| REDBACK NETWORKS INC Item 1A Risk Factors Interested persons should carefully consider the risks described below in evaluating our company |
| Additional risks and uncertainties not presently known to us, or that we currently consider immaterial, may also impair our business operations |
| If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected |
| In that case, the trading price of our common stock could decline |
| Our operating plan is based on assumptions concerning our realization of a certain level of revenue and the control of our costs, which are difficult to predict and there is no guarantee that our goals are achievable |
| Our operating plan is subject to uncertainty because of limited visibility into our customers’ future buying patterns and difficulty predicting the amount and timing of our revenue |
| We believe the majority of our revenue in the future will come from our SmartEdge product line |
| The sales cycle is difficult to predict with respect to our SmartEdge products due to our customers’ and potential customers’ needs to fully evaluate these products and compare them to competitive products |
| Our SMS product line revenue is expected to continue to decline as more customers are considering or are moving to next generation DSL networks |
| Our ability to predict future revenue will be dependent on customer acceptance of our SmartEdge product line and on the timing of securing purchasing commitments from customers |
| For our customers, such timing is driven, among other factors, by availability of budget spending and timing of network deployment plans to promote the growth of regional, national and international networks that support major broadband access technologies and IP-based networks to deliver Triple Play services |
| We often have had a limited view of our backlog of orders continuing into a subsequent quarter and this makes predicting future revenue difficult |
| Although we currently have significant backlog there continues to be risk that backlog may not convert to revenue or that conversion could be delayed, which could result in less predictability in the sales cycle and therefore lower revenue than planned |
| In addition, we may incur significant additional costs prior to obtaining the related revenue during the lead-time to manufacture our products |
| Additionally, investment costs may significantly increase during the development of new products |
| The market that we sell into is becoming increasingly competitive and as a result, fluctuations may occur in the prices obtained for our products, which then may have a significant impact on our gross margins |
| In addition, many of our customers’ sales decisions are not made until the final weeks or days of the calendar quarter, which leads to greater uncertainty for us in predicting the timing and amount of our revenue |
| Customers often view the purchase of our products as a significant and strategic decision, and this causes purchases of our products to become more susceptible to extensive testing and internal review and approval cycles by our customers, the length and outcome of which is difficult to predict |
| This is particularly true for larger customers who represent a significant percentage of our sales |
| 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 our customers |
| Our customers’ current capital constraints also make it difficult for them to commit in advance to buy our products in any given quarter or throughout the year |
| If sales from a specific customer for a particular quarter are not realized in that quarter or at all, our operating results could be materially adversely affected |
| Our projected results are also based upon assumptions about our overall cost structure, which could prove unreliable |
| For example, if our current pricing arrangement with our single contract manufacturer is not renewed beyond its current term, or is renegotiated on terms less favorable to us, our results of operations and financial condition could be materially harmed |
| Our quarterly operating results are inherently unpredictable and could continue to fluctuate significantly, which may result in volatility in the price of our securities |
| Our quarterly revenue and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control and any of which may cause our stock price to fluctuate |
| 15 ______________________________________________________________________ [41]Table of Contents Factors that may affect our quarterly results include the long sales and implementation cycles, competitive pricing pressures and our ability to control expenses |
| The majority of our expenses are essentially fixed in the short term |
| As a result, if we experience delays in generating or recognizing revenue, our quarterly operating results will likely decrease |
| Therefore, 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 above or below the expectations of public market analysts or investors |
| If this occurs, the price of our common stock would likely fluctuate |
| There are a limited number of customers that accounted for a disproportionate amount of our revenue, and the loss of any of these key customers would likely reduce our revenue significantly and have a negative impact on our cash position |
| A substantial portion of our revenue depends on sales to a limited number of customers |
| Our customers include both direct purchasers and resellers |
| During the twelve months ended December 31, 2005, revenue from product purchases by Bell South, AT&T (formerly SBC Communications) and Alcatel accounted for approximately 14prca, 13prca and 12prca of our total revenue, respectively |
| During the twelve months ended December 31, 2004, revenue from product purchases by AT&T accounted for approximately 18prca of our total revenue |
| Currently, a large portion of our revenue depends on sales to a limited number of customers |
| In the future, we expect that this customer concentration will further increase |
