REDBACK NETWORKS INC, 10-Q, 2000-08-14

REDBACK NETWORKS INC
10-Q, 2000-08-14
BUSINESS SERVICES, NEC

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

_______________

FORM 10-Q

[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000

		OR

[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		FOR THE TRANSITION PERIOD FROM ____________ TO _____________

COMMISSION FILE NUMBER 000-25853

REDBACK NETWORKS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE	77-0438443
(State of incorporation)	(IRS Employer Identification No.)

1195 BORREGAS AVENUE, SUNNYVALE, CA 94089
(Address of principal executive offices, including ZIP code)

(408) 571-5200
(Registrant's telephone number, including area code)

NONE
(Former name, former address and former fiscal year, if changed since last report)

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) Yes [X] No [ ], and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ].

The number of shares outstanding of the Registrant's Common Stock as of June 30, 2000 was 148,618,192 shares.

REDBACK NETWORKS INC.

INDEX

		PAGE NO.

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheet as of June 30, 2000 and December 31, 1999	3
	Unaudited Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2000 and 1999	4
	Unaudited Condensed Consolidated Statement of Cash Flows for the six months ended June 30, 2000 and 1999	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Qualitative and Quantitative Disclosure about Market Risk	21
PART II.	OTHER INFORMATION	21
Item 1.	Legal Proceedings	21
Item 2.	Changes in Securities and Use of Proceeds	21
Item 3.	Defaults Upon Senior Securities	21
Item 4.	Submission of Matters to a Vote of Security Holders	21
Item 5.	Other Information	21
Item 6.	Exhibits and Reports on Form 8-K	22
SIGNATURE		22
EXHIBIT INDEX		23

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

REDBACK NETWORKS INC.

CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

	JUNE 30,			DECEMBER 31,
	2000			1999

ASSETS
Current assets:
Cash and cash equivalents	$	222,418		$	13,888
Short-term investments		269,492			43,072
Accounts receivable, net		36,897			15,429
Inventories		4,353			3,960
Other current assets		11,015			1,374

Total current assets		544,175			77,723

Property and equipment, net		33,550			10,150
Other assets, net		4,145,841			6,957

Total assets	$	4,723,566		$	94,830


LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings, current	$	40		$	123
Capital lease obligations, current		2,302			755
Accounts payable		25,854			9,109
Accrued liabilities		30,430			7,993
Deferred revenue		13,307			9,945

Total current liabilities		71,933			27,925

Convertible subordinated notes		500,000			—
Capital lease obligations and other notes payable, less
current portion		7,705			1,012

Total liabilities		579,638			28,937


Stockholders' equity:
Convertible Preferred Stock: $0.0001 par value; 10,000
shares authorized; none issued and outstanding		—			—
Common Stock, par value $0.0001 per share; 750,000 shares
authorized; 148,618 and 87,794 shares issued and
outstanding, respectively		4,545,832			91,638
Deferred stock compensation		(2,217	)		(3,266	)
Notes receivable from stockholders		(5,730	)		(131	)
Other comprehensive income		288			—
Accumulated deficit		(394,245	)		(22,348	)

Total stockholders' equity		4,143,928			65,893

Total liabilities and stockholders' equity	$	4,723,566		$	94,830

See accompanying Notes to Condensed Consolidated Financial Statements.

REDBACK NETWORKS INC.

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

	THREE MONTHS ENDED						SIX MONTHS ENDED
	JUNE 30,						JUNE 30,

	2000			1999			2000			1999

Net revenues	$	48,728		$	11,087		$	82,891		$	17,604
Cost of revenues		14,853			3,291			23,150			5,262

Gross margin		33,875			7,796			59,741			12,342


Operating expenses:
Research and development (excluding amortization
of deferred stock compensation of $190, $421, $388
and $820, respectively)		23,783			4,133			35,922			7,238
Selling, general and administrative (excluding
amortization of deferred stock compensation of
$324, $718, $661 and $1,397, respectively)		16,597			6,519			29,852			10,657
Amortization of intangible assets		279,630			—			350,234			—
In-process research and development		—			—			15,300			—
Amortization of deferred stock compensation		514			1,139			1,049			2,217

Total operating expenses		320,524			11,791			432,357			20,112

Loss from operations		(286,649	)		(3,995	)		(372,616	)		(7,770	)
Interest and other income		7,493			365			8,534			368
Interest and other expense		(7,504	)		(107	)		(7,815	)		(136	)

Net loss	$	(286,660	)	$	(3,737	)	$	(371,897	)	$	(7,538	)


Basic and diluted net loss per share	$	(2.41	)	$	(0.08	)	$	(3.58	)	$	(0.24	)


Shares used in computing net loss per share		118,730			45,052			103,957			30,892

See accompanying Notes to Condensed Consolidated Financial Statements.

REDBACK NETWORKS INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

	SIX MONTHS ENDED
	JUNE 30,

	2000			1999

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(371,897	)	$	(7,538	)
Adjustments to reconcile net loss to net cash used in		—			—
operating activities:		—			—
Depreciation and amortization		355,322			915
Amortization of deferred stock compensation		1,049			2,217
In-process research and development		15,300			—
Other noncash charges		—			330
Changes in assets and liabilities, net of effects of acquisition:		—			—
Accounts receivable, net		(21,468	)		(6,720	)
Inventory		(393	)		(1,885	)
Other current assets		(8,769	)		(369	)
Other assets		(9,297	)		(183	)
Accounts payable		12,437			4,372
Accrued liabilities		20,113			2,668
Deferred revenue		3,362			3,000

Net cash used in operating activities		(4,241	)		(3,193	)


CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(19,175	)		(1,705	)
Purchases of short-term investments		(226,132	)		(5,640	)
Other investments		(11,160	)		—
Acquisition, net of cash acquired		(18,454	)		—

Net cash used in investing activities		(274,921	)		(7,345	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of convertible notes		486,443			—
Proceeds from the issuance of convertible preferred stock, net		—			491
Proceeds from the issuance of common stock, net		7,687			61,191
Principal payments under capital lease obligations		(6,355	)		(306	)
Proceeds from bank borrowings		—			2,500
Repayments of bank borrowings		(83	)		(4,123	)

Net cash provided by financing activities		487,692			59,753

Net increase in cash and cash equivalents		208,530			49,215
Cash and cash equivalents at beginning of period		13,888			8,189

Cash and cash equivalents at end of period	$	222,418		$	57,404


SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest	$	243		$	179


SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITY:
Property and equipment acquired under capital leases	$	—		$	768

Issuance of Common Stock in merger with Siara Systems	$	4,447,297

See accompanying Notes to Condensed Consolidated Financial Statements.

