Extreme Networks Annual Report 2007

Plain-text annual report

Table of ContentsUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 Form 10-K (Mark One)xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended July 1, 2007 OR ¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . Commission file number 000-25711 Extreme Networks, Inc.(Exact name of Registrant as specified in its charter) Delaware 77-0430270(State or other jurisdiction ofincorporation or organization) (I.R.S. EmployerIdentification No.)3585 Monroe StreetSanta Clara, California 95051(Address of principal executive offices) (Zip Code) 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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendmentto this Form 10-K. x Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One): Large Accelerated Filer ¨ Accelerated Filer x Non-Accelerated Filer ¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $478.1 million as of December 29, 2006, thelast business day of the Registrant’s most recently completed second fiscal quarter, based upon the closing price on The Nasdaq Global Market reported forsuch date. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose. 114,125,589 shares of the Registrant’s Common stock, $.001 par value, were outstanding July 29, 2007. DOCUMENTS INCORPORATED BY REFERENCE Part III incorporates by reference from the definitive proxy statement for the Company’s 2007 Annual Meeting of Stockholders to be filed with theCommission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. Table of ContentsEXTREME NETWORKS, INC. FORM 10-K INDEX PageForward Looking Statements 3 PART I Item 1. Business 3Item 1A. Risk Factors 21Item 1B. Unresolved Staff Comments 38Item 2. Properties 38Item 3. Legal Proceedings 39Item 4. Submission of Matters to a Vote of Security Holders 42 PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 43Item 6. Selected Financial Data 43Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 44Item 7A. Quantitative and Qualitative Disclosures About Market Risk 59Item 8. Financial Statements and Supplementary Data 61Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 96Item 9A. Controls and Procedures 96Item 9B. Other Information 98 PART III Item 10. Directors and Executive Officers of the Registrant 100Item 11. Executive Compensation 100Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 100Item 13. Certain Relationships and Related Transactions 100Item 14. Principal Accounting Fees and Services 100 PART IV Item 15. Exhibits and Financial Statement Schedules 101SIGNATURES 104 2Table of ContentsFORWARD LOOKING STATEMENTS This annual report on Form 10-K, including the following sections, contains forward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995, particularly statements relating to our expectations for the first quarter of fiscal 2008, our expectations regarding results ofoperations, our ability to expand our market penetration, our ability to expand our distribution channels, customer acceptance of our products, our ability tomeet the expectations of our customers, product demand and revenue, cash flows, product gross margins, our expectations to continue to develop newproducts and enhance existing products, our expectations regarding the amount of our research and development expenses, our expectations relating to ourselling, general and administrative expenses, our efforts to achieve additional operating efficiencies and to review and improve our business systems and coststructure, our expectations to continue investing in technology, resources and infrastructure, our expectations concerning the availability of products fromsuppliers and contract manufacturers, anticipated product costs and sales prices, our expectations that we have sufficient capital to meet our requirements forat least the next twelve months, our expectations regarding the rationalization of our workforce and facilities, and our expectations regarding materials andinventory management. These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth below and those containedin the section entitled “Risk Factors” identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. We caution investors that actual results may differ materially from those projected in the forward-looking statements as a result of certainrisk factors identified in this Form 10-K and other filings we have made with the Securities and Exchange Commission. More information about potentialfactors that could affect our business and financial results is set forth under “Risk Factors” and “Management’s Discussion and Analysis of FinancialCondition and Results of Operations.” PART I Item 1. Business Overview Extreme Networks, Inc., together with its subsidiaries, (collectively referred to as Extreme or the Company and as we, us and our) is a leading providerof network infrastructure equipment for corporate, government, education and health care enterprises and metropolitan telecommunications service providers.We were established in 1996 to address the issues caused by slow and expensive legacy networks. We endeavored to change the industry by replacingcomplex software-based routers with simple, fast, highly intelligent, hardware-based network switches. The subsequent and broad acceptance of thisinnovative, simplified approach to networking has enabled us to become an industry leader. Our technology vision since the founding of the Company hasbeen “Ethernet Everywhere” – a unifying network strategy that uses proven Ethernet technology to simplify each element of the network. Our vision ofEthernet Everywhere helped us deliver easily deployable, highly scalable, comprehensively managed networks with ubiquitous bandwidth for applicationsand users. The resulting proliferation of applications, users and devices on the network has lead to new opportunities, including securing the networkinfrastructure. This becomes more critical as voice and video converges on to the data network. An attack on a converged enterprise network exposes thevoice services within the company or in the case of a carrier exposes the voice services for their customers, to reliability and availability risks. Realizing thehigh availability requirement for converged Ethernet networks we have updated our vision of Ethernet Everywhere to ‘Insight and Control’. Our vision todayis to provide meaningful insight into and greater control over the Ethernet infrastructure. Extreme Networks recognized in early 2000 that new network operating systems would be needed by the industry as converged IP networks begin todrive more and more mission-critical traffic onto a single network infrastructure. ExtremeXOS™ now delivers revolutionary breakthroughs and industryleading capabilities that further the state-of-the-art in networking technology: Scalability, Resiliency, Security and Extensibility. 3Table of ContentsExtremeXOS™ provides a revolutionary foundation that for the first time delivers adaptability, scalability and increased responsiveness for Ethernetnetworks through its uniquely open, extensible architecture. Our portfolio of networking products provides insight and control for the network, while enabling greater flexibility and scalability, ease-of-use and alower cost of ownership. We have achieved these advantages by utilizing Application Specific Integrated Circuits (ASICs) as well as merchant silicon in ourproducts and by creating a common hardware, operating systems and network management architecture for our products. Industry Background Businesses, governments, educational institutions, service providers, and other enterprise organizations have become highly dependent on theirinternal networks and the Internet. These networks serve as a central communications infrastructure connecting internal and external sites, and hosting voicecalls and live and streamed video traffic. Computing applications, such as Enterprise Resource Planning (ERP) or Customer Relationship Management(CRM) systems, large enterprise data warehouses and sophisticated online transaction and other e-business applications, require the support of significantnetwork resources as does the increased use of converged communication applications like IP Telephony. The emergence of the desktop Internet browser as astandard user interface as well as the Internet Protocol, or IP, as a common, enabling network technology has enabled bandwidth-intensive applications thatintegrate voice, video and data over TCP/IP to be deployed extensively throughout organizations. The steady rise in application sophistication, theproliferation of network-delivered services to the residence and the associated bandwidth load demands a fast, flexible and scalable network infrastructure. Networking environments can be segmented into local area networks, or LANs, wide area networks, or WANs, and metropolitan area networks, orMetros. LANs. LANs are traditional networks designed for connecting users to many types of application servers, which may be held locally or where they areremotely accessed through either private WANs or through secured public Internet communications. The LAN consists of servers, clients, a network operatingsystem and a communications link to connect the LAN to other networks and to the Internet. The LAN market in which Extreme participates consistsprimarily of large and medium-sized enterprise customers. WANs. WANs are communication networks that span across large geographic areas, such as counties, states or countries. The addition of WAN support to ASIC-based or merchant silicon-based network switches permits encapsulated Ethernet services to reach customerswhere integration with existing Synchronous Optical Network/Synchronous Digital Hierarchy, or SONET/SDH, infrastructure is required. The WAN market includes service providers such as local exchange carriers, or ILECs, and competitive local exchange carriers, or CLECs, multipletenant/dwelling unit service providers, or MTUs, and Internet service providers, or ISPs, as primary customers. Metros. Metros are networks that link mid-sized geographic areas such as a city or an entire metropolitan area. Due to wide and steady deployment of increasingly scalable Ethernet technology, LAN traffic has achieved geometric growth in the aggregate amountsof data traffic delivered over networks and bandwidth rates, now delivered at Gigabit and 10 Gigabit speeds. Available bandwidth in WANs has also grown,as infrastructures are built out to accommodate the annual growth in Internet traffic. The Metro network has emerged as the key link between the LAN and theWAN. 4Table of ContentsIn recent years, the Metro network has become a critical and dynamically evolving arena within the overall IP network infrastructure landscape. Inaddition to steadily rising traffic load, the underlying network technologies, architectures and protocols are experiencing incremental change. The Metromarket includes ILECs and CLECs as well as alternative metropolitan service providers such as utility companies, railroads and municipalities that provideMetro network services to connect multiple facilities. For example, a local government might build a Metro network to interconnect agencies, such as cityhall, fire departments, road and vehicle maintenance facilities, hospitals and emergency centers, social services and public libraries. The same technologiesand network architectures associated with Metros are becoming popular within large and very large corporate enterprises, which can utilize private Metros,by lighting “dark” fiber optic cabling, to create a “super campus” network, connecting facilities spread over a city-size area. A converged network must meet the following four key requirements: High Availability. To avoid network outages hardware availability, network operating system availability and network-level availability have to becombined. Simply addressing just one of these is not sufficient to support a converged network. Switch hardware must support redundant managementmodules with hitless failover, hot swappable line cards and redundant power supplies for hardware high availability. High availability switches used toimplement a converged network must have a modular operating system. Switches must also support a variety of link-level resiliency protocols that allowscustomers to reroute IP Telephony calls in less than 50 milliseconds should a network link fail. Quality of Service. Network users expect high-quality connections for all converged services, regardless of whether other bandwidth intensiveapplications are placing heavy demands on the network. Quality of Service (QoS) solutions that allow network administrators and carriers to assign theappropriate amount of bandwidth to the applications deemed most important is crucial in implementing a converged network. Switches must introduce onlyvery low jitter and low latency if they are to be part of a converged network. Comprehensive security. Trying to manage a secure environment in a world full of threats has consistently increased the demands on all ITorganizations. Additionally, regulatory compliance has made enterprise security a critical component of meeting new legislation requirements. Acomprehensive security implementation has to make sure that only the authorized users, authorized devices and authorized applications are allowed on thenetwork. Identity based user access control, laptop and desktop scanning and authentication, and network wide coverage for rapidly propagating threats andintrusion prevention are key to achieving comprehensive security. Ease of management. Proactive network monitoring and ease of network management are key ingredients in the design and successful operation of aconverged network. IT administrators must be able to easily monitor converged applications like IP Telephony service and perform other critical operationaltasks while accommodating changes quickly. Opportunity for Next Generation Switching Solutions Several technology trends have enabled a new generation of networking equipment that is built to meet the key requirements demanded by today’senterprises and service providers. A variety of new requirements are now being placed on the enterprise LAN network. The resulting proliferation of applications, users and devices onthe network has lead to the challenge of securing the network infrastructure. This becomes more critical as voice and video converges on to the data network.An attack on a converged enterprise network exposes the voice services within the company to reliability and availability risks. Customers are demandinghigh availability switching solutions that are easy to install, secure and operate. These requirements offer great opportunity for next generation switchingsolutions in the enterprise LAN market. Ethernet started as an enterprise technology and when Metro Ethernet took hold in 2000, Extreme Networks pioneered the market by enhancingEthernet for service providers. We invented technologies such as EAPS and 5Table of ContentsvMANs. Over subsequent years, these technologies have been deployed widely to great success and are being used to deliver network services over fiber, tobuildings or a residence. This was great for Internet access where carriers sold and subscribers essentially bought bulk data transfer. But today, individualsubscribers – residential or businesses – want tailored services and guarantees driven by new applications such as voice and IPTV. Providing the opportunityfor carriers to address individual subscribers through mass customization and deliver valuable services, in a low cost Ethernet network, opens up the marketfor Ethernet switches in the carrier Ethernet market. The Extreme Networks Solution We provide Ethernet networking solutions that meet the requirements of today’s enterprises and service providers by providing high performance,solution scalability, advanced policy-based Quality of Service, simplicity of use and lower cost of ownership. Our products share a common hardware,operating system and network management architecture, are based on industry-standard routing and network management protocols and offer openextensibility and interoperability. Our switches can be managed from any browser-equipped computer or the Telnet applet supported in almost all operatingsystems. The Telnet applet allows access to the Command Line Interface, or CLI, which a system administrator may prefer to use. The key benefits of our solutions are: High Availability: Customers can choose redundant management modules with hitless failover, hot swappable line cards and redundant power suppliesfor hardware high availability; a modular operating system (ExtremeXOSTM) for high system availability; and a variety of link-level resiliency protocols,including Ethernet Automatic Protection Switching (EAPS). Developed by Extreme Networks, EAPS is a critical protocol in any converged network. Thisopen protocol allows you to reroute IP Telephony calls in less than 50 milliseconds should a network link fail, allowing businesses to continue uninterruptedeven if disaster strikes. Quality of Service: Extreme Networks offers an excellent and versatile Quality of Service (QoS) solution that allows IT administrators and carriers toassign the appropriate amount of bandwidth to mission critical applications such as IP Telephony and voice over wireless LANs. Policy based QoS offered byExtreme Networks allows network operators to automate and simplify bandwidth control. The ability to precisely deliver the specified bandwidth to a largenumber of applications and users is a hallmark of our QoS solution. Comprehensive Security: Extreme Networks’ security solution is truly innovative and delivers what all IT professionals seek – a network that hassecurity in its heart, rather than added as an afterthought. Our security solution, which combines secure switches with our powerful security rules engine,enables customers to implement unified wired and wireless network access and IP Telephony in a secure environment. CLEAR-Flow, our wire-speed securityrules engine, helps detect and mitigate denial of service attacks. In the case of rapidly propagating Day-Zero threats, such as worm storms, CLEAR-Flowcombined with Sentriant, our scalable, virtual security resource, can help protect the network. Ease of Management: We offer a suite of network management tools that allow network operators to monitor and manage the network in an automatedfashion. Using our tools, network administrators can quickly and easily monitor IP Telephony service, accommodate changes and perform other criticaloperational tasks. Also, software developers can interact directly with our products using a standards-based Application Programming Interface (API) tomanage the network and optimize application performance. The Extreme Networks Strategy Our goal is to be the provider of the most innovative and effective network solutions that create an improved applications and services infrastructurefor enterprises and service providers. We seek to provide our customers with a best-of-breed alternative to single-sourced, highly proprietary networkingequipment from larger competitors. 6Table of ContentsKey elements of our strategy include: Provide simple, easy-to-use, high-performance, cost-effective switching solutions. We offer customers easy-to-use, powerful, cost-effective switchingsolutions that meet the specific demands of enterprises, and service and content providers. Our products provide customers with scalability from 10 MbpsEthernet to 10 Gigabit Ethernet combined with the wire-speed, non-blocked routing of ASIC-based or merchant silicon-based Layer 3 switching. We intendto capitalize on our expertise in Ethernet, IP and hardware-based switching technologies to continuously develop new products that will meet the futurerequirements of a broad range of customers. Expand market penetration. We continue to market our products to new customers in multiple market segments. The majority of our business is withenterprise customers, including those in government and education sectors. Additionally, we aim to leverage our technology development, service, supportand business infrastructure resources to address the metropolitan Ethernet market. These service provider customers include ISPs, content providers andMetro service providers. While currently most of our service provider and Metro-related business is generated outside of the United States, we believe there isa long-term growth opportunity in the metropolitan Ethernet market on a worldwide basis. Once customers deploy our products they obtain the increasedbenefits of our solution by simplifying their networks, extending policy-based Quality of Service and reducing costs of ownership, while increasingperformance. Extend switching technology leadership. Our technological leadership is based on proprietary switching technology, the ExtremeXOS™ andExtremeWare® operating systems. We intend to invest our engineering resources in our proprietary switching technology, our operating system and otherdevelopment areas to create leading-edge technologies that will increase the performance and functionality of our products. We also intend to maintain ouractive 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 through select distributors and a large number of resellers. To quicklyreach a broad, worldwide audience, we have more than 800 resellers in approximately 70 countries, including regional networking system resellers, networkintegrators and wholesale distributors. We maintain a field sales force to support our resellers and to sell directly to a small number of select strategicaccounts. We are continually developing and refining our two-tier distribution channel strategy. Provide high-quality customer service and support. We seek to enhance customer satisfaction and build customer loyalty through high-quality serviceand support. This includes a wide range of standard support programs that provide the level of service our customers require, from standard business hours toglobal 24-hour-a-day, 365-day-a-year real-time response support. We intend to continue to enhance the ease of use of our products, and to invest inadditional support services by increasing staff and adding new support programs for our distributors and resellers. We are committed to providing customer-driven product functionality through feedback from key prospects, consultants, channel partners and end-user customers. Products We deliver wired and wireless networking solutions for enterprises and service providers who are facing tough infrastructure challenges. Our productsand services leverage a modern, modular operating system, innovative hardware technologies, and network-integrated security and mobility capabilities toprovide simplicity, high performance, and network insight and control at a low cost of ownership. During the past fiscal year, Extreme Networks introduced a series of new products that support our customers’ secure, converged networks. Release 12.0of ExtremeXOS™, our award-winning modular network operating system, continues to deliver leading capabilities that ease the deployment andmanagement of sophisticated enterprise and service provider networks. The Summit X250 series, powered by ExtremeXOS, 7Table of Contentsbreaks new ground in the network switching space. With advanced automation and quality of service features in an economical package, these switches areideal for connecting simple devices, like IP handsets or security cameras, to an advanced Enterprise network. In addition, we introduced new products andenhancements to both our Security and Wireless product lines. Our principal products are as follows: Products Configuration/DescriptionExtreme XOS-powered Summit StackableProduct Family Summit X250 24 or 48 10/100 Mbps Ethernet ports and 2 Gigabit Ethernet ports with or withoutPower-Over-Ethernet (POE)Summit X450 24 or 48 10/100/1000 BaseT Ethernet ports or 24 Gigabit Ethernet fiber ports, including4 dual personality (fiber or copper) Gigabit Ethernet ports and an optional 2-port 10Gigabit Ethernet ModuleExtremeWare-powered Summit StackableProduct Family Summit5i 12 100/1000 BaseT Ethernet ports and 4 1000BaseX Gigabit Ethernet portsSummit48si 48 10/100 Mbps Ethernet ports and 2 Gigabit Ethernet portsSummit 200 48 or 24 10/100 Mbps Ethernet ports and 2 Gigabit Ethernet portsSummit 300 48 or 24 10/100 Mbps Ethernet ports, supporting Power over Ethernet, and 2 or 4 GigabitEthernet portsSummit 400 48 or 24 10/100/1000 BaseT Ethernet ports, 4 Gigabit Ethernet 1000BaseX ports and anoptional 2-port 10 Gigabit Ethernet Module. One version of the 24 port model supportsPower over EthernetSummit WM Wireless Product Family Summit WM 100/1000 Wireless switch controller supporting 4 fast 10/100 ports or 2 Gigabit Ethernet ports andup to 200 wireless Access PointsSummit WM 200/2000 Wireless switch controllers supporting advanced voice over wireless capabilities as wellas enhanced failover features for demanding WLAN applicationsBlackDiamond Modular Chassis powered byExtremeXOS BlackDiamond 8806 192 10/100/1000 Gigabit Ethernet ports, or 18 10 Gigabit Ethernet ports in one chassis 6 slots to accommodate a variety of up to 4connectivity modules and 2 management modulesBlackDiamond 8810 432 10/100/1000 Gigabit Ethernet ports, or 36 10 Gigabit Ethernet ports in one chassis 10 slots to accommodate a variety of up to 8 connectivity modules and 2 managementmodules 8Table of ContentsProducts Configuration/DescriptionBlackDiamond 12804C 80 Gigabit Ethernet ports, or 8 10 Gigabit Ethernet ports in one chassis for the enterprisecore 6 slots to accommodate a variety of up to 4 connectivity modules and 2 managementmodulesBlackDiamond 12804R 80 Gigabit Ethernet ports, or 8 10 Gigabit Ethernet ports in one chassis for carrierEthernet services 6 slots to accommodate a variety of up to 4 connectivity modules and 2 managementmodulesBlackDiamond 10808 480 Gigabit Ethernet ports, or 48 10 Gigabit Ethernet ports in one chassis 10 slots to accommodate a variety of up to 8 connectivity modules and 2 managementmodulesBlackDiamond and Alpine Modular Chassispowered by ExtremeWare Alpine 3804 Up to 128 10/100 Mbps Ethernet ports or 64 Gigabit Ethernet ports in one chassis 5 slots to accommodate a variety of up to 4 connectivity modules and 1 managementmoduleAlpine 3808 Up to 256 10/100 Mbps Ethernet ports or 128 Gigabit Ethernet ports in one chassis 9 slots to accommodate a variety of up to 8 connectivity modules and 1 managementmoduleBlackDiamond 6808 Up to 672 10/100 Mbps Ethernet ports, 168 Gigabit Ethernet ports, or eight 10 GigabitEthernet ports in one chassis 10 slots to accommodate a variety of up to 8 connectivity modules and 2 managementmodulesOperating Systems ExtremeXOS™ A modular, POSIX-compliant modular switch operating system supporting open APIs fordevice to device collaboration and support for XML type interfaces. ExtremeXOSdelivers automated process restart for highly available networksExtremeWare® An embedded switch operating system featuring standard protocols, web-basedconfiguration and policy-based Quality of Service Summit Stackable Products Our Summit stackable switch family is designed to meet the demanding requirements of Enterprise and Service Provider customers. With a broad rangeof Gigabit and 10/100 Mbps speeds and switches built for edge and aggregation roles, these products meet the needs of Enterprises connecting desktops andservers as well as Service Providers connecting large Internet data centers and broadband points of presence in metropolitan-scale service areas. Extreme Networks was the first networking company to introduce fixed-configuration switches utilizing a modern, modular operating system. As aresult, our customers now can enjoy the high availability and 9Table of Contentsextensibility capabilities of ExtremeXOS – a network operating system originally designed to meet the demanding needs of core and service providerapplications – at the edge of their networks. We’ve moved aggressively to build our ExtremeXOS-based fixed-configuration product portfolio. In 2005, we announced the Summit 450 series ofswitches for Gigabit connectivity. In 2006 we extended the Summit portfolio again with the addition of the Summit 250 series of switches for 10/100connectivity. As a result, enterprise and service provider customers can now tailor their solution with a variety of form factors – 24 or 48 ports, powered ornon-powered, and 10/100 or 10/100/1000. When combined with our ExtremeXOS-based BlackDiamond core products, our Summit switches deliver a uniquevalue proposition: a single network operating system – running on the same release from the edge to the core – capable of creating high performanceconverged infrastructure solutions that are simple to deploy and operate. Our ExtremeWare stackable switch family continues to provide value to our customers in a variety of network connectivity roles, including: • The Summit 400 product line now includes the Summit 400-24p which offers Power over Ethernet (PoE), integrated stacking, and optional 10Gigabit uplinks. • The Summit 300 switch family supports an array of devices including IP phones, laptop and desktop PCs and emerging devices such as IP cameras. • The Summit 200 series switches offer low entry costs for sophisticated Layer 3 services. • The Summit48si switch delivers an aggregation switching solution with physical and logical access, security and user mobility features. • The Summit5i switches support server farms and data centers by maximizing server availability and performance with combining server load-balancing with wire-speed switching. Other members of the Summit product line address server-switching constraints by providing switched Fast Ethernet or Gigabit Ethernet ports and high speedGigabit uplinks to servers, delivering required bandwidth between servers, and to clients on attached segments. The Summit WM Wireless LAN Products Summit WM-series wireless LAN (WLAN) controllers deliver a high-performance wireless enterprise solution that is both secure and easy to manage.This allows Enterprise network managers to simplify the task of mobilizing their users without sacrificing features or performance. The Summit WM-seriesswitch is ready to support the most advanced wireless applications and mobile voice and multimedia networking challenges. Examples include cross-subnetroaming and sophisticated multicast. With capacities of up to 200 access points per switch, the Summit WM-series can scale to support the largest WLANinstallations while also providing centralized management for remote branch office installations. Sentriant Network-Integrated Security Solutions The Sentriant product family includes the Sentriant NG product for rapid threat detection and mitigation, and the Sentriant AG product for networkaccess control. Both products integrate with the network infrastructure by leveraging features within Extreme Network’s infrastructure portfolio. Sentriant AGand Sentriant NG can also deliver exceptional value as standalone products when used with networking infrastructure equipment from other vendors. When used in conjunction with the switch-based CLEAR-Flow security rules engine from Extreme Networks, Sentriant NG leverages insight andcontrol from the network to deliver a Virtualized Security Resource (VSR). VSR’s can deliver dynamic network security to proactively detect, contain andmitigate 10Table of Contentsnetwork threats including common denial of service attacks and harmful worm ‘storms’. The Sentriant NG appliance can be positioned at the core of thenetwork where it eliminates threats in a matter of seconds with its ability to detect storm patterns and contain malicious traffic. Sentriant NG uses behavior-based threat detection methods to detect threats – including new threats for which no signatures exist at the time of attack. It also includes a sophisticatedearly warning system that employs unused IP space to identify threats. The Sentriant NG VSR and CLEAR-Flow promote higher network availability whilereducing the need for numerous security devices across the edge of the network. Sentriant™ AG provides a complete Network Access Control (NAC) platform that works with a variety of network infrastructures, across all accesstypes (wired, wireless, VPN), and with a wide range of endpoint devices. Sentriant AG automatically tests each endpoint and verifies that its security levelmeets the organization’s security requirements before allowing access to the network. A non-compliant device can be placed in quarantine with restrictedaccess until it can be repaired through several remediation options before being granted full access. BlackDiamond 10808 Series The revolutionary BlackDiamond 10808 is the industry’s most advanced switch that redefines the intelligent core within the enterprise network—creating a highly available, open converged network that is both cost-effective and simple to operate. The BlackDiamond 10808 delivers security that scalesto 10 gigabit rates, voice-class availability and predictable performance, independent of application. Located in the core of some of the most demanding IPv4and IPv6 networks, the BlackDiamond 10808’s CLEAR-Flow Security Rules Engine and Layer 3 Virtual Switching capability has set the bar for coresecurity. With its redundant hardware design, ExtremeWare® XOS™ modular operating system and network resiliency protocol support, the BlackDiamond10808 provides the network uptime users expect of traditional circuit-based voice networks. BlackDiamond 12000 Series The new BlackDiamond 12804R and 12804C modular switches deliver key functionality and performance for Metro Ethernet service providers andcorporate enterprises. The switch assures the delivery of convergence applications, known as the “Triple Play” of voice, video and data with one networkplatform. The BlackDiamond 12804R allows Carriers to support tens of thousands of subscribers per I/O blade, control up to eight Quality of Service levelsper subscriber and offers unique controls for business and residential subscribers with ASIC-based bandwidth management with an economical Ethernetnetwork infrastructure. An Ethernet cross-connect allows service providers to connect subscribers easily to content networks. The BlackDiamond 12804Cdelivers deterministic performance for corporate enterprises, independent of what features are enabled and is capable of maintaining this performance undervarious failure conditions and/or under network attacks. The switch features the ExtremeXOS™ modular operating system, network security monitoring viathe CLEAR-Flow security rules engine and network resiliency, all in a compact form factor. This enables enterprises to deliver secure convergence. BlackDiamond 8800 Series The BlackDiamond 8800 series switch is designed for full-scale IP telephony deployments and high performance 10 Gigabit Ethernet. TheBlackDiamond 8800 modular switching solution enables users to address the critical requirements for voice production deployments: voice qualityconnectivity, increased uptime, better security and simple management. The BlackDiamond 8800 promotes higher network availability for data andconverged communications with its redundant design which is enhanced by a modular, highly-available, operating system, ExtremeXOS™. TheBlackDiamond 8800 provides Power over Ethernet connectivity and the industry’s only LAN resiliency protocol for voice – Extreme Networks’ EthernetAutomatic Protection Switching (EAPS) protocol. 