##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


Form 10-K


|                               |  |                                                                                             
|------------------------------ |  | --------------------------------------------------------------------------------------------
|þ                              |  | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934          
|                               |  | For the fiscal year ended January 1, 2005                                                   
|                              
|or                            
|o                              |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|Commission file number 1-10228

Enterasys Networks, Inc.


(Exact name of registrant as specified in its charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 04-2797263                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)

50 Minuteman Road


Andover, Massachusetts 01810


(978) 684-1000


(Address, including zip code, and telephone number, including
area code,


of registrants principal executive offices)


Securities registered pursuant to Section 12(b) of the
Act:


|                                       |  |                                 
|-------------------------------------- |  | --------------------------------
|Title of Each Class                    |  | Name of Exchange on Which Listed
|                                       |  |                                 
|Common Stock, Par Value $.01 Per Share |  | NYSE                            

Securities registered pursuant to Section 12(g) of the
Act: None


þ o


þ


þ o




Documents Incorporated by Reference












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TABLE OF CONTENTS


|                                              |    |   |  |                                                                                           |      |  |    | 
|--------------------------------------------- | -- | - |  | ----------------------------------------------------------------------------------------- | ---- |  | -- | 
|Item                                          |    |   |  |                                                                                           | Page | 
|                                              |    |   |  |                                                                                           |      | 
|PART I                                       
|                                              | 1  | . |  | Business                                                                                  |      |  | 2  | 
|                                              | 2  | . |  | Properties                                                                                |      |  | 12 | 
|                                              | 3  | . |  | Legal Proceedings                                                                         |      |  | 12 | 
|                                              | 4  | . |  | Submission of Matters to a Vote of Security
    Holders                                   |      |  | 13 | 
|PART II                                      
|                                              | 5  | . |  | Market for the Registrants Common
    Equity and Related Stockholder Matters             |      |  | 13 | 
|                                              | 6  | . |  | Selected Consolidated Financial Data                                                      |      |  | 15 | 
|                                              | 7  | . |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations |      |  | 16 | 
|                                              | 7A | . |  | Quantitative and Qualitative Disclosures
    About Market Risk                            |      |  | 41 | 
|                                              | 8  | . |  | Consolidated Financial Statements and
    Supplementary Data                              |      |  | 42 | 
|                                              | 9  | . |  | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure  |      |  | 42 | 
|                                              | 9A | . |  | Controls and Procedures                                                                   |      |  | 42 | 
|                                              | 9B | . |  | Other                                                                                     |      |  | 42 | 
|PART III                                     
|                                              | 10 | . |  | Directors and Executive Officers of the
    Registrant                                    |      |  | 43 | 
|                                              | 11 | . |  | Executive Compensation                                                                    |      |  | 43 | 
|                                              | 12 | . |  | Security Ownership of Certain Beneficial
    Owners and Management                        |      |  | 43 | 
|                                              | 13 | . |  | Certain Relationships and Related
    Transactions                                        |      |  | 43 | 
|                                              | 14 | . |  | Principal Accounting Fees and Services                                                    |      |  | 43 | 
|PART IV                                      
|                                              | 15 | . |  | Exhibits and Financial Statement
    Schedules                                            |      |  | 43 | 
|Ex-21.1 Subsidiaries of the Registrant       
|Ex-23.1 Consent of Independent Auditors      
|Ex-31.1 Sect. 302 Certification of the C.E.O.
|Ex-31.2 Sect. 302 Certification of the C.F.O.
|Ex-32.1 Sect. 906 Certification of the C.E.O.
|Ex-32.2 Sect. 906 Certification of the C.F.O.



1



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##### Table of Contents






PART I







|        |         
|------- | --------
|Item 1. | Business

This annual report on Form 10-K and the following
disclosure contain forward-looking statements. We caution you
that any statements contained in this report which are not
strictly historical statements constitute forward-looking
statements. Such statements include, but are not limited to,
statements reflecting managements expectations regarding
our future financial and operating performance, strategic
relationships and market opportunities, and our other business
and marketing strategies and objectives. These statements may be
identified with such words as we expect, we
believe, we anticipate, or similar indications
of future expectations. These statements are neither promises
nor guarantees, and involve risks and uncertainties that could
cause actual results to differ materially from such
forward-looking statements. Such risks and uncertainties
include, among other things, the following factors: our
quarterly operating results may fluctuate, which could cause us
to fail to meet quarterly operating targets and result in a
decline in our stock price; we earn a substantial portion of our
revenue for each quarter in the last month of each quarter,
which reduces our ability to accurately forecast our quarterly
results and increases the risk that we will be unable to achieve
our goals; we have a history of losses in recent years and may
not operate profitably in the future; worldwide and regional
economic uncertainty may continue to negatively affect our
business and revenue and continue to make forecasting more
difficult; we continue to introduce new products, and if our
customers delay product purchases or choose alternative
solutions, our revenue could decline, we may incur excess and
obsolete inventory charges, and our financial condition could be
harmed; we have experienced changes in senior management and our
current management team has been together for only a limited
time, which could harm our business and operations; the market
for enterprise network equipment is dominated by several large
competitors and is characterized by intense competition, which
could prevent us from increasing our revenue and achieving
profitability; many of our competitors may have greater
resources than us, which could harm our competitive position and
reduce our market share; we may be unable to effectively manage
and increase the productivity of our indirect distribution
channels, which may hinder our ability to grow our customer base
and increase our revenue; a portion of the enterprises we sell
to rely in whole or in part on public funding and often face
significant budgetary pressure, and if these customers must
delay, reduce or forego purchasing from us, our revenues could
be harmed; we depend upon a limited number of contract
manufacturers for substantially all of our manufacturing
requirements, and the loss of any of our primary contract
manufacturers would impair our ability to meet the demands of
our customers; and those additional risks and uncertainties
discussed in Managements Discussion and Analysis of
Financial Condition and Results of Operations under
Cautionary Statements and elsewhere in this report.
Readers are cautioned not to place undue reliance on these
forward looking statements, which speak only as of the date
hereof. We expressly disclaim any obligation to publicly update
or revise any such statements to reflect any change in these
forward-looking statements, or in events, conditions, or
circumstances on which any such statements may be based, or that
may affect the likelihood that actual results will differ from
those set forth in the forward-looking statements.




Introduction




2



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tm tm tm tm tm tm tm tm




| |                        
| | -----------------------
| | Enterprise Requirements





| |              
| | -------------
| | Our Solutions



Networks That Know.




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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Continuity  capability to continue business
    communications, despite new threats or attacks. Networks
    traditionally were measured on their ability to reliably
    transport packets of information. The increasing threat of
    network attacks coupled with the increasing importance of
    information flow means that concern is now focused on continuous
    communications despite malicious activity. We believe networks
    must both lower the success rate of attacks and limit the impact
    of attacks that do succeed in affecting the network.                                                                                                                                                                                                                                                                                                    
|
| |  | Context  communications with the ability to think and
    operate in more human terms. More than just transporting packets
    of information, networks must increasingly be capable of
    recognizing the context of an information flow in order to
    properly prioritize traffic and eliminate the flow of
    undesirable traffic. For example, networks must know who sent a
    packet, from where, to whom and how many packets were sent as
    well as place this information in context in order to more
    effectively prioritize traffic, limit or eliminate the flow of
    undesirable traffic and protect the network from internal and
    external security threats.                                                                                                                                                                                   
|
| |  | Control  capability to actively control network
    traffic at the end-user or device level. Networks that transport
    divergent communication types require enhanced ability to
    control network traffic at an end-user or device level without
    significantly increasing the number of networking focused, IT
    professionals. For example, networks which are able to
    automatically limit or eliminate network traffic at the end-user
    or device level in response to emerging security threats.                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Compliance  capability to align business
    communications services to a businesses needs. Network
    administrators and security officers share the responsibility
    for ensuring the network is aligned with business requirements.
    These requirements include expectations of privacy and
    accountability of digital information as enforced by an
    increasing number of domestic and foreign laws and regulations.
    Customers require networks that will facilitate their
    compliance efforts by protecting information flows over the
    network.                                                                                                                                                                                                                                                                                               
|
| |  | Consolidation  capability to integrate dissimilar
    communications types and user communities without compromising
    their needs or creating new restrictions. Networks have moved
    beyond supporting only data communications to integrating
    dissimilar communications types from various user communities.
    This handling of diverse communications on a single,
    consolidated network is referred to as convergence. Networks
    must support convergence without compromising performance or
    imposing new restrictions. In other words, the network must have
    the intelligence required to secure and prioritize
    communications flows based upon the type of communication and
    the role of the individual user. For example, a network must
    prioritize voice traffic over less important communication
    traffic such as e-mail.



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our Acceptable Use Policy, or AUP, solution is a unique,
    policy-based system that allows the network to provision
    required business services to users automatically, while
    preventing undesirable and malicious traffic from entering the
    infrastructure. Our AUP solution can secure the enterprise
    network from undesirable applications and protocols, respond
    quickly and effectively to changes in the environment, ensure
    reliable access to business-critical services by enforcing an
    application prioritization scheme, and enable automation and
    system-level control to lower the cost of network
    administration, implementation, and troubleshooting. Advanced
    deployments of AUP allow an enterprise to provision services and
    applications based upon the enterprises business rules and
    policies to improve business processes and enhance security.                                                                                                                                                             
|
| |  | Our Dynamic Intrusion Response, or DIR, solution detects
    abnormal behavior on the network, then intervenes to quarantine
    the offending user or deviant device. Our DIR solution can
    isolate and categorize each security vulnerability, identify the
    source and automatically reconfigure the network to mitigate the
    threat by leveraging our policy-enabled network switches. Our
    DIR solution also works at a less granular level with third
    party security appliances and third party switching
    infrastructure. This open approach allows IT professionals to
    leverage deployed point products, such as perimeter firewalls
    and intrusion detection products, while simultaneously reducing
    the exposure of IT resources to internal and external security
    threats.                                                                                                                                                                                                                                                              
|
| |  | Our Trusted End-System, or TES, solution allows an enterprise to
    deploy cost-effective, end-system admission control for every
    local area network connected user, enhancing the
    enterprises overall security posture and maximizing
    network availability. We believe our TES functionality is
    critical, as many workstations and other networked devices
    connect to the enterprise infrastructure without the latest
    security updates, leaving these end-systems vulnerable to
    malicious attacks that could compromise critical resources and
    lead to business disruption. Our TES solution uniquely addresses
    this challenge by enabling the automatic quarantine of suspect
    end-systems, providing protection against sophisticated network
    threats while simplifying the deployment of security updates.
    Since no user interaction is required, our TES solution enables
    enterprises to leverage the power of centralized, policy-based
    network management, increasing the ease of deployment and
    administration.

Our Products






| |                            
| | ---------------------------
| | Secure Multilayer Switching



5



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| |               
| | --------------
| | Secure Routing







| |                                         
| | ----------------------------------------
| | Security and Network Management Software







6



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| |                           
| | --------------------------
| | Secure Wireless Networking





Customer Service and Support










| |   |                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Extended Warranty consists of technical telephone support during
    our normal business hours, around-the-clock on-line support, and
    repair or replacement of failed products.           
|
| |  | Technical Access Service represents around-the-clock technical
    telephone support and on-line support, access to upgrades and
    repair or replacement of failed products.                
|
| |  | Express Parts Service includes Technical Access Service and
    express shipment of products and parts in the event of equipment
    failure.                                                 
|
| |  | On-Site Response includes all the features of our Express Parts
    Service and the on-site assistance of our customer support
    engineers.                                                 
|
| |  | Managed Network Service includes a full complement of support
    services along with network equipment usage for customers
    looking to outsource portions of their network infrastructure.

Sales Overview




7



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Marketing










8



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Customers






Competition








| |   |                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Products and solutions that offer integrated security
    functionality and proactive network monitoring to prevent,
    detect and protect the network against security threats;
|
| |  | technology leadership now and in the future;                                                                                                                                     
|
| |  | compatibility with industry standards, other vendor products and
    prior generations;                                                                                          
|
| |  | effective and reliable customer solutions, service and support
    offerings; and                                                                                                
|
| |  | price of products, total cost of ownership and cost to change
    vendors.                                                                                                       



9



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Manufacturing and Components










Research and Development






10



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Intellectual Property






Backlog




Employees




11



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|        |           
|------- | ----------
|Item 2. | Properties












|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings





Securities Class Action in the District of Rhode
Island. In re Cabletron Systems, Inc.
Securities Litigation (C.A. No. 97-542-JD (N.H.);
No. 99-408-S (R.I.)).




Indemnification Claims.


12



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Other.







|        |                                                    
|------- | ---------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security Holders






PART II







|        |                                                                              
|------- | -----------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common Equity and Related
    Stockholder Matters

Stock Price History




|                                     |  |      |      |  |     |   |      | 
|------------------------------------ |  | ---- | ---- |  | --- | - | ---- | 
|Year Ended January 1, 2005           |  | High |      |  | Low |  
|                                     |  |      |      |  |     |  
|First quarter ended April 3, 2004    |  | $    | 5.31 |  |     | $ | 2.20 | 
|Second quarter ended July 3, 2004    |  |      | 2.62 |  |     |   | 1.68 | 
|Third quarter ended October 2, 2004  |  |      | 2.06 |  |     |   | 1.48 | 
|Fourth quarter ended January 1, 2005 |  | $    | 1.90 |  |     | $ | 1.19 | 

|                                       |  |      |      |  |     |   |      | 
|-------------------------------------- |  | ---- | ---- |  | --- | - | ---- | 
|Year Ended January 3, 2004             |  | High |      |  | Low |  
|                                       |  |      |      |  |     |  
|First quarter ended March 29, 2003     |  | $    | 2.30 |  |     | $ | 1.50 | 
|Second quarter ended June 28, 2003     |  |      | 3.87 |  |     |   | 1.73 | 
|Third quarter ended September 27, 2003 |  |      | 6.70 |  |     |   | 2.84 | 
|Fourth quarter ended January 3, 2004   |  | $    | 5.80 |  |     | $ | 3.40 | 



Equity Compensation Plan Information




|                                                           |  |                      |            |     |                   |                      |                     |                      |  |  |            |    
|---------------------------------------------------------- |  | -------------------- | ---------- | --- | ----------------- | -------------------- | ------------------- | -------------------- |  |  | ---------- | ---
|                                                           |  | (a)                  |            |     | (b)               |                      |                     | (c)                  | 
|                                                           |  |                      |            |     |                   |                      |                     |                      | 
|                                                           |  |                      |            |     |                   | Number of Securities |                    
|                                                           |  | Number of Securities |            |     |                   |                      | Remaining Available |                     
|                                                           |  | Issuable Upon        |            |     | Weighted-Average  |                      |                     | for Issuance Under   | 
|                                                           |  | Exercise of          |            |     | Exercise Price of |                      |                     | Equity Compensation  | 
|                                                           |  | Outstanding Options, |            |     | Outstanding       |                      |                     | Plans (Excluding     | 
|                                                           |  | Warrants and         |            |     | Options, Warrants |                      |                     | Securities Reflected | 
|Plan Category                                              |  | Rights (#)           |            |     | and Rights ($)    |                      |                     | in Column (a)) (#)   | 
|                                                           |  |                      |            |     |                   |                      |                     |                      | 
|Equity Compensation Plans Approved by Security Holders     |  |                      | 18,190,694 | (1) |                   | $                    | 3.04                |                      |  |  | 11,722,325 | (2)
|Equity Compensation Plans Not Approved by Security Holders |  |                      | 12,413,094 | (3) |                   | $                    | 3.16                | (4)                  |  |  |           |    
|                                                           |  |                      |            |     |                   |                      |                     |                      | 
|Total                                                      |  |                      | 30,603,788 |     |                   | $                    | 3.09                |                      |  |  | 11,722,325 |    
|                                                           |  |                      |            |     |                   |                      |                     |                      | 






|    |                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Of this amount, 15,164,784 shares were issued under the
    1998 Equity Incentive Plan and 3,025,910 shares were issued
    under the 2004 Equity Incentive Plan.