REDBACK NETWORKS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. DESCRIPTION OF BUSINESS

Redback Networks Inc. (the "Company" or "Redback") was incorporated in Delaware on August 30, 1996. Redback is a leading provider of advanced networking solutions that enable carriers, cable operators and service providers to rapidly deploy high-speed broadband access to the Internet and corporate networks. Redback's product lines consist of the Subscriber Management System family and the SmartEdge family. Together, these product lines are designed to enable our customers to create end-to-end regional networks that will support all major broadband access technologies, as well as the new services that these high-speed connections will enable. Redback’s Subscriber Management System, or SMS, products connect and manage large numbers of subscribers across all major high-speed access technologies, including digital subscriber line, cable and wireless. Redback’s SmartEdge optical networking and multi-service products are being developed to simplify the architecture of today’s regional voice and data networks, as well as improve their capacity and performance. Redback sells its products through a direct sales force, resellers and distribution partners. The Company operates in one business segment.

2. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company and reflect all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary to present fairly the financial position, results of operations and cash flows for the interim periods. These condensed consolidated financial statements should be read in conjunction with the audited financial statements included in the Company's 1999 Annual Report on Form 10-K and the unaudited financial statements included in the Company’s 2000 first quarter filing on Form 10-Q. Results for the interim periods are not necessarily indicative of results for the entire fiscal year.

3. STOCKHOLDERS' EQUITY

Amendment of Authorized Shares of Common Stock

On June 8, 2000, the Company's stockholders approved an increase in the number of authorized shares of Common Stock from 200,000,000 to 750,000,000.

Stock Split

On March 8, 2000, Redback announced a two-for-one stock split of the outstanding shares of the Company's Common Stock. The stock split was effective on April 3, 2000 for holders of record on March 20, 2000. All share and per share information for all periods has been retroactively restated to reflect this two-for-one Common Stock split.

4. NET LOSS PER SHARE

Basic and diluted net loss per share have been computed using the weighted-average number of shares of common stock outstanding for the three and six months ended June 30, 2000 and 1999, less shares subject to repurchase.

The following table presents the calculation of basic and diluted net loss per share:

	THREE MONTHS ENDED						SIX MONTHS ENDED
	JUNE 30,						JUNE 30,

	2000			1999			2000			1999

	(IN THOUSANDS, EXCEPT						(IN THOUSANDS, EXCEPT
	PER SHARE DATA)						PER SHARE DATA)
Net loss	$	(286,660	)	$	(3,737	)	$	(371,897	)	$	(7,538	)

Basic and diluted:
Weighted-average shares of common stock
outstanding		147,666			57,964			125,699			44,396
Less weighted-average shares subject to repurchase		(28,936	)		(12,912	)		(21,742	)		(13,504	)

Weighted-average shares used in computing
basic and diluted net loss per share		118,730			45,052			103,957			30,892

Basic and diluted net loss per share	$	(2.41	)	$	(0.08	)	$	(3.58	)	$	(0.24	)

For the three and six month periods ended June 30, 2000, options to purchase 19,015,504 and 21,106,175 shares of Common Stock at an average exercise price of $20.97 and $24.76 per share, respectively, convertible promissory notes convertible into 2,621,500 shares of Common Stock and warrants to purchase 451,400 shares of Common Stock and an average exercise price of $1.30, have not been included in the computation of diluted net loss per share as their effect would have been anti-dilutive.

Also, for both the three and six month periods ended June 30, 1999, options to purchase 14,745,144 shares of Common Stock at an average exercise price of $1.70 per share and warrants to purchase 635,884 shares of Common Stock at an average exercise price of $1.30, have not been included in the computation of diluted net loss per share as their effect would have been anti-dilutive.

5.    MERGER WITH SIARA SYSTEMS COMPLETED

     On March 8, 2000, Redback and Siara Systems, Inc. ("Siara") completed their merger (the "Merger"). Siara was a development stage company that designed and developed optical access networking products that enable network service providers to offer data at multiple bandwidths to their customers in a cost-effective way and to create new high speed data services. In connection with the Merger, Redback issued 57,388,818 shares of its common stock and options and warrants to purchase 5,295,038 shares of its common stock.

     The Company accounted for the Merger under the purchase method of accounting. The consolidated financial statements include the results of operations of Siara commencing on March 9, 2000.

     The purchase price, including the value of options and warrants issued in connection with the Merger and professional fees directly related to the acquisition, was approximately $4.5 billion. The preliminary allocation of the purchase price to assets acquired and liabilities assumed is presented in the table that follows (in thousands).

Tangible assets acquired	$	16,381
Identifiable intangibles acquired:
In-process research and development		15,300
Existing technology		13,800
Noncompete agreements		10,000
In-place workforce		27,500
Goodwill		4,419,207
Liabilities assumed		(35,619	)

Net assets acquired	$	4,466,569

Amounts allocated to the non-compete agreements and in-place workforce are being amortized over their estimated useful lives of two and three years, respectively. Amounts allocated to existing technology and goodwill are being amortized over their estimated useful lives of four years.

In addition, the Company recorded a $15.3 million charge for in-process research and development related to the Merger with Siara during the first quarter of 2000. The amount was determined by identifying research projects for which technological feasibility had not been established and no alternative future uses existed.

The fair value allocation to in-process research and development was determined by identifying the research projects for which technological feasibility had not been achieved and which had no alternative future use at the merger date, assessing the stage and expected date of completion of the research and development effort at the merger date, and calculating the net present value of the cash flows expected to result from the successful deployment of the new technology resulting from the in-process research and development effort.

The stages of completion were determined by estimating the costs and time incurred to date relative to the costs and time incurred to develop the in-process technology into a commercially viable technology or product, while considering the relative difficulty of completing the various tasks and obstacles necessary to attain technological feasibility. As of the date of the acquisition, Siara had five projects in process that ranged from 24%-80% complete.

The estimated net present value of cash flows was based on incremental future cash flows from revenues expected to be generated by the technologies in the process of development, taking into account the characteristics and applications of the technologies, the size and growth rate of existing and future markets and an evaluation of past and anticipated technology and product life cycles. Estimated net future cash flows included allocations of operating expenses and income taxes but excluded the expected completion costs of the in-process projects, and were discounted at a rate of 26% to arrive at a net present value. The discount rate included a factor that took into account the uncertainty surrounding the successful deployment of in-process technology projects. This net present value was allocated to in-process research and development based on the percentage of completion at the merger date.

The following unaudited pro forma net revenues, net loss and net loss per share data for the six months ended June 30, 2000 and 1999 are based on the respective historical financial statements of the Company and Siara. The pro forma data reflects the consolidated results of operations as if the Merger with Siara occurred at the beginning of each of the periods indicated and includes the amortization of the resulting goodwill and other intangible assets. The pro forma data excludes deferred stock compensation amortization recorded in Siara's historical financial statements, as the value of the related options was included in the purchase price, and the charge for in-process research and development. The pro forma financial data presented are not necessarily indicative of the Company's results of operations that might have occurred had the transaction been completed at the beginning of the periods specified, and do not purport to represent what the Company's consolidated results of operations might be for any future period.