| In addition, we do not have contracts or other agreements that guarantee continued sales to these or any other customers, which means that any of our customers, including our key customers, may cease purchasing products from us at any time for any or no reason |
| The loss of any of our key customers would have a negative impact on our cash flow from our operations and significantly reduce our total revenue |
| In addition, the current consolidation in the telecommunications industry, such as the recent proposed merger of BellSouth and AT&T, the merger of Neuf Telecom and Cegetel in the European market, SBC’s acquisition of AT&T, and Verizon Communications’s acquisition of MCI, presents risks to us by further reducing the number of available customers and potentially causing delays and/or changes in orders and customers’ expected buying patterns |
| In the case of mergers, customers may purchase more or less product than expected and/or on different schedules than expected, depending on a variety of factors including the nature of the entities involved in the transaction, their strategic plans, their chosen architecture and the planned pace of deployment of such architecture |
| We expect the industry trend of consolidation to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations |
| This could lead to more variability in operating results and could have a material adverse affect on our business, operating results, and financial condition |
| If our products do not anticipate and meet specific customer requirements and demands, our revenue and operating results would be adversely affected |
| To achieve market acceptance of our products, we must anticipate and adapt to customer requirements and offer products and services that meet customer demands |
| Due to the complexity of our products and the complexity, diversity, and changing nature of our customer needs, many of our customers require product features and capabilities that our products may not have |
| The majority of demand for our products relates to our newer SmartEdge product line |
| We continue to invest in research and development to add features and develop new products to meet customer demand for our SmartEdge product line; however, we are constrained by limited resources and may be unable to deliver product or product features to efficiently meet such demand |
| The inability to deliver such product features may impact our revenue and operating results |
| In addition, we may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new products and enhancements |
| 16 ______________________________________________________________________ [42]Table of Contents If we experience difficulties in developing and delivering new products, our revenue and earnings may be adversely affected |
| We cannot guarantee that we will be able to anticipate future market needs or be able to develop new products or product enhancements to meet such needs or to meet them in a timely manner |
| If we fail to anticipate the market requirements or to develop new products or product enhancements to meet those needs, such failure could substantially decrease market acceptance and sales of our present and future products, which would significantly harm our business and financial results |
| Even if we are able to anticipate and develop and commercially introduce new products and enhancements, there can be no assurance that new products or enhancements will achieve widespread market acceptance |
| We intend to continue to invest in product and technology development, primarily in our SmartEdge product line |
| 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 and sale of new products and enhancements |
| We may also experience the loss of key development personnel that could impair our ability to develop and introduce new or enhanced products |
| 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, to ensure that adequate supplies of new products can be delivered to meet anticipated customer demand, and to limit the creation of excess inventory that may impact our financial results |
| Our inability to effectively manage the transition to newer products or accurately predict market and economic conditions in the future may cause us to incur additional charges of excess and obsolete inventory |
| If any of the foregoing occurs, our revenue, earnings, and cash generation may be adversely affected |
| If we fail to match production with product demand, we may need to incur additional costs and liabilities to meet such demand or we may lose customers to our competitors and our revenue may be harmed |
| We currently use a rolling 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 we underestimate our requirements, the contract manufacturer may have an inadequate inventory, which could interrupt manufacturing of our products and result in delays in shipments and revenue |
| If we overestimate our requirements or there are changes in the mix of products, the contract manufacturer may have excess inventory, which would increase our storage or obsolescence costs |
| For example, we incurred write-downs of excess and obsolete inventory and related claims of dlra1dtta0 million, dlra1dtta4 million, and dlra0dtta9 million in 2005, 2004, and 2003, respectively |
| The 2005 and 2004 excess and obsolete inventory charges resulted from reductions in forecasted revenue and reactions to then-current market conditions |
| We are under increased pressure to acquire inventory ahead of the placement of the product order because of the nature of the sales process |
| Our gross margin may continue to fluctuate over time, which could harm our results of operations |
