======      ========
</TABLE> 

          See accompanying notes to consolidated financial statements.

                                      F-5
<PAGE>
 
                       XYLAN CORPORATION AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                  Years ended December 31, 1998, 1997 and 1996
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                               1998         1997         1996
                                                                            ----------   ----------   ----------
<S>                                                                         <C>          <C>          <C>
Cash flows from operating activities:
 Net income..............................................................   $  39,393    $  24,127    $  15,245
 Adjustments to reconcile net income to net cash
 provided by operating activities:
  Depreciation and amortization..........................................      11,353        7,877        3,581
  Deferred income taxes..................................................      (3,741)      (4,334)      (1,766)
  Expense (benefit) related to warrants..................................          --         (274)         274
  Unearned compensation amortization.....................................         353          457          499
  Change in:
   Accounts receivable...................................................     (15,629)     (26,057)     (13,814)
   Inventories...........................................................      (8,180)      (6,153)      (9,450)
   Prepaid expenses and other current assets.............................        (411)        (645)      (1,864)
   Other assets..........................................................         157          (33)        (785)
   Accounts payable and accrued expenses.................................      12,380        8,622        8,131
   Deferred revenue......................................................       8,305        1,884        2,656
   Income taxes payable..................................................      10,375        5,679        9,519
                                                                             --------     --------     --------
    Net cash provided by operating activities............................      54,355       11,150       12,226
                                                                             --------     --------     --------
Cash flows from investing activities:
 Purchases of property and equipment.....................................     (23,258)     (12,106)     (15,173)
 Advances on note receivable.............................................          --       (1,500)      (6,000)
 Purchases of investments................................................    (315,165)    (192,745)    (147,125)
 Maturities of investments...............................................     332,686      165,475       68,842
                                                                             --------     --------     --------
    Net cash used in investing activities................................      (5,737)     (40,876)     (99,456)
                                                                             --------     --------     --------
Cash flows from financing activities:
 Proceeds from issuances of common stock.................................      11,208        3,463      144,008
 Repurchases of Company common stock.....................................     (53,237)          --           --
 Principal payments under capital lease obligations......................        (163)        (303)        (329)
                                                                             --------     --------     --------
    Net cash (used) provided by financing activities.....................     (42,192)       3,160      143,679
                                                                             --------     --------     --------
    Net increase (decrease) in cash and cash equivalents.................       6,426      (26,566)      56,449
    Cash and cash equivalents at beginning of year.......................      35,917       62,483        6,034
                                                                             --------     --------     --------
Cash and cash equivalents at end of year.................................   $  42,343    $  35,917    $  62,483
                                                                            =========    =========    =========
Supplemental disclosure of cash flow information:
    Cash paid during the year for interest...............................   $      21    $      33    $      97
    Cash paid during the year for income taxes...........................   $  13,710    $   6,177    $     222
                                                                            =========    =========    =========
Supplemental disclosure of noncash investing and financing activities:
    Unrealized gain on marketable securities, net of income tax..........   $   2,526    $      --    $      --
    Income tax benefit resulting from exercise of employee stock options.   $   7,702    $   2,689    $   9,507
                                                                            =========    =========    =========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-6
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                          December 31, 1998 and 1997
                                        

(1)  Summary of Significant Accounting Policies

 Description of Business

     Since its incorporation in July 1993, Xylan Corporation has focused on the
development, marketing and sale of dedicated, high-bandwidth switching systems
that easily integrate with and enhance the performance of customers' existing
LANs, as well as facilitate migration to new networking technologies.

 Principles of Consolidation

     The consolidated financial statements include the accounts of Xylan
Corporation and its wholly and majority-owned subsidiaries (collectively, the
Company). All significant inter-company accounts and transactions have been
eliminated in consolidation. The minority interest is not considered material.

 Cash Equivalents

     The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.

 Investment Securities

     The Company accounts for its investment securities in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," which requires investment
securities to be classified based on management's intent in one of three
categories: held-to-maturity, available-for-sale or trading. The Company has the
positive intent and ability to hold its debt securities to maturity and,
accordingly, classifies all debt securities as held-to-maturity which are
carried at amortized cost.  Marketable equity securities are classified as
available-for-sale and are recorded at fair value with unrealized gains, net of
taxes, included in shareholder's equity.

 Accounts Receivable

     Accounts receivable are shown net of an allowance for doubtful accounts of
$1,790,000 and $1,563,000 at December 31, 1998 and 1997, respectively.

 Inventories

     Inventories, consisting principally of component parts, are stated at the
lower of cost or market being determined using the first-in, first-out method.
Inventories are shown net of valuation reserves of $1,738,000 and $2,635,000 at
December 31, 1998 and 1997, respectively.

 Note Receivable

     The Company accounts for its note receivable in accordance with the
provisions of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan,"
as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan
Income Recognition and Disclosure." Management, considering current information
and events regarding the borrowers' ability to repay their obligations,
considers a note to be impaired when it is probable that the Company will be
unable to collect all amounts due according to the contractual terms of the note
agreement. The note receivable is recorded at cost.

                                      F-7
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


 Long-Lived Assets

     The Company adopted the provisions SFAS No. 121, "Accounting for the
Impairment of Long - Lived Assets and for Long - Lived Assets to Be Disposed
Of," on January 1, 1996. This Statement requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to the undiscounted operating cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Adoption of this Statement did not have a
material impact on the Company's financial position, results of operations or
liquidity.

 Financial Instruments

     The estimated fair values of cash and cash equivalents, accounts
receivable, note receivable, capital lease obligations, accounts payable and
accrued expenses, deferred revenue and income taxes payable approximate their
carrying values due to the short-term maturity of these instruments or because
the stated interest rates are indicative of market interest rates.

     The fair values of short-term and long-term investment securities are based
on quoted market prices at the reporting date for those investments. The
carrying values of investments are described in note 3.

 Revenue Recognition

     The Company generally recognizes product revenue at the time of shipment,
unless the Company has future obligations for installation or has to obtain
customer acceptance in which case revenue is deferred until earned.  Revenue
from service obligations is deferred and recognized on a straight-line basis
over the contractual period. Amounts billed in excess of revenue recognized are
included as deferred revenue in the accompanying consolidated balance sheets.
Allowances for sales returns are established based upon historical experience
and management's estimates as shipments are made.

