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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark one)

OR

Commission file number 0-26339

JUNIPER NETWORKS, INC.

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

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [   ]

     There were approximately 377,962,000 shares of the Company’s Common Stock, par value $0.00001, outstanding as of April 30, 2003.

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Juniper Networks, Inc.
Condensed Consolidated Balance Sheets
(in thousands)

(A)  The balance sheet at December 31, 2002 has been derived from the audited consolidated financial statements at that date, but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying Notes to the Condensed Consolidated Financial Statements

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Juniper Networks, Inc.
Condensed Consolidated Statement of Operations
(in thousands, except per share amounts)
(unaudited)

See accompanying Notes to the Condensed Consolidated Financial Statements

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Juniper Networks, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

See accompanying Notes to the Condensed Consolidated Financial Statements

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Juniper Networks, Inc.
Notes to the Condensed Consolidated Financial Statements
(unaudited)

Note 1. Description of Business

     Juniper Networks, Inc. (“Juniper Networks” or the “Company”) was founded in 1996 to develop and sell products that would be able to meet the stringent demands of service providers. Juniper Networks is a leading provider of network infrastructure solutions that transform the business of networking by converting bandwidth into a dependable, secure and highly valuable corporate asset. The Company sells and markets its products through its direct sales organization and value-added resellers.

     In July 2002, the Company completed its acquisition of Unisphere Networks, Inc. (“Unisphere”), a subsidiary of Siemens Corporation, which itself is a subsidiary of Siemens A.G. (“Siemens”). Unisphere developed, manufactured and sold data networking equipment optimized for applications at the edge of service provider networks. In accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141, “Business Combinations,” the Company has included in its results of operations for 2002, the results of Unisphere from July 1, 2002. Therefore, the quarter ended March 31, 2002 does not include the results of Unisphere, but the quarter ended March 31, 2003 does include the results of the combined companies.

Note 2. Summary of Significant Accounting Policies

     Stock-Based Compensation

     The Company’s stock option plans are accounted for under the intrinsic value recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. As the exercise price of all options granted under these plans was equal to the market price of the underlying common stock on the grant date, no stock-based employee compensation cost, other than acquisition-related compensation, is recognized in net income. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to employee stock benefits, including shares issued under the stock option plans and under the Company’s Stock Purchase Plan, collectively called “options.” Pro forma information, net of the tax effect, follows (in thousands, except per share amounts):

     Guarantees

     Financial Accounting Standards Board Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), was issued in November 2002. FIN 45 requires that the Company recognize the fair value for guarantee and indemnification arrangements issued or modified by the Company after December 31, 2002, if these arrangements are within the scope of FIN 45. In addition, the Company must continue to monitor the

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conditions that are subject to the guarantees and indemnifications, as required under previously existing generally accepted accounting principles, in order to identify if a loss has occurred. If the Company determines it is probable that a loss has occurred then any such estimable loss would be recognized under those guarantees and indemnifications. The Company has entered into agreements with some of its customers that contain indemnification provisions relating to claims alleging that the Company’s products infringes the intellectual property rights of a third party. The Company has not recorded a liability related to these indemnification provisions. The Company does not have any guarantees or indemnification arrangements other than the indemnification clause in some of its customer agreements and the guarantees of standby letters of credits for certain lease facilities. The Company implemented the provisions of FIN 45 as of January 1, 2003 and it has not had any impact on its financial position, results of operations or cash flows. In addition, the Company does not believe that FIN 45 will have a material impact on its financial position, results of operations or cash flows in the future.

     Recent Accounting Pronouncements

     In November 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue generating activities. The EITF will be effective for fiscal periods beginning after June 15, 2003. The Company is evaluating the impact of EITF 00-21, but currently does not believe it will have a material impact on the Company’s consolidated financial position or results of operations.

     In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), an interpretation of Accounting Research Bulletin (ARB) No. 51, “Consolidated Financial Statements.” FIN 46 establishes accounting guidance for consolidation of a variable interest entity (“VIE”), formerly referred to as special purpose entities. FIN 46 applies to any business enterprise, both public and private, that has a controlling interest, contractual relationship or other business relationship with a VIE. FIN 46 provides guidance for determining when an entity (the “Primary Beneficiary”) should consolidate another entity, a VIE, that functions to support the activities of the Primary Beneficiary. The Company currently has no contractual relationship or other business relationship with a VIE and therefore the adoption did not have an effect on its consolidated financial position or results of operations.

Note 3. Equity Investments

     As of March 31, 2003 and December 31, 2002, the carrying values of the Company’s minority equity investments in privately held companies were $4.8 million and $5.0 million, respectively. During the quarter ended March 31, 2003, the Company sold its entire position in one privately held company for approximately $250,000, which did not result in a material gain or loss. During the quarter ended March 31, 2002, the Company wrote down these investments for declines in value determined to be other than temporary by $30.6 million. No such write downs were made in the quarter ended March 31, 2003.

     In addition to the equity investments in privately held companies, the Company holds certain marketable equity securities classified as available-for-sale. During the quarter ended March 31, 2003, the Company sold some of these investments, which had a cost basis of approximately $2.1 million, and recognized a gain of approximately $4.4 million.

Note 4. Warranties

     Juniper Networks generally offers a one-year warranty on all of its hardware products as well as a 90-day warranty on the software embedded in the products. The warranty generally includes parts, labor and 24-hour service center support. The specific terms and conditions of those warranties may vary depending on the products sold and the locations into which they are sold. The Company estimates the costs that may be incurred under its warranty obligations and records a liability in the amount of such costs at the time revenue is recognized. Factors that affect the Company’s warranty liability include the number of installed units, historical and anticipated rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.

