________________________________________________________________________________
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- EXCHANGE ACT OF 1934
For the quarter ended April 1, 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 000-25711
EXTREME NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0430270
- --------------------------------- -----------------------------------
[State or other jurisdiction [I.R.S Employer Identification No.]
of incorporation or organization]
3585 Monroe Street
Santa Clara, California 95051
- --------------------------------------- -----------------
[Address of pricipal executive offices] [Zip Code]
Registrant's telephone number, including area code: (408) 579-2800
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
--------
The number of shares of the Registrant's Common Stock, $.001 par value,
outstanding at
May 3, 2001 was 113,263,361
_______________________________________________________________________________
EXTREME NETWORKS, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED MARCH 31, 2001
INDEX
PAGE
PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets
March 31, 2001 and June 30, 2000 3
Condensed Consolidated Statements of Operations
Three months ended and nine months ended March 31, 2001 and March 31, 2000 4
Condensed Consolidated Statements of Cash Flows
Nine months ended March 31, 2001 and March 31, 2000 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Changes in Securities Not applicable
Item 3. Defaults Upon Senior Securities Not applicable
Item 4. Submission of Matters to a Vote of Security Holders Not applicable
Item 5. Other Information Not applicable
Item 6. Exhibits and Reports on Form 8-K Not applicable
Signatures 32
2
Part I. Financial Information
Item 1. Financial Statements
EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31, June 30,
2001 2000
----------------- ------------------
(Unaudited) (Note 1)
Assets
Current assets:
Cash and cash equivalents $ 83,061 $116,721
Short-term investments 62,367 66,640
Accounts receivable, net 88,913 60,996
Inventories 63,186 23,801
Deferred tax assets 22,424 13,800
Other current assets 20,619 20,526
----------------- ------------------
Total current assets 340,570 302,484
Property and equipment, net 52,258 26,750
Restricted investments 80,000 80,000
Investments 23,936 44,144
Goodwill and purchased intangibles 125,910 49,782
Other assets 43,861 12,770
----------------- ------------------
$666,535 $515,930
================= ==================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 37,731 $ 39,023
Accrued compensation 15,223 11,041
Leasehold improvements allowance 7,611 8,424
Deferred revenue 46,328 22,042
Accrued purchase commitments 7,669 2,023
Other accrued liabilities 17,315 14,050
----------------- ------------------
Total current liabilities 131,877 96,603
Long term deposit 266 306
Commitments (Note 4)
Stockholders' equity:
Common stock 107 106
Additional paid-in capital 618,396 423,044
Deferred stock compensation (23,920) (78)
Accumulated other comprehensive income (loss) 758 (623)
Accumulated deficit (60,949) (3,428)
Total stockholders' equity 534,392 419,021
----------------- ------------------
$666,535 $515,930
================= ==================
See accompanying notes to the unaudited condensed consolidated financial statements.
3
EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine months Ended
---------------------------------------- --------------------------------------
March 31, March 31, March 31, March 31,
2001 2000 2001 2000
------------------- ------------------ ----------------- -----------------
Net revenue $112,106 $ 67,310 $376,163 $169,534
Cost of revenue 97,864 31,971 225,728 80,748
------------------- ------------------ ----------------- -----------------
Gross profit 14,242 35,339 150,435 88,786
Operating expenses:
Research and development 16,497 8,102 41,193 22,781
Sales and marketing 41,578 14,798 117,192 38,180
General and administrative 11,284 2,906 20,442 8,204
Goodwill, purchased intangibles and
deferred stock compensation 8,239 - 22,101 -
Other operating expense 34,020 - 34,020 -
------------------- ------------------ ----------------- -----------------
Total operating expenses 111,618 25,806 234,948 69,165
------------------- ------------------ ----------------- -----------------
Operating income (loss) (97,376) 9,533 (84,513) 19,621
Interest and other income, net 2,005 4,401 8,519 9,841
------------------- ------------------ ----------------- -----------------
Income (loss) before income taxes (95,371) 13,934 (75,994) 29,462
Provision (benefit) for income taxes (25,256) 4,877 (18,474) 10,003
------------------- ------------------ ----------------- -----------------
Net income (loss) $(70,115) $ 9,057 $(57,520) $ 19,459
=================== ================== ================= =================
*Basic net income (loss) per common share $ (0.64) $ 0.09 $ (0.54) $ 0.20
=================== ================== ================= =================
*Diluted net income (loss) per common share $ (0.64) $ 0.08 $ (0.54) $ 0.18
=================== ================== ================= =================
*Weighted average shares outstanding used in
computing basic net income (loss) per share 109,028 103,060 107,433 99,158
=================== ================== ================= =================
*Weighted average shares outstanding used in
computing diluted net income (loss) per share 109,028 113,584 107,433 110,654
=================== ================== ================= =================
See accompanying notes to the unaudited condensed consolidated financial statements.
* Share and per-share data presented reflect the two-for-one stock split effective August 24, 2000.
4
EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine months Ended
---------------------------------------------
March 31, March 31,
2001 2000
----------------- --------------------
Operating activities:
Net income (loss) $(57,520) $ 19,459
Adjustments to reconcile net income (loss) to net cash provided by
(used for) operating activities:
Depreciation 13,046 4,853
Amortization 21,684 -
Provision for doubtful accounts 4,621 -
Provision for inventory reserves 31,288 -
In-process research and development 30,142 -
Amortization of deferred stock compensation 575 94
Loss on equity investments 3,708 -
Loss on retirement of assets 2,014 -
Compensation expense for options granted to consultants 630 -
Changes in assets and liabilities:
Accounts receivable (32,537) (22,419)
Inventories (70,673) (4,494)
Other current and noncurrent assets (20,968) (12,251)
Accounts payable (1,422) 13,759
Accrued compensation 4,182 2,274
Deferred income taxes (3,624) -
Deferred revenue 24,286 11,414
Accrued purchase commitments 7,163 912
Other accrued liabilities 9,111 10,157
Long term deposit (40) -
----------------- --------------------
Net cash provided by (used for) operating activities (34,334) 23,758
----------------- --------------------
Investing activities:
Capital expenditures (39,077) (16,545)
Purchases and maturities of investments, net 25,861 (55,786)
Acquisition of business, net of cash assumed 2,291 -
Minority investments (7,500) (7,651)
----------------- --------------------
Net cash used for investing activities (18,425) (79,982)
----------------- --------------------
Financing activities:
Proceeds from issuance of common stock 19,099 179,923
Principal payments of capital lease obligations - (1,648)
----------------- --------------------
Net cash provided by financing activities 19,099 178,275
----------------- --------------------
Net increase (decrease) in cash and cash equivalents (33,660) 122,051
Cash and cash equivalents at beginning of period 116,721 107,143
----------------- --------------------
Cash and cash equivalents at end of period $ 83,061 $229,194
================= ====================
See accompanying notes to the unaudited condensed consolidated financial statements.