 Warranty and Technical Support Obligations

     The Company accrues the estimated costs to fulfill customer warranty and
technical support obligations upon the recognition of the related revenue.

 Depreciation and Amortization

     Depreciation of property and equipment is calculated on the straight-line
method over estimated useful lives ranging from three to five years, or in the
case of capital lease assets over the shorter of the lease term or the estimated
useful life of the asset.

 Research and Development Costs

     The Company charges all research and development costs to expense as
incurred.

                                      F-8
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


 Income Taxes

     The Company accounts for income taxes under SFAS No. 109, "Accounting for
Income Taxes." Under the asset and liability method of SFAS No. 109, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry-forwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period that includes the
enactment date.

 Net Income Share

     In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings per Share." SFAS No. 128 replaced the previously reported primary
and fully diluted earnings per share with basic and diluted earnings per share
and became effective for both interim and annual periods ending after December
15, 1997. Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options and convertible securities. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented, and
where necessary, restated to conform to the SFAS No. 128 requirements.

     In February 1998, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 98 which changes the calculation of
earnings per share in periods prior to initial public offerings as previously
applied under SAB No. 83. When a registrant issued common stock, warrants,
options, or other potentially dilutive instruments for consideration or with
exercise prices below the initial public offering price within a one year period
prior to the initial filing of a registration statement relating to an initial
public offering, SAB No. 83 required such equity instruments to be treated as
outstanding for all periods presented in the filing using the anticipated
initial public offering price and the treasury stock method. Under SAB No. 98,
when common stock, options, warrants, or other potentially dilutive instruments
have been issued for nominal consideration during the periods covered by income
statements in the filing, those nominal issuances are to be reflected in
earnings per share calculations for all periods presented. Based on the
Company's current understanding of the definition of "nominal consideration",
the Company has concluded that during all periods prior to the Company's initial
public offering, no equity instruments were issued for nominal consideration.
Per share results for periods prior to or including the Company's initial public
offering have been restated in accordance with SAB No. 98.

     Basic net income per share was based on the weighted average number of
shares of common stock outstanding during the period. Diluted net income per
share further included the effect of stock options outstanding during the
period.

                                      F-9
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

The following table sets forth the computation of basic and diluted net income
per share (In thousands, except per share data):

<TABLE>
<CAPTION>

                                                                                                 Year Ended December 31,
                                                                                                 -----------------------
                                                                                                1998       1997       1996
                                                                                                ----       ----       ----
<S>                                                                                            <C>       <C>       <C>
Numerator for basic and diluted per share computations -
   Net income available to common shareholders...........................................      $39,393   $24,127   $15,245
                                                                                               =======   =======   =======
Denominator:
   Shares used for basic per share computations
      Weighted average shares outstanding................................................       42,840    42,550    35,870
Effect of diluted securities:
   Stock options.........................................................................        4,645     4,246     5,582
   Preferred Stock.......................................................................           --        --     4,929
                                                                                               -------   -------   -------
      Shares used for diluted per share computations.....................................       47,485    46,796    46,381
                                                                                               =======   =======   =======
Net income per share:
      Basic..............................................................................      $  0.92   $  0.57   $  0.43
      Diluted............................................................................      $  0.83   $  0.52   $  0.33
                                                                                               =======   =======   =======
</TABLE>

     Options to purchase 32,000, 637,000 and 968,000 shares at a weighted
average exercise price of $27.39, $21.64 and $48.87 were outstanding at December
31, 1998 and 1997, respectively, but were not included in the computation of
diluted net income per share because the exercise price of the options was
greater than the average market price of the common shares and therefore, the
effect would be antidilutive.

 Accounting for Stock Options

     Prior to January 1, 1996, the Company accounted for its stock option plan
in accordance with the provisions of Accounting Principles Board (APB) Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
As such, compensation expense would be recorded only if the current market price
of the underlying stock on the date of grant exceeded the exercise price. On
January 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," which permits entities to recognize as expense over the vesting
period the fair value of all stock based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
net income per share disclosures for employee stock option grants made in 1995
and future years as if the fair-value-based method defined in SFAS No. 123 had
been applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.

 Reporting Comprehensive Income

     On January 1, 1998, the Company adopted SFAS 130, "Reporting Comprehensive
Income" (SFAS No. 130). SFAS No. 130 establishes standards for reporting and
displaying comprehensive income and its components in a full set of financial
statements. Comprehensive income consists of net income and net unrealized gains
on marketable securities and is presented in the consolidated statements of
shareholder's equity. SFAS No. 130 requires only additional disclosures in the
consolidated financial statements; it does not affect the Company's financial
position or results of operations. Prior year financial statements have been
reclassified to conform to the requirements of SFAS No. 130.

                                      F-10
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

 Segment Disclosure

     In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" effective
for financial statements for periods beginning after December 15, 1997. SFAS No.
131 establishes standards for the way that public business enterprises report
financial and descriptive information about reportable operating segments. The
Company adopted SFAS No. 131 effective January 1, 1998.  The disclosures
regarding operating segments are not applicable as the Company only has one
operating segment. Substantially all of the Company's long-lived assets are
located in the United States. Disclosure regarding the Company's revenue by
sales channel, geographic region, product line and significant customers in
dollars and as a percentage of total revenue is included in Footnote 11.

 Use of Estimates

     Company management has made a number of estimates and assumptions relating
to the reporting of assets and liabilities and the disclosure of contingent
assets and liabilities in conformity with generally accepted accounting
principles. Actual results could differ from these estimates.

 Reclassifications

     Certain amounts in the prior period financial statements have been
reclassified to conform with current period presentation.