13



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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Of this amount, 888,105 shares were available for issuance
    under the 1998 Equity Incentive Plan, 6,974,090 shares were
    available for issuance under the 2004 Equity Incentive Plan and
    3,860,130 shares were available for issuance under the 2002
    Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   
|(3) | Of this amount, 11,913,094 shares were issued under the
    2001 Equity Incentive Plan and 500,000 shares were issued
    under the 2002 Stock Option Plan for Eligible Executives. No
    additional options may be granted under these plans. Options
    issued under the 2001 Equity Incentive Plan were issued in
    connection with the merger of the Companys subsidiary,
    then known as Enterasys Networks, Inc., (the Enterasys
    Subsidiary) with and into us in August 2001, replacing
    options previously outstanding under the Enterasys Subsidiary
    2000 Equity Incentive Plan. In exchange for previously
    outstanding options, and subject to their agreement to forfeit
    any pre-existing options to purchase the Companys stock,
    holders of Enterasys Subsidiary options were granted options to
    purchase 1.39105 shares of the Companys stock
    for each share of the Enterasys Subsidiary covered by the
    previously outstanding options. The 2002 Stock Option Plan for
    Eligible Executives and the Enterasys 2001 Equity Incentive Plan
    are each described below in more detail.
|   
|(4) | The replacement options were granted at an exercise price equal
    to the exercise price of the original Enterasys Subsidiary Plan
    options, divided by 1.39105 to reflect the effect of the merger.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          



| |                                                             
| | ------------------------------------------------------------
| | Enterasys 2002 Stock Option Plan for Eligible
    Executives





| |                                     
| | ------------------------------------
| | Enterasys 2001 Equity Incentive Plan



14



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|        |                                     
|------- | ------------------------------------
|Item 6. | Selected Consolidated Financial Data



|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |         |         |          |   |          |         |          |  
|------------------------------------------------------------------------------------------------------- | ------------------------ | --------------------------------------------------- | ------- | ------- | ---------- | - | ------- | ------------ | -------- | - | ------------ | ------- | -------- | ---------- | ------- | ------- | -------- | - | -------- | ------- | -------- | -
|                                                                                                        |                          |                                                     |         |         |            |   |         | Ten Months   |          |   |             
|                                                                                                        |                          | Year Ended                                          |         |         | Year Ended |   |         | Year Ended   |          |   | Ended        |         |          | Year Ended |        
|                                                                                                        |                          | January 1,                                          |         |         | January 3, |   |         | December 28, |          |   | December 29, |         |          | March 3,   |        
|                                                                                                        |                          | 2005                                                |         |         | 2004       |   |         | 2002         |          |   | 2001         |         |          | 2001       |        
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        
|                                                                                                        |                          | (In thousands)                                      |        
|Consolidated Statements of Operations Data:                                                             |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |         |         |          |   |          |        
|Net revenue:                                                                                            |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |         |         |          |   |          |        
|                                                                                                        | Enterasys segment        |                                                     | $       | 356,879 |            |   | $       | 414,538      |          |   | $            | 484,797 |          |            | $       | 394,545 |          |   | $        | 704,665 |         
|                                                                                                        | Other segment(1)         |                                                     |         |        |            |   |         |             |          |   |              |        |          |            |         |        |          |   |          | 69,702  |         
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        
|                                                                                                        | Total net revenue        |                                                     |         | 356,879 |            |   |         | 414,538      |          |   |              | 484,797 |          |            |         | 394,545 |          |   |          | 774,367 |         
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        
|Gross margin                                                                                            |                          |                                                     | 185,754 |         |            |   | 208,375 |              |          |   | 209,795      |         |          |            | 44,169  |         |          |   | 342,600  |        
|Research and development                                                                                |                          |                                                     | 73,808  |         |            |   | 84,029  |              |          |   | 85,019       |         |          |            | 76,471  |         |          |   | 81,723   |        
|Selling, general and administrative                                                                     |                          |                                                     | 161,961 |         |            |   | 173,933 |              |          |   | 234,960      |         |          |            | 284,735 |         |          |   | 335,303  |        
|Amortization of intangible assets                                                                       |                          |                                                     | 4,385   |         |            |   | 6,503   |              |          |   | 8,708        |         |          |            | 32,366  |         |          |   | 23,176   |        
|Stock-based compensation                                                                                |                          |                                                     |        |         |            |   | 158     |              |          |   | 2,644        |         |          |            | 30,572  |         |          |   | 1,442    |        
|Restructuring and other charges                                                                         |                          |                                                     | 16,635  |         |            |   | 17,532  |              |          |   | 31,978       |         |          |            | 47,168  |         |          |   | 63,187   |        
|Shareholder litigation expense                                                                          |                          |                                                     | 625     |         |            |   | 15,900  |              |          |   |             |         |          |            |        |         |          |   |         |        
|Impairment of intangible assets                                                                         |                          |                                                     | 8,734   |         |            |   |        |              |          |   |             |         |          |            | 104,147 |         |          |   | 14,104   |        
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        
|                                                                                                        | Total operating expenses |                                                     |         | 266,148 |            |   |         | 298,055      |          |   |              | 363,309 |          |            |         | 575,459 |          |   |          | 518,935 |         
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        
|                                                                                                        |                          | Loss from operations                                |         |         | (80,394    | ) |         |              | (89,680  | ) |              |         | (153,514 | )          |         |         | (531,290 | ) |          |         | (176,335 | )
|Interest income, net                                                                                    |                          |                                                     | 3,110   |         |            |   | 5,132   |              |          |   | 8,347        |         |          |            | 17,672  |         |          |   | 29,981   |        
|Other expense, net                                                                                      |                          |                                                     | (4,954  | )       |            |   | (27,354 | )            |          |   | (42,625      | )       |          |            | (41,209 | )       |          |   | (557,355 | )      
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        
|                                                                                                        |                          | Loss from continuing operations before income taxes |         |         | (82,238    | ) |         |              | (111,902 | ) |              |         | (187,792 | )          |         |         | (554,827 | ) |          |         | (703,709 | )
|Income tax (benefit) expense                                                                            |                          |                                                     | (11,104 | )       |            |   | 749     |              |          |   | (85,247      | )       |          |            | 60,242  |         |          |   | (98,187  | )      
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        
|                                                                                                        |                          | Loss from continuing operations                     |         | $       | (71,134    | ) |         | $            | (112,651 | ) |              | $       | (102,545 | )          |         | $       | (615,069 | ) |          | $       | (605,522 | )
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        
|Basic and diluted loss from continuing operations available to
    common shareholders per common share |                          | $                                                   | (0.33   | )       |            | $ | (0.56   | )            |          | $ | (0.57        | )       |          | $          | (3.24   | )       |          | $ | (3.40    | )      
|                                                                                                        |                          |                                                     |         |         |            |   |         |              |          |   |              |         |          |            |        

|                                       |  |                |         |  |            |   |         |              |  |   |              |  |  |          |         |  |  |   |           | 
|-------------------------------------- |  | -------------- | ------- |  | ---------- | - | ------- | ------------ |  | - | ------------ |  |  | -------- | ------- |  |  | - | --------- | 
|                                       |  | January 1,     |         |  | January 3, |   |         | December 28, |  |   | December 29, |  |  | March 3, |        
|                                       |  | 2005           |         |  | 2004       |   |         | 2002         |  |   | 2001         |  |  | 2001     |        
|                                       |  |                |         |  |            |   |         |              |  |   |              |  |  |          |        
|                                       |  | (In thousands) |        
|Consolidated Balance Sheet Data:       |  |                |         |  |            |   |         |              |  |   |              |  |  |          |         |  |  |   |           | 
|Working capital                        |  | $              | 35,988  |  |            | $ | 54,120  |              |  | $ | 38,249       |  |  | $        | 134,324 |  |  | $ | 848,179   | 
|Total assets                           |  | $              | 290,313 |  |            | $ | 388,610 |              |  | $ | 581,347      |  |  | $        | 750,038 |  |  | $ | 1,733,514 | 
|Redeemable convertible preferred stock |  | $              |        |  |            | $ |        |              |  | $ |             |  |  | $        | 61,789  |  |  | $ | 109,589   | 
|Stockholders equity                   |  | $              | 109,738 |  |            | $ | 180,061 |              |  | $ | 245,950      |  |  | $        | 329,704 |  |  | $ | 1,214,319 | 






|    |                                                                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Other Segment included the revenue and cost of revenue
    relating to legacy products based on non-Ethernet standards that
    are no longer sold by us.

15



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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations

You should read the following discussion in conjunction with
the section below titled Cautionary Statements, our
Consolidated Financial Statements and related Notes, and other
financial information appearing elsewhere in this annual report
on Form 10-K. We refer to the twelve-month period ending
December 31, 2005 as our current fiscal year;
the twelve-month period ending January 1, 2005 as
fiscal year 2004; the twelve-month period ending
January 3, 2004 as fiscal year 2003; and the
twelve-month period ended December 28, 2002 as fiscal
year 2002 throughout this Item.


Business Overview














| |   |                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Continued the refresh of our entire product line including our
    Matrix C Series switch product and eleven new modules for our
    Matrix N Series Switching products; releasing enhancements
    to our

16



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| |   |                                                                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | Secure Networks offering with our Trusted End Systems
    (TES) admission control functionality and our Dynamic
    Intrusion Response (DIR) detection and intervention
    capability; and introducing a beta version of our Matrix X
    Series router;                          
|
| |  | Appointed a new Executive Vice President of Worldwide Sales and
    Service, and appointed several new senior sales leaders in North
    America;                                                                                                                                  
|
| |  | Launched an advertising and brand awareness campaign focusing on
    our Secure Networks
    tm
    solutions;                                                                                                                                                                     
|
| |  | Formed a new alliance with Lucent Technologies aimed at
    broadening our market reach through the Lucent professional
    services organization;                                                                                                                                 
|
| |  | Focused our efforts on increasing sales opportunities through
    our global partners: EDS, IBM, Lucent, Siemens and Dell; and                                                                                                                                                     
|
| |  | Completed a cost reduction plan to reduce our annual costs by an
    aggregate of approximately $28 million, consisting of
    approximately $24 million in reduced annual operating
    expenses and $4 million in reduced cost of revenue from the
    first quarter 2004 levels.



Results of Operations




|                 |          |                       |  |      |             |  |  |             |       |  |  |      |       | 
|---------------- | -------- | --------------------- |  | ---- | ----------- |  |  | ----------- | ----- |  |  | ---- | ----- | 
|                 |          | Fiscal Year           |  |      | Fiscal Year |  |  | Fiscal Year |      
|                 |          | 2004                  |  |      | 2003        |  |  | 2002        |      
|                 |          |                       |  |      |             |  |  |             |      
|Net revenue:     |          |                       |  |      |             |  |  |             |       |  |  |     
|                 | Product  |                       |  | 73.7 | %           |  |  | 72.4        | %     |  |  | 71.5 | %    
|                 | Services |                       |  | 26.3 |             |  |  | 27.6        |       |  |  | 28.5 |      
|                 |          |                       |  |      |             |  |  |             |      
|                 |          | Total revenue         |  |      | 100.0       |  |  |             | 100.0 |  |  |      | 100.0 | 
|                 |          |                       |  |      |             |  |  |             |      
|Cost of revenue: |          |                       |  |      |             |  |  |             |       |  |  |     
|                 | Product  |                       |  | 51.0 |             |  |  | 53.0        |       |  |  | 66.7 |      
|                 | Services |                       |  | 39.3 |             |  |  | 41.1        |       |  |  | 31.6 |      
|                 |          |                       |  |      |             |  |  |             |      
|                 |          | Total cost of revenue |  |      | 48.0        |  |  |             | 49.7  |  |  |      | 56.7  | 
|                 |          |                       |  |      |             |  |  |             |      

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|                                    |                       |                          |      |      |             |    |      |             |       |    |      |      |       |   
|----------------------------------- | --------------------- | ------------------------ | ---- | ---- | ----------- | -- | ---- | ----------- | ----- | -- | ---- | ---- | ----- | --
|                                    |                       | Fiscal Year              |      |      | Fiscal Year |    |      | Fiscal Year |      
|                                    |                       | 2004                     |      |      | 2003        |    |      | 2002        |      
|                                    |                       |                          |      |      |             |    |      |             |      
|Gross margin:                       |                       |                          |      |      |             |    |      |             |       |    |      |     
|                                    | Product gross margin  |                          |      | 49.0 |             |    |      | 47.0        |       |    |      | 33.3 |      
|                                    | Services gross margin |                          |      | 60.7 |             |    |      | 58.9        |       |    |      | 68.4 |      
|                                    |                       |                          |      |      |             |    |      |             |      
|                                    |                       | Total gross margin       |      |      | 52.0        |    |      |             | 50.3  |    |      |      | 43.3  |   
|                                    |                       |                          |      |      |             |    |      |             |      
|Research and development            |                       |                          | 20.7 |      |             |    | 20.3 |             |       |    | 17.5 |     
|Selling, general and administrative |                       |                          | 45.4 |      |             |    | 42.0 |             |       |    | 48.5 |     
|Amortization of intangible assets   |                       |                          | 1.2  |      |             |    | 1.6  |             |       |    | 1.8  |     
|Stock-based compensation            |                       |                          |     |      |             |    |     |             |       |    | 0.6  |     
|Shareholder litigation expense      |                       |                          | 0.1  |      |             |    | 3.8  |             |       |    |     |     
|Restructuring and other charges     |                       |                          | 4.7  |      |             |    | 4.2  |             |       |    | 6.6  |     
|Impairment of intangible assets     |                       |                          | 2.4  |      |             |    |     |             |       |    |     |     
|                                    |                       |                          |      |      |             |    |      |             |      
|                                    |                       | Total operating expenses |      |      | 74.5        |    |      |             | 71.9  |    |      |      | 75.0  |   
|                                    |                       |                          |      |      |             |    |      |             |      
|                                    |                       | Loss from operations     |      |      | (22.5       | )% |      |             | (21.6 | )% |      |      | (31.7 | )%
|                                    |                       |                          |      |      |             |    |      |             |      

Comparison of Fiscal Year 2004 with Fiscal Year 2003




| |            
| | -----------
| | Net Revenue









| |             
| | ------------
| | Gross Margin





18



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| |                   
| | ------------------
| | Operating Expenses







| |                                  
| | ---------------------------------
| | Amortization of Intangible Assets





| |                                
| | -------------------------------
| | Impairment of Intangible Assets





| |                               
| | ------------------------------
| | Shareholder Litigation Expense

In re Cabletron Systems, Inc. Securities
Litigation.


19



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| |                                
| | -------------------------------
| | Restructuring and Other Charges





| |                     
| | --------------------
| | Interest Income, net





| |                   
| | ------------------
| | Other Expense, net





| |                             
| | ----------------------------
| | Income Tax (Benefit) Expense



Comparison of Fiscal Year 2003 with Fiscal Year 2002




| |            
| | -----------
| | Net Revenue



20



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| |             
| | ------------
| | Gross Margin









| |                   
| | ------------------
| | Operating Expenses







| |                                  
| | ---------------------------------
| | Amortization of Intangible Assets



21



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| |                         
| | ------------------------
| | Stock-based Compensation





| |                               
| | ------------------------------
| | Shareholder Litigation Expense





| |                                
| | -------------------------------
| | Restructuring and Other Charges





| |                     
| | --------------------
| | Interest Income, net





| |                   
| | ------------------
| | Other Expense, net





| |                             
| | ----------------------------
| | Income Tax Expense (Benefit)





| |                                  
| | ---------------------------------
| | Loss from Discontinued Operations



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Liquidity and Capital Resources






| |            
| | -----------
| | Commitments



|                                         |  |               |      |           |        |   |      |           |  |   |           |  |  |         |     |  |  |   |     | 
|---------------------------------------- |  | ------------- | ---- | --------- | ------ | - | ---- | --------- |  | - | --------- |  |  | ------- | --- |  |  | - | --- | 
|                                         |  |               |      | Less Than |        |   |      |           |  |   | More Than | 
|Contractual Cash Obligations             |  | Total         |      |           | 1 Year |   |      | 1-3 Years |  |   | 4-5 Years |  |  | 5 Years |    
|                                         |  |               |      |           |        |   |      |           |  |   |           |  |  |         |    
|                                         |  | (In millions) |     
|Non-cancelable lease obligations         |  | $             | 27.0 |           |        | $ | 7.6  |           |  | $ | 12.1      |  |  | $       | 3.6 |  |  | $ | 3.7 | 
|Non-cancelable purchase commitments      |  |               | 21.9 |           |        |   | 21.9 |           |  |   |          |  |  |         |    |  |  |   |    | 
|Obligations under restructuring plans(1) |  |               | 13.1 |           |        |   | 9.5  |           |  |   | 2.6       |  |  |         | 0.8 |  |  |   | 0.2 | 
|Royalty and license obligations          |  |               | 10.3 |           |        |   | 6.1  |           |  |   | 4.2       |  |  |         |    |  |  |   |    | 
|                                         |  |               |      |           |        |   |      |           |  |   |           |  |  |         |    
|Total contractual cash obligations       |  | $             | 72.3 |           |        | $ | 45.1 |           |  | $ | 18.9      |  |  | $       | 4.4 |  |  | $ | 3.9 | 
|                                         |  |               |      |           |        |   |      |           |  |   |           |  |  |         |    
|                                        
|Other Commercial Commitments             |  |               |      |           |        |   |      |           |  |   |           |  |  |         |     |  |  |   |     | 
|                                         |  |               |      |           |        |   |      |           |  |   |           |  |  |         |    
|                                        
|Aprisma lease payment guarantees(2)      |  | $             | 4.0  |           |        | $ |     |           |  | $ |          |  |  | $       | 1.0 |  |  | $ | 3.0 | 
|Venture capital commitments(3)           |  |               | 1.0  |           |        |   | 1.0  |           |  |   |          |  |  |         |    |  |  |   |    | 
|                                         |  |               |      |           |        |   |      |           |  |   |           |  |  |         |    
|Total commercial commitments             |  | $             | 5.0  |           |        | $ | 1.0  |           |  | $ |          |  |  | $       | 1.0 |  |  | $ | 3.0 | 
|                                         |  |               |      |           |        |   |      |           |  |   |           |  |  |         |    






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes lease obligations for exited facilities of
    $1.8 million in 2005, $1.5 million in 2006,
    $0.7 million in 2007, $0.4 million in 2008,
    $0.4 million in 2009 and $0.5 million thereafter.                                                                                                                                                                                                                                                                                              
|   
|(2) | The Aprisma lease guarantee reduces to $3.0 million in
    2009, $2.0 million in 2010, $1.0 million in 2011 and
    terminates in 2012. We are indemnified for up to
    $3.5 million in losses.                                                                                                                                                                                                                                                                                                       
|   
|(3) | We are committed to make up to $1.0 million of additional
    capital contributions to a venture capital fund in which we are
    a limited partner. In the event of future capital calls, we
    could be required to fund some or all of this commitment. We
    cannot predict the likelihood or timing of capital calls for the
    remaining commitment. We are pursuing the sale of our remaining
    partnership interest in this fund to minimize future capital
    call funding requirements.



| |                             
| | ----------------------------
| | Balance Sheet and Cash Flows





23



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In re Cabletron Systems, Inc. Securities
Litigation.




Application of Critical Accounting Estimates




Revenue Recognition. Revenue Recognition Software Revenue
Recognition, Modification of SOP No. 97-2, Software Recognition
With Respect to Certain Transactions, Revenue Arrangements with Multiple
Deliverables.


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Allowance for Doubtful Accounts and
Notes Receivable.


Provision for Inventory Valuation.


Valuation of Goodwill.


Valuation of Long-lived Assets.


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Valuation of Investments.


Restructuring Reserves.