	SIX MONTHS ENDED
	JUNE 30,

	2000			1999

	(IN THOUSANDS,
	EXCEPT PER SHARE DATA)
Net revenue	$	82,891		$	17,604
Net loss	$	(577,562	)	$	(574,779	)
Basic and diluted net loss per share	$	(4.90	)	$	(9.20	)
Shares used in basic and diluted net loss per share
calculation		117,825			62,455

6. SELECTED BALANCE SHEET DATA

	JUNE 30,		DECEMBER 31,
	2000		1999

	(IN THOUSANDS)
INVENTORY
Raw materials	$	2,729	$	3,364
Finished goods		1,624		596

	$	4,353	$	3,960

OTHER ASSETS, NET
Goodwill, net	$	4,073,169		—
Other intangible assets, net		45,786		—
Other		26,886	$	6,957

	$	4,145,841	$	6,957

ACCRUED LIABILITIES
Accrued compensation and
related items	$	10,024	$	4,147
Accrued interest		6,389		—
Accrued sales commission		4,118		1,000
Accrued warranty		2,020		928
Other		7,879		1,918

	$	30,430	$	7,993

7. BORROWINGS AND COMMITMENTS

During March 2000, the Company issued $500 million of 5% Convertible Subordinated Notes (the "Convertible Notes") due in April 2007 raising net proceeds of approximately $486.5 million. The Convertible Notes are subordinated to all existing and future senior debt and to all indebtedness and other liabilities of the Company's subsidiaries. The Convertible Notes are convertible into shares of Redback Common Stock at any time before the close of business on the maturity date, unless the Company has previously redeemed or repurchased the notes, at a conversion rate of 5.2430 shares for each $1,000 principal amount of notes, which is equivalent to a conversion price of approximately $190.73 per share. After April 3, 2003, the Company has the right at any time to redeem some or all of the notes at the redemption price plus accrued interest. However, the notes will not be redeemed after April 3, 2003 and before April 1, 2005 unless the closing price for the Company's common stock exceeds 140% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending within five trading days of the notice of redemption. Each holder of the Convertible Notes may convert their notes prior to redemption of repurchase. Interest is payable semiannually. The Company paid approximately $13.5 million for debt issuance costs related to the Convertible Notes.

8. COMPREHENSIVE INCOME

Other comprehensive income for both the three and six month periods ended June 30, 2000 consisted of an unrealized gain on investments of $288,000. Other comprehensive income for all other periods is not material.

9. SUBSEQUENT EVENT

On July 31, 2000, the Company signed a definitive agreement to acquire Abatis Systems of Vancouver, British Columbia for common stock valued at approximately $636 million based on the closing price of Redback's stock on July 31, 2000. The Company will issue approximately 5.2 million shares of its common stock in the transaction, which is expected to close in the third or fourth quarter of 2000.

10.     NEW ACCOUNTING PRONOUNCEMENTS

     In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Financial Instruments and Hedging Activities," or SFAS No. 133, which establishes methods of accounting for derivative financial instruments and hedging activities. Because Redback currently holds no derivative instruments and does not engage in hedging activities, Redback expects that the adoption of SFAS No. 133 will not have a significant impact on its financial position, results of operations or cash flows. Redback will be required to adopt SFAS No. 133 in the first quarter of 2001.

     In December 1999, the SEC issued Staff Accounting Bulletin, or SAB 101, "Revenue Recognition," which provides guidance on the recognition, presentation, and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosure related to revenue recognition policies. The Company will be required to adopt SAB 101 in the fourth quarter of 2000. At this time, the Company is still assessing the impact of SAB 101 on its financial position and results of operations.

     In March 2000, the FASB issued Interpretation No. 44 ("FIN 44") "Accounting for Certain Transactions involving Stock Compensation - an Interpretation of APB Opinion No. 25." FIN 44 clarifies the application of Opinion 25 for (a) the definition of an employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000 but certain conclusions cover specific events that occur after either December 15, 1998 or January 12, 2000. Management believes that FIN 44 will not have a material effect on the historical financial position or results of operations of the Company.

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion in this Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those described in our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under the heading "Risk Factors" herein.

GENERAL

Redback Networks Inc. ("Redback") is a leading provider of advanced networking solutions that enable carriers, cable operators and service providers to rapidly deploy high-speed broadband access to the Internet and corporate networks. Redback's product lines consist of the Subscriber Management System family and the SmartEdge family. Together, these product lines are designed to enable our customers to create end to end regional networks that will support all major broadband access technologies, as well as the new services that these high speed connections will enable. Redback's Subscriber Management System, or SMS, products connect and manage large numbers of subscribers across all major high-speed access technologies, including digital subscriber line, cable and wireless. Redback's SmartEdge optical networking and multi-service products are being developed to simplify the architecture of today's regional voice and data networks, as well as improve their capacity and performance. Redback sells its products through a direct sales force, resellers and distribution partners. The Company operates in one business segment.

On March 8, 2000 Redback and Siara Systems, Inc. ("Siara") completed their merger. Siara was a development stage company that designed and developed optical access networking products that enable network service providers to offer data at multiple bandwidths to their customers in a cost-effective way and to create new high speed data services. In connection with the merger, Redback issued 57,388,818 shares of its common stock and options and warrants to purchase 5,295,038 shares of its common stock. The aggregate purchase price, including the value of options and warrants issued in connection with the merger and professional fees directly related to the merger, was approximately $4.5 billion. Results of operations of Siara are included with those of Redback since the merger date. See further discussion regarding the merger in Note 5 to the Condensed Consolidated Financial Statements.

On July 31, 2000, the Company signed a definitive agreement to acquire Abatis Systems of Vancouver, British Columbia for common stock valued at approximately $636 million based on the closing price of the Company's stock on July 31, 2000. The Company will issue approximately 5.2 million shares of its common stock in the transaction, which is expected to close in the third or fourth quarter of 2000.

RESULTS OF OPERATIONS

Net Revenues

Net revenues increased to $48.7 million for the three months ended June 30, 2000 from $11.1 million over the same three months in the prior year, a year-over-year increase of 340%. Net revenues increased to $82.9 million for the six months ended June 30, 2000 from $17.6 million over the same six months in the prior year, a year over year increase of 371%.

This increase in net revenues was a result of increased units sales of the SMS 1000, the SMS 1800, and the SMS 500, and sales of the SMS 10000, which was introduced in the second quarter of 2000. The increases in the sales of SMS 1000, SMS 1800 and SMS 10000 were attributable to an increased market penetration resulting in new customers as well as repeat sales to existing customers.