(2)  Property and Equipment

     Property and equipment, stated at cost, at December 31, 1998 and 1997 are
summarized as follows:
<TABLE>
<CAPTION>
                                                                                     1998           1997
                                                                                     ----           ----
                                                                                        (In thousands)
<S>                                                                               <C>          <C>
   Furniture and fixtures.......................................................     $ 4,430      $ 2,969
   Manufacture and test equipment...............................................      11,722        6,860
   Computer equipment and purchased software....................................      34,391       21,959
   Leasehold improvements.......................................................       6,118        1,615
                                                                                      ------       ------
      Total property and equipment..............................................      56,661       33,403
   Less accumulated depreciation and amortization...............................      23,862       12,509
                                                                                      ------       ------
      Net property and equipment................................................     $32,799      $20,894
                                                                                      ======       ======
</TABLE>

     Assets acquired through capitalized leases, which are included in property
and equipment, aggregated $1,176,000 at December 31, 1998 and 1997. Accumulated
depreciation related to these assets aggregated $1,133,000 and $841,000 at
December 31, 1998 and 1997, respectively.

                                      F-11
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
                                        

(3)  Investment Securities

     The Company's investment securities at December 31, 1998 and 1997 which
are carried at amortized cost and approximate market are summarized as follows:

<TABLE>
<CAPTION>
                                                                 1998        1997
                                                                 ----        ----
                                                                   (In thousands)
           <S>                                                  <C>      <C>
           (In thousands)
          Held-to-maturity debt investments:
           Municipal debt...................................    $77,949  $ 85,135
           Federal Government Agency debt...................      6,083     7,099
           Corporate debt...................................         --    10,319
                                                                 ------   ------- 
              Total held-to-maturity investments............     84,032   102,553

          Available-for-sale investments-Marketable equity
           securities, net of taxes.........................      3,526        -- 
                                                                 ------   ------- 
              Total investment securities...................     87,558   102,553

           Current..........................................     16,887    43,171
                                                                -------   ------- 
           Non-current......................................    $70,671  $ 59,382
                                                                =======   ======= 
</TABLE>

     At December 31, 1998, total net unrealized gain of marketable equity
securities aggregated $2,526,000 net of taxes of $1,302,000.  Such unrealized
gain is included in shareholders equity on the accompanying consolidated balance
sheet.

(4)  Note Receivable

     The Company agreed to loan up to $10 million to a contract manufacturer
that the Company has subcontracted with for component procurement, kitting and
printed circuit board assembly. The Company entered into the agreement to assist
the contract manufacturer in meeting the Company's increasing production
requirements. The Company purchases a majority of its inventory components from
this contract manufacturer. The loan is non-interest bearing, secured by raw
materials and electronic components purchased by the contract manufacturer and
matures in 1999. At December 31, 1998 and 1997, the note had an outstanding
balance of $7.5 million. The note as of December 31, 1998 is classified as a
current asset on the accompanying consolidated balance sheet.


(5)  Accounts Payable and Accrued Expenses

     Accounts payable and accrued expenses at December 31, 1998 and 1997 consist
of the following:

<TABLE>
                                                                                     1998        1997
                                                                                     ----        ----
                                                                                     (In thousands)
<S>                                                                                 <C>          <C>
     Accounts payable.......................................................        $15,142      $10,926
     Accrued payroll and related costs......................................         12,785        7,890
     Accrued warranty.......................................................          1,261        1,256
     Other accrued expenses.................................................          9,574        6,310
                                                                                    -------      -------
           Total accounts payable and accrued expenses......................        $38,762      $26,382
                                                                                    =======      =======
</TABLE>

                                      F-12
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


(6)  Capital Lease Obligations

     Capital lease obligations at December 31, 1998 and 1997 are summarized as
follows:
<TABLE>
<CAPTION>

                                                                               1998           1997
                                                                               ----           ----
     <S>                                                                       <C>            <C>
                                                                                 (In thousands)
     Capital lease obligations, secured by related assets, payable in
      monthly installments, including interest......................           $  43          $ 206
     Less current installments......................................              43            189
                                                                               -----          -----
           Total capital lease obligations..........................           $  --          $  17
                                                                               =====          =====
</TABLE>

(7)  Shareholders' Equity

    Convertible Preferred Stock

     Upon the effectiveness of the Company's initial public offering in March
1996, all of the Company's 25,698,676 outstanding shares of convertible
preferred stock which had certain liquidation preferences, voting rights, and
cumulative dividend provisions were converted into the same number of shares of
common stock upon the effectiveness of the Company's initial public offering.

    Preferred Stock

     During January 1996, the Board of Directors authorized 5,000,000 shares of
undesignated preferred stock.

    Common Stock

     During March 1996, the Company completed its initial public offering of a
total of 4,830,000 shares of common stock, of which 3,680,000 shares were sold
by the Company and 1,150,000 shares were sold by selling shareholders. Aggregate
net proceeds to the Company were $87.4 million.

     During May 1996, the Company completed a secondary public offering of
4,600,000 shares of common stock, of which 1,000,000 shares were sold by the
Company and 3,600,000 shares were sold by selling shareholders.  Aggregate net
proceeds to the Company were $56.2 million.

     In 1998, the Company's Board of Directors authorized the Company to
repurchase up to 3,000,000 shares of the Company's common stock to offset the
dilutive effect of new common stock issuances under the Company's stock option
and stock purchase plans. During the year ended December 31, 1998, the Company
repurchased 2,482,500 shares of its common stock for $53,237,000.

    Stock Warrants

     During 1994, the Company granted to an equipment lessor a warrant to
purchase 188,076 shares of series A convertible preferred stock of the Company
at a price per share of $.325. This warrant was exercisable at grant date and on
the effectiveness of the Company's initial public offering was converted into
185,725 shares of common stock.

                                      F-13
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

     During 1995, in connection with the issuance of series D convertible
preferred stock, the Company sold warrants, at $0.005 per share, to purchase
315,528 shares of common stock of the Company at an exercise price per share of
$3.50, and in connection with the issuance of series E convertible preferred
stock, the Company sold warrants, at $0.005 per share, to purchase 238,096
shares of common stock of the Company at a price per share of $4.60. These
warrants expired upon the closing of the Company's initial public offering.

     In 1996, Xylan and IBM entered into an agreement whereby Xylan committed to
grant IBM warrants to purchase up to a maximum of 2,350,000 shares of Xylan
common stock based on the achievement of specific business goals. During 1996,
the Company recognized $274,000 of expense related to these warrants.  In 1997,
the commitment to grant warrants to IBM was cancelled and the $274,000 of
expense was reversed.