| Our gross margin may continue to fluctuate and be hard to predict in the future due to, among other things, increasing pressure to reduce our current price levels in more competitive markets, particularly in Asia and Europe; our ability to reduce product costs; our ability to control inventory costs and other reserves; the introduction of new products which may initially have lower margins, our ability to control and absorb fixed costs; and our ability to sell multiple applications |
| If our gross margins declined as a result of one or more of the foregoing factors, our consolidated financial position, results of operations and cash flows would suffer |
| We have incurred losses in the past and we may incur net losses in the near future |
| We incurred net losses of approximately dlra22dtta0 million during the year ended December 31, 2005, dlra68dtta1 million in 2004, and dlra118dtta8 million in 2003 |
| We achieved quarterly net income of dlra0dtta7 million in the quarter 17 ______________________________________________________________________ [43]Table of Contents ended December 31, 2005, due primarily to a substantial increase in revenue during the third quarter of 2005 and including a change in estimate of pre-bankruptcy liabilities of dlra3dtta7 million |
| Although we expect to continue to generate positive cash flow in the near term, there can be no assurance that we will not incur additional net losses in the future |
| To date, we have funded our operations primarily from internal cash flow along with private and public sales of debt and equity securities |
| As of December 31, 2005, we had cash and cash equivalents of dlra43dtta8 million |
| On November 3, 2003, we filed a voluntary petition for relief under Chapter 11 of Title 11 of the United States Code |
| We emerged from bankruptcy on the effective date of the Plan, January 2, 2004 |
| After our emergence from bankruptcy, we continued to incur losses |
| Although we believe that our future operating cash flows will be sufficient to finance our operating requirements for the next 12 months, our limited availability of funds restricts our ability to expand or significantly increase our re-investment in our business and makes us more vulnerable to industry downturns |
| This may also place us at a competitive disadvantage |
| In addition, if we do not meet our operating plan, it is possible that we may need to raise additional capital to achieve our business objectives |
| There can be no assurance that such additional capital would be available on acceptable terms, or at all |
| We are dependent on sole source and limited source suppliers for several key components, and any interruptions or delay of supply could adversely affect our sales and business prospects |
| We currently purchase several key components used in our products from single or limited sources of supply |
| Specifically, we rely on a limited number of foundries for a number of our processors and memory components including our application specific integrated circuits (ACIS’s) |
| We have no guaranteed supply arrangement with these suppliers, and we, or our third party contract manufacturer, 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 of these components to us |
| 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 and adversely affect our sales and business prospects |
| In addition, locating and contracting with additional qualified suppliers is time-consuming and expensive |
| Our inability to obtain sufficient quantities of components from our suppliers in a timely manner could negatively impact our ability to generate revenue from existing products and delay or prevent introduction of new technologies |
| In addition, the development, licensing or acquisition of new products in the future may increase the complexity of supply chain management |
| Our failure to effectively manage the supply of key components and products would adversely affect our business |
| We currently depend on a single contract manufacturer, Jabil Circuit Inc, with whom we do not have a long-term supply contract, and the loss of any manufacturing capacity could materially and adversely affect our operating results |
| We depend on a single third party contract manufacturer, Jabil Circuit Inc, to manufacture our products, and certain strategic vendors to supply parts to our contract manufacturer, with whom we do not have a long-term contract |
| Jabil Circuit currently performs all of our production, including final assembly and testing, at a single facility |
| If we fail to effectively manage the relationship with our contract manufacturer or if they should experience delays, disruptions or quality control problems in manufacturing operations, our ability to ship products to our customers would be delayed |
| If our contract manufacturer were to cease doing business with us, our ability to deliver products to customers could be materially adversely affected |
| The loss of any of our contract manufacturer’s manufacturing capacity could prevent us from meeting our scheduled product deliveries to our customers and could materially and adversely affect our sales and operating results |
| If we fail to attract and retain skilled employees, we may not be able to timely develop, sell or support our products |
| Much of our future success depends on the continued service and availability of skilled personnel, including our Chief Executive Officer, members of our executive team, and those in technical, marketing and sales positions |
| 18 ______________________________________________________________________ [44]Table of Contents Over the past several years, we have experienced a significant decrease in our overall number of employees as a result of operational efficiencies and reductions in the workforce |
| To achieve our current operating plan, we will need to attract and retain highly qualified management, skilled engineers and other knowledgeable workers in an industry where competition for skilled personnel is intense and our competitors are larger and more established companies |
