Extreme Networks Annual Report 1999

---------------------------------------------------------------------------------------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- Form 10-K ----------------(Mark One) [X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1999 OR [_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission file number 333-71921 Extreme Networks, Inc. (Exact name of Registrant as specified in its charter) Delaware 77-0430270 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 95051 3585 Monroe Street (Zip Code) Santa Clara, California (Address of principal executive offices) Registrant's telephone number, including area code: (408) 579-2800 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock, $.001 par value Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item405 of Regulation S-K is not contained herein, and will not be contained, tothe best of the Registrant's knowledge, in definitive proxy or informationstatements incorporated by reference to Part III of this Form 10-K or anyamendment to this Form 10-K. [_] The aggregate market value of voting stock held by non-affiliates of theRegistrant was approximately $2,883,549,982 as of September 20, 1999, basedupon the closing price on the Nasdaq National Market reported for such date.This calculation does not reflect a determination that certain persons areaffiliates of the Registrant for any other purpose. 49,716,379 shares of the Registrant's Common stock, $.001 par value, wereoutstanding at September 20, 1999. DOCUMENTS INCORPORATED BY REFERENCE Items 10 (as to directors), 11 and 12 of Part III incorporate by referenceinformation from the Registrant's Proxy Statement to be filed with theSecurities and Exchange Commission in connection with the solicitation ofproxies for the Registrant's 1999 Annual Meeting of Stockholders. ---------------------------------------------------------------------------------------------------------------------------------------------------------------- EXTREME NETWORKS, INC. FORM 10-K INDEX Page ---- PART I Item 1. Business...................................................... 3 Item 2. Properties.................................................... 16 Item 3. Legal Proceedings............................................. 16 Item 4. Submission of Matters to a Vote of Security holders........... 16 PART II Market For Registrant's Common Equity and Related Stockholder Item 5. Matters....................................................... 18 Item 6. Selected Consolidated Financial Data.......................... 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................... 19 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 36 Item 8. Financial Statements and Supplementary Data................... 37 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure...................................... 56 PART III Item 10. Directors and Executive Officers of the Registrant............ 56 Item 11. Executive Compensation........................................ 56 Security Ownership of Certain Beneficial Owners and Item 12. Management.................................................... 56 Item 13. Certain Relationships and Related Transactions................ 56 PART IV Exhibits, Financial Statement Schedules and Reports on Form 8- Item 14. K............................................................. 56 SIGNATURES.............................................................. 59 2 PART I Item 1. Business. When used in this Report, the words "may," "should," "believes," "expects","anticipates", "estimates" and similar expressions are intended to identifyforward-looking statements. Such statements, which include statementsconcerning the availability and functionality of products under development,product mix, pricing trends, the mix of export sales, sales to significantcustomers and the availability and cost of products from the Company'ssuppliers, are subject to risks and uncertainties, including those set forthunder "Management's Discussion and Analysis of Financial Condition and Resultsof Operations--Factors That May Affect Our Results." Our actual results coulddiffer materially from those projected in these forward-looking statementswhich could have a material adverse effect on our business, operating resultsand financial condition. These forward-looking statements speak only as of thedate hereof and there may be events in the future that we are not able topredict accurately or over which we have no control. Overview Extreme Networks, Inc. ("Extreme" or "the Company") is a leading provider ofa next generation of switching solutions that meet the increasing needs ofenterprise local area networks, or LANs, internet service providers, or ISPs,and content providers. The key advantages of our Layer 3 switching solutionsare increased performance, the ability to easily grow, or "scale," in size ascustomer needs change, flexible allocation of network resources, ease of useand lower cost of ownership. These advantages are obtained through the use ofcustom semiconductors, known as ASICs, in our products and through hardware andsoftware designs that are common and uniform across our product line. Therouting of network traffic, a function referred to as Layer 3 switching, isdone primarily with ASICs in our products, and consequently, is faster than thesoftware implementations used in many competing products. Traditional Layer 3products rely primarily on software which can slow traffic speeds below thosewhich could otherwise be achieved and result in message packets being lost whennetwork traffic is high. Our products incorporate an ASIC-based, wire-speedarchitecture and are designed to avoid the loss of message packets in theswitch, or "non-blocking." As a result, our products are less expensive thansoftware-based routers, yet offer improved performance throughout the networkfrom the core to the desktop. The Dell'Oro Group, a research and consultingfirm, estimates in an independently prepared market report dated July 1999,that the market for Layer 3 switching totaled $637 million in 1998 and isexpected to increase to approximately $3.8 billion in 2001. Industry Background Businesses and other organizations have become increasingly dependent onnetworks as their central communications infrastructure to provide connectivityfor internal and external communications. New mission-critical computingapplications, such as enterprise resource planning, large enterprise databasesand sophisticated on-line connections with vendors, as well as the increaseduse of traditional applications, such as e-mail, require significantinformation technology resources. The emergence of the desktop browser as auser interface has enabled bandwidth-intensive applications that contain voice,video and graphics to be used extensively through intranets and externallythrough extranets. These new applications, combined with the growth inbusiness-to-business e-commerce and other on-line transactions, are furtherburdening the network infrastructure. Today's Networking Environments LANs. LANs have traditionally been designed for client/server applications,where traffic patterns were predictable and traffic loads are relativelystable. In this environment, the majority of traffic remained within a givenworkgroup, with only a small percentage traveling across the high trafficportion of a LAN which interconnects all or a large part of the LAN. Theincreased use of data-intensive, mission-critical applications, the widespreadimplementations of intranets and extranets, and the ubiquity of Internettechnologies have 3 created unpredictable traffic patterns, and unpredictable traffic loads withinthe LAN. In addition, as users utilize the desktop browser and Internettechnologies to access significant amounts of information from servers locatedinside and outside of the organization, a much higher percentage of trafficcrosses the enterprise LAN backbone. For example, an employee can make a simplerequest that may require data to be downloaded and analyzed from multiple datawarehouses outside his or her local workgroup, resulting in increased trafficacross the LAN. Similarly, multiple users could request a multimediapresentation from a company intranet or from the Internet consuming tremendousamounts of network capacity. Either of these situations could result in usersoverwhelming a company's enterprise LAN unknowingly. As a result, the increasedtraffic, bandwidth-intensive applications and unpredictable traffic patternsare straining traditional LAN environments and reducing the performance ofmission-critical applications. Early LANs supported limited numbers of users and used a variety ofprotocols to organize the transmission of data, including Ethernet, Token Ringor AppleTalk technologies. As the number of users and the amount of traffic ona network grew, network performance began to decline. In this sharedenvironment, each desktop received and was burdened by the communication ofevery other desktop. The need to improve network performance was initiallyaddressed by adding network devices known as bridges or hubs that separated theentire LAN into smaller workgroups. This arrangement was effective insupporting the traditional client/server environment where the majority oftraffic remained within the workgroup. As applications became more bandwidth-intensive and users increasingly communicated outside of their workgroup,bridges and hubs were unable to process this traffic effectively. To mitigatethis problem, Layer 2 switches were developed to provide a dedicated link foreach desktop and eliminate the unnecessary flow of information to everydesktop. In addition to the evolution of new devices, the need for increasedbackbone speeds led to the development of new and faster technologies such asFDDI, Fast Ethernet and ATM. However, each of these technologies employsdifferent protocols, further complicating the LAN by requiring software-basedrouters that use expensive CPUs and software tables to route this multi-protocol traffic. Today, it is not uncommon to find multiple protocols anddevices across the four basic areas of the network: . the desktop, which connects end users; . the segment, which interconnects networking devices; . the server, which connects servers to the network; and . the network core, which consists of the enterprise backbone that interconnects LAN segments. A network must be scalable in the following four dimensions: Speed. Speed refers to the number of bits per second that can be transmittedacross the network. Today's network applications increasingly require speeds ofup to 100 Mbps to the desktop. Hence, the backbone and server connections thataggregate traffic from desktops require speeds well in excess of 100 Mbps. Wirespeed refers to the ability of a network device to process an incoming datastream at the highest possible rate without loss of packets. Wire speed routingrefers to the ability to perform Layer 3 switching at the maximum possiblerate. Bandwidth. Bandwidth refers to the volume of traffic that a network or anetwork device can handle before traffic is "blocked," or unable to get throughwithout interruption. When traffic was more predictable, the amount of trafficacross a network link or through a network device grew basically in line withthe number of users on the network. With today's data-intensive applicationsaccessed in random patterns from within and outside of the network, users canspike traffic unpredictably, consuming significant bandwidth to the detrimentof other users. Network size. Network size refers to the number of users and servers thatare connected to a network. Today's networks must be capable of connecting andsupporting up to thousands, and even tens of thousands, of users and serverswhile providing performance and reliable connectivity. 4 Quality of service. Quality of service refers to the ability to control thedelivery of traffic based upon its level of importance. Mission-criticalenterprise and delay-sensitive multimedia applications require specificperformance minimums, while traffic such as general e-mail and Internet surfingmay not be as critical. In addition to basic standards-based prioritization oftraffic according to importance, true end-to-end quality of service wouldallocate bandwidth to specified applications. Opportunity for Next Generation Switching Solutions The emergence of several technology trends is enabling a new generation ofnetworking equipment that can meet the four scalability dimensions of today'senterprise LANs, ISPs and content providers by accommodating new unpredictabletraffic patterns and bandwidth-intensive, mission-critical applications. First,while many new and different technologies have been deployed in existing LANs,Ethernet has become the predominant LAN technology, with over 95% of the marketin 1998 and total shipments of over 350 million ports from 1991 to 1998,according to the Dell'Oro Group. Ethernet has evolved from the original 10 MbpsEthernet to 100 Mbps Fast Ethernet and, in 1998, to 1,000 Mbps GigabitEthernet. Gigabit Ethernet represents a viable network backbone protocol,enabling 100 Mbps Fast Ethernet connections to the desktop to be aggregated fornetwork backbone transport across the network core. Second, growth of theInternet and the subsequent development of applications based on Internettechnologies have increased the use of the Internet Protocol. With the wide acceptance of Ethernet and Internet Protocol-basedtechnologies, the need to support a multi-protocol environment is diminished.As a result, the simplified routing functionality can be embedded inapplication specific integrated circuits, or ASICs, instead of in the softwareand CPUs used in multi-protocol software-based routers. The resulting device,called a Layer 3 switch, functions as a less expensive and significantly fasterhardware-based router. The Dell'Oro Group estimates in an independentlyprepared July 1999 market report, that the market for Layer 3 switching totaled$637 million in 1998 and is expected to increase to approximately $3.8 billionin 2001. Layer 3 switches can operate at gigabit speeds and, as hardwarerouters, can support large networks. However, most Layer 3 switches still blocktraffic in high utilization scenarios and can only support standards-basedtraffic prioritization quality of service. While Layer 3 switching dramaticallyincreases network performance, many of today's offerings fail to realize thepotential of this technology because of the use of inconsistent hardware,software and management architectures. To effectively address the needs of today's enterprise LANs, ISPs andcontent providers customers need a solution that is easy to use and implementand can scale in terms of speed, bandwidth, network size and quality ofservice. Layer 3 switching represents the next critical step in addressingthese requirements. However, enterprises need a Layer 3 solution that providessufficient bandwidth to support unpredictable traffic spikes without impactingall other users connected to the network. In addition, enterprises require aquality of service solution that supports industry-standard prioritization andenables network administrators to offer quality of service that maps businessprocesses and network policies. Finally, to simplify their networks,enterprises need a family of interoperable devices that utilize a consistenthardware, software and management architecture. Through an integrated family ofproducts, network managers can effectively deploy the solution at any point inthe network and follow a migration path to a network implemented with aconsistent architecture from end-to-end. The Extreme Networks Solution Extreme provides end-to-end network switching solutions that meet therequirements of enterprise LANs, ISPs and content providers by providingincreased performance, scalability, policy-based quality of service, ease ofuse and lower cost of ownership. Our products share a common ASIC, software andnetwork management architecture that enables Layer 3 switching at wire speed ineach of the desktop, segment, server and core areas of the enterprise LAN. Inaddition, these products can be utilized by ISPs and content providers fortheir web-hosting and server co-location operations. Because our products arebased on industry standard routing and network management protocols, they areinteroperable with existing network infrastructures. We 5 offer policy-based quality of service that controls the delivery of networktraffic according to pre-set policies that specify priority and bandwidthlimits. All of our switches include integrated web server software that allowsthe switch to be managed from any browser-equipped desktop. In addition, ourJava-based enterprise management software utilizes integrated web serversoftware that allows simplified management from any locally connected computer,or remotely over the Internet. The key benefits of Extreme's solutions are: High performance. Our products provide 1,000 Mbps Gigabit Ethernet to thenetwork core and Fast Ethernet to the desktops, segments and servers, togetherwith the non-blocking, wire-speed routing of our ASIC-based Layer 3 switching.Using our products, customers can achieve forwarding rates that are up to 100times faster than with software-based routers. Ease of use and implementation. Our products share a common ASIC, softwareand network management architecture and offer consistent features for each ofthe key areas of the network. Our standard-based products can be integratedinto and installed within existing networks. Customers can upgrade with Extremeproducts without needing additional training. ExtremeWare software simplifiesnetwork management by enabling customers to manage any of our products remotelythrough a browser interface. Scalability. Our solutions offer customers the speed and bandwidth they needtoday with the capability to scale their networks to support demandingapplications in the future without the burden of additional training orsoftware or system complexity. Customers who purchase our products can upgradethem to advanced Layer 3 capability because this functionality is built intoour ASICs. ExtremeWare Enterprise Manager software simplifies software upgradesby allowing the network manager to upgrade all Extreme switches simultaneously. Quality of service. Extreme's policy-based quality of service enablescustomers to prioritize mission-critical applications by providing industry-leading tools for allocating network resources to specific applications. Withour policy-based quality of service, customers can use a web-based interface toidentify and control the delivery of traffic from specific applications inaccordance with specific policies that are set by the customer. The quality ofservice functionality of our ASICs allows our policy-based quality of serviceto be performed at wire speed. In addition to providing priority, customers canallocate specified amounts of bandwidth to specific applications or users. Lower cost of ownership. Our products are less expensive than software-basedrouters, yet offer higher routing performance. Because they share a commonhardware, software and management architecture, we believe our products cansubstantially reduce the cost and complexity of network management andadministration. This uniform architecture creates a simpler networkinfrastructure which leverages the knowledge and resources businesses haveinvested in Ethernet and the Internet Protocol, thereby requiring fewerresources and less time to maintain. The Extreme Networks Strategy Extreme's objective is to be the leading supplier of end-to-end networksolutions. The key elements of our strategy include: Provide easy to use, high-performance, cost-effective switchingsolutions. We offer customers easy to use, powerful, cost-effective switchingsolutions that meet the specific demands of switching environments inenterprise LANs, ISPs and content providers. Our products provide customerswith 1,000 Mbps Gigabit Ethernet and the wire speed, non-blocking routingcapabilities of ASIC-based Layer 3 switching. We intend to capitalize on ourexpertise in Ethernet, IP and switching technologies to develop new productsbased on our common architecture that meet the future requirements ofenterprise LANs, ISPs and content providers. These products will offer higherperformance with more advanced functionality and features while continuing toreduce total cost of ownership for our customers. 6 Expand market penetration. We are focused on product sales to new customersacross market segments, including ISPs, content providers and metropolitan areanetworks, or MANs, and on extending our product penetration within existingcustomers' networks. Once a customer buys our products for one area of theirnetwork, our strategy is to then offer that customer products for other areas.As additional products are purchased, a customer obtains the increased benefitsof our end-to-end solution by simplifying their networks, extending policy-based quality of service and reducing costs of ownership while increasingperformance. Extend switching technology leadership. Our technological leadership isbased on our custom ASICs and software and includes our wire-speed, Layer 3switching, policy-based quality of service, routing protocols and ExtremeWaresoftware. We intend to invest our engineering resources in ASIC and softwaredevelopment and provide leading edge technologies to increase the performanceand functionality of our products. We also intend to maintain our active rolein industry standards committees such as IEEE and IETF. Leverage and expand multiple distribution channels. We distribute ourproducts primarily through resellers and selected OEMs and through our fieldsales team. To quickly reach a broad, worldwide audience, we have more than 130resellers in 40 countries, including regional networking system resellers,network integrators and wholesale distributors, and have establishedrelationships with select OEMs. We maintain a field sales force primarily tosupport our resellers and to focus on select strategic and large accounts. Weintend to increase the size of our reseller programs and are developing twotier distribution channels in some regions. To complement and support ourdomestic and international reseller and OEM channels, we expect to increase ourworldwide field sales force. Provide high-quality customer service and support. We seek to enhancecustomer satisfaction and build customer loyalty through the quality of ourservice and support. We offer a wide range of standard support programs thatinclude emergency telephone support 24 hours a day, seven days a week andadvanced replacement of products. In addition, we have designed our products toallow easy service and administration. For example, we can access all of ourswitches remotely through a standard web browser to configure, troubleshoot andhelp maintain our products. We intend to continue to enhance the ease of use ofour products and invest in additional support services by increasing staffingand adding new programs for our OEMs and resellers. In addition, we also arecommitted to providing customer-driven product functionality through feedbackfrom key prospects, consultants, channel and OEM partners and customer surveys. Products Extreme provides end-to-end switching solutions that meet the requirementsof enterprise LANs, ISPs and content providers by providing increasedperformance, scalability, policy-based quality of service, ease of use andlower cost of ownership. Our Summit and BlackDiamond switches share a commonASIC, software and management architecture that facilitates a relatively shortproduct design and development cycle, thereby reducing the time-to-market fornew products and features. This common architecture enables customers to buildan end-to-end enterprise LAN switching solution that has consistentfunctionality, performance and management to each of the desktop, segment,server and core areas of the LAN. The common architecture and end-to-endfunctionality of our products also reduces the cost and complexity of networkadministration and management. Our products include two browser-based software application suites,ExtremeWare and ExtremeWare Policy Manager, that enable simple and efficientswitch management and configuration. ExtremeWare is a standards-based softwaresuite that delivers policy-based quality of service and enablesinteroperability with legacy switches and routers. ExtremeWare Policy Manageris an application suite that enables remote configuration and management ofmultiple switches from a single network station. 