REDBACK NETWORKS INC - 10-Q Quarterly Report

(Former name, former address and former fiscal year, if changed since last report)

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

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

The number of shares outstanding of the Registrant’s Common Stock as of May 7, 2003 was 182,839,905 shares, including 17,912 shares issuable in exchange for our subsidiary’s exchangeable shares.

The accompanying notes are an integral part of these condensed consolidated financial statements.

Redback Networks Inc. (“Redback” or the “Company”) is a leading provider of advanced telecommunications networking equipment that enables carriers and service providers to rapidly deploy high-speed access and services to the Internet and corporate networks. Redback’s product lines, which consist of the SMS^™ family of subscriber management systems and the SmartEdge^® product families, combine networking hardware and software. These product families are designed to enable Redback’s customers to create end-to-end regional and national networks that support major broadband access technologies, as well as the new services that these high-speed connections support.

The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are necessary to present fairly the financial position, results of operations and cash flows for the interim periods presented. These statements should be read in conjunction with the audited financial statements included in the Company’s 2002 Annual Report on Form 10-K. Results for interim periods are not necessarily indicative of results for the entire fiscal year. Based on the information that management reviews for assessing performance and allocating resources within the Company, the Company has concluded that it has one reportable segment.

To date, the Company has funded its operations largely through the issuance of debt and equity securities. However, the Company has incurred substantial losses and negative cash flows from operations since inception and has an accumulated deficit of $5.4 billion at March 31, 2003. For the three months ended March 31, 2003, the Company incurred a loss from operations of $20.5 million and negative cash flows from operations of $13.8 million. Management expects operating losses and negative cash flows to continue for at least the next 6 to 18 months. Management believes that its current cash, cash equivalent, and short-term investment balances are adequate to last for the next 12 months, notwithstanding the expected operating losses and negative cash flows. However, failure to generate sufficient revenue, potentially raise additional capital, restructure debt or lease agreements, or reduce operating expenses could have a material adverse effect on the Company’s ability to achieve its intended longer-term business objectives.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make extensive use of 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 reported amounts of revenue and expenses during the period. Significant estimates in these Consolidated Financial Statements include restructuring reserves, allowances for doubtful accounts receivable, warranty reserves, asset and investment impairments, net realizable value for inventories, and income tax valuation allowances. Actual results could differ from those estimates.

The Company provides a limited warranty for its products. A provision for the estimated warranty cost is recorded at the time revenue is recognized. Liabilities for the estimated future costs of repair or replacement are established and charged to cost of sales at the time the related sale is recognized. The amount of liability to be recorded is based on management’s best estimates of future warranty costs after considering historical and

projected product failure rates and product repair costs. Changes in the Company’s estimated liability for product warranty in the three months ended March 31, 2003 and 2002 are as follows:

During the three months ended March 31, 2003, two customers accounted for 25% and 10% of the Company’s revenue. During the three months ended March 31, 2002, two customers accounted for 25% and 11% of the Company’s revenue. Customers include both end user customers and distributors. At March 31, 2003, four customers accounted for 10%, 11%, 12% and 13% of total gross receivables. At December 31, 2002, four customers accounted for 10%, 11%, 13% and 15% of total gross receivables.

The Company accounts for employee stock-based compensation in accordance with the intrinsic value method of APB No. 25 and related interpretations. Stock-based compensation related to non-employees is based on the fair value of the related stock or options in accordance with SFAS 123. Expense associated with stock-based compensation is amortized on an accelerated basis under Financial Accounting Standards Board Interpretation (“FIN”) No. 28 over the vesting period of each individual award. In accordance with SFAS No. 148 Accounting for Stock-Based Compensation—Transition and Disclosures—an amendment to FASB Statement No. 123, the Company is required to disclose the effects on reported net loss and basic and diluted net loss per share as if the fair value based method had been applied to all awards. For the three months ended March 31, 2003 and 2002, had compensation cost been determined based on the fair value method pursuant to SFAS 123, the Company’s net loss would have been as follows:

In November 2002, the EITF finalized Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. EITF 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. EITF 00-21 also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. However, it does not address when the criteria for revenue recognition are met or provide guidance on the appropriate revenue recognition convention for a given unit of accounting. EITF 00-21 is effective for all revenue arrangements entered into in fiscal periods beginning after June 15, 2003, and early application is permitted. Upon adoption, entities may elect to either apply EITF 00-21 prospectively or report the change in accounting as a cumulative-effect adjustment. The Company has not yet determined the effect the adoption of EITF 00-21 will have on its financial condition or results of operations.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 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 46 is effective immediately 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 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company has not yet determined the effect, if any, the adoption of FIN 46 will have on its financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends SFAS No. 133 for certain decisions made by the FASB Derivatives Implementation Group. In particular, SFAS No. 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FIN 45, and (4) amends certain other existing pronouncements. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS No. 149 are to be applied prospectively. The Company does not expect the adoption of SFAS No. 149 to have a material impact on its financial position, cash flows or results of operations.

In May 2002, the Company sold approximately 17.7 million shares of common stock to Nokia Finance International BV (“Nokia”) for an aggregate cash issuance price of approximately $35.8 million pursuant to a Common Stock and Warrant Purchase Agreement (the “Purchase Agreement”). The issuance of shares was recorded at fair value on the date of closing. However, the cash issuance price paid by Nokia was based upon a five-day average Nasdaq closing price, which resulted in a discount in the amount of approximately $4.4 million from the market price on the date of closing. This discount, which is included in other assets, is being amortized on a straight-line basis over the three-year term of the expected commercial arrangement with periodic charges against revenue. In the three months ended March 31, 2003, revenue was reduced by approximately $369,000 for such non-cash amortization.

Revenue and accounts receivable from Nokia are reflected as related party in the three months ended March 31, 2003, since Nokia became a related party in May 2002. Revenue from Nokia was approximately $1.8 million and $1.6 million during the three months ended March 31, 2003 and 2002, respectively.

The Company also issued to Nokia a Common Stock Purchase Warrant (the “Warrant”) allowing Nokia the right to purchase an additional number of shares of Common Stock up to an aggregate of approximately 31.9 million shares of common stock. The Warrant’s exercise price will be the closing price of the Company’s common stock on the date of exercise. The Warrant may now become exercisable during two different periods as follows depending on the level of purchases made by Nokia: (1) during the ten business days beginning on

May 21, 2003, which is the twelve month anniversary of the Closing Date, and (2) during the ten business days beginning on November 21, 2003, which is the eighteen month anniversary of the Closing Date.

Consolidation of facilities. During 2001, the Company recorded a $96.6 million restructuring charge for the estimated costs to terminate or sublease excess facilities. This estimate was based upon current comparable market rates for leases and anticipated dates that these properties are subleased. Expected sublease income on all facilities included in the Company’s estimates is $22.1 million as of March 31, 2003. Should facilities rental rates continue to decrease in these markets or should it take longer than expected to sublease these facilities, the actual loss could exceed these estimates. The Company continues to evaluate and review its restructuring accrual for any indications in the market that could require Redback to change its assumptions for the restructuring accruals already recorded.

The movements of the Company’s restructuring reserves are summarized as follows (in thousands):

The current and long-term portions of the restructuring related reserves are $11.9 million and $55.0 million, respectively. These amounts are included on the balance sheet within accrued liabilities and other long-term liabilities, respectively.

In the three months ended March 31, 2003 and 2002, amortization of intangible assets was $1.7 million and $2.5 million, respectively.

The Company expects amortization expense on intangible assets to be $1.9 million for the remainder of fiscal 2003 and $456,000 in fiscal 2004, at which time intangible assets will be fully amortized, assuming no future impairments of these intangible assets or additions as the result of acquisitions.

Property and equipment includes $2.1 million of computer equipment, internal-use software and furniture and fixtures under capital leases at March 31, 2003. Accumulated amortization of assets under capital leases totaled $1.2 million at March 31, 2003.