5
EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements have been prepared by
Extreme Networks, Inc., pursuant to the rules and regulations of the Securities
and Exchange Commission and include the accounts of Extreme Networks, Inc. and
its wholly-owned subsidiaries ("Extreme" or collectively, the "Company").
Certain information and footnote disclosures, normally included in financial
statements prepared in accordance with generally accepted accounting principles,
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of the Company, the unaudited financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the financial position at March 31, 2001 and the operating
results and cash flows for the three and nine months ended March 31, 2001 and
March 31, 2000. The condensed balance sheet at June 30, 2000 has been derived
from audited financial statements as of that date but does not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. These financial statements and
notes should be read in conjunction with the Company's audited consolidated
financial statements and notes thereto for the year ended June 30, 2000,
included in the Company's Form 10-K filed with the Securities and Exchange
Commission.
The results of operations for the nine months ended March 31, 2001 are not
necessarily indicative of the results that may be expected for future quarters
or the fiscal year ending June 30, 2001. 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).
2. 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 high-performance, broadband networking
solutions.
Fiscal Year
The Company's fiscal year is the 52-week or 53-week period ending on the
last Sunday in June. Fiscal 2001 and 2000 are 52-week fiscal years. The March
31, 2001 quarter closed on April 1, 2001 and comprised 13 weeks of revenue and
expense activity.
Principles of Consolidation
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 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).
6
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 are 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
date of purchase to be cash equivalents. Extreme's investments are comprised of
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
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.
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):
March 31, 2001 June 30, 2000
-------------- -------------
Raw materials $ 22,751 $ 9,501
Finished goods 40,435 14,300
-------------- -------------
Total $ 63,186 $ 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 the Company's investment policy.
Concentration of Credit Risk, Product and Significant Customers
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
7
with high-credit quality issuers. Extreme will not invest an amount exceeding
10% of the corporation'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. To date, credit losses have
been within management's expectations. Extreme operates solely within one
business segment, the development and marketing of switching solutions.
Significant customer concentration is summarized below. No other customer
accounts for more than 10% of Extreme's net revenues.
Three Months Ended Nine Months Ended
------------------------------------ ------------------------------------
Customer March 31, 2001 March 31, 2000 March 31, 2001 March 31, 2000
-------------- -------------- -------------- --------------
A -- -- -- 11%
B -- 11% -- 11%
C 17% 12% 15% --
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 intangibles is generally amortized on
a straight-line basis over periods ranging from 2 to 5 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 goodwill and purchased intangible assets was
allocated based on independent appraisals obtained by the Company, to the
tangible and intangible assets acquired based on their respective fair values on
the dates of acquisition as follows (in thousands):
March 31, 2001 June 30, 2000
-------------- -------------
Goodwill $ 143,488 $ 48,050
Purchased intangible assets 11,158 8,784
-------------- -------------
154,646 56,834
Less: accumulated amortization (28,736) (7,052)
-------------- -------------
Total $ 125,910 $ 49,782
============== =============
Revenue Recognition
Extreme generally recognizes product revenue at the time of shipment,
unless Extreme has future obligations such as installation or is required 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. Revenue from service
obligations 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 and participate
in various cooperative marketing programs. Under specified conditions, we grant
the right to distributors to
8
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). Extreme defers 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 allowances based on
its experience.
Warranty Reserves
Extreme's hardware warranty period is typically 12 months from the date of
shipment to the end user. Software warranties are typically 90 days from date of
shipment to end user. 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
We expense advertising costs as incurred. Advertising expenses for the
three months ended March 31, 2001 and March 31, 2000 were approximately $1.3
million and $0.5 million, respectively. Advertising expenses for the nine months
ended March 31, 2001 and March 31, 2000 were approximately $3.2 million and $1.6
million, respectively.
Foreign Operations
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.
Extreme's export sales represented 54% and 46% of net revenue in the nine
months ended March 31, 2001 and March 31, 2000, respectively. All of the export
sales to date have been denominated in U.S. dollars and were derived from sales
primarily to customers located in Europe and Asia.
Net Income Per Share
Basic earnings per share is calculated by dividing net income 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 share calculation plus the dilutive effect
of options and warrants. Potentially dilutive securities have been excluded from
the diluted earnings per share computations as they have an antidilutive effect
due to the Company's net loss for the three months ended March 31, 2001.
The following table presents the calculation of basic and diluted net
income per share (unaudited in thousands, except per share data):
Three Months Ended March 31, Nine Months Ended March 31,
--------------------------- --------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Net income (loss) $ (70,115) $ 9,057 $ (57,520) $ 19,459
========== ========== ========== ==========
Weighted-average shares of common stock
outstanding 110,259 105,498 108,434 102,862
Less: Weighted-average shares subject
to repurchase (1,231) (2,438) (1,001) (3,704)
---------- ---------- ---------- ----------
Weighted-average shares used in
computing basic net income (loss)
per share 109,028 103,060 107,433 99,158
========== ========== ========== ==========
Incremental shares using the treasury
stock method -- 10,524 -- 11,496
Weighted-average shares used in computing
diluted net income (loss) per share 109,028 113,584 107,433 110,654
========== ========== ========== ==========
*Basic net income (loss) per share $ (0.64) $ 0.09 $ (0.54) $ 0.20
========== ========== ========== ==========
*Diluted net income (loss) per share $ (0.64) $ 0.08 $ (0.54) $ 0.18
========== ========== ========== ==========
*Share and per-share data presented reflect the two-for-one stock split
effective to stockholders of record on August 10, 2000.
9
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 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 adopted these
pronouncements for the year ending June 30, 2001. Extreme enters into foreign
exchange forward contracts to offset the impact of currency fluctuations on
certain nonfunctional operating expenses, denominated in Japanese Yen, the Euro
and 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 do not expect gains
or losses on these contracts to have a material impact on our financial results
(see Note 4). We did not hold any forward contracts as of March 31, 2001.
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. At this time, management does
not expect the adoption of SAB 101 to have a material effect on the Company's
operations or financial position. The Company is required to adopt SAB 101 in
the fourth quarter of fiscal 2001.
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 $1.5
million has been paid as of March 31, 2001. During the quarter ended September
30, 2000, Extreme acquired certain assets of a company for a total cost of $0.9
million. Extreme accounted for these acquisitions using the purchase method of
accounting, and incurs charges of approximately $212,000 per quarter related to
the amortization of goodwill over the estimated useful life of four years. The
entire amount of the purchase prices was allocated to goodwill and purchased
intangibles.
