Extreme Networks
Annual Report 2001

Plain-text annual report

---------------------------------------------------------------------------------------------------------------------------------------------------------------- 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 July 1, 2001 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission file number 0-25711 ----------------- Extreme Networks, Inc. (Exact name of Registrant as specified in its charter) Delaware 77-0430270 (State or other (I.R.S. Employer jurisdiction Identification No.) of incorporation or organization) 3585 Monroe Street 95051 Santa Clara, California (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (408) 579-2800 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock, $.001 par value ----------------- Indicate by check mark whether the Registrant (1) has filed all 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 $1,728,241,385 as of September 6, 2001, based uponthe closing price on the Nasdaq National Market reported for such date. Thiscalculation does not reflect a determination that certain persons areaffiliates of the Registrant for any other purpose. 113,924,943 shares of the Registrant's Common stock, $.001 par value, wereoutstanding September 6, 2001. DOCUMENTS INCORPORATED BY REFERENCE The information called for by Part III is incorporated by reference tospecified portions of the Registrant's Definitive Proxy Statement to be issuedin conjunction with the Registrant's 2001 Annual Meeting of Stockholders, whichis expected to be filed not later than 120 days after the Registrant's fiscalyear ended July 1, 2001.---------------------------------------------------------------------------------------------------------------------------------------------------------------- EXTREME NETWORKS, INC. FORM 10-K INDEX Page ---- PART IItem 1. Business................................................................................ 3Item 2. Properties.............................................................................. 19Item 3. Legal Proceedings....................................................................... 19Item 4. Submission of Matters to a Vote of Security Holders..................................... 20 PART IIItem 5. Market for Registrant's Common Equity and Related Stockholder Matters................... 22Item 6. Selected Consolidated Financial Data.................................................... 22Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations... 23Item 7A. Quantitative and Qualitative Disclosures About Market Risk.............................. 40Item 8. Financial Statements and Supplementary Data............................................. 42Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.... 68 PART IIIItem 10. Directors and Executive Officers of the Registrant...................................... 69Item 11. Executive Compensation.................................................................. 69Item 12. Security Ownership of Certain Beneficial Owners and Management.......................... 69Item 13. Certain Relationships and Related Transactions.......................................... 69 PART IVItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................... 69SIGNATURES....................................................................................... 74 2 PART I FORWARD LOOKING STATEMENTS This Annual Report on Form 10-K contains forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21E of theSecurities Act of 1934. These include forward-looking statements concerningexpected changes in expense levels, the availability of products from suppliersand contract manufacturers, product costs and sales prices, liquidity andsimilar language based on the expectations of our management as of the date ofthis filing. However, there may be events in the future that we are not able toaccurately predict or over which we have no control. We caution investors thatactual results may differ materially from those projected in theforward-looking statements as a result of certain risk factors identified inthis Form 10-K and other filings we have made with the Securities and ExchangeCommission. More information about potential factors that could affect ourbusiness and financial results is set forth under "Risk Factors" and"Management's Discussion and Analysis of Financial Condition and Results ofOperations."Item 1. BusinessOverview Extreme Networks, Inc., together with its subsidiaries, (collectivelyreferred to as Extreme or the Company and as we, us, and our) is a leadingprovider of network infrastructure equipment for business applications andservices. We were established in 1996 to address the issues caused by slow andexpensive networks. We set out to change the industry by replacing complexsoftware-based routers with simple, fast, highly intelligent, hardware-basedswitches. The acceptance of this innovative, simplified approach to networkinghas enabled us to become an industry leader. Our goal is to realize ourcorporate vision of Ethernet Everywhere - a unifying network strategy that usesproven Ethernet technology to simplify each element of the network.Accordingly, our strategy is to lay the foundation for a future of easilydeployable, highly scalable, ubiquitous bandwidth for networks, applicationsand users. Our Ethernet Everywhere switching products provide significant performanceincreases compared to legacy infrastructures, while allowing greater networkflexibility and scalability, ease of use and lower cost of ownership thancompetitive products. We have achieved these advantages primarily by using application specificintegrated circuits, or ASICs, in our products and creating designs that arecommon and uniform across our product lines. In our products, the routing ofnetwork traffic, a function referred to as Layer 3 switching, is done primarilywith ASICs. ASICs generally provide faster processing of data than the softwareimplementations used in many competing products and are more cost-effective,resulting in a higher return on investment. Traditional Layer 3 products route traffic primarily through the use ofsoftware. This method is much slower than routing with ASICs, and is lessdependable in message packet delivery because slow traffic speeds can result inmessage packets being lost when network traffic is high. Our productsincorporate an ASIC-based, wire-speed architecture and are designed to avoidthe loss of message packets in the switch. As a result, we are able to offerour products at a lower cost than software-based alternatives while improvingperformance throughout the network.Industry Background Businesses and other organizations have become increasingly dependent on theInternet as their central communications infrastructure to provide connectivityfor internal and external communications. New computing applications, such asenterprise resource planning, large enterprise databases and sophisticatedonline connections with vendors, as well as the increased use of traditionalapplications, such as e-mail and streaming 3media, require significant information technology resources. The emergence ofthe desktop browser as a user interface has enabled bandwidth-intensiveapplications that contain voice, video and graphics to be used extensivelythrough intranets and externally through extranets. These new applications,combined with the growth in e-commerce and online transactions, such as mobilecommunications and application service providers, demand a fast, flexible, andscalable network infrastructure. Networking environments can be segmented into Local Area Networks, or LANs,Wide Area Networks, or WANs, and Metropolitan Area Networks, or MANs. LANs. LANs are traditional networks designed for client/server applicationswithin a confined geographical area, such as a building or a campus. The LANconsists of servers, clients, a networking operating system, and acommunications link. In the past, LAN traffic patterns were predictable and traffic loads wererelatively stable. The majority of traffic would remain within a givenworkgroup, with only a small percentage traveling across the high trafficportion of a LAN. With the increased use of data-intensive, mission-criticalapplications, the widespread implementation of intranets and extranets, and thewidespread use of Internet technologies, LAN traffic has become highlyunpredictable. In addition, users within a LAN have full access to theInternet, downloading significant amounts of information from servers locatedinside and outside the organization with a much higher percentage of trafficcrossing the LAN backbone. The LAN market consists primarily of large and medium-sized enterprisecustomers. WANs. WANs are communication networks that span across large geographicareas, such as counties, states or countries. Recent technology developments such as very high-bit-rate digital subscriberlines, or VDSL, extend the reach of Ethernet WANs beyond current optical-basednetwork infrastructures, into areas where only voice-grade wiring exists. Theaddition of WAN support to ASIC-based network switches permits Ethernetservices to reach customers where only a limited fiber infrastructure isavailable. The WAN market includes building local exchange carriers, multipletenant/dwelling unit service providers, and Internet Service Providers, orISPs, as primary customers, though an enterprise may also utilize a privateWAN. MANs. MANs are networks that link metropolitan geographic areas such as acity or an entire metropolitan area. Owing to the availability and deployment of Gigabit Ethernet, LANs haveachieved geometric growth in bandwidth. The bandwidth in WANs has also grown,based on technology designed to accommodate the rapid annual growth in Internettraffic. The MAN is the key link between the LAN and the WAN. Over the last couple of years, MANs have emerged as a critical anddynamically evolving arena within the overall network infrastructure. Inaddition to the rising traffic demands, the underlying network architectures,protocols and technologies are also experiencing rapid change. The emergence ofwavelength division multiplexing, the rise of higher speed optical connections,and the drive toward voice and data convergence are all combining to imposelimits on the ability of existing network architectures to meet the need forincreased capacity. In addition, the competitive landscape for MAN serviceproviders is shifting, with the influx of new classes of carriers who do notnecessarily depend upon existing infrastructure, such as Synchronous OpticalNetwork/Synchronous Digital Hierarchy, or SONET/SDH. 4 The MAN market includes metropolitan service providers, in addition tomunicipalities that utilize the network to connect locations, such as CityHall, the fire department, road and vehicle maintenance facilities, hospitalsand emergency centers, social services, and public libraries. A network must be scalable in the following four dimensions: Speed. Speed refers to the number of bits per second that can be transmitted across the network. Today's network applications increasingly require speeds of up to 100 Mbps to the desktop. Therefore, the backbone and server connections that aggregate traffic from desktops require speeds in excess of 100 Mbps. Wire-speed refers to the ability of a network device to process an incoming data stream at the highest possible rate without loss of packets. Wire-speed routing refers to the ability to perform Layer 3 switching at the maximum possible rate. Bandwidth. Bandwidth refers to the volume of traffic that a network or a network device can handle before traffic is "blocked," or unable to get through without interruption. When traffic was more predictable, the amount of traffic across a network link or through a network device grew in line with the number of users on the network. With today's data-intensive applications accessed in random patterns from within and outside of the network, users can spike traffic unpredictably, consuming significant bandwidth to the detriment of other users. Network size. Network size refers to the number of users and servers that are connected to a network. Today's networks must be capable of connecting and supporting tens of thousands of users and servers while providing performance and reliable connectivity. Quality of service. Quality of service refers to the ability to control the delivery of traffic based upon its level of importance. Mission-critical enterprise and delay-sensitive multimedia applications require specific performance minimums, while traffic such as general e-mail and Internet surfing may not be as critical. In addition to basic standards-based prioritization of traffic according to importance, true quality of service would allocate bandwidth to specified applications. Opportunity for Next Generation Switching Solutions The emergence of several technology trends is enabling a new generation ofnetworking equipment that can meet the four scalability dimensions required bytoday's enterprises and service providers by accommodating new unpredictabletraffic patterns and bandwidth-intensive, mission-critical applications. While many different technologies have been deployed in existing LANs,Ethernet has become the predominant LAN technology, with over 99% of the marketin 2000 and total shipments of over 700 million ports over the precedingten-year period, according to the Dell'Oro Group, an independent researchorganization. Ethernet has evolved from the original 10 Mbps Ethernet to 100Mbps Fast Ethernet and, in 1998, to 1,000 Mbps Gigabit Ethernet. Today, GigabitEthernet and 10 Gigabit Ethernet represent a viable network backbone protocol,enabling broadband connections to be aggregated for network backbone transportacross the metropolitan core. With the widespread adoption of Ethernet and Internet Protocol, or IP,technologies, the need to support a multi-protocol environment is diminished.As a result, the simplified routing functionality can be embedded in ASICs,instead of in the software and CPUs used in multi-protocol software-basedrouters. The resulting device, called a Layer 3 switch, functions as a lessexpensive and significantly faster hardware-based router. Layer 3 switches canoperate at multi-gigabit speeds and, as hardware routers, can support largenetworks. However, most Layer 3 switches still block traffic in highutilization scenarios and can only support standards-based trafficprioritization quality of service. While Layer 3 switching dramaticallyincreases network performance, many other products fail to realize thepotential of this technology because of the use of inconsistent hardware,software and management architectures. 5 To effectively address the needs of today's enterprises and serviceproviders, the network industry needs a solution that must be easy to use andimplement and is scalable in terms of speed, bandwidth, network size andquality of service. Layer 3 switching represents the next critical step inaddressing these requirements. Customers need a Layer 3 solution that providessufficient speed and bandwidth to support unpredictable traffic spikes withoutimpacting all other users connected to the network. In addition, customersrequire a quality of service solution that supports industry-standardprioritization and enables network administrators to offer quality of servicethat maps business processes and network policies. Finally, to simplify theirnetworks, customers need a family of interoperable devices that utilize aconsistent hardware, software and management architecture. Through anintegrated family of products, network managers can effectively deploy thesolution at any point in the network and follow a migration path to a networkimplemented with a consistent architecture.The Extreme Networks Solution We provide Ethernet networking solutions that meet these requirements of theenterprise networkers and service providers by providing increased performance,scalability, policy-based quality of service, ease of use and lower cost ofownership. Our products share a common set of ASICs, software and networkmanagement architecture, enabling Layer 3 switching at wire-speed in each majorarea of the network. In addition, ISPs and content providers can use theseproducts for their web-hosting and server co-location operations. Our productsare based on industry standard routing and network management protocols thatare interoperable with existing network infrastructures. We offer policy-basedquality of service that controls the delivery of network traffic according topre-set policies that specify priority and bandwidth limits. All of ourswitches can be managed from any browser-equipped desktop. The key benefits of our solutions are: Simplicity. Networks typically consist of many different technologies and equipment. This complexity often makes it expensive and difficult to effectively manage and scale networks. We attempt to meet these challenges by focusing on product consistency and simplicity. Our products share a common ASIC, software and network management architecture and offer consistent features for each of the key areas of the network. This allows customers to build a consistent network that shares a common set of features, performance and management capabilities. Ease of use and implementation. Our products are designed to make networks easy to manage and administer, thereby reducing the overall cost of network ownership. Through the use of a standards-based design approach, our products can readily be integrated into existing networks. Customers can usually upgrade with our products without the need for additional training. Moreover, our proprietary ExtremeWare software simplifies network management by enabling customers to manage any of our products remotely through a browser interface. High performance. Our products provide broadband Ethernet and IP services together with the non-blocking, wire-speed routing of our ASIC-based Layer 3 switching. Using our products, customers may achieve forwarding rates that are significantly faster than with software-based routers. Scalability. Our solutions offer customers the speed and bandwidth needed today with the capability to scale their networks to support demanding applications in the future without the burden of additional training or software or system complexity. Customers who purchase our products may upgrade to advanced Layer 3 and Layer 4 ~ Layer 7 capability because this functionality is designed into our ASICs. Quality of service. Our policy-based quality of service enables customers to prioritize mission-critical applications by providing industry-leading tools for allocating network resources to specific applications. With our policy-based quality of service, customers can use a web-based interface to identify and control 6 the delivery of traffic from specific applications in accordance with specific policies that are set by the customer. The quality of service functionality of our ASICs allows our policy-based quality of service to be performed at wire-speed. In addition to providing priority, customers can allocate specified amounts of bandwidth to specific applications or users. Lower cost of ownership. Our products are less expensive than software-based routers, yet offer higher routing performance. We believe that by sharing a common hardware, software and management architecture, our products can substantially reduce the cost and complexity of network management and administration. This uniform architecture creates a simpler network infrastructure that leverages the knowledge and resources businesses have invested in Ethernet and Internet Protocol, or IP-based networks, thereby requiring fewer resources and less time to maintain.The Extreme Networks Strategy Extreme's objective is to be the leading provider of the most effectivenetwork infrastructure for business applications and services. The key elementsof our strategy include: Provide simple, easy to use, high-performance, cost-effective switching solutions. We offer customers easy to use, powerful, cost-effective switching solutions that meet the specific demands of switching environments in enterprise LANs, ISPs and content providers. Our products provide customers with Gigabit Ethernet and the wire-speed, non-blocking routing capabilities of ASIC-based Layer 3 switching. We intend to capitalize on our expertise in Ethernet, IP, and switching technologies to develop new products based on our common architecture that meet the future requirements of the enterprise service providers. These products will offer higher performance with more advanced functionality and features while continuing to reduce total cost of ownership for our customers. Expand market penetration. We are focused on product sales to new customers across market segments, including ISPs, content providers and MANs, and on extending our product penetration within existing customers' networks. Once a customer deploys our products in one area of its network, our strategy is then to offer products to the customer for other areas. As additional products are purchased, customers obtain the increased benefits of our solution by simplifying their networks, extending policy-based quality of service and reducing costs of ownership while increasing performance. Extend switching technology leadership. Our technological leadership is based on our custom ASICs and software and includes our wire-speed, Layer 3 switching, policy-based quality of service, routing protocols and ExtremeWare software. We intend to invest our engineering resources in ASIC and other development areas and provide leading-edge technologies to increase the performance and functionality of our products. We also intend to maintain our active role in industry standards committees such as the Institute for Electrical and Electronics Engineers, or IEEE, and the Internet Engineering Task Force, or IETF. Leverage and expand multiple distribution channels. We distribute our products primarily through selected distributors and a large number of resellers. To quickly reach a broad, worldwide audience, we have more than 250 resellers in approximately 50 countries, including regional networking system resellers, network integrators and wholesale distributors. We maintain a field sales force primarily to support our resellers and to focus on select strategic and large accounts. We intend to increase the size of our reseller programs while continuing to develop and refine our two-tier distribution channels. Provide high-quality customer service and support. We seek to enhance customer satisfaction and build customer loyalty through the quality of our service and support. This includes a wide range of standard support programs that are responsive to the level of service required by our customers, from standard business hours to global 24x7x365 real-time response support. We intend to continue to enhance the ease of 7 use of our products and invest in additional support services by increasing staffing and adding new programs for our distributors and resellers. In addition, we are committed to providing customer-driven product functionality through feedback from key prospects, consultants, channel partners and end-user customers.Products We deliver high-performance application and services infrastructure forenterprise, service provider and MANs based on award-winning technology thatcombines simplicity, high performance, intelligence and a low cost ofownership. Our family of Summit stackable, BlackDiamond and Alpine chassisswitches share the same consistent hardware, software and managementarchitecture, enabling businesses to build a network infrastructure that issimple, easy to manage and scalable to meet the demands of growing businesses.The Summit chipset is the original group of ASICs used in our products, whereasthe Inferno chipset is the second-generation. Our third-generation chipset,known as Genesis, is currently under development. Our product solutions enable the delivery of broadband Ethernet and IP overcurrent and legacy networks. Additionally, with fewer components and aconsistent management system, fewer dedicated network resources are required tomanage the network - thereby reducing the total cost of network ownership. Our principal hardware and software products are as follows:Products Configuration/Description------------------------------- -----------------------------------------------------------------------Summit Stackable Product Family------------------------------- ----------------------------------------------------------------------- Inferno chip-based products: Summit1i 8 Gigabit Ethernet ports Summit5i 16 Gigabit Ethernet ports Summit7i 32 Gigabit Ethernet ports Summit48i 48 Ethernet ports and 2 Gigabit Ethernet ports Summit chip-based products: Summit24 24 10/100 Mbps Ethernet ports and 1 Gigabit Ethernet port Summit48 48 10/100 Mbps Ethernet ports and 2 Gigabit Ethernet ports------------------------------- -----------------------------------------------------------------------BlackDiamond Modular Chassis------------------------------- ----------------------------------------------------------------------- BlackDiamond 6808 Up to 672 10/100 Mbps Ethernet ports or 96 Gigabit Ethernet ports in one chasis 10 slots to accommodate a variety of up to 8 connectivity modules and 2 management modules-------------------------------------------------------------------------------------------------------- BlackDiamond 6816 Up to 1,440 Mbps Ethernet ports or 192 Gigabit Ethernet ports in one chassis 20 slots to accommodate a variety of up to 16 connectivity modules and 4 management modules--------------------------------------------------------------------------------------------------------Alpine Chassis------------------------------- ----------------------------------------------------------------------- Alpine 3808 Up to 256 10/100 Mbps Ethernet ports or 32 Gigabit Ethernet ports in one chassis 9 slots to accommodate a variety of up to 8 connectivity modules and 1 management module-------------------------------------------------------------------------------------------------------- Alpine 3804 Up to 128 Mbps Ethernet ports or 16 Gigabit Ethernet ports in one chassis 5 slots to accommodate a variety of up to 4 connectivity modules and 1 management module 8Products Configuration/Description--------------------------- ---------------------------------------------------------------------------Software--------------------------- --------------------------------------------------------------------------- ExtremeWare Embedded switch management software suite featuring standard protocols, web-based configuration and policy-based quality of service--------------------------------------------------------------------------------------------------------Infrastructure and Services Next-generation network management software that manages Layer 2 ~ LayerManagement (ISM) Software, 7 application infrastructureincludes:EPI Center Next-generation integrated application suite that simplifies configuration, troubleshooting, and status monitoring of IP-based networksService Watch A monitoring and management software suite for mission-critical network services and applications Summit Stackable Products Products in the Summit family of switches are designed to meet the demandingrequirements emerging in intranet and Internet applications. All Summitswitches share a common switch architecture that provides scalability in fourareas: speed, bandwidth, network size and policy-based quality of service, orQoS. The Summit product family supports a range of gigabit and 10/100 Mbpsaggregation for enterprise desktops and servers, large Internet data centers,and broadband points of presence, or POP, in MANs and multi-tenant buildings. The enterprise desktop is the portion of the network where individualend-user workstations are connected to a hub or switch. In this sharedenvironment, each desktop in the workgroup receives and is burdened by thecommunication of every other desktop in the workgroup. As applications havebecome more bandwidth intensive and as user traffic has migrated outside theworkgroup via the Internet or an intranet or extranet, 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. Extreme became an industryleader in Layer 3 switching for the desktop with the introduction of ourSummit48, Summit24 and Summit48i desktop switching products. The Summit48switch addresses high-density enterprise desktop connections. This switchfeatures a non-blocking architecture to avoid the loss of data packets. TheSummit24 switch, with half the number of ports of the Summit48 switch, istargeted at local wiring closets with moderately dense desktop connections. Atthe network edge, the Summit48i switch delivers an aggregation switchingsolution with physical and logical access, security and user mobility features. Servers run the applications and store the data needed by all networkend-users. The traditional network architecture has been shifting toward morecentralized server clusters, or server farms, which require the physicaldeployment of multiple servers in a single central data center. This newarchitecture is easier to manage and can be configured in a redundant fashion,thereby reducing the risk of system failure. Additionally, remote offices andtelecommuters can access the same server-based data as desktop users,increasing the flexibility of the network to support users wherever they may belocated. 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 9turn, these servers have created the need for switches that can support theirhigher server-to-server and server-to-end-user communications speeds. A numberof our products address 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. Inserver farms and data centers, the Summit7i maximizes server availability andperformance by combining server load-balancing with wire-speed switching. As MANs evolve to handle more data rather than voice, the POP must alsoprogress from serving as a simple transport device to an application servicestool. Today's broadband POPs are moving closer to the customer and need tooffer services density and scalability without re-engineering discreetnarrow-band technologies. There is a growing need for consistent scalableservices in the multi-tenant market, which, according to Cahner's InStat Group,an independent research organization, will reach $2 billion by 2004. TheSummit1i and Summit5i Gigabit Ethernet switching systems are designed toeliminate the limitations associated with multiple narrow-band aggregationtechnologies traditionally used in metropolitan POPs. To keep up with thedemands of the MAN provider, more sophisticated network features are requiredto help them deliver revenue-generating services by ensuring latency,reliability, and security. The Summit48i extends Ethernet service provisioningto the network edge, enabling control and management over bandwidth, serviceprovisioning and usage-based billing. BlackDiamond 6800 Series The BlackDiamond 6800 series delivers carrier-class scalability, redundancyand high reliability for core switching in high-density Ethernet/IP enterpriseand service provider networks. These modular switches include thefault-tolerant features associated with mission-critical enterprise-class Layer3 core switching, including redundant system management and switch fabricmodules, hot-swappable modules and chassis components, load-sharing powersupplies and management modules, up to sixteen 10 Mbps, 100 Mbps, or 1,000 Mbpsaggregated links, dual software images and system configurations, spanning treeand multipath routing, and redundant router protocols for enhanced systemreliability. 