During March 2000, the Company issued $500 million of 5% Convertible Subordinated Notes (“Convertible Notes”) due in April 2007 raising net proceeds of approximately $486.4 million. The Convertible Notes are subordinated to all existing and future senior debt and effectively to all indebtedness and other liabilities of the Company’s subsidiaries. The Convertible Notes are convertible into shares of common stock at any time before the maturity date, unless the Company has previously redeemed or repurchased the notes, at a conversion rate of 5.2430 shares for each $1,000 principal amount of notes, which is equivalent to a conversion price of approximately $190.73 per share. On or after the third business day after April 1, 2003, the Company has the

right at any time to redeem some or all of the notes at the redemption price set forth in the indenture governing the Convertible Notes plus accrued interest. However, the notes will not be redeemed on or after the third business day after April 1, 2003 and before 2005, unless the closing price for the Company’s common stock exceeds 140% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending within five trading days of the notice of redemption. Each holder of the Convertible Notes may convert their notes prior to redemption or repurchase. Interest is payable semiannually. Upon a change of control of the Company, the repayment of the Convertible Notes will be accelerated and the Convertible Notes will be due immediately. In October 2001, the Company repurchased approximately $22.5 million of the Convertible Notes and recognized a gain of approximately $10.4 million, which is included in other income.

In the fourth quarter of 2002, the Company entered into a $15 million line of credit with a bank that expires in December 2003, which was amended in March 2003 to increase the available borrowings to $30.0 million. The line of credit is collateralized by restricted cash of approximately 105% of the outstanding borrowings ($13.7 million at March 31, 2003). Borrowings under this line of credit bear interest at an annual rate of the bank’s prime rate (4.25% minimum). The Company had $13.0 million and $12.0 million outstanding under this line of credit at March 31, 2003 and December 31, 2002, respectively. Under the terms of the agreement, there are no restrictive financial covenants.

At March 31, 2003, the Company held net foreign currency forward contracts to hedge future cash outflows to our subsidiaries with an aggregate face value of approximately $1.1 million, to mitigate future payments in Euros related to funding requirements for its subsidiaries. The Company records these contracts at fair value, and the gains and losses on the contracts are substantially offset by losses and gains on the underlying balances being hedged. The net financial impact of foreign exchange gains and losses are recorded in interest and other income, net, and have not been material in any of the periods presented. The Company’s policy is not to use hedges or other derivative financial instruments for speculative purposes.

Total comprehensive loss includes the Company’s net losses and other changes in equity during a period from non-owner sources. Accumulated other comprehensive loss consists of net unrealized gain (loss) on investments and the cumulative translation adjustments. For the three months ended March 31, 2003 and March 31, 2002, total comprehensive loss was $24.9 million and $35.4 million, respectively. The change in other comprehensive loss is as follows:

The following table sets forth the computation of basic and diluted net loss per share for the periods presented (in thousands, except per share amounts):

Options to purchase 32.4 million and 27.8 million shares of common stock at average exercise prices of $5.56 and $6.52 per share, respectively, convertible promissory notes convertible into 2.5 million shares of common stock and warrants to purchase approximately 136,000 shares of common stock at average exercise prices of $4.34 per share for the three months ended March 31, 2003 and 2002 have been excluded from the calculation of diluted net loss per share as their effect would have been anti-dilutive. Additionally, warrants to Nokia to purchase approximately 14.2 million shares of common stock for the three months ended March 31, 2003 have also been excluded from the calculation of diluted net loss per share as their effect would have been anti-dilutive.

In July 2001, plaintiffs filed a shareholder class action lawsuit against Redback and its former officers in the United States District Court for the Southern District of New York. The lawsuit asserts, among other claims, violations of the federal securities laws relating to how Redback’s underwriters of the initial public offering allegedly allocated IPO shares to the underwriters’ customers. In March 2002, the United States District Court for the Southern District of New York entered an order approving the joint request of the plaintiffs and Redback to dismiss the claims without prejudice. On April 20, 2002, plaintiffs filed a consolidated amended class action complaint against Redback and its current and former officers and directors, as well as certain underwriters involved in Redback’s initial public offering. Similar complaints have been filed concerning more than 300 other IPOs; all of these cases have been coordinated as In re Initial Public Offering Securities Litigation, 21 MC 92. On July 15, 2002, the issuer defendants filed an omnibus motion to dismiss for failure to comply with applicable pleading standards. On October 8, 2002, the Court entered an Order of Dismissal as to the individual defendants in the Redback IPO litigation, without prejudice, subject to a tolling agreement. On February 19, 2003, the Court denied the motion to dismiss Redback’s claims. Although the outcome of this lawsuit cannot be predicted with certainty, the Company believes it has meritorious defenses and intends to defend the action vigorously. Were an unfavorable ruling to occur, there exists the possibility of a material impact on business, results of operations, financial condition and cash flow.

In addition to amounts accrued in the condensed consolidated financial statements, the Company has future commitments for inventory of approximately $11 million.

Subsequent to March 31, 2003, the Company announced a plan to restructure its operations through a reduction in its workforce. The research and development functions will be primarily affected by the reduction. The affected employees will be entitled to severance and other benefits pursuant to the Company’s benefits program. The Company expects to record a charge for termination benefits and other related costs in the second quarter of 2003 in accordance with SFAS No. 146.

In April 2003, the Company and Nortel agreed to dismiss the four remaining patents and settle the pending lawsuit between the parties that was originally filed in November 2001. In connection with the settlement, the Company and Nortel entered into a cross-licensing agreement, which provides, among other terms, that the Company will pay Nortel a fee to license Nortel’s technology for a period of five years from the date of the agreement.

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

The following discussion should be read in conjunction with the condensed consolidated financial statements and the accompanying notes included in Part I., Financial Information, Item 1. Financial Statements, of this report.

This Quarterly Report—in particular Item 2 (Management’s Discussion and Analysis of Financial Condition and Results of Operations)—contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (which is codified in Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933). When we use the words, “anticipate,” “estimate,” “project,” “intend,” “expect,” “plan,” “believe,” “should,” “likely” and similar expressions, we are making forward-looking statements. In addition, forward-looking statements in this report include, but are not limited to, statements about our beliefs, estimates or plans regarding the following topics: our product and marketing strategy; increased customer acceptance of our SmartEdge Router and other products; our estimated revenue in 2003; our expected gross margins in 2003; future R&D and SG&A expenses; future charges associated with workforce reductions; expected sublease income; interest income and the cash requirement for interest expense; and our belief that cash and cash equivalents will be sufficient to fund our operations through at least the next 12 months. These forward-looking statements, wherever they occur in this report, are estimates reflecting the best judgment of the senior management of Redback. These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Forward-looking statements should, therefore, be considered in light of various important factors, including those set forth in this report under the caption “Risk Factors” and elsewhere in this report. Moreover, we caution you not to place undue reliance on these forward-looking statements, which speak only as of the date they were made. We do not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events. All subsequent forward-looking statements attributable to Redback or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this report.

Redback Networks Inc. is a leading provider of advanced networking systems that enable broadband service providers to rapidly deploy high-speed access to the Internet and corporate networks. Our product lines, which consist of the Subscriber Management System (“SMS^™”) and the SmartEdge^® product families, combine networking hardware and software. These product families are designed to enable our customers to create end-to-end regional and national networks that support major broadband access technologies, as well as the new services that these high-speed connections support.

Our net revenue decreased 27% to $29.5 million in the three months ended March 31, 2003 from $40.6 million in the prior year comparative period and increased 7% from $27.6 million in the three months ended December 31, 2002. The decrease from the prior year comparative period was primarily a result of decreased product revenue. During the three months ended March 31, 2003, there was a 29% decrease in our product revenue to $24.7 million from the prior year comparative period. Substantially all the product revenue decline related to lower aggregate unit volumes of both SmartEdge and SMS products. Service revenue decreased 19% from $5.9 million in the three months ended March 31, 2002 to $4.8 million in the three months ended March 31, 2003 due in part to a delay in timing of certain of our support renewals in the first quarter of 2003.

We currently have limited visibility into our business prospects. On a forward-looking basis, we are planning our business on the assumption that annual revenue in 2003 will be fairly consistent with our 2002 revenue. In order to achieve projected 2003 annual revenue, our quarterly revenue must increase during the remainder of the year from revenue of approximately $29.5 million in the first quarter of 2003. This revenue growth assumes: (1) continuing stabilization of our SMS business, faster acceptance of our SMS 10000 SL (2) growing traction for our Smart Edge Router product, and (3) general economic conditions. A sustained reduction in our quarterly revenue would require us to further re-evaluate our business investment and resource levels.