In April 2000, Extreme issued to a certain networking company 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. These warrants were issued as consideration for the networking company's
selection of Extreme as the preferred vendor of next generation core backbone
switching products
10
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, comprised of
customer list, workforce and goodwill.
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. 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 the Company'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 the Company'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, based on an independent valuation, to
goodwill of $41.2 million, 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.
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 revenues. The discounted cash flow analysis was based on
management's forecast of future revenues, cost of revenues 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, resulting in an
aggregate quarterly charge of $1.7 million during the amortization period.
Amortization of acquired intangibles and goodwill associated with this
acquisition totaled $0.6 million for the three months ended March 31, 2001. The
Company recognized stock-based compensation expense associated with unvested
stock options issued to employees in conjunction with the acquisition. This
amount is included as a component of stockholders' equity and is being amortized
by charges to operations over the vesting period of the options, resulting in an
aggregate quarterly charge of $1.6 million. Amortization of stock-based
compensation associated with this acquisition totaled $0.5 million for the three
months ended March 31, 2001.
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. 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 March 7, 2001, Webstack's results of
operations have been included in the Company'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 the Company'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, based on an independent valuation, to
goodwill of $53.1 million, assembled workforce of $0.9 million, in-process
research and development of $16.8 million, deferred compensation of $2.5
million, tangible net assets assumed of $0.7 million and deferred tax assets of
$0.7 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 revenues. The discounted cash flow analysis was based on
management's forecast of future revenues, cost of revenues 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, resulting in an
aggregate quarterly resulting in an aggregate quarterly charge of $2.7 million
during the amortization period. The Company recognized stock-based compensation
expense associated with unvested stock options issued to employees in
conjunction with the acquisition. This amount is included as a component of
stockholders' equity and is being amortized by charges to operations over the
vesting period of the options, resulting in an aggregate quarterly charge of
$0.2 million. There was no amortization of goodwill or stock-based compensation
associated with this acquisition for the three months ended March 31, 2001 due
to the Company's policy of starting amortization in the following month for
acquisitions.
Extreme has made several additional investments totaling $10.9 million,
which are reflected in "Other assets" in the accompanying consolidated balance
sheets. These investments are being accounted for under the cost method. We
expect to continue to make additional investments in the equity of companies
developing technology, products or services related to our business.
4. COMMITMENTS
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 serve as our corporate headquarters in Santa Clara, California. Our
lease payments will vary based on the LIBOR plus a spread, which was 5.5% at
March 31, 2001. Our combined lease payments are estimated to be approximately
$5.7 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 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
11
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 transactions, Extreme restricted $80.0 million
of its investment securities as collateral for specified obligations based on
its position as the lessee. 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 March 31, 2001.
Foreign Exchange Forward Contracts
While sales of the Extreme's products are generally denominated in U.S.
dollars, operating expenses of our foreign subsidiaries are remitted in foreign
currency. As such, Extreme is exposed to adverse movements in foreign currency
exchange rates. Extreme enters into foreign exchange forward contracts to reduce
the impact of certain currency exposures. These contracts hedge exposures
associated with nonfunctional operating expenses denominated in Japanese Yen,
the Euro and British pound. Extreme does not enter into foreign exchange forward
contracts for trading purposes. Gains and losses on the contracts are included
in interest and other income, net. Extreme's foreign exchange forward contracts
generally range from one to three months in original maturity.
5. INCOME TAXES
The Company's income tax liability for federal and state purposes has been
reduced and the deferred tax assets have been increased by the tax benefits of
employee stock option transactions. This benefit totaled $29 million in the
first nine months of fiscal 2001 and was credited directly to stockholders'
equity.
6. OTHER OPERATING EXPENSE
Other operating expense in the three months ended March 31, 2001 includes a
write-off of acquired technologies of $30.2 million and a restructuring charge
of $3.8 million.
The Company recorded non-recurring charges of $13.4 million related to the
purchase of Optranet on January 31, 2001 and $16.8 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, the Company implemented a restructuring plan in order to
lower the Company's overall cost structure. In connection with the
restructuring, the Company reduced its headcount and consolidated facilities.
Restructuring charges included in other operating expenses were $3.8 million in
the quarter ended March 31, 2001. The restructuring expense included $2.1
million in the write-off and write-down in carrying value of equipment, $1.7
million in facility closure expenses. In addition, the Company expects to record
charges of approximately $4.0 million in the fourth quarter of fiscal 2001 for
severance and benefits for terminated employees. The number of temporary
employees and contractors used by the Company will also be reduced. The
following analysis sets forth the significant components of the restructuring
reserve at March 31, 2001 (in thousands):
Facility Closure Equipment TOTAL
---------------- --------- --------
Restructuring charge $ 1,745 $ 2,133 $ 3,878
Cash charge -- -- --
Non-cash charge -- (2,133) (2,133)
---------------- --------- --------
Reserve balance at March 31, 2001 $ 1,745 $ -- $ 1,745
================ ========= ========
12
7. COMPREHENSIVE INCOME (LOSS)
The following are the components of accumulated other comprehensive income
(loss), net of tax (in thousands):
March 31, 2001 June 30, 2000
-------------- -------------
Unrealized gain (loss) on investments $ 932 $ (615)
Foreign currency translation adjustments (174) (8)
-------------- -------------
Accumulated other comprehensive income (loss) $ 758 $ (623)
============== =============
The following schedule of other comprehensive income shows the gross
current-period gain and the reclassification adjustment (in thousands):
Three Months Ended Nine Months Ended
------------------------------------ ------------------------------------
March 31, 2001 March 31, 2000 March 31, 2001 March 31, 2000
-------------- -------------- -------------- --------------
Net income (loss) $ (70,115) $ 9,057 $ (57,520) $ 19,459
Other comprehensive income:
Change in unrealized gain on
investment, net 489 (474) 1,547 (771)
Change in accumulated translation
adjustments (94) (25) (166) --
-------------- -------------- -------------- --------------
Total comprehensive income (loss) $ (69,720) $ 8,558 $ (56,139) $ 18,688
============== ============== ============== ==============
8. STOCKHOLDERS' EQUITY AND 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.
9. SUBSEQUENT EVENT
Stockholder Rights Plan
On April 27, 2001, the board of directors adopted a Stockholder Rights
Plan. Under the plan, 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. The plan calls for each
right to entitle stockholders to purchase a fractional share of the Company's
Series A preferred stock for $150.00. The rights may become exercisable if a
person or group acquires beneficial ownership of 15 percent or more of the
Company's common stock or begins a tender or exchange offer under which the
party would own 15 percent or more of the Company's common stock and in such
case are exercisable by all holders other than such person or group. When the
Rights become exercisable, the board of directors has the right to authorize the
issuance of one share of the Company's common stock in exchange for each right
that is then exercisable.