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     Changes in the Company’s warranty reserve during the period are as follows (in thousands):

Note 5. Acquisitions

     In July 2002, Juniper Networks completed its acquisition of 100% of Unisphere, a subsidiary of Siemens, who also was a significant customer during the quarter ended March 31, 2003. The acquisition resulted in the payment of $375.0 million of cash and the issuance of 36.5 million shares of Juniper Networks’ common stock with a fair value of approximately $359.9 million to the former stockholders of Unisphere. Juniper Networks also assumed all of the outstanding stock options of Unisphere with a fair value of approximately $151.2 million. The options were valued using the Black-Scholes option pricing model with the inputs of 0.8 for volatility, 2 years for expected life, 4% for the risk-free interest rate and a market value of $9.86 per share as described above. The Company also incurred direct costs associated with the acquisition of approximately $13.6 million and an estimated liability of approximately $14.8 million, consisting primarily of workforce reduction charges, including severance and other employee benefits, costs of vacating duplicate facilities and the cost of exiting certain contractual obligations. The total purchase price has been preliminarily allocated as follows (in thousands):

     The purchase price allocation depicted is preliminary and subject to change when the Company obtains additional information concerning certain contingencies of Unisphere.

Note 6. Goodwill and Purchased Intangible Assets

     The following table presents details of the Company’s total purchased intangibles assets (in thousands):

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     Amortization expense of purchased intangible assets of $5.3 million and $13.9 million were included in operating expenses for the quarter ended March 31, 2003 and the year ended December 31, 2002, respectively.

     The estimated future amortization expense of purchased intangible assets for the next five years is as follows (in thousands):

     The Company is required to perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances. The Company performed an impairment analysis as of November 2002 and determined that there was no impairment of the goodwill at that time. There were no impairment indictors during the quarter ended March 31, 2003.

Note 7. Restructuring Expenses

     2002 Plans

     During the third quarter of 2002, in connection with the acquisition of Unisphere, Juniper Networks’ Board of Directors approved and management initiated plans to restructure operations to eliminate certain duplicative activities, focus on strategic product and customer bases, reduce cost structure and better align product and operating expenses with existing general economic conditions. Consequently, Juniper Networks recorded restructuring expenses of approximately $14.9 million associated primarily with workforce related costs, costs of vacating duplicative facilities, contract termination costs, non-inventory asset impairment charges and other associated costs. These costs were included as a charge to the results of operations for the year ended December 31, 2002. As of March 31, 2003, the balance of the accrued restructuring charge consisted of the following (in thousands):

     Amounts related to the net lease expense due to the consolidation of facilities will be paid over the respective lease terms through 2009. The Company’s estimated costs to exit these facilities are based on available commercial rates for potential subleases. The actual loss incurred in exiting these facilities could be different from the Company’s estimates.

     Juniper Networks also recorded approximately $14.8 million of similar restructuring costs in connection with restructuring the Unisphere organization. These costs were recognized as a liability assumed in the purchase business combination and included in the allocation of the cost to acquire Unisphere. As of March 31, 2003, there was approximately $9.2 million remaining to be paid, primarily for facilities, which will be paid over the respective lease terms through 2009, and professional services. Changes to the estimates of executing the currently approved plans of restructuring the Unisphere organization will be recorded as an increase or decrease to goodwill, if such changes occur within one

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year of the acquisition, and any changes thereafter to the estimated costs of restructuring the former Unisphere organization or any similar changes to the costs of restructuring the Juniper Networks organization will be reflected in Juniper Networks’ results of operations.

Note 8. Segment Information

     Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company operates as one operating segment; however, the following table shows net revenues by geographic region (in thousands):

     The Americas region includes net revenues from countries other than the United States of approximately $7.6 million and $4.1 million for the quarters ended March 31, 2003 and 2002, respectively.

     During the quarter ended March 31, 2003, Ericsson A.B. and Siemens A.G. each accounted for greater than 10% of net revenues, compared to the quarter ended March 31, 2002, where Ericsson A.B. and WorldCom, Inc. each accounted for greater than 10% of net revenues.

Note 9. Net Income (Loss) Per Share

     The following table presents the calculation of basic and diluted net income (loss) per share (in thousands, except per share amounts):

     For the quarter ended March 31, 2002, Juniper Networks has excluded approximately 13,464,000 common stock equivalents from the calculation of diluted loss per share because such securities were antidilutive in that period due to the net loss. Employee stock options to purchase approximately 33,320,000 shares and 15,146,000 shares in the quarters ended March 31, 2003 and 2002, respectively, were outstanding, but were not included in the computation of diluted earnings per share because the exercise price of the stock options was greater than the average share price of the common shares and, therefore, the effect would have been antidilutive. For each of the periods presented, the Convertible Subordinate Notes were also excluded from the calculation of diluted loss per share because the effect of the assumed conversion of the notes is antidilutive.

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Note 10. Other Comprehensive Income (Loss)

     Comprehensive income (loss) is as follows (in thousands):

Note 11. Legal Proceedings

     The Company is subject to legal claims and litigation arising in the ordinary course of business, including the matters described below. The outcome of these matters is currently not determinable. However, the Company does not expect that such legal claims and litigation will ultimately have a material adverse effect on the Company’s consolidated financial position or results of operations.