Cost of Revenues; Gross Margins

Gross margin, expressed as a percentage of net revenues, remained the same for the three months ended June 30, 2000 as compared to the same period in the prior year at 70%. It increased for the six months ended June 30, 2000 as compared to the same period in the prior year from 70% to 72%.

The increase in gross margin in the six months ended June 30, 2000 as compared to the same period ended June 30, 1999, is primarily due to lower material costs on SMS products as a result of component cost reduction efforts and a decrease in percentage of related overhead costs to revenue resulting from shipments of our products in larger quantities.

Operating Expenses

Research and development. Research and development expenditures increased in the three and six months ended June 30, 2000 to $23.8 million from $4.1 million, and to $35.9 million from $7.2 million in the comparable prior year periods. These increases are primarily attributable to costs incurred to develop the SmartEdge product family and an overall increase in development personnel focusing on new products and existing product enhancements in part due to the merger with Siara. Because the market for our products is characterized by rapidly changing technology, industry standards and customer demands, we expect our research and development expenses to continue to increase in future periods.

Selling, general and administrative. Selling, general and administrative expenditures increased in the three and six months ended June 30, 2000 to $16.6 million from $6.5 million, and to $29.9 million from $10.7 million in the comparable prior year periods. This increase was mainly due to the hiring of additional sales and administrative personnel in part due to the merger with Siara, increased commissions resulting from increased sales and additional marketing expenses. We anticipate that selling, general and administrative expenses will continue to increase in future periods for the reasons mentioned above.

Amortization of intangible assets. Amortization of $279.6 million and $350.2 million for the three and six months ended June 30, 2000 represents amortization of intangibles related to the merger with Siara. On an annual basis, amortization of intangibles related to the merger with Siara will approximate $1.1 billion.

In-process research and development (IPR&D). In connection with the merger with Siara, we recorded a $15.3 million charge for IPR&D during the first quarter of 2000 for projects for which technological feasibility had not been achieved and which have no alternative future use.

Amortization of deferred stock compensation. Amortization of deferred stock compensation decreased in the three and six months ended June 30, 2000 from $1.1 million to $514,000 and from $2.2 million to $1.0 million in the comparable prior year periods. Deferred stock compensation expense results from compensatory option grants in prior years and is amortized over the vesting period of the options, generally four years.

Other Income, Expenses and Provision for Income Taxes

Interest income. Interest income increased to $7.5 million and $8.5 million for the three and six months ended June 30, 2000 as compared to $365,000 and $368,000 for the same periods in 1999 due primarily to the interest earned on larger invested cash and investment balances. The increase in cash and investment balances can be primarily attributed to the issuance of $500 million of Convertible Subordinated Notes in March 2000.

Interest expense. Interest expense increased to $7.5 million and $7.8 million for the three and six months ended June 30, 2000 as compared to $107,000 and $136,000 for the same periods in 1999, due primarily to additional interest expense arising from our $500 million offering of Convertible Subordinated Notes.

Provision for Income Taxes. We have not recorded a provision for income taxes because we have experienced net losses from inception through June 30, 2000. While the Company has generated deferred tax assets during the period, management believes that, based on a number of factors, it is more likely than not that the deferred tax assets will not be realized. Accordingly, a full valuation allowance has been recorded against these deferred tax assets.

LIQUIDITY AND CAPITAL RESOURCES

Our principal source of liquidity as of June 30, 2000 consisted of approximately $491.9 million in cash, cash equivalents and short-term investments. Since our inception, we have financed our operations through both private and public sales of debt and equity securities, bank borrowings and equipment lease financing.

During the six months ended June 30, 2000, we used $4.2 million from operating activities, as compared to the same period in the prior year where we used $3.2 million in operating activities. The use of cash in the six months ended June 30, 2000 was primarily due to an increase in accounts receivable offset by an increase in accounts payable and accrued liabilities. We anticipate that accounts receivable and accounts payable will continue to increase in the future if our business continues to grow and revenues continue to rise.

Investments in property and equipment increased to $19.2 million in the six months ended June 30, 2000 from $1.7 million in the same period in 1999 which consisted primarily of computer equipment and tenant improvements related to our new research and development facility. We expect our capital expenditures to remain at high levels as we further expand our research and development efforts and as our employee base grows. The timing and amount of future capital expenditures will depend primarily on our future growth.

We raised net proceeds of $486.5 million from our issuance of $500 million of 5% Convertible Subordinated Notes which are convertible at any time and due in April 2007. We anticipate using these net proceeds for working capital and other general corporate purposes, including financing growth, product development and capital expenditures. Should the opportunity arise, we may also use a portion of the net proceeds to fund acquisitions of, or investments in, businesses, partnerships, products or technologies that complement or expand our businesses.

We believe that our existing cash and investment balances and anticipated cash flows from operations will be sufficient to meet our operating and capital requirements for at least the next twelve months. However, we could be required, or could elect, to raise additional funds during that period and we may need to raise additional capital in the future. Additional capital may not be available at all, or may only be available on terms unfavorable to us. Any additional issuance of equity or equity-related securities will be dilutive to our stockholders.

YEAR 2000 IMPACT

We have not experienced any problems with our computer systems relating to such systems being unable to recognize appropriate dates related to the year 2000. We are also not aware of any material problems with our customers or suppliers. Accordingly, we do not anticipate incurring material expenses or experiencing any material operational disruption as a result of any year 2000 issues.

RISK FACTORS

OUR BUSINESS IS DIFFICULT TO EVALUATE BECAUSE WE HAVE A LIMITED OPERATING HISTORY

We were founded in August 1996 and only began shipping products in material quantities in the second quarter of 1998. You should consider the risks and difficulties frequently encountered by companies like us who are in new and rapidly evolving markets. Our ability to sell products and services, and the level of success, if any, we achieve, depends, among other things, on the level of demand for broadband access services, which is a new and rapidly evolving market. Our business strategy may be unsuccessful and we may not successfully address the risks we face.

WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR FUTURE LOSSES

We incurred net losses of $4.4 million for the year ended December 31, 1997, $9.9 million for the year ended December 31, 1998 and $7.9 million for the year ended December 31, 1999. As of June 30, 2000, we had an accumulated deficit of approximately $394.2 million. Although we were profitable in the fourth quarter of 1999, we have not had a history of profitability and expect to incur significant net losses in the future as a result of the acquisition of Siara, including operating losses from research and development expense, selling, general and administrative expense, and amortization of intangible assets.