Income Taxes. Accounting for Contingencies


26



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Summary of Critical Estimates Included in Our Consolidated
Results of Operations.


|                                                         |                                                  |               |       |      |      |   |       |      |  |   |      |      | 
|-------------------------------------------------------- | ------------------------------------------------ | ------------- | ----- | ---- | ---- | - | ----- | ---- |  | - | ---- | ---- | 
|                                                         |                                                  | Fiscal Year   |      
|                                                         |                                                  |               |      
|                                                         |                                                  | 2004          |       |      | 2003 |   |       | 2002 | 
|                                                         |                                                  |               |       |      |      |   |       |      | 
|                                                         |                                                  | (In millions) |      
|Net recoveries of doubtful accounts and notes receivable |                                                  | $             | (3.4  | )    |      | $ | (10.3 | )    |  | $ | (0.9 | )   
|Provision for product inventory write-downs              |                                                  |               | 9.2   |      |      |   | 6.8   |      |  |   | 17.9 |     
|Provision for service inventory valuations               |                                                  |               | 4.6   |      |      |   | 5.4   |      |  |   |     |     
|Loss on minority investments                             |                                                  |               | 8.7   |      |      |   | 27.8  |      |  |   | 22.1 |     
|Restructuring and other charges                          |                                                  |               | 16.6  |      |      |   | 17.5  |      |  |   | 32.0 |     
|Impairment of intangible assets                          |                                                  |               | 8.7   |      |      |   |      |      |  |   |     |     
|Provision for tax contingencies                          |                                                  |               | (12.7 | )    |      |   | (1.0  | )    |  |   | 20.5 |     
|                                                         |                                                  |               |       |      |      |   |       |      | 
|                                                         | Total expense from critical accounting estimates |               | $     | 31.7 |      |   | $     | 46.2 |  |   | $    | 91.6 | 
|                                                         |                                                  |               |       |      |      |   |       |      | 

New Accounting Pronouncements


The
Meaning of Other-Than-Temporary Impairment and its Application
to Certain Investments


Share-Based Payment Accounting for Stock-Based
Compensation, Accounting for Stock Issued to Employees,


Application of FASB
Statement No. 109, Accounting for Income Taxes, to the
Deduction on Qualified Production Activities Provided by the
American Jobs Creation Act of 2004.


Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provision within the American Jobs Creation Act of
2004.


27



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CAUTIONARY STATEMENTS


We may occasionally make forward-looking statements and
estimates such as forecasts and projections of our future
performance or statements of our plans and objectives. These
forward-looking statements may be contained in, among other
things, SEC filings, including this annual report on
Form 10-K, press releases made by us, and in oral
statements made by our officers. Actual results could differ
materially from those contained in such forward-looking
statements. Important factors that could cause our actual
results to differ from those contained in such forward-looking
statement include, among other things, the risks described
below.


Risks Related to our Financial Results and Condition




| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our quarterly operating results may fluctuate, which could
    cause us to fail to meet quarterly operating targets and result
    in a decline in our stock price







| |   |                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------
| |  | fluctuations in the demand for our products and services;                                                             
|
| |  | the timing and size of sales of our products or the cancellation
    or rescheduling of significant orders;           
|
| |  | the length and variability of the sales cycle for our products;                                                       
|
| |  | the timing of implementation and product acceptance by our
    customers and by customers of our distribution partners
|
| |  | the timing and success of new product introductions;                                                                  
|
| |  | increases in the prices or decreases in the availability of the
    components we purchase;                           
|
| |  | price and product competition in the networking industry;                                                             
|
| |  | our ability to source and receive from third party sources
    appropriate product volumes and quality;               
|
| |  | our ability to execute on our operating plan and strategy;                                                            
|
| |  | manufacturing lead times and our ability to maintain appropriate
    inventory levels;                                
|
| |  | the timing and level of research, development and prototype
    expenses;                                             
|
| |  | the mix of products and services sold;                                                                                
|
| |  | changes in the distribution channels through which we sell our
    products and the loss of distribution partners;    

28



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| |   |                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------
| |  | the uncertainties inherent in our accounting estimates and
    assumptions and the impact of changes in accounting principles;
|
| |  | our ability to achieve targeted cost reductions;                                                                              
|
| |  | indemnity claims by eligible current or former directors and
    officers; and                                                
|
| |  | general economic conditions as well as those specific to the
    networking industry.                                         





| |                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We earn a substantial portion of our revenue for each
    quarter in the last month of each quarter, which reduces our
    ability to accurately predict our quarterly results and
    increases the risk that we will be unable to achieve our
    goals





| |                                                                                             
| | --------------------------------------------------------------------------------------------
| | We have a history of losses in recent years and may not
    operate profitably in the future





| |                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Worldwide and regional economic uncertainty may continue
    to negatively affect our business and revenue and continue to
    make forecasting more difficult



29



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| |                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We continue to introduce new products, and if our
    customers delay product purchases or choose alternative
    solutions, our revenue could decline, we may incur excess and
    obsolete inventory charges, and our financial condition could be
    harmed





| |                                                                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have experienced changes in our senior management and
    our current management team has been together for only a limited
    time, which could harm our business and operations



30



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| |                                                                      
| | ---------------------------------------------------------------------
| | Retaining key management and employees is critical to our
    success







| |                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | There is intense competition in the market for enterprise
    network equipment, which could prevent us from increasing our
    revenue and achieving profitability





| |                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------
| | Our competitors may have greater resources than us, which
    could harm our competitive position and reduce our market
    share



31



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| |                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may need additional capital to fund our future
    operations, commitments and contingencies and, if it is not
    available when needed, our business and financial condition may
    be harmed







| |                                                               
| | --------------------------------------------------------------
| | We are exposed to the credit risk of some of our
    customers



Risks Related to the Market for our Products




| |                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may be unable to effectively manage and increase the
    productivity of our indirect distribution channels, which may
    hinder our ability to grow our customer base and increase our
    revenue



32



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| |                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------
| | We expect the average selling prices of our products to
    decrease over time, which may reduce our revenue and gross
    margins





| |                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we do not anticipate and respond to technological
    developments and evolving customer requirements and introduce
    new products in a timely manner, we may not retain our current
    customers or attract new customers







| |                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our focus on sales to enterprise customers subjects us to
    risks that may be greater than those for providers with a more
    diverse customer base



33



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Risks Related to our Products




| |                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our products are very complex, and undetected defects may
    increase our costs, harm our reputation with our customers and
    lead to costly litigation







| |                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If our products do not comply with complex governmental
    regulations and evolving industry standards, our products may
    not be widely accepted, which may prevent us from sustaining our
    revenue or achieving profitability





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| |                                                                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may periodically establish relationships with other
    companies to develop, manufacture and sell products, which could
    increase our reliance on others for development or supply
    capabilities or generation of revenue and may lead to disputes
    about ownership of intellectual property





| |                                                                                               
| | ----------------------------------------------------------------------------------------------
| | Our limited ability to protect our intellectual property
    may hinder our ability to compete

We regard our products and technology as proprietary.




| |                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may be subject to claims that our intellectual property
    infringes upon the proprietary rights of others, and a
    successful claim could harm our ability to sell and develop our
    products



35



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Risks Related to our Manufacturing and Components




| |                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We use several key components for our products that we
    purchase from sole, single or limited sources, and we could lose
    sales if these sources fail to fulfill our needs







| |                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We depend upon a limited number of contract manufacturers
    for substantially all of our manufacturing requirements, and the
    loss of either of our primary contract manufacturers would
    impair our ability to meet the demands of our customers



36



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







| |                                                                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We plan to continue introducing new and complex products,
    and if our contract manufacturers are unable to manufacture
    these products consistently and in required quantities, we could
    lose sales



Other Risks Related to our Business




| |                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our significant sales outside of North America subject us
    to increasing foreign political and economic risks, including
    foreign currency fluctuations





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| |   |                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | political and economic instability and changing regulatory
    environments in foreign countries;                                                                  
|
| |  | increased time to deliver solutions to customers due to the
    complexities associated with managing an international
    distribution system;                    
|
| |  | increased time to collect receivables caused by slower payment
    practices in many international markets;                                                        
|
| |  | managing export licenses, tariffs and other regulatory issues
    pertaining to international trade, including those related to
    counter-terrorism and security;
|
| |  | increased effort and costs associated with the protection of our
    intellectual property in foreign countries; and                                               
|
| |  | difficulties in hiring and managing employees in foreign
    countries.                                                                                            



| |                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------
| | The limitations of our director and officer liability
    insurance may materially harm our financial condition





| |                                                                                              
| | ---------------------------------------------------------------------------------------------
| | Our failure to maintain adequate systems, controls and
    procedures could harm our business



38



---



##### Table of Contents







| |                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have not established a comprehensive disaster recovery
    plan and if we are unable to quickly and successfully restore
    our operations our revenue and our business could be
    harmed





| |                                                                                                
| | -----------------------------------------------------------------------------------------------
| | We have made and may make future acquisitions or
    dispositions, which involve numerous risks





39



---



##### Table of Contents







| |   |                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulties and unanticipated costs incurred in assimilating
    the operations of the acquired business, technologies or product
    lines or of segregating, marketing and disposing of a business,
    technology;
|
| |  | potential disruption of our existing operations;                                                                                                                                                                      
|
| |  | an inability to successfully integrate, train and retain key
    personnel, or transfer or eliminate positions or key personnel;                                                                                      
|
| |  | diversion of management attention and employees from day-to-day
    operations;                                                                                                                                       
|
| |  | an inability to incorporate, develop or market acquired
    businesses, technologies or product lines, or realize value from
    technologies, products or businesses;                                                
|
| |  | operating inefficiencies associated with managing companies in
    different locations, or separating integrated
    operations; and                                                                                  
|
| |  | impairment of relationships with employees, customers, suppliers
    and strategic partners.                                                                                                                          





| |                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The market price of our common stock has historically been
    volatile, and declines in the market price of our common stock
    may negatively impact our ability to make future strategic
    acquisitions, raise capital, issue debt, and retain
    employees





| |                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Provisions of our articles of incorporation and bylaws and
    our investor rights plan could delay or prevent a change in
    control, which could reduce our stock price





40



---



##### Table of Contents










|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About Market
    Risk



Interest Rate Sensitivity.


Foreign Currency Exchange Risk.




Equity Price Risk.


41



---



##### Table of Contents








|        |                                                             
|------- | ------------------------------------------------------------
|Item 8. | Consolidated Financial Statements and Supplementary
    Data








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure








|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of Disclosure Controls and Procedures




Internal Control over Financial Reporting


Managements Annual Report on Internal Control
Over Financial Reporting






Changes In Internal Control Over Financial
Reporting









|         |                  
|-------- | -----------------
|Item 9B. | Other Information



42



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##### Table of Contents






PART III







|         |                                                   
|-------- | --------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant








|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation








|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management








|         |                                               
|-------- | ----------------------------------------------
|Item 13. | Certain Relationships and Related Transactions








|         |                                       
|-------- | --------------------------------------
|Item 14. | Principal Accounting Fees and Services






PART IV







|         |                                           
|-------- | ------------------------------------------
|Item 15. | Exhibits and Financial Statement Schedules

Documents filed as part of this report:




| |    |                                               
| | -- | ----------------------------------------------
| | 1. | Consolidated Financial Statements (See Item 8)

|                                                                                                                                                                                   |  |      |     | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|Statement                                                                                                                                                                          |  | Page |    
|                                                                                                                                                                                   |  |      |    
|Report of Independent Registered Public
    Accounting Firm                                                                                                                        |  |      | F-1 | 
|Consolidated Balance Sheets at
    January 1, 2005 and January 3, 2004                                                                                                             |  |      | F-2 | 
|Consolidated Statements of Operations for
    the years ended January 1, 2005, January 3, 2004, and
    December 28, 2002                                                          |  |      | F-3 | 
|Consolidated Statements of Redeemable
    Convertible Preferred Stock and Stockholders Equity for
    the years ended January 1, 2005, January 3, 2004, and
    December 28, 2002 |  |      | F-4 | 
|Consolidated Statements of Cash Flows for
    the years ended January 1, 2005, January 3, 2004 and
    December 28, 2002                                                           |  |      | F-5 | 
|Notes to Consolidated Financial
    Statements                                                                                                                                     |  |      | F-6 | 



| |    |                                           
| | -- | ------------------------------------------
| | 2. | Consolidated Financial Statement Schedules

|                                                                                            |  |      |     | 
|------------------------------------------------------------------------------------------- |  | ---- | --- | 
|Schedule                                                                                    |  | Page |    
|                                                                                            |  |      |    
|Schedule II  Valuation and
    Qualifying Accounts                                         |  |      | S-1 | 
|Report of Independent Registered Public
    Accounting Firm on Financial Statement Schedule |  |      | S-2 | 



43



---



##### Table of Contents





| |    |         
| | -- | --------
| | 3. | Exhibits

| |    |     |  |   |  |                                                                                                                                                                                                                                                                    
| | -- | --- |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 3  | .1  |  |  |  | Restated Certificate of Incorporation of the Registrant, a
    Delaware corporation, incorporated by reference to
    Exhibit 3.1 to the Registrants quarterly report on
    Form 10-Q for the period ended October 2, 2004, filed
    November 12, 2004.         
| | 3  | .2  |  |  |  | Amended and Restated By-laws of the Registrant, incorporated by
    reference to Exhibit 3.1 to the Registrants current
    report on Form 8-K filed November 10, 2004.                                                                                           
|
| | 4  | .1  |  |  |  | Specimen stock certificate of the Registrants Common
    Stock, incorporated by reference to Exhibit 4.1 to the
    Registrants transition report on Form 10-K, filed on
    November 26, 2002 (the November 2002 10-K).                                       
|
| | 4  | .2  |  |  |  | Rights Agreement, dated May 28, 2002, between the
    Registrant and EquiServe Trust Company, N.A., as Rights Agent,
    incorporated by reference to Exhibit 4.1 to the Registrants
    current report on Form 8-K, filed May 31, 2002.                           
|
| | 4  | .3  |  |  |  | Form of Rights Certificate, incorporated by reference to
    Exhibit 4.3 to the Registrants current report on
    Form 8-K, filed May 31, 2002.                                                                                                                   
|
| | 10 | .1  |  |  |  | Letter Sublease Agreement, dated June 4, 1998, between the
    Registrant and Picturetel Corporation, together with related
    documents, incorporated by reference to Exhibit 10.8 to the
    Registrants Annual report on Form 10-K, filed on
    June 4, 2001.
|
| | 10 | .2  |  |  |  | Manufacturing Services Agreement, dated as of March 1,
    2000, between the Registrant and Flextronics International USA,
    Inc., incorporated by reference to Exhibit 10.6 to the
    February 2001 10-Q/ A.                                                   
|
| | 10 | .3  |  |  |  | 2002 Employee Stock Purchase Plan, incorporated by reference to
    Exhibit 4.1 to the Registrants registration statement
    on Form S-8, No. 333-103587.                                                                                                       
|
| | 10 | .4  |  |  |  | 2002 Stock Option Plan for Eligible Executives, incorporated by
    reference to Exhibit 10.8 to the Registrants
    Quarterly Report on Form 10-Q for the three-month period
    ended June 29, 2002, filed on January 30, 2003 (the
    January 2003 10-Q).  
|
| | 10 | .5  |  |  |  | 2001 Equity Incentive Plan, incorporated by reference to
    Exhibit 4.1 to the Registrants registration statement
    on Form S-8, No. 333-66774.                                                                                                               
|
| | 10 | .6  |  |  |  | 1998 Equity Incentive Plan, as amended, incorporated by
    reference to Exhibit 4.2 to the Registrants
    registration statement on Form S-8,
    No. 333-103587.                                                                                              
|
| | 10 | .7  |  |  |  | 2004 Equity Incentive Plan, incorporated by reference to
    Exhibit 4.1 to the Registrants registration statement
    on Form S-8, No. 333-117236.                                                                                                              
|
| | 10 | .8  |  |  |  | Amended and Restated Change-in-Control Severance Benefit Plan
    for Key Employees, incorporated by reference to
    Exhibit 10.12 to the Registrants Annual Report on
    Form 10-K, filed on March 18, 2004.                                                  
|
| | 10 | .9  |  |  |  | Amended and Restated Executive Severance Pay Plan, incorporated
    by reference to Exhibit 10.13 to the Registrants
    Annual Report on Form 10-K filed on March 18,
    2004.                                                                                 
|
| | 10 | .10 |  |  |  | Deferral Plan for Directors, incorporated by reference to
    Exhibit 10.4 to the November 2002 10-K.                                                                                                                                                              
|
| | 10 | .11 |  |  |  | 2005 Enterasys Performance Incentive Plan, incorporated by
    reference to Exhibit 10.1 to the Registrants current
    report on Form 8-K filed on February 9, 2005.                                                                                            
|
| | 21 | .1  |  |  |  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                    
|
| | 23 | .1  |  |  |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                          
|
| | 31 | .1  |  |  |  | Certification of Mark Aslett under Section 302 of the
    Sarbanes-Oxley Act.                                                                                                                                                                                      
|
| | 31 | .2  |  |  |  | Certification of Richard S. Haak, Jr. under
    Section 302 of the Sarbanes-Oxley Act.                                                                                                                                                                             
|
| | 32 | .1  |  |  |  | Certification of Mark Aslett under Section 906 of the
    Sarbanes-Oxley Act.*                                                                                                                                                                                     
|
| | 32 | .2  |  |  |  | Certification of Richard S. Haak, Jr. under
    Section 906 of the Sarbanes-Oxley Act.*                                                                                                                                                                            

44



---



##### Table of Contents








|  |                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| | Management contract or compensatory contract, plan, contract or
    arrangement required to be filed as an exhibit to this Annual
    Report on Form 10-K.



|  |                                                                                                                                                                                    
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | The certifications under Section 906 are being
    furnished hereunder and shall not be deemed
    filed for purposes of Section 18 of the
    Securities Exchange Act of 1934.