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. Owing to the high-traffic nature ofthe network core, the critical elements in core switching include wire-speedLayer 3 switching, scalability, a non-blocking hardware architecture,fault-tolerant mission-critical features, redundancy, and link aggregation. Theabilities to support a variety of high-density speeds and feeds and toaccommodate an increasing number of high-capacity backbone connections are alsoimportant. Alpine 3800 Series The Alpine 3800 series provides a simple, resilient broadband infrastructurefor MANs, ISPs and mid-range enterprise networks. The Alpine 3800 seriesprovides total Ethernet coverage with support for both standard category 5 andfiber optic media as well as first mile technologies that extend the reach ofEthernet over VDSL and legacy WAN technologies. In addition, the Alpineplatform can be deployed throughout a network infrastructure consistently,regardless of the building topology or type of cabling available. The Alpine 3800 series switches can be configured to scale from 8 to 56Ethernet-over-VDSL ports. Even higher density can be achieved with acombination of Ethernet-over-VDSL and traditional copper or fiber Ethernetports. The FM-8Vi module provides Ethernet-over-VDSL at 10 Mbps full-duplex oneach port, up to 2500 feet. The four-port T1/E1 WAN, or WM-4T1, module for the Alpine 3800 seriesswitches provides WAN connectivity for the Alpine chassis switch. The WM-4T1module provides flexible WAN connectivity with T1 channel bonding that scalesfrom 1.5 Mbps to 6 Mbps of uplink capacity. Coupled with the sophisticatedbi-directional rate shaping and policy-based QoS capabilities of the Alpinechassis switch, the T1 module ensures 10delivery of real-time and mission-critical applications in the WAN. The WM-4T 1module is ideal for supporting both switched Ethernet and IP-routedconfigurations across T1 links. ExtremeWare Software ExtremeWare software is the embedded operating system software that isprovided on every one of our switches. It delivers the uncompromising switchingand routing protocol support, management, control and security needed ontoday's most demanding enterprise, service provider and co-located networks.Its standards-based, multi-layer switching and policy-based QoS give networkmanagers the tools they need to make the most of network capacity. Theflexibility of ExtremeWare software is key in making network design decisionsfor switching, independent from QoS and security policies. Infrastructure and Services Management Extreme Infrastructure and Services Management, or ISM, is the nextgeneration network management software platform that manages Layer 2 ~ Layer 7application infrastructures. ISM is a total software portfolio that includesEPICenter software, an integrated application suite for network management, andServiceWatch software, a Layer 4 ~ Layer 7 application monitoring suite,offering a unified management solution for a wide range of business sizes anddemands. EPICenter software, the primary application in the ISM portfolio, isan integrated application suite that simplifies configuration, troubleshooting,inventorying and status monitoring of IP-based networks. EPICenter softwareoffers a comprehensive set of network management applications, accessible froma workstation with a Java-enabled web browser. Our ServiceWatch software is a Layer 4 ~ Layer 7 monitoring and managementsoftware solution for mission-critical network services such as e-mail,e-commerce, and file transfer. The software is designed to give networkmanagers a user's perspective with respect to the performance of their networkservices to ensure these are performing at peak levels. If service responsetime starts to degrade, the software notifies the network manager to takecorrective action before a problem occurs. The software monitors web servers,such as HTTP, FTP servers, host and name servers, including DHCP and DNS, mailservers, including POP3, IMAP4 and SMTP, news servers, such as NNTP, and otherprotocols, and tests device availability and response time using ping, or ICMP,telnet and other protocols.Sales, Marketing and Distribution We conduct our sales and marketing activities on a worldwide basis throughdistributors, resellers, and our field sales organization. A majority of oursales are made to partners in two-tier distribution channels. The first tierconsists of a limited number of independent distributors that sell primarily toresellers and end-user customers. Distributors are generally given privilegesto return a portion of inventory and participate in various cooperativemarketing programs to promote the sale of our products and services. The secondtier of the distribution channel is comprised of a large number of independentresellers that sell directly to end-user customers. Resellers do not stockinventory and therefore are not granted return privileges. We maintain alimited number of relationships with strategic original equipment manufacturer,or OEM accounts, but we anticipate that OEM sales will continue to decline as apercentage of net revenue as we focus on our two-tier distribution and fieldsales strategy. Distributors. We have established several key relationships with leadingdistributors in the electronics and computer networking industries. We intendto maintain these relationships with distributors who may offer products ordistribution channels that complement our own channels. Each of ourdistributors resells our products to reseller and end-user customers. Thedistributors enhance our ability to sell and provide support to end-usercustomers, especially global accounts, who may benefit from the broad serviceand product fulfillment capabilities offered by these distributors. Weanticipate that sales by distributors will increase as a percentage of netrevenue in the future. Tech Data Corporation, a major electronics distributorand value-added services provider headquartered in Clearwater, Florida,accounted for 16% of our sales in fiscal 2001. No other customer accounted forgreater than 10% of our revenue in fiscal 2001. 11 Value-Added Resellers. We have entered into agreements to sell our productsthrough more than 250 resellers in approximately 50 countries. Our value-addedresellers include regional networking system resellers, resellers who focus onspecific vertical markets, network integrators and wholesale distributors. Weprovide training and support to our resellers and our resellers generallyprovide the first level of support to end users of our products. Ourrelationships with resellers are generally on a non-exclusive basis and providethe resellers with discounts based upon the volume of their orders. Field sales. We have trained our field sales organization to support anddevelop leads for our resellers and to establish and maintain a limited numberof key accounts and strategic customers. To support these objectives, our fieldsales 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, 2001, Extreme's worldwide sales and marketing organizationincluded 464 individuals, including directors, managers, sales representatives,and technical and administrative support personnel. We have domestic salesoffices located in the states of Arizona, California, Colorado, Connecticut,District of Columbia, Florida, Georgia, Illinois, Kansas, Massachusetts,Maryland, Michigan, North Carolina, New Jersey, New York, Ohio, Oklahoma,Oregon, Pennsylvania, Tennessee, Texas, Utah, Virginia, Washington andWisconsin. In addition, we have international sales offices located inArgentina, Australia, Brazil, Canada, Chile, France, Germany, Hong Kong, Italy,Japan, Korea, Malaysia, Mexico, the Netherlands, Sweden and the United Kingdom. We also maintain representative offices in the People's Republic of Chinalocated in the cities of Beijing, Chengdu, Shanghai and Wuhan. International sales International sales are an important and growing portion of our business. Infiscal 2001, sales to customers outside of North America accounted for 55% ofour consolidated net revenue, compared to 43% in fiscal 2000 and 52% in fiscal1999. These sales are conducted primarily through foreign-based distributorsand resellers managed by our worldwide sales organization, in addition todirect sales to end-user customers, including large global accounts. Theprimary markets for sales outside of North America include the countries inWestern Europe and Japan. We have also achieved growing sales to customers inthe People's Republic of China and other countries throughout the Asia-Pacificregion. Marketing We have a number of marketing programs to support the sale and distributionof our products and to inform existing and potential customers and ourdistributors and resellers about the features and performance of our products.Our marketing efforts include participation in industry tradeshows, technicalconferences and technology seminars, preparation of competitive analyses, salestraining, publication of technical and educational articles in industryjournals, a publicly available website, web-based training courses, advertisingand public relations. In addition, we have begun to develop anelectronic-commerce business directed at resellers. We also submit our productsfor independent product testing and evaluation. Our consolidated net revenue for fiscal 2001, 2000 and 1999 was $491million, $262 million and $98 million respectively. Although our annual growthrate has been substantial, we cannot assure you that we will be 12able to achieve similar rates of growth in the future. For further detail, see"Risk Factors--A Number of Factors Could Cause Our Quarterly Financial Resultsto Be Worse Than Expected, Resulting in a Decline in Our Stock Price."Backlog Our products are often sold on the basis of standard purchase orders thatare cancelable prior to shipment without significant penalties. In addition,purchase orders are subject to changes in quantities of products and deliveryschedules in order to reflect changes in customer requirements andmanufacturing capacity. Our business is characterized by seasonal variabilityin demand and short lead-time orders and delivery schedules. Actual shipmentsdepend on the then-current capacity of our contract manufacturers and theavailability of materials and components from our vendors. We believe that onlya small portion of our order backlog is non-cancelable and that the dollaramount associated with the non-cancelable portion is immaterial. Accordingly,we do not believe that backlog at any given time is a meaningful indicator offuture sales.Customer Support and Service We offer modular and comprehensive ExtremeWorks service solutions to helpprotect our customers' network investments and support their business goals.The markets we address--including enterprises, service providers, ande-businesses--all demand continuous uptime to maximize productivity. Our goalis to serve as a knowledgeable and experienced service partner who can tailorservice solutions to meet the specific business needs of our customers. Our service offerings are as follows: . ExtremeWorks Professional Services . ExtremeWorks Global Services Management . ExtremeWorks Support Programs . ExtremeWorks Education ExtremeWorks Professional Services. We specialize in providing solutions andconsultative services to improve network productivity in all phases of thenetwork lifecycle--evaluation, planning, design, implementation and management.The professional services include customized and packaged consulting servicesthat assist customers in an effort to optimize their networks by meeting theirobjectives for applications support, uptime and cost control. Our networkarchitects develop and execute customized hardware deployment plans to meetindividualized network strategies. These activities include the management andcoordination of the design and network configuration, resource planning,staging, logistics, migration and deployment. We also provide technicaldocumentation and training to assist customers in the transition to a newnetwork. We offer our customers a variety of technical consulting services,including: . Analysis--detailed audit and analysis of customer networks . Policy-Based QoS--analysis and recommendation for deploying advanced traffic management and bandwidth prioritization features to match actual traffic patterns . Multicasting--strategy for deploying PIM-DM, PIM-SM, or DVMRP to best suit streaming media requirements . Voice over IP--consulting strategy and recommendation to deploy voice-over-IP utilizing our technology 13 . Load Balancing--design and implementation of our integrated load balancing features to help maximize server response while reducing equipment costs . Security--analysis of customer security needs and recommendations on how to implement advanced security features to meet those needs . Interoperability Lab--use of the lab to analyze deployment options, resolve integration concerns, and assess performance and application thresholds ExtremeWorks Global Services Management. Post-sales customer services arean integral component of our comprehensive service solution. Global ServicesManagement delivers customer service by means of a service account manager whoserves as single point of contact to manage account service needs including thecoordination of activities with the Global Service Management team--thedesignated technical engineer, systems engineer and development engineersponsor. Service account managers facilitate communications withcross-functional teams, escalate support issues to streamline issue resolution,and maintain documentation of customer network configurations and topology mapsfor access by customer-authorized staff. ExtremeWorks Support Programs. Our support programs are designed to supporta broad range of customer service requirements. From standard business hours to24x7x365 global support, we attempt to meet the service requirements of all ourcustomers through Technical Assistance Centers, or TACs, located in SantaClara, California, Utrecht, Holland, and Tokyo, Japan. Our technical engineersassist in diagnosing and troubleshooting technical issues regarding customernetworks. This is part of our effort to ensure maximum network uptime andperformance. Regional systems engineers serve as on-site engineering resourcesto provide consultative support and advice for network operation. Developmentengineers work with the TACs to resolve product functionality issues specificto each customer. We utilize the Internet to distribute and obtain information from ourcustomer base as an integral part of our service solution. This allows us tokeep customers informed of the latest updates and developments at ExtremeNetworks, and contains up-to-date information and technical documentationenabling customers to research issues and find answers to technical questions.Special features include a TAC database to obtain troubleshooting assistanceand information for configuring software, diagnosing hardware, and researchingnetwork issues. On-site support services are available in most locationsworldwide for customers who require a more comprehensive level of service andsupport. ExtremeWorks Education. Our technical experts offer certified classes onour products. The classes cover a wide range of topics such as switchconfiguration, optimization, management and operation, so customers can acquirethe necessary knowledge and experience to successfully deploy and manage ourproducts in various networking environments. Class sizes are generally smalland lab-intensive to promote high retention in a hands-on learning environment,and are offered from time-to-time in the United States, Europe and Asia.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 flexibly respond tochanges in market demand. Where cost-effective, we may begin to perform certainof our non-manufacturing operations, such as product testing, at our ownfacilities. Currently, we use three contract manufacturers--Flextronics International,Ltd., located in San Jose, California to manufacture our BlackDiamond andSummit products; Solectron Corporation, located in Milpitas, California, tomanufacture our Alpine products; and MCMS, Inc., located in Nampa, Idaho, tomanufacture selected Summit products. Each of these manufacturing processes andprocedures is ISO 9002 certified. We 14design and develop the key components of our products, including ASICs andprinted circuit boards. In addition, we determine the components that areincorporated in our products and select the appropriate suppliers of suchcomponents. Our contract manufacturers utilize automated testing equipment toperform product testing and burn-in with specified tests. We also usecomprehensive inspection testing and statistical process controls to assure thequality and reliability of our products. We intend to regularly introduce newproducts and product enhancements that will require us to rapidly achievevolume production by coordinating our efforts with those of our suppliers andcontract manufacturers. See "Risk Factors--We May Need to Expand OurManufacturing Capacity and We Depend on Contract Manufacturers forSubstantially All of Our 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-sourcecomponents include: . ASICs; . microprocessors; . programmable integrated circuits; . selected other integrated circuits; . cables; . custom power supplies; and . custom-tooled sheet metal. Our principal limited-source components include: . flash memories; . dynamic and static random access memories, or DRAMS and SRAMS respectively; and . printed circuit boards. Purchase commitments with our single- or limited-source suppliers aregenerally on a purchase order basis. LSI Logic Corporation is the sole sourcefor the ASICs that are used in all of our switches, whereas a number of othervendors supply standard product integrated circuits and microprocessors for ourproducts. Any interruption or delay in the supply of any of these components,or the inability to procure these components from alternate sources atacceptable prices and within a reasonable time, may have a material adverseeffect on our business, operating results and financial condition. In addition,qualifying additional suppliers can be time-consuming and expensive and mayincrease the likelihood of errors. We use our forecast of expected demand to determine our materialrequirements. Lead times for materials and components we order varysignificantly, and depend on factors such as the specific supplier, contractterms and demand for a component at a given time. See "Risk Factors--WePurchase Several Key Components for Products From Single or Limited Sources andCould Lose Sales if These Suppliers Fail to Meet Our Needs" and "We May Need toExpand Our Manufacturing Capacity and We Depend on Contract Manufacturers forSubstantially All of Our Manufacturing Requirements."Research and Development The success of our products to date owes in large part to our focus onresearch and development. We believe that continued success in the marketplacewill depend on our ability to develop new and enhanced products employingleading-edge technology. Accordingly, we are undertaking development effortswith an emphasis on increasing the reliability, performance and features of ourfamily of products, and designing innovative products to reduce the overallnetwork operating costs of customers. 15 Our product development activities focus on solving the needs ofenterprises, service providers, telecommunications carriers, and metropolitanarea network markets. Current activities include the continuing development ofa next-generation chipset aimed at extending the capabilities of our products.Our ongoing research activities cover a broad range of areas, including, inparticular, 10 Gigabit Ethernet and SONET routers, metropolitan network andInternet routing software, ASIC design, and network management software. Thescope of our research and development activities has expanded to include thedevelopment of broadband access equipment and content networking devices inconnection with corporate acquisitions that we completed in fiscal 2001. Our products have been designed with a consistent system architecture acrossall product lines, enabling a relatively short product design and developmentcycle and reducing the time to market for new products and features. We haveutilized this design approach to develop and introduce new products andenhancements following the introduction of our first- and second-generationproducts. We intend to continue with a simplified approach to architecturaldesign to develop and introduce additional products and enhancements in thefuture. Our expenditures for research and development in fiscal 2001, 2000, and 1999were $57.9 million, $33.0 million, and $17.0 million respectively. Theseamounts do not include in-process research and development charges in theamount of $30.2 million related to our acquisitions of Optranet, Inc. andWebstacks, Inc. in fiscal 2001. There can be no assurance that our product development efforts will resultin commercially successful products, or that our products will not be renderedobsolete by changing technology or new product announcements by othercompanies. See "Risk Factors--The Market in Which We Compete is Subject toRapid Technological Change and to Compete We Must Continually Introduce NewProducts that Achieve Broad Market Acceptance."Competition The market for Internet switches is part of the broader market fornetworking equipment, which is dominated by a few large companies, particularlyCisco Systems and Nortel Networks. Each of these companies has introduced, orhas announced its intention to develop, switches that are or may be competitivewith our products, such as the Catalyst 6000 family of switches offered byCisco Systems. In addition, there are a number of large telecommunicationsequipment providers, including Alcatel, Ericsson, Nokia and Siemens, which haveentered the market for network equipment, particularly through acquisitions ofpublic and privately held companies. We expect to face increased competition,particularly price competition, from these and other telecommunicationsequipment providers. We also compete with other public and private companiesthat offer switching solutions, including Enterasys Networks, Foundry Networksand Riverstone Networks. These vendors may develop products with functionalitysimilar to our products or provide alternative network solutions. Current andpotential competitors have established or may establish cooperativerelationships among themselves or with third parties to develop and offercompetitive products. Furthermore, we compete with numerous companies thatoffer routers and other technologies and devices that traditionally havemanaged the flow of traffic on the enterprise or metropolitan area networks. Many of our current and potential competitors have longer 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 confident inand committed to the product offerings of our principal competitors, includingCisco Systems and Nortel Networks. Accordingly, these potential customers maynot consider or evaluate our products. When such potential customers haveconsidered or evaluated our products, we have in the past lost, and expect inthe future to lose, sales to some of these customers as large competitors haveoffered significant price discounts to secure such sales. 16 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 and that may have amaterial adverse effect on our business. See "Risk Factors--Intense Competitionin the Market for Networking Equipment Could Prevent Us from Increasing Revenueand Sustaining 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 seven patents in the United States and in additionhave filed twenty-one patent applications in the United States. Based on ourcommitment to build a patent portfolio, we have in process a number of otherpatent applications relating to our proprietary technology. We have filedpatents in selected countries abroad as deemed appropriate. There can be noassurance that these applications will be approved, that any issued patentswill protect our intellectual property or that these patents or applicationswill not be challenged by third parties. Furthermore, there can be no assurancethat others will not independently develop similar or competing technology ordesign around any patents that we may obtain. With respect to trademarks, wehave nine pending trademark applications and ten registered trademarks in theUnited States. In addition, we have a significant number of pending trademarkapplications and registered trademarks abroad. We 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-user customers primarily under"shrink-wrap" license agreements included within the packaged software. Theseagreements are not negotiated with or signed by the licensee, and thus theseagreements may not be enforceable in some jurisdictions. Despite our efforts toprotect our proprietary rights, unauthorized parties may attempt to copy orotherwise obtain and use our products or technology. There can be no assurancethat these precautions will prevent misappropriation or infringement of 17our intellectual property. Monitoring unauthorized use of our products isdifficult, and we cannot be certain that the steps we have taken will preventmisappropriation of our technology, particularly in foreign countries where thelaws may not protect 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 against usin regard to technologies and related standards that we consider to beimportant. We expect to increasingly be subject to infringement claims assertedby third parties as the numbers of products and competitors in the market fornetwork switches grow and product functionality overlaps. As detailed below under "Legal Proceedings," we are currently engaged inlitigation with Nortel Networks. Nortel Networks is asserting claims thatallege infringement of certain patent rights, against which we are defendingvigorously, but we cannot assure you that we will prevail in this litigation.See "Risk Factors--We Are Engaged in Litigation Regarding Intellectual PropertyRights, and an Adverse Outcome Could Harm Our Business and Require Us to IncurSignificant Costs." In addition to the litigation with Nortel Networks, since April 2000, wehave been in communication with two other companies that assert certain of ourproducts require a license under a number of their patents. These parties haveindicated in the past that they are willing to grant us a non-exclusive licenseunder the identified patents as well as other patents or technology that we mayrequire. We are currently reviewing the identified patents to determine whetherwe consider a license necessary. However, there can be no assurance that theselicenses would be obtainable on commercially acceptable terms. We also cannotassure you that these parties or other third parties will not assert additionalclaims or initiate litigation against us, our manufacturers, suppliers, orcustomers alleging infringement of their proprietary rights based on thetechnology in our current or future products. In the future, we may determine it is necessary to initiate claims orlitigation against third parties for infringement of our proprietary rights. Any claims, whether asserted by us or a third party against us, could betime-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. Royalty-bearing license agreements,if required, may not be available on acceptable terms, if at all. In the eventa third party is successful in a claim of infringement, our failure orinability to develop non-infringing technology or license the proprietaryrights on a timely basis may have a material, adverse effect on our business,operating results and financial condition. See "Risk Factors--Our Ability toProtect Our Intellectual Property and Defend Against Claims May be Limited andMay Adversely Affect Our Ability to Compete."Employees As of June 30, 2001, we employed a total of 970 people, including 464 insales and marketing, 252 in engineering, 76 in operations, 84 in customersupport, and 94 in finance and administration. We have never had a workstoppage and no personnel are represented under collective bargainingagreements. We consider our employee relations 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 personnel. None ofour personnel is bound by an employment agreement. The market for qualifiedpersonnel is competitive, particularly in the San Francisco Bay Area, where ourheadquarters is located. At times we have 18experienced 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 "RiskFactors--If We Lose Key Personnel or are Unable to Hire Additional QualifiedPersonnel as Necessary, We May Not Be Able to Successfully Manage Our Businessor Achieve Our Objectives."Item 2. Properties Our principal administrative, sales, marketing and research and developmentfacilities are located in Santa Clara, California. We also lease office spaceand executive suites in various other geographic locations domestically andinternationally for sales and service personnel and engineering operations. Ouraggregate lease expense for fiscal 2001 was approximately $11.7 million, net ofsublease income of approximately $3.6 million. We believe our currentfacilities will adequately meet our growth needs for the foreseeable future.Our principal facilities are as follows:# ofBldgs Location Leased/Owned Square Footage Purpose----- -------- ------------ -------------- ------- 6 Santa Clara, CA.......... 6 Leased Combined SF 6 bldgs. (leased) = Warehouse, 295,764 R&D, Sales, Headquarters 2 Pleasanton, CA........... Leased 84,428 Research & Development 1 Herndon, VA.............. Leased 14,451 Sales and Research & Development 1 Durham, NC............... Leased 12,500 Research & Development 2 Maarssen, the Netherlands Leased 12,000 Sales Office 1 Dallas, TX............... Leased 11,574 Sales Office 1 Oakbrook Terrace, IL..... Leased 11,430 Sales Office 1 Westlake Village, CA..... Leased 10,027 Research & Development 1 New York, NY............. Leased 9,185 Sales Office 1 Tokyo, Japan............. Leased 7,755 Sales Office 1 Sunnyvale, CA............ Leased 7,500 Research & Development 1 Denver, CO............... Leased 7,277 Sales Office 1 Houston, TX.............. Leased 6,347 Sales Office 1 Westborough, MA.......... Leased 5,553 Sales OfficeItem 3. Legal Proceedings On March 14, 2001, Nortel Networks, Inc. and Nortel Networks Limited(collectively, "Nortel") filed suit against us in the United States DistrictCourt for the District of Massachusetts, Civil Action No. 01-10443EFH. Thecomplaint alleges willful infringement of U.S. Patent Nos. 5,790,554 (the "554Patent"); 5,490,252; 5,408,469; 5,398,245; 5,159,595 and 4,736,363, and seeks ajudgment: (a) determining that the Company has infringed each of the sixpatents; (b) permanently enjoining and restraining the Company from furtherinfringement of each of the six patents; and (c) awarding unspecified amountsof trebled damages, together with interest, costs and attorneys' fees. Weanswered Nortel's complaint on May 17, 2001, denying that we have infringed anyof the six patents and also asserting various affirmative defenses andcounterclaims that seek judgment: (a) that Nortel's complaint be dismissed; (b)that each of the six patents be declared invalid; (c) declaring that we are notinfringing any of the six patents; and (d) that Nortel pay our attorneys' feesand costs. On May 17, 2001, we also sought transfer of the action to the UnitedStates District Court for the Northern District of California. On June 28,2001, the court denied our motion to transfer, and the action will thus proceedin Massachusetts. On July 9, 2001, the court granted a motion by F5 Networks,Inc. ("F5") to intervene in the action. F5 contends that it is the designer,developer, and manufacturer of the product accused of infringing the '554Patent of Count VI of Nortel's complaint. F5 had also sought to sever andtransfer Count VI in favor of an action concerning the '554 Patent pendingbetween F5 and Nortel in the United States District Court for the WesternDistrict of Washington, but that motion was denied on July 9, 2001 withoutopinion. On July 13, 2001, 19Nortel demanded $150 million in settlement of alleged past damages. Discoveryis proceeding. As set forth above, we have denied Nortel's allegations andintend to defend the action vigorously. We cannot assure you, however, that wewill prevail in this litigation, which could have a material, adverse effect onour business, financial condition and results of operations in the future. Other than the stated above and the multiple purported securities fraudclass action complaints that were filed in the United States District Court forthe Southern District of New York beginning on July 6, 2001 (see Note 10 toConsolidated Financial Statements), we are not aware of any pending legalproceedings against us that, individually or in the aggregate, would have amaterial adverse effect on our business, operating results or financialcondition. We may in the future be party to litigation arising in the course ofour business, including claims that we allegedly infringe third-partytrademarks and other intellectual property rights. Such claims, even if notmeritorious, could result in the expenditure of significant financial andmanagerial 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, 2001:Name Age Position---- --- -------- Gordon L. Stitt... 45 President, Chief Executive Officer and ChairmanStephen Haddock... 43 Vice President and Chief Technical OfficerHerb Schneider.... 42 Vice President of EngineeringHarold L. Covert.. 54 Vice President, Chief Financial Officer and SecretaryHarry Silverglide. 55 Vice President of Worldwide SalesDarrell Scherbarth 45 Vice President/General Manager--Access Business Unit 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 heco-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. 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 andwas 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. Harold L. Covert. Mr. Covert was appointed as Vice President, ChiefFinancial Officer and Secretary of Extreme Networks effective August 1, 2001.Prior to that Mr. Covert was with Silicon Graphics, Inc. from July 2000 untilJuly 2001 where he served as President and Chief Financial Officer. Before thatMr. Covert was Vice 20President and Chief Financial Officer of Red Hat, Inc. from March 2000 untilJuly 2000. Prior to that Mr. Covert was Executive Vice President and ChiefFinancial Officer of Adobe Systems from March 1998 until March 2000. FromDecember 1990 to March 1998, Mr. Covert was a partner in the firm of DHJ &Associates, Inc., Consultants and Certified Public Accountants and InterimChief Financial Officer. During the last half of this period he acted in a fulltime capacity as interim Chief Financial Officer for several companies. Mr.Covert holds an MBA from Cleveland State University, a BSBA from Lake ErieCollege and is a Certified Public Accountant. 