To date, we have funded our operations from both private and public sales of debt and equity securities, sales of convertible notes, from bank borrowings and by means of equipment lease financing. We expect to continue to incur significant product development, sales and marketing, and general and administrative expenses. As a result, we must generate significant revenues to achieve profitability. We may not sustain recent growth rates in our revenues, and we may never achieve sufficient revenue levels to achieve profitability again. If we do achieve profitability in some future period, we cannot be certain that we would sustain profitability on a quarterly or annual basis in the future.

WE FACE RISKS ASSOCIATED WITH ACQUISITIONS GENERALLY

We expect to continue our acquisition and expansion strategy. Future acquisitions, including the pending acquisition of Abatis, could materially adversely affect our operating results as a result of dilutive issuances of equity securities and the incurrence of additional debt. In addition, the purchase price for many of these acquired businesses likely will significantly exceed the current fair values of the net assets of the acquired businesses. As a result, we would be required to record material goodwill and other intangible assets that would result in significant amortization charges in future periods. These charges, in addition to the financial impact of such acquisitions, could have a material adverse effect on our business, financial condition and results of operations. We cannot assure you of the number, timing or size of future acquisitions, or the effect that any such acquisitions might have on our operating or financial results. Further, we must successfully combine the acquired businesses. We may not be able to integrate the technologies and operations quickly and smoothly. In the event that our integration does not go smoothly, serious harm to our business, financial condition and prospects may result. Integrating the two businesses entails significant diversion of management's time and attention. The integration of technology, products and services may require the partial or wholesale conversion or redesign of some or all of our technologies, products and services or those of the acquired business. In addition, we may be required to spend additional time or money on integration that would otherwise have been spent on developing our business and services or other matters.

OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY

Factors likely to cause quarterly fluctuations in revenues and operating results include:

- fluctuations in demand for broadband access services;

- the timing and size of sales of our products and services;

- announcements of new products and product enhancements by competitors;

- the entry of new competitors into our market, including by acquisition;

- unexpected delays in introducing new or enhanced products, including manufacturing delays;

- unexpected delays in product shipments due to component shortages;

- unanticipated requirements to deploy field upgrade programs;

- our ability to control expenses;

- our ability to ship products on a timely basis and at a reasonable cost; and

- the mix of our products sold and the mix of distribution channels through which our products are sold.

A high percentage of our expenses, including those related to engineering, sales and marketing, research and development, and general administrative functions, are essentially fixed in the short term. As a result, if we experience delays in generating or recognizing revenue, our quarterly operating results are likely to be materially adversely affected. In addition, we plan to increase our operating expenses to expand our engineering and sales and marketing operations, broaden our customer support capabilities, develop new distribution channels, fund increased levels of research and development and build our operational infrastructure. If growth in our revenues does not outpace the increase in these expenses, our business, results of operations and financial condition could be materially adversely affected.

We rely on a limited number of third-party manufacturers to build our products. Any interruption in the operations of such manufacturers would adversely affect our ability to meet our scheduled product deliveries to our customers. This would cause significant variations in our quarterly operating results and our business, results of operations and financial condition would be materially adversely affected.

Due to these and other factors, we believe that quarter-to-quarter comparisons of our operating results may not be meaningful. You should not rely on our results for one quarter as any indication of our future performance. It is likely that in some future quarter our operating results may be below the expectations of public market analysts or investors. If this occurs, the price of our common stock would likely decrease.

OUR LENGTHY AND VARIABLE SALES CYCLE MAKES IT DIFFICULT FOR US TO PREDICT IF OR WHEN A SALE WILL BE MADE

The timing of our sales revenue is difficult to predict because of the length and variability of the sales cycle for our products. Customers often view the purchase of our products as a significant and strategic decision. The process frequently results in a lengthy sales cycle, typically ranging from three months to over one year. While our customers are evaluating our products and before they place an order with us, we may incur substantial sales and marketing expenses and expend significant management efforts. In addition, product purchases are frequently subject to unplanned administrative, processing and other delays. This is particularly true for larger customers for whom our products represent a very small percentage of their overall purchase activities. These customers are often engaged in multiple simultaneous purchasing decisions, some of which may pertain to more immediate needs and absorb the immediate attention of the customer. If sales forecasted from a specific customer for a particular quarter are not realized in that quarter or at all, our business, results of operations and financial condition could be materially adversely affected.

IN ANY QUARTER, A SMALL NUMBER OF CUSTOMERS ARE LIKELY TO ACCOUNT FOR A SUBSTANTIAL MAJORITY OF OUR REVENUE

In each of the nine quarters in the period ended June 30, 2000, we have had at least one customer that accounted for 15% or more of our total revenue in the quarter. For the six months ended June 30, 2000, Southwestern Bell Information Systems ("SBIS"), a subsidiary of SBC, accounted for 16% of our total revenue and Bell Atlantic accounted for 12% of our total revenue. For the twelve months ended December 31, 1999, sales to Bell Atlantic and SBIS accounted for 24% and 11%. We anticipate that a small number of customers with large orders will continue to account for a majority of our quarterly revenue. However, we do not have any contracts or other agreements that guarantee continued sales to these or any other customers. If our customers alter their purchasing habits or reevaluate their need for our products, or if we fail to receive a large order in any future period, our business, results of operations and financial condition would be materially adversely affected.

WE ARE CURRENTLY ENTIRELY DEPENDENT ON A LIMITED PRODUCT SET

The SMS family of products and the SmartEdge family of products are the only products that we currently sell. We intend to introduce new products and enhancements to existing products in the future. We cannot be certain that the SMS or SmartEdge family of products or any future products will achieve widespread market acceptance. Our inability to timely and successfully introduce new products and product enhancements, or the failure of these new products or enhancements to achieve market acceptance, could materially adversely affect our business, results of operations and financial condition.

THERE ARE A LIMITED NUMBER OF POTENTIAL CUSTOMERS FOR OUR PRODUCTS

To date, substantially all of our revenues have been derived from sales and service related to the SMS family of products. The SMS 1000 and SMS 1800 and SMS 10000 and any other new high-end product that we may develop and introduce in the future are marketed primarily to large customers. There are only a limited number of large existing and potential customers and this number is not expected to increase significantly in the future.

IF OUR PRODUCTS DO NOT ANTICIPATE AND MEET SPECIFIC CUSTOMER REQUIREMENTS AND DEMANDS, OUR BUSINESS WOULD BE ADVERSELY AFFECTED

Many of our customers require product features and capabilities that our products may not have. The requirement that we add features to our products in order to achieve a sale may result in a longer sales cycle, increased research and development expenses and reduced margins on our products. To achieve market acceptance for our products, we must effectively and timely anticipate and adapt to customer requirements and offer products and services that meet customer demands. Our failure to develop products or offer services that satisfy customer requirements would materially adversely affect our business, results of operations and financial condition.