Part I. Financial Information
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
When used in this discussion and elsewhere in this Form 10-Q, the words
"may," "should," "believes," "expects," "anticipates," "estimates" and similar
expressions identify forward-looking statements. Such statements, which include
statements concerning operating expenses, anticipated growth, potential
expansion of research and development and sales and support staff, working
capital, product mix, pricing trends, the mix of export sales are subject to
risks and uncertainties, including those set forth below under "Factors That
13
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 only as of the date hereof and there may be
events in the future that would alter our expectations but which we are not able
to predict accurately or over which we have no control.
This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with "Factors That May
Affect Future Results" set forth on page 19 and in our other filings with the
U.S. Securities and Exchange Commission. All dollar amounts in this Management's
Discussion and Analysis are in millions.
Overview
Our revenue is derived from sales of our Summit, BlackDiamond and Alpine
product families 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 a Key Reseller, Distributor or Other Significant Customer Cancels or
Delays a Large Purchase, Our Revenues May Decline and the Price of Our Stock May
Fall." Significant customer concentration as a percentage of net revenue is
summarized below:
Three Months Ended Nine Months Ended
------------------------------------ ------------------------------------
Customer March 31, 2001 March 31, 2000 March 31, 2001 March 31, 2000
-------------- -------------- -------------- --------------
A -- -- -- 11%
B -- 11% -- 11%
C 17% 12% 15% --
We market and sell our products primarily through resellers, distributors
and, to a lesser extent, OEMs and our field sales organization. We sell our
products through more than 250 resellers in approximately 50 countries. For the
nine months ended March 31, 2001, sales to customers outside of North America
accounted for approximately 54% 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. Under specified conditions,
we allow third-party distributors to return products to us. Extreme defers
recognition of revenue on sales to distributors until the distributors sell the
product. Service revenue is recognized ratably over the term of the contract
period, which is typically 12 months.
We expect to experience some erosion of average selling prices of our
products due to a number of factors, including competitive pricing pressures,
promotional pricing and rapid technological change. Our gross margins may be
adversely affected by increases in material or labor costs, heightened price
competition, 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 effects of our two-tier distribution channel. Any
significant decline in sales to our resellers, distributors, or end-user
customers, or the loss of any of our resellers, distributors, or end-user
customers, could have a material adverse effect on our business, operating
results and financial condition. In addition, new product introductions may
result in excess or obsolete inventories. Any excess or obsolete inventories may
also reduce our gross margins. If product or related warranty costs associated
with these new products are greater than we have experienced, gross margin may
be adversely affected.
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 - Flextronics International, Ltd., MCMS, Inc., and
Solectron Corporation. We expect to realize lower per unit product costs as a
result of volume efficiencies if and as volumes increase. However,
14
we cannot assure you when or if such price reductions will occur. The failure to
obtain such price reductions could have a material adverse effect on our gross
margins and operating results.
Research and development expenses consist principally of salaries and
related personnel expenses, consultant fees and prototype expenses related to
the design, development, testing and enhancement of our products. 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. However, expenses may be flat or down in coming quarters
as a result of our reorganization. In addition, during the quarter ended March
31, 2001, we hired approximately 64 engineering personnel as part of the
Optranet and Webstacks acquisitions. See Note 3 of Notes to Condensed
Consolidated Financial Statements for further discussion.
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. Our recent
reorganization is expected to reduce sales and marketing expenses in the
immediate future. However, in the longer term and assuming that market
conditions improve, 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 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. Our recent
reorganization is expected to reduce general and administrative expenses in the
immediate future.
We did not achieve profitability in the quarter ended March 31, 2001 due to
impact on gross profit of $40.3 million for charges for excess and obsolete
inventory and lower of cost or market reserves established for the Company's
Summit based products. The Company also recorded non-recurring charges of $13.4
million related to the purchase of Optranet on January 31, 2001 and $16.8
related to the purchase of Webstacks on March 7, 2001 and a restructuring charge
of $3.8 million. The lengthy sales cycle of our products often results in a
significant delay between the time we incur expenses and the time we realize the
related revenue. See "Factors That May Affect Future Results - The Sales Cycle
for Our Products is Long and We 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 Future Results - A Number of
Factors Could Cause Our Quarterly Financial Results to Be Worse Than Expected,
Resulting in a Decline in Our Stock Price."
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. 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. These
transactions were accounted for as purchases and, accordingly, the results of
operations of Optranet and Webstacks and the estimated fair value of assets
acquired and liabilities assumed are included in the Company's consolidated
financial statements as of the effective dates of the purchases through the end
of the quarter ended March 31, 2001. See Note 3 of Notes to Condensed
Consolidated Financial Statements.
Due to the Company's issuance of warrants to a networking company as
discussed in Note 3 of Notes to Condensed Consolidated Financial Statements,
future operating income will be reduced by approximately $7.0 million per
quarter for the remaining quarter in fiscal 2001 and for three of the four
fiscal quarters in fiscal 2002. In addition, the Optranet and Webstacks
acquisitions will result in material charges
15
for amortization of the goodwill and intangibles arising and from the deferred
compensation charges. See Note 3 of Notes to Condensed Consolidated Financial
Statements.
Results of Operations
The following table sets forth for the periods indicated certain financial
data as a percentage of net revenue:
Three Months Ended Nine Months Ended
------------------------------------ ------------------------------------
March 31, 2001 March 31, 2000 March 31, 2001 March 31, 2000
-------------- -------------- -------------- --------------
Net revenue 100.0% 100.0% 100.0% 100.0%
Cost of revenue 87.3 47.5 60.0 47.6
-------------- -------------- -------------- --------------
Gross margin 12.7 52.5 40.0 52.4
-------------- -------------- -------------- --------------
Operating expenses:
Research and development 14.7 12.0 11.0 13.5
Sales and marketing 37.1 22.0 31.2 22.5
General and administrative 10.1 4.3 5.4 4.8
Goodwill, purchased intangibles
and deferred stock compensation 7.4 -- 5.9 --
Other operating expense 30.3 -- 9.0 --
-------------- -------------- -------------- --------------
Total operating expenses 99.6 38.3 62.5 40.8
-------------- -------------- -------------- --------------
Operating income (loss) (86.9) 14.2 (22.5) 11.6
Interest and other income, net 1.8 6.5 2.3 5.8
-------------- -------------- -------------- --------------
Income (loss) before income taxes (85.1) 20.7 (20.2) 17.4
Provision (benefit) for income taxes (22.6) 7.2 (4.9) 5.9
-------------- -------------- -------------- --------------
Net income (loss) (62.5)% 13.5% (15.3)% 11.5%
============== ============== ============== ==============
Net revenue. Net revenue increased from $67.3 million for the three months
ended March 31, 2000 to $112.1 million for the three months ended March 31,
2001, an increase of $44.8 million. Net revenue increased from $169.5 million
for the nine months ended March 31, 2000 to $376.2 million for the nine months
ended March 31, 2001, an increase of $206.7 million. The increases in net
revenues for both the three-month period and the nine-month period in 2001 as
compared to the comparable 2000 periods were primarily due to increased sales of
our Summit stackable products, BlackDiamond modular product family and our
Alpine product family, the market growing acceptance of Extremes existing and
new product offerings, and a significant increase in our sales and marketing
organizations. Net revenue for the three months ended March 31, 2001 did not
meet our expectations due to a general decline in demand for networking
products.