11Table of ContentsBlackDiamond 6800 Series The network core is the most critical point in the network, serving as the convergence point for the majority of network traffic, including desktop,aggregation and server traffic. Network core switching involves switching traffic from desktops, segments and servers within the network. Owing to the high-traffic nature of the network core, the critical elements in core switching include wire-speed Layer 3 switching and routing, scalability, non-blockinghardware architecture, fault-tolerant mission-critical features, redundancy, and link aggregation capabilities. The ability to support a variety of high-densityport speeds and to accommodate an increasing number of high-capacity backbone connections is also important. The BlackDiamond 6800 series switch delivers carrier-class scalability, redundancy and high reliability for core switching in high-density Ethernet/IPenterprise and service provider networks. These modular switches include the fault-tolerant features associated with mission-critical enterprise-class Layer 3core switching, including redundant system management and switch fabric modules, hot-swappable modules and chassis components, load-sharing powersupplies and management modules, up to eight 10 Mbps, 100 Mbps or Gigabit aggregated links, dual software images and system configurations, spanningtree and multipath routing, and redundant router protocols for enhanced system and network reliability. The BlackDiamond 6800 series switch is certified tobe compliant with Network Equipment Building Systems, or NEBS Level 3. Alpine 3800 Series The Alpine 3800 series switch provides a simple, resilient broadband infrastructure for Metros, ISPs and mid-range enterprise networks. The Alpine3800 series provides total Ethernet coverage with support for both standard category 5 and fiber optic media. ExtremeXOS™ ExtremeXOS is an open network operating system that delivers meaningful insight and unprecedented control for mission-critical applications. Withexceptional support for voice over IP, integrated security, and high availability, ExtremeXOS stands out as a real alternative to closed, proprietary productsthat limit choice and compromise performance. Four powerful capabilities combine to make ExtremeXOS an exceptional operating system for solving the toughest networking challenges: 1)modularity enhances availability by isolating software processes to limit the impact of changes, attacks, or instabilities; 2) open interfaces allow applicationsto effectively control the network without unnecessarily tight integration that can limit flexibility and force system-wide upgrade cycles; 3) ExtremeXOS is aPOSIX-compliant operating system, making on-switch application integration straightforward and fast; and 4) wire-rate instrumentation provides deepinsight into critical network activities to build sophisticated security and voice applications. ExtremeXOS™ now delivers revolutionary breakthroughs and industry leading capabilities that further the state-of-the-art in networking technology.We pioneered an innovative approach for communicating with the network control plane using an application programming interface or API. The extensiblemarkup language or XML based APIs can be used by third parties to access processes within the switch in a secure fashion. For example, a security appliancecan utilize ExtremeXOS™ to limit access, control bandwidth or redirect traffic from a client that is attempting to connect to the network. This XMLinfrastructure embraces the concept of open yet secure communications to allow business applications to easily interact with the network for security policyenforcement, regulatory compliance and performance management, and improved security. ExtremeWare® ExtremeWare® represents our first generation of Operating System and is embedded on specific switches. It delivers the robust switching and routingprotocol support, management, control and security needed on current 12Table of Contentsenterprise and service provider networks. Its standards-based, multi-layer switching and policy-based Quality of Service give network managers the toolsneeded to optimize network capacity with consistent fault-tolerant behavior. Sales, Marketing and Distribution We conduct our sales and marketing activities on a worldwide basis through a two-tier product/solution distribution channel utilizing distributors,value-added resellers and our field sales organization. A majority of our sales are currently made to partners in our distributor and reseller channels. The firsttier consists of a limited number of independent distributors that sell primarily to resellers. The second tier of the distribution channel is comprised of a largenumber of independent resellers that sell directly to end-user customers. In addition, Extreme utilizes its field sales organization to sell direct to end-usercustomers, including large global accounts. Strategic Alliances. In October 2003 we entered into a mutual, non-exclusive, comprehensive strategic alliance with Avaya Inc. Avaya designs, buildsand manages communications networks for more than one million businesses worldwide, including 90 percent of the Fortune 500. Focused on businesseslarge to small, Avaya is a world leader in secure and reliable IP telephony systems and communications software applications and services. Avaya andExtreme Networks are jointly developing and marketing converged communications solutions as part of this multi-year, multimillion-dollar strategicalliance. Avaya is also reselling Extreme Networks’ data networking products and will provide customers with comprehensive planning, design, implementationand management services support through Avaya Global Services. Distributors. We have established several key relationships with leading distributors in the electronics and computer networking industries. We intendto maintain these relationships with distributors who may offer products or distribution channels that complement our own channels. Each of our distributorsprimarily resells our products to resellers. The distributors enhance our ability to sell and provide support to resellers, especially global accounts, who maybenefit from the broad service and product fulfillment capabilities offered by these distributors. One distributor, Tech Data, accounted for 12%, 12% and 11%of our net revenues in fiscal 2007, 2006 and 2005, respectively. Distributors are generally given privileges to return a portion of inventory to us for thepurpose of stock rotation and participate in various cooperative marketing programs to promote the sale of our products and services. We defer recognition ofrevenue on all sales to these distributors until the distributors sell the product, as evidenced by monthly “sales-out” reports that the distributors provide to us.(See “Revenue Recognition” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.) Value-Added Resellers, or VARs. We have entered into agreements to sell our products through more than 800 resellers in approximately 70 countries.Our value-added resellers include regional networking system resellers, resellers who focus on specific vertical markets, network integrators and wholesaledistributors. We provide training and support to our resellers and our resellers generally provide the first level of support to end-users of our products. Ourrelationships with resellers are generally on a non-exclusive basis. Our resellers are not given privileges to return inventory and do not automaticallyparticipate in any cooperative marketing programs. We generally recognize product revenue from our reseller and end-user customers at the time of shipment,provided that persuasive evidence of an arrangement exists, delivery has occurred, the price of the product is fixed or determinable and collection of the salesproceeds is reasonably assured. When significant obligations or contingencies remain after products are delivered, such as installation or customeracceptance, revenue and related costs are deferred until such obligations or contingencies are satisfied. (See “Revenue Recognition” in Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations.) Field sales. We have trained our field sales organization to support and develop leads for our value-added resellers and to establish and maintain alimited number of key accounts and strategic end user customers. To support these objectives, our field sales force: • assists end-user customers in finding solutions to complex network system and architecture problems; 13Table of Contents • differentiates the features and capabilities of our products from competitive offerings; • continually monitors and understands the evolving networking needs of enterprise and service provider customers; • promotes our products and ensures direct contact with current and potential customers; • partners with our key resellers to drive closure of business opportunities; and • monitors the changing requirements of our customers. As of July 1, 2007, our worldwide sales and marketing organization consisted of 299 individuals, including directors, managers, sales representatives,and technical and administrative support personnel. We have domestic sales offices located in 16 states and international sales offices located in 22countries. International sales International sales are an important portion of our business. In fiscal 2007, sales to customers outside of the United States accounted for 60% of ourconsolidated net revenues, compared to 59% in fiscal 2006 and 56% in fiscal 2005. These sales are conducted primarily through foreign-based distributorsand resellers managed by our worldwide sales organization, in addition to direct sales to end-user customers, including large global accounts. The primarymarkets for sales outside of the United States include the countries in Western Europe, the Asia- Pacific region and Japan. Although not a significantcomponent of total revenues to date, we also sell our products in South America, Canada and Mexico. Marketing We have a number of marketing programs to support the sale and distribution of our products and to inform existing and potential customers and 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, sales training, and publication of technical and educational articles in industryjournals, a publicly available website, web-based training courses, advertising and public relations. In addition, we are developing e-commerce processes andsystems for our resellers, distributors and end-user customers. We also submit our products for independent product testing and evaluation. Backlog Our products are often sold on the basis of standard purchase orders that are cancelable prior to shipment without significant penalties. In addition,purchase orders are subject to changes in quantities of products and delivery schedules in order to reflect changes in customer requirements andmanufacturing capacity. Our business is characterized by seasonal variability in demand and short lead-time orders and delivery schedules. Actual shipmentsdepend on the then-current capacity of our contract manufacturer and the availability of materials and components from our vendors. We believe that only asmall portion of our order backlog is non-cancelable and that the dollar amount associated with the non-cancelable portion is not material. Accordingly, wedo not believe that backlog at any given time is a meaningful indicator of future revenue. Customer Support and Service We offer modular and comprehensive extended warranty service contracts under our ExtremeWorks service solutions to help protect our customers’network investments and support their business goals. The markets we address, including enterprises and service providers, all seek high reliability andmaximum uptime. Our goal is to serve as a knowledgeable and experienced service partner who can tailor service solutions to meet the specific businessneeds of our customers. For the provision of on-site hardware support to customers we have agreements in place with International Business Machines, Inc.and Equant N.V. Expenses related to these agreements are 14Table of Contentsrecorded in cost of service revenue on our consolidated statements of operations. We also maintain relationship with Flextronics International, Ltd. for thehandling of product returns and repairs covered by our warranty and service contracts in various locations worldwide. We provide our customers with ourstandard, limited hardware warranty, which is typically 12 months from the date of shipment to end-users and our 90-day software warranty. Warrantyexpenses related to these relationships are recorded in cost of product revenue on our consolidated statements of operations. Our service offerings are as follows: • ExtremeWorks and PartnerWorks Support Programs • ExtremeWorks Professional Services • ExtremeWorks Education ExtremeWorks and PartnerWorks Support Programs. Our support programs are designed to support a broad range of customer service requirements forour resale partners and direct customers. We meet the service requirements of our customers and channel partners through Technical Assistance Centers, orTACs, located in Santa Clara, California; Utrecht, Holland; Research Triangle Park, North Carolina; and Tokyo, Japan. Our technical engineers assist indiagnosing and troubleshooting technical issues regarding customer networks. This is part of our effort to ensure maximum network uptime and performance.Regional systems engineers serve as on-site engineering resources to provide consultative support and advice for network operation on an as needed basis.Development engineers work with the TACs to resolve product functionality issues specific to each customer. We utilize the Internet to distribute and obtain information from our customer base as an integral part of our service solution. This allows us to keepcustomers informed of the latest updates and developments at Extreme Networks, and contains up-to-date information and technical documentation enablingcustomers to research issues and find answers to technical questions. Special features include a TAC database to obtain troubleshooting assistance andinformation for diagnosing hardware and researching network issues. On-site support services are available in most locations worldwide for customers whorequire a more comprehensive level of service and support. ExtremeWorks Professional Services. We specialize in providing solutions and consultative services to improve network productivity in all phases ofthe network lifecycle – planning, design, implementation, operations and optimization management. The professional services include customized andpackaged consulting services that assist customers in meeting their objectives for applications support, uptime and cost control. Our network architectsdevelop and execute customized hardware deployment plans to meet individualized network strategies. These activities include the management andcoordination of the design and network configuration, resource planning, staging, logistics, migration and deployment. We also provide customized trainingand operational best practices documentation to assist customers in the transition and sustaining of their networks. 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 matchactual traffic patterns • Multicasting – strategy for deploying PIM-DM, PIM-SM, or DVMRP to best suit streaming media requirements • Voice over IP – strategy and recommendations to deploy voice-over-IP utilizing our technology • Wireless LAN – site surveys, WLAN design and implementation of Unified Access solutions 15Table of Contents • Security – analysis of customer security needs and recommendations on how to implement advanced security features to meet those needs • Resident engineering services – dedicated on-site technical engineering resources providing high level staff expertise ExtremeWorks Education. Leveraging our Authorized Training Partner strategy, Extreme Networks licenses partners to provide education throughcertified technical experts that teach classes dealing with all of our products. The classes cover a wide range of topics such as installation, configuration,operation, management and optimization – providing customers with the necessary knowledge and experience to successfully deploy and manage ourproducts in various networking environments. Classes are scheduled and available at numerous locations worldwide. We also deliver customized trainingusing Extreme Networks staff upon customer request. Manufacturing We outsource the majority of our manufacturing and supply chain management operations as part of our strategy to maintain global manufacturingcapabilities and to reduce our costs. We conduct quality assurance, manufacturing engineering, document control and test development at our main campusin Santa Clara, California. This approach enables us to reduce fixed costs and to flexibly respond to changes in market demand. We have a strategic partnership with Flextronics International, Ltd. for the manufacture of our OEM products in San Jose, California and Guadalajara,Mexico. Flextronics’ manufacturing processes and procedures are ISO 9001 certified. Our commitment with Flextronics is formalized through a one-yearcontract. We design and develop the key components of our products, including ASICs and printed circuit boards. We determine the components that areincorporated in our products and select the appropriate suppliers of such components. Flextronics utilizes automated testing equipment to perform producttesting and burn-in with specified tests. Together we rely upon comprehensive inspection testing and statistical process controls to assure the quality andreliability of our products. We also maintain a strategic relationship with Alpha Networks, Inc. headquartered in Hsinchu, Taiwan. Alpha Networks is a global networking OriginalDesign Manufacturer (ODM) leader with core competencies in areas such as Ethernet, LAN/MAN, Wireless, Broadband and Voice Over Internet Protocol(VoIP). Alpha has over 6,000 employees worldwide and maintains relationships with players such as Broadcom and Marvell. Alpha trades on the TaiwanStock Exchange under stock code T3380. Extreme Networks partners with Alpha Networks to build key product lines including the XOS based SummitProduct Family. Following review of Extreme’s design specifications, Alpha manufactures and tests to those specifications. Extreme Networks is one ofAlpha’s top five strategic partners (as measured by revenue). We intend to regularly introduce new products and product enhancements that will require us to rapidly achieve volume production by coordinatingour efforts with those of our suppliers and contract manufacturer. Although we use standard parts and components for our products where it is appropriate, we currently purchase several key components used in themanufacture of our products from single or limited sources. Our principal single-source components include: • ASICs; • merchant silicon; • microprocessors; • programmable integrated circuits; • selected other integrated circuits; 16Table of Contents • custom power supplies; and • custom-tooled sheet metal. Our principal limited-source components include: • flash memory; • dynamic and static random access memories, or DRAMS and SRAMS respectively; • printed circuit boards; and • content addressable memories (CAMs). Purchase commitments with our single or limited-source suppliers are generally on a purchase order basis. A number of vendors supply standardproduct integrated circuits and microprocessors for our products. Any interruption or delay in the supply of any of these components, or the inability toprocure these components from alternate sources at acceptable prices and within a reasonable time, may have a material adverse effect on our business,operating results and financial condition. Qualifying additional suppliers can be time-consuming and expensive and may increase the likelihood of errors. We use our forecast of expected demand to determine our material requirements. Lead times for materials and components vary significantly, anddepend on factors such as the specific supplier, contract terms and demand for a component at a given time. We order most of our materials and componentson an indirect basis through our contract manufacturer. Research and Development The success of our products to date is due in large part to our focus on research and development. We believe that continued success in the marketplacewill depend on our ability to develop new and enhanced products employing leading-edge technology. Accordingly, we are undertaking development effortswith an emphasis on increasing the reliability, performance and features of our family of products, and designing innovative products to reduce the overallnetwork operating costs of customers. Our product development activities focus on solving the needs of enterprises, service providers and Metro markets. Current activities include thecontinuing development of our proprietary switching technology aimed at extending the capabilities of our products. Our ongoing research activities cover abroad range of areas, including, in particular, 10 Gigabit Ethernet, Metro and Internet routing, ASIC design, network security, network management software,broadband access equipment and wireless networking equipment. We continued to enhance the functionality of our modular operating system (ExtremeXOS™) which has been designed to provide high reliability andavailability. This architecture allows us to leverage common operating system architecture across different hardware and ASIC implementation. As of July 1, 2007, our research and development organization consisted of 288 individuals. Research and development efforts are conducted inseveral locations in the U.S., including our headquarters in Santa Clara, California and Raleigh, North Carolina. In fiscal 2005, we opened a research anddevelopment center in Chennai, India focusing on the development and verification of our operating systems. Our research and development expenses infiscal 2007, fiscal 2006 and fiscal 2005 were $67.1 million, $62.0 million, and $61.5 million, respectively. Competition The market for switches is part of the broader market for networking equipment, which is dominated by a few large companies, particularly CiscoSystems. In addition, there are a number of large telecommunications 17Table of Contentsequipment providers, including Alcatel and Nortel Networks, which have entered 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 companies that offer switching solutions, including Enterasys Networks, Inc., FoundryNetworks, Inc., Huawei Technologies Corporation, 3Com Corporation, Hewlett-Packard Company and Dell Computer Corporation. These vendors offerproducts with functionality similar to our products or provide alternative network solutions. Current and potential competitors have established or mayestablish cooperative relationships among themselves or with third parties to develop and offer competitive products. Furthermore, we compete withnumerous companies that offer routers and other technologies and devices that traditionally have managed the flow of traffic on the enterprise or Metronetworks. Some of our current and potential competitors have longer operating histories and substantially greater financial, technical, sales, marketing and otherresources, as well as greater name recognition and a larger installed customer base, than we do. As a result, these competitors are able to devote greaterresources to the development, promotion, sale and support of their products. In addition, competitors with a large installed customer base may have asignificant competitive advantage over us. We have encountered, and expect to continue to encounter, many potential customers who are confident in andcommitted to the product offerings of our principal competitors, including Cisco Systems. Accordingly, these potential customers may not consider orevaluate our products. When such potential customers have considered or evaluated our products, we have in the past lost, and expect in the future to lose,sales to some of these customers as large competitors have offered significant price discounts to secure these sales. We believe the principal competitive factors in the network switching market are: • expertise and familiarity with network protocols, network switching and network management; • product performance, features, functionality and reliability; • price/performance characteristics; • timeliness of new product introductions; • adoption of emerging industry standards; • customer service and support; • size and scope of distribution network; • brand name; • access to customers; and • size of installed customer base. We believe that we compete favorably with our competitors with respect to each of the foregoing factors. However, because many of our existing andpotential competitors have longer operating histories, greater name recognition, larger customer bases, broader product lines and substantially greaterfinancial, technical, sales, marketing and other resources, they may have larger distribution channels, stronger brand names, access to more customers and alarger installed customer base than we do. Such competitors may, among other things, be able to undertake more extensive marketing campaigns, adopt moreaggressive pricing policies and make more attractive offers to distribution partners than we can. To remain competitive, we believe that we must, among otherthings, invest significant resources in developing new products and enhancing our current products and maintain customer satisfaction worldwide. If we failto do so, our products will not compete favorably with those of our competitors and that may have a material adverse effect on our business. Intellectual Property We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights.Based on our commitment to build a patent portfolio, we 18Table of Contentshave in process a number of patent applications relating to our proprietary technology. We have filed patent applications in selected countries abroad asdeemed appropriate. There can be no assurance that these applications will be approved, that any issued patents will protect our intellectual property, or thatthird parties will not challenge these patents or applications. Furthermore, there can be no assurance that others will not independently develop similar orcompeting technology or design around any patents that we may obtain. With respect to trademarks, we have a number of pending and registered trademarksin the United States and abroad. We enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to, and distribution of,our software, documentation and other proprietary information. In addition, we provide our software products to end-user customers primarily under “shrink-wrap” license agreements included within the packaged software. These agreements are not negotiated with or signed by the licensee, and thus theseagreements may not be enforceable in some jurisdictions. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy orotherwise obtain and use our products or technology. There can be no assurance that these precautions will prevent misappropriation or infringement of ourintellectual property. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will preventmisappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. As detailed below under “Legal Proceedings,” we are currently engaged in litigation with Enterasys Networks, Inc (“Enterasys”). Enterasys is assertingclaims that allege infringement of certain patent rights, against which we are defending vigorously, but we cannot assure you that we will prevail in thislitigation. In addition to the litigation with Enterasys, in the normal course of our business from time to time, we are in discussions with companies that assertcertain of our products require a license under a number of patents. Due to the number of companies with extensive patent portfolios in our industry who areor may be actively involved in licensing programs, we believe that even if we do not infringe any patents, we may incur significant expenses in the future dueto disputes or licensing negotiations, though the amounts and timing of such expenses cannot be determined with any reasonable certainty. As thefunctionality and features of our products expand, these disputes and discussions could increase or become harder to resolve. Employees As of July 1, 2007, we employed 825 people, including 299 in sales and marketing, 288 in engineering, 50 in operations, 94 in customer support andservice, and 94 in finance and administration. We have never had a work stoppage and no personnel are represented under collective bargaining agreements.We consider our employee relations to be good. We believe that our future success depends on our continued ability to attract, integrate, retain, train and motivate highly qualified personnel, andupon the continued service of our senior management and key personnel. None of our personnel is bound by an employment agreement. The market forqualified personnel is competitive, particularly in the San Francisco Bay Area, where our headquarters is located. At times, we have experienced difficultiesin attracting new personnel and we have experienced attrition that has affected our operating results. Organization We were incorporated in California in May 1996 and reincorporated in Delaware in March 1999. Our corporate headquarters are located at3585 Monroe Street, Santa Clara, CA 95051 and our telephone number is (408) 579-2800. Our website can be found at www.extremenetworks.com. Investorscan obtain copies of our SEC filings from this website free of charge, or on the SEC’s website at www.sec.gov. Our corporate governance guidelines, the charters of our audit committee, our compensation committee and our nominating and corporate governancecommittee and our code of ethics policy (including code of ethics 19Table of Contentsprovisions that apply to our principal executive officer, principal financial officers, controller and senior financial officers) are available on our website atwww.extremenetworks.com under “Corporate Governance.” These items are also available to any stockholder who requests them by calling (408) 579-2800. Executive Officers of the Registrant The following table sets forth information regarding our executive officers as of August 1, 2007: Name Age PositionMark Canepa 52 President, Chief Executive Officer, DirectorKaren M. Rogge 52 Senior Vice President, Chief Financial OfficerAlexander J. Gray 50 Senior Vice President and General Manager of Scalable ProductsHelmut Wilke 55 Senior Vice President of Worldwide Sales Mark Canepa. Mr. Canepa joined Extreme as President and Chief Executive Officer on August 30, 2006. Prior to joining Extreme, he was with SunMicrosystems where he served as Executive Vice President of the Network Storage Products Group. Prior to that role, he served in multiple vice president andgeneral manager roles at Sun, after joining the company in 1996. Mr. Canepa’s prior experience also includes several general manager positions at Hewlett-Packard Company, including development and marketing of the firm’s workstation products. Mr. Canepa holds a B.S. and an M.S. in Electrical Engineeringfrom Carnegie Mellon University, and he has also completed the University of Pennsylvania’s Advanced Management Program at the Wharton School. Karen Rogge. Ms Rogge joined Extreme as Senior Vice President and Chief Financial Officer on April 2, 2007. Prior to joining Extreme, she was withSeagate Technology where she served as Vice President, Corporate Finance and Treasurer from January 2004 to November 2006. From January 2001 toDecember 2003, Ms. Rogge was an independent consultant providing business strategy and interim executive management services to high-tech companies.From January 2000 to July 2000, Ms Rogge served as Vice President and General Manager for the internet search division at Inktomi Corporation. FromNovember 1976 to February 2000, Ms. Rogge served in various executive roles at Hewlett-Packard Company in financial management, informationtechnology management and general management. Ms. Rogge holds an M.B.A. from Santa Clara University and a Bachelor of Science in BusinessAdministration, with a concentration in accounting from California State University Fresno. Alexander J. Gray. Mr. Gray joined Extreme as Chief Operating Officer in September 2002, and has served as Senior Vice President and GeneralManager of Scalable Products since January 2007. From January 2001 through August 2002, Mr. Gray was Chief Operating Officer at LGC Wireless, atelecommunications provider. From November 1999 until January 2001, Mr. Gray worked for Replay TV, a digital media provider, as Executive VicePresident of Business Operations. From December 1992 through October 1999, Mr. Gray held senior management positions with Lucent Technologies, Inc.and Octel Communications Corporation, both telecommunications providers. Prior to that time, Mr. Gray held positions as Director of Information Servicesfor American President Lines, a container shipping company, from September 1991 to November 1992 and NEXT Computer, a computer and equipmentmanufacturer, from July 1988 to August 1991. He also spent four years as a research and development engineer for Hewlett-Packard Company, a computerand equipment manufacturer. Mr. Gray holds a B.S. and an M.S. in Electrical Engineering from Washington University in St. Louis, Missouri. Helmut Wilke. Mr. Wilke joined Extreme as Senior Vice President of Worldwide Sales in April 2007. From May 2001 to March 2007, Mr. Wilke heldvarious positions with Sun Microsystems where most recently he served as Senior Vice President of Operations and Field Support. His prior positions withSun Microsystems include Vice President of Sales and President of Sun Microsystems, Germany. From 1997 to 2001, Mr. Wilke was the CEO and president ofSoftware AG, a leading manufacturer of software and systems for large corporations. Mr. Wilke holds a PhD in Social Sciences from the University of Berlin,Germany. 20Table of Contents Item 1A. Risk Factors We are subject to a number of risks. Some of these risks are endemic to the networking industry and are the same or similar to those disclosed in ourprevious SEC filings. The following is a list of risks and uncertainties which may have a material and adverse effect on our business, financial condition orresults of operations. The risks and uncertainties set out below are not the only risks and uncertainties we face. We were not in compliance with SEC reporting requirements during fiscal year 2007, and Nasdaq listing requirements during portions of fiscal years2007 and 2008, and we may continue to face compliance issues with both. If we are unable to remain in compliance with SEC reporting requirementsand Nasdaq listing requirements, there may be a material adverse effect on the Company and our stockholders. On September 11, 2006, based on information developed by Company management and at the Audit Committee’s recommendation, the Board ofDirectors appointed a special committee of the Board (the “Special Committee”) to conduct an independent investigation of our historical practices forgranting and accounting for stock options and to present findings and recommendations to the Board. Pending completion of our Special Committeeinvestigation, we were delinquent in filing certain of our periodic reports with the SEC during fiscal year 2007, and we were unable to hold our annualmeeting of stockholders within the time required under Nasdaq Marketplace Rules. Although such delinquent reports were filed with the SEC on June 28,2007, and our annual meeting of stockholders occurred on July 30, 2007, we were not in compliance with Nasdaq’s Marketplace Rules during portions offiscal years 2007 and 2008. As a result, we underwent a review and hearing process with Nasdaq to determine our listing status. Nasdaq ultimately permittedour securities to remain listed on the Nasdaq Global Select Market, but our securities could be delisted in the future if we do not maintain compliance withapplicable listing requirements in the future. If this happens, the price of our stock, the ability of our stockholders to trade in our stock, and our ability to raisecapital could be adversely affected. If we are unable to remain in compliance with the SEC reporting requirements, we would be subject to a number ofrestrictions regarding the registration of our stock under federal securities laws, and we may not be able to issue stock options or other equity awards to ouremployees or allow them to exercise their outstanding options, which would adversely affect our business and results of operations. We have been named as a party to shareholder derivative lawsuits relating to our historical stock option practices, and we may be named in additionallawsuits in the future. This litigation could become time consuming and expensive and could result in the payment of significant judgments andsettlements, which could have a material adverse effect on our financial condition and results of operations. In connection with our historical stock option practices and resulting restatement of our financial statements for the fiscal years 2000 through 2005,derivative actions were filed against certain of our current and former directors and officers purporting to assert claims on the Company’s behalf. There maybe additional lawsuits filed in the future. We cannot predict the outcome of these lawsuits, nor can we predict the amount of time and expense that will berequired to resolve these lawsuits. If these lawsuits become time consuming and expensive, or if there are unfavorable outcomes in any of these cases, therecould be a material adverse effect on our business, financial condition and results of operations. Our insurance coverage will not cover all of our liabilities and expenses in these lawsuits, in part because we have a significant deductible on certainaspects of the coverage. In addition, subject to certain limitations, we may be obligated to indemnify our current and former directors, officers and employees.We currently hold insurance policies for the benefit of our directors and officers, however our insurance coverage may not be sufficient in some or all of thesematters to cover all of the costs the Company may need to incur. Furthermore, the insurers may seek to deny or limit coverage in some or all of these matters,in which case we may have to self-fund all or a substantial portion of our indemnification obligations. If we need to self-fund, there is no assurance that wewill prevail in our efforts to recover payment from our insurers. 21Table of ContentsThe Special Committee investigation of our historical stock option practices and resulting restatements has been time consuming and expensive, andmay have a material adverse effect on us. The Special Committee investigation and the activities related to the restatement of our fiscal 2000 through fiscal 2005 financial statements haverequired us to expend significant management time and to incur significant accounting, legal, and other expenses. Although the Special Committee hasconcluded its investigation, the Special Committee may continue to assist the Company with follow-up activities arising from the restatement or otherwiserelated to its investigation. The issues surrounding the historical stock option grant practices were complex and required substantial resources to resolve. Thecost and time associated with concluding any follow-up activities by the Special Committee may have a material adverse effect on our operating results orour common stock price. The period of time necessary to resolve any such follow-up matters is uncertain, and these matters could require significantadditional attention and resources. The discovery that we had not accounted correctly for historical stock option grants has had, and may continue to have, a material adverse effect onour financial results. We cannot predict the outcome of any government inquiry or the pending shareholder derivative lawsuits, and we may face future government actions,shareholder lawsuits and other legal proceedings related to our historical stock option practices. All of these events have required us, and will continue torequire us, to expend significant management time and to incur significant accounting, legal, and other expenses. This has and could continue to divertattention and resources from the operation of our business and adversely affects our financial condition and results of operations. Any government inquiry relating to our historical stock option practices may be time consuming and expensive and could result in injunctions, finesand penalties that may have a material adverse effect on our financial condition and results of operations. The SEC issued an informal request to us for information relating to our historical stock option grant practices. We have responded to the SEC’sinquiry and will respond to inquiries from other government authorities if made. The SEC and/or other government authorities may conduct a formalinvestigation into our historical stock option grant practices. The period of time necessary to resolve any such inquiry is uncertain, and we cannot predict theoutcome of any such inquiry or whether we will face additional government inquiries, investigations or other actions related to our historical stock optionpractices, or otherwise. These matters will likely require us to continue to expend significant management time and incur significant legal and otherexpenses, and could result in civil and criminal actions seeking, among other things, injunctions against the Company and the payment of significant finesand penalties by the Company, which may have a material adverse effect on our financial condition, results of operations and cash flow. A formalinvestigation by the SEC and/or other government authorities could adversely affect our business, results of operations, financial position and cash flows. It may be difficult or costly to obtain director and officer insurance coverage as a result of our stock option related issues. We expect that the issues arising from our previous historical stock option grant practices and related accounting may make it more difficult to obtaindirector and officer insurance coverage in the future. If we are able to obtain this coverage, it could be significantly more costly than in the past, which wouldhave an adverse effect on our financial results and cash flow. As a result of this and related factors, our directors and officers could face increased risks ofpersonal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified directors andofficers, which could adversely affect our business. We Cannot Assure You That We Will Be Profitable in the Future. We reported losses for fiscal 2007, 2004, 2003, 2002 and 2001 and our revenue declined in fiscal 2007. In addition, while we have reported profits inboth fiscal 2006 and 2005, we were not profitable in each quarter 22Table of Contentsduring those years. We anticipate continuing to incur significant sales and marketing, product development and general and administrative expenses and, asa result, we will continue to need to rationalize expense levels and increase revenue levels to achieve profitability in future fiscal periods. Failure to maintain effective internal control over financial reporting may cause us to delay filing our periodic reports with the SEC, affect our Nasdaqlisting, and adversely affect our stock price. The Securities and Exchange Commission, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies toinclude a report of management on internal control over financial reporting in their annual reports on Form 10-K. In addition, our independent registeredpublic accounting firm must attest to and report on our internal control over financial reporting. Although we review our internal control over financialreporting in order to ensure compliance with the Section 404 requirements, if our independent registered public accounting firm is not satisfied with ourinternal control over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if the independent registeredpublic accounting firm interprets the requirements, rules and/or regulations differently from our interpretation, then they may decline to attest tomanagement’s assessment or may issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investorconfidence in the reliability of our financial statements, which ultimately could negatively impact our stock price. Federal securities laws, rules and regulations, as well as Nasdaq rules and regulations, require companies to maintain extensive corporate governancemeasures, impose comprehensive reporting and disclosure requirements, set strict independence and financial expertise standards for audit and othercommittee members and impose civil and criminal penalties for companies and their chief executive officers, chief financial officers and directors forsecurities law violations. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporategovernance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations. A Number of Factors Could Cause Our Quarterly Financial Results to Be Worse Than Expected, Resulting in a Decline in Our Stock Price. Our ability to control our operating expenses at a level that is consistent with anticipated revenue is significant to our financial results. A highpercentage of our expenses are fixed in the short term, so any delay in generating or recognizing revenue could cause our quarterly operating results to fallbelow the expectations of public market analysts or investors, which could cause the price of our stock to fall. Orders in our backlog at the beginning of each quarter do not equal expected revenues for that quarter and are generally cancelable at any time.Accordingly, we are dependent upon obtaining orders during a quarter and shipping those orders in the same quarter to achieve our revenue objectives. Inaddition, the timing of product releases and purchase orders, and product availability, often results in a majority of our product shipments being schedulednear the end of a quarter. Failure to ship these products by the end of a quarter may adversely affect our operating results. Our customer agreements generallyallow customers to delay scheduled delivery dates or to cancel orders within specified timeframes without significant charges to the customers. Furthermore,some of our customers require that we provide installation or inspection services that may delay the recognition of revenue for both products and services,and some of our customer agreements include acceptance provisions that prevent our ability to recognize revenue upon shipment. We may experience a delay in generating or recognizing revenue for a number of reasons and our quarterly revenue and operating results have variedsignificantly in the past 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-Pacific and Europe; 23Table of Contents • the level of attrition of our employees, and of our sales force in particular; • a disproportionate percentage of our sales occurring in the last month of the quarter; • reduced visibility into the implementation cycles for our products and our customers’ spending plans; • our ability to forecast demand for our products, which in the case of lower-than-expected sales, may result in excess or obsolete inventory inaddition to non-cancelable purchase commitments for component parts; • 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; • fluctuations in warranty or other service expenses actually incurred; • 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; • impairment charges associated with long-lived assets; • restructuring costs associated with adjustments to the size of our operations; • costs relating to possible acquisitions and the integration of technologies or businesses; • the effect of amortization of purchased intangibles resulting from new transactions; and • costs relating to the recognition of share-based payments. In fiscal 2007 and fiscal 2006, we reported revenues below our expectations. Our results were particularly impacted by lower sales in most regions infiscal 2007. We believe that revenues will increase in coming quarters; however, our future results could be adversely affected if longer term economic orindustry trends are unfavorable. Due to the foregoing factors, we believe that period-to-period comparisons of our operating results should not be relied upon as an indicator of ourfuture performance. Intense Competition in the Market for Networking Equipment Could Prevent Us from Increasing Revenue and Achieving Profitability. The market for networking equipment is intensely competitive. The market for switches is part of the broader market for networking equipment, whichis dominated by a few large companies, particularly Cisco Systems. In addition, there are a number of large telecommunications equipment providers,including Alcatel and Nortel Networks, which have entered the market for network equipment, particularly through acquisitions of 24Table of Contentspublic 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 companies that offer switching solutions, including Enterasys Networks, Inc., FoundryNetworks, Inc., Huawei Technologies Corporation, 3Com Corporation, Hewlett-Packard Company and Dell Computer Corporation. These vendors offerproducts with functionality similar to our products or provide alternative network solutions. Current and potential competitors have established or mayestablish cooperative relationships among themselves or with third parties to develop and offer competitive products. Furthermore, we compete withnumerous companies that offer routers and other technologies and devices that traditionally have managed the flow of traffic on the enterprise or Metronetworks. Some of our current and potential competitors have longer operating histories and substantially greater financial, technical, sales, marketing and otherresources, as well as greater name recognition and a larger installed customer base, than we do. As a result, these competitors are able to devote greaterresources to the development, promotion, sale and support of their products. In addition, competitors with a large installed customer base may have asignificant competitive advantage over us. We have encountered, and expect to continue to encounter, many potential customers who are confident in andcommitted to the product offerings of our principal competitors, including Cisco Systems. Accordingly, these potential customers may not consider orevaluate our products. When such potential customers have considered or evaluated our products, we have in the past lost, and expect in the future to lose,sales to some of these customers as large competitors have offered significant price discounts to secure these sales. The pricing policies of our competitors impact the overall demand for our products and services. Some of our competitors are capable of operating atsignificant losses for extended periods of time, increasing pricing pressure on our products and services. If we do not maintain competitive pricing, thedemand for our products and services, as well as our market share, may decline. From time to time, we may lower the prices of our products and services.When this happens, if we are unable to reduce our component costs or improve operating efficiencies, our revenues and margins will be adversely affected. To remain competitive, we believe that we must, among other things, invest significant resources in developing new products, improve our currentproducts and maintain customer satisfaction. Such investment will increase our expenses and affect our profitability. If we fail to make this investment, wemay not be able to compete successfully with our competitors, which could have a material adverse effect on our revenue and future profitability. When Our Products Contain Undetected Errors, We May Incur Significant Unexpected Expenses and Could Lose Sales. Network products frequently contain undetected errors when new products or new versions or updates of existing products are released to themarketplace. In the past, we have experienced such errors in connection with new products and product upgrades. We have experienced component problemsin prior years that caused us to incur higher than expected warranty, service costs and expenses, and other related operating expenses. In the future, we expectthat, from time to time, such errors or component failures will be found in new or existing products after the commencement of commercial shipments. Theseproblems may have a material adverse effect on our business by causing us to incur significant warranty and repair costs, diverting the attention of ourengineering personnel from new product development efforts, delaying the recognition of revenue and causing significant customer relations problems.Further, if products are not accepted by customers due to such defects, and such returns exceed the amount we accrued for defect returns based on ourhistorical experience, our operating results would be adversely affected. Our products must successfully interoperate with products from other vendors. As a result, when problems occur in a network, it may be difficult toidentify the sources of these problems. The occurrence of system errors, whether or not caused by our products, could result in the delay or loss of marketacceptance of our products and 25Table of Contentsany necessary revisions may cause us to incur significant expenses. The occurrence of any such problems would likely have a material adverse effect on ourbusiness, operating results and financial condition. Our Future Success Will Depend in Part Upon Increasing Our Revenue in the U.S. Market. Revenues in the U.S. declined 5.8% in fiscal 2007 from fiscal 2006 and declined 12.7% in fiscal 2006 from fiscal 2005. We believe a number of factorshave contributed to the decline in our revenues in the U.S., including turnover in our sales and marketing personnel, intense competition, as well as thetiming of customer purchase decisions. Our success will depend upon increasing our revenue in the United States and we may need to identify new strategiesor markets to increase revenue. We are initiating a number of programs to improve retention of our sales personnel and to compete more effectively in the U.S.market. If these efforts are not successful, our ability to sustain and grow our revenue and to achieve increased profitability would be adversely affected. We Depend Upon International Sales for a Significant Portion of Our Revenue and Our Ability to Grow Our International Sales Depends onSuccessfully Expanding Our International Operations. International sales constitute a significant portion of our net revenues. Our ability to grow will depend in part on the expansion of international sales.Sales to customers outside of the United States accounted for approximately 60%, 59% and 56% of our net revenues for fiscal 2007, fiscal 2006 and fiscal2005, respectively. Our international sales primarily depend on the success of our resellers and distributors. The failure of these resellers and distributors tosell our products internationally would limit our ability to sustain and grow our revenue. There are a number of risks arising from our international business,including: • longer accounts receivable collection cycles; • difficulties in managing operations across disparate geographic areas; • difficulties associated with enforcing agreements through foreign legal systems; • the payment of operating expenses in local currencies, which exposes us to risks of currency fluctuations; • higher credit risks requiring cash in advance or letters of credit; • difficulty in safeguarding intellectual property; • political and economic turbulence; • potential adverse tax consequences; and • unexpected changes in existing regulatory requirements and the addition of new regulatory requirements. Our international sales currently are U.S. dollar-denominated. Future increases in the value of the U.S. dollar relative to foreign currencies could makeour products less competitive in international markets. In the future, we may elect to invoice some of our international customers in local currency, which willexpose us to fluctuations in exchange rates between the U.S. dollar and the particular local currency. If we do so, we may decide to engage in hedgingtransactions to minimize the risk of such fluctuations. We have entered into foreign exchange forward contracts to offset the impact of payment of operating expenses in local currencies to some of ouroperating foreign subsidiaries. However, if we are not successful in managing these hedging transactions, we could incur losses from hedging activities. Conducting our Business on a Global Basis Requires Us to Comply with Various Foreign and Domestic Regulatory Requirements. Conducting our business on a global basis subjects us to a number of frequently changing and complex regulatory requirements, and as we expand ouroperations into new territories, we may become subject to an 26Table of Contentsincreasing number of such regulatory requirements. These regulatory requirements vary from jurisdiction to jurisdiction, and may be inconsistent with oneanother. Our efforts to comply with the new and differing requirements increases our costs of goods and other expenses and may delay the production andshipment of our products, which could adversely impact revenue recognition and harm our financial results. In addition, failure to comply with therequirements of a single jurisdiction may adversely impact our ability to do business in that jurisdiction as well as other jurisdictions, which would harm ourfinancial results. Trade measures, environmental and import and export requirements are among the regulations with which we must comply. Failure to comply withsuch requirements may result in the imposition of financial penalties and restrictions on our ability to conduct business in and with certain countries, whichmay harm our business and damage our reputation. In the past, we were subject to an investigation by the U.S. Department of Commerce in connection withthe possible violation of certain export regulations. The Department of Commerce has completed an investigation and we were required to pay a fine of$35,000. While this matter was resolved and we have also implemented procedures to reduce the risk of violations in the future, there can be no assurancesthat we will not become subject to such investigations in the future. In connection with compliance with regulatory requirements, from time to time, we have been and may in the future become subject to audit by variousgovernmental agencies seeking to review the compliance of our products or business practices with their regulations. When such audits occur and whether ornot we are in compliance with the particular regulation, we may be required to cease shipment or production of our product in that particular jurisdictionwhile we seek to show our compliance with such regulations and our business may be adversely affected as a result. We Expect the Average Selling Prices of Our Products to Decrease, Which May Reduce Gross Margin and/or Revenue. The network equipment industry has traditionally experienced a rapid erosion of average selling prices due to a number of factors, includingcompetitive pricing pressures, promotional pricing and technological progress. We anticipate that the average selling prices of our products will decrease inthe future in response to competitive pricing pressures, excess inventories, increased sales discounts and new product introductions by us or our competitors,including, for example, competitive products manufactured with low-cost merchant silicon. We may experience substantial decreases in future operatingresults due to the erosion of our average selling prices. To maintain our gross margin, we must develop and introduce on a timely basis new products andproduct enhancements and continually reduce our product costs. Our failure to do so would likely cause our revenue and gross margins to decline, whichcould have a material adverse effect on our operating results and cause the price of our common stock to decline. Some of Our Customers May Not Have the Resources to Pay for Our Products as a Result of the Current Economic Environment. As of July 1, 2007, no customers accounted for more than 10% of our accounts receivable balance. Some of our customers are likely to experienceserious cash flow problems and, as a result, may find it difficult to obtain financing, if financing is available at all. If our customers are not successful ingenerating sufficient revenue or securing alternate financing arrangements, they may not be able to pay, or may delay payment of, the amounts that they oweus. In addition, sales to the service provider market are especially volatile and continued declines or delays in sale orders from this market may harm ourfinancial condition. Furthermore, they may not order as many products from us as originally forecast, or cancel orders with us entirely. The inability of someof our potential customers to pay us for our products may adversely affect our cash flow, the timing of our revenue recognition and the amount of revenue,which may cause our stock price to decline. 