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SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission File Number 1-10228

Enterasys Networks, Inc.

35 Industrial Way
Rochester, New Hampshire 03866
(603) 332-9400
(Address, including zip code, and telephone number, including area code, of
registrant’s principal executive offices)

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

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

     As of January 10, 2003, there were 201,966,247 shares of the Registrant’s common stock, $0.01 par value, outstanding.

Explanatory Statement

     This quarterly report on Form 10-Q contains consolidated financial statements for the quarterly period ended June 2, 2001 which have previously been restated. On November 26, 2002, we filed our transition report on Form 10-K for the ten-month transition period ended December 29, 2001. The Form 10-K contained restated consolidated financial statements for the fiscal year ended March 3, 2001 and certain restated financial information with respect to the quarters within that fiscal year and within the ten-month transition period ended December 29, 2001.

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PART I — FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

ENTERASYS NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS

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ENTERASYS NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

See accompanying notes to consolidated financial statements.

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ENTERASYS NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

See accompanying notes to consolidated financial statements.

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ENTERASYS NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1.

Basis of Presentation

     The accompanying unaudited consolidated financial statements of Enterasys Networks, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 2 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation of the results of operations for the interim periods presented have been reflected herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire year. Certain prior period balances have been reclassified to conform to the current period presentation. The accompanying financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Transition Report on Form 10-K for the transition period ended December 29, 2001 filed with the SEC on November 26, 2002.

     On September 28, 2001, the Company’s Board of Directors amended the by-laws to change the Company’s fiscal year-end from the Saturday closest to the last day in February of each year to the Saturday closest to the last day in December of each year, and the Company filed a Form 10-K for the ten-month transition period ended December 29, 2001. The Company has filed this Form 10-Q for the three-month period ended on March 30, 2002, which is the first quarter of fiscal year 2002. The Company did not include comparable three-month financial information for the period December 30, 2000 through March 31, 2001, because it was impracticable to do so due to certain inherent limitations in the Company’s interim monthly closing process and the complexity of the restatement of the Company’s quarterly 2001 financial statements.

2.

Restatement

     On January 31, 2002, the Company discovered that a previously recognized $4.0 million sale in its Asia Pacific region did not qualify for revenue recognition during the period in which the Company had originally reported the revenue. Also on January 31, 2002, the Company learned that the SEC had opened a formal order of investigation into the financial accounting and reporting practices of the Company and its affiliates. In response to these developments, the Company’s Board of Directors formed a Special Committee to conduct an internal review into the Company’s financial accounting and reporting for the fiscal year ended March 3, 2001 and the ten-month transition period ended December 29, 2001. The Special Committee appointed the law firm of Ropes & Gray to conduct the internal review, and Ropes & Gray hired the forensic accounting group of Deloitte & Touche LLP to assist with the internal review. The Special Committee has completed the internal review, and the Company has restated its financial statements for the fiscal year ended March 3, 2001, the fiscal quarters within that fiscal year, and the first three fiscal quarters within the ten-month transition period ended December 29, 2001. The restatements are included in the Company’s Transition Report on Form 10-K filed with the SEC on November 26, 2002. The principal adjustments to restate the financial statements for the three months ended June 2, 2001 were as follows:

     Sales/Investment Transactions

     The Company entered into a number of transactions in which it made an investment in a customer in exchange for cash and/or the Company’s products and services. The amounts originally recorded by the Company relating to a number of these transactions were in error. The Company reviewed all investment transactions and corrected the amount recorded for each transaction for which an error was noted. In making those corrections, the investment value and the amount of revenue recorded by the Company were determined based upon the nature of the transaction and fair value of the investment instrument received. When it was not appropriate to recognize revenue, the Company recorded the difference between the cost of the consideration given and the fair value of the investment received as other expense. The fair value of the investment in these instances was limited to the cost of the product given. These corrections resulted in a reduction to reported investments and revenue of $0.3 million and $13.5 million, respectively, for the three months ended June 2, 2001. The Company also increased other expense, net by $6.0 million for the three months ended June 2, 2001.