Export sales accounted for 54% and 46% of net revenue in the nine months
ended March 31, 2001 and 2000, respectively. As a result of our growing customer
base abroad, 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. The gross profit rate decreased from 52.5% for the three
months ended March 31, 2000 to 12.7% for the three months ended March 31, 2001.
The gross profit rate decreased from 52.4% for the nine months ended March 31,
2000 to 40.0% for the nine months ended March 31, 2001. The gross profit rates
for the three and nine months ended March 31, 2001 were impacted by $40.3
million in charges for excess and obsolete inventory and lower of cost or market
reserves established for the Company's Summit based products. Excluding the
impact of these charges, gross profit rates would have been 48.7% and 50.7% for
the three and nine months ended March 31, 2001, respectively. These decreases
from the comparable periods in
16
fiscal 2000 were due a shift in the mix of products sold, a shift in our channel
mix and lower average selling prices due primarily to increased competition.
Research and development expenses. Research and development expenses
increased from $8.1 million for the three months ended March 31, 2000 to $16.5
million for the three months ended March 31, 2001, an increase of $8.4 million.
Research and development expenses increased from $22.8 million for the nine
months ended March 31, 2000 to $41.2 million for the nine months ended March 31,
2001, an increase of $18.4 million. The increases in both the three-month and
nine-month periods ended March 31, 2001 as compared to the comparable fiscal
2000 periods were due to increases in headcount to support the Company's
multiple product development efforts, nonrecurring engineering and initial
product verification expenses. In addition, during the quarter ended March 31,
2001, we hired approximately 64 engineering personnel as part of the Optranet
and Webstacks acquisitions. See Note 3 of Notes to Condensed Consolidated
Financial Statements for further discussion.
Sales and marketing expenses. Sales and marketing expenses increased from
$14.8 million for the three months ended March 31, 2000 to $41.6 million for the
three months ended March 31, 2001, an increase of $26.8 million. Sales and
marketing expenses increased from $38.2 million for the nine months ended March
31, 2000 to $117.2 million for the nine months ended March 31, 2001, an increase
of $79.0 million. This increase was primarily due to the hiring of additional
sales, marketing and customer support personnel, increased sales commission
expenses resulting from increased revenues, increased promotional expenses and
the establishment of new sales offices.
General and administrative expenses. General and administrative expenses
increased from $2.9 million for the three months ended March 31, 2000 to $11.3
million for the three months ended March 31, 2001, an increase of $8.4 million.
General and administrative expenses increased from $8.2 million for the nine
months ended March 31, 2000 to $20.4 million for the nine months ended March 31,
2001, an increase of $12.2 million. This increase was due primarily to an
increase in bad debt expense, the hiring of additional finance, information
technology and legal and administrative personnel and increased professional
fees and facilities costs.
Goodwill, Purchased Intangibles and Deferred Stock Compensation.
Amortization of goodwill and intangibles was $22.1 million for the nine months
ended March 31, 2001. This amount was primarily due to the Company's issuance of
fully earned, non-forfeitable, fully exercisable warrants with a two year life
to purchase 3 million shares of the Company's common stock with an exercise
price of $39.50 per share as discussed in Note 3 of Notes to Condensed
Consolidated Financial Statements. Future operating income will be reduced by
approximately $7.0 million per quarter for the remaining quarter in fiscal 2001
and for three fiscal quarters in fiscal 2002 related to this transaction. In
addition, the Optranet and Webstacks acquisitions will result in material
charges for amortization of the goodwill and intangibles arising and from the
deferred compensation charges (see Note 3 of Notes to Condensed Consolidated
Financial Statements). We expect that future operating income may be reduced as
a result of purchase accounting acquisitions, such as our recent Optranet and
Webstacks acquisitions.
Other operating expense. Other operating expense in the three months ended
March 31, 2001 includes a write-off of acquired technologies of $30.2 million
and a restructuring charge of $3.8 million, as described below.
The Company recorded non-recurring charges of $13.4 million related to the
purchase of Optranet on January 31, 2001 and $16.8 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 of Notes to Condensed Consolidated Financial Statements.
17
In March 2001, the Company implemented a restructuring plan in order to
lower the Company's overall cost structure. In connection with the
restructuring, the Company reduced its headcount and consolidated facilities.
Restructuring charges included in other operating expenses were $3.8 million in
the quarter ended March 31, 2001. The restructuring expense included $2.1
million in the write-off and write-down in carrying value of equipment and $1.7
million in facility closure expenses. In addition, the Company expects to record
charges of approximately $4.0 million in the fourth quarter of fiscal 2001 for
severance and benefits for terminated employees. The number of temporary
employees and contractors used by the Company will also be reduced.
Interest and other income, net. Interest and other income, net decreased
from $4.4 million for the three months ended March 31, 2000 to $2.0 million for
the three months ended March 31, 2001, a decrease of $2.4 million. Interest and
other income, net decreased from $9.8 million for the nine months ended March
31, 2000 to $8.5 million for the nine months ended March 31, 2001, a decrease of
$1.3 million. The decreases were due to decreased interest income earned as a
result of the decreased amount of cash and cash equivalents, short-term
investments, restricted investments and long-term investments and the write-off
of cost investments.
Income taxes. We recorded tax benefits of $25.3 million for the three
months ended March 31, 2001 and $18.5 million for the nine months ended March
31, 2001, which resulted in effective tax rates of 26.5% and 24.3%,
respectively. The effective rates include the impact of nondeductible in-process
R&D and other acquisition-related costs.
Liquidity and Capital Resources
Cash and cash equivalents, short-term investments, and investments
decreased from $227.5 million at June 30, 2000 to $169.4 million at March 31,
2001, a decrease of $58.1 million. The decrease is primarily due to increases in
accounts receivable and inventories and capital expenditures, partially offset
by proceeds from issuance of common stock.