7 The following table identifies our principal hardware products: Product name Forwarding speed and date of (packets per Per port first shipment Configuration second) list price range -------------- ------------- ---------------- ----------------The Summit Stackable product family Summit1 8 Gigabit Ethernet ports 11.9 million $1,500 to $3,000 October 1997Summit4 16 10/100 Mbps 11.3 million Ethernet: March 1998 Ethernet ports $250 to $550 Gigabit Ethernet: 6 Gigabit Ethernet ports $1,400 to $3,000Summit48 48 10/100 Mbps 10.1 million Ethernet: April 1998 Ethernet ports $140 to $250 Gigabit Ethernet: 2 Gigabit Ethernet ports $570 to $1,000Summit24 24 10/100 Mbps 5.1 million Ethernet: November 1998 Ethernet ports $195 to $375 Gigabit Ethernet: 1 Gigabit Ethernet port $785 to $1,500Summit Virtual Up to 64 Gbps of up to 48.0 million $1,125 Chassis bandwidth July 1998 8 SummitLink Channels The BlackDiamond Modular Chassis BlackDiamondChassis Up to 256 10/100 Mbps 48.0 million Ethernet: September 1998 Ethernet ports or 48 $400 to $1,400 Gigabit Ethernet ports in Gigabit Ethernet: one chassis $2,475 to $11,250 10 slots to accommodate a variety of up to 8 connectivity modules and 1 or 2 management modules Desktop Switches The enterprise desktop is the portion of the network where individual end-user workstations are connected to a hub or switch. Traditionally, a discretegroup of desktop users, or a workgroup, shared a single hub, which connectedtheir workgroup to the rest of the network. In this shared environment, eachdesktop in the workgroup receives and is burdened by the communication of everyother desktop in the workgroup. This topology is effective so long as themajority of traffic remains within the workgroup. As applications have becomemore bandwidth intensive and as user traffic has migrated outside the workgroupvia the Internet or an intranet or extranet, however, the hubs are unable toeffectively process this traffic, resulting in diminished desktop performance.Replacing the hub with a Layer 3 switch alleviates this problem by providing adedicated link for each desktop and eliminating unnecessary broadcasts ofinformation to every desktop in the workgroup. Enterprise desktop switchingprovides the desktop with features typically found only at the network core,such as redundancy, greater speed and the ability to aggregate multiple switchports into a single high-bandwidth connection. We became an industry leader in Layer 3 switching for the desktop with theintroduction of our Summit48 and Summit24 desktop switching products. TheSummit48 addresses high-density enterprise desktop 8 connections. This switch features a non-blocking architecture to avoid the lossof data packets. The Summit24, with half the number of ports of the Summit48,is targeted at local wiring closets with moderately dense desktop connections. Segment Switches Enterprise segment switching involves the switching among workgroups ofmultiple network desktops. While enterprise segment switching faces the samechallenges as desktop switching, it must also address increased congestion fromtraffic generated by hubs and other devices that enterprises use to connectmultiple desktop computers. Our primary product for enterprise segmentswitching is the chassis-based BlackDiamond. The BlackDiamond chassis addressesthe needs of enterprises that interconnect high-density 10/100 Mbps segments.It can also be equipped with switched Gigabit Ethernet connectivity modules toprovide high-speed uplinks to servers and switches in the network core. Server Switches Servers run the applications and store the data needed by all network end-users. In a traditional LAN, most of the network resources needed by any givendesktop user, such as printer servers, file servers or database servers, are onthe same workgroup segment as the desktop user. The traditional networkarchitecture has been shifting toward more centralized server clusters, orserver farms, which require the physical deployment of multiple servers in asingle central data center. This new architecture is easier to manage and canbe configured in a redundant fashion, thereby reducing the risk of systemfailure. Additionally, remote offices and telecommuters can access the sameserver-based data as desktop users, increasing the flexibility of the networkto support users wherever they may be located. As more people access the network and as server requests increasinglyinvolve more bandwidth-intensive applications, network traffic to and fromservers has increased dramatically, causing bandwidth to be consumed bytraffic. Servers also communicate with each other, creating a high volume ofserver-to-server traffic within the server farm. Recent technology developmentsallow enterprises to install network interface cards that enable connectionsusing Gigabit Ethernet or the aggregation of multiple 100 Mbps ports on asingle card. This development increases the communication speed of the servers.In turn, these servers have created the need for switches that can supporttheir higher server-to-server and server-to-end-user communications speeds. OurSummit 4 product addresses server switching constraints by providing switchedGigabit Ethernet and multiple 100 Mbps links to the servers, thereby deliveringsufficient bandwidth between servers and to clients on attached segments. TheBlackDiamond may also be configured to address the needs of a server switchingenvironment that requires higher port density and modular configurationflexibility. Core Switches The network core is the most critical point in the network, as it is wherethe majority of network traffic, including desktop, segment and server traffic,converges. Network core switching involves switching traffic from the desktops,segments and servers within the network. Because of the high-traffic nature ofthe network core, wire-speed Layer 3 switching, scalability, a non-blockinghardware architecture, fault-tolerant mission-critical features, redundancy,link aggregation, the ability to support a variety of high-density "speeds andfeeds" and the ability to accommodate an increasing number of high-capacitybackbone connections are critical in core switching. Our network core productssatisfy these criteria and include the BlackDiamond, the Summit1 and the SummitVirtual Chassis. The BlackDiamond switch includes the fault-tolerant features associated withmission-critical enterprise-class Layer 3 switching, including redundant systemmanagement and switch fabric modules, hot-swappable modules and chassiscomponents, load-sharing power supplies and management modules, up to four 10Mbps, 100 Mbps, or 1,000 Mbps aggregated links, dual software images and systemconfigurations, spanning tree and multipath routing, and redundant routerprotocols for enhanced system reliability. In addition, our Summit1 9 switch, which interconnects multiple Gigabit Ethernet backbones from variousparts of the network, is well-suited for network core applications that requirelower density backbone connections. The Summit Virtual Chassis is a high-speedexternal backplane that interconnects multiple Summit or BlackDiamond switches.The Summit Virtual Chassis enables network flexibility by interconnectinggeographically dispersed or co-located Summit and BlackDiamond switches,thereby creating a distributed core. ExtremeWare Our ExtremeWare software suite is pre-installed on every Summit andBlackDiamond switch. For Extreme switches that are Layer 3 enabled, ExtremeWaredelivers policy-based quality of service capabilities and supports a range ofrouting protocols that enable interoperability with legacy switches androuters. Our policy-based quality of service also enables network managers todefine numerous levels of control, or policies, that determine the amount ofbandwidth available to a group of users or network devices at a given time. Thepolicies can describe traffic based on port number, protocol type, VLAN, orLayer 2, Layer 3 or Layer 4 information. Using 802.1p and 802.1Q for VLANtagging, policy-based quality of service is passively signaled across thenetwork to enable standards-based interoperability. For Extreme switches thatare Layer 2 enabled, ExtremeWare provides policy-based quality of service andsupports a range of standards-based management and Layer 2 protocols. Inaddition, the basic Layer 3 version of ExtremeWare can be upgraded to advancedLayer 3 via software that may be downloaded from the web. ExtremeWare Policy Manager ExtremeWare Policy Manager simplifies the task of managing and configuringgroups of our switches. With ExtremeWare Policy Manager, an entire network ofour switches can be managed from a single management console using a standardweb browser. This enterprise-wide management enables VLANs and policy-basedquality of service to be established and managed for the entire LAN.ExtremeWare Policy Manager can also manage centralized and distributed stacksof Summit switches and the Summit Virtual Chassis as aggregated entities.ExtremeWare Policy Manager can be accessed using any Java-enabled browser. TheExtremeWare Policy Manager application and database support both MicrosoftWindows NT and Sun Microsystems' Solaris. The ExtremeWare Policy Manager clientcan be launched from within the HP OpenView Network Node Manager application.In May 1999, we introduced our Enterprise Policy System, a multi-vendor policysystem providing layer independent policy enforcement, address mappingcapability and multi-vendor support. Sales, Marketing and Distribution Extreme's sales and marketing strategy is focused on domestic andinternational resellers, OEMs and field sales. Resellers. We have entered into agreements to sell our products through morethan 130 resellers in 40 countries. Our resellers include regional networkingsystem resellers, resellers who focus on specific vertical markets, networkintegrators and wholesale distributors. We provide training and support to ourresellers and our resellers generally provide the first level of support to endusers of our products. We intend to increase the number of our resellerrelationships, to target vertical markets and support a two-tier distributionchannel. OEMs. We have established four key OEM relationships with leaders in thetelecommunications, personal computer and computer networking industries. Forfiscal 1999, sales to our OEMs accounted for 20% of our net revenue. Compaq,which is both an OEM and an end-user customer, accounted for 21% of our netrevenue in fiscal 1999. We intend to maintain a limited number of relationshipswith key strategic OEMs who may offer products or distribution channels thatcompliment ours. Each of our OEMs resells our products under its own name. Webelieve that our OEM relationships enhance our ability to sell and providesupport to large organizations because certain end-user organizations mayprefer to do business with very large suppliers. We anticipate that OEM saleswill decline as a percentage of net revenue as we expand our reseller andfields sales efforts. 10 Field sales. We have designed and established our field sales organizationto support and develop leads for our resellers and to establish and maintain alimited number of key accounts and strategic customers. To support theseobjectives, our field sales force: . assists end-user customers in finding solutions to complex network system and architecture problems; . differentiates the features and capabilities of our products from competitive offerings; . continually monitors and understands the evolving networking needs of enterprise customers; . promotes our products and ensures direct contact with current and potential customers; and . monitors the changing requirements of our customers. As of June 30, 1999, Extreme's worldwide sales and marketing organizationincluded 116 individuals, including managers, sales representatives, andtechnical and administrative support personnel. We have domestic sales officeslocated in major metropolitan areas, including Atlanta, Boston, Chicago,Dallas, Houston, Los Angeles, New York, San Jose, Seattle and Washington DC. Inaddition, we have international sales offices located in France, Germany, HongKong, Italy, Japan, The Netherlands, Sweden and United Kingdom. International sales We believe that there is a strong international market for our switchingproducts. Our international sales are conducted primarily through our overseasoffices and foreign resellers. Sales to customers outside of North Americaaccounted for approximately 53% of our net revenue in fiscal 1999. Marketing We have a number of marketing programs to support the sale and distributionof our products and to inform existing and potential enterprise customers andour resellers and OEMs about the capabilities and benefits of our products. Ourmarketing efforts include participation in industry tradeshows, technicalconferences and technology seminars, preparation of competitive analyses, salestraining, publication of technical and educational articles in industryjournals, maintenance of our web site, advertising and public relations. Inaddition, we have begun to develop an e-commerce business directed atresellers. We also participate in third-party, independent product tests. Customer Support and Service Our customer service and support organization maintains and supportsproducts sold by our field sales force to end users, and provides technicalsupport to our resellers and OEMs. Generally, our resellers and OEMs provideinstallation, maintenance and support services to their customers and we assistour resellers and OEMs in providing such support. In addition to designing custom maintenance programs to satisfy specificcustomer requirements, we also offer several standard maintenance programs toour resellers and customers, including ExtremeAssist1 and ExtremeAssist2. ExtremeAssist1. This program is designed for customers which have strongtechnical networking skills and are interested in keeping service and supportcosts to a minimum. With ExtremeAssist1, the customers' information technologyorganizations provide first-level support for configuration, hardware andtrouble shooting, while our technical assistance center provides advancedsecond-level support on an essential need basis. The ExtremeAssist1 programincludes 2 hour telephone response time, 10 e-mail inquiries per month andresponses within 24 hours, rapid-response emergency telephone support 24 hoursa day, seven days a week and 72-hour advanced replacement of hardware. 11 ExtremeAssist2. This program is designed for mission-critical environmentsthat require the highest degree of network availability, data integrity andend-user productivity. The ExtremeAssist2 program includes 1 hour telephoneresponse time, unlimited e-mail inquiries and next business-day responses,rapid-response emergency/ network down telephone support 24 hours a day, sevendays a week and next business-day advance replacement of hardware. With the ExtremeAssist1 and ExtremeAssist2 programs, our customers are ableto access our web-based database to immediately obtain software updates, buglists, technical support alerts and on-line documentation. We typically provideend users with a one-year hardware and 90-day software warranty. We also offervarious training courses for their third-party resellers or end-user customers. Manufacturing We outsource the majority of our manufacturing and supply chain managementoperations, and we conduct quality assurance, manufacturing engineering,documentation control and repairs at our facility in Santa Clara, California.This approach enables us to reduce fixed costs and to provide flexibility inmeeting market demand. Where cost-effective, we may begin to perform certain ofour non-manufacturing outsourced operations in-house. Currently, we use two contract manufacturers--Flextronics, located in SanJose, California, to manufacture our Summit1, Summit2 and Summit4 andBlackDiamond products and MCMS, located in Boise, Idaho, to manufacture ourSummit24 and Summit48 products. Each of these manufacturing processes andprocedures is ISO 9002 certified. We design and develop the key components ofour products, including ASICs, printed circuit boards and software. Inaddition, we determine the components that are incorporated in our products andselect the appropriate suppliers of such components. Product testing and burn-in is performed by our contract manufacturers using tests we specify andautomated testing equipment. We also use comprehensive inspection testing andstatistical process controls to assure the quality and reliability of ourproducts. We intend to regularly introduce new products and productenhancements, which will require that we rapidly achieve volume production bycoordinating our efforts with those of our suppliers and contractmanufacturers. See "Factors That May Affect Our Results--Extreme Needs toExpand Its Manufacturing Operations and Depends on Contract Manufacturers forSubstantially All of Its Manufacturing Requirements." Although we use standard parts and components for our products wherepossible, we currently purchase several key components used in the manufactureof our products from single or limited sources. Our principal single-sourcedcomponents include: . ASICs; . microprocessors; . programmable integrated circuits; . selected other integrated circuits; . cables; and . custom-tooled sheet metal. Our principal limited-source components include: . flash memories; . DRAMs; . SRAMs; and . printed circuit boards. 12 Generally, purchase commitments with our single or limited source suppliersare on a purchase order basis. LSI Logic manufacturers all of our ASICs whichare used in all of our switches. Any interruption or delay in the supply of anyof these components, or the inability to procure these components fromalternate sources at acceptable prices and within a reasonable time, wouldmaterially adversely affect our business, operating results and financialcondition. In addition, qualifying additional suppliers can be time-consumingand expensive and may increase the likelihood of errors. We use a rolling six-month forecast based on anticipated product orders todetermine our material requirements. Lead times for materials and components weorder vary significantly, and depend on factors such as the specific supplier,contract terms and demand for a component at a given time. See "Factors ThatMay Affect Our Results--Extreme Purchases Several Key Components for ProductsFrom Single or Limited Sources and Could Lose Sales if These Sources Fail toFill Its Needs" and "--Extreme Needs To Expand Its Manufacturing Operations andDepends on Contract Manufacturers for Substantially All of Its ManufacturingRequirements." Research and Development We believe that our future success depends on our ability to continue toenhance our existing products and to develop new products that maintaintechnological competitiveness. We focus our product development activities onsolving the needs of enterprise LANs, ISPs and content providers. We monitorchanging customer needs and work closely with users, value-added resellers anddistributors, and market research organizations to monitor changes in themarketplace. We design our products around current industry standards and willcontinue to support emerging standards that are consistent with our productstrategy. Our products have been designed to incorporate the same core ASICs andsoftware and system architecture, facilitating a relatively short productdesign and development cycle and reducing the time to market for new productsand features. We have utilized this architectural design to develop andintroduce other product models and enhancements since the introduction of ourfirst products in 1997. We intend to continue to utilize this architecturaldesign to develop and introduce additional products and enhancements in thefuture. We are undertaking development efforts for our family of products withemphasis on increasing reliability, performance and scalability and reducingthe overall network operating costs to end users. We are developing a newchipset which will be compatible with our existing architecture. We expect toship new products that incorporate the new chipset in this fiscal year. We arealso focusing on cost reduction engineering to reduce the cost of our products.There can be no assurance that our product development efforts will result incommercially successful products, or that our products will not be renderedobsolete by changing technology or new product announcements by othercompanies. See "Factors That May Affect Our Results--Extreme's Market isSubject to Rapid Technological Change and to Compete, Extreme Must ContinuallyIntroduce New Products that Achieve Broad Market Acceptance." Competition The market for network switches is part of the broader market for enterpriseLAN equipment, which is dominated by a few large companies, particularlyCabletron Systems, Cisco Systems, Nortel and 3Com. Each of these companies hasintroduced, or has announced its intention to develop, switches that are or maybe competitive with our products. For example, in January 1999, Cisco announcedits Catalyst 6000 family of chassis-based switches. In addition, there are anumber of large telecommunications equipment providers, including Alcatel,Ericsson, Lucent Technologies, Nokia, Nortel Networks and Siemens, which haveentered the market for network equipment, particularly through acquisitions ofpublic and privately held companies. For example, in January 1998, Lucentacquired Prominet, a private switching company. We expect to face increasedcompetition, particularly price competition, from these and othertelecommunications equipment providers. We also expect to compete with otherpublic and private companies that offer switching solutions, such as Alteon WebSystems and Foundry Networks. These vendors may develop products withfunctionality 13 similar to our products or provide alternative network solutions. Our OEMs maycompete with us with their current products or products they may develop, andwith the products they purchase from us. Current and potential competitors haveestablished or may establish cooperative relationships among themselves or withthird parties to develop and offer competitive products. Furthermore, wecompete with numerous companies that offer routers and other technologies anddevices that traditionally have managed the flow of traffic on the enterpriseLAN or in ISP networks. Many of our current and potential competitors have longer operatinghistories and substantially greater financial, technical, sales, marketing andother resources, as well as greater name recognition and a larger installedcustomer base, than we do. As a result, these competitors are able to devotegreater resources to the development, promotion, sale and support of theirproducts. In addition, competitors with a large installed customer base mayhave a significant competitive advantage over us. We have encountered, andexpect to continue to encounter, many potential customers who are extremelyconfident in and committed to the product offerings of our principalcompetitors, including Cisco Systems, Nortel Networks and 3Com. Accordingly,such potential customers may not consider or evaluate our products. When suchpotential customers have considered or evaluated our products, we have in thepast lost, and expect in the future to lose, sales to some of these customersas large competitors have offered significant price discounts to secure suchsales. We believe the principal competitive factors in the network switching marketare: . expertise and familiarity with network protocols, network switching and network management; . product performance, features, functionality and reliability; . price/performance characteristics; . timeliness of new product introductions; . adoption of emerging industry standards; . customer service and support; . size and scope of distribution network; . brand name; . access to customers; and . size of installed customer base. We believe we compete favorably with our competitors with respect to each ofthe foregoing factors. However, because many of our existing and potentialcompetitors have longer operating histories, greater name recognition, largercustomer bases and substantially greater financial, technical, sales, marketingand other resources, they may have larger distribution channels, stronger brandnames, access to more customers and a larger installed customer base than wedo. Such competitors may, among other