     IPO Allocation Case

     In December 2001, a class action complaint was filed in the United States District Court for the Southern District of New York against the Goldman Sachs Group, Inc., Credit Suisse First Boston Corporation, FleetBoston Robertson Stephens, Inc., Royal Bank of Canada (Dain Rauscher Wessels), SG Cowen Securities Corporation, UBS Warburg LLC (Warburg Dillon Read LLC), Chase (Hambrecht & Quist LLC), J.P. Morgan Chase & Co., Lehman Brothers, Inc., Salomon Smith Barney, Inc., Merrill Lynch, Pierce, Fenner & Smith, Incorporated (collectively, the “Underwriters”), the Company and certain of the Company’s officers. This action was brought on behalf of purchasers of the Company’s common stock in the Company’s initial public offering in June 1999 and its secondary offering in September 1999. Specifically, among other things, this complaint alleged that the prospectus pursuant to which shares of common stock were sold in the Company’s initial public offering and its subsequent secondary offering contained certain false and misleading statements or omissions regarding the practices of the Underwriters with respect to their allocation of shares of common stock in these offerings and their receipt of commissions from customers related to such allocations. Various plaintiffs have filed actions asserting similar allegations concerning the initial public offerings of approximately 300 other companies. These various cases pending in the Southern District of New York have been coordinated for pretrial proceedings as In re Initial Public Offering Securities Litigation, 21 MC 92. In April 2002, plaintiffs filed a consolidated amended complaint in the action against the Company, alleging violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. Defendants in the coordinated proceeding filed motions to dismiss. In October 2002, the Company’s officers were dismissed from the case without prejudice pursuant to a stipulation. On February 19, 2003, the Court granted in part and denied in part the motion to dismiss, but declined to dismiss the claims against the Company. The Company believes that it has meritorious defenses to the claims against it and intends to defend itself vigorously.

     Federal Securities Class Action Suit

     During the quarter ended March 31, 2002, a number of essentially identical shareholder class action lawsuits were filed in the United States District Court for the Northern District of California against the Company and certain of its officers and former officers purportedly on behalf of those stockholders who purchased the Company’s publicly traded securities between April 12, 2001 and June 7, 2001. In April 2002, the judge granted the defendants’ motion to consolidate all of these actions into one; in May 2002, the court appointed the lead plaintiffs and approved their selection of lead counsel and an amended complaint was filed in July 2002. The plaintiffs allege that the defendants made false and misleading statements, assert claims for violations of the federal securities laws and seek unspecified compensatory damages and other relief. In September 2002, the defendants moved to dismiss the amended complaint.

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In March 2003, the judge granted defendants motion to dismiss with leave to amend. The Company continues to believe the claims are without merit and intends to defend the action vigorously.

     State Derivative Claim Based on the Federal Securities Class Action Suit

     In August 2002, a consolidated amended shareholder derivative complaint purportedly filed on behalf of the Company, captioned In re Juniper Networks, Inc. Derivative Litigation, Civil Action No. CV 807146, was filed in the Superior Court of the State of California, County of Santa Clara. The complaint alleges that certain of the Company’s officers and directors breached their fiduciary duties to the Company by engaging in alleged wrongful conduct including conduct complained of in the securities litigation described above. The complaint also asserts claims against a Juniper Networks investor. The Company is named solely as a nominal defendant against whom the plaintiff seeks no recovery. In October 2002, the Company as a nominal defendant and the individual defendants filed demurrers to the consolidated amended shareholder derivative complaint. In March 2003, the judge sustained defendants’ demurrers with leave to amend. Plaintiffs must file an amended complaint on or before May 12, 2003. The Company continues to believe the claims are without merit and intends to defend the action vigorously.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This report contains forward-looking statements made within the meaning of the securities laws. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed or forecasted. You should not place undue reliance on forward-looking statements, which reflect only our opinion as of the date hereof.

     The following information should be read in conjunction with our Annual Report on Form 10-K filed on March 11, 2003 with the Securities and Exchange Commission and “Factors That May Affect Future Results” herein. The Company undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

     Overview

     Juniper Networks, Inc. (“Juniper Networks” or “we”) was founded in 1996 to develop and sell products that would be able to meet the stringent demands of service providers. We are a leading provider of network infrastructure solutions that transform the business of networking by converting bandwidth into a dependable, secure and highly valuable corporate asset. We sell and market our products through our direct sales organization and value-added resellers.

     Critical Accounting Policies

     The preparation of the consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to establish accounting policies that contain estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. These policies include:

          •     revenue recognition;

          •      the allowance for doubtful accounts, which impacts general and administrative expenses;

          •      the valuation of exposures associated with the contract manufacturing operations; and

          •      estimating future warranty costs, which impacts cost of product revenues and gross margins.

     We have other equally important accounting policies and practices; however, once adopted, these other policies either generally do not require us to make significant estimates or assumptions or otherwise only require implementation of the adopted policy not a judgment as to policy itself. Despite our intention to establish accurate estimates and assumptions, actual results could differ from those estimates.

     Revenue Recognition

     We recognize product revenue in accordance with Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements.” Specifically, product revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is reasonably assured, unless we have future obligations for such things as network interoperability or customer acceptance, in which case revenue and related costs are deferred until those obligations are met. In most cases, we recognize product revenue upon shipment to our customers, including resellers, as it is our policy to ensure an end user has been identified prior to shipment. Service revenue is recognized over the service period. Our ability to recognize revenue in the future will be impacted by conditions imposed by our customers and by our assessment of collectibility. We assess the probability of collection by reviewing our customers’ payment history, financial condition and credit report. If the probability of collection is not reasonably assured, revenue is deferred until the payment is collected.

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     The amount of product revenue recognized in a given period is also impacted by our judgments made in establishing our reserve for potential future product returns. Although our arrangements do not include any contractual rights of return, and our general policy is that we do not accept returns, under unique circumstances we have and may in the future accept product returns from our customers. Therefore, we do provide a reserve for our estimate of future returns against revenue in the period the revenue is recorded. Our estimate of future returns is based on such factors as historical return data and current economic condition of our customer base. In addition, we get input from our sales and support organizations with respect to specific customer issues. The amount of revenue we recognize will be directly impacted by our estimates made to establish the reserve for potential future product returns.

     Allowance for Doubtful Accounts

     We make ongoing assumptions relating to the collectibility of our accounts receivable. In determining the amount of the allowance, we consider our historical level of credit losses. We also make judgments about the creditworthiness of significant customers based on ongoing credit evaluations, and assess current economic trends affecting our customers that might impact the level of credit losses in the future and result in different rates of bad debts than previously seen. Our reserves have historically been adequate to cover our actual credit losses. However, since we cannot predict future changes in the financial stability of our customers or the industries that we sell to, we cannot guarantee that our current level of reserves will continue to be adequate. If actual credit losses were to be significantly greater than the reserves we have established, that would increase our general and administrative expenses. Conversely, if actual credit losses were to be significantly less than our reserves, our general and administrative expenses would decrease.