27Table of ContentsIf We Lose Key Personnel or are Unable to Hire Additional Qualified Personnel as Necessary, We May Not Be Able to Successfully Manage OurBusiness or Achieve Our Goals. Our success depends to a significant degree upon the continued contributions of our key management, engineering, sales and marketing, service andoperations personnel, many of whom would be difficult to replace. We do not have employment contracts with these individuals nor do we carry lifeinsurance on any of our key personnel and we have experienced significant turn over in our executive personnel. We believe our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales andmarketing, service, finance and operations personnel. The market for these personnel is competitive, especially in the San Francisco Bay Area, and we havehad difficulty in hiring employees, particularly engineers, in the timeframe we desire. In addition, retention has become more difficult for us and other publictechnology companies as a result of the stock market decline, which caused the price of many of our employees’ stock options to be above the current marketprice of our stock and we are experiencing a high level of attrition. There can be no assurance that we will be successful in attracting and retaining our keypersonnel. A number of our key executives have left the Company in the last year, including our founder and Chief Executive Officer, our Chief FinancialOfficer, our Senior Vice President of Worldwide Sales, and our founder and Chief Technology Officer. These departures may cause other employees to leavethe Company. We have and are initiating a number of employee retention programs, but we cannot assure you that these will be successful. The loss of theservices of any of our key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring desired personnel, particularlyengineers and sales personnel, could make it difficult for us to manage our business and meet key objectives, such as new product introductions. In addition,companies in the networking industry whose employees accept positions with competitors frequently claim that competitors have engaged in unfair hiringpractices. We have from time to time been involved in claims like this with other companies and, although to date they have not resulted in materiallitigation, we do not know whether we will be involved in additional claims in the future as we seek to hire and retain qualified personnel or that such claimswill not result in material litigation. We could incur substantial costs in litigating any such claims, regardless of the merits. The Market in Which We Compete is Subject to Rapid Technological Progress and to Compete We Must Continually Introduce New Products thatAchieve Broad Market Acceptance. The network equipment market is characterized by rapid technological progress, frequent new product introductions, changes in customer requirementsand evolving industry standards. If we do not regularly introduce new products in this dynamic environment, our product lines will become obsolete.Developments in routers and routing software could also significantly reduce demand for our products. Alternative technologies could achieve widespreadmarket acceptance and displace the Ethernet technology on which we have based our product architecture. We cannot assure you that our technologicalapproach will achieve broad market acceptance or that other technologies or devices will not supplant our own products and technology. When we announce new products or product enhancements that have the potential to replace or shorten the life cycle of our existing products,customers may defer or cancel orders for our existing products. These actions could have a material adverse effect on our operating results by unexpectedlydecreasing sales, increasing inventory levels of older products and exposing us to greater risk of product obsolescence. The market for switching products isevolving and we believe our ability to compete successfully in this market is dependent upon the continued compatibility and interoperability of ourproducts with products and architectures offered by other vendors. We have experienced delays in releasing new products and product enhancements in thepast that resulted in lower quarterly revenue than anticipated. We may experience similar delays in product development and releases in the future, and anydelay in product introduction could adversely affect our ability to compete, causing our operating results to be below our expectations or the expectations ofpublic market analysts or investors. 28Table of ContentsOur Limited Ability to Protect Our Intellectual Property May Adversely Affect Our Ability to Compete. We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights.However, we cannot ensure that the actions we have taken will adequately protect our intellectual property rights or that other parties will not independentlydevelop similar or competing products that do not infringe on our patents. We generally enter into confidentiality or license agreements with our employees,consultants and corporate partners, and control access to and distribution of our intellectual property and other proprietary information. Despite our efforts toprotect our proprietary rights, unauthorized parties may attempt to copy or otherwise misappropriate or use our products or technology, which wouldadversely affect our ability to compete. Claims of Infringement by Others May Increase and the Resolution of such Claims May Adversely Affect our Ability to Compete and Our OperatingResults. Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patents, copyrights,including rights to “open source” software, and other intellectual property rights. Because of the existence of a large number of patents in the networkingfield, the secrecy of some pending patents and the issuance of new patents at a rapid pace, it is not possible to determine in advance if a product orcomponent might infringe the patent rights of others. Because of the potential for courts awarding substantial damages and the lack of predictability of suchawards, it is not uncommon for companies in our and similar industries to settle even potentially unmeritorious claims for very substantial amounts. Weexpect to increasingly be subject to infringement claims asserted by third parties as the numbers of products and competitors in the market for networkswitches grow and product functionality overlaps. In addition, products or technologies acquired by us may include so-called “open source” software. Open source software is typically licensed for useat no initial charge, but imposes on the user of the open source software certain requirements to license to others both the open source software as well as thesoftware that relates to, or interacts with, the open source software. Our use of open source software subjects us to certain additional risks for the followingreasons: • open source license terms may be ambiguous and may result in unanticipated obligations regarding our products; • open source software cannot be protected under trade secret law; and • it may be difficult for us to accurately determine the developers of the open source code and whether the acquired software infringes third-partyintellectual property rights. We are actively involved in disputes and licensing discussions with, and have received notices from, third parties regarding their claimed proprietaryrights. As the functionality and features of our products expands these disputes and discussions could increase or become harder to resolve. The corporationswith whom we have or could have disputes or discussions include corporations with extensive patent portfolios and substantial financial assets who areactively engaged in programs to generate substantial revenues from their patent portfolios, and who are seeking or may seek significant payments or royaltiesfrom us and others in our industry. We cannot ensure that we will always be able successfully to defend ourselves against such claims or conclude licensingdiscussions on favorable terms. If we are found to infringe the proprietary rights of others, or if we otherwise settle such claims or enter into licensingarrangement to resolve potential disputes, we could be compelled to pay damages, royalties or other payments and either obtain a license to those intellectualproperty rights or alter our products so that they no longer infringe upon such proprietary rights. Any license could be very expensive to obtain or may not beavailable at all. Similarly, changing our products or processes to avoid infringing the rights of others may be costly or impractical. Litigation resulting fromclaims that we are infringing the proprietary rights of others has resulted and could in the future result in substantial costs and a diversion of resources, andcould have a material adverse effect on our business, financial condition and results of operations. Due to the number of companies with extensive patentportfolios in our industry who are or may be actively involved in 29Table of Contentslicensing programs, as well as the increasing number of trade secret and “open source” disputes, we believe that even if we do not infringe the rights of others,we will incur significant expenses in the future due to disputes or licensing negotiations, though the amounts can not be determined. We cannot assure youthat any such expenses will not be material or otherwise adversely affect our operating results. We Are Engaged in Litigation Regarding Intellectual Property Rights, and an Adverse Outcome Could Harm Our Business and Require Us to IncurSignificant Costs. We have received notice from some companies alleging that we may be infringing their patents. One company, Enterasys Networks, Inc., recently fileda claim against us alleging patent infringement. We are evaluating the merits of the claim and have filed counter claims in the matter. Without regard to themerits of this or any other claim, if judgments by a court of law on this or any other claim received in the future were to be upheld, or if we were otherwise toagree to the settlement of such claims, the consequences to us may be severe and could require us, among other actions to: • stop selling our products that incorporate the challenged intellectual property; • obtain a royalty bearing license to sell or use the relevant technology, which license may not be available on reasonable terms or available at all; • pay damages; or • redesign those products that use the disputed technology. If we are compelled to take any of the foregoing actions, our business could be severely harmed. We Must Continue to Develop and Increase the Productivity of Our Indirect Distribution Channels to Increase Net Revenues and Improve OurOperating Results. Our distribution strategy focuses primarily on developing and increasing the productivity of our indirect distribution channels. If we fail to developand cultivate relationships with significant resellers, or if these resellers are not successful in their sales efforts, sales of our products may decrease and ouroperating results could suffer. Many of our resellers also sell products from other vendors that compete with our products. We cannot assure you that we willbe able to enter into additional reseller and/or distribution agreements or that we will be able to successfully manage our product sales channels. Our failureto do any of these could limit our ability to grow or sustain revenue. In addition, our operating results will likely fluctuate significantly depending on thetiming and amount of orders from our resellers. We cannot assure you that our resellers and/or distributors will continue to market or sell our productseffectively or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. Most of Our Revenue is Derived From Sales of Three Product Families, So We are Dependent on Widespread Market Acceptance of These Products. We derive substantially all of our revenue from sales of our Summit, BlackDiamond and Alpine products and related services. We expect that revenuefrom these product families will account for a substantial portion of our revenue for the foreseeable future. Accordingly, widespread market acceptance of ourproduct families is vital to our future success. Factors that may affect the sales of our products, some of which are beyond our control, include: • the demand for switching products (Gigabit Ethernet and Layer 3 switching technologies in particular) in the enterprise and service providermarkets; • the performance, price and total cost of ownership of our products; • the availability and price of competing products and technologies; 30Table of Contents • our ability to match supply with demand for certain products; and • the success and development of our resellers, distributors and field sales channels. We may not be able to achieve widespread market acceptance of our product families, which could reduce our revenue. Our Reliance on Industry Standards, Technological Change in the Marketplace and New Product Initiatives May Cause our Sales to Fluctuate orDecline. The network equipment industry in which we compete is characterized by rapid changes in technology and customers requirements and evolvingindustry standards. As a result, our success depends on: • the timely adoption and market acceptance of industry standards, and timely resolution of conflicting U.S. and international industry standards;and • our ability to influence the development of emerging industry standards and to introduce new and enhanced products that are compatible withsuch standards. Slow market acceptance of new technologies, products or industry standards could adversely affect our sales or overall results of operations. Inaddition, if our technology is not included in an industry standard on a timely basis or if we fail to achieve timely certification of compliance to industrystandards for our products, our sales of such products or our results of operations could be adversely affected. If a Key Reseller, Distributor, or Other Significant Customer Cancels or Delays a Large Purchase, Our Net Revenues May Decline and the Price of OurStock May Fall. To date, a limited number of resellers, distributors and other customers have accounted for a significant portion of our revenue. One distributor, TechData, accounted for greater than 10% of our net revenue in fiscal 2007, 2006 and 2005. In addition, while no other distributor or customer has accounted for10% or more of revenue in the recent fiscal years, sales to several distributors represent a high percentage of our sales. If any of our large customers stop ordelay purchases, our revenue and profitability would be adversely affected. Our expense levels are based on our expectations as to future revenue and to a large extent are fixed in the short term, so a substantial reduction ordelay in sales of our products to a significant reseller, distributor or other customer could harm our business, operating results and financial condition.Although our largest customers may differ from period-to-period, we anticipate that our operating results for any given period will continue to depend to asignificant extent on large orders from a relatively small number of customers. While our financial performance depends on large orders from a limited number of key resellers, distributors and other significant customers, we do nothave binding purchase commitments from any of them. For example: • our service providers 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 to return products to us. We do not recognize revenue on sales to distributorsuntil the distributors sell the product to their customers. 31Table of ContentsThe Sales Cycle for Our Products is Long and We May Incur Substantial Non-Recoverable Expenses or Devote Significant Resources to Sales that DoNot Occur When Anticipated. The use of indirect sales channels may contribute to the length and variability of our sales cycle. Our products represent a significant strategic decisionby a customer regarding its communications infrastructure. The decision by customers to purchase our products is often based on the results of a variety ofinternal procedures associated with the evaluation, testing, implementation and acceptance of new technologies. Accordingly, the product evaluation processfrequently results in a lengthy sales cycle, typically ranging from three months to longer than a year, and as a result, our ability to sell products is subject to anumber 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 resourcesdifficult to assess; • the risk that we may incur substantial sales and marketing expenses and expend significant management time in an attempt to initiate or increasethe sale of products to customers, but not succeed; • 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 forthe shortfall, which could harm our operating results; and • the risk that downward pricing pressures could occur during this lengthy sales cycle. We Purchase Several Key Components for Products From Single or Limited Sources and Could Lose Sales if These Suppliers Fail to Meet Our Needs. We currently purchase several key components used in the manufacture of our products from single or limited sources and are dependent upon supplyfrom these sources to meet our needs. Certain components such as tantalum capacitors, static random access memory, or SRAM, dynamic random accessmemory, or DRAM, and printed circuit boards, have been in the past, and may in the future be, in short supply. We have encountered, and are likely in thefuture to encounter, shortages and delays in obtaining these or other components, and this could have a material adverse effect on our ability to meetcustomer orders. Our principal sole-source components include: • ASICs; • microprocessors; • programmable integrated circuits; • selected other integrated circuits; • custom power supplies; and • custom-tooled sheet metal. Our principal limited-source components include: • flash memories; • DRAMs, SRAMs and CAMs; and • printed circuit boards. We use our forecast of expected demand to determine our material requirements. Lead times for materials and components we order vary significantly,and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. If forecasts exceed orders, we may haveexcess and/or obsolete 32Table of Contentsinventory on hand or under non-cancelable purchase commitments that could have a material adverse effect on our operating results and financial condition.If orders exceed forecasts, we may have inadequate supplies of certain materials and components, which could have a material adverse effect on our operatingresults and financial condition. We do not have agreements fixing long-term prices or minimum volume requirements from suppliers. From time to time wehave experienced shortages and allocations of certain components, resulting in delays in filling orders. Qualifying new suppliers to compensate for suchshortages may be time-consuming and costly, and may increase the likelihood of errors in design or production. In addition, during the development of ourproducts, we have experienced delays in the prototyping of our chipsets, which in turn has led to delays in product introductions. We cannot ensure thatsimilar delays will not occur in the future. Furthermore, we cannot ensure that the performance of the components as incorporated in our products will meetthe quality requirements of our customers. Our Dependence on Two Contract Manufacturers for All of Our Manufacturing Requirements Could Harm Our Operating Results. If the demand for our products grows, we will need to increase our material purchases, contract manufacturing capacity, and internal test and qualityfunctions. Any disruptions in product flow could limit our revenue, adversely affect our competitive position and reputation, and result in additional costs orcancellation of orders under agreements with our customers. We rely on two independent contractors to manufacture all of our products. Flextronics International, Ltd. manufactures products for one of our productlines. This company’s facilities are located in San Jose, California and Guadalajara, Mexico. Our commitment with Flextronics is formalized through a one-year contract. Alpha Networks, located in Hsinchu, Taiwan, manufactures products for our second product line. We have experienced delays in productshipments from contract manufacturers in the past, which in turn delayed product shipments to our customers. These or similar problems may arise in thefuture, such as products of inferior quality, insufficient quantity of products, or the interruption or discontinuance of operations of a manufacturer, any ofwhich could have a material adverse effect on our business and operating results. We do not know whether we will effectively manage our contract manufacturers or that these manufacturers will meet our future requirements for timelydelivery of products of sufficient quality and quantity. We intend to introduce new products and product enhancements, which will require that we rapidlyachieve volume production by coordinating our efforts with those of our suppliers and contract manufacturers. The inability of our contract manufacturer toprovide us with adequate supplies of high-quality products may cause a delay in our ability to fulfill orders and may have a material adverse effect on ourbusiness, operating results and financial condition. Moreover, our current dependence on two manufacturers makes us particularly vulnerable to these risks. As part of our cost-reduction efforts, we will need to realize lower per unit product costs from our contract manufacturers by means of volumeefficiencies and the utilization of manufacturing sites in lower-cost geographies. However, we cannot be certain when or if such price reductions will occur.The failure to obtain such price reductions would adversely affect our gross margins and operating results. If We Do Not Adequately Manage and Evolve Our Financial Reporting and Managerial Systems and Processes, Our Ability to Manage and Grow OurBusiness May Be Harmed. Our ability to successfully implement our business plan and comply with regulations requires an effective planning and management process. We needto continue improving our existing, and implement new, operational and financial systems, procedures and controls. Any delay in the implementation of, ordisruption in the transition to, new or enhanced systems, procedures or controls, could harm our ability to record and report financial and managementinformation on a timely and accurate basis, or to forecast future results. 33Table of ContentsWe May Be Unable to Reasonably Anticipate Whether a Change in Our Process Will Have a Material Affect on Our Internal Control Over FinancialReporting. As we improve our controls and procedures in our ongoing effort to improve our business systems, we may be required to make changes to our internalcontrol over financial reporting. We may be unable to reasonably anticipate, both during the period in which such changes are made and at the time we filethe periodic reports covering such period, that such changes will have a material affect on our internal control over financial reporting. If we are unable toreasonably anticipate such material affect, it will have an adverse effect on our ability to accurately report our changes in internal control over financialreporting. Changes in Financial Accounting Standards May Cause Adverse Unexpected Revenue Fluctuations and Affect Our Reported Results of Operations. A change in accounting policies can have a significant effect on our reported results and may even affect our reporting of transactions completedbefore the change is effective. New pronouncements and varying interpretations of existing pronouncements have occurred with frequency and may occur inthe future. Changes to existing rules, or changes to the interpretations of existing rules could lead to the questioning of our accounting practices, which maycause us to reevaluate or change such practices, and such changes could adversely affect our reported financial results or the way we conduct our business. In particular, in December 2004 the Financial Accounting Standards Board issued a statement requiring companies to record stock option grants ascompensation expense in their income statements. This statement was effective beginning with the first quarter of our fiscal 2006. The methodology forexpensing such stock options is based on, among other things, the historical volatility of the underlying stock and the expected life of our stock options. Ourstock price has been historically volatile. Therefore, the adoption of this accounting standard has, and will continue to, negatively impact our profitabilityand may adversely impact our stock price. In addition, our adoption of this standard could limit our ability to continue to use stock options as an incentiveand retention tool, which could, in turn, hurt our ability to recruit employees and retain existing employees. In addition, various accounting rules and regulations have been established over the recent past relating to revenue recognition. These regulationsfrequently require judgments in their application, and are subject to numerous subsequent clarifications and interpretations, some of which may requirechanges in the way we recognize revenue and may require restatement of prior period revenue and results, either of which could adversely affect our reportedresults. Compliance with Changing Regulation of Corporate Governance and Public Disclosure May Result in Additional Expenses. Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SECregulations and Nasdaq Stock Market rules, are creating uncertainty for companies such as ours. We are committed to maintaining high standards of corporategovernance and public disclosure. As a result, we are investing all reasonably necessary resources to comply with evolving standards and changinginterpretations of existing standards and this investment may result in increased general and administrative expenses and a diversion of management timeand attention from revenue-generating activities to compliance activities and efforts to evaluate current practices and achieve compliance. We Have Been Named as a Defendant in a Shareholder Class Action Lawsuit Arising Out of Our Public Offerings of Securities in 1999 and May beInvolved in Additional Litigation in the Future. Beginning on July 6, 2001, purported securities fraud class action complaints were filed in the United States District Court for the Southern District ofNew York. The cases were consolidated and the litigation is now captioned as In re Extreme Networks, Inc. Initial Public Offering Securities Litigation, Civ.No. 01-6143 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). The 34Table of Contentsoperative amended complaint is brought purportedly on behalf of all persons who purchased Extreme Networks’ common stock from April 8, 1999 throughDecember 6, 2000. It names as defendants Extreme Networks; six of our present and former officers and/or directors, including our CEO (the “ExtremeNetworks Defendants”); and several investment banking firms that served as underwriters of our initial public offering and October 1999 secondary offering.