Gross profit improved from 39% in the three months ended March 31, 2002 to 41% in the current period, primarily as a result of product cost improvements and a decrease in other manufacturing costs.

We took charges for excess and obsolete inventory of $480,000 in the three months ended March 31, 2003. The charges for 2003 resulted from the comparison of on hand, on order and committed inventories to various factors including reductions in our anticipated demand.

The lower level of manufacturing overhead resulted from lower departmental spending in our manufacturing and customer support organizations in 2003 since we scaled down our operations to support the lower levels of business we have been experiencing.

On a forward-looking basis, we are planning our business based on the assumption that our gross margin will increase from the 41% gross margins reported in the first quarter of 2003. However, gross profit could be lower during the remaining months of 2003, subject to the factors below:

Our research and development (“R&D”) expenditures include salary related expenses for our engineering staff, costs for engineering equipment and prototypes and other departmental expenses. Our R&D expenditures decreased 17% to $18.6 million for the three months ended March 31, 2003 from $22.2 million in the prior year comparative period, and represented 63% and 55% of net revenue in the three months ended March 31, 2003 and 2002, respectively. The decrease in our R&D expenses in absolute dollars is primarily due to a decrease in salary and related costs consistent with the decrease in our R&D headcount from 406 at March 31, 2002 to 335 at March 31, 2003, and a decrease in the use of consultants, equipment related expenses and office related expenses including license and royalty fees. Subsequent to March 31, 2003, we announced a plan to restructure our operations through a reduction in workforce. The research and development functions will be primarily affected by the reduction, which will result in reduced R&D expenses going forward. Because the market for our products involves rapidly changing technology, industry standards and customer demands, our R&D expenses will most likely fluctuate in future periods both in absolute dollars spent and as a percentage of revenue. We continue to re-evaluate our product strategy, which may result in further realignment or reductions in R&D resources or a change in the mix of skills with our staff.

Selling, general and administrative (“SG&A”) expenses include salaries and related costs for our non-engineering staff in sales, marketing, and administration, office and equipment related expenditures including depreciation of property and equipment, costs for operating leases and office supplies, professional services including audit, tax, legal and non-engineering consulting fees, promotions and advertising, and selling expenses. Our SG&A expenditures decreased 27% to $13.5 million for the three months ended March 31, 2003 from $18.5 million in the prior year comparative period, and represented 46% of net revenue in the three months ended March 31, 2003 and 2002. The decrease in our SG&A expenditures is primarily due to the decrease in salary and related costs consistent with the decrease in our SG&A headcount from 306 at March 31, 2002 to 171 at March 31, 2003, equipment related expenses, professional services including relocation, recruiting, training and conferences, and a decrease in our sales-related travel expenditures consistent with decreased revenue. We expect our SG&A expenses to fluctuate in future periods in both absolute dollars and as a percentage of revenue.

Consolidation of facilities. During 2001, we recorded a $96.6 million restructuring charge for the estimated costs to terminate or sublease excess facilities. This estimate was based upon current comparable market rates for leases and anticipated dates that these properties are subleased. Expected sublease income on all facilities included in our estimates is $22.1 million as of March 31, 2003. Should facilities rental rates continue to decrease in these markets or should it take longer than expected to sublease these facilities, the actual loss could exceed these estimates. We continue to evaluate and review our restructuring accrual for any indications in the market that could require us to change our assumptions for the restructuring accruals already recorded.

Workforce reductions. Subsequent to March 31, 2003, we announced a plan to restructure our operations through a reduction in our workforce. The research and development functions will be primarily affected by the reduction. The affected employees are entitled to severance and other benefits pursuant to our benefits program. We expect to record a charge for termination benefits and other related costs in the second quarter of 2003 in accordance with SFAS No. 146.

The movements in our restructuring reserves are summarized as follows (in thousands):

The current and long-term portions of the restructuring related reserves are $11.9 million and $55.0 million, respectively. These amounts are being included on the balance sheet within accrued liabilities and other long-term liabilities, respectively.

Amortization of intangible assets decreased from $984,000 in the three months ended March 31, 2002 to $83,000 in the current period due primarily to certain intangibles now being fully amortized. Total amortization expense for the three months ended March 31, 2003 and 2002 was approximately $1.7 million and $2.5 million, respectively, of which $1.6 million and $1.5 million, respectively, was recorded in cost of revenue.

Stock-based compensation decreased 89% to $363,000 in the three months ended March 31, 2003 from $3.2 million in the prior year comparative period. The decrease in stock-based compensation expense in the current year period can be attributed to our accelerated amortization methodology and the reversals of stock-based compensation as a consequence of reductions in work force.

Due to the stock price on the last trading day of the quarter (March 31, 2003), there was no stock-based compensation recorded for the voluntary stock option replacement program. In future periods, stock-based compensation using variable accounting relating to the voluntary stock option replacement program may impact results significantly from period to period.

Interest and other income, net decreased 12% from $1.0 million in the three months ended March 31, 2002 to $890,000 in the current period. Included in interest and other income in the three months ended March 31, 2003 is a $429,000 realized gain on our minority investments. Also included in interest and other income, net was interest income of $1.0 million on cash, cash equivalents and short-term investments, partially offset by a foreign exchange loss of approximately $453,000 and other expense of $100,000, including bank fees. In the three months ended March 31, 2002, interest and other income includes interest income of $1.3 million on cash, cash equivalents and short term investments, partially offset by a foreign exchange loss of approximately $223,000 and other expense of $84,000, including bank fees.

The change in interest income from $1.3 million in the three months ended March 31, 2002 to $1.0 million in the three months ended March 31, 2003 was due primarily to lower applicable interest rates and the decrease in our invested funds from $156.0 million at March 31, 2002 to $100.9 million at March 31, 2003.

We expect interest income to decrease as a result of the expected use of our cash to fund operations.

Interest expense decreased 20% to $5.2 million in the three months ended March 31, 2003 from $6.5 million in the prior year comparative period. Interest expense resulted primarily from the issuance of our Convertible Notes in March 2000. The decrease in interest expense from the prior year comparative period is due primarily from:

On a forward-looking basis, we anticipate that the cash requirement for interest expense will be approximately $6.0 million on a quarterly basis.

No provisions for income taxes have been recorded, as we have incurred net losses since inception.

Our principal source of liquidity as of March 31, 2003 consisted of approximately $100.9 million in cash, cash equivalents, short-term investments and restricted cash and investments. The primary contributors to the reduction of this balance from $116.0 million at December 31, 2002 were our net loss before non-cash depreciation, amortization and stock-based compensation of approximately $12.4 million, purchases of property and equipment of approximately $1.5 million, and an increase in accounts receivable of $2.0 million.

Cash used in operating activities was $13.8 million for the three months ended March 31, 2003, compared to $17.2 million in the prior year comparative period. Cash used in operating activities in the three months ended March 31, 2003 resulted primarily from our net loss of $24.9 million, offset by depreciation and amortization of $12.1 million. Cash used in operating activities for the three months ended March 31, 2002 resulted primarily from our net loss of $34.7 million, offset by depreciation and amortization of $13.0 million, stock compensation expense of $3.2 million and an increase from the change in liabilities over assets of approximately $1.4 million.

Cash provided by investing activities was $22.5 million for the three months ended March 31, 2003, compared to $10.9 million in the prior year comparative period. Cash provided by investing activities for the three months ended March 31, 2003 was due primarily to the net sale of investments of $26.8 million, offset by changes in restricted cash and investments of approximately $2.8 million and purchases of property and equipment of $1.5 million. Cash provided by investing activities in the three months ended March 31, 2002 was due primarily from net sales of investments of approximately $15.4 million, offset by purchases of property and equipment of $4.5 million.

Cash provided by financing activities was $505,000 for the three months ended March 31, 2003, compared to $125,000 in the prior year comparative period. Cash provided by financing activities for the three months ended March 31, 2003 was primarily due to net proceeds from borrowings on our line of credit of $1.0 million, offset by approximately $412,000 for principal payments under capital lease obligations and other borrowings. Cash provided

by financing activities in the three months ended March 31, 2002 was due primarily to proceeds from the issuance of common stock of $596,000, partially offset by payments on capital lease obligations of $524,000.