     Asia Pacific and Latin America Distributors

     As a result of the internal review, the Company determined that beginning in the fiscal year ended March 3, 2001 practices related to several distributor relationships in the Asia Pacific and Latin America regions were such that, with respect to sales to these distributors, the Company should not recognize revenue until the distributor has paid the Company. As a result of these findings, and

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in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements,” the Company restated sales to such distributors in these two regions to a cash basis methodology. This resulted in a reduction to reported revenue of $7.8 million for the three months ended June 2, 2001.

     Pricing Allowances

     In the course of the internal review, the Company identified certain pricing allowances extended to customers that had not been recorded by the Company in the appropriate period. The impact of correcting these errors resulted in a reduction to reported revenue of $2.0 million for the three months ended June 2, 2001.

     Return Rights

     The Company determined that sales reserves established to account for future product returns in certain cases did not properly take into consideration all relevant information available at the time the estimates were made; and as a result, the Company has adjusted reserves for certain periods. The impact of correcting for these errors resulted in an increase to reported revenue of $0.5 million for the three months ended June 2, 2001.

     Other Revenue Corrections

     The Company determined that other reductions to revenue for the three months ended June 2, 2001 were required to correct previously reported amounts including premature recognition of revenue associated with incomplete integration projects and software arrangements aggregating $0.2 million, barter transactions of $3.1 million, premature recognition of intermediary shipments as revenue totaling $6.6 million, and other miscellaneous transactions aggregating $14.6 million.

     Cost of Revenues

     Cost of revenues was reduced by $20.8 million in the three months ended June 2, 2001, primarily as a result of the foregoing adjustments reducing revenue.

     Operating Expenses

     Operating expenses were decreased by $1.1 million in the three months ended June 2, 2001, primarily as a result of expenses not properly recorded in Latin America as well as errors associated with the recognition of cooperative marketing expenses.

     Discontinued Operations

     The loss from discontinued operations was increased by $2.5 million in the three months ended June 2, 2001 primarily due to sales/investment transactions and return rights as discussed above.

     Balance Sheet

     The balance sheet impact at June 2, 2001 of correcting the revenue items discussed above decreased accounts receivable by $34.2 million, increased inventory by $33.3 million and decreased investments by $30.0 million. Other balance sheet corrections included a $51.1 million decrease in cash and cash equivalents and a $1.2 million decrease in accounts payable to properly record outstanding checks and to record deposits in transit, a $3.5 million increase in intangible assets, a $2.7 million increase in accrued expenses to correct product credits and a $6.7 million increase in deferred revenue.

     Cash Flow

     The restatements discussed above account for substantially all of the changes to the consolidated statement of cash flows for the three months ended June 2, 2001.

     Summary of Restatement Adjustments

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     The following table outlines the effect of the restatement adjustments on the three months ended June 2, 2001 as well as the reclassifications of discontinued operations as discussed in Note 4 and marketing development expenses as discussed in Note 3:

3.

Accounting Policies

     Principles of Consolidation

     The consolidated financial statements include the accounts of Enterasys Networks, Inc. and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The consolidated financial statements and related notes have been reclassified to reflect the results of Aprisma, Riverstone and GNTS as discontinued operations as discussed in Note 4. In addition to the reclassification due to discontinued operations, certain prior year balances have been reclassified to conform to the current period presentation.

     Use of Estimates

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     The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates include assessing the fair value of acquired assets, the amount and timing of revenue recognition, the collectibility of accounts and notes receivable, the valuation of fair value investments, the use and recoverability of inventory and tangible and intangible assets, and the amounts of incentive compensation liabilities, accrued restructuring charges, litigation liabilities and contingencies, among others. The Company bases its estimates on historical experience, current conditions and various other assumptions that are believed to be reasonable under the circumstances. The markets for the Company’s products are characterized by rapid technological development, intense competition and frequent new product introductions, all of which could affect the future realizability of the Company’s assets. Estimates and assumptions are reviewed on an on-going basis and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results could differ from those estimates under different assumptions or conditions.