     Contract Manufacturer Exposures

     We outsource the majority of our manufacturing, repair operations and supply chain management operations to our independent contract manufacturers. Accordingly, a significant portion of the cost of revenues consists of payments to them. Our independent contract manufacturers procure components and manufacture products based on build forecasts we provide them. Our forecasts are based on our estimates of future demand for our products. Our estimates of future demand for our products are based on historical trends and an analysis from our sales and marketing organizations, adjusted for overall market conditions. If the actual component usage and product demand are significantly lower than forecast, we have contractual liabilities and exposures with all of the contract manufacturers, such as carrying costs and excess material exposures, that would have an adverse impact on our gross margins and profitability. The majority of factors that affect component usage and demand for our products are outside of our control.

     Warranty Reserves

     We generally offer a one-year warranty on all of our hardware products as well as a 90-day warranty on the software embedded in the products. The warranty generally includes parts, labor and 24-hour service center support. The specific terms and conditions of those warranties may vary. We estimate the costs that may be incurred under our warranty obligations and record a liability and charge to cost of product sales in the amount of such costs at the time revenue is recognized. Factors that affect our warranty liability include the number of installed units, our estimates of anticipated rates of warranty claims and costs per claim. Our estimates of anticipated rates of warranty claims and costs per claim are primarily based on historical information. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary. If actual warranty claims are significantly higher than forecast, or if the actual costs incurred to provide the warranty is greater than the forecast, our gross margins could be adversely affected.

     Results of Operations

     In July 2002, we completed our acquisition of Unisphere Networks, Inc. (“Unisphere”), a subsidiary of Siemens Corporation, which itself is a subsidiary of Siemens A.G. (“Siemens”). Following the acquisition Siemens, itself and through its local country affiliates, was one of our significant resellers. Unisphere

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developed, manufactured and sold data networking equipment optimized for applications at the edge of service provider networks. In accordance with Statement of Financial Accounting Standard (“SFAS”) No. 141, “Business Combinations,” we have included in our results of operations for 2002 the results of Unisphere from July 1, 2002. Therefore, the quarter ended March 31, 2002 does not include the results of Unisphere, but the quarter ended March 31, 2003 does include the results of the combined companies.

     Net Revenues

     The following table shows product and service net revenues for the quarters ended March 31, 2003 and 2002 (in thousands):

     Product net revenues increased $30.6 million in the quarter ended March 31, 2003 compared to the same period in 2002. The increase was due primarily to the sales of the E-series products we acquired through the Unisphere acquisition, as well as adoption of our T-series products, which were introduced during 2002.

     Service net revenues increased $4.4 million in the quarter ended March 31, 2003 compared to the same period in 2002. Service net revenues increased as a result of service contracts acquired as part of the Unisphere acquisition and a larger installed base of customers and products. Our service revenue primarily is from customers who previously purchased our products and enter into a service contract. In addition to product-related service contracts, service revenue is generated from providing professional and educational services.

     During the quarter ended March 31, 2003, Ericsson A.B. and Siemens A.G. each accounted for greater than 10% of net revenues, compared to the quarter ended March 31, 2002, where Ericsson A.B. and WorldCom, Inc. each accounted for greater than 10% of net revenues.

     The following table shows net revenues and the percent of total net revenues by geographic region for the quarters ended March 31, 2003 and 2002 (in thousands):

     We experienced a shift in net revenues as a percentage of total net revenues from the Americas region to Europe and Asia in 2003 compared to 2002. The shift was primarily due to both the capital spending market decline in the United States, as well as the increase in our international customer base, which was partially due to the Unisphere acquisition.

     Cost of Revenues

     The following table shows cost of product and service revenues and the related gross margin percentages for the quarters ended March 31, 2003 and 2002 (in thousands):

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     Our gross margins can be highly variable and are dependent on many factors, some of which are outside of our control. We have outsourced the majority of our manufacturing, repair operations and supply chain management operations. Accordingly, a significant portion of the cost of revenues consists of payments to our independent contract manufacturers. The independent contract manufacturers manufacture our products using quality assurance programs and standards that we established. Controls around manufacturing, engineering and documentation are conducted at our facilities in Sunnyvale, California and Westford, Massachusetts. Our independent contract manufacturers have facilities in Neenah, Wisconsin and Toronto, Canada. Our contract manufacturers retain title to the underlying components and finished goods inventory until our customers take title to the assembled final product upon shipment from the contract manufacturer’s facility.

     Cost of product revenues increased $8.7 million in the quarter ended March 31, 2003 compared to the same period in 2002. The increase was primarily due to an increase in standard cost of goods sold, which was a direct result from the increase in product revenues, partially offset by a decrease in certain contract manufacturer charges.

     Cost of service revenues increased $2.7 million in the quarter ended March 31, 2003 compared to the same period in 2002. The increase was primarily due to increases in service revenues, personnel related expenses and shipment of spare parts for replacements.

     We expect our gross margin to remain relatively the same next quarter as compared to this quarter.

     Operating Expenses

     The following table shows operating expenses for the quarters ended March 31, 2003 and 2002 (in thousands):

     The $8.4 million increase in research and development expenses in the quarter ended March 31, 2003 compared to the same period in the prior year was primarily a result of an increase in personnel related expenses and certain overhead costs, partially offset by savings in prototype equipment. We expense our research and development costs as they are incurred. Several components of our research and development effort require significant expenditures, the timing of which can cause significant quarterly variability in our expenses. We expect to continue to devote substantial resources to the development of new products and the enhancement of existing products. We believe that research and development is critical to our strategic product development objectives and that to leverage our leading technology and meet the changing requirements of our customers, we will need to fund investments in several development projects in parallel. Although we may experience significant quarterly variability in our research and development expenses, we expect next quarter’s research and development expenses to be relatively the same in absolute dollars as compared to this quarter.