Accounts receivable increased 46% from June 30, 2000 to March 31, 2001.
Days sales outstanding in receivables increased from 59 days at June 30, 2000 to
71 days at March 31, 2001. The increase in accounts receivable and days sales
outstanding was due, in part, to growth in net sales combined with conditions in
a number of markets resulting in longer payment terms. We expect that accounts
receivable will continue to increase to the extent our revenues continue to
rise. Inventory levels increased 165% from June 30, 2000 to March 31, 2001.
Extreme has increased inventory in order to support revenue growth, develop
distribution channels, maintain shorter lead times on certain projects and to
provide assurance to our customers that we will be able to meet demand.
Inventory management remains an area of focus as we balance the need to maintain
strategic inventory levels to ensure competitive lead times versus the risk of
inventory obsolescence because of rapidly changing technology and customer
requirements. For example, as a result of the rapid change in the market for
networking products, the Company recorded $40.3 million in charges for excess
and obsolete inventory and lower of cost or market reserves established for the
Company's Summit based products in the quarter ended March 31, 2001.
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 the LIBOR plus a spread, which was 5.5% at March 31,
2001. Our combined lease payments are estimated to be approximately $5.7 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 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.
18
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 transactions, the Company restricted $80.0
million of its investment securities as collateral for specified obligations as
the lessee. 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. The lease also requires us to maintain specified financial
covenants with which we were in compliance as of March 31, 2001.
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 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.
Factors That May Affect Future Results
We Have a Limited History of Profitability and We Cannot Assure You that We Will
Continue to Achieve Profitability
Fiscal 2000 was the first year in which Extreme achieved profitability in
each of the four quarters and we reported a loss for the quarter ended March 31,
2001. 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 significantly higher revenue to return to and sustain
profitability. In addition, the amortization of purchased goodwill and
intangibles, and deferred compensation associated with acquisitions, will result
in material charges.
A Number of Factors Could Cause Our Quarterly Financial Results to Be Worse Than
Expected, Resulting in a Decline in Our Stock Price
We plan to increase our operating expenses to expand our sales and
marketing activities, broaden our customer support capabilities, develop new
distribution channels, fund increased levels of research and development and
build 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
such occurred in the quarter ended March 31, 2001, could cause our quarterly
operating results to be 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 for 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 in 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
significant product shipments at the end of a quarter. Failure to ship these
products by the end of a quarter may adversely affect our operating results.
Furthermore, our customer agreements typically provide that the customer may
delay scheduled delivery dates and cancel orders within
19
specified timeframes without significant penalty. 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, but not limited to, the following:
. fluctuations in demand for our products and services, including seasonality,
particularly in Asia and Europe;
. unexpected product returns or the cancellation or rescheduling of 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 service
providers and other potential large customers;
. our ability to achieve targeted cost reductions;
. our ability to obtain sufficient supplies of sole or limited source
components for our products on a timely basis;
. increases in the prices of the components we purchase;
. our ability to achieve and maintain desired production volumes and quality
levels for our products;
. the mix of products sold and the mix of distribution channels through which
products are sold;
. costs relating to possible acquisitions and the integration
of technologies or businesses;
. the effect of amortization of goodwill, deferred compensation, and purchased
intangibles resulting from existing or new transactions; and
. changes in general and/or specific economic conditions in the networking
industry.
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.
Intense Competition in the Market for Networking Equipment Could Prevent Us from
Increasing Revenue and Prevent Us from Sustaining Profitability
The market for networking switches is intensely competitive. Our principal
competitors include Cisco Systems, Foundry Networks, Riverstone Networks, and
Nortel Networks. In addition, a number of private companies have announced plans
for new products that may compete with our own products. Many of our current and
potential competitors have the advantages over us of longer operating histories
and substantially greater financial, technical, sales, marketing, and other
resources, in addition to greater name recognition and larger installed customer
bases. These competitors may have developed, or could in the future, develop new
competing products based on technologies that render our products obsolete.
To remain competitive, we believe we must, among other things, invest
significant resources in developing new products enhancing our current products
and maintaining customer satisfaction. If we fail to do so, our products may not
compete favorably with those of our competitors, which could have a material
adverse effect on our revenue and future profitability.
We Expect the Average Selling Prices of Our Products to Decrease 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 and rapid technological change. We may experience substantial period-
to-period fluctuations in future 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
cost merchant silicon.
20
Competitive pressures are expected to increase as a result of the industry
slowdown that occurred in the first calendar quarter of 2001. Therefore, 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 have a material adverse effect on our operating results and cause the
price of our common stock to decline.
The Market in Which We Compete is Subject to Rapid Technological Change and to
Compete, We 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. Alternative technologies could achieve widespread market acceptance and
displace the Ethernet technology on which our product lines and architecture are
based. We cannot assure you that our technological approach will achieve broad
market acceptance or that other technologies or devices will not supplant our
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 have a
material adverse effect on our operating results by unexpectedly decreasing
sales, increasing 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 emerging technologies. We cannot assure you that new products will be
commercially successful. We have experienced delays in releasing new products
and product enhancements in the past that has resulted in lower quarterly
revenue than anticipated. We may experience similar delays in product
development and release in the future and any delay in product introduction
could adversely affect our ability to compete and cause our operating results to
be below our expectations or the expectations of public market analysts or
investors.
Continued Rapid Growth Will Strain Our Operations and Will Require Us to Incur
Costs to Upgrade Our Infrastructure
We have experienced a period of rapid growth and expansion that has placed,
and continues to place, a significant strain on our resources. Even if we manage
this growth effectively, we may make mistakes in operating our business such as
inaccurate sales forecasting, incorrect material planning, or inaccurate
financial reporting, which may result in unanticipated fluctuations in our
operating results. Our net revenue increased significantly during the last
fiscal year, and from March 31, 2000 to March 31, 2001, the number of our
employees increased from 404 to 1,067. 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 and update operational, information and financial systems, procedures
and controls;
. hire, train, and manage additional qualified personnel in the fields of
engineering, sales, marketing, and 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
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operations. We may need 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 need to expand our
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.
We Must Develop and Expand Our Indirect Distribution Channels to Increase
Revenues and Improve Our Operating Results
Our distribution strategy focuses primarily on developing and expanding
indirect distribution channels through resellers and distributors, in addition
to 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 which has and will require us to enter into
agreements with a 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 so 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.
In an effort to support and develop leads for our indirect distribution
channels and to expand our direct sales to customers, we plan to continue to
expand our field sales and support staff. We cannot assure you that this
internal expansion will be successfully completed, that the cost of this
expansion will not exceed the revenues 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 affect our ability to grow and increase revenue.