     New Accounting Pronouncements

     Effective December 30, 2001, the Company adopted the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor's Products,” which requires among other things, that payments made to resellers by the Company for cooperative advertising, buy-downs and similar arrangements should be classified as reductions to net sales or an increase in selling expenses, depending upon the application of the funds by the customer. As a result, the financial statement presentation for the three months ended March 30, 2002 conforms to the requirements of EITF No. 00-25, and the amounts for the three months ended June 2, 2001 have been reclassified to comply with the guidelines of the consensus. The reclassification for the three months ended June 2, 2001 resulted in a reduction of net revenue of $3.4 million, a reduction of cost of revenue of $5.0 million and an increase in selling, general and administrative expenses of $1.6 million. The above reclassification had no impact on net loss or loss per share.

     Effective December 30, 2001, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” See Note 8 for further information concerning the Company’s adoption of SFAS 142.

     In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires recognition of asset retirement obligations as a liability rather than a contra-asset. SFAS No. 143 is effective for the Company’s fiscal year ending January 3, 2004. The Company is currently evaluating the impact that the adoption will have on the consolidated financial statements.

     Effective December 30, 2001, the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which excludes from the definition of long-lived assets goodwill and other intangibles that are not amortized in accordance with SFAS No. 142. SFAS No. 144 requires long-lived assets disposed of by sale to be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. SFAS No. 144 also expands the reporting of discontinued operations to include components of an entity that have been or will be disposed of rather than limiting such discontinuance to a segment of a business.

     The transition provisions of SFAS No. 144 require that disposal activities that were initiated before the initial application of SFAS No. 144 continue to be accounted for and displayed in the income statement in accordance with the prior pronouncement applicable to the disposal. However, SFAS No. 144 requires a company to reclassify previously issued statements of financial position presented for comparative purposes if a company presented as a single net line item the assets and liabilities of a disposal group. As a result, the Company continues to account for and present in its consolidated statements of operations, the Riverstone, Aprisma and GNTS discontinued operations in accordance with Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,” and has reclassified the assets and liabilities of Aprisma on the consolidated balance sheets to conform to the

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presentation required by SFAS No. 144. See Note 4 for a discussion of the Company’s discontinued operations. The adoption of SFAS No. 144 did not have any impact on the book value of the Company’s long-lived assets.

     In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145, among other things, rescinds SFAS No. 4, which required all gains and losses from the extinguishment of debt to be classified as an extraordinary item and amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. This statement was issued effective for fiscal years beginning May 15, 2002 or later. The Company does not expect this statement will have an impact on its consolidated financial statements.

     In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which requires companies to recognize costs associated with exit or disposal activities when a liability is incurred rather than at the date of a commitment to an exit or disposal plan. This statement is effective for fiscal years beginning after December 31, 2002. The Company is currently evaluating the impact the adoption will have on the consolidated financial statements.

4.

Discontinued Operations

     In February 2000, Cabletron Systems, Inc. (“Cabletron”) transferred substantially all of its operating assets and liabilities to four operating subsidiaries, Enterasys Networks, Inc. (“Enterasys Subsidiary”), Riverstone Networks, Inc. (“Riverstone”), Aprisma Management Technologies, Inc. (“Aprisma”), and GlobalNetwork Technology Services, Inc. (“GNTS”). In July 2001, the operations of GNTS were discontinued through the acquisition of a portion of GNTS by a third party, the assumption of certain contracts and employees of GNTS by Enterasys Subsidiary and Aprisma, and the discontinuance of the remaining business operations of GNTS. Following the initial public offering of a portion of Riverstone’s common stock in February 2001, Cabletron distributed its holdings of Riverstone’s common stock to Cabletron’s stockholders in a spin-off transaction on August 6, 2001. Also on August 6, 2001, Enterasys Subsidiary was merged with and into Cabletron and the name of the surviving corporation was changed to “Enterasys Networks, Inc.” On August 9, 2002, the Company completed the sale of Aprisma to a third party for proceeds, net of expenses, of approximately $7.4 million. For the three months ended March 30, 2002, the Company recorded an additional charge of $11.7 million due to a change in estimate of the loss on disposal of Aprisma. The consolidated financial statements present GNTS, Riverstone and Aprisma as discontinued operations for all applicable periods presented.

     The Company’s discontinued operations for the three months ended June 2, 2001, included sales to customers in which the Company had investments in debt and equity securities accounted for under the cost method of accounting. These revenues are disclosed separately in the following table as “Revenue from related parties — minority investees.” The following revenue is recorded in the consolidated statements of operations in loss from discontinued operations:

5.

