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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

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                                   Form 10-K
                                ----------------

(Mark One)

    [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
        EXCHANGE ACT OF 1934

        For the fiscal year ended July 2, 20001, 2001

                                      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 333-719210-25711

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                            Extreme Networks, Inc.
            (Exact name of Registrant as specified in its charter)

                      
Delaware 77-0430270 (State or other jurisdiction of (I.R.S. Employer jurisdiction Identification No.) of incorporation or organization) 3585 Monroe Street 95051 Santa Clara, California (Zip Code) (Address of principal executive offices)
Registrant's telephone number, including area code: (408) 579-2800 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock, $.001 par value ----------------- 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference to Part III of this Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $9,892,125,000$1,728,241,385 as of September 15, 2000,6, 2001, based upon the closing price on the Nasdaq National Market reported for such date. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose. 109,912,500113,924,943 shares of the Registrant's Common stock, $.001 par value, were outstanding September 15, 2000.6, 2001. DOCUMENTS INCORPORATED BY REFERENCE Items 10 (as to directors), 11,12 and 13 ofThe information called for by Part III incorporateis incorporated by reference information fromto specified portions of the Registrant's Definitive Proxy Statement to be filedissued in conjunction with the Securities and Exchange Commission in connection with the solicitation of proxies for the Registrant's 20002001 Annual Meeting of Stockholders. ================================================================================Stockholders, which is expected to be filed not later than 120 days after the Registrant's fiscal year ended July 1, 2001. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- EXTREME NETWORKS, INC. FORM 10-K INDEX
Page ---- PART I Item 1. BusinessBusiness................................................................................ 3 Item 2. Properties 14Properties.............................................................................. 19 Item 3. Legal Proceedings 14Proceedings....................................................................... 19 Item 4. Submission of Matters to a Vote of Security holders 14Holders..................................... 20 PART II Item 5. Market Forfor Registrant's Common Equity and Related Stockholder Matters 16Matters................... 22 Item 6. Selected Consolidated Financial Data 16Data.................................................... 22 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item7A.Operations... 23 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 30Risk.............................. 40 Item 8. Financial Statements and Supplementary Data 32Data............................................. 42 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 49Disclosure.... 68 PART III Item 10. Directors and Executive Officers of the Registrant 49Registrant...................................... 69 Item 11. Executive Compensation 49Compensation.................................................................. 69 Item 12. Security Ownership of Certain Beneficial Owners and Management 50Management.......................... 69 Item 13. Certain Relationships and Related Transactions 50Transactions.......................................... 69 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 50 SIGNATURES 538-K......................... 69 SIGNATURES....................................................................................... 74
2 PART I Item 1. Business. When used in thisFORWARD LOOKING STATEMENTS This Annual Report on Form 10-K contains forward-looking statements within the words "may," "should," "believes," "expects," "anticipates," "estimates"meaning of Section 27A of the Securities Act of 1933 and similar expressions are intended to identifySection 21E of the Securities Act of 1934. These include forward-looking statements. Such statements, which include statements concerning expected changes in expense levels, the availability and functionality of products under development, product mix, pricing trends, the mix of export sales, sales to significant customers and the availability and cost of products from suppliers and contract manufacturers, product costs and sales prices, liquidity and similar language based on the Company's suppliers, are subject to risks and uncertainties, including those set forth under "Management's Discussion and Analysisexpectations of Financial Condition and Results of Operations -- Factors That May Affect Our Results." Our actual results could differ materially from those projected in these forward-looking statements which could have a material adverse effect on our business, operating results and financial condition. These forward-looking statements speak onlymanagement as of the date hereof andof this filing. However, there may be events in the future that we are not able to accurately predict accurately or over which we have no control. We caution investors that actual results may differ materially from those projected in the forward-looking statements as a result of certain risk factors identified in this Form 10-K and other filings we have made with the Securities and Exchange Commission. More information about potential factors that could affect our business and financial results is set forth under "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Item 1. Business Overview Extreme Networks, Inc. ("Extreme", together with its subsidiaries, (collectively referred to as Extreme or "the Company")the Company and as we, us, and our) is a leading provider of broadband ethernetnetwork infrastructure equipment for business applications and services. We were established in 1996 to address the issues caused by slow and expensive networks. We set out to change the industry by replacing complex software-based routers with simple, fast, highly intelligent, hardware-based switches. The acceptance of this innovative, simplified approach to networking solutionshas enabled us to become an industry leader. Our goal is to realize our corporate vision of Ethernet Everywhere - a unifying network strategy that uses proven Ethernet technology to simplify each element of the network. Accordingly, our strategy is to lay the foundation for the Internet economy. The key advantagesa future of our etherneteasily deployable, highly scalable, ubiquitous bandwidth for networks, applications and users. Our Ethernet Everywhere switching solutions are increasedproducts provide significant performance the abilityincreases compared to easily grow, or "scale," in size as customer needs change, flexible allocation oflegacy infrastructures, while allowing greater network resources,flexibility and scalability, ease of use and lower cost of ownership. Theseownership than competitive products. We have achieved these advantages are obtained through the use of custom semiconductors, known asprimarily by using application specific integrated circuits, or ASICs, in our products and throughcreating designs that are common and uniform across our product line. Thelines. In our products, the routing of network traffic, a function referred to as Layer 3 switching, is done primarily with ASICs. ASICs in our products, and consequently, isgenerally provide faster processing of data than the software implementations used in many competing products.products and are more cost-effective, resulting in a higher return on investment. Traditional Layer 3 products relyroute traffic primarily on software which canthrough the use of software. This method is much slower than routing with ASICs, and is less dependable in message packet delivery because slow traffic speeds below those which could otherwise be achieved andcan result in message packets being lost when network traffic is high. Our products incorporate an ASIC-based, wire-speed architecture and are designed to avoid the loss of message packets in the switch, or "non-blocking."switch. As a result, we are able to offer our products are less expensiveat a lower cost than software-based routers, yet offer improvedalternatives while improving performance throughout the network. Industry Background Businesses and other organizations have become increasingly dependent on the internetInternet as their central communications infrastructure to provide connectivity for internal and external communications. New mission-critical computing applications, such as enterprise resource planning, large enterprise databases and sophisticated on-lineonline connections with vendors, as well as the increased use of traditional applications, such as e-mail and streaming 3 media, require significant information technology resources. The emergence of the desktop browser as a user interface has enabled bandwidth-intensive applications that contain voice, video and graphics to be used extensively through intranets and externally through extranets. These new applications, combined with the growth in business-to- business e-commerce and other on-lineonline transactions, such as mobile communications and application service providers, for example, are further burdening thedemand a fast, flexible, and scalable network infrastructure. Today's Networking Environmentsenvironments can be segmented into Local Area Networks, or LANs, Wide Area Networks, or WANs, and Metropolitan Area Networks, or MANs. LANs. LANs have traditionally beenare traditional networks designed for client/server applications wherewithin a confined geographical area, such as a building or a campus. The LAN consists of servers, clients, a networking operating system, and a communications link. In the past, LAN traffic patterns were predictable and traffic loads arewere relatively stable. In this environment, theThe majority of traffic remainedwould remain within a given workgroup, with only a small percentage traveling across the high traffic portion of a LAN which interconnects all or a large part ofLAN. With the LAN. The increased use of data-intensive, mission-critical applications, the widespread implementationsimplementation of intranets and extranets, and the ubiquitywidespread use of Internet technologies, have created unpredictableLAN traffic patterns, and unpredictable traffic loads within the LAN.has become highly unpredictable. In addition, as users utilizewithin a LAN have full access to the desktop browser and Internet, technologies to accessdownloading significant amounts of information from servers located inside and outside of the organization with a much higher percentage of traffic crossescrossing the enterprise LAN backbone. For example,The LAN market consists primarily of large and medium-sized enterprise customers. WANs. WANs are communication networks that span across large geographic areas, such as counties, states or countries. Recent technology developments such as very high-bit-rate digital subscriber lines, or VDSL, extend the reach of Ethernet WANs beyond current optical-based network infrastructures, into areas where only voice-grade wiring exists. The addition of WAN support to ASIC-based network switches permits Ethernet services to reach customers where only a limited fiber infrastructure is available. The WAN market includes building local exchange carriers, multiple tenant/dwelling unit service providers, and Internet Service Providers, or ISPs, as primary customers, though an employee can makeenterprise may also utilize a simple requestprivate WAN. MANs. MANs are networks that may require datalink metropolitan geographic areas such as a city or an entire metropolitan area. Owing to be downloadedthe availability and analyzed from multiple data warehouses outside his or her local workgroup, resultingdeployment of Gigabit Ethernet, LANs have achieved geometric growth in increased traffic acrossbandwidth. The bandwidth in WANs has also grown, based on technology designed to accommodate the LAN. Similarly, multiple users could request a multimedia presentation from a company intranet or fromrapid annual growth in Internet traffic. The MAN is the Internet consuming tremendous amounts of network capacity. Either of these situations could result in users overwhelming a company's enterprisekey link between the LAN unknowingly. As a result, the increased traffic, bandwidth-intensive applications and unpredictable traffic patterns are straining traditional LAN environments and reducing the performance of mission-critical applications. Early LANs supported limited numbers of users and used a variety of protocols to organize the transmission of data, including Ethernet, Token Ring or AppleTalk technologies. As the number of users and the amountWAN. Over the last couple of traffic onyears, MANs have emerged as a network grew, network performance began to decline. In this shared environment, each desktop receivedcritical and was burdened by the communication of every other desktop. The need to improve network performance was initially addressed by adding network devices known as bridges or hubs 3 that separated the entire LAN into smaller workgroups. This arrangement was effective in supporting the traditional client/server environment where the majority of traffic remaineddynamically evolving arena within the workgroup. As applications became more bandwidth-intensive and users increasingly communicated outside of their workgroup, bridges and hubs were unable to process this traffic effectively. To mitigate this problem, Layer 2 switches were developed to provide a dedicated link for each desktop and eliminate the unnecessary flow of information to every desktop.overall network infrastructure. In addition to the evolutionrising traffic demands, the underlying network architectures, protocols and technologies are also experiencing rapid change. The emergence of new devices,wavelength division multiplexing, the rise of higher speed optical connections, and the drive toward voice and data convergence are all combining to impose limits on the ability of existing network architectures to meet the need for increased backbone speeds led tocapacity. In addition, the developmentcompetitive landscape for MAN service providers is shifting, with the influx of new and faster technologiesclasses of carriers who do not necessarily depend upon existing infrastructure, such as FDDI, Fast EthernetSynchronous Optical Network/Synchronous Digital Hierarchy, or SONET/SDH. 4 The MAN market includes metropolitan service providers, in addition to municipalities that utilize the network to connect locations, such as City Hall, the fire department, road and ATM. However, each of these technologies employs different protocols, further complicating the LAN by requiring software-based routers that use expensive CPUsvehicle maintenance facilities, hospitals and software tables to route this multi-protocol traffic. Today, it is not uncommon to find multiple protocolsemergency centers, social services, and devices across the enterprise network.public libraries. A network must be scalable in the following four dimensions: Speed. Speed refers to the number of bits per second that can be transmitted across the network. Today's network applications increasingly require speeds of up to 100 Mbps to the desktop. Hence,Therefore, the backbone and server connections that aggregate traffic from desktops require speeds well in excess of 100 Mbps. Wire speedWire-speed refers to the ability of a network device to process an incoming data stream at the highest possible rate without loss of packets. Wire speedWire-speed routing refers to the ability to perform Layer 3 switching at the maximum possible rate. Bandwidth. Bandwidth refers to the volume of traffic that a network or a network device can handle before traffic is "blocked," or unable to get through without interruption. When traffic was more predictable, the amount of traffic across a network link or through a network device grew basically in line with the number of users on the network. With today's data-intensive applications accessed in random patterns from within and outside of the network, users can spike traffic unpredictably, consuming significant bandwidth to the detriment of other users. Network size. Network size refers to the number of users and servers that are connected to a network. Today's networks must be capable of connecting and supporting up to thousands, and even tens of thousands of users and servers while providing performance and reliable connectivity. Quality of service. Quality of service refers to the ability to control the delivery of traffic based upon its level of importance. Mission-critical enterprise and delay-sensitive multimedia applications require specific performance minimums, while traffic such as general e-mail and Internet surfing may not be as critical. In addition to basic standards-based prioritization of traffic according to importance, true end-to-end quality of service would allocate bandwidth to specified applications. Opportunity for Next Generation Switching Solutions The emergence of several technology trends is enabling a new generation of networking equipment that can meet the four scalability dimensions ofrequired by today's enterprise ISPsenterprises and metropolitan area networksservice providers by accommodating new unpredictable traffic patterns and bandwidth-intensive, mission-critical applications. First, whileWhile many new and different technologies have been deployed in existing LANs, Ethernet has become the predominant LAN technology, with over 97%99% of the market in 19992000 and total shipments of over 490700 million ports from 1991 to 1999,over the preceding ten-year period, according to the Dell'Oro Group.Group, an independent research organization. Ethernet has evolved from the original 10 Mbps Ethernet to 100 Mbps Fast Ethernet and, in 1998, to 1,000 Mbps Gigabit Ethernet. Today, Gigabit ethernetEthernet and 10 gigabit ethernetGigabit Ethernet represent a viable network backbone protocol, enabling broadband connections to be aggregated for network backbone transport across the metropolitan core. Second, growth of the Internet and the subsequent development of application based on Internet technologies have increased the use of the Internet Protocol. With the wide acceptancewidespread adoption of Ethernet and Internet Protocol-basedProtocol, or IP, technologies, the need to support a multi-protocol environment is diminished. As a result, the simplified routing functionality can be embedded in application specific integrated circuits, or ASICs, instead of in the software and CPUs used in multi-protocol software-based routers. The resulting device, called a Layer 3 switch, 4 functions as a less expensive and significantly faster hardware-based router. Layer 3 switches can operate at multi-gigabit speeds and, as hardware routers, can support large networks. However, most Layer 3 switches still block traffic in high utilization scenarios and can only support standards-based traffic prioritization quality of service. While Layer 3 switching dramatically increases network performance, many of today's offeringsother products fail to realize the potential of this technology because of the use of inconsistent hardware, software and management architectures. 5 To effectively address the needs of today's enterprise ISPsenterprises and metro area networks, customers needservice providers, the network industry needs a solution that ismust be easy to use and implement an can scaleand is scalable in terms of speed, bandwidth, network size and quality of service. Layer 3 switching represents the next critical step in addressing these requirements. However, customersCustomers need a Layer 3 solution that provides sufficient speed and bandwidth to support unpredictable traffic spikes without impacting all other users connected to the network. In addition, customers require a quality of service solution that supports industry-standard prioritization and enables network administrators to offer quality of service that maps business processes and network policies. Finally, to simplify their networks, customers need a family of interoperable devices that utilize a consistent hardware, software and management architecture. Through an integrated family of products, network managers can effectively deploy the solution at any point in the network and follow a migration path to a network implemented with a consistent architecture from end-to-end.architecture. The Extreme Networks Solution Extreme provides broadband ethernetWe provide Ethernet networking solutions that meet thethese requirements of the enterpriseISPs networkers and Metropolitan Area Networksservice providers by providing increased performance, scalability, policy-based quality of service, ease of use and lower cost of ownership. Our products share a common ASIC,set of ASICs, software and network management architecture, that enablesenabling Layer 3 switching at wire speedwire-speed in each major area of the network. In addition, these products can be utilized by ISPs and content providers can use these products for their web-hosting and server co-location operations. Because ourOur products are based on industry standard routing and network management protocols theythat are interoperable with existing network infrastructures. We offer policy-based quality of service that controls the delivery of network traffic according to pre-set policies that specify priority and bandwidth limits. All of our switches allow the switch tocan be managed from any browser-equipped desktop. The key benefits of Extreme'sour solutions are: High performance. Our products provide BroadbandSimplicity. Networks typically consist of many different technologies and IP services Ethernet together with the non-blocking, wire-speed routing of our ASIC-based Layer 3 switching. Using our products, customers can achieve forwarding rates that are upequipment. This complexity often makes it expensive and difficult to 100 times faster than with software-based routers. Ease of useeffectively manage and implementation.scale networks. We attempt to meet these challenges by focusing on product consistency and simplicity. Our products share a common ASIC, software and network management architecture and offer consistent features for each of the key areas of the network. This allows customers to build a consistent network that shares a common set of features, performance and management capabilities. Ease of use and implementation. Our standard-basedproducts are designed to make networks easy to manage and administer, thereby reducing the overall cost of network ownership. Through the use of a standards-based design approach, our products can readily be integrated into and installed within existing networks. Customers can usually upgrade with Extremeour products without needingthe need for additional training. Moreover, our proprietary ExtremeWare software simplifies network management by enabling customers to manage any of our products remotely through a browser interface. High performance. Our products provide broadband Ethernet and IP services together with the non-blocking, wire-speed routing of our ASIC-based Layer 3 switching. Using our products, customers may achieve forwarding rates that are significantly faster than with software-based routers. Scalability. Our solutions offer customers the speed and bandwidth they needneeded today with the capability to scale their networks to support demanding applications in the future without the burden of additional training or software or system complexity. Customers who purchase our products canmay upgrade them to advanced Layer 3 and Layer 4-74 ~ Layer 7 capability because this functionality is builtdesigned into our ASICs. Quality of service. Extreme'sOur policy-based quality of service enables customers to prioritize mission-critical applications by providing industry-leading tools for allocating network resources to specific applications. With our policy-based quality of service, customers can use a web-based interface to identify and control 6 the delivery of traffic from specific applications in accordance with specific policies that are set by the customer. The quality of service functionality of our ASICs allows our policy-based quality of service to be performed at wire speed.wire-speed. In addition to providing priority, customers can allocate specified amounts of bandwidth to specific applications or users. Lower cost of ownership. Our products are less expensive than software-based routers, yet offer higher routing performance. Because they shareWe believe that by sharing a common hardware, software and management architecture, we believe our products can substantially reduce the cost and complexity of network management and administration. This uniform architecture creates a simpler network infrastructure whichthat leverages the knowledge and resources businesses have invested in Ethernet and the Internet Protocol, or IP-based networks, thereby requiring fewer resources and less time to maintain. 5 The Extreme Networks Strategy Extreme's objective is to be the leading supplierprovider of end-to-endthe most effective network solutions.infrastructure for business applications and services. The key elements of our strategy include: Provide simple, easy to use, high-performance, cost-effective switching solutions. We offer customers easy to use, powerful, cost-effective switching solutions that meet the specific demands of switching environments in enterprise LANs, ISPs and content providers. Our products provide customers with 1,000 Mbps Gigabit Ethernet and the wire speed,wire-speed, non-blocking routing capabilities of ASIC-based Layer 3 switching. We intend to capitalize on our expertise in Ethernet, Internet protocol ("IP")IP, and switching technologies to develop new products based on our common architecture that meet the future requirements of the enterprise LANs, ISPs and contentservice providers. These products will offer higher performance with more advanced functionality and features while continuing to reduce total cost of ownership for our customers. Expand market penetration. We are focused on product sales to new customers across market segments, including ISPs, content providers and metropolitan area networks, or MANs, and on extending our product penetration within existing customers' networks. Once a customer buysdeploys our products forin one area of theirits network, our strategy is then to then offer thatproducts to the customer products for other areas. As additional products are purchased, a customer obtainscustomers obtain the increased benefits of our end-to-end solution by simplifying their networks, extending policy-based quality of service and reducing costs of ownership while increasing performance. Extend switching technology leadership. Our technological leadership is based on our custom ASICs and software and includes our wire-speed, Layer 3 switching, policy-based quality of service, routing protocols and ExtremeWare software. We intend to invest our engineering resources in ASIC and other development areas and provide leading edgeleading-edge technologies to increase the performance and functionality of our products. We also intend to maintain our active role in industry standards committees such as the Institute for Electrical and Electronics Engineers, or IEEE, and the Internet Engineering Task Force, or IETF. Leverage and expand multiple distribution channels. We distribute our products primarily through resellersselected distributors and selected OEMs and through our field sales team.a large number of resellers. To quickly reach a broad, worldwide audience, we have more than 250 resellers in approximately 50 countries, including regional networking system resellers, network integrators and wholesale distributors, and have established relationships with select OEMs.distributors. We maintain a field sales force primarily to support our resellers and to focus on select strategic and large accounts. We intend to increase the size of our reseller programs while continuing to develop and are developing two tierrefine our two-tier distribution channels in some regions. To complement and support our domestic and international reseller and OEM channels, we expect to increase our worldwide field sales force.channels. Provide high-quality customer service and support. We seek to enhance customer satisfaction and build customer loyalty through the quality of our service and support. We offerThis includes a wide range of standard support programs that include emergency telephone support 24are responsive to the level of service required by our customers, from standard business hours a day, seven days a week and advanced replacement of products. In addition, we have designed our products to allow easy service and administration. For example, we can access all of our switches remotely through a standard web browser to configure, troubleshoot and help maintain our products.global 24x7x365 real-time response support. We intend to continue to enhance the ease of 7 use of our products and invest in additional support services by increasing staffing and adding new programs for our OEMsdistributors and resellers. In addition, we also are committed to providing customer-driven product functionality through feedback from key prospects, consultants, channel and OEM partners and customer surveys.end-user customers. Products Extreme provides broadband networking solutionsWe deliver high-performance application and services infrastructure for enterprise, service provider and MANs based on award-winning technology that meet the requirements of enterprise, ISPscombines simplicity, high performance, intelligence and IP carrier and Metropolitan Area Networks by providing increased performance, scalability, policy-based quality of service, ease of use and lowera low cost of ownership. Our family of Summit stackable, BlackDiamond and Alpine chassis switches share a common ASIC,the same consistent hardware, software and management architecture, enabling businesses to build a network infrastructure that facilitatesis simple, easy to manage and scalable to meet the demands of growing businesses. The Summit chipset is the original group of ASICs used in our products, whereas the Inferno chipset is the second-generation. Our third-generation chipset, known as Genesis, is currently under development. Our product solutions enable the delivery of broadband Ethernet and IP over current and legacy networks. Additionally, with fewer components and a relatively short product design and development cycle,consistent management system, fewer dedicated network resources are required to manage the network - thereby reducing the time-to-market for new products and features. This common architecture enables customers to build a broadband networking solution that has consistent functionality, performance and management. The common architecture and end-to-end functionality of our products also reduces thetotal cost and complexity of network administration and management. The following table identifies ourownership. Our principal hardware and software products: 6 products are as follows:
Product name Product name and date of and date of first shipment Configuration / Products Configuration/Description first shipment Configuration / Description The------------------------------- ----------------------------------------------------------------------- Summit Stackable product family TheProduct Family ------------------------------- ----------------------------------------------------------------------- Inferno chip-based products: Summit1i 8 Gigabit Ethernet ports Summit5i 16 Gigabit Ethernet ports Summit7i 32 Gigabit Ethernet ports Summit48i 48 Ethernet ports and 2 Gigabit Ethernet ports Summit chip-based products: Summit24 24 10/100 Mbps Ethernet ports and 1 Gigabit Ethernet port Summit48 48 10/100 Mbps Ethernet ports and 2 Gigabit Ethernet ports ------------------------------- ----------------------------------------------------------------------- BlackDiamond Modular Chassis - ----------------------------------- --------------------------------------------------------------- ----------------------------------------------------------------------- Summit-based products: BlackDiamond 6808 Up to 576672 10/100 Mbps Summit4 16 10/100 Mbps September 1998 Ethernet ports or 96 March 1998 Ethernet ports and Gigabit Ethernet ports in 6 Gigabit Ethernet ports one chassis Summit24 24 10/100 Mbpschasis 10 slots to accommodate November 1998 Ethernet ports a variety of up to 8 connectivity and modules and 1 or 2 management 1modules -------------------------------------------------------------------------------------------------------- BlackDiamond 6816 Up to 1,440 Mbps Ethernet ports or 192 Gigabit Ethernet ports in one chassis 20 slots to accommodate a variety of up to 16 connectivity modules Summit48 48 10/100 Mbps Theand 4 management modules -------------------------------------------------------------------------------------------------------- Alpine Chassis April 1998 Ethernet ports and ------------------ 2 Gigabit Ethernet ports------------------------------- ----------------------------------------------------------------------- Alpine 3808 Up to 256 10/100 Mbps April 2000 Ethernet ports or 32 Gigabit Ethernet ports in one chassis Inferno-based products: Summit1i 8 Gigabit Ethernet ports 9 slots to accommodate September 2000 a variety of up to 8 connectivity modules and 1 management module Summit5i-------------------------------------------------------------------------------------------------------- Alpine 3804 Up to 128 Mbps Ethernet ports or 16 Gigabit Ethernet ports September 2000 Summit7i 32 Gigabit Ethernet portsin one chassis 5 slots to accommodate a variety of up to 4 connectivity modules and 1 management module
8
Products Configuration/Description --------------------------- --------------------------------------------------------------------------- Software December 1999 ----------------------------------- --------------------------------------------------------------------------- ExtremeWare SoftwareEmbedded switch management software suite that hasfeaturing standard September 1997 protocols, web-based configuration and Policy-Based Qualitypolicy-based quality of Service ExtremeWare Enterprise Anservice -------------------------------------------------------------------------------------------------------- Infrastructure and Services Next-generation network management software that manages Layer 2 ~ Layer Management (ISM) Software, 7 application infrastructure includes: EPI Center Next-generation integrated management Manager application suite that protects August 1998 the deliverysimplifies configuration, troubleshooting, and status monitoring of provisionedIP-based networks Service Watch A monitoring and management software suite for mission-critical network services and applications
Summit Stackable Products Products in the Summit family of switches are designed to meet the demanding requirements emerging in intranet and Internet applications. All Summit switches share a common non-blocking switch architecture that provides scalability in four areas: speed, bandwidth, network size and policy-based quality of service, (QoS).or QoS. The Summit product family supports a range of gigabit and 10/100 Mbps aggregation for enterprise desktops and servers, large Internet data centers, and broadband points of presence, ("POP")or POP, in metropolitan area networksMANs and multi-tenant buildings. The enterprise desktop is the portion of the network where individual end-user workstations are connected to a hub or switch. In this shared environment, each desktop in the workgroup receives and is burdened by the communication of every other desktop in the workgroup. As applications have become more bandwidth intensive and as user traffic has migrated outside the workgroup via the Internet or an intranet or extranet, the hubs are unable to effectively process this traffic, resulting in diminished desktop performance. Replacing the hub with a Layer 3 switch alleviates this problem by providing a dedicated link for each desktop and eliminating unnecessary broadcasts of information to every desktop in the workgroup. Enterprise desktop switching provides the desktop with features typically found only at the network core, such as redundancy, greater speed and the ability to aggregate multiple switch ports into a single high-bandwidth connection. Extreme became an industry leader in Layer 3 switching for the desktop with the introduction of our Summit48, Summit24 and Summit24Summit48i desktop switching products. The Summit48 switch addresses high-density enterprise desktop connections. This switch features a non-blocking architecture to avoid the loss of data packets. The Summit24 switch, with half the number of ports of the Summit48 switch, is targeted at local wiring closets with moderately dense desktop connections. At the network edge, the Summit48i switch delivers an aggregation switching solution with physical and logical access, security and user mobility features. Servers run the applications and store the data needed by all network end-users. The traditional network architecture has been shifting toward more centralized server clusters, or server farms, which require the physical deployment of multiple servers in a single central data center. This new architecture is easier to manage and can be configured in a redundant fashion, thereby reducing the risk of 7 system failure. Additionally, remote offices and telecommuters can access the same server-based data as desktop users, increasing the flexibility of the network to support users wherever they may be located. As more people access the network and as server requests increasingly involve more bandwidth-intensive applications, network traffic to and from servers has increased dramatically, causing bandwidth to be consumed by traffic. Servers also communicate with each other, creating a high volume of server-to-server traffic within the server farm. Recent technology developments allow enterprises to install network interface cards that enable connections using Gigabit Ethernet or the aggregation of multiple 100 Mbps ports on a single card. This development increases the communication speed of the servers. In 9 turn, these servers have created the need for switches that can support their higher server-to-server and server-to-end-user communications speeds. Our Summit4 product addresses server switchingA number of our products address server-switching constraints by providing switched Gigabit Ethernet and multiple 100 Mbps links to the servers, thereby delivering sufficient bandwidth between servers and to clients on attached segments. In server farms and data centers, the Summit7i maximizes server availability and performance by combining server load-balancing with wire-speed switching. As metropolitan area networksMANs evolve to handle more data rather than voice, the POP must also progress from serving as a simple transport device to an application services tool. Today's broadband POPs are moving closer to the customer and need to offer services density and scalability without re-engineering discreet narrowbandnarrow-band technologies. There is a growing need for consistent scalable services in the multi-tenant market, which, according to Cahner's InStat Group, an independent research organization, will reach $2 billion by 2004. The new Summit1i and Summit5i Gigabit Ethernet switching systems are designed to eliminate the limitations associated with multiple narrowbandnarrow-band aggregation technologies traditionally used in metropolitan POPs. To keep up with the demands of the MAN provider, more sophisticated network features are required to help them deliver revenue-generating services by ensuring latency, reliability, and security. The Summit48i extends Ethernet service provisioning to the network edge, enabling control and management over bandwidth, service provisioning and usage-based billing. BlackDiamond Modular Chassis6800 Series The BlackDiamond modular chassis6800 series delivers carrier-class scalability, redundancy and high reliability for core switching in high-density Ethernet/IP enterprise and service provider networks. The BlackDiamond switch includesThese modular switches include the fault-tolerant features associated with mission-critical enterprise-class Layer 3 core switching, including redundant system management and switch fabric modules, hot-swappable modules and chassis components, load-sharing power supplies and management modules, up to eightsixteen 10 Mbps, 100 Mbps, or 1,000 Mbps aggregated links, dual software images and system configurations, spanning tree and multipath routing, and redundant router protocols for enhanced system reliability. The network core is the most critical point in the network, as it is where the majority of network traffic, including desktop, segment and server traffic, converges. Network core switching involves switching traffic from the desktops, segments and servers within the network. Because ofOwing to the high-traffic nature of the network core, the critical elements in core switching include wire-speed Layer 3 switching, scalability, a non-blocking hardware architecture, fault-tolerant mission-critical features, redundancy, and link aggregation, the abilityaggregation. The abilities to support a variety of high-density "speedsspeeds and feeds"feeds and the ability to accommodate an increasing number of high-capacity backbone connections are critical in core switching.also important. Alpine Chassis3800 Series The Alpine 3808 chassis switch3800 series provides a simpler, moresimple, resilient broadband infrastructure for metropolitan area networks ("MANs"),MANs, ISPs and mid-range enterprise networks. The Alpine 3800 series provides total Ethernet coverage with support for both standard category 5 and fiber optic media as well as first mile technologies that extend the reach of Ethernet over VDSL and legacy WAN technologies. In addition, the Alpine platform can be deployed throughout a network infrastructure consistently, regardless of the building topology or type of cabling available. The Alpine 3800 series switches can be configured to scale from 8 to 56 Ethernet-over-VDSL ports. Even higher density can be achieved with a combination of Ethernet-over-VDSL and traditional copper or fiber Ethernet ports. The FM-8Vi module provides Ethernet-over-VDSL at 10 Mbps full-duplex on each port, up to 2500 feet. The four-port T1/E1 WAN, or WM-4T1, module for the Alpine 3800 series switches provides WAN connectivity for the Alpine chassis switch. The WM-4T1 module provides flexible WAN connectivity with T1 channel bonding that scales from 1.5 Mbps to 6 Mbps of uplink capacity. Coupled with the sophisticated bi-directional rate shaping and policy-based QoS capabilities of the Alpine chassis switch, the T1 module ensures 10 delivery of real-time and mission-critical applications in the WAN. The WM-4T 1 module is ideal for supporting both switched Ethernet and IP-routed configurations across T1 links. ExtremeWare Software ExtremeWare software is the embedded operating system software that is provided on every one of our switches. It delivers the uncompromising switching and routing protocol support, management, control and security needed on today's most demanding enterprise, service provider data centers, multi-tenant buildings and enterprise wiring closets.co-located networks. Its standards-based, multi-layer switching and policy-based QoS give network managers the tools they need to make the most of network capacity. The Alpine 3808flexibility of ExtremeWare software is key in making network design decisions for switching, independent from QoS and security policies. Infrastructure and Services Management Extreme Infrastructure and Services Management, or ISM, is the industry's first broadband provisioning switch based on Ethernet and IPnext generation network management software platform that enables MANs and carriers to deliver more infrastructure bandwidth, slice and dicemanages Layer 2 ~ Layer 7 application infrastructures. ISM is a total software portfolio that bandwidthincludes EPICenter software, an integrated application suite for optimal usage, and guarantee fixed latency for delay-sensitive services such as video and voice. ExtremeWare The ExtremeWare software suite combines industry-standard protocols to provide interoperability with legacy switches and routers, plus Policy-Based Quality of Service (QoS) for bandwidthnetwork management, and traffic prioritization in today's networks. With ExtremeWare, QoS policies are easy to define and assign to traffic groups. TheServiceWatch software, a Layer 4 ~ Layer 7 application monitoring suite, offering a unified management solution for a wide range of QoS profiles includes minimum bandwidth, maximum bandwidthbusiness sizes and relative priority. These QoS profiles are key to optimizing bandwidth management effectiveness. Our policy-based quality of service also enables network managers to define numerous levels of control, or policies, that determinedemands. EPICenter software, the amount of bandwidth available to a group of users or network devices at a given time. ExtremeWare Enterprise Manager ExtremeWare Enterprise Managerprimary application in the ISM portfolio, is a value-addedan integrated application suite that makes it easier to performsimplifies configuration, troubleshooting, inventorying and status monitoring and deploy multi-vendor policy-based management. ExtremeWare Enterprise Managerof IP-based networks. EPICenter software offers a comprehensive 8 set of network management tools that are easy to useapplications, accessible from a workstation with a Java-enabled web browser. ExtremeWare Enterprise Manager simplifies the task of managing and configuring groups of our switches. With ExtremeWare Enterprise Manager, an entire network of our switches can be managed from a single management console using a standard web browser. ExtremeWareOur ServiceWatch In August 2000 Extreme announced ExtremeWare ServiceWatch. This software is designed to help businesses avoid costly downtime and help to ensure that network services remain up and performing at peak levels. Just like the telephone dial tone that indicates the availability and quality of voice services, ServiceWatch delivers application dial tone to facilitate "always-on"a Layer 4 ~ Layer 7 network services. It monitorsmonitoring and manages the response time ofmanagement software solution for mission-critical network services such as e-mail, e-commerce, and filer transfer activities.file transfer. The software is designed to give network managers a user's perspective with respect to the performance of their network services to ensure these are performing at peak levels. If service response time starts to degrade, ServiceWatch can be configured to notifythe software notifies the network manager to take corrective action before a problem occurs. ServiceWatch is also usedThe software monitors web servers, such as a bandwidth-capacity planning toolHTTP, FTP servers, host and can help track ISP service level agreements (SLAs) using historical reportingname servers, including DHCP and graphing of serviceDNS, mail servers, including POP3, IMAP4 and SMTP, news servers, such as NNTP, and other protocols, and tests device availability and response time.time using ping, or ICMP, telnet and other protocols. Sales, Marketing and Distribution Extreme'sWe conduct our sales and marketing strategyactivities on a worldwide basis through distributors, resellers, and our field sales organization. A majority of our sales are made to partners in two-tier distribution channels. The first tier consists of a limited number of independent distributors that sell primarily to resellers and end-user customers. Distributors are generally given privileges to return a portion of inventory and participate in various cooperative marketing programs to promote the sale of our products and services. The second tier of the distribution channel is focusedcomprised of a large number of independent resellers that sell directly to end-user customers. Resellers do not stock inventory and therefore are not granted return privileges. We maintain a limited number of relationships with strategic original equipment manufacturer, or OEM accounts, but we anticipate that OEM sales will continue to decline as a percentage of net revenue as we focus on domestic and international resellers, distributors, OEMsour two-tier distribution and field sales.sales strategy. Distributors. We have established several key relationships with leading distributors in the electronics and computer networking industries. We intend to maintain these relationships with distributors who may offer products or distribution channels that complement our own channels. Each of our distributors resells our products to reseller and end-user customers. The distributors enhance our ability to sell and provide support to end-user customers, especially global accounts, who may benefit from the broad service and product fulfillment capabilities offered by these distributors. We anticipate that sales by distributors will increase as a percentage of net revenue in the future. Tech Data Corporation, a major electronics distributor and value-added services provider headquartered in Clearwater, Florida, accounted for 16% of our sales in fiscal 2001. No other customer accounted for greater than 10% of our revenue in fiscal 2001. 