things, be able to undertake moreextensive marketing campaigns, adopt more aggressive pricing policies and makemore attractive offers to distribution partners than we can. To remaincompetitive, we believe we must, among other things, invest significantresources in developing new products and enhancing our current products andmaintain customer satisfaction worldwide. If we fail to do so, our productswill not compete favorably with those of our competitors which will materiallyadversely affect our business. See "Factors That May Affect Our Results--Intense Competition in the Market for Networking Equipment Could PreventExtreme From Increasing Revenue and Prevent Extreme From Achieving orSustaining Profitability." Intellectual Property We rely on a combination of patent, copyright, trademark and trade secretlaws and restrictions on disclosure to protect our intellectual propertyrights. We have been issued one patent in the U.S. We have filed twelve patentapplications in the U.S. and selected countries abroad relating to thearchitecture of our network switches and quality of service features. There canbe no assurance that these applications will be approved, 14 that any issued patents will protect our intellectual property or that theywill not be challenged by third parties. Furthermore, there can be no assurancethat others will not independently develop similar or competing technology ordesign around any patents that may be issued. We also have six pendingtrademark applications in the U.S. We also enter into confidentiality or license agreements with our employees,consultants and corporate partners, and control access to and distribution ofour software, documentation and other proprietary information. In addition, weprovide our software products to end-users primarily under "shrink-wrap"license agreements included within the packaged software. These agreements arenot negotiated with or signed by the licensee, and thus these agreements maynot be enforceable in some jurisdictions. Despite our efforts to protect ourproprietary rights, unauthorized parties may attempt to copy or otherwiseobtain and use our products or technology. There can be no assurance that theseprecautions will prevent misappropriation or infringement of our intellectualproperty. Monitoring unauthorized use of our products is difficult, and wecannot be certain that the steps we have taken will prevent misappropriation ofour technology, particularly in foreign countries where the laws may notprotect our proprietary rights as fully as in the United States. The networking industry is characterized by the existence of a large numberof patents and frequent claims and related litigation regarding patent andother intellectual property rights. In particular, leading companies in thedata communications and networking markets have extensive patent portfolioswith respect to networking technology. From time to time, third parties,including these leading companies, have asserted and may assert exclusivepatent, copyright, trademark and other intellectual property rights totechnologies and related standards that are important to us. We expect that wemay increasingly be subject to infringement claims as the numbers of productsand competitors in the market for network switches grow and the functionalityof products overlaps. In this regard, in February 1999, we received verbalcommunications from one of our OEM customers that one of these companiesbelieves that our products may infringe patents pertaining to a GigabitEthernet industry standard, which standard was developed by committees andincludes contributions from numerous parties. As such, it is not currentlyknown whether a license is necessary; however, if it is determined to benecessary, we believe that a license would be made available in a timely andnon-discriminatory manner and on reasonable terms. Although we have not been a party to any litigation asserting claims thatallege infringement of intellectual property rights, we cannot assure you thatwe will not be a party to litigation in the future. In addition, we cannotassure you that third parties will not assert additional claims or initiatelitigation against us or our manufacturers, suppliers or customers alleginginfringement of their proprietary rights with respect to existing or futureproducts. We may in the future initiate claims or litigation against third parties forinfringement of our proprietary rights to determine the scope and validity ofour proprietary rights. Any such claims, with or without merit, could be time-consuming, result in costly litigation and diversion of technical andmanagement personnel or require us to develop non-infringing technology orenter into royalty or licensing agreements. Such royalty or licensingagreements, if required, may not be available on acceptable terms, if at all.In the event of a successful claim of infringement and our failure or inabilityto develop non-infringing technology or license the proprietary rights on atimely basis, our business, operating results and financial condition could bematerially adversely affected. Employees As of June 30, 1999, we employed 249 persons, including 116 in sales andmarketing, 62 in research and development, 33 in operations and 38 in financeand administration. We have never had a work stoppage and no personnel arerepresented under collective bargaining agreements. We consider our employeerelations to be good. We believe that our future success will depend on our continued ability toattract, integrate, retain, train and motivate highly qualified personnel, andupon the continued service of our senior management and key 15 personnel. None of our personnel is bound by an employment agreement.Competition for qualified personnel is intense, particularly in the SanFrancisco Bay Area, where our headquarters is located. At times we haveexperienced difficulties in attracting new personnel. There can be no assurancethat we will successfully attract, integrate, retain and motivate a sufficientnumber of qualified personnel to conduct our business in the future. See"Factors That May Affect Our Results--If Extreme Loses Key Personnel or isUnable to Hire Additional Qualified Personnel as Necessary, It May Not Be Ableto Successfully Manage Its Business or Achieve Its Objectives." Item 2. Properties. Our principal administrative, sales, marketing and research developmentfacilities are located in an approximately 77,000 square feet facility locatedin Santa Clara, California which we moved to in March 1999. The Companybelieves that suitable additional space will be available as needed toaccommodate any further physical expansion of corporate operations and for anyadditional sales offices. We also lease office space in Connecticut, Florida,Georgia, Illinois, Massachusetts, New Jersey, Texas, Washington, WashingtonD.C. and Wisconsin and in Germany, Hong Kong, The Netherlands and UnitedKingdom. Item 3. Legal Proceedings. We are not aware of any pending legal proceedings against us that,individually or in the aggregate, would have a material adverse effect on ourbusiness, operating results or financial condition. We may in the future beparty to litigation arising in the course of our business, including claimsthat we allegedly infringe third-party trademarks and other intellectualproperty rights. Such claims, even if not meritorious, could result in theexpenditure of significant financial and managerial resources. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Executive Officers of the Registrant The following table sets forth information regarding the executive officersof Extreme as of August 31, 1999: Name Age Position---- --- ----------------------------------------------------- Gordon L. Stitt...... 43 President, Chief Executive Officer and ChairmanStephen Haddock...... 41 Vice President and Chief Technical OfficerHerb Schneider....... 40 Vice President of EngineeringJune Hull............ 44 Vice President of Human ResourcesWilliam Kelly........ 48 Vice President of Corporate DevelopmentVito E. Palermo...... 35 Vice President, Chief Financial Officer and SecretaryGeorge Prodan........ 46 Vice President of MarketingPaul Romeo........... 50 Vice President of OperationsHarry Silverglide.... 53 Vice President of Sales Gordon L. Stitt. Mr. Stitt co-founded Extreme in May 1996 and has served asPresident, Chief Executive Officer and a director of Extreme since itsinception. From 1989 to 1996, Mr. Stitt worked at another company he co-founded, Network Peripherals, a designer and manufacturer of high-speednetworking technology. He served first as its Vice President of Marketing, thenas Vice President and General Manager of the OEM Business Unit. Mr. Stitt holdsan MBA from the Haas School of Business of the University of California,Berkeley and a BSEE/CS from Santa Clara University. 16 Stephen Haddock. Mr. Haddock co-founded Extreme in May 1996 and has servedas Vice President and Chief Technical Officer of Extreme since its inception.From 1989 to 1996, Mr. Haddock worked as Chief Engineer at Network Peripherals.Mr. Haddock is a member of IEEE, an editor of the Gigabit Ethernet Standard andChairman of the IEEE 802.3ad link aggregation committee. Mr. Haddock holds anMSEE and a BSME from Stanford University. Herb Schneider. Mr. Schneider co-founded Extreme in May 1996 and has servedas Vice President of Engineering of Extreme since its inception. From 1990 to1996, Mr. Schneider worked as Engineering Manager at Network Peripherals andwas responsible for the development of LAN switches. From 1981 to 1990,Mr. Schneider held various positions at National Semiconductor, a developer andmanufacturer of semiconductor products, where he was involved in thedevelopment of early Ethernet chipsets and FDDI chipsets. Mr. Schneider holds aBSEE from the University of California, Davis. June Hull. Ms. Hull has served as Vice President of Human Resources sinceSeptember 1999. From October 1996 to August 1999, she served as RegionalDirector of Human Resources and Corporate Director of Human Resources atNetscape Communications, an e-commerce company. From April 1989 to September1996, she served in a variety of senior Human Resource management positions forApple Computer, Inc. William Kelly. Mr. Kelly has served as Vice President of CorporateDevelopment of Extreme since January 1999. From October 1996 to January 1999,he served as Vice President of Finance and Chief Financial Officer of Extreme.From August 1995 to October 1996, he served as Vice President of WorldwideFinance and Chief Financial Officer at SCM Microsystems, a manufacturer ofpersonal computer smart-card technology. From March 1991 to June 1995, Mr.Kelly served in various positions at Network Peripherals, most recently as VicePresident, Controller and Treasurer. Mr. Kelly holds a BBA in accounting fromLoyola University, Chicago and is a Certified Public Accountant. Vito E. Palermo. Mr. Palermo has served as Vice President, Chief FinancialOfficer and Secretary of Extreme since January 1999. From January 1997 toJanuary 1999, he served as Senior Vice President, Chief Financial Officer andSecretary of Metawave Communications, a wireless communications company. From1992 to 1996, Mr. Palermo served in various financial management positions atBay Networks, a networking communications company, most recently serving asVice President and Corporate Controller and previously serving as Director ofTechnology Finance, Corporate Financial and Planning Manager, and Manufacturingand Customer Service Controller. Mr. Palermo holds an MBA from St. Mary'sCollege and a BS in Business Administration from California State University. George Prodan. Mr. Prodan has served as Vice President of Marketing ofExtreme since February 1997. From January 1994 to January 1997, he served asDirector of Marketing and Senior Director of Worldwide Channels at FORESystems, a networking equipment company. From April 1991 to December 1993, heserved as a product line manager for a division of 3Com, a networking company.He holds an MS in Instructional Communications from Shippensburg StateUniversity and a BS in Industrial Arts Education from California StateUniversity. Paul Romeo. Mr. Romeo has served as Vice President of Operations of Extremesince April 1997. From 1989 to 1997, he served as Vice President of Operationsat Compression Labs, a videoconferencing company. Mr. Romeo holds an MBA fromSanta Clara University and a BS in Engineering/Production Management from theUniversity of Illinois. Harry Silverglide. Mr. Silverglide has served as Vice President of Sales ofExtreme since January 1997. From May 1995 to January 1997, he served as VicePresident of Western Region Sales for Bay Networks. From July 1994 to May 1995,he served as Vice President of Sales for Centillion Networks, a provider of LANswitching products which was acquired by Bay Networks in 1995. From April 1984to July 1994, he worked in sales and senior sales management positions atUngermann Bass, a network communications company. 17 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The Company's common stock commenced trading on the Nasdaq National Marketon April 9, 1999 under the symbol "EXTR." See "Item 6--Selected ConsolidatedFinancial Data" below for the range of the high and low closing prices asreported by Nasdaq. At June 30, 1999, there were approximately 277 stockholders of record of theCompany's common stock and approximately 8,500 beneficial stockholders. TheCompany has never declared or paid cash dividends on its capital stock and doesnot anticipate paying any cash dividends in the foreseeable future. The Companycurrently intends to retain future earnings for the development of itsbusiness. Item 6. Selected Consolidated Financial Data. For the Period from May 8, 1996 Years Ended June 30, (Date of Inception) -------------------- through 1999 1998 June 30, 1997 --------- --------- ------------------- (In thousands, except per share amounts) Consolidated Statement of Operations Data:Net revenue........................... $ 98,026 $ 23,579 $ 256Gross profit (loss)................... 49,506 8,682 (132)Total operating expenses.............. 50,951 22,709 7,928Operating loss........................ (1,445) (14,027) (8,060)Net loss.............................. (1,617) (13,936) (7,923)Basic and diluted net loss per common share................................ $ (0.17) $ (3.18) $ (4.51)Weighted average shares outstanding used in computing basic and diluted net loss per share........... 9,462 4,379 1,758Pro forma basic and diluted net loss per share (unaudited)................ $ (0.04) $ (0.44)Shares used in computing pro forma basic and diluted net loss per share (unaudited).......................... 38,523 31,701 As of June 30, ---------------------------------------- 1999 1998 1997 -------- -------- -------------------- (In thousands) Consolidated Balance Sheet DataCash and cash equivalents............. $107,143 $ 9,510 $10,047Short-term investments................ 16,422 10,995 --Working capital....................... 119,039 13,796 8,251Total assets.......................... 171,803 33,731 11,942Long-term debt and capital lease obligations, net of current portion.. -- 2,634 502Total stockholders' equity............ $141,876 $ 15,869 $ 9,305 High LowStock Prices ------- ------- 1999Fourth quarter 1................................................ $ 58.06 $ 38.31--------(1) The Company's common stock commenced trading on the Nasdaq National Market on April 9, 1999 under the symbol "EXTR". The table indicates the range of the high and low closing prices, as reported by Nasdaq. 18 Item 7. Management's Discussion and Analysis of Financial Condition and Resultsof Operations. When used in this discussion and elsewhere in this Form 10-K, the words"may," "should," "believes," "expects," "anticipates," "estimates" and similarexpressions are intended to identify forward-looking statements. Suchstatements, which include statements concerning the availability andfunctionality of products under development, product mix, pricing trends, themix of export sales, sales to significant customers and the availability andcost of products from the Company's suppliers, are subject to risks anduncertainties, including those set forth below under "Factors That May AffectOur Results." Our actual results could differ materially from those projectedin these forward-looking statements which could have a material adverse effecton our business, operating results and financial condition. These forward-looking statements speak only as of the date hereof and there may be events inthe future that we are not able to predict accurately or over which we have nocontrol. Overview From our inception in May 1996 through September 1997, our operatingactivities related primarily to developing a research and developmentorganization, testing prototype designs, building an ASIC designinfrastructure, commencing the staffing of our marketing, sales and fieldservice and technical support organizations, and establishing relationshipswith resellers and OEMs. We commenced volume shipments of our Summit1 andSummit2, the initial products in our Summit stackable product family, inOctober 1997, and we began shipping our BlackDiamond modular product family inSeptember 1998. Since inception, we have incurred significant losses and as ofJune 30, 1999, we had an accumulated deficit of $23.5 million. Our revenue is derived primarily from sales of our Summit and BlackDiamondproduct families and fees for services relating to our products, includingmaintenance and training. The level of sales to any customer may vary fromperiod to period; however, we expect that significant customer concentrationwill continue for the foreseeable future. See "Factors That May Affect OurResults--If a Key Reseller, OEM or Other Significant Customer Cancels or Delaysa Large Purchase, Extreme's Revenues May Decline and the Price of Its Stock MayFall." Significant customer concentration in fiscal 1999 and fiscal 1998 as apercentage of net revenue is summarized below: Year Ended June 30, ---------- 1999 1998 ---- ---- Customer 3Com............................ -- 25% Compaq.......................... 21% 21% Hitachi Cable................... 13% -- We market and sell our products primarily through resellers and, to a lesserextent, OEMs and our field sales organization. We sell our products throughmore than 130 resellers in 40 countries. In fiscal 1999, sales to customersoutside of North America accounted for approximately 53% of our net revenue.Currently, all of our international sales are denominated in U.S. dollars. Wegenerally recognize product revenue at the time of shipment, unless we havefuture obligations for installation or have to obtain customer acceptance, inwhich case revenue is deferred until such obligations have been satisfied. Wehave established a program which, under specified conditions, enables thirdparty resellers to return products to us. The amount of potential productreturns is estimated and provided for in the period of the sale. Servicerevenue is recognized ratably over the term of the contract period, which istypically 12 months. We expect to experience rapid erosion of average selling prices of ourproducts due to a number of factors, including competitive pricing pressures,promotional pricing and rapid technological change. Our gross margins will beaffected by such declines and by fluctuations in manufacturing volumes,component costs and the mix of product configurations sold. In addition, ourgross margins may fluctuate due to the mix of 19 distribution channels through which our products are sold, including thepotential effects of our development of a two-tier distribution channel. Wegenerally realize higher gross margins on sales to resellers than on salesthrough our OEMs. Any significant decline in sales to our OEMs or resellers, orthe loss of any of our OEMs or resellers, could materially adversely affect ourbusiness, operating results and financial condition. In addition, new productintroduction may result in excess or obsolete inventories. Any excess orobsolete inventories may also reduce our gross margins. We outsource the majority of our manufacturing and supply chain managementoperations, 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 paymentsto our contract manufacturers, Flextronics and MCMS. We expect to realize lowerper unit product costs as a result of volume efficiencies. However, we cannotassure you when or if such price reductions will occur. The failure to obtainsuch price reductions could materially adversely affect our gross margins andoperating results. Research and development expenses consist principally of salaries andrelated personnel expenses, consultant fees and prototype expenses related tothe design, development, testing and enhancement of our ASICs and software. Weexpense all research and development expenses as incurred. We believe thatcontinued investment in research and development is critical to attaining ourstrategic objectives and, as a result, we expect these expenses to increase inabsolute dollars in the future. Selling and marketing expenses consist of salaries, commissions and relatedexpenses for personnel engaged in marketing, sales and field service supportfunctions, as well as trade shows and promotional expenses. We intend to pursueselling and marketing campaigns aggressively and therefore expect theseexpenses to increase significantly in absolute dollars in the future. Inaddition, we expect to substantially expand our field sales operations tosupport and develop leads for our resellers, which would also result in anincrease in selling and marketing expenses. General and administrative expenses consist primarily of salaries andrelated expenses for executive, finance and administrative personnel,recruiting expenses, professional fees and other general corporate expenses. Weexpect general and administrative expenses to increase in absolute dollars aswe add personnel, increase spending on our information systems and incuradditional costs related to the growth of our business and operation as apublic company. During fiscal 1998, in connection with the grant of certain stock options toemployees, we recorded deferred stock compensation of $437,000 representing thedifference between the exercise price and the deemed fair value of our commonstock on the date such stock options were granted. Such amount is included as areduction of stockholders' equity and is being amortized by charges tooperations on a graded vesting method. We recorded amortization of deferredstock compensation expense of approximately $172,000 and $68,000 for fiscal1999 and fiscal 1998, respectively. At June 30, 1999, we had a total ofapproximately $197,000 remaining to be amortized over the corresponding vestingperiod of each respective option, generally four years. The amortizationexpense relates to options awarded to employees in all operating expensecategories. Despite growing revenues, we have only been profitable for the quartersended June 30, 1999 and March 31, 1999. Our net losses have not decreasedproportionately with the increase in our revenue primarily because of increasedexpenses relating to our growth in operations. Because of the lengthy salescycle of our products, there is often a significant delay between the time weincur expenses and the time we realize the related revenue. See "Factors ThatMay Affect Our Results--The Sales Cycle for Extreme's Products is Long andExtreme May Incur Substantial Non-Recoverable Expenses or Devote SignificantResources to Sales that Do Not Occur When Anticipated." To the extent thatfuture revenues do not increase significantly in the same periods in whichoperating expenses increase, our operating results would be adversely affected.See "Factors That May Affect Our Results--A Number of Factors Could CauseExtreme's Quarterly Financial Results to Be Worse Than Expected, Resulting in aDecline in Its Stock Price." 20 Results of Operations The following table sets forth for the years indicated certain financialdata as a percentage of net revenue: Years ended June 30, ----------------------- 1999 1998 1997 ----- ----- ------- Net revenue...................... 100.0% 100.0% 100.0% Cost of revenue.................. 49.5 63.2 151.6 ----- ----- ------- Gross profit (loss).............. 50.5 36.8 (51.6) Operating expenses: Research and development....... 17.4 45.2 2090.2 Selling and marketing.......... 27.6 40.7 607.0 General and administrative..... 7.0 10.4 399.6 ----- ----- ------- Total operating expenses..... 