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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the Quarter Ended June 28, 2003

OR

Commission File Number 1-10228

Enterasys Networks, Inc.

(Exact name of registrant as specified in its charter)

50 Minuteman Road

Andover, Massachusetts 01810

(978) 684-1000

(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 [X] No [  ]

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

     As of August 5, 2003, there were 205,187,836 shares of the Enterasys common stock, $0.01 par value, outstanding.

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PART I — FINANCIAL INFORMATION

ENTERASYS NETWORKS, INC.

See accompanying notes to consolidated financial statements.

(a)

The balance sheet at December 28, 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.

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ENTERASYS NETWORKS, INC.

(a)

Excludes non-cash, stock-based compensation expense.

See accompanying notes to consolidated financial statements.

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ENTERASYS NETWORKS, INC.

See accompanying notes to consolidated financial statements.

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ENTERASYS NETWORKS, INC.

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 3 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 (which include normal recurring adjustments except as disclosed herein) 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. The accompanying financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2002.

2. 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.

Use of Estimates

     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 and certain accrued employee benefits, 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.

Stock-Based Compensation Plans

     The Company accounts for its stock-based employee compensation plans using the intrinsic method under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” to stock-based employee compensation:

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     The pro forma information above is required by SFAS No. 123, as amended by SFAS No. 148, and has been prepared as if the Company had accounted for its employee stock options (including shares issued under the Employee Stock Purchase Plan) under the fair value method of that statement. The fair value of each Company option grant was estimated on the date of grant using the Black-Scholes option pricing model, with the following weighted-average assumptions used for grants:

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

New Accounting Pronouncements

     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 an asset retirement obligation as a liability rather than a contra-asset. SFAS No. 143 is effective for the Company’s fiscal year which began December 29, 2002. The adoption of SFAS No. 143 did not have a material impact on the Company’s consolidated financial statements.

     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 extraordinary items, 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 is effective for the Company’s fiscal year which began December 29, 2002. The adoption of SFAS No. 145 did not have a material impact on the Company’s 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 exit or disposal activities initiated after December 31, 2002. The Company recorded restructuring charges of $8.2 million in the second quarter of fiscal year 2003 that were in accordance with the new requirements.

     In November 2002, the FASB issued FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others.” FIN No. 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN No. 45 requires disclosures about the guarantees that an entity has issued, including a roll-forward of the entity’s product warranty liabilities. The Company’s warranty experience has not been significant. The Company adopted the annual disclosure provisions of FIN No. 45 at December 28, 2002. The Company adopted the provisions for initial recognition and measurement and interim disclosures during the first quarter of fiscal year 2003. The adoption of FIN No. 45 did not have a material impact on the Company’s consolidated financial statements.

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     In November 2002, the FASB issued EITF No. 00-21, “Revenue Arrangements with Multiple Deliverables,” which provides guidance on how to account for revenue arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of this EITF are effective for revenue arrangements entered into beginning in the Company’s third quarter of fiscal year 2003. The Company is currently evaluating the impact the adoption will have on its consolidated financial statements.

     In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN No. 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN No. 46 must be applied for the first interim or annual period beginning after June 25, 2003. The Company has no significant ownership in any minority investment that might be considered a variable interest entity and, as such, the adoption of FIN 46 will not have an effect on the consolidated financial statements.

     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”. This statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003 and is to be applied prospectively. The Company has no derivatives imbedded in other contracts and no hedging relationships at this time and, as such, the adoption of SFAS No. 149 will not have an effect on the consolidated financial statements.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 is not expected to have a material impact on the Company’s consolidated financial statements.

     In May 2003, the FASB issued EITF No. 03-5, “Applicability of AICPA Statement of Position 97-2, Software Revenue Recognition, to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software,” which provides guidance on how to account for non-software deliverables included in an arrangement that contains software that is more than incidental to the products or services as a whole. The provisions of this EITF are effective for revenue arrangements entered into beginning in the Company’s third quarter of fiscal year 2003. The Company is currently evaluating the impact the adoption will have on its consolidated financial statements.

Reclassifications

     Certain prior period balances have been reclassified to conform to the current period presentation.

3. Accounts Receivable

     Accounts receivable were as follows:

     The Company defers revenue on product shipments to certain stocking distributors until those distributors have sold the product to their customer. At June 28, 2003 and December 28, 2002, $21.8 million and $21.4 million, respectively, of product shipments to distributors had been billed and revenue had not been recognized, of which $7.5 million and $3.8 million, respectively, were paid and are included in customer advances and billings in excess of revenues. The balance of $14.3 million and $17.6 million, respectively, was unpaid and is recorded as an offset to gross accounts receivable.