11 Value-Added Resellers. We have entered into agreements to sell our products through more than 250 resellers in approximately 50 countries. Our value-added resellers include regional networking system resellers, resellers who focus on specific vertical markets, network integrators and wholesale distributors. We provide training and support to our resellers and our resellers generally provide the first level of support to end users of our products. We intend to increase the number of our reseller relationships, to target vertical markets and support a two-tier distribution channel. OEMs. We have established several key OEMOur relationships with leaders in the telecommunications, personal computer and computer networking industries. We intend to maintainresellers are generally on a limited number of relationships with key strategic OEMs who may offer products or distribution channels that compliment ours. Each of our OEMs resells our products under its own name. We believe that our OEM relationships enhance our ability to sellnon-exclusive basis and provide support to large organizations because certain end-user organizations may prefer to do businessthe resellers with very large suppliers. We anticipate that OEM sales will decline as a percentagediscounts based upon the volume of net revenue as we expand our reseller and fields sales efforts.their orders. Field sales. We have designed and establishedtrained our field sales organization to support and develop leads for our resellers and to establish and maintain a limited number of key accounts and strategic customers. To support these objectives, our field sales force: . assists end-user customers in finding solutions to complex network system and architecture problems; . differentiates the features and capabilities of our products from competitive offerings; . continually monitors and understands the evolving networking needs of enterprise customers; . promotes our products and ensures direct contact with current and potential customers; and . monitors the changing requirements of our customers. As of June 30, 2000,2001, Extreme's worldwide sales and marketing organization included 376464 individuals, including directors, managers, sales representatives, and technical and administrative support personnel. We have domestic sales offices located in major metropolitan areas inthe states of Arizona, California, Colorado, Connecticut, District of Columbia, Florida, Georgia, Illinois, Kansas, Massachusetts, Maryland, Michigan, North Carolina, New Jersey, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Tennessee, Texas, Utah, Virginia, Washington and Wisconsin. In addition, we have international sales offices located in Argentina, Australia, Brazil, Canada, Chile, Columbia, France, Germany, Hong Kong, Italy, Japan, Korea, TheMalaysia, Mexico, the Netherlands, Sweden and the United Kingdom. We also maintain representative offices in the People's Republic of China located in the cities of Beijing, Chengdu, Shanghai and Wuhan. International sales We believe that there is a strong international market for our switching products. Our internationalInternational sales are conducted primarily throughan important and growing portion of our overseas offices and foreign resellers. Salesbusiness. In fiscal 2001, sales to customers outside of North America accounted for approximately 45%55% of our consolidated net revenue, compared to 43% in fiscal 2000. 9 2000 and 52% in fiscal 1999. These sales are conducted primarily through foreign-based distributors and resellers managed by our worldwide sales organization, in addition to direct sales to end-user customers, including large global accounts. The primary markets for sales outside of North America include the countries in Western Europe and Japan. We have also achieved growing sales to customers in the People's Republic of China and other countries throughout the Asia-Pacific region. Marketing We have a number of marketing programs to support the sale and distribution of our products and to inform existing and potential customers and our resellers, distributors and OEMsresellers about the capabilitiesfeatures and benefitsperformance of our products. Our marketing efforts include participation in industry tradeshows, technical conferences and technology seminars, preparation of competitive analyses, sales training, publication of technical and educational articles in industry journals, maintenance of our web site,a publicly available website, web-based training courses, advertising and public relations. In addition, we have begun to develop an e-commerceelectronic-commerce business directed at resellers. We also participate in third-party,submit our products for independent product tests.testing and evaluation. Our consolidated net revenue for fiscal 2001, 2000 and 1999 was $491 million, $262 million and $98 million respectively. Although our annual growth rate has been substantial, we cannot assure you that we will be 12 able to achieve similar rates of growth in the future. For further detail, see "Risk Factors--A Number of Factors Could Cause Our Quarterly Financial Results to Be Worse Than Expected, Resulting in a Decline in Our Stock Price." Backlog Our products are often sold on the basis of standard purchase orders that are cancelable prior to shipment without significant penalties. In addition, purchase orders are subject to changes in quantities of products and delivery schedules in order to reflect changes in customer requirements and manufacturing capacity. Our business is characterized by seasonal variability in demand and short lead-time orders and delivery schedules. Actual shipments depend on the then-current capacity of our contract manufacturers and the availability of materials and components from our vendors. We believe that only a small portion of our order backlog is non-cancelable and that the dollar amount associated with the non-cancelable portion is immaterial. Accordingly, we do not believe that backlog at any given time is a meaningful indicator of future sales. Customer Support and Service We offer modular and comprehensive ExtremeWorks service solutions to help protect our customers' network investments and support their business goals. The markets we address--including enterprises, service providers, and e-businesses--all demand continuous uptime to maximize productivity. Our goal is to serve as a knowledgeable and experienced service partner who can tailor service solutions to meet the specific business needs of our customers. Our service offerings are as follows: . ExtremeWorks Professional Services . ExtremeWorks Global Services Management . ExtremeWorks Support Programs . ExtremeWorks Education ExtremeWorks Professional Services. We specialize in providing solutions and consultative services to improve network productivity in all phases of the network lifecycle--evaluation, planning, design, implementation and management. The professional services include customized and packaged consulting services that assist customers in an effort to optimize their networks by meeting their objectives for applications support, uptime and cost control. Our network architects develop and execute customized hardware deployment plans to meet individualized network strategies. These activities include the management and coordination of the design and network configuration, resource planning, staging, logistics, migration and deployment. We also provide technical documentation and training to assist customers in the transition to a new network. We offer our customers a variety of technical consulting services, including: . Analysis--detailed audit and analysis of customer networks . Policy-Based QoS--analysis and recommendation for deploying advanced traffic management and bandwidth prioritization features to match actual traffic patterns . Multicasting--strategy for deploying PIM-DM, PIM-SM, or DVMRP to best suit streaming media requirements . Voice over IP--consulting strategy and recommendation to deploy voice-over-IP utilizing our technology 13 . Load Balancing--design and implementation of our integrated load balancing features to help maximize server response while reducing equipment costs . Security--analysis of customer security needs and recommendations on how to implement advanced security features to meet those needs . Interoperability Lab--use of the lab to analyze deployment options, resolve integration concerns, and assess performance and application thresholds ExtremeWorks Global Services Management. Post-sales customer services are an integral component of our comprehensive service solution. Global Services Management delivers customer service by means of a service account manager who serves as single point of contact to manage account service needs including the coordination of activities with the Global Service Management team--the designated technical engineer, systems engineer and development engineer sponsor. Service account managers facilitate communications with cross-functional teams, escalate support organization maintainsissues to streamline issue resolution, and supports products soldmaintain documentation of customer network configurations and topology maps for access by customer-authorized staff. ExtremeWorks Support Programs. Our support programs are designed to support a broad range of customer service requirements. From standard business hours to 24x7x365 global support, we attempt to meet the service requirements of all our field sales forcecustomers through Technical Assistance Centers, or TACs, located in Santa Clara, California, Utrecht, Holland, and Tokyo, Japan. Our technical engineers assist in diagnosing and troubleshooting technical issues regarding customer networks. This is part of our effort to end users,ensure maximum network uptime and providesperformance. Regional systems engineers serve as on-site engineering resources to provide consultative support and advice for network operation. Development engineers work with the TACs to resolve product functionality issues specific to each customer. We utilize the Internet to distribute and obtain information from our customer base as an integral part of our service solution. This allows us to keep customers informed of the latest updates and developments at Extreme Networks, and contains up-to-date information and technical supportdocumentation enabling customers to our resellersresearch issues and OEMs. Generally, our resellersfind answers to technical questions. Special features include a TAC database to obtain troubleshooting assistance and OEMs provide installation, maintenanceinformation for configuring software, diagnosing hardware, and researching network issues. On-site support services to their customers and we assist our resellers and OEMsare available in providing such support. In addition to designing custom maintenance programs to satisfy specific customer requirements, we also offer several standard maintenance programs to our resellers and customers, including ExtremeAssist Basic, ExtremeAssist1, ExtremeAssist2, ExtremeAssist Premium and ExtremeAssist Elite. ExtremeAssist Basic. This program is designedmost locations worldwide for customers who are interested in keepingrequire a more comprehensive level of service and support costssupport. ExtremeWorks Education. Our technical experts offer certified classes on our products. The classes cover a wide range of topics such as switch configuration, optimization, management and operation, so customers can acquire the necessary knowledge and experience to successfully deploy and manage our products in various networking environments. Class sizes are generally small and lab-intensive to promote high retention in a minimum but want access to basic support services. Basic service includes access to Extreme's web-accessible knowledge database and software upgrades and bug fixes. The ExtremeAssist program includes eight-hour, five-day technical assistance center telephone support, e-mail inquiries and responses within 24 hours and rapid-response emergency/network down telephone support 24 hours a day, 7 days a week. ExtremeAssist1. This program is designed for customers who have strong technical networking skillshands-on learning environment, and are interested in keeping service and support costs to a minimum. With ExtremeAssist1, the customers' information technology organizations provide first-level support for configuration, hardware and trouble shooting, while Extreme's technical assistance center provides advanced second-level support on an essential need basis. The ExtremeAssist1 program includes all the features in ExtremeAssist Basic plus 48-hour advanced replacement of hardware. ExtremeAssist2. This program is designed for network environments that require a high degree of network availability, data integrity and end-user productivity. The ExtremeAssist2 program includes all the features in ExtremeAssist1 plus twelve-hour, five-day technical assistance center telephone support and next business day replacement of hardware. As switched broadband infrastructures become more vital to a company's ability to compete, networks are doing much more than just sharing and distributing information. Networks have become the brains of day-to-day business operations and are the key to reducing time to market and sharpening a company's competitive edge. Extreme recognizes the critical nature of the switched broadband infrastructure in today's business environment and the ever-expanding demands that will be put on networksoffered from time-to-time in the future. To meet these needs, Extreme has developed a series of comprehensive on-site support plans to fit the needs of the most demanding network environments. ExtremeAssist Premium. ExtremeAssist Premium is designed to meetUnited States, Europe and exceed all the essential requirements of supporting and maintaining enterprise LANs. Ideal for mission-critical network environments that require a high degree of network availability, data integrity and end-user productivity. The ExtremeAssist Premium plan includes faster on-site service and spares. The ExtremeAssist Premium program includes all the features in ExtremeAssist2 plus 24 hours a day, 7 days a week on-site emergency network down assistance within 4 hours. ExtremeAssist Elite. ExtremeAssist Elite is Extreme's most comprehensive support plan for mission-critical switched broadband networks. Elite is limited to the top 20% of Extreme's customer base to ensure a very individualized, flexible and focused approach to providing Elite support services. ExtremeWorks Elite adds dedicated level 3 technical support engineers and our fastest on-site service and spares response time. We typically provide end users with a one-year hardware and 90-day software warranty. We also offer various training courses for their third-party resellers or end-user customers. 10 Asia. Manufacturing We outsource the majority of our manufacturing and supply chain management operations, and we conduct quality assurance, manufacturing engineering, documentation control and repairs at our facility in Santa Clara, California. This approach enables us to reduce fixed costs and to provide flexibilityflexibly respond to changes in meeting market demand. Where cost-effective, we may begin to perform certain of our non-manufacturing outsourced operations, in-house.such as product testing, at our own facilities. Currently, we use three contract manufacturers--Flextronics International, Ltd., located in San Jose, California to manufacture our Summit1, Summit4,BlackDiamond and Summit RPS and BlackDiamond products, MCMS, located in Boise, Idaho, to manufacture our Summit24, Summit48, Summit1i, Summit5i and Summit7i products andproducts; Solectron Corporation, located in Milpitas, California, to manufacture our Alpine products; and MCMS, Inc., located in Nampa, Idaho, to manufacture selected Summit products. Each of these manufacturing processes and procedures is ISO 9002 certified. We 14 design and develop the key components of our products, including ASICs and printed circuit boards. In addition, we determine the components that are incorporated in our products and select the appropriate suppliers of such components. ProductOur contract manufacturers utilize automated testing equipment to perform product testing and burn-in is performed by our contract manufacturers using tests we specify and automated testing equipment.with specified tests. We also use comprehensive inspection testing and statistical process controls to assure the quality and reliability of our products. We intend to regularly introduce new products and product enhancements whichthat will require that weus to rapidly achieve volume production by coordinating our efforts with those of our suppliers and contract manufacturers. See "Factors That"Risk Factors--We May Affect Our Results--Extreme NeedsNeed to Expand ItsOur Manufacturing OperationsCapacity and DependsWe Depend on Contract Manufacturers for Substantially All of ItsOur Manufacturing Requirements." Although we use standard parts and components for our products where possible, we currently purchase several key components used in the manufacture of our products from single or limited sources. Our principal single-sourcedsingle-source components include: . ASICs; . microprocessors; . programmable integrated circuits; . selected other integrated circuits; . cables; . custom power supplies; and . custom-tooled sheet metal. Our principal limited-source components include: . flash memories; . DRAMs; . SRAMs;dynamic and static random access memories, or DRAMS and SRAMS respectively; and . printed circuit boards. Generally, purchasePurchase commitments with our singlesingle- or limited sourcelimited-source suppliers are generally on a purchase order basis. LSI Logic manufacturers all of ourCorporation is the sole source for the ASICs whichthat are used in all of our switches.switches, whereas a number of other vendors supply standard product integrated circuits and microprocessors for our products. Any interruption or delay in the supply of any of these components, or the inability to procure these components from alternate sources at acceptable prices and within a reasonable time, would materially adversely affectmay have a material adverse effect on our business, operating results and financial condition. In addition, qualifying additional suppliers can be time-consuming and expensive and may increase the likelihood of errors. We use a rolling nine-monthour forecast based on anticipated product ordersof expected demand to determine our material requirements. Lead times for materials and components we order vary significantly, and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. See "Factors That May Affect Our Results--Extreme Purchases"Risk Factors--We Purchase Several Key Components for Products From Single or Limited Sources and Could Lose Sales if These SourcesSuppliers Fail to Fill ItsMeet Our Needs" and "--Extreme Needs To"We May Need to Expand ItsOur Manufacturing OperationsCapacity and DependsWe Depend on Contract Manufacturers for Substantially All of ItsOur Manufacturing Requirements." Research and Development The success of our products to date owes in large part to our focus on research and development. We believe that our futurecontinued success dependsin the marketplace will depend on our ability to continue to enhancedevelop new and enhanced products employing leading-edge technology. Accordingly, we are undertaking development efforts with an emphasis on increasing the reliability, performance and features of our existingfamily of products, and designing innovative products to develop new products that maintain technological competitiveness. We focus ourreduce the overall network operating costs of customers. 15 Our product development activities focus on solving the needs of enterprise,enterprises, service providers, telecommunications carriers, and IP carriermetropolitan area network markets. Current activities include the continuing development of a next-generation chipset aimed at extending the capabilities of our products. Our ongoing research activities cover a broad range of areas, including, in particular, 10 Gigabit Ethernet and Metropolitan Area Network markets. We monitor changing customer needsSONET routers, metropolitan network and work closelyInternet routing software, ASIC design, and network management software. The scope of our research and development activities has expanded to include the development of broadband access equipment and content networking devices in connection with 11 users, value-added resellers and distributors, and market research organizations to monitor changescorporate acquisitions that we completed in the marketplace. We design our products around current industry standards and will continue to support emerging standards that are consistent with our product strategy.fiscal 2001. Our products have been designed to incorporate the same core ASICs and software andwith a consistent system architecture facilitatingacross all product lines, enabling a relatively short product design and development cycle and reducing the time to market for new products and features. We have utilized this architectural design approach to develop and introduce other product modelsnew products and enhancements sincefollowing the introduction of our first products in 1997.first- and second-generation products. We intend to continue with a simplified approach to utilize this architectural design to develop and introduce additional products and enhancements in the future. We are undertakingOur expenditures for research and development efforts for our family of products with emphasis on increasing reliability, performancein fiscal 2001, 2000, and scalability1999 were $57.9 million, $33.0 million, and reducing the overall network operating costs to end users. This fiscal year we introduced a new generation chipset which was incorporated in a new product family which began shipping$17.0 million respectively. These amounts do not include in-process research and development charges in the quarter ended December 31. We are also focusing on cost reduction engineeringamount of $30.2 million related to reduce the costour acquisitions of our products.Optranet, Inc. and Webstacks, Inc. in fiscal 2001. There can be no assurance that our product development efforts will result in commercially successful products, or that our products will not be rendered obsolete by changing technology or new product announcements by other companies. See "Factors That May Affect Our Results--Extreme's"Risk Factors--The Market in Which We Compete is Subject to Rapid Technological Change and to Compete ExtremeWe Must Continually Introduce New Products that Achieve Broad Market Acceptance." Competition The market for internetInternet switches is part of the broader market for networking equipment, which is dominated by a few large companies, particularly Cabletron Systems, Cisco Systems Lucent Technologies and Nortel Networks. Each of these companies has introduced, or has announced its intention to develop, switches that are or may be competitive with our products. For example, in January 1999, Cisco announced itsproducts, such as the Catalyst 6000 family of chassis-based switches.switches offered by Cisco Systems. In addition, there are a number of large telecommunications equipment providers, including Alcatel, Ericsson, Nokia and Siemens, which have entered the market for network equipment, particularly through acquisitions of public and privately held companies. We expect to face increased competition, particularly price competition, from these and other telecommunications equipment providers. We also expect to compete with other public and private companies that offer switching solutions, such as Alteon Web Systemsincluding Enterasys Networks, Foundry Networks and FoundryRiverstone Networks. These vendors may develop products with functionality similar to our products or provide alternative network solutions. Our OEMs may compete with us with their current products or products they may develop, and with the products they purchase from us. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to develop and offer competitive products. Furthermore, we compete with numerous companies that offer routers and other technologies and devices that traditionally have managed the flow of traffic on the enterprise or metropolitan area networks. Many of our current and potential competitors have longer operating histories and substantially greater financial, technical, sales, marketing and other resources, as well as greater name recognition and a larger installed customer base, than we do. As a result, these competitors are able to devote greater resources to the development, promotion, sale and support of their products. In addition, competitors with a large installed customer base may have a significant competitive advantage over us. We have encountered, and expect to continue to encounter, many potential customers who are extremely confident in and committed to the product offerings of our principal competitors, including Cisco Systems and Nortel Networks. Accordingly, suchthese potential customers may not consider or evaluate our products. When such potential customers have considered or evaluated our products, we have in the past lost, and expect in the future to lose, sales to some of these customers as large competitors have offered significant price discounts to secure such sales. 16 We believe the principal competitive factors in the network switching market are: . expertise and familiarity with network protocols, network switching and network management; . product performance, features, functionality and reliability; . price/performance characteristics; . timeliness of new product introductions; . adoption of emerging industry standards; . customer service and support; . size and scope of distribution network; 12 . brand name; . access to customers; and . size of installed customer base. We believe we compete favorably with our competitors with respect to each of the foregoing factors. However, because many of our existing and potential competitors have longer operating histories, greater name recognition, larger customer bases and substantially greater financial, technical, sales, marketing and other resources, they may have larger distribution channels, stronger brand names, access to more customers and a larger installed customer base than we do. Such competitors may, among other things, be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to distribution partners than we can. To remain competitive, we believe we must, among other things, invest significant resources in developing new products and enhancing our current products and maintain customer satisfaction worldwide. If we fail to do so, our products will not compete favorably with those of our competitors which will materially adversely affectand that may have a material adverse effect on our business. See "Factors That May Affect Our Results--Intense"Risk Factors--Intense Competition in the Market for Networking Equipment Could Prevent Extreme FromUs from Increasing Revenue and Prevent Extreme From Achieving or Sustaining Profitability." Intellectual Property We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We have been issued sixseven patents in the U.S. WeUnited States and in addition have filed eighttwenty-one patent applications in the U.S. andUnited States. Based on our commitment to build a patent portfolio, we have in process a number of other patent applications relating to our proprietary technology. We have filed patents in selected countries abroad relating to the architecture of our network switches and quality of service features.as deemed appropriate. There can be no assurance that these applications will be approved, that any issued patents will protect our intellectual property or that theythese patents or applications will not be challenged by third parties. Furthermore, there can be no assurance that others will not independently develop similar or competing technology or design around any patents that we may be issued. We alsoobtain. With respect to trademarks, we have five registered trademarks and fournine pending trademark applications and ten registered trademarks in the U.S.United States. In addition, we have a significant number of pending trademark applications and registered trademarks abroad. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our software, documentation and other proprietary information. In addition, we provide our software products to end-usersend-user customers primarily under "shrink-wrap" license agreements included within the packaged software. These agreements are not negotiated with or signed by the licensee, and thus these agreements may not be enforceable in some jurisdictions. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. There can be no assurance that these precautions will prevent misappropriation or infringement of 17 our intellectual property. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. The networking industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. In particular, leading companies in the data communications and networking markets have extensive patent portfolios with respect to networking technology. From time to time, third parties, including these leading companies, have asserted and may assert exclusive patent, copyright, trademark and other intellectual property rights against us. Indeed, a number of third parties, including leading companies, have asserted patent rightsus in regard to technologies and related standards that are importantwe consider to us.be important. We expect to increasingly be subject to infringement claims asserted by third parties as the numbers of products and competitors in the market for network switches grow and product functionality overlaps. As detailed below under "Legal Proceedings," we are currently engaged in litigation with Nortel Networks. Nortel Networks is asserting claims that allege infringement of certain patent rights, against which we are defending vigorously, but we cannot assure you that we will prevail in this litigation. See "Risk Factors--We Are Engaged in Litigation Regarding Intellectual Property Rights, and an Adverse Outcome Could Harm Our Business and Require Us to Incur Significant Costs." In addition to the functionality of products overlaps. In this regard,litigation with Nortel Networks, since April 2000, we have been in communication with one of these leadingtwo other companies that believesassert certain of our products require a license under a number of their patents. The third party isThese parties have indicated in the past that they are willing to grant us a non-exclusive license under the identified patents as well as other patents or technology that we may require. We are currently are reviewing the identified patents to examinedetermine whether we consider a license necessary. However, there can be no assurance that this licensethese licenses would be obtainable on commercially acceptable terms. Although we have not been a party to any litigation asserting claims that allege infringement of intellectual property rights, weWe also cannot assure you that we will not be a party to litigation in the future. In addition, we cannot assure you thatthese parties or other third parties will not assert additional claims or initiate litigation against us, or our manufacturers, suppliers, or customers alleging infringement of their proprietary rights with respect to existingbased on the technology in our current or future products. WeIn the future, we may in the futuredetermine it is necessary to initiate claims or litigation against third parties for infringement of our proprietary rights to determine the 13 scope and validity of our proprietary rights. Any such claims, withwhether asserted by us or without merit,a third party against us, could be time-consuming, result in costly litigation and diversion of technical and management personnel or require us to develop non-infringing technology or enter into royalty or licensing agreements. Such royalty or licensingRoyalty-bearing license agreements, if required, may not be available on acceptable terms, if at all. In the event of a third party is successful in a claim of infringement, and our failure or inability to develop non-infringing technology or license the proprietary rights on a timely basis may have a material, adverse effect on our business, operating results and financial condition couldcondition. See "Risk Factors--Our Ability to Protect Our Intellectual Property and Defend Against Claims May be materially adversely affected.Limited and May Adversely Affect Our Ability to Compete." Employees As of June 30, 2000,2001, we employed 680 persons,a total of 970 people, including 376464 in sales and marketing, 110252 in research and development, 67engineering, 76 in operations, 6584 in technicalcustomer support, and 6294 in finance and administration. We have never had a work stoppage and no personnel are represented under collective bargaining agreements. We consider our employee relations to be good. We believe that our future success will depend on our continued ability to attract, integrate, retain, train and motivate highly qualified personnel, and upon the continued service of our senior management and key personnel. None of our personnel is bound by an employment agreement. CompetitionThe market for qualified personnel is intense,competitive, particularly in the San Francisco Bay Area, where our headquarters is located. At times we have 18 experienced difficulties in attracting new personnel. There can be no assurance that we will successfully attract, integrate, retain and motivate a sufficient number of qualified personnel to conduct our business in the future. See "Factors That May Affect Our Results--If Extreme Loses"Risk Factors--If We Lose Key Personnel or isare Unable to Hire Additional Qualified Personnel as Necessary, ItWe May Not Be Able to Successfully Manage ItsOur Business or Achieve ItsOur Objectives." Item 2. Properties.Properties Our principal administrative, sales, marketing and research and development facilities are located in an approximately 77,000 square feet facility located in Santa Clara, California. In June 2000, we entered into a five-year operating lease agreement to lease 275,000 square feet in Santa Clara, California to house further physical expansion of our principal operations. We also lease office space and executive suites in various other geographic locations domestically and internationally for sales and service personnel.personnel and engineering operations. Our aggregate lease expense for fiscal 2001 was approximately $11.7 million, net of sublease income of approximately $3.6 million. We believe our current facilities will adequately meet our growth needs for the foreseeable future. Our principal facilities are as follows:
# of Bldgs Location Leased/Owned Square Footage Purpose ----- -------- ------------ -------------- ------- 6 Santa Clara, CA.......... 6 Leased Combined SF 6 bldgs. (leased) = Warehouse, 295,764 R&D, Sales, Headquarters 2 Pleasanton, CA........... Leased 84,428 Research & Development 1 Herndon, VA.............. Leased 14,451 Sales and Research & Development 1 Durham, NC............... Leased 12,500 Research & Development 2 Maarssen, the Netherlands Leased 12,000 Sales Office 1 Dallas, TX............... Leased 11,574 Sales Office 1 Oakbrook Terrace, IL..... Leased 11,430 Sales Office 1 Westlake Village, CA..... Leased 10,027 Research & Development 1 New York, NY............. Leased 9,185 Sales Office 1 Tokyo, Japan............. Leased 7,755 Sales Office 1 Sunnyvale, CA............ Leased 7,500 Research & Development 1 Denver, CO............... Leased 7,277 Sales Office 1 Houston, TX.............. Leased 6,347 Sales Office 1 Westborough, MA.......... Leased 5,553 Sales Office
Item 3. Legal Proceedings.Proceedings On March 14, 2001, Nortel Networks, Inc. and Nortel Networks Limited (collectively, "Nortel") filed suit against us in the United States District Court for the District of Massachusetts, Civil Action No. 01-10443EFH. The complaint alleges willful infringement of U.S. Patent Nos. 5,790,554 (the "554 Patent"); 5,490,252; 5,408,469; 5,398,245; 5,159,595 and 4,736,363, and seeks a judgment: (a) determining that the Company has infringed each of the six patents; (b) permanently enjoining and restraining the Company from further infringement of each of the six patents; and (c) awarding unspecified amounts of trebled damages, together with interest, costs and attorneys' fees. We answered Nortel's complaint on May 17, 2001, denying that we have infringed any of the six patents and also asserting various affirmative defenses and counterclaims that seek judgment: (a) that Nortel's complaint be dismissed; (b) that each of the six patents be declared invalid; (c) declaring that we are not infringing any of the six patents; and (d) that Nortel pay our attorneys' fees and costs. On May 17, 2001, we also sought transfer of the action to the United States District Court for the Northern District of California. On June 28, 2001, the court denied our motion to transfer, and the action will thus proceed in Massachusetts. On July 9, 2001, the court granted a motion by F5 Networks, Inc. ("F5") to intervene in the action. F5 contends that it is the designer, developer, and manufacturer of the product accused of infringing the '554 Patent of Count VI of Nortel's complaint. F5 had also sought to sever and transfer Count VI in favor of an action concerning the '554 Patent pending between F5 and Nortel in the United States District Court for the Western District of Washington, but that motion was denied on July 9, 2001 without opinion. On July 13, 2001, 19 Nortel demanded $150 million in settlement of alleged past damages. Discovery is proceeding. As set forth above, we have denied Nortel's allegations and intend to defend the action vigorously. We cannot assure you, however, that we will prevail in this litigation, which could have a material, adverse effect on our business, financial condition and results of operations in the future. Other than the stated above and the multiple purported securities fraud class action complaints that were filed in the United States District Court for the Southern District of New York beginning on July 6, 2001 (see Note 10 to Consolidated Financial Statements), we are not aware of any pending legal proceedings against us that, individually or in the aggregate, would have a material adverse effect on our business, operating results or financial condition. We may in the future be party to litigation arising in the course of our business, including claims that we allegedly infringe third-party trademarks and other intellectual property rights. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Executive Officers of the Registrant The following table sets forth information regarding the executive officers of Extreme as of August 31, 2000:2001:
Name Age Position ---- --- -------- Gordon L. Stitt.......................................... 44Stitt... 45 President, Chief Executive Officer and Chairman Stephen Haddock.......................................... 42Haddock... 43 Vice President and Chief Technical Officer Herb Schneider........................................... 41Schneider.... 42 Vice President of Engineering Sam Halabi............................................... 35 Vice President of IP Carrier Business Development June Hull................................................ 45 Vice President of Human Resources Allan G. Miller.......................................... 48 Vice President of Manufacturing Operations Vito E. Palermo.......................................... 36Harold L. Covert.. 54 Vice President, Chief Financial Officer and Secretary George Prodan............................................ 47Harry Silverglide. 55 Vice President of Marketing Harry Silverglide........................................ 54Worldwide Sales Darrell Scherbarth 45 Vice President of SalesPresident/General Manager--Access Business Unit
Gordon L. Stitt. Mr. Stitt co-founded Extreme in May 1996 and has served as President, Chief Executive Officer and a director of Extreme since its inception. From 1989 to 1996, Mr. Stitt worked at another company he co-founded, Network Peripherals, a designer and manufacturer of high-speed networking technology. He served first as its Vice President of Marketing, then as Vice President and General Manager of the OEM Business Unit. Mr. Stitt holds an MBA from the Haas School of Business of the University of 14 California, Berkeley and a BSEE/CS from Santa Clara University. Stephen Haddock. Mr. Haddock co-founded Extreme in May 1996 and has served as Vice President and Chief Technical Officer of Extreme since its inception. From 1989 to 1996, Mr. Haddock worked as Chief Engineer at Network Peripherals. Mr. Haddock is a member of IEEE, an editor of the Gigabit Ethernet Standard and Chairman of the IEEE 802.3ad link aggregation committee. Mr. Haddock holds an MSEE and a BSME from Stanford University. Herb Schneider. Mr. Schneider co-founded Extreme in May 1996 and has served as Vice President of Engineering of Extreme since its inception. From 1990 to 1996, Mr. Schneider worked as Engineering Manager at Network Peripherals and was responsible for the development of LAN switches. From 1981 to 1990, Mr. Schneider held various positions at National Semiconductor, a developer and manufacturer of semiconductor products, where he was involved in the development of early Ethernet chipsets and FDDI chipsets. Mr. Schneider holds a BSEE from the University of California, Davis. Sam Halabi.California--Davis. Harold L. Covert. Mr. Halabi has served as Vice President of IP Carrier business development of Extreme since July 2000. Prior to joining Extreme Networks, Mr. Halabi held various marketing positions with leading data communications companies, including Cisco Systems. Mr. Halabi holds a MS in Computer Science from San Jose State University and a BS in Computer Engineering from American University-Beirut. June Hull. Ms. Hull has served as Vice President of Human Resources since September 1999. From October 1996 to August 1999, she served as Regional Director of Human Resources and Corporate Director of Human Resources at Netscape Communications, an e-commerce company. From April 1989 to September 1996, she served in a variety of senior Human Resource management positions for Apple Computer, Inc. Allan G. Miller. Mr. Miller has served as Vice President of Manufacturing Operations of Extreme since July 2000. Prior to joining Extreme Networks, Mr. Miller spent 22 years at Amdahl Corporation. He held several senior management positions in manufacturing operations and quality assurance, the most recentCovert was Vice President of Operations. He holds a MS in Mechanical Engineering and a MBA from the University of California at Berkeley and a BS in Mechanical Engineering from California State University, Northridge. Vito E. Palermo. Mr. Palermo has servedappointed as Vice President, Chief Financial Officer and Secretary of Extreme since January 1999. From January 1997Networks effective August 1, 2001. Prior to January 1999,that Mr. Covert was with Silicon Graphics, Inc. from July 2000 until July 2001 where he served as SeniorPresident and Chief Financial Officer. Before that Mr. Covert was Vice 20 President and Chief Financial Officer and Secretary of Metawave Communications, a wireless communications company. From 1992Red Hat, Inc. from March 2000 until July 2000. Prior to 1996,that Mr. Palermo served in various financial management positions at Bay Networks, a networking communications company, most recently serving asCovert was Executive Vice President and Corporate ControllerChief Financial Officer of Adobe Systems from March 1998 until March 2000. From December 1990 to March 1998, Mr. Covert was a partner in the firm of DHJ & Associates, Inc., Consultants and previously servingCertified Public Accountants and Interim Chief Financial Officer. During the last half of this period he acted in a full time capacity as Director of Technology Finance, Corporateinterim Chief Financial and Planning Manager, and Manufacturing and Customer Service Controller.Officer for several companies. Mr. PalermoCovert holds an MBA from St. Mary'sCleveland State University, a BSBA from Lake Erie College and is a BS in Business Administration from California State University. George Prodan. Mr. Prodan has served as Vice President of Marketing of Extreme since February 1997. From January 1994 to January 1997, he served as Director of Marketing and Senior Director of Worldwide Channels at FORE Systems, a networking equipment company. From April 1991 to December 1993, he served as a product line manager for a division of 3Com, a networking company. He holds an MS in Instructional Communications from Shippensburg State University and a BS in Industrial Arts Education from California State University.Certified Public Accountant. Harry Silverglide. Mr. Silverglide has served as Vice President of Sales of Extreme since January 1997. From May 1995 to January 1997, he served as Vice President of Western Region Sales for Bay Networks. From July 1994 to May 1995, he served as Vice President of Sales for Centillion Networks, a provider of LAN switching products which was acquired by Bay Networks in 1995. From April 1984 to July 1994, he worked in sales and senior sales management positions at Ungermann Bass, a network communications company. 15Darrell Scherbarth. Mr. Scherbarth has served as Vice President/General Manager of the Access Business Unit of Extreme since February 2001. Mr. Scherbarth joined us as a result of our acquisition of Optranet, Inc., which he founded and where he served as president and CEO from November 1999 to January 2001. From April 1997 to September 1998, he was the Vice President of Engineering at Redback Networks, a leading developer and manufacturer of high performance broadband access systems. Mr. Scherbarth was also a co-founder and Vice President of R&D of Network Peripherals Inc., where he served from March 1989 to April 1996. Mr. Scherbarth holds a BSEE from California State University. 21 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The Company'sExtreme's common stock commenced trading on the Nasdaq National Market on April 9, 1999 under the symbol "EXTR." The following table sets forth the high and low closing prices as reported by Nasdaq. Such prices represent prices between dealers, do not include retail mark-ups, mark-downs or commissions and may not represent actual transactions. All prices have been adjusted to reflect a 2-for-1 stock split effected in August 2000.