(See “Other Matters” in Item 3 Legal Proceedings) We cannot assure you that we will prevail in the lawsuit. Failure to prevail could have a material adverseeffect on our consolidated financial position, results of operations and cash flows in the future. In addition, in the past, we have, and may in the future, become subject to other types of litigation, and may in the future become subject to other typesof litigation. Litigation is often expensive and diverts management’s attention and resources, which could materially and adversely affect our business. Our Headquarters and Some Significant Supporting Businesses Are Located in Northern California and Other Areas Subject to Natural Disasters ThatCould Disrupt Our Operations and Harm Our Business. Our corporate headquarters are located in Silicon Valley in Northern California. Historically, this region has been vulnerable to natural disasters andother risks, such as earthquakes, fires and floods, which at times have disrupted the local economy and posed physical risks to our property. We have contractmanufacturers located in Northern California, Mexico and Taiwan where similar natural disasters and other risks may disrupt the local economy and posephysical risks to our property and the property of our contract manufacturer. In addition, the continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, maycause further disruptions to the economies of the U.S. and other countries. If such disruptions result in delays or cancellations of customer orders for ourproducts, our business and operating results will suffer. We currently do not have redundant, multiple site capacity in the event of a natural disaster, terrorist act or other catastrophic event. In the event ofsuch an occurrence, our business would suffer. Failure of Our Products to Comply With Evolving Industry Standards and Complex Government Regulations May Cause Our Products to Not BeWidely Accepted, Which May Prevent Us From Growing Our Net Revenues or Achieving Profitability on a Fiscal Year Basis. The market for network equipment products is characterized by the need to support industry standards as different standards emerge, evolve andachieve acceptance. We will not be competitive unless we continually introduce new products and product enhancements that meet these emergingstandards. In the past, we have introduced new products that were not compatible with certain technological standards, and in the future we may not be ableto effectively address the compatibility and interoperability issues that arise as a result of technological changes and evolving industry standards. Ourproducts must comply with various United States federal government regulations and standards defined by agencies such as the Federal CommunicationsCommission, in addition to standards established by governmental authorities in various foreign countries and recommendations of the InternationalTelecommunication Union. If we do not comply with existing or evolving industry standards or if we fail to obtain timely domestic or foreign regulatoryapprovals or certificates we will not be able to sell our products where these standards or regulations apply, which may prevent us from sustaining our netrevenue or achieving profitability on a fiscal year basis. Production and marketing of products in certain states and countries may subject us to environmental and other regulations including, in someinstances, the requirement to provide customers the ability to return product at the end of its useful life, and place the responsibility for environmentally safedisposal or recycling with us. Additionally, certain states and countries may pass regulations requiring our products to meet certain requirements to useenvironmentally friendly components. Such laws and regulations have recently been passed in several jurisdictions in which we operate, including theEuropean Union which issued a Directive 2002/96/EC 35Table of ContentsWaste Electrical and Electronic Equipment (“WEEE”) to mandate funding, collection, treatment, recycling and recovery of WEEE by producers of electricalor electronic equipment into Europe. China is in the final approval stage of compliance programs which will harmonize with the European Union WEEE. Inthe future, Japan and other countries are expected to adopt environmental compliance programs. If we fail to comply with these regulations, we may not beable to sell our products in jurisdictions where these regulations apply, which would have a material adverse affect on our results of operations. In addition, the EU also adopted Directive 2002/95/EC on Restriction on the Certain Hazardous Substances in Electrical and Electronic Equipment(the “RoHS Directive”). The RoHS Directive bans in the EU the use of certain hazardous materials in electrical and electronic equipment. The RoHS Directivewent into effect on July 1, 2006, the date by which each EU-member country was required to adopt legislation implementing the RoHS Directive in thatcountry. Certain EU-member countries where we import products have adopted such implementing legislation effective July 1, 2006, while other EU-membercountries have either not yet adopted implementing legislation or have not yet adopted rules under their implementing legislation. The manner ofimplementation of the RoHS Directive in each EU country will likely vary, and we will face challenges complying with the differing implementation of theRoHS Directive in each country. Failure to comply with the regulatory requirements in one jurisdiction may adversely impact our ability to do business inthat jurisdiction as well as others. We have incurred higher manufacturing costs and increased our European service spare parts inventory by approximately$5.1 million as of July 2, 2006 as a result of complying with the RoHS Directive. During fiscal 2007, we did not increase our European service spare partsinventory further as a result of complying with the RoHS Directive. As of July 1, 2007, we were fully compliant with the RoHS Directive. Similar legislationhas been or could be enacted in other countries outside the EU, the cumulative impact of which could similarly impact our financial condition or results ofoperations. Failure to Successfully Expand Our Sales and Support Teams or Educate Them In Regard to Technologies and Our Product Families May Harm OurOperating Results. The sale of our products and services requires a concerted effort that is frequently targeted at several levels within a prospective customer’sorganization. We may not be able to increase net revenues unless we expand our sales and support teams in order to address all of the customer requirementsnecessary to sell our products. We cannot assure you that we will be able to successfully integrate employees into our company or to educate current and future employees in regardto rapidly evolving technologies and our product families. A failure to do so may hurt our revenue growth and operating results. We May Engage in Future Acquisitions that Dilute the Ownership Interests of Our Stockholders, Cause Us to Incur Debt and Assume ContingentLiabilities. As part of our business strategy, we review acquisition and strategic investment prospects that we believe would complement our current productofferings, augment our market coverage or enhance our technical capabilities, or otherwise offer growth opportunities. From time to time we reviewinvestments in new businesses and we expect to make investments in, and to acquire, businesses, products, or technologies in the future. In the event of anyfuture acquisitions, we could: • issue equity securities which would dilute current stockholders’ percentage ownership; • incur substantial debt; • assume contingent liabilities; or • expend significant cash. These actions could have a material adverse effect on our operating results or the price of our common stock. Moreover, even if we do obtain benefitsin the form of increased sales and earnings, there may be a lag 36Table of Contentsbetween the time when the expenses associated with an acquisition are incurred and the time when we recognize such benefits. This is particularly relevant incases where it is necessary to integrate new types of technology into our existing portfolio and new types of products may be targeted for potential customerswith which we do not have pre-existing relationships. Acquisitions and investment activities also entail numerous risks, including: • difficulties in the assimilation of acquired operations, technologies and/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; and • substantial charges for the amortization of certain purchased intangible assets, deferred stock compensation or similar items. We cannot ensure that we will be able to successfully integrate any businesses, products, technologies, or personnel that we might acquire in the future,and our failure to do so could have a material adverse effect on our business, operating results and financial condition. We May Need Additional Capital to Fund Our Future Operations and, If It Is Not Available When Needed, We May Need to Reduce Our PlannedDevelopment and Marketing Efforts, Which May Reduce Our Net Revenues and Prevent Us From Achieving Profitability on a Fiscal Year Basis. We believe that our existing working capital and cash available from credit facilities and future operations will enable us to meet our working capitalrequirements for at least the next 12 months. However, if cash from future operations is insufficient, or if cash is used for acquisitions or other currentlyunanticipated uses, we may need additional capital. The development and marketing of new products and the expansion of reseller and distribution channelsand associated support personnel requires a significant commitment of resources. In addition, if the markets for our products develop more slowly thananticipated, or if we fail to establish significant market share and achieve sufficient net revenues, we may continue to consume significant amounts of capital.As a result, we could be required to raise additional capital. To the extent that we raise additional capital through the sale of equity or convertible debtsecurities, the issuance of such securities could result in dilution of the shares held by existing stockholders. If additional funds are raised through theissuance of debt securities, 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 cannot assure you that additional capital, if required, will be available on acceptableterms, or at all. If we are unable to obtain sufficient amounts of additional capital, we may be required to reduce the scope of our planned productdevelopment and marketing efforts, which could harm our business, financial condition and operating results. We Have Entered into Long-Term Lease Agreements for Several Facilities that are Currently Vacant and May be Difficult to Sublease due to CurrentReal Estate Market Conditions. We have certain long-term real estate lease commitments carrying future obligations for non-cancelable lease payments. Reductions in our workforceand the restructuring of operations since fiscal 2002 have resulted in the need to consolidate certain of these leased facilities, located primarily in NorthernCalifornia, for which we recorded excess facilities charges of approximately $4.0 million in fiscal 2007, $3.3 million in fiscal 2006, $6.5 million in fiscal2004, and $9.6 million in fiscal 2003. For more information, see Note 12 of Notes to Consolidated Financial Statements. We may incur additional charges forexcess facilities as a result of additional reductions in our workforce or future restructuring of operations. We will continue to be responsible for all carryingcosts of these facilities until such time as we can sublease these facilities or terminate the applicable 37Table of Contentsleases based on the contractual terms of the lease agreements, and these costs may have an adverse effect on our business, operating results and financialcondition. Our Stock Price Has Been Volatile In the Past and Our Stock Price May Significantly Fluctuate in the Future. In the past, our common stock price has fluctuated significantly. This could continue as we or our competitors announce new products, our results orthose of our customers or competition fluctuate, conditions in the networking or semiconductor industry change, or when investors, change their sentimenttoward stocks in the networking technology sector. In addition, fluctuations in our stock price and our price-to-earnings multiple may make our stock attractive to momentum, hedge or day-tradinginvestors who often shift funds into and out of stock rapidly, exacerbating price fluctuations in either direction, particularly when viewed on a quarterlybasis. Provisions in Our Charter Documents and Delaware Law and Our Adoption of a Stockholder Rights Plan May Delay or Prevent an Acquisition ofExtreme, Which Could Decrease the Value of Our Common Stock. Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us withoutthe consent of our Board of Directors. Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of15% or more of our outstanding common stock. In addition, our Board of Directors has the right to issue preferred stock without stockholder approval, whichcould be used to dilute the stock ownership of a potential hostile acquirer. Although we believe these provisions of our certificate of incorporation andbylaws and Delaware law and our stockholder rights plan, which is described below, will provide for an opportunity to receive a higher bid by requiringpotential acquirers to negotiate with our Board of Directors, these provisions apply even if the offer may be considered beneficial by some of ourstockholders. Our Board of Directors adopted a stockholder rights plan, pursuant to which we declared and paid a dividend of one right for each share of commonstock held by stockholders of record as of May 14, 2001. Under the plan, each right will entitle stockholders to purchase a fractional share of our preferredstock for $150.00. Each such fractional share of the new preferred stock has terms designed to make it substantially the economic equivalent of one share ofcommon stock. Initially the rights will not be exercisable and will trade with our common stock. Generally, the rights may become exercisable if a person orgroup acquires beneficial ownership of 15% or more of our common stock or commences a tender or exchange offer upon consummation of which suchperson or group would beneficially own 15% or more of our common stock. When the rights become exercisable, our Board of Directors has the right toauthorize the issuance of one share of our common stock in exchange for each right that is then exercisable. Item 1B. Unresolved Staff Comments Not applicable. Item 2. Properties Our principal administrative, sales, marketing and research and development facilities are located in Santa Clara, California. We also lease office spaceand executive suites in various other geographic locations domestically and internationally for sales and service personnel and engineering operations. Ouraggregate lease expense for fiscal 2007 was approximately $4.8 million, net of sublease income of approximately $0.1 million. We believe our currentfacilities will adequately meet our growth needs for the foreseeable future, and we are actively engaged in efforts to sublease excess space we acquired inprior years to meet the anticipated growth at that time. 38Table of Contents Item 3. Legal Proceedings Government Inquiries Relating to Historical Stock Option Practices On June 27, 2006, the Company received an informal inquiry letter from the Staff of the SEC Enforcement Division requesting that the Companyvoluntarily provide documents related to its policies, practices and procedures for granting stock options for the period since its initial public offering onApril 9, 1999 (“IPO”). The Company responded to the request, is cooperating fully with the SEC inquiry, and intends to continue to do so. This inquiry likely will require the Company to expend significant management time and incur significant legal and other expenses, and could resultin civil actions seeking, among other things, injunctions against the Company and the payment of significant fines and penalties by the Company, whichmay adversely affect the Company’s results of operations and cash flow. The Company cannot predict how long it will take to or how much more time and resources the Company will have to expend to resolve thisgovernment inquiry, nor can we predict the outcome of this inquiry. Also, there can be no assurance that other inquiries, investigations or actions will not bestarted by other United States federal or state regulatory agencies or by foreign governmental agencies. Late SEC Filings, Failure to Hold Annual Meeting and Nasdaq Delisting Proceedings Due to the Special Committee investigation and the resulting restatement of our fiscal 2000 through 2005 financial statements, the Company did nottimely file its Form 10-K for the fiscal year ending July 2, 2006 or the Quarterly Reports on Forms 10-Q for the quarters ended October 1, 2006, December 31,2006 and April 1, 2007. The Company initially received Nasdaq Staff Determination notices stating that the Company was not in compliance withMarketplace Rule 4310(c)(14) because it had not timely filed such periodic reports with the SEC. Those filings were made on June 28, 2007. On July 2, 2007,the Company received a written notice from the Nasdaq Stock Market stating that the Nasdaq Listing and Hearing Review Council (the “Listing Council”)had determined that as of that date the Company had demonstrated compliance with all Nasdaq Marketplace Rules. On July 3, 2007, the Company received a further Staff Determination notice from the Nasdaq Stock Market stating that the Company was not incompliance with Nasdaq’s Marketplace Rule 4350(e) due to a failure by the Company to hold its annual meeting of shareholders within the time required byRule 4350(e). On July 30, 2007, the Company had held an annual meeting of shareholders and subsequently received a written notice from the Panelconfirming that the Company had demonstrated compliance with all Nasdaq Marketplace Rules, and that the Panel determined to continue the listing of theCompany’s securities on The Nasdaq Stock Market. Accordingly, the Company believes that the Nasdaq delisting proceedings have concluded. We cannot predict, however, whether the SEC will review these reports and, if so, whether the SEC will have comments on these reports (or otherreports that we previously filed) that may require us to file amended reports with the SEC. In addition, we cannot predict whether the Nasdaq ListingQualifications Panel or Listing Council will concur that we are in compliance with all relevant listing requirements. If either of those events occurs, we mightbe unable to remain in compliance with SEC reporting requirements and Nasdaq listing requirements, and, therefore, we might be unable to maintain aneffective listing of our common stock on the Nasdaq Global Select Market or any other national securities exchange. Shareholder Litigation Relating to Historical Stock Option Practices On April 25, 2007, an individual identifying herself as a shareholder of the Company filed a derivative action in the United States District Court for theNorthern District of California purporting to assert claims on behalf of and in the name of the Company against various of our current and former directorsand officers relating to our stock option granting practices for stock options issued from 2000 to 2003. The complaint alleges 39Table of Contentsthat the individual defendants breached their fiduciary duties and other obligations to the Company and violated federal securities laws in connection withour historical stock option granting process and our accounting for past stock options. The plaintiff has asserted claims for violations of Sections 10(b) (including Rule 10b-5 thereunder), 14(a), and 20(a) of the Securities Exchange Act of1934, unjust enrichment, breach of fiduciary duty and aiding and abetting such breach, rescission, and a claim for an accounting of all stock option grantsmade to the named defendants. Extreme Networks, Inc. is named as a nominal defendant in these actions. On behalf of Extreme Networks, Inc., the plaintiffseeks unspecified monetary and other relief against the named defendants. The plaintiff is Yenna Wu. The individual named defendants are Gordon L. Stitt,Herb Schneider, Stephen Haddock, Paul Romeo, Vito Palermo, Harold Covert, Darrell Scherbarth, Christopher, N. Todd, Alexander J. Gray, Frank C. Carlucci,William R. Slakey, Charles Carinalli, Harry Silverglide, Michael West, Kenneth Levy, Robert L. Corey, Peter Wolken, and Promod Haque. A similar derivative action was filed in the same court on May 2, 2007, by Linda Erikson, another individual identifying herself as a shareholder of theCompany, alleging the same legal claims against the same individual defendants concerning the same subject matter. A third derivative action was filed in the same court on May 31, 2007 by Frank A. Grucel, Jr., an individual identifying himself as a shareholder of theCompany, purporting to assert claims on the Company’s behalf relating to the Company’s historic stock options granting practices. The complaint seeksunspecified monetary and injunctive relief and asserts claims for violations of Section 14(a) of the Securities Exchange Act of 1934, an accounting of allstock option grants made to the named defendants, breach of fiduciary duty and aiding and abetting such breach, abuse of control, gross mismanagement,constructive fraud, corporate waste, unjust enrichment, rescission, violations of California Corporations Code Section 25402, and breach of fiduciary dutiesrelated to insider selling and alleged misappropriation of information. Extreme Networks, Inc. is named as a nominal defendant in this action, and theindividual named defendants are Gordon L. Stitt, Herb Schneider, Stephen Haddock, Alexander J. Gray, Frank C. Carlucci, William R. Slakey, CharlesCarinalli, Harry Silverglide, Michael West, Kenneth Levy, Robert L. Corey, Peter Wolken, Michael Palu, and Alicia Moore. The foregoing actions have been related and assigned to the same judge. On June 15, 2007, Yenna Wu filed an amended complaint in her action. Theamended complaint names one additional individual defendant, Mark Canepa, as well as the individual defendants named in the derivative complaints filedon April 25, 2007 and May 2, 2007, is purportedly brought both as a derivative action and as a class action on behalf of all current shareholders of theCompany, and alleges a claim for violation of Delaware General Corporations Code Section 211(c), seeking an order compelling the Company to hold ashareholder’s meeting. The amended complaint otherwise alleges the same claims as the derivative complaints filed on April 25, 2007 and May 2, 2007 byplaintiffs Wu and Erikson, respectively. On August 2, 2007, the foregoing actions were consolidated for all purposes. Subsequently, on August 13, 2007, plaintiff Frank A. Grucel, Jr. wasnamed lead plaintiff and his attorneys named lead counsel in the consolidated actions. This consolidated action is at an early stage, with a consolidatedcomplaint to be filed by September 27, 2007. Discovery has not yet commenced and the defendants are not required to respond to the complaints currentlyon file. We cannot at this time predict whether this consolidated action will result in any material recovery by or expense to the Company. Indemnification Obligations Subject to certain limitations, we may be obligated to indemnify our current and former directors, officers and employees. These obligations arise underthe terms of our certificate of incorporation, our bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify, whereapplicable, generally means that we are required to pay or reimburse, and in certain circumstances we have paid or reimbursed, the individuals’ 40Table of Contentsreasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters. It is not possible to estimate the maximumpotential amount under these indemnification agreements due to the limited history of these claims. The cost to defend the Company and the namedindividuals could have a material adverse effect on our consolidated financial position, results of operations and cash flows in the future. Recovery of suchcosts under our directors and officers insurance coverage is uncertain. Other Legal Matters On April 20, 2007, Extreme Networks filed suit against Enterasys in the United States District Court for the Western District of Wisconsin, Civil ActionNo. 07-C-0229-C. The complaint alleges willful infringement of U.S. patents Nos. 6,104,700, 6,678,248, and 6,859,438, and seeks injunctive relief againstEnterasys’ continuing sale of infringing goods and monetary damages. Enterasys responded to the complaint on May 30, 2007. Enterasys also filed acounterclaim alleging infringement of three U.S. patents owned by Enterasys. The case is in its early stages, however a Markman Hearing has been scheduledfor October 2007, and a trial date has been set for May 2008. On December 27, 2005, Broadband Office Inc. (“Broadband”) served an amended complaint, adding Extreme Networks as a defendant in its lawsuitagainst Technology Credit Corporation (“TCC”) and Key Equipment Finance, Inc., seeking recovery of an alleged preferential payment in the amount of$0.8 million plus interest, purportedly paid by Broadband to TCC within ninety days prior to Broadband’s petition for bankruptcy protection. Extremedisputes that it owes any money to Broadband, and intends vigorously to defend against the claims. On June 21, 2005, Enterasys filed suit against Extreme Networks and Foundry Networks, Inc. (“Foundry”) in the United States District Court for theDistrict of Massachusetts, Civil Action No.05-11298 DPW. The complaint alleges willful infringement of U. S. Patent Nos. 5,251,205; 5,390,173; 6,128,665;6,147,995; 6,539,022; and 6,560, 236, and seeks: a) a judgment that Extreme willfully infringes each of the patents; (b) a permanent injunction frominfringement, inducement of infringement and contributory infringement of each of the six patents; (c) damages and a “reasonable royalty” to be determinedat trial; (d) trebled damages; (e) attorneys fees, costs and interest; and (f) equitable relief at the court’s discretion. The Markman hearing has been rescheduledfor October 2007. We intend vigorously to defend against Enterasys’ assertions, which we believe to be without merit. On May 27, 2003, Lucent filed suit against Extreme Networks and Foundry in the United States District Court for the District of Delaware, Civil ActionNo. 03-508. The complaint alleged willful infringement of U.S. Patent Nos. 4,769,810, 4,769,811, 4,914,650, 4,922,486 and 5,245,607. After the Markmanhearing, Lucent dropped its claims relating to the 5,245,607 patent. The judge split the case into three parts to be tried separately: phase 1 to coverinfringement, willfulness and damages; phase 2 to cover invalidity; and phase 3 to cover equitable defenses and our counterclaims. On May 9, 2005, a jury inDelaware awarded a verdict to Extreme in the phase 1 trial of non-infringement on 18 out of the 19 claims asserted. The jury did award Lucent damages ofapproximately $275,000 on the remaining claim; which covers a feature that is not offered in our current product line. The parties each filed post-trialmotions; and on August 16, 2005, the judge granted Lucent’s motion for a new trial, ruling that Extreme impermissibly introduced to the jury evidence of itsprior relationship with Lucent. Extreme’s motion for reconsideration was denied. On August 9, 2006, the parties entered into a settlement agreement toresolve all outstanding claims which includes the dismissal of all claims and a patent cross-license for a defined term. Beginning on July 6, 2001, purported securities fraud class action complaints were filed in the United States District Court for the Southern District ofNew York. The cases were consolidated and the litigation is now captioned as In re Extreme Networks, Inc. Initial Public Offering Securities Litigation, Civ.No. 01-6143 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.).The operative amended complaintnames as defendants Extreme Networks; six of our present and former officers 41Table of Contentsand/or directors, including our CEO (the “Extreme Networks Defendants”); and several investment banking firms that served as underwriters of our initialpublic offering and October 1999 secondary offering. The complaint alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that the registration statement for the offerings did not disclose that: (1) theunderwriters had agreed to allow certain customers to purchase shares in the offerings in exchange for excess commissions paid to the underwriters; and(2) the underwriters had arranged for certain customers to purchase additional shares in the aftermarket at predetermined prices. Similar allegations were madein other lawsuits challenging over 300 other initial public offerings and follow-on offerings conducted in 1999 and 2000. The cases were consolidated forpretrial purposes. Previously, we executed a settlement agreement presented to all issuer defendants. In that settlement, plaintiffs would dismiss and release all claimsagainst the Extreme Network Defendants, in exchange for a contingent payment by the insurance companies collectively responsible for insuring the issuersin all of the IPO cases, and for the assignment or surrender of control of certain claims we may have against the underwriters. The Extreme NetworksDefendants would not be required to make any cash payments in the settlement, unless the pro rata amount paid by the insurers in the settlement exceededthe amount of the insurance coverage. The Court gave preliminary approval to the settlement in February 2005 and held a hearing in April 2006 to considerfinal approval of the settlement. Before the Court issued a final decision on the settlement, on December 5, 2006 the United States Court of Appeals for theSecond Circuit vacated the class certification of plaintiffs’ claims against the underwriters in six cases designated as focus or test cases. Thereafter, onDecember 14, 2006, the Court ordered a stay of all proceedings in all of the lawsuits pending the outcome of plaintiffs’ petition to the Second Circuit Courtof Appeals for a rehearing en banc and resolution of the class certification issue. On April 6, 2007, the Second Circuit Court of Appeals denied plaintiffs’petition for a rehearing, but clarified that the plaintiffs may seek to certify a more limited class. Accordingly, the plaintiffs and issuers have stated that theyare prepared to discuss how the settlement might be amended or renegotiated to comply with the decision of the Second Circuit Court of Appeals. OnApril 30, 2007, Plaintiffs stated that they intend to present a proposed redefined class to the Court. If the settlement is not amended or renegotiated and thenapproved by the Court, there is no assurance that we will prevail in the lawsuit. Failure to prevail could have a material adverse effect on our consolidatedfinancial position, results of operations and cash flows in the future. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 42Table of Contents PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Common Stock Market Prices and Dividends Our common stock commenced trading on The Nasdaq Global Market on April 9, 1999 under the symbol “EXTR.” The following table sets forth thehigh and low sales prices as reported by Nasdaq. Such prices represent prices between dealers, do not include retail mark-ups, mark-downs or commissionsand may not represent actual transactions. Stock Prices High LowFiscal year ended July 1, 2007: First quarter $4.22 $3.39Second quarter $4.26 $3.60Third quarter $4.65 $3.94Fourth quarter $4.47 $3.72Fiscal year ended July 2, 2006: First quarter $5.14 $4.06Second quarter $5.26 $4.34Third quarter $5.22 $4.48Fourth quarter $5.09 $4.02 At August 15, 2007, there were approximately 358 stockholders of record of our common stock and approximately 25,778 beneficial stockholders. Wehave never declared or paid cash dividends on our capital stock and do not anticipate paying any cash dividends in the foreseeable future. We currentlyintend to retain future earnings for the development of our business. Item 6. Selected Financial Data The following table sets forth selected consolidated financial data for each of the fiscal years ended July 1, 2007, July 2, 2006, July 3, 2005, June 27,2004 and June 29, 2003. These tables should be reviewed in conjunction with the Consolidated Financial Statements in Item 8 and related Notes, as well asItem 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Historical results may not be indicative of future results. Year Ended July 1,2007(1) July 2,2006(2) July 3,2005(3) June 27,2004(4) June 29,2003(5) (In thousands, except per share amounts) Consolidated Statements of Operations Data: Net revenues $342,834 $358,601 $383,347 $351,848 $363,276 Net income (loss) $(14,197) $8,509 $12,519 $(3,292) $(282,171)Net income (loss) per share – basic $(0.12) $0.07 $0.10 $(0.02) $(2.45)Net income (loss) per share – diluted $(0.12) $0.07 $0.10 $(0.02) $(2.45)Shares used in per share calculation – basic 114,122 121,286 121,225 118,348 115,186 Shares used in per share calculation – diluted 114,122 123,049 124,166 118,348 115,186 43Table of Contents As of July 1,2007 July 2,2006 July 3,2005 June 27,2004 June 29,2003 (In thousands) Consolidated Balance Sheets Data: Cash and cash equivalents, short-term investments and marketable securities $215,855 $433,105 $440,404 $425,672 $402,157 Deferred tax asset $1,118 $500 $430 $886 $609 Total assets $341,897 $558,718 $583,614 $579,273 $550,257 Convertible subordinated notes $— $200,000 $200,000 $200,000 $200,000 Other long-term liabilities $21,392 $23,056 $30,698 $41,308 $22,313 Common stock and capital in excess of par value $934,540 $927,835 $915,945 $910,546 $876,186 Accumulated deficit $(670,585) $(656,387) $(664,896) $(677,415) $(674,123)(1)Fiscal 2007 net loss includes share-based compensation expense of $6.2 million and restructuring charge of $4.0 million.