Redback Sees End to Red Ink

Redback Networks Inc. (Nasdaq: RBAK) CEO Kevin DeNuccio held a meeting Friday to rally the company after a complex restructuring, and he's confident the company could return to profitability either late this year or early in 2005, say sources close to the company.

It's clear that one of the goals was motivating the employees, who were all clutching their brand-new stock options. The sources, speaking on the condition of anonymity, say employees at Friday's meeting were shown how the company's newly issued shares could, in theory, more than triple by 2006, if Redback hits its goals.

DeNuccio told the company that it will hit its cash-flow break-even point when it brings in $33 million in quarterly revenues, according to those who were there. The earnings break-even point -- where Redback's quarterly sales would equal its costs -- is only slightly above that, sources say DeNuccio told employees.

This all brings up the question of the "new" Redback and whether its fortunes have changed dramatically after its bankruptcy reorganization. The company's bankruptcy helped clear Redback of its long-term debt and put it in a better position to make money. It also added to the board, perhaps providing the company with more savvy financial guidance going forward.

Redback filed its financial restructuring plan on November 3, 2003. The court confirmed it 49 days later. On January 2, when the plan went into effect, Redback executed a 73-to-1 reverse stock split, where it reduced the number of its shares as a way to increase the value of its stock. The company's ticker symbol will include a "D" for a few more days as an indicator of the reverse split. The new shares opened for trading last week and closed today at $9.85, down $0.38 (3.71%). Now with 52 million shares outstanding, that gives the company a market cap of about $512 million.

The financial restructuring wiped out about $467 million of Redback's debt and eliminated $44 million in annual expenses (see Redback Closes a Chapter). Redback's bondholders now own about 85 percent of the company, leaving Redback's previous shareholders with about 4 percent, according to information from a slideshow at the meeting. Redback's public equity used to be worth about $40 million, or 8 percent of the company. In essence, shareholders who still held the older shares of Redback in the week prior to the restructuring saw their share value cut in half once the reverse-split was completed last week.

The upshot of all this is that most of the debt is gone and profitability seems attainable. Redback's not too far from its break-even point. Its net revenues for the third quarter of 2003 were $27.4 million, compared with $17.4 million for the year-earlier quarter (see Redback Reports on 3Q03).

Helping Redback's financial picture is the recently closed $30 million round of funding from Technology Crossover Ventures. TCV got 650,000 preferred shares in the transaction, and it now owns as much as 11 percent of Redback, according to SEC filings. TCV invested in Redback at a $240 million pre-money valuation, according to sources close to the company. TCV partner John Drew now has a seat on Redback's board, as does Redback bondholder Roy Behren and Paul Giordano, the company's largest shareholder.

Drew did not respond to requests for comment.

In the company meeting, DeNuccio dismissed any rumors that Redback was considering selling itself to a suitor (see Redback's Ready to Rise Again). DeNuccio told the crowd that the company would be selling itself short if it sold today, a source says. Instead, DeNuccio said Redback intends to build more value in itself before considering an exit of that sort.

After giving a disclosure about forward-looking statements, Redback's managers put up a slide showing that the company's 2003 revenues would hit $115 million; its 2004 revenues would hit $160 million; and its 2005 revenues would hit $185 million, sources close to Redback say. The purpose was to give employees some idea that the company would become more valuable in the long term, perhaps trying to sell employees on their new options package.

Table 1: Redback's Upside

Year	2004	2005	2006
Redback Revenues	$160M	$185M	$220M
Implied Market Cap	$801M	$1.48B	$2.20B
Implied Share Price	$13.70	$25.30	$37.50
Note: Implied Market Cap and Implied Stock Price assume 58.6 million shares oustanding. Source: Light Reading, using data from sources close to Redback.

On January 21, Redback will release its fourth-quarter and year-end earnings. Two days later the company is planning a big party, followed by the "official" launch of the new Redback on January 26.

Table 2: Redback Restructured

Date	Jan 9, 2004	Dec 31, 2003
Shares Outstanding	52 million	183 million
Stock Price	$10.23	$0.23
Market Cap	$532M	$42M
Source: Company data and Light Reading sources

For Redback employees, the restructuring may be bittersweet. The good news: Employee options granted for the new Redback now only take three years to vest and have a strike price of $4.60, the same strike price as TCV, DeNuccio told employees.

The bad news: All of the old employee stock options -- vested and unvested -- were canceled. So everyone's essentially starting over.

New options are being issued by Redback managers according to each employee's perceived value to the company going forward. So years of service will count for something, but not as much as before, under the new, more subjective system, according to one source close to Redback.

Redback did not respond to several requests for comment.

— Phil Harvey, Senior Editor, Light Reading