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. Darrell Scherbarth. Mr. Scherbarth has served as Vice President/GeneralManager of the Access Business Unit of Extreme since February 2001. Mr.Scherbarth joined us as a result of our acquisition of Optranet, Inc., which hefounded and where he served as president and CEO from November 1999 to January2001. From April 1997 to September 1998, he was the Vice President ofEngineering at Redback Networks, a leading developer and manufacturer of highperformance broadband access systems. Mr. Scherbarth was also a co-founder andVice President of R&D of Network Peripherals Inc., where he served from March1989 to April 1996. Mr. Scherbarth holds a BSEE from California StateUniversity. 21 PART IIItem 5. Market for Registrant's Common Equity and Related Stockholder Matters. Extreme's common stock commenced trading on the Nasdaq National Market onApril 9, 1999 under the symbol "EXTR." The following table sets forth the highand low closing prices as reported by Nasdaq. Such prices represent pricesbetween dealers, do not include retail mark-ups, mark-downs or commissions andmay not represent actual transactions. All prices have been adjusted to reflecta 2-for-1 stock split effected in August 2000.Stock Prices High Low------------ ------- ------ Fiscal year ended June 30, 2000:First quarter................... $ 42.25 $22.81Second quarter.................. $ 49.03 $30.66Third quarter................... $ 59.50 $38.00Fourth quarter.................. $ 52.75 $21.44Fiscal year ended June 30, 2001:First quarter................... $120.69 $46.25Second quarter.................. $123.56 $31.13Third quarter................... $ 50.38 $14.96Fourth quarter.................. $ 39.50 $12.27 At August 31, 2001, there were approximately 75,000 stockholders of recordof Extreme's common stock and approximately 413 beneficial stockholders.Extreme has never declared or paid cash dividends on its capital stock and doesnot anticipate paying any cash dividends in the foreseeable future. Extremecurrently intends to retain future earnings for the development of ourbusiness.Item 6. Selected Consolidated Financial Data. For the Period from May 8, 1996 (Date of Years Ended June 30, Inception) ------------------------------------- through 2001 2000 1999 1998 June 30, 1997 --------- -------- ------- -------- -------------- (In thousands, except per share amounts) Consolidated Statements of Operations Data:Net revenue.................................. $ 491,232 $261,956 $98,026 $ 23,579 $ 256Gross profit (loss).......................... 210,000 135,040 49,506 8,682 (132)Total operating expenses(1).................. 311,893 118,786 50,951 22,709 7,928Operating income (loss)...................... (101,893) 16,254 (1,445) (14,027) (8,060)Net income (loss)............................ (68,883) 20,048 (1,617) (13,936) (7,923)Net income (loss) per share--basic(2)........ $ (0.64) $ 0.20 $ (0.09) $ (1.59) $ (2.26)Net income (loss) per share--diluted(2)...... $ (0.64) $ 0.18 $ (0.09) $ (1.59) $ (2.26)Shares used in per share calculation--basic.. 108,353 100,516 18,924 8,758 3,516Shares used in per share calculation--diluted 108,353 111,168 18,924 8,758 3,516 22 As of June 30, ------------------------------------------ 2001 2000 1999 1998 1997 -------- -------- -------- ------- ------- (In thousands) Consolidated Balance Sheets Data:Cash and cash equivalents............................. $ 87,722 $116,721 $107,143 $ 9,510 $10,047Short-term investments................................ 69,374 66,640 16,422 10,995 --Working capital....................................... 211,432 205,881 119,039 13,796 8,251Total assets.......................................... 688,357 515,930 171,803 33,731 11,942Long-term debt, deposit and capital lease obligations, net of current portion.............................. 266 306 -- 2,634 502Total stockholders' equity............................ $548,762 $419,021 $141,876 $15,869 $ 9,305--------(1)Fiscal 2001 amount includes $37.5 million in amortization of goodwill, purchased intangible assets and deferred stock compensation, write-offs of $30.2 million of acquired in-process research and development and $5.9 million in restructuring charges. Fiscal 2000 amount includes $6.8 million in amortization of goodwill and purchased intangible assets.(2)Share and per share data have been restated to give retroactive effect to a two-for-one stock split in the form of a stock dividend effected in August 2000.Item 7. Management's Discussion and Analysis of Financial Condition andResults of Operations.Results of OperationsNet Revenue Net revenue increased from $262.0 million in fiscal 2000 to $491.2 millionin fiscal 2001, an increase of 87.5%. The increase in net revenue for fiscal2001 resulted primarily from higher volume of sales of our Summit, BlackDiamondand Alpine products due to an increase in market acceptance of our products,which was partially offset by some price reductions. Net revenue increased from $98.0 million in fiscal 1999 to $262.0 million infiscal 2000, an increase of 167.2%. The increase in net revenue for fiscal 2000resulted primarily from increased sales of our Summit stackable products andour BlackDiamond modular products, the market's growing acceptance of Extreme'sexisting and new product offerings, and a significant increase in our sales andmarketing organizations. Sales outside of North America accounted for 55%, 43% and 52% of net revenuein fiscal 2001, fiscal 2000 and fiscal 1999, respectively. We expect thatexport sales will continue to represent a significant portion of net revenue,although we do not know whether export sales as a percentage of net revenuewill remain at current levels. All sales transactions are currently denominatedin U.S. dollars. We generally recognize product revenue at the time of shipment, assumingthat collectibility is probable, unless we have future obligations such asinstallation or are required to obtain customer acceptance, in which caserevenue and related costs are deferred until those obligations are met. Wedefer recognition of revenue on sales to distributors until the distributorssell the product. Revenue from service obligations under maintenance contracts,is deferred and recognized on a straight-line basis over the contractualperiod, which is typically 12 months. Amounts billed in excess of revenuerecognized are included as deferred revenue, accounts receivable and currentassets in the accompanying consolidated balance sheets of our financialstatements. On a prospective basis as of July 2, 2001 we will report deferredrevenue and accounts receivable on a net basis in the consolidated balancesheets. The increase in deferred revenue from fiscal 2000 to fiscal 2001 of$35.3 million was due to the increase in inventory held by distributors,deferred service revenue and other allowances for customer acceptance. Our products generally carry a one year warranty that includes factoryrepair services as needed for replacement parts. Estimated expenses forwarranty obligations are accrued as revenue is recognized based on our bestestimate of warranty costs for delivered products. 23 We have experienced a rapid and increasingly severe downturn in the economy.This has adversely affected our product demand and made it increasinglydifficult to accurately forecast future production requirements. We expect thiseconomic downturn to continue for at least the remainder of calendar year 2001and we do not know the extent, severity or length of this economic downturn inthe United States or in the other geographic regions where we currently sellour products. We expect to experience some erosion of average selling prices of ourproducts due to a number of factors, including competitive pricing pressures,promotional pricing and rapid technological change. Our revenue is derivedprimarily from sales of our Summit, BlackDiamond and Alpine products and feesfor services relating to our products, including maintenance and training. Thelevel of sales to any customer may vary from period to period; however, weexpect that significant customer concentration will continue for theforeseeable future. See "Risk Factors--If a Key Reseller, Distributor or OtherSignificant Customer Cancels or Delays a Large Purchase, Our Net Revenue MayDecline and the Price of Our Stock May Fall." One customer accounted for 16% ofour net revenue in fiscal 2001; no customer accounted for more than 10% of ournet revenue in fiscal 2000 and two customers accounted for 21% and 13 % of ournet revenue in fiscal 1999.Gross Profit Gross profit increased from $135.0 million in fiscal 2000 to $210.0 millionin fiscal 2001, an increase of 55.5%, primarily due to the related increase inrevenue. Gross margins decreased from 51.6% in fiscal 2000 to 42.7% in fiscal2001. The decrease in gross margin in fiscal 2001 was primarily due to a $40.3million charge for excess and obsolete inventory and non-cancelable purchasecommitments. Gross profit increased from $49.5 million in fiscal 1999 to $135.0 millionin fiscal 2000, an increase of 172.7%, primarily due to the related increase inrevenue. Gross margins increased from 50.5% in fiscal 1999 to 51.6% in fiscal2000. The increase in gross margin resulted primarily from a shift in productmix, a shift in our channel mix from OEMs to resellers and distributors andimproved manufacturing efficiencies, this increase was offset in part by loweraverage selling prices due primarily to increased competition. We recorded a provision for excess and obsolete inventory, includingnon-cancelable purchase commitments, totaling $40.3 million in the thirdquarter of fiscal 2001. Inventory purchases and commitments are based upon ourforecast of future sales. To mitigate the component supply constraints thathave existed in the past, we built inventory levels for certain components withlong lead times and entered into longer-term commitments for certaincomponents. Due to a sudden and significant decrease in demand for our productsthat became apparent in the third quarter of fiscal 2001, inventory levels,including non cancelable purchase commitments, exceeded our requirements basedon our forecast of expected demand. This additional excess inventory charge wascalculated based on the inventory levels in excess of our forecast of expecteddemand for each specific product. We do not currently anticipate that theexcess inventory subject to this provision will be used at a later date basedon our future demand forecast. Furthermore, we may be required to takeadditional write-downs in the future related to excess inventory. Our gross margin is highly variable and dependent on many factors, some ofwhich are outside of our control. Some of the primary factors affecting grossmargin include demand for our products, changes in our pricing policies andthose of our competitors and the mix of products sold. Our gross margins may beadversely affected by increases in material or labor costs, heightened pricecompetition, obsolescence charges and higher inventory balances. In addition,our gross margins may fluctuate due to the mix of distribution channels throughwhich our products are sold, including the effects of our two-tier distributionchannel. Any significant decline in sales to our resellers, distributors orend-user customers, or the loss of any of our resellers, distributors orend-user customers, could have a material adverse effect on our business,operating results and financial condition. In addition, increasing third-partyand indirect distribution channels generally result in greater difficulty inforecasting the mix of our products, and to a certain degree, the timing oforders from our customers. New product introductions may create excess orobsolete inventories, which may also reduce our gross margins. Furthermore, ifproduct or related warranty costs associated with these new products aregreater than we have experienced, gross margin may be adversely affected. 24 Cost of revenue includes the cost of our manufacturing overhead. Weoutsource 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 International, MCMS and Solectron.See "Risk Factors--We May Need to Expand Our Manufacturing Capacity and WeDepend on Contract Manufacturers for Substantially All of Our ManufacturingRequirements". As part of our business relationship with MCMS, we have enteredinto a $9.0 million equipment lease for manufacturing equipment with a thirdparty financing company; we in turn sublease the equipment to MCMS. OnSeptember 18, 2001 MCMS announced that it had reached an agreement to sellsubstantially all of its operating assets to Manufacturers' Services Limited.Simultaneously, MCMS announced that it, and its two U.S. subsidiaries, havevoluntarily filed for protection under Chapter 11 of the U.S. Bankruptcy Codein the United States Bankruptcy Court for the District of Delaware inWilmington to implement the sale. We expect to realize lower per unit product costs as a result of volumeefficiencies if and as volumes increase. However, we do not know if or whensuch price reductions will occur. The failure to obtain such price reductionscould have a material adverse effect upon our gross margins and operatingresults.Research and Development Expenses Research and development expenses increased from $33.0 million in fiscal2000 to $57.9 million in fiscal 2001, an increase of 75.4%. The increase wasprimarily due to higher payroll and related personnel expenses due to theaddition of new personnel, partly through acquisitions, to support our multipleproduct development efforts as well as non-recurring engineering charges,prototype costs and depreciation expense. Research and development expenses, asa percentage of net revenue, decreased to 11.8% in fiscal 2001, compared with12.6% in fiscal 2000. The percentage decrease was primarily the result of anincrease in our net revenue. We expense all research and development expensesas incurred. We believe that continued investment in research and developmentis critical to attaining our strategic objectives and, as a result, we expectthese expenses to increase in absolute dollars in the future. Research and development expenses increased from $17.0 million in fiscal1999 to $33.0 million in fiscal 2000, an increase of 93.7%. The increase wasprimarily due to nonrecurring engineering and initial product verificationexpenses and higher payroll and related personnel expenses due to the hiring ofadditional engineers. From fiscal 1999 to fiscal 2000, research and developmentexpenses decreased as a percentage of net revenue from 17.4% to 12.6%. Thispercentage decrease was primarily the result of an increase in our net revenue.Sales and Marketing Expenses Sales and marketing expenses increased from $67.1 million in fiscal 2000 to$154.6 million in fiscal 2001, an increase of 130.2%. Sales and marketingexpenses, as a percentage of net revenue, increased to 31.5% in fiscal 2001,compared with 25.6% in fiscal 2000. This increase was primarily due to thehiring of additional sales, marketing and customer support personnel, increasedsales commission expenses resulting from increased net revenue and increasedpromotional expenses. The rate of future spending increases, if any, will bedependent on the speed with which the market recovers. Sales and marketing expenses increased from $27.1 million in fiscal 1999 to$67.1 million in fiscal 2000, an increase of 148.2%. This increase wasprimarily due to the hiring of additional sales, marketing and customer supportpersonnel, increased sales commission expenses resulting from increased netrevenue, increased tradeshow and promotional expenses and the establishment ofnew sales offices. From fiscal 1999 to fiscal 2000, sales and marketingexpenses decreased as a percentage of net revenue from 27.6% to 25.6%. Thispercentage decrease was primarily the result of an increase in our net revenue. 25General and Administrative Expenses General and administrative expenses increased from $11.9 million in fiscal2000 to $25.8 million in fiscal 2001, an increase of 116.8%. General andadministrative expenses, as a percentage of net revenue, increased to 5.2% infiscal 2001, compared with 4.5% in fiscal 2000. This increase was due primarilyto an increase in bad debt expense, the hiring of additional finance,information technology, legal and administrative personnel and increasedprofessional fees. The rate of any future spending increases if any will bedependent on the speed with which the market recovers. General and administrative expenses increased from $6.9 million in fiscal1999 to $11.9 million in fiscal 2000, an increase of 72.8%. This increase wasdue primarily to the hiring of additional finance, information technology,legal and administrative personnel and increased professional fees andoccupancy costs. From fiscal 1999 to fiscal 2000, general and administrativeexpenses decreased as a percentage of net revenue from 7.0% to 4.5%. Thispercentage decrease was primarily the result of an increase in our net revenue.Amortization of Goodwill, Purchased Intangible Assets and Deferred StockCompensation Amortization of goodwill, purchased intangible assets and deferred stockcompensation increased from $6.8 million in fiscal 2000 to $37.5 million infiscal 2001, an increase of $30.7 million. In fiscal 2001, amortization ofgoodwill arising from warrants issued in April 2000 increased by $20.4 millionto $27.2 million and amortization of goodwill, purchased intangible assets anddeferred stock compensation related to the Optranet and Webstacks acquisitionswas $9.6 million (see Note 3 of Notes to Consolidated Financial Statements).Anticipated amortization of goodwill, intangibles and deferred compensation forfiscal 2002, assuming no more acquisitions, will be $53.3 million. Amortizationof purchased intangible assets and deferred stock compensation may continue toincrease if we acquire companies and technologies. Amortization of goodwillwill not increase in future periods because under Statement of FinancialAccounting Standards No. 142, "Goodwill and Other Intangible Assets," anygoodwill arising from business combinations closing after June 30, 2001 is notamortized, but rather is periodically evaluated for impairment. See "NewAccounting Pronouncements." Amortization of goodwill, purchased intangible assets and deferred stockcompensation was $6.8 million in fiscal 2000. This amount was due to ourissuance in April 2000 of fully earned, non-forfeitable, fully exercisablewarrants with a two year life to purchase 3,000,000 shares of our common stockwith an exercise price of $39.50 per share (see Note 3 of Notes to ConsolidatedFinancial Statements).Other Operating Expense In fiscal 2001, other operating expense included a write-off of acquiredin-process research and development of $30.2 million and a restructuring chargeof $5.9 million, as described below. We recorded non-recurring charges of $13.4 million related to the purchaseof Optranet in January 2001, and $16.8 million related to the purchase ofWebstacks in March 2001. The value assigned to purchased in-process researchand development was determined through valuation techniques generally used byappraisers in the high-technology industry and was immediately expensed in theperiod of acquisition because technological feasibility had not beenestablished and no alternative use had been identified. The charges arediscussed in more detail in Note 3 of Notes to Consolidated FinancialStatements. In March 2001, we implemented a restructuring plan in order to lower ouroverall cost structure. In connection with the restructuring, we reduced ourheadcount and consolidated facilities. Restructuring charges included in otheroperating expenses were $3.8 million in the quarter ended March 31, 2001 and$2.1 million in the quarter ended June 30, 2001. The restructuring expenseincluded $1.8 million for severance and benefits for terminated employees, $2.3million for the write-off and write-down in carrying value of Summit basedequipment and $1.8 million in facility closure expenses. 26Interest Income Interest income increased from $14.6 million in fiscal 2000 to $15.5 millionin fiscal 2001, an increase of $0.9 million. Interest income increased from$1.9 million in fiscal 1999 to $14.6 million in fiscal 2000, an increase of$12.7 million. The increases were due to the increased amount of cash and cashequivalents, short-term investments, restricted investments and long-terminvestments from the proceeds we received from our initial public offering inApril 1999 and our secondary public offering in October 1999.Other Income (Expense), net Other income (expense), net increased from $33,000 in expense in fiscal 2000to $4.7 million in expense in fiscal 2001. This increase was primarilyattributable to Extreme's share of affiliates' losses accounted for under theequity method of accounting of $2.9 million and write-downs of investmentsaccounted for under the cost method of accounting of $1.8 million.Income Taxes We recorded a tax benefit of $22.7 million for fiscal 2001. The benefit forfiscal 2001 results in an effective tax benefit rate of 24.8% which consistsprimarily of federal and state income tax benefits, offset by foreign taxes,nondeductible in-process research and development and goodwill. FASB StatementNo. 109 provides for the recognition of deferred tax assets if realization ofsuch assets is more likely than not. We evaluate the realizability of thedeferred tax assets on a quarterly basis. We recorded a tax provision of $10.3million for fiscal 2000, which consisted primarily of federal taxes, stateincome taxes and foreign taxes, offset by the recognition of deferred taxassets. We recorded a tax provision of $1.7 million for fiscal 1999, whichconsisted primarily of foreign taxes currently payable, federal alternativeminimum taxes and state minimum and capital taxes.Liquidity and Capital Resources Cash and cash equivalents and short-term investments decreased from $183.4million at June 30, 2000 to $157.1 million at June 30, 2001, a decrease of$26.3 million. This decrease is primarily due to an increase in inventory,purchases of property and equipment and increases in accounts receivable andother current and noncurrent assets, partially offset by increases in deferredrevenue and proceeds from issuance of common stock. Accounts receivable increased 24.2% from June 30, 2000 to June 30, 2001. Theincrease in accounts receivable was due to growth in net revenue. We expectthat accounts receivable will continue to increase to the extent our netrevenue continues to rise. Inventory levels increased 154.3% from June 30, 2000to June 30, 2001. We have increased inventory in order to support revenuegrowth, develop distribution channels, maintain shorter lead times on certainprojects and to provide assurance to our customers that we will be able to meetdemand. Inventory management remains an area of focus as we balance the need tomaintain strategic inventory levels to ensure competitive lead times and avoidstock-outs with the risk of inventory excess or obsolescence because of recentdeclining demand, rapidly changing technology and customer requirements. As aresult of the rapid change in the market for networking products, we recorded$40.3 million in charges for excess and obsolete inventory and non-cancelablepurchase commitments in the quarter ended March 31, 2001. In June 2000, we entered into two operating lease agreements forapproximately 16 acres of land and the accompanying 275,000 square feet ofbuildings to house our primary facility in Santa Clara, California. Our leasepayments will vary based on LIBOR which was 4.3% at June 30, 2001, plus aspread. Our combined lease payments for this facility are estimated to beapproximately $3.4 million on an annual basis over the lease terms. The leasesare for five years and can be renewed for two five-year periods, subject to theapproval of the lessor. At the expiration or termination of the leases, we havethe option to either purchase these properties for $31.4 million and $48.6million, respectively, or arrange for the sale of the properties to a thirdparty for at least $31.4 million and $48.6 million, respectively, with acontingent liability for any deficiency. If the properties under these leasesare not purchased or sold as described above, we will be obligated foradditional lease payments of approximately $30.5 million and $41.3 million,respectively. 27 As part of the above lease transactions, we restricted $80.0 million of ourinvestment securities as collateral for specified obligations as the lessee.These investment securities are restricted as to withdrawal and are managed bya third party subject to certain limitations under our investment policy. Thelease also requires us to maintain specified financial covenants with which wewere in compliance as of June 30, 2001. Under the terms of the Merger Agreement with Webstacks, Extreme is obligatedto pay $15.0 million of additional cash consideration on or before October 31,2001 provided that certain technology milestones are met. At this time it isour expectation that these milestones will be met and the payment made. We require substantial capital to fund our business, particularly to financeinventories and accounts receivable and for capital expenditures. As a result,we could be required to raise substantial additional capital. To the extentthat we raise additional capital through the sale of equity or convertible debtsecurities, the issuance of such securities could result in dilution toexisting stockholders. If additional funds are raised through the issuance ofdebt securities, these securities may have rights, preferences and privilegessenior to holders of common stock and the terms of such debt could imposerestrictions on our operations. We cannot assure you that such additionalcapital, if required, will be available on acceptable terms, or at all. If weare unable to obtain such additional capital, we may be required to reduce thescope of our planned product development and marketing efforts, which wouldmaterially adversely affect our business, financial condition and operatingresults. We believe that our current cash and cash equivalents, short-terminvestments, long-term investments and cash available from credit facilitiesand future operations will enable us to meet our working capital requirementsfor at least the next 12 months.New Accounting Pronouncements In December 1999, the Staff of the Securities and Exchange Commission("SEC") issued Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognitionin Financial Statements", which provides guidance on the recognition,presentation and disclosure of revenue in financial statements. Extreme adoptedSAB 101 in the fourth quarter of fiscal 2001. The adoption of SAB 101 did nothave a material effect on our operations or financial position. In September 2000, the Financial Accounting Standards Board issued SFAS No.140, "Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities--a replacement of FASB Statement No. 125" ("SFAS140"). SFAS 140 revises certain standards for accounting for securitization andother transfers of financial assets and collateral. In addition, SFAS No. 140requires certain additional disclosures that were not previously required. Theadditional disclosure requirements were effective for financial statements forfiscal years ending after December 15, 2000 and have been adopted for the yearended June 30, 2001. The revised accounting standards of SFAS 140 are effectivefor transactions occurring after March 31, 2001. The application of the revisedaccounting standards of SFAS 140 has not had a material adverse effect on ourbusiness, results of operations or financial condition. In July 2001, the FASB issued Statement of Financial Accounting Standards("SFAS") No. 141, "Business Combinations" ("FAS 141"). FAS 141 establishes newstandards for accounting and reporting for business combinations and requiresthat the purchase method of accounting be used for all business combinationsinitiated after June 30, 2001. We will adopt this statement in fiscal 2002. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other IntangibleAssets" ("FAS 142"), which establishes new standards for goodwill and otherintangible assets. Under the new rules, goodwill and indefinite livedintangible assets are no longer amortized but are reviewed annually forimpairment. Separable intangible assets that are not deemed to have anindefinite life will continue to be amortized over their useful lives. Theamortization provisions of SFAS No. 142 apply to goodwill and intangible assetsacquired after June 30, 2001. With respect to goodwill and intangible assetsacquired prior to July 1, 2001, we will apply the new accounting 28rules beginning fiscal year 2003. We are currently assessing the financialimpact SFAS No. 142 will have on our Consolidated Financial Statements.Goodwill and intangible assets from business combinations before July 1, 2001will continue to be amortized prior to the adoption of FAS 142. Upon theadoption of FAS 142, we are required to evaluate our existing goodwill andintangible assets from business combinations completed before July 1, 2001 andmake any necessary reclassifications in order to comply with the new criteriain FAS 141 for recognition of intangible assets. At June 30, 2001, we had goodwill and intangible assets of $113.9 million.Amortization expense for goodwill and intangible assets amounted to $33.4million for fiscal 2001. Anticipated amortization of goodwill and intangibleassets for fiscal 2002 assuming no more acquisitions will be $43.1 million.Risk FactorsWe Have a Limited History of Profitability, We Are Not Currently Profitable andWe Cannot Assure You That We Will Return to Profitability in the Future Fiscal 2000 was the first year in which Extreme achieved profitability ineach of the four quarters. We reported a loss for each of the quarters endedMarch 31, 2001 and June 30, 2001, and for the fiscal year ended June 30, 2001.In the foreseeable future, we anticipate continuing to incur significant salesand marketing, product development and general and administrative expenses and,as a result, we will need to generate and sustain significantly higher revenueto return to and sustain profitability. In addition, the amortization ofpurchased goodwill and intangibles, and deferred compensation associated withacquisitions, will result in material charges that will reduce ourprofitability. Further, the impact of the current economic slowdown couldresult in additional one-time charges.A Number of Factors Could Cause Our Quarterly Financial Results to Be WorseThan Expected, Resulting in a Decline in Our Stock Price We plan to increase our operating expenses to expand our sales and marketingactivities, broaden our customer support capabilities, develop new distributionchannels, fund increased levels of research and development, and expand ouroperational infrastructure. We base our operating expenses on anticipatedrevenue trends, and a high percentage of our expenses are fixed in the shortterm. As a result, any delay in generating or recognizing revenue, as occurredin the quarter ended March 31, 2001, could cause our quarterly operatingresults to fall below the expectations of public market analysts or investors,which could cause the price of our stock to fall. We may experience a delay in generating or recognizing revenue for a numberof reasons. Orders at the beginning of each quarter typically do not equalexpected revenue for that quarter and are generally cancelable at any time.Accordingly, we are dependent upon obtaining orders during a quarter forshipment in that quarter to achieve our revenue objectives. In addition, thetiming of product releases, purchase orders and product availability couldresult in a majority of our product shipments to be scheduled for the end of aquarter. Failure to ship these products by the end of a quarter may adverselyaffect our operating results. Our customer agreements generally allow customersto delay scheduled delivery dates or to cancel orders within specifiedtimeframes without significant charges to the customers. Furthermore, some ofour customer agreements include acceptance provisions that delay our ability torecognize revenue upon shipment. 