Most of Our Revenue is Derived From Sales of Three Product Families, So We are
Dependent on Widespread Market Acceptance of These Products; Future Performance
will Depend on the Introduction and Acceptance of New Products
In the quarter ended March 31, 2001, we derived substantially all of our
revenue from sales of our Summit, BlackDiamond, and Alpine product families. We
expect that revenue from these product families will account for a substantial
portion of our revenue for the foreseeable future. Accordingly, widespread
market acceptance of our product families is vital to our future success.
Factors that may affect the sales of our products include:
. the demand for switching products (Gigabit Ethernet and Layer 3 switching
technologies in particular) in the enterprise, service provider and
metropolitan area network markets;
. the performance, price and total cost of ownership of our products;
. the availability and price of competing products and technologies; and
. the success and development of our resellers, distributors, and field sales
channels.
Some of these factors are beyond our control. 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. In the past, we have experienced delays in product development
22
and such delays may occur in the future. We introduced a new product family in
fiscal 2000 that is based on a new generation chipset. We also introduced other
products incorporating this chipset within our existing product 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, any delay in the
development or introduction of new products could cause our operating results to
suffer. The risk that we will be unable to achieve and maintain widespread
levels of market acceptance for our current and future products may
significantly impair our revenue growth.
If a Key Reseller, Distributor, or Other Significant Customer Cancels or Delays
a Large Purchase, Our Revenues May Decline and the Price of Our Stock May Fall
To date, a limited number of resellers, distributors, 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, for the nine months ended March 31, 2001, Tech
Data Corporation accounted for 15% of our net revenue. Because our expense
levels are based on our expectations as to future revenue and to a large extent
are fixed in the short term, a substantial reduction or delay in sales of our
products to, or the loss of any significant reseller, distributor, or other
customer, or unexpected returns from 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 small number of customers, particularly in view of the high sales price
per unit of our products and the length of our sales cycles.
While our financial performance depends on large orders from a few key
resellers, distributors, and other significant customers, we do not have binding
commitments from any of them. For example:
. our service provider and enterprise network customers can stop purchasing and
our resellers, and distributors can stop marketing our products at any time;
. our reseller agreements generally are not exclusive and are for one-year
terms, with no obligation of 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 end-user customer agreements generally do not
require minimum purchases.
Under specified conditions, some third-party distributors are allowed to
return products to us. Extreme defers recognition of revenue on sales to
distributors until the distributors sell the product.
Some of Our Customers Depend on the Internet and its Rapid Growth for All or
Substantially All of Their Revenue and May Not Have the Resources to Pay for Our
Products as a Result of the Current Economic Environment
Some of our customers depend on the Internet and its rapid growth for all
or substantially all of their revenue. However, with the recent economic
slowdown, these customers are forecasting that their revenue for the foreseeable
future will generally be lower than anticipated, and some of these customers are
experiencing, or are likely to experience, serious cash flow problems. As a
result, if some of these customers are not successful in generating sufficient
revenue or securing alternate financing arrangements, we may not be able to
collect the receivables that they owe us. The inability of some of our potential
customers to pay us for our products may adversely affect our timing of revenue
recognition, which may cause our stock price to decline.
The Sales Cycle for Our Products is Long and We May Incur Substantial Non-
Recoverable Expenses or Devote Significant Resources to Sales that Do Not Occur
When Anticipated
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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 sales price per unit, and often
represent a significant and strategic decision by an enterprise regarding its
communications infrastructure. Accordingly, we point out that:
. the decision by customers to purchase our products is often based on the
results of a variety of internal procedures associated with the evaluation,
testing, implementation and acceptance of new technologies;
. the evaluation process frequently results in a lengthy sales process,
typically ranging from three months to longer than a year, and as a result,
our ability to sell products is subject to a number of significant risks,
including budgetary constraints and internal acceptance reviews; and
. the length of our sales cycle may also vary substantially from customer to
customer. We may incur substantial sales and marketing expenses and expend
significant management effort during the time that customers are evaluating
products in consideration of a possible purchase; and
. if a sales forecast from a specific customer for a particular quarter is not
realized in that quarter, we may be unable to compensate for the shortfall,
which could harm our operating results.
We Purchase Several Key Components for Products From Single or Limited Sources
and Could Lose Sales if These Sources Fail to Meet 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, 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 have
a material adverse effect on our ability to meet customer orders. Our principal
sole-sourced components include:
. application specific integrated circuits, referred to as ASICs;
. microprocessors;
. programmable integrated circuits;
. selected other integrated circuits;
. cables;
. custom power supplies; and
. custom-tooled sheet metal.
Our principal limited sourced components include:
. flash memories;
. dynamic and static random access memories, commonly known as DRAMs and SRAMs,
respectively; and
. printed circuit boards.
We use a rolling six-month forecast based on anticipated product orders 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
match forecasts, we may have excess or inadequate inventory of certain materials
and components, which could have a material adverse effect on our operating
results and financial condition. 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.
We May Need to Expand Our Manufacturing Operations and We Depend on Contract
Manufacturers for Substantially All of Our Manufacturing Requirements
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If the demand for our products 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 contractors to manufacture our products. We
currently subcontract our manufacturing to three companies - Flextronics
International, Ltd., located in San Jose, California, MCMS, Inc., located in
Boise, Idaho, and Solectron Corporation, located in Milpitas, California. We
have experienced delays in product shipments from contract manufacturers in the
past, which in turn delayed product shipments to our customers. We may in the
future experience similar or other problems, such as inferior quality and
insufficient quantity of product, any of which could have a material adverse
effect on our business and operating results. There can be no assurance that 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 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 any of our contract manufacturers would
cause a delay in our ability to fulfill orders and would 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 by 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.
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 would hurt 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 our 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.
If We Lose Key Personnel or are Unable to Hire Additional Qualified Personnel as
Necessary, We May Not Be Able to Successfully Manage Our Business or Achieve Our
Objectives
Our success depends to a significant degree upon the continued
contributions of our key management, engineering, sales and marketing and
operations personnel, many of whom would be difficult to replace. In particular,
we believe that our future success is highly dependent on Gordon Stitt,
chairman, president and chief executive officer, Stephen Haddock, vice president
and chief technical officer, and Herb Schneider,
25
vice president of engineering. We do not have employment contracts with these
personnel nor do 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 operations personnel. Competition for these personnel is
intense, especially in the San Francisco Bay Area, and we have had difficulty
hiring employees, particularly software engineers, in the timeframe we 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 "underwater." 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 desired
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. 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 other companies and, although to date they have not resulted in material
litigation, we cannot assure you that 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.