| Our future performance depends, in part, on the ability of our senior management team to effectively work together, manage our workforce and attract and retain highly qualified technical and managerial personnel |
| There can be no assurance that we will continue to be able to successfully attract and retain key personnel |
| A number of our customers are evaluating our next generation products, which may lead to an extended evaluation period or a decision to use a competitor’s products, and this may have a material adverse effect on our business |
| A significant number of our customers are in the process of evaluating our SmartEdge platform and new software releases for use in their next generation networks |
| These evaluations are often lengthy and may cause delays in purchasing decisions |
| There is no guarantee that customers will select our products at all |
| Redback may incur significant costs and resources during the evaluation process |
| Due to the competitive nature of these evaluations, we may be forced to provide significant price concessions or commit to onerous contract terms to win the business, and this may negatively impact our revenue and cost structure |
| Recent rulemaking by the Financial Accounting Standards Board will require us to expense equity compensation given to our employees and will significantly impact our operating results and may reduce our ability to effectively utilize equity compensation to attract and retain employees |
| We will adopt SFAS 123(R) in the first quarter of 2006 |
| SFAS 123(R) requires the measurement and recognition of compensation expense for all stock-based compensation based on estimated fair values |
| We have not yet completed our analysis of the impact of adopting SFAS 123R and are therefore currently unable to quantify the effect on our financial statements |
| However, using the fair value method will result in a material impact on the results of operations and net income per share, as we will be required to expense the fair value of all share-based payments |
| We historically have used stock options as a significant component of our employee compensation program in order to align employees’ interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages |
| The SFAS 123(R) expense calculation depends largely on numerous factors including, without limitation, volatility, option term, vesting, forfeiture and interest rate and on the trading price of our securities at the time of grant |
| We cannot predict the effect that this adverse impact on our reported operating results will have on the trading price of our common stock |
| This also may require us to reduce the availability and amount of equity incentives provided to employees, which may make it more difficult for us to attract, retain and motivate key personnel |
| Each of these results could materially and adversely affect our business |
| While we believe that we currently have adequate internal control over financial reporting, changes in our business and increasing complexity may cause risks to ongoing compliance |
| Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control structure and procedures for financial reporting |
| We continue to develop a program to perform the system and process evaluation and testing necessary to comply with these requirements on a sustained basis |
| As our business continues to change and increase in complexity, we have continued to increase and improve our infrastructure relating to controls over financial reporting |
| In addition, these business changes and increased complexity may cause a risk that we may not be able to continue to comply on an ongoing basis |
| Companies do not have significant experience in complying with these requirements on an ongoing and sustained basis |
| As a result, we expect to continue to incur substantial expense and to devote additional management resources to Section 404 compliance |
| In the event that our Chief Executive Officer, Chief Financial Officer or our independent registered public accounting firm determine that our internal control over financial reporting are not effective as defined under Section 404, investor perceptions of Redback may be adversely affected and could cause a decline in the market price of our stock |
| 19 ______________________________________________________________________ [45]Table of Contents Future changes in financial accounting standards or practices may cause adverse unexpected fluctuations to our reported results of operations |
| We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America |
| These principles are subject to interpretation by the SEC and various bodies formed to interpret and create appropriate accounting policies |
| A change in these policies can have a significant effect on our reported results and may even retroactively affect previously reported transactions |
| In particular, as described above, recent changes to the Financial Accounting Standards Board pronouncements relating to accounting for stock-based compensation will likely increase our compensation expense, could make our net income or loss less predictable in any given reporting period and could change the way we compensate our employees or cause other changes in the way we conduct our business |
| In addition, other accounting policies that have recently been or may be affected by changes in the accounting rules include the following: • software revenue recognition • accounting for income taxes • accounting for share-based payments • accounting for business combinations and related goodwill A change in any of these policies could have a significant effect on our reported results and may materially and adversely affect our business |
| Our products are highly technical, and any undetected software or hardware errors in our products could have a material adverse effect on our operating results |
| Our products are highly technical and complex, are critical to the operation of many networks, and may protect valuable information |