In the fourth quarter of 2002, we entered into a $15.0 million line of credit with a bank that expires in December 2003, which was amended in March 2003 to increase the available borrowings to $30.0 million. The line of credit is collateralized by restricted cash of approximately 105% of the outstanding borrowings ($13.7 million at March 31, 2003). Borrowings under this line of credit bear interest at an annual rate of the bank’s prime rate (4.25% minimum). We had $13.0 million outstanding under this line of credit at March 31, 2003. Under the terms of the agreement, there are no restrictive financial covenants.

To date, we have funded our operations largely through the issuance of debt and equity securities. However, we have incurred substantial losses and negative cash flows from operations since inception and have an accumulated deficit of $5.4 billion at March 31, 2003. For the three months ended March 31, 2003, we incurred a loss from operations of $20.5 million and negative cash flows from operations of $13.8 million. Management expects operating losses and negative cash flows to continue for at least the next 6 to 18 months. Management believes that its current cash, cash equivalent, and short-term investment balances are adequate to last for the next 12 months, notwithstanding the expected operating losses and negative cash flows. However, failure to generate sufficient revenue, potentially raise additional capital, restructure debt or lease agreements, or reduce operating expenses could have a material adverse effect on our ability to achieve our intended longer-term business objectives. As the cash available for use in operations continues to decline, customer confidence may be affected, which in turn may result in lower than anticipated revenue and further reduce our cash balance. Within the next 12 months, we may be required to raise additional capital in the future, or could elect to raise capital, if certain events occur, including, but not limited to:

In the event that we are forced to raise additional capital, we may have to sell assets or undertake other transactions that may seriously harm our business and financial condition. Additional capital may not be available at all, or may only be available on terms unfavorable to us. Any additional issuance of equity or equity-related securities could be substantially dilutive to our stockholders.

If we continue to incur losses and negative cash flows, or are unable to restructure our outstanding convertible notes, it is likely we will need to raise additional funds in 2004. There can be no assurance that we would be able to obtain financing or accomplish a restructuring of the notes, or that such financing or restructuring would be available on terms acceptable to us.

In addition, we have significant commitments for cash payments that will occur regardless of our revenue as follows (in millions):

We also have purchase commitments with our contract manufacturer in the normal course of operations totaling $11 million as of March 31, 2003.

In May 2002, we sold approximately 17.7 million shares of common stock to Nokia Finance International BV (“Nokia”) for an aggregate cash issuance price of approximately $35.8 million pursuant to a Common Stock and Warrant Purchase Agreement (the “Purchase Agreement”). The issuance of shares was recorded at fair value on the date of closing. However, the cash issuance price paid by Nokia was based upon a five-day average Nasdaq closing price, which resulted in a discount in the amount of approximately $4.4 million from the market price on the date of closing. This discount, which is included in other non-current assets, is being amortized on a straight-line basis over the three-year term of the expected commercial arrangement with periodic charges against revenue. In the three months ended March 31, 2003, revenue was reduced by approximately $369,000 for such non-cash amortization.

We also issued to Nokia a Common Stock Purchase Warrant (the “Warrant”) allowing Nokia the right to purchase an additional number of shares of Common Stock up to an aggregate of approximately 31.9 million shares of common stock. The Warrant’s exercise price will be the closing price of our common stock on the date of exercise. The Warrant may now be exercisable during two different periods as follows depending on the level of purchases made by Nokia: (1) during the ten business days beginning on May 21, 2003, which is the twelve month anniversary of the Closing Date, and (2) during the ten business days beginning on November 21, 2003, which is the eighteen month anniversary of the Closing Date.

apply EITF 00-21 prospectively or report the change in accounting as a cumulative-effect adjustment. We have not yet determined the effect the adoption of EITF 00-21 will have on our financial condition or results of operations.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 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 46 is effective immediately 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 46 must be applied for the first interim or annual period beginning after June 15, 2003. We have not yet determined the effect, if any, the adoption of FIN 46 will have on our financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends SFAS No. 133 for certain decisions made by the FASB Derivatives Implementation Group. In particular, SFAS No. 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FIN 45, and (4) amends certain other existing pronouncements. This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS No. 149 are to be applied prospectively. We do not expect the adoption of SFAS No. 149 to have a material impact on our financial position, cash flows or results of operations.

To date, we have incurred significant losses and we have not generated enough cash from operations to finance our business.

To date, we have not been profitable. We incurred net losses of approximately $24.9 million in the three months ended March 31, 2003, $186.9 million during fiscal year 2002, $4.1 billion in 2001 and $1.0 billion in 2000, and we will continue to expend substantial funds in fiscal year 2003. To date, we have funded our operations primarily from private and public sales of debt and equity securities, as well as from bank borrowings. As of March 31, 2003, we had cash, cash equivalents, short-term investments and restricted cash and investments of $100.9 million, down from $116.0 million at the end of 2002. Of this cash balance of $100.9 million, $29.4 million was restricted as to secured loans or letters of credit. Although we believe that we maintain adequate cash and investment balances to last through the next 12 months, this belief is based on our belief that we will realize annual revenue at least consistent with that of 2002, reduce our product costs and be able to appropriately manage our operating expenses. However, our net revenues for the three months ended March 31, 2003 were $29.5 million, as compared with $40.6 million for the corresponding period in 2002. With respect to expenses, we expect to continue to incur significant product development, sales and marketing, and general and administrative expenses. As a result, we must generate significant revenues to achieve profitability, and we may fail to do so. In addition, the current downturn in the telecommunications market may worsen, which would have a negative effect on our revenue, and consequently, on our cash and cash equivalents.

If revenue were to be less than anticipated or if our costs were to be greater than anticipated, we may need to raise additional funds by alternative financings in order to meet our cash requirements. We may also choose to raise additional funds to reduce our outstanding debt and the corresponding interest payments. There can be no assurance that we will be able to obtain alternative financing, that any such financing would be on acceptable terms, or that we will be permitted to do so under the terms of our existing financing arrangements, or our financing arrangements in effect in the future. In the absence of such financing, our ability to fund our operations, respond to changing business and economic conditions, reduce our outstanding debt and related interest payments, make future acquisitions, react to adverse operating results, fund required capital expenditures or increased working capital requirements will be adversely affected.

Our business and results of operations may be negatively impacted due to our cash needs and debt load.

We have substantial amounts of outstanding indebtedness and commitments, primarily in the form of convertible notes and long-term real estate commitments. The degree to which we are leveraged, coupled with our cash needs, could have significant negative consequences, including:

We may be unable to repay our convertible notes when they become due; any restructuring of our outstanding indebtedness would likely cause substantial dilution to our stockholders.

On April 1, 2007, the entire outstanding principal of $467.5 million on our outstanding 5% convertible subordinated notes issued in April 2000 will become due and payable. Our ability to meet our debt service obligations and other commitments will be dependent upon our future performance, which will be subject to

financial, business and other factors affecting our operations, many of which are beyond our control. We are currently in discussions with third parties regarding restructuring our outstanding indebtedness. As part of any restructuring, the Company intends to re-negotiate the leases on any of its unused real estate. These real estate lease discussions may delay the overall debt restructuring. In addition, there is no guarantee that either of these discussions will be successful or that the terms of any restructured indebtedness or leases will be materially more favorable than the current terms.

Any restructuring of our indebtedness would likely involve the issuance of new equity, a new debt instrument or the use of cash. Given the recent market value of the 5% convertible subordinated notes and our common stock, if equity is the primary vehicle for restructuring our indebtedness, we expect that there would be substantial dilution to our stockholders.

Our operating plan is based on revenue assumptions, and there is no guarantee that we will achieve those revenue assumptions.

The current downturn in economic activity is continuing at a greater than anticipated rate into 2003. The current sales environment remains very difficult, and we have limited visibility into our business prospects. It is therefore difficult to predict the amount and timing of our revenue, and consequently, our revenue projections and operating plan are subject to great uncertainty. For example, in the first quarter of 2003, we did not achieve our revenue plan, and consequently, our losses were greater than anticipated and our stock price dropped significantly. Specifically, the sales cycle is difficult to predict with respect to our newer SmartEdge^® Router products due to our customers’ and potential customers’ needs to fully evaluate these products and compare them to competitive products. The difficulty in predicting the sales cycle is aggravated by the fact that we have a limited backlog of orders continuing into 2003.