(8)  Stock Option Plans

    1993 Stock Incentive Plan

     The Company has a 1993 Stock Incentive Plan (the 1993 Plan) which reserves
8,000,000 shares of the Company's authorized but unissued common stock for
options or stock purchase grants issuable to officers, employees, consultants
and the members of the Board of Directors of the Company.

     The Board of Directors or committees named by the Board of Directors (Plan
Administrator) have sole discretion and authority to promulgate, amend and
rescind rules and regulations relating to the administration of the 1993 Plan
and to select the eligible participants to whom options will be granted or
shares sold, the number of shares covered by the option or to be sold, the
exercise or purchase price and the form and terms of agreement to be used.
Outstanding options under the 1993 Plan vest in varying increments and expire
five to ten years after grant or upon earlier termination. Stock options shall
be exercisable over the exercise period as determined by the Plan Administrator,
not to exceed five years from the date the option is granted in the case of
optionees who own at least 10% of the total combined voting power of all classes
of stock of the Company.

     The Company determined subsequent to the grant of certain options, based in
part on an independent appraisal of the common stock at September 30, 1995, to
record for financial statement presentation purposes unearned compensation of
$941,000 for the difference between the exercise price and the deemed fair
market value. The methods of valuation used by the independent appraiser to
determine fair market value (based on an armslength transaction) were primarily
estimates of future cash flows, and also a comparison to similar publicly traded
companies, with a discount applied for the lack of a public market for the
Company's stock.

     During 1996, the Company recorded additional unearned compensation of
$1,395,000, for the difference between the grant price and the deemed fair
market value for options issued during the period from January 1, 1996 through
March 4, 1996.

     The unearned compensation is recorded as an offset to additional paid-in
capital and will be recorded as compensation expense ratably over the related
vesting periods. During 1998, 1997 and 1996, the Company recorded $353,000,
$457,000 and $499,000 of compensation expense, respectively.

     In September 1998, the Board of Directors approved the repricing of options
with an exercise price in excess of $10.50 for all employees.  In July 1997, the
Board of Directors approved the repricing of options with an exercise price in
excess of $15.81 for all employees.  In June and July 1996, the Board of
Directors approved the repricing of options with an exercise price in excess of
$50.75 and $34.75, respectively, for all employees excluding executive officers.

                                      F-14
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


1996 Stock Option Plan

     The Company has a 1996 Stock Option Plan (the 1996 Plan) which reserves
8,000,000 shares of the Company's authorized but unissued common stock for
option grants. The 1996 Plan provides for the grant to Company employees of
incentive stock options and for the grant of nonstatutory stock options to
employees and consultants of the Company.  Incentive stock options are granted
at 100% of fair market value. Nonstatutory stock options granted to certain of
the Company's executive officers must be at fair market value and grants to all
other persons must be at least 85% of fair market value at grant date.
Outstanding options under the 1996 Plan vest in varying increments and expire
five to ten years after grant or upon earlier termination.

     In September 1998, the Board of Directors approved the repricing of options
with an exercise price in excess of $10.50 for all employees.  In July 1997, the
Board of Directors approved the repricing of options with an exercise price in
excess of $15.81 for all employees.  In June and July 1996, the Board of
Directors approved the repricing of options with an exercise price in excess of
$50.75 and $34.75, respectively, for all employees excluding executive officers.


    1996 Stock Purchase Plan

     The Company has a 1996 Employee Stock Purchase Plan (the Purchase Plan)
which reserves 1,500,000 shares of common stock for issuance. The Purchase Plan
permits eligible employees to purchase common stock through payroll deductions,
which may not exceed 10% of an employee's salary, at a price equal to the lower
of 95% of the fair market value of the Company's common stock at the beginning
of the offering period or the purchase date. The Purchase Plan expires in 20
years.

     At December 31, 1998 and 1997, the Company recorded $759,000 and $492,000
in employee payroll deductions which have been included in accounts payable and
accrued expenses on the accompanying consolidated balance sheet. During December
31, 1998, 95,471 shares were issued pursuant to the Purchase Plan for aggregate
proceeds of $1,502,000. During December 31, 1997, 81,051 shares were issued
pursuant to the Purchase Plan for aggregate proceeds of $1,690,000.

    1996 Directors' Stock Option Plan

     The Company has a 1996 Directors' Stock Option Plan (the Directors' Plan)
which reserves 150,000 shares of common stock for issuance related to
nonstatutory stock options to nonemployee directors of the Company. Options are
exercisable at the fair market value of common stock on the grant date and have
a term of ten years.

1998 Employee Stock Option Plan

     In January 1998, the Company adopted the 1998 Employee Stock Option Plan
(the 1998 Plan) which reserves 1,000,000 shares of the Company's authorized but
unissued common stock for option grants. The 1998 Plan provides for the grant of
nonstatutory stock options to Company employees, excluding named executive
officers. In September 1998, the Board of Directors approved the repricing of
options with an exercise price in excess of $10.50 for all employees.

                                      F-15
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


Summary Stock Option Activity

     As of December 31, 1998, exercisable options aggregated 3,278,000. Summary
stock option activity during the years ended December 31, 1998, 1997 and 1996 is
as follows:
<TABLE>
<CAPTION>

                                                                  Number of Options                                    Weighted
                                             ----------------------------------------------------                       Average
                                                                        Directors                                      Exercise
                                             1993 Plan     1996 Plan      Plan          1998 Plan         Total          Price
                                             ---------     ---------     ------         ----------        --------     --------
<S>                                         <C>           <C>            <C>            <C>              <C>           <C>
Balance at December 31, 1995.............    6,375,000            --         --                 --        6,375,000     $  .48

Granted..................................    2,262,000     1,968,000     20,000                 --        4,250,000      35.98
Exercised................................   (1,062,000)           --         --                 --       (1,062,000)       .33
Canceled.................................   (1,238,000)      (37,000)        --                 --       (1,275,000)     27.19
                                             ---------     ---------     ------         ----------        ---------      -----

Balance at December 31, 1996.............    6,337,000     1,931,000     20,000                 --        8,288,000      14.75

 Granted.................................      114,000     4,222,000     30,000                 --        4,366,000      18.37
 Exercised................................    (935,000)      (30,000)        --                 --         (965,000)      1.84
 Canceled................................     (679,000)   (1,265,000)    (5,000)                --       (1,949,000)     19.74
                                             ---------     ---------     ------         ----------        ---------      -----