| Due to the complexity of both our products’ and our customers’ environments, we may not detect product defects until full deployment in our customers’ networks |
| This may be particularly true of our relatively newer products, including those in our SmartEdge product line |
| Furthermore, due to the intricate nature of our products, it is possible that our products may not interoperate with our customers’ networks |
| This possibility is enhanced by the fact that our customers typically use our products in conjunction with products from other vendors |
| Our products will be required to interoperate with many or all of the products within these networks as well as future products in order to meet our customers’ requirements |
| Regardless of whether warranty coverage exists for a product, we may be required to dedicate significant technical resources to resolve any defects |
| Therefore, costs associated with defects under warranty may be higher |
| If we encounter significant product problems, we could experience, among other things, loss of major customers, cancellation of product orders, increased costs, delay in recognizing revenue, and damage to our reputation |
| In addition, we could face claims for product liability, tort, or breach of warranty |
| Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention |
| In addition, if our business liability insurance is inadequate or future coverage is unavailable on acceptable terms or at all, our financial condition could be harmed |
| Our future success depends on sales to companies in the telecommunications sector |
| We are highly dependent on sales to companies in the telecommunications sector |
| Our future depends on the financial strength of the telecommunications sector, as our sales depend on the increased use and widespread adoption of broadband access services; sustained capital expenditures by the telecommunications carriers (which often occurs on a sporadic and unpredictable basis); and the ability of our customers to market and sell broadband access services |
| If the telecommunications industry experiences another downturn or broadband deployments do not increase steadily, our customers may forego sustained or increased levels of capital investments, and reevaluate their need for our products |
| In addition, our total revenue may be adversely impacted by natural disasters |
| 20 ______________________________________________________________________ [46]Table of Contents In addition, traditional telecommunications companies and other large companies, because of their size, generally have had greater purchasing power and, accordingly, have requested and received more favorable terms, which often translate into more onerous terms and conditions for their vendors |
| As we seek to sell more products to this class of customer, we may be required to agree to such terms and conditions, which may include terms that affect our ability to recognize revenue and have an adverse affect on our business and financial condition |
| Our business substantially depends upon the continued growth of the Internet and the use of IP-based networks to deliver Triple Play services |
| A substantial portion of our business and revenue growth depends on the expanded acceptance of the utilization of IP-based networks to deliver Triple Play services (voice, video, and data) |
| Our future growth depends, in part, on the acceptance by consumers of expanded services delivered over IP-based networks |
| In addition, our future growth depends on our customers’ ability to use IP-based networks to deliver voice, video, and data services to successfully compete with established providers of such services |
| To the extent that an economic slowdown and reduction in capital spending adversely affect spending on Internet infrastructure, consumers are slow to accept and adopt the delivery of expanded services delivered over an IP-based network, or our customers cannot successfully compete against established providers of voice, video and data services, we could experience material harm to our business, operating results, and financial condition |
| We rely, in part, on value-added resellers and distribution partners to sell our products, and disruptions to or our failure to effectively develop and manage our distribution channel and the processes and procedures that support it could adversely affect our ability to generate revenue from the sale of our products |
| Our future success is dependent, in part, upon establishing and maintaining successful relationships with a variety of value-added reseller and distribution partners |
| Some of these resellers also sell competitor’s products and some of these resellers are, in fact, our competitors |
| We expect to continue to utilize value-added resellers and distribution partners to grow our business, especially in non-US territories |
| Our revenue depends, in part, on the performance of these distributors and value-added resellers |
| The loss of or reduction in sales to these value-added resellers or distributors could materially reduce our total revenue |
| Our competitors may in some cases be effective in providing incentives to resellers or potential resellers to favor their products or to prevent or reduce sales of our products |
| If we fail to maintain relationships with these distribution partners, fail to develop new relationships with value-added resellers and distributors in new markets or expand the number of resellers in existing markets, fail to manage, train or providing incentives to existing value-added resellers and distributors effectively or if these partners are not successful in their sales efforts, sales of our products may decrease and our operating results would suffer |
| Our operating results will suffer if we do not successfully commercialize our product lines |
| The growth of our business is dependent on increasing sales of our SmartEdge products |