(2)Fiscal 2006 net loss includes share-based compensation expense of $7.0 million and restructuring charge of $3.3 million.(3)Fiscal 2005 net income includes share-based compensation expense of $0.8 million and other income includes $3.9 million from the relief of a foreignconsumption tax obligation.(4)Fiscal 2004 net loss includes share-based compensation expense of $4.0 million and other income includes $7.9 million in cash settlements fromvendors, net of related expenses, and other income of $2.5 million from the relief of a foreign consumption tax obligation.(5)Fiscal 2003 net loss includes share-based compensation expense of $23.1 million and a $194.8 million charge in our tax provision reflecting ourprovision of a full valuation allowance against deferred tax assets. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation Business Overview We develop and sell a family of modular and stackable network infrastructure equipment and offer related service contracts for extended warranty andmaintenance agreements. Substantially all of our revenue is derived from the sale of our networking equipment and the related service contracts. We believethat understanding the following key developments is helpful to an understanding of our operating results for fiscal 2007. Increased Product Breadth We believe that continued success in the marketplace will depend on our ability to develop new and enhanced products employing leading-edgetechnology. In fiscal 2007 we introduced several new products that allow for the continued deployment of secure, converged networks as well as theexpansion of the ExtremeXOS™ operating system from the core to the edge of the network. The following products were released in fiscal 2007: release 12.0of ExtremeXOS™, our award-winning modular network operating system, the Summit X250 ExtremeXOS™-based fixed switches, and Summit WM 200 andWM 2000 wireless network controllers. Convergence of Voice, Video and Data We have a vision of providing customers with the systems to build a converged communications infrastructure that can easily accommodate voice,video and data on a seamless wired and wireless network. We believe that these two aspects of convergence, the convergence of voice, video and data, andthe convergence of wired and wireless, are important underlying demand creators in the Enterprise market. We have a comprehensive strategic alliance with Avaya, Inc. to jointly develop and market converged communications solutions. The alliance bringstogether Avaya’s global market leadership in IP voice and 44Table of Contentstelephony with Extreme’s expertise in high performance IP data network infrastructure. Under a joint development agreement, the companies develop nextgeneration, standards-based technologies in the areas of network management and provisioning, Quality of Service, security, and network resilience.Additionally, Avaya sells services and supports Extreme’s entire portfolio of data networking products through their worldwide sales organization and theAvaya Global Services organization. Business Environment The market for network infrastructure equipment is highly competitive and dominated by a few large companies. The layer 2 and layer 3 ethernetswitch market growth rates have been in the high single digit to low double digit range over the most recent three years. In fiscal 2006 and fiscal 2007,however, we experienced a significant decline in demand in the service provider segment in Japan and lower revenue in the enterprise segment in the U.S. Results of Operations Our operations and financial performance have been affected by the economic factors described above, and during fiscal 2007, we achieved thefollowing results: • Net revenues of $342.8 million, a decrease of 4.4% over fiscal 2006 net revenues of $358.6 million. • Service revenue of $62.3 million, a decrease of 2.3% from fiscal 2006 service revenue of $63.8 million. • Although net revenues decreased in fiscal 2007 from fiscal 2006, total gross margin remained fairly consistent in fiscal 2007 at 54.0% of netrevenues (including share-based compensation expense of $1.1 million), compared to 54.1% in fiscal 2006. • Net loss of $14.2 million (including share-based compensation expense of $6.2 million), a decrease from net income of $8.5 million in fiscal 2006. • Cash flow used in operating activities was $0.3 million in fiscal 2007, compared with $28.0 million of cash generated in operating activities infiscal 2006, a decrease of $28.3 million. Cash and cash equivalents, short-term investments and marketable securities were $215.9 million as ofJuly 1, 2007. In December 2006, we retired $200 million of convertible subordinated notes on their maturity date. Net Revenues The following table presents net product and service revenues for the fiscal years 2007, 2006 and 2005 (dollars in thousands): Year Ended July 1,2007 % of NetRevenues July 2,2006 % of NetRevenues July 3,2005 % of NetRevenues Net revenues: Product $280,497 81.8% $294,824 82.2% $324,256 84.6%Service 62,337 18.2% 63,777 17.8% 59,091 15.4%Total net revenues $342,834 100.0% $358,601 100.0% $383,347 100.0% Net revenues were $342.8 million in fiscal 2007, $358.6 million in fiscal 2006 and $383.3 million in fiscal 2005, representing a decrease of 4.4% infiscal 2007 from fiscal 2006 and a decrease of 6.5% in fiscal 2006 from fiscal 2005. Fiscal 2007 and 2006 had 52 weeks, compared with 53 weeks in fiscal2005, and we believe that the additional week in fiscal 2005 may have a negative impact on the comparison of our sales from fiscal 2005 to fiscal 2006.However, we are not able to quantify the effect of the additional week of sales on our revenue in fiscal 2005. 45Table of ContentsProduct revenue was $280.5 million in fiscal 2007, $294.8 million in fiscal 2006 and $324.3 million in fiscal 2005, representing a decrease of 4.9% infiscal 2007 from fiscal 2006, and a decrease of 9.1% in fiscal 2006 from fiscal 2005. The decrease in product revenue in fiscal 2007 from fiscal 2006 wasprincipally due to lower sales volume and an increase in discounts. The decrease in product revenue in fiscal 2006 from fiscal 2005 was primarily due to adecline in volume and to a lesser extent, higher discounts caused by a slight shift in geographic mix of sales. We expect that average selling prices across theindustry will continue to be subject to competitive pressure and may decline somewhat going forward. Service revenue was $62.3 million in fiscal 2007, or a 2.3% decrease over fiscal 2006 service revenue of $63.8 million. Service revenue was $63.8million in fiscal 2006, or a 7.9% increase over fiscal 2005 service revenues of $59.1 million. The decrease in service revenue in fiscal 2007 from fiscal 2006was due to a decrease in maintenance contract revenue as a result of lower product revenue. The increase in service revenue in fiscal 2006 from fiscal 2005was the result of our efforts to focus on increasing the number of service contracts initially sold with new products and increasing contract renewal rates. As apercentage of total net revenues, service revenue was 18.2% in fiscal 2007, 17.8% in fiscal 2006 and 15.4% in fiscal 2005. The following table presents the total net revenues geographically for the fiscal years 2007, 2006 and 2005 (dollars in thousands): Year Ended July 1,2007 % of NetRevenues July 2,2006 % of NetRevenues July 3,2005 % of NetRevenues Net revenues: United States $137,364 40.1% $145,870 40.7% $167,027 43.6%Europe, Middle East and Africa 136,577 39.8% 124,768 34.8% 117,521 30.6%Japan 17,844 5.2% 35,812 10.0% 58,100 15.2%Other 51,049 14.9% 52,151 14.5% 40,699 10.6%Total net revenues $342,834 100.0% $358,601 100.0% $383,347 100.0% Revenues outside of the United States accounted for 59.9%, 59.3% and 56.4% of net revenues in fiscal 2007, fiscal 2006, and fiscal 2005, respectively.In fiscal 2007, U.S. revenues were $137.4 million, a decrease of $8.5 million, or 5.8% over the fiscal 2006 results. The decline in revenue in the U.S. isprimarily a result of lower sales volume. Revenues outside the U.S., as a percentage of total net revenues, in fiscal 2007 decreased by 0.6% compared to fiscal2006 due to a decrease of 4.8% and 0.4% in net revenues in Japan and other international regions, respectively, offset in part by an increase in net revenues inEurope, the Middle East and Africa of 5.0%. The decline in net revenue in Japan was a result of lower demand for networking products within the serviceprovider customer segment. Revenue in Europe, the Middle East, and Africa increased by $11.8 million, or 9.5%, in fiscal 2007 as compared to fiscal 2006.Revenue in other international regions, primarily Asia Pacific, decreased by $1.1 million in fiscal 2007 as compared to fiscal 2006 due to weak demand fromenterprise customers in that region. In fiscal 2006, U.S. revenues were $145.9 million, a decrease of $21.2 million, or 12.7% over the fiscal 2005 results. The decline in revenue in the U.S.is primarily a result of lower sales volume, in part attributed to a smaller sales force. Revenues outside the U.S., as a percentage of total net revenues, in fiscal2006 increased by 2.9% compared to fiscal 2005 due to an increase of 4.2% and 3.9% in net revenues in Europe, the Middle East and Africa and otherinternational regions, respectively, offset in part by a decrease in net revenues in Japan of 5.2%. The decline in net revenue in Japan was a result of lowerdemand for networking products within the service provider customer segment. Revenue in Europe, the Middle East, and Africa increased by $7.2 million, or6.2%, in fiscal 2006 as compared to fiscal 2005. Revenue in other international regions, primarily Asia Pacific, increased by $11.5 million in fiscal 2006 ascompared to fiscal 2005 due to strong demand from enterprise customers in that region. 46Table of ContentsWe rely upon multiple channels of distribution, including two-tiered distribution in which large distributors purchase our product and make itavailable to resellers. Revenue through our distributor channel was 49% of total product revenue in fiscal 2007 and 40% in fiscal 2006. The level of sales toany one customer, including a distributor, may vary from period to period; however, we expect that significant customer concentration will continue for theforeseeable future. One distributor, Tech Data, accounted for just over 10% of our net revenues in fiscal 2007, 2006 and 2005. Cost of Revenues and Gross Margin The following table presents the gross margin on product and service revenues and the gross margin percentage of net revenues for the fiscal years2007, 2006 and 2005 (dollars in thousands): Year Ended July 1,2007 % of NetRevenues July 2,2006 % of NetRevenues July 3,2005 % of NetRevenues Gross margin: Product $156,199 55.7% $164,267 55.7% $177,747 54.8%Service 28,996 46.5% 29,609 46.4% 24,832 42.0%Total gross margin $185,195 54.0% $193,876 54.1% $202,579 52.8% Gross margin was $185.2 million in fiscal 2007, $193.9 million in fiscal 2006 and $202.6 million in fiscal 2005, representing a decrease of 4.5% infiscal 2007 from fiscal 2006 and 4.3% in fiscal 2006 from fiscal 2005. Gross margin as a percentage of net revenues was 54.0%, 54.1% and 52.8% in fiscal2007, fiscal 2006 and fiscal 2005, respectively. Cost of product revenue includes costs of raw materials, amounts paid to third-party contract manufacturers, costs related to warranty obligations,charges for excess and obsolete inventory, royalties under technology license agreements, and internal costs associated with manufacturing overhead,including management, manufacturing engineering, quality assurance, development of test plans, and document control. Product gross margin in fiscal 2007was $156.2 million, representing 55.7% of product revenues as compared to $164.3 million in fiscal 2006, or 55.7% of product revenue. The product grossmargin percentage in fiscal 2007 was influenced negatively by lower sales available to absorb the fixed component of our manufacturing overhead costs andalso higher inventory obsolescence costs of $1.8 million, offset positively by lower warranty expense of $1.4 million on lower volume, a reduction in per-unit product costs due to a shift in product mix, and a reduction in operations overhead costs of $3.2 million. The cost of product revenue in fiscal 2007includes $0.8 million in share-based compensation expense compared with $0.7 million in fiscal 2006. Product gross margin in fiscal 2006 was $164.3 million, representing 55.7% of product revenues as compared to $177.7 million in fiscal 2005, or54.8% of product revenue. The increase in product gross margin percentage in fiscal 2006 was due to a reduction in per-unit product costs, a reduction inoperations overhead and lower warranty expense on lower volume. The cost of product revenue in fiscal 2006 includes $0.7 million in share-basedcompensation expense compared with less than $0.1 million in fiscal 2005, as well as a decrease in expenses of $0.7 million from the transfer of a departmentto research and development to better align costs with current functional activities. Cost of product revenue in all periods includes the cost of our manufacturing overhead. We outsource substantially all of our manufacturing andsupply chain management operations, and we conduct quality assurance, manufacturing engineering and document control at our facility in Santa Clara,California. Accordingly, a significant portion of our cost of product revenue consists of payments to our primary contract manufacturers, FlextronicsInternational, Ltd. located in San Jose, California and Guadalajara, Mexico and Alpha Networks, located in Hsinchu, Taiwan. 47Table of ContentsOur cost of service revenue consists primarily of labor, overhead, repair and freight costs and the cost of spares used in providing support undercustomer service contracts. Service gross margin in fiscal 2007 was $29.0 million, a decrease of $0.6 million from fiscal 2006 gross margin of $29.6 million.Service gross margin was 46.5% in fiscal 2007 as compared to 46.4% in fiscal 2006. Service gross margin in fiscal 2007 was negatively impacted by thedecrease in service revenue, offset by improved cost control reduction. The cost of service revenue in fiscal 2007 includes $0.4 million in share-basedcompensation expense, consistent with $0.4 million in fiscal 2006. Service gross margin in fiscal 2006 was $29.6 million, an increase of $4.8 million from fiscal 2005 gross margin of $24.8 million. Service gross marginwas 46.4% in fiscal 2006 as compared to 42.0% in fiscal 2005. Service gross margin in fiscal 2006 was favorably impacted by the increase in service revenueand reduction in cost of service revenue, due primarily to a reduction in the costs associated with processing repairs and replacements. The cost of servicerevenue in fiscal 2006 includes $0.4 million in share-based compensation expense compared with zero in fiscal 2005. Our product and service gross margins are variable and dependent on many factors, some of which are outside of our control. Some of the primaryfactors affecting gross margin include demand for our products, changes in our pricing policies and those of our competitors, and the mix of products sold.Our gross margin may be adversely affected by increases in material or labor costs, increases in warranty expense or the cost of providing services underextended service contracts, heightened price competition, obsolescence charges and higher inventory balances. In addition, our gross margin may fluctuatedue to the mix of distribution channels through which our products are sold, including the effects of our two-tier distribution model. Sales and Marketing Expenses Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing and sales functions, as well astrade shows and promotional expenses. Sales and marketing expenses were $102.1 million in fiscal 2007, $98.5 million in fiscal 2006 and $97.0 million infiscal 2005, representing an increase of 3.7% in fiscal 2007 from fiscal 2006, and an increase of 1.5% in fiscal 2006 from fiscal 2005. The increase in fiscal2007 was primarily due to an increase in salaries, benefits and commission expenses of $3.8 million due to a higher average headcount and employeeretention program expenses and an increase in contract labor of $0.9 million, offset by decreases in professional fees of $0.5 million and share-basedcompensation expense of $0.6 million. The increase in fiscal 2006 was primarily due to share-based compensation expense of $2.6 million, increasedinformation technology costs of $1.0 million, increased outsourcing of the service contract renewal process expenses of $0.6 million, increased expenses of$1.0 million from the inclusion of an additional department to better align costs with current functional activities, which in fiscal 2005 were included underGeneral & Administrative expenses, offset by $3.8 million lower compensation costs due to lower average headcount in our sales force. As a percentage of netrevenues, sales and marketing expenses were 29.8% in fiscal 2007, 27.5% in fiscal 2006 and 25.3% in fiscal 2005. The level of our sales and marketingspending in the future, in dollars and as a percentage of net revenues will depend on many factors, including the rate at which we expand our sales force andthe rate at which our net revenues change. Research and Development Expenses Research and development expenses consist principally of salaries and related personnel expenses, consultant fees and prototype expenses related tothe design, development, and testing of our products. Research and development expenses were $67.1 million in fiscal 2007, $62.0 million in fiscal 2006 and$61.5 million in fiscal 2005. The increase in fiscal 2007 was primarily due to $5.5 million increase in employee related expenses as a result of increasedheadcount, offset by a decrease of $1.0 million in the Avaya warrant amortization cost. The increase in fiscal 2006 was primarily due to share-basedcompensation expense of $1.6 million and increased engineering project expenses of $2.6 million, offset by $2.0 million lower warrant amortization expenseand $1.7 million related to all other research and development expenses. Research and development expenses include $3.0 48Table of Contentsmillion, $4.0 million and $6.0 million in fiscal 2007, 2006 and 2005, respectively, in amortization expense related to the fair value of the warrant issued toAvaya as part of the Joint Development Agreement. The fair value of the warrant allocated to the Joint Development Agreement with Avaya is $17.9 millionand is being amortized over the term of the agreement (see Note 13 of Notes to Consolidated Financial Statements). The decrease in the warrant amortizationin fiscal 2007 compared to fiscal 2006 and 2005 is due to an extension of the development agreement with Avaya signed in fiscal 2006. As a percentage oftotal net revenues, research and development expenses were 19.6% in fiscal 2007, 17.3% in fiscal 2006 and 16.1% in fiscal 2005. We expense all researchand development expenses as incurred. We believe that continued investment in research and development is critical to attaining our strategic objectives andas a result, we expect research and development expenses to increase in absolute dollars. General and Administrative Expenses General and administrative expenses consist primarily of salaries and related expenses for executive, finance and administrative personnel, legal fees,professional fees and other general corporate expenses. General and administrative expenses were $33.6 million in fiscal 2007, $25.5 million in fiscal 2006and $31.7 million in fiscal 2005, representing an increase of 31.9% in fiscal 2007 from fiscal 2006, and a decrease of 19.6% in fiscal 2006 from fiscal 2005.The increase in fiscal 2007 was primarily due to $6.9 million related to the costs of the special investigation into our historical stock option grantingpractices, $2.3 million in legal fees related to defending claims related to our intellectual property and a shareholder derivative lawsuit related to ourhistorical stock option granting practices, offset by a decrease of $1.2 million in bad debt expense recognized in 2006. The decrease in fiscal 2006 from fiscal2005 of $6.2 million was primarily due to a $5.9 million decrease in legal expenses as fiscal 2005 included litigation to defend our intellectual propertyrights. As a percentage of net revenues, general and administrative expenses were 9.8% in fiscal 2007, 7.1% in fiscal 2006 and 8.3% in fiscal 2005. Futuregeneral and administrative expense levels will depend significantly on the level of legal expenses related to intellectual property litigation and shareholderderivative lawsuit. Technology Agreement On March 31, 2005, we entered into a Patent and Cross License Agreement (“Technology Agreement”) with IBM. The agreement provides for a releaseof prior claims and a cross license of patents extending into the future from the effective date of the agreement. We charged the estimated value of the releaseof prior claims of $2.0 million to operating expenses in the year ended July 3, 2005 under the caption “Technology agreement”. The remaining costs payableunder the Technology Agreement will be charged to cost of product revenue over the license term. We expect these costs to have a small impact on the totalproduct cost of revenue. Amortization of Deferred Stock Compensation Amortization of deferred stock compensation in accordance with APB 25 was zero in fiscal 2007 and fiscal 2006 and $0.1 million in fiscal 2005,representing no change in fiscal 2007 from fiscal 2006, and a decrease of $0.1 million in fiscal 2006 from fiscal 2005. Amortization of deferred stockcompensation is attributable to unvested stock options subject to forfeiture issued to employees that we assumed in conjunction with acquisitions duringfiscal 2001. Deferred stock compensation was amortized as charges to operations, using the graded method, over the vesting periods of the individual stockoptions, generally four years. Upon termination of an employee, the amount of expense recognized under the graded vesting method that is in excess of theamount actually earned is reversed. For fiscal 2007, fiscal 2006 and fiscal 2005 there was no reversal of excess compensation expense related to terminatedemployees. The deferred stock compensation was fully amortized at the end of fiscal 2005. Restructuring Charge During fiscal 2007 and 2006, we recorded restructuring charges of $4.0 million, and $3.3 million, respectively. The charges in fiscal 2007 included$1.1 million in the first through third quarters to rationalize our 49Table of Contentssales force in Japan, and $2.9 million in the fourth quarter to reduce headcount across several functional areas, terminate certain redundant contracts, and toexit an excess facility. We expect to reduce annual operating costs by $3.0 million to $4.0 million in fiscal 2008 as a result of the June 2007 restructuringcharge. The charge in fiscal 2006 was for an excess facilities charge and represented an increase to the charge initially recognized during the third quarter offiscal 2002. The commercial real estate market continued to deteriorate in fiscal 2006 and we were not able to find suitable tenants to sublease these facilitiesnecessitating an additional charge due to lower projected sublease receipts. Interest Income Interest income was $13.6 million in fiscal 2007, $15.1 million in fiscal 2006 and $10.7 million in fiscal 2005, representing a decrease of $1.5 millionin fiscal 2007 from fiscal 2006, and an increase of $4.4 million in fiscal 2006 from fiscal 2005. The decrease in interest income in fiscal 2007 from fiscal 2006was due primarily to a decrease in funds available for investment as a result of our retiring $200 million in convertible subordinated notes. The increase ininterest income in fiscal 2006 from fiscal 2005 was due primarily to an increase in average interest rates. Interest Expense Interest expense was $3.1 million, $7.3 million and $7.0 million in fiscal 2007, fiscal 2006 and fiscal 2005, respectively. Interest expense in each of thefiscal years presented is primarily attributable to the $200 million of convertible subordinated notes. The notes matured and were fully paid in December2006. Interest on the notes was payable semi-annually at 3.5% per annum. Other Income (Expense), net Other income (expense) net, was expense of $0.9 million in fiscal 2007, expense of $2.3 million in fiscal 2006 and income of $2.1 million in fiscal2005. Other expense in fiscal 2007 was primarily comprised of amortization of costs associated with the $200 million convertible subordinated notes of $0.7million and foreign currency losses of $0.2 million. Other expense in fiscal 2006 was primarily comprised of amortization of costs associated with the $200 million convertible subordinated notes of $1.4million and foreign currency losses of $0.9 million. Other income in fiscal 2005 includes income of $3.9 million from the relief of a foreign consumption tax obligation, expense of $1.3 million foramortization of the costs associated with the convertible subordinated notes, and $0.7 million of foreign exchange losses due primarily to the decline in theU.S. dollar relative to the Yen and the Euro. The tax holiday that generated the foreign consumption tax relief expired in fiscal 2005, and no further benefitsare expected. Provision (Benefit) for Income Taxes The provisions for income taxes of $2.1 million for fiscal 2007 were recorded for taxes due on income generated in certain states and foreign taxjurisdictions. The effective tax rate in fiscal 2007 was negative 17.7% which differs from the statutory tax rate of 35% due primarily to the tax impact ofincome from foreign operations. As of July 1, 2007, we had net operating loss carryforwards for federal and state tax purposes of $268.5 million and $45.6million, respectively, of which $53.1 million and $21.3 million, respectively, represent deductions from share-based compensation for which a benefit wouldbe recorded in additional paid-in capital when realized. We also had federal and state tax credit carryforwards of $10.8 million and $14.8 million,respectively, as of July 1, 2007. Federal net operating loss carryforwards of $268.5 million will start to expire beginning 2021 through 2027 and state netoperating losses of $45.6 million will expire between 2011 through 2017, if not utilized. Federal tax credits of $10.4 million will expire beginning 2012through 2027 and state tax 50Table of Contentscredits of $1.4 million will expire beginning 2008 through 2013, if not utilized. Under FAS 123R, the deferred tax asset for net operating losses excludesdeductions for excess tax benefits related to share-based compensation. The provisions for income taxes of $1.8 million and $3.5 million for fiscal 2006 and fiscal 2005, respectively, were recorded for taxes due on incomegenerated in certain states and foreign tax jurisdictions. The effective tax rate was 17.4% and 22.1% for fiscal 2006 and 2005, respectively, which differs fromthe statutory tax rate of 35% due primarily to benefits for U.S. taxes from net operating loss carryforwards and tax credits, offset by the tax impact of incomefrom foreign operations. Critical Accounting Policies and Estimates Our significant accounting policies are more fully described in Note 2 of Notes to Consolidated Financial Statements included in Item 8 of this AnnualReport on Form 10-K. The preparation of consolidated financial statements in accordance with generally accepted accounting principles requiresmanagement to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assetsand liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the period reported. By theirnature, these estimates, assumptions and judgments are subject to an inherent degree of uncertainty. We base our estimates, assumptions and judgments onhistorical experience, market trends and other factors that are believed to be reasonable under the circumstances. Estimates, assumptions and judgments arereviewed on an ongoing basis and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to benecessary. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies have been discussedwith the Audit Committee of the Board of Directors. We believe the critical accounting policies stated below, among others, affect our more significantjudgments and estimates used in the preparation of our consolidated financial statements. We believe there have been no material changes to our criticalaccounting policies during the year ended July 1, 2007 compared to the prior years. Share-based Payments On July 4, 2005, we adopted the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123(R), Share-Based Payment, (“FAS 123R”). Prior to July 4, 2005, we accounted for share-based payments under the recognition and measurement provisions of APBOpinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related Interpretations, as permitted by FASB Statement No. 123, Accounting forShare-based Compensation (“FAS 123”). In accordance with APB 25 no compensation cost was required to be recognized for options granted that had anexercise price equal to the market value of the underlying common stock on the date of grant. We adopted FAS 123R using the modified-prospective-transition method. Under that transition method, compensation cost recognized in the yearended July 2, 2006 includes: a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 4, 2005, based on the grant-datefair value estimated in accordance with the original provisions of FAS 123, and b) compensation cost for all share-based payments granted subsequent toJuly 4, 2005, based on the grant-date fair value estimated in accordance with the provisions of FAS 123R. The results for the prior periods have not beenrestated. 