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     The $5.4 million increase in sales and marketing expenses in the quarter ended March 31, 2003 compared to the same period in the prior year was primarily a result of increases in personnel related and travel expenses. We intend to continue to focus and expand our sales and marketing efforts across all the geographies and markets we serve in order to increase market awareness of our products and to better support our existing customers worldwide. We believe that continued investment in sales and marketing is critical to our success and expect these expenses to remain relatively the same in absolute dollars in the next quarter as compared to this quarter as we continue sales and marketing programs to support our products.

     The $2.1 million decrease in general and administrative expenses in the quarter ended March 31, 2003 compared to the same period in the prior year was primarily a result of decreases in bad debt expenses and personnel related expenses, partially offset by increases in professional services. We expect general and administrative expenses to remain relatively the same in absolute dollars in the next quarter as compared to this quarter.

     The $7.8 million decrease in amortization of purchased intangible assets and deferred stock compensation in the quarter ended March 31, 2003 compared to the same period in the prior year was primarily a result of a decrease of $11.4 million in amortization of deferred stock compensation, offset by an increase of $3.7 million in amortization of purchased intangible assets. The decrease in amortization of deferred stock compensation was due to the restructuring activities in 2002, which resulted in less deferred stock compensation to be amortized in future periods. The increase in amortization of purchased intangible assets was due to the intangible assets purchased in the Unisphere acquisition in July 2002.

     Other Income and Expenses

     The following table shows other income and expenses for the quarters ended March 31, 2003 and 2002 (in thousands):

     Interest income decreased $7.5 million in the quarter ended March 31, 2003 from the same period in the prior year. The decrease was a result of lower cash, cash equivalents and investment balances in the first quarter of 2003, compared to the first quarter of 2002, primarily due to cash utilized to acquire Unisphere in July 2002 and for the partial retirement of the 4.75% Convertible Subordinated Notes (the “Notes”) in the third quarter of 2002. In addition, the interest rates earned on cash, cash equivalents and investments were lower this quarter than they were in the same period a year ago.

     Interest expense consists of interest accrued on the Notes and decreased $3.2 million in the quarter ended March 31, 2003 from the same period of the prior year. The decrease was a result of the partial retirement of the Notes in the third quarter of 2002.

     During the quarter ended March 31, 2003, we sold some of our equity investments in publicly traded companies that were classified as available-for-sale, which had a cost basis of approximately $2.1 million, and recognized a gain of approximately $4.4 million.

     During the quarter ended March 31, 2002, we recorded an impairment write-down of our minority equity investments of $30.6 million. There were no impairments recorded in the quarter ended March 31, 2003.

     Equity in net loss of joint venture was $1.0 million in the quarter ended March 31, 2002. During the quarter ended June 30, 2001, we entered into a joint venture agreement with Ericsson A.B., through our

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respective subsidiaries, to develop and market products for the wireless Internet infrastructure market. Accordingly, we began recording our 40% share of the joint venture’s loss. To date, we have funded the joint venture in the amount of $5.4 million. In addition to this joint venture, Ericsson is also one of our significant resellers, representing greater than 10% of our revenues in each of the quarters ending March 31, 2003 and 2002. As of December 31, 2002, we have no further obligations to fund this joint venture.

     Provision for Income Taxes

     We recorded tax provisions of $2.4 million and $0.8 million for the quarters ended March 31, 2003 and 2002, or an effective tax rate of 39% and - -1.7%, respectively. The 2002 rate differs from the federal statutory rate of 35% and the 2003 rate primarily due to taxes payable in certain foreign jurisdictions and the inability to benefit certain charges and losses.

     The IRS is currently auditing the Company’s federal income tax returns for fiscal years 1999 and 2000. Proposed adjustments have not been received for these years. Management believes the ultimate outcome of the IRS audits will not have a material adverse impact on the Company’s financial position or results of operations.

     Liquidity and Capital Resources

     We have funded our business by selling our common stock in the public market, issuing convertible subordinated notes and through our operating activities.

     At March 31, 2003, we had cash and cash equivalents of $250.3 million, short-term investments of $305.7 million and long-term investments of $625.8 million. We regularly invest excess funds in money market funds, commercial paper and government and non-government debt securities with maturities of up to five years.

     Net cash provided by operating activities was $12.4 million and $12.0 million for the quarters ended March 31, 2003 and 2002, respectively. Net cash provided by operating activities during the first quarter of 2003 was due to the net income of $3.7 million, which was adjusted by non-cash charges such as depreciation and amortization expenses, and increases in accounts payable and deferred revenue, partially offset by the gain on sale of investments, an increase is accounts receivable and decreases in other accrued liabilities. Net cash provided by operating activities in the first quarter of 2002 was due to the net loss of $46.0 million, which was adjusted by non-cash charges such as depreciation and amortization expenses and a write-down of minority investments, and a decrease in accounts receivable, partially offset by decreases in accounts payable, other accrued liabilities and deferred revenue.

     Cash provided by investing activities was $32.4 million and $79.0 million for the quarters ended March 31, 2003 and 2002, respectively. Cash provided by investing activities during all periods was due to maturities of available-for-sale investments and the sale of available-for-sale investments in the first quarter of 2003, partially offset by the purchase of capital equipment and available-for-sale investments.

     Cash provided by financing activities was $11.1 million and $7.4 million for the quarters ended March 31, 2003 and 2002, respectively. Cash provided by financing activities during all periods was due to proceeds from the issuance of common stock through employee option exercises and employee stock purchase plans.

     As of March 31, 2003, our principal commitments consisted of obligations outstanding under operating leases and our 4.75% Convertible Subordinated Notes. We have potential contractual liabilities and exposures to the independent contract manufacturers, such as carrying costs and excess material exposures, in the event that they procure components and build products based on our build forecasts and the actual component usage and product sales are lower than forecast. As of March 31, 2003, we had accrued $25.5 million for potential exposures with our contract manufacturers, such as excess material and carrying costs.