52.0 96.3 3096.8 ----- ----- ------- Operating loss................... (1.5) (59.5) (3148.4) Interest income.................. 1.9 2.6 91.4 Interest expense................. (.4) (1.4) (30.9) Other income (loss), net......... .0 (.8) (7.0) ----- ----- ------- Income (loss) before income taxes........................... .0 (59.1) (3094.9) Provision for income taxes....... (1.7) -- -- ----- ----- ------- Net loss......................... (1.7)% (59.1)% (3094.9)% ===== ===== ======= Net Revenue Net revenue increased from $23.6 million in fiscal 1998 to $98.0 million infiscal 1999, an increase of $74.4 million. The increase in net revenue forfiscal 1999 resulted primarily from increased sales of our Summit stackableproducts and the introduction of our BlackDiamond modular product family inSeptember 1998. Net revenue increased from $256,000 in fiscal 1997 to $23.6 million infiscal 1998, an increase of $23.3 million. The increase in net revenue forfiscal 1998 reflected the commencement of shipments by our OEMs in the quarterending September 30, 1997 and the introduction of our Summit stackable productfamily in the quarter ending December 31, 1997. Net revenue for fiscal 1997was negligible as we were in the start-up stage of development. Export sales accounted for 53% and 61% of net revenue in fiscal 1999 andfiscal 1998, respectively. The overall increase in export sales reflected thegrowth in demand for our Summit and BlackDiamond products and an increase inthe number of resellers, offset in part by a decrease in OEM sales. We expectthat export sales will continue to represent a significant portion of netrevenue, although we cannot assure you that export sales as a percentage ofnet revenue will remain at current levels. All sales transactions aredenominated in U.S. dollars. Gross Profit Gross profit increased from $8.7 million in fiscal 1998 to $49.5 million infiscal 1999, an increase of $40.8 million. Gross margins increased from 36.8%in fiscal 1998 to 50.5% in fiscal 1999. The increase in gross margin resultedprimarily from reductions in component costs, improved manufacturingefficiencies and a shift in our channel mix from OEMs to resellers, which wereoffset in part by lower average selling prices due to increased competition. Gross profit increased from a loss of ($132,000) in fiscal 1997 to a profitof $8.7 million in fiscal 1998, an increase of $8.8 million. Gross marginsincreased from (51.6%) in fiscal 1997 to 36.8% in fiscal 1998. The increaseresulted from a shift from primarily research and development activities toproduction and sales of our products. 21 Research and Development Expenses Research and development expenses increased from $10.7 million in fiscal1998 to $17.0 million in fiscal 1999, an increase of $6.3 million. The increasewas primarily due to nonrecurring engineering and initial product verificationexpenses, the hiring of additional engineers and an increase in depreciationcharges due to increases in capital spending on design and simulation softwareand test equipment. For fiscal 1998 and fiscal 1999, research and developmentexpenses decreased as a percentage of net revenue from 45.2% to 17.4%. Thispercentage decrease was primarily the result of an increase in our net revenue. Research and development expenses increased from $5.4 million in fiscal 1997to $10.7 million in fiscal 1998, an increase of $5.3 million. The increaseresulted primarily from the hiring of additional engineers and an increase inprototype material expenses for new product development. For fiscal 1997 andfiscal 1998, research and development expenses decreased as a percentage of netrevenue from 2090.2% to 45.2%. This percentage decrease was primarily theresult of an increase in our net revenue. Selling and Marketing Expenses Selling and marketing expenses increased from $9.6 million in fiscal 1998 to$27.1 million in fiscal 1999, an increase of $17.5 million. This increase wasprimarily due to the hiring of additional sales and customer support personnel,tradeshow and promotional expenses, increased commission expenses resultingfrom higher sales, and the establishment of new sales offices. For fiscal 1998and fiscal 1999, selling and marketing expenses decreased as a percentage ofnet revenue from 40.7% to 27.6%. This percentage decrease was primarily theresult of an increase in our net revenue. Selling and marketing expenses increased from $1.6 million in fiscal 1997 to$9.6 million in fiscal 1998, an increase of $8.0 million. This increase wasprimarily due to the hiring of additional sales and customer support personnel,advertising and promotional campaigns in support of the introduction of ourSummit stackable product family. For fiscal 1997 and fiscal 1998, selling andmarketing expenses decreased as a percentage of net revenue from 607.0% to40.7%. This percentage decrease was primarily the result of an increase in ournet revenue. General and Administrative Expenses General and administrative expenses increased from $2.4 million in fiscal1998 to $6.9 million in fiscal 1999, an increase of $4.5 million. This increasewas due primarily to the hiring of additional finance, information technologyand legal and administrative personnel, recruiting expenses, professional feesand increased spending on information systems. For fiscal 1998 and fiscal 1999,general and administrative expenses decreased as a percentage of net revenuefrom 10.4% to 7.0%. This percentage decrease was primarily the result of anincrease in our net revenue. General and administrative expenses increased from $1.0 million in fiscal1997 to $2.4 million in fiscal 1998, an increase of $1.4 million. This increasereflected primarily additional finance, information technology and legal andadministrative personnel, recruiting expenses, professional fees and increasedspending on our information systems. For fiscal 1997 and fiscal 1998, generaland administrative expenses decreased as a percentage of net revenue from399.6% to 10.4%. This percentage decrease was primarily the result of anincrease in our net revenue. Interest Income Interest income increased from $.6 million in fiscal 1998 to $1.9 million infiscal 1999, an increase of $1.3 million. The increase is due to the increasedamount of cash and cash equivalents, short-term investments and long-terminvestments from the proceeds we received from our initial public offering inApril 1999. 22 Income Taxes We incurred significant operating losses for all fiscal years from inceptionthrough June 30, 1999. We recorded a tax provision of $1,650,000 for the yearended June 30, 1999. The provision for income taxes consists primarily offoreign taxes, federal alternative minimum taxes and state income taxes. FASBStatement No. 109 provides for the recognition of deferred tax assets ifrealization of such assets is more likely than not. Based upon the weight ofavailable evidence, which includes our historical operating performance and thereported cumulative net losses in all prior years, we have provided a fullvaluation allowance against our net deferred tax assets as the futurerealization of the tax benefit is not sufficiently assured. We intend toevaluate the realizability of the deferred tax assets on a quarterly basis. Liquidity and Capital Resources Cash and cash equivalents and short-term investments increased from $20.5million at June 30, 1998 to $123.6 million at June 30, 1999, an increase of$103.1 million. The increase is primarily a result of our initial publicoffering of common stock in April 1999, which generated net proceeds of $125.3million. Cash provided by operating activities was $2.8 million in fiscal 1999,as compared to cash used for operating activities of $8.3 million in fiscal1998. The decrease was primarily due to increases in accounts receivable,inventories and other current and noncurrent assets, offset by our operatingloss, depreciation and increases in accounts payable and accrued liabilities.We expect that accounts receivable will continue to increase to the extent ourrevenues continue to rise. We expect our inventory levels to increase inconnection with our development of a two-tier distribution system. Any suchincrease can be expected to reduce cash, cash equivalents and short-terminvestments. Investing activities used cash of $29.1 million in fiscal 1999 due tocapital expenditures of $7.5 million and net purchases of short-terminvestments of $21.6 million. Our investing activities used cash of$13.5 million in fiscal 1998 for purchases of short-term investments of $11.0million and capital expenditures of $2.5 million. Our investing activities usedcash of $1.2 million in fiscal 1997 for capital expenditures. We expect capitalexpenditures of approximately $20.0 million in fiscal 2000. Financing activities provided cash of $124.0 million in fiscal 1999, arisingprimarily from proceeds from the issuance of common stock in conjunction withour initial public offering, partially offset by principal payments on notespayable and capital lease obligations. Financing activities provided cash of$21.2 million in fiscal 1998, primarily from the issuance of convertiblepreferred stock and proceeds from notes payable, partially offset by principalpayments on notes payable and capital lease obligations. Financing activitiesprovided cash of $17.8 million in fiscal 1997, primarily from the issuance ofconvertible preferred stock and proceeds from notes payable. We have a revolving line of credit for $5.0 million with Silicon ValleyBank. Borrowings under this line of credit bear interest at the bank's primerate. As of June 30, 1999, there were no outstanding borrowings under this lineof credit. We also have a capital equipment line with Silicon Valley Bank for$4.0 million. Borrowings under this capital equipment line bear interest at thebank's prime rate. This agreement requires that we maintain certain financialratios and levels of tangible net worth, profitability and liquidity. We werein compliance with the financial statement covenants as of June 30, 1999. As ofJune 30, 1999, there were no outstanding borrowings under this capitalequipment line. In addition, we have a $2.0 million capital equipment line withComdisco, Inc. As of June 30, 1999, there were no outstanding borrowings underthis capital equipment line. In February 1999, we agreed to lease a 77,000 square foot facility in SantaClara, California. The related cost of this lease is expected to beapproximately $120,000 per month. The lease has a term of 47 months. We require substantial capital to fund our business, particularly to financeinventories and accounts receivable and for capital expenditures. In order tobuild a sustainable business, the trend of using cash in our 23 operations is expected to continue over the next several quarters. We areworking toward a business model that will allow us to consistently generatecash from operations. Achieving this model will depend on many factors,including the rate of revenue growth, the timing and extent of spending tosupport product development efforts and expansion of sales and marketing, thetiming of introductions of new products and enhancements to existing products,and market acceptance of our products. As a result, we could be required toraise substantial additional capital. To the extent that we raise additionalcapital through the sale of equity or convertible debt securities, the issuanceof such securities could result in dilution to existing stockholders. Ifadditional funds are raised through the issuance of debt securities, thesesecurities may have rights, preferences and privileges senior to holders ofcommon stock and the term of such debt could impose restrictions on ouroperations. We cannot assure you that such additional capital, if required,will be available on acceptable terms, or at all. If we are unable to obtainsuch additional capital, we may be required to reduce the scope of our plannedproduct development and marketing efforts, which would materially adverselyaffect our business, financial condition and operating results. We believe that our current cash and cash equivalents, short-terminvestments and cash available from credit facilities and future operationswill enable us to meet our working capital requirements for at least the next12 months. Year 2000 Readiness Disclosure Some computers, software and other equipment include computer code in whichcalendar year data is abbreviated to only two digits. As a result of thisdesign decision, some of these systems could fail to operate or fail to producecorrect results if "00" is interpreted to mean 1900, rather than 2000. Theseproblems are widely expected to increase in frequency and severity as the year2000 approaches, and are commonly referred to as the "year 2000 problem." Assessment. The year 2000 problem affects the computers, software and otherequipment that we use, operate or maintain for our operations. Accordingly, wehave organized a program team responsible for monitoring the assessment andremediation status of our year 2000 projects and reporting such status to ourboard of directors. This program team has assessed the potential effect andcosts of remediating the year 2000 problem for our internal systems. To date,we have not obtained verification or validation from any independent thirdparties of our processes to assess and correct any of our year 2000 problems orthe costs associated with these activities. Internal infrastructure. We have identified and evaluated approximately 250personal computers and servers, six software applications, including MicrosoftWindows 95, Microsoft Office 97 and Outlook 98 and Microsoft Mail Server, andour enterprise resource planning system, and related equipment used inconnection with our internal operations to determine if they must be modified,upgraded or replaced to minimize the possibility of a material disruption toour business. We have commenced the process of modifying, upgrading, andreplacing major systems that have been assessed as adversely affected, andexpect to complete this process before the occurrence of any materialdisruption of our business. Systems other than information technology systems. In addition to computersand related systems, the operation of office and facilities equipment, such asfax machines, telephone switches, security systems, and other common devicesmay be affected by the year 2000 problem. To date, we have been able to correctany problems with our systems other than information technology systemsrelating to year 2000. We currently do not expect any significant problems toarise with our systems other than information technology systems relating tothe year 2000. Products and software programs. We have tested and intend to continue totest all of our products and software programs for year 2000 problems. To date,we have been able to correct any problems with our products and softwareprograms relating to year 2000 prior to releasing them to our customers. Wecurrently do not expect any significant problems to arise with our products andsoftware programs relating to the year 2000. 24 We estimate the total cost to us of completing any required modifications,upgrades or replacements of our internal systems will not exceed $200,000,almost all of which we believe will be incurred during calendar 1999. Thisestimate is being monitored and we will revise it as additional informationbecomes available. Based on the activities described above, we do not believe that the year2000 problem will have a material adverse effect on our business or operatingresults. In addition, we have not deferred any material information technologyprojects as a result of our year 2000 problem activities. Suppliers. We are checking the web sites of third-party suppliers ofcomponents used in the manufacture of our products to determine if thesesuppliers are certifying that the components they provide us are year 2000compliant. To date, we believe all critical components that we obtain fromthird party suppliers are year 2000 compliant, except that Microsoft has notindicated that Windows 95 and its office mail programs are year 2000 compliant.We expect that we will be able to resolve any significant year 2000 problemswith Microsoft and any other third-party suppliers of components; however,there can be no assurance that these suppliers will resolve any or all year2000 problems before the occurrence of a material disruption to the operationof our business. Any failure of these third parties to timely resolve year 2000problems with their systems could have a material adverse effect on ourbusiness, operating results and financial condition. Most likely consequences of year 2000 problems. We expect to identify andresolve all year 2000 problems that could materially adversely affect ourbusiness operations. However, we believe that it is not possible to determinewith complete certainty that all year 2000 problems affecting us have beenidentified or corrected. The number of devices that could be affected and theinteractions among these devices are simply too numerous. In addition, no onecan accurately predict how many year 2000 problem-related failures will occuror the severity, duration, or financial consequences of these perhapsinevitable failures. As a result, we believe that the following consequencesare possible: . a significant number of operational inconveniences and inefficiencies for us, our contract manufacturers and our customers that will divert management's time and attention and financial and human resources from ordinary business activities; . several business disputes and claims for pricing adjustments or penalties due to year 2000 problems by our customers, which we believe will be resolved in the ordinary course of business; and . a few serious business disputes alleging that we failed to comply with the terms of contracts or industry standards of performance, some of which could result in litigation or contract termination. Contingency plans. We have developed contingency plans to be implemented ifour efforts to identify and correct year 2000 problems affecting our internalsystems are not effective. Depending on the systems affected, these plans couldinclude: . accelerated replacement of affected equipment or software; . short to medium-term use of backup equipment and software; . increased work hours for our personnel; and . use of contract personnel to correct on an accelerated schedule any year 2000 problems that arise or to provide manual workarounds for information systems. Our implementation of any of these contingency plans could have a materialadverse effect on our business, operating results and financial condition. Disclaimer. The discussion of our efforts and expectations relating to year2000 compliance are forward-looking statements. Our ability to achieve year2000 compliance and the level of incremental costs associated therewith, couldbe adversely affected by, among other things, the availability and cost ofprogramming and testing resources, third party suppliers' ability to modifyproprietary software, and unanticipated problems identified in the ongoingcompliance review. 25 Factors That May Affect Our Results Extreme Has a General History of Losses, and Limited History of Profitabilityand Cannot Assure You that it Will Continue to Achieve Profitability We have not achieved profitability on an annual basis and although ourrevenue has grown in recent quarters, we cannot be certain that we will realizesufficient revenue to achieve profitability on an annual basis. Extreme hasincurred net losses of $7.9 million from inception through June 30, 1997, $13.9million for fiscal 1998 and $1.6 million for fiscal 1999. As of June 30, 1999,we had an accumulated deficit of $23.5 million. We anticipate continuing toincur significant sales and marketing, product development and general andadministrative expenses and, as a result, we will need to generatesignificantly higher revenue to sustain profitability. Although our revenueshave grown in recent quarters and we have recently achieved quarterlyprofitability, we cannot be certain that we will continue to realize sufficientrevenue to sustain profitability. A Number of Factors Could Cause Extreme's Quarterly Financial Results to BeWorse Than Expected, Resulting in a Decline in Its Stock Price We plan to significantly increase our operating expenses to expand our salesand marketing activities, broaden our customer support capabilities, developnew distribution channels, fund increased levels of research and developmentand build our operational infrastructure. We base our operating expenses onanticipated revenue trends and a high percentage of our expenses are fixed inthe short term. As a result, any delay in generating or recognizing revenuecould cause our quarterly operating results to be below the expectations ofpublic market analysts or investors, which could cause the price of our commonstock to fall. We may experience a delay in generating or recognizing revenue because of anumber of reasons. Orders at the beginning of each quarter typically do notequal expected revenue for that quarter and are generally cancelable at anytime. Accordingly, we are dependent upon obtaining orders in a quarter forshipment in that quarter to achieve our revenue objectives. In addition, thetiming of product releases, purchase orders and product availability couldresult in significant product shipments at the end of a quarter. Failure toship these products by the end of a quarter may adversely affect our operatingresults. Furthermore, our customer agreements typically provide that thecustomer may delay scheduled delivery dates and cancel orders within specifiedtime frames without significant penalty. Our quarterly revenue and operating results have varied significantly in thepast and may vary significantly in the future due to a number of factors,including: . fluctuations in demand for our products and services, including seasonality, particularly in Asia and Europe; . unexpected product returns or the cancellation or rescheduling of significant orders; . our ability to develop, introduce, ship and support new products and product enhancements and manage product transitions; . announcements and new product introductions by our competitors; . our ability to develop and support customer relationships with ISPs and other potential large customers; . our ability to achieve required cost reductions; . our ability to obtain sufficient supplies of sole or limited sourced components for our products; . unfavorable changes in the prices of the components we purchase; . our ability to attain and maintain production volumes and quality levels for our products; . the mix of products sold and the mix of distribution channels through which they are sold; and . costs relating to possible acquisitions and integration of technologies or businesses. 