Balance at December 31, 1997.............    4,837,000     4,858,000     45,000                 --        9,740,000      10.48

 Granted.................................      934,000     3,297,000     20,000          1,052,000        5,303,000      13.04
 Exercised...............................   (1,134,000)     (427,000)        --             (4,000)      (1,565,000)      6.20
 Cancelled...............................     (444,000)     (963,000)   (15,000)          (140,000)      (1,562,000)     13.52
                                             ---------     ---------     ------         ----------        ---------      -----

Balance at December 31, 1998.............    4,193,000     6,765,000     50,000            908,000       11,916,000    $ 8.90
                                             =========     =========    =======         ==========       ==========    ======

Reserved for future issuance.............      356,000       779,000    100,000            588,000         1,823,000
                                             =========     =========    =======         ==========        ==========
</TABLE>

                                      F-16
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES
                                        
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


(9)  Accounting For Stock-Based Compensation

     The Company has adopted the disclosure-only provisions of Statement 123,
"Accounting for Stock-Based Compensation," but applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its plans and
warrants. If the Company had elected to recognize compensation cost based on the
fair value at the date of grants for award under the plans and warrants
(including modified awards), consistent with the method as prescribed by
Statement No. 123, net income (loss) and net income (loss) per share for the
years ended December 31, 1998, 1997 and 1996 would have changed to the pro forma
amounts indicated below (in thousands, except per share data):

<TABLE>
<CAPTION>


                                                                             1998        1997        1996
                                                                             ----        ----        ----
<S>                                                                          <C>         <C>         <C>
     Net income (loss):
         As reported...................................................      $39,393     $ 24,127    $15,245
         Pro forma.....................................................      $ 1,060     $ (1,672)   $ 7,690
                                                                             =======     ========    =======
     Net income (loss) per share:
         As reported:
          Basic.........................................................     $  0.92     $  0.57     $   0.43
          Diluted ......................................................     $  0.83     $  0.52     $   0.33

     Pro forma:
          Basic.........................................................     $  0.02     $ (0.04)    $   0.21
          Diluted ......................................................     $  0.02     $ (0.04)    $   0.17
                                                                             =======     =======     ========
</TABLE>

     The pro forma disclosure of compensation cost under this pronouncement was
based on the Black-Scholes single-option pricing model with the following
weighted average assumptions for 1998, 1997 and 1996:

<TABLE>
<CAPTION>

                                                                             1998      1997     1996
                                                                             ----      ----     ----
<S>                                                                          <C>       <C>      <C>
     Expected volatility:.............................................        45%       45%      55%
     Expected risk-free interest rate.................................       4.9%      6.1%     6.2%
     Expected dividend yield..........................................       0.0%      0.0%     0.0%
     Expected option life (in years)..................................       4.5       5.5      5.5
                                                                             ====      ====     ====
</TABLE>

     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion the existing models do not necessarily provide a reliable
single measure of the fair value of the Company's options.

     Pro forma net income (loss) reflects only options granted in 1998, 1997 and
1996. Therefore the full amount of calculating compensation cost for stock
options under Statement No. 123 is not reflected in the pro forma net income
(loss) amounts presented above because compensation cost is reflected over the
options' vesting period of five years and compensation cost for options granted
prior to January 1, 1995 is not considered.  The disclosure of compensation cost
under this pronouncement may not be representative of the effects on net income
(loss) for future years.

                                      F-17
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

     The weighted average fair value of options granted in 1998, 1997 and 1996
was $11.09, $18.37 and $35.98, respectively. The following table summarizes
information regarding options outstanding and options exercisable at December
31, 1998:


<TABLE> 

                                Outstanding Options                      Options Exercisable
             ----------------------------------------------------     ---------------------------
                                                         Weighted                        Weighted
             Range Of    Outstanding At    Remaining     Average      Exercisable At     Average
             Exercise      December 31,    Contractual   Exercise     December 31,       Exercise
              Prices          1998           Life          Price         1998             Price
              -----           ----           ----          -----         ----             ----- 
<S>                          <C>            <C>           <C>         <C>                <C>

           $ 0.06 -  0.38     1,555,000      6.0 years     $ 0.21       924,000          $ 0.18
             1.00    5.25       883,000      6.9             1.85       513,000            1.68
             7.50   10.50     8,126,000      8.7            10.46     1,721.000           10.41
             10.69  30.50     1,351,000      9.5            14.08       120,000           14.25
                              ----------                              ---------
             $0.06  30.50    11,915,000      8.3 years     $ 8.90     3,278,000          $ 6.30
             ============     ==========     =========     ======     =========          ======

 (10)  Income Taxes
</TABLE>

     The components of income tax expense for the years ended December 31, 1998,
1997 and 1996 are summarized as follows (in thousands):

<TABLE>
<CAPTION>



<S>
     Current:                                                          1998      1997         1996
     -------                                                           ----      ----         ----
                                                                     <C>       <C>          <C> 
        Federal..................................................    $12,829   $ 9,381      $7,454
        State....................................................      2,722     2,480       2,123
        Foreign..................................................      2,474     1,450          --
                                                                      ------    ------       -----
           Total current.........................................     18,025    13,311       9,577
                                                                      ------    ------       ----- 

     Deferred:
     --------
        Federal..................................................      2,190    (4,712)       (823)
        State....................................................        585      (978)       (943)
                                                                       -----     -----        ---- 
           Total deferred........................................      2,775    (5,690)      1,766
                                                                      ------     -----       ----- 
           Total income taxes....................................    $20,800   $ 7,621      $7,811
                                                                     =======     =====      ======
</TABLE>

     Total income tax expense differs from expected income tax expense (computed
by applying the U.S. Federal corporate tax rate of 35%) for the years ended
December 31, 1998, 1997 and 1996 as follows (in thousands):