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     Based on past performance and current expectations, we believe that our cash and cash equivalents, short-term investments, and cash generated from operations will satisfy our working capital needs, capital expenditures, commitments and other liquidity requirements associated with our existing operations through at least the next 12 months. In addition, there are no transactions, arrangements, and other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of our requirements for capital resources.

     Factors That May Affect Future Results

     Set forth below and elsewhere in this Report and in other documents we file with the Securities and Exchange Commission are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Report.

     We face intense competition that could reduce our market share.

     Competition in the Internet infrastructure market is intense. This market has historically been dominated by Cisco with other companies such as Nortel Networks and Lucent Technologies providing products to a smaller segment of the market. In addition, a number of other small public or private companies have announced plans for new products to address the same challenges that our products address.

     If we are unable to compete successfully against existing and future competitors from a product offering standpoint or from potential price competition by such competitors, we could experience a loss in market share and/or be required to reduce prices, resulting in reduced gross margins, either of which could materially and adversely affect our business, operating results and financial condition.

     The current economic conditions, combined with the financial condition of some of our customers, limit our visibility and makes revenue forecasting difficult.

     The continuing economic downturn generally, and in the telecommunication industry specifically, combined with our own relatively limited operating history in the context of such a continuing economic downturn, makes it difficult to accurately forecast revenue.

     We have experienced and expect, in the foreseeable future, to continue to experience limited visibility into our customers’ spending plans and capital budgets. This limited visibility complicates the revenue forecasting process. Additionally, many customers funded their network infrastructure purchases through a variety of debt and similar instruments and many of these same customers are carrying a significant debt burden and are experiencing reduced cash flow with which to carry the cost of the debt and the corresponding interest charges, which reduces their ability to both justify and make future purchases. The telecommunications industry has experienced consolidation and rationalization of its participants and we expect this trend to continue. There have been adverse changes in the public and private equity and debt markets for telecommunications industry participants, which have affected their ability to obtain financing or to fund capital expenditures. In some cases the significant debt burden carried by these customers has reduced their ability to pay for the purchases made to date. This has contributed, and we expect it to continue to contribute, to the uncertainty of the amounts and timing of capital expenditures, further limiting visibility and complicating the forecasting process. Certain of these customers have filed for bankruptcy as a result of their debt burdens. Although these customers generally expect that they will emerge from the bankruptcy proceedings in the future, a bankruptcy proceeding can be a slow and cumbersome process further limiting the visibility and complicating the revenue forecasting process as to these customers. Even if they should emerge from such proceedings, the extent and timing of any future purchases of equipment is uncertain. This uncertainty will further complicate the revenue forecasting process.

     In addition, our operating expenses are largely based on anticipated revenue trends and a high percentage of our expenses are, and will continue to be, fixed in the short-term. If we do not achieve our

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expected revenues, the operating results will be below our expectations and those of investors and market analysts, which could cause the price of our common stock to decline.

     Our failure to continue to increase our revenues may prevent us from being profitable in future periods.

     We have large fixed expenses there can be no assurances that net revenues will grow or that we will be profitable in future periods.

     Although our customer base has increased substantially, there are still a limited number of customers who comprise a significant portion of our revenues and any decrease in revenue from these customers could have an adverse effect.

     We expect that a large portion of our net revenues will continue to depend on sales to a limited number of customers. Any downturn in the business of these customers or potential new customers could significantly decrease sales to such customers that could adversely affect our net revenues and results of operations.

     We rely on distribution partners to sell our products, and disruptions to these channels could adversely affect our ability to generate revenues from the sale of our products.

     We believe that our future success is dependent upon establishing and maintaining successful relationships with a variety of distribution partners. We have entered into agreements with several value added resellers, some of which also sell products that compete with our products. We cannot be certain that we will be able to retain or attract resellers on a timely basis or at all, or that the resellers will devote adequate resources to selling our products.

     Our products are highly technical and if they contain undetected software or hardware errors, our business could be adversely impacted.

     Our products are highly technical and are designed to be deployed in very large and complex networks. Certain of our products can only be fully tested when deployed in networks that generate high amounts of data and/or voice traffic. As a result, we may experience errors in connection with such product and for new products and enhancements. Any defects or errors in our products discovered in the future could result in loss of or delay in revenue, loss of customers, increased service and warranty cost, any of which could adversely impact our business and our results of operations.

     If our products do not interoperate with our customers’ networks, installations will be delayed or cancelled and could result in substantial product returns, which could harm our business.

     Our products are designed to interface with our customers’ existing networks, each of which have different specifications and utilize multiple protocol standards. Many of our customers’ networks contain multiple generations of products that have been added over time as these networks have grown and evolved. Our products must interoperate with all of the products within these networks as well as future products in order to meet our customers’ requirements. If we find errors in the existing software used in our customers’ networks, we must modify our software to fix or overcome these errors so that our products will interoperate and scale with the existing software and hardware. If our products do not interoperate with those of our customers’ networks, installations could be delayed, orders for our products could be cancelled or our products could be returned. This would also damage our reputation, which could seriously harm our business and prospects.

     Problems arising from use of our products in conjunction with other vendors’ products could disrupt our business and harm our financial condition.

     Service providers typically use our products in conjunction with products from other vendors. As a result, when problems occur, it may be difficult to identify the source of the problem. These problems may

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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.

     Traditional telecommunications companies generally require more onerous terms and conditions of their vendors. As we seek to sell more products to such customers we may be required to agree to terms and conditions that may have an adverse impact on our business.

     Traditional telecommunications 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 impact our ability to recognize revenue and have an adverse effect on our business and financial condition.