26 Due to the foregoing factors, we believe that period-to-period comparisonsof our operating results should not be relied upon as an indicator of ourfuture performance. Intense Competition in the Market for Networking Equipment Could PreventExtreme From Increasing Revenue and Prevent Extreme From SustainingProfitability The market for network switches is intensely competitive. Our principalcompetitors include Alcatel, Cabletron Systems, Cisco Systems, Ericsson,Foundry Networks, Lucent Technologies, Nokia, Nortel Networks, Siemens and3Com. Many of our current and potential competitors have longer operatinghistories and substantially greater financial, technical, sales, marketing andother resources, as well as greater name recognition and larger installedcustomer bases, than we do. These competitors may have developed or could inthe future develop new technologies that compete with our products or evenrender our products obsolete. To remain competitive, we believe we must, among other things, investsignificant resources in developing new products and enhancing our currentproducts and maintaining customer satisfaction. If we fail to do so, ourproducts may not compete favorably with those of our competitors and ourrevenue and future profitability could be materially adversely affected. Extreme Expects the Average Selling Prices of Its Products to Decrease RapidlyWhich May Reduce Gross Margins or Revenue The network equipment industry has experienced rapid erosion of averageselling prices due to a number of factors, including competitive pricingpressures and rapid technological change. We may experience substantial period-to-period fluctuations in future operating results due to the erosion of ouraverage selling prices. We anticipate that the average selling prices of ourproducts will decrease in the future in response to competitive pricingpressures, increased sales discounts, new product introductions by us or ourcompetitors, including, for example, competitive products manufactured with lowcost merchant silicon, or other factors. Therefore, to maintain our grossmargins, we must develop and introduce on a timely basis new products andproduct enhancements and continually reduce our product costs. Our failure todo so would cause our revenue and gross margins to decline, which couldmaterially adversely affect our operating results and cause the price of ourcommon stock to decline. Extreme's Market is Subject to Rapid Technological Change and to Compete,Extreme Must Continually Introduce New Products that Achieve Broad MarketAcceptance The network equipment market is characterized by rapid technological change,frequent new product introductions, changes in customer requirements andevolving industry standards. If we do not address these changes by regularlyintroducing new products, our product line will become obsolete. Developmentsin routers and routing software could also significantly reduce demand for ourproduct. Alternative technologies could achieve widespread market acceptanceand displace Ethernet technology on which our product lines and architectureare based. We cannot assure you that our technological approach will achievebroad market acceptance or that other technologies or devices will not supplantour approach. When we announce new products or product enhancements that have thepotential to replace or shorten the life cycle of our existing products,customers may defer purchasing our existing products. These actions couldmaterially adversely affect our operating results by unexpectedly decreasingsales, increasing our inventory levels of older products and exposing us togreater risk of product obsolescence. The market for switching products isevolving and we believe our ability to compete successfully in this market isdependent upon the continued compatibility and interoperability of our productswith products and architectures offered by other vendors. In particular, thenetworking industry has been characterized by the successive introduction ofnew technologies or standards that have dramatically reduced the price andincreased the performance of switching equipment. To remain competitive we needto introduce products in a timely manner that incorporate 27 or are compatible with these new technologies as they emerge. We haveexperienced delays in releasing new products and product enhancements in thepast which delayed sales and resulted in lower quarterly revenue thananticipated. We may experience similar delays in product development in thefuture and any delay in product introduction could adversely affect our abilityto compete and cause our operating results to be below our expectations or theexpectations of public market analysts or investors. Continued Rapid Growth Will Strain Extreme's Operations and Will RequireExtreme to Incur Costs to Upgrade Its Infrastructure Since the introduction of our product line, we have experienced a period ofrapid growth and expansion which has placed, and continues to place, asignificant strain on our resources. Unless we manage such growth effectively,we may make mistakes in operating our business such as inaccurate salesforecasting, incorrect material planning or inaccurate financial reporting,which may result in unanticipated fluctuations in our operating results. Ournet revenue increased significantly during the last year, and from June 30,1998 to June 30, 1999, the number of our employees increased from 119 to 249.We expect our anticipated growth and expansion to strain our management,operational and financial resources. Our management team has had limitedexperience managing such rapidly growing companies on a public or privatebasis. To accommodate this anticipated growth, we will be required to: . improve existing and implement new operational, information and financial systems, procedures and controls; . hire, train and manage additional qualified personnel, including in the near future sales and marketing personnel; 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 andtimely manner, and our current or planned personnel systems, procedures andcontrols may not be adequate to support our future operations. For example, inthe quarter ended June 30, 1998, our operating results were adversely impacteddue to a provision of approximately $900,000 that we recorded for purchaseorder commitments for certain components that exceeded our estimatedrequirements at the end of that quarter. This was due primarily to anengineering change in certain of our Summit family of products and a reduceddemand forecast from one of our customers. In August 1998, we installed a newmanagement information system, which we may continue to modify and improve tomeet the increasing needs associated with our expected growth. The difficultiesassociated with installing and implementing these new systems, procedures andcontrols may place a significant burden on our management and our internalresources. In addition, as we grow internationally, we will have to expand ourworldwide operations and enhance our communications infrastructure. Any delayin the implementation of such new or enhanced systems, procedures or controls,or any disruption in the transition to such new or enhanced systems, proceduresor controls, could adversely affect our ability to accurately forecast salesdemand, manage our supply chain and record and report financial and managementinformation on a timely and accurate basis. Extreme Must Develop and Expand Its Indirect Distribution Channels to IncreaseRevenues and Improve Its Operating Results Our distribution strategy focuses primarily on developing and expandingindirect distribution channels through resellers and, to a lesser extent,original equipment manufacturers, or OEMs, as well as expanding our field salesorganization. If we fail to develop and cultivate relationships withsignificant resellers, or if these resellers are not successful in their salesefforts, sales of our products may decrease and our operating results wouldsuffer. Many of our resellers also sell products that compete with ourproducts. We are developing a two-tier distribution structure in Europe and theUnited States which has and will require us to enter into agreements with asmall number of stocking distributors. We cannot assure you that we willcontinue to be able to enter into such agreements or that we will be able tosuccessfully manage our resellers and distributors. Our failure to do so couldlimit our ability to grow or sustain revenue. In addition, our operatingresults will likely fluctuate significantly depending on the timing and amountof orders from our resellers. We cannot assure you 28 that our resellers will market our products effectively or continue to devotethe resources necessary to provide us with effective sales, marketing andtechnical support. In order to support and develop leads for our indirect distributionchannels, we plan to expand our field sales and support staff significantly. Wecannot assure you that this internal expansion will be successfully completed,that the cost of this expansion will not exceed the revenues generated or thatour expanded sales and support staff will be able to compete successfullyagainst the significantly more extensive and well-funded sales and marketingoperations of many of our current or potential competitors. Our inability toeffectively establish our distribution channels or manage the expansion of oursales and support staff would materially adversely affect our ability to growand increase revenue. Because Substantially All of Extreme's Revenue is Derived From Sales of TwoProduct Families, Extreme is Dependent on Widespread Market Acceptance of TheseProducts; Future Performance will Depend on the Introduction and Acceptance ofNew Products We currently derive substantially all of our revenue from sales of ourSummit and BlackDiamond product families. We expect that revenue from theseproduct families will account for a substantial portion of our revenue for theforeseeable future. Accordingly, widespread market acceptance of our productfamilies is critical to our future success. Factors that may affect the marketacceptance of our products include market acceptance of switching products, andGigabit Ethernet and Layer 3 switching technologies in particular in theenterprise LAN, ISP and content provider markets, the performance, price andtotal cost of ownership of our products, the availability and price ofcompeting products and technologies, and the success and development of ourresellers, OEMs and field sales channels. Many of these factors are beyond ourcontrol. Our future performance will also depend on the successful development,introduction and market acceptance of new and enhanced products that addresscustomer requirements in a cost-effective manner. We are developing productswhich we expect to introduce this fiscal year which are based on a new chip setunder development. The introduction of new and enhanced products may cause ourcustomers to defer or cancel orders for existing products. We have in the pastexperienced delays in product development and such delays may occur in thefuture. Therefore, to the extent customers defer or cancel orders in theexpectation of any new product release, any delay in development orintroduction could cause our operating results to suffer. Failure of ourexisting or future products to maintain and achieve widespread levels of marketacceptance may significantly impair our revenue growth. If a Key Reseller, OEM or Other Significant Customer Cancels or Delays a LargePurchase, Extreme's Revenues May Decline and the Price of Its Stock May Fall To date, a limited number of resellers, OEMs and other customers haveaccounted for a significant portion of our revenue. If any of our largecustomers stop or delay purchases, our revenue and profitability would beadversely affected. For fiscal 1998, 3Com and Compaq accounted for 25% and 21%of our net revenue, respectively, and for fiscal 1999, Compaq and Hitachi Cableaccounted for 21% and 13% of our net revenue, respectively. Compaq is both anOEM and an end-user customer. Because our expense levels are based on ourexpectations as to future revenue and to a large extent are fixed in the shortterm, a substantial reduction or delay in sales of our products to, or the lossof any significant reseller, OEM or other customer, or unexpected returns fromresellers could harm our business, operating results and financial condition.Although our largest customers may vary from period-to-period, we anticipatethat our operating results for any given period will continue to depend to asignificant extent on large orders from a small number of customers,particularly in light of the high sales price per unit of our products and thelength of our sales cycles. While our financial performance depends on large orders from a few keyresellers, OEMs and other significant customers, we do not have bindingcommitments from any of them. For example: . our ISP and enterprise network customers can stop purchasing and our resellers and OEMs can stop marketing our products at any time; 29 . 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 and OEM agreements generally do not require minimum purchases. We have established a program which, under specified conditions, enablessome third party resellers to return products to us. The amount of potentialproduct returns is estimated and provided for in the period of the sale. Someof our OEM agreements also provide manufacturing rights and access to oursource code upon the occurrence of specified conditions of default. If we wereto default on these agreements, our OEMs could use our source code to developand manufacture competing products, which would negatively affect ourperformance and ability to compete. The Sales Cycle for Extreme's Products is Long and Extreme May IncurSubstantial Non-Recoverable Expenses or Devote Significant Resources to Salesthat Do Not Occur When Anticipated The timing of our sales revenue is difficult to predict because of ourreliance on indirect sales channels and the length and variability of our salescycle. Our products have a relatively high sales price per unit, and oftenrepresent a significant and strategic decision by an enterprise regarding itscommunications infrastructure. Accordingly, the purchase of our productstypically involves significant internal procedures associated with theevaluation, testing, implementation and acceptance of new technologies. Thisevaluation process frequently results in a lengthy sales process, typicallyranging from three months to longer than a year, and subjects the sales cycleassociated with the purchase of our products to a number of significant risks,including budgetary constraints and internal acceptance reviews. The length ofour sales cycle also may vary substantially from customer to customer. Whileour customers are evaluating our products and before they may place an orderwith us, we may incur substantial sales and marketing expenses and expendsignificant management effort. Consequently, if sales forecasted from aspecific customer for a particular quarter are not realized in that quarter, wemay be unable to compensate for the shortfall, which could harm our operatingresults. Extreme Purchases Several Key Components for Products From Single or LimitedSources and Could Lose Sales if These Sources Fail to Fill Its Needs We currently purchase several key components used in the manufacture of ourproducts from single or limited sources and are dependent upon supply fromthese sources to meet our needs. Certain components such as gigabit interfaceconverter transceivers, or GBICs, are currently in short supply. While we havebeen able to meet our needs to date, we are likely to encounter shortages anddelays in obtaining these or other components in the future which couldmaterially adversely affect our ability to meet customer orders. Our principalsole sourced components include: . ASICs; . microprocessors; . programmable integrated circuits; . selected other integrated circuits; . cables; and . custom-tooled sheet metal. Our principal limited sourced components include: . flash memories; 30 . 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 todetermine our material requirements. Lead times for materials and components weorder 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 notmatch forecasts, we may have excess or inadequate inventory of certainmaterials and components, which could materially adversely affect our operatingresults and financial condition. From time to time we have experiencedshortages and allocations of certain components, resulting in delays in fillingorders. In addition, during the development of our products we have experienceddelays in the prototyping of our ASICs, which in turn has led to delays inproduct introductions. Extreme Needs to Expand Its Manufacturing Operations and Depends on ContractManufacturers for Substantially All of Its Manufacturing Requirements If the demand for our products grows, we will need to increase our materialpurchases, contract manufacturing capacity and internal test and qualityfunctions. Any disruptions in product flow could limit our revenue, adverselyaffect our competitive position and reputation and result in additional costsor cancellation of orders under agreements with our customers. We rely on third party manufacturing vendors to manufacture our products. Wecurrently subcontract substantially all of our manufacturing to two companies--Flextronics International, Ltd., located in San Jose, California, whichmanufactures our Summit1, Summit2 and Summit4 and BlackDiamond products, andMCMS, Inc., located in Boise, Idaho, which manufactures our Summit24 andSummit48 products. We have experienced a delay in product shipments from acontract manufacturer in the past, which in turn delayed product shipments toour customers. We may in the future experience similar or other problems, suchas inferior quality and insufficient quantity of product, any of which couldmaterially adversely affect our business and operating results. There can be noassurance that we will effectively manage our contract manufacturers or thatthese manufacturers will meet our future requirements for timely delivery ofproducts of sufficient quality and quantity. We intend to regularly introducenew products and product enhancements, which will require that we rapidlyachieve volume production by coordinating our efforts with those of oursuppliers and contract manufacturers. The inability of our contractmanufacturers to provide us with adequate supplies of high-quality products orthe loss of either of our contract manufacturers would cause a delay in ourability to fulfill orders while we obtain a replacement manufacturer and wouldhave a material adverse effect on our business, operating results and financialcondition. As part of our cost-reduction efforts, we will need to realize lower perunit product costs from our contract manufacturers as a result of volumeefficiencies. However, we cannot be certain when or if such price reductionswill occur. The failure to obtain such price reductions would adversely affectour gross margins and operating results. If Extreme Loses Key Personnel or is Unable to Hire Additional QualifiedPersonnel as Necessary, It May Not Be Able to Successfully Manage Its Businessor Achieve Its Objectives Our success depends to a significant degree upon the continued contributionsof our key management, engineering, sales and marketing and manufacturingpersonnel, many of whom would be difficult to replace. In particular, webelieve that our future success is highly dependent on Gordon Stitt, Chairman,President and Chief Executive Officer, Stephen Haddock, Vice President andChief Technical Officer, and Herb Schneider, Vice President of Engineering. Weneither have employment contracts with nor key person life insurance on any ofour key personnel. 31 We believe our future success will also depend in large part upon ourability to attract and retain highly skilled managerial, engineering, sales andmarketing, finance and manufacturing personnel. Competition for these personnelis intense, especially in the San Francisco Bay Area, and we have haddifficulty hiring employees in the timeframe we desire, particularly softwareengineers. There can be no assurance that we will be successful in attractingand retaining such personnel. The loss of the services of any of our keypersonnel, the inability to attract or retain qualified personnel in the futureor delays in hiring required personnel, particularly engineers and salespersonnel, could make it difficult for us to manage our business and meet keyobjectives, such as product introductions, on time. In addition, companies inthe networking industry whose employees accept positions with competitorsfrequently claim that competitors have engaged in unfair hiring practices. Wehave from time to time received claims like this from other companies and,although to date they have not resulted in material litigation, we cannotassure you that we will not receive additional claims in the future as we seekto hire qualified personnel or that such claims will not result in materiallitigation. We could incur substantial costs in defending ourselves against anysuch claims, regardless of the merits of such claims. Extreme's Products Must Comply With Evolving Industry Standards and ComplexGovernment Regulations or Its Products May Not Be Widely Accepted, Which MayPrevent Extreme From Sustaining Its Revenues or Achieving Profitability The market for network equipment products is characterized by the need tosupport industry standards as different standards emerge, evolve and achieveacceptance. We will not be competitive unless we continually introduce newproducts and product enhancements that meet these emerging standards. In thepast, we have introduced new products that were not compatible with certaintechnological changes, and in the future we may not be able to effectivelyaddress the compatibility and interoperability issues that arise as a result oftechnological changes and evolving industry standards. In addition, in theUnited States, our products must comply with various regulations and standardsdefined by the Federal Communications Commission and Underwriters Laboratories.Internationally, products that we develop may be required to comply withstandards established by telecommunications authorities in various countries aswell as with recommendations of the International Telecommunication Union. Ifwe do not comply with existing or evolving industry standards or if we fail toobtain timely domestic or foreign regulatory approvals or certificates we wouldnot be able to sell our products where these standards or regulations apply,which may prevent us from sustaining our revenues or achieving profitability. Extreme Needs to Expand Its Sales and Support Organizations to Increase MarketAcceptance of Its Products and If It Fails to Do So, Extreme Will Not Be Ableto Increase Revenues Our products and services require a sophisticated sales effort targeted atseveral levels within a prospective customer's organization. Unless we expandour sales force we will not be able to increase revenues. We have recentlyexpanded our sales force and plan to hire additional sales personnel. However,competition for qualified sales personnel is intense, and we might not be ableto hire the kind and number of sales personnel we are targeting. We currently have a small customer service and support organization and willneed to increase our staff to support new customers and the expanding needs ofexisting customers. The design and installation of networking products can becomplex; accordingly, we need highly-trained customer service and supportpersonnel particularly for large ISP and enterprise network customers. Hiringcustomer service and support personnel is very competitive in our industry dueto the limited number of people available with the necessary technical skillsand understanding of our products. Extreme Depends Upon International Sales for Much of Its Revenue and Extreme'sAbility to Sustain and Increase Its International Sales Depends on SuccessfullyExpanding Its International Operations Our ability to grow will depend in part on the expansion of internationalsales and operations which have and are expected to constitute a significantportion of our sales. Sales to customers outside of North America 32 accounted for approximately 61% and 53% of our net revenue in fiscal 1998 andfiscal 1999, respectively. Our international sales primarily depend on ourresellers and OEMs. The failure of our resellers and OEMs to sell our productsinternationally would limit our ability to sustain and grow our revenue. Inaddition, 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; . payment of operating expenses in local currencies, which subjects 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 currenciescould make our products less competitive in international markets. In thefuture, we may elect to invoice some of our international customers in localcurrency which will subject us to fluctuations in exchange rates between theU.S. dollar and the particular local currency. If we do so, we may determine toengage in hedging transactions to minimize the risk of such fluctuations.However, if we are not successful in managing such hedging transactions, wecould incur losses from hedging activities. Because we currently denominatesales in U.S. dollars, we do not anticipate that the adoption of the Euro as afunctional legal currency of certain European countries will materially affectour business. Extreme May Engage in Future Acquisitions that Dilute the Ownership Interestsof Our Stockholders, Cause Us to Incur Debt and Assume Contingent Liabilities As part of our business strategy, we expect to review acquisition andstrategic investment prospects that would complement our current productofferings, augment our market coverage or enhance our technical capabilities,or that may otherwise offer growth opportunities. While we have no currentagreements or negotiations underway with respect to any such acquisitions, weare reviewing investments in new businesses and we may acquire businesses,products or technologies in the future. In the event of any futureacquisitions, we could: . issue equity securities which would dilute current stockholders' percentage ownership; . incur substantial debt; or . assume contingent liabilities. These actions by us could materially adversely affect our operating resultsand/or the price of our common stock. Acquisitions and investment activitiesalso 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; and . potential loss of key employees of acquired organizations. We cannot assure you that we will be able to successfully integrate anybusinesses, products, technologies or personnel that we might acquire in thefuture, and our failure to do so could materially adversely affect ourbusiness, operating results and financial condition. 