| Our product line expanded when we began shipping our SmartEdge during the fourth quarter of 2001 |
| In the second quarter of 2003, we introduced the SmartEdge 400 router and the Service Gateway software for all SmartEdge platforms |
| In the second quarter of 2005, we launched the Ethernet Aggregation application in the SmartEdge platform |
| During 2004, the revenue from SmartEdge products grew by 229prca compared with revenue from SmartEdge products in 2003, but the revenue from SMS products in 2004 decreased 36prca compared to 2003 |
| During 2005, the revenue from SmartEdge products grew by 105prca compared with revenue from SmartEdge products in the same period in 2004, but the revenue from SMS products in 2005 decreased 22prca compared to the same period in 2004 |
| If sales of the SmartEdge products do not meet our revenue targets, our operating results, financial condition or business prospects may be negatively impacted |
| 21 ______________________________________________________________________ [47]Table of Contents If we fail to adequately evolve our financial and managerial control and reporting systems and processes to meet the changing needs of our business, our ability to manage and grow our business will be negatively affected |
| Our ability to successfully offer our products and implement our business plan in a rapidly evolving market depends upon an effective planning and management process |
| We will need to continue to evolve our financial and managerial control and our reporting systems and procedures in order to manage our business effectively in the future |
| If we fail to continue to implement systems and processes to meet the changes and expected growth in our business, our ability to manage our business and results of operations may be negatively affected |
| We rely on sales in international markets for a substantial portion of our revenue, which exposes us to additional risks that may affect our revenue levels |
| A significant portion of our sales has been to international customers during the last three years |
| During the years ended December 31, 2005, 2004 and 2003, we derived approximately 58prca, 66prca and 62prca, respectively, of our total revenue from sales to international customers |
| Our international presence exposes us to risks including: • foreign currency fluctuations; • difficulties in managing operations across disparate geographic areas; • political, legal and economic instability in many parts of the world; • protectionist tariffs and other unpredictable regulatory requirements; • reduced or limited protection of our intellectual property rights; • dependence on local and global resellers; • greater expenses associated with customizing products for foreign countries; • international taxes; • longer accounts receivable cycles; and • disruptions to our business related to terrorist activities, widespread disease or natural disasters |
| In addition, demand for our products and services can fluctuate materially by customer and region due to our customer concentration |
| Moreover, the recent turmoil in the geopolitical environment in many parts of the world, including terrorist activities and military actions, particularly the continuing tension in and surrounding Iraq, and changes in energy costs, has and may continue to put negative pressure on global economic conditions |
| If one or more of these risks materialize, our sales to international customers may decrease and/or our costs may increase, which could negatively impact our overall revenue, operating results and financial condition |
| 22 ______________________________________________________________________ [48]Table of Contents We are exposed to fluctuations in currency exchange rates which could negatively affect our financial results and cash flows |
| Because a significant portion of our business is conducted outside the United States, we face exposure to adverse movements in non-US currency exchange rates |
| These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results and cash flows |
| We also have some transactions that are denominated in foreign currencies, primarily expenses incurred in Canadian dollars and the Euro and sales and service transactions conducted in the Euro |
| An increase in the value of the US dollar could increase the real cost to our customers of our products in those markets outside the United States where we sell in US Dollars, and a weakened dollar could increase the cost of local operating expenses and procurement of raw materials to the extent we must purchase components in foreign currencies |
| Currently, we hedge only those currency exposures associated with certain assets and liabilities denominated in nonfunctional currencies and periodically will hedge anticipated foreign currency cash flows |
| The hedging activities undertaken by us are intended to offset the impact of currency fluctuations on certain nonfunctional currency assets and liabilities |
| If our attempts to hedge against these risks are not successful, our net income could be adversely impacted |
| Intense competition in our industry could result in the loss of customers or an inability to attract new customers |
| Competition is intense in the markets that we serve |
| Our SmartEdge platform competes in a market characterized by new geographic builds and an upgrade cycle of swapping existing edge routers for denser next-generation routers with higher interface speeds and richer software functionality |
| Industry analysts expect this transition to occur over the next four years |
| Our competitors are expected to continue improving their existing products and to introduce new competitive products within the next 12 months |
| Additional competition exists from companies in emerging nations, such as China, and existing competitors who make multi-service edge devices, or are adding subscriber management features to their existing routers, as well as startup companies who are developing next generation technologies that may compete with our products |