Stock Prices High Low ---- --------------- ------- ------ 1999 Fourth quarter (1)............................................$ 29.03 $ 19.16 2000Fiscal year ended June 30, 2000: First quarter.................................................quarter................... $ 42.25 $ 22.81$22.81 Second quarter................................................quarter.................. $ 49.03 $ 30.66$30.66 Third quarter.................................................quarter................... $ 59.50 $ 38.00$38.00 Fourth quarter................................................quarter.................. $ 52.75 $21.44 Fiscal year ended June 30, 2001: First quarter................... $120.69 $46.25 Second quarter.................. $123.56 $31.13 Third quarter................... $ 21.4450.38 $14.96 Fourth quarter.................. $ 39.50 $12.27
-------------- (1) Commencing April 9, 1999 At September 14, 2000,August 31, 2001, there were approximately 28475,000 stockholders of record of the Company'sExtreme's common stock and approximately 36,000413 beneficial stockholders. The CompanyExtreme has never declared or paid cash dividends on its capital stock and does not anticipate paying any cash dividends in the foreseeable future. The CompanyExtreme currently intends to retain future earnings for the development of itsour business. Item 6. Selected Consolidated Financial Data.
For the Period from May 8, 1996 (Date of Years Ended June 30, Inception) --------------------------------------------------------- through 2001 2000 1999 1998 June 30, 1997 ---- ---- ---- ---------------------- -------- ------- -------- -------------- (In thousands, except per share amounts) ---------------------------------------- Consolidated Statements of Operations Data: Net revenue...................................................revenue.................................. $ 261,956 $ 98,026491,232 $261,956 $98,026 $ 23,579 $ 256 Gross profit (loss)..................................................................... 210,000 135,040 49,506 8,682 (132) Total operating expenses......................................expenses(1).................. 311,893 118,786 50,951 22,709 7,928 Operating income (loss)............................................................. (101,893) 16,254 (1,445) (14,027) (8,060) Net income (loss)......................................................................... (68,883) 20,048 (1,617) (13,936) (7,923) Basic netNet income (loss) per share (1).........................share--basic(2)........ $ (0.64) $ 0.20 $ (0.09) $ (1.59) $ (2.26) Diluted netNet income (loss) per share (1).......................share--diluted(2)...... $ (0.64) $ 0.18 $ (0.09) $ (1.59) $ (2.26) Weighted average shares outstandingShares used in computing basic net income (loss) per share (1)...........calculation--basic.. 108,353 100,516 18,924 8,758 3,516 Weighted average shares outstandingShares used in computing diluted net income (loss) per share (1).........calculation--diluted 108,353 111,168 18,924 8,758 3,516
1622
As of June 30, ----------------------------------------------------------------------------- 2001 2000 1999 1998 ---- ---- ----1997 -------- -------- -------- ------- ------- (In thousands) Consolidated Balance Sheets DataData: Cash and cash equivalents.....................................equivalents............................. $ 87,722 $116,721 $107,143 $ 9,510 $10,047 Short-term investments........................................investments................................ 69,374 66,640 16,422 10,995 -- Working capital...............................................capital....................................... 211,432 205,881 119,039 13,796 8,251 Total assets..................................................assets.......................................... 688,357 515,930 171,803 33,731 11,942 Long-term debt, deposit and capital lease obligations, net of current portion..........................portion.............................. 266 306 -- 2,634 502 Total stockholders' equity....................................equity............................ $548,762 $419,021 $141,876 $15,869 $ 15,8699,305
-------------------------- (1)Fiscal 2001 amount includes $37.5 million in amortization of goodwill, purchased intangible assets and deferred stock compensation, write-offs of $30.2 million of acquired in-process research and development and $5.9 million in restructuring charges. Fiscal 2000 amount includes $6.8 million in amortization of goodwill and purchased intangible assets. (2)Share and per share data have been restated to give retroactive effect to a two-for-one stock split in the form of a stock dividend effected in August 2000. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. When usedResults of Operations Net Revenue Net revenue increased from $262.0 million in this discussion and elsewherefiscal 2000 to $491.2 million in this Form 10-K, the words "may," "should," "believes," "expects," "anticipates," "estimates" and similar expressions identify forward-looking statements. Such statements, which include statements concerning the availability and functionalityfiscal 2001, an increase of products under development, product mix, pricing trends, the mix87.5%. The increase in net revenue for fiscal 2001 resulted primarily from higher volume of export sales sales to significant customers and the availability and cost of products from the Company's suppliers, are subject to risks and uncertainties, including those set forth below under "Factors That May Affect Our Results." Our actual results could differ materially from those anticipated in these forward-looking statements which could have a material adverse effect on our business, operating results and financial condition. These forward-looking statements speak only as of the date hereof and there may be events in the future that we are not able to predict accurately or over which we have no control which would affect or alter our expectations. Overview From our inception in May 1996 through September 1997, our operating activities related primarily to developing a research and development organization, testing prototype designs, building an ASIC design infrastructure, commencing the staffing of our marketing, salesSummit, BlackDiamond and field service and technical support organizations, and establishing relationships with resellers and OEMs. We commenced volume shipmentsAlpine products due to an increase in market acceptance of our Summit1 and Summit2, the initial products, which was partially offset by some price reductions. Net revenue increased from $98.0 million in fiscal 1999 to $262.0 million in fiscal 2000, an increase of 167.2%. The increase in net revenue for fiscal 2000 resulted primarily from increased sales of our Summit stackable product family, in October 1997,products and we began shipping our BlackDiamond modular products, the market's growing acceptance of Extreme's existing and new product familyofferings, and a significant increase in September 1998. We introduced our new Alpine product familysales and marketing organizations. Sales outside of North America accounted for 55%, 43% and 52% of net revenue in fiscal 2001, fiscal 2000 and fiscal 1999, respectively. We expect that export sales will continue to represent a significant portion of net revenue, although we do not know whether export sales as a percentage of net revenue will remain at current levels. All sales transactions are currently denominated in U.S. dollars. We generally recognize product revenue at the time of shipment, assuming that collectibility is probable, unless we have future obligations such as installation or are required to obtain customer acceptance, in which case revenue and related costs are deferred until those obligations are met. We defer recognition of revenue on sales to distributors until the distributors sell the product. Revenue from service obligations under maintenance contracts, is deferred and recognized on a straight-line basis over the contractual period, which is typically 12 months. Amounts billed in excess of revenue recognized are included as deferred revenue, accounts receivable and current assets in the accompanying consolidated balance sheets of our financial statements. On a prospective basis as of July 2, 2001 we will report deferred revenue and accounts receivable on a net basis in the consolidated balance sheets. The increase in deferred revenue from fiscal 2000 to fiscal 2001 of $35.3 million was due to the increase in inventory held by distributors, deferred service revenue and other allowances for customer acceptance. Our products generally carry a one year warranty that includes factory repair services as needed for replacement parts. Estimated expenses for warranty obligations are accrued as revenue is recognized based on our best estimate of warranty costs for delivered products. 23 We have experienced a new generation chip set. In addition,rapid and increasingly severe downturn in the economy. This has adversely affected our product demand and made it increasingly difficult to accurately forecast future production requirements. We expect this economic downturn to continue for at least the remainder of calendar year 2001 and we also introduced newdo not know the extent, severity or length of this economic downturn in the United States or in the other geographic regions where we currently sell our products. We expect to experience some erosion of average selling prices of our products within our existing product lines that incorporate this new chip set.due to a number of factors, including competitive pricing pressures, promotional pricing and rapid technological change. Our revenue is derived primarily from sales of our Summit, BlackDiamond and BlackDiamond product familiesAlpine products and fees for services relating to our products, including maintenance and training. The level of sales to any customer may vary from period to period; however, we expect that significant customer concentration will continue for the foreseeable future. See "Factors That May Affect Our Results--If"Risk Factors--If a Key Reseller, OEMDistributor or Other Significant Customer Cancels or Delays a Large Purchase, Extreme's RevenuesOur Net Revenue May Decline and the Price of ItsOur Stock May Fall." ForOne customer accounted for 16% of our net revenue in fiscal 2001; no customer accounted for more than 10% of our net revenue in fiscal 2000 there were noand two customers with sales greater than 10%. For fiscal 1999, Compaq and Hitachi Cable accounted for 21% and 13%13 % of our net revenue respectively. We marketin fiscal 1999. Gross Profit Gross profit increased from $135.0 million in fiscal 2000 to $210.0 million in fiscal 2001, an increase of 55.5%, primarily due to the related increase in revenue. Gross margins decreased from 51.6% in fiscal 2000 to 42.7% in fiscal 2001. The decrease in gross margin in fiscal 2001 was primarily due to a $40.3 million charge for excess and sellobsolete inventory and non-cancelable purchase commitments. Gross profit increased from $49.5 million in fiscal 1999 to $135.0 million in fiscal 2000, an increase of 172.7%, primarily due to the related increase in revenue. Gross margins increased from 50.5% in fiscal 1999 to 51.6% in fiscal 2000. The increase in gross margin resulted primarily from a shift in product mix, a shift in our products primarily throughchannel mix from OEMs to resellers and distributors and to a lesser extent, OEMs and our field sales organization. We sell our products through more than 250 resellersimproved manufacturing efficiencies, this increase was offset in 50 countries. In fiscal 2000, sales to customers outside of North America accounted for approximately 45% of our net revenue. Currently, all of our international sales are denominated in U.S. dollars. We generally recognize product revenue at the time of shipment, unless we have future obligations for installation or have to obtain customer acceptance, in which case revenue is deferred until such obligations have been satisfied. We have established a program which, under specified conditions, enables third party resellers to return products to us. The amount of potential product returns is estimated and provided for in the period of the sale. Service revenue is recognized ratably over the term of the contract period, which is typically 12 months. We expect to experience rapid erosion ofpart by lower average selling prices due primarily to increased competition. We recorded a provision for excess and obsolete inventory, including non-cancelable purchase commitments, totaling $40.3 million in the third quarter of fiscal 2001. Inventory purchases and commitments are based upon our forecast of future sales. To mitigate the component supply constraints that have existed in the past, we built inventory levels for certain components with long lead times and entered into longer-term commitments for certain components. Due to a sudden and significant decrease in demand for our products that became apparent in the third quarter of fiscal 2001, inventory levels, including non cancelable purchase commitments, exceeded our requirements based on our forecast of expected demand. This additional excess inventory charge was calculated based on the inventory levels in excess of our products dueforecast of expected demand for each specific product. We do not currently anticipate that the excess inventory subject to this provision will be used at a number of factors, including competitive 17 pricing pressures, promotional pricing and rapid technological change.later date based on our future demand forecast. Furthermore, we may be required to take additional write-downs in the future related to excess inventory. Our gross margins will be affected by such declinesmargin is highly variable and by fluctuationsdependent on many factors, some of which are outside of our control. Some of the primary factors affecting gross margin include demand for our products, changes in manufacturing volumes, component costsour pricing policies and those of our competitors and the mix of product configurationsproducts sold. Our gross margins may be adversely affected by increases in material or labor costs, heightened price competition, obsolescence charges and higher inventory balances. In addition, our gross margins may fluctuate due to the mix of distribution channels through which our products are sold, including the potential effects of our development of a two-tier distribution channel. We generally realize higher gross margins on sales to resellers and distributors than on sales through our OEMs. Any significant decline in sales to our OEMsresellers, distributors or resellers or distributors,end-user customers, or the loss of any of our OEMsresellers, distributors or resellers or distributorsend-user customers, could materially adversely affecthave a material adverse effect on our business, operating results and financial condition. In addition, newincreasing third-party and indirect distribution channels generally result in greater difficulty in forecasting the mix of our products, and to a certain degree, the timing of orders from our customers. New product introductions may result increate excess or obsolete inventories. Any excess or obsolete inventories, which may also reduce our gross margins. Furthermore, if product or related warranty costs associated with these new products are greater than we have experienced, gross margin may be adversely affected. 24 Cost of revenue includes the cost of our manufacturing overhead. We outsource the majority of our manufacturing and supply chain management operations, and we conduct quality assurance, manufacturing engineering, documentation control and repairs at our facility in Santa Clara, California. Accordingly, a significant portion of our cost of revenue consists of payments to our contract manufacturers,manufacturers: Flextronics International, MCMS and Solectron. See "Risk Factors--We May Need to Expand Our Manufacturing Capacity and We Depend on Contract Manufacturers for Substantially All of Our Manufacturing Requirements". As part of our business relationship with MCMS, we have entered into a $9.0 million equipment lease for manufacturing equipment with a third party financing company; we in turn sublease the equipment to MCMS. On September 18, 2001 MCMS announced that it had reached an agreement to sell substantially all of its operating assets to Manufacturers' Services Limited. Simultaneously, MCMS announced that it, and its two U.S. subsidiaries, have voluntarily filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware in Wilmington to implement the sale. We expect to realize lower per unit product costs as a result of volume efficiencies.efficiencies if and as volumes increase. However, we cannot assure youdo not know if or when or if such price reductions will occur. The failure to obtain such price reductions could materially adversely affecthave a material adverse effect upon our gross margins and operating results. Research and Development Expenses Research and development expenses consist principallyincreased from $33.0 million in fiscal 2000 to $57.9 million in fiscal 2001, an increase of salaries75.4%. The increase was primarily due to higher payroll and related personnel expenses consultant fees and prototype expenses relateddue to the design,addition of new personnel, partly through acquisitions, to support our multiple product development testingefforts as well as non-recurring engineering charges, prototype costs and enhancementdepreciation expense. Research and development expenses, as a percentage of net revenue, decreased to 11.8% in fiscal 2001, compared with 12.6% in fiscal 2000. The percentage decrease was primarily the result of an increase in our products.net revenue. We expense all research and development expenses as incurred. We believe that continued investment in research and development is critical to attaining our strategic objectives and, as a result, we expect these expenses to increase in absolute dollars in the future. Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing, sales and field service support functions, as well as trade shows and promotional expenses. We intend to pursue sales and marketing campaigns aggressively and therefore expect these expenses to increase significantly in absolute dollars in the future. In addition, we recently hired approximately 200 sales and marketing personnel. We expect to continue to expand our field sales operations to support and develop leads for our resellers and distributors, which will also result in an increase in sales and marketing expenses. General and administrative expenses consist primarily of salaries and related expenses for executive, finance and administrative personnel, professional fees and other general corporate expenses. We expect general and administrative expenses to increase in absolute dollars as we add personnel, increase spending on our information systems and incur additional costs related to the anticipated growth of our business and operation as a public company. During fiscal 1998, in connection with the grant of certain stock options to employees, we recorded deferred stock compensation of $437,000 representing the difference between the exercise price and the deemed fair value of our common stock on the date such stock options were granted. Such amount is included as a reduction of stockholders' equity and is being amortized by charges to operations on a graded vesting method. We recorded amortization of deferred stock compensation expense of approximately $119,000, $172,000 and $68,000 for the years ended June 30, 2000, 1999 and 1998, respectively. At June 30, 2000, we had a total of approximately $78,000 remaining to be amortized over the corresponding vesting period of each respective option, generally four years. The amortization expense relates to options awarded to employees in all operating expense categories. Despite growing revenues in all fiscal years since our inception, fiscal 2000 was the first year we have achieved profitability in each of the four quarters. Our net income has not increased proportionately with the increase in our revenue primarily because of increased expenses relating to our growth in operations and in particular the recent accelerated hiring of sales and marketing personnel. Because of the lengthy sales cycle of our products, there is often a significant delay between the time we incur expenses and the time we realize any related revenue. See "Factors That May Affect Our Results--The Sales Cycle for Extreme's Products is Long and Extreme May Incur Substantial Non-Recoverable Expenses or Devote Significant Resources to Sales that Do Not Occur When Anticipated." To the extent that future revenues do not increase significantly in the same periods in which operating expenses increase, our operating results would be adversely affected. See "Factors That May Affect Our Results--A Number of Factors Could Cause Extreme's Quarterly Financial Results to Be Worse Than Expected, Resulting in a Decline in Its Stock Price." Due to the Company's issuance of warrants to a networking company as discussed in Note 3, future operating income will be reduced by $7.1 million per quarter for each quarter in fiscal 2001 and for three of the four fiscal quarters in fiscal 2002. Notwithstanding this charge the Company still anticipates being profitable in the first quarter of fiscal 2001. Results of Operations 18 The following table sets forth for the years indicated certain financial data as a percentage of net revenue:
Years ended June 30, --------------------------------- 2000 1999 1998 ---- ---- ---- Net revenue............................ 100.0% 100.0% 100.0% Cost of revenue........................ 48.5 49.5 63.2 ----- ----- ----- Gross profit .......................... 51.5 50.5 36.8 Operating expenses: Research and development............. 12.6 17.4 45.2 Sales and marketing.................. 25.6 27.6 40.7 General and administrative........... 4.5 7.0 10.4 Amortization of goodwill and purchased intangibles 2.6 -- -- ----- ----- ------ Total operating expenses..... 45.3 52.0 96.3 ----- ----- ------ Operating income (loss)................ 6.2 (1.5) (59.5) Interest income........................ 5.6 1.9 2.6 Interest expense....................... (.2) (.4) (1.4) Other income (loss), net............... -- -- (.8) ----- ----- ------ Income (loss) before income taxes...... 11.6 .0 (59.1) Provision for income taxes............. 3.9 1.7 -- ----- ----- ------ Net income (loss)...................... 7.7% (1.7)% (59.1)% ===== ===== ======
Net Revenue Net revenue increased from $98.0 million in fiscal 1999 to $262.0 million in fiscal 2000, an increase of $164.0 million. The increase in net revenue for fiscal 2000 resulted primarily from increased sales of our Summit stackable products and our BlackDiamond modular product family, the market's growing acceptance of Extreme's existing and new product offerings, and a significant increase in our sales and marketing organizations. Net revenue increased from $23.6 million in fiscal 1998 to $98.0 million in fiscal 1999, an increase of $74.4 million. The increase in net revenue for fiscal 1999 resulted primarily from increased sales of our Summit stackable products and the introduction of our BlackDiamond modular product family in September 1998. Export sales accounted for 45% and 53% of net revenue in fiscal 2000 and fiscal 1999, respectively. We expect that export sales will continue to represent a significant portion of net revenue, although we cannot assure you that export sales as a percentage of net revenue will remain at current levels. All sales transactions are denominated in U.S. dollars. Gross Profit Gross profit increased from $49.5 million in fiscal 1999 to $135.0 million in fiscal 2000, an increase of $85.5 million, primarily due to the related increase in revenue. Gross margins increased from 50.5% in fiscal 1999 to 51.5% in fiscal 2000. The increase in gross margin resulted primarily from a shift in product mix, a shift in our channel mix from OEMs to resellers and distributors and improved manufacturing efficiencies, offset in part by lower average selling prices due primarily to increased competition. Gross profit increased from $8.7 million in fiscal 1998 to $49.5 million in fiscal 1999, an increase of $40.8 million. Gross margins increased from 36.8% in fiscal 1998 to 50.5% in fiscal 1999. The increase in gross margin resulted primarily from reductions in component costs, improved manufacturing efficiencies and a shift in our channel mix from OEMs to resellers, which were offset in part by lower average selling prices due to increased competition. Research and Development Expenses Research and development expenses increased from $17.0 million in fiscal 1999 to $33.0 million in fiscal 2000, an increase of $16.0 million.93.7%. The increase was primarily due to nonrecurring engineering and initial product verification expenses and increased salarieshigher payroll and related personnel expenses due to the hiring of additional engineers. ForFrom fiscal 1999 andto fiscal 2000, research and development expenses decreased as a percentage of net revenue from 17.4% to 12.6%. This percentage decrease was primarily the result of an increase in our net revenue. 19 Research and development expenses increased from $10.7 million in fiscal 1998 to $17.0 million in fiscal 1999, an increase of $6.3 million. The increase was primarily due to nonrecurring engineering and initial product verification expenses, the hiring of additional engineers and an increase in depreciation charges due to increases in capital spending on design and simulation software and test equipment. For fiscal 1998 and fiscal 1999, research and development expenses decreased as a percentage of net revenue from 45.2% to 17.4%. This percentage decrease was primarily the result of an increase in our net revenue. Sales and Marketing Expenses Sales and marketing expenses increased from $27.1 million in fiscal 1999 to $67.1 million in fiscal 2000 to $154.6 million in fiscal 2001, an increase of $40.0 million.130.2%. Sales and marketing expenses, as a percentage of net revenue, increased to 31.5% in fiscal 2001, compared with 25.6% in fiscal 2000. This increase was primarily due to the hiring of additional sales, marketing and customer support personnel, increased sales commission expenses resulting from increased revenues,net revenue and increased promotional expenses. The rate of future spending increases, if any, will be dependent on the speed with which the market recovers. Sales and marketing expenses increased from $27.1 million in fiscal 1999 to $67.1 million in fiscal 2000, an increase of 148.2%. This increase was primarily due to the hiring of additional sales, marketing and customer support personnel, increased sales commission expenses resulting from increased net revenue, increased tradeshow and promotional expenses and the establishment of new sales offices. ForFrom fiscal 1999 andto fiscal 2000, sales and marketing expenses decreased as a percentage of net revenue from 27.6% to 25.6%. This percentage decrease was primarily the result of an increase in our net revenue. We intend to pursue sales25 General and marketing campaigns aggressivelyAdministrative Expenses General and therefore expect these expenses to increase significantly in absolute dollars in the future. In addition, we recently hired approximately 200 sales and marketing personnel. We expect to continue to expand our field sales operations to support and develop leads for our resellers and distributors, which will also result in an increase in sales and marketing expenses. Sales and marketingadministrative expenses increased from $9.6$11.9 million in fiscal 19982000 to $27.1$25.8 million in fiscal 1999,2001, an increase of $17.5 million. This increase was primarily due to the hiring of additional sales116.8%. General and customer support personnel, tradeshow and promotionaladministrative expenses, increased commission expenses resulting from higher sales, and the establishment of new sales offices. For fiscal 1998 and fiscal 1999, sales and marketing expenses decreased as a percentage of net revenue, from 40.7%increased to 27.6%.5.2% in fiscal 2001, compared with 4.5% in fiscal 2000. This percentage decreaseincrease was due primarily the result ofto an increase in our net revenue. Generalbad debt expense, the hiring of additional finance, information technology, legal and Administrative Expensesadministrative personnel and increased professional fees. The rate of any future spending increases if any will be dependent on the speed with which the market recovers. General and administrative expenses increased from $6.9 million in fiscal 1999 to $11.9 million in fiscal 2000, an increase of $5.0 million.72.8%. This increase was due primarily to the hiring of additional finance, information technology, legal and administrative personnel and increased professional fees and occupancy costs. ForFrom fiscal 1999 andto fiscal 2000, general and administrative expenses decreased as a percentage of net revenue from 7.0% to 4.5%. This percentage decrease was primarily the result of an increase in our net revenue. GeneralAmortization of Goodwill, Purchased Intangible Assets and administrative expensesDeferred Stock Compensation Amortization of goodwill, purchased intangible assets and deferred stock compensation increased from $2.4$6.8 million in fiscal 19982000 to $6.9$37.5 million in fiscal 1999,2001, an increase of $4.5$30.7 million. This increase was due primarilyIn fiscal 2001, amortization of goodwill arising from warrants issued in April 2000 increased by $20.4 million to $27.2 million and amortization of goodwill, purchased intangible assets and deferred stock compensation related to the hiringOptranet and Webstacks acquisitions was $9.6 million (see Note 3 of additional finance, information technologyNotes to Consolidated Financial Statements). Anticipated amortization of goodwill, intangibles and legal and administrative personnel, recruiting expenses, professional fees and increased spending on information systems. Fordeferred compensation for fiscal 1998 and fiscal 1999, general and administrative expenses decreased as a percentage of net revenue from 10.4% to 7.0%. This percentage decrease was primarily the result of an increase in our net revenue.2002, assuming no more acquisitions, will be $53.3 million. Amortization of Goodwillpurchased intangible assets and Purchased Intangiblesdeferred stock compensation may continue to increase if we acquire companies and technologies. Amortization of goodwill will not increase in future periods because under Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," any goodwill arising from business combinations closing after June 30, 2001 is not amortized, but rather is periodically evaluated for impairment. See "New Accounting Pronouncements." Amortization of goodwill, purchased intangiblesintangible assets and deferred stock compensation was $7.1$6.8 million in fiscal 2000. This amount was due to the Company'sour issuance in April 2000 of fully earned, non-forfeitable, fully exercisable warrants with a two year life to purchase 3 million3,000,000 shares of the Company'sour common stock with an exercise price of $39.50 per share (see Note 3 of Notes to Consolidated Financial Statements). Other Operating Expense In fiscal 2001, other operating expense included a write-off of acquired in-process research and development of $30.2 million and a restructuring charge of $5.9 million, as described below. We recorded non-recurring charges of $13.4 million related to the purchase of Optranet in January 2001, and $16.8 million related to the purchase of Webstacks in March 2001. The value assigned to purchased in-process research and development was determined through valuation techniques generally used by appraisers in the high-technology industry and was immediately expensed in the period of acquisition because technological feasibility had not been established and no alternative use had been identified. The charges are discussed in more detail in Note 3 of notesNotes to Consolidated Financial Statements. In March 2001, we implemented a restructuring plan in order to lower our overall cost structure. In connection with the restructuring, we reduced our headcount and consolidated financial statements. Futurefacilities. Restructuring charges included in other operating expenses were $3.8 million in the quarter ended March 31, 2001 and $2.1 million in the quarter ended June 30, 2001. The restructuring expense included $1.8 million for severance and benefits for terminated employees, $2.3 million for the write-off and write-down in carrying value of Summit based equipment and $1.8 million in facility closure expenses. 26 Interest Income Interest income will be reduced by approximately $7.1increased from $14.6 million per quarter for each quarterin fiscal 2000 to $15.5 million in fiscal 2001, and for three fiscal quarters in fiscal 2002. Interest Incomean increase of $0.9 million. Interest income increased from $1.9 million in fiscal 1999 to $14.6 million in fiscal 2000, an increase of $12.7 million. The increase isincreases were due to the increased amount of cash and cash equivalents, short-term investments, restricted investments and long-term investments from the proceeds we received from our initial public offering in April 1999 and our secondary public offering in October 1999. InterestOther Income (Expense), net Other income (expense), net increased from $.6$33,000 in expense in fiscal 2000 to $4.7 million in fiscal 1998 to $1.9 millionexpense in fiscal 1999, an2001. This increase was primarily attributable to Extreme's share of $1.3affiliates' losses accounted for under the equity method of accounting of $2.9 million and write-downs of investments accounted for under the cost method of accounting of $1.8 million. The increase 20 is due to the increased amount of cash and cash equivalents, short-term investments and long-term investments from the proceeds we received from our initial public offering in April 1999. Income Taxes We recorded a tax provisionbenefit of $10.3$22.7 million for the year ended June 30, 2000.fiscal 2001. The provisionbenefit for fiscal 20002001 results in an effective tax benefit rate of 34%24.8% which consists primarily of federal taxes,and state income taxes andtax benefits, offset by foreign taxes, offset by the recognition of deferred tax assets.nondeductible in-process research and development and goodwill. FASB Statement No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. We intend to evaluate the realizability of the deferred tax assets on a quarterly basis. We incurred significant operating lossesrecorded a tax provision of $10.3 million for all fiscal years from inception through June 30, 1999.2000, which consisted primarily of federal taxes, state income taxes and foreign taxes, offset by the recognition of deferred tax assets. We recorded a tax provision of $1.7 million for the year ended June 30,fiscal 1999, which consisted primarily of foreign taxes currently payable, federal alternative minimum taxes and state incomeminimum and capital taxes. Liquidity and Capital Resources Cash and cash equivalents and short-term investments increaseddecreased from $123.6 million at June 30, 1999 to $183.4 million at June 30, 2000 an increaseto $157.1 million at June 30, 2001, a decrease of $59.8$26.3 million. The increaseThis decrease is primarily a result of our secondary public offering of common stock in October 1999, which generated net proceeds of $174.0 million, primarily offset bydue to an increase in long-term investmentsinventory, purchases of property and restricted investments of $108.0 million. Cash provided by operating activities was $24.8 million in fiscal 2000, as compared to cash provided by operating activities of $2.8 million in fiscal 1999. The increase was primarily due to net income, depreciation, amortizationequipment and increases in accounts payable, deferred revenue and accrued liabilities, offset by increases in accounts receivable inventories and other current and noncurrent assets.assets, partially offset by increases in deferred revenue and proceeds from issuance of common stock. Accounts receivable increased 24.2% from June 30, 2000 to June 30, 2001. The increase in accounts receivable was due to growth in net revenue. We expect that accounts receivable will continue to increase to the extent our revenues continuenet revenue continues to rise. Inventory levels increased 154.3% from June 30, 2000 to June 30, 2001. We expect ourhave increased inventory levelsin order to increase in connection with our development of a two-tiersupport revenue growth, develop distribution system, new product introductions and the need tochannels, maintain shorter lead times on certain products. Any such increase can be expectedprojects and to reduce cash, cash equivalents, short-term investments and long-term investments. Investing activities used cash of $195.0 million in fiscal 2000 dueprovide assurance to capital expenditures of $27.2 million, net purchases of investments of $158.8 million and minority investments of $9.0 million. Our investing activities used cash of $29.1 million in fiscal 1999 for net purchases of investments of $21.6 million and capital expenditures of $7.5 million. Our investing activities used cash of $13.5 million in fiscal 1998 for capital expenditures of $2.5 million and net purchases of investments of $11.0 million. We expect capital expenditures of approximately $30.0 million in fiscal 2001. Under the terms of a certain equity investment, upon the attainment of certain technological milestones,our customers that we will be obligatedable to purchase allmeet demand. Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times and avoid stock-outs with the risk of inventory excess or obsolescence because of recent declining demand, rapidly changing technology and customer requirements. As a result of the outstanding capital stockrapid change in fiscal 2001, payable in any combination of cash or shares of Extreme common stock. Financing activities provided cash of $179.7the market for networking products, we recorded $40.3 million in fiscal 2000, arising primarily from proceeds fromcharges for excess and obsolete inventory and non-cancelable purchase commitments in the issuance of common stock in conjunction with our secondary public offering, partially offset by payments of capital lease obligations. Financing activities provided cash of $124.0 million in fiscal 1999, arising primarily from proceeds from the issuance of common stock in conjunction with our initial public offering, partially offset by principal payments on notes payable and capital lease obligations. Financing activities provided cash of $21.2 million in fiscal 1998, primarily from the issuance of convertible preferred stock and proceeds from notes payable, partially offset by principal payments on notes payable and capital lease obligations.quarter ended March 31, 2001. In June 2000, we entered into antwo operating lease agreement to leaseagreements for approximately 16 acres of land and the accompanying 275,000 square feet of buildings to house our primary facility in Santa Clara, California. Our lease payments will vary based on the LIBOR plus a spread which was 7.14%4.3% at June 30, 2000.2001, plus a spread. Our combined lease payments for this facility are estimated to be approximately $5.7$3.4 million on an annual basis over the lease term.terms. The lease isleases are for five years and can be renewed for two five-year periods, subject to the approval of the lessor. At the expiration or termination of the lease,leases, we have the option to either purchase the propertythese properties for $80.0$31.4 million and $48.6 million, respectively, or arrange for the sale of the propertyproperties to a third party for at least $80.0$31.4 million and $48.6 million, respectively, with a contingent liability for any deficiency. If the property isproperties under these leases are not purchased or sold as described above, we will be obligated for an additional lease paymentpayments of approximately $68.0 million.$30.5 million and $41.3 million, respectively. 27 As part of the above lease transaction, the Companytransactions, we restricted $80.0 million of itsour investment securities as collateral for specified obligations ofas the lessee under the lease.lessee. These investment securities are restricted as to withdrawal and are managed by a third party subject to certain limitations under the Company'sour investment policy. The lease also requires us to maintain specified financial covenants with which we were in compliance as of June 30, 2000.2001. Under the terms of the Merger Agreement with Webstacks, Extreme is obligated to pay $15.0 million of additional cash consideration on or before October 31, 2001 provided that certain technology milestones are met. At this time it is our expectation that these milestones will be met and the payment made. We require substantial capital to fund our business, particularly to finance inventories and accounts receivable and for capital expenditures. As a result, we could be required to raise substantial additional capital. To the extent that we raise additional capital 21 through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution to existing stockholders. If additional funds are raised through the issuance of debt securities, these securities may have rights, preferences and privileges senior to holders of common stock and the terms of such debt could impose restrictions on our operations. We cannot assure you that such additional capital, if required, will be available on acceptable terms, or at all. If we are unable to obtain such additional capital, we may be required to reduce the scope of our planned product development and marketing efforts, which would materially adversely affect our business, financial condition and operating results. We believe that our current cash and cash equivalents, short-term investments, long-term investments and cash available from credit facilities and future operations will enable us to meet our working capital requirements for at least the next 12 months. New Accounting Pronouncements In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 establishes methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", which extended the deferral of the application of FAS 133 to all fiscal quarters of fiscal years beginning after June 15, 2000. In June 15, 2000 the FASB also issued FAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities) an Amendment to FASB Statement No. 133". FAS 138 amends the accounting and reporting standards of Statement 133 for certain derivative instruments and certain hedging activities. The Company will be required to adopt these pronouncements for the year ending June 30, 2001. Because the Company currently holds no derivative financial instruments and does not currently engage in hedging activities, adoption of FAS 133 and 138 are expected to have no material impact on the Company's financial condition or results of operations. In December 1999, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 101.101 "Revenue Recognition in Financial Statements", which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. Extreme adopted SAB 101 in the fourth quarter of fiscal 2001. The implementationadoption of SAB 101 has recently been deferred to no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. The Company is presently evaluating the potential impact of the adoption of SAB 101.did not have a material effect on our operations or financial position. In MarchSeptember 2000, the FASB issued Financial Accounting Standards Board Interpretationissued SFAS No. 44,140, "Accounting for Certain Transactions involving Stock Compensation -Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--a replacement of FASB Statement No. 125" ("SFAS 140"). SFAS 140 revises certain standards for accounting for securitization and other transfers of financial assets and collateral. In addition, SFAS No. 140 requires certain additional disclosures that were not previously required. The additional disclosure requirements were effective for financial statements for fiscal years ending after December 15, 2000 and have been adopted for the year ended June 30, 2001. The revised accounting standards of SFAS 140 are effective for transactions occurring after March 31, 2001. The application of the revised accounting standards of SFAS 140 has not had a material adverse effect on our business, results of operations or financial condition. In July 2001, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" ("FAS 141"). FAS 141 establishes new standards for accounting and reporting for business combinations and requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. We will adopt this statement in fiscal 2002. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"), which establishes new standards for goodwill and other intangible assets. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually for impairment. Separable intangible assets that are not deemed to have an interpretationindefinite life will continue to be amortized over their useful lives. The amortization provisions of APB OpinionSFAS No. 25" (Interpretation No. 44). Interpretation No. 44 is effective142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2000. The interpretation clarifies2001, we will apply the application of APB Opinionnew accounting 28 rules beginning fiscal year 2003. We are currently assessing the financial impact SFAS No. 25 for certain issues, specifically, (a) the definition of an employee, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications142 will have on our Consolidated Financial Statements. Goodwill and intangible assets from business combinations before July 1, 2001 will continue to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange or stock compensation awards in a business combination. We do not anticipate thatbe amortized prior to the adoption of Interpretation No. 44FAS 142. Upon the adoption of FAS 142, we are required to evaluate our existing goodwill and intangible assets from business combinations completed before July 1, 2001 and make any necessary reclassifications in order to comply with the new criteria in FAS 141 for recognition of intangible assets. At June 30, 2001, we had goodwill and intangible assets of $113.9 million. Amortization expense for goodwill and intangible assets amounted to $33.4 million for fiscal 2001. Anticipated amortization of goodwill and intangible assets for fiscal 2002 assuming no more acquisitions will have a material impact on our financial position or the results of our operations.be $43.1 million. Risk Factors That May Affect Our Results Extreme HasWe Have a Limited History of Profitability, We Are Not Currently Profitable and We Cannot Assure You that itThat We Will ContinueReturn to Achieve Profitability Although our revenue has grown in recent quarters, we cannot be certain that we will realize sufficient revenue to achieve continued profitability on a fiscal year basis.the Future Fiscal 2000 was the first year in which Extreme achieved profitability in each of the four quarters. We reported a loss for each of the quarters ended March 31, 2001 and June 30, 2001, and for the fiscal year ended June 30, 2001. In the foreseeable future, we anticipate continuing to incur significant sales and marketing, product development and general and administrative expenses and, as a result, we will need to generate and sustain significantly higher revenue to return to and sustain profitability. In particular, our recent hiring of approximately 200 sales and marketing personnel has substantially increased expenses. We expect that the hiring of such personnel will allow us to increase sales, however, we can not assure you that this will occur and we cannot assure you that operating margins will not be adversely affected by this or other hiring. In addition, the amortization of purchased goodwill and intangibles, and goodwill is estimated to be approximately $27.7 million and $21.0 milliondeferred compensation associated with acquisitions, will result in fiscal 2001 and 2002, respectively.material charges that will reduce our profitability. Further, the impact of the current economic slowdown could result in additional one-time charges. A Number of Factors Could Cause Extreme'sOur Quarterly Financial Results to Be Worse Than Expected, Resulting in a Decline in ItsOur Stock Price We plan to significantly increase our operating expenses to expand our sales and marketing activities, broaden our customer 22 support capabilities, develop new distribution channels, fund increased levels of research and development, and buildexpand our operational infrastructure. We base our operating expenses on anticipated revenue trends, and a high percentage of our expenses are fixed in the short term. As a result, any delay in generating or recognizing revenue, as occurred in the quarter ended March 31, 2001, could cause our quarterly operating results to befall below the expectations 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 because offor a number of reasons. Orders at the beginning of each quarter typically do not equal expected revenue for that quarter and are generally cancelable at any time. Accordingly, we are dependent upon obtaining orders induring a quarter for shipment in that quarter to achieve our revenue objectives. In addition, the timing of product releases, purchase orders and product availability could result in significanta majority of our product shipments atto be scheduled for the end of a quarter. Failure to ship these products by the end of a quarter may adversely affect our operating results. Furthermore, ourOur customer agreements typically provide that the customer maygenerally allow customers to delay scheduled delivery dates andor to cancel orders within specified time framestimeframes without significant penalty.charges to the customers. Furthermore, some of our customer agreements include acceptance provisions that delay our ability to recognize revenue upon shipment. Our quarterly revenue and operating results have varied significantly in the past and may vary significantly in the future due to a number of factors, including:including, but not limited to, the following: . changes in general and/or specific economic conditions in the networking industry; . seasonal fluctuations in demand for our products and services, including seasonality, particularly in Asia and Europe; . our ability to accurately forecast demand for our products, which in the case of lower-than-expected sales may result in excess and/or obsolete inventory on hand or under non cancelable purchase commitments; 29 . unexpected product returns or the cancellation or rescheduling of significant orders; . our ability to develop, introduce, ship and support new products and product enhancements and manage product transitions; . announcements and new product introductions by our competitors; . our ability to develop and support customer relationships with enterprise customers, service providers and other potential large customers; . our ability to achieve requiredtargeted cost reductions; . our ability to obtain sufficient supplies of sole or limited sourcedlimited-source components for our products;products on a timely basis; . unfavorable changesincreases in the prices of the components that we purchase; . decreases in the prices of the products that we sell; . our ability to attainachieve and maintain desired production volumes and quality levels for our products; . the mix of products sold and the mix of distribution channels through which theyproducts are sold; and . costs relating to possible acquisitions and the integration of technologies or businesses.businesses; and . the affecteffect of amortization of goodwill, deferred compensation, and purchased intangibles resulting from existing or new transactions. Due to the foregoing factors, we believe that period-to-period comparisons of our operating results should not be relied upon as an indicator of our future performance. As a result of the September 11, 2001 events in New York City and Washington, D.C., U.S. and global economies may weaken, which may result in a decrease in our revenues and cause our stock price to decline. In addition, it is anticipated that in the wake of these events, U.S. and global capital markets will experience a period of extreme volatility. Intense Competition in the Market for Networking Equipment Could Prevent Extreme FromUs from Increasing Revenue and Prevent Extreme From Sustaining Profitability The market for Internet switchesnetworking equipment is intensely competitive. Our principal competitors include Cabletron Systems, Cisco Systems, Enterasys Networks, Foundry Networks, Lucent TechnologiesNortel Networks and NortelRiverstone Networks. ManyIn addition, a number of private companies have announced plans for new products that may compete with our own products. Some of our current and potential competitors have superior market leverage, longer operating histories and substantially greater financial, technical, sales, and marketing and other resources, as well as greaterin addition to wider name recognition and larger installed customer bases, than we do.bases. These competitors may have developed, or couldmay in the future develop, new competing products based on technologies that compete with our own products or even render our products obsolete. Furthermore, a number of these competitors may merge or form strategic partnerships that enable them to offer or bring to market competitive products. To remain competitive, we believe that we must, among other things, invest significant resources in developing new products, and enhancingimprove our current products and maintainingmaintain customer satisfaction. If we fail to do so, our productswe may not compete favorablysuccessfully with those of our competitors, andwhich could have a material adverse effect on our revenue and future profitability could be materially adversely affected. Extreme Expectsprofitability. We Expect the Average Selling Prices of ItsOur Products to Decrease Rapidly Which May Reduce Gross Margins or Revenue The network equipment industry has experienced rapid erosion of average selling prices due to a number of factors, including competitive pricing pressures, andpromotional pricing, rapid technological change.change and a 30 slowdown in the economy that has resulted in excess inventory and lower prices as companies attempt to liquidate this inventory. We may experience substantial period-to-period fluctuationsdecreases in future 23 operating results due to the erosion of our average selling prices. We anticipate that the average selling prices of our products will decrease in the future in response to competitive pricing pressures, increased sales discounts and new product introductions by us or our competitors, including, for example, competitive products manufactured with low costlow-cost merchant silicon, or other factors. Therefore,silicon. Competitive pressures are expected to increase as a result of the industry slowdown that occurred in the first half of 2001 coupled with the recent downturn in the broader economy. To maintain our gross margins, we must develop and introduce on a timely basis new products and product enhancements and continually reduce our product costs. Our failure to do so would cause our revenue and gross margins to decline, which could materially adversely affecthave a material adverse effect on our operating results and cause the price of our common stock to decline. Extreme'sSome of Our Customers May Not Have the Resources to Pay for Our Products as a Result of the Current Economic Environment With the recent economic slowdown, some of our customers are forecasting that their revenue for the foreseeable future will generally be lower than anticipated. Some of these customers are experiencing, or are likely to experience, serious cash flow problems and they are finding it increasingly difficult to obtain financing on attractive terms, if at all. As a result, if some of these customers are not successful in generating sufficient revenue or securing alternate financing arrangements, they may not be able to pay, or may delay payment for the amounts that they owe us. Furthermore, they may not order as many products from us as originally forecast. The inability of some of our potential customers to pay us for our products may adversely affect our cash flow and the timing of our revenue recognition, which may cause our stock price to decline. The Market in Which We Compete is Subject to Rapid Technological Change and to Compete ExtremeWe Must Continually Introduce New Products that Achieve Broad Market Acceptance The network equipment market is characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. If we do not address these changes by regularly introducing new products, our product line will become obsolete. Developments in routers and routing software could also significantly reduce demand for our product.products. Alternative technologies could achieve widespread market acceptance and displace the Ethernet technology on which we have based our product lines and architecture are based.architecture. We cannot assure you that our technological approach will achieve broad market acceptance or that other technologies or devices will not supplant our approach.own products and technology. When we announce new products or product enhancements that have the potential to replace or shorten the life cycle of our existing products, customers may defer purchasing our existing products. These actions could materially adversely affecthave a material adverse effect on our operating results by unexpectedly decreasing sales, increasing our inventory levels of older products and exposing us to greater risk of product obsolescence. The market for switching products is evolving and we believe our ability to compete successfully in this market is dependent upon the continued compatibility and interoperability of our products with products and architectures offered by other vendors. In particular, the networking industry has been characterized by the successive introduction of new technologies or standards that have dramatically reduced the price and increased the performance of switching equipment. To remain competitive we need to introduce products in a timely manner that incorporate or are compatible with these new technologies as they emerge. For example, this fiscal year we introduced a new generation chipset which was incorporated in a new product family which began shipping in the quarter ended March 31, 2000.emerging technologies. We cannot assure you that these new products will be commercially successful. We have experienced delays in releasing new products and product enhancements in the past which delayed sales andthat resulted in lower quarterly revenue than anticipated. We may experience similar delays in product development and releasereleases in the future, and any delay in product introduction could adversely affect our ability to compete, and causecausing our operating results to be below our expectations or the expectations of public market analysts or investors. Continued Rapid Growth Will Strain Extreme'sOur Operations and Will Require ExtremeUs to Incur Costs to Upgrade ItsOur Infrastructure We have experienced a period of rapid growth and expansion whichthat has placed, and continues to place, a significant strain on our resources. Even if we manage this growth effectively, we may make mistakes in 31 operating our business such as inaccurate sales forecasting, incorrect material planning or inaccurate financial reporting, whichreporting. This may result inlead to unanticipated fluctuations in our operating results. Our net revenue increased significantly during the last fiscal year, and from June 30, 19992000 to June 30, 2000,2001, the number of our employees increased from 249680 to 680.970. We expect our anticipated growth and expansion to strain our management, operational and financial resources. Our management team has had limited experience managing such rapidly growing companies on a public or private basis. To accommodate this anticipated growth, we will be required to: . improve existing and implement newupdate operational, information and financial systems, procedures and controls; . hire, train and manage additional qualified personnel includingin the fields of engineering, sales, marketing personnel and research and development personnel;networking technology; and . effectively manage multiple relationships with our customers, suppliers and other third parties. We may not be able to install adequate control systems in an efficient and timely manner, and our current or planned personnel systems, procedures, and controls may not be adequate to support our future operations. In August 1998, we installed a new management information system, which weWe may continueneed to modify and improve our management information system to meet the increasing needs associated with our growth. The difficulties associated with installing and implementing these new systems, procedures, and controls may place a significant burden on our management and our internal resources. In addition, as we grow internationally, we will haveneed to expand our 24 worldwide operations and enhance our communications infrastructure. Any delay in the implementation of such new or enhanced systems, procedures or controls, or any disruption in the transition to such new or enhanced systems, procedures or controls, could adversely affect 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. ExtremeWe Must Develop and Expand ItsOur Indirect Distribution Channels to Increase RevenuesNet Revenue and Improve ItsOur Operating Results Our distribution strategy focuses primarily on developing and expanding indirect distribution channels through resellers and distributors, and,in addition to a lesser extent, original equipment manufacturers, or OEMs, as well as expanding our field sales organization. If we fail to develop and cultivate relationships with significant resellers, or if these resellers are not successful in their sales efforts, sales of our products may decrease and our operating results would suffer. Many of our resellers also sell products that compete with our products. We are developing a two-tier distribution structure in Europe and the United States whichthat has required, and will in the future require, us to enter into agreements with a small number of stocking distributors. We have entered into two-tier distribution agreements; however, we cannot assure you that we will continue to be able to enter into additional distribution agreements or that we will be able to successfully manage the transition of resellers to a two-tier distribution channel. Our failure to do soany of these could limit our ability to grow or sustain revenue. In addition, our operating results will likely fluctuate significantly depending on the timing and amount of orders from our resellers. We cannot assure you that our resellers will market our products effectively or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. ToIn an effort to support and develop leads for our indirect distribution channels and to attempt to expand our direct sales effort, to service providers and content providers,customers, we plan to continue to expand our field sales and support staff significantly.staff. We cannot assure you that this internal expansion will be successfully completed, that the cost of this expansion will not exceed the revenuesnet revenue generated, or that our expanded sales and support staff will be able to compete successfully against the significantly more extensive and well-funded sales and marketing operations of many of our current or potential competitors. Our inability to effectively establish our distribution channels or manage the expansion of our sales and support staff would materially adversely affectmay have a material adverse effect on our ability to grow our business and increase revenue. Because Substantially AllMost of Extreme'sOur Revenue is Derived From Sales of TwoThree Product Families, Extreme isSo We are Dependent on Widespread Market Acceptance of These Products; Future Performance will Depend on the Introduction and Acceptance of New Products In fiscal 2000,the year ended June 30, 2001, we derived substantially all of our revenue from sales of our Summit, BlackDiamond and BlackDiamond product families.Alpine products. We expect that revenue from these product families will account for a 32 substantial portion of our revenue for the foreseeable future. Accordingly, widespread market acceptance of our product families is criticalvital to our future success. Factors that may affect the market acceptancesales of our products, include market acceptancesome of which are beyond our control, include: . the demand for switching products and Gigabit(Gigabit Ethernet and Layer 3 switching technologies in particularparticular) in the enterprise, service provider and metropolitan area network markets,MAN markets; . the performance, price and total cost of ownership of our products,products; . the availability and price of competing products and technologies,technologies; . our ability to match supply with demand for certain products; and . the success and development of our resellers, distributors OEMs and field sales channels. ManyFuture Performance will Depend on the Introduction and Acceptance of these factors are beyond our control.New Products Our future performance will also depend on the successful development, introduction, and market acceptance of new and enhanced products that address customer requirements in a cost-effective manner. We have inIn the past, we have experienced delays in product development and such delays may occur in the future. We introduced a new product family in fiscal 2000 whichthat is based on a new generation chip set. In addition, wesecond-generation chipset. We also introduced newother products incorporating this chipset within our existing product lines that incorporate this new chip set.lines. The introduction of new and enhanced products may cause our customers to defer or cancel orders for existing products. Therefore, to the extent customers defer or cancel orders in the expectation of any new product release,releases, any delay in the development or introduction of new products could cause our operating results to suffer. Failure of our existing or future productsThe risk that we will be unable to maintainachieve and achievemaintain widespread levels of market acceptance for our current and future products may significantly impair our revenue growth. If a Key Reseller, Distributor, OEM or Other Significant Customer Cancels or Delays a Large Purchase, Extreme's RevenuesOur Net Revenue May Decline and the Price of ItsOur Stock May Fall To date, a limited number of resellers, distributors OEMs and other customers have accounted for a significant portion of our revenue. If any of our large customers stop or delay purchases, our revenue and profitability would be adversely affected. For example, infor the fiscal 1999, Compaq and Hitachi Cableyear ended June 30, 2001, Tech Data Corporation accounted for 21% and 13%16% of our net revenue, respectively. Because ourrevenue. Our expense levels are based on our expectations as to future revenue and to a large extent are fixed in the short term, so a substantial reduction or delay in sales of our products to or the loss of anya significant reseller, distributor OEM or other customer or unexpected returns from 25 resellers could harm our business, operating results and financial condition. Although our largest customers may vary from period-to-period, we anticipate that our operating results for any given period will continue to depend to a significant extent on large orders from a relatively small number of customers, particularly in lightview of the high per unit sales price per unit of our products and the length of our sales cycles. While our financial performance depends on large orders from a fewlimited number of key resellers, distributors OEMs and other significant customers, we do not have binding purchase commitments from any of them. For example: . our service provider and enterprise network customers can stop purchasing and our resellers distributors and OEMsdistributors can stop marketing our products at any time; . our reseller agreements generally are not exclusivenon-exclusive and are for one yearone-year terms, with no obligation ofupon the resellers to renew the agreements; . our reseller agreements provide for discounts based on expected or actual volumes of products purchased or resold by the reseller in a given period; and . our reseller, distributor and OEMend-user customer agreements generally do not require minimum purchases. We have established a program which, underUnder specified conditions, enables some third party resellersthird-party distributors are allowed to return products to us. The amountWe defer recognition of potential product returns is estimated and provided for inrevenue on sales to distributors until the period ofdistributors sell the sale. Some of our OEM agreements also provide manufacturing rights and access to our source code upon the occurrence of specified conditions of default. If we were to default on these agreements, our OEMs could use our source code to develop and manufacture competing products, which would negatively affect our performance and ability to compete.product. The Sales Cycle for Extreme'sOur Products is Long and ExtremeWe May Incur Substantial Non-Recoverable Expenses or Devote Significant Resources to Sales that Do Not Occur When Anticipated The timing of our sales revenue is difficult to predict because of our reliance on indirect sales channels and the length and variability of our sales cycle. Our products have a relatively high per unit sales price, per unit, and the purchase 33 of our products often representconstitutes a significant and strategic decision by an enterprise regarding its communications infrastructure. Accordingly, theThe decision by customers to purchase of our products typically involves significantis often based on the results of a variety of internal procedures associated with the evaluation, testing, implementation and acceptance of new technologies. ThisAccordingly, the product evaluation process frequently results in a lengthy sales process,cycle, typically ranging from three months to longer than a year, and subjects the sales cycle associated with the purchase ofas a result, our ability to sell products is subject to a number of significant risks, includingincluding: . the risk that budgetary constraints and internal acceptance reviews. Thereviews by customers will result in the loss of potential sales; . the risk of substantial variation in the length of ourthe sales cycle also may vary substantially from customer to customer. While our customers are evaluating our products and before they may place an order with us,customer, making decisions on the expenditure of resources difficult to assess; . the risk that we may incur substantial sales and marketing expenses and expend significant management effort. Consequently,time in an attempt to initiate or increase the sale of products to customers, but not succeed; and . the risk that, if a sales forecastedforecast from a specific customer for a particular quarter areis not realizedachieved in that quarter, we may be unable to compensate for the shortfall, which could harm our operating results. Extreme PurchasesWe Purchase Several Key Components for Products From Single or Limited Sources and Could Lose Sales if These SourcesSuppliers Fail to Fill ItsMeet Our Needs We currently purchase several key components used in the manufacture of our products from single or limited sources and are dependent upon supply from these sources to meet our needs. Certain components such as tantalum capacitors, static random access memory, or SRAM, and printed circuit boards have been, and may be in the future, be in short supply. While we have been able to meet our needs to date, we have in the past, and are likely in the future, to encounter shortages and delays in obtaining these or other components and this could materially adversely affecthave a material adverse effect on our ability to meet customer orders. Our principal sole sourcedsole-source components include: . ASICs; . microprocessors; . programmable integrated circuits; . selected other integrated circuits; . cables; . custom power supplies; and . custom-tooled sheet metal. 26 Our principal limited sourcedlimited-source components include: . flash memories; . dynamic and static random access memories, commonly known asor DRAMs and SRAMs, respectively; and . printed circuit boards. We use a rolling six-monthour forecast based on anticipated product ordersof expected demand to determine our material requirements. Lead times for materials and components we order vary significantly, and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. If orders do not matchexceed forecasts, we may have excess or inadequate inventory of certain materials and components, which could materially adversely affecthave a material adverse effect on our operating results and financial condition. We do not have agreements fixing long-term prices or minimum volume requirements from these suppliers. From time to time we have experienced shortages and allocations of certain components, resulting in delays in filling orders. In addition, during the development of our products, we have experienced delays in the prototyping of our ASICs, which in turn has led to delays in product introductions. Extreme Needs to Expand Its Manufacturing Operations and DependsWe cannot assure you that such delays will not occur in the future. 34 Our Dependence on Contract Manufacturers for Substantially All of ItsOur Manufacturing Requirements Could Harm Our Operating Results If the demand for our products continues to grow,grows, we will need to increase our material purchases, contract manufacturing capacity, and internal test and quality functions. Any disruptions in product flow could limit our revenue, adversely affect our competitive position and reputation, and result in additional costs or cancellation of orders under agreements with our customers. We rely on third party manufacturing vendorsindependent contractors to manufacture our products. We do not have long-term contracts with any of these manufacturers. We currently subcontract substantially all of our manufacturing toutilize three companies--Flextronicscompanies - Flextronics International, Ltd., located in San Jose, California, Solectron Corporation, located in Milpitas, California, and MCMS, Inc., located in Boise, Idaho and Solectron, located in Milpitas, California.Nampa, Idaho. We have experienced a delaydelays in product shipments from contract manufacturers in the past, which in turn delayed product shipments to our customers. WeSimilar or other problems may arise in the future, experience similar or other problems, such as inferior quality, and insufficient quantity of product,products, or the interruption or discontinuance of operations of any manufacturer, any of which could materially adversely affecthave a material adverse effect on our business and operating results. There canSpecifically, as stated in their Form 10-Q filed with the Securities and Exchange Commission on July 16, 2001, MCMS faces severe near-term liquidity problems. In the wake of a significant deterioration in demand from nearly all of their customers, over-advances on a revolving credit facility and non-compliance with a covenant requirement have created events of default under the terms of the credit facility. It is not clear whether MCMS will be no assuranceable to successfully reorganize its operations. Accordingly, we are addressing this situation by perfecting security interests in our personal property located on the premises of MCMS, obtaining a written acknowledgement from MCMS in regard to manufacturing equipment, products and materials owned and/or leased by us that are located on the premises of MCMS, and managing the orderly transition of production processes to other manufacturers. Our inability to execute this plan may cause a delay in our ability to fulfill orders and may have a material adverse effect on our business, operating results and financial condition. On September 18, 2001 MCMS announced that it had reached an agreement to sell substantially all of its operating assets to Manufacturers' Services Limited. Simultaneously, MCMS announced that it, and its two U.S. subsidiaries, have voluntarily filed for protection under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware in Wilmington to implement the sale. We do not know whether we will effectively manage our contract manufacturers or that these manufacturers will meet our future requirements for timely delivery of products of sufficient quality and quantity. We intend to regularly introduce new products and product enhancements, which will require that we rapidly achieve a critical mass of volume production by coordinating our efforts with those of our suppliers and contract manufacturers. The inability of our contract manufacturers to provide us with adequate supplies of high-quality products or the loss of eitherany of our contract manufacturers wouldmay cause a delay in our ability to fulfill orders while we obtain a replacement manufacturer and wouldmay have a material adverse effect on our business, operating results and financial condition. As part of our cost-reduction efforts, we will need to realize lower per unit product costs from our contract manufacturers as a resultby means of volume efficiencies. However, we cannot be certain when or if such price reductions will occur. The failure to obtain such price reductions would adversely affect our gross margins and operating results. Our Limited Ability to Protect Our Intellectual Property and Defend Against Claims May Adversely Affect Our Ability to Compete We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. However, we cannot assure you that the actions we have taken will adequately protect our intellectual property rights or that other parties will not independently develop similar or competing products that do not infringe on our patents. Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual 35 property rights. We are actively involved in disputes and licensing discussions with others regarding their claimed proprietary rights. If we infringe the proprietary rights of others, we could be compelled to either obtain a license to those intellectual property rights or alter our products so that these no longer infringe upon such proprietary rights. Any license could be very expensive to obtain or may not be available at all. Similarly, changing our products or processes to avoid infringing the rights of others may be costly or impractical. Litigation resulting from claims that we are infringing the propriety rights of others could result in substantial costs and a diversion of resources, and could have a material adverse effect on our business, financial condition and results of operations. The networking industry in which we operate is prone to intellectual property claims by and among competing parties. We cannot assure you that we will always successfully defend ourselves against such claims. We enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our software, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise misappropriate or use our products or technology. We Are Engaged in Litigation Regarding Intellectual Property Rights, and an Adverse Outcome Could Harm Our Business and Require Us to Incur Significant Costs We have received notice from three major companies alleging that we are infringing their patents. One of these companies, Nortel Networks, filed a claim against us alleging patent infringement and we are in litigation as of the date of this filing. Following examination of this claim, we have denied Nortel's allegations and intend to defend the action vigorously. Without regard to the merits of this or any other claim, if judgments by a court of law on this or any other claim received in the future were to be upheld, the consequences to us may be severe and could require us to, among other actions: . stop selling our products that incorporate the challenged intellectual property; . obtain a license to sell or use the relevant technology, which license may not be available on reasonable terms or available at all; . pay damages; or . redesign those products that use the disputed technology. If we are compelled to take any of the foregoing actions, our business could be severely harmed. We and Manufacturers of Our Products Rely on a Continuous Power Supply to Conduct Operations, and California's Current Energy Crisis Could Disrupt Our Business and Increase Our Expenses California is in the midst of an energy crisis that could disrupt our operations and increase our expenses. In the event of an acute power shortage, that is, when power reserves for California fall below 1.5%, electricity providers have on some occasions implemented, and may in the future continue to implement, rolling blackouts. Two of the three manufacturers of our products, Flextronics and Solectron, are located in California. As a result of this crisis, these contractors may be unable to manufacture sufficient quantities of our products to meet our needs, or they may increase the fees charged for their services. We do not have long-term contracts with either Flextronics or Solectron. The inability of our contract manufacturers to provide us with adequate supplies of products would cause a delay in our ability to fulfill our orders, which could harm our business, and any increase in their fees could adversely affect our financial condition. In addition, the majority of our operations are located in California. We currently do not have backup generators or alternate sources of power in the event of a blackout. If blackouts interrupt our power supply, we would temporarily be unable to continue operations at our facilities. Any such interruption in our ability to continue operations at these facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operation. 36 Our Headquarters Are Located in Northern California Where Disasters May Occur That Could Disrupt Our Operations and Harm Our Business Our corporate headquarters are located in Silicon Valley in Northern California. Northern California historically has been vulnerable to natural disasters and other risks, such as earthquakes, fires and floods, which at times have disrupted the local economy and posed physical risks to our and our manufacturers' property. In addition, terrorist acts or acts of war targeted at the U.S and specifically Silicon Valley could cause damage or disruption to Extreme, Losesour employees, facilities, partners, suppliers, distributors and resellers, and customers which could have a material adverse effect on our operations and financial results. We currently do not have redundant, multiple site capacity in the event of a natural disaster or catastrophic event. In the event of such an occurrence, our business would suffer. If We Lose Key Personnel or isare Unable to Hire Additional Qualified Personnel as Necessary, ItWe May Not Be Able to Successfully Manage ItsOur Business or Achieve ItsOur Objectives Our success depends to a significant degree upon the continued contributions of our key management, engineering, sales and marketing and manufacturingoperations personnel, many of whom would be difficult to replace. In particular, we believe that our future success is highly dependent on Gordon Stitt, Chairman, Presidentchairman, president and Chief Executive Officer,chief executive officer; Stephen Haddock, Vice Presidentvice president and Chief Technical Officer,chief technical officer; and Herb Schneider, Vice Presidentvice president of Engineering.engineering. We neitherdo not have employment contracts with these personnel nor key persondo we carry life insurance on any of our key personnel. We believe our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing, finance and manufacturingoperations personnel. CompetitionThe market for these personnel is intense,competitive, especially in the San Francisco Bay Area, and we have had difficulty hiring employees, particularly software engineers, in the timeframe we desire, particularly software engineers.desire. In addition, retention has become more difficult for us and other public technology companies as a result of the recent stock market decline, which has caused many of our employees' options to be "under water." There can be no assurance that we will be successful in attracting and retaining such personnel. The loss of the services of any of our key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring requireddesired personnel, particularly engineers and sales personnel, could make it difficult for us to manage our business and meet key objectives, such as new product introductions, on time.introductions. In addition, companies in the networking industry whose employees accept positions with competitors frequently claim that competitors have engaged in unfair hiring practices. We have from time to time received claims like this from 27 other companies and, although to date they have not resulted in material litigation, we cannot assure you thatdo not know whether we will not receive additional claims in the future as we seek to hire qualified personnel or that such claims will not result in material litigation. We could incur substantial costs in defending ourselves against any such claims, regardless of the merits of such claims. Extreme'sOur Products Must Comply With Evolving Industry Standards and Complex Government Regulations or ItsElse Our Products May Not Be Widely Accepted, Which May Prevent ExtremeUs From Sustaining Its RevenuesGrowing Our Net Revenue or Achieving Profitability The market for network equipment products is characterized by the need to support industry standards as different standards emerge, evolve and achieve acceptance. We will not be competitive unless we continually introduce new products and product enhancements that meet these emerging standards. In the past, we have introduced new products that were not compatible with certain technological changes, and in the future we may not be able to effectively address the compatibility and interoperability issues that arise as a result of technological changes and evolving industry standards. In addition, in the United States, ourOur products must comply with various U.S. federal government regulations and standards defined by agencies such as the Federal Communications Commission, and Underwriters Laboratories. Internationally, products that we develop may be requiredin addition to comply with standards established by telecommunicationsgovernmental authorities in various foreign countries as well as withand recommendations of the International Telecommunication Union. If we do not comply with existing or evolving industry standards 37 or if we fail to obtain timely domestic or foreign regulatory approvals or certificates we wouldwill not be able to sell our products where these standards or regulations apply, which may prevent us from sustaining our revenuesnet revenue or achieving profitability. Failure to Successfully Integrate Extreme's ExpandedExpand Our Sales and Support Organizations into Its Operation or Educate Them About ItsOur Product Families Will Hurt ItsMay Harm Our Operating Results. OurResults The sale of our products and services requirerequires a sophisticated salesconcerted effort targeted at several levels within a prospective customer's organization. Unless we expand our sales force we willWe may not be able to increase revenues. In April 2000, a significant number of formernet revenue unless we expand our sales and system engineer employees of another networking company joined our operation.force. We cannot assure you that we will be able to educate these new employees about our product families orsuccessfully integrate these new employees into our company.company or to educate our employees about our rapidly evolving product families. A failure to do so willmay hurt our revenue growth and mayconsequently hurt our operating results. Extreme DependsWe Depend Upon International Sales for Mucha Significant Portion of ItsOur Revenue and Extreme'sOur Ability to Sustain and Increase ItsOur International Sales Depends on Successfully Expanding ItsOur International Operations International sales constitute a significant portion of our sales. Our ability to grow will depend in part on the continued expansion of international sales and operations which have and are expected to constitute a significant portion of our sales. Sales to customers outside of North America accounted for approximately 53%55% and 45%43% of our net revenue in fiscal 19992001 and fiscal 2000, respectively. Our international sales primarily depend on our resellers distributors and OEMs.distributors. The failure of our resellers distributors and OEMsdistributors to sell our products internationally would limit our ability to sustain and grow our revenue. In addition, there are a number of risks arising from our international business, including: . longer accounts receivable collection cycles; . difficulties in managing operations across disparate geographic areas; . difficulties associated with enforcing agreements through foreign legal systems; . the payment of operating expenses in local currencies, which subjectsexposes us to risks of currency fluctuations; . import or export licensing requirements; . difficulty in safeguarding intellectual property; . political and economic turbulence; . potential adverse tax consequences; and . unexpected changes in regulatory requirements.requirements, including export restrictions. Our international sales currently are U.S. dollar-denominated. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. In the future, we may elect to invoice some of our international customers in local currency which will subjectexpose us to fluctuations in exchange rates between the U.S. dollar and the particular local currency. If we do so, we may determinedecide to engage in hedging transactions to minimize the risk of such fluctuations. We have entered into foreign exchange forward contracts to offset the impact of payment of operating expenses in local currencies to some of our operating foreign subsidiaries. However, if we are not successful in managing suchthese hedging transactions, we could incur losses from hedging activities. Because we currently denominate sales in U.S. dollars, we do not anticipate that the adoption of the Euro as a functional legal currency of certain European countries will materially affect our business. 28 ExtremeWe May Engage in Future Acquisitions that Dilute the Ownership Interests of Our Stockholders, Cause Us to Incur Debt and Assume Contingent Liabilities As part of our business strategy, we review acquisition and strategic investment prospects that would complement our current product offerings, augment our market coverage or enhance our technical capabilities, or that may otherwise offer growth opportunities. We are reviewing investments in new businesses and we expect to make investments in, and to acquire, businesses, products, or technologies in the future. In the event of any future acquisitions, we could: 38 . issue equity securities which would dilute current stockholders' percentage ownership; . incur substantial debtdebt; . assume contingent liabilities; or . expend significant cash. These actions by us could materially adversely affecthave a material adverse effect on our operating results and/or the price of our common stock. In addition, with any acquisition, we may be required to absorb the costs associated with the acquisition long before we are able to realize any benefits from the acquisition. Acquisitions and investment activities also entail numerous risks, including: . difficulties in the assimilation of acquired operations, technologies or products; . unanticipated costs associated with the acquisition or investment transaction; . the diversion of management's attention from other business concerns; . adverse effects on existing business relationships with suppliers and customers; . risks associated with entering markets in which we have no or limited prior experienceexperience; . the potential loss of key employees of acquired organizations; and . substantial charges for the amortization of goodwill orcertain purchased intangiblesintangible assets, deferred stock compensation or similar items.items; and . impairment charges taken in the future for goodwill amounts that cannot be supported in future periods. We cannot assure you that we will be able to successfully integrate any businesses, products, technologies, or personnel that we might acquire in the future, and our failure to do so could materially adversely affecthave a material adverse effect on our business, operating results and financial condition. ExtremeMoreover, even if we do obtain benefits in the form of increased sales and earnings, there may be a lag between the time when the expenses associated with an acquisition are incurred and the time when we recognize such benefits. This is particularly relevant in cases where it is necessary to integrate new types of technology into our existing portfolio and new types of products may be targeted for potential customers with which we do not have pre-existing relationships. We May Need Additional Capital to Fund ItsOur Future Operations And,and, If It Is Not Available When Needed, ExtremeWe May Need to Reduce ItsOur Planned Development and Marketing Efforts, Which May Reduce Its RevenuesOur Net Revenue and Prevent ExtremeUs From Achieving Profitability We believe that our existing working capital, based on proceeds from the initial public offering in April 1999, proceeds from the secondary offering in October 1999, and cash available from credit facilities and future operations, will enable us to meet our working capital requirements for at least the next 12 months. However, if cash from future operations is insufficient, or if cash is used for acquisitions or other currently unanticipated uses, we may need additional capital. The development and marketing of new products and the expansion of reseller and distribution channels and associated support personnel is expected to requirerequires a significant commitment of resources. In addition, if the marketmarkets for our products were to develop more slowly than anticipated, or if we fail to establish significant market share and achieve a meaningful level of revenues,sufficient net revenue, we may continue to utilizeconsume significant amounts of capital. As a result, we could be required to raise substantial additional capital. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution toof the shares held by existing stockholders. If additional funds are raised through the issuance of debt securities, such securities may haveprovide the holders certain rights, preferences, and privileges senior to holdersthose of common stockstockholders, and the termterms of such debt could impose restrictions on our operations. We cannot assure you that such additional capital, if required, will be available on acceptable terms, or at all. If we are unable to 39 obtain suchsufficient amounts of additional capital, we may be required to reduce the scope of our planned product development and marketing efforts, which wouldcould harm our business, financial condition and operating results. 29 If Extreme'sOur Products Contain Undetected Software or Hardware Errors, ExtremeWe Could Incur Significant Unexpected Expenses and LostLose Sales Network products frequently contain undetected software or hardware errors when first introduced or as new versions are released. Wefirst released to the marketplace. In the past, we have experienced such errors in the past in connection with new products and product upgrades. We expect that such errors will be found from time to time in new or enhanced products after the commencement of commercial shipments. These problems may materially adversely affecthave a material adverse effect on our business by causing us to incur significant warranty and repair costs, diverting the attention of our engineering personnel from ournew product development efforts, and causing significant customer relations problems. Our products must successfully interoperate with products from other vendors. As a result, when problems occur in a network, it may be difficult to identify the sourcesources of the problem.these problems. The occurrence of hardware and software errors, whether caused by our products or another vendor's products, could result in the delay or loss of market acceptance of our products and any necessary revisions may result in the incurrence ofcause us to incur significant expenses. The occurrence of any such problems would likely have a material adverse effect on our business, operating results and financial condition. Extreme's Limited Ability to Protect Its Intellectual Property May Adversely Affect Its Ability to Compete We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. However, we cannot assure you that the actions we have taken will adequately protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our software, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Provisions in Extreme'sOur Charter or Agreements May Delay or Prevent a Change of Control Provisions in our certificate of incorporation and bylaws may delay or prevent a change of control or changes in our management. These provisions include: . the division of the board of directors into three separate classes; . the right of the board of directors to elect a director to fill a vacancy created by the expansion of the board of directors; and . the ability of the board of directors to alter our bylaws without getting stockholder approvalapproval. Furthermore, we are subject to the provisions of section 203 of the Delaware General Corporation Law. These provisions prohibit large stockholders, in particular those owning 15% or more of the outstanding voting stock, from consummating a merger or combination with a corporation unless this stockholder receives board approval for the transaction or 66 2/3% of the shares of voting stock not owned by the stockholder approve the merger or combination. In addition, we recently adopted a stockholders' rights agreement as described in Note 6 of Notes to Consolidated Financial Statements. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Interest Rate Sensitivity The primary objective of our investment activities is to preserve principal while at the same time maximizingmaximize the income we receive from our investments without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, other non-government debt securities and money market funds. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. The following table presents the amounts of our cash equivalents and short-term investments that are subject to market risk by range of expected maturity 40 and weighted-average interest rates as of June 30, 20002001 and June 30, 1999.2000. This table does not include money market funds because those funds are not subject to market risk. 30
June 30, 2000: Maturing in ---------------------------------------------------------------------------------------------------- ------- Three Three Greater months Threeor months Greaterto than one Fair or less to one year one year Total Value --------- --------- -------- ------- ----------- -------- ----- ------------ June 30, 2001: (In thousands) Included in cash and cash equivalents................. $ 100,696 $ 100,696 $ 100,696equivalents.. $36,846 $36,846 $36,846 Weighted average interest rate...................... 6.37%rate..... 4.53% Included in short-term investments.................... $ 66,640 $ 66,640 $ 66,640investments..... $69,374 $69,374 $69,374 Weighted average interest rate...................... 6.50%rate..... 6.94% Included in investments............................... $ 44,144 $ 44,144 $ 44,144investments................ $34,406 $34,406 $34,406 Weighted average interest rate...................... 7.29%rate..... 4.72%
Maturing in --------------------------------------------------------------- June 30, 1999:------------------------------------ ------- Three Three Greater months Threeor months Greaterto than one Fair or less to one year one year Total Value --------- --------- -------- ------- ----------- -------- ----- ------------ June 30, 2000: (In thousands) Included in cash and cash equivalents................ $ 93,819 $ 93,819 $ 93,819equivalents.. $88,324 $88,324 $88,324 Weighted average interest rate..................... 5.12%rate..... 6.37% Included in short-term investments................... $ 16,422 $ 16,422 $ 16,422investments..... $66,640 $66,640 $66,640 Weighted average interest rate..................... 5.04%rate..... 6.50% Included in investments.............................. 300 $ 15,797 $ 16,097 $ 16,097investments................ $44,144 $44,144 $44,144 Weighted average interest rate..................... 6.02% 6.36%rate..... 7.29%
Exchange Rate Sensitivity Currently, all of our sales and the majority of our expenses are denominated in U.S. dollars and as a result, we have experienced no significant foreign exchange gains and losses to date. While we have conducted some transactions in foreign currencies during the year ended June 30, 20002001 and expect to continue to do so, we do not anticipate that foreign exchange gains or losses will be significant. Foreign Exchange Forward Contracts We enter into foreign exchange forward contracts to offset the impact of currency fluctuations on certain nonfunctional operating expenses, denominated in Japanese Yen, the Euro, Swedish Krona and British pound. The foreign exchange forward contracts we enter into have original maturities ranging from one to three months. We do not engaged inenter into foreign currency hedging activitiesexchange forward contracts for trading purposes. Extreme did not hold any foreign exchange forward contracts as of June 30, 2001 (see Note 5 of Notes to date, however, we may do so in the future. 31Consolidated Financial Statements). 41 Item 8. Financial Statements and Supplementary Data. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF EXTREME NETWORKS, INC.