33 Extreme May Need Additional Capital to Fund Its Future Operations Which, If ItIs Not Available When Needed, Extreme May Need to Reduce Its PlannedDevelopment and Marketing Efforts, Which May Reduce Its Revenues and PreventExtreme From Achieving Profitability We believe that our existing working capital, proceeds from the initialpublic offering in April 1999 and cash available from credit facilities andfuture operations will enable us to meet our working capital requirements forat least the next 12 months. However, if cash from future operations isinsufficient, or if cash is used for acquisitions or other currentlyunanticipated uses, we may need additional capital. The development andmarketing of new products and the expansion of our reseller and distributionchannels and associated support personnel is expected to require a significantcommitment of resources. In addition, if the market for Layer 3 switches wereto develop more slowly than anticipated or if we fail to establish significantmarket share and achieve a meaningful level of revenues, we may continue toutilize significant amounts of capital. As a result, we could be required toraise substantial additional capital. To the extent that we raise additionalcapital through the sale of equity or convertible debt securities, the issuanceof such securities could result in dilution to existing stockholders. Ifadditional funds are raised through the issuance of debt securities, suchsecurities may have rights, preferences and privileges senior to holders ofcommon stock and the term of such debt could impose restrictions on ouroperations. We cannot assure you that such additional capital, if required,will be available on acceptable terms, or at all. If we are unable to obtainsuch additional capital, we may be required to reduce the scope of our plannedproduct development and marketing efforts, which would harm our business,financial condition and operating results. If Extreme's Products Contain Undetected Software or Hardware Errors, ExtremeCould Incur Significant Unexpected Expenses and Lost Sales Network products frequently contain undetected software or hardware errorswhen first introduced or as new versions are released. We have experienced sucherrors in the past in connection with new products and product upgrades. Weexpect that such errors will be found from time to time in new or enhancedproducts after commencement of commercial shipments. These problems maymaterially adversely affect our business by causing us to incur significantwarranty and repair costs, diverting the attention of our engineering personnelfrom our product development efforts and causing significant customer relationsproblems. Our products must successfully interoperate with products from othervendors. As a result, when problems occur in a network, it may be difficult toidentify the source of the problem. The occurrence of hardware and softwareerrors, whether caused by our products or another vendor's products, couldresult in the delay or loss of market acceptance of our products and anynecessary revisions may result in the incurrence of significant expenses. Theoccurrence of any such problems would likely have a material adverse effect onour business, operating results and financial condition. Extreme's Limited Ability to Protect Its Intellectual Property May AdverselyAffect Its Ability to Compete We rely on a combination of patent, copyright, trademark and trade secretlaws and restrictions on disclosure to protect our intellectual propertyrights. However, we cannot assure you that the actions we have taken willadequately protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees,consultants and corporate partners, and control access to and distribution ofour software, documentation and other proprietary information. Despite ourefforts to protect our proprietary rights, unauthorized parties may attempt tocopy or otherwise obtain and use our products or technology. 34 If Extreme or Its Key Suppliers and Customers Fail to Be Year 2000 Compliant,Extreme's Business May Be Severely Disrupted And Its Revenues May Decline The year 2000 computer issue creates a risk for us. If systems do notcorrectly recognize date information when the year changes to 2000, there couldbe an adverse impact on our operations. The risk exists in four areas: . potential warranty or other claims from our customers; . systems we use to run our business; . systems used by our suppliers; and . the potential reduced spending by other companies on networking solutions as a result of significant information systems spending on year 2000 remediation. We are currently evaluating our exposure in all of these areas. We are conducting an inventory and evaluation of the information systemsused to run our business. Systems which have been and may be identified as non-compliant have been or will be upgraded or replaced. For the year 2000 non-compliance issues identified to date, the cost of remediation is not expectedto be material to our operating results. However, if implementation ofreplacement systems is delayed, or if significant new non-compliance issues areidentified, our operating results or financial condition could be materiallyadversely affected. We are checking the websites of our suppliers to determine if thesesuppliers are certifying that the components they provide us are year 2000compliant. To date, we believe all critical components that we obtain fromthird party suppliers are year 2000 compliant, except that Microsoft has notindicated that Windows 95 and its office mail programs are year 2000 compliant.We expect that we will be able to resolve any significant year 2000 problemswith Microsoft and any other third-party suppliers of components; however,there can be no assurance that these suppliers will resolve any or all year2000 problems before the occurrence of a material disruption to the operationof our business. Any failure of these third parties to timely resolve year 2000problems with their systems could have a material adverse effect on ourbusiness, operating results and financial condition. Since all customer situations cannot be anticipated, we may see an increasein warranty and other claims as a result of the year 2000 transition. Inaddition, litigation regarding year 2000 compliance issues is expected toescalate. For these reasons, the impact of customer claims could have amaterial adverse impact on our operating results or financial condition. Businesses that face year 2000 compliance issues may require significanthardware and software upgrades or modifications to their computer systems andapplications. These companies may plan to devote a substantial portion of theirinformation systems' spending to fund such upgrades and modifications anddivert spending away from networking solutions. This change in customers'spending patterns could materially adversely impact our business, operatingresults or financial condition. Provisions in Extreme's Charter or Agreements May Delay or Prevent a Change ofControl Provisions in our certificate of incorporation and bylaws may delay orprevent a change of control or changes in our management. These provisionsinclude: . 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; . the ability of the board of directors to alter our bylaws without getting stockholder approval; and 35 . the requirement that at least 10% of the outstanding shares are needed to call a special meeting of stockholders. Furthermore, we are subject to the provisions of section 203 of the DelawareGeneral Corporation Law. These provisions prohibit large stockholders, inparticular those owning 15% or more of the outstanding voting stock, fromconsummating a merger or combination with a corporation unless this stockholderreceives board approval for the transaction or 66 2/3% of the shares of votingstock not owned by the stockholder approve the merger or combination. Further,we have investor agreements with Compaq, Siemens and 3Com which require us togive these companies notice if we receive an acquisition offer or if we intendto pursue one. Substantial Future Sales of Extreme's Common Stock in the Public Market CouldCause Its Stock Price to Fall The market price of our common stock could drop as a result of sales of alarge number of shares in the market or in response to the perception thatthese sales could occur. All of the 8,050,000 shares sold in the initial publicoffering are freely tradeable, with the 41,295,230 other shares outstanding,based on the number of shares outstanding as of June 30, 1999, are "restrictedsecurities" as defined in Rule 144 of the Securities Act of 1933, and tradablein the near future. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Interest Rate Sensitivity The primary objective of our investment activities is to preserve principalwhile at the same time maximizing the income we receive from our investmentswithout significantly increasing risk. Some of the securities that we haveinvested in may be subject to market risk. This means that a change inprevailing interest rates may cause the principal amount of the investment tofluctuate. For example, if we hold a security that was issued with a fixedinterest rate at the then-prevailing rate and the prevailing interest ratelater rises, the principal amount of our investment will probably decline. Tominimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, othernon-government debt securities and money market funds. In general, money marketfunds are not subject to market risk because the interest paid on such fundsfluctuates with the prevailing interest rate. The following table presents theamounts of our cash equivalents and short-term investment that are subject tomarket risk by range of expected maturity and weighted-average interest ratesas of June 30, 1999. This table does not include money market funds becausethose funds are not subject to market risk. Maturing in ------------------------------------------------------ Three months Three months Greater than Fair or less to one year one year Total Value ------------ ------------ ------------ ------- ------- (In thousands) Included in cash and cash equivalents....... $93,819 $93,819 $93,819Weighted average interest rate.......... 5.12%Included in short-term investments............ $16,422 $16,422 $16,422Weighted average interest rate.......... 5.04%Included in investments............ $ 300 $15,797 $16,097 $16,097Weighted average interest rate.......... 6.02% 6.36% 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 exchangegains and losses to date. While we have conducted some transactions in foreigncurrencies during the year ended June 30, 1999 and expect to continue to do so,we do not anticipate that foreign exchange gains or losses will be significant.We have not engaged in foreign currency hedging activities to date, however, wemay do so in the future. 36 Item 8. Financial Statements and Supplementary Data. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF EXTREME NETWORKS, INC. Page(s) ------- Report of Ernst & Young LLP, Independent Auditors....................... 38Consolidated Balance Sheets............................................. 39Consolidated Statements of Operations................................... 40Consolidated Statement of Stockholders' Equity.......................... 41Consolidated Statements of Cash Flows................................... 42Notes to Consolidated Financial Statements.............................. 43 37 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and StockholdersExtreme Networks, Inc. We have audited the accompanying consolidated balance sheets of ExtremeNetworks, Inc. as of June 30, 1999 and 1998, and the related consolidatedstatements of operations, stockholders' equity and cash flows for the periodfrom inception, May 8, 1996 to June 30, 1997 and for each of the two years inthe period ended June 30, 1999. Our audits also included the financialstatement schedule listed in the Index at Item 14(a). These financialstatements and schedule are the responsibility of the Company's management. Ourresponsibility is to express an opinion on these financial statements andschedule based on our audits. We conducted our audits in accordance with generally accepted auditingstandards. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion. In our opinion, the financial statements referred to above present fairly,in all material respects, the consolidated financial position of ExtremeNetworks, Inc. at June 30, 1999 and 1998, and the consolidated results of itsoperations and its cash flows for the period from inception, May 8, 1996 toJune 30, 1997, and for each of the two years in the period ended June 30, 1999,in conformity with generally accepted accounting principles. Also, in ouropinion, the related financial statement schedule, when considered in relationto the basic financial statements taken as a whole, presents fairly in allmaterial respects the information set forth therein. Ernst & Young LLP Palo Alto, CaliforniaJuly 20, 1999 38 EXTREME NETWORKS, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts) June 30, ------------------- 1999 1998 --------- -------- ASSETSCurrent assets: Cash and cash equivalents................................ $ 107,143 $ 9,510 Short-term investments................................... 16,422 10,995 Accounts receivable, net of allowance for doubtful accounts of $1,374 in 1999 and $433 in 1998)............................... 20,797 7,808 Inventories.............................................. 2,626 123 Other current assets..................................... 1,978 588 --------- -------- Total current assets.................................... 148,966 29,024Property and equipment, net............................... 6,506 4,469Investments............................................... 16,097 --Other assets.............................................. 234 238 --------- -------- $ 171,803 $ 33,731 ========= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable......................................... $ 13,418 $ 9,993 Accrued compensation..................................... 2,500 462 Accrued commissions...................................... 1,600 473 Accrued warranty......................................... 1,400 1,073 Accrued purchase commitments............................. 1,111 893 Deferred revenue......................................... 1,717 283 Other accrued liabilities................................ 4,883 701 Income tax liability..................................... 1,650 -- Notes payable, current portion........................... -- 834 Capital lease obligations, current portion............... 1,648 516 --------- -------- Total current liabilities............................... 29,927 15,228Notes payable, net of current portion..................... -- 1,167Capital lease obligations, net of current portion......... -- 1,467CommitmentsStockholders' equity: Convertible preferred stock, $.001 par value, issuable in series: 2,000,000 shares authorized at June 30, 1999 (29,900,000 shares authorized at June 30, 1998); no shares and 29,061,315 shares issued and outstanding at June 30, 1999 and 1998, respectively.................... -- 29 Common stock, $.001 par value; 150,000,000 shares authorized at June 30, 1999, (50,000,000 shares authorized at June 30, 1998); 49,345,230 and 11,534,525, shares issued and outstanding at June 30, 1999 and 1998, respectively............................................ 49 12 Additional paid-in capital............................... 165,618 38,056 Deferred stock compensation.............................. (197) (369) Accumulated other comprehensive loss..................... (118) -- Accumulated deficit...................................... (23,476) (21,859) --------- -------- Total stockholders' equity.............................. 141,876 15,869 --------- -------- $ 171,803 $ 33,731 ========= ======== See accompanying notes to consolidated financial statements. 39 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) Year Ended June 30, ------------------- For the Period from May 8, 1996 (Date of Inception) 1999 1998 through June 30, 1997 -------- --------- --------------------- Net revenue......................... $ 98,026 $ 23,579 $ 256Cost of revenue..................... 48,520 14,897 388 -------- --------- -------Gross profit (loss)................. 49,506 8,682 (132)Operating expenses: Research and development.......... 17,036 10,668 5,351 Selling and marketing............. 27,056 9,601 1,554 General and administrative........ 6,859 2,440 1,023 -------- --------- ------- Total operating expenses........ 50,951 22,709 7,928 -------- --------- -------Operating loss...................... (1,445) (14,027) (8,060)Interest income..................... 1,855 613 234Interest expense.................... (398) (326) (79)Other income (loss), net............ 21 (196) (18) -------- --------- -------Income (loss) before income taxes... 33 (13,936) (7,923)Provision for income taxes.......... 1,650 -- -- -------- --------- -------Net loss............................ $ (1,617) $ (13,936) $(7,923) ======== ========= =======Basic and diluted net loss per common share....................... $ (0.17) $ (3.18) $ (4.51)Weighted average shares outstanding used in computing basic and diluted net loss per share............................. 9,462 4,379 1,758Pro forma basic and diluted net loss per share (unaudited).............. $ (0.04) $ (0.44)Shares used in computing pro forma basic and diluted net loss per share (unaudited).................. 38,523 31,701 See accompanying notes to consolidated financial statements. 40 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (in thousands, except share amounts) Convertible Accumulated Preferred Stock Common Stock Additional Deferred Other Total ----------------- ------------- Paid-In Stock Comprehensive Accumulated Stockholders' Shares Amount Shares Amount Capital Compensation Loss Deficit Equity -------- ------- ------ ------ ---------- ------------ ------------- ----------- ------------- Issuance of common stock to founders............ -- $ -- 4,725 $ 4 $ 12 $ -- $ -- $ -- $ 16Issuance of Series A convertible preferred stock to investors for cash (less issuance costs of $5)........... 14,580 14 -- -- 4,841 -- -- -- 4,855Issuance of common stock to the former share- holders of Mammoth Technology............. -- -- 675 1 12 -- -- -- 13Issuance of Series B convertible preferred stock to investors for cash (less issuance costs of $27).......... 8,886 9 -- -- 12,227 -- -- -- 12,236Exercise of options to purchase common stock.. -- -- 5,410 6 102 -- -- -- 108Net loss................ -- -- -- -- -- -- -- (7,923) (7,923) -------- ------ ------ --- -------- ----- ----- -------- --------Balances at June 30, 1997................... 23,466 23 10,810 11 17,194 -- -- (7,923) 9,305Issuance of warrant for 48,347 shares of Series B convertible preferred stock.................. -- -- -- -- 28 -- -- -- 28Issuance of Series C convertible preferred stock to investors for cash (less issuance costs of $416)......... 5,595 6 -- -- 20,111 -- -- -- 20,117Issuance of warrant for 70,176 shares of Series C convertible preferred stock.................. -- -- -- -- 140 -- -- -- 140Exercise of options to purchase common stock.. -- -- 725 1 146 -- -- -- 147Deferred stock compensa- tion................... -- -- -- -- 437 (437) -- -- --Amortization of deferred stock compensation..... -- -- -- -- -- 68 -- -- 68Net loss................ -- -- -- -- -- -- -- (13,936) (13,936) -------- ------ ------ --- -------- ----- ----- -------- --------Balances at June 30, 1998................... 29,061 29 11,535 12 38,056 (369) -- (21,859) 15,869Comprehensive loss:Net loss................ -- -- -- -- -- -- -- (1,617) (1,617)Other comprehensive loss, net of tax: Change in unrealized loss on investments... -- -- -- -- -- -- (112) -- (112) Foreign currency trans- lation adjustment..... -- -- -- -- -- -- (6) -- (6) --------Other comprehensive loss................... -- -- -- -- -- -- -- -- (118) --------Comprehensive loss...... -- -- -- -- -- -- -- -- (1,735)Issuance of warrants to purchase 40,000 shares of common stock........ -- -- -- -- 948 -- -- -- 948Issuance of common stock in conjunction with initial public offering (less issuance costs of $1,948)................ -- -- 8,050 8 125,314 -- -- -- 125,322Conversion of preferred stock to common stock in conjunction with initial public offer- ing.................... (29,061) (29) 29,061 29 -- -- -- -- --Exercise of warrants to purchase common stock.. -- -- 132 -- -- -- -- -- --Exercise of options to purchase common stock.. -- -- 567 -- 1,300 -- -- -- 1,300Amortization of deferred stock compensation..... -- -- -- -- -- 172 -- -- 172 -------- ------ ------ --- -------- ----- ----- -------- --------Balances at June 30, 1999................... -- $ -- 49,345 $49 $165,618 $(197) $(118) $(23,476) $141,876 ======== ====== ====== === ======== ===== ===== ======== ======== See accompanying notes to consolidated financial statements. 41 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) For the Period Year Ended June 30, from May 8, 1996 --------------------- (Date of Inception) 1999 1998 through June 30, 1997 --------- ---------- --------------------- Operating activities Net loss......................... $ (1,617) $ (13,936) $ (7,923) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization.. 5,733 1,453 315 Warrants issued to customer.... 948 -- -- Amortization of deferred stock compensation.................. 172 68 -- Changes in operating assets and liabilities: Accounts receivable.......... (12,989) (7,545) (262) Inventories.................. (2,503) (86) (37) Other current and noncurrent assets...................... (1,392) (585) (241) Accounts payable............. 3,425 9,244 749 Accrued compensation......... 2,038 272 189 Accrued commissions.......... 1,127 473 -- Accrued warranty............. 327 1,073 -- Accrued purchase commitments................. 218 893 -- Deferred revenue............. 1,434 283 -- Other accrued liabilities.... 4,182 237 464 Income tax liability......... 1,650 -- -- Due to shareholder........... -- (109) 109 --------- ---------- -------- Net cash provided by (used in) operating activities............ 2,753 (8,265) (6,637) --------- ---------- --------Investing activities Capital expenditures ............ (7,492) (2,511) (1,151) Purchases of short-term investments..................... (35,685) (10,996) -- Maturities of short-term investments..................... 14,049 -- -- --------- ---------- -------- Net cash used in investing activities...................... (29,128) (13,507) (1,151) --------- ---------- --------Financing activities Proceeds from issuance of convertible preferred stock..... -- 20,285 17,091 Proceeds from issuance of common stock........................... 126,622 147 124 Proceeds from notes payable...... 783 1,606 700 Principal payments on notes payable......................... (2,784) (241) (64) Principal payments of capital lease obligations............... (613) (562) (16) --------- ---------- -------- Net cash provided by financing activities...................... 124,008 21,235 17,835 --------- ---------- -------- Net increase (decrease) in cash and cash equivalents............ 97,633 (537) 10,047Cash and cash equivalents at beginning of period.............. 9,510 10,047 -- --------- ---------- --------Cash and cash equivalents at end of period........................ $ 107,143 $ 9,510 $ 10,047 ========= ========== ========Supplemental disclosure of cash flow information: Interest paid.................... $ 185 $ 326 $ 73Supplemental schedule of noncash investing and financing activities: Property and equipment acquired under capital lease obligations..................... $ 278 $ 1,588 $ 505 Common stock issued for assets... $ -- $ -- $ 14 Warrants issued in connection with capital lease.............. $ -- $ 168 $ -- Warrants issued to customer...... $ 948 $ -- $ -- Deferred stock compensation...... $ -- $ 437 $ -- Conversion of preferred stock to common stock.................... $ 29 $ -- $ -- See accompanying notes to consolidated financial statements. 