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, but not limited to, the following: . changes in general and/or specific economic conditions in the networking industry; . seasonal fluctuations in demand for our products and services, particularly in Asia and Europe; . our ability to accurately forecast demand for our products, which in the case of lower-than-expected sales may result in excess and/or obsolete inventory on hand or under non cancelable purchase commitments; 29 . unexpected product returns or the cancellation or rescheduling of 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 relationships with enterprise customers, service providers and other potential large customers; . our ability to achieve targeted cost reductions; . our ability to obtain sufficient supplies of sole or limited-source components for our products on a timely basis; . increases in the prices of the components that we purchase; . decreases in the prices of the products that we sell; . our ability to achieve and maintain desired production volumes and quality levels for our products; . the mix of products sold and the mix of distribution channels through which products are sold; . costs relating to possible acquisitions and the integration of technologies or businesses; and . the effect of amortization of goodwill, deferred compensation, and purchased intangibles resulting from existing or new transactions. Due to the foregoing factors, we believe that period-to-period comparisonsof our operating results should not be relied upon as an indicator of ourfuture performance. As a result of the September 11, 2001 events in New York City andWashington, D.C., U.S. and global economies may weaken, which may result in adecrease in our revenues and cause our stock price to decline. In addition, itis anticipated that in the wake of these events, U.S. and global capitalmarkets will experience a period of extreme volatility.Intense Competition in the Market for Networking Equipment Could Prevent Usfrom Increasing Revenue and Sustaining Profitability The market for networking equipment is intensely competitive. Our principalcompetitors include Cisco Systems, Enterasys Networks, Foundry Networks, NortelNetworks and Riverstone Networks. In addition, a number of private companieshave announced plans for new products that may compete with our own products.Some of our current and potential competitors have superior market leverage,longer operating histories and substantially greater financial, technical,sales, and marketing resources, in addition to wider name recognition andlarger installed customer bases. These competitors may have developed, or mayin the future develop, new competing products based on technologies thatcompete with our own products or render our products obsolete. Furthermore, anumber of these competitors may merge or form strategic partnerships thatenable them to offer or bring to market competitive products. To remain competitive, we believe that we must, among other things, investsignificant resources in developing new products, improve our current productsand maintain customer satisfaction. If we fail to do so, we may not competesuccessfully with our competitors, which could have a material adverse effecton our revenue and future profitability.We Expect the Average Selling Prices of Our Products to Decrease Which MayReduce Gross Margins or Revenue The network equipment industry has experienced rapid erosion of averageselling prices due to a number of factors, including competitive pricingpressures, promotional pricing, rapid technological change and a 30slowdown in the economy that has resulted in excess inventory and lower pricesas companies attempt to liquidate this inventory. We may experience substantialdecreases in future operating results due to the erosion of our average sellingprices. We anticipate that the average selling prices of our products willdecrease in the future in response to competitive pricing pressures, increasedsales discounts and new product introductions by us or our competitors,including, for example, competitive products manufactured with low-costmerchant silicon. Competitive pressures are expected to increase as a result ofthe industry slowdown that occurred in the first half of 2001 coupled with therecent downturn in the broader economy. To maintain our gross margins, we mustdevelop and introduce on a timely basis new products and product enhancementsand continually reduce our product costs. Our failure to do so would cause ourrevenue and gross margins to decline, which could have a material adverseeffect on our operating results and cause the price of our common stock todecline.Some of Our Customers May Not Have the Resources to Pay for Our Products as aResult of the Current Economic Environment With the recent economic slowdown, some of our customers are forecastingthat their revenue for the foreseeable future will generally be lower thananticipated. Some of these customers are experiencing, or are likely toexperience, serious cash flow problems and they are finding it increasinglydifficult to obtain financing on attractive terms, if at all. As a result, ifsome of these customers are not successful in generating sufficient revenue orsecuring alternate financing arrangements, they may not be able to pay, or maydelay payment for the amounts that they owe us. Furthermore, they may not orderas many products from us as originally forecast. The inability of some of ourpotential customers to pay us for our products may adversely affect our cashflow and the timing of our revenue recognition, which may cause our stock priceto decline.The Market in Which We Compete is Subject to Rapid Technological Change and toCompete We 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 ourproducts. Alternative technologies could achieve widespread market acceptanceand displace the Ethernet technology on which we have based our productarchitecture. We cannot assure you that our technological approach will achievebroad market acceptance or that other technologies or devices will not supplantour own products and technology. 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 could havea material adverse effect on our operating results by unexpectedly decreasingsales, increasing inventory levels of older products and exposing us to greaterrisk of product obsolescence. The market for switching products is evolving andwe believe our ability to compete successfully in this market is dependent uponthe continued compatibility and interoperability of our products with productsand architectures offered by other vendors. In particular, the networkingindustry has been characterized by the successive introduction of newtechnologies 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 or are compatiblewith these emerging technologies. We cannot assure you that new products willbe commercially successful. We have experienced delays in releasing newproducts and product enhancements in the past that resulted in lower quarterlyrevenue than anticipated. We may experience similar delays in productdevelopment and releases in the future, and any delay in product introductioncould adversely affect our ability to compete, causing our operating results tobe below our expectations or the expectations of public market analysts orinvestors.Continued Rapid Growth Will Strain Our Operations and Will Require Us to IncurCosts to Upgrade Our Infrastructure We have experienced a period of rapid growth and expansion that has placed,and continues to place, a significant strain on our resources. Even if wemanage this growth effectively, we may make mistakes in 31operating our business such as inaccurate sales forecasting, incorrect materialplanning or inaccurate financial reporting. This may lead to unanticipatedfluctuations in our operating results. Our net revenue increased significantlyduring the last fiscal year, and from June 30, 2000 to June 30, 2001, thenumber of our employees increased from 680 to 970. We expect our anticipatedgrowth and expansion to strain our management, operational and financialresources. Our management team has had limited experience managing rapidlygrowing companies on a public or private basis. To accommodate this anticipatedgrowth, we will be required to: . improve and update operational, information and financial systems, procedures and controls; . hire, train and manage additional qualified personnel in the fields of engineering, sales, marketing and networking technology; and . effectively manage multiple relationships with our customers, suppliers and other third parties. We may not be able to install adequate control systems in an efficient andtimely manner, and our current or planned personnel systems, procedures, andcontrols may not be adequate to support our future operations. We may need tomodify and improve our management information system to meet the increasingneeds associated with our growth. The difficulties associated with installingand implementing these new systems, procedures, and controls may place asignificant burden on our management and our internal resources. In addition,as we grow internationally, we need to expand our worldwide operations andenhance our communications infrastructure. Any delay in the implementation ofsuch new or enhanced systems, procedures or controls, or any disruption in thetransition to such new or enhanced systems, procedures or controls, couldadversely affect our ability to accurately forecast sales demand, manage oursupply chain, and record and report financial and management information on atimely and accurate basis.We Must Develop and Expand Our Indirect Distribution Channels to Increase NetRevenue and Improve Our Operating Results Our distribution strategy focuses primarily on developing and expandingindirect distribution channels through resellers and distributors, in additionto expanding our field sales organization. If we fail to develop and cultivaterelationships with significant resellers, or if these resellers are notsuccessful in their sales efforts, sales of our products may decrease and ouroperating results would suffer. Many of our resellers also sell products thatcompete with our products. We are developing a two-tier distribution structurein Europe and the United States that has required, and will in the futurerequire, us to enter into agreements with a number of stocking distributors. Wehave entered into two-tier distribution agreements; however, we cannot assureyou that we will be able to enter into additional distribution agreements orthat we will be able to successfully manage the transition of resellers to atwo-tier distribution channel. Our failure to do any of these could limit ourability to grow or sustain revenue. In addition, our operating results willlikely fluctuate significantly depending on the timing and amount of ordersfrom our resellers. We cannot assure you that our resellers will market ourproducts effectively or continue to devote the resources necessary to provideus with effective sales, marketing and technical support. In an effort to support and develop leads for our indirect distributionchannels and to attempt to expand our direct sales to customers, we plan tocontinue to expand our field sales and support staff. We cannot assure you thatthis internal expansion will be successfully completed, that the cost of thisexpansion will not exceed the net revenue generated, or that our expanded salesand support staff will be able to compete successfully against thesignificantly more extensive and well-funded sales and marketing operations ofmany of our current or potential competitors. Our inability to effectivelyestablish our distribution channels or manage the expansion of our sales andsupport staff may have a material adverse effect on our ability to grow ourbusiness and increase revenue.Most of Our Revenue is Derived From Sales of Three Product Families, So We areDependent on Widespread Market Acceptance of These Products In the year ended June 30, 2001, we derived substantially all of our revenuefrom sales of our Summit, BlackDiamond and Alpine products. We expect thatrevenue from these product families will account for a 32substantial portion of our revenue for the foreseeable future. Accordingly,widespread market acceptance of our product families is vital to our futuresuccess. Factors that may affect the sales of our products, some of which arebeyond our control, include: . the demand for switching products (Gigabit Ethernet and Layer 3 switching technologies in particular) in the enterprise, service provider and MAN markets; . the performance, price and total cost of ownership of our products; . the availability and price of competing products and technologies; . our ability to match supply with demand for certain products; and . the success and development of our resellers, distributors and field sales channels.Future Performance will Depend on the Introduction and Acceptance of NewProducts 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. In the past, we haveexperienced delays in product development and such delays may occur in thefuture. We introduced a new product family in fiscal 2000 that is based on asecond-generation chipset. We also introduced other products incorporating thischipset within our existing product lines. The introduction of new and enhancedproducts may cause our customers to defer or cancel orders for existingproducts. Therefore, to the extent customers defer or cancel orders in theexpectation of new product releases, any delay in the development orintroduction of new products could cause our operating results to suffer. Therisk that we will be unable to achieve and maintain widespread levels of marketacceptance for our current and future products may significantly impair ourrevenue growth.If a Key Reseller, Distributor, or Other Significant Customer Cancels or Delaysa Large Purchase, Our Net Revenue May Decline and the Price of Our Stock MayFall To date, a limited number of resellers, distributors and other customershave accounted for a significant portion of our revenue. If any of our largecustomers stop or delay purchases, our revenue and profitability would beadversely affected. For example, for the fiscal year ended June 30, 2001, TechData Corporation accounted for 16% of our net revenue. Our expense levels arebased on our expectations as to future revenue and to a large extent are fixedin the short term, so a substantial reduction or delay in sales of our productsto a significant reseller, distributor or other customer could harm ourbusiness, operating results and financial condition. Although our largestcustomers may vary from period-to-period, we anticipate that our operatingresults for any given period will continue to depend to a significant extent onlarge orders from a relatively small number of customers, particularly in viewof the high per unit sales price of our products and the length of our salescycles. While our financial performance depends on large orders from a limitednumber of key resellers, distributors and other significant customers, we donot have binding purchase commitments from any of them. For example: . our service provider and enterprise customers can stop purchasing and our resellers and distributors can stop marketing our products at any time; . our reseller agreements are non-exclusive and are for one-year terms, with no obligation upon the resellers to renew the agreements; and . our reseller, distributor and end-user customer agreements generally do not require minimum purchases. Under specified conditions, some third-party distributors are allowed toreturn products to us. We defer recognition of revenue on sales to distributorsuntil the distributors sell the product.The Sales Cycle for Our Products is Long and We May Incur SubstantialNon-Recoverable Expenses or Devote Significant Resources to Sales that Do NotOccur When Anticipated The timing of our revenue is difficult to predict because of our reliance onindirect sales channels and the length and variability of our sales cycle. Ourproducts have a relatively high per unit sales price, and the purchase 33of our products often constitutes a significant strategic decision by anenterprise regarding its communications infrastructure. The decision bycustomers to purchase our products is often based on the results of a varietyof internal procedures associated with the evaluation, testing, implementationand acceptance of new technologies. Accordingly, the product evaluation processfrequently results in a lengthy sales cycle, typically ranging from threemonths to longer than a year, and as a result, our ability to sell products issubject to a number of significant risks, including: . the risk that budgetary constraints and internal acceptance reviews by customers will result in the loss of potential sales; . the risk of substantial variation in the length of the sales cycle from customer to customer, making decisions on the expenditure of resources difficult to assess; . the risk that we may incur substantial sales and marketing expenses and expend significant management time in an attempt to initiate or increase the sale of products to customers, but not succeed; and . the risk that, if a sales forecast from a specific customer for a particular quarter is not achieved in that quarter, we may be unable to compensate for the shortfall, which could harm our operating results.We Purchase Several Key Components for Products From Single or Limited Sourcesand Could Lose Sales if These Suppliers Fail to Meet Our 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 tantalumcapacitors, static random access memory, or SRAM, and printed circuit boardshave been, and may be in the future, in short supply. While we have been ableto meet our needs to date, we have in the past, and are likely in the future,to encounter shortages and delays in obtaining these or other components andthis could have a material adverse effect on our ability to meet customerorders. Our principal sole-source components include: . ASICs; . microprocessors; . programmable integrated circuits; . selected other integrated circuits; . cables; . custom power supplies; and . custom-tooled sheet metal. Our principal limited-source components include: . flash memories; . dynamic and static random access memories, or DRAMs and SRAMs, respectively; and . printed circuit boards. We use our forecast of expected demand to determine our materialrequirements. Lead times for materials and components we order varysignificantly, and depend on factors such as the specific supplier, contractterms and demand for a component at a given time. If orders exceed forecasts,we may have inadequate inventory of certain materials and components, whichcould have a material adverse effect on our operating results and financialcondition. We do not have agreements fixing long-term prices or minimum volumerequirements from these suppliers. 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 haveexperienced delays in the prototyping of our ASICs, which in turn has led todelays in product introductions. We cannot assure you that such delays will notoccur in the future. 34Our Dependence on Contract Manufacturers for Substantially All of OurManufacturing Requirements Could Harm Our Operating Results 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 independent contractors to manufacture our products. We do nothave long-term contracts with any of these manufacturers. We currently utilizethree companies - Flextronics International, Ltd., located in San Jose,California, Solectron Corporation, located in Milpitas, California, and MCMS,Inc., located in Nampa, Idaho. We have experienced delays in product shipmentsfrom contract manufacturers in the past, which in turn delayed productshipments to our customers. Similar or other problems may arise in the future,such as inferior quality, insufficient quantity of products, or theinterruption or discontinuance of operations of any manufacturer, any of whichcould have a material adverse effect on our business and operating results. Specifically, as stated in their Form 10-Q filed with the Securities andExchange Commission on July 16, 2001, MCMS faces severe near-term liquidityproblems. In the wake of a significant deterioration in demand from nearly allof their customers, over-advances on a revolving credit facility andnon-compliance with a covenant requirement have created events of default underthe terms of the credit facility. It is not clear whether MCMS will be able tosuccessfully reorganize its operations. Accordingly, we are addressing thissituation by perfecting security interests in our personal property located onthe premises of MCMS, obtaining a written acknowledgement from MCMS in regardto manufacturing equipment, products and materials owned and/or leased by usthat are located on the premises of MCMS, and managing the orderly transitionof production processes to other manufacturers. Our inability to execute thisplan may cause a delay in our ability to fulfill orders and may have a materialadverse effect on our business, operating results and financial condition. OnSeptember 18, 2001 MCMS announced that it had reached an agreement to sellsubstantially all of its operating assets to Manufacturers' Services Limited.Simultaneously, MCMS announced that it, and its two U.S. subsidiaries, havevoluntarily filed for protection under Chapter 11 of the U.S. Bankruptcy Codein the United States Bankruptcy Court for the District of Delaware inWilmington to implement the sale. We do not know whether we will effectively manage our contract manufacturersor that these manufacturers will meet our future requirements for timelydelivery of products of sufficient quality and quantity. We intend to regularlyintroduce new products and product enhancements, which will require that werapidly achieve a critical mass of volume production by coordinating ourefforts with those of our suppliers and contract manufacturers. The inabilityof our contract manufacturers to provide us with adequate supplies ofhigh-quality products or the loss of any of our contract manufacturers maycause a delay in our ability to fulfill orders and may have a material adverseeffect on our business, operating results and financial condition. As part of our cost-reduction efforts, we will need to realize lower perunit product costs from our contract manufacturers by means 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.Our Limited Ability to Protect Our Intellectual Property and Defend AgainstClaims May Adversely Affect Our 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 or that other parties willnot independently develop similar or competing products that do not infringe onour patents. Our industry is characterized by the existence of a large numberof patents and frequent claims and related litigation regarding patent andother intellectual 35property rights. We are actively involved in disputes and licensing discussionswith others regarding their claimed proprietary rights. If we infringe theproprietary rights of others, we could be compelled to either obtain a licenseto those intellectual property rights or alter our products so that these nolonger infringe upon such proprietary rights. Any license could be veryexpensive to obtain or may not be available at all. Similarly, changing ourproducts or processes to avoid infringing the rights of others may be costly orimpractical. Litigation resulting from claims that we are infringing thepropriety rights of others could result in substantial costs and a diversion ofresources, and could have a material adverse effect on our business, financialcondition and results of operations. The networking industry in which we operate is prone to intellectualproperty claims by and among competing parties. We cannot assure you that wewill always successfully defend ourselves against such claims. We enter into confidentiality or license agreements with our employees,consultants and corporate partners, and control access to and distribution ofour software, documentation and other proprietary information. Despite ourefforts to protect our proprietary rights, unauthorized parties may attempt tocopy or otherwise misappropriate or use our products or technology.We Are Engaged in Litigation Regarding Intellectual Property Rights, and anAdverse Outcome Could Harm Our Business and Require Us to Incur SignificantCosts We have received notice from three major companies alleging that we areinfringing their patents. One of these companies, Nortel Networks, filed aclaim against us alleging patent infringement and we are in litigation as ofthe date of this filing. Following examination of this claim, we have deniedNortel's allegations and intend to defend the action vigorously. Without regardto the merits of this or any other claim, if judgments by a court of law onthis or any other claim received in the future were to be upheld, theconsequences to us may be severe and could require us to, among other actions: . stop selling our products that incorporate the challenged intellectual property; . obtain a license to sell or use the relevant technology, which license may not be available on reasonable terms or available at all; . pay damages; or . redesign those products that use the disputed technology. If we are compelled to take any of the foregoing actions, our business couldbe severely harmed.We and Manufacturers of Our Products Rely on a Continuous Power Supply toConduct Operations, and California's Current Energy Crisis Could Disrupt OurBusiness and Increase Our Expenses California is in the midst of an energy crisis that could disrupt ouroperations and increase our expenses. In the event of an acute power shortage,that is, when power reserves for California fall below 1.5%, electricityproviders have on some occasions implemented, and may in the future continue toimplement, rolling blackouts. Two of the three manufacturers of our products,Flextronics and Solectron, are located in California. As a result of thiscrisis, these contractors may be unable to manufacture sufficient quantities ofour products to meet our needs, or they may increase the fees charged for theirservices. We do not have long-term contracts with either Flextronics orSolectron. The inability of our contract manufacturers to provide us withadequate supplies of products would cause a delay in our ability to fulfill ourorders, which could harm our business, and any increase in their fees couldadversely affect our financial condition. In addition, the majority of our operations are located in California. Wecurrently do not have backup generators or alternate sources of power in theevent of a blackout. If blackouts interrupt our power supply, we wouldtemporarily be unable to continue operations at our facilities. Any suchinterruption in our ability to continue operations at these facilities coulddamage our reputation, harm our ability to retain existing customers and toobtain new customers, and could result in lost revenue, any of which couldsubstantially harm our business and results of operation. 36Our Headquarters Are Located in Northern California Where Disasters May OccurThat Could Disrupt Our Operations and Harm Our Business Our corporate headquarters are located in Silicon Valley in NorthernCalifornia. Northern California historically has been vulnerable to naturaldisasters and other risks, such as earthquakes, fires and floods, which attimes have disrupted the local economy and posed physical risks to our and ourmanufacturers' property. In addition, terrorist acts or acts of war targeted at the U.S andspecifically Silicon Valley could cause damage or disruption to Extreme, ouremployees, facilities, partners, suppliers, distributors and resellers, andcustomers which could have a material adverse effect on our operations andfinancial results. We currently do not have redundant, multiple site capacity in the event of anatural disaster or catastrophic event. In the event of such an occurrence, ourbusiness would suffer.If We Lose Key Personnel or are Unable to Hire Additional Qualified Personnelas Necessary, We May Not Be Able to Successfully Manage Our Business or AchieveOur Objectives Our success depends to a significant degree upon the continued contributionsof our key management, engineering, sales and marketing and operationspersonnel, 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. Wedo not have employment contracts with these personnel nor do we carry lifeinsurance on any of our key personnel. 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 operations personnel. The market for these personnel iscompetitive, especially in the San Francisco Bay Area, and we have haddifficulty hiring employees, particularly software engineers, in the timeframewe desire. In addition, retention has become more difficult for us and otherpublic technology companies as a result of the recent stock market decline,which has caused many of our employees' options to be "under water." There canbe no assurance that we will be successful in attracting and retaining suchpersonnel. The loss of the services of any of our key personnel, the inabilityto attract or retain qualified personnel in the future or delays in hiringdesired personnel, particularly engineers and sales personnel, could make itdifficult for us to manage our business and meet key objectives, such as newproduct introductions. In addition, companies in the networking industry whoseemployees accept positions with competitors frequently claim that competitorshave engaged in unfair hiring practices. We have from time to time receivedclaims like this from other companies and, although to date they have notresulted in material litigation, we do not know whether we will receiveadditional claims in the future as we seek to hire qualified personnel or thatsuch claims will not result in material litigation. We could incur substantialcosts in defending against any such claims, regardless of the merits of suchclaims.Our Products Must Comply With Evolving Industry Standards and ComplexGovernment Regulations or Else Our Products May Not Be Widely Accepted, WhichMay Prevent Us From Growing Our Net Revenue 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. Our products must complywith various U.S. federal government regulations and standards defined byagencies such as the Federal Communications Commission, in addition tostandards established by governmental authorities in various foreign countriesand recommendations of the International Telecommunication Union. If we do notcomply with existing or evolving industry standards 37or if we fail to obtain timely domestic or foreign regulatory approvals orcertificates we will not be able to sell our products where these standards orregulations apply, which may prevent us from sustaining our net revenue orachieving profitability.Failure to Successfully Expand Our Sales and Support Organizations or EducateThem About Our Product Families May Harm Our Operating Results The sale of our products and services requires a concerted effort targetedat several levels within a prospective customer's organization. We may not beable to increase net revenue unless we expand our sales force. We cannot assureyou that we will be able to successfully integrate new employees into ourcompany or to educate our employees about our rapidly evolving productfamilies. A failure to do so may hurt our revenue growth and consequently hurtour operating results.We Depend Upon International Sales for a Significant Portion of Our Revenue andOur Ability to Increase Our International Sales Depends on SuccessfullyExpanding Our International Operations International sales constitute a significant portion of our sales. Ourability to grow will depend in part on the continued expansion of internationalsales. Sales to customers outside of North America accounted for approximately55% and 43% of our net revenue in fiscal 2001 and fiscal 2000, respectively.Our international sales primarily depend on our resellers and distributors. Thefailure of our resellers and distributors to sell our products internationallywould limit our ability to sustain and grow our revenue. In addition, there area number of risks arising from our international business, including: . longer accounts receivable collection cycles; . difficulties in managing operations across disparate geographic areas; . difficulties associated with enforcing agreements through foreign legal systems; . the payment of operating expenses in local currencies, which exposes us to risks of currency fluctuations; . import or export licensing requirements; . difficulty in safeguarding intellectual property; . political and economic turbulence; . potential adverse tax consequences; and . unexpected changes in regulatory requirements, including export restrictions. Our international sales currently are U.S. dollar-denominated. As a result,an increase in the value of the U.S. dollar relative to foreign 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 expose us to fluctuations in exchange rates between theU.S. dollar and the particular local currency. If we do so, we may decide toengage in hedging transactions to minimize the risk of such fluctuations. Wehave entered into foreign exchange forward contracts to offset the impact ofpayment of operating expenses in local currencies to some of our operatingforeign subsidiaries. However, if we are not successful in managing thesehedging transactions, we could incur losses from hedging activities.We May Engage in Future Acquisitions that Dilute the Ownership Interests of OurStockholders, Cause Us to Incur Debt and Assume Contingent Liabilities As part of our business strategy, we review acquisition and strategicinvestment prospects that would complement our current product offerings,augment our market coverage or enhance our technical capabilities, or that mayotherwise offer growth opportunities. We are reviewing investments in newbusinesses and we expect to make investments in, and to acquire, businesses,products, or technologies in the future. In the event of any futureacquisitions, we could: 38 . issue equity securities which would dilute current stockholders' percentage ownership; . incur substantial debt; . assume contingent liabilities; or . expend significant cash. These actions by us could have a material adverse effect on our operatingresults and/or the price of our common stock. In addition, with anyacquisition, we may be required to absorb the costs associated with theacquisition long before we are able to realize any benefits from theacquisition. Acquisitions and investment activities also entail numerous risks,including: . difficulties in the assimilation of acquired operations, technologies or products; . unanticipated costs associated with the acquisition or investment transaction; . the diversion of management's attention from other business concerns; . adverse effects on existing business relationships with suppliers and customers; . risks associated with entering markets in which we have no or limited prior experience; . the potential loss of key employees of acquired organizations; . substantial charges for the amortization of certain purchased intangible assets, deferred stock compensation or similar items; and . impairment charges taken in the future for goodwill amounts that cannot be supported in future periods. We cannot assure you that we will be able to successfully integrate anybusinesses, products, technologies, or personnel that we might acquire in thefuture, and our failure to do so could have a material adverse effect on ourbusiness, operating results and financial condition. Moreover, even if we doobtain benefits in the form of increased sales and earnings, there may be a lagbetween the time when the expenses associated with an acquisition are incurredand the time when we recognize such benefits. This is particularly relevant incases where it is necessary to integrate new types of technology into ourexisting portfolio and new types of products may be targeted for potentialcustomers with which we do not have pre-existing relationships.We May Need Additional Capital to Fund Our Future Operations and, If It Is NotAvailable When Needed, We May Need to Reduce Our Planned Development andMarketing Efforts, Which May Reduce Our Net Revenue and Prevent Us FromAchieving Profitability We believe that our existing working capital, based on proceeds from theinitial public offering in April 1999, proceeds from the secondary offering inOctober 1999, and cash available from credit facilities and future operations,will enable us to meet our working capital requirements for at least the next12 months. However, if cash from future operations is insufficient, or if cashis used for acquisitions or other currently unanticipated uses, we may needadditional capital. The development and marketing of new products and theexpansion of reseller and distribution channels and associated supportpersonnel requires a significant commitment of resources. In addition, if themarkets for our products develop more slowly than anticipated, or if we fail toestablish significant market share and achieve sufficient net revenue, we maycontinue to consume significant amounts of capital. As a result, we could berequired to raise 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 of the shares held by existingstockholders. If additional funds are raised through the issuance of debtsecurities, such securities may provide the holders certain rights,preferences, and privileges senior to those of common stockholders, and theterms of such debt could impose restrictions on our operations. We cannotassure you that additional capital, if required, will be available onacceptable terms, or at all. If we are unable to 39obtain sufficient amounts of additional capital, we may be required to reducethe scope of our planned product development and marketing efforts, which couldharm our business, financial condition and operating results.If Our Products Contain Undetected Software or Hardware Errors, We Could IncurSignificant Unexpected Expenses and Lose Sales Network products frequently contain undetected software or hardware errorswhen new versions are first released to the marketplace. In the past, we haveexperienced such errors in connection with new products and product upgrades.We expect that such errors will be found from time to time in new or enhancedproducts after the commencement of commercial shipments. These problems mayhave a material adverse effect on our business by causing us to incursignificant warranty and repair costs, diverting the attention of ourengineering personnel from new product development efforts, and causingsignificant customer relations problems. Our products must successfully interoperate with products from othervendors. As a result, when problems occur in a network, it may be difficult toidentify the sources of these problems. 