We intend to continue to invest in product and technology development. The development of new or enhanced products is a complex and uncertain process that requires the accurate anticipation of technological and market trends. We may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new products and enhancements. The introduction of new or enhanced products also requires that we manage the transition from older products in order to minimize disruption in customer ordering patterns and ensure that adequate supplies of new products can be delivered to meet anticipated customer demand. Our inability to effectively manage this transition would materially adversely affect our business, results of operations and financial condition.

WE NEED TO GAIN ACCEPTANCE IN OTHER BROADBAND ACCESS MARKETS

To date, we have derived substantially all of our revenues from sales of the SMS family products for use in the digital subscriber line market for broadband access. We intend to expend a substantial amount of time and resources to achieve market acceptance of our products in other markets, including the cable, wireless and optical markets. We may be unable to simultaneously or effectively address evolving demands in these markets, and customers in these markets may choose to implement competing technologies or products. In addition, if our competitors gain market acceptance in these markets first, it will be difficult, if not impossible, for us to gain subsequent market acceptance in these markets. If we are unable to achieve acceptance of our products in these markets, our ability to generate revenues will be limited, and our business, results of operations and financial condition would be materially adversely affected.

WE EXPECT INCREASED COMPETITION

We may be unable to compete successfully with current or future competitors. If we do not compete successfully against current or future competitors, our business, results of operations and financial condition will be materially adversely affected. Currently, competition in our market is intense. The broadband access markets we are targeting, including digital subscriber line, cable, wireless and optical, are new and rapidly evolving and we expect these markets to become highly competitive in the future. In addition, we expect new competitors to emerge in the broadband access market as that market evolves due to technological innovation and regulatory changes. We face actual and potential competition from public and private companies providing routers connecting to the Internet backbone, access concentrators and subscriber aggregation systems. For instance, Cisco Systems, Inc., the leading provider of routers connecting to the Internet backbone, offers products that compete directly with our products, and also provides a comprehensive range of broadband access systems and network access systems.

We expect companies that offer access concentrators and routers to incorporate some subscriber management functionality into their products. These companies include Nortel Networks, which acquired Shasta Networks, a private company providing subscriber management services, and Ascend, which was acquired by Lucent Technologies. In addition, there are several other private companies that provide subscriber management features in access concentrators or routing platforms.

Many of our principal competitors, including Alcatel, Cisco, Fujitsu, Lucent Technologies, Nortel Networks, Siemens/Unisphere and some companies that may compete with us in the future, are large public companies that have longer operating histories and significantly greater financial, technical, marketing and other resources than we have. As a result, these competitors are able to devote greater resources to the development, promotion, sale and support of their products. In addition, our competitors that have large market capitalizations or cash reserves are much better positioned than we are to acquire other companies, including our competitors, and thereby acquire new technologies or products that may displace our product lines. Any of these acquisitions could give our competitors a strategic advantage that would materially adversely affect our business, results of operations and financial condition.

Many of our competitors have significantly more established customer support and professional services organizations than we do. In addition, many of our competitors have much greater name recognition and have a more extensive customer base, broader customer relationships and broader product offerings than we have. These companies can leverage their customer bases and broader product offerings and adopt aggressive pricing policies to gain market share. We have encountered, and expect to continue to encounter, potential customers that, due to existing relationships with our competitors, are committed to the product offerings of these competitors. As a result, these potential customers may not consider purchasing our products. We expect to face competition in the following areas:

- product pricing;

- breadth of product lines;

- sales and distribution capabilities;

- product features and enhancements, including product performance, reliability, size, compatibility and scalability;

- product ease of deployment;

- conformance to industry standards; and

- technical support and service.

We expect that competitive pressures may result in price reductions, reduced margins and loss of market share, which would materially adversely affect our business, results of operations and financial condition.

THE ACCOUNTING TREATMENT OF THE SIARA MERGER WILL RESULT IN SIGNIFICANT CHARGES TO OUR OPERATIONS

We are accounting for the merger with Siara as a purchase under generally accepted accounting principles. The results of operations of Siara are included in our consolidated financial statements for all periods after March 8, 2000. The purchase price has been allocated to Siara's assets and liabilities based on the fair values of the assets acquired and the liabilities assumed. The excess of cost over the fair value of the net tangible assets of Siara acquired has been recorded as goodwill and other intangible assets and will be amortized by charges to operations under generally accepted accounting principles. This amount of goodwill and other intangible assets is significant. Our annual amortization of goodwill and other intangible assets is currently estimated to be approximately $1.1 billion per year, which will have a significant negative impact on our operating results and could cause our stock price to decline.

WE ARE DEPENDENT ON A LIMITED NUMBER OF CONTRACT MANUFACTURERS

We currently use a single third-party manufacturer to assemble our SMS products. In addition, we use another single third party as our primary contractor to assemble our SmartEdge products. We may not be able to effectively manage our relationship with these manufacturers and they may not meet our future requirements for timely delivery. We have no written agreement with those manufacturers. We have relationships with a limited number of other third-party manufacturers, one of which currently builds our prototypes. Although these other third-party manufacturers are capable of building our products, any interruption in the operations of our primary contract manufacturers would adversely affect our ability to meet our scheduled product deliveries to our customers. This could cause the loss of existing or potential customers and could materially adversely affect our business, results of operations and financial condition.

In addition, the products that our contract manufacturers build for us may be insufficient in quality or in quantity to meet our needs. These manufacturers may not meet the technological or delivery requirements of our current products or any future products that we may develop and introduce. The inability of our contract manufacturers in the future to provide us with adequate supplies of high-quality products, or the loss of our contract manufacturers in the future would cause a delay in our ability to fulfill customer orders while another of our third-party manufacturers begins production and would have a material adverse effect on our business, results of operations and financial condition.

SOME OF THE KEY COMPONENTS IN OUR PRODUCTS COME FROM SINGLE OR LIMITED SOURCES OF SUPPLY

We currently purchase several key components used in our products from single or limited sources of supply. These manufacturers include Altera, Brooktree, Connector Technologies, Foresight, Intel, Level One, Powerspec, Siemens and Ziatech. In addition, we rely on Wyle Electronics and LSI Logic as our foundry for a number of our application specific integrated circuits, or ASICs, and IBM Microelectronics as a foundry for other ASICs. We have no guaranteed supply arrangement with these suppliers, and we, or our manufacturers, may fail to obtain these supplies in a timely manner in the future. Financial or other difficulties faced by these suppliers or significant changes in demand for these components could limit the availability to us of these components. Any interruption or delay in the supply of any of these components, or the inability to obtain these components from alternate sources at acceptable prices and within a reasonable amount of time, would adversely affect our ability to meet scheduled product deliveries to our customers and would materially adversely affect our business, results of operations and financial condition. In addition, qualifying additional suppliers is time-consuming and expensive.