Additionally, customers often view the purchase of our products as a significant and strategic decision, and this causes purchases of our products to become more susceptible to unplanned administrative, processing and other delays. This is particularly true for larger customers who represent a significant percentage of our sales and for whom our products represent a very small percentage of their overall purchasing activity. These customers are often engaged in multiple simultaneous purchasing decisions, some of which may pertain to more immediate needs and absorb the immediate attention of the customer. Consequently, many of our customers’ sales decisions are not made until the final weeks or days of the calendar quarter, which leads to greater uncertainty for us in predicting the timing and amount of our revenue. In addition, our customers’ current capital constraints makes it difficult for them to commit in advance to buy our products in any given quarter. If sales from a specific customer for a particular quarter are not realized in that quarter or at all, our operating results could be materially adversely affected.

Our operating results will suffer if we do not successfully commercialize our product lines.

Our product line expanded when we began shipping our SmartEdge Router product in the fourth quarter of 2001. In addition, in the fourth quarter of 2002 we introduced new technology for the SMS^™ 10000, a product known as SMS 10000 SL. The growth of our business is highly dependent on customer acceptance of the SmartEdge Router product and the SMS 10000 SL product. If sales of our SmartEdge Router and SMS 10000 SL products do not meet our 2003 operating plan expectations, our operating results, financial condition or business prospects may be negatively impacted.

If we are unable to successfully collect timely on our accounts receivable, we will have less cash available for general operating purposes.

Given the current state of the general economy and the telecommunications industry in particular, some of our customers may choose to delay paying us money owed for our products or services in an attempt to increase their available cash, which would have the effect of reducing the amount of cash available to us for general

operating purposes. If this trend develops and we are unable to successfully collect our accounts receivable from our customers on a timely basis, our business and operating results could be materially adversely affected.

Our customers include both end-user customers and resellers. During the three months ended March 31, 2003, revenue from product purchases by NEC and British Telecom accounted for approximately 25% and 10% of our revenue, respectively. During the three months ended March 31, 2002, revenue from product purchases by Verizon and Sumitomo accounted for approximately 25% and 11% of our revenue, respectively. We anticipate that a large portion of our revenues will continue to depend on sales to a limited number of customers, and we do not have contracts or other agreements that guarantee continued sales to these or any other customers.

Our future success depends in large part on sales to companies in the telecommunications sector, which has been depressed.

We are highly dependent on sales to companies in the telecommunications sector. Over the last two years, this sector has been depressed. Our future depends on a rebound in the telecommunications sector because our sales depend on the increased use and widespread adoption of broadband access services, increased capital expenditures by the telecommunications carriers (which often occurs on a sporadic and unpredictable basis), and the ability of our customers to market and sell broadband access services. If the telecommunications industry does not recover, our customers may continue to encounter a shortage of capital, forego sustained or increased level of capital investments, and reevaluate their need for our products. Recovery of the telecommunications sector is beyond our control, and if it fails to recover in the near future, our revenues may be less than we currently anticipate, and our business will suffer.

We have become increasingly reliant on sales to international customers during the last two years. During the three months ended March 31, 2003 and 2002, we derived approximately 70% and 45%, respectively, of our revenue from sales to international customers. Our growing international presence exposes us to risks including:

If one or more of these risks materialize, our sales to international customers may decrease and our costs may increase, which could negatively impact our revenues and operating results.

In October 2002, we received notification from the Nasdaq Stock Market that we were out of compliance with the minimum bid price requirement of $1.00 per share and that we had 90 calendar days, or until January 13, 2003, to regain compliance. We were unable to regain compliance by that date. A hearing before the Listing Qualifications Panel (the “Panel”) to appeal the decision to delist our common stock was held on February 20, 2003. On March 14, 2003, the SEC approved certain changes to the Nasdaq Stock Market’s bid price rules,

which effectively gave Redback an additional 90 calendar days until April 14, 2003, to regain compliance for minimum price of $1.00. On March 25, 2003, Redback received notification from Nasdaq that Redback was granted a 90 day exception to allow for additional developments in the rulemaking process. Accordingly, Redback has until June 23, 2003 to regain compliance with Nasdaq listing requirements. Our stock will remain listed on the Nasdaq National Market until at least June 23, 2003.

If we are unable to regain compliance by June 23, 2003 and if the SEC rejects or does not timely approve additional rule changes proposed by Nasdaq which would provide us with an additional grace period for minimum bid compliance, our current plan is to apply for transfer to the Nasdaq SmallCap Market or take action to perform a reverse stock split, until we can again meet the minimum bid pricing and other requirements of the Nasdaq National Market. If we are unable to meet and maintain the requirements to transfer to the Nasdaq SmallCap Market, we will attempt to have our common stock traded on the Nasdaq over-the counter Bulletin Board. If our common stock is delisted from Nasdaq, it would seriously limit the liquidity of our common stock and impair our potential to raise future capital through the sale of our common stock, which could have a material adverse effect on our business. Delisting could also reduce the ability of holders of our common stock to purchase or sell shares as quickly and as inexpensively as they have done historically, and may have an adverse effect on the trading price of our common stock. Delisting could also adversely affect our relationships with our vendors and customers.

If our products do not anticipate and meet specific customer requirements and demands, our sales and operating results would be adversely affected.

To achieve market acceptance of our products, we must anticipate and adapt to customer requirements and offer products and services that meet customer demands. Due to the complexity of our products and the complexity, diversity, and changing nature of our customer needs, many of our customers require product features and capabilities that our products may not have or may not satisfy over time. In addition, we may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new products and enhancements.

There can be no assurance that we will be able to provide products that will satisfy new customer demands or evolving industry standards, or that the standards we choose to develop will position our products to compete with others in the market. In addition, if we are required to add features to our products, we may experience longer sales cycles, higher research and development spending and lower margins. Furthermore, if we are required to modify our products for a few customers, we may experience delays in developing other product features desired by different customers, which may cause us to lose sales to those customers. Our failure to develop products or offer services that satisfy customer requirements would materially adversely affect our sales, operating results, financial condition and business prospects.

Undetected software or hardware errors in our products before deployment could have a material adverse effect on our operating results.

Due to the complexity of both our products and our customers’ environments, we may not detect product defects until full deployment in our customers’ networks. Furthermore, due to the intricate nature of our products, it is possible that our products may not interoperate with our customers’ networks. This possibility is enhanced by the fact that our customers typically use our products in conjunction with products from other vendors. Regardless of whether warranty coverage exists for a product, we may be required to dedicate significant technical resources to resolve any defects or interoperability problems in order to maintain our customer relationships. If this occurs, we could experience, among other things, loss of major customers, cancellation of product orders, increased costs, delay in recognizing revenue, and damage to our reputation.

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

We currently purchase several key components used in our products from single or limited sources of supply. Specifically, we rely on a limited number of foundries for a number of our application specific integrated

circuits, (“ASICs”). We have no guaranteed supply arrangement with these suppliers, and we, or our third party contract manufacturer, may fail to obtain these supplies in a timely manner in the future. Financial or other difficulties faced by these suppliers or significant changes in demand for these components could limit the availability of these components to us. Any interruption or delay in the supply of any of these components, or the inability to obtain these components from alternate sources at acceptable prices and within a reasonable amount of time, would adversely affect our ability to meet scheduled product deliveries to our customers and would materially adversely affect our sales and business prospects. In addition, locating and contracting with additional qualified suppliers is time-consuming and expensive. Our inability to obtain sufficient quantities of components from our suppliers in a timely manner could negatively impact our ability to timely introduce and generate revenue from this new technology.

We currently depend on a single contract manufacturer with whom we do not have a long-term supply contract.

We depend on a single third party contract manufacturer, Jabil Circuits Inc. (“Jabil”), to manufacture our products, and certain strategic vendors to supply parts to our contract manufacturer, with whom we do not have long-term contracts. If we should fail to effectively manage the relationship with our contract manufacturer or if it should experience delays, disruptions or quality control problems in our manufacturing operations, our ability to ship products to our customers would be delayed. If our contract manufacturer were to cease doing business with us, our ability to deliver products to customers could be materially adversely affected.