Our Products Must Comply With Evolving Industry Standards and Complex Government
Regulations or Our Products May Not Be Widely Accepted, Which May Prevent Us
From Sustaining Our Revenues 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. Our products must comply
with various U.S. federal government regulations and standards defined by
agencies such as the Federal Communications Commission, in addition to standards
established by governmental authorities in various foreign countries and
recommendations of the International Telecommunication Union. If we do not
comply with existing or evolving industry standards or if we fail to obtain
timely domestic or foreign regulatory approvals or certificates we will not be
able to sell our products where these standards or regulations apply, which may
prevent us from sustaining our revenues or achieving profitability.
Failure to Successfully Integrate Our Expanded Sales and Support Organizations
into Our Operation or Educate Them About Our Product Families May Hurt Our
Operating Results
Our products and services require a sophisticated sales effort targeted at
several levels within a prospective customer's organization. Unless we expand
our sales force we will not be able to increase revenues. We cannot assure you
that we will be able to educate new employees about our product families or
successfully integrate new employees into our company. A failure to do so may
hurt our revenue growth and consequently hurt our operating results.
We Depend Upon International Sales for Much of Our Revenue and Our Ability to
Sustain and Increase Our International Sales Depends on Successfully Expanding
Our International Operations
Our ability to grow will depend in part on the expansion of international
sales that are expected to continue to constitute a significant portion of our
sales. Sales to customers outside of North America accounted for approximately
54% and 46% of our net revenue in the nine months ended March 31, 2001 and March
31, 2000, respectively. Our international sales primarily depend on our
resellers and distributors. The failure of our resellers and distributors to
sell our products internationally would limit our ability to sustain
26
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 exposes us to
risks of currency fluctuations;
. import or export licensing requirements;
. potential adverse tax consequences; and
. unexpected changes in regulatory requirements.
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 expose us to fluctuations in exchange rates between the U.S. dollar and the
particular local currency. If we do so, we may decide 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 these hedging transactions, we
could incur losses from hedging activities. We currently denominate sales in
U.S. dollars, so we do not anticipate that the adoption of the Euro as a
functional legal currency of certain European countries will materially affect
our business.
We 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:
. issue equity securities which would dilute current stockholders' percentage
ownership;
. incur substantial debt;
. incur goodwill that, under current accounting rules, must be amortized over
time, reducing our net income;
. assume contingent liabilities; or
. expend significant cash.
These actions by us could have 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;
. 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
experience;
. potential loss of key employees of acquired organizations; and
. substantial charges for amortization of goodwill or purchased intangibles or
similar items.
27
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 have a material adverse effect on our
business, operating results and financial condition. Moreover, even if the
company does obtain benefits in the form of increased sales and earnings, often
times there is a lag between the time when the expenses associated with an
acquisition are incurred and the time when the company achieves such results.
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 Our Future Operations and, If It Is Not
Available When Needed, We May Need to Reduce Our Planned Development and
Marketing Efforts, Which May Reduce Our Revenues and Prevent Us From Achieving
Profitability
We believe that our existing working capital, 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 require a significant commitment of resources. In addition, if
the market 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, we may continue to utilize 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 to existing stockholders. If additional funds are raised through the
issuance of debt securities, such securities may have rights, preferences and
privileges senior to holders of common stock and the term 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 harm
our business, financial condition and operating results.
If Our Products Contain Undetected Software or Hardware Errors, We Could Incur
Significant Unexpected Expenses and Lost Sales
Network products frequently contain undetected software or hardware errors
when first introduced upon the release of new versions. In the past, we have
experienced such errors 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 affect our business by causing us to incur significant
warranty and repair costs, diverting the attention of our engineering personnel
from our 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 source of the problem. 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 of significant expenses. The
occurrence of any such problems would likely have a material adverse effect on
our business, operating results and financial condition.
Our Ability to Protect Our Intellectual Property and Defend Against Claims May
be Limited and 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
28
have taken will adequately protect our intellectual property rights. The
networking industry in which Extreme operates is prone to intellectual property
claims by and among competing parties. We cannot assure you that we will always
successfully defend against such claims.
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.
We Are Subject to a Claim and Could Enter Litigation Regarding Intellectual
Property Rights, Which Could Seriously Harm Our Business and Require Us to Incur
Significant Costs
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 the proprietary rights of a third
party. 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 others propriety rights could result in substantial costs
and diversion of resources and could have a material adverse effect on our
business, financial condition, and results of operations.
We have received notice from three companies alleging that we are
infringing their patents. One of these companies, Nortel Networks, has filed a
claim against us alleging patent infringement. We are examining this claim and
believe it is without merit. However, we are continuing our investigation of the
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 at all;
. pay damages; or
. redesign those products that use the disputed technology.
If we are forced to take any of the foregoing actions, our business could be
severely harmed.
Provisions in Our 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 approval.
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 stockholder rights plan as described in Note 9
of Notes to Consolidated Financial Statements.
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Item 3. 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 maximizing 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, short-term
investments, restricted investments and 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, short-
term investments and long-term investments that are subject to market risk by
range of expected maturity and weighted-average interest rates as of March 31,
2001. This table does not include money market funds because those funds are not
subject to market risk.
Maturing in
---------------------------------------------------------------------------------
Three months Three months Greater than
or less to one year one year Total Fair Value
------------ ------------ ------------ -------- ----------
(In thousands)
Included in cash and cash
equivalents.................. $ 69,663 $ 69,663 $ 69,663
Weighted average interest
rate...................... 5.16%
Included in short-term
investments.................. $ 62,367 $ 62,367 $ 62,367
Weighted average interest
rate......................... 6.08%
Included in investments ...... $ 23,936 $ 23,936 $ 23,936
Weighted average interest rate 6.03%
Exchange Rate Sensitivity
Currently, the majority of our sales and 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 nine months ended March 31, 2001 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 and 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 do not expect gains or losses on these contracts to have a material
impact on our financial results (see Note 4 of Notes to Condensed Consolidated
Financial Statements).
PART II. Other Information
Item 1. Legal Proceedings
On March 14, 2001, Nortel Networks, Inc. and Nortel Networks Limited
(collectively, "Nortel") filed suit against the Company in the United States
District Court for the District of Massachusetts, Civil Action No. 01-10443EFH.
The complaint alleges infringement of U.S. Patent Nos. 5,790,554; 5,490,252;
5,408,469; 5,398,245;
30
5,159,595 and 4,736,363, and seeks unspecified damages and injunctive relief.
The complaint has not been served. In the event that Nortel pursues the action,
the Company intends to defend the action vigorously.
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K - None
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EXTREME NETWORKS, INC.
(Registrant)
/S/ VITO PALERMO
-------------------------
VITO PALERMO
Vice President, Chief Financial Officer
And Secretary
May 15, 2001
32