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 cause us to incur significant expenses. The occurrenceof any such problems would likely have a material adverse effect on ourbusiness, operating results and financial condition.Provisions in Our 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; and . the ability of the board of directors to alter our bylaws without getting stockholder approval. Furthermore, we are subject to the provisions of section 203 of the 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. Inaddition, we recently adopted a stockholders' rights agreement as described inNote 6 of Notes to Consolidated Financial Statements.Item 7A. Quantitative and Qualitative Disclosures About Market RiskInterest Rate Sensitivity The primary objective of our investment activities is to preserve principalwhile at the same time maximize 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 andshort-term investments in a variety of securities, including commercial paper,other non-government debt securities and money market funds. In general, moneymarket funds are not subject to market risk because the interest paid on suchfunds fluctuates with the prevailing interest rate. The following tablepresents the amounts of our cash equivalents and short-term investments thatare subject to market risk by range of expected maturity 40and weighted-average interest rates as of June 30, 2001 and June 30, 2000. Thistable does not include money market funds because those funds are not subjectto market risk. Maturing in ------------------------------------ ------- Three Three Greater months or months to than one Fair less one year year Total Value --------- --------- -------- ------- ------- June 30, 2001: (In thousands) Included in cash and cash equivalents.. $36,846 $36,846 $36,846 Weighted average interest rate..... 4.53% Included in short-term investments..... $69,374 $69,374 $69,374 Weighted average interest rate..... 6.94% Included in investments................ $34,406 $34,406 $34,406 Weighted average interest rate..... 4.72% Maturing in ------------------------------------ ------- Three Three Greater months or months to than one Fair less one year year Total Value --------- --------- -------- ------- ------- June 30, 2000: (In thousands) Included in cash and cash equivalents.. $88,324 $88,324 $88,324 Weighted average interest rate..... 6.37% Included in short-term investments..... $66,640 $66,640 $66,640 Weighted average interest rate..... 6.50% Included in investments................ $44,144 $44,144 $44,144 Weighted average interest rate..... 7.29%Exchange Rate Sensitivity Currently, all of our sales and the majority of our expenses are denominatedin U.S. dollars and as a result, we have experienced no significant foreignexchange gains and losses to date. While we have conducted some transactions inforeign currencies during the year ended June 30, 2001 and expect to continueto do so, we do not anticipate that foreign exchange gains or losses will besignificant.Foreign Exchange Forward Contracts We enter into foreign exchange forward contracts to offset the impact ofcurrency fluctuations on certain nonfunctional operating expenses, denominatedin Japanese Yen, the Euro, Swedish Krona and British pound. The foreignexchange forward contracts we enter into have original maturities ranging fromone to three months. We do not enter into foreign exchange forward contractsfor trading purposes. Extreme did not hold any foreign exchange forwardcontracts as of June 30, 2001 (see Note 5 of Notes to Consolidated FinancialStatements). 41Item 8. Financial Statements and Supplementary Data. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF EXTREME NETWORKS, INC. Page(s) ------- Consolidated Balance Sheets...................... 43Consolidated Statements of Operations............ 44Consolidated Statements of Cash Flows............ 45Consolidated Statement of Stockholders' Equity... 46Notes to Consolidated Financial Statements....... 47Report of Ernst & Young LLP, Independent Auditors 67Quarterly Financial Data (unaudited)............. 68 42 EXTREME NETWORKS, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except par value and share amounts) June 30, ------------------ 2001 2000 -------- -------- ASSETSCurrent assets: Cash and cash equivalents.......................................................... $ 87,722 $116,721 Short-term investments............................................................. 69,374 66,640 Accounts receivable, net of allowance for doubtful accounts of $1,942 ($1,237 in 2000)................................................................. 75,738 60,996 Inventories........................................................................ 60,529 23,801 Deferred taxes..................................................................... 35,855 13,800 Other current assets............................................................... 21,543 20,526 -------- -------- Total current assets........................................................... 350,761 302,484Property and equipment, net........................................................... 57,251 26,750Restricted investments................................................................ 80,000 80,000Investments........................................................................... 34,406 44,144Goodwill and purchased intangible assets, net......................................... 113,886 49,782Deferred taxes........................................................................ 40,028 4,600Other assets.......................................................................... 12,025 8,170 -------- -------- $688,357 $515,930 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities: Accounts payable................................................................... $ 35,890 $ 39,023 Accrued compensation and benefits.................................................. 13,309 11,041 Accrued purchase commitments....................................................... 9,926 506 Leasehold improvements allowance................................................... 6,662 8,424 Deferred revenue................................................................... 57,372 22,042 Other accrued liabilities.......................................................... 16,170 15,567 -------- -------- Total current liabilities...................................................... 139,329 96,603Long-term deposit..................................................................... 266 306Commitments and contingencies (Note 4)Stockholders' equity: Convertible preferred stock, $.001 par value, issuable in series; 2,000,000 shares authorized; none issued.......................................................... -- -- Common stock, $.001 par value; 750,000,000 shares authorized; 113,416,000 issued and outstanding (106,670,000 in 2000) and capital in excess of par value......... 640,655 423,150 Deferred stock compensation........................................................ (20,351) (78) Accumulated other comprehensive income (loss)...................................... 769 (623) Accumulated deficit................................................................ (72,311) (3,428) -------- -------- Total stockholders' equity..................................................... 548,762 419,021 -------- -------- $688,357 $515,930 ======== ======== See accompanying notes to consolidated financial statements. 43 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) Years Ended June 30, ---------------------------- 2001 2000 1999 --------- -------- ------- Net revenue $ 491,232 $261,956 $98,026Costs and expenses: Cost of revenue.......................................................... 281,232 126,916 48,520 Research and development................................................. 57,876 32,998 17,036 Sales and marketing...................................................... 154,601 67,146 27,056 General and administrative............................................... 25,789 11,852 6,859 Amortization of goodwill, purchased intangible assets and deferred stock compensation........................................................... 37,530 6,790 -- Other operating expenses................................................. 36,097 -- -- --------- -------- ------- Total costs and expenses............................................. 593,125 245,702 99,471 --------- -------- -------Operating income (loss)..................................................... (101,893) 16,254 (1,445)Interest income............................................................. 15,474 14,638 1,855Interest expense............................................................ (387) (490) (398)Other income (expense), net................................................. (4,745) (33) 21 --------- -------- -------Income (loss) before income taxes........................................... (91,551) 30,369 33Provision (benefit) for income taxes........................................ (22,668) 10,321 1,650 --------- -------- -------Net income (loss)........................................................... $ (68,883) $ 20,048 $(1,617) ========= ======== =======* Net income (loss) per share--basic........................................ $ (0.64) $ 0.20 $ (0.09)* Net income (loss) per share--diluted...................................... $ (0.64) $ 0.18 $ (0.09)* Shares used in per share calculation--basic............................... 108,353 100,516 18,924* Shares used in per share calculation--diluted............................. 108,353 111,168 18,924 See accompanying notes to consolidated financial statements.* Share and per-share data presented reflect the two-for-one stock spliteffective August 24, 2000. 44 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Years Ended June 30, ----------------------------- 2001 2000 1999 -------- --------- -------- Operating activities Net income (loss).................................................. $(68,883) $ 20,048 $ (1,617) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation..................................................... 19,328 6,992 5,733 Amortization..................................................... 33,387 7,052 -- Provision for doubtful accounts.................................. 5,274 -- 1,364 Provision for inventory reserves................................. 32,753 1,144 1,087 Deferred income taxes............................................ (64,173) (18,400) -- In-process research and development.............................. 30,142 -- -- Tax benefits from employee stock transactions.................... 45,020 21,600 -- Warrants issued to a business partner............................ -- -- 948 Amortization of deferred stock compensation...................... 4,143 119 172 Equity share of affiliate losses and write-down of investments... 4,942 248 -- Loss on retirement of assets..................................... 2,886 -- -- Compensation expense for options granted to consultants.......... 841 176 -- Changes in operating assets and liabilities; excluding impact of acquisitions: Accounts receivable............................................. (20,016) (40,199) (14,353) Inventories..................................................... (69,481) (22,319) (3,590) Other current and noncurrent assets............................. (2,950) (18,832) (1,392) Accounts payable................................................ (3,262) 25,605 3,425 Accrued compensation and benefits............................... 2,268 6,941 3,165 Accrued purchase commitments.................................... 9,420 -- -- Leasehold improvements allowance................................ (1,762) 8,424 -- Deferred revenue................................................ 35,330 20,325 1,434 Other accrued liabilities....................................... 180 5,589 6,377 Long term deposit............................................... (40) 306 -- -------- --------- -------- Net cash provided by (used in) operating activities................ (4,653) 24,819 2,753 -------- --------- --------Investing activities Capital expenditures............................................... (51,224) (27,236) (7,492) Purchases and maturities of investments............................ 8,398 (158,770) (21,636) Acquisition of business, net of cash assumed....................... 1,179 -- -- Minority investments............................................... (7,750) (8,970) -- -------- --------- -------- Net cash used in investing activities.............................. (49,397) (194,976) (29,128) -------- --------- --------Financing activities Proceeds from issuance of common stock............................. 25,051 181,383 126,622 Proceeds from notes payable........................................ -- -- 783 Principal payments on notes payable................................ -- -- (2,784) Principal payments of capital lease obligations.................... -- (1,648) (613) -------- --------- -------- Net cash provided by financing activities.......................... 25,051 179,735 124,008 -------- --------- -------- Net increase (decrease) in cash and cash equivalents............... (28,999) 9,578 97,633Cash and cash equivalents at beginning of year....................... 116,721 107,143 9,510 -------- --------- --------Cash and cash equivalents at end of year............................. $ 87,722 $ 116,721 $107,143 ======== ========= ========Supplemental disclosure of cash flow information: Interest paid...................................................... $ 387 $ 744 $ 185 Cash paid (refund received) for taxes.............................. $ (3,803) $ 5,828 --Supplemental schedule of noncash investing and financing activities: Property and equipment acquired under capital lease obligations.... $ -- $ -- $ 278 Warrants issued for goodwill and purchased intangibles............. $ -- $ 54,324 $ -- Warrants issued to a business partner.............................. $ -- $ -- $ 948 Conversion of preferred stock to common stock...................... $ -- $ -- $ 58 See accompanying notes to consolidated financial statements. 45 EXTREME NETWORKS, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (in thousands) Common Stock and Convertible capital in excess of Accumulated Preferred Stock par value Deferred Other -------------- -------------------- Stock Comprehensive Shares Amount Shares Amount Compensation Income (Loss) ------- ------ ------- -------- ------------ ------------- Balances at June 30, 1998............................... 58,122 $ 58 23,070 $ 38,039 $ (369) $ --Components of comprehensive loss: Net loss........................................... -- -- -- -- -- -- Change in unrealized loss on investments........... -- -- -- -- -- (112) Foreign currency translation adjustment............ -- -- -- -- -- (6) Total comprehensive loss........................... -- -- -- -- -- --Issuance of warrants to purchase common stock........... -- -- -- 948 -- --Issuance of common stock in conjunction with initial public offering (less issuance costs of $1,948)........ -- -- 16,100 125,322 -- --Conversion of preferred stock to common stock in conjunction with initial public offering............ (58,122) (58) 58,122 58 -- --Exercise of warrants to purchase common stock........... -- -- 264 -- -- --Exercise of options to purchase common stock, net of repurchases..................................... -- -- 1,134 1,300 -- --Amortization of deferred stock compensation............. -- -- -- -- 172 -- ------- ---- ------- -------- -------- ------Balances at June 30, 1999............................... -- -- 98,690 165,667 (197) (118)Components of comprehensive income: Net income......................................... -- -- -- -- -- -- Change in unrealized loss on investments........... -- -- -- -- -- (503) Foreign currency translation adjustment............ -- -- -- -- -- (2) Total comprehensive income......................... -- -- -- -- -- --Issuance of common stock in conjunction with secondary public offering (less issuance costs of $910) -- -- 4,748 174,028 -- --Exercise of warrants to purchase common stock........... -- -- 370 -- -- --Exercise of options to purchase common stock, net of repurchases..................................... -- -- 2,392 3,389 -- --Issuance of common stock under employee stock purchase plan.................................... -- -- 470 3,966 -- --Issuance of warrants for goodwill and purchased intangible assets...................................... -- -- -- 54,324 -- --Tax benefit from employee stock transactions............ -- -- -- 21,600 -- --Stock compensation for options granted to consultants... -- -- -- 176 -- --Amortization of deferred stock compensation............. -- -- -- -- 119 -- ------- ---- ------- -------- -------- ------Balances at June 30, 2000............................... -- -- 106,670 423,150 (78) (623)Components of comprehensive loss: Net loss........................................... -- -- -- -- -- -- Change in unrealized gain on investments........... -- -- -- -- -- 1,325 Foreign currency translation adjustment............ -- -- -- -- -- 67 Total comprehensive loss........................... -- -- -- -- -- --Exercise of warrants to purchase common stock........... -- -- 58 -- -- --Exercise of options to purchase common stock, net of repurchases..................................... -- -- 2,128 16,251 -- --Issuance of common stock under employee stock purchase plan.................................... -- -- 318 8,800 -- --Issuance of common stock and assumption of stock options in connection with acquisitions................ -- -- 4,242 146,593 (24,416) --Tax benefit from employee stock transactions............ -- -- -- 45,020 -- --Stock compensation for options granted to consultants... -- -- -- 841 -- --Amortization of deferred stock compensation............. -- -- -- -- 4,143 -- ------- ---- ------- -------- -------- ------Balances at June 30, 2001............................... -- $ -- 113,416 $640,655 $(20,351) $ 769 ======= ==== ======= ======== ======== ====== Total Accumulated Stockholders' Deficit Equity ----------- ------------- Balances at June 30, 1998............................... $(21,859) $ 15,869Components of comprehensive loss: Net loss........................................... (1,617) (1,617) Change in unrealized loss on investments........... -- (112) Foreign currency translation adjustment............ -- (6) -------- Total comprehensive loss........................... -- (1,735) --------Issuance of warrants to purchase common stock........... -- 948Issuance of common stock in conjunction with initial public offering (less issuance costs of $1,948)........ -- 125,322Conversion of preferred stock to common stock in conjunction with initial public offering............ -- --Exercise of warrants to purchase common stock........... -- --Exercise of options to purchase common stock, net of repurchases..................................... -- 1,300Amortization of deferred stock compensation............. -- 172 -------- --------Balances at June 30, 1999............................... (23,476) 141,876Components of comprehensive income: Net income......................................... 20,048 20,048 Change in unrealized loss on investments........... -- (503) Foreign currency translation adjustment............ -- (2) -------- Total comprehensive income......................... -- 19,543 --------Issuance of common stock in conjunction with secondary public offering (less issuance costs of $910) -- 174,028Exercise of warrants to purchase common stock........... -- --Exercise of options to purchase common stock, net of repurchases..................................... -- 3,389Issuance of common stock under employee stock purchase plan.................................... -- 3,966Issuance of warrants for goodwill and purchased intangible assets...................................... -- 54,324Tax benefit from employee stock transactions............ -- 21,600Stock compensation for options granted to consultants... -- 176Amortization of deferred stock compensation............. -- 119 -------- --------Balances at June 30, 2000............................... (3,428) 419,021Components of comprehensive loss: Net loss........................................... (68,883) (68,883) Change in unrealized gain on investments........... -- 1,325 Foreign currency translation adjustment............ -- 67 -------- Total comprehensive loss........................... -- (67,491) --------Exercise of warrants to purchase common stock........... -- --Exercise of options to purchase common stock, net of repurchases..................................... -- 16,251Issuance of common stock under employee stock purchase plan.................................... -- 8,800Issuance of common stock and assumption of stock options in connection with acquisitions................ -- 122,177Tax benefit from employee stock transactions............ -- 45,020Stock compensation for options granted to consultants... -- 841Amortization of deferred stock compensation............. -- 4,143 -------- --------Balances at June 30, 2001............................... $(72,311) $548,762 ======== ======== See accompanying notes to consolidated financial statements. 46 EXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS1) Summary of Significant Accounting Policies Nature of Operations and Basis of Presentation Extreme Networks, Inc. ("Extreme" or the "Company") was incorporated inCalifornia on May 8, 1996 and was reincorporated in Delaware on March 31, 1999.Extreme is a leading provider of network infrastructure equipment for businessapplications and services. The consolidated financial statements include the accounts of Extreme andits wholly-owned subsidiaries. All significant inter-company balances andtransactions have been eliminated. Investments in which Extreme intends tomaintain more than a temporary 20% to 50% interest, or otherwise has theability to exercise significant influence, are accounted for under the equitymethod. Investments in which we have less than a 20% interest and/or do nothave the ability to exercise significant influence are carried at the lower ofcost or estimated realizable value. Assets and liabilities of foreign operations are translated to U.S. dollarsat current rates of exchange, and revenues and expenses are translated usingweighted average rates. Foreign currency transaction gains and losses have notbeen significant. Gains and losses from foreign currency translation areincluded as a separate component of other comprehensive income (loss). Certain items previously reported in specific financial statement captionshave been reclassified to conform to the 2001 presentation. Suchreclassifications have not impacted previously reported operating income (loss)or net income (loss). Fiscal Year Effective July 1, 1999, Extreme changed its fiscal year from June 30/th/ toa 52/53-week fiscal accounting year. The June 30, 2001 year closed on July 1,2001 and comprised 52 weeks of revenue and expense activity. All referencesherein to "fiscal 2001" or "2001" represent the fiscal year ended July 1, 2001.Quarterly results are based upon a 13-week reporting period. Accounting Estimates The preparation of financial statements and related disclosures inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes. Estimates are usedfor, but not limited to, the accounting for the allowance for doubtfulaccounts, inventory reserves, depreciation and amortization, sales returns,warranty costs and income taxes. Actual results could differ materially fromthese estimates. Cash Equivalents and Short-Term and Long Term Investments Extreme considers cash and all highly liquid investment securities purchasedwith an original or remaining maturity of less than three months at the date ofpurchase to be cash equivalents. Extreme's investments comprise U.S., state andmunicipal government obligations and corporate securities. Investments withmaturities of less than one year are considered short term and investments withmaturities greater than one year are considered long term. 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 ofstockholders' equity. 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. 47 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Extreme also has certain other minority investments in privately heldcompanies. These investments are included in other assets on our balance sheetand are generally carried at cost. We monitor these investments for other thantemporary impairment and make appropriate reductions in carrying values whennecessary. Extreme recorded write-downs of $1.8 million during the year endedJune 30, 2001 related to impairments of its privately held investments. Noimpairment write-downs were recorded in fiscal 2000 or 1999. A total of $9.9million of carrying value remained as of June 30, 2001. Fair Value of Financial Instruments The carrying amounts of certain of Extreme's financial instruments,including cash and cash equivalents, approximate fair value because of theirshort maturities. The fair values of investments are determined using quotedmarket prices for those securities or similar financial instruments. Derivatives Extreme adopted Statement of Financial Accounting Standards ("SFAS") No.133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133")for the year ending June 30, 2001. We enter into foreign exchange forwardcontracts to offset the impact of currency fluctuations on certainnonfunctional operating expenses, denominated in Japanese Yen, the Euro,Swedish Krona and the British pound. The foreign exchange forward contracts weenter into have original maturities ranging from one to three months. We do notenter into foreign exchange forward contracts for trading purposes. We did nothold any forward contracts upon adoption of FAS 133 and recorded no transitionadjustments. Extreme did not hold any foreign exchange forward contracts as ofJune 30, 2001 (see Note 5). Transfer of Financial Assets From time to time, Extreme transfers specifically identified accountsreceivable balances from customers to financing institutions, on a non-recoursebasis. Extreme records such transfers as sales of the related accountsreceivable when it is considered to have surrendered control of suchreceivables under the provisions of SFAS No. 125, "Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities." The impactof the above transactions reduced receivables and increased cash byapproximately $9.4 million during fiscal 2001. Inventories Inventories consist of raw materials and finished goods and are stated atthe lower of cost or market (on a first-in, first-out basis). Inventories consist of (in thousands): June 30, 2001 June 30, 2000 ------------- ------------- Raw materials. $20,671 $ 9,501Finished goods 39,858 14,300 ------- ------- Total...... $60,529 $23,801 ======= ======= Restricted Investments Extreme restricted $80.0 million of its investment securities as collateralfor specified obligations of Extreme, as the lessee, under an operating leasefor its campus facility. These investment securities are restricted as to theterms of withdrawal and are managed by a third party subject to certainlimitations under our investment policy (See Note 4). 48 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Concentration of Credit Risk, Product and Significant Customers and Supplier Information Extreme may be subject to concentration of credit risk as a result ofcertain financial instruments consisting principally of marketable investmentsand accounts receivable. Extreme has placed its investments with high-creditquality issuers. Extreme will not invest an amount exceeding 10% of Extreme'scombined cash, cash equivalents, short-term and long-term investments in thesecurities of any one obligor or maker, except for obligations of the UnitedStates, obligations of United States agencies and money market accounts.Extreme performs ongoing credit evaluations of its customers and generally doesnot require collateral. One customer accounted for 16% of our net revenue in2001, no customer accounted for more than 10% of our net revenue in 2000 andtwo customers accounted for 21% and 13 % of our net revenue in 1999. 