45



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##### Table of Contents



SIGNATURES






| |                         
| | ------------------------
| | Enterasys Networks, Inc.



| |     |                
| | --- | ---------------
| | By: | /s/ Mark Aslett

| |                                                
| | -----------------------------------------------
| |                                                
| | Mark Aslett                                    
| | Chief Executive Officer, President and Director





|                                                     |  |                                                                                   |  |                |  | 
|---------------------------------------------------- |  | --------------------------------------------------------------------------------- |  | -------------- |  | 
|Signature                                            |  | Title(s)                                                                          |  | Date          
|                                                     |  |                                                                                   |  |               
|                                                    
|/s/ Mark AslettMark
    Aslett                       |  | Chief Executive Officer, President and Director (Principal
    Executive Officer) |  | March 17, 2005
|                                                    
|/s/ Richard S.
    Haak, Jr.Richard
    S. Haak, Jr. |  | Chief Financial Officer (Principal Financial and Accounting
    Officer)          |  | March 17, 2005
|                                                    
|/s/ William K.
    OBrienWilliam
    K. OBrien     |  | Executive Chairman and Director                                                   |  | March 17, 2005
|                                                    
|/s/ Paul R. DuncanPaul
    R. Duncan                 |  | Director                                                                          |  | March 17, 2005
|                                                    
|/s/ Michael GallagherMichael
    Gallagher           |  | Director                                                                          |  | March 17, 2005
|                                                    
|/s/ Edwin A. HustonEdwin
    A. Huston               |  | Director                                                                          |  | March 17, 2005
|                                                    
|/s/ Ronald T. MaheuRonald
    T. Maheu               |  | Director                                                                          |  | March 17, 2005
|                                                    
|/s/ James K. SimsJames
    K. Sims                   |  | Director                                                                          |  | March 17, 2005

46



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##### Table of Contents



EXHIBIT INDEX


| |    |     |  |   |  |                                                                                                                                                                                                                                                                    
| | -- | --- |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 3  | .1  |  |  |  | Restated Certificate of Incorporation of the Registrant, a
    Delaware corporation, incorporated by reference to
    Exhibit 3.1 to the Registrants quarterly report on
    Form 10-Q for the period ended October 2, 2004, filed
    November 12, 2004.         
|
| | 3  | .2  |  |  |  | Amended and Restated By-laws of the Registrant, incorporated by
    reference to Exhibit 3.1 to the Registrants current
    report on Form 8-K filed November 10, 2004.                                                                                           
|
| | 4  | .1  |  |  |  | Specimen stock certificate of the Registrants Common
    Stock, incorporated by reference to Exhibit 4.1 to the
    Registrants transition report on Form 10-K, filed on
    November 26, 2002 (the November 2002 10-K).                                       
|
| | 4  | .2  |  |  |  | Rights Agreement, dated May 28, 2002, between the
    Registrant and EquiServe Trust Company, N.A., as Rights Agent,
    incorporated by reference to Exhibit 4.1 to the Registrants
    current report on Form 8-K, filed May 31, 2002.                           
|
| | 4  | .3  |  |  |  | Form of Rights Certificate, incorporated by reference to
    Exhibit 4.3 to the Registrants current report on Form
    8-K, filed May 31, 2002.                                                                                                                   
|
| | 10 | .1  |  |  |  | Letter Sublease Agreement, dated June 4, 1998, between the
    Registrant and Picturetel Corporation, together with related
    documents, incorporated by reference to Exhibit 10.8 to the
    Registrants Annual report on Form 10-K, filed on
    June 4, 2001.
|
| | 10 | .2  |  |  |  | Manufacturing Services Agreement, dated as of March 1,
    2000, between the Registrant and Flextronics International USA,
    Inc., incorporated by reference to Exhibit 10.6 to the
    February 2001 10-Q/A.                                                    
|
| | 10 | .3  |  |  |  | 2002 Employee Stock Purchase Plan, incorporated by reference to
    Exhibit 4.1 to the Registrants registration statement
    on Form S-8, No. 333-103587.                                                                                                       
|
| | 10 | .4  |  |  |  | 2002 Stock Option Plan for Eligible Executives, incorporated by
    reference to Exhibit 10.8 to the Registrants
    Quarterly Report on Form 10-Q for the three-month period ended
    June 29, 2002, filed on January 30, 2003 (the
    January 2003 10-Q).  
|
| | 10 | .5  |  |  |  | 2001 Equity Incentive Plan, incorporated by reference to
    Exhibit 4.1 to the Registrants registration statement
    on Form S-8, No. 333-66774.                                                                                                               
|
| | 10 | .6  |  |  |  | 1998 Equity Incentive Plan, as amended, incorporated by
    reference to Exhibit 4.2 to the Registrants
    registration statement on Form S-8,
    No. 333-103587.                                                                                              
|
| | 10 | .7  |  |  |  | 2004 Equity Incentive Plan, incorporated by reference to
    Exhibit 4.1 to the Registrants registration statement
    on Form S-8, No. 333-117236.                                                                                                              
|
| | 10 | .8  |  |  |  | Amended and Restated Change-in-Control Severance Benefit Plan
    for Key Employees, incorporated by reference to
    Exhibit 10.12 to the Registrants Annual Report on
    Form 10-K, filed on March 18, 2004.                                                  
|
| | 10 | .9  |  |  |  | Amended and Restated Executive Severance Pay Plan, incorporated
    by reference to Exhibit 10.13 to the Registrants
    Annual Report on Form 10-K filed on March 18, 2004.                                                                                     
|
| | 10 | .10 |  |  |  | Deferral Plan for Directors, incorporated by reference to
    Exhibit 10.4 to the November 2002 10-K.                                                                                                                                                              
|
| | 10 | .11 |  |  |  | 2005 Enterasys Performance Incentive Plan, incorporated by
    reference to Exhibit 10.1 to the Registrants current
    report on Form 8-K filed on February 9, 2005.                                                                                            
|
| | 21 | .1  |  |  |  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                    
|
| | 23 | .1  |  |  |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                          
|
| | 31 | .1  |  |  |  | Certification of Mark Aslett under Section 302 of the
    Sarbanes-Oxley Act.                                                                                                                                                                                      
|
| | 31 | .2  |  |  |  | Certification of Richard S. Haak, Jr. under
    Section 302 of the Sarbanes-Oxley Act.                                                                                                                                                                             
|
| | 32 | .1  |  |  |  | Certification of Mark Aslett under Section 906 of the
    Sarbanes-Oxley Act.*                                                                                                                                                                                     
|
| | 32 | .2  |  |  |  | Certification of Richard S. Haak, Jr. under
    Section 906 of the Sarbanes-Oxley Act.*                                                                                                                                                                            






|  |                                                                                                                                                           
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| | Management contract or compensatory contract, plan, contract or
    arrangement required to be filed as an exhibit to this Annual
    Report on Form 10-K.



|  |                                                                                                                                                                                    
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | The certifications under Section 906 are being
    furnished hereunder and shall not be deemed
    filed for purposes of Section 18 of the
    Securities Exchange Act of 1934.



---



##### Table of Contents






REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM














| |             
| | ------------
| | /s/ KPMG LLP





F-1



---



##### Table of Contents






ENTERASYS NETWORKS, INC.


CONSOLIDATED BALANCE SHEETS


|                                                            |                                                                                                                                                                      |                                            |         |            |            |  |         |           |         | 
|----------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ---------- | ---------- |  | ------- | --------- | ------- | 
|                                                            |                                                                                                                                                                      | January 1,                                 |         |            | January 3, | 
|                                                            |                                                                                                                                                                      | 2005                                       |         |            | 2004       | 
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 
|                                                            |                                                                                                                                                                      | (In thousands, except share                |        
|                                                            |                                                                                                                                                                      | and per share amounts)                     |        
|ASSETS                                                     
|Current assets:                                             |                                                                                                                                                                      |                                            |         |            |            |  |         |          
|                                                            | Cash and cash equivalents                                                                                                                                            |                                            | $       | 70,947     |            |  | $       | 136,801   |        
|                                                            | Marketable securities                                                                                                                                                |                                            |         | 48,472     |            |  |         | 29,851    |        
|                                                            | Accounts receivable, net                                                                                                                                             |                                            |         | 29,088     |            |  |         | 37,541    |        
|                                                            | Inventories                                                                                                                                                          |                                            |         | 27,200     |            |  |         | 29,049    |        
|                                                            | Income tax receivable                                                                                                                                                |                                            |         | 1,732      |            |  |         | 595       |        
|                                                            | Insurance receivable                                                                                                                                                 |                                            |         | 11,008     |            |  |         |          |        
|                                                            | Prepaid expenses and other current assets                                                                                                                            |                                            |         | 18,334     |            |  |         | 18,497    |        
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 
|                                                            |                                                                                                                                                                      | Total current assets                       |         |            | 206,781    |  |         |           | 252,334 | 
|Restricted cash, cash equivalents and marketable securities |                                                                                                                                                                      |                                            | 5,357   |            |            |  | 18,693  |          
|Long-term marketable securities                             |                                                                                                                                                                      |                                            | 30,596  |            |            |  | 35,803  |          
|Investments                                                 |                                                                                                                                                                      |                                            | 388     |            |            |  | 11,417  |          
|Property, plant and equipment, net                          |                                                                                                                                                                      |                                            | 27,828  |            |            |  | 37,881  |          
|Goodwill                                                    |                                                                                                                                                                      |                                            | 15,129  |            |            |  | 15,129  |          
|Intangible assets, net                                      |                                                                                                                                                                      |                                            | 4,234   |            |            |  | 17,353  |          
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 
|                                                            |                                                                                                                                                                      | Total assets                               |         | $          | 290,313    |  |         | $         | 388,610 | 
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 
|                                                           
|LIABILITIES AND STOCKHOLDERS EQUITY                       
|Current liabilities:                                        |                                                                                                                                                                      |                                            |         |            |            |  |         |          
|                                                            | Accounts payable                                                                                                                                                     |                                            | $       | 28,841     |            |  | $       | 39,738    |        
|                                                            | Accrued compensation and benefits                                                                                                                                    |                                            |         | 23,574     |            |  |         | 26,832    |        
|                                                            | Other accrued expenses                                                                                                                                               |                                            |         | 19,001     |            |  |         | 24,114    |        
|                                                            | Accrued legal and litigation costs                                                                                                                                   |                                            |         | 12,945     |            |  |         | 8,338     |        
|                                                            | Accrued restructuring charges                                                                                                                                        |                                            |         | 9,528      |            |  |         | 6,407     |        
|                                                            | Deferred revenue                                                                                                                                                     |                                            |         | 33,136     |            |  |         | 41,187    |        
|                                                            | Customer advances and billings in excess of revenues                                                                                                                 |                                            |         | 11,341     |            |  |         | 7,323     |        
|                                                            | Income taxes payable                                                                                                                                                 |                                            |         | 32,427     |            |  |         | 44,275    |        
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 
|                                                            |                                                                                                                                                                      | Total current liabilities                  |         |            | 170,793    |  |         |           | 198,214 | 
|Long-term deferred revenue                                  |                                                                                                                                                                      |                                            | 6,214   |            |            |  | 6,217   |          
|Long-term accrued restructuring charges                     |                                                                                                                                                                      |                                            | 3,568   |            |            |  | 4,118   |          
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 
|Total liabilities                                           |                                                                                                                                                                      |                                            | 180,575 |            |            |  | 208,549 |          
|                                                            | Commitments and contingencies (Note 19)                                                                                                                              |                                            |         |            |            |  |         |           |        
|Stockholders equity:                                       |                                                                                                                                                                      |                                            |         |            |            |  |         |          
|                                                            | Series F preferred stock, $1.00 par value;
    300,000 shares authorized; none outstanding                                                                           |                                            |         |           |            |  |         |          |        
|                                                            | Undesignated preferred stock, $1.00 par value;
    1,700,000 shares authorized; none outstanding                                                                     |                                            |         |           |            |  |         |          |        
|                                                            | Common stock, $0.01 par value; 450,000,000 shares
    authorized; 212,350,461 and 210,805,013 shares issued at
    January 1, 2005 and January 3, 2004, respectively |                                            |         | 2,124      |            |  |         | 2,108     |        
|                                                            | Additional paid-in capital                                                                                                                                           |                                            |         | 1,191,026  |            |  |         | 1,187,449 |        
|                                                            | Accumulated deficit                                                                                                                                                  |                                            |         | (1,061,384 | )          |  |         | (990,250  | )      
|                                                            | Treasury stock, at cost; 1,748,861 common shares at
    January 1, 2005 and January 3, 2004, respectively                                                            |                                            |         | (30,119    | )          |  |         | (30,119   | )      
|                                                            | Accumulated other comprehensive income                                                                                                                               |                                            |         | 8,091      |            |  |         | 10,873    |        
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 
|                                                            |                                                                                                                                                                      | Total stockholders equity                 |         |            | 109,738    |  |         |           | 180,061 | 
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 
|                                                            |                                                                                                                                                                      | Total liabilities and stockholders equity |         | $          | 290,313    |  |         | $         | 388,610 | 
|                                                            |                                                                                                                                                                      |                                            |         |            |            | 



F-2



---



##### Table of Contents






ENTERASYS NETWORKS, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |          |          |         |         |          |          |  
|---------------------------------------------------------------------------- | ---------------------------------------------------------------- | --------------------------------------------------- | ----------------------------------------- | ------- | ---------- | ------- | ------- | ------------ | -------- | -------- | ------- | ------- | -------- | -------- | -
|                                                                             |                                                                  | Year Ended                                          |                                          
|                                                                             |                                                                  |                                                     |                                          
|                                                                             |                                                                  | January 1,                                          |                                           |         | January 3, |         |         | December 28, |         
|                                                                             |                                                                  | 2005                                                |                                           |         | 2004       |         |         | 2002         |         
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  | (In thousands, except per share amounts)            |                                          
|Net revenue:                                                                 |                                                                  |                                                     |                                           |         |            |         |         |              |          |          |         |        
|                                                                             | Product                                                          |                                                     | $                                         | 263,125 |            |         | $       | 300,119      |          |          | $       | 346,610 |         
|                                                                             | Services                                                         |                                                     |                                           | 93,754  |            |         |         | 114,419      |          |          |         | 138,187 |         
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  | Total net revenue                                   |                                           |         | 356,879    |         |         |              | 414,538  |          |         |         | 484,797  |         
|Cost of revenue:                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |          |          |         |        
|                                                                             | Product                                                          |                                                     |                                           | 134,279 |            |         |         | 159,186      |          |          |         | 231,359 |         
|                                                                             | Services                                                         |                                                     |                                           | 36,846  |            |         |         | 46,977       |          |          |         | 43,643  |         
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  | Total cost of revenue                               |                                           |         | 171,125    |         |         |              | 206,163  |          |         |         | 275,002  |         
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  |                                                     | Gross margin                              |         |            | 185,754 |         |              |          | 208,375  |         |         |          | 209,795  |  
|Operating expenses:                                                          |                                                                  |                                                     |                                           |         |            |         |         |              |          |          |         |        
|                                                                             | Research and development(a)                                      |                                                     |                                           | 73,808  |            |         |         | 84,029       |          |          |         | 85,019  |         
|                                                                             | Selling, general and administrative                              |                                                     |                                           | 161,961 |            |         |         | 173,933      |          |          |         | 234,960 |         
|                                                                             | Amortization of intangible assets                                |                                                     |                                           | 4,385   |            |         |         | 6,503        |          |          |         | 8,708   |         
|                                                                             | Stock-based compensation                                         |                                                     |                                           |        |            |         |         | 158          |          |          |         | 2,644   |         
|                                                                             | Shareholder litigation expense                                   |                                                     |                                           | 625     |            |         |         | 15,900       |          |          |         |        |         
|                                                                             | Restructuring and other charges                                  |                                                     |                                           | 16,635  |            |         |         | 17,532       |          |          |         | 31,978  |         
|                                                                             | Impairment of intangible assets                                  |                                                     |                                           | 8,734   |            |         |         |             |          |          |         |        |         
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  | Total operating expenses                            |                                           |         | 266,148    |         |         |              | 298,055  |          |         |         | 363,309  |         
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  |                                                     | Loss from operations                      |         |            | (80,394 | )       |              |          | (89,680  | )       |         |          | (153,514 | )
|Interest income, net                                                         |                                                                  |                                                     | 3,110                                     |         |            |         | 5,132   |              |          |          | 8,347   |        
|Other expense, net                                                           |                                                                  |                                                     | (4,954                                    | )       |            |         | (27,354 | )            |          |          | (42,625 | )      
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  | Loss from continuing operations before income taxes |                                           |         | (82,238    | )       |         |              | (111,902 | )        |         |         | (187,792 | )       
|Income tax (benefit) expense                                                 |                                                                  |                                                     | (11,104                                   | )       |            |         | 749     |              |          |          | (85,247 | )      
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  | Loss from continuing operations                     |                                           |         | (71,134    | )       |         |              | (112,651 | )        |         |         | (102,545 | )       
|Loss on disposal from discontinued operations (net of tax
    expense of $0) |                                                                  |                                                     |                                          |         |            |         |        |              |          |          | (11,700 | )      
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  |                                                     | Net loss                                  |         |            | (71,134 | )       |              |          | (112,651 | )       |         |          | (114,245 | )
|Accretive dividend and accretion of discount on preferred shares             |                                                                  |                                                     |                                          |         |            |         | (2,192  | )            |          |          | (12,963 | )      
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  |                                                     | Net loss available to common shareholders |         | $          | (71,134 | )       |              | $        | (114,843 | )       |         | $        | (127,208 | )
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|Basic and diluted loss per common share:                                     |                                                                  |                                                     |                                           |         |            |         |         |              |          |          |         |        
|                                                                             | Loss from continuing operations available to common shareholders |                                                     | $                                         | (0.33   | )          |         | $       | (0.56        | )        |          | $       | (0.57   | )       
|                                                                             | Loss on disposal from discontinued operations                    |                                                     |                                           |        |            |         |         |             |          |          |         | (0.06   | )       
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|                                                                             |                                                                  |                                                     | Net loss available to common shareholders |         | $          | (0.33   | )       |              | $        | (0.56    | )       |         | $        | (0.63    | )
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         
|Weighted average number of basic and diluted common shares
    outstanding   |                                                                  |                                                     | 217,594                                   |         |            |         | 205,009 |              |          |          | 201,562 |        
|                                                                             |                                                                  |                                                     |                                           |         |            |         |         |              |         






|    |                                                    
|--- | ---------------------------------------------------
|(a) | Excludes non-cash, stock-based compensation expense



F-3



---



##### Table of Contents



ENTERASYS NETWORKS, INC.





CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED
STOCK


AND STOCKHOLDERS EQUITY


|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |   |   |         |   |   |   |        |   |        |   |         |          |        |          |  
|----------------------------------------------------------- | ---------------------------------- | ------------------------------------------------ | ------------------------ | -------------------- | ------------ | ---------- | ------- | ------ | --- | ----------- | ----------- | ------- | - | -------------- | -------- | - | ------------- | ----------- | --------- | ------------ | - | - | ---------- | -------- | - | ---- | ------------- | - | ------ | - | ---------- | ------ | - | - | ------- | - | - | - | ------ | - | ------ | - | ------- | -------- | ------ | -------- | -
|                                                            |                                    |                                                  |                          | Stockholders Equity |             
|                                                            |                                    | Redeemable                                       |                          |                      |              |           
|                                                            |                                    | Convertible                                      |                          |                      |              |            |        
|                                                            |                                    | Preferred Stock                                  |                          |                      | Common Stock |            |         |        |     | Accumulated |             |         |  
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             | Other   |   |                |         
|                                                            |                                    |                                                  |                          |                      |              | Additional |         |        |     |             | Unearned    |         |   | Treasury Stock |          |   | Comprehensive |             |           | Total        |  
|                                                            |                                    |                                                  |                          | Carrying             |              |            |         |        | Par |             |             | Paid-in |   |                | Retained |   |               | Stock-based |           |              |   |   |            | Income   |   |      | Stockholders |  
|                                                            |                                    | Shares                                           |                          |                      | Value        |            |         | Shares |     |             | Value       |         |   | Capital        |          |   | Earnings      |             |           | Compensation |   |   | Shares     |          |   | Cost |               |   | (Loss) |   |            | Equity |  
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|                                                            |                                    | (In thousands, except number of shares)          |                         
|Balance at December 29, 2001                                |                                    |                                                  | 90,000                   |                      |              | $          | 61,789  |        |     |             | 202,941,544 |         |   | $              | 2,029    |   |               | $           | 1,141,089 |              |   | $ | (748,199   | )        |   | $    | (2,802        | ) |        |   | (3,053,201 | )      |   | $ | (64,890 | ) |   | $ | 2,477  |   |        | $ | 329,704 |         
|Comprehensive loss:                                         |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |   |   |         |   |   |   |        |   |        |   |         |         
|                                                            | Net loss                           |                                                  |                          |                     |              |            |         |       |     |             |             |        |   |                |          |  |               |             |           |             |   |   |            | (114,245 | ) |      |               |  |        |   |            |       |   |   |         |  |   |   |        |  |        |   |         | (114,245 | )     
|                                                            | Other comprehensive income (loss): |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |   |   |         |   |   |   |        |   |        |   |         |          |       
|                                                            |                                    | Unrealized gain on available-for-sale securities |                          |                      |             |            |         |        |    |             |             |         |  |                |          |   |              |             |           |              |  |   |            |          |  |      |               |   |       |   |            |        |  |   |         |   |  |   |        |   | 930    |   |         |          | 930    |         
|                                                            |                                    | Effect of foreign currency translation           |                          |                      |             |            |         |        |    |             |             |         |  |                |          |   |              |             |           |              |  |   |            |          |  |      |               |   |       |   |            |        |  |   |         |   |  |   |        |   | 4,106  |   |         |          | 4,106  |         
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|                                                            |                                    |                                                  | Total comprehensive loss |                      |              |           |         |        |     |            |             |         |   |               |          |   |               |            |           |              |   |  |            |          |   |     |               |   |        |  |            |        |   |  |         |   |   |  |        |   |        |  |         |          |        | (109,209 | )
|Exercise of options and warrants for shares of common stock |                                    |                                                  |                         |                      |              |            |        |        |     |             | 1,333,995   |         |   |                | 13       |   |               |             | 3,833     |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 3,846   |         
|Tax adjustment for options exercised                        |                                    |                                                  |                         |                      |              |            |        |        |     |             |            |         |   |                |         |   |               |             | 30,266    |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 30,266  |         
|Issuance of shares under employee share purchase plan       |                                    |                                                  |                         |                      |              |            |        |        |     |             | 665,189     |         |   |                | 7        |   |               |             | 813       |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 820     |         
|Adjustment to Riverstone stock derivative                   |                                    |                                                  |                         |                      |              |            | 20,048  |        |     |             |            |         |   |                |         |   |               |             |          |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   |        |         
|Accretion of preferred stock discount and dividend          |                                    |                                                  |                         |                      |              |            | 12,963  |        |     |             |            |         |   |                |         |   |               |             |          |              |   |   | (12,963    | )        |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | (12,963 | )       
|Expiration of put options                                   |                                    |                                                  |                         |                      |              |            |        |        |     |             |            |         |   |                |         |   |               |             | 842       |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 842     |         
|Amortization of unearned stock-based compensation           |                                    |                                                  |                         |                      |              |            |        |        |     |             |            |         |   |                |         |   |               |             |          |              |   |   |           |          |   |      | 2,644         |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 2,644   |         
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|Balance at December 28, 2002                                |                                    |                                                  | 90,000                   |                      |              | $          | 94,800  |        |     |             | 204,940,728 |         |   | $              | 2,049    |   |               | $           | 1,176,843 |              |   | $ | (875,407   | )        |   | $    | (158          | ) |        |   | (3,053,201 | )      |   | $ | (64,890 | ) |   | $ | 7,513  |   |        | $ | 245,950 |         
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|Comprehensive loss:                                         |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |   |   |         |   |   |   |        |   |        |   |         |         
|                                                            | Net loss                           |                                                  |                          |                     |              |            |         |       |     |             |             |        |   |                |          |  |               |             |           |             |   |   |            | (112,651 | ) |      |               |  |        |   |            |       |   |   |         |  |   |   |        |  |        |   |         | (112,651 | )     
|                                                            | Other comprehensive income (loss): |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |   |   |         |   |   |   |        |   |        |   |         |          |       
|                                                            |                                    | Unrealized loss on available-for-sale securities |                          |                      |             |            |         |        |    |             |             |         |  |                |          |   |              |             |           |              |  |   |            |          |  |      |               |   |       |   |            |        |  |   |         |   |  |   |        |   | (1,676 | ) |         |          | (1,676 | )       
|                                                            |                                    | Effect of foreign currency translation           |                          |                      |             |            |         |        |    |             |             |         |  |                |          |   |              |             |           |              |  |   |            |          |  |      |               |   |       |   |            |        |  |   |         |   |  |   |        |   | 5,036  |   |         |          | 5,036  |         
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|                                                            |                                    |                                                  | Total comprehensive loss |                      |              |           |         |        |     |            |             |         |   |               |          |   |               |            |           |              |   |  |            |          |   |     |               |   |        |  |            |        |   |  |         |   |   |  |        |   |        |  |         |          |        | (109,291 | )
|Exercise of options and warrants for shares of common stock |                                    |                                                  |                         |                      |              |            |        |        |     |             | 4,693,445   |         |   |                | 47       |   |               |             | 10,940    |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 10,987  |         
|Issuance of shares under employee share purchase plan       |                                    |                                                  |                         |                      |              |            |        |        |     |             | 1,170,840   |         |   |                | 12       |   |               |             | 1,437     |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 1,449   |         
|Adjustment to Riverstone stock derivative                   |                                    |                                                  |                         |                      |              |            | (178    | )      |     |             |            |         |   |                |         |   |               |             |          |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   |        |         
|Accretion of preferred stock discount and dividend          |                                    |                                                  |                         |                      |              |            | 2,192   |        |     |             |            |         |   |                |         |   |               |             |          |              |   |   | (2,192     | )        |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | (2,192  | )       
|Redemption of preferred stock                               |                                    |                                                  | (90,000                  | )                    |              |            | (96,814 | )      |     |             |            |         |   |                |         |   |               |             |          |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   |        |         
|Treasury stock issued for litigation settlement             |                                    |                                                  |                         |                      |              |            |        |        |     |             |            |         |   |                |         |   |               |             | (34,771   | )            |   |   |           |          |   |      |              |   |        |   | 1,304,340  |        |   |   | 34,771  |   |   |   |       |   |        |   |        |         
|Litigation settlement                                       |                                    |                                                  |                         |                      |              |            |        |        |     |             |            |         |   |                |         |   |               |             | 33,000    |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 33,000  |         
|Amortization of unearned stock-based compensation           |                                    |                                                  |                         |                      |              |            |        |        |     |             |            |         |   |                |         |   |               |             |          |              |   |   |           |          |   |      | 158           |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 158     |         
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|Balance at January 3, 2004                                  |                                    |                                                  |                         |                      |              | $          |        |        |     |             | 210,805,013 |         |   | $              | 2,108    |   |               | $           | 1,187,449 |              |   | $ | (990,250   | )        |   | $    |              |   |        |   | (1,748,861 | )      |   | $ | (30,119 | ) |   | $ | 10,873 |   |        | $ | 180,061 |         
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|Comprehensive loss:                                         |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |   |   |         |   |   |   |        |   |        |   |         |         
|                                                            | Net loss                           |                                                  |                          |                     |              |            |         |       |     |             |             |        |   |                |          |  |               |             |           |             |   |   |            | (71,134  | ) |      |               |  |        |   |            |       |   |   |         |  |   |   |        |  |        |   |         | (71,134  | )     
|                                                            | Other comprehensive income (loss): |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |   |   |         |   |   |   |        |   |        |   |         |          |       
|                                                            |                                    | Unrealized gain on available-for-sale securities |                          |                      |             |            |         |        |    |             |             |         |  |                |          |   |              |             |           |              |  |   |            |          |  |      |               |   |       |   |            |        |  |   |         |   |  |   |        |   | (900   | ) |         |          | (900   | )       
|                                                            |                                    | Effect of foreign currency translation           |                          |                      |             |            |         |        |    |             |             |         |  |                |          |   |              |             |           |              |  |   |            |          |  |      |               |   |       |   |            |        |  |   |         |   |  |   |        |   | (1,882 | ) |         |          | (1,882 | )       
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|                                                            |                                    |                                                  | Total comprehensive loss |                      |              |           |         |        |     |            |             |         |   |               |          |   |               |            |           |              |   |  |            |          |   |     |               |   |        |  |            |        |   |  |         |   |   |  |        |   |        |   |         |          |        | (73,916  | )
|Exercise of options for shares of common stock              |                                    |                                                  |                         |                      |              |            |        |        |     |             | 840,745     |         |   |                | 9        |   |               |             | 1,871     |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 1,880   |         
|Issuance of shares under employee share purchase plan       |                                    |                                                  |                         |                      |              |            |        |        |     |             | 716,094     |         |   |                | 7        |   |               |             | 1,706     |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   | 1,713   |         
|Other                                                       |                                    |                                                  |                         |                      |              |            |        |        |     |             | (11,391     | )       |   |                |         |   |               |             |          |              |   |   |           |          |   |      |              |   |        |   |           |        |   |   |        |   |   |   |       |   |        |   |        |         
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  
|Balance at January 1, 2005                                  |                                    |                                                  |                         |                      |              | $          |        |        |     |             | 212,350,461 |         |   | $              | 2,124    |   |               | $           | 1,191,026 |              |   | $ | (1,061,384 | )        |   | $    |              |   |        |   | (1,748,861 | )      |   | $ | (30,119 | ) |   | $ | 8,091  |   |        | $ | 109,738 |         
|                                                            |                                    |                                                  |                          |                      |              |            |         |        |     |             |             |         |   |                |          |   |               |             |           |              |   |   |            |          |   |      |               |   |        |   |            |        |  



F-4



---



##### Table of Contents



ENTERASYS NETWORKS, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |         |   |         |          |         |  
|---------------------------------------------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ------- | ------- | ---------- | - | ------- | ------------ | ------- | - | ------- | -------- | ------- | -
|                                                     |                                                                                               | Year Ended                                                        |        
|                                                     |                                                                                               |                                                                   |        
|                                                     |                                                                                               | January 1,                                                        |         |         | January 3, |   |         | December 28, |        
|                                                     |                                                                                               | 2005                                                              |         |         | 2004       |   |         | 2002         |        
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|                                                     |                                                                                               | (In thousands)                                                    |        
|Cash flows from operating activities:                |                                                                                               |                                                                   |         |         |            |   |         |              |         |   |         |         
|                                                     | Net loss                                                                                      |                                                                   | $       | (71,134 | )          |   | $       | (112,651     | )       |   | $       | (114,245 | )      
|                                                     | Adjustments to reconcile net loss to net cash provided by (used
    in) operating activities: |                                                                   |         |         |            |   |         |              |         |   |         |          |        
|                                                     |                                                                                               | Loss from discontinued operations                                 |         |         |           |   |         |              |        |   |         |          | 11,700  |  
|                                                     |                                                                                               | Depreciation and amortization                                     |         |         | 22,851     |   |         |              | 31,257  |   |         |          | 42,833  |  
|                                                     |                                                                                               | Provision for (recoveries) losses on accounts receivable          |         |         | (3,444     | ) |         |              | (7,852  | ) |         |          | 1,630   |  
|                                                     |                                                                                               | Provision for inventory write-downs                               |         |         | 13,816     |   |         |              | 12,246  |   |         |          | 17,885  |  
|                                                     |                                                                                               | Recovery of note receivable                                       |         |         |           |   |         |              | (2,450  | ) |         |          | (2,500  | )
|                                                     |                                                                                               | Impairment of intangible assets and property, plant and equipment |         |         | 9,188      |   |         |              |        |   |         |          |        |  
|                                                     |                                                                                               | Stock-based compensation                                          |         |         |           |   |         |              | 158     |   |         |          | 2,644   |  
|                                                     |                                                                                               | Net realized gain on sale of securities                           |         |         | (7         | ) |         |              | (838    | ) |         |          | (1,121  | )
|                                                     |                                                                                               | Loss on minority investments                                      |         |         | 8,698      |   |         |              | 27,775  |   |         |          | 22,119  |  
|                                                     |                                                                                               | Unrealized (gain) loss on Riverstone stock derivative             |         |         |           |   |         |              | (178    | ) |         |          | 20,048  |  
|                                                     |                                                                                               | Unrealized (gain) loss on foreign currency transactions           |         |         | (1,403     | ) |         |              | 5,644   |   |         |          | 2,937   |  
|                                                     |                                                                                               | Common stock commitment relating to shareholder litigation        |         |         |           |   |         |              | 33,000  |   |         |          |        |  
|                                                     |                                                                                               | Non-cash tax benefit                                              |         |         | (12,049    | ) |         |              |        |   |         |          |        |  
|                                                     |                                                                                               | Other, net                                                        |         |         | (1,048     | ) |         |              |        |   |         |          |        |  
|                                                     | Changes in operating assets and liabilities:                                                  |                                                                   |         |         |            |   |         |              |         |   |         |          |        
|                                                     |                                                                                               | Accounts receivable                                               |         |         | 11,962     |   |         |              | 14,117  |   |         |          | 24,385  |  
|                                                     |                                                                                               | Inventories                                                       |         |         | (11,507    | ) |         |              | 5,145   |   |         |          | 55,777  |  
|                                                     |                                                                                               | Prepaid expenses and other assets                                 |         |         | (11,172    | ) |         |              | 3,208   |   |         |          | 4,676   |  
|                                                     |                                                                                               | Accounts payable and accrued expenses                             |         |         | (12,948    | ) |         |              | (23,130 | ) |         |          | (34,422 | )
|                                                     |                                                                                               | Customer advances and billings in excess of revenues              |         |         | 4,018      |   |         |              | (75     | ) |         |          | (48,717 | )
|                                                     |                                                                                               | Deferred revenue                                                  |         |         | (8,489     | ) |         |              | (10,343 | ) |         |          | (21,394 | )
|                                                     |                                                                                               | Income taxes receivable, net                                      |         |         | (450       | ) |         |              | 30,400  |   |         |          | 7,458   |  
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|                                                     |                                                                                               | Net cash (used in) provided by operating activities               |         |         | (63,118    | ) |         |              | 5,433   |   |         |          | (8,307  | )
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|Cash flows from investing activities:                |                                                                                               |                                                                   |         |         |            |   |         |              |         |   |         |         
|                                                     | Capital expenditures and purchases of intangible assets                                       |                                                                   |         | (8,783  | )          |   |         | (18,589      | )       |   |         | (24,608  | )      
|                                                     | Purchase of investments                                                                       |                                                                   |         | (1,652  | )          |   |         | (1,750       | )       |   |         | (1,677   | )      
|                                                     | Proceeds from sales of investments                                                            |                                                                   |         | 3,583   |            |   |         | 1,923        |         |   |         | 4,107    |        
|                                                     | Proceeds from sale of fixed assets                                                            |                                                                   |         |        |            |   |         | 1,250        |         |   |         |         |        
|                                                     | Proceeds from Aprisma settlement                                                              |                                                                   |         | 1,048   |            |   |         |             |         |   |         |         |        
|                                                     | Purchase of marketable securities                                                             |                                                                   |         | (48,593 | )          |   |         | (67,628      | )       |   |         | (142,151 | )      
|                                                     | Maturities of marketable securities                                                           |                                                                   |         | 34,701  |            |   |         | 159,281      |         |   |         | 143,685  |        
|                                                     | Release of restricted cash                                                                    |                                                                   |         | 13,336  |            |   |         |             |         |   |         |         |        
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|                                                     | Net cash (used in) provided by investing activities                                           |                                                                   |         | (6,360  | )          |   |         | 74,487       |         |   |         | (20,644  | )      
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|Cash flows from financing activities:                |                                                                                               |                                                                   |         |         |            |   |         |              |         |   |         |         
|                                                     | Proceeds from common stock issued pursuant to employee stock
    purchase plans               |                                                                   |         | 1,713   |            |   |         | 1,449        |         |   |         | 820      |        
|                                                     | Cash flows related to discontinued operations                                                 |                                                                   |         |        |            |   |         |             |         |   |         | 29,509   |        
|                                                     | Proceeds from notes receivable                                                                |                                                                   |         |        |            |   |         | 4,950        |         |   |         | 15,000   |        
|                                                     | Net payments for redemption of preferred stock                                                |                                                                   |         |        |            |   |         | (96,814      | )       |   |         |         |        
|                                                     | Proceeds from exercise of stock options                                                       |                                                                   |         | 1,880   |            |   |         | 10,987       |         |   |         | 3,846    |        
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|                                                     | Net cash provided by (used in) financing activities                                           |                                                                   |         | 3,593   |            |   |         | (79,428      | )       |   |         | 49,175   |        
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|Effect of exchange rate changes on cash              |                                                                                               |                                                                   | 31      |         |            |   | 116     |              |         |   | 1,169   |         
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|Net (decrease) increase in cash and cash equivalents |                                                                                               |                                                                   | (65,854 | )       |            |   | 608     |              |         |   | 21,393  |         
|Cash and cash equivalents at beginning of year       |                                                                                               |                                                                   | 136,801 |         |            |   | 136,193 |              |         |   | 114,800 |         
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|Cash and cash equivalents at end of year             |                                                                                               | $                                                                 | 70,947  |         |            | $ | 136,801 |              |         | $ | 136,193 |         
|                                                     |                                                                                               |                                                                   |         |         |            |   |         |              |        
|Supplemental disclosures of cash flow information:   |                                                                                               |                                                                   |         |         |            |   |         |              |         |   |         |         
|                                                     | Cash (paid) refunds received for income taxes, net                                            |                                                                   | $       | (2,364  | )          |   | $       | 34,602       |         |   | $       | 96,656   |        
|                                                     | Non-cash transactions:                                                                        |                                                                   |         |         |            |   |         |              |         |   |         |          |        
|                                                     | Accretive dividend and accretion of discount on preferred shares                              |                                                                   | $       |        |            |   | $       | 2,192        |         |   | $       | 12,963   |        



F-5



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##### Table of Contents






ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




|   |                    
|-- | -------------------
|1. | Business Operations







|   |                                           
|-- | ------------------------------------------
|2. | Summary of Significant Accounting Policies



| |                            
| | ---------------------------
| | Principles of Consolidation





| |                  
| | -----------------
| | Reclassifications





| |                 
| | ----------------
| | Use of Estimates



F-6



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                    
| | -------------------
| | Revenue Recognition

Revenue Recognition, Software Revenue
Recognition, Modification of SOP No. 97-2, Software
Recognition, With Respect to Certain Transactions, Revenue Arrangements with Multiple Deliverables.








| |                          
| | -------------------------
| | Cash and Cash Equivalents





| |                      
| | ---------------------
| | Marketable Securities







F-7



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








| |                                
| | -------------------------------
| | Allowance for Doubtful Accounts





| |                                                                         
| | ------------------------------------------------------------------------
| | Fair Value of Financial Instruments and Concentration of
    Credit Risk















| |            
| | -----------
| | Inventories



F-8



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                              
| | -----------------------------
| | Property, Plant and Equipment





| |         
| | --------
| | Goodwill





| |                                                          
| | ---------------------------------------------------------
| | Impairment of Intangible Assets and Long-Lived
    Assets





| |            
| | -----------
| | Derivatives

Accounting for Derivative
Instruments and Hedging Activities, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities


F-9



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                     
| | --------------------
| | Comprehensive Income





| |            
| | -----------
| | Investments









| |                                                  
| | -------------------------------------------------
| | Research and Development Costs and Software Costs





| |                  
| | -----------------
| | Advertising Costs



F-10



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                               
| | ------------------------------
| | Stock-Based Compensation Plans

Accounting for
Stock Issued to Employees, Accounting for Stock-Based Compensation, Accounting for
Stock-Based Compensation  Disclosure,


|                                                                                                                                                                                    |             |                                          |         |       |                 |   |          |                   |   |   |          |       |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------- | ---------------------------------------- | ------- | ----- | --------------- | - | -------- | ----------------- | - | - | -------- | ----- | -
|                                                                                                                                                                                    |             | Year Ended                               |        
|                                                                                                                                                                                    |             |                                          |        
|                                                                                                                                                                                    |             | January 1, 2005                          |         |       | January 3, 2004 |   |          | December 28, 2002 |  
|                                                                                                                                                                                    |             |                                          |         |       |                 |   |          |                   |  
|                                                                                                                                                                                    |             | (In thousands, except per share amounts) |        
|Net loss available to common shareholders, as reported                                                                                                                              |             | $                                        | (71,134 | )     |                 | $ | (114,843 | )                 |   | $ | (127,208 | )    
|Add: Stock compensation charge recorded in net loss determined
    under the intrinsic value method                                                                                 |             |                                          |        |       |                 |   | 158      |                   |   |   | 2,644    |      
|Deduct: Total stock-based employee compensation expense
    determined under fair-value-based method for the employee stock
    option awards and the employee stock purchase plans |             |                                          | (14,772 | )     |                 |   | (21,573  | )                 |   |   | (25,704  | )    
|                                                                                                                                                                                    |             |                                          |         |       |                 |   |          |                   |  
|Pro forma net loss available to common shareholders                                                                                                                                 |             | $                                        | (85,906 | )     |                 | $ | (136,258 | )                 |   | $ | (150,268 | )    
|                                                                                                                                                                                    |             |                                          |         |       |                 |   |          |                   |  
|Basic and diluted loss per share:                                                                                                                                                   |             |                                          |         |       |                 |   |          |                   |   |   |          |      
|                                                                                                                                                                                    | As reported |                                          | $       | (0.33 | )               |   | $        | (0.56             | ) |   | $        | (0.63 | )
|                                                                                                                                                                                    | Pro forma   |                                          | $       | (0.39 | )               |   | $        | (0.66             | ) |   | $        | (0.75 | )



|                                     |  |                 |            |  |                 |  |            |                   |  |  |             | 
|------------------------------------ |  | --------------- | ---------- |  | --------------- |  | ---------- | ----------------- |  |  | ----------- | 
|                                     |  | Year Ended      |           
|                                     |  |                 |           
|                                     |  | January 1, 2005 |            |  | January 3, 2004 |  |            | December 28, 2002 | 
|                                     |  |                 |            |  |                 |  |            |                   | 
|Employee stock options:              |  |                 |            |  |                 |  |            |                   |  |  |             | 
|Risk-free interest rate              |  |                 | 3.23%      |  |                 |  | 2.90%      |                   |  |  | 2.79%       | 
|Expected option life                 |  |                 | 4.42 years |  |                 |  | 5.61 years |                   |  |  | 5.40  years | 
|Expected volatility                  |  |                 | 112.0%     |  |                 |  | 111.93%    |                   |  |  | 113.28%     | 
|Expected dividend yield              |  |                 | 0.0%       |  |                 |  | 0.0%       |                   |  |  | 0.0%        | 
|Fair value of options granted        |  |                 | $2.08      |  |                 |  | $3.09      |                   |  |  | $0.97       | 
|Employee stock purchase plan shares: |  |                 |            |  |                 |  |            |                   |  |  |             | 
|Risk-free interest rate              |  |                 | 2.11%      |  |                 |  | 0.98%      |                   |  |  | 1.23%       | 
|Expected option life                 |  |                 | 6 months   |  |                 |  | 6 months   |                   |  |  | 11 months   | 
|Expected volatility                  |  |                 | 72.58%     |  |                 |  | 82.36%     |                   |  |  | 98.11%      | 
|Expected dividend yield              |  |                 | 0.0%       |  |                 |  | 0.0%       |                   |  |  | 0.0%        | 
|Fair value of plan shares            |  |                 | $0.97      |  |                 |  | $1.04      |                   |  |  | $1.05       | 

F-11



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |             
| | ------------
| | Income Taxes





| |                   
| | ------------------
| | Net Loss Per Share





| |                                                                  
| | -----------------------------------------------------------------
| | Foreign Currency Translation and Transaction Gains and
    Losses







| |                       
| | ----------------------
| | Restructuring Reserves



F-12



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                              
| | -----------------------------
| | New Accounting Pronouncements

The
Meaning of Other-Than-Temporary Impairment and its Application
to Certain Investments


Share-Based Payment Accounting for Stock-Based
Compensation, Accounting for Stock Issued to Employees,


Application of FASB
Statement No. 109, Accounting for Income Taxes, to the
Deduction on Qualified Production Activities Provided by the
American Jobs Creation Act of 2004.


Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provision within the American Jobs Creation Act of
2004


F-13



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |                      
|-- | ---------------------
|3. | Marketable Securities



|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |      |   |   |        |         | 
|----------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------- | --------- | ------ | -------------- | ---------- | - | ----- | ---------- |  | - | ---------- | ---- | - | - | ------ | ------- | 
|                                                                                    |                                                                                     |           |        | Gross          |            |   | Gross |            |  |  
|                                                                                    |                                                                                     | Amortized |        |                | Unrealized |   |       | Unrealized |  |   |           
|                                                                                    |                                                                                     | Cost      |        |                | Gains      |   |       | Losses     |  |   | Fair Value |     
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|                                                                                    |                                                                                     |           |        | (In thousands) |            |   |      
|January 1, 2005                                                                     |                                                                                     |           |        |                |            |   |       |            |  |   |            |      |   |   |        |        
|Held-to-Maturity Securities                                                         |                                                                                     |           |        |                |            |   |       |            |  |   |            |      |   |   |        |        
|U.S. government and agency obligations                                              |                                                                                     | $         | 24,747 |                |            | $ |      |            |  | $ | (115       | )    |   | $ | 24,632 |        
|U.S. corporate obligations                                                          |                                                                                     |           | 35,027 |                |            |   | 18    |            |  |   | (184       | )    |   |   | 34,861 |        
|State, municipal and county government notes and bonds                              |                                                                                     |           | 5,844  |                |            |   | 6     |            |  |   | (6         | )    |   |   | 5,844  |        
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|                                                                                    | Total held-to-maturity marketable securities                                        |           | $      | 65,618         |            |   | $     | 24         |  |   | $          | (305 | ) |   | $      | 65,337  | 
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|Amounts included in short-term marketable securities                                |                                                                                     | $         | 35,022 |                |            | $ | 17    |            |  | $ | (105       | )    |   | $ | 34,934 |        
|Amounts included in long-term marketable securities                                 |                                                                                     |           | 30,596 |                |            |   | 7     |            |  |   | (200       | )    |   |   | 30,403 |        
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|                                                                                    | Total held-to-maturity marketable securities                                        |           | $      | 65,618         |            |   | $     | 24         |  |   | $          | (305 | ) |   | $      | 65,337  | 
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|Available-for-Sale Securities                                                       |                                                                                     |           |        |                |            |   |       |            |  |   |            |      |   |   |        |        
|U.S. government and agency obligations                                              |                                                                                     | $         | 4,790  |                |            | $ |      |            |  | $ | (37        | )    |   | $ | 4,753  |        
|Auction rate securities                                                             |                                                                                     |           | 13,450 |                |            |   |      |            |  |   |           |      |   |   | 13,450 |        
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|                                                                                    | Total available-for-sale marketable securities                                      |           | $      | 18,240         |            |   | $     |           |  |   | $          | (37  | ) |   | $      | 18,203  | 
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|                                                                                    | Amounts included in short-term marketable securities                                |           | $      | 13,450         |            |   | $     |           |  |   | $          |     |   |   | $      | 13,450  | 
|                                                                                    | Amounts included in restricted cash, cash equivalents and
    marketable securities |           |        | 4,790          |            |   |       |           |  |   |            | (37  | ) |   |        | 4,753   | 
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|                                                                                    | Total available-for-sale marketable securities                                      |           | $      | 18,240         |            |   | $     |           |  |   | $          | (37  | ) |   | $      | 18,203  | 
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|January 3, 2004                                                                     |                                                                                     |           |        |                |            |   |       |            |  |   |            |      |   |   |        |        
|Available-for-Sale Securities                                                       |                                                                                     |           |        |                |            |   |       |            |  |   |            |      |   |   |        |        
|U.S. government and agency obligations                                              |                                                                                     | $         | 81,561 |                |            | $ | 444   |            |  | $ | (14        | )    |   | $ | 81,991 |        
|U.S. corporate obligations                                                          |                                                                                     |           | 20,597 |                |            |   | 153   |            |  |   | (4         | )    |   |   | 20,746 |        
|Asset-backed securities                                                             |                                                                                     |           | 1,009  |                |            |   | 10    |            |  |   |           |      |   |   | 1,019  |        
|State, municipal and county government notes and bonds                              |                                                                                     |           | 9,826  |                |            |   | 143   |            |  |   |           |      |   |   | 9,969  |        
|Repurchase agreements                                                               |                                                                                     |           | 12,425 |                |            |   |      |            |  |   |           |      |   |   | 12,425 |        
|Corporate equity securities                                                         |                                                                                     |           | 318    |                |            |   | 132   |            |  |   |           |      |   |   | 450    |        
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|                                                                                    | Total available-for-sale marketable securities                                      |           | $      | 125,736        |            |   | $     | 882        |  |   | $          | (18  | ) |   | $      | 126,600 | 
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|Amounts included in cash and cash equivalents                                       |                                                                                     | $         | 49,423 |                |            | $ |      |            |  | $ |           |      |   | $ | 49,423 |        
|Amounts included in short-term marketable securities                                |                                                                                     |           | 29,471 |                |            |   | 380   |            |  |   |           |      |   |   | 29,851 |        
|Amounts included in long-term marketable securities                                 |                                                                                     |           | 35,373 |                |            |   | 447   |            |  |   | (17        | )    |   |   | 35,803 |        
|Amounts included in restricted cash, cash equivalents and
    marketable securities |                                                                                     |           | 11,469 |                |            |   | 55    |            |  |   | (1         | )    |   |   | 11,523 |        
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     
|                                                                                    | Total available-for-sale marketable securities                                      |           | $      | 125,736        |            |   | $     | 882        |  |   | $          | (18  | ) |   | $      | 126,600 | 
|                                                                                    |                                                                                     |           |        |                |            |   |       |            |  |   |            |     

F-14



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                   |       |                  |        |                |                    |   |        |           |  |   |        |        |  |   |        |        | 
|------------------ | ----- | ---------------- | ------ | -------------- | ------------------ | - | ------ | --------- |  | - | ------ | ------ |  | - | ------ | ------ | 
|                   |       | Held-to-Maturity |        |                | Available-for-Sale |  
|                   |       |                  |        |                |                    |  
|                   |       | Amortized        |        |                | Fair               |   |        | Amortized |  |   | Fair   |       
|                   |       | Cost             |        |                | Value              |   |        | Cost      |  |   | Value  |       
|                   |       |                  |        |                |                    |   |        |           |  |   |        |       
|                   |       |                  |        | (In thousands) |                    |   |       
|Less than one year |       | $                | 35,022 |                |                    | $ | 34,934 |           |  | $ | 17,240 |        |  | $ | 17,213 |       
|Due in 1-3 years   |       |                  | 30,596 |                |                    |   | 30,403 |           |  |   | 1,000  |        |  |   | 990    |       
|                   |       |                  |        |                |                    |   |        |           |  |   |        |       
|                   | Total |                  | $      | 65,618         |                    |   | $      | 65,337    |  |   | $      | 18,240 |  |   | $      | 18,203 | 
|                   |       |                  |        |                |                    |   |        |           |  |   |        |       





|   |                                                                
|-- | ---------------------------------------------------------------
|4. | Restricted Cash, Cash Equivalents and Marketable
    Securities





|   |                    
|-- | -------------------
|5. | Accounts Receivable



|                                |  |                |        |   |            |   |        |  
|------------------------------- |  | -------------- | ------ | - | ---------- | - | ------ | -
|                                |  | January 1,     |        |   | January 3, |  
|                                |  | 2005           |        |   | 2004       |  
|                                |  |                |        |   |            |  
|                                |  | (In thousands) |       
|Gross accounts receivable       |  | $              | 29,641 |   |            | $ | 40,938 |  
|Allowance for doubtful accounts |  |                | (553   | ) |            |   | (3,397 | )
|                                |  |                |        |   |            |  
|Accounts receivable, net        |  | $              | 29,088 |   |            | $ | 37,541 |  
|                                |  |                |        |   |            |  



F-15



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |                 
|-- | ----------------
|6. | Notes Receivable









|   |            
|-- | -----------
|7. | Inventories



|                  |             |                |        |        |            |   |        |        | 
|----------------- | ----------- | -------------- | ------ | ------ | ---------- | - | ------ | ------ | 
|                  |             | January 1,     |        |        | January 3, |  
|                  |             | 2005           |        |        | 2004       |  
|                  |             |                |        |        |            |  
|                  |             | (In thousands) |       
|Raw materials     |             | $              | 1,690  |        |            | $ | 4,170  |       
|Service spares    |             |                | 2,520  |        |            |   | 2,184  |       
|Finished goods(1) |             |                | 22,990 |        |            |   | 22,695 |       
|                  |             |                |        |        |            |  
|                  | Inventories |                | $      | 27,200 |            |   | $      | 29,049 | 
|                  |             |                |        |        |            |  






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Company defers revenue on product shipments to certain
    stocking distributors until those distributors have sold the
    product to their customer and certain resellers and stocking
    distributors until cash payment has been received. At
    January 1, 2005 and January 3, 2004, $6.6 million
    and $8.7 million, respectively, of inventory related to
    this deferred revenue was recorded in finished goods.