Page(s) --------------- Consolidated Balance Sheets...................... 43 Consolidated Statements of Operations............ 44 Consolidated Statements of Cash Flows............ 45 Consolidated Statement of Stockholders' Equity... 46 Notes to Consolidated Financial Statements....... 47 Report of Ernst & Young LLP, Independent Auditors........................................................................Auditors 67 Quarterly Financial Data (unaudited)............. 68
42 EXTREME NETWORKS, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except par value and share amounts)
June 30, ------------------ 2001 2000 -------- -------- ASSETS Current assets: Cash and cash equivalents.......................................................... $ 87,722 $116,721 Short-term investments............................................................. 69,374 66,640 Accounts receivable, net of allowance for doubtful accounts of $1,942 ($1,237 in 2000)................................................................. 75,738 60,996 Inventories........................................................................ 60,529 23,801 Deferred taxes..................................................................... 35,855 13,800 Other current assets............................................................... 21,543 20,526 -------- -------- Total current assets........................................................... 350,761 302,484 Property and equipment, net........................................................... 57,251 26,750 Restricted investments................................................................ 80,000 80,000 Investments........................................................................... 34,406 44,144 Goodwill and purchased intangible assets, net......................................... 113,886 49,782 Deferred taxes........................................................................ 40,028 4,600 Other assets.......................................................................... 12,025 8,170 -------- -------- $688,357 $515,930 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable................................................................... $ 35,890 $ 39,023 Accrued compensation and benefits.................................................. 13,309 11,041 Accrued purchase commitments....................................................... 9,926 506 Leasehold improvements allowance................................................... 6,662 8,424 Deferred revenue................................................................... 57,372 22,042 Other accrued liabilities.......................................................... 16,170 15,567 -------- -------- Total current liabilities...................................................... 139,329 96,603 Long-term deposit..................................................................... 266 306 Commitments and contingencies (Note 4) Stockholders' equity: Convertible preferred stock, $.001 par value, issuable in series; 2,000,000 shares authorized; none issued.......................................................... -- -- Common stock, $.001 par value; 750,000,000 shares authorized; 113,416,000 issued and outstanding (106,670,000 in 2000) and capital in excess of par value......... 640,655 423,150 Deferred stock compensation........................................................ (20,351) (78) Accumulated other comprehensive income (loss)...................................... 769 (623) Accumulated deficit................................................................ (72,311) (3,428) -------- -------- Total stockholders' equity..................................................... 548,762 419,021 -------- -------- $688,357 $515,930 ======== ========
See accompanying notes to consolidated financial statements. 43 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
Years Ended June 30, ---------------------------- 2001 2000 1999 --------- -------- ------- Net revenue $ 491,232 $261,956 $98,026 Costs and expenses: Cost of revenue.......................................................... 281,232 126,916 48,520 Research and development................................................. 57,876 32,998 17,036 Sales and marketing...................................................... 154,601 67,146 27,056 General and administrative............................................... 25,789 11,852 6,859 Amortization of goodwill, purchased intangible assets and deferred stock compensation........................................................... 37,530 6,790 -- Other operating expenses................................................. 36,097 -- -- --------- -------- ------- Total costs and expenses............................................. 593,125 245,702 99,471 --------- -------- ------- Operating income (loss)..................................................... (101,893) 16,254 (1,445) Interest income............................................................. 15,474 14,638 1,855 Interest expense............................................................ (387) (490) (398) Other income (expense), net................................................. (4,745) (33) 21 --------- -------- ------- Income (loss) before income taxes........................................... (91,551) 30,369 33 Consolidated Balance Sheets.............................................................................................. 34 Consolidated StatementsProvision (benefit) for income taxes........................................ (22,668) 10,321 1,650 --------- -------- ------- Net income (loss)........................................................... $ (68,883) $ 20,048 $(1,617) ========= ======== ======= * Net income (loss) per share--basic........................................ $ (0.64) $ 0.20 $ (0.09) * Net income (loss) per share--diluted...................................... $ (0.64) $ 0.18 $ (0.09) * Shares used in per share calculation--basic............................... 108,353 100,516 18,924 * Shares used in per share calculation--diluted............................. 108,353 111,168 18,924
See accompanying notes to consolidated financial statements. * Share and per-share data presented reflect the two-for-one stock split effective August 24, 2000. 44 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended June 30, ----------------------------- 2001 2000 1999 -------- --------- -------- Operating activities Net income (loss).................................................. $(68,883) $ 20,048 $ (1,617) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation..................................................... 19,328 6,992 5,733 Amortization..................................................... 33,387 7,052 -- Provision for doubtful accounts.................................. 5,274 -- 1,364 Provision for inventory reserves................................. 32,753 1,144 1,087 Deferred income taxes............................................ (64,173) (18,400) -- In-process research and development.............................. 30,142 -- -- Tax benefits from employee stock transactions.................... 45,020 21,600 -- Warrants issued to a business partner............................ -- -- 948 Amortization of Operations.................................................................................... 35 Consolidated Statementdeferred stock compensation...................... 4,143 119 172 Equity share of affiliate losses and write-down of investments... 4,942 248 -- Loss on retirement of assets..................................... 2,886 -- -- Compensation expense for options granted to consultants.......... 841 176 -- Changes in operating assets and liabilities; excluding impact of acquisitions: Accounts receivable............................................. (20,016) (40,199) (14,353) Inventories..................................................... (69,481) (22,319) (3,590) Other current and noncurrent assets............................. (2,950) (18,832) (1,392) Accounts payable................................................ (3,262) 25,605 3,425 Accrued compensation and benefits............................... 2,268 6,941 3,165 Accrued purchase commitments.................................... 9,420 -- -- Leasehold improvements allowance................................ (1,762) 8,424 -- Deferred revenue................................................ 35,330 20,325 1,434 Other accrued liabilities....................................... 180 5,589 6,377 Long term deposit............................................... (40) 306 -- -------- --------- -------- Net cash provided by (used in) operating activities................ (4,653) 24,819 2,753 -------- --------- -------- Investing activities Capital expenditures............................................... (51,224) (27,236) (7,492) Purchases and maturities of investments............................ 8,398 (158,770) (21,636) Acquisition of business, net of cash assumed....................... 1,179 -- -- Minority investments............................................... (7,750) (8,970) -- -------- --------- -------- Net cash used in investing activities.............................. (49,397) (194,976) (29,128) -------- --------- -------- Financing activities Proceeds from issuance of common stock............................. 25,051 181,383 126,622 Proceeds from notes payable........................................ -- -- 783 Principal payments on notes payable................................ -- -- (2,784) Principal payments of capital lease obligations.................... -- (1,648) (613) -------- --------- -------- Net cash provided by financing activities.......................... 25,051 179,735 124,008 -------- --------- -------- Net increase (decrease) in cash and cash equivalents............... (28,999) 9,578 97,633 Cash and cash equivalents at beginning of year....................... 116,721 107,143 9,510 -------- --------- -------- Cash and cash equivalents at end of year............................. $ 87,722 $ 116,721 $107,143 ======== ========= ======== Supplemental disclosure of cash flow information: Interest paid...................................................... $ 387 $ 744 $ 185 Cash paid (refund received) for taxes.............................. $ (3,803) $ 5,828 -- Supplemental schedule of noncash investing and financing activities: Property and equipment acquired under capital lease obligations.... $ -- $ -- $ 278 Warrants issued for goodwill and purchased intangibles............. $ -- $ 54,324 $ -- Warrants issued to a business partner.............................. $ -- $ -- $ 948 Conversion of preferred stock to common stock...................... $ -- $ -- $ 58
See accompanying notes to consolidated financial statements. 45 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (in thousands)
Common Stock and Convertible capital in excess of Accumulated Preferred Stock par value Deferred Other -------------- -------------------- Stock Comprehensive Shares Amount Shares Amount Compensation Income (Loss) ------- ------ ------- -------- ------------ ------------- Balances at June 30, 1998............................... 58,122 $ 58 23,070 $ 38,039 $ (369) $ -- Components of comprehensive loss: Net loss........................................... -- -- -- -- -- -- Change in unrealized loss on investments........... -- -- -- -- -- (112) Foreign currency translation adjustment............ -- -- -- -- -- (6) Total comprehensive loss........................... -- -- -- -- -- -- Issuance of warrants to purchase common stock........... -- -- -- 948 -- -- Issuance of common stock in conjunction with initial public offering (less issuance costs of $1,948)........ -- -- 16,100 125,322 -- -- Conversion of preferred stock to common stock in conjunction with initial public offering............ (58,122) (58) 58,122 58 -- -- Exercise of warrants to purchase common stock........... -- -- 264 -- -- -- Exercise of options to purchase common stock, net of repurchases..................................... -- -- 1,134 1,300 -- -- Amortization of deferred stock compensation............. -- -- -- -- 172 -- ------- ---- ------- -------- -------- ------ Balances at June 30, 1999............................... -- -- 98,690 165,667 (197) (118) Components of comprehensive income: Net income......................................... -- -- -- -- -- -- Change in unrealized loss on investments........... -- -- -- -- -- (503) Foreign currency translation adjustment............ -- -- -- -- -- (2) Total comprehensive income......................... -- -- -- -- -- -- Issuance of common stock in conjunction with secondary public offering (less issuance costs of $910) -- -- 4,748 174,028 -- -- Exercise of warrants to purchase common stock........... -- -- 370 -- -- -- Exercise of options to purchase common stock, net of repurchases..................................... -- -- 2,392 3,389 -- -- Issuance of common stock under employee stock purchase plan.................................... -- -- 470 3,966 -- -- Issuance of warrants for goodwill and purchased intangible assets...................................... -- -- -- 54,324 -- -- Tax benefit from employee stock transactions............ -- -- -- 21,600 -- -- Stock compensation for options granted to consultants... -- -- -- 176 -- -- Amortization of deferred stock compensation............. -- -- -- -- 119 -- ------- ---- ------- -------- -------- ------ Balances at June 30, 2000............................... -- -- 106,670 423,150 (78) (623) Components of comprehensive loss: Net loss........................................... -- -- -- -- -- -- Change in unrealized gain on investments........... -- -- -- -- -- 1,325 Foreign currency translation adjustment............ -- -- -- -- -- 67 Total comprehensive loss........................... -- -- -- -- -- -- Exercise of warrants to purchase common stock........... -- -- 58 -- -- -- Exercise of options to purchase common stock, net of repurchases..................................... -- -- 2,128 16,251 -- -- Issuance of common stock under employee stock purchase plan.................................... -- -- 318 8,800 -- -- Issuance of common stock and assumption of stock options in connection with acquisitions................ -- -- 4,242 146,593 (24,416) -- Tax benefit from employee stock transactions............ -- -- -- 45,020 -- -- Stock compensation for options granted to consultants... -- -- -- 841 -- -- Amortization of deferred stock compensation............. -- -- -- -- 4,143 -- ------- ---- ------- -------- -------- ------ Balances at June 30, 2001............................... -- $ -- 113,416 $640,655 $(20,351) $ 769 ======= ==== ======= ======== ======== ======
Total Accumulated Stockholders' Equity........................................................................... 36 Consolidated StatementsDeficit Equity ----------- ------------- Balances at June 30, 1998............................... $(21,859) $ 15,869 Components of comprehensive loss: Net loss........................................... (1,617) (1,617) Change in unrealized loss on investments........... -- (112) Foreign currency translation adjustment............ -- (6) -------- Total comprehensive loss........................... -- (1,735) -------- Issuance of warrants to purchase common stock........... -- 948 Issuance of common stock in conjunction with initial public offering (less issuance costs of $1,948)........ -- 125,322 Conversion of preferred stock to common stock in conjunction with initial public offering............ -- -- Exercise of warrants to purchase common stock........... -- -- Exercise of options to purchase common stock, net of repurchases..................................... -- 1,300 Amortization of deferred stock compensation............. -- 172 -------- -------- Balances at June 30, 1999............................... (23,476) 141,876 Components of comprehensive income: Net income......................................... 20,048 20,048 Change in unrealized loss on investments........... -- (503) Foreign currency translation adjustment............ -- (2) -------- Total comprehensive income......................... -- 19,543 -------- Issuance of common stock in conjunction with secondary public offering (less issuance costs of $910) -- 174,028 Exercise of warrants to purchase common stock........... -- -- Exercise of options to purchase common stock, net of repurchases..................................... -- 3,389 Issuance of common stock under employee stock purchase plan.................................... -- 3,966 Issuance of warrants for goodwill and purchased intangible assets...................................... -- 54,324 Tax benefit from employee stock transactions............ -- 21,600 Stock compensation for options granted to consultants... -- 176 Amortization of deferred stock compensation............. -- 119 -------- -------- Balances at June 30, 2000............................... (3,428) 419,021 Components of comprehensive loss: Net loss........................................... (68,883) (68,883) Change in unrealized gain on investments........... -- 1,325 Foreign currency translation adjustment............ -- 67 -------- Total comprehensive loss........................... -- (67,491) -------- Exercise of warrants to purchase common stock........... -- -- Exercise of options to purchase common stock, net of repurchases..................................... -- 16,251 Issuance of common stock under employee stock purchase plan.................................... -- 8,800 Issuance of common stock and assumption of stock options in connection with acquisitions................ -- 122,177 Tax benefit from employee stock transactions............ -- 45,020 Stock compensation for options granted to consultants... -- 841 Amortization of deferred stock compensation............. -- 4,143 -------- -------- Balances at June 30, 2001............................... $(72,311) $548,762 ======== ========
See accompanying notes to consolidated financial statements. 46 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1) Summary of Significant Accounting Policies Nature of Operations and Basis of Presentation Extreme Networks, Inc. ("Extreme" or the "Company") was incorporated in California on May 8, 1996 and was reincorporated in Delaware on March 31, 1999. Extreme is a leading provider of network infrastructure equipment for business applications and services. The consolidated financial statements include the accounts of Extreme and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated. Investments in which Extreme intends to maintain more than a temporary 20% to 50% interest, or otherwise has the ability to exercise significant influence, are accounted for under the equity method. Investments in which we have less than a 20% interest and/or do not have the ability to exercise significant influence are carried at the lower of cost or estimated realizable value. Assets and liabilities of foreign operations are translated to U.S. dollars at current rates of exchange, and revenues and expenses are translated using weighted average rates. Foreign currency transaction gains and losses have not been significant. Gains and losses from foreign currency translation are included as a separate component of other comprehensive income (loss). Certain items previously reported in specific financial statement captions have been reclassified to conform to the 2001 presentation. Such reclassifications have not impacted previously reported operating income (loss) or net income (loss). Fiscal Year Effective July 1, 1999, Extreme changed its fiscal year from June 30/th/ to a 52/53-week fiscal accounting year. The June 30, 2001 year closed on July 1, 2001 and comprised 52 weeks of revenue and expense activity. All references herein to "fiscal 2001" or "2001" represent the fiscal year ended July 1, 2001. Quarterly results are based upon a 13-week reporting period. Accounting Estimates The preparation of financial statements and related disclosures 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 notes. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, inventory reserves, depreciation and amortization, sales returns, warranty costs and income taxes. Actual results could differ materially from these estimates. Cash Equivalents and Short-Term and Long Term Investments Extreme considers cash and all highly liquid investment securities purchased with an original or remaining maturity of less than three months at the date of purchase to be cash equivalents. Extreme's investments comprise U.S., state and municipal government obligations and corporate securities. Investments with maturities of less than one year are considered short term and investments with maturities greater than one year are considered long term. To date, all marketable securities have been classified as available-for-sale and are carried at fair value, with unrealized gains and losses, when material, reported net-of-tax as a separate component of stockholders' equity. Realized gains and losses on available-for-sale securities are included in interest income. The cost of securities sold is based on specific identification. Premiums and discounts are amortized over the period from acquisition to maturity and are included in investment income, along with interest and dividends. 47 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Extreme also has certain other minority investments in privately held companies. These investments are included in other assets on our balance sheet and are generally carried at cost. We monitor these investments for other than temporary impairment and make appropriate reductions in carrying values when necessary. Extreme recorded write-downs of $1.8 million during the year ended June 30, 2001 related to impairments of its privately held investments. No impairment write-downs were recorded in fiscal 2000 or 1999. A total of $9.9 million of carrying value remained as of June 30, 2001. Fair Value of Financial Instruments The carrying amounts of certain of Extreme's financial instruments, including cash and cash equivalents, approximate fair value because of their short maturities. The fair values of investments are determined using quoted market prices for those securities or similar financial instruments. Derivatives Extreme adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133") for the year ending June 30, 2001. We enter into foreign exchange forward contracts to offset the impact of currency fluctuations on certain nonfunctional operating expenses, denominated in Japanese Yen, the Euro, Swedish Krona and the British pound. The foreign exchange forward contracts we enter into have original maturities ranging from one to three months. We do not enter into foreign exchange forward contracts for trading purposes. We did not hold any forward contracts upon adoption of FAS 133 and recorded no transition adjustments. Extreme did not hold any foreign exchange forward contracts as of June 30, 2001 (see Note 5). Transfer of Financial Assets From time to time, Extreme transfers specifically identified accounts receivable balances from customers to financing institutions, on a non-recourse basis. Extreme records such transfers as sales of the related accounts receivable when it is considered to have surrendered control of such receivables under the provisions of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The impact of the above transactions reduced receivables and increased cash by approximately $9.4 million during fiscal 2001. Inventories Inventories consist of raw materials and finished goods and are stated at the lower of cost or market (on a first-in, first-out basis). Inventories consist of (in thousands):
June 30, 2001 June 30, 2000 ------------- ------------- Raw materials. $20,671 $ 9,501 Finished goods 39,858 14,300 ------- ------- Total...... $60,529 $23,801 ======= =======
Restricted Investments Extreme restricted $80.0 million of its investment securities as collateral for specified obligations of Extreme, as the lessee, under an operating lease for its campus facility. These investment securities are restricted as to the terms of withdrawal and are managed by a third party subject to certain limitations under our investment policy (See Note 4). 48 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Concentration of Credit Risk, Product and Significant Customers and Supplier Information Extreme may be subject to concentration of credit risk as a result of certain financial instruments consisting principally of marketable investments and accounts receivable. Extreme has placed its investments with high-credit quality issuers. Extreme will not invest an amount exceeding 10% of Extreme's combined cash, cash equivalents, short-term and long-term investments in the securities of any one obligor or maker, except for obligations of the United States, obligations of United States agencies and money market accounts. Extreme performs ongoing credit evaluations of its customers and generally does not require collateral. One customer accounted for 16% of our net revenue in 2001, no customer accounted for more than 10% of our net revenue in 2000 and two customers accounted for 21% and 13 % of our net revenue in 1999. One supplier currently manufacturers all of Extreme's ASICs which are used in all of Extreme's networking products. Any interruption or delay in the supply of any of these components, or the inability to procure these components from alternate sources at acceptable prices and within a reasonable time, would materially adversely affect Extreme's business, operating results and financial condition. In addition, qualifying additional suppliers can be time-consuming and expensive and may increase the likelihood of errors. Extreme attempts to mitigate these risks by working closely with its ASIC supplier regarding production planning and product introduction timing. Extreme currently derives substantially all of its revenue from sales of our Summit, BlackDiamond and Alpine products. Extreme expects that revenue from these products will account for a substantial portion of our revenue for the foreseeable future. Accordingly, widespread market acceptance of Extreme's products is critical to our future success. Property and Equipment Property and equipment are stated at cost and depreciated on a straight-line basis over the estimated useful lives of the assets of approximately three years. Property and equipment consist of the following (in thousands):
June 30, 2001 June 30, 2000 ------------- ------------- Computer and other related equipment.......... $ 54,318 $27,257 Office equipment, furniture and fixtures...... 4,291 1,905 Software...................................... 18,613 4,956 Leasehold improvements........................ 3,927 1,802 -------- ------- 81,149 35,920 Less accumulated depreciation and amortization (23,898) (9,170) -------- ------- Property and equipment, net................... $ 57,251 $26,750 ======== =======
49 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Goodwill and Purchased Intangible assets We record goodwill when the cost of net assets we acquire exceeds their fair value. Goodwill is amortized on a straight-line basis over lives ranging from 2 to 5 years. The cost of identified intangible assets is generally amortized on a straight-line basis over periods ranging from 2 to 4 years. Goodwill and purchased intangible assets consist of the following (in thousands):
June 30, 2001 June 30, 2000 ------------- ------------- Goodwill...................... $143,325 $48,050 Purchased intangible assets... 11,158 8,784 -------- ------- 154,483 56,834 Less: accumulated amortization (40,597) (7,052) -------- ------- $113,886 $49,782 ======== =======
Income Taxes Income tax expense (benefit) is based on pre-tax financial accounting income (loss). Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Valuation of Long-Lived Assets, Certain Identifiable Intangibles and Goodwill In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," we regularly perform reviews of the carrying value of long-lived assets and certain identifiable intangibles for impairment. The reviews look for the existence of facts or circumstances, either internal or external, which indicate that the carrying value of the asset cannot be recovered. No such impairment has been indicated to date. If, in the future, management determines the existence of impairment indicators, we would use undiscounted cash flows to initially determine whether impairment should be recognized. If necessary, we would perform a subsequent calculation to measure the amount of the impairment loss based on the excess of the carrying value over the fair value of the impaired assets. If quoted market prices for the assets are not available, the fair value would be calculated using the present value of estimated expected future cash flows. The cash flow calculations would be based on management's best estimates, using appropriate assumptions and projections at the time. Revenue Recognition Extreme generally recognizes product revenue at the time of shipment, assuming that collectibility is probable, unless we have future obligations such as installation or are required to obtain customer acceptance. When significant obligations remain after products are delivered, revenue and related costs are deferred until such obligations are fulfilled. Amounts billed in excess of revenue recognized are included as deferred revenue and accounts receivable in the accompanying consolidated balance sheets. On a prospective basis as of July 2, 2001 we will report deferred revenue and accounts receivable on a net basis in the consolidated balance sheets. Revenue from service obligations under maintenance contracts, is deferred and recognized on a straight-line basis over the contractual period, which is typically 12 months. Extreme makes certain sales to partners in two-tier distribution channels. The first tier consists of a limited number of third-party distributors that sell primarily to resellers and on occasion to end-user customers. Distributors are generally given privileges to return a portion of inventory. Under specified conditions, we grant 50 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) the right to distributors to return unsold products to us. The distributors are contractually limited in terms of the value of products that can be returned to Extreme (up to 15% of net purchases in the immediately preceding calendar quarter to be credited against future purchases). We defer recognition of revenue on sales to distributors until the distributors sell the product. The second tier of the distribution channel consists of a large number of third-party resellers that sell directly to end-users and are not granted return privileges. Extreme generally records revenue to resellers upon shipment net of returns allowances based on its experience. In certain cases, Extreme has guaranteed financial obligations for its customers for the purchase of Extreme equipment. In such cases, Extreme records revenue as payments are received by the financing party. The related equipment cost is amortized to cost of revenue over the financing term. Warranty Reserves Extreme's hardware warranty period is typically 12 months from the date of shipment to the end user. Upon shipment of products to its customers, Extreme estimates expenses for the cost to repair or replace products that may be returned under warranty and accrues the amount as revenue is recognized. Advertising Cooperative advertising obligations are accrued and the costs expensed at the same time the related revenue is recognized. All other advertising costs are expensed as incurred. Advertising expenses for the years ended June 30, 2001, 2000 and 1999 were approximately $11.0 million, $5.5 million and $2.6 million, respectively. Stock-Based Compensation Extreme accounts for its stock options and equity awards in accordance with the provisions of the Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and has elected to follow the "disclosure only" alternative prescribed by SFAS No. 123, "Accounting of Stock-Based Compensation" ("FAS 123"). For non-employees, Extreme computes the fair value of stock-based compensation in accordance with FAS No. 123 and Emerging Issues Task Force (EITF) 96-18, "Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services". In March 2000, the FASB issued Interpretation No. 44 (FIN 44) "Accounting for Certain Transactions involving Stock Compensation--an Interpretation of Accounting Principles Board (APB) Opinion No. 25". FIN 44 clarifies the application of APB Opinion No. 25 and was effective July 1, 2000. The application of FIN 44 did not have a material effect on Extreme's financial position or results of operations. Disclosure about Segments of an Enterprise and Geographic Areas Extreme adopted SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information," (FAS 131), in 1999. FAS 131 establishes standards for reporting information about operating segments as well as geographic areas and major customers. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. 51 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Extreme operates in one segment, the development and marketing of network infrastructure equipment. Extreme markets its products in the United States and in foreign countries through its sales personnel and subsidiaries. Extreme's foreign offices consist of sales, marketing and support activities. Operating income (loss) generated by Extreme's operating foreign subsidiaries and their corresponding identifiable assets were not material in any period presented. Information regarding geographic areas is as follows (in thousands):
Years Ended June 30, ------------------------- 2001 2000 1999 -------- -------- ------- Net revenue: Americas (including North and South).. $231,001 $145,663 $46,186 Europe, Middle East and Asia ("EMEA"). 120,878 51,092 17,880 Japan................................. 91,425 49,942 31,379 Other................................. 47,928 15,259 2,581 -------- -------- ------- $491,232 $261,956 $98,026 ======== ======== =======
Revenue is attributed to regions based on the location of the customers. Net Income (Loss) Per Share Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period, less shares subject to repurchase, and excludes any dilutive effects of options, warrants and convertible securities. Dilutive earnings per share is calculated by dividing net income (loss) by the weighted average number of common shares used in the basic earnings per share calculation plus the dilutive effect of options, warrants and convertible securities. Diluted net loss per share is the same as basic net loss per share in fiscal 2001 and fiscal 1999 because Extreme had net losses in those periods. Had Extreme been profitable in these years, diluted earnings per share would have been impacted by the calculated effect of outstanding stock options of 10,446,000 and 14,390,000, respectively and warrants of 3,000,000 and 0, respectively for fiscal 2001 and fiscal 1999. The following table presents the calculation of basic and diluted net income (loss) per share (in thousands, except per share data):
Years Ended June 30, --------------------------- 2001 2000 1999 -------- -------- ------- Net income (loss)............................................. $(68,883) $ 20,048 $(1,617) ======== ======== ======= Weighted-average shares of common stock outstanding........ 109,655 103,734 27,324 Less: Weighted-average shares subject to repurchase........ (1,302) (3,218) (8,400) -------- -------- ------- Weighted-average shares used in per share calculation--basic.. 108,353 100,516 18,924 Incremental shares using the treasury stock method............ -- 10,652 -- -------- -------- ------- Weighted-average shares used in per share calculation--diluted 108,353 111,168 18,924 ======== ======== ======= Net income (loss) per share--basic............................ $ (0.64) $ 0.20 $ (0.09) ======== ======== ======= Net income (loss) per share--diluted.......................... $ (0.64) $ 0.18 $ (0.09) ======== ======== =======
52 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Share and per-share data presented reflect the two-for-one stock split effective to stockholders of record on August 10, 2000. Recently Issued Accounting Standards In December 1999, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No.101, "Revenue Recognition in Financial Statements", which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. Extreme adopted SAB 101 in the fourth quarter of fiscal 2001. The application of SAB 101 has not had a material impact on the business, results of operations or financial condition of Extreme. In September 2000, the Financial Accounting Standards Board issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--a replacement of FASB Statement No. 125" ("FAS 140"). FAS 140 revises certain standards for accounting for securitization and other transfers of financial assets and collateral. In addition, FAS No. 140 requires certain additional disclosures that were not previously required. The additional disclosure requirements were effective for financial statements for fiscal years ending after December 15, 2000 and have been adopted for the year ended June 30, 2001. The revised accounting standards of FAS 140 are effective for transactions occurring after March 31, 2001. The application of the revised accounting standards of FAS 140 has not had a material impact on the business, results of operations or financial condition of Extreme. In July 2001, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" ("FAS 141"). FAS 141 establishes new standards for accounting and reporting for business combinations and requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. We will adopt this statement in fiscal 2002. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"), which establishes new standards for goodwill and other intangible assets. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The amortization provisions of FAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company will apply the new accounting rules beginning fiscal year 2003. We are currently assessing the financial impact FAS No. 142 will have on our Consolidated Financial Statements. Goodwill and intangible assets from business combinations before July 1, 2001 will continue to be amortized prior to the adoption of FAS 142. Upon the adoption of FAS 142, we are required to evaluate our existing goodwill and intangible assets from business combinations completed before July 1, 2001 and make any necessary reclassifications in order to comply with the new criteria in FAS 141 for recognition of intangible assets. 53 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 2) Available-for-Sale Securities The following is a summary of available-for-sale securities (in thousands):
Unrealized Unrealized Amortized Fair Holding Holding Cost Value Gains Losses --------- -------- ---------- ---------- June 30, 2001: Money market fund.............. $ 387 $ 387 $ -- $ -- Commercial paper............... 20,964 20,952 2 (14) U.S. corporate debt securities. 98,291 99,013 862 (140) U.S. government agencies....... 8,624 8,624 -- -- Market auction preferreds...... 12,037 12,037 -- -- -------- -------- ---- ----- $140,303 $141,013 $864 $(154) ======== ======== ==== ===== Classified as: Cash Flows.................................................................................... 37 Notes to Consolidated Financial Statements............................................................................... 38equivalents........... $ 37,233 $ 37,233 $ 14 $ (14) Short-term investments..... 68,576 69,374 798 -- Investments................ 34,494 34,406 52 (140) -------- -------- ---- ----- $140,303 $141,013 $864 $(154) ======== ======== ==== ===== Unrealized Unrealized Amortized Fair Holding Holding Cost Value Gains Losses --------- -------- ---------- ---------- June 30, 2000: Money market fund.............. $ 12,372 $ 12,372 $ -- $ -- Commercial paper............... 71,929 71,889 -- (40) U.S. corporate debt securities. 107,994 107,410 29 (613) U.S. government agencies....... 9,800 9,809 11 (2) U.S. tax exempt securities..... 10,000 10,000 -- -- -------- -------- ---- ----- $212,095 $211,480 $ 40 $(655) ======== ======== ==== ===== Classified as: Cash equivalents........... $100,736 $100,696 $ -- $ (40) Short-term investments..... 66,976 66,640 26 (362) Investments................ 44,383 44,144 14 (253) -------- -------- ---- ----- $212,095 $211,480 $ 40 $(655) ======== ======== ==== =====