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 ourSummit, BlackDiamond and Alpine products. Extreme expects that revenue fromthese products will account for a substantial portion of our revenue for theforeseeable future. Accordingly, widespread market acceptance of Extreme'sproducts is critical to our future success. Property and Equipment Property and equipment are stated at cost and depreciated on a straight-linebasis over the estimated useful lives of the assets of approximately threeyears. Property and equipment consist of the following (in thousands): June 30, 2001 June 30, 2000 ------------- ------------- Computer and other related equipment.......... $ 54,318 $27,257 Office equipment, furniture and fixtures...... 4,291 1,905 Software...................................... 18,613 4,956 Leasehold improvements........................ 3,927 1,802 -------- ------- 81,149 35,920 Less accumulated depreciation and amortization (23,898) (9,170) -------- ------- Property and equipment, net................... $ 57,251 $26,750 ======== ======= 49 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Goodwill and Purchased Intangible assets We record goodwill when the cost of net assets we acquire exceeds their fairvalue. Goodwill is amortized on a straight-line basis over lives ranging from 2to 5 years. The cost of identified intangible assets is generally amortized ona straight-line basis over periods ranging from 2 to 4 years. Goodwill andpurchased intangible assets consist of the following (in thousands): June 30, 2001 June 30, 2000 ------------- ------------- Goodwill...................... $143,325 $48,050 Purchased intangible assets... 11,158 8,784 -------- ------- 154,483 56,834 Less: accumulated amortization (40,597) (7,052) -------- ------- $113,886 $49,782 ======== ======= Income Taxes Income tax expense (benefit) is based on pre-tax financial accounting income(loss). Deferred tax assets and liabilities are recognized for the expected taxconsequences of temporary differences between the tax bases of assets andliabilities and their reported amounts. Valuation of Long-Lived Assets, Certain Identifiable Intangibles and Goodwill In accordance with SFAS No. 121, "Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to be Disposed of," we regularlyperform reviews of the carrying value of long-lived assets and certainidentifiable intangibles for impairment. The reviews look for the existence offacts or circumstances, either internal or external, which indicate that thecarrying value of the asset cannot be recovered. No such impairment has beenindicated to date. If, in the future, management determines the existence ofimpairment indicators, we would use undiscounted cash flows to initiallydetermine whether impairment should be recognized. If necessary, we wouldperform a subsequent calculation to measure the amount of the impairment lossbased on the excess of the carrying value over the fair value of the impairedassets. If quoted market prices for the assets are not available, the fairvalue would be calculated using the present value of estimated expected futurecash flows. The cash flow calculations would be based on management's bestestimates, using appropriate assumptions and projections at the time. Revenue Recognition Extreme generally recognizes product revenue at the time of shipment,assuming that collectibility is probable, unless we have future obligationssuch as installation or are required to obtain customer acceptance. Whensignificant obligations remain after products are delivered, revenue andrelated costs are deferred until such obligations are fulfilled. Amounts billedin excess of revenue recognized are included as deferred revenue and accountsreceivable in the accompanying consolidated balance sheets. On a prospectivebasis as of July 2, 2001 we will report deferred revenue and accountsreceivable on a net basis in the consolidated balance sheets. Revenue fromservice obligations under maintenance contracts, is deferred and recognized ona straight-line basis over the contractual period, which is typically 12months. Extreme makes certain sales to partners in two-tier distribution channels.The first tier consists of a limited number of third-party distributors thatsell primarily to resellers and on occasion to end-user customers. Distributorsare generally given privileges to return a portion of inventory. Underspecified conditions, we grant 50 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)the right to distributors to return unsold products to us. The distributors arecontractually limited in terms of the value of products that can be returned toExtreme (up to 15% of net purchases in the immediately preceding calendarquarter to be credited against future purchases). We defer recognition ofrevenue on sales to distributors until the distributors sell the product. Thesecond tier of the distribution channel consists of a large number ofthird-party resellers that sell directly to end-users and are not grantedreturn privileges. Extreme generally records revenue to resellers upon shipmentnet of returns allowances based on its experience. In certain cases, Extreme has guaranteed financial obligations for itscustomers for the purchase of Extreme equipment. In such cases, Extreme recordsrevenue as payments are received by the financing party. The related equipmentcost is amortized to cost of revenue over the financing term. Warranty Reserves Extreme's hardware warranty period is typically 12 months from the date ofshipment to the end user. Upon shipment of products to its customers, Extremeestimates expenses for the cost to repair or replace products that may bereturned under warranty and accrues the amount as revenue is recognized. Advertising Cooperative advertising obligations are accrued and the costs expensed atthe same time the related revenue is recognized. All other advertising costsare expensed as incurred. Advertising expenses for the years ended June 30,2001, 2000 and 1999 were approximately $11.0 million, $5.5 million and $2.6million, respectively. Stock-Based Compensation Extreme accounts for its stock options and equity awards in accordance withthe provisions of the Accounting Principles Board Opinion No. 25, "Accountingfor Stock Issued to Employees," and has elected to follow the "disclosure only"alternative prescribed by SFAS No. 123, "Accounting of Stock-BasedCompensation" ("FAS 123"). For non-employees, Extreme computes the fair valueof stock-based compensation in accordance with FAS No. 123 and Emerging IssuesTask Force (EITF) 96-18, "Accounting for Equity Instruments that are Issued toOther Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices". In March 2000, the FASB issued Interpretation No. 44 (FIN 44) "Accountingfor Certain Transactions involving Stock Compensation--an Interpretation ofAccounting Principles Board (APB) Opinion No. 25". FIN 44 clarifies theapplication of APB Opinion No. 25 and was effective July 1, 2000. Theapplication of FIN 44 did not have a material effect on Extreme's financialposition or results of operations. Disclosure about Segments of an Enterprise and Geographic Areas Extreme adopted SFAS No. 131, "Disclosure about Segments of an Enterpriseand Related Information," (FAS 131), in 1999. FAS 131 establishes standards forreporting information about operating segments as well as geographic areas andmajor customers. Operating segments are defined as components of an enterpriseabout which separate financial information is available that is evaluatedregularly by the chief operating decision maker in deciding how to allocateresources and in assessing performance. 51 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Extreme operates in one segment, the development and marketing of networkinfrastructure equipment. Extreme markets its products in the United States andin foreign countries through its sales personnel and subsidiaries. Extreme'sforeign offices consist of sales, marketing and support activities. Operatingincome (loss) generated by Extreme's operating foreign subsidiaries and theircorresponding identifiable assets were not material in any period presented. Information regarding geographic areas is as follows (in thousands): Years Ended June 30, ------------------------- 2001 2000 1999 -------- -------- ------- Net revenue: Americas (including North and South).. $231,001 $145,663 $46,186 Europe, Middle East and Asia ("EMEA"). 120,878 51,092 17,880 Japan................................. 91,425 49,942 31,379 Other................................. 47,928 15,259 2,581 -------- -------- ------- $491,232 $261,956 $98,026 ======== ======== ======= Revenue is attributed to regions based on the location of the customers. Net Income (Loss) Per Share Basic earnings (loss) per share is calculated by dividing net income (loss)by the weighted average number of common shares outstanding during the period,less shares subject to repurchase, and excludes any dilutive effects ofoptions, warrants and convertible securities. Dilutive earnings per share iscalculated by dividing net income (loss) by the weighted average number ofcommon shares used in the basic earnings per share calculation plus thedilutive effect of options, warrants and convertible securities. Diluted netloss per share is the same as basic net loss per share in fiscal 2001 andfiscal 1999 because Extreme had net losses in those periods. Had Extreme beenprofitable in these years, diluted earnings per share would have been impactedby the calculated effect of outstanding stock options of 10,446,000 and14,390,000, respectively and warrants of 3,000,000 and 0, respectively forfiscal 2001 and fiscal 1999. The following table presents the calculation of basic and diluted net income(loss) per share (in thousands, except per share data): Years Ended June 30, --------------------------- 2001 2000 1999 -------- -------- ------- Net income (loss)............................................. $(68,883) $ 20,048 $(1,617) ======== ======== ======= Weighted-average shares of common stock outstanding........ 109,655 103,734 27,324 Less: Weighted-average shares subject to repurchase........ (1,302) (3,218) (8,400) -------- -------- -------Weighted-average shares used in per share calculation--basic.. 108,353 100,516 18,924Incremental shares using the treasury stock method............ -- 10,652 -- -------- -------- -------Weighted-average shares used in per share calculation--diluted 108,353 111,168 18,924 ======== ======== =======Net income (loss) per share--basic............................ $ (0.64) $ 0.20 $ (0.09) ======== ======== =======Net income (loss) per share--diluted.......................... $ (0.64) $ 0.18 $ (0.09) ======== ======== ======= 52 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Share and per-share data presented reflect the two-for-one stock spliteffective to stockholders of record on August 10, 2000. Recently Issued Accounting Standards In December 1999, the Staff of the Securities and Exchange Commission("SEC") issued Staff Accounting Bulletin ("SAB") No.101, "Revenue Recognitionin Financial Statements", which provides guidance on the recognition,presentation and disclosure of revenue in financial statements. Extreme adoptedSAB 101 in the fourth quarter of fiscal 2001. The application of SAB 101 hasnot had a material impact on the business, results of operations or financialcondition of Extreme. In September 2000, the Financial Accounting Standards Board issued SFAS No.140, "Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities--a replacement of FASB Statement No. 125" ("FAS140"). FAS 140 revises certain standards for accounting for securitization andother transfers of financial assets and collateral. In addition, FAS No. 140requires certain additional disclosures that were not previously required. Theadditional disclosure requirements were effective for financial statements forfiscal years ending after December 15, 2000 and have been adopted for the yearended June 30, 2001. The revised accounting standards of FAS 140 are effectivefor transactions occurring after March 31, 2001. The application of the revisedaccounting standards of FAS 140 has not had a material impact on the business,results of operations or financial condition of Extreme. In July 2001, the FASB issued Statement of Financial Accounting Standards("SFAS") No. 141, "Business Combinations" ("FAS 141"). FAS 141 establishes newstandards for accounting and reporting for business combinations and requiresthat the purchase method of accounting be used for all business combinationsinitiated after June 30, 2001. We will adopt this statement in fiscal 2002. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other IntangibleAssets" ("FAS 142"), which establishes new standards for goodwill and otherintangible assets. Under the new rules, goodwill and indefinite livedintangible assets are no longer amortized but are reviewed annually forimpairment. Separable intangible assets that are not deemed to have anindefinite life will continue to be amortized over their useful lives. Theamortization provisions of FAS No. 142 apply to goodwill and intangible assetsacquired after June 30, 2001. With respect to goodwill and intangible assetsacquired prior to July 1, 2001, the Company will apply the new accounting rulesbeginning fiscal year 2003. We are currently assessing the financial impact FASNo. 142 will have on our Consolidated Financial Statements. Goodwill andintangible assets from business combinations before July 1, 2001 will continueto be amortized prior to the adoption of FAS 142. Upon the adoption of FAS 142,we are required to evaluate our existing goodwill and intangible assets frombusiness combinations completed before July 1, 2001 and make any necessaryreclassifications in order to comply with the new criteria in FAS 141 forrecognition of intangible assets. 53 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)2) Available-for-Sale Securities The following is a summary of available-for-sale securities (in thousands): Unrealized Unrealized Amortized Fair Holding Holding Cost Value Gains Losses --------- -------- ---------- ---------- June 30, 2001: Money market fund.............. $ 387 $ 387 $ -- $ -- Commercial paper............... 20,964 20,952 2 (14) U.S. corporate debt securities. 98,291 99,013 862 (140) U.S. government agencies....... 8,624 8,624 -- -- Market auction preferreds...... 12,037 12,037 -- -- -------- -------- ---- ----- $140,303 $141,013 $864 $(154) ======== ======== ==== ===== Classified as: Cash equivalents........... $ 37,233 $ 37,233 $ 14 $ (14) Short-term investments..... 68,576 69,374 798 -- Investments................ 34,494 34,406 52 (140) -------- -------- ---- ----- $140,303 $141,013 $864 $(154) ======== ======== ==== ===== Unrealized Unrealized Amortized Fair Holding Holding Cost Value Gains Losses --------- -------- ---------- ---------- June 30, 2000: Money market fund.............. $ 12,372 $ 12,372 $ -- $ -- Commercial paper............... 71,929 71,889 -- (40) U.S. corporate debt securities. 107,994 107,410 29 (613) U.S. government agencies....... 9,800 9,809 11 (2) U.S. tax exempt securities..... 10,000 10,000 -- -- -------- -------- ---- ----- $212,095 $211,480 $ 40 $(655) ======== ======== ==== ===== Classified as: Cash equivalents........... $100,736 $100,696 $ -- $ (40) Short-term investments..... 66,976 66,640 26 (362) Investments................ 44,383 44,144 14 (253) -------- -------- ---- ----- $212,095 $211,480 $ 40 $(655) ======== ======== ==== =====3) Business Combinations and Investments During the fiscal year ended June 30, 2000, Extreme acquired certain assetsof a company for a total cost of approximately $2.5 million. During the quarterended September 30, 2000, Extreme acquired certain assets of a company for atotal cost of $1.1 million. Extreme accounted for these acquisitions using thepurchase method of accounting. The entire amount of the purchase prices wasallocated to goodwill and purchased intangible assets. Extreme recordedapproximately $829,000 and $261,000 for amortization related to theseacquisitions in the years ended June 30, 2001 and 2000, respectively. In April 2000, Extreme issued fully earned, non-forfeitable, fullyexercisable warrants with a two year life to purchase 3 million shares ofExtreme's common stock with an exercise price of $39.50 per share to anetworking company in consideration of the networking company's selection ofExtreme as the preferred vendor of next generation core backbone switchingproducts to a certain group of the networking company's customers. The fairvalue of the warrants was approximately $54.3 million. The warrants were valuedunder a Black-Scholes 54 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)model, using a volatility assumption of 104% and a two-year term. The value ofthe warrants is being amortized over approximately two years, which is theestimated economic life of the acquired intangibles, comprising of customerlist, workforce and goodwill. Extreme recorded approximately $27.2 million and$6.8 million for amortization related to this acquisition in the years endedJune 30, 2001 and 2000, respectively. Optranet On January 31, 2001 Extreme acquired privately-held Optranet, Inc.("Optranet"), a developer of broadband access equipment in which Extremepreviously held a minority interest. In addition, a related party of Extremewas a significant investor of Optranet at the time of Extreme's initialinvestment. The acquisition was accounted for using the purchase method ofaccounting and accordingly, the purchase price was allocated to the assetsacquired and liabilities assumed based on their estimated fair values on theacquisition date. Since January 31, 2001, Optranet's results of operations havebeen included in Extreme's Consolidated Statements of Operations. The fairvalue of the intangible assets was determined based upon a valuation using acombination of methods, including an income approach for the technology and acost approach for the assembled workforce. The purchase price of approximately $73.2 million consisted of an exchangeof 1.4 million shares of Extreme's common stock with a fair value of $50.5million, assumed stock options with a fair value of $22.3 million, $0.2 millionin acquisition related expenses and Extreme's net minority investment of $0.2million. The purchase price was allocated, with the assistance of anindependent valuation, to assembled workforce of $1.5 million, in-processresearch and development of $13.4 million, deferred compensation of $21.9million and tangible net assets assumed of $2.6 million, net of deferred taxliabilities of $7.4 million resulting in goodwill of $41.2 million. The value of the acquired in-process technology was computed using adiscounted cash flow analysis rate of 30% on the anticipated income stream ofthe related product revenue. The discounted cash flow analysis was based onmanagement's forecast of future revenue, cost of revenue and operating expensesrelated to the products and technologies purchased from Optranet. Thecalculation of value was then adjusted to reflect only the value creationefforts of Optranet prior to the close of the acquisition. The acquiredintangible assets and goodwill are being amortized using the straight-linemethod over their estimated useful lives of five years. Amortization ofacquired intangibles and goodwill associated with this acquisition totaled $2.8million for fiscal 2001. Extreme recognized deferred stock compensationassociated with unvested stock options issued to employees that were assumed inconjunction with the acquisition. This amount is included as a component ofstockholders' equity and is being amortized ratably by charges to operationsover the vesting period of the options. Amortization of stock-basedcompensation associated with this acquisition totaled $3.8 million in fiscal2001 and relates to options awarded to employees in research and development. As of January 31, 2001, Optranet had in-process research and developmentefforts under way for the design and development of printed circuit boards("PCB"). These PCBs will deliver networking solutions that allow for high speedEthernet Layer 3 switching and IP services over wide area T-1 and DS-3 networktechnologies, and VDSL modules over voice grade cabling. The developmentefforts for the products were at varying levels of completion estimated to bebetween 20% and 85%, had a fair value of $13.4 million as of January 31, 2001and are expected to be completed during the first six months of fiscal 2002. Webstacks On March 7, 2001 Extreme acquired privately-held Webstacks, Inc.("Webstacks"), a developer of broadband access equipment in which Extremepreviously held a minority interest. In addition, a related party of Extremewas a significant investor of Webstacks at the time of Extreme's initialinvestment. The acquisition was 55 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)accounted for using the purchase method of accounting and accordingly, thepurchase price was allocated to the assets acquired and liabilities assumedbased on their estimated fair values on the acquisition date. Since March 7,2001, Webstack's results of operations have been included in Extreme'sConsolidated Statements of Operations. The fair value of the intangible assetswas determined based upon a valuation using a combination of methods, includingan income approach for the technology and a cost approach for the assembledworkforce. The purchase price of approximately $74.7 million consisted of an exchangeof 2.9 million shares of Extreme's common stock with a fair value of $71.2million, assumed stock options with a fair value of $2.8 million, $0.3 millionin acquisition related expenses and Extreme's net minority investment of $0.4million. The purchase price was allocated, with the assistance of anindependent valuation, to assembled workforce of $0.9 million, in-processresearch and development of $16.8 million, deferred compensation of $2.5million, tangible and other net assets assumed of $1.4 million, resulting ingoodwill of $53.1 million. Under the terms of the Merger Agreement withWebstacks, Extreme is obligated to pay $15.0 million of additional cashconsideration on or before October 31, 2001 provided that certain technologymilestones are met. The value of the acquired in-process technology was computed using adiscounted cash flow analysis rate of 30% on the anticipated income stream ofthe related product revenue. The discounted cash flow analysis was based onmanagement's forecast of future revenue, cost of revenue and operating expensesrelated to the products and technologies purchased from Webstacks. Thecalculation of value was then adjusted to reflect only the value creationefforts of Webstacks prior to the close of the acquisition. The acquiredintangible assets and goodwill are being amortized using the straight-linemethod over their estimated useful lives of five years. Amortization ofacquired intangibles and goodwill associated with this acquisition totaled $2.7million for fiscal 2001. Extreme recognized deferred stock compensationassociated with unvested stock options issued to employees that were assumed inconjunction with the acquisition. This amount is included as a component ofstockholders' equity and is being amortized ratably by charges to operationsover the vesting period of the options. Amortization of stock-basedcompensation associated with this acquisition totaled $0.3 million in fiscal2001 and relates to options awarded to employees in research and development. As of March 7, 2001, Webstacks had in-process research and developmentefforts under way for the design and development of both stand alone proxyswitches and PCBs. These switches and PCBs will extend Extreme's IP services toprovide robust Layer 4 - 7 switching solutions required for building today'shigh-performance content aware networks. The development efforts for theproducts were at varying levels of completion estimated to be between 45% and60%, had a fair value of $16.8 million as of March 7, 2001 and are expected tobe completed by January 2002. Pro forma results of operations have not been presented for Optranet orWebstacks because the prior operating results of these entities were notmaterial on either an individual or an aggregate basis.4) Commitments and contingenciesLeases In June 2000, we entered into two operating lease agreements forapproximately 16 acres of land and the accompanying 275,000 square feet ofbuildings to house our primary facility in Santa Clara, California. Our leasepayments will vary based on LIBOR which was 4.3% at June 30, 2001, plus aspread. Our combined lease payments are estimated to be approximately $3.4million on an annual basis over the lease terms. The leases are for five yearsand can be renewed for two five-year periods, subject to the approval of thelessor. At the expiration or termination of the leases, we have the option toeither purchase these properties for $31.4 million 56 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)and $48.6 million, respectively, or arrange for the sale of the properties to athird party for at least $31.4 million and $48.6 million, respectively, with acontingent liability for any deficiency. If the properties under these leasesare not purchased or sold as described above, we will be obligated foradditional lease payments of approximately $30.5 million and $41.3 millionrespectively. As part of the above lease transaction, Extreme restricted $80.0 million ofits investment securities as collateral for specified obligations of the lessorunder the lease. These investment securities are restricted as to withdrawaland are managed by a third party subject to certain limitations under Extreme'sinvestment policy. The lease also requires us to maintain specified financialcovenants with which we were in compliance as of June 30, 2001. Extreme also leases office space for its various U.S. and internationalsales offices. Future payments under all noncancelable operating leases (net offuture committed sublease proceeds of $6,869 under noncancelable subleases) atJune 30, 2001 are as follows (in thousands):Years ending June 30: 2002............... $ 7,573 2003............... 8,943 2004............... 10,074 2005............... 10,182 2006............... 6,497 Thereafter......... 17,205 -------Total minimum payments $60,474 ======= Rent expense was approximately $11.7 million, $2.9 million and $0.7 millionfor 2001, 2000 and 1999, respectively, net of sublease income of $3.6 million,$0.3 million and $ 0.0 in the respective periods. Sublease income netted fromthe amounts in the above schedule for the fiscal years 2002, 2003, 2004 and2005 is projected to be $3.6 million, $2.1million, $0.7 million and $0.5million, respectively. As part of our business relationship with MCMS, one of our contractmanufacturers, we have entered into a $9.0 million equipment lease formanufacturing equipment with a third party financing company; we in turnsublease the equipment to MCMS.Legal Proceedings On March 14, 2001, Nortel Networks, Inc. and Nortel Networks Limited(collectively, "Nortel") filed suit against us in the United States DistrictCourt for the District of Massachusetts, Civil Action No. 01-10443EFH. Thecomplaint alleges willful infringement of U.S. Patent Nos. 5,790,554 (the "554Patent"); 5,490,252; 5,408,469; 5,398,245; 5,159,595 and 4,736,363, and seeks ajudgment: (a) determining that the Company has infringed each of the sixpatents; (b) permanently enjoining and restraining the Company from furtherinfringement of each of the six patents; and (c) awarding unspecified amountsof trebled damages, together with interest, costs and attorneys' fees. Weanswered Nortel's complaint on May 17, 2001, denying that we have infringed anyof the six patents and also asserting various affirmative defenses andcounterclaims that seek judgment: (a) that Nortel's complaint be dismissed; (b)that each of the six patents be declared invalid; (c) declaring that we are notinfringing any of the six patents; and (d) that Nortel pay our attorneys' feesand costs. On May 17, 2001, we also sought transfer of the action to the UnitedStates District Court for the Northern District of California. On June 28,2001, the court denied our motion to transfer, and the action will thus proceed 57 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)in Massachusetts. On July 9, 2001, the court granted a motion by F5 Networks,Inc. ("F5") to intervene in the action. F5 contends that it is the designer,developer, and manufacturer of the product accused of infringing the '554Patent of Count VI of Nortel's complaint. F5 had also sought to sever andtransfer Count VI in favor of an action concerning the '554 Patent pendingbetween F5 and Nortel in the United States District Court for the WesternDistrict of Washington, but that motion was denied on July 9, 2001 withoutopinion. On July 13, 2001, Nortel demanded $150 million in settlement ofalleged past damages. Discovery is proceeding. As set forth above, we havedenied Nortel's allegations and intend to defend the action vigorously. Wecannot assure you, however, that we will prevail in this litigation, whichcould have a material, adverse effect on our business, financial condition andresults of operations in the future. Extreme is subject to other legal proceedings, claims and litigation arisingin the ordinary course of business. While the outcome of these matters iscurrently not determinable, management does not expect that the ultimate coststo resolve these matters will have a material adverse effect on ourconsolidated financial position, results of operations or cash flows.5) Foreign Exchange Forward Contracts On July 2, 2000, Extreme adopted FAS 133, which requires that allderivatives be recorded on the balance sheet at fair value. Changes in the fairvalue of derivatives that do not qualify, or are not effective as hedges mustbe recognized currently in earnings. Upon adoption, we did not hold anyderivative instruments. Extreme sells products around the globe in US dollars but has internationaloperations with expenses in foreign currencies which are paid from Extreme's USdollar cash flows. Extreme has a foreign currency cash flow hedging program tominimize the foreign currency risk associated with the forecasted cash flowsusing forward contracts with a maximum term of 90 days. If the US dollarweakens against the foreign currencies (primarily Japanese Yen, the Euro,Swedish Krona and the British pound), the increase in the cost of theforecasted foreign currency denominated expenses is offset by the increase invalue of the forward contracts designated as hedges. Conversely, when the USdollar strengthens, the decline in cost of the forecasted foreign currency cashflows offsets the losses in the value of the forward contracts. As the criticalterms of the forward contract and the underlying exposure are matched atinception, forward contract effectiveness is calculated by comparing the changein the fair value of the contract to the change in fair value of theanticipated expense, with the effective portion of the hedge recorded inaccumulated other comprehensive income (loss). Any residual change in fairvalue of the instruments is recognized immediately in other income (expense),net. No ineffectiveness was recognized in fiscal 2001. We did not hold anyforward exchange forward contracts as of June 30, 2001.6) Stockholders' Equity Common Stock Offerings In April 1999, Extreme completed an initial public offering of 16,100,000shares of common stock (including the underwriters' over-allotment provision)at a price of $8.50 per share. Concurrent with the initial public offering, alloutstanding shares of preferred stock were converted to a total of 58,122,630shares of common stock. Net proceeds from the offering were approximately$125.3 million net of offering costs. On October 20, 1999, Extreme announced the completion of a secondary publicoffering of approximately 15 million shares (including the underwriters'over-allotment provision) of its common stock at a price of $38.50 per share.Of these shares, Extreme sold 4,745,416 shares and existing stockholders sold10,204,584 shares. Extreme raised approximately $174.0 million net of offeringcosts. 