51Table of ContentsShare-based compensation recognized in the financial statements by line item caption is as follows (dollars in thousands): Year Ended July 1, 2007 July 2, 2006 July 3, 2005 Cost of product revenue $771 $718 $65 Cost of service revenue 359 417 40 Sales and marketing 2,173 2,764 195 Research and development 1,834 1,993 438 General and administrative 1,046 1,103 (45)Amortization of deferred stock compensation — — 69 Total share-based compensation expense 6,183 6,995 762 Share-based compensation cost capitalized in inventory (1) 25 — Total share-based compensation cost $6,182 $7,020 $762 In accordance with FAS 123R, the fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option valuationmodel with the weighted average assumptions noted in the table in Note 7 of Notes to Consolidated Financial Statements. The expected term of optionsgranted is derived from historical data on employee exercise and post-vesting employment termination behavior. The risk-free rate for periods within thecontractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on both the impliedvolatilities from traded options on our stock and historical volatility on our stock. For options granted prior to July 4, 2005, and valued (on a pro forma basis) in accordance with FAS 123, the expected volatility used to estimate thefair value of the options was based solely on the historical volatility on our stock; we used the graded vesting method for expense attribution, and werecognized option forfeitures as they occurred as allowed by FAS 123. For options granted after July 4, 2005, and valued in accordance with FAS 123R, the expected volatility used to estimate the fair value of the optionswas based on a combination of the historical volatility on our stock and the implied volatility; we used the straight-line method for expense attribution andwe estimate forfeitures and only recognize expense for those shares expected to vest. Our estimated forfeiture rate in fiscal 2007, based on our historicalforfeiture experience, is approximately 9%. We modified our estimated forfeiture rate in the fourth quarter of fiscal 2007 and recognized the cumulative effectof the change, as an increase in compensation expense, in that quarter of approximately $0.1 million. The Black-Scholes-Merton option valuation model requires the input of highly subjective assumptions, including the expected life of the share-basedaward and stock price volatility. The assumptions used in calculating the fair value of share-based compensation represent management’s best estimates, butthese estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used, our share-basedcompensation expense could have been materially different. In addition, we are required to estimate the expected forfeiture rate and only recognize expensefor those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could bematerially different. In the fourth quarter of fiscal 2005, the compensation committee of the Board of Directors approved the acceleration of vesting of certain unvestedstock options with exercise prices equal to or greater than $7.00 per share previously awarded to employees, including executive officers, and directors.Options to purchase approximately 4,544,000 shares of common stock were subject to acceleration. In accordance with APB 25, no compensation expensewas required to be recorded in our consolidated statement of operations in fiscal 2005 in 52Table of Contentsconnection with the acceleration of the vesting of these options, as the exercise price of the employee stock options was higher than the market price of ourstock on the date of the modification of the options. We believe that such options had limited economic value and were not offering sufficient incentive tothe employees when compared to the potential future expense of approximately $11.4 million that would have been required to be recorded in future periodsunder FAS 123R had the options not been accelerated. Revenue Recognition We derive the majority of our revenue from sales of our modular and stackable networking equipment, with the remaining revenue generated fromservice fees relating to the service contracts and training on our products. We generally recognize product revenue from our value-added resellers and end-user customers at the time of shipment, provided that persuasive evidence of an arrangement exists, delivery has occurred, the price of the product is fixed ordeterminable and collection of the sales proceeds is reasonably assured. In instances where the criteria for revenue recognition are not met, revenue is deferreduntil all criteria have been met. Our total deferred product revenue was $0.6 million and $2.5 million as of July 1, 2007 and July 2, 2006, respectively.Revenue from service obligations under service contracts is deferred and recognized on a straight-line basis over the contractual service period. Our totaldeferred revenue for services, primarily from service contracts, was $40.8 million and $41.7 million as of July 1, 2007 and July 2, 2006, respectively. Servicecontracts typically range from one to five years. When sales arrangements contain multiple deliverables, such as hardware, service contracts and other services, we determine whether the deliverablesrepresent separate units of accounting and then allocate revenue to each unit of accounting based on their relative fair values. We recognize revenue for eachunit of accounting when the revenue recognition criteria for each unit of accounting are met. The amount of product revenue recognized is impacted by ourjudgments as to whether an arrangement includes multiple units of accounting and if so, whether fair value exists for those units of accounting. The ability toestablish fair value for any unit of accounting could affect the timing of the revenue recognition. We make certain sales to partners in two distribution channels, or tiers. The first tier consists of a limited number of independent distributors that sellprimarily to resellers and, on occasion, to end-user customers. We defer recognition of revenue on all sales to these distributors until the distributors sell theproduct, as evidenced by monthly “sales-out” reports that the distributors provide to us. We grant these distributors the right to return a portion of unsoldinventory to us for the purpose of stock rotation. We also grant these distributors certain price protection rights. The distributor-related deferred revenue andreceivables are adjusted at the time of the stock rotation return or price reduction. We also provide distributors with credits for changes in selling prices, andallow them to participate in cooperative marketing programs. We maintain estimated accruals and allowances for these exposures based upon our historicalexperience. If actual credits to distributors for changes in selling prices and cooperative marketing programs were to deviate significantly from our estimates,which are based on contractual arrangements and historical experience, our future revenue could be adversely affected. The second tier of the distribution channel consists of a large number of third-party value-added resellers that sell directly to end-users and aregenerally not granted return privileges, except for defective products during the warranty period. We reduce product revenue for certain price protectionrights that may occur under contractual arrangements we have with our resellers. We provide an allowance for sales returns based on our historical returns, analysis of credit memo data and our return policies. The allowance for salesreturns was $2.1 million and $1.7 million as of July 1, 2007 and July 2, 2006, respectively, for estimated future returns that were recorded as a reduction ofour accounts receivable. The provision for returns is charged to net revenues in the accompanying consolidated statements of operations, and was $3.2million in fiscal 2007, $0.7 million in fiscal 2006 and $1.0 million in fiscal 2005. If the historical data we use to calculate the estimated sales returns andallowances does not properly reflect future levels of product returns, these estimates will be revised, thus resulting in an impact on future net revenues. Weestimate and adjust this allowance at each balance sheet date. 53Table of ContentsInventory Valuation Our inventory balance was $25.3 million as of July 1, 2007, compared with $19.3 million as of July 2, 2006. We value our inventory at lower of cost(determined on a first-in, first-out basis) or replacement cost. The networking industry is characterized by rapid technological change, frequent new productintroductions, changes in customer requirements and evolving industry standards. We perform a detailed assessment of inventory at each balance sheet date,which includes a review of, among other factors, demand requirements, product lifecycle and product development plans and quality issues. Based on thisanalysis, we record adjustments, when appropriate, to reflect inventory at net realizable value. Inventory write-downs charged to cost of product revenue were$3.0 million in fiscal 2007, $1.3 million in fiscal 2006 and $1.1 million in fiscal 2005. Although we make every effort to ensure the accuracy of our forecastsof product demand, any significant unanticipated changes in demand or technological developments would significantly impact the value of our inventoryand our reported operating results. In the future, if we find that our estimates are too optimistic and we determine that our inventory needs to be written down,we will be required to recognize such costs in our cost of product revenue at the time of such determination. Conversely, if we find our estimates are toopessimistic and we subsequently sell product that has previously been written down, our operating margin in that period will be favorably impacted. Accrued Warranty Networking products may contain undetected hardware or software errors when new products or new versions or updates of existing products arereleased to the marketplace. We have experienced such errors in connection with products and product updates. Our standard hardware warranty period istypically 12 months from the date of shipment to end-users and 90 days for software. Upon shipment of products to our customers, including both end-usersand channel partners, we estimate expenses for the cost to repair or replace products that may be returned under warranty and accrue a liability throughcharges to cost of product revenue for this amount. Our accrued warranty balance was $7.2 million as of July 1, 2007, compared with $7.0 million as of July 2, 2006. The determination of our warrantyrequirements is based on our actual historical experience with the product or product family, estimates of repair and replacement costs and any productwarranty problems that are identified after shipment. We estimate and adjust this accrual at each balance sheet date in accordance with changes in thesefactors. The cost of new warranties issued that was charged to cost of product revenue was $8.8 million in fiscal 2007, $10.2 million in fiscal 2006 and $12.3million in fiscal 2005. While we believe that our warranty accrual is adequate and that the judgments applied in calculating this accrual are appropriate, theassumptions used are based on estimates and these estimated amounts could differ materially from our actual warranty expenses in the future. In fiscal 2005,we recognized $1.1 million in additional warranty expense due to a change in the method we use to accumulate the warranty return rates. If actual expensesexceed those we have estimated, our future cost of product revenue would be adversely affected. Accounts Receivable and Allowance for Doubtful Accounts Our accounts receivable balance, net of allowance for doubtful accounts, was $23.1 million and $27.7 million as of July 1, 2007 and July 2, 2006,respectively. The allowance for doubtful accounts for trade accounts receivable as of July 1, 2007 was $0.7 million, compared with $0.7 million as of July 2,2006. The distributor accounts receivable balance, net of allowance for doubtful accounts, recorded in prepaid expenses and other current assets, was $23.3million and $17.2 million as of July 1, 2007 and July 2, 2006, respectively. The allowance for doubtful distributor accounts, also recorded in prepaidexpenses and other current assets, as of July 1, 2007 was $0.2 million, compared with $0.3 million as of July 2, 2006. We continually monitor and evaluatethe collectibility of our trade receivables based on a combination of factors. We record specific allowances for bad debts in general and administrativeexpense when we become aware of a specific customer’s inability to meet its financial obligation to us, such as in the case of bankruptcy filings ordeterioration of financial position. Estimates are used in determining our allowances for all other customers based on factors such 54Table of Contentsas current trends in the length of time the receivables are past due and historical collection experience. We mitigate some collection risk by requiring most ofour customers in the Asia-Pacific region, excluding Japan and Australia, to pay cash in advance or secure letters of credit when placing an order with us. Ourprovision for doubtful accounts was an expense of $0.1 million in fiscal 2007, expense of $1.2 million in fiscal 2006 and an expense of $0.4 million in fiscal2005. If a major customer’s creditworthiness deteriorates, or if actual defaults are higher than our historical experience, or if other circumstances arise, ourestimates of the recoverability of amounts due to us could be overstated, and additional allowances could be required. We write-off receivables to theallowance after all collection efforts are exhausted. In the fourth quarter of fiscal 2005, one large distributor in Europe became delinquent in its payments tous due to cash flow problems and difficulty in obtaining financing. We increased our allowance for doubtful accounts to cover a higher percentage of thiscustomer’s outstanding balance in fiscal 2005 and ultimately wrote off $1.8 million in receivables in fiscal 2006. Deferred Tax Asset Valuation Allowance We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assetsand liabilities. Significant management judgment is required in determining our valuation allowance recorded against our net deferred tax assets. We makean assessment of the likelihood that our net deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not believed tobe likely, a valuation allowance is established. We provided a full valuation allowance against all of our U.S. federal and state net deferred tax assets in fiscal2003 in the amount of $194.8 million in accordance with the provisions of SFAS No. 109, Accounting for Income Taxes. In fiscal 2007, the valuationallowance increased by $8.0 million to $166.6 million, and in fiscal 2006, the valuation allowance decreased by $17.2 million to $158.6 million. The valuation allowance is determined in accordance with the provisions of SFAS 109, which requires an assessment of both negative and positiveevidence when measuring the need for a valuation allowance. In accordance with SFAS 109, evidence, such as operating results during the most recent three-year period at the time the charge was incurred, was given more weight than our expectations of future profitability, which is inherently uncertain. Our lossesduring those periods represented sufficient negative evidence to require a full valuation allowance against our net deferred tax assets under SFAS 109. Thisvaluation allowance will be evaluated periodically and can be reversed partially or totally if business results have sufficiently improved to supportrealization of our deferred tax assets. Legal Contingencies We are currently involved in various claims and legal proceedings, including negotiations regarding potential licenses from third parties who havenotified us that they believe our products may infringe certain patents. Periodically, we review the status of each significant matter, whether litigation orlicensing negotiation, and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and theamount can be estimated, we accrue a liability for the estimated loss. Because of uncertainties related to these matters, accruals, if any, are based only on themost current and dependable information available at any given time. As additional information becomes available, we may reassess the potential liabilityfrom pending claims and litigation and the probability of claims being successfully asserted against us. As a result, we may revise our estimates related tothese pending claims and litigation. Such revisions in the estimates of the potential liabilities could have a material impact on our consolidated results ofoperations, financial position and cash flows in the future. For further detail, see Note 4 of Notes to Consolidated Financial Statements for a description oflegal proceedings. Liquidity and Capital Resources Cash and cash equivalents, short-term investments and marketable securities were $215.9 million and $433.1 million at July 1, 2007 and July 2, 2006,respectively, representing a decrease of $217.2 million. This 55Table of Contentsdecrease was primarily due to cash used to repay the principal payment of convertible subordinated notes of $200.0 million, repurchase treasury stock of$14.6 million and capital expenditures of $4.6 million, and cash used in operating activities of $0.3 million, partially offset by proceeds from issuance ofcommon stock of $0.5 million and a decrease in the unrealized loss on investments of $1.7 million. Cash used in operating activities was $0.3 million in fiscal 2007, a decline of $28.3 million compared to cash from operations of $28.0 million in fiscal2006. The decline in cash from operating activities was primarily due to net loss in fiscal 2007 of $14.2 million, which included significant non-cash charges,including depreciation and amortization of $7.9 million, share-based compensation expense of $6.2 million, and amortization expense related to the warrantissued to Avaya of $4.0 million. Accounts receivable, net, decreased to $23.1 million at July 1, 2007 from $27.7 million at July 2, 2006. Days salesoutstanding in receivables decreased to 24 days at July 1, 2007 from 30 days at July 2, 2006. The decrease in accounts receivable and decrease in days salesoutstanding were primarily due to improved collection efforts. Inventories increased to $25.3 million at July 1, 2007 from $19.3 million at July 2, 2006.Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times and avoidstock-outs with the risk of inventory excess or obsolescence because of declining demand, rapidly changing technology, environmental regulations andcustomer requirements. Deferred revenue decreased to $42.4 million at July 1, 2007 from $45.1 million at July 2, 2006. This decrease was due primarily tolower service contracts booked as a result of lower product sales. We have a revolving line of credit for $10.0 million with a major lending institution. As of July 1, 2007, there were no outstanding borrowings underthis facility. The line of credit contains a provision for the issuance of letters of credit not to exceed the unused balance of the line. At July 1, 2007, we hadletters of credit totaling $0.7 million. These letters of credit were primarily issued to satisfy requirements of certain of our customers for performance bonds.The line of credit requires us to maintain specified financial covenants related to tangible net worth and liquidity with which we were in compliance as ofJuly 1, 2007. The line of credit was renewed on January 24, 2007 and expires on January 24, 2008. It is our intention to renew this line of credit when itexpires. In December 2001, we completed a private placement of $200.0 million of convertible subordinated notes. The notes matured on December 1, 2006.Interest was payable semi-annually at 3.5% per annum. The notes were paid off on their maturity date of December 1, 2006. On October 20, 2005, our Board of Directors authorized the repurchase of up to $50 million of our common stock. In fiscal 2007, we repurchasedapproximately 3.9 million shares for approximately $14.6 million bringing the cumulative total to 11.1 million repurchased shares for approximately $48.3million. In fiscal 2006, we repurchased approximately 7.1 million shares for approximately $33.7 million. The repurchases were made in compliance with theSecurities and Exchange Commission’s Rule 10b-18, and were subject to market conditions as well as applicable legal and other considerations. In October2006, the Board of Directors terminated the share repurchase program. We own our corporate headquarters in Santa Clara, California. The campus is located on approximately 16 acres of property in an area that mayultimately be suitable for residential development. The following summarizes our contractual obligations (including interest payments) at July 1, 2007, and the effect such obligations are expected tohave on our liquidity and cash flow in future periods (in thousands): Total Less Than1 Year 1–3 Years 3–5 Years More Than5 YearsContractual Obligations: Non-cancelable inventory purchase commitments $27,287 $27,287 — — — Non-cancelable operating lease obligations 21,340 7,044 9,969 4,327 — Other non-cancelable purchase commitments 3,900 1,650 1,500 750 — Total contractual cash obligations $52,527 $35,981 $11,469 $5,077 — 56Table of ContentsWe did not have any material commitments for capital expenditures as of July 1, 2007. Other non-cancelable purchase commitments represent OEMand technology agreements. We did not have any off-balance sheet arrangements as of July 1, 2007. We require substantial capital to fund our business, particularly to finance inventories and accounts receivable and for capital expenditures. As a result,we could be required to raise substantial additional capital at any time. To the extent that we raise additional capital through the sale of equity or convertibledebt securities, the issuance of such securities could result in dilution to existing stockholders. If additional funds are raised through the issuance of debtsecurities, these securities may have rights, preferences and privileges senior to holders of common stock and the terms of such debt could impose restrictionson our operations. If we are unable to obtain such additional capital, we may be required to reduce the scope of our planned product development andmarketing efforts, which would have a material adverse affect on our business, financial condition and operating results. We believe that our current cash and cash equivalents, short-term investments, marketable securities and cash available from credit facilities and futureoperations will enable us to meet our working capital requirements for at least the next 12 months. New Accounting Pronouncements Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretative guidance on the process of quantifying financialstatement misstatements and is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on ourconsolidated financial statements. Accounting for Consideration Given by a Service Provider to a Manufacturer or Reseller of Equipment Necessary for an End-Customer to Receive Servicefrom the Service Provider In September 2006, the FASB issued Emerging Issues Task Force Issue, or EITF, No. 06-1, Accounting for Consideration Given by a Service Providerto a Manufacturer or Reseller of Equipment Necessary for an End-Customer to Receive Service from the Service Provider. EITF No. 06-1 requires companiesto provide disclosures regarding the nature of arrangements in which they provide consideration to manufacturers or resellers of equipment necessary for anend-customer to receive service from them, including the amounts recognized in the Consolidated Statements of Operations. EITF 06-1 is effective for fiscalyears beginning after June 15, 2007. We do not expect the adoption of EITF No. 06-1 to have a material impact on our consolidated financial statements. Fair Value Measurements In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. SFAS 157 replaces thedifferent definitions of fair value in the accounting literature with a single definition. It defines fair value as the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS 157 is effective for fair-value measurementsalready required or permitted by other standards for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods withinthose fiscal years. We are currently in the process of determining the impact of adopting the provisions of SFAS 157 on our financial position, results ofoperations and cash flows. 57Table of ContentsFair Value Option for Financial Assets and Liabilities In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendmentof FASB Statement No. 115 (FAS 159). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value thatare not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons betweencompanies that choose different measurement attributes for similar types of assets and liabilities. The provisions of FAS 159 become effective for fiscal yearsbeginning after November 15, 2007. We believe that the adoption of SFAS 159 will not have a material effect on our financial statements. Accounting for Income Taxes In July 2006, the Financial Accounting Standards Board (FASB) released its final Interpretation on uncertain tax positions, FIN 48, Accounting forUncertainty in Income Taxes—an interpretation of FAS 109. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes a recognitionthreshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.The guidance will become effective as of the beginning of a company’s fiscal year beginning after December 15, 2006. The Company is currently assessingthe impact of adopting this standard. 58Table of Contents Item 7A. Quantitative and Qualitative Disclosures About Market Risk Interest Rate Sensitivity The primary objective of our investment activities is to preserve principal while at the same time maximize the income we receive from our investmentswithout significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailinginterest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at thethen-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. To minimize this risk, wemaintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, other non-government debtsecurities and money market funds. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with theprevailing interest rate. The following table presents the amounts of our cash equivalents, short-term investments, marketable securities and long-term debtthat are subject to market risk by range of expected maturity and weighted-average interest rates as of July 1, 2007 and July 2, 2006. This table does notinclude money market funds because those funds are generally not subject to market risk. Maturing in Fair Value Threemonthsor less Threemonths toone year Greaterthan oneyear Total (In thousands)July 1, 2007: Included in cash and cash equivalents $31,091 $31,091 $31,091Weighted average interest rate 5.29% Included in short-term investments $30,486 $61,113 $91,599 $91,599Weighted average interest rate 5.32% 4.38% Included in marketable securities $52,683 $52,683 $52,683Weighted average interest rate 5.18% Maturing in Threemonthsor less Threemonths toone year Greaterthan oneyear Total Fair Value (In thousands)July 2, 2006: Included in cash and cash equivalents $31,830 $31,830 $31,830Weighted average interest rate 4.76% Included in short-term investments $196,940 $100,786 $297,726 $297,726Weighted average interest rate 4.41% 3.43% Included in marketable securities $42,781 $42,781 $42,781Weighted average interest rate 3.99% Long-term debt $200,000 $200,000 $197,750Weighted average interest rate 3.50% Exchange Rate Sensitivity Currently, substantially all of our sales and the majority of our expenses are denominated in United States dollars and, as a result, we have experiencedno significant foreign exchange gains and losses to date. While we conduct some sales transactions and incur certain operating expenses in foreign currenciesand expect to continue to do so, we do not anticipate that foreign exchange gains or losses will be significant, in part because of our foreign exchange riskmanagement process discussed below. 59Table of ContentsForeign Exchange Forward Contracts We enter into foreign exchange forward contracts to hedge foreign currency forecasted transactions related to certain operating expenses, denominatedin Japanese Yen, the Euro, the Swedish Krona and the British Pound. These derivatives are designated as cash flow hedges under SFAS No. 133, Accountingfor Derivative Instruments and Hedging Activities, as amended and interpreted (“SFAS 133”). At July 1, 2007, these forward foreign currency contracts had anotional principal amount and fair value of $5.5 million. These contracts have maturities of less than 60 days. Additionally, we enter into foreign exchange forward contracts to mitigate the effect of gains and losses generated by the remeasurement of certainassets and liabilities denominated in Japanese Yen, the Euro, the Swedish Krona and the British Pound. These derivatives are not designated as hedges underSFAS 133. At July 1, 2007, we held foreign currency forward contracts with a notional principal amount and fair value of $8.6 million. These contracts havematurities of less than 45 days. Changes in the fair value of these foreign exchange forward contracts are offset largely by remeasurement of the underlyingassets and liabilities. We do not enter into foreign exchange forward contracts for speculative or trading purposes. Foreign currency transaction gains and losses fromoperations, including the impact of hedging, were a loss of $0.2 million in fiscal 2007, a loss of $0.9 million in fiscal 2006 and a loss of $0.6 million in fiscal2005. 60Table of Contents Item 8. Financial Statements and Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF EXTREME NETWORKS, INC. Page(s)Report of Independent Registered Public Accounting Firm 62Consolidated Balance Sheets 63Consolidated Statements of Operations 64Consolidated Statements of Stockholders’ Equity 65Consolidated Statements of Cash Flows 66Notes to Consolidated Financial Statements 67 61Table of ContentsReport of Independent Registered Public Accounting Firm The Board of Directors and StockholdersExtreme Networks, Inc. We have audited the accompanying consolidated balance sheets of Extreme Networks, Inc. as of July 1, 2007 and July 2, 2006 and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended July 1, 2007. Our audits alsoincluded the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ExtremeNetworks, Inc. at July 1, 2007 and July 2, 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period endedJuly 1, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, whenconsidered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 8 to the consolidated financial statements, in fiscal 2006 the Company adopted the fair value recognition provisions of Statementof Financial Accounting Standards No. 123(R), “Share-Based Payment,” using the modified-prospective-transition method. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Extreme Networks, Inc.’sinternal control over financial reporting as of July 1, 2007, based on criteria established in Internal Control – Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our report dated August 28, 2007 expressed an unqualified opinion on internalcontrol over financial reporting. Ernst & Young LLP Palo Alto, CaliforniaAugust 28, 2007 62Table of ContentsEXTREME NETWORKS, INC. CONSOLIDATED BALANCE SHEETS(In thousands, except par value and share amounts) July 1,2007 July 2,2006 ASSETS Current assets: Cash and cash equivalents $71,573 $92,598 Short-term investments 91,599 297,726 Accounts receivable, net of allowances of $2,863 at July 1, 2007($2,387 at July 2, 2006) 23,066 27,681 Inventories, net 25,261 19,303 Deferred income taxes 1,118 500 Prepaid expenses and other current assets, net 13,339 8,920 Total current assets 225,956 446,728 Property and equipment, net 43,156 46,499 Marketable securities 52,683 42,781 Other assets, net 20,102 22,710 Total assets $341,897 $558,718 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $21,303 $20,138 Accrued compensation and benefits 14,841 11,758 Restructuring liabilities 5,532 5,571 Accrued warranty 7,182 7,027 Deferred revenue 32,160 35,406 Convertible subordinated notes — 200,000 Other accrued liabilities 23,263 19,581 Total current liabilities 104,281 299,481 Restructuring liabilities, less current portion 8,456 11,471 Deferred revenue, less current portion 10,286 9,699 Deferred income taxes 688 579 Other long-term liabilities 1,961 1,307 Commitments and contingencies (Note 4) Stockholders’ equity: Convertible preferred stock, $.001 par value, issuable in series, 2,000,000 shares authorized; none issued — — Common stock, $.001 par value, 750,000,000 shares authorized; 125,105,000 issued and outstanding at July 1,2007 (124,469,000 July 2, 2006) and capital in excess of par value 934,540 927,835 Treasury stock, 11,053,877 shares at July 1, 2007 (48,303) (33,700)Accumulated other comprehensive income (loss) 572 (1,567)Accumulated deficit (670,584) (656,387)Total stockholders’ equity 216,225 236,181 Total liabilities and stockholders’ equity $341,897 $558,718 See accompanying notes to consolidated financial statements. 