During 2002, Jabil provided, through its California and Idaho locations, the labor to assemble, test and ship our products. We shared manufacturing knowledge and processes for the SMS and SmartEdge products between the two different locations of Jabil. At the end of 2002, Jabil moved our manufacturing operations to its California location only. The loss of any of Jabil’s manufacturing capacity could prevent us from meeting our scheduled product deliveries to our customers and could materially and adversely affect our sales and operating results.

Our business will be adversely affected if we are unable to protect our intellectual property rights.

We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our software, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

Furthermore, other parties may independently develop similar or competing technology, design around any patents that may be issued to us, otherwise gain access to our trade secrets or intellectual property, or disclose our intellectual property or trade secrets. Although we attempt to protect our intellectual property rights, we may be unable to prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

As of December 31, 2002, we have filed over 100 patent applications in the United States, over 20 international patents, and have been granted two U.S. patents. The patent applications may not result in the issuance of any additional patents. Any patent that is issued might be invalidated or circumvented or otherwise fail to provide us any meaningful protection. In addition, we cannot be certain that others will not independently develop substantially equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property, or disclose our intellectual property or trade secrets, or that we can meaningfully protect our intellectual property. Our failure to protect our intellectual property effectively could have a material adverse effect on our business, financial condition or results of operations. We have licensed technology from third parties for incorporation into our products, and we expect to continue to enter into such agreements for future products.

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

We may be required to license technology from third parties to develop new products or product enhancements. However, these licenses may not be available to us on commercially reasonable terms, if at all. The inability to obtain any third-party licenses required to develop new products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost either of which could seriously harm our business, financial condition and results of operations.

We could become subject to litigation regarding intellectual property rights.

In recent years, we have been involved in litigation involving patents other intellectual property rights, including our recently settled litigation with Nortel Networks. Moreover, many patents have been issued in the United States and throughout the world relating to many aspects of networking technology, and therefore, we may become a party to additional litigation to protect our intellectual property or as a result of an alleged infringement of others’ intellectual property rights. If we do not prevail in potential lawsuits, we could be subject to significant liability for damages and we could be forced to redesign any of our products that use such infringing technology.

Our business and financial condition would be materially harmed due to reduction in our cash as a result of damage awards, lost or delayed sales or additional development or licensing expenses. Moreover, lawsuits, even those in which we prevail are time-consuming and expensive to resolve and divert management and technical time and attention. Although we carry general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed.

In 2002, we were a defendant in a securities class action litigation, which is still pending. We remain at risk of additional litigation, including in the areas of securities class action, intellectual property rights, employment (unfair hiring or terminations), product liability, etc. and remain at risk of obtaining liability insurance at a reasonable cost when our current policies expire. Litigation involves costs in defending the action and the risk of an adverse judgment. Any material litigation could result in substantial costs and divert management’s attention and resources, which could seriously harm our business, financial condition and results of operations.

Intense competition in our industry could result in the loss of customers or an inability to attract new customers.

Our SmartEdge Router platform competes in a market characterized by an upgrade cycle of swapping existing edge routers for more dense next-generation edge routers with higher interface speeds and richer software functionality. Industry analysts expect this transition to occur over the next four years. Our competitors are repositioning their existing core routers with additional features for use in the edge of the networks. Additional competition exists from companies who make multi-service edge devices, those who are adding subscriber management features to their existing core routers, as well as startup companies who are developing next generation technologies that may compete with our products.

SmartEdge Router competitive pressures may result in price reductions, reduced margins and lost market share, which would materially adversely affect our business, results of operations and financial condition. In addition, some of our competitors are large public companies that have greater name recognition, broader product offerings, more extensive customer bases, more established customer support and professional services organizations, and significantly greater financial, technical, marketing and other resources than we have. As a result, these competitors are able to devote greater resources to the development, promotion, sale and support of their products, and they can leverage their customer relationships and broader product offerings and adopt aggressive pricing policies to gain market share. Our competitors with large market capitalization or cash reserves are much better positioned than we are to acquire other companies, including our competitors, and

thereby acquire new technologies or products that may displace our product lines. As a result of the foregoing, we may be unable to maintain a competitive position against our competitors, which could result in a decrease in sales, earnings, and cash generation.

Our quarterly operating results have and are expected to continue to fluctuate significantly.

Our quarterly operating results are likely to be affected by a number of factors, including the timing of significant sales to large customers, the long sales and implementation cycles, our ability to control expenses, and the recovery of the telecommunications industry and the economy in general. The majority of our expenses are essentially fixed in the short term. As a result, if we experience delays in generating or recognizing revenue, our quarterly operating results will likely decrease. Therefore, we believe that quarter-to-quarter comparisons of our operating results may not be meaningful. You should not rely on our results for one quarter as any indication of our future performance. It is likely that in some future quarter our operating results may be above or below the expectations of public market analysts or investors. If this occurs, the prices of our common stock and convertible notes would likely fluctuate.

We intend to continue to invest in product and technology development. The development of new or enhanced products is a complex and uncertain process that requires the accurate anticipation of technological and market trends. We may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new products and enhancements. We may also experience the loss of key development personnel that could impair our ability to develop and introduce new or enhanced products. The introduction of new or enhanced products also requires that we manage the transition from older products in order to minimize disruption in customer ordering patterns, to ensure that adequate supplies of new products can be delivered to meet anticipated customer demand, and to limit the creation of excess inventory that may impact our financial results. Our inability to effectively manage the transition to newer products or accurately predict market and economic conditions in the future may cause us to incur additional charges of excess and obsolete inventory. If any of the foregoing occurs, our revenue, earnings, and cash generation may be adversely affected.

If we fail to retain or attract employees, we may not be able to timely develop, sell or support our products.

The size of our workforce has experienced rapid fluctuations over the last few years, as we grew from 270 employees as of December 31, 1999, to 1,180 employees as of December 31, 2000, then contracted to 820 employees at December 31, 2001, decreased to 596 at December 31, 2002 and decreased further to 564 at March 31, 2003, as a result of restructuring activities. Many members of our senior management joined the company in 2001. Additionally, we streamlined our management structure in early 2003, and appointed a new chief financial officer and senior vice president of engineering. Our future performance depends, in part, on the ability of our restructured senior management team to effectively work together, manage our workforce and retain highly qualified technical and managerial personnel. The loss of the services of key personnel or the inability to continue to retain, attract or assimilate qualified personnel could delay product development cycles or otherwise materially harm our business, financial condition and operating results.

One of our officers is facing a civil SEC lawsuit related to his previous employment.

On February 25, 2003, the SEC filed a civil lawsuit against eight current and former officers and employees of Qwest Communications, regarding activities that occurred while each was employed at Qwest. One of the individuals named is Joel Arnold, our Senior Vice President of Field Operations, who was formerly Executive Vice President of Qwest’s Global Business Unit. The SEC is seeking, among other remedies, that Mr. Arnold and four other defendants be permanently barred from serving as an officer or director of any public company.

Although it is expected that such a civil procedure will take two to three years or longer to be adjudicated, an unfavorable result at the end of such action against Mr. Arnold may result in him being unable to serve as an officer. In addition, Mr. Arnold may be distracted while defending against the allegations.

We have been informed that the SEC is examining certain transactions involving Qwest Communications.

The Company has been informed that the SEC is examining various transactions involving Qwest Communications, some of which were entered into between the Company and Qwest. The Company is fully cooperating with the SEC regarding this matter. The transactions of which the Company is aware that are being reviewed were entered into prior to fiscal year 2002. The Company cannot predict the duration or outcome of the SEC’s examination.

If we fail to match production with product demand, we may need to incur additional costs to meet such demand.

We currently use a rolling forecast based on anticipated product orders, product order history and backlog to determine our materials requirements. Lead times for the materials and components that we order vary significantly and depend on numerous factors, including the specific supplier, contract terms and demand for a component at a given time. If we overestimate our requirements or there are changes in the mix of products, the contract manufacturer may have excess inventory, which would increase our storage or obsolescence costs. For example, we incurred write-downs of excess and obsolete inventory and related claims of $34.4 million and $142.6 million in 2002 and 2001, respectively. The 2002 excess and obsolete inventory charges resulted from reductions in forecasted revenue and reactions to current market conditions. The 2001 excess inventory resulted from purchases that we made directly or that were committed on our behalf by our contract manufacturers to meet demand that was anticipated in 2001, before we experienced a sudden and significant decrease in our forecasted revenue. If we underestimate our requirements, the contract manufacturer may have an inadequate inventory, which could interrupt manufacturing of our products and result in delays in shipments and revenues.