     In addition, many of this class of customer have purchased products from other vendors who promised certain functionality and failed to deliver such functionality and/or had products that caused problems and outages in the networks of these customers. As a result, this class of customer may request additional features from us and require substantial penalties for failure to deliver such features or may require substantial penalties for any network outages that may be caused by our products. These additional requests and penalties, if we are required to agree to them, may impact our ability to recognize the revenue from such sales, which may negatively impact our business and our financial condition.

     Our success depends on our ability to anticipate market needs and to develop products and product enhancements that will meet those needs and gain market acceptance.

     We cannot ensure that we will be able to anticipate future market needs or that we will 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. Any failure of our future products to achieve market acceptance could adversely affect the business and financial results.

     We depend on key personnel to manage our business effectively in a rapidly changing market and if we are unable to retain or hire key personnel, our ability to develop, market and sell products could be harmed.

     Our future success depends upon the continued services of our executive officers and other key engineering, sales, marketing and support personnel. None of the officers or key employees is bound by an employment agreement for any specific term.

     The loss of the services of any of our key employees, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel, particularly engineers, could delay the development and introduction of and negatively impact our ability to develop, market or sell our products.

     In addition, although we completed the acquisition of Unisphere on July 1, 2002, integration of the products, product roadmap and operations is a continuing activity and will be for the foreseeable future. As a result of these activities, we may lose opportunities and employees, which could disrupt our business and harm our financial results.

     If we fail to accurately predict our manufacturing requirements, we could incur additional costs or experience manufacturing delays.

     Our contract manufacturers are not obligated to supply products for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order

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because we do not have long-term supply contracts with them. In addition, lead times for required materials and components vary significantly and depend on factors such as the specific supplier, contract terms and demand for each component at a given time. We provide to our contract manufacturers a demand forecast. If we overestimate our requirements, the contract manufacturers may assess charges that could negatively impact our gross margins. If we underestimate our requirements, the contract manufacturers may have inadequate inventory, which could interrupt manufacturing of our products and result in delays in shipments and revenues.

     We currently depend on contract manufacturers with whom we do not have long-term supply contracts, and if we unexpectedly have to qualify a new contract manufacturer we may lose revenue and damage our customer relationships.

     We depend on independent contract manufacturers (each of whom is a third party manufacturer for numerous companies) to manufacture our products. We do not have a long-term supply contract with such manufacturers and if we should fail to effectively manage our contract manufacturer relationships or if one or more of them should experience delays, disruptions or quality control problems in its manufacturing operations, our ability to ship products to our customers could be delayed which could adversely affect our business and financial results.

     The long sales and implementation cycles for our products, as well as our expectation that customers will sporadically place large orders with short lead times may cause revenues and operating results to vary significantly from quarter to quarter.

     A customer’s decision to purchase our products involves a significant commitment of its resources and a lengthy evaluation and product qualification process. As a result, the sales cycle may be lengthy. Throughout the sales cycle, we often spend considerable time educating and providing information to prospective customers regarding the use and benefits of our products. Even after making the decision to purchase, customers tend to deploy the products slowly and deliberately. Timing of deployment can vary widely and depends on the skill set of the customer, the size of the network deployment, the complexity of the customer’s network environment and the degree of hardware and software configuration necessary to deploy the products. Customers with large networks usually expand their networks in large increments on a periodic basis. Accordingly, we expect to receive purchase orders for significant dollar amounts on an irregular basis. These long cycles, as well as our expectation that customers will tend to sporadically place large orders with short lead times, may cause revenues and operating results to vary significantly and unexpectedly from quarter to quarter.

     We face risks associated with our restructuring plans that may adversely affect our business, operating results and financial condition.

     In response to industry and market conditions, we have restructured our business and reduced our workforce. The assumptions underlying our restructuring efforts will be assessed on an ongoing basis and may prove to be inaccurate and we may have to restructure our business again in the future to achieve certain cost savings and to strategically realign our resources.

     Our restructuring plan is based on certain assumptions regarding the cost structure of our business and the nature, severity, and duration of the current industry adjustment, which may not prove to be accurate. While restructuring, we have assessed, and will continue to assess, whether we should further reduce our workforce, as well as review the recoverability of our tangible and intangible assets, including the land purchased in January 2001. Any such decisions may result in the recording of additional charges, such as workforce reduction costs, facilities reduction costs, asset write-downs, and contractual settlements.

     Additionally, estimates and assumptions used in asset valuations are subject to uncertainties, as are accounting estimates with respect to the useful life and ultimate recoverability of our carrying basis of assets, including goodwill and other intangible assets. As a result, future market conditions may result in further charges for the write down of tangible and intangible assets.

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     We may not be able to successfully implement the initiatives we have undertaken in restructuring our business and, even if successfully implemented, these initiatives may not be sufficient to meet the changes in industry and market conditions and to achieve future profitability. Furthermore, our workforce reductions may impair our ability to realize our current or future business objectives. Lastly, costs actually incurred in connection with restructuring actions may be higher than the estimated costs of such actions and/or may not lead to the anticipated cost savings. As a result, our restructuring efforts may not result in our return to profitability.

     We could become subject to litigation regarding intellectual property rights, which could seriously harm the business.

     In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. Although we are not involved in any intellectual property litigation, we may be a party to litigation in the future to protect our intellectual property or as a result of an alleged infringement of others’ intellectual property. Claims for alleged infringement and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights and may require us to stop selling, incorporating or using products that use the challenged intellectual property. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention.

     Necessary licenses of third-party technology may not be available to us or may be very expensive.

     We integrate third-party licensed technology in certain of our products. From time to time we may be required to license additional technology from third parties to develop new products or product enhancements. Third-party licenses may not be available or continue to be available to us on commercially reasonable terms. Our inability to maintain or re-license any third party licenses required in our current products or our inability to obtain third-party licenses necessary to develop new products and product enhancements, could require us to obtain substitute technology of lower quality or performance standards or at a greater cost, any of which could seriously harm our business, financial condition and results of operations.

     Due to the global nature of our operations, economic or social conditions or changes in a particular country or region could result in a reduction in sales, increase our costs, expenses and have a material adverse impact on our financial condition.