323) Business Combinations and Investments During the fiscal year ended June 30, 2000, Extreme acquired certain assets of a company for a total cost of approximately $2.5 million. During the quarter ended September 30, 2000, Extreme acquired certain assets of a company for a total cost of $1.1 million. Extreme accounted for these acquisitions using the purchase method of accounting. The entire amount of the purchase prices was allocated to goodwill and purchased intangible assets. Extreme recorded approximately $829,000 and $261,000 for amortization related to these acquisitions in the years ended June 30, 2001 and 2000, respectively. In April 2000, Extreme issued fully earned, non-forfeitable, fully exercisable warrants with a two year life to purchase 3 million shares of Extreme's common stock with an exercise price of $39.50 per share to a networking company in consideration of the networking company's selection of Extreme as the preferred vendor of next generation core backbone switching products to a certain group of the networking company's customers. The fair value of the warrants was approximately $54.3 million. The warrants were valued under a Black-Scholes 54 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) model, using a volatility assumption of 104% and a two-year term. The value of the warrants is being amortized over approximately two years, which is the estimated economic life of the acquired intangibles, comprising of customer list, workforce and goodwill. Extreme recorded approximately $27.2 million and $6.8 million for amortization related to this acquisition in the years ended June 30, 2001 and 2000, respectively. Optranet On January 31, 2001 Extreme acquired privately-held Optranet, Inc. ("Optranet"), a developer of broadband access equipment in which Extreme previously held a minority interest. In addition, a related party of Extreme was a significant investor of Optranet at the time of Extreme's initial investment. The acquisition was accounted for using the purchase method of accounting and accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. Since January 31, 2001, Optranet's results of operations have been included in Extreme's Consolidated Statements of Operations. The fair value of the intangible assets was determined based upon a valuation using a combination of methods, including an income approach for the technology and a cost approach for the assembled workforce. The purchase price of approximately $73.2 million consisted of an exchange of 1.4 million shares of Extreme's common stock with a fair value of $50.5 million, assumed stock options with a fair value of $22.3 million, $0.2 million in acquisition related expenses and Extreme's net minority investment of $0.2 million. The purchase price was allocated, with the assistance of an independent valuation, to assembled workforce of $1.5 million, in-process research and development of $13.4 million, deferred compensation of $21.9 million and tangible net assets assumed of $2.6 million, net of deferred tax liabilities of $7.4 million resulting in goodwill of $41.2 million. The value of the acquired in-process technology was computed using a discounted cash flow analysis rate of 30% on the anticipated income stream of the related product revenue. The discounted cash flow analysis was based on management's forecast of future revenue, cost of revenue and operating expenses related to the products and technologies purchased from Optranet. The calculation of value was then adjusted to reflect only the value creation efforts of Optranet prior to the close of the acquisition. The acquired intangible assets and goodwill are being amortized using the straight-line method over their estimated useful lives of five years. Amortization of acquired intangibles and goodwill associated with this acquisition totaled $2.8 million for fiscal 2001. Extreme recognized deferred stock compensation associated with unvested stock options issued to employees that were assumed in conjunction with the acquisition. This amount is included as a component of stockholders' equity and is being amortized ratably by charges to operations over the vesting period of the options. Amortization of stock-based compensation associated with this acquisition totaled $3.8 million in fiscal 2001 and relates to options awarded to employees in research and development. As of January 31, 2001, Optranet had in-process research and development efforts under way for the design and development of printed circuit boards ("PCB"). These PCBs will deliver networking solutions that allow for high speed Ethernet Layer 3 switching and IP services over wide area T-1 and DS-3 network technologies, and VDSL modules over voice grade cabling. The development efforts for the products were at varying levels of completion estimated to be between 20% and 85%, had a fair value of $13.4 million as of January 31, 2001 and are expected to be completed during the first six months of fiscal 2002. Webstacks On March 7, 2001 Extreme acquired privately-held Webstacks, Inc. ("Webstacks"), a developer of broadband access equipment in which Extreme previously held a minority interest. In addition, a related party of Extreme was a significant investor of Webstacks at the time of Extreme's initial investment. The acquisition was 55 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) accounted for using the purchase method of accounting and accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. Since March 7, 2001, Webstack's results of operations have been included in Extreme's Consolidated Statements of Operations. The fair value of the intangible assets was determined based upon a valuation using a combination of methods, including an income approach for the technology and a cost approach for the assembled workforce. The purchase price of approximately $74.7 million consisted of an exchange of 2.9 million shares of Extreme's common stock with a fair value of $71.2 million, assumed stock options with a fair value of $2.8 million, $0.3 million in acquisition related expenses and Extreme's net minority investment of $0.4 million. The purchase price was allocated, with the assistance of an independent valuation, to assembled workforce of $0.9 million, in-process research and development of $16.8 million, deferred compensation of $2.5 million, tangible and other net assets assumed of $1.4 million, resulting in goodwill of $53.1 million. Under the terms of the Merger Agreement with Webstacks, Extreme is obligated to pay $15.0 million of additional cash consideration on or before October 31, 2001 provided that certain technology milestones are met. The value of the acquired in-process technology was computed using a discounted cash flow analysis rate of 30% on the anticipated income stream of the related product revenue. The discounted cash flow analysis was based on management's forecast of future revenue, cost of revenue and operating expenses related to the products and technologies purchased from Webstacks. The calculation of value was then adjusted to reflect only the value creation efforts of Webstacks prior to the close of the acquisition. The acquired intangible assets and goodwill are being amortized using the straight-line method over their estimated useful lives of five years. Amortization of acquired intangibles and goodwill associated with this acquisition totaled $2.7 million for fiscal 2001. Extreme recognized deferred stock compensation associated with unvested stock options issued to employees that were assumed in conjunction with the acquisition. This amount is included as a component of stockholders' equity and is being amortized ratably by charges to operations over the vesting period of the options. Amortization of stock-based compensation associated with this acquisition totaled $0.3 million in fiscal 2001 and relates to options awarded to employees in research and development. As of March 7, 2001, Webstacks had in-process research and development efforts under way for the design and development of both stand alone proxy switches and PCBs. These switches and PCBs will extend Extreme's IP services to provide robust Layer 4 - 7 switching solutions required for building today's high-performance content aware networks. The development efforts for the products were at varying levels of completion estimated to be between 45% and 60%, had a fair value of $16.8 million as of March 7, 2001 and are expected to be completed by January 2002. Pro forma results of operations have not been presented for Optranet or Webstacks because the prior operating results of these entities were not material on either an individual or an aggregate basis. 4) Commitments and contingencies Leases In June 2000, we entered into two operating lease agreements for approximately 16 acres of land and the accompanying 275,000 square feet of buildings to house our primary facility in Santa Clara, California. Our lease payments will vary based on LIBOR which was 4.3% at June 30, 2001, plus a spread. Our combined lease payments are estimated to be approximately $3.4 million on an annual basis over the lease terms. The leases are for five years and can be renewed for two five-year periods, subject to the approval of the lessor. At the expiration or termination of the leases, we have the option to either purchase these properties for $31.4 million 56 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) and $48.6 million, respectively, or arrange for the sale of the properties to a third party for at least $31.4 million and $48.6 million, respectively, with a contingent liability for any deficiency. If the properties under these leases are not purchased or sold as described above, we will be obligated for additional lease payments of approximately $30.5 million and $41.3 million respectively. As part of the above lease transaction, Extreme restricted $80.0 million of its investment securities as collateral for specified obligations of the lessor under the lease. These investment securities are restricted as to withdrawal and are managed by a third party subject to certain limitations under Extreme's investment policy. The lease also requires us to maintain specified financial covenants with which we were in compliance as of June 30, 2001. Extreme also leases office space for its various U.S. and international sales offices. Future payments under all noncancelable operating leases (net of future committed sublease proceeds of $6,869 under noncancelable subleases) at June 30, 2001 are as follows (in thousands):
Years ending June 30: 2002............... $ 7,573 2003............... 8,943 2004............... 10,074 2005............... 10,182 2006............... 6,497 Thereafter......... 17,205 ------- Total minimum payments $60,474 =======
Rent expense was approximately $11.7 million, $2.9 million and $0.7 million for 2001, 2000 and 1999, respectively, net of sublease income of $3.6 million, $0.3 million and $ 0.0 in the respective periods. Sublease income netted from the amounts in the above schedule for the fiscal years 2002, 2003, 2004 and 2005 is projected to be $3.6 million, $2.1million, $0.7 million and $0.5 million, respectively. As part of our business relationship with MCMS, one of our contract manufacturers, we have entered into a $9.0 million equipment lease for manufacturing equipment with a third party financing company; we in turn sublease the equipment to MCMS. Legal Proceedings On March 14, 2001, Nortel Networks, Inc. and Nortel Networks Limited (collectively, "Nortel") filed suit against us in the United States District Court for the District of Massachusetts, Civil Action No. 01-10443EFH. The complaint alleges willful infringement of U.S. Patent Nos. 5,790,554 (the "554 Patent"); 5,490,252; 5,408,469; 5,398,245; 5,159,595 and 4,736,363, and seeks a judgment: (a) determining that the Company has infringed each of the six patents; (b) permanently enjoining and restraining the Company from further infringement of each of the six patents; and (c) awarding unspecified amounts of trebled damages, together with interest, costs and attorneys' fees. We answered Nortel's complaint on May 17, 2001, denying that we have infringed any of the six patents and also asserting various affirmative defenses and counterclaims that seek judgment: (a) that Nortel's complaint be dismissed; (b) that each of the six patents be declared invalid; (c) declaring that we are not infringing any of the six patents; and (d) that Nortel pay our attorneys' fees and costs. On May 17, 2001, we also sought transfer of the action to the United States District Court for the Northern District of California. On June 28, 2001, the court denied our motion to transfer, and the action will thus proceed 57 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) in Massachusetts. On July 9, 2001, the court granted a motion by F5 Networks, Inc. ("F5") to intervene in the action. F5 contends that it is the designer, developer, and manufacturer of the product accused of infringing the '554 Patent of Count VI of Nortel's complaint. F5 had also sought to sever and transfer Count VI in favor of an action concerning the '554 Patent pending between F5 and Nortel in the United States District Court for the Western District of Washington, but that motion was denied on July 9, 2001 without opinion. On July 13, 2001, Nortel demanded $150 million in settlement of alleged past damages. Discovery is proceeding. As set forth above, we have denied Nortel's allegations and intend to defend the action vigorously. We cannot assure you, however, that we will prevail in this litigation, which could have a material, adverse effect on our business, financial condition and results of operations in the future. Extreme is subject to other legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows. 5) Foreign Exchange Forward Contracts On July 2, 2000, Extreme adopted FAS 133, which requires that all derivatives be recorded on the balance sheet at fair value. Changes in the fair value of derivatives that do not qualify, or are not effective as hedges must be recognized currently in earnings. Upon adoption, we did not hold any derivative instruments. Extreme sells products around the globe in US dollars but has international operations with expenses in foreign currencies which are paid from Extreme's US dollar cash flows. Extreme has a foreign currency cash flow hedging program to minimize the foreign currency risk associated with the forecasted cash flows using forward contracts with a maximum term of 90 days. If the US dollar weakens against the foreign currencies (primarily Japanese Yen, the Euro, Swedish Krona and the British pound), the increase in the cost of the forecasted foreign currency denominated expenses is offset by the increase in value of the forward contracts designated as hedges. Conversely, when the US dollar strengthens, the decline in cost of the forecasted foreign currency cash flows offsets the losses in the value of the forward contracts. As the critical terms of the forward contract and the underlying exposure are matched at inception, forward contract effectiveness is calculated by comparing the change in the fair value of the contract to the change in fair value of the anticipated expense, with the effective portion of the hedge recorded in accumulated other comprehensive income (loss). Any residual change in fair value of the instruments is recognized immediately in other income (expense), net. No ineffectiveness was recognized in fiscal 2001. We did not hold any forward exchange forward contracts as of June 30, 2001. 6) Stockholders' Equity Common Stock Offerings In April 1999, Extreme completed an initial public offering of 16,100,000 shares of common stock (including the underwriters' over-allotment provision) at a price of $8.50 per share. Concurrent with the initial public offering, all outstanding shares of preferred stock were converted to a total of 58,122,630 shares of common stock. Net proceeds from the offering were approximately $125.3 million net of offering costs. On October 20, 1999, Extreme announced the completion of a secondary public offering of approximately 15 million shares (including the underwriters' over-allotment provision) of its common stock at a price of $38.50 per share. Of these shares, Extreme sold 4,745,416 shares and existing stockholders sold 10,204,584 shares. Extreme raised approximately $174.0 million net of offering costs. 58 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Stock Split On July 19, 2000 Extreme announced a two-for-one stock split in the form of a stock dividend paid on August 24, 2000 to stockholders of record on August 10, 2000. All share and per share data have been restated to give retroactive effect to this stock split. Preferred Stock The number of shares of preferred stock authorized to be issued at June 30, 2001 is 2,000,000 with a par value of $0.001 per share. The preferred stock may be issued from time to time in one or more series. The board of directors is authorized to provide for the rights, preferences and privileges of the shares of each series and any qualifications, limitations or restrictions on these shares. As of June 30, 2001, no shares of preferred stock were outstanding. Warrants In November 1996, Extreme issued warrants to a lease financing company to purchase 420,000 shares of Series A convertible preferred stock with an exercise price of $0.17 per share, in consideration for equipment leases and a loan. In July 1997, Extreme issued warrants to the same lease financing company to purchase 96,694 shares of Series B convertible preferred stock with an exercise price of $0.69 per share, in consideration for equipment leases. Concurrent with the initial public offering, these warrants converted into the right to purchase an equivalent number of shares of common stock at the same exercise price per share. In May 1999, 294,000 of the shares under these warrants were exercised. In August 1999, the remaining 222,694 of the shares under these warrants were exercised. In November 1997, Extreme issued warrants to a lease financing company to purchase 158,102 shares of Series C convertible preferred stock with an exercise price of $1.27, in consideration for a loan. Concurrent with the initial public offering, these warrants converted into the right to purchase an equivalent number of shares of common stock at the same exercise price per share. In August 1999, all of the 158,102 warrants were exercised. In June 1999, Extreme issued fully vested, non-forfeitable and exercisable warrants to a business partner to purchase 80,000 shares of Extreme's common stock with an exercise price of $29.03 per share. The fair value of these warrants was approximately $948,000. This value was expensed in fiscal 1999 as the warrants were issued in exchange for services rendered. In fiscal 2001, all of these warrants were exercised. As discussed in Note 3, in April 2000 in connection with the acquisition of purchased intangibles and goodwill, Extreme issued fully earned, non-forfeitable, fully exercisable warrants with a two year life to purchase 3 million shares of Extreme's common stock with an exercise price of $39.50 per share. At June 30, 2001 all of these warrants were outstanding. These warrants will expire in April 2002 if unexercised at that date. Deferred Stock Compensation In June 2000, Extreme issued fully vested, non-forfeitable and exercisable options to consultants to purchase 120,000 shares of Extreme's common stock with an exercise price of $14.02 per share. The fair value of these options was approximately $1.7 million. The options were valued under a Black-Scholes model, using a volatility assumption of 104%. This amount will be amortized over two years as the services are rendered. The compensation expense for the years ended June 30, 2001 and 2000 was $841,000 and $176,000, respectively. 59 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) During fiscal 2001, Extreme recognized stock-based compensation expense associated with unvested stock options issued to employees assumed in the acquisitions of Optranet and Webstacks of $21.9 million and $2.5 million, respectively (see Note 3). These amounts are included as a reduction of stockholders' equity and are being amortized ratably by charges to operations over the vesting period of the options. Extreme recorded amortization of deferred stock compensation expense of approximately $4.1 million, $119,000 and $172,000 for the years ended June 30, 2001, 2000 and 1999, respectively. At June 30, 2001, Extreme had a total of approximately $20.4 million remaining to be amortized over the corresponding vesting period of each respective option, generally four years. Stockholders' Rights Agreement In April 2001, the board of directors approved a Stockholders' Rights Agreement ("Rights Agreement"), declaring a dividend of one preferred share purchase right for each outstanding share of common stock, par value $0.001 per share, of Extreme common stock. The Rights Agreement is intended to protect stockholders' rights in the event of an unsolicited takeover attempt. It is not intended to prevent a takeover of Extreme on terms that are favorable and fair to all stockholders and will not interfere with a merger approved by the board of directors. In the event the rights become exercisable, each right entitles stockholders to buy, at an exercise price of $150 per right owned, a unit equal to a portion of a new share of Extreme Series A Preferred Stock. The rights will be exercisable only if a person or a group acquires or announces a tender or exchange offer to acquire 15% or more of the Extreme's common stock. The rights, which expire in April 2011, are redeemable for $0.001 per right at the approval of the board of directors. Comprehensive Income (Loss) The following are the components of accumulated other comprehensive income (loss), net of tax (in thousands):
June 30, June 30, 2001 2000 -------- -------- Unrealized gain (loss) on investments......... $710 $(615) Foreign currency translation adjustments...... 59 (8) ---- ----- Accumulated other comprehensive income (loss) $769 $(623) ==== =====
7) Employee Benefit Plans 1999 Employee Stock Purchase Plan In January 1999, the board of directors approved the adoption of Extreme's 1999 Employee Stock Purchase Plan (the "1999 Purchase Plan"). A total of 4,000,000 shares of common stock have been reserved for issuance under the 1999 Purchase Plan. The 1999 Purchase Plan permits eligible employees to acquire shares of Extreme's common stock through periodic payroll deductions of up to 15% of total compensation. No more than 1,250 shares may be purchased on any purchase date per employee. Each offering period will have a maximum duration of 12 months. The price at which the common stock may be purchased is 85% of the lesser of the fair market value of Extreme's common stock on the first day of the applicable offering period or on the last day of the respective purchase period. The initial offering period commenced on the effectiveness of the initial public offering and ended on April 30, 2000. Through June 30, 2001, 788,797 shares were purchased under the 1999 Purchase Plan. 60 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Amended 1996 Stock Option Plan In January 1999, the board of directors approved an amendment to the 1996 Stock Option Plan (the "1996 Plan") to (i) increase the share reserve by 10,000,000 shares, (ii) to remove certain provisions which are required to be in option plans maintained by California privately-held companies and (iii) to rename the 1996 Plan as the "Amended 1996 Stock Option Plan." Under the 1996 Plan, which was originally adopted in September 1996, options may be granted for common stock, pursuant to actions by the board of directors, to eligible participants. A total of 39,322,098 shares have been reserved under the 1996 Plan. Options granted are exercisable as determined by the board of directors. Options vest over a period of time as determined by the board of directors, generally four years. The term of the 1996 Plan is ten years. Options to purchase approximately 153,402, 1,470,286 and 4,655,558 shares of common stock have been exercised as of June 30, 2001, 2000 and 1999, respectively, but are subject to repurchase until vested. As of June 30, 2001, 445,483 shares were available for future grant under the 1996 Plan. 2000 Stock Option Plan In March 2000, the board of directors adopted the 2000 Nonstatutory Stock Option Plan (the "2000 Plan"). Options may be granted for common stock, pursuant to actions by the board of directors, to eligible participants. Generally, only non-officer employees are eligible to participate in this stock plan, except that options may be granted to officers under this plan in connection with written offers of employment. A total of 4,000,000 shares have been reserved under the 2000 Plan. Options vest over a period of time as determined by the board of directors, generally four years. The term of the 2000 Plan is ten years. As of June 30, 2001, 453,414 shares were available for future grant under the 2000 Plan. 2001 Stock Option Plan In May 2001, the board of directors adopted the 2001 Nonstatutory Stock Option Plan (the "2001 Plan"). Options may be granted for common stock, pursuant to actions by the board of directors, to eligible participants. Generally, only non-officer employees are eligible to participate in this stock plan, except that options may be granted to officers under this plan in connection with written offers of employment. A total of 4,000,000 shares have been reserved under the 2001 Plan. Options vest over a period of time as determined by the board of directors, generally four years. The term of the 2001 Plan is ten years. As of June 30, 2001, 4,000,000 shares were available for future grant under the 2001 Plan. 61 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table summarizes stock option activity under all plans:
Weighted- Average Number of Exercise Price Shares Per Share ---------- -------------- Options outstanding at June 30, 1998 5,207,870 $ .42 Granted.......................... 5,875,516 $ 5.05 Exercised........................ (1,135,600) $ .93 Canceled......................... (190,252) $ 3.34 ---------- Options outstanding at June 30, 1999 9,757,534 $ 3.04 Granted.......................... 12,404,750 $33.99 Exercised........................ (2,392,472) $ 1.23 Canceled......................... (1,374,704) $26.91 ---------- Options outstanding at June 30, 2000 18,395,108 $22.74 Granted.......................... 11,777,681 $33.27 Exercised........................ (2,128,206) $ 7.56 Canceled......................... (3,067,210) $33.35 ---------- Options outstanding at June 30, 2001 24,977,373 $27.69 ==========
In connection with the acquisitions of Optranet and Webstacks, Extreme has assumed the stock option plans of each company. During fiscal 2001, a total of approximately 608,401 and 115,676 shares of Extreme's common stock have been reserved for issuance under the assumed plans of Optranet and Webstacks, respectively, and the related options have been included as granted in fiscal 2001 in the preceding table. Options to purchase approximately 368,358 and 987,119 shares of common stock have been exercised under the Optranet and Webstacks plans, respectively, as of June 30, 2001 but are subject to repurchase until vested. The following table summarizes significant ranges of outstanding and exercisable options at June 30, 2001:
Options Outstanding Options Exercisable -------------------------------------- --------------------- Weighted- Weighted- Weighted- Average Average Average Number Remaining Exercise Number Exercise Range of Exercise Prices Outstanding Contractual Life Price Exercisable Price ------------------------ ----------- ---------------- --------- ----------- --------- (In years) $ 0.01 -- 5.00 4,686,188 7.10 $ 2.80 4,679,771 $ 2.80 $14.57 -- 14.57 5,942,046 9.44 $14.57 16,664 $14.57 $18.02 -- 33.31 6,529,627 8.37 $30.20 2,200,205 $30.85 $33.56 -- 47.47 5,258,162 8.80 $39.86 1,131,190 $36.15 $47.50 -- 100.69 2,561,350 9.02 $72.30 126,820 $52.85 ---------- --------- $ 0.01 -- 100.69 24,977,373 8.54 $27.69 8,154,650 $15.80 ========== =========
Options to purchase 6,721,582 and 9,368,034 shares were exercisable at June 30, 2000 and 1999, respectively, with a weighted-average exercise price of $3.75 and $2.22, respectively. Stock-Based Compensation Extreme has elected to follow APB Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123, "Accounting for Stock-Based Compensation," ("FAS 123") requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB No. 25, because the exercise price of Extreme's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized in Extreme's financial statements. 62 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENT--(Continued) Pro forma information regarding net income and earnings per share is required by FAS 123. This information is required to be determined as if Extreme had accounted for its employee stock options and shares issued under the 1999 Employee Stock Purchase Plan under the fair value method of that statement. The fair value of options granted in 2001, 2000 and 1999 reported below was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
Stock Option Plan Employee Stock Purchase Plan ----------------------- ---------------------------- Years Ended June 30, Years Ended June 30, ----------------------- ---------------------------- 2001 2000 1999 2001 2000 1999 ------- ------- ------- ------- ------- -------- Expected life.......... 3.1 yrs 3.4 yrs 3.5 yrs 0.6 yrs 0.6 yrs 0.7 yrs. Risk-free interest rate 5.3% 6.3% 5.1% 4.1% 5.4% 5.0% Volatility............. 134% 112% 55% 134% 112% 55% Expected dividend yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because Extreme's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of employee stock options. The weighted-average estimated fair value of options granted in the years ended June 30, 2001, 2000 and 1999 was $25.82 $24.23 and $2.21, respectively. The weighted-average estimated fair value of shares granted under the 1999 Purchase Plan in the years ended June 30, 2001, 2000 and 1999 was $18.91, $7.51 and $2.81, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. Pro forma information follows (in thousands, except per share amounts):
Years Ended June 30, ---------------------------- 2001 2000 1999 --------- -------- ------- Pro forma net loss under FAS 123............. $(216,018) $(31,088) $(4,066) Net loss per share - pro forma under FAS 123: Basic and diluted......................... $ (2.18) $ (0.32) $ (0.22)
The pro forma impact of options on the net loss for the years ended June 30, 2001, 2000 and 1999 is not representative of the effects on net income (loss) for future years as future years will include the effects of additional years of stock option grants. 401(k) Plan Extreme provides a tax-qualified employee savings and retirement plan, commonly known as a 401(k) plan (the "Plan"), which covers our eligible employees. Pursuant to the Plan, employees may elect to reduce their current compensation up to the lesser of 20% or the statutorily prescribed limit of $10,500 for calendar years 2000 and 2001. The amount of the reduction is contributed to the 401(k) plan on a pre-tax basis. 63 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Extreme provides for discretionary matching contributions as determined by the board of directors for each calendar year. As of September 2000, the board of directors set the match at $0.25 for every dollar contributed by the employee up to the first 4% of pay. The same level of match was continued during the 2001 calendar year. All matching contributions vest immediately effective September 2000. In addition, the Plan provides for discretionary contributions as determined by the board of directors each year. Extreme's matching contributions to the Plan totaled $378,391 for the fiscal year ended June 30, 2001. No discretionary contributions were made in fiscal 2001, 2000, or 1999. 8) Income Taxes The provision for (benefit from) income taxes for the years ended June 30, 2001, 2000 and 1999 consists of the following (in thousands):
Years Ended June 30, -------------------------- 2001 2000 1999 -------- -------- ------ Current: Federal............................... $ 5,234 $ 24,811 $ 350 State................................. 823 2,026 200 Foreign............................... 1,560 306 1,100 -------- -------- ------ Total current............................ $ 7,617 $ 27,143 $1,650 ======== ======== ====== Deferred: Federal............................... $(25,477) $(15,497) $ -- State................................. (4,808) (1,325) -- -------- -------- ------ Total deferred........................... $(30,285) $(16,822) $ -- ======== ======== ====== Provision for (benefit from) income taxes $(22,668) $ 10,321 $1,650 ======== ======== ======
The tax benefit resulting from the exercise of nonqualified stock options and the disqualifying dispositions of shares acquired under Extreme's incentive stock option plans was $45.0 million and $21.6 million for the fiscal years ended June 30, 2001 and 2000, respectively. Such benefit was credited to additional paid-in capital. Pretax income (loss) from foreign operations was $649,000, $(10.7 million) and $(7.0 million) in the fiscal years ended June 30, 2001, 2000 and 1999, respectively. 64 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The difference between the provision (benefit) for income taxes and the amount computed by applying the Federal statutory income tax rate (35 percent) to income (loss) before taxes is explained below (in thousands):
Years Ended June 30, ------------------------- 2001 2000 1999 -------- ------- ------ Tax at federal statutory rate (benefit).... $(32,043) $10,666 $ 11 State income tax........................... (2,739) 1,018 200 Federal alternative minimum taxes.......... -- -- 350 Foreign taxes.............................. -- 69 1,100 Unbenefited (utilized) net operating losses -- (773) (11) Tax credits................................ (1,209) (1,576) -- Valuation allowance decrease............... -- (5,148) -- Unbenefited foreign loss................... 1,187 3,974 -- Nondeductible goodwill..................... 1,894 -- -- Nondeductible in-process R&D............... 10,555 -- -- Other...................................... (313) 2,091 -- -------- ------- ------ Total................................... $(22,668) $10,321 $1,650 ======== ======= ======
Significant components of Extreme's deferred tax assets are as follows (in thousands):
As of June 30, ---------------- 2001 2000 ------- ------- Deferred tax assets: Net operating loss carryforwards..................... $27,948 $ 431 Tax credit carryforwards............................. 10,183 2,358 Depreciation......................................... 1,085 1,951 Deferred revenue..................................... 8,859 3,545 Warrant amortization................................. 13,200 2,673 Inventory reserves................................... 9,799 734 Other reserves and accruals.......................... 13,484 6,708 ------- ------- Total deferred tax assets............................... 84,558 18,400 Deferred tax liability - acquisition related intangibles (8,675) -- ------- ------- Net deferred tax assets................................. $75,883 $18,400 ======= =======
The net valuation allowance decreased by $8.5 million during the year ended June 30, 2000. As of June 30, 2001, Extreme had net operating loss carryforwards for federal and state tax purposes of approximately $74.1 million and $38.0 million, respectively. Extreme also had federal and state tax credit carryforwards of approximately $6.6 million and $5.4 million, respectively. Unused net operating loss and tax credit carryforwards will expire at various dates beginning in the years 2004 and 2012, respectively. Utilization of the net operating losses and tax credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating losses and tax credits before utilization. 65 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 9) Other Operating Expenses Other operating expenses for fiscal 2001 consists of a write-off of acquired in-process research and development of $30.2 million and a restructuring charge of $5.9 million. Extreme recorded in-process research and development charges of $13.4 million related to the purchase of Optranet on January 31, 2001 and $16.8 million related to the purchase of Webstacks on March 7, 2001. The value assigned to purchased in-process research and development was determined through valuation techniques generally used by appraisers in the high-technology industry and was immediately expensed in the period of acquisition because technological feasibility had not been established and no alternative use had been identified. The charges are discussed in more detail in Note 3. In March 2001, we implemented a restructuring plan in order to lower our overall cost structure. In connection with the restructuring, we reduced our headcount and consolidated facilities. The restructuring expense included $2.3 million for the write-off and write-down in carrying value of Summit based equipment, $1.8 million for severance and benefits for approximately 100 terminated employees and $1.8 million in facility closure expenses. The number of temporary employees and contractors used by us was also reduced. The following analysis sets forth the significant components of the restructuring reserve at June 30, 2001 (in thousands):
Severance Facility Equipment and Benefits Closure Total --------- ------------ -------- ------- Restructuring charge............ $ 2,321 $ 1,848 $1,772 $ 5,941 Cash charge..................... -- (1,848) (29) (1,877) Non-cash charge................. (2,321) -- -- (2,321) ------- ------- ------ ------- Reserve balance at June 30, 2001 $ -- $ -- $1,743 $ 1,743 ======= ======= ====== =======
10) Subsequent Event Beginning on July 6, 2001, multiple purported securities fraud class action complaints were filed in the United States District Court for the Southern District of New York. We are aware of at least two such complaints, Capuano v. Morgan Stanley & Co., Inc., et al, No. 01 CV 6148 (S.D.N.Y. July 6, 2001) (which does not name us or our officers or directors as defendants) and Hui v. Extreme Networks, Inc., et al., No. 01 CV 6700 (S.D.N.Y. July 23, 2001). The complaints are brought purportedly on behalf of all persons who purchased our common stock from November 17, 1999 through December 6, 2000. The Hui complaint names as defendants Extreme Networks and certain of our present and former officers; and several investment banking firms that served as underwriters of our initial public offering. It alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that the registration statement for the offering did not disclose that: (1) the underwriters had agreed to allow certain customers to purchase shares in the offering in exchange for excess commissions paid to the underwriters; and (2) the underwriters had arranged for certain customers to purchase additional shares in the aftermarket at pre-determined prices. We are aware that similar allegations have been made in lawsuits challenging over 140 other initial public offerings conducted in 1999 and 2000. No specific damages are claimed. We believe that the allegations against us and the officers are without merit, and intend to contest them vigorously. We cannot assure you, however, that we will prevail in this litigation. Failure to prevail could have a material adverse effect on our consolidated financial position, results of operations and cash flows in the future. 66 Report of Ernst & Young LLP, Independent Auditors The Board of Directors and Stockholders Extreme Networks, Inc. We have audited the accompanying consolidated balance sheets of Extreme Networks, Inc. as of June 30, 20002001 and 1999,2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended June 30, 2000.2001. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Extreme Networks, Inc. at June 30, 20002001 and 1999,2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2000,2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ErnstERNST & YoungYOUNG LLP Palo Alto, California July 18, 2000, except for Note 9, as to which the date is August 24, 2000 3316, 2001 67 EXTREME NETWORKS, INC. CONSOLIDATED BALANCE SHEETSQUARTERLY FINANCIAL DATA (In thousands, except share and per share amounts) ASSETS(unaudited)