WE DEPEND ON THIRD-PARTY TECHNOLOGY FOR OUR SMARTEDGE PRODUCT

Cerent Corporation granted Siara a non-exclusive license to technology related to two ASICs and parts of Cerent's system-level hardware technology that are used in the SmartEdge product. In November 1999, Cerent was acquired by Cisco Systems, a provider of networking products and a significant competitor of ours. Although we believe we have sufficient rights to this Cerent technology to conduct our business as currently conducted, we do not have a business relationship with Cisco. Any loss of access to the technology that is the subject of the agreement with Cerent would seriously harm our business.

WE MAY BE UNABLE TO MATCH PRODUCTION WITH PRODUCT DEMAND

We currently use a rolling six-month forecast based on anticipated product orders, product order history and backlog to determine our materials requirements. Lead times for the materials and components that we order vary significantly and depend on numerous factors, including the specific supplier, contract terms and demand for a component at a given time. If actual orders do not match our forecasts, we may have excess or inadequate inventory of materials and components, which could materially adversely affect our business, results of operations and financial condition.

WE MAY BE UNABLE TO RETAIN EMPLOYEES OR PROPERLY MANAGE GROWTH

We have expanded our operations rapidly since our inception. The number of our employees increased from 39 on February 28, 1998 to approximately 702 by the end of June, 2000.

Our future performance depends on our continuing ability to attract and retain highly qualified technical and managerial personnel. We intend to continue to expand in order to pursue existing and potential market opportunities and are in the process of hiring additional engineering and sales personnel. Our ability to continue to attract and retain highly skilled personnel is a critical factor in determining whether we will be successful in the future. Competition for highly skilled personnel is intense, especially in the San Francisco Bay Area. We may fail to attract, assimilate or retain qualified personnel to fulfill our current or future needs. If we fail, our business, results of operations and financial condition could be materially adversely affected. Our planned rapid growth places a significant demand on management and financial and operational resources.

IF WE BECOME SUBJECT TO UNFAIR HIRING CLAIMS, WE COULD INCUR SUBSTANTIAL COSTS IN DEFENDING AGAINST THESE CLAIMS

Companies in our industry whose employees accept positions with competitors frequently claim that their competitors have engaged in unfair hiring practices. We have received in the past, and may receive in the future, claims of this kind as we seek to hire qualified personnel and those claims may result in material litigation. We could incur substantial costs in defending ourselves or our employees against such claims, regardless of their merits. In addition, defending ourselves from such claims could divert the attention of our management away from our operations.

OUR BUSINESS MAY BE ADVERSELY AFFECTED BY GOVERNMENT REGULATION OF THE COMMUNICATIONS INDUSTRY

The jurisdiction of the Federal Communications Commission, or FCC, extends to the communications industry, to our customers and to the products and services that our customers sell. Future FCC regulations, or regulations established by other regulatory bodies, may slow or end the growth of the broadband access services industry. Regulation of our customers may materially harm our business and financial condition. For example, FCC regulatory policies that affect the availability of data and Internet services may impede our customers' penetration into broadband access markets. In addition, international regulatory bodies are beginning to adopt standards for the communications industry. The delays that these governmental processes entail may cause order cancellations or postponements or product purchases by our customers, which would materially harm our business, results of operations and financial condition.

OUR PLANNED EXPANSION TO INTERNATIONAL MARKETS WILL INVOLVE NEW RISKS

In 1998 and 1999, we derived approximately 15% and 7%, respectively, of our revenues from sales to customers outside of the United States. Our ability to achieve future success will depend in part on the expansion of our international sales and operations. International operations are generally subject to a number of risks, including:

- expenses associated with customizing products for foreign countries;

- protectionist laws and business practices that favor local competition;

- dependence on local vendors;

- multiple, conflicting and changing governmental laws and regulations;

- longer sales cycles;

- longer accounts receivable cycles;

- increased difficulties in collecting accounts receivable;

- difficulties in managing operations across disparate geographic areas;

- difficulties associated with enforcing agreements through foreign legal systems;

- reduced or limited protection of our intellectual property rights in some countries;

- foreign currency exchange rate fluctuations; and

- political and economic instability.

In addition, if we grow internationally, we will need to expand our worldwide operations and enhance our communications infrastructure. If we fail to implement and improve these systems, our ability to accurately forecast sales demand, manage our supply chain and record and report financial and management information would be adversely affected. This could materially adversely affect our business, results of operations and financial condition.

UNDETECTED SOFTWARE OR HARDWARE ERRORS COULD HAVE A MATERIAL ADVERSE EFFECT ON US

Networking products frequently contain undetected software or hardware errors when first introduced or as new versions are released. We have experienced minor errors in the past in connection with new products. We expect that errors will be found from time to time in new or enhanced products after we begin commercial shipments. These problems may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems. The occurrence of these problems could result in the delay or loss of market acceptance of our products and would likely have a material adverse effect on our business, results of operations and financial condition.

Our customers use our products to provide broadband access to their customers. Defects, integration issues or other performance problems in our products could result in financial or other damages to our customers or could damage market acceptance for our products. Our customers could seek damages for losses from us, which, if they were successful, could have a material adverse effect on our business, results of operations and financial condition. A product liability claim brought against us, even if unsuccessful, would likely be time-consuming and costly.

WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY TECHNOLOGY

We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We have filed one U.S. patent application. There can be no assurance that this application will be approved, that any issued patents will protect our intellectual property or that any issued patents will not be challenged by third parties. Furthermore, other parties may independently develop similar or competing technology or design around any patents that may be issued to us. Although we attempt to protect our intellectual property rights, we may be unable to prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

Others may allege that our products infringe upon their proprietary rights. Any parties asserting that our products infringe upon their proprietary rights would force us to defend ourselves or our customers, manufacturers or suppliers against alleged infringement of intellectual property rights. We could incur substantial costs to prosecute or defend this litigation. In addition, intellectual property litigation could force us to do one or more of the following:

- cease selling, incorporating or using products or services that incorporate the challenged intellectual property;

- obtain from the holder of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on acceptable terms, if at all; or

- redesign those products or services that incorporate the disputed technology.

In the event of a successful claim of infringement against us and our failure or inability to develop non-infringing technology or license the infringed technology on acceptable terms and on a timely basis, our business, results of operations and financial condition would be materially adversely affected. We may be subject to these claims in the future.

We may in the future initiate claims or litigation against third parties for infringement of our proprietary rights in order to determine the scope and validity of our proprietary rights or the proprietary rights of competitors. These claims could result in costly litigation and the diversion of our technical and management personnel. As a result, our business, results of operations and financial condition could be materially adversely affected.

WE MAY NEED ADDITIONAL CAPITAL, WHICH MAY NOT BE AVAILABLE

The development and marketing of new products will require a significant commitment of resources. Likewise, the expansion of our operations and reseller channels as a result of the merger will require significant resources.