<TABLE>
<CAPTION>
                                                                               1998       1997       1996
                                                                               ----       ----       ----
<S>                                                                           <C>        <C>        <C>
       Computed U.S. Federal income taxes..................................   $21,068    $11,112     8,070
       Computed state income taxes, net of Federal benefit.................     2,473      1,765     1,401
       Computed foreign taxes..............................................     1,787      1,450        --
       Benefit from foreign sales corporation..............................    (1,774)      (405)     (867)
       Nondeductible travel and entertainment expense......................        52        587        86
       Tax exempt interest income..........................................    (1,671)      (831)       --
       Research and experimentation credits................................     (1869)      (796)     (598)
       Federal alternative minimum tax.....................................        --         --        71
       Net change in valuation allowance...................................        --     (5,618)     (443)
       Other...............................................................       734        357        91
                                                                              -------    -------    ------
         Income tax expense................................................   $20,800    $ 7,621    $7,811
                                                                              =======    =======    ======

</TABLE>

                                      F-18
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued


     For the years ended December 31, 1998, 1997 and 1996, the Company realized
income tax benefits totaling $7,702,000 and $2,689,000 and $9,507,000,
respectively, related to exercised stock options. The total income tax benefit
related to these deductions is recorded as an addition to additional paid-in
capital in the accompanying consolidated balance sheet.

     Under FAS 109, deferred tax assets and liabilities are recognized for the
expected future tax consequences of differences between the carrying amount of
assets and liabilities and their respective tax bases using enacted tax rates in
effect for the year in which the differences are expected to reverse. The
deferred tax assets (liabilities) at December 31, 1998 and 1997 consist of the
following:

<TABLE>
<CAPTION>
                                                                                     1998       1997
                                                                                     ----       ----
                                                                                     (In thousands)
<S>                                                                                <C>        <C>
     Deferred tax assets:
      Allowances and reserves...................................................   $ 7,318    $ 6,834
      Accrued expenses..........................................................     2,624      1,749
      Depreciation and amortization.............................................       673     (1,076)
      Other.....................................................................       572        393
                                                                                   -------    -------
         Total gross deferred tax assets........................................    11,187      7,900
                                                                                   -------    -------
     Deferred tax liabilities:
      Foreign taxes.............................................................    (1,234)    (1,357)
      State taxes...............................................................      (112)      (443)
                                                                                   -------    -------
         Total gross deferred tax liabilities...................................    (1,346)    (1,800)
                                                                                   -------    -------
         Net deferred tax assets................................................   $ 9,841    $ 6,100
                                                                                   =======    =======
</TABLE>

     In assessing the realizability of deferred tax assets, the Company
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the projected future taxable income and tax planning strategies in
making this assessment.

     Based on the level of historical taxable income and projections for future
taxable income over the periods in which the level of deferred tax assets are
deductible, management believes it is more likely than not that the Company will
realize all  of the benefits related to these deductible temporary differences
at December 31, 1998, accordingly, there is no valuation allowance at either
December 31, 1998 or 1997.

(11) Significant Customers, Concentration Of Credit Risk And Export Sales

     The Company operates in a single industry segment encompassing the design,
development, manufacture, marketing and technical support of internetworking
products and services.

                                      F-19
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued

    Significant Customers

     For years ended December 31, 1998, 1997 and 1996 customers comprising 10%
or more of revenue are as follows:
<TABLE>
<CAPTION>
                                                                   1998    1997    1996
                                                                   ----    ----    ----
<S>                                                                <C>     <C>     <C>
     IBM......................................................     18.0%   21.5%   11.7%
     Alcatel..................................................     15.8%   11.6%      *
     Hitachi Computer Products................................        *       *    13.5%
     NTT PC Communications....................................        *       *    12.3%
</TABLE>

* -- Percentage is less than 10%

    Concentration of Credit Risk

     Financial instruments which potentially subject the Company to
concentration of credit risk consist primarily of accounts receivable. The
credit risk associated with accounts receivable is mitigated by the Company's
credit evaluation process, reasonably short collection terms and the
geographical dispersion of sales transactions.

     The Company's two major customers in 1998, each of whom accounted for more
than 10% of revenue, aggregated 10% and 9%, respectively, of accounts receivable
at December 31, 1998.

     The Company's two major customers in 1997, each of whom accounted for more
than 10% of revenue, aggregated 23% and 17%, respectively, of accounts
receivable at December 31, 1997.

    Revenues by Geographic Area, Channel and Product Line

     Revenues by geographic area, channel and product line for the years ended
December 31, 1998, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                                   1998        1997       1996
                                                                   ----        ----       ----
                                                                         (In thousands)
<S>                                                              <C>         <C>        <C>
     Geographic Area:
      North America............................................    $173,701   $ 98,823   $ 62,767
      Asia.....................................................      50,428     45,864     48,092
      Europe...................................................     112,552     60,069     16,359
      Other....................................................      10,899      6,093      1,238
                                                                   --------   --------   --------
           Total revenue.......................................    $347,580   $210,849   $128,456
                                                                   ========   ========   ========
     Revenues by channel:
     Channel:
      OEM......................................................    $120,143   $ 77,132   $ 59,432
      System Integrator and direct.............................     227,437    133,717     69,024
                                                                   --------   --------   --------
           Total revenue......................................     $347,580   $210,849   $128,456
                                                                   ========   ========   ========
</TABLE>

                                      F-20
<PAGE>
 
                      XYLAN CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
<TABLE>
<CAPTION>


                                                                  1998       1997       1996
                                                                  ----       ----       ----
<S>                                                              <C>         <C>        <C>
     Product Line:
      OmniSwitch...............................................   $275,576   $191,379   $116,259
      Omniswitch/Router........................................     13,385         --         --
      OmniStack................................................     51,632         --         --
      PizzaSwitch..............................................      7,017     19,470     12,197
                                                                  --------   --------    -------
          Total revenue.......................................    $347,580   $210,849   $128,456
                                                                  ========   ========   ========

</TABLE>

(12) Employee Benefit Plan

     The Company has a defined contribution 401(k) plan. The plan covers all
full-time employees who are at least 21 years of age and have completed one year
of service. Participants may contribute 1% to 12% of their pretax compensation.
The plan permits the Company to make matching contributions up to 25% of the
participant's contribution to a maximum of $2,000 and the matching contributions
vest over five years. The Company's matching contribution for 1998, 1997 and
1996 was $762,000, $459,000 and $265,000, respectively.