58 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Stock Split On July 19, 2000 Extreme announced a two-for-one stock split in the form ofa stock dividend paid on August 24, 2000 to stockholders of record on August10, 2000. All share and per share data have been restated to give retroactiveeffect to this stock split. Preferred Stock The number of shares of preferred stock authorized to be issued at June 30,2001 is 2,000,000 with a par value of $0.001 per share. The preferred stock maybe issued from time to time in one or more series. The board of directors isauthorized to provide for the rights, preferences and privileges of the sharesof each series and any qualifications, limitations or restrictions on theseshares. As of June 30, 2001, no shares of preferred stock were outstanding. Warrants In November 1996, Extreme issued warrants to a lease financing company topurchase 420,000 shares of Series A convertible preferred stock with anexercise price of $0.17 per share, in consideration for equipment leases and aloan. In July 1997, Extreme issued warrants to the same lease financing companyto purchase 96,694 shares of Series B convertible preferred stock with anexercise price of $0.69 per share, in consideration for equipment leases.Concurrent with the initial public offering, these warrants converted into theright to purchase an equivalent number of shares of common stock at the sameexercise price per share. In May 1999, 294,000 of the shares under thesewarrants were exercised. In August 1999, the remaining 222,694 of the sharesunder these warrants were exercised. In November 1997, Extreme issued warrants to a lease financing company topurchase 158,102 shares of Series C convertible preferred stock with anexercise price of $1.27, in consideration for a loan. Concurrent with theinitial public offering, these warrants converted into the right to purchase anequivalent number of shares of common stock at the same exercise price pershare. In August 1999, all of the 158,102 warrants were exercised. In June 1999, Extreme issued fully vested, non-forfeitable and exercisablewarrants to a business partner to purchase 80,000 shares of Extreme's commonstock with an exercise price of $29.03 per share. The fair value of thesewarrants was approximately $948,000. This value was expensed in fiscal 1999 asthe warrants were issued in exchange for services rendered. In fiscal 2001, allof these warrants were exercised. As discussed in Note 3, in April 2000 in connection with the acquisition ofpurchased intangibles and goodwill, Extreme issued fully earned,non-forfeitable, fully exercisable warrants with a two year life to purchase 3million shares of Extreme's common stock with an exercise price of $39.50 pershare. At June 30, 2001 all of these warrants were outstanding. These warrantswill expire in April 2002 if unexercised at that date. Deferred Stock Compensation In June 2000, Extreme issued fully vested, non-forfeitable and exercisableoptions to consultants to purchase 120,000 shares of Extreme's common stockwith an exercise price of $14.02 per share. The fair value of these options wasapproximately $1.7 million. The options were valued under a Black-Scholesmodel, using a volatility assumption of 104%. This amount will be amortizedover two years as the services are rendered. The compensation expense for theyears ended June 30, 2001 and 2000 was $841,000 and $176,000, respectively. 59 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) During fiscal 2001, Extreme recognized stock-based compensation expenseassociated with unvested stock options issued to employees assumed in theacquisitions of Optranet and Webstacks of $21.9 million and $2.5 million,respectively (see Note 3). These amounts are included as a reduction ofstockholders' equity and are being amortized ratably by charges to operationsover the vesting period of the options. Extreme recorded amortization of deferred stock compensation expense ofapproximately $4.1 million, $119,000 and $172,000 for the years ended June 30,2001, 2000 and 1999, respectively. At June 30, 2001, Extreme had a total ofapproximately $20.4 million remaining to be amortized over the correspondingvesting period of each respective option, generally four years. Stockholders' Rights Agreement In April 2001, the board of directors approved a Stockholders' RightsAgreement ("Rights Agreement"), declaring a dividend of one preferred sharepurchase right for each outstanding share of common stock, par value $0.001 pershare, of Extreme common stock. The Rights Agreement is intended to protectstockholders' rights in the event of an unsolicited takeover attempt. It is notintended to prevent a takeover of Extreme on terms that are favorable and fairto all stockholders and will not interfere with a merger approved by the boardof directors. In the event the rights become exercisable, each right entitlesstockholders to buy, at an exercise price of $150 per right owned, a unit equalto a portion of a new share of Extreme Series A Preferred Stock. The rightswill be exercisable only if a person or a group acquires or announces a tenderor exchange offer to acquire 15% or more of the Extreme's common stock. Therights, which expire in April 2011, are redeemable for $0.001 per right at theapproval of the board of directors. Comprehensive Income (Loss) The following are the components of accumulated other comprehensive income(loss), net of tax (in thousands): June 30, June 30, 2001 2000 -------- -------- Unrealized gain (loss) on investments......... $710 $(615)Foreign currency translation adjustments...... 59 (8) ---- ----- Accumulated other comprehensive income (loss) $769 $(623) ==== =====7) Employee Benefit Plans 1999 Employee Stock Purchase Plan In January 1999, the board of directors approved the adoption of Extreme's1999 Employee Stock Purchase Plan (the "1999 Purchase Plan"). A total of4,000,000 shares of common stock have 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 to15% of total compensation. No more than 1,250 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 ended on April 30, 2000. Through June 30, 2001,788,797 shares were purchased under the 1999 Purchase Plan. 60 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Amended 1996 Stock Option Plan In January 1999, the board of directors approved an amendment to the 1996Stock Option Plan (the "1996 Plan") to (i) increase the share reserve by10,000,000 shares, (ii) to remove certain provisions which are required to bein option plans maintained by California privately-held companies and (iii) torename the 1996 Plan as the "Amended 1996 Stock Option Plan." Under the 1996 Plan, which was originally adopted in September 1996, optionsmay be granted for common stock, pursuant to actions by the board of directors,to eligible participants. A total of 39,322,098 shares have been reserved underthe 1996 Plan. Options granted are exercisable as determined by the board ofdirectors. Options vest over a period of time as determined by the board ofdirectors, generally four years. The term of the 1996 Plan is ten years.Options to purchase approximately 153,402, 1,470,286 and 4,655,558 shares ofcommon stock have been exercised as of June 30, 2001, 2000 and 1999,respectively, but are subject to repurchase until vested. As of June 30, 2001,445,483 shares were available for future grant under the 1996 Plan. 2000 Stock Option Plan In March 2000, the board of directors adopted the 2000 Nonstatutory StockOption Plan (the "2000 Plan"). Options may be granted for common stock,pursuant to actions by the board of directors, to eligible participants.Generally, only non-officer employees are eligible to participate in this stockplan, except that options may be granted to officers under this plan inconnection with written offers of employment. A total of 4,000,000 shares havebeen reserved under the 2000 Plan. Options vest over a period of time asdetermined by the board of directors, generally four years. The term of the2000 Plan is ten years. As of June 30, 2001, 453,414 shares were available forfuture grant under the 2000 Plan. 2001 Stock Option Plan In May 2001, the board of directors adopted the 2001 Nonstatutory StockOption Plan (the "2001 Plan"). Options may be granted for common stock,pursuant to actions by the board of directors, to eligible participants.Generally, only non-officer employees are eligible to participate in this stockplan, except that options may be granted to officers under this plan inconnection with written offers of employment. A total of 4,000,000 shares havebeen reserved under the 2001 Plan. Options vest over a period of time asdetermined by the board of directors, generally four years. The term of the2001 Plan is ten years. As of June 30, 2001, 4,000,000 shares were availablefor future grant under the 2001 Plan. 61 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table summarizes stock option activity under all plans: Weighted- Average Number of Exercise Price Shares Per Share ---------- -------------- Options outstanding at June 30, 1998 5,207,870 $ .42 Granted.......................... 5,875,516 $ 5.05 Exercised........................ (1,135,600) $ .93 Canceled......................... (190,252) $ 3.34 ----------Options outstanding at June 30, 1999 9,757,534 $ 3.04 Granted.......................... 12,404,750 $33.99 Exercised........................ (2,392,472) $ 1.23 Canceled......................... (1,374,704) $26.91 ----------Options outstanding at June 30, 2000 18,395,108 $22.74 Granted.......................... 11,777,681 $33.27 Exercised........................ (2,128,206) $ 7.56 Canceled......................... (3,067,210) $33.35 ----------Options outstanding at June 30, 2001 24,977,373 $27.69 ========== In connection with the acquisitions of Optranet and Webstacks, Extreme hasassumed the stock option plans of each company. During fiscal 2001, a total ofapproximately 608,401 and 115,676 shares of Extreme's common stock have beenreserved for issuance under the assumed plans of Optranet and Webstacks,respectively, and the related options have been included as granted in fiscal2001 in the preceding table. Options to purchase approximately 368,358 and987,119 shares of common stock have been exercised under the Optranet andWebstacks plans, respectively, as of June 30, 2001 but are subject torepurchase until vested. The following table summarizes significant ranges of outstanding andexercisable options at June 30, 2001: Options Outstanding Options Exercisable -------------------------------------- --------------------- Weighted- Weighted- Weighted- Average Average Average Number Remaining Exercise Number ExerciseRange of Exercise Prices Outstanding Contractual Life Price Exercisable Price------------------------ ----------- ---------------- --------- ----------- --------- (In years) $ 0.01 -- 5.00 4,686,188 7.10 $ 2.80 4,679,771 $ 2.80 $14.57 -- 14.57 5,942,046 9.44 $14.57 16,664 $14.57 $18.02 -- 33.31 6,529,627 8.37 $30.20 2,200,205 $30.85 $33.56 -- 47.47 5,258,162 8.80 $39.86 1,131,190 $36.15 $47.50 -- 100.69 2,561,350 9.02 $72.30 126,820 $52.85 ---------- --------- $ 0.01 -- 100.69 24,977,373 8.54 $27.69 8,154,650 $15.80 ========== ========= Options to purchase 6,721,582 and 9,368,034 shares were exercisable at June30, 2000 and 1999, respectively, with a weighted-average exercise price of$3.75 and $2.22, respectively. Stock-Based Compensation Extreme has elected to follow APB Opinion No. 25, "Accounting for StockIssued to Employees," in accounting for its employee stock options because, asdiscussed below, the alternative fair value accounting provided for under SFASNo. 123, "Accounting for Stock-Based Compensation," ("FAS 123") requires theuse of option valuation models that were not developed for use in valuingemployee stock options. Under APB No. 25, because the exercise price ofExtreme's employee stock options equals the market price of the underlyingstock on the date of grant, no compensation expense is recognized in Extreme'sfinancial statements. 62 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENT--(Continued) Pro forma information regarding net income and earnings per share isrequired by FAS 123. This information is required to be determined as ifExtreme had accounted for its employee stock options and shares issued underthe 1999 Employee Stock Purchase Plan under the fair value method of thatstatement. The fair value of options granted in 2001, 2000 and 1999 reportedbelow was estimated at the date of grant using a Black-Scholes option pricingmodel with the following weighted average assumptions: Stock Option Plan Employee Stock Purchase Plan ----------------------- ---------------------------- Years Ended June 30, Years Ended June 30, ----------------------- ---------------------------- 2001 2000 1999 2001 2000 1999 ------- ------- ------- ------- ------- -------- Expected life.......... 3.1 yrs 3.4 yrs 3.5 yrs 0.6 yrs 0.6 yrs 0.7 yrs. Risk-free interest rate 5.3% 6.3% 5.1% 4.1% 5.4% 5.0% Volatility............. 134% 112% 55% 134% 112% 55% Expected dividend yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% The Black-Scholes option valuation model was developed for use in estimatingthe fair value of traded options that have no vesting restrictions and arefully transferable. In addition, option valuation models require the input ofhighly subjective assumptions, including the expected stock price volatility.Because Extreme's employee stock options have characteristics significantlydifferent from those of traded options, and because changes in the subjectiveinput assumptions can materially affect the fair value estimate, in the opinionof management, the existing models do not necessarily provide a reliable singlemeasure of the fair value of employee stock options. The weighted-averageestimated fair value of options granted in the years ended June 30, 2001, 2000and 1999 was $25.82 $24.23 and $2.21, respectively. The weighted-averageestimated fair value of shares granted under the 1999 Purchase Plan in theyears ended June 30, 2001, 2000 and 1999 was $18.91, $7.51 and $2.81,respectively. For purposes of pro forma disclosures, the estimated fair value of theoptions is amortized to expense over the options' vesting periods. Pro formainformation follows (in thousands, except per share amounts): Years Ended June 30, ---------------------------- 2001 2000 1999 --------- -------- ------- Pro forma net loss under FAS 123............. $(216,018) $(31,088) $(4,066) Net loss per share - pro forma under FAS 123: Basic and diluted......................... $ (2.18) $ (0.32) $ (0.22) The pro forma impact of options on the net loss for the years ended June 30,2001, 2000 and 1999 is not representative of the effects on net income (loss)for future years as future years will include the effects of additional yearsof stock option grants. 401(k) Plan Extreme provides a tax-qualified employee savings and retirement plan,commonly known as a 401(k) plan (the "Plan"), which covers our eligibleemployees. Pursuant to the Plan, employees may elect to reduce their currentcompensation up to the lesser of 20% or the statutorily prescribed limit of$10,500 for calendar years 2000 and 2001. The amount of the reduction iscontributed to the 401(k) plan on a pre-tax basis. 63 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Extreme provides for discretionary matching contributions as determined bythe board of directors for each calendar year. As of September 2000, the boardof directors set the match at $0.25 for every dollar contributed by theemployee up to the first 4% of pay. The same level of match was continuedduring the 2001 calendar year. All matching contributions vest immediatelyeffective September 2000. In addition, the Plan provides for discretionarycontributions as determined by the board of directors each year. Extreme'smatching contributions to the Plan totaled $378,391 for the fiscal year endedJune 30, 2001. No discretionary contributions were made in fiscal 2001, 2000,or 1999.8) Income Taxes The provision for (benefit from) income taxes for the years ended June 30,2001, 2000 and 1999 consists of the following (in thousands): Years Ended June 30, -------------------------- 2001 2000 1999 -------- -------- ------ Current: Federal............................... $ 5,234 $ 24,811 $ 350 State................................. 823 2,026 200 Foreign............................... 1,560 306 1,100 -------- -------- ------Total current............................ $ 7,617 $ 27,143 $1,650 ======== ======== ======Deferred: Federal............................... $(25,477) $(15,497) $ -- State................................. (4,808) (1,325) -- -------- -------- ------Total deferred........................... $(30,285) $(16,822) $ -- ======== ======== ======Provision for (benefit from) income taxes $(22,668) $ 10,321 $1,650 ======== ======== ====== The tax benefit resulting from the exercise of nonqualified stock optionsand the disqualifying dispositions of shares acquired under Extreme's incentivestock option plans was $45.0 million and $21.6 million for the fiscal yearsended June 30, 2001 and 2000, respectively. Such benefit was credited toadditional paid-in capital. Pretax income (loss) from foreign operations was $649,000, $(10.7 million)and $(7.0 million) in the fiscal years ended June 30, 2001, 2000 and 1999,respectively. 64 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The difference between the provision (benefit) for income taxes and theamount computed by applying the Federal statutory income tax rate (35 percent)to income (loss) before taxes is explained below (in thousands): Years Ended June 30, ------------------------- 2001 2000 1999 -------- ------- ------ Tax at federal statutory rate (benefit).... $(32,043) $10,666 $ 11State income tax........................... (2,739) 1,018 200Federal alternative minimum taxes.......... -- -- 350Foreign taxes.............................. -- 69 1,100Unbenefited (utilized) net operating losses -- (773) (11)Tax credits................................ (1,209) (1,576) --Valuation allowance decrease............... -- (5,148) --Unbenefited foreign loss................... 1,187 3,974 --Nondeductible goodwill..................... 1,894 -- --Nondeductible in-process R&D............... 10,555 -- --Other...................................... (313) 2,091 -- -------- ------- ------ Total................................... $(22,668) $10,321 $1,650 ======== ======= ====== Significant components of Extreme's deferred tax assets are as follows (inthousands): As of June 30, ---------------- 2001 2000 ------- ------- Deferred tax assets: Net operating loss carryforwards..................... $27,948 $ 431 Tax credit carryforwards............................. 10,183 2,358 Depreciation......................................... 1,085 1,951 Deferred revenue..................................... 8,859 3,545 Warrant amortization................................. 13,200 2,673 Inventory reserves................................... 9,799 734 Other reserves and accruals.......................... 13,484 6,708 ------- ------- Total deferred tax assets............................... 84,558 18,400 Deferred tax liability - acquisition related intangibles (8,675) -- ------- ------- Net deferred tax assets................................. $75,883 $18,400 ======= ======= The net valuation allowance decreased by $8.5 million during the year endedJune 30, 2000. As of June 30, 2001, Extreme had net operating loss carryforwards forfederal and state tax purposes of approximately $74.1 million and $38.0million, respectively. Extreme also had federal and state tax creditcarryforwards of approximately $6.6 million and $5.4 million, respectively.Unused net operating loss and tax credit carryforwards will expire at variousdates beginning in the years 2004 and 2012, respectively. 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, as amended, and similar state provisions.The annual limitation may result in the expiration of net operating losses andtax credits before utilization. 65 EXTREME NETWORKS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)9) Other Operating Expenses Other operating expenses for fiscal 2001 consists of a write-off of acquiredin-process research and development of $30.2 million and a restructuring chargeof $5.9 million. Extreme recorded in-process research and development charges of $13.4million related to the purchase of Optranet on January 31, 2001 and $16.8million related to the purchase of Webstacks on March 7, 2001. The valueassigned to purchased in-process research and development was determinedthrough valuation techniques generally used by appraisers in thehigh-technology industry and was immediately expensed in the period ofacquisition because technological feasibility had not been established and noalternative use had been identified. The charges are discussed in more detailin Note 3. In March 2001, we implemented a restructuring plan in order to lower ouroverall cost structure. In connection with the restructuring, we reduced ourheadcount and consolidated facilities. The restructuring expense included $2.3million for the write-off and write-down in carrying value of Summit basedequipment, $1.8 million for severance and benefits for approximately 100terminated employees and $1.8 million in facility closure expenses. The numberof temporary employees and contractors used by us was also reduced. Thefollowing analysis sets forth the significant components of the restructuringreserve at June 30, 2001 (in thousands): Severance Facility Equipment and Benefits Closure Total --------- ------------ -------- ------- Restructuring charge............ $ 2,321 $ 1,848 $1,772 $ 5,941 Cash charge..................... -- (1,848) (29) (1,877) Non-cash charge................. (2,321) -- -- (2,321) ------- ------- ------ ------- Reserve balance at June 30, 2001 $ -- $ -- $1,743 $ 1,743 ======= ======= ====== =======10) Subsequent Event Beginning on July 6, 2001, multiple purported securities fraud class actioncomplaints were filed in the United States District Court for the SouthernDistrict of New York. We are aware of at least two such complaints, Capuano v.Morgan Stanley & Co., Inc., et al, No. 01 CV 6148 (S.D.N.Y. July 6, 2001)(which does not name us or our officers or directors as defendants) and Hui v.Extreme Networks, Inc., et al., No. 01 CV 6700 (S.D.N.Y. July 23, 2001). Thecomplaints are brought purportedly on behalf of all persons who purchased ourcommon stock from November 17, 1999 through December 6, 2000. The Hui complaintnames as defendants Extreme Networks and certain of our present and formerofficers; and several investment banking firms that served as underwriters ofour initial public offering. It alleges liability under Sections 11 and 15 ofthe Securities Act of 1933 and Sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934, on the grounds that the registration statement for theoffering did not disclose that: (1) the underwriters had agreed to allowcertain customers to purchase shares in the offering in exchange for excesscommissions paid to the underwriters; and (2) the underwriters had arranged forcertain customers to purchase additional shares in the aftermarket atpre-determined prices. We are aware that similar allegations have been made inlawsuits challenging over 140 other initial public offerings conducted in 1999and 2000. No specific damages are claimed. We believe that the allegationsagainst us and the officers are without merit, and intend to contest themvigorously. We cannot assure you, however, that we will prevail in thislitigation. Failure to prevail could have a material adverse effect on ourconsolidated financial position, results of operations and cash flows in thefuture. 66 Report of Ernst & Young LLP, Independent AuditorsThe Board of Directors and StockholdersExtreme Networks, Inc. We have audited the accompanying consolidated balance sheets of ExtremeNetworks, Inc. as of June 30, 2001 and 2000, and the related consolidatedstatements of operations, stockholders' equity and cash flows for each of thethree years in the period ended June 30, 2001. Our audits also included thefinancial statement 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 auditing standards generallyaccepted in the United States. Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof Extreme Networks, Inc. at June 30, 2001 and 2000, and the consolidatedresults of its operations and its cash flows for each of the three years in theperiod ended June 30, 2001, in conformity with accounting principles generallyaccepted in the United States. Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, presents fairly in all material respectsthe information set forth therein. ERNST & YOUNG LLPPalo Alto, CaliforniaJuly 16, 2001 67 EXTREME NETWORKS, INC. QUARTERLY FINANCIAL DATA (In thousands, except share and per share amounts) (unaudited) June 30, Mar. 31, Dec. 31, Sept. 30, 2001 2001 2000 2000 -------- -------- -------- --------- Net revenue...................................... $115,069 $112,106 $144,715 $119,342Gross profit..................................... 59,565 14,242 74,941 61,252Total operating expenses......................... 76,945 111,618 65,343 57,987Operating income (loss).......................... (17,380) (97,376) 9,598 3,265Net income (loss)................................ (11,363)(2) (70,115)(3) 8,062(4) 4,533(4)Net income (loss) per share--basic (1)........... $ (0.10)(2) $ (0.64)(3) $ 0.08(4) $ 0.04(4)Net income (loss) per share--diluted (1)......... $ (0.10)(2) $ (0.64)(3) $ 0.07(4) $ 0.04(4)Shares used in per share calculation--basic (1).. 111,114 109,028 107,283 105,990Shares used in per share calculation--diluted (1) 111,114 109,028 118,745 118,892 June 30, Mar. 31, Dec. 31, Sept. 30, 2000 2000 1999 1999 -------- -------- -------- --------- Net revenue...................................... $ 92,422 $ 67,310 $ 55,006 $ 47,218Gross profit..................................... 46,254 35,339 28,846 24,601Total operating expenses......................... 49,621 25,806 22,846 20,512Operating income (loss).......................... (3,367) 9,533 6,000 4,089Net income....................................... 589(5) 9,057 6,355 4,047Net income per share--basic (1).................. $ 0.01(5) $ 0.09 $ 0.06 $ 0.04Net income per share--diluted (1)................ $ 0.01(5) $ 0.08 $ 0.06 $ 0.04Shares used in per share calculation--basic (1).. 104,590 103,060 100,362 94,052Shares used in per share calculation--diluted (1) 112,532 113,584 111,726 107,166--------(1)Share and per share data have been restated to give retroactive effect to a two-for-one stock split in the form of a stock dividend effected in August 2000.(2)Net loss and net loss per share include amortization of goodwill, purchased intangible assets and deferred stock compensation of $15.4 million and restructuring charges of $2.1 million.(3)Net loss and net loss per share include certain inventory charges of $40.3 million, in-process research and development of $30.1 million, amortization of goodwill and purchased intangible assets of $8.2 million and restructuring charges of $3.8 million.(4)Net income and net income per share include amortization of goodwill and purchased intangible assets of $6.9 million.(5)Net income and net income per share include amortization of goodwill and purchased intangible assets of $6.8 million.Item 9. Changes in and Disagreements with Accountants on Accounting andFinancial Disclosure. Not applicable. 68 PART III Certain information required by Part III is incorporated by reference fromExtreme's definitive Proxy Statement to be filed with the Securities andExchange Commission in connection with the solicitation of proxies forExtreme's 2001 Annual Meeting of Stockholders (the "Proxy Statement").Item 10. Directors and Executive Officers of the Registrant. The information required by this section is incorporated by reference fromthe information in the section entitled "Proposal 1--Election of Directors" inthe Proxy Statement. The required information concerning executive officers ofExtreme 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 ofDirectors--Directors' Compensation", "Executive Compensation" and "Stock PricePerformance Graph" 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 ofDirectors--Security Ownership of Certain Beneficial Owners and Management" inthe Proxy Statement.Item 13. Certain Relationships and Related Transactions. The information required by this section is incorporated by reference fromthe information in the section titled "Certain relationships and relatedtransactions" in the Proxy statement. PART IVItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.(a) The following documents are filed as a part of this Form 10-K: (1) Financial Statements: Reference is made to the Index to Consolidated Financial Statements of Extreme Networks, Inc. under Item 8 in Part II of this Form 10-K. (2) Financial Statement Schedules: 69 The following financial statement schedule of Extreme Networks, Inc. for theyears ended June 30, 2001, 2000 and 1999 is filed as part of this Report andshould be read in conjunction with the Consolidated Financial Statements ofExtreme Networks, Inc. Reference Page --------- Schedule II -- Valuation and Qualifying Accounts 73 All other schedules are omitted because they are not applicable or therequired information is shown in the financial statements or notes thereto. 70 (3) Exhibits: The exhibits listed below are required by Item 601 of Regulation S-K. Eachmanagement contract or compensatory plan or arrangement required to be filed asan exhibit to this Form 10-K has been identified. Incorporated by ReferenceExhibit ----------------------- FiledNumber Description of Document Form Date Number Herewith------ --------------------------------------------------------- ------- -------- ------ -------- 2.1 Form of Agreement and Plan of Merger between Extreme Networks, a California corporation, and Extreme Networks, Inc., a Delaware corporation........... S -1/A 03/11/99 2.1 3.1 Certificate of Incorporation of Extreme Networks, Inc., a Delaware Corporation..................................... S - 1 02/05/99 3.1 3.2 Form of Certificate of Amendment of Certificate of Incorporation of Extreme Networks, Inc., a Delaware Corporation.............................................. S - 1 02/05/99 3.2 3.4 Amended and Restated Bylaws of Extreme Networks, Inc...................................................... 8 - K/A 06/07/01 3.4 3.5 Restated Certificate of Incorporation of Extreme Networks, Inc............................................ X 3.6 Certificate of Amendment of Restated Certificate of Incorporation of Extreme Networks, Inc................... X 3.7 Certificate of Designation, Preferences and Rights of the Terms of the Series A Preferred Stock.................... X 4.1 Second Amended and Restated Rights Agreement dated January 12, 1998 between Extreme Network and certain stockholders............................................. S - 1 02/05/99 4.1 4.2 Registration Rights Agreement............................ S - 3 04/11/01 4.1 10.1 Form of Indemnification Agreement for directors and officers................................................. S - 1 02/05/99 10.1 10.2* Amended 1996 Stock Option Plan and forms of agreements thereunder.................................... S - 1 02/05/99 10.2 10.3* 1999 Employee Stock Purchase Plan........................ S - 1 02/05/99 10.3 10.4 Sublease, dated June 5, 1997 between NetManage, Inc. and Extreme Networks, Inc., a California corporation, to Master Lease, dated September 30, 1994, between Cupertino Industrial Associates and NetManage, Inc....... S - 1 02/05/99 10.4 10.5 Sublease, dated January 1, 1999 between Apple Computer, Inc., a California corporation, and Extreme Networks, Inc., a California corporation, to Lease Agreement, as amended.................................... S - 1/A 03/11/99 10.5 10.6 Form of Warrant to Purchase Common Stock between 3Com Corporation and Extreme Networks, Inc............... 10 - K 06/30/00 10.6 10.7* Form of 2000 Nonstatutory Stock Option Plan.............. 10 - K 06/30/00 10.7 71 Incorporated by ReferenceExhibit ---------------------- FiledNumber Description of Document Form Date Number Herewith------ -------------------------------------------------------- ------ -------- ------ -------- 10.8 Form of Lease Agreement (Land) dated June 1, 2000 by and between BNP Leasing Corporation, a Delaware corporation ("BNPLC") and Extreme Networks, Inc. a Delaware corporation ("Extreme")........................ 10 - K 06/30/00 10.8 10.9 Form of Lease Agreement (Improvements) dated June 1,2000, executed by and between BNPLC and Extreme....... 10 - K 06/30/00 10.9 10.10 Form of Purchase Agreement (Land) dated to be effective as of June 1, 2000, executed by and between BNPLC and Extreme................................................. 10 - K 06/30/00 10.10 10.11 Form of Purchase Agreement (Improvements) dated to be effective as of June 1, 2000, executed by and between BNPLC and Extreme....................................... 10 - K 06/30/00 10.11 10.12 Form of Pledge Agreement (Land) dated to be effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme............................................. 10 - K 06/30/00 10.12 10.13 Form of Pledge Agreement (Improvements) dated to be effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme................................. 10 - K 06/30/00 10.13 10.14 Exhibit 10.14 Lease agreement dated July 28, 2000 between San Tomas Properties LLC, a Delaware limited liability company, as Landlord, and Extreme Networks, Inc, a Delaware Corporation, as Tenant.................. 10 - Q 09/30/00 10.14 21.1 Subsidiaries of Registrant.............................. X 23.1 Consent of Ernst and Young LLP, Independent Auditors.... X 24.1 Power of Attorney (see page 74 of this Form 10-K)....... X * Indicates managment contract or compensatory plan or arrangement.(b)Reports on Form 8-K: Extreme filed the following reports on Form 8-K during the three monthsended June 30, 2001:Date of Report: Item(s): Description:--------------- -------- ------------ April 6, 2001 5,7 EXTREME announced financial results for its third quarter ended March 31, 2001 and included the press release relating thereto. May 14, 2001 5,7 EXTREME announced the adoption of a Stockholder Rights Plan pursuant to which rights will be distributed as a dividend at the rate of one right for each share of the company's common stock held by stockholders of record as of the close of business on May 14, 2001. May 15, 2001 5 EXTREME amended the Form 8-K filed on May 14, 2001 for the purpose of filing certain exhibits to Exhibit 4.2. June 7, 2001 5,7 EXTREME amended and restated the Form 8-K filed on May 14, 2001 for the purpose of correcting certain exhibit numbers. 