Segment Information

     As a result of the Company’s decision to discontinue or dispose of the operations of Riverstone, GNTS and Aprisma, the Company operates its business as one segment, which is the business of developing, marketing and supporting comprehensive network solutions.

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     Revenues by geography

6.

Accounts Receivable

     Accounts receivable are summarized as follows:

     Beginning in September 2001, the Company deferred revenue on product shipments to certain stocking distributors until those distributors have sold the product to their customer. At March 30, 2002 and December 29, 2001, $26.0 million and $68.9 million, respectively, of product shipments had been billed and deferred, of which $17.4 million and $25.4 million, respectively, are reflected as a reduction to accounts receivable and $8.6 million and $43.5 million, respectively, have been collected (or credited) and are included in customer advances and billings in excess of revenues.

7.

Income Tax Receivable

     The Company established an income tax receivable during the three months ended March 30, 2002 to reflect the refunds anticipated as a result of the Job Creation and Worker Assistance Act of 2002. This receivable at March 30, 2002 was approximately $119.1 million, and was comprised of the realization of tax benefits of approximately $17.4 million, $24.5 million and $47.0 million for the three months ended March 30, 2002, the ten months ended December 29, 2001 and fiscal year ended March 3, 2001, respectively. Also included in the income tax receivable were increases to additional paid-in capital of approximately $11.7 million and $18.5 million for the ten months ended December 29, 2001 and fiscal year ended March 3, 2001, respectively.

8.

Goodwill and Intangible Assets

     The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” on December 30, 2001. SFAS No. 142 requires that existing and future goodwill and intangible assets with indefinite lives not be amortized, but written down, as needed, based upon an impairment analysis that must occur at least annually. Intangible assets that have finite useful lives continue to be amortized over their useful lives. The Company is currently in the process of completing the transitional impairment test required by SFAS No. 142 to determine whether there was an impairment of recorded goodwill as of December 30, 2001. In accordance with SFAS No. 142, step one of the two-part transitional impairment test requires the Company to compare the fair value of each reporting unit with its respective carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, step two of the transitional impairment test will be performed to measure the amount of impairment loss. Step one of the transitional impairment test must be completed in connection with our reporting for the second quarter of fiscal year 2002. Step two of the transitional impairment test must be completed by the end of fiscal year 2002 and the resulting impairment loss, if any, will be recorded as a cumulative effect of accounting change in the consolidated statements of operations. The amount of any such impairment loss cannot be determined at this time. The amount of any such loss, however, could

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be material to the Company’s consolidated financial results. In addition to the transitional impairment test, SFAS No. 142 also requires the Company to perform an annual impairment test and an impairment test if an event occurs or circumstances change that would more likely than not result in an impairment loss. Such subsequent impairment losses, if any, will be reflected in operating income in the consolidated statement of operations in the period the event occurs. Such an event occurred during the quarter ended June 29, 2002. The Company is assessing the impact of this event and anticipates that any necessary adjustment would be recorded in the quarter ended June 29, 2002. Goodwill, net of accumulated amortization, as of March 30, 2002 and December 29, 2001 was $15,129.

     The impact of discontinuing the amortization of goodwill on net income and on basic and diluted earnings per share for the quarter ended March 30, 2002 is approximately $1.1 million, or $.01 per share on a basic and fully diluted basis as presented below:

     The table below presents gross amortizable intangible assets and the related accumulated amortization at March 30, 2002:

     The table below presents expected amortization expense for intangible assets at March 30, 2002:

																							After
			2002				2003				2004				2005				2006				2006
Estimated amortization expense		$	6,531			$	6,007			$	5,693			$	5,693			$	2,988			$	1,383

 

9.

Inventories, net

     Inventories, net, consisted of the following:

     Finished goods at March 30, 2002 and December 29, 2001 included $29.6 million and $43.8 million, respectively, of inventory held by certain distributors as a result of the Company’s decision in September of 2001 to recognize revenue from certain distributors when the distributor ships the Company’s product to its customers.

10.

Accrued Expenses

     Accrued expenses consisted of the following:

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11.

Accrued Restructuring Charges

     The following table summarizes accrued restructuring activity for the three months ended March 30, 2002: