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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q  (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2004 OR [   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 000-26689 FOUNDRY NETWORKS, INC.  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    77-0431154
(I.R.S. Employer
Identification No.)
 2100 Gold Street
P.O. Box 649100
San Jose, CA 95164-9100
(Address of principal executive offices, including zip code) (408) 586-1700
(Registrants telephone number, including area code) N/A
(Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]    No [ ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X]    No [ ] As of July 28, 2004,
there were 135,625,153 shares of the registrants common stock
outstanding, par value $0.0001.




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FOUNDRY NETWORKS, INC.
TABLE OF CONTENTS PAGEPART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (Unaudited):Condensed Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003
    
    3Condensed Consolidated Statements of Income for the Three and Six Months Ended
June 30, 2004 and 2003
    
    4Condensed Consolidated Statements of Cash Flows for the Six Months Ended June
30, 2004 and 2003
    
    5Notes to Condensed Consolidated Financial Statements
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    16Risk Factors That May Affect Future Results and the Market Price of Our Stock
    
    22Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    30Item 4.
    
    Controls and Procedures
    
    30PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    31Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    32Item 3.
    
    Defaults Upon Senior Securities
    
    32Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    33Item 5.
    
    Other Information
    
    33Item 6.
    
    Exhibits and Reports on Form 8-K
    
    34SIGNATURES
    
    
    
    36EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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FOUNDRY NETWORKS, INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
 June 30,
    
    December 31,2004
    
    2003(unaudited)
    
    (1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    151,614
    
    
    $
    161,718Short-term investments
    
    
    240,433
    
    
    
    184,859Accounts receivable, net of allowances for doubtful accounts of $4,110 and $4,151 and sales returns
of $1,158 and $2,020 at June 30, 2004 and December 31, 2003, respectively
    
    
    75,195
    
    
    
    77,077Inventories
    
    
    38,393
    
    
    
    28,017Deferred tax assets
    
    
    34,977
    
    
    
    33,308Prepaid expenses and other current assets
    
    
    3,795
    
    
    
    5,001Total current assets
    
    
    544,407
    
    
    
    489,980Property and equipment, net
    
    
    10,325
    
    
    
    7,866Long-term investments
    
    
    201,713
    
    
    
    159,107Other long-term assets
    
    
    1,240
    
    
    
    1,191Total assets
    
    $
    757,685
    
    
    $
    658,144LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    19,466
    
    
    $
    10,080Accrued payroll and related expenses
    
    
    16,127
    
    
    
    16,650Other accrued expenses
    
    
    8,119
    
    
    
    5,804Current portion of deferred support revenue
    
    
    31,717
    
    
    
    27,408Total current liabilities
    
    
    75,429
    
    
    
    59,942Deferred support revenue
    
    
    9,509
    
    
    
    7,707Total liabilities
    
    
    84,938
    
    
    
    67,649Commitments and contingencies (Note 3)Stockholders equity:Preferred stock, $0.0001 par value:Authorized5,000 shares at June 30, 2004 and December 31, 2003; None issued and outstanding as of
June 30, 2004 and December 31, 2003
    
    
    
    
    
    
    Common stock, $0.0001 par value:Authorized300,000 shares at June 30, 2004 and December 31, 2003:Issued and outstanding135,482 and 131,623 shares at June 30, 2004 and December 31, 2003, respectively
    
    
    14
    
    
    
    13Additional paid-in capital
    
    
    446,817
    
    
    
    399,789Note receivable from stockholder
    
    
    
    
    
    
    (480
    )Accumulated other comprehensive income
    
    
    (99
    )
    
    
    47Retained earnings
    
    
    226,015
    
    
    
    191,126Total stockholders equity
    
    
    672,747
    
    
    
    590,495Total liabilities and stockholders equity
    
    $
    757,685
    
    
    $
    658,144
  (1)
    
    Derived from December 31, 2003 audited consolidated financial
statements. The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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FOUNDRY NETWORKS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
(in thousands, except per share amounts)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net revenues:Product
    
    $
    83,489
    
    
    $
    83,444
    
    
    $
    172,789
    
    
    $
    164,457Service
    
    
    14,338
    
    
    
    12,268
    
    
    
    29,054
    
    
    
    22,393Total net revenues
    
    
    97,827
    
    
    
    95,712
    
    
    
    201,843
    
    
    
    186,850Cost of revenues:Product
    
    
    30,442
    
    
    
    32,428
    
    
    
    62,436
    
    
    
    67,870Service
    
    
    3,566
    
    
    
    2,196
    
    
    
    6,692
    
    
    
    4,257Total cost of revenues
    
    
    34,008
    
    
    
    34,624
    
    
    
    69,128
    
    
    
    72,127Gross profit
    
    
    63,819
    
    
    
    61,088
    
    
    
    132,715
    
    
    
    114,723Operating expenses:Research and development
    
    
    10,003
    
    
    
    10,045
    
    
    
    20,015
    
    
    
    19,966Sales and marketing
    
    
    25,094
    
    
    
    23,415
    
    
    
    48,262
    
    
    
    43,396General and administrative
    
    
    6,268
    
    
    
    2,948
    
    
    
    11,693
    
    
    
    6,947Amortization of deferred stock compensation
    
    
    
    
    
    
    72
    
    
    
    
    
    
    
    194Total operating expenses
    
    
    41,365
    
    
    
    36,480
    
    
    
    79,970
    
    
    
    70,503Income from operations
    
    
    22,454
    
    
    
    24,608
    
    
    
    52,745
    
    
    
    44,220Interest and other income, net
    
    
    1,720
    
    
    
    1,229
    
    
    
    3,527
    
    
    
    2,294Income before provision for income taxes
    
    
    24,174
    
    
    
    25,837
    
    
    
    56,272
    
    
    
    46,514Provision for income taxes
    
    
    9,186
    
    
    
    9,043
    
    
    
    21,383
    
    
    
    16,280Net income
    
    $
    14,988
    
    
    $
    16,794
    
    
    $
    34,889
    
    
    $
    30,234Basic net income per share
    
    $
    0.11
    
    
    $
    0.14
    
    
    $
    0.26
    
    
    $
    0.25Weighted average shares used in computing
basic net income per share
    
    
    135,183
    
    
    
    123,353
    
    
    
    133,964
    
    
    
    122,241Diluted net income per share
    
    $
    0.11
    
    
    $
    0.13
    
    
    $
    0.24
    
    
    $
    0.23Weighted average shares used in computing
diluted net income per share
    
    
    141,475
    
    
    
    132,609
    
    
    
    142,624
    
    
    
    129,359
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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FOUNDRY NETWORKS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands)
 Six Months Ended June 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    34,889
    
    
    $
    30,234Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    3,490
    
    
    
    2,509Amortization of deferred stock compensation
    
    
    
    
    
    
    194Reduction of allowance for doubtful accounts
    
    
    
    
    
    
    (600
    )Inventory provisions
    
    
    8,723
    
    
    
    5,655Tax benefit from stock option exercises
    
    
    19,860
    
    
    
    6,467Changes in operating assets and liabilities:Accounts receivable
    
    
    1,882
    
    
    
    (2,652
    )Inventories
    
    
    (19,099
    )
    
    
    2,708Deferred tax assets, prepaid expenses and other assets
    
    
    (512
    )
    
    
    (382
    )Accounts payable
    
    
    9,386
    
    
    
    2,842Accrued payroll and related expenses
    
    
    (523
    )
    
    
    2,326Other accrued expenses
    
    
    2,315
    
    
    
    6,063Deferred support revenue
    
    
    6,111
    
    
    
    9,550Net cash provided by operating activities
    
    
    66,522
    
    
    
    64,914CASH FLOWS FROM INVESTING ACTIVITIES:Maturities of short-term investments
    
    
    223,971
    
    
    
    139,929Purchases of short-term and long-term investments
    
    
    (322,151
    )
    
    
    (186,902
    )Purchases of property and equipment, net
    
    
    (5,949
    )
    
    
    (2,719
    )Net cash used in investing activities
    
    
    (104,129
    )
    
    
    (49,692
    )CASH FLOWS FROM FINANCING ACTIVITIES:Repayment of note receivable
    
    
    480
    
    
    
    Proceeds from issuances of common stock
    
    
    27,169
    
    
    
    22,636Net cash provided by financing activities
    
    
    27,649
    
    
    
    22,636INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    (9,958
    )
    
    
    37,858Effect of exchange rate changes on cash
    
    
    (146
    )
    
    
    (3
    )CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
    
    161,718
    
    
    
    187,719CASH AND CASH EQUIVALENTS, END OF PERIOD
    
    $
    151,614
    
    
    $
    225,574SUPPLEMENTAL CASH FLOW INFORMATION:Cash paid for income taxes, net of refunds received
    
    $
    (4,143
    )
    
    $
    (4,018
    )
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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FOUNDRY NETWORKS, INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Information for the three and six months ended June 30, 2004 and 2003 is unaudited)
 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis of Presentation The condensed interim consolidated financial statements included herein
have been prepared by Foundry Networks, Inc., without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission (SEC) and
include the accounts of Foundry Networks, Inc. and its wholly-owned
subsidiaries (collectively Foundry or we). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States have been
condensed or omitted pursuant to such rules and regulations. The information
included in this Quarterly Report on Form 10-Q should be read in conjunction
with Managements Discussion and Analysis of Financial Condition and Results
of Operations, Quantitative and Qualitative Disclosures About Market Risk,
and the Consolidated Financial Statements and notes thereto included in Items
7, 7A, and 8, respectively, of the Foundry Networks, Inc. Annual Report on Form
10-K for the year ended December 31, 2003. The unaudited condensed consolidated financial statements included herein
reflect all adjustments, including normal recurring adjustments, which are, in
the opinion of management, necessary for a fair presentation of financial
position, results of operations and cash flows for the periods presented. The
results of operations for the three and six months ended June 30, 2004 are not
necessarily indicative of the results that may be expected for future quarters
or for the year ending December 31, 2004. Principles of Consolidation and Foreign Currency Translation Our condensed consolidated financial statements reflect the operations of
Foundry and our wholly-owned subsidiaries. All intercompany transactions and
balances have been eliminated. The functional currency of our foreign
subsidiaries is deemed to be the local countrys currency. Assets and
liabilities of foreign operations are translated to U.S. dollars at the
exchange rate in effect at the applicable balance sheet date, and revenues and
expenses are translated using average exchange rates prevailing during that
period. Translation adjustments have not been material to date and are included
as a component of accumulated other comprehensive income within stockholders
equity. Reclassifications Certain prior period amounts have been reclassified to conform to the June
30, 2004 presentation. Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying footnotes. Actual results could differ from those
estimates. Estimates are used in accounting for allowances for doubtful
accounts and sales returns, inventory provisions, product warranty liability,
income taxes, deferred tax assets, contingencies and similar items. Estimates
and assumptions are reviewed periodically by management and the effects of
revisions are reflected in the condensed consolidated financial statements in
the period in which they are made. Cash Equivalents and Investments We consider all investments with original maturities of 90 days or less to
be cash equivalents. Cash and cash equivalents consist of corporate and
government debt securities and cash deposited in checking and money market
accounts. Our investment portfolio includes only marketable securities with
original maturities of less than two years and with secondary or resale markets
to ensure portfolio liquidity. Investments in financial instruments that mature less than one year from
the balance sheet date are classified as short-term investments and investments
with maturities greater than one year from the balance sheet date are
classified as long-term investments. All of our investments are stated at
amortized cost and are held-to-maturity. 6




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We monitor our investments for impairment on a quarterly basis and
determine whether a decline in fair value is other-than-temporary by
considering factors such as current economic and market conditions, the credit
rating of the securitys issuer, the length of time an
investments fair value
has been below our carrying value, and our ability and intent to hold
investments to maturity. If an investments decline in fair value, caused by
factors other than changes in interest rates, is deemed to be
other-than-temporary, we would reduce its carrying value to its estimated fair
value, as determined based on quoted market prices or liquidation values.
Declines in value judged to be other-than-temporary, if any, are recorded in
operations as incurred. Cash equivalents and investments consist of the following (in thousands): June 30, 2004Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair ValueMoney market funds
    
    $
    80,991
    
    
    $
    
    
    
    $
    
    
    
    $
    80,991Corporate securities
    
    
    8,380
    
    
    
    
    
    
    
    (62
    )
    
    
    8,318Government securities
    
    
    433,766
    
    
    
    44
    
    
    
    (1,377
    )
    
    
    432,433$
    523,137
    
    
    $
    44
    
    
    $
    (1,439
    )
    
    $
    521,742Cash equivalents
    
    $
    80,991
    
    
    $
    
    
    
    $
    
    
    
    $
    80,991Short-term investments
    
    
    240,433
    
    
    
    
    
    
    
    (7
    )
    
    
    240,426Long-term investments
    
    
    201,713
    
    
    
    44
    
    
    
    (1,432
    )
    
    
    200,325$
    523,137
    
    
    $
    44
    
    
    $
    (1,439
    )
    
    $
    521,742
 December 31, 2003Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    EstimatedCost
    
    Gains
    
    Losses
    
    Fair ValueMoney market funds
    
    $
    84,952
    
    
    $
    
    
    
    $
    
    
    
    $
    84,952Corporate securities
    
    
    98,388
    
    
    
    4
    
    
    
    
    
    
    
    98,392Corporate commercial paper
    
    
    21,983
    
    
    
    
    
    
    
    
    
    
    
    21,983Government securities
    
    
    254,741
    
    
    
    293
    
    
    
    (56
    )
    
    
    254,978$
    460,064
    
    
    $
    297
    
    
    $
    (56
    )
    
    $
    460,305Cash equivalents
    
    $
    116,098
    
    
    $
    
    
    
    $
    
    
    
    $
    116,098Short-term investments
    
    
    184,859
    
    
    
    1
    
    
    
    (34
    )
    
    
    184,826Long-term investments
    
    
    159,107
    
    
    
    296
    
    
    
    (22
    )
    
    
    159,381$
    460,064
    
    
    $
    297
    
    
    $
    (56
    )
    
    $
    460,305
 7




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Inventories Inventories are stated on a first-in, first-out basis at the lower of cost
or estimated net realizable value, and include purchased parts, labor and
manufacturing overhead. Inventories consist of the following (in thousands): June 30,
    
    December 31,2004
    
    2003Purchased parts
    
    $
    10,969
    
    
    $
    9,495Work-in-process
    
    
    20,094
    
    
    
    13,528Finished goods
    
    
    7,330
    
    
    
    4,994$
    38,393
    
    
    $
    28,017
 The networking industry is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements, and
evolving industry standards. Our inventory purchases and commitments are made
based on anticipated demand for our products, as estimated by management, and
our expected service requirements. We perform an assessment of our inventory
each period, which includes a review of, among other factors, demand
requirements, manufacturing lead-times, product life cycles and development
plans, component cost trends, product pricing and quality issues. Based on this
analysis, we estimate the amount of excess and obsolete inventory on hand and
make adjustments to record inventory at the lower of cost or estimated net
realizable value. Once inventory has been written down to the lower of cost or
estimated net realizable value, it is reflected on our balance sheet at its new
carrying value until it is sold or otherwise disposed. We have recorded
inventory adjustments of $25.7 million and $25.6 million as of June 30, 2004
and December 31, 2003, respectively, and such adjustments are reflected in the
table above. Concentrations Financial instruments that potentially subject us to a concentration of
credit risk consist principally of cash equivalents, short and long-term
investments and accounts receivable. We seek to reduce credit risk on financial
instruments by investing in high-quality debt issuances and, by policy, we
limit the amount of credit exposure with any one issuer or fund. Additionally,
we grant credit only to customers that meet or exceed our guidelines. As of
June 30, 2004 and December 31, 2003, ten customers accounted for approximately
46% and 55% of our net outstanding trade receivables, respectively. We purchase our proprietary ASICs used in the manufacture of our products
from sole sources and depend on their supply to meet our needs. Our custom
designed ASICs may not be readily available from other suppliers as the
development period required to fabricate our ASICs can be lengthy. The
inability of an ASIC supplier to fulfill our production requirements, or the
time required for us to identify new suppliers if a relationship is terminated,
could negatively affect our future results of operations. Revenue Recognition General.We sell our products through our direct sales force to domestic
customers and through distribution channels to international customers. We
generate the majority of our revenue from sales of chassis and stackable-based
networking equipment, with the remainder of our revenue coming from customer
support fees, training and installation services. We recognize revenue when
persuasive evidence of an arrangement exists, delivery or performance has
occurred, the sales price is fixed or determinable and collectibility is
reasonably assured. Evidence of an arrangement consists of customer purchase
orders and, in certain instances, sales contracts or agreements. Shipping terms
and related documents, or written evidence of customer acceptance, when
applicable, are used to verify delivery or performance. We assess whether the
sales price is fixed or determinable based on payment terms and whether the
sales price is subject to refund or adjustment. We assess collectibility based
on the creditworthiness of the customer as determined by our credit checks and
the customers payment history with us. When sales arrangements contain multiple elements (i.e., hardware,
training and installation), we allocate revenue to each element based on its
relative fair value, which is generally the price we charge when we sell the
item separately, and recognize revenue for each element when revenue
recognition criteria have been met for that element. This is in accordance with
Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables (EITF 00-21), which was effective for revenue arrangements entered into
in fiscal periods beginning after June 15, 2003. We adopted EITF 00-21 in the
third quarter of 2003, and its adoption did not have a material effect on our
results of operations or financial position. 8




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Product.Product revenue is generally recognized at the time of shipment,
unless an acceptance period or other contingency exists, in which case revenue
is recognized upon the earlier of customer acceptance or expiration of the
acceptance period, or upon satisfaction of the contingency. Shipping charges
billed to customers are included in product revenue and the related shipping
costs are included in cost of product revenues. At the time product revenue is recognized, we estimate the amount of
warranty costs to be incurred and record the amount as a cost of product
revenue. Our standard warranty period extends 12 months from the date of sale,
and our estimate of the amount necessary to settle warranty claims is based
primarily on our past experience. We also provide for estimated sales returns
at the time product revenue is recognized and record that amount as a reduction
to product revenue. Our sales return provision is based primarily on actual
historical sales returns and our return policies. Our resellers generally do
not have a right of return and our contracts with original equipment
manufacturers only provide for rights of return in the event our products do
not meet specifications or there is an epidemic failure, as defined in the
contracts. Services.Service revenues consist primarily of revenue from customer
support services and, to a lesser extent, training and installation services.
Our suite of customer support programs provides customers with access to
technical assistance, unspecified software updates and upgrades on a
when-and-if available basis, hardware repair and replacement parts. Support services are offered under renewable, fee-based contracts or as
part of multiple-element arrangements. Revenue from customer support contracts
is deferred and recognized ratably over the contractual support period, which
generally ranges from one to five years. Revenue from training and installation services is recognized when
services have been performed, and represented less than 1% of total revenues
for all periods presented. Segment and Geographic Information Operating segments are defined as components of an enterprise for which
separate financial information is available and is evaluated regularly by the
chief operating decision-maker, or decision-making group, in deciding how to
allocate resources and in assessing performance. We are organized as, and
operate in, one reportable segment: the design, development, manufacturing and
marketing of a comprehensive, end-to-end suite of high-performance data
networking solutions, including Ethernet Layer 2 and Layer 3 switches, Metro
routers and Internet traffic management products. Our chief operating
decision-making group reviews consolidated financial information, accompanied
by information about revenues by geographic region and configuration type. We sell to customers located in various countries in North and South
America, Europe, Asia, and Australia. Our foreign offices conduct sales,
marketing and support activities. We determine revenues by geographic location
based on the physical destination of our product shipments. International sales
represented 34% and 37% of our net product revenue for the three and six months
ended June 30, 2004, respectively, and 33% of our net product revenue for the
three and six months ended June 30, 2003. One individual country outside of
the United States, Japan, accounted for 11% and 10% of our net
product revenue for the three and six months ended June 30, 2004, respectively.
Japan represented 10% and 11% of net product revenue for the three and six
months ended June 30, 2003, respectively. Sales to the U.S. federal government
accounted for approximately 28% of our total revenues in the three months ended
June 30, 2004 and 2003, and approximately 29% of our total revenues for the six months ended
June 30, 2004 and 2003. Net product revenue from customers representing 10% or more
of net product revenue for the respective periods is summarized as follows: Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Customer A
    
    
    
    
    
    
    14
    %
    
    
    
    
    
    
    19
    %Customer B
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    %Customer C
    
    
    
    
    
    
    
    
    
    
    10
    %
    
    
    
 9




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##### Table of Contents



Computation of Per Share Amounts Basic earnings per share (EPS) has been calculated using the
weighted-average number of shares of common stock outstanding during the
period. Diluted EPS has been calculated using the weighted-average number of
shares of common stock outstanding during the period and potentially dilutive
weighted-average common stock equivalents. Weighted-average dilutive common
stock equivalents include the potentially dilutive effect of in-the-money stock
options, determined based on the average share price for each period using the
treasury stock method. Under the treasury stock method, the tax-effected
proceeds that would be received assuming the exercise of all in-the-money stock
options are assumed to be used to repurchase shares in the open market. Certain
common stock equivalents were excluded from the calculation of diluted EPS
because the exercise price of these common stock equivalents was greater than
the average market price of the common stock for the respective period and,
therefore, their inclusion would have been anti-dilutive. There were 9.7
million and 2.7 million anti-dilutive common stock equivalents for the three
months ended June 30, 2004 and 2003, respectively. For the six months ended
June 30, 2004 and 2003, there were 5.6 million and 7.8 million anti-dilutive
common stock equivalents, respectively. Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(in thousands, except per share data)Net income
    
    $
    14,988
    
    
    $
    16,794
    
    
    $
    34,889
    
    
    $
    30,234Basic:Weighted average shares outstanding
    
    
    135,183
    
    
    
    123,353
    
    
    
    133,964
    
    
    
    122,241Basic EPS
    
    $
    0.11
    
    
    $
    0.14
    
    
    $
    0.26
    
    
    $
    0.25Diluted:Weighted average shares outstanding
    
    
    135,183
    
    
    
    123,353
    
    
    
    133,964
    
    
    
    122,241Add: Weighted average dilutive potential shares
    
    
    6,292
    
    
    
    9,256
    
    
    
    8,660
    
    
    
    7,118Weighted average shares used in computing diluted EPS
    
    
    141,475
    
    
    
    132,609
    
    
    
    142,624
    
    
    
    129,359Diluted EPS
    
    $
    0.11
    
    
    $
    0.13
    
    
    $
    0.24
    
    
    $
    0.23
 Stock-Based Compensation As permitted by Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation (SFAS 123), we follow the intrinsic
value method of accounting for employee stock options as prescribed by
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees. Accordingly, we recognize compensation expense if options are
granted with an exercise price below fair market value at the date of grant or
if options are modified subsequent to the date of grant. Any resulting
compensation expense is recognized either ratably over the vesting period or
using variable accounting over the period from the date of modification to
exercise or cancellation of the award. 10




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##### Table of Contents



The following table illustrates the effect on reported net income and
earnings per share had we accounted for our employee stock options and employee
stock purchase plan under the fair value method prescribed by SFAS 123. Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(in thousands, except per share data)Net income as reported
    
    $
    14,988
    
    
    $
    16,794
    
    
    $
    34,889
    
    
    $
    30,234Add: Total stock-based
compensation expense
included in reported net
income, net of tax effect
    
    
    
    
    
    
    47
    
    
    
    
    
    
    
    126Deduct: Total stock-based
compensation expense
determined under
fair value method for all
awards, net of related tax
effect
    
    
    (9,506
    )
    
    
    (7,517
    )
    
    
    (18,362
    )
    
    
    (15,119
    )Pro forma net income
    
    $
    5,482
    
    
    $
    9,324
    
    
    $
    16,527
    
    
    $
    15,241Basic net income per share:As reported
    
    $
    0.11
    
    
    $
    0.14
    
    
    $
    0.26
    
    
    $
    0.25Pro forma
    
    $
    0.04
    
    
    $
    0.08
    
    
    $
    0.12
    
    
    $
    0.12Diluted net income per share:As reported
    
    $
    0.11
    
    
    $
    0.13
    
    
    $
    0.24
    
    
    $
    0.23Pro forma
    
    $
    0.04
    
    
    $
    0.07
    
    
    $
    0.12
    
    
    $
    0.12
 We estimate the fair value of our stock options using the Black-Scholes
option valuation model, which is the most commonly used model for purposes of
disclosure pursuant to SFAS 123. However, the Black-Scholes model was developed
for use in estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. The Black-Scholes model requires the
input of highly-subjective assumptions, including expected stock price
volatility. Because our stock options have characteristics significantly
different than those of traded options, and because changes in assumptions can
materially affect fair value estimates, the Black-Scholes model does not
provide a reliable measure of the fair value of our options in managements
opinion. The following weighted-average assumptions were used to estimate the
fair value of stock options granted: Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2004
    
    2003
    
    2004
    
    2003Stock Option Plan:Average risk free interest rate
    
    
    3.45
    %
    
    
    1.85
    %
    
    
    2.91
    %
    
    
    2.03
    %Average expected life of option
    
    3.7 years
    
    4.0 years
    
    3.9 years
    
    3.7 yearsDividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Volatility of common stock
    
    
    70
    %
    
    
    63
    %
    
    
    73
    %
    
    
    69
    %
 Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,2004
    
    2003
    
    2004
    
    2003Employee Stock Purchase Plan:Average risk free interest rate
    
    
    2.67
    %
    
    
    2.00
    %
    
    
    1.96
    %
    
    
    2.00
    %Average expected life of option
    
    1.9 years
    
    0.5 years
    
    1.6 years
    
    0.5 yearsDividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Volatility of common stock
    
    
    70
    %
    
    
    75
    %
    
    
    67
    %
    
    
    75
    %
 11




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##### Table of Contents



Recent Accounting Pronouncements In March 2004, the Emerging Issues Task Force (EITF) reached a consensus
on recognition and measurement guidance previously discussed under EITF 03-01,
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments. The consensus clarifies the meaning of other-than-temporary
impairment and its application to investments classified as either
available-for-sale or held-to-maturity under SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities, and investments accounted
for under the cost method or the equity method. The Task Force developed a
basic three-step model in evaluating whether an investment is
other-than-temporarily impaired and reached a consensus that additional
disclosures are required for cost method investments. The recognition and
measurement guidance is applied to other-than-temporary impairment evaluations
in reporting periods beginning after June 15, 2004. The application of this
consensus did not have an effect on our consolidated results of operations for
the quarter ended June 30, 2004. 2. COMPREHENSIVE INCOME Comprehensive income is defined in SFAS No. 130, Reporting Comprehensive
Income, as the changes in equity of an enterprise except those resulting from
stockholder transactions. Non-net income components of comprehensive income for
the three and six months ended June 30, 2004 and 2003 were insignificant and
consisted entirely of foreign currency translation adjustments. 3. COMMITMENTS AND CONTINGENCIES Guarantees and Product Warranties FASB Interpretation No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45), requires that upon issuance of a guarantee, the guarantor
must disclose and recognize a liability for the fair value of the obligation it
assumes under that guarantee. FIN 45 is applicable to our product warranty
liability and to indemnification obligations contained in commercial
agreements, including customary intellectual property indemnifications for our
products contained in agreements with our resellers and end-users. We provide all customers with a standard one-year hardware and 90-day
software warranty. Customers can upgrade and/or extend the warranty for up to
five years by purchasing one of our customer support programs. Our warranty
accrual represents our best estimate of the amount necessary to settle future
and existing claims as of the balance sheet date. We periodically assess the
adequacy of our warranty accrual and adjust the amount as considered necessary. Changes in product warranty liability for the six months ended June 30,
2004 were as follows: Balance, December 31, 2003
    
    $
    1,781Liabilities accrued for warranties issued during the period
    
    
    508Warranty claims settled during the period
    
    
    (227
    )Expirations and changes in estimates
    
    
    (497
    )Balance, June 30, 2004
    
    $
    1,565
 We offer our customers renewable support arrangements, including extended
warranties, that generally range from one to five years. We do not separate
extended warranty revenues from routine support service revenues, as it is not
practical to do so. The change in our deferred support revenue balance was as
follows for the six months ended June 30, 2004: Deferred support revenue at December 31, 2003
    
    $
    35,115Additions to deferred support revenue
    
    
    34,474Recognition of support revenue
    
    
    (28,363
    )Ending balance at June 30, 2004
    
    $
    41,226
 12




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##### Table of Contents



In the ordinary course of business, we enter into contractual arrangements
under which we may agree to indemnify the counter-party to such an arrangement
from any losses relating to a breach of representations and warranties, a
failure to perform certain covenants, or claims and losses arising from certain
external events as outlined within the particular contract, which may include,
for example, losses arising from litigation or claims relating to past
performance. Such indemnification clauses may not be subject to maximum loss
clauses. No amounts are reflected in our financial statements as of June 30,
2004 or December 31, 2003 related to these indemnifications as, historically,
payments made related to these indemnifications have not been material to our
financial position or results of operations. Purchase Commitments with Suppliers and Contract Manufacturers We use contract manufacturers to assemble and test our products. In order
to reduce manufacturing lead-times and ensure an adequate supply of
inventories, our agreements with some of these contract manufacturers allow
them to procure long lead-time component inventory on our behalf based on a
rolling production forecast provided by us. We may be contractually obligated
to purchase long lead-time component inventory procured by certain contract
manufacturers in accordance with our forecast, unless we give notice of order
cancellation at least 90 days prior to the delivery date. In addition, we issue
purchase orders to our component suppliers and contract manufacturers that may not
be cancelable at any time. As of June 30, 2004, we had approximately $48.9
million of open purchase orders with our component suppliers and contract
manufacturers that may not be cancelable. Litigation In December 2000, several similar stockholder class action lawsuits were
filed against us and certain of our officers in the United States District
Court for the Northern District of California, following our announcement of
our anticipated financial results for the fourth quarter ended December 31,
2000. The lawsuits were subsequently consolidated as a class action by the
District Court, under the caption In re Foundry Networks, Inc. Securities
Litigation,Master File No. C-00-4823-MMC, and lead plaintiffs were selected
and filed a consolidated amended complaint which alleged violations of federal
securities laws and purported to seek damages on behalf of a class of
stockholders who purchased our common stock during the period from September 7,
2000 to December 19, 2000. We then brought four successful motions to dismiss
the complaint. Although the District Court granted each of the four dismissal
motions, it also provided plaintiffs leave to amend the complaint. On August
29, 2003, following the dismissal of the four amended complaints, the District
Court granted our motion to dismiss the case with prejudice and without leave
to amend and, on September 2, 2003, entered judgment in our favor, dismissing
the plaintiffs fifth amended complaint. On September 29, 2003, plaintiffs
filed a Notice of Appeal with the United States Court of Appeals for the Ninth
Circuit (Court of Appeals). On January 15, 2004, the plaintiff/appellants
filed their opening brief with the Court of Appeals. On April 2, 2004, we filed
our responsive brief. On May 14, 2004, the plaintiff appellants filed a reply
brief. The briefing is now complete and the parties are awaiting a schedule for
oral argument from the Court of Appeals. We believe the District Courts
judgment validates our conviction that the lawsuit is without merit and we will
defend the District Courts judgment vigorously. A class action lawsuit was filed on November 27, 2001 in the United States
District Court for the Southern District of New York on behalf of purchasers of
our common stock alleging violations of federal securities laws. The case was
designated as In re Foundry Networks, Inc. Initial Public Offering Securities
Litigation,No. 01-CV-10640 (SAS) (S.D.N.Y.), related to In re Initial Public
Offering Securities Litigation,No. 21 MC 92 (SAS) (S.D.N.Y.). The case is
brought purportedly on behalf of all persons who purchased our common stock
from September 27, 1999 through December 6, 2000. The operative amended
complaint names as defendants us and three of our officers (the Foundry
Defendants), including our Chief Executive Officer and Chief Financial
Officer; and investment banking firms that served as underwriters for our
initial public offering in September 1999. The amended complaint alleged
violations of Sections 11 and 15 of the Securities Act of 1933, and Section
10(b) of the Securities Exchange Act of 1934, on the grounds that the
registration statement for the initial public offering ( IPO) failed to
disclose that (i) the underwriters agreed to allow certain customers to
purchase shares in the IPO in exchange for excess commissions to be paid to the
underwriters, and (ii) the underwriters arranged for certain customers to
purchase additional shares in the aftermarket at predetermined prices. The
amended complaint also appears to allege that false or misleading analyst
reports were issued. Similar allegations were made in lawsuits challenging over
300 other initial public offerings conducted in 1999 and 2000. The cases were
consolidated for pretrial purposes. On February 19, 2003, the Court ruled on
all defendants motions to dismiss. In ruling on motions to dismiss, the Court
must treat the allegations in the complaint as if they were true solely for
purposes of deciding the motions. The motion was denied as to claims under the
Securities Act of 1933 in the case involving us. The same ruling was made in
all but 10 of the other cases. The Court dismissed the claims under Section
10(b) of the Securities Exchange Act of 1934 against us and one of the
individual defendants and dismissed all of the Section 20(a) control person
claims. The Court denied the motion to dismiss the Section 10(b) claims against
our remaining individual defendants on the basis that those defendants
allegedly sold our stock following the IPO, allegations 13




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##### Table of Contents



found sufficient purely for pleading purposes to allow those claims to
move forward. A similar ruling was made with respect to 62 of the individual
defendants in the other cases. We have accepted a settlement proposal presented
to all issuer defendants. Under the terms of this settlement, plaintiffs will
dismiss and release all claims against the Foundry Defendants in exchange for a
contingent payment by the insurance companies collectively responsible for
insuring the issuers in all of the IPO cases and for the assignment or
surrender of control of certain claims we may have against the underwriters.
The settlement will require approval of the Court, which cannot be assured,
after class members are given the opportunity to object to the settlement or
opt out of the settlement. In March 2001, Nortel Networks Corp. (Nortel) filed a lawsuit against us
in the United States District Court for the District of Massachusetts alleging
that certain of our products infringe several of Nortels patents and seeking
injunctive relief and unspecified damages. Nortel has also brought suit, on the
same or similar patents, against other networking companies. We have analyzed
the validity of Nortels claims and believe that Nortels suit is without
merit. Discovery has closed and both sides have filed expert reports. A Markman Hearing to construe disputed
terms has been scheduled for September 17, 2004. A hearing on outstanding summary judgement motions has been
scheduled for September 23, 2004. We are committed to vigorously defending ourself against these
claims. On October 9, 2002, we filed a lawsuit against Nortel in the United States
District Court, Northern District of California alleging that certain of
Nortels products infringe one of our patents and alleging breach of contract
by Nortel. We are seeking injunctive relief and damages. On November 18, 2002,
Nortel filed an Answer and Counter Claims asserting infringement of five
additional patents against us. On December 6, 2002, we filed an Answer to
Nortels counter claims denying infringement and asserting invalidity as to
Nortels five asserted patents. On April 11, 2003, the District Court set a
trial date for November 29, 2004. On November 18, 2003, after a Markman
Hearing, the District Court issued an order on ten disputed terms as to the
asserted patents construing each disputed term in our favor. Discovery has
been completed and expert reports have been filed. On April 2, 2004, we filed
summary judgment motions on two of Nortels asserted patents. The parties are
awaiting a hearing date on the motions. We analyzed the validity of Nortels
counter claims and believe they are without merit. In May 2003, Lucent Technologies Inc. (Lucent) filed a lawsuit against
us in the United States District Court for the District of Delaware alleging
that certain of our products infringe several of Lucents patents, and seeking
injunctive relief, as well as unspecified damages. Lucent also brought suit on
the same patents (and one additional patent) against one of our competitors. On
August 12, 2003, we filed a motion to sever the cases, and on February 6, 2004,
the District Court granted the motion. Discovery is ongoing. The parties have
been instructed by the court to be prepared for trial in the spring of 2005.
We have analyzed the validity of Lucents claims and believe that Lucents suit
is without merit. We are committed to vigorously defending ourself against
Lucents claims. On February 13, 2004, we filed a lawsuit against Lucent in the United
States District Court, Eastern District of Texas, Marshall Division. The
lawsuit alleges that certain of Lucents products infringe one of our patents.
We are seeking injunctive relief and damages. On March 22, 2004, Lucent filed
an Answer and Counter Claim seeking a declaration of invalidity as to our
asserted patent. On April 9, 2004, Lucent filed an Amended Answer and Counter
Claim asserting infringement of U.S. patent #5649131. We analyzed the validity
of Lucents counter claim and believe it is without merit. From time to time, we are subject to other legal proceedings and claims in
the ordinary course of business, including claims of alleged infringement of
trademarks, copyrights, patents and other intellectual property rights. In
addition, from time to time, third parties assert patent infringement claims
against us in the form of letters, lawsuits and other forms of communication.
Regardless of the merits of our position, litigation is always an expensive and
uncertain proposition. In accordance with SFAS No. 5, Accounting for
Contingencies (SFAS 5), we record a liability when it is both probable that
a liability has been incurred and the amount of the loss can be reasonably
estimated. We review the need for any such provision on a quarterly basis and
record any necessary adjustments to reflect the effect of ongoing negotiations,
settlements, rulings, advice of legal counsel, and other information and events
pertaining to a particular case in the period they become known. To date, we
have not recorded any such provisions in accordance with SFAS 5. We believe we
have valid defenses with respect to the legal matters pending against us. In
the event of a determination adverse to us, we could incur substantial monetary
liability, and be required to change our business practices. Any unfavorable
determination could have a material adverse effect on our financial position,
results of operations, or cash flows. 4. INCOME TAXES: Our interim effective income tax rate is based on our best estimate of our
annual effective income tax rate. We recorded income tax provisions of $21.4
million and $16.3 million for the six months ended June 30, 2004 and 2003,
respectively. The effective tax rate for the three and six months ended June
30, 2004 was 38%, compared to 35% for the same periods in 2003. These rates reflect federal and state statutory tax
rates, offset by tax benefits associated with research and development tax
credits, export sales incentives, and tax-exempt interest income. 14




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##### Table of Contents



Our income taxes payable for federal and state purposes have been reduced
by the tax benefits associated with taxable dispositions of employee stock
options. When an employee exercises a stock option issued under a nonqualified
plan or has a disqualifying disposition related to a qualified plan, we receive
an income tax benefit for the difference between the fair market value of the
stock issued at the time of exercise or disposition and the option price, tax
effected. These benefits are recorded in stockholders equity and were $19.9
million and $6.5 million for the six months ended June 30, 2004 and 2003,
respectively. Management believes Foundry will likely generate sufficient taxable income
in the future to realize the tax benefits arising from its existing net
deferred tax assets of $35.0 million at June 30, 2004. 15




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and
Results Of Operations The following discussion and analysis of our financial condition and
results of operations should be read together with our condensed consolidated
financial statements and related notes appearing elsewhere in thisForm 10-Q.
This discussion and analysis contain forward-looking statements that involve
risks, uncertainties and assumptions. Our actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including, but not limited to, those discussed in the section entitled
Managements Discussion and Analysis of Financial Condition and Results of
OperationsRisk Factors That May Affect Future Results and the Market Price of
Our Stock. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect managements opinions only as of the
date hereof. We undertake no obligation to revise or publicly release the
results of any revision to these forward-looking statements. Readers should
carefully review the risk factors described in this document as well as in
other documents we file from time to time with the SEC. All public reports
filed by us with the SEC are available free of charge on our website at
www.foundrynetworks.com or from the SEC at www.sec.gov as soon as practicable
after we electronically file such reports with the SEC. Overview Founded in 1996, Foundry designs, develops, manufactures and markets a
comprehensive, end-to-end suite of high performance data networking solutions,
including Ethernet Layer 2 and Layer 3 switches, Metro routers, and Internet
traffic management products. Our customers include U.S. government agencies and
enterprises such as healthcare, universities, financial and manufacturing
companies, e-commerce sites, and entertainment companies, as well as Internet and Metro service
providers. Critical Accounting Policies and Estimates Managements discussion and analysis of financial condition and results of
operations are based on our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the condensed consolidated financial statements, and the reported amounts of
revenue and expenses during the period reported. By their nature, these
estimates and judgments are subject to an inherent degree of uncertainty.
Management bases their estimates and judgments on historical experience, market
trends, and other factors that are believed to be reasonable under the
circumstances. The results of these estimates form the basis for judgments
about the carrying value of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions. Management believes critical
accounting policies as disclosed in our Annual Report on Form 10-K for the year
ended December 31, 2003 reflect the more significant judgments and estimates
used in preparation of our financial statements. Management has discussed the
development, selection, and disclosure of these estimates with the Audit
Committee of Foundrys Board of Directors. Management believes there have been
no material changes to our critical accounting policies and estimates during
the six months ended June 30, 2004 compared to those discussed in our Annual
Report on Form 10-K for the year ended December 31, 2003. Results of Operations Net Revenues We offer products in two configuration platforms, a fixed configuration
stackable and a flexible configuration chassis. A stackable has a fixed
configuration that cannot be altered. Chassis use a modular platform that can
be populated and reconfigured with various management and line card modules as
frequently as desired by the customer. For example, customers can use our
chassis products at the edge of their network and then reconfigure the chassis
to be used in the backbone or core of their network. The physical connection
between the stackable or chassis to a copper or fiber cable is called a port.
Customers purchase a number of ports based on their desired network
functionality and throughput. The networking industry generally uses ports as a
unit of measure for networking devices because it provides a more meaningful
comparison of customer and market trends over time. Higher port shipments in a
particular period are generally an indicator of potential network and revenue
growth. Our selling prices and gross margins on chassis-based products are
generally higher than our stackable products because of the flexible
configuration offered by chassis-based products. 16




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##### Table of Contents



The following table presents product and service revenues for the three
and six months ended June 30, 2004 and 2003 (dollars in thousands): Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003% of
    
    
    
    
    
    % of
    
    
    
    
    
    % of
    
    
    
    
    
    % of$
    
    Revenues
    
    $
    
    Revenues
    
    $
    
    Revenues
    
    $
    
    RevenuesNet revenues:Product
    
    $
    83,489
    
    
    
    85
    %
    
    $
    83,444
    
    
    
    87
    %
    
    $
    172,789
    
    
    
    86
    %
    
    $
    164,457
    
    
    
    88
    %Service
    
    
    14,338
    
    
    
    15
    %
    
    
    12,268
    
    
    
    13
    %
    
    
    29,054
    
    
    
    14
    %
    
    
    22,393
    
    
    
    12
    %Total net revenues
    
    $
    97,827
    
    
    
    100
    %
    
    $
    95,712
    
    
    
    100
    %
    
    $
    201,843
    
    
    
    100
    %
    
    $
    186,850
    
    
    
    100
    %
 Product revenues were $83.5 million and $83.4 million for the three months
ended June 30, 2004 and 2003, respectively. Total ports shipped were
essentially the same for both periods, and the effect on revenue in the second
quarter of 2004 of selling price erosion, caused by heightened competition in
the IT marketplace, was offset by a shift in product mix from lower priced
10/100 Ethernet ports to higher-priced 10-Gigabit Ethernet products. For the
six months ended June 30, 2004 and 2003, product revenues were $172.8 million
and $164.5 million, respectively, an increase of 5%. The overall increase was
due to increased port shipments of 9%, mitigated somewhat by lower average
selling prices as a result of competitive pressures. Sales to the U.S. federal
government as a percentage of total revenues were approximately 28% for the
three months ended June 30, 2004 and 2003, and approximately 29% for the six months ended
June 30, 2004 and 2003. The following table presents net chassis and stackable revenues for the
three and six months ended June 30, 2004 and 2003 (dollars in thousands): Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003% of
    
    
    
    
    
    % of
    
    
    
    
    
    % of
    
    
    
    
    
    % of$
    
    Revenues
    
    $
    
    Revenues
    
    $
    
    Revenues
    
    $
    
    RevenuesTotal net revenues:Chassis
    
    $
    74,349
    
    
    
    76
    %
    
    $
    76,569
    
    
    
    80
    %
    
    $
    157,562
    
    
    
    78
    %
    
    $
    149,480
    
    
    
    80
    %Stackable
    
    
    23,478
    
    
    
    24
    %
    
    
    19,143
    
    
    
    20
    %
    
    
    44,281
    
    
    
    22
    %
    
    
    37,370
    
    
    
    20
    %Total net revenues
    
    $
    97,827
    
    
    
    100
    %
    
    $
    95,712
    
    
    
    100
    %
    
    $
    201,843
    
    
    
    100
    %
    
    $
    186,850
    
    
    
    100
    %
 Revenue from our chassis products accounted for 76% and 80% of our total
net revenues for the three months ended June 30, 2004 and 2003, respectively.
For the six months ended June 30, 2004 and 2003, revenue from chassis products
was 78% and 80% of our total net revenues, respectively. The shift in product
mix from chassis to stackable products was due to our increased efforts in 2004
to sell a complete solution that combines both stackable and chassis products
to customers who may otherwise purchase high-end Layer 2-3 chassis products
from us and low-end Layer 2-3 stackable products from another vendor. We do
not expect sales of our chassis and stackable products to fluctuate
significantly as a percentage of total net revenues in the future. Service revenues consist primarily of revenue from customer support
contracts, and to a lesser extent, from providing training and installation
services. Service revenues were $14.3 million and $12.3 million, or 15% and 13%
of total revenues, for the three months ended June 30, 2004 and 2003,
respectively. For the six months ended June 30, 2004 and 2003, service revenues
were $29.1 million and $22.4 million, or 14% and 12% of total revenues,
respectively. Service revenues increased in absolute dollars in 2004 due to a
growth in our installed base of networking equipment and increased efforts to
renew customer support contracts. Our international sales represented 34% and 37% of our net product revenue
for the three and six months ended June 30, 2004, respectively, and 33% of our
net product revenue for the three and six months ended June 30, 2003. One
individual country outside of the United States, Japan, accounted for
11% and 10% of our net product revenue for the three and six months ended June 30, 2004, respectively.
Japan accounted for 10% and 11% of our net product revenue for the three and
six months ended June 30, 2003, respectively. 17




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##### Table of Contents



Net product revenue from customers representing 10% or more
of net product revenue for the respective periods is summarized as follows: Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Customer A
    
    
    
    
    
    
    14
    %
    
    
    
    
    
    
    19
    %Customer B
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    %Customer C
    
    
    
    
    
    
    
    
    
    
    10
    %
    
    
    
 Gross Margins The following table presents gross margins and the related gross margin
percentages for the three and six months ended June 30, 2004 and 2003 (dollars in
thousands): Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Gross
    
    
    
    
    
    Gross
    
    
    
    
    
    Gross
    
    
    
    
    
    Gross$
    
    Margin %
    
    $
    
    Margin %
    
    $
    
    Margin %
    
    $
    
    Margin %Gross margins:Product
    
    $
    53,047
    
    
    
    64
    %
    
    $
    51,016
    
    
    
    61
    %
    
    $
    110,353
    
    
    
    64
    %
    
    $
    96,587
    
    
    
    59
    %Service
    
    
    10,772
    
    
    
    75
    %
    
    
    10,072
    
    
    
    82
    %
    
    
    22,362
    
    
    
    77
    %
    
    
    18,136
    
    
    
    81
    %Total gross margins
    
    $
    63,819
    
    
    
    65
    %
    
    $
    61,088
    
    
    
    64
    %
    
    $
    132,715
    
    
    
    66
    %
    
    $
    114,723
    
    
    
    61
    %
 Our cost of product revenue consists primarily of material, labor,
manufacturing overhead, freight, warranty costs, and provisions for excess and
obsolete inventory. Product gross margins were $53.0 million and $51.0 million,
or 64% and 61% of net product revenue, for the three months ended June 30, 2004
and 2003, respectively. Product gross margins were $110.4 million and $96.6
million, or 64% and 59% of net product revenue, for the six months ended June 30,
2004 and 2003, respectively. The increases in product gross margins as a
percentage of product net revenue were the result of reduced component and
contract manufacturing costs, lower provisions for excess and obsolete
inventory and favorable shifts in product mix, offset somewhat by lower average
selling prices. Our cost of service revenues consists primarily of costs of providing
services under customer support contracts. These costs include material costs,
labor, and overhead. Service gross margins were $10.8 million and $10.1
million, or 75% and 82% of service revenues, for the three months ended June
30, 2004 and 2003, respectively. For the six months ended June 30, 2004 and
2003, service gross margins were $22.4 million and $18.1 million, or 77% and
81% of service revenues, respectively. The decreases in our service gross
margin percentages were due primarily to increased inventory provisions
associated with supporting a larger customer base and a broader product
portfolio, and costs associated with operating more service facilities. Our gross margins may be adversely affected by increased price
competition, component shortages, increases in material or labor costs, excess
and obsolete inventory charges, changes in channels of distribution, or
customer, product and geographic mix. See also Risk Factors That May Affect
Future Results and Market Price of StockOur gross margins may decline over
time and the average selling prices of our products may decrease as a result of
competitive pressures and other factors. 18




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##### Table of Contents



Research and Development, Sales and Marketing, and General and
Administrative Expenses The following table presents research and development, sales and
marketing, and general and administrative expenses for the three and six months
ended June 30, 2004 and 2003 (dollars in thousands): Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003% of
    
    
    
    
    
    % of
    
    
    
    
    
    % of
    
    
    
    
    
    % of$
    
    Revenues
    
    $
    
    Revenues
    
    $
    
    Revenues
    
    $
    
    RevenuesResearch and Development
    
    $
    10,003
    
    
    
    10
    %
    
    $
    10,045
    
    
    
    10
    %
    
    $
    20,015
    
    
    
    10
    %
    
    $
    19,966
    
    
    
    11
    %Sales and Marketing
    
    
    25,094
    
    
    
    26
    %
    
    
    23,415
    
    
    
    24
    %
    
    
    48,262
    
    
    
    24
    %
    
    
    43,396
    
    
    
    23
    %General and Administrative
    
    
    6,268
    
    
    
    6
    %
    
    
    2,948
    
    
    
    3
    %
    
    
    11,693
    
    
    
    6
    %
    
    
    6,947
    
    
    
    4
    %
 Research and development expenses consist primarily of salaries and
related personnel expenses, prototype materials, costs incurred for the
development of our ASICs, software development and testing costs, and
depreciation of equipment used in research and development activities. Research
and development expenses were approximately the same for the three months ended
June 30, 2004 and 2003, and for the six months ended June 30, 2004 and 2003.
Headcount increased in 2004, but its effect on expenses was offset by reduced
costs for prototype materials. We have continued to invest in research and
development efforts in areas such as data, voice, and video over IP; security;
network management; and advanced core and edge switching technologies. Sales and marketing expenses consist primarily of salaries, commissions
and related expenses for personnel engaged in marketing, sales and customer
service functions, as well as trade shows, advertising, promotional expenses
and the cost of facilities. Sales and marketing expenses were $25.1 million and
$23.4 million for the three months ended June 30, 2004 and 2003, or 26% and 24%
of total revenues, respectively. For the six months ended June 30, 2004 and
2003, sales and marketing expenses were $48.3 million and $43.4 million, or 24%
and 23% of total revenues, respectively. The increases in absolute dollars were
primarily due to increases in advertising and trade show expenses to enhance
our brand recognition and to announce our Terabit-capacity Ethernet switching
products. During the three and six months ended June 30, 2004, our headcount
for sales personnel increased 6% and 4%, respectively, over the same periods in
2003, as did carrying costs associated with additional evaluation and
demonstration inventory units in the field. These increases were offset by
significantly lower commissions as our sales achievement relative to our sales
quotas decreased for the first half of 2004. General and administrative expenses consist primarily of salaries and
related expenses for executive, finance and administrative personnel,
facilities, bad debt, legal, and other general corporate expenses. General and
administrative expenses were $6.3 million and $2.9 million for the three months
ended June 30, 2004 and 2003, or 6% and 3% of total revenues, respectively. The
increase in absolute dollars was primarily due to an increase of $1.7 million
in legal fees associated with a higher level of litigation and claims activity,
a benefit of $0.6 million from reduced bad debt reserve requirements in the
second quarter of 2003, compared to no bad debt reserve requirements in the
second quarter of 2004, and an increase of $0.3 million for consulting fees
related to compliance with Section 404 of the Sarbanes-Oxley Act in the second
quarter of 2004. For the six months ended June 30, 2004 and 2003, general and
administrative expenses were $11.7 million and $6.9 million, or 6% and 4% of
total revenues, respectively. The increase in absolute dollars was due to a
benefit of $0.6 million from reduced bad debt reserve requirements in the first
half of 2003, compared to no bad debt reserve requirements in the first half of
2004, an increase of $2.3 million in legal costs associated with litigation
matters discussed in Note 3, and increased general corporate expenses for
headcount and consulting fees related to compliance with Section 404 of the
Sarbanes-Oxley Act. Interest and other income, net We earn interest income on funds maintained in interest-bearing money
market and investment accounts. We recorded net interest and other income of
$1.7 million and $1.2 million for the three months ended June 30, 2004 and
2003, respectively, and $3.5 million and $2.3 million for the six months ended
June 30, 2004 and 2003, respectively. The increase in net interest and other
income was primarily a result of higher investment balances maintained during
the three and six months ended June 30, 2004. Our total cash and investments
increased $182.5 million from June 30, 2003 to June 30, 2004. Income Taxes 19




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We recorded income tax provisions of $9.2 million and $9.0 million for the
three months ended June 30, 2004 and 2003, respectively, and $21.4 million and
$16.3 million for the six months ended June 30, 2004 and 2003, respectively.
The effective tax rates for the three and six months ended June 30, 2004 and
2003 were 38% and 35%, respectively. The increase in the effective tax rate can
be attributed to reduced effects from research and development tax credits and
tax-exempt interest income. The effects of these items were reduced since the
amounts did not increase at the same rate as pre-tax income. Our income taxes payable for federal and state purposes has been reduced,
and stockholders equity increased, by the tax benefits associated with taxable
dispositions of employee stock options. When an employee exercises a stock
option issued under a nonqualified plan, or has a disqualifying disposition
related to a qualified plan, we receive an income tax benefit for the
difference between the fair market value of the stock issued at the time of the
exercise or disposition and the employees option price, tax effected. These
benefits are recorded in stockholders equity and were $19.9 million and $6.5
million for the six months ended June 30, 2004 and 2003, respectively. Liquidity and Capital Resources At June 30, 2004, we had cash and investments totaling $593.8 million, an
increase of $88.1 million from $505.7 million at December 31, 2003. The
increase can be attributed to $66.5 million of cash from operations in the
first six months of 2004 and $27.2 million of proceeds from the exercise of
employee stock options, offset by $5.9 million of equipment purchases during
the six months ended June 30, 2004. Net accounts receivable was $75.2 million at June 30, 2004 and $77.1
million at December 31, 2003. Our accounts receivable and days sales
outstanding (DSO) are primarily affected by sale volume, shipment linearity
and collections performance. Our DSO increased to 69 days as of June 30, 2004,
from 63 days as of December 31, 2003 primarily as a result of less linear
shipments during the second quarter, in which more than 60% of our revenues
shipped during the month of June. We received significant tax benefits, in the form of reduced payments,
during the past twelve months associated with disqualifying dispositions of
employee stock options. If stock option exercise patterns change, we may receive less cash from stock option exercises and may not
receive the same level of tax benefits in the future, which could cause our
cash payments for income taxes to increase. Net inventories were $38.4 million and $28.0 million as of June 30, 2004
and December 31, 2003, respectively. We significantly increased our production
inventory levels to support a broader product offering, including new products,
and also increased our service inventory levels to support a growing installed
customer base. Annualized net inventory turnover was approximately 3.2 and 4.2
for the three months ended June 30, 2004 and December 31, 2003, respectively.
The decrease in inventory turns was due to lower product sales and higher
average net inventory levels during the second quarter of 2004. Based on past performance and current expectations, we believe our cash
and cash equivalents, short-term investments, and cash generated from
operations will satisfy our working capital needs, capital expenditures,
commitments, and other liquidity requirements associated with our existing
operations through at least the next twelve months. Disclosures about Contractual Obligations and Commercial Commitments The following table summarizes our contractual obligations at June 30,
2004 and the effect such obligations are expected to have on our liquidity and
cash flow in future periods (in thousands): Less Than
    
    13
    
    MoreTotal
    
    1 Year
    
    Years
    
    Than 3 YearsOperating office leases
    
    $
    13,313
    
    
    $
    4,811
    
    
    $
    6,777
    
    
    $
    1,725Purchase commitments with our contract manufacturers
    
    
    48,853
    
    
    
    48,853
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    62,166
    
    
    $
    53,664
    
    
    $
    6,777
    
    
    $
    1,725
 Operating lease obligations represent the minimum lease rental payments
under noncancelable leases for our office space in various locations around the
world. Purchase commitments represent agreements to purchase component
inventory from our suppliers and contract manufacturers that are enforceable
and legally binding against us. 20




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##### Table of Contents



Key factors affecting our cash flows include our ability to effectively
manage our working capital, in particular inventory and accounts receivable, as
well as future demand for our products and related pricing. We may incur higher
capital expenditures in the near future if market conditions improve and we
expand our operations. Although we do not have any current plans or commitments
to do so, from time to time, we may also consider the acquisition of products
and businesses complementary to our business. Any acquisition or investment may
reduce our current capital or require additional capital. Off-Balance Sheet Arrangements We do not maintain any off-balance sheet transactions, arrangements, or
obligations that are reasonably likely to have a material effect on our
financial condition, results of operations, liquidity, or capital resources. Recent Accounting Pronouncements In March 2004, the Emerging Issues Task Force (EITF) reached a consensus
on recognition and measurement guidance previously discussed under EITF 03-01,
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments. The consensus clarifies the meaning of other-than-temporary
impairment and its application to investments classified as either
available-for-sale or held-to-maturity under SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities, and investments accounted
for under the cost method or the equity method. The Task Force developed a
basic three-step model in evaluating whether an investment is
other-than-temporarily impaired and reached a consensus that additional
disclosures are required for cost method investments. The recognition and
measurement guidance is applied to other-than-temporary impairment evaluations
in reporting periods beginning after June 15, 2004. The application of this
consensus did not have an effect on our consolidated results of operations for
the quarter ended June 30, 2004. 21




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##### Table of Contents



RISK FACTORS THAT MAY AFFECT FUTURE RESULTS AND THE MARKET PRICE OF OUR STOCK Weak economic and market conditions or geopolitical turmoil may adversely
affect our revenues, gross margins and expenses. Our quarterly revenues and operating results may continue to fluctuate,
due to the effects of general economic conditions in the United States and
globally, and, in particular, market conditions in the communications and
networking industries. Additionally, current political turmoil in many parts of
the world, including terrorist and military actions, may weaken the global
economy. If economic conditions in the United States and globally do not
improve, or if they worsen, we may experience material negative effects on our
business, operating results and financial condition. There can be no assurance
that we will be able to maintain or improve our financial results or that
economic and market conditions will continue to improve and will not
deteriorate. Because our financial results are difficult to predict, we may not meet
quarterly financial expectations, which could cause our stock price to decline. Our quarterly revenues and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter. Our quarterly revenue and
earnings per share guidance is our best estimate at the time we provide
guidance. Delays in generating or recognizing forecasted revenues could cause
our quarterly operating results to be below our expectations and those of
public market analysts or investors, which could cause the price of our common
stock to fall. We may experience a delay in generating or recognizing revenue for a
number of reasons. Unfulfilled orders at the beginning of each quarter are
typically substantially less than our expected revenue for that quarter.
Therefore, we depend on obtaining orders in a quarter for shipment in that
quarter to achieve our revenue objectives. In addition, our reseller agreements
typically allow the reseller to delay scheduled delivery dates without penalty.
Moreover, demand for our products may fluctuate as a result of seasonality. Orders are generally cancelable at any time prior to shipment. Reasons
for cancellation could include our inability to deliver products within the
customers specified timeframe due to component shortages or high priority
government orders that take precedence to commercial enterprise orders, as well
as other reasons. Our revenues for a particular period may also be difficult to predict and
may be adversely affected if we experience a non-linear (back-end loaded) sales
pattern during the period. We sometimes experience significantly higher levels
of sales towards the end of a period as a result of customers submitting their
orders late in the period or as a result of manufacturing issues or component
shortages which may delay shipments. Such non-linearity in shipments can
increase costs, as irregular shipment patterns result in periods of
underutilized capacity and periods when overtime expenses may be incurred, as
well as leading to additional costs associated with inventory planning and
management. Furthermore, orders received towards the end of the period may not
ship within the period due to our manufacturing lead times. In addition, we may incur increased costs and expenses related to sales
and marketing, including expansion of our direct sales operations and
distribution channels, product marketing, customer support, expansion of our
corporate infrastructure, legal matters, and facilities expansion. We base our
operating expenses on anticipated revenue levels, and a high percentage of our
expenses are fixed in the short-term. As a result, any significant shortfall in
revenue relative to our expectations could cause a significant decline in our
quarterly operating results. Because of the uncertain nature of the economic environment and rapidly
changing market we serve, period-to-period comparisons of operating results may
not be meaningful. In addition, you may not be able to rely on the results for
any period as an indication of future performance. In the future, our revenue
may remain the same, decrease or increase, and we may not be able to sustain or
increase profitability on a quarterly or annual basis. As a consequence,
operating results for a particular quarter are extremely difficult to predict. Although our customer base has increased, we still depend on large,
recurring purchases from certain customers, and a loss, cancellation or delay
in purchases by these customers could negatively affect our revenue. Sales to our ten largest customers accounted for 42% and 52% of total
revenues for the six months ended June 30, 2004 and 2003, respectively. The
loss of continued orders from any of our more significant customers, such as
the U.S. government or individual agencies within the U.S. government, Mitsui,
America Online, or Hewlett Packard, could cause our revenue and profitability
to suffer. Our ability to attract new customers will depend on a variety of
factors, including the cost-effectiveness, reliability, scalability, breadth
and depth of our products. 22




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##### Table of Contents



Although our financial performance may depend on large, recurring orders
from certain customers and resellers, we do not generally have binding
commitments from them. For example:  
    
    our reseller agreements generally do not require minimum purchases;
    
    our customers can stop purchasing and our resellers can stop marketing our products at any time; and
    
    our reseller agreements generally are not exclusive and are for
one-year terms, with no obligation of the resellers to renew the
agreements. Because our expenses are based on our revenue forecasts, a substantial
reduction or delay in sales of our products to, or unexpected returns from,
customers and resellers, or the loss of any significant customer or reseller,
could harm our business. Although our largest customers may vary from period to
period, we anticipate that our operating results for any given period will
continue to depend on large orders from a small number of customers. The United States government is a significant customer and has been one
key to our financial success. However, government demand is unpredictable and
there is no guarantee of future contract awards. As part of the changing economic environment, the United States government
has become an important customer for the networking industry, and for us in
particular. The process of becoming a qualified government vendor, especially
for high-security projects, takes considerable time and effort, and the timing
of contract awards and deployment of our products are hard to predict.
Typically, six to twelve months may elapse between the initial evaluation of
our systems by governmental agencies and the execution of a contract. The
revenue stream from these contracts is hard to predict and may be materially
uneven between quarters. Government agency contracts are frequently awarded
only after formal competitive bidding processes, which are often protracted and
may contain provisions that permit cancellation in the event funds are
unavailable to the government agency. Even if we are awarded contracts,
substantial delays or cancellations of purchases could result from protests
initiated by losing bidders. In addition, government agencies are subject to
budgetary processes and expenditure constraints that could lead to delays or
decreased capital expenditures in certain areas. If we fail to win significant
government contract awards, if the government or individual agencies within the
government terminate or reduce the scope and value of our existing contracts,
or if the government fails to reduce the budget deficit, our financial results
may be harmed. Additionally, government orders may be subject to priority
requirements that may affect scheduled shipments to our other customers. Intense competition in the market for network solutions could prevent us
from maintaining or increasing revenue and sustaining profitability. The market for network solutions is intensely competitive. In particular,
Cisco Systems, Inc. maintains a dominant position in this market and several of
its products compete directly with our products. Ciscos substantial resources
and market dominance have enabled it to reduce prices on its products within a
short period of time following the introduction of these products, which
reduces margins and, therefore, the profitability of its competitors.
Purchasers of networking solutions may choose Ciscos products because of its
longer operating history, broader product line and strong reputation in the
networking market. In addition, Cisco may have developed, or could in the
future develop, new technologies that directly compete with our products or
render our products obsolete. Although we are currently among the top providers
of network infrastructure solutions, we cannot assure you that we will be able
to compete successfully against Cisco, currently the leading provider in the
networking market. We also compete with other companies, such as Extreme Networks, Juniper
Networks, Nortel Networks, Enterasys Networks, 3Com, Huawei, and Alcatel. Some
of our current and potential competitors have greater market leverage, longer
operating histories, greater financial, technical, sales, marketing and other
resources, more name recognition and larger installed customer bases.
Additionally, we may face competition from unknown companies and emerging
technologies that may offer new LAN, MAN and LAN/WAN solutions. Furthermore, a
number of these competitors may merge or form strategic relationships that
would enable them to apply greater resources and sales coverage than we can,
and to offer, or bring to market earlier, products that are superior to ours in
terms of features, quality, pricing or other factors. In order to remain competitive, we must, among other things, invest
significant resources in developing new products with superior performance at
lower prices than our competitors, enhance our current products and maintain
customer satisfaction. In addition, we must make certain our sales and
marketing capabilities allow us to compete effectively against our competitors.
If we fail to do so, our products may not compete favorably with those of our
competitors and our revenues and profitability could suffer. 23




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##### Table of Contents



We must continue to introduce new products with superior performance and
features in a timely manner in order to sustain and increase our revenue. The networking industry is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements, and
evolving industry standards. Therefore, in order to remain competitive, we must
introduce new products in a timely manner that offer substantially greater
performance and support a greater number of users per device, all at lower
price points. Even if these objectives are accomplished, new products may not
be successful in the marketplace, or may take more time than anticipated to
start generating meaningful revenue. The process of developing new technology
is complex and uncertain, and if we fail to develop or obtain important
intellectual property and accurately predict customers changing needs and
emerging technological trends, our business could be harmed. We must commit
significant resources to develop new products before knowing whether our
investments will eventually result in products the market will accept. After a
product is developed, we must be able to forecast sales volumes and quickly
manufacture a sufficient volume of products and mix of configurations that meet
customer requirements, all at low costs. The current life cycle of our products is typically 18 to 24 months. The
introduction of new products or product enhancements may shorten the life cycle
of our existing products or replace sales of some of our current products,
thereby offsetting the benefit of even a successful product introduction, and
may cause customers to defer purchasing our existing products in anticipation
of the new products. This could harm our operating results by decreasing sales,
increasing our inventory levels of older products and exposing us to greater
risk of product obsolescence. In addition, we have experienced, and may in the
future experience, delays in developing and releasing new products and product
enhancements and in achieving volume manufacturing for such new products. This
has led to, and may in the future lead to, delayed sales, increased expenses
and lower quarterly revenues than anticipated. During the development of our
products, we have also experienced delays in the prototyping of our ASICs,
which in turn has led to delays in product introductions. Our ability to increase our revenues depends on expanding our direct sales
operations and reseller distribution channels and continuing to provide
excellent customer support. If we are unable to effectively develop and retain our sales and support
staff, or establish and cultivate relationships with our indirect distribution
channels, our ability to grow and increase revenue could be harmed.
Additionally, if our resellers are not successful in their sales efforts, sales
of our products may decrease and our operating results could suffer. Some of
our resellers also sell products that compete with our products. As a result,
we cannot assure you that our resellers will market our products effectively or
continue to devote the resources necessary to provide us with adequate sales,
marketing and technical support. In an effort to gain market share and support our customers, we may need
to expand our direct sales operations and customer service staff to support new
and existing customers. The timing and extent of any such expansion are
uncertain in light of the current economic environment. Expansion of our direct
sales operations and reseller distribution channels may not be successfully
implemented and the cost of any expansion may exceed the revenues generated. Our gross margins may decline over time and the average selling prices of
our products may decrease as a result of competitive pressures and other
factors. Our industry has experienced erosion of average product selling prices due
to a number of factors, particularly competitive and macroeconomic pressures
and rapid technological change. The average selling prices of our products have
decreased in the past and may continue to decrease in response to competitive
pressures, increased sales discounts, new product introductions by our
competitors or other factors. Both we and our competitors occasionally lower
sales prices in order to gain market share or create more demand. Furthermore,
as a result of the recent disruption in the technology sector, coupled with
more broad macro-economic factors, both we and our competitors may pursue more
aggressive pricing strategies in an effort to maintain sales levels. Such
intense pricing competition could cause our gross margins to decline and may
adversely affect our business, operating results or financial condition. Our gross margins may be adversely affected if we are unable to reduce
manufacturing costs and effectively manage our inventory levels. Although
management continues to closely monitor inventory levels, declines in demand
for our products could result in additional provisions for excess inventory.
Additionally, our gross margins may be negatively affected by fluctuations in
manufacturing volumes, component costs, the mix of product configurations sold
and the mix of distribution channels through which our products are sold. For
example, we generally realize higher gross margins on direct sales to an end
user than on sales through resellers or to our OEMs. As a result, any
significant shift in revenues through resellers or to our OEMs could harm our
gross margins. If product or related warranty costs associated with our
products are greater than we have experienced, our gross margins may also be
adversely affected. 24




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We need additional qualified personnel to maintain and expand our
business. If we are unable to promptly attract and retain qualified personnel,
our business may be harmed. We believe our future success will depend in large part on our ability to
identify, attract and retain highly-skilled managerial, engineering, sales and
marketing, finance and manufacturing personnel. Competition for these
personnel can be intense, especially in the San Francisco Bay Area, and we may
experience some difficulty hiring employees in the timeframe we desire,
particularly engineering and sales personnel. Volatility or lack of positive
performance in our stock price may also adversely affect our ability to retain
key employees, all of whom have been granted stock options. In order to improve
productivity, we have historically used stock options to motivate and retain
our employees. Some of the proposals currently under consideration by the
accounting standard setting body regarding the accounting treatment of stock
options could limit our ability to continue to use stock options as an
incentive and retention tool. We may not succeed in identifying, attracting and
retaining personnel. The loss of the services of any of our key personnel, the
inability to identify, attract or retain qualified personnel in the future, or
delays in hiring required personnel, particularly engineers and sales
personnel, could make it difficult for us to manage our business and meet key
objectives, such as timely product introductions. Our success also depends to a significant degree on the continued
contributions of our key management, engineering, sales and marketing, finance
and manufacturing personnel, many of whom would be difficult to replace. In
particular, we believe that our future success depends on Bobby R. Johnson,
Jr., President, Chief Executive Officer and Chairman of the Board. We do not
have employment contracts or key person life insurance for any of our
personnel. If we fail to protect our intellectual property, our business and ability
to compete could suffer. Our success and ability to compete are substantially dependent on our
internally developed technology and know-how. Our proprietary technology
includes our ASICs, our IronCore, JetCore, and Terathon hardware architecture,
our IronWare software, our IronView network management software, and certain
mechanical designs. We rely on a combination of patent, copyright, trademark
and trade secret laws and contractual restrictions on disclosure to protect our
intellectual property rights in these proprietary technologies. Although we
have patent applications pending, there can be no assurance that patents will
be issued from pending applications, or that claims allowed on any future
patents will be sufficiently broad to protect our technology. We provide software to customers under license agreements included in the
packaged software. These agreements are not negotiated with or signed by the
licensee, and thus may not be enforceable in some jurisdictions. Despite our
efforts to protect our proprietary rights through confidentiality and license
agreements, unauthorized parties may attempt to copy or otherwise obtain and
use our products or technology. These precautions may not prevent
misappropriation or infringement of our intellectual property. Monitoring
unauthorized use of our products is difficult and the steps we have taken may
not prevent misappropriation of our technology, particularly in some foreign
countries in which the laws may not protect our proprietary rights as fully as
in the United States. We may be subject to litigation risks and intellectual property
infringement claims that are costly to defend and could limit our ability to
use certain technologies in the future. The networking industry is increasingly characterized by the existence of
a large number of patent claims and related litigation regarding patent and
other intellectual property rights. In particular, some companies in the
networking industry claim extensive patent portfolios. As a result of the
existence of a large number of patents and rapid rate of issuance of new
patents in the networking industry, it is not economically practical for a
company of our size to determine in advance whether a product or any of its
components may infringe intellectual property rights claimed by others. From
time-to-time third parties have asserted exclusive patent, copyright and
trademark rights to technologies and related standards that are important to
us. Such third parties may assert claims or initiate litigation against us or
our manufacturers, suppliers or customers alleging infringement of their
intellectual property rights with respect to our existing or future products.
We are committed to vigorously defending ourself against such claims.
Regardless of the merits of our position, we may incur substantial expenses in
defending against third party claims. In the event of a determination adverse
to us, we could incur substantial monetary liability, and be required to change
our business practices. Either of these could have a material adverse effect on
our financial position, results of operations, or cash flows. In difficult economic times, some companies have attempted to realize
revenues from their patent portfolios by using licensing programs. Some of
these companies have contacted us regarding a license. We carefully review all
license requests, but are unwilling to license technology not required for our
product portfolio. However, any asserted license demand can require
considerable effort to review and respond. Moreover, a refusal by us to a
license request could result in threats of litigation or actual litigation,
which, if initiated, could harm our business. We are a party to lawsuits in the normal course of our business.
Litigation in general, and intellectual property and securities litigation in
particular, can be expensive, lengthy and disruptive to normal business
operations. Moreover, the results of complex legal proceedings are difficult to
predict. We believe that we have defenses in the lawsuits pending against us as
indicated in Part I, Item 3 Legal Proceedings, and we are vigorously
contesting these allegations. Responding to the allegations has been, and
probably will continue to be, expensive and time-consuming for us. An
unfavorable resolution of the lawsuits could adversely affect our business,
results of operations, or financial condition. Our presence in international markets involves inherent risks that we may
not be able to control. As a result, our business may be harmed if we are
unable to successfully address these risks. Our success will depend, in part, on increasing international sales and
expanding our international operations. Our international sales primarily
depend on our resellers, including Pervasive Networks and Spot Distribution
Ltd. in Europe, Mitsui in Japan, Shanghai Gentek and GTI in China, and Samsung
in Korea. The failure of our international resellers to sell our products would
limit our ability to sustain and grow our revenue. In particular, our revenue
from Japan depends primarily on Mitsuis ability to sell our products and on
the strength of the Japanese economy, which has been weak in recent years.
There are a number of risks arising from our international business, including:  
    
    potential recessions in economies outside the United States;
    
    longer accounts receivable collection cycles;
    
    seasonal reductions in business activity;
    
    higher costs of doing business in foreign countries;
    
    difficulties in managing operations across disparate geographic areas;
    
    difficulties associated with enforcing agreements through foreign legal systems;
    
    political instability and export restrictions;
    
    potential adverse tax consequences; 25




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
    
    unexpected changes in regulatory requirements;
    
    military conflict and terrorist activities; and
    
    widespread medical epidemics, such as SARS. One or more of such factors may have a material adverse effect on our
future international operations and, consequently, on our business, operating
results and financial condition. Generally, our international sales are denominated in U.S. dollars. As a
result, an increase in the value of the U.S. dollar relative to foreign
currencies could make our products less competitive on a price basis in
international markets. In the future, we may elect to invoice some of our
international customers in local currency, which could subject us to
fluctuations in exchange rates between the U.S. dollar and the local currency. We purchase several key components for our products from sole sources; if
these components are not available, our revenues may be harmed. We purchase several key components used in our products from sole sources,
and depend on supply from these sources to meet our needs. The inability of any
supplier to provide us with an adequate supply of key components, or the loss
of any of our suppliers, may cause a delay in our ability to fulfill orders and
may have a material adverse effect on our business and financial condition.
Lead-times for various components have lengthened recently as a result of
limits on IT spending and the economic uncertainty, which has made certain
components scarce. As component demand increases and lead-times become longer,
our suppliers may increase component costs. If component costs increase, our
gross margins may also decline. Our principal limited or sole-sourced components include high-speed
dynamic and static random access memories, commonly known as DRAMs and SRAMs,
ASICs, printed circuit boards, optical components, microprocessors and power
supplies. We acquire these components through purchase orders and have no
long-term commitments regarding supply or price from these suppliers. From
time-to-time, we have experienced shortages in allocations of components,
resulting in delays in filling orders. We may encounter shortages and delays in
obtaining components in the future which could impede our ability to meet
customer orders. We depend on anticipated product orders to determine our material
requirements. Lead-times for limited-sourced materials and components can be as
long as six months, vary significantly and depend on factors such as the
specific supplier, contract terms and demand for a component at a given time.
Inventory management remains an area of focus as we balance the need to
maintain strategic inventory levels to ensure competitive lead-times with the
risk of inventory obsolescence due to rapidly changing technology and customer
requirements. If orders do not match forecasts, or if we do not manage
inventory effectively, we may have either excess or insufficient inventory of
materials and components, which could negatively affect our operating results
and financial condition. Our reliance on third-party manufacturing vendors to manufacture our
products may cause a delay in our ability to fill orders. We subcontract substantially all of our manufacturing to companies that
assemble and test our products. Our agreements with some of these companies
allow them to procure long lead-time component inventory on our behalf based on
a rolling production forecast provided by us. We may be contractually obligated
to purchase long lead-time component inventory procured by our contract
manufacturers in accordance with our forecast, unless we give notice of order
cancellation at least 90 days prior to the delivery date. If actual demand for
our products is below our projections, we may have excess inventory as a result
of our purchase commitments with our contract manufacturers. We do not have
long-term contracts with these manufacturers. We have experienced delays in product shipments from our contract
manufacturers, which in turn delayed product shipments to our customers. We may
in the future experience similar delays or other problems, such as inferior
quality and insufficient quantity of product, any of which could harm our
business and operating results. We intend to regularly introduce new products
and product enhancements, which will require us to rapidly achieve volume
production by coordinating our efforts with our suppliers and contract
manufacturers. We attempt to increase our material purchases, contract
manufacturing capacity and internal test and quality functions to meet
anticipated demand. The inability of our contract manufacturers to provide us
with adequate supplies of high-quality products, the loss of any of our
contract manufacturers, or the inability to obtain raw materials, could cause a
delay in our ability to fulfill orders. Additionally, from time to time, we
transition, via our contract manufacturers, to different manufacturing
locations, including lower-cost foreign countries. Such transitions are
inherently risky and could cause a delay in our ability to fulfill orders or a
deterioration in product quality. 26




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Due to the lengthy sales cycles of some of our products, the timing of our
revenue is difficult to predict and may cause us to fail to meet our revenue
expectations. Some of our products have a relatively high sales price, and often
represent a significant and strategic decision by a customer. The decision by
customers to purchase our products is often based on their internal budgets and
procedures involving rigorous evaluation, testing, implementation and
acceptance of new technologies. As a result, our sales cycle in these
situations can be as long as 12 months and may vary substantially from customer
to customer. While our customers are evaluating our products and before they
may place an order with us, we may incur substantial sales and marketing
expenses and expend significant management effort. Consequently, if sales
forecasted from a specific customer for a particular quarter are not realized
in that quarter, we may not meet our revenue expectations. If we do not adequately manage and evolve our financial reporting and
managerial systems and processes, our ability to manage and grow our business
may be harmed. Our ability to successfully implement our business plan and comply with
regulations requires an effective planning and management process. We expect
that we will need to continue to improve existing, and implement new,
operational and financial systems, procedures and controls to manage our
business effectively in the future. Any delay in the implementation of, or
disruption in the transition to, new or enhanced systems, procedures or
controls, could harm our ability to accurately forecast sales demand, manage
our supply chain and record and report financial and management information on
a timely and accurate basis. In addition, rules adopted by the Securities and Exchange Commission
pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual review
and evaluation of our internal control systems, and attestation of these
systems by our independent auditors. We are currently undergoing a review of
our internal control systems and procedures and considering improvements that
will be necessary in order for us to comply with the requirements of Section
404 by the end of 2004. This evaluation process may require us to hire
additional personnel and outside advisory services and could result in
additional accounting and legal expenses, all of which could cause our
operating expenses to increase. In addition, the evaluation and attestation
processes required by Section 404 are new and untested, and we may encounter
problems or delays in completing the implementation of improvements and
receiving a favorable review and attestation by our independent auditors. 27




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The timing of the adoption of industry standards may negatively affect
widespread market acceptance of our products. Our success depends in part on both the adoption of industry standards for
new technologies in our market and our products compliance with industry
standards. Many technological developments occur prior to the adoption of the
related industry standard. The absence or delay of an industry standard related
to a specific technology may prevent market acceptance of products using the
technology. We intend to develop products using new technological advancements,
such as MPLS Draft-Martini, and may develop these products prior to the
adoption of industry standards related to these technologies. As a result, we
may incur significant expenses and losses due to lack of customer demand,
unusable purchased components for these products and the diversion of our
engineers from future product development efforts. Further, if the adoption of
industry standards moves too quickly, we may develop products that do not
comply with a later-adopted industry standard, which could hurt our ability to
sell these products. If the industry evolves to new standards, we may not be
able to successfully design and manufacture new products in a timely fashion
that meet these new standards. Even after industry standards are adopted, the
future success of our products depends on widespread market acceptance of their
underlying technologies. At least one networking equipment standards body has
reportedly stopped all work on a standard in response to assertions by Nortel
that it controls the patent rights to certain industry standards. Attempts by
third parties to impose licensing fees on industry standards could undermine
the adoption of such standards and lessen industry opportunities. If our products contain undetected software or hardware errors, we could
incur significant unexpected expenses and lost sales and be subject to product
liability claims. Our products are complex and may contain undetected defects or errors,
particularly when first introduced or as new enhancements and versions are
released. Despite our testing procedures, these defects and errors may be found
after commencement of commercial shipments. Any defects or errors in our
products discovered in the future or failures of our customers networks,
whether caused by our products or another vendors products, could result in:  
    
    negative customer reactions;
    
    product liability claims;
    
    negative publicity regarding us and our products;
    
    delays in or loss of market acceptance of our products;
    
    product returns;
    
    lost sales; and
    
    unexpected expenses to remedy errors. Our products may not meet the standards required for their sale, which may
harm our business. In the United States, our products must comply with various regulations
and standards defined by the Federal Communications Commission and Underwriters
Laboratories. Internationally, products that we develop may be required to
comply with standards established by telecommunications authorities in various
countries, as well as those of certain international bodies. Although we
believe our products are currently in compliance with domestic and
international standards and regulations in countries in which we currently
sell, there can be no assurance that our existing and future product offerings
will continue to comply with evolving standards and regulations. If we fail to
obtain timely domestic or foreign regulatory approvals or certification, we may
not be able to sell our products where these standards or regulations apply,
which may prevent us from sustaining our revenues or maintaining profitability. We may engage in acquisitions that could result in the dilution of our
stockholders, cause us to incur substantial expenses and harm our business if
we cannot successfully integrate the acquired business, products, technologies
or personnel. Although we focus on internal product development and growth, we may learn
of acquisition prospects that would complement our existing business or enhance
our technological capabilities. Any acquisition by us could result in large and
immediate write-offs, the incurrence of debt and contingent liabilities, or
amortization expenses related to amortizable intangible assets, any of which
could negatively affect our results of operations. Furthermore, acquisitions
involve numerous risks and uncertainties, including:  
    
    difficulties in the assimilation of products, operations, personnel and technologies of the acquired companies; 28




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
    
    diversion of managements attention from other business concerns;
    
    risks of entering geographic and business markets in which we have no or limited prior experience; and
    
    potential loss of key employees of acquired organizations. Although we do not currently have any agreements or plans with respect to
any material acquisitions, we may make acquisitions of complementary
businesses, products or technologies in the future. We may not be able to
successfully integrate any businesses, products, technologies or personnel that
might be acquired, and our failure to do so could harm our business. Our stock price has been volatile historically, which may make it more
difficult to sell shares when needed at attractive prices. The trading price of our common stock has been, and may continue to be,
subject to wide fluctuations. Our stock price may fluctuate in response to a
number of events and factors, such as quarterly variations in operating
results, announcements of technological innovations or new products by us or
our competitors, changes in financial estimates and recommendations by
securities analysts, the operating and stock price performance of other
companies that investors may deem comparable, and news reports relating to
trends in our markets. In addition, the stock market in general, and technology
companies in particular, have experienced extreme volatility that often has
been unrelated to the operating performance of such companies. These broad
market and industry fluctuations may adversely affect the price of our stock,
regardless of our operating performance. Additionally, volatility or lack of
positive performance in our stock price may adversely affect our ability to
retain key employees, all of whom have been granted stock options. If we are required to record compensation expense in connection with stock
option grants, our profitability may be reduced significantly. The Financial Accounting Standards Board (FASB) has recently proposed an
accounting standard that will require the fair value of all equity-based awards
granted to employees be recognized in the income statement as compensation
expense. The various methods for determining the fair value of stock options
are based on, among other things, the volatility of the underlying stock. As
noted above, our stock price has historically been volatile. Therefore, the
adoption of an accounting standard requiring companies to expense stock options
could negatively affect our profitability and may adversely affect our stock
price. Such adoption could also limit our ability to continue to use stock
options as an incentive and retention tool, which could, in turn, hurt our
ability to recruit employees and retain existing employees. FASB is expected to
issue final rules on stock option expensing in late 2004. We will continue to
monitor FASBs progress on the issuance of this standard. Anti-takeover provisions could make it more difficult for a third party to
acquire us. Our board of directors has the authority to issue up to 5,000,000 shares
of preferred stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights, of those shares without any further
vote or action by the stockholders. The rights of the holders of common stock
may be subject to, and may be adversely affected by, the rights of the holders
of any preferred stock that may be issued in the future. The issuance of
preferred stock may have the effect of delaying, deferring or preventing a
change of control of Foundry without further action by the stockholders and may
adversely affect the voting and other rights of the holders of common stock. We
have no present plans to issue shares of preferred stock. Further, certain
provisions of our charter documents, including provisions eliminating the
ability of stockholders to take action by written consent and limiting the
ability of stockholders to raise matters at a meeting of stockholders without
giving advance notice, may have the effect of delaying or preventing changes in
control or management of Foundry, which could have an adverse effect on the
market price of our stock. In addition, our charter documents do not permit
cumulative voting, which may make it more difficult for a third party to gain
control of our board of directors. Our operations could be significantly hindered by the occurrence of a
natural disaster, terrorist acts or other catastrophic event. Our operations are susceptible to outages due to fire, floods, power loss,
power shortages, telecommunications failures, break-ins and similar events. In
addition, certain of our local and foreign offices and contract manufacturers
are located in areas susceptible to earthquakes and acts of terrorism, which
could cause a material disruption in our operations. The prospect of such
unscheduled interruptions may continue for the foreseeable future and we are
unable to predict either their occurrence, duration or cessation. We do not
have multiple site capacity for all of our services in the event of any such
occurrence. Despite our implementation of network security measures, our
servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering
with our computer systems. We may not carry sufficient insurance to compensate
us for losses that may occur as a result of any of these events. Any such event
could have a material adverse effect on our business, operating results, and
financial condition. 29




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Item 3. Quantitative and Qualitative Disclosures about Market Risk. Management believes there have been no material changes to our
quantitative and qualitative disclosures about market risk during the six-month
period ended June 30, 2004, compared to those discussed in our Annual Report on
Form 10-K for the year ended December 31, 2003. 
 Item 4. Controls and Procedures We evaluated the design and operation of our disclosure controls and
procedures to determine whether they are effective in ensuring that the
disclosure of required information is made in accordance with the Securities
Exchange Act of 1934, as amended (the Exchange Act), and the rules and forms
of the Securities and Exchange Commission. This evaluation was made under the
supervision, and with the participation of, management, including our principal
executive officer and principal financial officer, as of the end of the period
covered by this Quarterly Report on Form 10-Q. There are inherent limitations
to the effectiveness of any system of disclosure controls and procedures,
including the possibility of human error and the circumvention or overriding of
the controls and procedures. Accordingly, even effective disclosure controls
and procedures can only provide reasonable assurance of achieving their control
objectives. Subject to these limitations, our Chief Executive Officer and
Chief Financial Officer have concluded that, as of the evaluation date, the
disclosure controls and procedures were effective to provide reasonable
assurance that information required to be disclosed in the reports we file and
submit under the Exchange Act is recorded, processed, and summarized and
reported as and when recorded. As required by Section 404 of the Sarbanes Oxley Act of 2002, management
is continuing to test and evaluate its internal control structure to determine
whether our controls are designed and operating effectively. As a result of
our testing and evaluation performed to date, we have noted that improvements
could be made in the design or operation of our internal control structure,
particularly with respect to general computer controls, segregation of duties,
and inventory monitoring. We believe adequate compensating controls exist in
these areas; however, we are developing plans to implement improvements. We
have disclosed these matters to the audit committee of our board of directors
and to our independent auditors. There were no significant changes to our internal controls during our most
recent quarter that have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting. 30




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PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings. In December 2000, several similar stockholder class action lawsuits were
filed against us and certain of our officers in the United States District
Court for the Northern District of California, following our announcement of
our anticipated financial results for the fourth quarter ended December 31,
2000. The lawsuits were subsequently consolidated as a class action by the
District Court, under the caption In re Foundry Networks, Inc. Securities
Litigation,Master File No. C-00-4823-MMC and lead plaintiffs were selected and
filed a consolidated amended complaint which alleged violations of federal
securities laws and purported to seek damages on behalf of a class of
stockholders who purchased our common stock during the period from September 7,
2000 to December 19, 2000. We then brought four successful motions to dismiss
the complaint. Although the District Court granted each of the four dismissal
motions, it also provided plaintiffs leave to amend the complaint. On August
29, 2003, following the dismissal of the four amended complaints, the District
Court granted our motion to dismiss the case with prejudice and without leave
to amend and, on September 2, 2003, entered judgment in our favor, dismissing
the plaintiffs fifth amended complaint. On September 29, 2003, plaintiffs
filed a Notice of Appeal with the United States Court of Appeals for the Ninth
Circuit (Court of Appeals). On January 15, 2004, the plaintiff/appellants
filed their opening brief with the Court of Appeals. On April 2, 2004, we filed
our responsive brief. On May 14, 2004, the plaintiff appellants filed a reply
brief. The briefing is now complete, and the parties are awaiting a schedule
for oral argument from the Court of Appeals. We believe the District Courts
judgment validates our conviction that the lawsuit is without merit and we will
defend the District Courts judgment vigorously. A class action lawsuit was filed on November 27, 2001 in the United States
District Court for the Southern District of New York on behalf of purchasers of
our common stock alleging violations of federal securities laws. The case was
designated as In re Foundry Networks, Inc. Initial Public Offering Securities
Litigation,No. 01-CV-10640 (SAS) (S.D.N.Y.), related to In re Initial Public
Offering Securities Litigation,No. 21 MC 92 (SAS) (S.D.N.Y.). The case is
brought purportedly on behalf of all persons who purchased our common stock
from September 27, 1999 through December 6, 2000. The operative amended
complaint names as defendants us and three of our officers (the Foundry
Defendants), including our Chief Executive Officer and Chief Financial
Officer; and investment banking firms that served as underwriters for our
initial public offering in September 1999. The amended complaint alleged
violations of Sections 11 and 15 of the Securities Act of 1933, and Section
10(b) of the Securities Exchange Act of 1934, on the grounds that the
registration statement for the initial public offering ( IPO) failed to
disclose that (i) the underwriters agreed to allow certain customers to
purchase shares in the IPO in exchange for excess commissions to be paid to the
underwriters, and (ii) the underwriters arranged for certain customers to
purchase additional shares in the aftermarket at predetermined prices. The
amended complaint also appears to allege that false or misleading analyst
reports were issued. Similar allegations were made in lawsuits challenging over
300 other initial public offerings conducted in 1999 and 2000. The cases were
consolidated for pretrial purposes. On February 19, 2003, the Court ruled on
all defendants motions to dismiss. In ruling on motions to dismiss, the Court
must treat the allegations in the complaint as if they were true solely for
purposes of deciding the motions. The motion was denied as to claims under the
Securities Act of 1933 in the case involving us. The same ruling was made in
all but 10 of the other cases. The Court dismissed the claims under Section
10(b) of the Securities Exchange Act of 1934, against us and one of the
individual defendants and dismissed all of the Section 20(a) control person
claims. The Court denied the motion to dismiss the Section 10(b) claims against
our remaining individual defendants on the basis that those defendants
allegedly sold our stock following the IPO, allegations found sufficient purely
for pleading purposes to allow those claims to move forward. A similar ruling
was made with respect to 62 of the individual defendants in the other cases. We
have accepted a settlement proposal presented to all issuer defendants. Under
the terms of this settlement, plaintiffs will dismiss and release all claims
against the Foundry Defendants in exchange for a contingent payment by the
insurance companies collectively responsible for insuring the issuers in all of
the IPO cases and for the assignment or surrender of control of certain claims
we may have against the underwriters. The settlement will require approval of
the Court, which cannot be assured, after class members are given the
opportunity to object to the settlement or opt out of the settlement. In March 2001, Nortel Networks Corp. (Nortel) filed a lawsuit against us
in the United States District Court for the District of Massachusetts alleging
that certain of our products infringe several of Nortels patents and seeking
injunctive relief and unspecified damages. Nortel has also brought suit, on the
same or similar patents, against other networking companies. We have analyzed
the validity of Nortels claims and believe that Nortels suit is without
merit. Discovery has closed and both sides have filed expert reports.
A Markman Hearing to construe disputed terms has been scheduled for
September 17, 2004. A hearing on outstanding summary judgment motions has been scheduled
for September 23, 2004. We are committed to vigorously defending ourself against these
claims. 31




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On October 9, 2002, we filed a lawsuit against Nortel in the United States
District Court, Northern District of California alleging that certain of
Nortels products infringe one of our patents and alleging breach of contract
by Nortel. We are seeking injunctive relief and damages. On November 18, 2002,
Nortel filed an Answer and Counter Claims asserting infringement of five
additional patents against us. On December 6, 2002, we filed an Answer to
Nortels counter claims denying infringement and asserting invalidity as to
Nortels five asserted patents. On April 11, 2003, the District Court set a
trial date for November 29, 2004. On November 18, 2003, after a Markman
Hearing, the District Court issued an order on ten disputed terms as to the
asserted patents construing each disputed term in our favor. Discovery has
been completed and expert reports have been filed. On April 2, 2004, we filed
summary judgment motions on two of Nortels asserted patents. The parties are
awaiting a hearing date on the motions. We analyzed the validity of Nortels
counter claims and believe they are without merit. In May 2003, Lucent Technologies Inc. (Lucent) filed a lawsuit against
us in the United States District Court for the District of Delaware alleging
that certain of our products infringe several of Lucents patents, and seeking
injunctive relief, as well as unspecified damages. Lucent also brought suit on
the same patents (and one additional patent) against one of our competitors. On
August 12, 2003, we filed a motion to sever the cases, and on February 6, 2004,
the District Court granted the motion. Discovery is ongoing. The parties have
been instructed by the court to be prepared for trial in the spring of 2005.
We have analyzed the validity of Lucents claims and believe that Lucents suit
is without merit. We are committed to vigorously defending ourself against
Lucents claims. On February 13, 2004, we filed a lawsuit against Lucent in the United
States District Court, Eastern District of Texas, Marshall Division. The
lawsuit alleges that certain of Lucents products infringe one of our patents.
We are seeking injunctive relief and damages. On March 22, 2004, Lucent filed
an Answer and Counter Claim seeking a declaration of invalidity as to our
asserted patent. On April 9, 2004, Lucent filed an Amended Answer and Counter
Claim asserting infringement of U.S. patent #5649131. We analyzed the validity
of Lucents counter claim and believe it is without merit. From time to time, we are subject to other legal proceedings and claims in
the ordinary course of business, including claims of alleged infringement of
trademarks, copyrights, patents and other intellectual property rights. In
addition, from time to time, third parties assert patent infringement claims
against us in the form of letters, lawsuits and other forms of communication.
Regardless of the merits of our position, litigation is always an expensive and
uncertain proposition. In accordance with SFAS No. 5, Accounting for
Contingencies (SFAS 5), we record a liability when it is both probable that
a liability has been incurred and the amount of the loss can be reasonably
estimated. We review the need for any such provision on a quarterly basis and
record any necessary adjustments to reflect the effect of ongoing negotiations,
settlements, rulings, advice of legal counsel, and other information and events
pertaining to a particular case in the period they become known. To date, we
have not recorded any such provisions in accordance with SFAS 5. We believe we
have valid defenses with respect to the legal matters pending against us. In
the event of a determination adverse to us, we could incur substantial monetary
liability, and be required to change our business practices. Any unfavorable
determination could have a material adverse effect on our financial position,
results of operations, or cash flows. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities. None 
 Item 3. Defaults Upon Senior Securities. None 32




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Item 4. Submission of Matters to a Vote of Security Holders. On June 1, 2004, the Company held its Annual Meeting of Stockholders. The
vote for the nominated directors was as follows: Name of Director Nominee
    
    In Favor
    
    Withheld
    
    AbstainBobby R. Johnson, Jr.
    
    
    112,458,036
    
    
    
    
    
    
    
    1,524,543Andrew K. Ludwick
    
    
    109,107,124
    
    
    
    
    
    
    
    4,875,455Alfred J. Amoroso
    
    
    112,970,983
    
    
    
    
    
    
    
    1,011,596C. Nicholas Keating, Jr.
    
    
    109,102,446
    
    
    
    
    
    
    
    4,880,133J. Steven Young
    
    
    80,930,887
    
    
    
    
    
    
    
    35,051,692Alan L. Earhart
    
    
    113,466,411
    
    
    
    
    
    
    
    516,168
 The stockholders also ratified the appointment of Ernst & Young LLP as
Foundrys independent auditors for the fiscal year ending December 31, 2004
with 112,903,205 affirmative votes, 1,055,146 opposing votes, and 24,224
abstaining. 
 Item 5. Other Information. None 33




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Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Number
    
    Description3.1
    
    Amended and Restated Certificate of Incorporation of Foundry Networks, Inc. (Amended and
Restated Certificate of Incorporation filed as Exhibit 3.2 to Registrants Registration
Statement on Form S-1 (Commission File No. 333-82577) and incorporated herein by reference;
Certificate of Amendment to the foregoing filed as Exhibit 3.1 to Registrants Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000 and incorporated herein by reference.)3.2
    
    Amended and Restated Bylaws of Foundry Networks, Inc. (Filed as Exhibit 3.2 to Registrants
Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 and incorporated herein
by reference.)10.1
    
    1996 Stock Plan. (1)10.2
    
    1999 Employee Stock Purchase Plan. (2)10.3
    
    1999 Directors Stock Option Plan. (3)10.5
    
    OEM Purchase Agreement dated January 6, 1999 between Foundry Networks, Inc. and
Hewlett-Packard Company, Workgroup Networks Division. (4)10.6
    
    Reseller Agreement dated July 1, 1997 between Foundry Networks, Inc. and Mitsui & Co., Ltd. (4)10.7
    
    2000 Non-Executive Stock Option Plan. (5)10.11
    
    Lease agreement dated September 28, 1999, between Foundry Networks, Inc., and Legacy Partners
Commercial Inc., for offices located at 2100 Gold Street, San Jose, CA 95002. (6)31.1
    
    Rule 13a-14(a) Certification (CEO)31.2
    
    Rule 13a-14(a) Certification (CFO)32.1
    
    Section 1350 Certification (CEO)32.2
    
    Section 1350 Certification (CFO)
   (1)
    
    Copy of original 1996 Stock Plan incorporated herein by reference to the
exhibit filed with the Companys Registration Statement on Form S-1
(Commission File No. 333-82577). Copy of 1996 Stock Plan reflecting the
amendments approved at the 2000 Annual Meeting of Stockholders
incorporated by reference to the Companys Definitive Proxy Statement for
such meeting (Commission File No. 000-26689). Copy of 1996 Stock Plan
reflecting the amendments for approval at the 2002 Annual Meeting of
Stockholders incorporated by reference to the Companys Definitive Proxy
Statement for such meeting (Commission File No. 000-26689).(2)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Registration Statement on Form S-1 (Commission File No. 333-82577).(3)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Registration Statement on Form S-1 (Commission File No. 333-82577). Copy
of Directors Plan reflecting the amendment for approval at the 2002
Annual Meeting of Stockholders incorporated by reference to the Companys
Definitive Proxy Statement for such meeting (Commission File No.
000-26689).(4)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Registration Statement on Form S-1 (Commission File No. 333-82577);
Confidential treatment has been granted by the Securities and Exchange
Commission with respect to this exhibit.(5)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Registration Statement on Form S-8 filed on October 25, 2000 (Commission
File No. 333-48560).(6)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Form 10-Q for the quarter ended September 30, 1999 (Commission File No.
000-26689). 34




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##### Table of Contents



(b) Reports on Form 8-K. The Registrant furnished a Current Report on Form 8-K dated April 29, 2004
to report the announcement of our financial results for the quarter ended March
31, 2004 pursuant to Item 12 of Form 8-K. 35




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Foundry Networks, Inc.
(Registrant)By:
    /s/ TIMOTHY D. HEFFNERTimothy D. HeffnerVice President, Finance and
Administration, Chief Financial Officer
(Principal Financial and Accounting
Officer) Date: July 30, 2004 36




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EXHIBIT INDEX Number
    
    Description3.1
    
    Amended and Restated Certificate of Incorporation of Foundry Networks, Inc. (Amended and
Restated Certificate of Incorporation filed as Exhibit 3.2 to Registrants Registration
Statement on Form S-1 (Commission File No. 333-82577) and incorporated herein by reference;
Certificate of Amendment to the foregoing filed as Exhibit 3.1 to Registrants Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000 and incorporated herein by reference.)3.2
    
    Amended and Restated Bylaws of Foundry Networks, Inc. (Filed as Exhibit 3.2 to Registrants
Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 and incorporated herein
by reference.)10.1
    
    1996 Stock Plan. (1)10.2
    
    1999 Employee Stock Purchase Plan. (2)10.3
    
    1999 Directors Stock Option Plan. (3)10.5
    
    OEM Purchase Agreement dated January 6, 1999 between Foundry Networks, Inc. and
Hewlett-Packard Company, Workgroup Networks Division. (4)10.6
    
    Reseller Agreement dated July 1, 1997 between Foundry Networks, Inc. and Mitsui & Co., Ltd. (4)10.7
    
    2000 Non-Executive Stock Option Plan. (5)10.11
    
    Lease agreement dated September 28, 1999, between Foundry Networks, Inc., and Legacy Partners
Commercial Inc., for offices located at 2100 Gold Street, San Jose, CA 95002. (6)31.1
    
    Rule 13a-14(a) Certification (CEO)31.2
    
    Rule 13a-14(a) Certification (CFO)32.1
    
    Section 1350 Certification (CEO)32.2
    
    Section 1350 Certification (CFO)
   (1)
    
    Copy of original 1996 Stock Plan incorporated herein by reference to the
exhibit filed with the Companys Registration Statement on Form S-1
(Commission File No. 333-82577). Copy of 1996 Stock Plan reflecting the
amendments approved at the 2000 Annual Meeting of Stockholders
incorporated by reference to the Companys Definitive Proxy Statement for
such meeting (Commission File No. 000-26689). Copy of 1996 Stock Plan
reflecting the amendments for approval at the 2002 Annual Meeting of
Stockholders incorporated by reference to the Companys Definitive Proxy
Statement for such meeting (Commission File No. 000-26689).(2)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Registration Statement on Form S-1 (Commission File No. 333-82577).(3)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Registration Statement on Form S-1 (Commission File No. 333-82577). Copy
of Directors Plan reflecting the amendment for approval at the 2002
Annual Meeting of Stockholders incorporated by reference to the Companys
Definitive Proxy Statement for such meeting (Commission File No.
000-26689).(4)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Registration Statement on Form S-1 (Commission File No. 333-82577);
Confidential treatment has been granted by the Securities and Exchange
Commission with respect to this exhibit.(5)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Registration Statement on Form S-8 filed on October 25, 2000 (Commission
File No. 333-48560).(6)
    
    Incorporated herein by reference to the exhibit filed with the Companys
Form 10-Q for the quarter ended September 30, 1999 (Commission File No.
000-26689).