June 30, ---------------------Mar. 31, Dec. 31, Sept. 30, 2001 2001 2000 1999 --------- --------- Current assets: Cash and cash equivalents................................. $ 116,721 $ 107,143 Short-term investments.................................... 66,640 16,422 Accounts receivable, net of allowance for doubtful accounts of $1,237 in 2000 and $1,374 in 1999........... 60,996 20,797 Inventories............................................... 23,801 2,626 Other current assets...................................... 34,326 1,978 --------- --------- Total current assets.............................. 302,484 148,966 Property and equipment, net................................. 26,750 6,506 Restricted investments...................................... 80,000 -- Investments................................................. 44,144 16,097 Goodwill and purchased intangibles.......................... 49,782 -- Other assets................................................ 12,770 234 --------- --------- $ 515,930 $ 171,803 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 39,023 $ 13,418 Accrued compensation...................................... 6,759 2,500 Accrued commissions....................................... 4,282 1,600 Leasehold improvements allowance.......................... 8,424 -- Deferred revenue.......................................... 22,042 1,717 Other accrued liabilities................................. 12,935 7,394 Income tax liability...................................... 3,138 1,650 Capital lease obligations, current portion................ -- 1,648 ---------- ---------- Total current liabilities......................... 96,603 29,927 Long term deposit........................................... 306 -- Commitments (Note 4) Stockholders' equity: Convertible preferred stock, $.001 par value, issuable in series: 2,000,000 shares authorized; no shares issued and outstanding.................................. -- -- Common stock, $.001 par value; 150,000,000 shares authorized; 106,670,964 and 98,690,460 shares issued and June 30, 2000 and 1999, respectively........ 106 98 Additional paid-in capital................................ 423,044 165,569 Deferred stock compensation............................... (78) (197) Accumulated other comprehensive loss...................... (623) (118) Accumulated deficit....................................... (3,428) (23,476) --------- --------- Total stockholders' equity........................ 419,021 141,876 --------- --------- $ 515,930 $ 171,803 ========= =========
See accompanying notes to consolidated financial statements. 34 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
Years Ended June 30, ----------------------------------- 2000 1999 1998 ----------- --------- -------- Net revenue....................................... $261,956 $ 98,026 $ 23,579 Cost of revenue................................... 126,916 48,520 14,897 -------- --------- -------- Gross profit...................................... 135,040 49,506 8,682 Operating expenses: Research and development........................ 32,737 17,036 10,668 Sales and marketing............................. 67,146 27,056 9,601 General and administrative...................... 11,852 6,859 2,440 Amortization of goodwill and purchased intangibles.................................... 7,051 -- -- -------- -------- -------- Total operating expenses................... 118,786 50,951 22,709 -------- -------- -------- Operating income (loss)........................... 16,254 (1,445) (14,027) Interest income................................... 14,638 1,855 Interest expense.................................. (490) (398) (326) Other income (loss), net.......................... (33) 21 (196) -------- -------- -------- Income (loss) before income taxes................. 30,369 33 (13,936) Provision for income taxes........................ 10,321 1,650 -- -------- -------- -------- Net income (loss)................................. $ 20,048 $ (1,617) $(13,936) ======== ======== ======== Basic net income (loss) per share................. $ 0.20 $ (0.09) $ (1.59) Diluted net income (loss) per share............... $ 0.18 $ (0.09) $ (1.59) Weighted average shares outstanding used in computing basic net income (loss) per share................................. 100,516 18,924 8,758 Weighted average shares outstanding used in computing diluted net income (loss) per share.......................... 111,168 18,924 8,758
See accompanying notes to consolidated financial statements. 35 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (in thousands, except share amounts)
Convertible Accumulated Preferred Stock Common Stock Additional Deferred Other --------------- ------------ Paid-In Stock Comprehensive Shares Amount Shares Amount Capital Compensation Loss ------ ------ ------ ------ ------- ------------ ---- Balances at June 30, 1997 ................. 46,932 $ 46 21,620 $ 22 $ 17,160 $ -- $ -- Issuance of warrant for 96,694 shares of Series B convertible preferred stock ..... -- -- -- -- 28 -- -- Issuance of Series C convertible preferred stock to investors for cash (less issuance costs of $416)................... 11,190 12 -- -- 20,105 -- -- Issuance of warrant for 140,352 shares of Series C convertible preferred stock ..... -- -- -- -- 140 -- -- Exercise of options to purchase common stock ............................. -- -- 1,450 2 145 -- -- Deferred stock compensation ............... -- -- -- -- 437 (437) -- Amortization of deferred stock compensation ............................. -- -- -- -- -- 68 -- Net loss .................................. -- -- -- -- -- -- -- ------ ---- ------- ---- ------ ----- ---- Balances at June 30, 1998 ................. 58,122 58 23,070 24 38,015 (369) -- Comprehensive loss: Net loss ................................. -- -- -- -- -- -- -- Other comprehensive loss, net of tax: Change in unrealized loss on investments............................. -- -- -- -- -- -- (112) Foreign currency translation adjustment.. -- -- -- -- -- -- (6) Other comprehensive loss ................. -- -- -- -- -- -- -- Comprehensive loss ........................ -- -- -- -- -- -- -- Issuance of warrants to purchase 80,000 shares of common stock ................... -- -- -- -- 948 -- -- Issuance of common stock in conjunction with initial public offering (less issuance costs of $1,948)................. -- -- 16,100 16 125,306 -- -- Conversion of preferred stock to common stock in conjunction with initial public offering .......................... (58,122) (58) 58,122 58 -- -- -- Exercise of warrants to purchase common stock ............................. -- -- 264 -- -- -- -- Exercise of options to purchase common stock ............................. -- -- 1,134 -- 1,300 -- -- Amortization of deferred stock compensation ............................. -- -- -- -- -- 172 -- ------ ---- ------- ---- ------ ------ ---- Balances at June 30, 1999 ................. -- -- 98,690 98 165,569 (197) (118) Comprehensive income: Net income ............................... -- -- -- -- -- -- -- Other comprehensive loss, net of tax: Change in unrealized loss on investments............................. -- -- -- -- -- -- (503) Foreign currency translation adjustment.. -- -- -- -- -- -- (2) Other comprehensive loss ................. -- -- -- -- -- -- -- Comprehensive income ...................... -- -- -- -- -- -- -- Issuance of common stock in conjunction with secondary public offering(less issuance costs of $910) .................. -- -- 4,748 6 174,022 -- -- Exercise of warrants to purchase common stock ............................. -- -- 370 -- -- -- -- Exercise of options to purchase common stock ............................. -- -- 2,392 2 3,387 -- -- Issuance of common stock under employee stock purchase plan ...................... -- -- 470 -- 3,966 -- -- Issuance of warrants for goodwill and purchased intangibles .................... -- -- -- -- 54,324 -- -- Tax benefit from employee stock transactions ............................. -- -- -- -- 21,600 -- -- Stock compensation for options granted to consultants .............................. -- -- -- -- 176 -- -- Amortization of deferred stock compensation ............................. -- -- -- -- -- 119 -- ------ ---- -------- ---- -------- ----- ----- Balances at June 30, 2000 ................. -- $ -- $106,670 $106 $423,044 $ (78) $(623) ====== ==== ======== ==== ======== ===== ===== Total Accumulated Stockholders' Deficit Equity ------- ------ Balances at June 30, 1997 ................. $ (7,923) $ 9,305 Issuance of warrant for 96,694 shares of Series B convertible preferred stock ..... -- 28 Issuance of Series C convertible preferred stock to investors for cash (less issuance costs of $416)................... -- 20,117 Issuance of warrant for 140,352 shares of Series C convertible preferred stock ..... -- 140 Exercise of options to purchase common stock ............................. -- 147 Deferred stock compensation ............... -- -- Amortization of deferred stock compensation ............................. -- 68 Net loss .................................. (13,936) (13,936) -------- -------- Balances at June 30, 1998 ................. (21,859) 15,869 Comprehensive loss: Net loss ................................. (1,617) (1,617) Other comprehensive loss, net of tax: Change in unrealized loss on investments............................. -- (112) Foreign currency translation adjustment.. -- (6) -------- Other comprehensive loss ................. -- (118) -------- Comprehensive loss ........................ -- (1,735) Issuance of warrants to purchase 80,000 shares of common stock ................... -- 948 Issuance of common stock in conjunction with initial public offering (less ....... issuance costs of $1,948)................. -- 125,322 Conversion of preferred stock to common stock in conjunction with initial public offering .......................... -- -- Exercise of warrants to purchase common stock ............................. -- -- Exercise of options to purchase common stock ............................. -- 1,300 Amortization of deferred stock compensation ............................. -- 172 -------- ------- Balances at June 30, 1999 ................. (23,476) 141,876 Comprehensive income: Net income ............................... 20,048 20,048 Other comprehensive loss, net of tax: Change in unrealized loss on investments............................. -- (503) Foreign currency translation adjustment.. -- (2) -------- Other comprehensive loss ................. -- (505) -------- Comprehensive income ...................... -- 19,543 Issuance of common stock in conjunction with secondary public offering(less issuance costs of $910) .................. -- 174,028 Exercise of warrants to purchase common stock ............................. -- -- Exercise of options to purchase common stock ............................. -- 3,389 Issuance of common stock under employee stock purchase plan....................... -- 3,966 Issuance of warrants for goodwill and purchased intangibles..................... -- 54,324 Tax benefit from employee stock transactions.............................. -- 21,600 Stock compensation for options granted to consultants............................... -- 176 Amortization of deferred stock compensation ............................. -- 119 -------- -------- Balances at June 30, 2000 ................. $ (3,428) $419,021 ======== ========
See accompanying notes to consolidated financial statements. 36 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended June 30, -------------------- 2000 1999 1998 -------- -------- -------- Operating activities Net income (loss)............................................... $ 20,048 $ (1,617) $ (13,936) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation................................................... 6,992 5,733 1,453 Amortization................................................... 7,052 -- -- Warrants issued to a business partner.......................... -- 948 -- Amortization of deferred stock compensation.................... 119 172 68 Loss on equity investments..................................... 248 -- -- Compensation expense for options granted to consultants........ 176 -- -- Changes in operating assets and liabilities: Accounts receivable........................................ (40,199) (12,989) (7,545) Inventories................................................ (21,175) (2,503) (86) Other current and noncurrent assets........................ (18,832) (1,392) (585) Accounts payable........................................... 25,605 3,425 9,244 Accrued compensation....................................... 4,259 2,038 272 Accrued commissions........................................ 2,682 1,127 473 Leasehold improvements allowance........................... 8,424 -- -- Deferred revenue........................................... 20,325 1,434 283 Other accrued liabilities.................................. 4,101 4,727 2,203 Income tax liability....................................... 4,688 1,650 -- Long term deposit.......................................... 306 -- -- Due to shareholder......................................... -- -- (109) ---------- ---------- ----------- Net cash provided by (used in) operating activities............. 24,819 2,753 (8,265) ---------- ---------- ----------- Investing activities Capital expenditures............................................ (27,236) (7,492) (2,511) Purchases and maturities of investments......................... (158,770) (21,636) (10,996) Minority investments............................................ (8,970) -- -- ---------- ---------- ----------- Net cash used in investing activities........................... (194,976) (29,128) (13,507) ---------- ---------- ----------- Financing activities Proceeds from issuance of convertible preferred stock........... -- -- 20,285 Proceeds from issuance of common stock.......................... 181,383 126,622 147 Proceeds from notes payable..................................... -- 783 1,606 Principal payments on notes payable............................. -- (2,784) (241) Principal payments of capital lease obligations................. (1,648) (613) (562) ---------- ---------- ----------- Net cash provided by financing activities....................... 179,735 124,008 21,235 ---------- ---------- ----------- Net increase (decrease) in cash and cash equivalents............ 9,578 97,633 (537) Cash and cash equivalents at beginning of period.................. 107,143 9,510 10,047 ---------- ---------- ----------- Cash and cash equivalents at end of period........................ $ 116,721 $ 107,143 $ 9,510 ========== ========== =========== Supplemental disclosure of cash flow information: Interest paid................................................... $ 744 $ 185 $ 326 Cash paid for taxes............................................. $ 5,828 $ -- $ -- Supplemental schedule of noncash investing and financing activities: Property and equipment acquired under capital lease obligations................................................... $ -- $ 278 $ 1,588 Warrants issued in connection with capital lease................ $ -- $ -- $ 168 Warrants issued for goodwill and purchased intangibles.......... $ 54,324 $ -- $ -- Warrants issued to a business partner........................... $ -- $ 948 $ -- Deferred stock compensation..................................... $ -- $ -- $ 437 Conversion of preferred stock to common stock................... $ -- $ 58 $ -- Tax benefit from disqualifying dispositions..................... $ 21,600 $ -- $ --
See accompanying notes to consolidated financial statements. 37 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1) Summary of Significant Accounting Policies Nature of Operations Extreme Networks, Inc. ("Extreme" or the "Company") was incorporated in California on May 8, 1996 and was reincorporated in Delaware on March 31, 1999. Extreme is a leading provider of broadband networking solutions for the Internet economy. Principles of Consolidation and Basis of Presentation The consolidated financial statements include the accounts of Extreme and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated. Investments in which management intends to maintain more than a temporary 20% to 50% interest, or otherwise has the ability to exercise significant influence, are accounted for under the equity method. Investments in which we have less than a 20% interest and/or do not have the ability to exercise significant influence are carried at the lower of cost or estimated realizable value. Assets and liabilities of foreign operations are translated to U.S. dollars at current rates of exchange, and revenues and expenses are translated using weighted average rates. Foreign currency transaction gains and losses have not been material. Gains and losses from foreign currency translation are included as a separate component of other comprehensive income (loss). Certain items previously reported in specific financial statement captions have been reclassified to conform to the 2000 presentation. Such reclassifications have not impacted previously reported operating income (loss). Fiscal Year Effective July 1, 1999, Extreme changed its fiscal year from June 30/th/ to a 52/53-week fiscal accounting year. The June 30, 2000 year closed on July 2, 2000 and comprised 52 weeks of revenue and expense activity. All references herein to "fiscal 2000" or "2000" represent the fiscal year ended July 2, 2000. Quarterly results are based upon a 13-week reporting period. Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates are used for, but not limited to, the accounting for doubtful accounts, inventory reserves, depreciation and amortization, sales returns, warranty costs and income taxes. Actual results could differ from these estimates. Cash Equivalents and Short-Term Investments Extreme considers cash and all highly liquid investment securities purchased with an original or remaining maturity of less than three months at the date of purchase to be cash equivalents. Extreme's investments comprise U.S., state and municipal government obligations and corporate securities. Investments with maturities of less than one year are considered short term and investments with maturities greater than one year are considered long term. To date, all marketable securities have been classified as available-for-sale and are carried at fair value, with unrealized gains and losses, when material, reported net-of-tax as a separate component of other comprehensive income. Realized gains and losses on available-for-sale securities are included in interest income. The cost of securities sold is based on specific identification. Premiums and discounts are amortized over the period from acquisition to maturity and are included in investment income, along with interest and dividends. Fair Value of Financial Instruments 38 The carrying amounts of certain of Extreme's financial instruments, including cash and equivalents, approximate fair value because of their short maturities. The fair values of investments are determined using quoted market prices for those securities or similar financial instruments (see Note 2). Transfer of Financial Assets The Company from time to time transfers specifically identified accounts receivable balances from customers to financing institutions, on a non-recourse basis. The Company records such transfers as sales of the related accounts receivable when it is considered to have surrendered control of such receivables under the provisions of Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The impact of the above transaction reduced receivables and increased cash flows from operating activities in the consolidated statements of cash flows. Inventories Inventories consist of raw materials and finished goods and are stated at the lower of cost or market (on a first-in, first-out basis). Inventories consist of: June 30, 2000 June 30, 1999 ------------- ------------- Raw materials $ 9,501 $ 700 Finished goods 14,300 1,926 ---------------- ---------------- Total $23,801 $2,626 ================ ================ Restricted Investments Extreme restricted $80.0 million of its investment securities as collateral for specified obligations of the lessee under the operating lease. These investment securities are restricted as to withdrawal and are managed by a third party subject to certain limitations under the Company's investment policy. (See Note 4) Concentration of Credit Risk, Product and Significant Customers and Supplier Information Financial instruments that potentially subject Extreme to concentration of credit risk consist principally of marketable investments and accounts receivable. Extreme places its investments only with high-credit quality issuers. Extreme will not invest an amount exceeding 10% of the corporation's combined cash, cash equivalent, short-term and long-term investments, in the securities of any one obligor or maker, except for obligations of the United States, obligations of United States agencies and money market accounts. Extreme performs ongoing credit evaluations of its customers and generally does not require collateral. To date, credit losses have been insignificant and within management's expectations. Extreme operates solely within one business segment, the development and marketing of switching solutions for the Internet economy. For fiscal 2000, there were no customers with sales greater than 10%. For fiscal 1999, Compaq and Hitachi Cable accounted for 21% and 13% of our net revenue, respectively. One supplier currently manufacturers all of Extreme's ASICs which are used in all of Extreme's networking products. Any interruption or delay in the supply of any of these components, or the inability to procure these components from alternate sources at acceptable prices and within a reasonable time, would materially adversely affect Extreme's business, operating results and financial condition. In addition, qualifying additional suppliers can be time-consuming and expensive and may increase the likelihood of errors. Extreme attempts to mitigate these risks by working closely with its ASIC supplier regarding production planning and product introduction timing. Extreme currently derives substantially all of its revenue from sales of two product families. Extreme expects that revenue from these two product families will account for a substantial portion of its revenue for the foreseeable future. Accordingly, widespread market acceptance of Extreme's product families is critical to their future success. Property and Equipment 39 Property and Equipment Property and equipment are stated at cost and depreciated on a straight-line basis over the estimated useful lives of the assets of approximately three years. Property and equipment consist of the following (in thousands):
June 30, ----------------------------- 2000 1999 ---- ---- Computer and other related equipment.................... $ 27,257 $ 8,661 Office equipment, furniture and fixtures................ 1,905 1,090 Software................................................ 4,956 3,146 Leasehold improvements.................................. 1,802 1,111 --------- -------- 35,920 14,008 Less accumulated depreciation and amortization.......... (9,170) (7,502) --------- -------- Property and equipment, net............................. $ 26,750 $ 6,506 ========= ========
Goodwill and Purchased Intangible Assets We record goodwill when the cost of net assets we acquire exceeds their fair value. Goodwill is amortized on a straight-line basis over lives ranging from 2 to 4 years. The cost of identified intangibles is generally amortized on a straight-line basis over periods ranging from 2 to 4 years. We regularly perform reviews to determine if the carrying value of assets is impaired. The reviews look for the existence of facts or circumstances, either internal or external, which indicate that the carrying value of the asset cannot be recovered. No such impairment has been indicated to date. If, in the future, management determines the existence of impairment indicators, we would use undiscounted cash flows to initially determine whether impairment should be recognized. If necessary, we would perform a subsequent calculation to measure the amount of the impairment loss based on the excess of the carrying value over the fair value of the impaired assets. If quoted market prices for the assets are not available, the fair value would be calculated using the present value of estimated expected future cash flows. The cash flow calculations would be based on management's best estimates, using appropriate assumptions and projections at the time. The total purchase price of the goodwill and purchased intangible assets was allocated based on an independent appraisal obtained by the Company, to the tangible and intangible assets acquired based on their respective fair values on the date of acquisition as follows (in thousands): Customer list.............................. $ 4,169 Acquired workforce......................... 4,615 Goodwill................................... 48,050 ----------- $56,834 =========== Revenue Recognition Extreme generally recognizes product revenue at the time of shipment, unless Extreme has future obligations such as installation or has to obtain customer acceptance. When significant obligations remain after products are delivered, revenue is only recognized after such obligations are fulfilled. Amounts billed in excess of revenue recognized are included as deferred revenue in the accompanying consolidated balance sheets. Extreme has established a program which, under specified conditions, enables third party resellers to return products to us. The amount of potential product returns is estimated and provided for in the period of the sale. Revenue from service obligations is recognized ratably over the term of the contract period, which is typically 12 months. Extreme makes certain sales to partners in two-tier distribution channels. These customers are generally given privileges to return a portion of inventory and participate in various cooperative marketing programs. Extreme defers recognition of revenue on such sales until the product is sold by the distributors and also maintains appropriate accruals and allowances for all other programs. Upon shipment of products to its customers, Extreme provides for the estimated cost to repair or replace products that may be returned under warranty. Extreme's warranty period is typically 12 months from the date of shipment to the end user. Advertising 40 Advertising We expense advertising costs as incurred. Advertising expenses for the years ended June 30, 2000, 1999 and 1998 were approximately $2.2 million, $1.1 million and $0.4 million, respectively. Foreign Operations Extreme's foreign offices consist of sales, marketing and support activities through its foreign subsidiaries and overseas resellers and distributors. Operating income (loss) generated by Extreme's operating foreign subsidiaries and their corresponding identifiable assets were not material in any period presented. Extreme's export sales represented 45% and 53% of net revenue in 2000 and 1999, respectively. All of the export sales to date have been denominated in U.S. dollars and were derived from sales to Europe and Asia. Extreme recorded export sales over 10% (as a percentage of total net revenue) to the following countries:
Years Ended June 30, -------------------- 2000 1999 ---- ---- Japan..................................................................... 19% 29% All other export sales to countries totaling less than 10% each........... 26% 24%
Net Income (Loss) Per Share Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period, less shares subject to repurchase, and excludes any dilutive effects of options, warrants, and convertible securities. Dilutive earnings per common share is calculated by dividing net income by the weighted average number of common shares used in the basic earnings per common share calculation plus the dilutive effect of options and warrants. The following table presents the calculation of basic and diluted net income (loss) per share (in thousands, except per share data):
Years Ended June 30, -------------------- 2000 1999 1998 ---- ---- ---- Net income (loss).................................................. $ 20,048 $ (1,617) $ (13,936) ======== ======== ========== Weighted-average shares of common stock outstanding........... 103,734 27,324 22,384 Less: Weighted-average shares subject to repurchase........... (3,218) (8,400) (13,626) ---------- ---------- ---------- Weighted-average shares used in computing basic net income (loss) per common share.............................. 100,516 18,924 8,758 ========== ========== ========== Incremental shares using the treasury stock method 10,652 -- -- Weighted-average shares used in computing diluted net income (loss) per common share.............................. 111,168 18,924 8,758 ---------- ====== ===== Basic net income (loss) per common share........................... $ 0.20 $ (0.09) $ (1.59) ========== ========== ========== Diluted net income (loss) per common share......................... $ 0.18 $ (0.09) $ (1.59) ========== ========== ==========
Share and per-share data presented reflect the two-for-one stock split effective to stockholders of record on August 10, 2000. Accounting for Stock-Based Compensation Extreme's grants of stock options are for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. As permitted under SFAS Statement No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"), Extreme accounts for stock option grants to employees and directors in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and, accordingly, recognizes no compensation expense for stock option grants with an exercise price equal to the fair value of the shares at the date of grant. Recently Issued Accounting Standards In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS 131") effective for financial statements for periods beginning after December 15, 1997. 41 FAS 131 establishes standards for the way that public business enterprises report financial and descriptive information about reportable operating segments in annual financial statements and interim financial reports issued to shareholders. FAS 131 supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," but retains the requirement to report information about major customers. Extreme has determined that it has a single reportable segment. Management uses one measurement of profitability and does not disaggregate its business for internal reporting. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 establishes methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", which extended the deferral of the application of FAS 133 to all fiscal quarters of fiscal years beginning after June 15, 2000. In June 15, 2000 the FASB also issued FAS 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities) an Amendment to FASB Statement No. 133". FAS 138 amends the accounting and reporting standards of Statement 133 for certain derivative instruments and certain hedging activities. The Company will be required to adopt these pronouncements for the year ending June 30, 2001. Because the Company currently holds no derivative financial instruments and does not currently engage in hedging activities, adoption of FAS 133 and 138 are expected to have no material impact on the Company's financial condition or results of operations. In December 1999, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No.101, "Revenue Recognition in Financial Statements", which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. The implementation of SAB 101 has recently been deferred to no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. Extreme is presently evaluating the potential impact of the adoption of SAB 101. In March 2000, the FASB issued Financial Accounting Standards Board Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation - an interpretation of APB Opinion No. 25" (Interpretation No. 44). Interpretation No. 44 is effective July 1, 2000. The interpretation clarifies the application of APB Opinion No. 25 for certain issues, specifically, (a) the definition of an employee, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange or stock compensation awards in a business combination. We do not anticipate that the adoption of Interpretation No. 44 will have a material impact on our financial position or the results of our operations. 2) Financial Instruments The following is a summary of available-for-sale securities (in thousands):
Unrealized Unrealized Amortized Fair Holding Holding Cost Value Gains Losses ---- ----- ----- ------ June 30, 2000: Money market fund........................................ $ 12,372 $ 12,372 $ -- $ -- Commercial paper......................................... 71,929 71,889 -- (40) U.S. corporate debt securities........................... 107,994 107,410 29 (613) U.S. government agencies................................. 9,800 9,809 11 (2) U.S. tax exempt securities............................... 10,000 10,000 -- -- --------- -------- ------- -------- $ 212,095 $211,480 $ 40 $ (655) ========= ======== ======= ======== Classified as: Cash equivalents.................................... $ 100,736 $100,696 $ -- $ (40) Short-term investments.............................. 66,976 66,640 26 (362) Investments......................................... 44,383 44,144 14 (253) --------- -------- ------- -------- $ 212,095 $211,480 $ 40 $ (655) ========= ======== ======= ======== Unrealized Unrealized Amortized Fair Holding Holding Cost Value Gains Losses ---- ----- ----- ------ June 30, 1999: Money market fund...................................... $ 2 $ 2 $ - $ --
42 Commercial paper.......................... 110,265 110,241 -- (24) U.S. corporate debt securities............ 15,885 15,797 -- (88) U.S. government agencies.................. 300 300 -- -- -------- --------- ----- ------ $126,452 $126,340 $ -- $ (112) ======== ========= ===== ====== Classified as: Cash equivalents..................... $ 93,840 $ 93,821 $ -- $ (19) Short-term investments............... 16,427 16,422 -- (5) Investments.......................... 16,185 16,097 -- (88) -------- -------- ----- ------ $126,452 $126,340 $ -- $ (112) ======== ======== ===== ======