42 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies Nature of Operations Extreme Networks, Inc. ("Extreme" or the "Company") was incorporated in thestate of California on May 8, 1996 and was reincorporated in the state ofDelaware on January 7, 1999. The Company is engaged in the design, development,manufacture and sale of high performance networking products based on GigabitEthernet technology. The financial operations for the period ended June 30,1996 were insignificant (generating a net loss of approximately $94,000) andhave been combined with Extreme's results for the year ended June 30, 1997.Through June 30, 1997, Extreme was in the development stage. Extreme hasincurred operating losses to date and has an accumulated deficit of $23.5million at June 30, 1999. Principles of Consolidation and Basis of Presentation The consolidated financial statements include the accounts of Extreme andits wholly-owned subsidiaries. All significant inter-company balances andtransactions have been eliminated. Assets and liabilities of foreign operationsare translated to U.S. dollars at current rates of exchange, and revenues andexpenses are translated using weighted average rates. Foreign currencytransaction gains and losses have not been material. Gains and losses fromforeign currency translation are included as a separate component ofcomprehensive income. Certain items previously reported in specific financial statement captionshave been reclassified to conform with the 1999 presentation. Accounting Estimates The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that materially affect the amounts reported in the financialstatements. Actual results could differ materially from these estimates. Cash Equivalents and Short-Term Investments Extreme considers all highly liquid investment securities with maturity fromdate of purchase of three months or less to be cash equivalents and investmentsecurities with maturity from date of purchase of more than three months butless than one year, to be short-term investments. Management determines the appropriate classification of debt and equitysecurities at the time of purchase and reevaluates such designation as of eachbalance sheet date. To date, all marketable securities have been classified asavailable-for-sale and are carried at fair value, with unrealized gains andlosses, when material, reported net-of-tax as a separate component ofcomprehensive income. Realized gains and losses on available-for-salesecurities are included in interest income. The cost of securities sold isbased on specific identification. Premiums and discounts are amortized over theperiod from acquisition to maturity and are included in investment income,along with interest and dividends. Fair Value of Financial Instruments The estimated fair value amounts have been determined by Extreme usingavailable market information and valuation methodologies considered to beappropriate. However, considerable judgment is required in interpreting marketdata to develop the estimates of fair value. Accordingly, the estimatespresented herein are not necessarily indicative of the amounts that Extremecould realize in a current market exchange. The fair value for marketable debt securities is based on quoted marketprices. The carrying value of those securities approximates their fair value. 43 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The fair value of notes is estimated by discounting the future cash flowsusing the current interest rates at which similar loans would be made toborrowers with similar credit ratings and for the same remaining maturities.The carrying values of these obligations approximate their respective fairvalues. The fair value of short-term and long-term capital lease obligations isestimated based on current interest rates available to Extreme for debtinstruments with similar terms, degrees of risk and remaining maturities. Thecarrying values of these obligations approximate their respective fair values. Inventories Inventories are stated at the lower of cost or market (on a first-in, first-out basis) and are comprised substantially of finished goods. Concentration of Credit Risk, Product and Significant Customers and Supplier Information Financial instruments that potentially subject Extreme to concentration ofcredit risk consist principally of marketable investments and accountsreceivable. Extreme has placed its investments with six high-credit qualityissuers with no more than $2 million due from any one issuer. Extreme sells itsproducts primarily to United States corporations in the technology marketplace.Extreme performs ongoing credit evaluations of its customers and generally doesnot require collateral. Credit losses have been immaterial and withinmanagement's expectations. Extreme operates solely within one business segment,the development and marketing of end-to-end LAN switching solutions.Significant customer concentration in the years ended June 30, 1999 and 1998 issummarized below. No other customer accounts for more than 10% of Extreme's netrevenues. Year Ended June 30, ------------- 1999 1998 ----- ----- Customer........................ 3Com.......................... -- 25% Compaq........................ 21% 21% Hitachi Cable................. 13% -- One supplier currently manufacturers all of Extreme's ASICs which are usedin all of Extreme's networking products. Any interruption or delay in thesupply of any of these components, or the inability to procure these componentsfrom alternate sources at acceptable prices and within a reasonable time, wouldmaterially adversely affect Extreme's business, operating results and financialcondition. In addition, qualifying additional suppliers can be time-consumingand expensive and may increase the likelihood of errors. Extreme attempts tomitigate these risks by working closely with its ASIC supplier regardingproduction planning and product introduction timing. Extreme currently derives substantially all of its revenue from sales of twoproduct families. Extreme expects that revenue from these two product familieswill account for a substantial portion of its revenue for the foreseeablefuture. Accordingly, widespread market acceptance of Extreme's product familiesis critical to their future success. Property and Equipment Property and equipment are stated at cost, net of accumulated amortizationand depreciation. Property and equipment are depreciated on a straight-linebasis over the estimated useful lives of the assets of approximately threeyears or the applicable lease term, if shorter. Equipment acquired undercapital lease obligations is amortized over the shorter of the lease term orthe estimated useful lives of the related assets. 44 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Revenue Recognition Extreme generally recognizes product revenue at the time of shipment, unlessExtreme has future obligations for installation or has to obtain customeracceptance in which case revenue is deferred until these obligations are met.Revenue from service obligations is deferred and recognized on a straight-linebasis over the contractual period. Amounts billed in excess of revenuerecognized are included as deferred revenue in the accompanying consolidatedbalance sheets. Extreme has established a program which enables third partyresellers to return up to 15% of their previous month's purchases in exchangefor a purchase order of equal or greater dollar value. The amount of estimatedproduct returns is provided for in the period of the sale. Upon shipment to its customers, Extreme provides for the estimated cost torepair or replace products to be returned under warranty. Extreme's warrantyperiod is typically 12 months from the date of shipment to the end user. Foreign Operations Extreme's foreign offices consist of sales, marketing and support activitiesthrough its foreign subsidiaries and an overseas reseller network. Operatingincome generated by the foreign operations of Extreme and their correspondingidentifiable assets were not material in any period presented. Extreme's export sales represented 53% and 61% of net revenue in 1999 and1998, respectively. All of the export sales to date have been denominated inU.S. dollars and were derived from sales to Europe and Asia. Extreme recordedexport sales over 10% (as a percentage of total net revenue) to the followingcountries: Years Ended June 30, ------------- 1999 1998 ----- ----- United Kingdom....................... 8% 30% Japan................................ 29% 19% All other export sales to countries totaling less than 10% each......... 16% 12% Net Loss Per Share Basic net loss per share and diluted net loss per share are presented inconformity with Financial Accounting Standards Board's ("FASB") Statement ofFinancial Accounting Standards (SFAS) No. 128, "Earnings Per Share," for allperiods presented. 45 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In accordance with SFAS No. 128, basic net loss per share has been computedusing the weighted-average number of shares of common stock outstanding duringthe period, less shares subject to repurchase. Basic and diluted pro forma netloss per share for the two years ended June 30, 1999 and 1998, as presented inthe consolidated statements of operations, has been computed as described aboveand also gives effect to the conversion of the convertible preferred stock(using the if-converted method) from the original date of issuance. Thefollowing table presents the calculation of basic and diluted and pro formabasic and diluted net loss per common share (in thousands, except per sharedata): Years Ended June 30, ------------------- For the Period From May 8, 1996 (Date of Inception) through 1999 1998 June 30, 1997 -------- --------- ------------------- Net loss.............................. $ (1,617) $ (13,936) $(7,923) ======== ========= =======Basic and diluted: Weighted-average shares of common stock outstanding.................. 13,662 11,192 6,468 Less: Weighted-average shares subject to repurchase.............. (4,200) (6,813) (4,710) -------- --------- -------Weighted-average shares used in computing basic and diluted net loss per common share..................... 9,462 4,379 1,758 ======== ========= =======Basic and diluted net loss per common share................................ $ (0.17) $ (3.18) $ (4.51) ======== ========= =======Pro forma: Net loss............................ $ (1,617) $ (13,936) ======== ========= Shares used above................... 9,462 4,379 Pro forma adjustment to reflect weighted effect of assumed conversion of convertible preferred stock.............................. 29,061 27,322 -------- --------- Shares used in computing pro forma basic and diluted net loss per common share (unaudited)........... 38,523 31,701 ======== ========= Pro forma basic and diluted net loss per common share (unaudited).................. $ (.04) $ (.44) ======== ========= Extreme has excluded all convertible preferred stock, warrants forconvertible preferred stock, outstanding stock options and shares subject torepurchase from the calculation of diluted loss per common share because allsuch securities are anti-dilutive for all periods presented. The total numbersof shares excluded from the calculations of diluted net loss per share was37,927,370, 36,082,561 and 30,834,912 for the years ended June 30, 1999, 1998and 1997, respectively. See Note 6 for further information on these securities. Accounting for Stock-Based Compensation Extreme's grants of stock options are for a fixed number of shares toemployees with an exercise price equal to the fair value of the shares at thedate of grant. As permitted under SFAS Statement No. 123, "Accounting forStock-Based Compensation" ("FAS 123"), Extreme accounts for stock option grantsto employees and directors in accordance with APB Opinion No. 25, "Accountingfor Stock Issued to Employees" ("APB 25") and, accordingly, recognizes nocompensation expense for stock option grants with an exercise price equal tothe fair value of the shares at the date of grant. 46 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Recently Issued Accounting Standards In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments ofan Enterprise and Related Information" ("FAS 131") effective for financialstatements for periods beginning after December 15, 1997. FAS 131 establishesstandards for the way that public business enterprises report financial anddescriptive information about reportable operating segments in annual financialstatements and interim financial reports issued to shareholders. FAS 131supersedes SFAS No. 14, "Financial Reporting for Segments of a BusinessEnterprise," but retains the requirement to report information about majorcustomers. Extreme adopted FAS 131 effective for its fiscal year ending June30, 1999. Extreme has determined that it has a single reportable segment.Management uses one measurement of profitability and does not disaggregate itsbusiness for internal reporting. In June 1998, the FASB issued SFAS No. 133, "Accounting for DerivativeInstruments and Hedging Activities" ("FAS 133"). Extreme is required to adoptFAS 133 for the year ending June 30, 2002. FAS 133 establishes methods ofaccounting for derivative financial instruments and hedging activities relatedto those instruments as well as other hedging activities. Because Extremecurrently holds no derivative financial instruments and does not currentlyengage in hedging activities, adoption of FAS 133 is expected to have nomaterial impact on Extreme's financial condition or results of operations. In March 1998, the American Institute of Certified Public Accountants issuedSOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtainedfor Internal Use." SOP 98-1 requires that entities capitalize certain costsrelated to internal use software once certain criteria have been met. Extremeis required to implement SOP 98-1 for the year ending June 30, 2000. Adoptionof SOP 98-1 is expected to have no material impact on Extreme's financialcondition or results of operations. 2. Financial Instruments The following is a summary of available-for-sale securities (in thousands)at June 30, 1999. Amortized cost at June 30, 1998 approximated market value: June 30, 1999 ----------------------------------------- Unrealized Unrealized June Amortized Market Holding Holding 30, Cost Value Gains Losses 1998 --------- --------- ---------- ---------- ------- Money market fund........... $ 2 $ 2 $ -- $ -- $ 99Commercial paper............ 110,265 110,241 -- (24) --U.S. corporate debt securities................. 15,885 15,797 -- (88) 12,410U.S. government agencies.... 300 300 -- -- --Foreign corporate debt securities................. -- -- -- -- 6,938 -------- --------- ----- ------ ------- $126,452 $ 126,340 $ -- $ (112) $19,447 ======== ========= ===== ====== =======Classified as: Cash equivalents.......... $ 93,840 $ 93,821 $ -- $ (19) $ 8,452 Short-term investments.... 16,427 16,422 -- (5) 10,995 Investments............... 16,185 16,097 -- (88) -- -------- --------- ----- ------ ------- $126,452 $ 126,340 $ -- $ (112) $19,447 ======== ========= ===== ====== ======= 47 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 3. Property and Equipment Property and equipment are stated at cost, net of accumulated amortizationand depreciation. Property and equipment are depreciated on a straight-linebasis over the estimated useful lives of the assets of approximately threeyears or the applicable lease term, if shorter. Equipment acquired undercapital lease obligations is amortized over the shorter of the lease term orthe estimated useful lives of the related assets. Property and equipmentconsist of the following (in thousands): June 30, ---------------- 1999 1998 ------- ------- Computer and other related equipment....................... $ 8,661 $ 3,465 Office equipment, furniture and fixtures................... 1,090 522 Software................................................... 3,146 2,106 Leasehold improvements..................................... 1,111 145 ------- ------- 14,008 6,238 Less accumulated depreciation and amortization............. (7,502) (1,769) ------- ------- Property and equipment, net................................ $ 6,506 $ 4,469 ======= ======= Included in property and equipment are assets acquired under capital leaseobligations with a cost and related accumulated amortization of approximately$2,371,000 and $1,494,000, respectively, at June 30, 1999, and approximately$2,093,000 and $490,000, respectively, at June 30, 1998. The amortizationexpense on assets recorded under capital leases is included within depreciationexpense. 4. Notes Payable In October 1996, Extreme entered into a note payable with a bank thatallowed the Company to borrow up to $400,000. Interest was payable monthlybased on an annual rate of 11%. The note was secured by Extreme's assets. Thenote was paid off during the fiscal year ended June 30, 1999. In November 1996, Extreme entered into a $300,000 note payable agreementwith a leasing company. The note accrued interest monthly based on an annualrate of 9%. The note was secured by all of Extreme's fixed assets. The note waspaid off during the fiscal year ended June 30, 1999. In November 1997, Extreme entered into a $2,000,000 note payable with aleasing company. The note accrued interest monthly based on an annual rate of9.75%. The note was secured by all of Extreme's fixed assets. The note was paidoff during the fiscal year ended June 30, 1999. 5. Commitments Extreme had outstanding purchase order commitments for materials ofapproximately $26.4 million and $4.4 million at June 30, 1999 and 1998,respectively. Extreme expects the 1999 purchase orders to be fulfilled and therelated invoices to be paid in fiscal year 2000. Of this amount, the Companyhas accrued and expensed approximately $1.1 million of the outstanding purchaseorder commitments for materials due to obligations to suppliers as of June 30,1999. This expense is included within cost of revenue in the year ended June30, 1999. The Company has entered into capital equipment lease lines of credit for atotal of $6.0 million, of which approximately $4.0 million remains available atJune 30, 1999. These arrangements are secured by the property and equipmentsubject to the leases. Under the terms of these lines of credit, Extreme maynot declare or pay any dividends without prior consent of the lenders. 48 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Extreme has entered into a revolving line of credit for $5.0 million.Borrowings under this line of credit bear interest at the bank's prime rate. AtJune 30, 1999 there were no outstanding borrowings under this line of credit. In February 1999, Extreme agreed to lease 77,000 square feet to house itsprimary facility in Santa Clara, California. The related cost of this lease isapproximately $120,000 per month. The lease expires in December 2002. Extremecommenced occupancy in March 1999. Rent expense was approximately $759,000,$712,000 and $220,000 for the years ended June 30, 1999, 1998 and 1997,respectively. Future payments under all noncancelable leases at June 30, 1999 are asfollows (in thousands): Capital Operating Leases Leases ------- --------- Years ending June 30: 2000....................................................... $ 721 $ 1,241 2001....................................................... 709 1,456 2002....................................................... 387 1,641 2003....................................................... 8 859 ------- -------Total minimum payments....................................... 1,825 $ 5,197 =======Less amount representing interest............................ (177) -------Present value of minimum payments............................ 1,648Less current portion......................................... (1,648) -------Long-term portion............................................ $ -- ======= The Company plans to pay off the capital lease obligations during the fiscalyear ending June 30, 2000 and has therefore classified the total present valueof the minimum payments of capital lease obligations as current at June 30,1999. 6. Stockholders' Equity Common Stock Offering In April 1999, the Company completed an initial public offering of 8,050,000shares of common stock (including the underwriters over-allotment provision) ata price of $17.00 per share. Concurrent with the initial public offering, eachof the 14,579,999 shares of Series A convertible preferred stock outstanding,each of the 8,886,228 shares of Series B convertible preferred stockoutstanding and each of the 5,595,088 shares of Series C convertible preferredstock outstanding were converted into one share of common stock, resulting inan issuance of 29,061,315 shares of common stock. Net proceeds from theoffering were approximately $125.3 million net of offering costs. Convertible Preferred Stock A summary of convertible stock is as follows (in thousands): June 30, 1998 ---------------------------------- Issued and Liquidation Authorized Outstanding Preference ---------- ----------- ----------- Series A........ 15,000 14,580 $ 5,249 Series B........ 9,000 8,886 12,263 Series C........ 5,900 5,595 20,534 ------ ------ -------- 29,900 29,061 $ 38,046 ====== ====== ======== 49 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In May 1996, under a stock purchase agreement, Extreme issued 14,579,999Series A convertible preferred shares at a price of $.333 per share. In May andJune 1997, under a stock purchase agreement, Extreme issued 8,886,228 Series Bconvertible preferred shares at a price of $1.38 per share. In January andMarch of 1998, under a stock purchase agreement, Extreme issued 5,595,088Series C convertible preferred shares at a price of $3.67 per share. Each share of Series A, B, and C convertible preferred stock wasconvertible, at the option of the holder, into one share of common stock,subject to certain provisions. The outstanding shares of convertible preferredstock would automatically convert into common stock either upon the close ofbusiness on the day immediately preceding the closing of an underwritten publicoffering of common stock under the Securities Act of 1933 in which Extremereceives at least $10,000,000 in gross proceeds and the price per share is atleast $5.00, or at the election of the holders of at least a majority of eachseries of the outstanding shares of preferred stock. Series A, B, and C convertible preferred stockholders were entitled toannual noncumulative dividends of $.0267, $.1104, and $.2936, respectively, pershare if and when declared by the board of directors. No dividends weredeclared. All outstanding shares of preferred stock were converted to commonshares in Extreme's Initial Public Offering in April 1999. Concurrent with theinitial public offering, each of the 14,579,999 shares of Series A convertiblepreferred stock outstanding, each of the 8,886,228 shares of Series Bconvertible preferred stock outstanding and each of the 5,595,088 shares ofSeries C convertible preferred stock outstanding were converted into one shareof common stock, resulting in an issuance of 29,061,315 shares of common stock. Preferred Stock The number of shares of preferred stock authorized to be issued is 2,000,000with a par value of $0.001 per share. The preferred stock may be issued fromtime to time in one or more series. The board of directors is authorized toprovide for the rights, preferences and privileges of the shares of each seriesand any qualifications, limitations or restrictions on these shares. As of June30, 1999, no shares of preferred stock had been issued. Common Stock In May 1996, Extreme issued 4,725,000 shares of common stock to founders forcash. The common stock is subject to repurchase until vested; vesting withrespect to 25% occurs on the first anniversary of the issuance date, with thebalance vesting ratably over a period of three years as specified in thepurchase agreements. At June 30, 1999 and 1998, approximately 591,000 and1,772,000 shares, respectively, were subject to repurchase at their originalissuance price. Warrants In November 1996, Extreme issued warrants to a lease financing company topurchase 210,000 shares of Series A convertible preferred stock with anexercise price of $.33 per share, in consideration for equipment leases and aloan. In July 1997, Extreme issued warrants to the same lease financing companyto purchase 48,347 shares of Series B convertible preferred stock with anexercise price of $1.38 per share, in consideration for equipment leases.Concurrent with the initial public offering, these warrants converted into theright to purchase equivalent number of shares of common stock at the sameexercise price per share. The warrants may be exercised at any time within aperiod of (i) 10 years or (ii) 5 years from the effective date of the initialpublic offering, whichever is longer. In May 1999, 147,000 of these warrantswere exercised. 