72 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JUNE 30, 2001, 2000 AND 1999 (In thousands) Reversals Balance at Charged to to costs Balance at beginning costs and and end of Description of period expenses expenses (Deductions) period ----------- ---------- ---------- --------- ------------ ---------- Year Ended June 30, 1999: Allowance for doubtful accounts............. $ 433 $ 1,364 $-- $ (423) $ 1,374 Allowance for excess and obsolete inventory. $ 145 $ 1,087 $-- $ (292) $ 940Year Ended June 30, 2000: Allowance for doubtful accounts............. $1,374 $ -- $-- $ (137) $ 1,237 Allowance for excess and obsolete inventory. $ 940 $ 1,144 $-- $ (155) $ 1,929Year Ended June 30, 2001: Allowance for doubtful accounts............. $1,237 $ 5,274 $-- $(4,569) $ 1,942 Allowance for excess and obsolete inventory. $1,929 $32,753 $(9,771) $24,911 73 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 26,2001. EXTREME NETWORKS, INC. (Registrant) By:/s/ HAROLD L. COVERT Harold L. Covert Vice President Chief Financial Officer September 26, 2001 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appearsbelow constitutes and appoints Gordon L. Stitt and Harold L. Covert, and eachof them, 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 saidattorneys-in-fact or their substitute or substitutes may do or cause to be doneby virtue hereof. 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: /s/ GORDON L. STITT /s/ PROMOD HAQUE -------------------------------------------- ------------------- Gordon L. Stitt Promod Haque President, Chief Executive Officer Director Chairman of the Board September 26, 2001 September 26, 2001 /s/ HAROLD L. COVERT /s/ LAWRENCE K. ORR -------------------------------------------- ------------------- Harold L. Covert Lawrence K. Orr Vice President & Chief Financial Officer Director (Principal Financial and Accounting Officer) September 26, 2001 September 26, 2001 /s/ CHARLES CARINALLI /s/ PETER WOLKEN -------------------------------------------- ------------------- Charles Carinalli Peter Wolken Director Director September 26, 2001 September 26, 2001 74 EXHIBIT INDEX Incorporated By ReferenceExhibit --------------------- FiledNumber Description of Document Form Date Number Herewith------- ----------------------- ----- -------- ------ -------- 2.1 Form of Agreement and Plan of Merger between Extreme S-1/A 03/11/99 2.1 Networks, a California corporation, and Extreme Networks, Inc., a Delaware corporation. 3.1 Certificate of Incorporation of Extreme Networks, Inc., a S-1 02/05/99 3.1 Delaware Corporation. 3.2 Form of Certificate of Amendment of Certificate of S-1 02/05/99 3.2 Incorporation of Extreme Networks, Inc., a Delaware Corporation. 3.4 Amended and Restated Bylaws of Extreme Networks, Inc. 8-K/A 06/07/01 3.4 3.5 Restated Certificate of Incorporation of Extreme Networks, X Inc. 3.6 Certificate of Amendment of Restated Certificate of X Incorporation of Extreme Networks, Inc. 3.7 Certificate of Designation, Preferences and Rights of the X Terms of the Series A Preferred Stock 4.1 Second Amended and Restated Rights Agreement dated S-1 02/05/99 4.1 January 12, 1998 between Extreme Network and certain stockholders. 4.2 Registration Rights Agreement S-3 04/11/01 4.1 10.1 Form of Indemnification Agreement for directors and officers. S-1 02/05/99 10.1 10.2* Amended 1996 Stock Option Plan and forms of agreements S-1 02/05/99 10.2 thereunder. 10.3* 1999 Employee Stock Purchase Plan. S-1 02/05/99 10.3 10.4 Sublease, dated June 5, 1997 between NetManage, Inc. and S-1 02/05/99 10.4 Extreme Networks, Inc., a California corporation, to Master Lease, dated September 30, 1994, between Cupertino Industrial Associates and NetManage, Inc. 10.5 Sublease, dated January 1, 1999 between Apple Computer, S-1/A 03/11/99 10.5 Inc., a California corporation, and Extreme Networks, Inc., a California corporation, to Lease Agreement, as amended. 10.6 Form of Warrant to Purchase Common Stock between 3Com 10-K 06/30/00 10.6 Corporation and Extreme Networks, Inc. 10.7* Form of 2000 Nonstatutory Stock Option Plan. 10-K 06/30/00 10.7 10.8 Form of Lease Agreement (Land) dated June 1, 2000 by and 10-K 06/30/00 10.8 between BNP Leasing Corporation, a Delaware corporation ("BNPLC") and Extreme Networks, Inc. a Delaware corporation ("Extreme"). 10.9 Form of Lease Agreement (Improvements) dated June 1, 2000, 10-K 06/30/00 10.9 executed by and between BNPLC and Extreme. 10.10 Form of Purchase Agreement (Land) dated to be effective as of 10-K 06/30/00 10.10 June 1, 2000, executed by and between BNPLC and Extreme. 10.11 Form of Purchase Agreement (Improvements) dated to be 10-K 06/30/00 10.11 effective as of June 1, 2000, executed by and between BNPLC and Extreme. 10.12 Form of Pledge Agreement (Land) dated to be effective as of 10-K 06/30/00 10.12 June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme. 10.13 Form of Pledge Agreement (Improvements) dated to be 10-K 06/30/00 10.13 effective as of June 1, 2000, among BNPLC, BNP Paribas (as Agent), and Extreme. 10.14 Exhibit 10.14 Lease agreement dated July 28, 2000 between 10-Q 09/30/00 10.14 San Tomas Properties LLC, a Delaware limited liability company, as Landlord, and Extreme Networks, Inc, a Delaware Corporation, as Tenant. 21.1 Subsidiaries of Registrant. X 23.1 Consent of Ernst and Young LLP, Independent Auditors. X 24.1 Power of Attorney (see page 74 of this Form 10-K). X--------* Indicates management contract or compensatory plan or arrangement. 75 EXHIBIT 3.5 RESTATED CERTIFICATE OF INCORPORATION OF EXTREME NETWORKS, INC. (Pursuant to Sections 242 and 245 of the General Corporation Law of the State of Delaware) Extreme Networks, Inc., a corporation organized and existing under theGeneral Corporation Law of the State of Delaware on January 7, 1999, (the"Corporation") certifies as follows: 1. The Corporation's Restated Certificate of Incorporation was duly adoptedby the Board of Directors and sole stockholder by written consent in accordancewith Sections 242 and 245 of the General Corporation Law. 2. The Corporation's Certificate of Incorporation is restated to read infull as follows: FIRST: The name of the Corporation is Extreme Networks, Inc. ----- SECOND: The address of the registered office of the Corporation in the ------ State of Delaware is Incorporating Services, Ltd., 15 East North Street, in the City of Dover, County of Kent. The name of the registered agent at that address is Incorporating Services, Ltd. THIRD: The purpose of the Corporation is to engage in any lawful act or ----- activity for which a corporation may be organized under the General Corporation Law of Delaware. FOURTH: ------ A. The Corporation is authorized to issue a total of 152,000,000 shares of stock in two classes designated respectively "Preferred Stock" and "Common Stock". The total number of shares of all series of Preferred Stock that the Corporation shall have the authority to issue is 2,000,000 and the total number of shares of Common Stock that the Corporation shall have the authority to issue is 150,000,000. All of the authorized shares shall have a par value of $0.001. The shares of Preferred Stock may be divided into such number of series as the Board of Directors may determine. The Board of Directors is authorized to determine and alter the rights, preferences, privileges and restrictions granted to and imposed upon the Preferred Stock or any series thereof with respect to any wholly unissued series of Preferred Stock, and to fix the number of shares of any such series of Preferred Stock. The Board of Directors, within the limits and restrictions stated in any 1 resolution or resolutions of the Board of Directors originally fixing the number of shares constituting any series, may increase or decrease (but not below the number of shares of such series then outstanding) the number of shares of any series subsequent to the issue of shares of that series. FIFTH: The following provisions are inserted for the management of ----- the business and the conduct of the affairs of the Corporation, and for further definition, limitation and regulation of the powers of the Corporation and of its directors and stockholders: A. The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors. In addition to the powers and authority expressly conferred upon them by statute or by this Certificate of Incorporation or the Bylaws of the Corporation, the directors are hereby empowered to exercise all such powers and do all such acts and things as may be exercised or done by the Corporation. B. The directors of the Corporation need not be elected by written ballot unless the Bylaws so provide. C. On and after the closing date of the first sale of the Corporation's Common Stock pursuant to a firmly underwritten registered public offering (the "IPO"), any action required or permitted to be taken by the stockholders of the Corporation must be effected at a duly called annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing by such stockholders. Prior to such sale, unless otherwise provided by law, any action which may otherwise be taken at any meeting of the stockholders may be taken without a meeting and without prior notice, if a written consent describing such actions is signed by the holders of outstanding shares having not less than the minimum number of votes which would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. D. Special meetings of stockholders of the Corporation may be called only by the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board for adoption). 2 SIXTH: ----- A. The number of directors shall initially be set at five (5) and, thereafter, shall be fixed from time to time exclusively by the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board for adoption). Upon the closing of the IPO, the directors shall be divided into three classes with the term of office of the first class (Class I) to expire at the first annual meeting of the stockholders following the IPO; the term of office of the second class (Class II) to expire at the second annual meeting of stockholders held following the IPO; the term of office of the third class (Class III) to expire at the third annual meeting of stockholders; and thereafter for each such term to expire at each third succeeding annual meeting of stockholders after such election. Subject to the rights of the holders of any series of Preferred Stock then outstanding, a vacancy resulting from the removal of a director by the stockholders as provided in Section 3 below may be filled at a special meeting of the stockholders held for that purpose. All directors shall hold office until the expiration of the term for which elected, and until their respective successors are elected, except in the case of the death, resignation, or removal of any director. B. Subject to the rights of the holders of any series of Preferred Stock then outstanding, newly created directorships resulting from any increase in the authorized number of directors or any vacancies in the Board of Directors resulting from death, resignation or other cause (other than removal from office by a vote of the stockholders) may be filled only by a majority vote of the directors then in office, though less than a quorum, and directors so chosen shall hold office for a term expiring at the next annual meeting of stockholders at which the term of office of the class to which they have been elected expires, and until their respective successors are elected, except in the case of the death, resignation, or removal of any director. No decrease in the number of directors constituting the Board of Directors shall shorten the term of any incumbent director. C. Subject to the rights of the holders of any series of Preferred Stock then outstanding, any directors, or the entire Board of Directors, may be removed from office at any time, with or without cause, but only by the affirmative vote of the holders of at least a majority of the voting power of all of the then outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class. Vacancies in the Board of Directors resulting from such removal may be filled by a majority of the directors then in office, though less than a quorum, or by the stockholders as provided in Section 1 above. Directors so chosen shall hold office for a term expiring at the next annual 3 meeting of stockholders at which the term of office of the class to which they have been elected expires, and until their respective successors are elected, except in the case of the death, resignation, or removal of any director. SEVENTH: The Board of Directors is expressly empowered to adopt, ------- amend or repeal Bylaws of the Corporation. Any adoption, amendment or repeal of Bylaws of the Corporation by the Board of Directors shall require the approval of a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any resolution providing for adoption, amendment or repeal is presented to the Board). The stockholders shall also have power to adopt, amend or repeal the Bylaws of the Corporation. Any adoption, amendment or repeal of Bylaws of the Corporation by the stockholders shall require, in addition to any vote of the holders of any class or series of stock of the Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least sixty-six and two-thirds percent (66-2/3%) of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class. EIGHTH: A director of the Corporation shall not be personally liable to ------ the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involved intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the director derived an improper personal benefit. If the Delaware General Corporation Law is hereafter amended to authorize the further elimination or limitation of the liability of a director, then the liability of a director of the Corporation shall be eliminated or limited to the fullest extent permitted by the Delaware General Corporation Law, as so amended. Any repeal or modification of the foregoing provisions of this Article EIGHTH by the stockholders of the Corporation shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal or modification. 4 NINTH: The Corporation reserves the right to amend or repeal any ----- provision contained in this Certificate of Incorporation in the manner prescribed by the laws of the State of Delaware and all rights conferred upon stockholders are granted subject to this reservation; provided, however, that, notwithstanding any other -------- ------- provision of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any vote of the holders of any class or series of the stock of this Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least 66-2/3% of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to amend or repeal this Article NINTH, Article FIFTH, Article SIXTH, Article SEVENTH or Article EIGHTH. IN WITNESS WHEREOF, the Corporation has caused this Restated Certificate tobe signed by a duly authorized officer on this 16th day of February, 2000. EXTREME NETWORKS, INC. By: /s/ Gordon Stitt --------------------------------------- Gordon Stitt, Chief Executive Officer 5 EXHIBIT 3.6 CERTIFICATE OF AMENDMENT OF RESTATED CERTIFICATE OF INCORPORATION OF EXTREME NETWORKS, INC. (Pursuant to Sections 242 and 245 of the General Corporation Law of the State of Delaware) I, Gordon Stitt, Chief Executive Officer of Extreme Networks, Inc. (the"Corporation"), a corporation organized and existing under the Delaware GeneralCorporation Law ("DGCL"), DO HEREBY CERTIFY AS FOLLOWS: 1. That the Board of Directors of the Corporation, at a meeting of itsmembers, adopted a resolution proposing and declaring advisable the followingamendment to the Restated Certificate of Incorporation of the Corporation: RESOLVED FURTHER, that the Restated Certificate of Incorporation be amended by changing the first paragraph of Section A of the Article thereof numbered "FOURTH" so that, as amended, said first paragraph of Section A of the Article thereof numbered "FOURTH" shall be and read as follows: "A. The Corporation is authorized to issue a total of 752,000,000 shares of stock in two classes designated respectively "Preferred Stock" and "Common Stock". The total number of shares of all series of Preferred Stock that the Corporation shall have the authority to issue is 2,000,000 and the total number of shares of Common Stock that the Corporation shall have the authority to issue is 750,000,000. All of the authorized shares shall have a par value of $0.001." 2. That the stockholders of the Corporation, at a meeting and vote of thestockholders, have given consent to said amendment in accordance with theprovisions of Section 216 of the DGCL. 3. That the aforesaid amendments were duly adopted in accordance with theapplicable provisions of Sections 242 and 216 of the DGCL. IN WITNESS WHEREOF, the Corporation has caused this Certificate ofAmendment to be signed by a duly authorized officer on this 7th day of December,2000. EXTREME NETWORKS, INC. By: /s/ Gordon Stitt --------------------------------------- Gordon Stitt, Chief Executive Officer EXHIBIT 3.7 EXTREME NETWORKS, INC. CERTIFICATE OF DESIGNATION, PREFERENCES AND RIGHTS OF THE TERMS OF THE SERIES A PREFERRED STOCK Pursuant to Section 151 of the General Corporation Law of the State ofDelaware We, the President and Chief Executive Officer and the Secretary,respectively, of Extreme Networks, Inc., organized and existing under theGeneral Corporation Law of the State of Delaware, in accordance with theprovisions of Section 103 thereof, DO HEREBY CERTIFY: That pursuant to the authority conferred upon the Board of Directors by theCertificate of Incorporation of the said Corporation, the said Board ofDirectors on April 26, 2001, adopted the following resolution creating a seriesof 750,000 shares of Preferred Stock designated as Series A Preferred Stock: RESOLVED, that pursuant to the authority vested in the Board of Directorsof this Corporation in accordance with the provisions of its Certificate ofIncorporation, a series of Preferred Stock of the Corporation be and it herebyis created, and that the designation and amount thereof and the powers,preferences and relative, participating, optional and other special rights ofthe shares of such series, and the qualifications, limitations or restrictionsthereof are as follows: Section 1. Designation and Amount. The shares of such series shall be ----------------------designated as "Series A Preferred Stock" (the "Series A Preferred Stock"), $.001par value per share, and the number of shares constituting such series shall be750,000. Section 2. Dividends and Distributions. --------------------------- (A) The dividend rate on the shares of Series A Preferred Stock shallbe for each quarterly dividend (hereinafter referred to as a "quarterly dividendperiod"), which quarterly dividend periods shall commence on April 1, July 1,October 1 and January 1 each fiscal year (each such date being referred toherein as a "Quarterly Dividend Payment Date") (or in the case of originalissuance, from the date of original issuance) and shall end on and include theday next preceding the first date of the next quarterly dividend period, at arate per quarterly dividend period (rounded to the nearest cent) equal to thegreater of (a) $3,750.00 or (b) subject to the provisions for adjustmenthereinafter set forth, 1,000 times the aggregate per share amount of all cashdividends, and 1,000 times the aggregate per share amount (payable in cash,based upon the fair market value at the time the non-cash dividend or otherdistribution is declared as determined in good faith by the Board of Directors)of all non-cash dividends or other 1distributions other than a dividend payable in shares of Common Stock or asubdivision of the outstanding shares of Common Stock (by reclassification orotherwise), declared (but not withdrawn) on the Common Stock, par value $.001per share, of the Corporation (the "Common Stock") during the immediatelypreceding quarterly dividend period, or, with respect to the first quarterlydividend period, since the first issuance of any share or fraction of a share ofSeries A Preferred Stock. In the event this Corporation shall at any time afterMay 14, 2001 (the "Rights Declaration Date") (i) declare any dividend on CommonStock payable in shares of Common Stock, (ii) subdivide the outstanding CommonStock, or (iii) combine the outstanding Common Stock into a smaller number ofshares, then in each such case the amount to which holders of shares of Series APreferred Stock were entitled immediately prior to such event under clause (b)of the preceding sentence shall be adjusted by multiplying such amount by afraction the numerator of which is the number of shares of Common Stockoutstanding immediately after such event and the denominator of which is thenumber of shares of Common Stock that were outstanding immediately prior to suchevent. (B) Dividends shall begin to accrue and be cumulative on outstandingshares of Series A Preferred Stock from the Quarterly Dividend Payment Date nextpreceding the date of issue of such shares of Series A Preferred Stock, unlessthe date of issue of such shares is prior to the record date for the firstQuarterly Dividend Payment Date, in which case dividends on such shares shallbegin to accrue from the date of issue of such shares, or unless the date ofissue is a Quarterly Dividend Payment Date or is a date after the record datefor the determination of holders of shares of Series A Preferred Stock entitledto receive a quarterly dividend and before such Quarterly Dividend Payment Date,in either of which events such dividends shall begin to accrue and be cumulativefrom such Quarterly Dividend Payment Date. Accrued but unpaid dividends shallnot bear interest. Dividends paid on the shares of Series A Preferred Stock inan amount less than the total amount of such dividends at the time accrued andpayable on such shares shall be allocated pro rata on a share-by-share basisamong all such shares at the time outstanding. The Board of Directors may fix arecord date for the determination of holders of shares of Series A PreferredStock entitled to receive payment of a dividend or distribution declaredthereon, which record date shall be no more than forty-five (45) days prior tothe date fixed for the payment thereof. Section 3. Voting Rights. The holders of shares of Series A Preferred Stock -------------shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth,each share of Series A Preferred Stock shall entitle the holder thereof to 1,000votes on all matters submitted to a vote of the stockholders of the Corporation.In the event the Corporation shall at any time after the Rights Declaration Date(i) declare any dividend on Common Stock payable in shares of Common Stock, (ii)subdivide the outstanding Common Stock, or (iii) combine the outstanding CommonStock into a smaller number of shares, then in each such case the number ofvotes per share to which holders of shares of Series A Preferred Stock wereentitled immediately prior to such event shall be adjusted by multiplying suchnumber by a fraction the numerator of which is the number of shares of CommonStock outstanding immediately after such event and the denominator of which isthe number of shares of Common Stock that were outstanding immediately prior tosuch event. 2 (B) Except as otherwise provided herein, in the Certificate ofIncorporation or Bylaws, the holders of shares of Series A Preferred Stock andthe holders of shares of Common Stock shall vote together as one class on allmatters submitted to a vote of stockholders of the Corporation. (C) Except as set forth herein, in the Certificate of Incorporationand in the Bylaws, holders of Series A Preferred Stock shall have no specialvoting rights and their consent shall not be required (except to the extent theyare entitled to vote with holders of Common Stock as set forth herein) fortaking any corporate action. Section 4. Reacquired Shares. Any shares of Series A Preferred Stock -----------------purchased or otherwise acquired by the Corporation in any manner whatsoevershall be retired and canceled promptly after the acquisition thereof. All suchshares shall upon their cancellation become authorized but unissued shares ofPreferred Stock and may be reissued as part of a new series of Preferred Stockto be created by resolution or resolutions of the Board of Directors, subject tothe conditions and restrictions on issuance set forth herein. Section 5. Liquidation, Dissolution or Winding Up. In the event of any --------------------------------------voluntary or involuntary liquidation, dissolution or winding up of theCorporation, the holders of the Series A Preferred Stock shall be entitled toreceive the greater of (a) $150,000.00 per share, plus accrued dividends to thedate of distribution, whether or not earned or declared, or (b) an amount pershare, subject to the provision for adjustment hereinafter set forth, equal to1,000 times the aggregate amount to be distributed per share to holders ofCommon Stock. In the event the Corporation shall at any time after the RightsDeclaration Date (i) declare any dividend on Common Stock payable in shares ofCommon Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine theoutstanding Common Stock into a smaller number of shares, then in each such casethe amount to which holders of shares of Series A Preferred Stock were entitledimmediately prior to such event pursuant to clause (b) of the preceding sentenceshall be adjusted by multiplying such amount by a fraction the numerator ofwhich is the number of shares of Common Stock outstanding immediately after suchevent and the denominator of which is the number of shares of Common Stock thatwere outstanding immediately prior to such event. Section 6. Consolidation, Merger, etc. In case the Corporation shall enter --------------------------into any consolidation, merger, combination or other transaction in which theshares of Common Stock are exchanged for or changed into other stock orsecurities, cash and/or any other property, then in any such case the shares ofSeries A Preferred Stock shall at the same time be similarly exchanged orchanged in an amount per share (subject to the provision for adjustmenthereinafter set forth) equal to 1,000 times the aggregate amount of stock,securities, cash and/or any other property (payable in kind), as the case maybe, into which or for which each share of Common Stock is changed or exchanged.In the event the Corporation shall at any time after the Rights Declaration Date(i) declare any dividend on Common Stock payable in shares of Common Stock, (ii)subdivide the outstanding Common Stock, or (iii) combine the outstanding CommonStock into a smaller number of shares, then in each such case the amount setforth in the preceding sentence with respect to the exchange or change of sharesof Series A Preferred Stock shall be adjusted by multiplying such amount by afraction the numerator of which is the number of shares of Common Stockoutstanding immediately after such event and the denominator of 3which is the number of shares of Common Stock that were outstanding immediatelyprior to such event. Section 7. No Redemption. The shares of Series A Preferred Stock shall not -------------be redeemable. Section 8. Fractional Shares. Series A Preferred Stock may be issued in -----------------fractions of a share which shall entitle the holder, in proportion to suchholder's fractional shares, to exercise voting rights, receive dividends,participate in distributions and have the benefit of all other rights of holdersof Series A Preferred Stock. All payments made with respect to fractional shareshereunder shall be rounded to the nearest whole cent. Section 9. Certain Restrictions. -------------------- (A) Whenever quarterly dividends or other dividends or distributionspayable on the Series A Preferred Stock as provided in Section 2 are in arrears,thereafter and until all accrued and unpaid dividends and distributions, whetheror not declared, on shares of Series A Preferred Stock outstanding shall havebeen paid in full, the Corporation shall not: (i) declare or pay dividends on, make any other distributions on, or redeem or purchase or otherwise acquire for consideration any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock; (ii) declare or pay dividends on or make any other distributions on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except dividends paid ratably on the Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such parity stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Preferred Stock; or (iv) purchase or otherwise acquire for consideration any shares of Series A Preferred Stock, or any shares of stock ranking on a parity with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes shall determine in good faith will result in fair and equitable treatment among the respective series or classes. 4 (B) The Corporation shall not permit any subsidiary of the Corporationto purchase or otherwise acquire for consideration any shares of stock of theCorporation unless the Corporation could, under paragraph (A) of this Section 9,purchase or otherwise acquire such shares at such time and in such manner. Section 10. Ranking. The Series A Preferred Stock shall be junior to all -------other Series of the Corporation's preferred stock as to the payment of dividendsand the distribution of assets, unless the terms of any series shall provideotherwise. Section 11. Amendment. The Certificate of Incorporation of the Corporation ---------shall not be amended in any manner which would materially alter or change thepowers, preferences or special rights of the Series A Preferred Stock so as toaffect them adversely without the affirmative vote of the holders of two-thirdsor more of the outstanding shares of Series A Preferred Stock voting together asa single class. IN WITNESS WHEREOF, we have executed and subscribed this Certificate and doaffirm the foregoing as true under the penalties of perjury this 27th day ofApril, 2001. /s/ Gordon L. Stitt -------------------------------------- Gordon L. Stitt Chief Executive Officer and PresidentAttest:/s/ Vito Palermo------------------------------Vito PalermoSecretary 5 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 KingdomExtreme Networks B.V. The NetherlandsExtreme Networks GmbH GermanyExtreme Networks Sarl FranceExtreme Networks Srl ItalyExtreme Networks Canada, Inc. CanadaExtreme Networks Korea, Ltd. KoreaIHC Networks AB SwedenExtreme Networks Australia PTE, Ltd. AustraliaExtreme Networks EMEA DubaiExtreme Networks Argentina, SRL ArgentinaExtreme Networks Brasil, Ltda. BrazilExtreme Networks Columbia, Ltda. ColumbiaExtreme Networks Mexico, Ltda. MexicoExtreme Networks Chile, Ltda. ChileExtreme Networks Singapore PTE, Ltd. SingaporeExtreme Networks China Ltd. ChinaExtreme Networks Spain, SL Spain Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORSWe consent to the incorporation by reference in this Annual Report (Form 10-K)of Extreme Networks, Inc. of our report dated July 16, 2001 included in the 2001Annual Report to Stockholders of Extreme Networks, Inc.Our audits also included the financial statement schedule of Extreme Networks,Inc. listed in Item 14(a). This schedule is the responsibility of the Company'smanagement. Our responsibility is to express an opinion based on our audits. Inour opinion, the financial statement schedule referred to above, when consideredin relation to the basic financial statements taken as a whole, presents fairlyin all material respects the information set forth therein.We also consent to the incorporation by reference in the following registrationstatements of Extreme Networks, Inc. of our report dated July 16, 2001, withrespect to the consolidated financial statements incorporated by reference andour report included in the preceding paragraph with respect to the financialstatement schedule included in the Annual Report (Form 10-K) for the year endedJune 30, 2001: RegistrationForm StatementNumber Number Description--------------------------------------------------------------------------------Form S-8 333-65636 Extreme Networks, Inc. 2001 Nonstatutory Stock Option PlanForm S-3 333-58734 Equity SecuritiesForm S-3 333-58714 Equity SecuritiesForm S-8 333-58634 Extreme Networks, Inc. Individual Option Agreements Granted Under the Webstacks, Inc. 2000 Stock Option Plan and Assumed by Extreme Networks, Inc.Form S-8 333-55644 Extreme Networks, Inc. Individual Option Agreements Granted Under the Optranet, Inc. 2000 Option Plan and Assumed by Extreme Networks, Inc.Form S-8 333-54278 Extreme Networks, Inc. Amended 1996 Stock Option Plan, 1999 Employee Stock Purchase Plan and 2000 Nonstatutory Stock Option Plan /s/ Ernst & Young LLPPalo Alto, CaliforniaSeptember 25, 2001

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