Our gross margin may continue to fluctuate in the future due to, among other things: any changes in the mix of sales between our products and geographies; competitive pressure to reduce our current price levels; our ability to control inventory costs and other reserves; our ability to control and absorb fixed costs; and our ability to introduce new products, product enhancements and upgrades. Based on the foregoing, our gross margin could decline and our results of operations would suffer.

We may continue to record reserves for currently unused leased facilities, and plan to further consolidate our facilities.

In 2001, we recorded reserves for unused facilities totaling approximately $96.6 million. In addition, we are actively marketing approximately 468,000 square feet of unoccupied office space for sublease, in markets with substantial excess space available for rent. We may experience difficulties in subleasing this space because substantial excess office space is available for rent in the Silicon Valley. Furthermore, in the second quarter of 2003, we plan to further consolidate our facilities. If we are unable to sublease some or all of this unused space, we will have to continue to record reserves for the unused facilities. Additionally, we may experience unanticipated expenses or delays in our product development in connection with any such consolidation.

Our business may suffer slower or less growth due to further government regulation of the communications industry.

The jurisdiction of the Federal Communications Commission, or FCC, extends to the communications industry, to our customers and to the products and services that our customers sell. Continued regulations that adversely affect our customers or future FCC regulations, or regulations established by other regulatory bodies, may limit the amounts of money capital available for investment in broadband. Regulation of our customers may materially harm our business and financial condition. The delays that these governmental processes entail may cause order cancellations or postponements of product purchases by our customers, which would materially harm our business, results of operations and financial condition.

Given our presence in Asia and Canada, the outbreak of SARS may negatively impact our operating results.

The recent outbreak of severe acute respiratory syndrome (SARS), a disease of unknown etiology that has caused numerous deaths in Asia, North America and Europe, could have a negative impact on our operations. In particular, we have both customers and sales personnel third party suppliers located in the affected areas of Asia and Canada, and therefore, our normal operating processes could be hindered by a number of SARS-related factors, including, but not limited to:

If the number of cases continues to rise or spread to other areas, our sales and operating results could be harmed.

Our debt agreements may make it more difficult to consummate merger transactions.

The networking and telecommunications industry is undergoing a consolidation phase, and it is generally believed that a substantial number of current companies working in this space will be bought by larger competitors or will merge to form larger businesses. It is possible that certain companies in this sector will seek a merger transaction with us. However, the amounts and terms of our outstanding debt may discourage potential acquirers. For example, the terms of our convertible notes issued in April 2000 provide the holder of the convertible notes the option to require us to repurchase all or a portion of that holder’s convertible notes at face value upon a change in control, which would significantly increase the liability to a potential acquiror and make us less attractive as a target. Moreover, our borrowing agreements relating to our debt may contain restrictions on, or prohibitions against, our repurchasing or repaying the convertible notes until we pay the senior debt in full.

Provisions of our charter documents have anti-takeover effects that could prevent a change in our control.

In 2001, we adopted a Stockholder Rights Plan. This plan could delay or impede the removal of incumbent directors and could make more difficult a merger, tender offer or proxy contest involving us, even if such events could be beneficial, in the short term, to the interests of the stockholders. In addition, such provisions could limit the price that some investors might be willing to pay in the future for shares of our common stock. Our certificate of incorporation and bylaws contain provisions that limit liability and provide for indemnification of our directors and officers, and provide that our stockholders can take action only at a duly called annual or special meeting of stockholders. These provisions also may have the effect of deterring hostile takeovers or delaying changes in control or management.

As of March 31, 2003, we maintained cash, cash equivalents, short-term investments, and restricted cash and investments of $100.9 million and long-term restricted cash of $1.7 million, of which $71.6 million was unrestricted. We also had debt and capital leases with fixed and variable interest rates with principal amounts totaling $481.8 million. If interest rates were to change by 10%, interest expense would not increase significantly, largely due to the fixed interest rates on the majority of our borrowings. We are exposed to financial market risk from fluctuations in foreign currency exchange rates. We manage our exposure to these risks through our regular operating and financing activities and, when appropriate, through hedging activities.

In 2001, we commenced using foreign exchange contracts to hedge significant intercompany account balances denominated in foreign currencies. Market value gains and losses on these hedge contracts are

substantially offset by fluctuations in the underlying balances being hedged. At March 31, 2003 and December 31, 2002, our primary net foreign currency exposures were in Canadian dollars, Euros, Australian dollars, Singaporean dollars, Taiwanese dollars, and British pounds. At March 31, 2003, we held net foreign currency forward contracts to hedge future cash outflows to our subsidiaries with an aggregate face value of approximately $1.1 million, to mitigate exposure related to intercompany balances with our European subsidiaries and to mitigate future payments in Euros related to funding requirements for our subsidiaries. We record these contracts at fair value, and the gains and losses on the contracts are substantially offset by losses and gains on the underlying balances being hedged. The net financial impact of foreign exchange gains and losses are recorded in other income and have not been material in any of the periods presented. Our policy is not to use hedges or other derivative financial instruments for speculative purposes.

A 10% adverse move in currency exchange rates affecting the contracts from their March 31, 2003 levels would decrease the fair value of the forward contracts by an immaterial amount. However, if this occurred, the fair value of the underlying exposures hedged by the contracts would increase by a similar amount. Accordingly, we believe that our hedging strategy should yield no material net impact to income or cash flows. Actual gains or losses in the future may differ materially from this analysis, depending on actual changes in the timing and amount of interest rate and foreign currency exchange rate movements and our actual balances and hedges.

An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures (as defined by Exchange Act Rules 13a-14(c) and 15d-14(c)) within 90 days before the filing date of this quarterly report. Based on that evaluation the CEO and CFO, concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed is accumulated and communicated to management to allow timely decisions regarding required disclosures.

There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation.

In November 2001, Nortel Networks, Inc. (“Nortel”) claimed that certain Redback products infringed five identified Nortel patents and requested that Redback enter into a royalty bearing license agreement. Redback filed a complaint against Nortel in Federal District Court, Northern District of California in December 2001 and amended that complaint in March 2002, seeking a judgment that the identified Nortel patents are invalid and unenforceable, and that Redback does not infringe any valid claim of the those patents. Nortel has answered the amended complaint and has filed a counter claim alleging that Redback infringed the five identified Nortel patents. In June 2002, the parties agreed to drop one of the five patents from the lawsuit. In April 2003, the Company and Nortel agreed to dismiss the four remaining patents and settle the pending lawsuit. In connection with the settlement, the Company and Nortel entered into a cross-licensing agreement, which provides, among other terms, that the Company will pay Nortel a fee to license Nortel’s technology for a period of five years from the date of the agreement.

On January 16, 2003, the Company filed a Current Report on Form 8-K to report the announcement of its financials results for the first fiscal quarter of 2003.

On January 21, 2003, the Company filed a Current Report on Form 8-K to report the announcement that Nasdaq’s Listing Qualifications Department has determined Redback’s common stock is subject to delisting from the Nasdaq National Market.

On March 28, 2003, the Company filed a Current Report on Form 8-K to report the announcement that Redback received a decision from Nasdaq’s Listing Qualifications Panel granting Redback’s request for an exception to the National Market’s minimum bid price requirement until at least June 23, 2003.

Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

REDBACK NETWORKS INC. (REGISTRANT)

By:		/s/ THOMAS L. CRONAN III
		Thomas L. Cronan III Senior Vice President of Finance and Administration and Chief Financial Officer (Principal Financial and Accounting Officer)

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

		Page
PART I.	FINANCIAL INFORMATION	2

Item 1.	Financial Statements	2

	Condensed Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002 (unaudited)	2

	Condensed Consolidated Statements of Operations for the three months ended March 31, 2003 and 2002 (unaudited)	3

	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002 (unaudited)	4

	Notes to Condensed Consolidated Financial Statements (unaudited)	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28

Item 4.	Controls and Procedures	29

PART II.	OTHER INFORMATION	30

Item 1.	Legal Proceedings	30

Item 2.	Changes in Securities and Use of Proceeds	30

Item 3.	Defaults Upon Senior Securities	30

Item 4.	Submission of Matters to a Vote of Security Holders	30

Item 5.	Other Information	30

Item 6.	Exhibits and Reports of Form 8-K	31

Signatures		32

Certifications		33

	March 31, 2003			December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	32,231		$	22,995
Short-term investments		39,356			66,506
Restricted cash and investments		29,350			26,545
Accounts receivable, less allowances of $3,223 and $3,262		8,204			5,992
Accounts receivable from related party		1,548			1,754
Inventories		10,532			10,143
Other current assets		5,581			7,414

Total current assets		126,802			141,349
Property and equipment, net		54,353			61,475
Goodwill		431,742			431,742
Intangible assets, net		2,661			4,358
Other assets		20,982			21,820

Total assets	$	636,540		$	660,744


LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Borrowings and capital lease obligations, current	$	13,919		$	13,122
Accounts payable		10,698			16,797
Accrued liabilities		68,570			64,407
Deferred revenue		10,515			8,184

Total current liabilities		103,702			102,510
Convertible notes		487,010			488,140
Other long-term liabilities		57,028			56,631

Total liabilities		647,740			647,281

Commitments and contingencies (Note 11)
Stockholders’ equity (deficit):
Convertible Preferred Stock: $0.0001 par value; 10,000 shares authorized, none issued and outstanding		—			—
Common Stock: $0.0001 par value; 750,000 shares authorized; 181,798 and 181,986 shares issued and outstanding, respectively		5,376,072			5,376,163
Deferred stock-based compensation		(1,475	)		(1,845	)
Notes receivable from stockholders		(47	)		(47	)
Accumulated other comprehensive loss		(26,091	)		(26,017	)
Accumulated deficit		(5,359,659	)		(5,334,791	)

Total stockholders’ equity (deficit)		(11,200	)		13,463

Total liabilities and stockholders’ equity (deficit)	$	636,540		$	660,744

	Three Months Ended March 31,
	2003			2002
Product revenue	$	22,920		$	34,639
Related party product revenue		1,769			—
Service revenue		4,801			5,933

Total revenue		29,490			40,572

Product cost of revenue		14,204			20,174
Service cost of revenue		3,339			4,662

Total cost of revenue		17,543			24,836

Gross profit		11,947			15,736

Operating expenses:
Research and development(1)		18,551			22,247
Selling, general and administrative(1)		13,495			18,544
Amortization of intangible assets		83			984
Stock-based compensation		363			3,165

Total operating expenses		32,492			44,940

Loss from operations		(20,545	)		(29,204	)

Other expense, net:
Interest and other income, net		890			1,006
Interest expense		(5,213	)		(6,503	)

Other expense, net		(4,323	)		(5,497	)

Net loss	$	(24,868	)	$	(34,701	)

Net loss per share—basic and diluted	$	(0.14	)	$	(0.23	)

Shares used in computing basic and diluted net loss per share		179,695			152,284

(1) Amounts exclude stock-based compensation as follows:
Research and development	$	209		$	1,843
Selling, general and administrative		154			1,322

Total	$	363		$	3,165

	Three Months Ended March 31,
	2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(24,868	)	$	(34,701	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		9,279			10,468
Amortization of intangible assets		1,716			2,514
Amortization of deferred swap gain		1,130			—
Stock-based compensation		363			3,165
Changes in assets and liabilities:
Accounts receivable, net		(2,006	)		9,057
Inventories		(1,338	)		14,483
Other assets		3,225			515
Accounts payable		(6,099	)		(11,856	)
Accrued liabilities		4,163			(11,145	)
Deferred revenue		2,331			3,005
Other long-term liabilities		(1,654	)		(2,664	)

Net cash used in operating activities		(13,758	)		(17,159	)


CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(1,466	)		(4,462	)
Purchase of short-term investments		(6,480	)		—
Sales of short-term investments		33,240			15,402
Change in restricted cash		(2,805	)		—

Net cash provided by investing activities		22,489			10,940


CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock		62			664
Repurchases of Common Stock		(145	)		(68	)
Principal payments on capital lease obligations and borrowings		(412	)		(524	)
Proceeds from bank borrowings, net		1,000			—
Proceeds from stockholder notes receivable		—			53

Net cash provided by financing activities		505			125

Net increase (decrease) in cash and cash equivalents		9,236			(6,094	)
Cash and cash equivalents at beginning of period		22,995			65,642

Cash and cash equivalents at end of period	$	32,231		$	59,548


SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest	$	16		$	54

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	Three months ended March 31,
	2003			2002
	(in thousands)
Beginning balance	$	2,304		1,787
Charges to costs and expenses		373		400
Warranty expenditures		(399	)	(400	)

Ending balance	$	2,278		1,787

	Workforce Reductions			Consolidation of Excess Facilities			Total
Restructuring Accrual at December 31, 2002	$	60		$	70,552		$	70,612
Cash payments		(60	)		(3,671	)		(3,731	)

Restructuring Accrual at March 31, 2003	$	—		$	66,881		$	66,881

	March 31, 2003			December 31, 2002
	(in thousands)
Intangible assets, net
Existing technology	$	24,522		$	24,091
Non-compete agreements		10,400			10,400

		34,922			34,491
Less: Accumulated amortization		(32,261	)		(30,133	)

	$	2,661		$	4,358

	March 31, 2003			December 31, 2002
Inventories
Raw materials and work in process	$	2,460		$	3,775
Finished assemblies		8,072			6,368

	$	10,532		$	10,143

Property and equipment, net
Machinery and computer equipment	$	86,103		$	84,879
Software		24,563			23,910
Leasehold improvements		16,529			16,524
Spares		12,211			11,742
Furniture and fixtures		7,154			7,090

		146,560			144,145
Less: Accumulated depreciation and amortization		(92,207	)		(82,670	)

	$	54,353		$	61,475

Other assets
Deferred financing costs	$	8,277		$	8,741
Long-term restricted cash		1,733			1,733
Deposits and other		10,972			11,346

	$	20,982		$	21,820

Accrued liabilities
Accrued compensation	$	6,864		$	5,402
Accrued interest payable		11,812			5,970
Accrued restructuring, current		11,852			16,257
Accrued inventory related commitments		7,887			8,622
Other		30,155			28,156

	$	68,570		$	64,407

Other long-term liabilities
Accrued restructuring, long-term	$	55,029		$	54,355
Deferred rent and leases		1,999			2,276

	$	57,028		$	56,631

	Unrealized gains (losses) on investments			Cumulative translation adjustments			Accumulated other comprehensive loss
Balances at December 31, 2002	$	959		$	(26,976	)	$	(26,017	)
Changes during the three months ended March 31, 2003		(390	)		316			(74	)

Balances at March 31, 2003	$	569		$	(26,660	)	$	(26,091	)

	Three Months Ended March 31,
	2003			2002
Realized gain from investments	$	429		$	—
Net foreign currency losses		(453	)		(223	)
Interest income		1,014			1,313
Other expense		(100	)		(84	)

Total interest and other income, net	$	890		$	1,006

	Nine months ending December 31, 2003		2004-2006		2007-2008		After 2008		Total
Repayment of convertible subordinated notes	$	—	$	—	$	468	$	—	$	468
Interest on convertible subordinated notes		23		70		12		—		105
Lease payments due on properties we occupy		7		26		9		10		52
Lease payments due on properties we currently do not occupy		8		26		7		40		81
Accounts payable to contract manufacturers for inventory on hand		11		—		—		—		11
Lease payments due on equipment leases and related borrowings		1		—		—		—		1
Payments contracted for IT systems hosting		1		4		—		—		5

Total	$	51	$	126	$	496	$	50	$	723

Exhibit Number		Description
10.1		Amendment No. 1 to Loan and Security Agreement by and between Redback Networks Inc. and Silicon Valley Bank dated March 28, 2003.

99.1		Certification of Chief Executive Officer and Chief Financial Officer.