F-16



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |                                   
|-- | ----------------------------------
|8. | Property, Plant and Equipment, Net



|                                               |                                          |                |         |         |            |   |          |             |  |             | 
|---------------------------------------------- | ---------------------------------------- | -------------- | ------- | ------- | ---------- | - | -------- | ----------- |  | ----------- | 
|                                               |                                          | January 1,     |         |         | January 3, |   |          | Estimated  
|                                               |                                          | 2005           |         |         | 2004       |   |          | Useful Life
|                                               |                                          |                |         |         |            |   |          |            
|                                               |                                          | (In thousands)
|Land and improvements                          |                                          | $              | 1,045   |         |            | $ | 1,045    |             |  | 15 years   
|Buildings and improvements                     |                                          |                | 14,361  |         |            |   | 14,396   |             |  | 15-40 years
|Equipment                                      |                                          |                | 63,112  |         |            |   | 119,620  |             |  | 1.5-7 years
|Furniture and fixtures                         |                                          |                | 2,430   |         |            |   | 6,018    |             |  | 5 years    
|Software                                       |                                          |                | 28,178  |         |            |   | 24,939   |             |  | 3 years    
|Leasehold improvements                         |                                          |                | 4,676   |         |            |   | 7,879    |             |  | 5 years    
|                                               |                                          |                |         |         |            |   |          |            
|                                               | Total property, plant and equipment      |                |         | 113,802 |            |   |          | 173,897     |  |             | 
|Less accumulated depreciation and amortization |                                          |                | (85,974 | )       |            |   | (136,016 | )           |  |            
|                                               |                                          |                |         |         |            |   |          |            
|                                               | Total property, plant and equipment, net |                | $       | 27,828  |            |   | $        | 37,881      |  |             | 
|                                               |                                          |                |         |         |            |   |          |            







|   |                       
|-- | ----------------------
|9. | Intangible Assets, Net







|                       |                                      |                |        |        |              |   |              |                   |  |   |             |       |  |         | 
|---------------------- | ------------------------------------ | -------------- | ------ | ------ | ------------ | - | ------------ | ----------------- |  | - | ----------- | ----- |  | ------- | 
|                       |                                      | Gross          |        |        |              |   | Net Carrying |                   |  |  
|                       |                                      | Carrying       |        |        | Accumulated  |   |              | Value of          |  |   | Estimated  
|                       |                                      | Amount         |        |        | Amortization |   |              | Intangible Assets |  |   | Useful Life
|                       |                                      |                |        |        |              |   |              |                   |  |   |            
|                       |                                      | (In thousands)
|Customer relations     |                                      | $              | 28,600 |        |              | $ | 25,265       |                   |  | $ | 3,335       |       |  | 8 years
|Patents and technology |                                      |                | 2,092  |        |              |   | 1,193        |                   |  |   | 899         |       |  | 3 years
|                       |                                      |                |        |        |              |   |              |                   |  |   |            
|                       | Total identifiable intangible assets |                | $      | 30,692 |              |   | $            | 26,458            |  |   | $           | 4,234 |  |         | 
|                       |                                      |                |        |        |              |   |              |                   |  |   |            

F-17



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                       |                                      |                |        |        |              |   |              |                   |  |   |             |        |  |  |            |  | 
|---------------------- | ------------------------------------ | -------------- | ------ | ------ | ------------ | - | ------------ | ----------------- |  | - | ----------- | ------ |  |  | ---------- |  | 
|                       |                                      | Gross          |        |        |              |   | Net Carrying |                   |  |  
|                       |                                      | Carrying       |        |        | Accumulated  |   |              | Value of          |  |   | Estimated   |       
|                       |                                      | Amount         |        |        | Amortization |   |              | Intangible Assets |  |   | Useful Life |       
|                       |                                      |                |        |        |              |   |              |                   |  |   |             |       
|                       |                                      | (In thousands) |       
|Customer relations     |                                      | $              | 28,600 |        |              | $ | 22,246       |                   |  | $ | 6,354       |        |  |  | 8 years    | 
|Patents and technology |                                      |                | 34,300 |        |              |   | 23,301       |                   |  |   | 10,999      |        |  |  | 3-10 years | 
|                       |                                      |                |        |        |              |   |              |                   |  |   |             |       
|                       | Total identifiable intangible assets |                | $      | 62,900 |              |   | $            | 45,547            |  |   | $           | 17,353 |  |  |            |  | 
|                       |                                      |                |        |        |              |   |              |                   |  |   |             |       





|    |                       
|--- | ----------------------
|10. | Other Accrued Expenses



|                                                  |                              |                 |       |        |                 |   |       |        | 
|------------------------------------------------- | ---------------------------- | --------------- | ----- | ------ | --------------- | - | ----- | ------ | 
|                                                  |                              | January 1, 2005 |       |        | January 3, 2004 |  
|                                                  |                              |                 |       |        |                 |  
|                                                  |                              | (In thousands)  |      
|Accrued audit and Sarbanes-Oxley Section 404 cost |                              | $               | 3,194 |        |                 | $ | 2,285 |       
|Accrued marketing and selling costs               |                              |                 | 4,459 |        |                 |   | 7,180 |       
|Accrued IT and engineering                        |                              |                 | 1,236 |        |                 |   | 1,701 |       
|Accrued sales tax and VAT expense                 |                              |                 | 1,760 |        |                 |   | 4,462 |       
|Accrued utilities                                 |                              |                 | 789   |        |                 |   | 822   |       
|Other                                             |                              |                 | 7,563 |        |                 |   | 7,664 |       
|                                                  |                              |                 |       |        |                 |  
|                                                  | Total other accrued expenses |                 | $     | 19,001 |                 |   | $     | 24,114 | 
|                                                  |                              |                 |       |        |                 |  



|    |             
|--- | ------------
|11. | Income Taxes



|                         |                                |                 |         |                |                 |   |         |                   |   |   |          |          |  
|------------------------ | ------------------------------ | --------------- | ------- | -------------- | --------------- | - | ------- | ----------------- | - | - | -------- | -------- | -
|                         |                                | Year Ended      |        
|                         |                                |                 |        
|                         |                                | January 1, 2005 |         |                | January 3, 2004 |   |         | December 28, 2002 |  
|                         |                                |                 |         |                |                 |   |         |                   |  
|                         |                                |                 |         | (In thousands) |                 |   |        
|Total U.S. domestic loss |                                | $               | (65,924 | )              |                 | $ | (52,839 | )                 |   | $ | (152,686 | )       
|Total foreign loss       |                                |                 | (16,314 | )              |                 |   | (59,063 | )                 |   |   | (35,106  | )       
|                         |                                |                 |         |                |                 |   |         |                   |  
|                         | Total loss before income taxes |                 | $       | (82,238        | )               |   | $       | (111,902          | ) |   | $        | (187,792 | )
|                         |                                |                 |         |                |                 |   |         |                   |  

F-18



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|          |         |                 |                                    |                |                 |         |   |                   |     |     |   |         |         |         |  
|--------- | ------- | --------------- | ---------------------------------- | -------------- | --------------- | ------- | - | ----------------- | --- | --- | - | ------- | ------- | ------- | -
|          |         | Year Ended      |                                   
|          |         |                 |                                   
|          |         | January 1, 2005 |                                    |                | January 3, 2004 |         |   | December 28, 2002 |    
|          |         |                 |                                    |                |                 |         |   |                   |    
|          |         |                 |                                    | (In thousands) |                 |         |  
|Current:  |         |                 |                                    |                |                 |         |   |                   |     |     |   |        
|          | Federal |                 | $                                  | (12,403        | )               |         | $ | (4,487            | )   |     | $ | (90,127 | )      
|          | State   |                 |                                    | 325            |                 |         |   | 625               |     |     |   | 650     |        
|          | Foreign |                 |                                    | 974            |                 |         |   | 4,611             |     |     |   | 4,230   |        
|          |         |                 |                                    |                |                 |         |   |                   |    
|          |         | Total current   |                                    |                | (11,104         | )       |   |                   | 749 |     |   |         | (85,247 | )      
|          |         |                 |                                    |                |                 |         |   |                   |    
|Deferred: |         |                 |                                    |                |                 |         |   |                   |     |     |   |        
|          | Federal |                 |                                    |               |                 |         |   |                  |     |     |   | (237    | )      
|          | State   |                 |                                    |               |                 |         |   |                  |     |     |   |        |        
|          | Foreign |                 |                                    |               |                 |         |   |                  |     |     |   | 237     |        
|          |         |                 |                                    |                |                 |         |   |                   |    
|          |         | Total deferred  |                                    |                |                |         |   |                   |    |     |   |         |        |        
|          |         |                 |                                    |                |                 |         |   |                   |    
|          |         |                 | Total income tax expense (benefit) |                | $               | (11,104 | ) |                   | $   | 749 |   |         | $       | (85,247 | )
|          |         |                 |                                    |                |                 |         |   |                   |    



|                                                 |                                      |                 |       |       |                 |  |       |                   |   |  |       |       |   
|------------------------------------------------ | ------------------------------------ | --------------- | ----- | ----- | --------------- |  | ----- | ----------------- | - |  | ----- | ----- | --
|                                                 |                                      | Year Ended      |      
|                                                 |                                      |                 |      
|                                                 |                                      | January 1, 2005 |       |       | January 3, 2004 |  |       | December 28, 2002 |  
|                                                 |                                      |                 |       |       |                 |  |       |                   |  
|Statutory federal income tax (benefit) rate      |                                      |                 | (35.0 | )%    |                 |  | (35.0 | )%                |   |  | (35.0 | )%   
|State income tax, net of federal tax benefit     |                                      |                 | 0.4   |       |                 |  | 0.4   |                   |   |  | 0.2   |      
|Research and experimentation credit              |                                      |                 | (3.2  | )     |                 |  | (3.3  | )                 |   |  | (1.7  | )    
|Rate differential on foreign operations          |                                      |                 | 6.0   |       |                 |  | 4.7   |                   |   |  | 6.8   |      
|Unbenefited losses/change in valuation allowance |                                      |                 | 34.1  |       |                 |  | 34.7  |                   |   |  | (31.0 | )    
|Change in estimate for tax contingencies         |                                      |                 | (15.4 | )     |                 |  | (0.9  | )                 |   |  | 10.9  |      
|Other                                            |                                      |                 | (0.4  | )     |                 |  | 0.1   |                   |   |  | 4.4   |      
|                                                 |                                      |                 |       |       |                 |  |       |                   |  
|                                                 | Effective tax expense (benefit) rate |                 |       | (13.5 | )%              |  |       | 0.7               | % |  |       | (45.4 | )%
|                                                 |                                      |                 |       |       |                 |  |       |                   |  

F-19



---



##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                     |                                                      |                           |   |          |                 |  |   |          |         | 
|-------------------- | ---------------------------------------------------- | ------------------------- | - | -------- | --------------- |  | - | -------- | ------- | 
|                     |                                                      | January 1, 2005           |   |          | January 3, 2004 | 
|                     |                                                      |                           |   |          |                 | 
|                     |                                                      | (In thousands)            |  
|Deferred tax assets: |                                                      |                           |   |          |                 |  |   |         
|                     | Accounts receivable                                  |                           | $ | 2,086    |                 |  | $ | 1,572    |        
|                     | Inventories                                          |                           |   | 9,549    |                 |  |   | 12,451   |        
|                     | Deferred revenue                                     |                           |   | 2,651    |                 |  |   | 1,849    |        
|                     | Property, plant and equipment                        |                           |   | 4,112    |                 |  |   | 4,331    |        
|                     | Other reserves and accruals                          |                           |   | 56,264   |                 |  |   | 38,709   |        
|                     | Acquired intangible assets                           |                           |   | 149,036  |                 |  |   | 148,796  |        
|                     | Domestic net operating loss and credit carryforwards |                           |   | 163,725  |                 |  |   | 141,360  |        
|                     | Foreign net operating loss carryforwards             |                           |   | 43,043   |                 |  |   | 39,687   |        
|                     |                                                      |                           |   |          |                 | 
|                     |                                                      | Gross deferred tax assets |   |          | 430,466         |  |   |          | 388,755 | 
|                     | Valuation allowance                                  |                           |   | (430,466 | )               |  |   | (388,755 | )      
|                     |                                                      |                           |   |          |                 | 
|                     |                                                      | Total deferred tax assets |   | $        |                |  |   | $        |        | 
|                     |                                                      |                           |   |          |                 | 











F-20



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Accounting for Contingencies.












|    |                                
|--- | -------------------------------
|12. | Restructuring and Other Charges



|                              |                                       |                 |        |                |                 |   |        |                   |  |   |        |        | 
|----------------------------- | ------------------------------------- | --------------- | ------ | -------------- | --------------- | - | ------ | ----------------- |  | - | ------ | ------ | 
|                              |                                       | Year Ended      |       
|                              |                                       |                 |       
|                              |                                       | January 1, 2005 |        |                | January 3, 2004 |   |        | December 28, 2002 | 
|                              |                                       |                 |        |                |                 |   |        |                   | 
|                              |                                       |                 |        | (In thousands) |                 |   |       
|Fixed assets                  |                                       | $               | 454    |                |                 | $ |       |                   |  | $ | 129    |       
|Severance benefits            |                                       |                 | 14,074 |                |                 |   | 14,704 |                   |  |   | 25,974 |       
|Facility exit costs           |                                       |                 | 2,107  |                |                 |   | 2,828  |                   |  |   | 6,079  |       
|Reversal of prior year charge |                                       |                 |       |                |                 |   |       |                   |  |   | (204   | )     
|                              |                                       |                 |        |                |                 |   |        |                   | 
|                              | Total restructuring and other charges |                 | $      | 16,635         |                 |   | $      | 17,532            |  |   | $      | 31,978 | 
|                              |                                       |                 |        |                |                 |   |        |                   | 



F-21



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










|                           |                               |                               |       |         |               |   |       |        |   |   |        |         |  
|-------------------------- | ----------------------------- | ----------------------------- | ----- | ------- | ------------- | - | ----- | ------ | - | - | ------ | ------- | -
|                           |                               | Accrued Restructuring Charges |      
|                           |                               |                               |      
|                           |                               | Severance                     |       |         | Facility Exit |   |       |       
|                           |                               | Benefits                      |       |         | Costs         |   |       | Total  |  
|                           |                               |                               |       |         |               |   |       |        |  
|                           |                               | (In thousands)                |      
|Balance, December 29, 2001 |                               | $                             | 3,952 |         |               | $ | 2,230 |        |   | $ | 6,182  |        
|                           | Second quarter charges        |                               |       | 20,239  |               |   |       |       |   |   |        | 20,239  |  
|                           | Third quarter charges         |                               |       | 5,646   |               |   |       | 5,089  |   |   |        | 10,735  |  
|                           | Fourth quarter charges        |                               |       | 89      |               |   |       | 1,120  |   |   |        | 1,209   |  
|                           | Cash payments                 |                               |       | (27,534 | )             |   |       | (2,945 | ) |   |        | (30,479 | )
|                           | Reclassification              |                               |       | (572    | )             |   |       | 572    |   |   |        |        |  
|                           | Reversal of prior year charge |                               |       | (204    | )             |   |       |       |   |   |        | (204    | )
|                           |                               |                               |       |         |               |   |       |        |  
|Balance, December 28, 2002 |                               |                               | 1,616 |         |               |   | 6,066 |        |   |   | 7,682  |        
|                           | Second quarter charges        |                               |       | 7,431   |               |   |       | 772    |   |   |        | 8,203   |  
|                           | Third quarter charges         |                               |       | 6,282   |               |   |       | 2,056  |   |   |        | 8,338   |  
|                           | Fourth quarter charges        |                               |       | 990     |               |   |       |       |   |   |        | 990     |  
|                           | Cash payments                 |                               |       | (12,477 | )             |   |       | (2,211 | ) |   |        | (14,688 | )
|                           |                               |                               |       |         |               |   |       |        |  
|Balance, January 3, 2004   |                               |                               | 3,842 |         |               |   | 6,683 |        |   |   | 10,525 |        
|                           | First quarter charges         |                               |       | 3,800   |               |   |       | 685    |   |   |        | 4,485   |  
|                           | Second quarter charges        |                               |       | 1,173   |               |   |       | 235    |   |   |        | 1,408   |  
|                           | Third quarter charges(1)      |                               |       | 4,231   |               |   |       | 1,187  |   |   |        | 5,418   |  
|                           | Fourth quarter charges        |                               |       | 4,870   |               |   |       |       |   |   |        | 4,870   |  
|                           | Cash payments                 |                               |       | (10,168 | )             |   |       | (3,442 | ) |   |        | (13,610 | )
|                           |                               |                               |       |         |               |   |       |        |  
|Balance, January 1, 2005   |                               | $                             | 7,748 |         |               | $ | 5,348 |        |   | $ | 13,096 |        
|                           |                               |                               |       |         |               |   |       |        |  






|    |                                           
|--- | ------------------------------------------
|(1) | Excludes asset impairment charges of $454.



F-22



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|    |                   
|--- | ------------------
|13. | Other Expense, Net



|                                                      |                          |                 |        |                |                 |   |         |                   |   |   |         |         |  
|----------------------------------------------------- | ------------------------ | --------------- | ------ | -------------- | --------------- | - | ------- | ----------------- | - | - | ------- | ------- | -
|                                                      |                          | Year Ended      |       
|                                                      |                          |                 |       
|                                                      |                          | January 1, 2005 |        |                | January 3, 2004 |   |         | December 28, 2002 |  
|                                                      |                          |                 |        |                |                 |   |         |                   |  
|                                                      |                          |                 |        | (In thousands) |                 |   |        
|Loss on minority investments                          |                          | $               | (8,698 | )              |                 | $ | (27,775 | )                 |   | $ | (22,119 | )      
|Unrealized gain (loss) on Riverstone stock derivative |                          |                 |       |                |                 |   | 178     |                   |   |   | (20,048 | )      
|Net realized gain on sale of marketable securities    |                          |                 | 7      |                |                 |   | 838     |                   |   |   | 1,121   |        
|Recovery of note receivable                           |                          |                 |       |                |                 |   | 2,450   |                   |   |   | 2,500   |        
|Foreign currency gain (loss)                          |                          |                 | 1,727  |                |                 |   | (4,119  | )                 |   |   | (2,711  | )      
|Gain on legal settlement                              |                          |                 | 1,048  |                |                 |   |        |                   |   |   |        |        
|Other, net                                            |                          |                 | 962    |                |                 |   | 1,074   |                   |   |   | (1,368  | )      
|                                                      |                          |                 |        |                |                 |   |         |                   |  
|                                                      | Total other expense, net |                 | $      | (4,954         | )               |   | $       | (27,354           | ) |   | $       | (42,625 | )
|                                                      |                          |                 |        |                |                 |   |         |                   |  







F-23



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                   
|--- | ------------------
|14. | Net Loss Per Share



|                                                                 |  |                 |         |                |                 |   |          |                   |  |   |          |  
|---------------------------------------------------------------- |  | --------------- | ------- | -------------- | --------------- | - | -------- | ----------------- |  | - | -------- | -
|                                                                 |  | Year Ended      |        
|                                                                 |  |                 |        
|                                                                 |  | January 1, 2005 |         |                | January 3, 2004 |   |          | December 28, 2002 | 
|                                                                 |  |                 |         |                |                 |   |          |                   | 
|                                                                 |  |                 |         | (In thousands) |                 |   |         
|Loss from continuing operations                                  |  | $               | (71,134 | )              |                 | $ | (112,651 | )                 |  | $ | (102,545 | )
|Effect of preferred shares                                       |  |                 |        |                |                 |   | (2,192   | )                 |  |   | (12,963  | )
|                                                                 |  |                 |         |                |                 |   |          |                   | 
|Loss from continuing operations available to common shareholders |  |                 | (71,134 | )              |                 |   | (114,843 | )                 |  |   | (115,508 | )
|Loss on disposal from discontinued operations                    |  |                 |        |                |                 |   |         |                   |  |   | (11,700  | )
|                                                                 |  |                 |         |                |                 |   |          |                   | 
|Net loss available to common shareholders                        |  | $               | (71,134 | )              |                 | $ | (114,843 | )                 |  | $ | (127,208 | )
|                                                                 |  |                 |         |                |                 |   |          |                   | 



Earnings Per Share,




|    |                        
|--- | -----------------------
|15. | Discontinued Operations





|    |                                     
|--- | ------------------------------------
|16. | Segment and Geographical Information