Furthermore, if the market for broadband access develops at a slower pace than anticipated or if we fail to establish significant market share and achieve a meaningful level of revenue, we may continue to incur significant operating losses and utilize significant amounts of capital. While we believe that our existing capital resources are adequate to meet our current needs, we may require additional capital in the future. Additional capital may not be available to us at all, or, if available, may be available only on unfavorable terms. Any inability to raise additional capital when we require it would materially adversely affect our business, results of operations and financial condition.

WE ARE DEPENDENT ON THE WIDESPREAD ADOPTION OF BROADBAND ACCESS SERVICES

Sales of our products depend on the increased use and widespread adoption of broadband access services, and the ability of our customers to market and sell broadband access services. Our business, results of operations and financial condition would be materially adversely affected if the use of broadband access services does not increase as anticipated or if our customers' broadband access services are not received well by the marketplace. Critical issues concerning use of broadband access services are unresolved and will likely affect use of broadband access services. These issues include:

- security;

- reliability;

- bandwidth;

- congestion;

- cost;

- ease of access; and

- quality of service.

Even if these issues are resolved, if the market for products that provide broadband access to the Internet and to corporate networks fails to develop, or develops at a slower pace than anticipated, our business, results of operations and financial condition would be materially adversely affected.

WE MAY HAVE INSUFFICIENT CASH FLOW TO MEET OUR DEBT SERVICE OBLIGATIONS

We are required to generate cash sufficient to pay all amounts due on the convertible debt notes and to conduct our business operations. Currently, our earnings are insufficient to cover our anticipated debt service obligations, and this may materially hinder our ability to make payments on the notes. Our ability to meet our future debt service obligations will be dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control.

SUBSTANTIAL LEVERAGE AND DEBT SERVICE OBLIGATIONS MAY ADVERSELY AFFECT OUR CASH FLOW

We have substantial amounts of outstanding indebtedness, and we also may obtain additional long-term debt and working capital lines of credit. As a result of this indebtedness, our principal and interest payment obligations will increase substantially. There is the possibility that we may be unable to generate cash sufficient to pay the principal of, interest on and other amounts due in respect of our indebtedness when due.

Our substantial leverage could have significant negative consequences, including:

- increasing our vulnerability to general adverse economic and industry conditions;
- limiting our ability to obtain additional financing;

- requiring the dedication of a substantial portion of our cash from operations to service our indebtedness, thereby reducing the amount of our cash available for other purposes, including capital expenditures;

- limiting our flexibility in planning for, or reacting to, changes in our business and the industry which we compete; and

- placing us at a possible competitive disadvantage vis-a-vis less leveraged competitors and competitors that have better access to capital resources.

WE MAY BE UNABLE TO REPURCHASE THE NOTES

At maturity, the entire outstanding principal amount of the convertible notes will become due and payable. In addition, if a change in control occurs, each holder of the notes may require us to repurchase all or a portion of that holder's notes. At maturity or if a change in control occurs, we may not have sufficient funds or may be unable to arrange for additional financing to pay the principal amount or repurchase price due. Under the terms of the indenture for the notes, we may elect, if we meet certain conditions, to pay the repurchase price with shares of common stock. Our borrowing arrangements or agreements relating to senior debt to which we become a party may contain restrictions on, or prohibitions against, our repurchases of the notes. If the maturity date or change in control occurs at a time when our other arrangements prohibit us from repurchasing the notes, we could try to obtain the consent of the lenders under those arrangements to purchase the notes, or we could attempt to refinance these borrowings that contain the restrictions. If we do not obtain the necessary consents or refinance these borrowings, we will be unable to repurchase the notes. In that case, our failure to repurchase any tendered notes or notes due upon maturity would constitute an event of default under the indenture. Any such default, in turn, may cause a default under the terms of our senior debt. As a result, in those circumstances, the subordination provisions of the indenture would, absent a waiver, prohibit any repurchase of the notes until we pay the senior debt in full.

PROVISIONS OF OUR CHARTER DOCUMENTS MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE IN OUR CONTROL

Provisions of our amended and restated certificate of incorporation, bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.

ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

As of June 30, 2000, the Company maintained cash and cash equivalents of $222.4 million and short-term investments of $269.5 million. The Company also has long term debt and capital leases with fixed interest rates totaling $510 million. If interest rates were to decrease by 10%, the Company's net loss could increase by approximately $3.0 million, as the Company's short-term investments would yield less interest income when the amounts were reinvested at maturity at the lower interest rates.

Redback's sales to customers in foreign countries are denominated in U.S. dollars. Accordingly, the company is not directly exposed to market risks from currency exchange rate fluctuations. However, significant fluctuations in foreign exchange rates relative to the U.S. dollar could impact our customers' ability to pay for our products. Any changes in foreign exchange rates relative to the U.S. dollar could have a material adverse effect on Redback's financial position, results of operations and cash flow.

PART II. OTHER INFORMATION

REDBACK NETWORKS INC.

ITEM 1. LEGAL PROCEEDINGS.

Redback is not aware of any pending legal proceedings against it that, individually or in the aggregate, would have a material adverse effect on its business, results of operations or financial condition. We may in the future be party to litigation arising in the course of our business, including claims that we allegedly engaged in unfair hiring practices or infringed third-party trademarks and other intellectual property rights. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

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

The Special Meeting of Stockholders of Redback Networks was held on June 8, 2000 in Sunnyvale, California. Of the total 145,953,179 shares outstanding as of the record date, 115,970,750 shares (79.46%) were present or represented by proxy at the meeting.

The stockholders approved an amendment to the Company's Certificate of Incorporation to increase the number of shares authorized from 200,000,000 to 750,000,000. The proposal received 102,653,267 affirmative votes, 13,280,799 negative votes, 36,684 abstentions, and zero non-votes.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits.

	Exhibit No.	Description

	3.1	Amended and Restated Certificate of Incorporation of Redback Networks Inc.
	27.1	Financial Data Schedule

(b) Reports on Form 8-K

On July 20, 2000, pursuant to Item 5 and Item 7 to report selected financial information set forth with Registrant's press release dated July 12, 2000.

On August 2, 2000, pursuant to Item 5 to report portions of information set forth in the Registrant's press release dated July 31, 2000.

REDBACK NETWORKS INC.
SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	REDBACK NETWORKS INC.

Date: August 11, 2000	By: /s/ Craig M. Gentner

	Craig M. Gentner
	Sr. Vice President of Finance, Chief Financial Officer and
	Secretary (Duly Authorized Officer and Principal
	Financial and Accounting Officer)

EXHIBIT INDEX

Exhibit No.		Description


3.1		Amended and Restated Certificate of Incorporation of Redback Networks Inc.
27.1		Financial Data Schedule