| Our primary competitors are Alcatel, Cisco Systems, Inc, Huawei Technologies and Juniper Networks |
| Other competitors include companies in the networking and telecommunications equipment markets, including: Avici Systems; Ciena; ECI Telecom; Enterasys Networks; Extreme Networks; F5 Networks, Inc |
| ; Foundry Networks; Fujitsu; Lucent Technologies; Nortel Networks; Siemens; and Sycamore Networks, among others |
| SmartEdge competitive pressures may result in price reductions, reduced profit margins and lost market share, which would materially adversely affect our business, results of operations and financial condition |
| In addition, some of our competitors are larger public companies that have greater name recognition, broader product offerings, more extensive customer bases, more established customer support and professional services organizations, 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, and they can leverage their customer relationships and broader product offerings and adopt aggressive pricing policies to gain market share |
| Our competitors with large market capitalization 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 |
| In addition, current and emerging competitors in foreign markets such as China are able to take advantage of reduced costs in those locations to adopt aggressive pricing |
| As a result of the foregoing, we may be unable to maintain a competitive position against our competitors, which could result in a decrease in sales, earnings, and cash generation |
| We are exposed to the credit risk of some of our customers and to credit exposures in weakened markets, which could result in material losses |
| Most of our sales, except in the Asia-Pacific region, are on an open credit basis, with standard payment terms of 30 to 45 days in the United States and, because of local customs or conditions, longer in some markets outside the United States |
| Throughout the regions in which we sell, our larger customers demand, and are able to 23 ______________________________________________________________________ [49]Table of Contents secure in some cases, longer payment terms than our standard terms |
| We monitor individual customer payment capability in granting such open credit arrangements, seek to limit such open credit to amounts we believe the customers can pay, and maintain reserves we believe are adequate to cover exposure for doubtful accounts |
| Beyond our open credit arrangements, we have also experienced demands for customer financing and facilitation of leasing arrangements |
| While we have engaged in very minimal financing arrangements to date, we believe customer financing is a competitive factor in obtaining business, and we expect demand for customer financing to continue |
| Although we have programs in place that are designed to monitor and mitigate risk associated with financing activities, including monitoring of particular risks in certain geographic areas, there can be no assurance that such programs will be effective in reducing our credit risks |
| Our business will be adversely affected if we are unable to protect our intellectual property rights |
| We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights |
| We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our software, documentation and other proprietary information |
| Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology |
| Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology |
| Furthermore, other parties may independently develop similar or competing technology, design around any patents that may be issued to us, otherwise gain access to our trade secrets or intellectual property, or disclose our intellectual property or trade secrets |
| 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 |
| We currently have 33 issued patents in the United States and five issued patents in foreign jurisdictions |
| In addition, we have actively filed numerous other patent applications but these applications may not result in the issuance of any patents |
| Any patent that is issued might be invalidated, circumvented or otherwise fail to provide us any meaningful protection |
| In addition, we cannot be certain that others will not independently develop equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property, or disclose our intellectual property or trade secrets, or that we can meaningfully protect our intellectual property |
| Our failure to protect our intellectual property effectively could have a material adverse effect on our business, financial condition or results of operations |
| We have licensed technology from third parties for incorporation into our products, and we expect to continue to enter into such agreements for future products |
| We could become subject to litigation regarding intellectual property rights that could subject us to significant liability or force us to redesign our products |
| In recent years, we have been involved in litigation involving patents and other intellectual property rights, including our settled litigation with Nortel Networks |
| Moreover, many patents have been issued in the United States and throughout the world relating to many aspects of networking technology, and therefore, we may become a party to additional litigation to protect our intellectual property or as a result of an alleged infringement of others’ intellectual property rights |
| If we do not prevail in potential lawsuits, we could be subject to significant liability for damages and we could be forced to redesign any of our products that use such infringing technology |
| Our business and financial condition would be materially harmed due to reduction in our cash as a result of damage awards, lost or delayed sales or additional development or licensing expenses |