(13) Commitments and Contingencies

     The Company is obligated under noncancelable operating lease agreements for
equipment and facilities expiring on various dates through 2009. Rental expense
for the years ended December 31, 1998, 1997 and 1996 aggregated $4,134,000,
$3,096,000 and $1,482,000, respectively.

     Future annual minimum rental commitments under noncancelable operating
leases at December 31, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>

     Year ended December 31:
          <S>                              <C>

         1999..........................  $ 3,813
         2000..........................    3,372
         2001..........................    3,216
         2002..........................    2,633
         2003..........................    1,409
         Thereafter....................    6,754
                                           -----
                                         $21,197
                                         =======
</TABLE> 

     The Company is involved in various investigations, lawsuits and claims
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse effect on
the Company's consolidated financial position, results of operations or
liquidity.

                                      F-21
<PAGE>
 
(14) Selected Quarterly Financial Data (Unaudited)

     Selected quarterly financial data for 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
                                                                                Three months ended
                                                                   ------------------------------------------------
                                                                   December 31   September 30   June 30    March 31
                                                                   -----------   ------------   --------   --------
<S>                                                                <C>           <C>            <C>        <C>
                                                                        (In thousands, except per share data)

1998:
 Revenue........................................................       $97,399        $91,133    $83,678    $75,370
 Gross profit...................................................        55,037         51,708     47,550     42,718
 Operating income...............................................        15,192         14,632     13,600     11,586
 Net income.....................................................        10,968         10,438      9,603      8,384
 Net income per share basic.....................................          0.26           0.24       0.22       0.19
 Net income per share - diluted.................................          0.23           0.22       0.20       0.18


1997:
 Revenue........................................................       $64,202        $53,517    $45,122    $48,008
 Gross profit...................................................        36,287         29,799     24,867     27,345
 Operating income...............................................         8,609          5,542      3,262      7,641
 Net income.....................................................         6,562          4,607      7,090      5,868
 Net income per share  basic....................................          0.15           0.11       0.17       0.14
 Net income per share  diluted..................................          0.14           0.10       0.15       0.13

</TABLE>

(15) Subsequent Event

     Xylan and Alcatel, a French corporation ("Alcatel"), and Zeus Acquisition
Corp., a California corporation and a wholly owned subsidiary of Alcatel
("Sub"), entered into an Agreement and Plan of Merger dated as of March 1, 1999
(the "Merger Agreement"), pursuant to which and subject to the conditions
thereof, Xylan will become a wholly-owned indirect subsidiary of Alcatel through
the merger of Sub with and into Xylan (the "Merger").

     On April 5, 1999, Alcatel announced that it successfully completed its
tender offer (the "the Offer") to purchase the outstanding shares of Xylan for
$37 per share. The tender offer expired at 12:00 midnight, New York City time,
on Friday, April 2, 1999. Based on a preliminary count, approximately 97% of the
outstanding shares of Xylan (together with shares already owned by Alcatel) were
tendered. Alcatel has accepted for purchase all of these shares. Following the
closing of the Offer, Alcatel appointed a majority of the directors of Xylan.

     Under California Law, since Sub has acquired pursuant to the Offer at least
90% of the outstanding Xylan shares, it will be able to approve the Merger
Agreement and the transactions contemplated thereby, including the Merger,
without a vote of the shareholders of Xylan.  Alcatel, Sub and Xylan have agreed
in the Merger Agreement to take, subject to the satisfaction or waiver of the
conditions set forth in the Merger Agreement, all necessary and appropriate
action to cause the Merger to become effective as soon as practicable after the
acceptance of the payment for Xylan shares by Sub pursuant to the Offer, without
a meeting of shareholders of Xylan, in accordance with Section 1110 of the
California General Corporation Law.

     Alcatel expects the Merger to be completed by the end of April. As a result
of the Merger, the shares of Xylan that were not tendered in the tender offer
will be converted into the right to receive $37 per share in cash and Xylan will
become a wholly-owned indirect subsidiary of Alcatel.

                                      F-22
<PAGE>
 
     On March 2, 1999, an action entitled Daniel W. Krasner v. Xylan Corporation
et. al. was filed, on March 5, 1999, an action entitled Jay Gentile v. Xylan
Corporation et. al. was filed, and on March 9, 1999, an action entitled Marilyn
Mandel v. Xylan Corporation et. al. was filed, each in the Superior Court of the
State of California, for the County of Los Angeles, in which the respective
plaintiffs named as defendants the Company, the directors of the Company and
Alcatel.  The complaints purport to assert claims on behalf of all public
shareholders of the Company.  The complaints allege that Alcatel and the members
of the Company Board have breached their fiduciary duties to the Company and
that Alcatel used its relationship with the Company and the Company Board to
force the Company Board to accept an inadequate proposal.  The complaints seek
class certification and other equitable and monetary relief, including enjoining
the Offer and the Merger or awarding damages.  Alcatel and the Company believe
that the allegations are without merit and intend to vigorously contest these
actions.  There can be no assurance that the defendants will be successful.

                                      F-23
<PAGE>
 
                       XYLAN CORPORATION AND SUBSIDIARIES

                                  Schedule II
                       Valuation and Qualifying Accounts
                  Years Ended December 31, 1998, 1997 and 1996





<TABLE> 
<CAPTION> 
                                    
                                                                   Balance at                                 Balance at
                                                                    Beginning    Charged to                      end
                                                                     of Year      Expense      Deductions      of Year
                                                                   ----------    ----------    ----------     ----------
<S>                                                                <C>           <C>           <C>            <C> 
 Year ended December 31, 1998:
   Allowance for doubtful accounts.............................    $1,563,000    $1,093,000      $866,000      $1,790,000
   Allowance for excess and obsolete inventory.................     2,635,000       821,000      1,718,00       1,738,000

 Year ended December 31, 1997:
   Allowance for doubtful accounts.............................       270,000      1,293,000           --       1,563,000
   Allowance for excess and obsolete inventory.................       458,000      2,177,000           --       2,635,000

 Year ended December 31, 1996:
   Allowance for doubtful accounts.............................       376,644         35,056      141,700         270,000
   Allowance for excess and obsolete inventory.................      $132,400       $355,423      $29,823        $458,000