     We conduct significant sales and customer support operations directly and indirectly through our distributors in countries outside of the United States and also depend on the operations of our contract manufacturers that are located outside of the United States. For the quarters ended March 31, 2003 and 2002, we derived 62% and 31% of our revenues, respectively, from sales outside North America. Accordingly, our future results could be materially adversely affected by a variety of factors including, among others, social unrest or economic instability in a specific country or region; trade protection measures and other regulatory requirements which may affect our ability to import or export; service provider and government spending patterns affected by political considerations; and difficulties in staffing and managing international operations. Specifically, as of the date of this filing, potential global concerns include the military action in Iraq and the Severe Acute Respiratory Syndrome (SARS) outbreak in Asia and other parts of the world. If these conditions persist and build in magnitude, there is a risk that our operations in these regions may be harmed or require additional cost to manage. Any or all of these factors could have a material adverse impact on our revenue, costs, expenses and financial condition.

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     We are exposed to fluctuations in currency exchange rates.

     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.

     The majority of our revenue and expenses are transacted in US Dollars. We also have some transactions that are denominated in foreign currencies, primarily the Japanese Yen, Hong Kong Dollar, British Pound and the Euro, related to our sale and service operations outside of the United States. 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. Our attempts to hedge against these risks may not be successful resulting in an adverse impact on our net income.

     Any acquisition we make could disrupt the business and harm our financial condition.

     We have made and may continue to make acquisitions and investments in order to enhance our business. Acquisitions involve numerous risks, including problems combining the purchased operations, technologies or products, unanticipated costs, diversion of management’s attention from our core business, adverse effects on existing business relationships with suppliers and customers, risks associated with entering markets in which we have no or limited prior experience and potential loss of key employees. There can be no assurance that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire.

     We intend to make investments in complementary companies, products or technologies. In the event of any such investments or acquisitions, we could issue stock that would dilute our current stockholders’ percentage ownership, incur debt, assume liabilities, incur amortization expenses related to purchases of intangible assets, or incur large and immediate write-offs.

     We are a party to lawsuits, which, if determined adversely to us, could result in the imposition of damages against us and could harm our business and financial condition.

     We and certain of our former officers and current and former members of our board of directors are subject to various lawsuits brought by classes of stockholders alleging, among other things, violations of federal and state securities laws breach of various fiduciary obligations. There can be no assurance that actions that have been or will be brought against us will be resolved in our favor. Any losses resulting from these claims could adversely affect our profitability and cash flow.

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     The unpredictability of our quarterly results may adversely affect the trading price of our common stock.

     Our revenues and operating results will vary significantly from quarter to quarter due to a number of factors, including many of which are outside of our control and any of which may cause our stock price to fluctuate.

     The factors that may impact the unpredictability of our quarterly results include the reduced visibility into customers’ spending plans, the changing market conditions, which have resulted in some customer and potential customer bankruptcies, a change in the mix of our products sold, from higher priced core products to lower priced edge products, and long sales and implementation cycle. As a result, we believe that quarter-to-quarter comparisons of operating results are not a good indication of future performance. It is likely that in some future quarters, operating results may be below the expectations of public market analysts and investors in which case the price of our common stock may fall.

     We are dependent on sole source and limited source suppliers for several key components.

     With the current demand for electronic products, component shortages are possible and the predictability of the availability of such components may be limited. We currently purchase several key components, including ASICs, from single or limited sources. We may not be able to develop an alternate or second source in a timely manner, which could hurt our ability to deliver product to customers. If we are unable to buy these components on a timely basis, we will not be able to deliver product to our customers, which would seriously impact present and future sales, which would, in turn, adversely affect our business.

     If we fail to adequately evolve our systems and processes in a changing business environment, our ability to manage our business and results of operations may be negatively impacted.

     Our ability to successfully offer our products and implement our business plan in a rapidly evolving market requires an effective planning and management process. We expect that we will need to continue to improve our financial and managerial control and our reporting systems and procedures. If we fail to continue to evolve our systems and processes, our ability to manage our business and results of operations may be negatively impacted.

     Our business substantially depends upon the continued growth of the Internet and Internet-based systems; changes in industry structure could lead to product discontinuances.

     A substantial portion of our business and revenue depends on growth of the Internet and on the deployment of our product by customers that depend on the continued growth of the Internet. As a result of the economic slowdown and the reduction in capital spending, which have particularly affected telecommunications service providers, spending on Internet infrastructure has declined, which has had a material adverse effect on our business. To the extent that the economic slowdown and reduction in capital spending continue to adversely affect spending on Internet infrastructure, we could continue to experience material adverse effects on our business, operating results and financial condition.

     We face risks from the uncertainties of regulation of the telecommunications industry as well as the Internet and commerce over the Internet.

     The telecommunications industry is highly regulated and our business and financial condition could be adversely affected by the changes in the regulations relating to the telecommunications industry. Also, there are few laws or regulations that apply directly to access to or commerce on the Internet. We could be adversely affected by regulation of the Internet and Internet commerce in any country where we operate. Such regulations could include matters such as voice over the Internet or using Internet Protocol, encryption technology, and access charges for Internet service providers. The adoption of regulation of the Internet and Internet commerce could decrease demand for our products, and at the

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same time increase the cost of selling our products, which could have a material adverse effect on our business, operating result and financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     Interest Rate Risk

     We maintain an investment portfolio of various holdings, types and maturities. These securities are generally classified as available-for-sale and, consequently, are recorded on the Consolidated Balance Sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss).

     At any time, a rise in interest rates could have a material adverse impact on the fair value of our investment portfolio. Conversely, declines in interest rates could have a material impact on interest earnings of our investment portfolio. We do not currently hedge these interest rate exposures.

     The following table presents the hypothetical changes in fair value of the financial instruments held at March 31, 2003 that are sensitive to changes in interest rates (in thousands):