| Moreover, lawsuits, even those in which we prevail, are time-consuming and expensive to resolve and divert management and technical time and attention |
| Although we carry general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed |
| 24 ______________________________________________________________________ [50]Table of Contents We may be at risk of additional litigation, which could be costly and time consuming to defend |
| In 2002, we were a defendant in a securities class action litigation, which is still pending, although it is subject to a pending settlement proposal covered by insurance |
| In addition, more recently, certain of our current and former executive officers and board members have become the subject of several purported class actions and a stockholder derivative lawsuit |
| These complaints allege, among other things, that the named defendants breached their fiduciary duties to us and failed to disclose information relating to transactions we entered into with Qwest Communications |
| The stockholder derivative lawsuit was dismissed with prejudice, although the purported class actions remain |
| These lawsuits could seriously harm our business and financial condition |
| In particular, the lawsuits could harm our relationships with existing customers and our ability to obtain new customers |
| The continued defense of the lawsuits could also result in the diversion of our management’s time and attention away from business operations, which could harm our business |
| The lawsuits could also have the effect of discouraging potential acquirers from bidding for us or reducing the consideration they would otherwise be willing to pay in connection with an acquisition |
| Although we are unable to determine the amount, if any, we may be required to pay in connection with the resolution of these lawsuits by way of settlement, indemnification obligations or otherwise, the size of any such payments, unless covered by insurance or recovered from third parties, could seriously harm our financial condition or liquidity |
| All litigation that was commenced prior to or during the course of bankruptcy was stayed once we entered bankruptcy and was handled pursuant to the Plan |
| However, we remain at risk of post Chapter 11 litigation claims, including in the areas of securities class action, intellectual property rights, employment (unfair hiring or terminations), product liability, etc, and we remain at risk of being able to obtain liability insurance at a reasonable cost when our current policies expire |
| Litigation involves costs in defending the action and the risk of an adverse judgment |
| Any material litigation could result in substantial costs and divert management’s attention and resources, which could seriously harm our business, financial condition, results of operations or liquidity |
| If necessary licenses of third-party technology are not available to us or are unreasonably expensive to obtain, our results of operations could be adversely affected |
| We may be required to license technology from third parties to develop new products or product enhancements |
| However, these licenses may not be available to us on commercially reasonable terms, if at all |
| The inability to obtain any third-party licenses required for developing new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost of which could seriously harm our business, financial condition and results of operations |
| Our business may suffer slower or less growth due to further 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 |
| Continued regulations that adversely affect our customers or future FCC regulations, or regulations established by other regulatory bodies, may limit the amounts of capital available for investment in broadband |
| We could be adversely affected by further regulation of IP networks and commerce in any country where we operate |
| The adoption of such regulations could decrease the demand for our products, and at the same time increase the cost of selling our products |
| In addition, the United States and various foreign governments have imposed controls, export license requirements and restrictions on the import or export of technologies such as ours |
| Regulation of our customers may materially harm our business and financial condition |
| The delays that these governmental processes entail may cause order cancellations or postponements of product purchases by our customers, which would materially harm our business, results of operations and financial condition |
| We have adopted anti-takeover measures that could prevent a change in our control |
| In 2001, we adopted a stockholder rights plan |
| The Company assumed this plan in the bankruptcy |
| This plan could delay or impede the removal of incumbent directors and could make more difficult a merger, tender offer 25 ______________________________________________________________________ [51]Table of Contents or proxy contest involving us, even if such events could be beneficial, in the short term, to the interests of the stockholders |
| In addition, such provisions could limit the price that some investors might be willing to pay in the future for shares of our common stock |
| Our certificate of incorporation and bylaws contain provisions that limit liability and provide for indemnification of our directors and officers, and provide that our stockholders can take action only at a duly called annual or special meeting of stockholders |
| These provisions and others also may have the effect of deterring hostile takeovers or delaying changes in control or management |
| Our business and operations are especially subject to the risks of earthquakes and other natural catastrophic events |
| Our corporate headquarters, including certain of our research and development operations and our contract manufacturer’s facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity |
| A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results, and financial condition |