F-24



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                   |                   |                 |         |         |                 |                |      |                   |   |   |         |         |  |         |      |       |         |   |         |         |  |  |      |       |  
|---------------------------------- | ----------------- | --------------- | ------- | ------- | --------------- | -------------- | ---- | ----------------- | - | - | ------- | ------- |  | ------- | ---- | ----- | ------- | - | ------- | ------- |  |  | ---- | ----- | -
|                                   |                   | Year Ended      |        
|                                   |                   |                 |        
|                                   |                   | January 1, 2005 |         |         | January 3, 2004 |                |      | December 28, 2002 |  
|                                   |                   |                 |         |         |                 |                |      |                   |  
|                                   |                   | Revenue         |         |         | Percent         |                |      | Revenue           |   |   | Percent |         |  | Revenue |      |       | Percent |  
|                                   |                   |                 |         |         |                 |                |      |                   |   |   |         |         |  |         |      |       |         |  
|                                   |                   |                 |         |         |                 | (In thousands) |      |                   |   |   |        
|North America                      |                   | $               | 172,727 |         |                 |                | 48.4 | %                 |   | $ | 204,510 |         |  |         | 49.3 | %     |         | $ | 273,218 |         |  |  | 56.4 | %    
|Europe, the Middle East and Africa |                   |                 | 126,973 |         |                 |                | 35.6 | %                 |   |   | 136,674 |         |  |         | 33.0 | %     |         |   | 142,934 |         |  |  | 29.5 | %    
|Asia Pacific                       |                   |                 | 30,770  |         |                 |                | 8.6  | %                 |   |   | 47,479  |         |  |         | 11.5 | %     |         |   | 36,267  |         |  |  | 7.5  | %    
|Latin America                      |                   |                 | 26,409  |         |                 |                | 7.4  | %                 |   |   | 25,875  |         |  |         | 6.2  | %     |         |   | 32,378  |         |  |  | 6.6  | %    
|                                   |                   |                 |         |         |                 |                |      |                   |   |   |         |         |  |         |      |       |         |  
|                                   | Total net revenue |                 | $       | 356,879 |                 |                |      | 100.0             | % |   | $       | 414,538 |  |         |      | 100.0 | %       |   | $       | 484,797 |  |  |      | 100.0 | %
|                                   |                   |                 |         |         |                 |                |      |                   |   |   |         |         |  |         |      |       |         |  





|                    |                         |                |        |        |            |   |        |        | 
|------------------- | ----------------------- | -------------- | ------ | ------ | ---------- | - | ------ | ------ | 
|                    |                         | January 1,     |        |        | January 3, |  
|                    |                         | 2005           |        |        | 2004       |  
|                    |                         |                |        |        |            |  
|                    |                         | (In thousands) |       
|U.S.                |                         | $              | 45,089 |        |            | $ | 66,735 |       
|All other countries |                         |                | 2,102  |        |            |   | 3,628  |       
|                    |                         |                |        |        |            |  
|                    | Total long-lived assets |                | $      | 47,191 |            |   | $      | 70,363 | 
|                    |                         |                |        |        |            |  



|    |                     
|--- | --------------------
|17. | Stockholders Equity



| |                        
| | -----------------------
| | Common Stock Commitment





| |                   
| | ------------------
| | Put Option Program



F-25



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                        
| | -----------------------
| | Stockholder Rights Plan





| |                             
| | ----------------------------
| | Preferred Stock and Warrants



| |                                     
| | ------------------------------------
| | Series A, B, D and E Preferred Stock









F-26



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                         
| | ------------------------
| | Series F Preferred Stock





| |                             
| | ----------------------------
| | Undesignated Preferred Stock





| |         
| | --------
| | Warrants







F-27



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |            
|--- | -----------
|18. | Stock Plans



| |                       
| | ----------------------
| | Equity Incentive Plans









F-28



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                         |           |           |            |             |                |   |      |      | 
|---------------------------------------- | --------- | --------- | ---------- | ----------- | -------------- | - | ---- | ---- | 
|                                         |           |           |            | Weighted-   |               
|                                         |           | Number of |            |             | Average        |  
|                                         |           | Options   |            |             | Exercise Price |  
|                                         |           |           |            |             |                |  
|Options outstanding at December 29, 2001 |           |           | 35,727,588 |             |                | $ | 3.91 |     
|                                         | Granted   |           |            | 8,075,121   |                |   |      | 1.21 | 
|                                         | Exercised |           |            | (1,333,995  | )              |   |      | 2.88 | 
|                                         | Cancelled |           |            | (13,444,802 | )              |   |      | 3.98 | 
|                                         |           |           |            |             |                |  
|Options outstanding at December 28, 2002 |           |           | 29,023,912 |             |                |   | 3.18 |     
|                                         | Granted   |           |            | 8,259,260   |                |   |      | 3.71 | 
|                                         | Exercised |           |            | (4,693,445  | )              |   |      | 2.34 | 
|                                         | Cancelled |           |            | (5,162,797  | )              |   |      | 4.13 | 
|                                         |           |           |            |             |                |  
|Options outstanding at January 3, 2004   |           |           | 27,426,930 |             |                |   | 3.32 |     
|                                         | Granted   |           |            | 9,055,930   |                |   |      | 2.67 | 
|                                         | Exercised |           |            | (840,745    | )              |   |      | 2.24 | 
|                                         | Cancelled |           |            | (5,038,327  | )              |   |      | 3.72 | 
|                                         |           |           |            |             |                |  
|Options outstanding at January 1, 2005   |           |           | 30,603,788 |             |                | $ | 3.09 |     
|                                         |           |           |            |             |                |  

|                                |  |                 |            |  |                 |   |            |                   |  |   |            | 
|------------------------------- |  | --------------- | ---------- |  | --------------- | - | ---------- | ----------------- |  | - | ---------- | 
|                                |  | January 1, 2005 |            |  | January 3, 2004 |   |            | December 28, 2002 | 
|                                |  |                 |            |  |                 |   |            |                   | 
|Options exercisable             |  |                 | 17,315,461 |  |                 |   | 14,949,071 |                   |  |   | 13,245,695 | 
|Weighted average exercise price |  | $               | 3.28       |  |                 | $ | 3.30       |                   |  | $ | 3.60       | 



|                  |                 |  |             |                  |            |            |  |  |                  |  |  |             |       |  |                  |  |            |  |  |   |       | 
|----------------- | --------------- |  | ----------- | ---------------- | ---------- | ---------- |  |  | ---------------- |  |  | ----------- | ----- |  | ---------------- |  | ---------- |  |  | - | ----- | 
|                  |                 |  |             | Weighted Average |            |            |  |  |                  |  | 
|Range of Exercise |                 |  | Options     |                  |            | Remaining  |  |  | Weighted Average |  |  | Options     |       |  | Weighted Average | 
|Prices            |                 |  | Outstanding |                  |            | Years Life |  |  | Exercise Price   |  |  | Exercisable |       |  | Exercise Price   | 
|                  |                 |  |             |                  |            |            |  |  |                  |  |  |             |       |  |                  | 
|                  | $ 0.90  $ 1.68 |  |             |                  | 3,894,955  |            |  |  | 7.48             |  |  | $           | 1.11  |  |                  |  | 2,428,634  |  |  | $ | 1.09  | 
|                  | $ 1.69  $ 1.72 |  |             |                  | 4,049,708  |            |  |  | 6.77             |  |  | $           | 1.71  |  |                  |  | 91,641     |  |  | $ | 1.70  | 
|                  | $ 1.73  $ 2.41 |  |             |                  | 3,598,092  |            |  |  | 8.60             |  |  | $           | 1.99  |  |                  |  | 1,016,242  |  |  | $ | 1.99  | 
|                  | $ 2.42  $ 2.52 |  |             |                  | 9,070,449  |            |  |  | 5.37             |  |  | $           | 2.52  |  |                  |  | 9,063,754  |  |  | $ | 2.52  | 
|                  | $ 2.53  $ 4.61 |  |             |                  | 5,464,678  |            |  |  | 8.03             |  |  | $           | 3.88  |  |                  |  | 2,148,166  |  |  | $ | 3.49  | 
|                  | $ 4.62  $12.58 |  |             |                  | 4,142,750  |            |  |  | 7.90             |  |  | $           | 6.19  |  |                  |  | 2,183,868  |  |  | $ | 7.05  | 
|                  | $12.59  $24.31 |  |             |                  | 383,156    |            |  |  | 5.00             |  |  | $           | 16.55 |  |                  |  | 383,156    |  |  | $ | 16.55 | 
|                  |                 |  |             |                  |            |            |  |  |                  |  |  |             |       |  |                  | 
|                  |                 |  |             |                  | 30,603,788 |            |  |  | 7.02             |  |  | $           | 3.09  |  |                  |  | 17,315,461 |  |  | $ | 3.28  | 
|                  |                 |  |             |                  |            |            |  |  |                  |  |  |             |       |  |                  | 



| |                              
| | -----------------------------
| | Employee Stock Purchase Plans



F-29



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








| |                         
| | ------------------------
| | Stock-Based Compensation





|    |                              
|--- | -----------------------------
|19. | Commitments and Contingencies



| |                  
| | -----------------
| | Legal Proceedings





Securities Class Action in the District of Rhode
Island. In re Cabletron Systems, Inc.
Securities Litigation (C.A. No. 97-542-JD (N.H.);
No. 99-408-S (R.I.)).


F-30



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








Indemnification Claims.


Other.




| |                                    
| | -----------------------------------
| | Other Commitments and Contingencies



F-31



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)














F-32



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |            
|--- | -----------
|20. | 401(K) Plan





|    |                           
|--- | --------------------------
|21. | Related Party Transactions



| |            
| | -----------
| | Investments





| |          
| | ---------
| | Severance







| |                        
| | -----------------------
| | Consulting Arrangements



F-33



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |             
| | ------------
| | Indebtedness











|    |                                     
|--- | ------------------------------------
|22. | Quarterly Financial Data (Unaudited)

|                                                                          |  |                                          |         |               |                |   |                |            |  |   |            |   |  |   |         |  
|------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | ------------- | -------------- | - | -------------- | ---------- |  | - | ---------- | - |  | - | ------- | -
|                                                                          |  | Year Ended January 1, 2005               |        
|                                                                          |  |                                          |        
|                                                                          |  |                                          |         | Third Quarter |                |   | Fourth Quarter |           
|                                                                          |  | First Quarter                            |         |               | Second Quarter |   |                | Ended      |  |   | Ended      |  
|                                                                          |  | Ended                                    |         |               | Ended July 3,  |   |                | October 2, |  |   | January 1, |  
|                                                                          |  | April 3, 2004                            |         |               | 2004           |   |                | 2004       |  |   | 2005       |  
|                                                                          |  |                                          |         |               |                |   |                |            |  |   |            |  
|                                                                          |  | (In thousands, except per share amounts) |        
|Net revenue                                                               |  | $                                        | 87,194  |               |                | $ | 91,734         |            |  | $ | 87,410     |   |  | $ | 90,541  |  
|Gross margin(1)                                                           |  | $                                        | 43,768  |               |                | $ | 47,087         |            |  | $ | 46,714     |   |  | $ | 48,185  |  
|Net loss available to common shareholders(2)(3)(4)                        |  | $                                        | (35,699 | )             |                | $ | (19,259        | )          |  | $ | (5,807     | ) |  | $ | (10,369 | )
|Basic and diluted net loss per share available to common
    shareholders |  | $                                        | (0.16   | )             |                | $ | (0.09          | )          |  | $ | (0.03      | ) |  | $ | (0.05   | )

|                                                                          |  |                                          |         |   |                |   |         |               |  |   |                |   |  |   |         |  
|------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | -------------- | - | ------- | ------------- |  | - | -------------- | - |  | - | ------- | -
|                                                                          |  | Year Ended January 3, 2004               |        
|                                                                          |  |                                          |        
|                                                                          |  | First Quarter                            |         |   | Second Quarter |   |         | Third Quarter |  |   | Fourth Quarter |  
|                                                                          |  | Ended                                    |         |   | Ended          |   |         | Ended         |  |   | Ended          |  
|                                                                          |  | March 29,                                |         |   | June 28,       |   |         | September 27, |  |   | January 3,     |  
|                                                                          |  | 2003                                     |         |   | 2003           |   |         | 2003          |  |   | 2004           |  
|                                                                          |  |                                          |         |   |                |   |         |               |  |   |                |  
|                                                                          |  | (In thousands, except per share amounts) |        
|Net revenue                                                               |  | $                                        | 104,457 |   |                | $ | 108,375 |               |  | $ | 98,417         |   |  | $ | 103,289 |  
|Gross margin(1)                                                           |  | $                                        | 52,950  |   |                | $ | 54,538  |               |  | $ | 43,036         |   |  | $ | 57,851  |  
|Net loss available to common shareholders(2)(3)(4)(5)                     |  | $                                        | (14,485 | ) |                | $ | (35,373 | )             |  | $ | (56,050        | ) |  | $ | (8,935  | )
|Basic and diluted net loss per share available to common
    shareholders |  | $                                        | (0.07   | ) |                | $ | (0.17   | )             |  | $ | (0.27          | ) |  | $ | (0.05   | )






|    |                                                                                                                                                                                                                                                                                                                           
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Company recorded inventory write-downs of $3.7 million,
    $3.9 million, $3.2 million and $3.0 million for
    the quarters ended April 3, 2004, July 3, 2004,
    October 2, 2004, and January 1, 2005, respectively.
    The Company recorded inventory write-downs of $1.9 million,
    $0.9 million, $7.8 million

F-34



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##### Table of Contents



ENTERASYS NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | and $1.6 million for the quarters ended March 29,
    2003, June 28, 2003, September 27, 2003 and
    January 3, 2004, respectively.                                                                                                                                                                                                                                                                                                                                                                           
|   
|(2) | The Company recorded recoveries on bad debt and lease guarantees
    of $1.0 million, $0.9 million, $5.9 million and
    $0.5 million for the quarters ended April 3, 2004,
    July 3, 2004, October 2, 2004, and January 1,
    2005, respectively. The Company recorded recoveries on bad debt
    and lease guarantees of $1.5 million, $6.0 million,
    $1.8 million and $2.7 million for the quarters ended
    March 29, 2003, June 28, 2003, September 27, 2003
    and January 3, 2004, respectively.
|   
|(3) | The Company recorded restructuring and other charges of
    $4.5 million, $1.4 million, $5.9 million and
    $4.9 million for the quarters ended April 3, 2004,
    July 3, 2004, October 2, 2004 and January 1,
    2005, respectively. The Company recorded restructuring and other
    charges of $8.2 million, $8.3 million and
    $1.0 million for the quarters ended June 28, 2003,
    September 27, 2003 and January 3, 2004, respectively.
    See Note 12 for further details.                      
|   
|(4) | The Company recorded an impairment charge of $8.7 million
    for the first quarter ended April 3, 2004 relating to the
    write-down of patents and technology intangible assets. See
    Note 9 for further details.                                                                                                                                                                                                                                                                                        
|   
|(5) | The Company recorded a loss on shareholder litigation of
    $0.6 million and $15.9 million for the quarter ended
    January 1, 2005, and September 27, 2003, respectively.
    See Note 19 for further details.                                                                                                                                                                                                                                                                                              

F-35



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##### Table of Contents






ENTERASYS NETWORKS, INC.


SCHEDULE II  VALUATION AND QUALIFYING
ACCOUNTS


For the Three Years Ended January 1, 2005


|                                     |  |                |         |  |            |   |        |       |  |         |             |            |         |           |          |      |  |   |         | 
|------------------------------------ |  | -------------- | ------- |  | ---------- | - | ------ | ----- |  | ------- | ----------- | ---------- | ------- | --------- | -------- | ---- |  | - | ------- | 
|                                     |  | Balance at     |         |  | Additions  |   |        |       |  |         |             | Balance at |        
|                                     |  | Beginning      |         |  | Charged to |   |        |       |  | Amounts |             |            | the End |          
|                                     |  | of Period      |         |  | Expense    |   |        | Other |  |         | Written Off |            |         | of Period |         
|                                     |  |                |         |  |            |   |        |       |  |         |             |            |         |           |         
|                                     |  | (In thousands) |        
|Allowance for doubtful accounts      |  |                |         |  |            |   |        |       |  |         |             |            |         |           |          |      |  |   |         | 
|January 1, 2005                      |  | $              | 3,397   |  |            | $ | (3,444 | )     |  | $       | 2,079       |            |         | $         | (1,479   | )    |  | $ | 553     | 
|January 3, 2004                      |  | $              | 19,250  |  |            | $ | (7,852 | )     |  | $       | 1,518       |            |         | $         | (9,519   | )    |  | $ | 3,397   | 
|December 28, 2002                    |  | $              | 32,569  |  |            | $ | 1,630  |       |  | $       | 154         |            |         | $         | (15,103  | )    |  | $ | 19,250  | 
|Notes receivable valuation allowance |  |                |         |  |            |   |        |       |  |         |             |            |         |           |          |      |  |   |         | 
|January 1, 2005                      |  | $              | 31,175  |  |            | $ |       |       |  | $       |            |            |         | $         |         |      |  | $ | 31,175  | 
|January 3, 2004                      |  | $              | 33,625  |  |            | $ | (2,450 | )     |  | $       |            |            |         | $         |         |      |  | $ | 31,175  | 
|December 28, 2002                    |  | $              | 36,125  |  |            | $ | (2,500 | )     |  | $       |            |            |         | $         |         |      |  | $ | 33,625  | 
|Deferred tax valuation allowance     |  |                |         |  |            |   |        |       |  |         |             |            |         |           |          |      |  |   |         | 
|January 1, 2005                      |  | $              | 388,755 |  |            | $ | 41,711 |       |  | $       |            |            |         | $         |         |      |  | $ | 430,466 | 
|January 3, 2004                      |  | $              | 358,479 |  |            | $ | 30,276 |       |  | $       |            |            |         | $         |         |      |  | $ | 388,755 | 
|December 28, 2002                    |  | $              | 452,052 |  |            | $ | 19,828 |       |  | $       |            |            |         | $         | (113,401 | )(a) |  | $ | 358,479 | 






|    |                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------
|(a) | Realization of deferred tax assets for which a valuation
    allowance had previously been provided.

S-1



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##### Table of Contents






REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


ON FINANCIAL STATEMENT SCHEDULE
















S-2