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4. Inventories

     Inventories consisted of the following:

5. Income Taxes

     For the six months ended June 28, 2003, the Company incurred net tax expense of $0.7 million due to certain foreign and state taxes. Effective for fiscal year 2003, the Company no longer records an income tax benefit for losses generated in the U.S. due to the uncertainty of realizing such benefits and the fact that the Company has fully utilized its tax loss carryback benefits. Due to the favorable resolution in the second quarter of fiscal year 2003 of certain US Federal tax audit matters, net tax expense for the three months ended June 28, 2003 was $0.0 million. For the three and six months ended June 29, 2002, the Company recorded net income tax benefits of $4.7 and $65.7 million, respectively, due primarily to the tax loss carry back benefits associated with the passage of the Job Creation and Worker Assistance Act of 2002, whereby the allowable period to carry back net operating losses was increased from two to five years. The Company received net tax refunds of $31.2 million during the six months ended June 28, 2003, primarily related to the Job Creation and Workers Assistance Act of 2002.

6. Goodwill and Intangible Assets

     In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is subject to an annual impairment test using a fair-value-based approach. All other intangible assets are amortized over their estimated useful lives and assessed for impairment under SFAS No. 144, “Accounting for the Impairment and Disposal of Long-lived Assets.” The Company has designated the end of the third quarter of the fiscal year as the date of the annual test. In addition to the annual impairment test, SFAS No. 142 also requires the Company to perform an impairment test if an event or circumstances indicate that it is more likely than not that an impairment loss has occurred. Goodwill at June 28, 2003 and December 28, 2002 was $15,129.

     The Company acquired certain fixed assets and intellectual property from Tenor Networks in April of 2003. The Company allocated the purchase price between the fixed assets and intellectual property acquired. The amount allocated to the Patents and Technology intangibles was $2.1 million, and this amount will be amortized over the estimated useful life of the intangibles, or 36 months.

The table below presents gross amortizable intangible assets and the related accumulated amortization at June 28, 2003:

     All of the Company’s identifiable intangible assets are subject to amortization. Total amortization expense was $1.6 million and $3.3 million for the three months and six months ended June 28, 2003, respectively and $2.2 million and $4.4 million for the three and six months ended June 29, 2002, respectively. Based on intangible assets recorded at June 28, 2003, the estimated amortization expense is $3.2 million for the remainder of fiscal year 2003; $6.4 million for each of the fiscal years 2004 and 2005; $3.2 million for fiscal year 2006; $0.5 million for fiscal year 2007 and $0.8 million thereafter.

7. Other Accrued Expenses

     Other accrued expenses consisted of the following:

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8. Special Charges

     The following table summarizes accrued restructuring activity:

     The majority of remaining accrued severance costs of $6.3 million as of June 28, 2003 will be paid out during fiscal year 2003; and the remaining accrued facility exit costs of $6.0 million, which consist of long-term lease commitments, will be paid out primarily over the next several years.

     The Company recorded a restructuring charge of $8.2 million during the second quarter of fiscal year 2003, which included $7.4 million in employee severance related costs for 56 individuals terminated during the quarter and 160 individuals scheduled to be terminated during the second half of fiscal year 2003. In addition, the Company recorded $0.8 million of facility exit costs as a result of a decrease in estimated future sublease income anticipated from a vacated facility. During the fourth quarter of fiscal year 2002, the Company recorded a restructuring charge of $1.2 million primarily for facilities exit costs related to the closure of two facilities. During the third quarter of fiscal year 2002, the Company recorded a special charge of $10.7 million related to restructuring costs, which consisted of exit costs of $5.1 million related to the closure or reduction in size of seven facilities and employee severance costs of $5.6 million. The employee severance costs were associated with the reduction of approximately 130 individuals or 8% of the Company’s global workforce. During the second quarter of fiscal year 2002, the Company recorded a special charge of $20.2 million related to restructuring costs. These restructuring costs consisted of employee severance costs associated with the reduction of approximately 600 individuals or 26% of the Company’s global workforce. The reductions in the global workforce involved most functions within the Company.

9. Other Income (Expense), Net

     The following schedule reflects the components of other income (expense), net:

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