</TABLE> 


                                      S-1
<PAGE>
 
                               INDEX TO EXHIBITS
<TABLE>
<CAPTION>

<C>        <S>
Number                     Description
------                     -----------
2.1        Form of Offer to Purchase, dated March 8, 1999.(5)
2.2        Agreement and Plan of Merger, dated as of March 1, 1999, among Registrant, Zeus Acquisition Corp. ("Sub"),
           and Alcatel.(5)
2.3        Stock Option Agreement, dated as of March 1, 1999, among Registrant, Sub, and Alcatel.(5)
3.1        Amended and Restated Articles of Incorporation of Registrant.(1)
3.2        Amended and Restated Bylaws of Registrant.(8)
4.1        Form of Common Stock Certificate.(1)
4.2        Preferred Shares Rights Agreement dated as of April 17, 1997 between the Registrant and the First National
           Bank of Boston, including Certificate of Determination of Rights, Preferences and Privileges of Series A
           Participating Preferred Stock, the Form of Rights Certificate and the Summary of Rights attached thereto
           as Exhibits A, B and C, respectively.(2)
4.3        Amendment No. 1 to Preferred Shares Rights Agreement, dated as of March 2, 1999.(6)
9.1        Shareholder Agreement between Alcatel, Sub, Yuri Pikover and Pikover 1995 Irrevocable Trust, Pikover
           Trust, and Pikover Irrevocable Children's Trust dated as of March 1, 1999.(5)
9.2        Shareholder Agreement between Alcatel, Sub, Steve Y. Kim and Steve Y. Kim Living Trust and Kim Irrevocable
           Children's Trust dated as of March 1, 1999.(5)
9.3        Shareholder Agreement between Alcatel, Sub, and John Walecka dated as of March 1, 1999.(5)
10.1       Form of Indemnification Agreement.(1)
10.2       1993 Stock Incentive Plan.(1)
10.3       Form of 1996 Employee Stock Purchase Plan and related agreements.(1)
10.4       Form of 1996 Directors' Option Plan and related agreements.(1)
10.5       Form of amended 1996 Stock Plan.(4)
10.6       Fourth Restated Registration Rights Agreement among the Registrant and certain security holders of the
           Registrant, dated as of December 11, 1995.(1)
10.7       Lease Agreement between the Registrant and Malibu Canyon Office Partners, L.P. dated as of April 14, 1994,
           as amended November 3, 1994, January 2, 1995, and April 25, 1995.(1)
10.8       Security and Loan Agreement dated September 1, 1995 between the Registrant and Imperial Bank.(1)
10.9       Master Lease Agreement dated as of May 31, 1994, as amended between the Registrant and Dominion Ventures,
           Inc.(1)
10.10      Master Lease Agreement dated as of June 9, 1995 between the Registrant and Copelco Capital, Inc.(1)
10.11      Value-Added Product Sales Agreement dated as of July 1, 1995 between the Registrant and Hamilton Hallmark,
           a division of Avnet, Inc.(1)
10.12      401(k) Plan.(1)
10.13      Series C Preferred Stock Agreement dated as of March 13, 1995 between the Registrant and Alcatel Data
           Networks S.A.(1)
10.14      International Distributor Agreement between the Registrant and Alcatel N.V., dated as of March 13, 1995.(1)
10.15      Product and Technology Agreement between the Registrant and Alcatel N.V. dated as of March 13, 1995.(1)
10.16      Original Equipment Manufacturer Agreement dated as of June 14, 1995 between the Registrant and Hitachi
           Computer Products (America), Inc.(1)
10.17      Original Equipment Manufacturer Agreement dated as of April 12, 1995 between the Registrant and Digital
           Equipment Corporation.(1)
10.18      Manufacturing and Purchase Agreement dated as of March 28, 1996 between the Registrant and Victron, Inc.(1)
10.19      Amendment to Manufacturing and Purchase Agreement between Registrant and Victron, Inc. dated as of
           December 30, 1996.(3)
</TABLE> 

                                      E-1
<PAGE>
 
<TABLE>
<CAPTION>

Number                     Description
-----                      -----------
<S>       <C>
10.20     Dale Bartos Employment Agreement dated as of January 4, 1997.(3)
10.21     Form of 1998 Employee Stock Option Plan and related agreements.(4)
10.22     Form of Change of Control Agreement.(4)
10.23     Employment Agreement between Sub and Steve Y. Kim, dated as of March 1, 1999.(5)
10.24     Industrial Real Estate Lease between Cypress Land Company and the Registrant, dated as of June 1, 1998.(7)
10.25     First Amendment to Industrial Real Estate Lease, dated as of October 19, 1998.(10)
23.1      Consent of KPMG LLP.(10)
24.1      Power of Attorney (see page 31).(10)
27.1      Financial Data Schedule for (current) fiscal year ended December 31, 1998.(10)
27.2      Restated Financial Data Schedule for fiscal year ended December 31, 1996.(4)
27.3      Restated Financial Data Schedule three months ended March 31,1997.(4)
</TABLE> 
________

(1)  Incorporated by reference to exhibits filed in response to Item 16(a),
     "Exhibits," of the Registrant's Registration Statement on Form S-1 and
     Amendments thereto, which became effective on May 29, 1996.
(2)  Incorporated by reference to exhibits to the Registrant's Registration
     Statement on Form 8-A filed on August 24, 1997.
(3)  Incorporated by reference to exhibits to the Registrant's Annual Report on
     Form 10-K filed on March 31, 1997.
(4)  Incorporated by reference to exhibits to the Registrant's Annual Report on
     Form 10-K filed on March 31, 1998.
(5)  Incorporated by reference to exhibits to Alcatel and Sub's Tender Offer
     Statement on Schedule 14D-1 filed on March 8, 1999.
(6)  Incorporated by reference to an exhibit to the Registrant's Registration
     Statement on Form8-A/A filed on March 8, 1999.
(7)  Incorporated by reference to exhibits to the Registrant's Form 10-Q filed
     on August 12, 1998.
(8)  Incorporated by reference to exhibits to the Registrant's Form 10-Q filed
     on November 13, 1998.
(9)  Incorporated by reference to an exhibit to the Registrant's
     Solicitation/Recommendation Statement on Schedule 14D-9 filed on March 8,
     1999.
(10) Filed herewith.

                                      E-2