50 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In November 1997, the Company issued warrants to a lease financing companyto purchase 79,051 shares of Series C convertible preferred stock with anexercise price of $2.53, in consideration for a loan. Concurrent with theinitial public offering, these warrants converted into the right to purchaseequivalent number of shares of common stock at the same exercise price pershare. The warrants may be exercised at any time within a period which expiresthe sooner of (i) 10 years or (ii) 3 years from the effective date of theinitial public offering. In June 1999, Extreme issued fully vested and exercisable warrants to acustomer to purchase 40,000 shares of the Company's common stock with anexercise price of $58.063 per share. The value of these warrants wasapproximately $948,000. This value was expensed in fiscal 1999 as the warrantswere issued in exchange for services rendered. Deferred Stock Compensation During the year ended June 30, 1998, in connection with the grant of certainstock options to employees, Extreme recorded deferred stock compensation of$437,000 representing the difference between the exercise price and the deemedfair value of Extreme's common stock on the date such stock options weregranted. Such amount is included as a reduction of stockholders' equity and isbeing amortized by charges to operations on a graded vesting method. Extremerecorded amortization of deferred stock compensation expense of approximately$172,000 and $68,000 for the years ended June 30, 1999 and 1998, respectively.At June 30, 1999, Extreme had a total of approximately $197,000 remaining to beamortized over the corresponding vesting period of each respective option,generally four years. The amortization expense relates to options awarded toemployees in all operating expense categories. Amended 1996 Stock Option Plan In January 1999, the board of directors approved an amendment to the 1996Stock Option Plan (the "Plan") to (i) increase the share reserve by 5,000,000shares, (ii) to remove certain provisions which are required to be in optionplans maintained by California privately-held companies and (iii) to rename thePlan as the "Amended 1996 Stock Option Plan." Under the Plan, which was adopted in September 1996, options may be grantedfor common stock, pursuant to actions by the board of directors, to eligibleparticipants. A total of 17,014,309 shares have been reserved under the Plan.Options granted are exercisable as determined by the board of directors.Options vest over a period of time as determined by the board of directors,generally four years. The term of the Plan is ten years. Options to purchaseapproximately 2,327,779 and 4,297,346 shares of common stock have beenexercised as of June 30, 1999 and 1998, respectively, but are subject torepurchase until vested. As of June 30, 1999, 5,433,217 shares were availablefor future grant under the Plan. 51 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table summarizes stock options activity: Weighted-Average Number of Exercise Price Shares Per Share ---------- ---------------- Granted........................................... 7,150,500 $ .03 Exercised......................................... (5,409,750) $ .02 Canceled.......................................... (165,000) $ .03 ---------- -------Options outstanding at June 30, 1997............... 1,575,750 $ .05 Granted........................................... 1,771,460 $ 1.29 Exercised......................................... (724,775) $ .21 Canceled.......................................... (18,500) $ .35 ---------- -------Options outstanding at June 30, 1998............... 2,603,935 $ .84 Granted........................................... 2,937,758 $ 10.09 Exercised......................................... (567,800) $ 1.86 Canceled.......................................... (95,126) $ 6.68 ---------- -------Options outstanding at June 30, 1999............... 4,878,767 $ 6.08 ========== ======= Options to purchase 4,684,017, 2,603,935 and 1,575,750 shares wereexercisable at June 30, 1999, 1998 and 1997, respectively, with a weighted-average exercise price of $4.44, $0.84 and $0.05, respectively. 1999 Employee Stock Purchase Plan In January 1999, the board of directors approved the adoption of Extreme's1999 Employee Stock Purchase Plan (the "1999 Purchase Plan"). A total of1,000,000 shares of common stock has been reserved for issuance under the 1999Purchase Plan. The 1999 Purchase Plan permits eligible employees to acquireshares of Extreme's common stock through periodic payroll deductions of up to15% of total compensation. No more than 625 shares may be purchased on anypurchase date per employee. Each offering period will have a maximum durationof 12 months. The price at which the common stock may be purchased is 85% ofthe lesser of the fair market value of Extreme's common stock on the first dayof the applicable offering period or on the last day of the respective purchaseperiod. The initial offering period commenced on the effectiveness of theinitial public offering and will end on April 30, 2000. Stock-Based Compensation The Company has elected to continue to follow APB 25 and relatedinterpretations in accounting for its employee and director stock-basedcompensation plans. Because the exercise price of Extreme's employee stockoptions equals the market price of the underlying stock on the date of grant,no compensation expense was recognized. Pro forma information regarding net income has been determined as if Extremehad accounted for its stock-based awards to employees under the fair valuemethod prescribed by FAS 123. The resulting effect on pro forma net incomedisclosed is not likely to be representative of the effects on net income on apro forma basis in future years, due to subsequent years including additionalgrants and years of vesting. 52 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table summarizes significant ranges of outstanding andexercisable options at June 30, 1999: Options Outstanding Options Exercisable -------------------------------------- ------------------------ Weighted- Average Weighted- Weighted- Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price -------- ----------- ----------- --------- ----------- --------- (In years) $ 0.02-- 0.40 1,263,179 7.14 $ 0.07 1,263,179 $ 0.07$ 0.60-- 5.75 1,883,799 8.90 $ 3.76 1,883,799 $ 3.76$ 6.50--10.00 1,528,039 9.37 $ 8.79 1,521,039 $ 8.79$14.00--58.06 203,750 9.93 $44.40 16,000 $15.50------------- --------- ---------$ 0.02--58.06 4,878,767 8.63 $ 6.08 4,684,017 $ 4.44============= ========= ========= Prior to the Company's initial public offering, the fair value of eachoption grant was determined on the date of grant using the minimum valuemethod. Subsequent to the offering, the fair value of the Company's stock-basedawards to employees was estimated using the Black-Scholes option pricing model.Except for the volatility assumption which was only used under the Black-Scholes model, the following weighted-average assumptions were used to performthe calculations: Stock Option Plan Employee Stock Option Plan ----------------------------------------- ----------------------------------------- For the Period From For the Period From May 8, 1996 May 8, 1996 (Date of Inception) (Date of Inception) Years Ended June 30, through Years Ended June 30, through --------------------- ------------------- -------------------- ------------------- 1999 1998 June 30, 1997 1999 1998 June 30, 1997 ---------- ---------- ------------------- ------------ ------- ------------------- Expected life........... 3.5 yrs 6.0 yrs 6.0 yrs 0.7 yrs. -- --Volatility.............. 55% 0% 0% 55% -- --Risk-free interest rate................... 5.1% 6.0% 6.7% 5.0% -- --Dividend yield.......... 0% 0% 0% 0% -- -- The weighted-average estimated fair value of options granted in the yearsended June 30, 1999, 1998 and 1997 was $4.41, $0.37 and $0.01, respectively.The weighted-average estimated fair value of shares granted under the 1999Purchase Plan in the year ended June 30, 1999 was $5.61. For purposes of pro forma disclosures, the estimated fair value of optionsis amortized to pro forma expense over the options' vesting period. Pro formainformation follows (in thousands, except per share amounts): For the Period From Years Ended June May 8, 1996 30, (Date of Inception) ----------------- through 1999 1998 June 30, 1997 ------- -------- ------------------- Pro forma net loss under FAS 123....... $(4,066) $(14,053) $(7,935)Net loss per common share--pro forma under FAS 123: Basic and diluted.................... $ (0.43) $ (3.21) 53 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 7. Income Taxes The provision for income taxes consists of the following (in thousands): June 30, 1999 ------------- Current provision: Federal........................................................ $ 350 State.......................................................... 200 Foreign........................................................ 1,100 ------Total current provision.......................................... $1,650 ====== The difference between the provision for income taxes and the amountcomputed by applying the Federal statutory income tax rate (35 percent) toincome before taxes is explained below (in thousands): For the Period From May 8, 1996 Years Ended June 30, (Date of Inception) --------------------- through 1999 1998 June 30, 1997 ---------- ---------- ------------------- Tax at federal statutory rate (benefit)......................... $ 11 $ (4,878) $(2,773)State income tax................... 200 -- --Federal alternative minimum taxes.. 350 -- --Foreign taxes...................... 1,100 -- --Unutilized (utilized) net operating losses............................ (11) 4,878 2,773 --------- ---------- ------- Total............................ $ 1,650 $ -- $ -- ========= ========== ======= Significant components of the Company's deferred tax assets are as follows(in thousands): Years Ended June 30, ---------------------- 1999 1998 ---------- ---------- Deferred tax assets: Net operating loss carryforwards................ $ 1,647 $ 7,448 Tax credit carryforwards........................ 2,238 1,139 Bad debt reserve................................ 801 177 Other reserves and accruals..................... 3,866 807 ---------- ---------- Total deferred tax assets......................... 8,552 9,571 Valuation allowance............................... (8,552) (9,571) ---------- ---------- Net deferred tax assets........................... $ -- $ -- ========== ========== FASB Statement No. 109 provides for the recognition of deferred tax assetsif realization of such assets is more likely than not. Based upon the weight ofavailable evidence, which includes the Company's historical operatingperformance and the reported cumulative net losses in all prior years, theCompany has provided a full valuation allowance against its net deferred taxassets. The Company will continue to evaluate the realizability of the deferredtax assets on a quarterly basis. The net valuation allowance decreased by $ 1,019,000 during the year endedJune 30, 1999 and increased by $6,242,000 during the year ended June 30, 1998. 54 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) As of June 30, 1999, the Company had net operating loss carryforwards forfederal and state tax purposes of approximately $4,100,000 and $3,900,000,respectively. The Company also had federal and state research and developmenttax credit carryforwards of approximately $1,202,000 and $918,000,respectively. The federal and state net operating loss carryforwards willexpire at various dates beginning in 2004 through 2019, if not utilized. Utilization of the net operating losses and tax credits may be subject to asubstantial annual limitation due to the ownership change limitations providedby the Internal Revenue Code of 1986 and similar state provisions. The annuallimitation may result in the expiration of net operating losses and taxcredits before utilization. 8. Comprehensive Income (Loss) Extreme adopted SFAS No. 130, "Reporting Comprehensive Income" at December31, 1998. SFAS 130 establishes new rules for the reporting and display ofcomprehensive income and its components; however, the adoption of theStatement had no impact on the Company's net income (loss) or stockholders'equity. SFAS 130 requires unrealized gains or losses on the Company'savailable-for-sale securities and foreign currency translation adjustments tobe included in other comprehensive income. Prior to adoption of SFAS 130, theCompany had no unrealized gains or losses on available-for-sale securities orforeign currency translation adjustments. The following are the components of accumulated other comprehensive loss,net of tax (in thousands): For the Period From Years Ended May 8, 1996 June 30, (Date of Inception) ------------- through 1999 1998 June 30, 1997 ------ ----- ------------------- Unrealized gain (loss) on investments........ $ (112) $ -- $ --Foreign currency translation adjustments..... (6) -- -- ------ ----- ----- Accumulated other comprehensive loss........ $ (118) $ -- $ -- ====== ===== ===== The following schedule of other comprehensive income (loss) shows the grosscurrent-period gain (loss) and the reclassification adjustment (in thousands): For the Period From Years Ended May 8, 1996 June 30, (Date of Inception) ------------- through 1999 1998 June 30, 1997 ------ ----- ------------------- Unrealized gain (loss) on investments: Unrealized gain (loss) on available-for-sale securities.................................. $ (112) $ -- $ -- Less: reclassification adjustment for gain (loss) realized in net loss................. -- -- -- ------ ----- -----Net unrealized gain (loss) on investments..... (112) -- --Foreign currency translation adjustments...... (6) -- -- ------ ----- -----Other comprehensive income (loss)............. $ (118) $ -- $ -- ====== ===== ===== 9. 401(k) Plan Extreme provides a tax-qualified employee savings and retirement plan,commonly known as a 401(k) plan, which covers our eligible employees. Pursuantto the 401(k) plan, employees may elect to reduce their current annualcompensation up to the lesser of 20% or the statutorily prescribed limit,which is $10,000 in calendar year 1999, and have the amount of the reductioncontributed to the 401(k) plan. 55 Item 9. Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure. None. PART III Certain information required by Part III is incorporated by reference fromthe Company's definitive Proxy Statement to be filed with the Securities andExchange Commission in connection with the solicitation of proxies for theCompany's 1999 Annual Meeting of Stockholders (the "Proxy Statement"). Item 10. Directors and Executive Officers of the Registrant. The information required by this section is incorporated by reference fromthe information in the section entitled "Proposal 1-Election of Directors" inthe Proxy Statement. The required information concerning executive officers ofthe Company is contained in the section entitled "Executive Officers of theRegistrant" in Part I of this Form 10-K. Item 405 of Regulation S-K calls for disclosure of any known late filing orfailure by an insider to file a report required by Section 16 of the ExchangeAct. This disclosure is contained in the section entitled "Section 16(a)Beneficial Ownership Reporting Compliance" in the Proxy Statement and isincorporated herein by reference. Item 11. Executive Compensation. The information required by this section is incorporated by reference fromthe information in the sections entitled "Proposal 1-Election of Directors --Directors' Compensation", "Executive Compensation" and "Stock Price PerformanceGraph" in the Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required by this section is incorporated by reference fromthe information in the section entitled "Proposal 1- Election of Directors-Security Ownership of Certain Beneficial Owners and Management" in the ProxyStatement. Item 13. Certain Relationships and Related Transactions. Not applicable. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) The following documents are filed as a part of this Form 10-K: (1) Financial Statements: Reference is made to the Index to Consolidated Financial Statements of Extreme Networks, Inc. under Item 8 in Part II of this Form 10-K. 56 (2) Financial Statement Schedules: The following financial statement schedule of Extreme Networks, Inc. for the period from inception, May 8, 1996 to June 30, 1997 and for the years ended June 30, 1999 and 1998 is filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Extreme Networks, Inc. Reference Page --------- Schedule II--Valuation and Qualifying Accounts................... 58 All other schedules are omitted because they are not applicable or therequired information is shown in the financial statements or notes thereto. (3) Exhibits: The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K has been identified. Exhibit Number Notes Description of Document ------- ----- ----------------------- 2.1 (1) Form of Agreement and Plan of Merger between Extreme Networks, a California corporation, and Extreme Networks, Inc., a Delaware corporation. Certificate of Incorporation of Extreme Networks, Inc., a 3.1 (1) Delaware Corporation. 3.2 (1) Form of Amended and Restated Bylaws of Extreme Networks, Inc., a Delaware Corporation. 4.1 (1) Second Amended and Restated Rights Agreement dated January 12, 1998 between Extreme Network and certain stockholders. 10.1 (1) Form of Indemnification Agreement for directors and officers. Amended 1996 Stock Option Plan and forms of agreements 10.2 (1) thereunder. 10.3 (1) 1999 Employee Stock Purchase Plan. 10.4 (1) Sublease, dated June 5, 1997 between NetManage, Inc. and Extreme Networks, Inc., a California corporation, to Master Lease, dated September 30, 1994, between Cupertino Industrial Associates and NetManage, Inc. 10.5 (1) Sublease, dated January 1, 1999 between Apple Computer, Inc., a California corporation, and Extreme Networks, Inc., a California corporation, to Lease Agreement, as amended. 21.1 Subsidiaries of Registrant. 23.1 Consent of Ernst and Young LLP, Independent Auditors. 24.1 Power of Attorney (see page 59 of this Form 10-K). 27.1 Financial Data Schedule (available in EDGAR format only).--------* Indicates management contract or compensatory plan or arrangement.(1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 (File No. 333-71921). (b) Reports on Form 8-K: No reports on form 8-K were filed by the Company during the three months ended June 30, 1999. 57 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS THE PERIOD FROM INCEPTION, MAY 8, 1996 TO JUNE 30, 1997 AND THE YEARS ENDED JUNE 30, 1999 AND 1998 (In thousands) Charged Balance to Reversals Balance at costs to costs at beginning and and end of Description of period expenses expenses (Deductions) period ----------- --------- -------- --------- ------------ ------- Allowance for doubtful accounts 1999...................... $433 $1,364 $ -- $ (423) $1,374 1998...................... -- 470 -- (37) 433 1997...................... -- -- -- -- -- 58 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized, on September 24,1999. EXTREME NETWORKS, INC. (Registrant) /s/ Gordon L. Stitt By: _________________________________ Gordon L. Stitt President Chief Executive Officer Chairman of the Board September 24, 1999 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appearsbelow constitutes and appoints Gordon L. Stitt and Vito E. Palermo, and each ofthem, his or her true and lawful attorneys-in-fact, each with full power ofsubstitution, for him or her in any and all capacities, to sign any amendmentsto this report on Form 10-K and to file the same, with exhibits thereto andother documents in connection therewith, with the Securities and ExchangeCommission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtuehereof. Pursuant to the requirements of the Securities Exchange Act of 1934, thisreport has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the date indicated: Signature Title Date --------- ----- ---- /s/ Gordon L. Stitt President, Chief Executive September 24, 1999____________________________________ Officer Chairman of the Gordon L. Stitt Board /s/ Vito E. Palermo Vice President & Chief September 24, 1999____________________________________ Financial Officer Vito E. Palermo (Principal Financial and Accounting Officer) /s/ Charles Carinalli Director September 24, 1999____________________________________ Charles Carinalli /s/ Promod Haque Director September 24, 1999____________________________________ Promod Haque /s/ Lawrence K. Orr Director September 24, 1999____________________________________ Lawrence K. Orr /s/ Peter Wolken Director September 24, 1999____________________________________ Peter Wolken 59 EXHIBIT INDEX Exhibit Number Notes Description of Document ------- ----- ----------------------- 2.1 (1) Form of Agreement and Plan of Merger between Extreme Networks, a California corporation, and Extreme Networks, Inc., a Delaware corporation. Certificate of Incorporation of Extreme Networks, Inc., a 3.1 (1) Delaware Corporation. 3.2 (1) Form of Certificate of Amendment of Certificate of Incorporation of Extreme Networks, Inc., a Delaware Corporation. 3.3 (1) Form of Amended and Restated Bylaws of Extreme Networks, Inc., a Delaware Corporation. 4.1 (1) Second Amended and Restated Rights Agreement dated January 12, 1998 between Extreme Network and certain stockholders. 10.1 (1) Form of Indemnification Agreement for directors and officers. Amended 1996 Stock Option Plan and forms of agreements 10.2 (1) thereunder. 10.3 (1) 1999 Employee Stock Purchase Plan. 10.4 (1) Sublease, dated June 5, 1997 between NetManage, Inc. and Extreme Networks, Inc., a California corporation, to Master Lease, dated September 30, 1994, between Cupertino Industrial Associates and NetManage, Inc. 10.5 (1) Sublease, dated January 1, 1999 between Apple Computer, Inc., a California corporation, and Extreme Networks, Inc., a California corporation, to Lease Agreement, as amended. 21.1 Subsidiaries of Registrant. 23.1 Consent of Ernst and Young LLP, Independent Auditors. 24.1 Power of Attorney (see page 59 of this Form 10-K). 27.1 Financial Data Schedule (available in EDGAR format only).--------* Indicates management contract or compensatory plan or arrangement.(1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 (File No. 333-71921). 60 EXHIBIT 21.1 ------------ SUBSIDIARIES OF REGISTRANT --------------------------NAME LOCATION---- --------Extreme Networks International Cayman IslandsExtreme Networks Japan K.K. JapanExtreme Networks Hong Kong Limited Hong KongExtreme Networks IHC, Inc. DelawareExtreme Networks FSC, Inc. BarbadosExtreme Networks UK Limited United Kingdom EXHIBIT 23.1 ------------ Consent of Ernst & Young LLP, Independent Auditors --------------------------------------------------We consent to the incorporation by reference in the Registration Statement (FormS-8) pertaining to the Extreme Networks, Inc. Amended 1996 Stock Option Plan,1999 Employee Stock Purchase Plan and an Individual Stock Option Agreement ofour report dated July 20, 1999, with respect to the consolidated financialstatements and schedule of Extreme Networks, Inc. included in the Annual Report(Form 10-K) for the year ended June 30, 1999.Palo Alto, California /s/ Ernst & Young LLPSeptember 23, 1999

5 1,000 YEAR JUN-30-1999 JUL-01-1998 JUN-30-1999 107,143 16,422 20,797 1,374 2,626 1,978 14,008 7,502 171,803 29,927 0 0 0 49 141,827 171,803 98,026 98,026 48,520 48,520 50,951 0 398 33 1,650 (1,617) 0 0 0 (1,617) (.17) (.17)

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Extreme Networks Annual Report 1999

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Extreme Networks
Annual Report 1999