3) Business Combinations and Investments During the fiscal year ended June 30, 2000, Extreme acquired certain assets of a Company for a total cost of approximately $2.5 million of which $1.1 million has been paid. Extreme accounted for the acquisition using the purchase method of accounting, and incurs charges of approximately $157,000 per quarter related to the amortization of goodwill over the estimated useful life of four years. The entire purchase price was allocated to goodwill and purchased intangibles. Extreme recorded approximately $261,000 for amortization related to this acquisition in the year ended June 30, 2000. In April 2000, Extreme issued fully earned, non-forfeitable, fully exercisable warrants with a two year life to purchase 3 million shares of Extreme's common stock with an exercise price of $39.50 per share to a networking company in consideration of the networking company's selection of Extreme as the preferred vendor of next generation core backbone switching products to a certain group of the networking company's customers. The fair value of the warrants was approximately $54.3 million. The warrants were valued under a Black-Scholes model, using a volatility assumption of 1.04% and a two-year term. The value of the warrants is being amortized over approximately two years, which is the estimated economic life of the acquired intangibles, comprising of customer list, workforce and goodwill. Extreme made several additional investments during the year ended June 30, 2000 totaling $7.7 million, which are reflected in "Other assets" in the accompanying consolidated balance sheets. Two investments were made in entities in which a related party of Extreme is also a significant investor. These investments totaled $3.4 million, net of Extreme's share of these affiliates' losses of $0.3 million. As these investments are being accounted for under the equity-method, the revenue and operating costs of these entities have not been included in Extreme's results from operations, however Extreme's share of these affiliates' losses have been included in other expense from the closing date of the related transactions forward. Pursuant to the terms of these two agreements, Extreme has certain rights to acquire the remaining shares of these entities under certain conditions for additional consideration. Under the terms of one of these equity investments, Extreme has been granted the right at any time prior to December 31, 2000 to purchase all of the outstanding capital stock and options for shares of Extreme common stock. Upon the attainment of certain technological milestones, the terms of one investment will obligate Extreme to purchase all the outstanding capital stock in fiscal 2001, payable in any combination of cash or shares of Extreme common stock. At June 30, 2000 the possibility of attainment of any of the technical milestones was remote. The remaining $4.3 million of investments at June 30, 2000 are being accounted for under the cost method. We expect to continue to make additional investments in the future. 4) Commitments Extreme currently has outstanding fiscal year 2001 non-cancelable purchase order commitments for materials of approximately $73.3 million. The fiscal year 2000 purchase orders have been fulfilled and the related invoices have been accrued as of June 30, 2000. This expense is included within cost of revenue in the year ended June 30, 2000. In June 2000, we entered into an operating lease agreement to lease 275,000 square feet to house our primary facility in Santa Clara, California. Our lease payments will vary based on the LIBOR plus a spread which was 7.14% at June 30, 2000. Our lease payments are estimated to be approximately $5.7 million on an annual basis over the lease term. The lease is for five years and can be renewed for two five-year periods, subject to the approval of the lessor. At the expiration or termination of the lease, we have the option to either purchase the property for $80.0 million, or arrange for the sale of the property to a third party for at least $80.0 million with a contingent liability for any deficiency. If the property is not purchased or sold as described above, we will be obligated for an additional lease payment of approximately $68.0 million. 43 As part of the above lease transaction, Extreme restricted $80.0 million of its investment securities as collateral for specified obligations of the lessor under the lease. These investment securities are restricted as to withdrawal and are managed by a third party subject to certain limitations under Extreme's investment policy. The lease also requires us to maintain specified financial covenants with which we were in compliance as of June 30, 2000. Future payments under all noncancelable leases (net of future committed sublease proceeds of $9,161) at June 30, 2000 are as follows (in thousands): Years ending June 30: 2001...................................... $ 2,691 2002...................................... 2,758 2003...................................... 5,200 2004...................................... 6,504 2005...................................... 6,242 ------- Total minimum payments......................... $23,395 ======= Rent expense was approximately $2.9 million, $0.7 million and $0.8 million for 2000, 1999 and 1998, respectively. Sublease income for the years ended 2001, 2002 and 2003 was $3.9 million, $3.9 million and $1.4 million, respectively. These amounts were netted from the amounts in the above schedule. 5) Stockholders' Equity Common Stock Offering In April 1999, Extreme completed an initial public offering of 16,100,000 shares of common stock (including the underwriters' over-allotment provision) at a price of $8.50 per share. Concurrent with the initial public offering, all outstanding shares of preferred stock were converted to a total of 58,122,630 shares of common stock. Net proceeds from the offering were approximately $125.3 million net of offering costs. On October 20, 1999, Extreme announced the completion of a secondary public offering of approximately 15 million shares (including the underwriters' over-allotment provision) of its common stock at a price of $38.50 per share. Of these shares, Extreme sold 4,745,416 shares and existing stockholders sold 10,204,584 shares. Extreme raised approximately $174.0 million net of offering costs. Preferred Stock The number of shares of preferred stock authorized to be issued at June 30, 2000 is 2,000,000 with a par value of $0.001 per share. The preferred stock may be issued from time to time in one or more series. The board of directors is authorized to provide for the rights, preferences and privileges of the shares of each series and any qualifications, limitations or restrictions on these shares. As of June 30, 2000, no shares of preferred stock had been issued. Common Stock In May 1996, Extreme issued 9,450,000 shares of common stock to founders for cash. The common stock is subject to repurchase until vested; vesting with respect to 25% occurs on the first anniversary of the issuance date, with the balance vesting ratably over a period of three years as specified in the purchase agreements. At June 30, 1999, approximately 1,182,000 shares were subject to repurchase at their original issuance price (none at June 30, 2000). Warrants In November 1996, Extreme issued warrants to a lease financing company to purchase 420,000 shares of Series A convertible preferred stock with an exercise price of $.17 per share, in consideration for equipment leases and a loan. In July 1997, Extreme issued warrants to the same lease financing company to purchase 96,694 shares of Series B convertible preferred stock with an exercise price of $.69 per share, in consideration for equipment leases. Concurrent with the initial public offering, these warrants converted into the 44 right to purchase equivalent number of shares of common stock at the same exercise price per share. The warrants may be exercised at any time within a period of (i) 10 years or (ii) 5 years from the effective date of the initial public offering, whichever is longer. In May 1999, 294,000 of these warrants were exercised. In August 1999, 222,694 of these warrants were exercised. In November 1997, Extreme issued warrants to a lease financing company to purchase 158,102 shares of Series C convertible preferred stock with an exercise price of $1.27, in consideration for a loan. Concurrent with the initial public offering, these warrants converted into the right to purchase equivalent number of shares of common stock at the same exercise price per share. The warrants may be exercised at any time within a period which expires the sooner of (i) 10 years or (ii) 3 years from the effective date of the initial public offering. In August 1999, all of the 158,102 warrants were exercised. In June 1999, Extreme issued fully vested, non-forfeitable and exercisable warrants to a business partner to purchase 80,000 shares of Extreme's common stock with an exercise price of $29.03 per share. The fair value of these warrants was approximately $948,000. This value was expensed in fiscal 1999 as the warrants were issued in exchange for services rendered. As discussed in Note 3, in April 2000, Extreme issued fully earned, non-forfeitable, fully exercisable warrants with a two year life to purchase 3 million shares of Extreme's common stock with an exercise price of $39.50 per share. In June 2000, Extreme issued fully vested, non-forfeitable and exercisable options to consultants to purchase 120,000 shares of Extreme's common stock with an exercise price of $14.02 per share. The fair value of these options was approximately $1.7 million. The options were valued under a Black-Scholes model, using a volatility assumption of 1.04%. This amount will be amortized over two years as the services are rendered. The compensation expense for the year ended June 30, 2000 was $176,000. Deferred Stock Compensation During the year ended June 30, 1998, in connection with the grant of certain stock options to employees, Extreme recorded deferred stock compensation of $437,000 representing the difference between the exercise price and the deemed fair value of Extreme's common stock on the date such stock options were granted. Such amount is included as a reduction of stockholders' equity and is being amortized by charges to operations on a graded vesting method. Extreme recorded amortization of deferred stock compensation expense of approximately $119,000, $172,000 and $68,000 for the years ended June 30, 2000, 1999 and 1998, respectively. At June 30, 2000, Extreme had a total of approximately $78,000 remaining to be amortized over the corresponding vesting period of each respective option, generally four years. The amortization expense relates to options awarded to employees in all operating expense categories. Amended 1996 Stock Option Plan In January 1999, the board of directors approved an amendment to the 1996 Stock Option Plan (the "Plan") to (i) increase the share reserve by 10,000,000 shares, (ii) to remove certain provisions which are required to be in option plans maintained by California privately-held companies and (iii) to rename the Plan as the "Amended 1996 Stock Option Plan." Under the Plan, which was originally adopted in September 1996, options may be granted for common stock, pursuant to actions by the board of directors, to eligible participants. A total of 34,028,618 shares have been reserved under the Plan. Options granted are exercisable as determined by the board of directors. Options vest over a period of time as determined by the board of directors, generally four years. The term of the Plan is ten years. Options to purchase approximately 1,470,286 and 4,655,558 shares of common stock have been exercised as of June 30, 2000 and 1999, respectively, but are subject to repurchase until vested. As of June 30, 2000, 3,834,388 shares were available for future grant under the Plan. 2000 Stock Option Plan In March 2000, the board of directors adopted the 2000 Nonstatutory Stock Option Plan (the "Plan"). Options may be granted for common stock, pursuant to actions by the board of directors, to eligible participants. A total of 4,000,000 shares have been reserved under the Plan. Options vest over a period of time as determined by the board of directors, generally four years. The term of the Plan is ten years. The following table summarizes stock option activity under all plans: 45
Weighted- Average Number of Exercise Price Shares Per Share ------ --------- Options outstanding at June 30, 1997........................... 3,151,500 $ .03 Granted..................................................... 3,542,920 $ .65 Exercised................................................... (1,449,550) $ .11 Canceled.................................................... (37,000) $ .18 ------------ Options outstanding at June 30, 1998........................... 5,207,870 $ .42 Granted..................................................... 5,875,516 $ 5.05 Exercised................................................... (1,135,600) $ .93 Canceled.................................................... (190,252) $ 3.34 ------------ Options outstanding at June 30, 1999........................... 9,757,534 $ 3.04 Granted..................................................... 12,404,750 $ 33.99 Exercised................................................... (2,392,472) $ 1.23 Canceled.................................................... (1,374,704) $ 26.91 ------------ Options outstanding at June 30, 2000........................... 18,395,108 $ 22.74 ============
Options to purchase 6,721,582 and 9,368,034 shares were exercisable at June 30, 2000 and 1999, respectively, with a weighted-average exercise price of $3.75 and $2.22, respectively. The following table summarizes significant ranges of outstanding and exercisable options at June 30, 2000:
Options Outstanding Options Exercisable ----------------------------------------------------------- ---------------------------------------- Weighted- Weighted- Weighted- Range of Average Average Average Exercise Number Remaining Exercise Number Exercise Prices Outstanding Contractual Life Price Exercisable Price ------ ----------- ---------------- ----- ----------- ----- (In years) $ 0.01 - 2.88 3,854,758 7.32 $ 1.43 3,854,758 $ 1.43 $ 3.25 - 28.00 3,869,580 8.63 $ 11.15 2,769,948 $ 5.96 $ 28.03 - 32.57 1,896,868 9.25 $ 29.97 8,126 $ 29.03 $ 32.72 - 33.32 4,051,500 9.39 $ 33.30 88,750 $ 33.32 $ 33.57 - 57.50 4,722,402 8.87 $ 37.66 -- $ -- ----------- ----------- $ 0.01 - 57.50 18,395,108 8.65 $ 22.74 6,721,582 $ 3.75 =========== ===========
1999 Employee Stock Purchase Plan In January 1999, the board of directors approved the adoption of Extreme's 1999 Employee Stock Purchase Plan (the "1999 Purchase Plan"). A total of 2,000,000 shares of common stock have been reserved for issuance under the 1999 Purchase Plan. The 1999 Purchase Plan permits eligible employees to acquire shares of Extreme's common stock through periodic payroll deductions of up to 15% of total compensation. No more than 1,250 shares may be purchased on any purchase date per employee. Each offering period will have a maximum duration of 12 months. The price at which the common stock may be purchased is 85% of the lesser of the fair market value of Extreme's common stock on the first day of the applicable offering period or on the last day of the respective purchase period. The initial offering period commenced on the effectiveness of the initial public offering and ended on April 30, 2000. Through June 30, 2000, 470,978 shares were purchased under the 1999 Purchase Plan. Stock-Based Compensation Extreme has elected to continue to follow APB 25 and related interpretations in accounting for its employee and director stock-based compensation plans. Because the exercise price of Extreme's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense has been recognized. Pro forma information regarding net income (loss) has been determined as if Extreme had accounted for its stock-based awards to employees under the fair value method prescribed by FAS 123. The resulting effect on pro forma net income (loss) disclosed is not 46 likely to be representative of the effects on net income (loss) on a pro forma basis in future years, due to subsequent years including additional grants and years of vesting. Prior to Extreme's initial public offering, the fair value of each option grant was determined on the date of grant using the minimum value method. Subsequent to the offering, the fair value of Extreme's stock-based awards to employees has been estimated using the Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. The Black-Scholes model requires the input of highly subjective assumptions including the expected stock price volatility. Because Extreme's stock-based awards have characteristics significantly different from those in traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of Extreme's stock-based awards. The following weighted-average assumptions were used to estimate fair value:
Stock Option Plan Employee Stock Purchase Plan --------------------------------------- -------------------------------------- Years Ended June 30, Years Ended June 30, --------------------------------------- -------------------------------------- 2000 1999 1998 2000 1999 1998 --------- ---------- ----------- ---------- ----------- --------- Expected life 3.4 yrs 3.5 yrs 6.0 yrs 0.6yrs 0.7 yrs. -- Volatility 1.12% 55% -- 1.12% 55% -- Risk-free interest rate 6.3% 5.1% 6.0% 5.4% 5.0% --
The weighted-average estimated fair value of options granted in the years ended June 30, 2000, 1999 and 1998 was $24.23 $2.21 and $0.19, respectively. The weighted-average estimated fair value of shares granted under the 1999 Purchase Plan in the years ended June 30, 2000 and 1999 was $7.51 and $2.81, respectively. For purposes of pro forma disclosures, the estimated fair value of options is amortized to pro forma expense over the options' vesting period. Pro forma information follows (in thousands, except per share amounts): Net revenue...................................... $115,069 $112,106 $144,715 $119,342 Gross profit..................................... 59,565 14,242 74,941 61,252 Total operating expenses......................... 76,945 111,618 65,343 57,987 Operating income (loss).......................... (17,380) (97,376) 9,598 3,265 Net income (loss)................................ (11,363)(2) (70,115)(3) 8,062(4) 4,533(4) Net income (loss) per share--basic (1)........... $ (0.10)(2) $ (0.64)(3) $ 0.08(4) $ 0.04(4) Net income (loss) per share--diluted (1)......... $ (0.10)(2) $ (0.64)(3) $ 0.07(4) $ 0.04(4) Shares used in per share calculation--basic (1).. 111,114 109,028 107,283 105,990 Shares used in per share calculation--diluted (1) 111,114 109,028 118,745 118,892
Years Ended June 30, --------------------Mar. 31, Dec. 31, Sept. 30, 2000 2000 1999 1998 ---- ---- ----1999 -------- -------- -------- --------- Pro forma net loss under FAS 123................................... Net revenue...................................... $ (31,088)92,422 $ (4,066)67,310 $ (14,053)55,006 $ 47,218 Gross profit..................................... 46,254 35,339 28,846 24,601 Total operating expenses......................... 49,621 25,806 22,846 20,512 Operating income (loss).......................... (3,367) 9,533 6,000 4,089 Net lossincome....................................... 589(5) 9,057 6,355 4,047 Net income per commonshare--basic (1).................. $ 0.01(5) $ 0.09 $ 0.06 $ 0.04 Net income per share--diluted (1)................ $ 0.01(5) $ 0.08 $ 0.06 $ 0.04 Shares used in per share - pro forma under FAS 123: Basic and diluted............................................... $ (0.32) $ (0.22) $ (1.61)calculation--basic (1).. 104,590 103,060 100,362 94,052 Shares used in per share calculation--diluted (1) 112,532 113,584 111,726 107,166
6) Income Taxes Due to operating losses and the inability to recognize the benefits therefrom, there was no tax provision for the year ended June 30, 1998. The provision for income taxes for the years ended June 30, 2000 and 1999 consists of the following (in thousands):
Years Ended June 30, -------------------- 2000 1999 ---- ---- Current: Federal........................................ $ 24,811 $ 350 State.......................................... 2,026 200 Foreign........................................ 306 1,100 --------- -------- Total current ...................................... $ 27,143 $ 1,650 ========= ======== Deferred: Federal $(15,497) $ - State (1,325) - -------- -------- Total deferred $(16,822) $ - ======== ======== Provision for income taxes $ 10,321 $ 1,650 ======== ========
47 The tax benefit resulting from the exercise of nonqualified stock options and the disqualifying dispositions of shares acquired under Extreme's incentive stock option plans was $21,600,000 for the year ended June 30, 2000. Such benefit was credited to additional paid-in capital. Pretax loss from foreign operations was $10,663,288 and $7,021,204 in the years ended June 30, 2000 and 1999, respectively. The difference between the provision for income taxes and the amount computed by applying the Federal statutory income tax rate (35 percent) to income before taxes is explained below (in thousands):
Years Ended June 30, -------------------- 2000 1999 1998 ---- ----- ---- Tax at federal statutory rate (benefit)........................ $ 10,666 $ 11 $(4,878) State income tax............................................... 1,018 200 -- Federal alternative minimum taxes.............................. -- 350 -- Foreign taxes.................................................. 69 1,100 -- Unbenefited (utilized) net operating losses.................... (773) (11) 4,878 Tax credits.................................................... (1,576) -- -- Valuation allowance decrease................................... (5,148) -- -- Unbenefited foreign loss....................................... 3,974 -- -- Other.......................................................... 2,091 -- -- ---------- -------- ------- Total..................................................... $ 10,321 $ 1,650 $ -- ========== ======== =======
Significant components of Extreme's deferred tax assets are as follows (in thousands):
Years Ended June 30, -------------------- 2000 1999 ---- ---- Deferred tax assets: Net operating loss carryforwards......................................... $ 431 $ 1,647 Tax credit carryforwards................................................. 2,358 2,238 Depreciation............................................................. 1,951 407 Deferred revenue......................................................... 3,545 373 Warrant amortization..................................................... 2,673 -- Other reserves and accruals ............................................. 7,500 3,887 -------- -------- Total deferred tax assets..................................................... 18,458 8,552 Valuation allowance........................................................... -- (8,552) -------- -------- Net deferred tax assets....................................................... $ 18,458 $ -- ======== ========
The net valuation allowance decreased by $8,522,000 and $1,019,000 during the years ended June 30, 2000 and 1999, respectively. As of June 30, 2000, Extreme had net operating loss carryforwards for state tax purposes of approximately $7,500,000. Extreme also had federal and state research and development tax credit carryforwards of approximately $1,000,000 and $1,800,000, respectively. The state net operating loss carryforwards will expire in 2004, if not utilized. Utilization of the net operating losses and tax credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating losses and tax credits before utilization. 7) Comprehensive Income (Loss) The following are the components of accumulated other comprehensive loss, net of tax (in thousands):
Years Ended June 30, -------------------- 2000 1999 1998 ---- ----- ----
48 Unrealized gain (loss) on investments...................................... $ (615) $ (112) $ -- Foreign currency translation adjustments................................... (8) (6) -- ------- ------- ------ Accumulated other comprehensive loss.................................... $ (623) $ (118) $ -- ======= ======= ======
The following schedule of other comprehensive income (loss) shows the gross current-period gain (loss) and the reclassification adjustment (in thousands):
Years Ended June 30, -------------------- 2000 1999 1998 ---- ----- ---- Unrealized gain (loss) on investments: Unrealized gain (loss) on available-for-sale securities................. $ (508) $ (112) $ -- Less: reclassification adjustment for gain (loss) realized in net income (loss)................................................ 5 -- -- ------ ------ ------ Net unrealized gain (loss) on investments.................................. (503) (112) -- Foreign currency translation adjustments................................... (2) (6) -- ------ ------ ------ Other comprehensive income (loss).......................................... $ (505) $ (118) $ -- ====== ====== ======
8) 401(k) Plan Extreme provides a tax-qualified employee savings and retirement plan, commonly known as a 401(k) plan, which covers our eligible employees. Pursuant to the 401(k) plan, employees may elect to reduce their current annual compensation up to the lesser of 20% or the statutorily prescribed limit, which is $10,000 in calendar year 2000, and have the amount of the reduction contributed to the 401(k) plan. 9) Subsequent Event On July 19, 2000 Extreme announced a two-for-one stock split in the form of a stock dividend to be paid on August 24, 2000 to stockholders of record on August 10, 2000. All share-------- (1)Share and per share data have been restated to give retroactive effect to thisa two-for-one stock split.split in the form of a stock dividend effected in August 2000. (2)Net loss and net loss per share include amortization of goodwill, purchased intangible assets and deferred stock compensation of $15.4 million and restructuring charges of $2.1 million. (3)Net loss and net loss per share include certain inventory charges of $40.3 million, in-process research and development of $30.1 million, amortization of goodwill and purchased intangible assets of $8.2 million and restructuring charges of $3.8 million. (4)Net income and net income per share include amortization of goodwill and purchased intangible assets of $6.9 million. (5)Net income and net income per share include amortization of goodwill and purchased intangible assets of $6.8 million. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. 68 PART III Certain information required by Part III is incorporated by reference from the Company'sExtreme's definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Company's 2000Extreme's 2001 Annual Meeting of Stockholders (the "Proxy Statement"). Item 10. Directors and Executive Officers of the Registrant. The information required by this section is incorporated by reference from the information in the section entitled "Proposal 1-Election1--Election of Directors" in the Proxy Statement. The required information concerning executive officers of the CompanyExtreme is contained in the section entitled "Executive Officers of the Registrant" in Part I of this Form 10-K. Item 405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16 of the Exchange Act. This disclosure is contained in the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement and is incorporated herein by reference. Item 11. Executive Compensation. The information required by this section is incorporated by reference from the information in the sections entitled "Proposal 1-Election1--Election of Directors -- Directors'Directors--Directors' Compensation", "Executive Compensation" and "Stock Price Performance Graph" in the Proxy Statement. 49 Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required by this section is incorporated by reference from the information in the section entitled "Proposal 1- Election1--Election of Directors- SecurityDirectors--Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. Item 13. Certain Relationships and Related Transactions. The information required by this section is incorporated by reference from the information in the section titled "Certain relationships and related transactions" in the Proxy statement. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) The following documents are filed as a part of this Form 10-K: (1) Financial Statements: Reference is made to the Index to Consolidated Financial Statements of Extreme Networks, Inc. under Item 8 in Part II of this Form 10-K. (2) Financial Statement Schedules: 69 The following financial statement schedule of Extreme Networks, Inc. for the years ended June 30, 2001, 2000 1999 and 19981999 is filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Extreme Networks, Inc. Reference Page Schedule II-- Valuation and Qualifying Accounts....................... 52
Reference Page --------- Schedule II -- Valuation and Qualifying Accounts 73
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 70 (3) Exhibits: The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K has been identified. Exhibit Number Notes Description of Document --------- ----- ----------------------- 2.1 (1) Form of Agreement and Plan of Merger between Extreme Networks, a California corporation, and Extreme Networks, Inc., a Delaware corporation. 3.1 (1) Certificate of Incorporation of Extreme Networks, Inc., a Delaware Corporation. 3.2 (1) Form of Certificate of Amendment of Certificate of Incorporation of Extreme Networks, Inc., a Delaware Corporation. 3.3 (1) Form of Amended and Restated Bylaws of Extreme Networks, Inc., a Delaware Corporation. 4.1 (1) Second Amended and Restated Rights Agreement dated January 12, 1998 between Extreme Network and certain stockholders. 10.1 (1) Form of Indemnification Agreement for directors and officers. 10.2 (1) Amended 1996 Stock Option Plan and forms of agreements thereunder.* 10.3 (1) 1999 Employee Stock Purchase Plan.* 10.4 (1) Sublease, dated June 5, 1997 between NetManage, Inc. and Extreme Networks, Inc., a California corporation, to Master Lease, dated September 30, 1994, between Cupertino Industrial Associates and NetManage, Inc. 10.5 (1) Sublease, dated January 1, 1999 between Apple Computer, Inc., a California corporation, and Extreme Networks, Inc., a California corporation, to Lease Agreement, as amended. 50
Incorporated by Reference Exhibit ----------------------- Filed Number Description of Document Form Date Number Herewith ------ --------------------------------------------------------- ------- -------- ------ -------- 2.1 Form of Agreement and Plan of Merger between Extreme Networks, a California corporation, and Extreme Networks, Inc., a Delaware corporation........... S -1/A 03/11/99 2.1 3.1 Certificate of Incorporation of Extreme Networks, Inc., a Delaware Corporation..................................... S - 1 02/05/99 3.1 3.2 Form of Certificate of Amendment of Certificate of Incorporation of Extreme Networks, Inc., a Delaware Corporation.............................................. S - 1 02/05/99 3.2 3.4 Amended and Restated Bylaws of Extreme Networks, Inc...................................................... 8 - K/A 06/07/01 3.4 3.5 Restated Certificate of Incorporation of Extreme Networks, Inc............................................ X 3.6 Certificate of Amendment of Restated Certificate of Incorporation of Extreme Networks, Inc................... X 3.7 Certificate of Designation, Preferences and Rights of the Terms of the Series A Preferred Stock.................... X 4.1 Second Amended and Restated Rights Agreement dated January 12, 1998 between Extreme Network and certain stockholders............................................. S - 1 02/05/99 4.1 4.2 Registration Rights Agreement............................ S - 3 04/11/01 4.1 10.1 Form of Indemnification Agreement for directors and officers................................................. S - 1 02/05/99 10.1 10.2* Amended 1996 Stock Option Plan and forms of agreements thereunder.................................... S - 1 02/05/99 10.2 10.3* 1999 Employee Stock Purchase Plan........................ S - 1 02/05/99 10.3 10.4 Sublease, dated June 5, 1997 between NetManage, Inc. and Extreme Networks, Inc., a California corporation, to Master Lease, dated September 30, 1994, between Cupertino Industrial Associates and NetManage, Inc....... S - 1 02/05/99 10.4 10.5 Sublease, dated January 1, 1999 between Apple Computer, Inc., a California corporation, and Extreme Networks, Inc., a California corporation, to Lease Agreement, as amended.................................... S - 1/A 03/11/99 10.5 10.6 Form of Warrant to Purchase Common Stock between 3Com Corporation and Extreme Networks, Inc............... 10 - K 06/30/00 10.6 10.7* Form of 2000 Nonstatutory Stock Option Plan.............. 10 - K 06/30/00 10.7
71 10.6 Form of Warrant to Purchase Common Stock between 3Com Corporation and Extreme Networks, Inc. 10.7 Form of 2000 Nonstatutory Stock Option Plan.* 10.8 Form of Lease Agreement (Land) dated June 1, 2000 by and between BNP Leasing Corporation, a Delaware corporation ("BNPLC") and Extreme Networks, Inc. a Delaware corporation ("Extreme"). 10.9 Form of Lease Agreement (Improvements) dated June 1, 2000, executed by and between BNPLC and Extreme. 10.10 Form of Purchase Agreement (Land) dated to be effective as of June 1, 2000, executed by and between BNPLC and Extreme. 10.11 Form of Purchase Agreement (Improvements) dated to be effective as of June 1, 2000, executed by and between BNPLC and Extreme. 10.12 Form of Pledge Agreement (Land) dated to be effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme. 10.13 Form of Pledge Agreement (Improvements) dated to be effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme. 21.1 Subsidiaries of Registrant. 23.1 Consent of Ernst and Young LLP, Independent Auditors. 24.1 Power of Attorney (see page 53 of this Form 10-K). 27.1 Financial Data Schedule (available in EDGAR format only). _____________
Incorporated by Reference Exhibit ---------------------- Filed Number Description of Document Form Date Number Herewith ------ -------------------------------------------------------- ------ -------- ------ -------- 10.8 Form of Lease Agreement (Land) dated June 1, 2000 by and between BNP Leasing Corporation, a Delaware corporation ("BNPLC") and Extreme Networks, Inc. a Delaware corporation ("Extreme")........................ 10 - K 06/30/00 10.8 10.9 Form of Lease Agreement (Improvements) dated June 1,2000, executed by and between BNPLC and Extreme....... 10 - K 06/30/00 10.9 10.10 Form of Purchase Agreement (Land) dated to be effective as of June 1, 2000, executed by and between BNPLC and Extreme................................................. 10 - K 06/30/00 10.10 10.11 Form of Purchase Agreement (Improvements) dated to be effective as of June 1, 2000, executed by and between BNPLC and Extreme....................................... 10 - K 06/30/00 10.11 10.12 Form of Pledge Agreement (Land) dated to be effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme............................................. 10 - K 06/30/00 10.12 10.13 Form of Pledge Agreement (Improvements) dated to be effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme................................. 10 - K 06/30/00 10.13 10.14 Exhibit 10.14 Lease agreement dated July 28, 2000 between San Tomas Properties LLC, a Delaware limited liability company, as Landlord, and Extreme Networks, Inc, a Delaware Corporation, as Tenant.................. 10 - Q 09/30/00 10.14 21.1 Subsidiaries of Registrant.............................. X 23.1 Consent of Ernst and Young LLP, Independent Auditors.... X 24.1 Power of Attorney (see page 74 of this Form 10-K)....... X
* Indicates managementmanagment contract or compensatory plan or arrangement. (1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 (File No. 333-71921). (b)Reports on Form 8-K: NoExtreme filed the following reports on formForm 8-K were filed by the Company during the three months ended June 30, 2000. 512001:
Date of Report: Item(s): Description: --------------- -------- ------------ April 6, 2001 5,7 EXTREME announced financial results for its third quarter ended March 31, 2001 and included the press release relating thereto. May 14, 2001 5,7 EXTREME announced the adoption of a Stockholder Rights Plan pursuant to which rights will be distributed as a dividend at the rate of one right for each share of the company's common stock held by stockholders of record as of the close of business on May 14, 2001. May 15, 2001 5 EXTREME amended the Form 8-K filed on May 14, 2001 for the purpose of filing certain exhibits to Exhibit 4.2. June 7, 2001 5,7 EXTREME amended and restated the Form 8-K filed on May 14, 2001 for the purpose of correcting certain exhibit numbers.
72 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JUNE 30, 2001, 2000 1999 AND 19981999 (In thousands)
Reversals Balance at Charged to to costs Balance at beginning costs and and end of Description of period expenses expenses (Deductions) period ----------- ---------------------- ---------- --------- ------------ ---------- -------------- ----------- Year Ended June 30, 1999: Allowance for doubtful accounts 2000.........................accounts............. $ 433 $ 1,364 $-- $ (423) $ 1,374 Allowance for excess and obsolete inventory. $ 145 $ 1,087 $-- $ (292) $ 940 Year Ended June 30, 2000: Allowance for doubtful accounts............. $1,374 $ -- $ --$-- $ (137) $ 1,237 1999......................... 433 1,364 -- (423) 1,374 1998......................... -- 470 -- (37) 433Allowance for excess and obsolete inventory. $ 940 $ 1,144 $-- $ (155) $ 1,929 Year Ended June 30, 2001: Allowance for doubtful accounts............. $1,237 $ 5,274 $-- $(4,569) $ 1,942 Allowance for excess and obsolete inventory. $1,929 $32,753 $(9,771) $24,911
5273 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on September 28, 2000.26, 2001. EXTREME NETWORKS, INC. (Registrant) By: /s/ GORDON/s/ HAROLD L. STITT ------------------------------------- GordonCOVERT Harold L. StittCovert Vice President Chief ExecutiveFinancial Officer Chairman of the Board September 28, 200026, 2001 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Gordon L. Stitt and Vito E. Palermo,Harold L. Covert, and each of them, his or her true and lawful attorneys-in-fact, each with full power of substitution, for him or her in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated: /s/ GORDON L. STITT /s/ PROMOD HAQUE - ----------------------------------------------- ----------------------------------------------- Gordon L. Stitt Promod Haque President, Chief Executive Officer Director Chairman of the Board September 28, 2000 September 28, 2000 /s/ VITO E. PALERMO /s/ LAWRENCE K. ORR - ----------------------------------------------- ----------------------------------------------- Vito E. Palermo Lawrence K. Orr Vice President & Chief Financial Officer Director (Principal Financial and Accounting Officer) September 28, 2000 September 28, 2000 /s/ CHARLES CARINALLI /s/ PETER WOLKEN - ----------------------------------------------- ----------------------------------------------- Charles Carinalli Peter Wolken Director Director September 28, 2000 September 28, 2000
53/s/ GORDON L. STITT /s/ PROMOD HAQUE -------------------------------------------- ------------------- Gordon L. Stitt Promod Haque President, Chief Executive Officer Director Chairman of the Board September 26, 2001 September 26, 2001 /s/ HAROLD L. COVERT /s/ LAWRENCE K. ORR -------------------------------------------- ------------------- Harold L. Covert Lawrence K. Orr Vice President & Chief Financial Officer Director (Principal Financial and Accounting Officer) September 26, 2001 September 26, 2001 /s/ CHARLES CARINALLI /s/ PETER WOLKEN -------------------------------------------- ------------------- Charles Carinalli Peter Wolken Director Director September 26, 2001 September 26, 2001 74 EXHIBIT INDEX Exhibit Number Notes Description of Document --------- ----- ----------------------- 2.1 (1) Form of Agreement and Plan of Merger between Extreme Networks, a California corporation, and Extreme Networks, Inc., a Delaware corporation. 3.1 (1) Certificate of Incorporation of Extreme Networks, Inc., a Delaware Corporation. 3.2 Form of Certificate of Amendment of Certificate of Incorporation of Extreme Networks, Inc., a Delaware (1) Corporation. 3.3 (1) Form of Amended and Restated Bylaws of Extreme Networks, Inc., a Delaware Corporation. 4.1 (1) Second Amended and Restated Rights Agreement dated January 12, 1998 between Extreme Network and certain stockholders. 10.1 (1) Form of Indemnification Agreement for directors and officers. 10.2 (1) Amended 1996 Stock Option Plan and forms of agreements thereunder.* 10.3 (1) 1999 Employee Stock Purchase Plan.* 10.4 (1) Sublease, dated June 5, 1997 between NetManage, Inc. and Extreme Networks, Inc., a California corporation, to Master Lease, dated September 30, 1994, between Cupertino Industrial Associates and NetManage, Inc. 10.5 (1) Sublease, dated January 1, 1999 between Apple Computer, Inc., a California corporation, and Extreme Networks, Inc., a California corporation, to Lease Agreement, as amended. 10.6 Form of Warrant to Purchase Common Stock between 3Com Corporation and Extreme Networks, Inc. 10.7 Form of 2000 Nonstatutory Stock Option Plan.* 10.8 Form of Lease Agreement (Land) dated June 1, 2000 by and between BNP Leasing Corporation, a Delaware corporation ("BNPLC") and Extreme Networks, Inc. a Delaware corporation ("Extreme"). 10.9 Form of Lease Agreement (Improvements) dated June 1, 2000, executed by and between BNPLC and Extreme. 10.10 Form of Purchase Agreement (Land) dated to be effective as of June 1, 2000, executed by and between BNPLC and Extreme. 10.11 Form of Purchase Agreement (Improvements) dated to be effective as of June 1, 2000, executed by and between BNPLC and Extreme. 10.12 Form of Pledge Agreement (Land) dated to be effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme. 10.13 Form of Pledge Agreement (Improvements) dated to be effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme. 21.1 Subsidiaries of Registrant. 23.1 Consent of Ernst and Young LLP, Independent Auditors. 24.1 Power of Attorney (see page 53 of this Form 10-K). 27.1 Financial Data Schedule (available in EDGAR format only). ____________
Incorporated By Reference Exhibit --------------------- Filed Number Description of Document Form Date Number Herewith ------- ----------------------- ----- -------- ------ -------- 2.1 Form of Agreement and Plan of Merger between Extreme S-1/A 03/11/99 2.1 Networks, a California corporation, and Extreme Networks, Inc., a Delaware corporation. 3.1 Certificate of Incorporation of Extreme Networks, Inc., a S-1 02/05/99 3.1 Delaware Corporation. 3.2 Form of Certificate of Amendment of Certificate of S-1 02/05/99 3.2 Incorporation of Extreme Networks, Inc., a Delaware Corporation. 3.4 Amended and Restated Bylaws of Extreme Networks, Inc. 8-K/A 06/07/01 3.4 3.5 Restated Certificate of Incorporation of Extreme Networks, X Inc. 3.6 Certificate of Amendment of Restated Certificate of X Incorporation of Extreme Networks, Inc. 3.7 Certificate of Designation, Preferences and Rights of the X Terms of the Series A Preferred Stock 4.1 Second Amended and Restated Rights Agreement dated S-1 02/05/99 4.1 January 12, 1998 between Extreme Network and certain stockholders. 4.2 Registration Rights Agreement S-3 04/11/01 4.1 10.1 Form of Indemnification Agreement for directors and officers. S-1 02/05/99 10.1 10.2* Amended 1996 Stock Option Plan and forms of agreements S-1 02/05/99 10.2 thereunder. 10.3* 1999 Employee Stock Purchase Plan. S-1 02/05/99 10.3 10.4 Sublease, dated June 5, 1997 between NetManage, Inc. and S-1 02/05/99 10.4 Extreme Networks, Inc., a California corporation, to Master Lease, dated September 30, 1994, between Cupertino Industrial Associates and NetManage, Inc. 10.5 Sublease, dated January 1, 1999 between Apple Computer, S-1/A 03/11/99 10.5 Inc., a California corporation, and Extreme Networks, Inc., a California corporation, to Lease Agreement, as amended. 10.6 Form of Warrant to Purchase Common Stock between 3Com 10-K 06/30/00 10.6 Corporation and Extreme Networks, Inc. 10.7* Form of 2000 Nonstatutory Stock Option Plan. 10-K 06/30/00 10.7 10.8 Form of Lease Agreement (Land) dated June 1, 2000 by and 10-K 06/30/00 10.8 between BNP Leasing Corporation, a Delaware corporation ("BNPLC") and Extreme Networks, Inc. a Delaware corporation ("Extreme"). 10.9 Form of Lease Agreement (Improvements) dated June 1, 2000, 10-K 06/30/00 10.9 executed by and between BNPLC and Extreme. 10.10 Form of Purchase Agreement (Land) dated to be effective as of 10-K 06/30/00 10.10 June 1, 2000, executed by and between BNPLC and Extreme. 10.11 Form of Purchase Agreement (Improvements) dated to be 10-K 06/30/00 10.11 effective as of June 1, 2000, executed by and between BNPLC and Extreme. 10.12 Form of Pledge Agreement (Land) dated to be effective as of 10-K 06/30/00 10.12 June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme. 10.13 Form of Pledge Agreement (Improvements) dated to be 10-K 06/30/00 10.13 effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme. 10.14 Exhibit 10.14 Lease agreement dated July 28, 2000 between 10-Q 09/30/00 10.14 San Tomas Properties LLC, a Delaware limited liability company, as Landlord, and Extreme Networks, Inc, a Delaware Corporation, as Tenant. 21.1 Subsidiaries of Registrant. X 23.1 Consent of Ernst and Young LLP, Independent Auditors. X 24.1 Power of Attorney (see page 74 of this Form 10-K). X
-------- * Indicates management contract or compensatory plan or arrangement. (1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 (File No. 333-71921).75