63Table of ContentsEXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share amounts) Year Ended July 1,2007 July 2,2006 July 3,2005 Net revenues: Product $280,497 $294,824 $324,256 Service 62,337 63,777 59,091 Total net revenues 342,834 358,601 383,347 Cost of revenues: Product(1) 124,298 130,557 146,509 Service(1) 33,341 34,168 34,259 Total cost of revenues 157,639 164,725 180,768 Gross margin: Product 156,199 164,267 177,747 Service 28,996 29,609 24,832 Total gross margin 185,195 193,876 202,579 Operating expenses: Sales and marketing(1) 102,052 98,452 96,951 Research and development(1) 67,085 61,966 61,516 General and administrative(1) 33,638 25,498 31,709 Technology agreement — — 2,000 Amortization of deferred stock compensation(1) — — 69 Restructuring charge 4,003 3,268 — Total operating expenses 206,778 189,184 192,245 Operating income (loss) (21,583) 4,692 10,334 Interest income 13,551 15,136 10,713 Interest expense (3,149) (7,252) (7,037)Other income (expense), net (876) (2,269) 2,052 Income before income taxes (12,057) 10,307 16,062 Provision for income taxes 2,140 1,798 3,543 Net Income (loss) $(14,197) $8,509 $12,519 Basicand diluted net loss per share: Net income (loss) per share – basic $(0.12) $0.07 $0.10 Net income (loss) per share – diluted $(0.12) $0.07 $0.10 Sharesused in per share calculation – basic 114,122 121,286 121,225 Sharesused in per share calculation – diluted 114,122 123,049 124,166 (1) Includes stock-based compensation expense as follows: Cost of product revenue $771 $718 $65 Cost of service revenue 359 417 40 Sales and marketing 2,173 2,764 195 Research and development 1,834 1,993 438 General and administrative 1,046 1,103 (45)Amortization of deferred stock compensation — — 69 Total stock-based compensation expense $6,183 $6,995 $762 See accompanying notes to consolidated financial statements. 64Table of ContentsEXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands) Common Stockandcapital in excess ofpar value Treasury Stock DeferredStockCompensation AccumulatedOtherComprehensiveIncome (Loss) AccumulatedDeficit TotalStockholders’Equity Shares Amount Shares Amount Balances at June 27, 2004 120,423 $910,546 — $— $(1,185) $(2,388) $(677,415) $229,558 Components of comprehensive income: Net income — — — — — — 12,519 12,519 Change in unrealized loss on investments, net of tax expense of $156 — — — — — (540) — (540)Change in unrealized gain on derivatives — — — — — 12 — 12 Foreign currency translation adjustment — — — — — 29 — 29 Total comprehensive income 12,020 Exercise of options to purchase common stock, net of repurchases 542 1,799 — — — — — 1,799 Issuance of common stock under employee stock purchase plan 943 4,143 — — — — — 4,143 Stock-based compensation expense — (543) — — 966 — — 423 Amortization of deferred stock compensation — — — — 69 — — 69 Balances at July 3, 2005 121,908 915,945 — — (150) (2,887) (664,896) 248,012 Components of comprehensive income: Net income — — — — — — 8,509 8,509 Change in unrealized gain on investments, net of tax expense of $0 — — — — — 1,313 — 1,313 Change in unrealized gain on derivatives — — — — — (10) — (10)Foreign currency translation adjustment — — — — — 17 — 17 Total comprehensive income 9,829 Exercise of options to purchase common stock, net of repurchases 795 1,566 — — — — — 1,566 Issuance of common stock under employee stock purchase plan 907 3,445 — — — — — 3,445 Exercise of warrant by Avaya 859 9 — — — — — 9 Share-based payments, net of repurchases — 7,020 — — — — — 7,020 Repurchase of common stock — — (7,136) (33,700) — — — (33,700)Amortization of deferred stock compensation — (150) — — 150 — — — Balances at July 2, 2006 124,469 927,835 (7,136) (33,700) — (1,567) (656,387) 236,181 Components of comprehensive income: Net loss — — — — — — (14,197) (14,197)Change in unrealized gain on investments, net of tax expense of $0 — — — — — 1,737 — 1,737 Change in unrealized loss on derivatives — — — — — (2) — (2)Foreign currency translation adjustment — — — — — 404 — 404 Total comprehensive loss (12,058)Exercise of options to purchase common stock, net of repurchases 419 (180) — — — — — (180)Issuance of common stock under employee stock purchase plan 217 702 — — — — — 702 Share-based payments, net of repurchases — 6,183 — — — — — 6,183 Repurchase of common stock — — (3,918) (14,603) — — — (14,603)Balances at July 1, 2007 125,105 $934,540 (11,054) $(48,303) $— $572 $(670,584) $216,225 See accompanying notes to consolidated financial statements. 65Table of ContentsEXTREME NETWORKS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands) Year Ended July 1,2007 July 2,2006 July 3,2005 Cash flows from operating activities: Net income (loss) $(14,197) $8,509 $12,519 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 7,926 11,899 16,244 Provision for doubtful accounts — 1,166 380 Provision for excess and obsolete inventory 3,030 1,259 1,061 Deferred income taxes 64 (249) 451 Amortization of warrant 4,048 4,691 7,566 Restructuring charge 4,003 3,268 — Amortization of deferred stock compensation — — 492 Loss on disposal of assets 54 9 212 Stock-based compensation 6,183 6,995 — Changes in operating assets and liabilities, net Accounts receivable 4,541 3,306 2,271 Inventories (8,990) 5,405 (1,114)Prepaid expenses and other assets (6,358) (2,075) (9,558)Accounts payable 1,165 1,855 (712)Accrued compensation and benefits 3,083 (2,274) (1,795)Restructuring liabilities (7,057) (6,182) (6,607)Lease liability — (471) (1,884)Accrued warranty 155 (444) (825)Deferred revenue (2,659) (5,368) (3,201)Other accrued liabilities 4,084 (2,304) (987)Other long-term liabilities 655 (958) 1,945 Net cash provided by (used in) operating activities (270) 28,037 16,458 Cash flows from investing activities: Capital expenditures (4,637) (7,969) (7,127)Purchases of investments (210,711) (273,986) (297,051)Proceeds from sales and maturities of investments and marketable securities 408,673 247,726 350,084 Net cash provided by (used in) investing activities 193,325 (34,229) 45,906 Cash flows from financing activities: Proceeds from issuance of common stock, net of repurchases 523 5,020 5,942 Repurchase of common stock (14,603) (33,700) — Principal payment on convertible debt (200,000) — — Net cash provided by (used in) financing activities (214,080) (28,680) 5,942 Net increase (decrease) in cash and cash equivalents (21,025) (34,872) 68,306 Cash and cash equivalents at beginning of year 92,598 127,470 59,164 Cash and cash equivalents at end of year $71,573 $92,598 $127,470 Supplemental disclosure of cash flow information: Interest paid $3,500 $7,000 $7,037 Cash paid for income taxes $5,285 $587 $1,819 See accompanying notes to consolidated financial statements. 66Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Description of Business Extreme Networks, Inc. (“Extreme Networks”, the “Company”, “we” or “our”) is a leading provider of network infrastructure equipment and markets itsproducts primarily to business, governmental, health care, service provider, and educational customers with a focus on large corporate enterprises andmetropolitan service providers on a global basis. We conduct our sales and marketing activities on a worldwide basis through a two-tier distribution channelutilizing distributors, resellers and our field sales organization. Extreme Networks was incorporated in California in 1996 and reincorporated in Delaware in1999. 2. Basis of Presentation and Summary of Significant Accounting Policies Fiscal Year Our fiscal year is a 52/53-week fiscal accounting year that closes on the Sunday closest to June 30th every year. Fiscal 2007 and fiscal 2006 were 52-week fiscal years; fiscal 2005 was a 53-week fiscal year. All references herein to “fiscal 2007” or “2007” represent the fiscal year ended July 1, 2007. Principles of Consolidation The consolidated financial statements include the accounts of Extreme Networks and its wholly-owned subsidiaries. All inter-company accounts andtransactions have been eliminated. Investments in which management intends to maintain more than a temporary 20% to 50% interest, or otherwise has theability to exercise significant influence, are accounted for under the equity method. Investments in which management has less than a 20% interest and doesnot have the ability to exercise significant influence are carried at the lower of cost or estimated realizable value. We use the U.S. dollar predominately as our functional currency. The functional currency for certain of our foreign subsidiaries is the local currencybased on the criteria of SFAS No. 52, Foreign Currency Translation. For those subsidiaries that operate in a local currency functional environment, allmonetary assets and liabilities are translated to United States dollars at current rates of exchange; non-monetary assets and liabilities are translated athistorical rates of exchange; and revenues and expenses are translated using average rates. Gains and losses from foreign currency translation are included asa separate component of other comprehensive income (loss). Foreign currency transaction losses from operations, including the impact of hedging, were $0.2million in fiscal 2007, $0.9 million in fiscal 2006 and $0.6 million in fiscal 2005. Accounting Estimates The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates areused for, but are not limited to, the accounting for the allowances for doubtful accounts and sales returns, inventory valuation, depreciation and amortization,impairment of long-lived assets, warranty accruals, restructuring liabilities, measurement of share-based compensation costs and income taxes. Actual resultscould differ materially from these estimates. Revenue Recognition We derive the majority of our revenue from sales of our modular and stackable networking equipment, with the remaining revenue generated fromservice fees relating to the service contracts and training on our products. We generally recognize product revenue from our value-added resellers and end-users at the time of shipment, provided that persuasive evidence of an arrangement exists, delivery has occurred, the price of the product is fixed ordeterminable and collection of the sales proceeds is reasonably assured. Revenue from service obligations under service contracts is deferred and recognizedon a straight-line basis over the contractual service 67Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) period. Service contracts typically range from one to five years. When sales arrangements contain multiple deliverables, such as hardware, service contractsand other services, we determine whether the deliverables represent separate units of accounting and then allocate revenue to each unit of accounting basedon their relative fair values. We recognize revenue for each unit of accounting when the revenue recognition criteria for each unit of accounting are met.Shipping costs are included in cost of product revenues. We make certain sales to partners in two distribution channels, or tiers. The first tier consists of a limited number of independent distributors that sellprimarily to resellers and, on occasion, to end-user customers. We defer recognition of revenue on all sales to these distributors until the distributors sell theproduct, as evidenced by monthly “sales-out” reports that the distributors provide to us. We grant these distributors the right to return a portion of unsoldinventory to us for the purpose of stock rotation. We also grant these distributors certain price protection rights. The distributor-related deferred revenue andreceivables are adjusted at the time of the stock rotation return or price reduction. We also provide distributors with credits for changes in selling prices, andallow them to participate in cooperative marketing programs. Cooperative advertising expenses are recorded as marketing expenses to the extent that anadvertising benefit separate from the revenue transaction can be identified and the cash paid does not exceed the fair value of that advertising benefitreceived. We maintain estimated accruals and allowances for these exposures based upon our historical experience. The second tier of the distributionchannel consists of a large number of third-party resellers that sell directly to end-users and are not granted return privileges, except for defective productsduring the warranty period. We reduce product revenue for certain price protection rights that may occur under contractual arrangements we have with ourresellers. Cash Equivalents, Short-Term Investments and Marketable Securities Highly liquid investment securities with insignificant interest rate risk and with original maturities of three months or less at date of purchase areclassified as cash equivalents. Investment securities with original maturities greater than three months and remaining maturities of less than one year areclassified as short-term investments. Investment securities with remaining maturities greater than one year are classified as marketable securities. Ourinvestments are primarily comprised of United States and municipal government obligations and corporate securities. To date, all marketable securities have been classified as available-for-sale and are carried at fair value, with unrealized gains and losses reported net-of-tax as a separate component of stockholders’ equity. Realized gains and losses on available-for-sale securities are recorded in interest income. Declines invalue on available-for-sale securities judged to be other than temporary are recorded in other income (expense), net. None of our marketable securities aredeemed impaired as of July 1, 2007, as substantially all of our investments are investment grade government and corporate debt securities that havematurities of less than 3 years, and we have both the ability and intent to hold the investments until maturity. The cost of securities sold is based on specificidentification. Premiums and discounts are amortized over the period from acquisition to maturity and are included in investment income, along with interestand dividends. 68Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Fair Value of Financial Instruments The carrying amounts and estimated fair values of our financial instruments were as follows (in thousands): July 1, 2007 July 2, 2006 Carryingamount Fair value Carryingamount Fair value Financial assets: Cash and cash equivalents $71,573 $71,573 $92,598 $92,598 Short-term investments $91,599 $91,599 $297,726 $297,726 Marketable securities $52,683 $52,683 $42,781 $42,781 Financial liabilities: Convertible subordinated notes $— $— $200,000 $197,750 Forward foreign currency contracts $(14) $(14) $(171) $(171) The fair values of short-term investments and marketable securities are determined using quoted market prices for those securities or similar financialinstruments. The fair value of the convertible subordinated notes paid off on December 1, 2006 was estimated using quoted market prices. Concentrations We may be subject to concentration of credit risk as a result of certain financial instruments consisting principally of marketable investments andaccounts receivable. We have placed our investments with high-credit quality issuers. We do not invest an amount exceeding 10% of our combined cash,cash equivalents, short-term investments and marketable securities in the securities of any one obligor or maker, except for obligations of the United Statesgovernment, obligations of United States government agencies and money market accounts. We perform ongoing credit evaluations of our customers and generally do not require collateral in exchange for credit. We mitigate some collectionrisk by requiring most of our customers in the Asia-Pacific region, excluding Japan, to pay cash in advance or secure letters of credit when placing an orderwith us. One distributor, Tech Data, accounted for 12%, 12% and 11% of our net revenues in fiscal 2007, fiscal 2006 and fiscal 2005, respectively. Nocustomer accounted for more than 10% of our accounts receivable balance at July 1, 2007, July 2, 2006 or July 3, 2005. One supplier currently manufacturers all of our application specific integrated circuits, or ASICs, used in certain of our hardware products. Anyinterruption or delay in the supply of any of these or other single source components, or the inability to procure these components from alternate sources atacceptable prices and within a reasonable timeframe, would have a material adverse effect on our ability to meet customer orders, which would negativelyimpact our business, operating results and financial condition. In addition, qualifying additional suppliers can be time-consuming and expensive, and mayincrease the likelihood of design or production related errors. We attempt to mitigate these risks by working closely with our ASIC supplier regardingproduction planning and timing of new product introductions. We currently derive substantially all of our revenue from sales of our Summit, BlackDiamond and Alpine products. We expect that revenue from theseproducts will account for a substantial portion of our revenue for the foreseeable future. Accordingly, widespread market acceptance of these products iscritical to our future success. Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable are recorded at the invoiced amount and do not bear interest. Substantially all receivables were trade receivables as of July 1, 2007and July 2, 2006. 69Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) We continually monitor and evaluate the collectibility of our trade receivables based on a combination of factors. We record specific allowances forbad debts in general and administrative expense when we become aware of a specific customer’s inability to meet its financial obligation to us, such as in thecase of bankruptcy filings or deterioration of financial position. We write-off receivables to the allowance after all collection efforts are exhausted. Estimatesare used in determining our allowances for all other customers based on factors such as current trends in the length of time the receivables are past due andhistorical collection experience. We mitigate some collection risk by requiring most of our customers in the Asia-Pacific region, excluding Japan, to pay cashin advance or secure letters of credit when placing an order with us. Inventories Inventories consist of raw materials and finished goods and are stated at the lower of cost, determined on a first-in, first-out basis, or replacement cost.Inventories, net of write-downs for excess and obsolete inventory (which we determine primarily based on future demand forecasts) of $2,932 and $5,136 atJuly 1, 2007 and July 2, 2006, respectively, consist of (in thousands): July 1, 2007 July 2, 2006Raw materials $— $431Finished goods 25,261 18,872Total $25,261 $19,303 Sales to Distributors We defer recognition of revenue on all sales to distributors until the distributor successfully resells the product, typically to an authorizedreseller. Distributors regularly provide us their “sales-out” reports for this purpose. Until it is sold, inventory held by distributors is included in our reportedfinished goods inventory and was $3.2 million at July 1, 2007 and July 2, 2006. The accounts receivable owed us by distributors, net of the deferred revenuefrom sales to distributors, is recorded in prepaid expenses and other current assets, as reflected in the following table (in thousands): July 1, 2007 July 2, 2006 Accounts receivable, net of allowance for doubtful accounts of $225($300 in fiscal 2006) $23,288 $17,158 Deferred revenue (15,203) (13,325)Net, included in Prepaid expenses and other current assets $8,085 $3,833 70Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Property and Equipment, Net Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using thestraight-line method over the estimated useful lives of the assets, with the exception of land, which is not depreciated. Estimated useful lives of 25 years areused for buildings. Estimated useful lives of one to four years are used for computer equipment and software. Estimated useful lives of three years are used foroffice equipment, furniture and fixtures. Depreciation and amortization of leasehold improvements is computed using the lesser of the remaining lease termsor three years. Property and equipment consist of the following (in thousands): July 1, 2007 July 2, 2006 Computer equipment $62,651 $61,164 Land 20,600 20,600 Buildings and improvements 17,546 17,524 Purchased software 33,775 32,995 Office equipment, furniture and fixtures 4,335 4,205 Leasehold improvements 6,327 6,309 145,234 142,797 Less accumulated depreciation and amortization (102,078) (96,298)Property and equipment, net $43,156 $46,499 In April 2006, we entered into a contract for the sale of our corporate headquarters campus in Santa Clara, California, at a price of $70 million. OnOctober 31, 2006, the Company announced that the Campus Sale Agreement expired under its terms. Accordingly, the parties are no longer bound to proceedwith the transaction, and the proposed purchaser has the right not to proceed with the transaction. Long-Lived Assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may notbe recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventualdisposition. Measurement of an impairment loss for long-lived assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. Other assets include technology agreements that are amortized over their contractual periods using the straight-line method of amortization. Therelated liability for the technology agreement is recorded in other accrued liabilities and other long-term liabilities. Guarantees and Product Warranties Financial Accounting Standards Board (“FASB”) Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others (“FIN 45”) requires that upon issuance of a guarantee, the guarantor must disclose and recognize aliability for the fair value of the obligation it assumes under that guarantee. 71Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) We have determined that the requirements of FIN 45 apply to our standard product warranty liability. The following table summarizes the activityrelated to our product warranty liability during fiscal 2007, fiscal 2006 and fiscal 2005: Year Ended July 1, 2007 July 2, 2006 June 3, 2005 Balance beginning of period $7,027 $7,471 $8,297 New warranties issued 8,752 10,189 12,251 Warranty expenditures (8,597) (10,633) (14,205)Change in estimate — — 1,128 Balance end of period $7,182 $7,027 $7,471 Our standard hardware warranty period is typically 12 months from the date of shipment to end-users. Upon shipment of products to our customers, weestimate expenses for the cost to repair or replace products that may be returned under warranty and accrue a liability in cost of product revenue for thisamount. The determination of our warranty requirements is based on actual historical experience with the product or product family, estimates of repair andreplacement costs and any product warranty problems that are identified after shipment. We estimate and adjust these accruals at each balance sheet date inaccordance with changes in these factors. The change in estimate in fiscal 2005 results from a change in the method we use to accumulate warranty returnrates. There have been no further changes in these estimates since fiscal 2005. In the normal course of business to facilitate sales of our products, we indemnify our resellers and end-user customers with respect to certain matters.We have agreed to hold the customer harmless against losses arising from a breach of intellectual property infringement or other claims made against certainparties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. It is not possible to estimatethe maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts andcircumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on ouroperating results or financial position. Deferred Support Revenue We offer renewable support arrangements, including extended warranty contracts, to our customers that range generally from one to five years. Thechange in our deferred support revenue balance in relation to these arrangements was as follows (in thousands): Year Ended July 1, 2007 July 2, 2006 Balance beginning of period $41,722 $47,849 New support arrangements 55,983 52,149 Recognition of support revenue (56,918) (58,276)Balance end of period 40,787 41,722 Less current portion 30,501 32,023 Non-current deferred revenue $10,286 $9,699 72Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Other Accrued Liabilities The following are the components of other accrued liabilities (in thousands): July 1, 2007 July 2, 2006Accrued income taxes $1,877 $3,435Accrued indirect taxes 308 490Accrued interest on subordinated debt — 583Other accrued liabilities 21,078 15,073Total $23,263 $19,581 Derivatives We use derivative financial instruments to manage exposures to foreign currency. Our objective for holding derivatives is to use the most effectivemethods to minimize the impact of these exposures. We do not enter into derivatives for speculative or trading purposes. All derivatives, whether designatedin hedging relationships or not, are required to be recorded on the balance sheet at fair value. The accounting for changes in the fair value of a derivativedepends on the intended use of the derivative and the resulting designation. For a derivative designated as a cash flow hedge, the effective portion of thederivative’s gain or loss is initially reported as a component of accumulated other comprehensive income (loss) and, upon occurrence of the forecastedtransaction, is subsequently reclassified into the consolidated statement of operations line item to which the hedged transaction relates. The ineffectiveportion of the gain or loss is reported in other expense immediately. For a derivative not designated as a cash flow hedge, the gain or loss is recognized inother expense in the period of change together with the offsetting gain or loss on the hedged item attributed to the risk being hedged. Advertising Cooperative advertising obligations with customers are accrued and the costs expensed at the time the related revenue is recognized. All otheradvertising costs are expensed as incurred. Cooperative advertising expenses are recorded as marketing expenses to the extent that an advertising benefitseparate from the revenue transaction can be identified and the cash paid does not exceed the fair value of that advertising benefit received. Otherwise, suchcooperative advertising obligations with customers are recorded as a reduction of revenue. Advertising expenses were $0.2 million, zero and $0.5 million forfiscal 2007, fiscal 2006, and fiscal 2005, respectively. Recently Issued Accounting Standards Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretative guidance on the process of quantifying financialstatement misstatements and is effective for fiscal years ending after November 15, 2006. The adoption of SAB 108 did not have a material impact on ourconsolidated financial statements. 73Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Accounting for Consideration Given by a Service Provider to a Manufacturer or Reseller of Equipment Necessary for an End-Customer to Receive Servicefrom the Service Provider In September 2006, the FASB issued Emerging Issues Task Force Issue, or EITF, No. 06-1, Accounting for Consideration Given by a Service Providerto a Manufacturer or Reseller of Equipment Necessary for an End-Customer to Receive Service from the Service Provider. EITF No. 06-1 requires companiesto provide disclosures regarding the nature of arrangements in which they provide consideration to manufacturers or resellers of equipment necessary for anend-customer to receive service from them, including the amounts recognized in the Consolidated Statements of Operations. EITF 06-1 is effective for fiscalyears beginning after June 15, 2007. We do not expect the adoption of EITF No. 06-1 to have a material impact on our consolidated financial statements. Fair Value Measurements In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. SFAS 157 replaces thedifferent definitions of fair value in the accounting literature with a single definition. It defines fair value as the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS 157 is effective for fair-value measurementsalready required or permitted by other standards for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods withinthose fiscal years. We currently are in the process of determining the impact of adopting the provisions of SFAS 157 on our financial position, results ofoperations and cash flows. Fair Value Option for Financial Assets and Liabilities In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendmentof FASB Statement No. 115 (FAS 159). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value thatare not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons betweencompanies that choose different measurement attributes for similar types of assets and liabilities. The provisions of FAS 159 become effective for fiscal yearsbeginning after November 15, 2007. We believe that the adoption of SFAS 159 will not have a material effect on our financial statements. Accounting for Income Taxes In July 2006, the Financial Accounting Standards Board (FASB) released its final Interpretation on uncertain tax positions, FIN 48, Accounting forUncertainty in Income Taxes – an interpretation of FAS 109. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes a recognitionthreshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.The guidance will become effective as of the beginning of a company’s fiscal year beginning after December 15, 2006. The Company is currently assessingthe impact of adopting this standard. 74Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 3. Available-for-Sale Securities The following is a summary of available-for-sale securities (in thousands): AmortizedCost Fair Value UnrealizedHoldingGains UnrealizedHoldingLosses July 1, 2007: Money market funds $198 $198 $— $— U.S. corporate debt securities 90,436 90,190 — (246)U.S. government agency securities 48,309 48,160 — (149)U.S. municipal bonds 1,991 1,985 — (6)Market auction preferred securities 34,840 34,840 — $— $175,774 $175,373 $— $(401)Classified as: Cash equivalents $31,109 $31,091 $— $(18)Short-term investments 91,772 91,599 — (173)Marketable securities 52,893 52,683 — (210) $175,774 $175,373 $— $(401)July 2, 2006: Money market funds $2,830 $2,830 $— $— U.S. corporate debt securities 150,536 149,432 — (1,104)U.S. government agency securities 98,519 97,510 — (1,009)U.S. municipal bonds 970 945 — (25)Market auction preferred securities 121,620 121,620 — — $374,475 $372,337 $— $(2,138)Classified as: Cash equivalents $31,841 $31,830 $— $(11)Short-term investments 299,043 297,726 — (1,317)Marketable securities 43,591 42,781 — (810) $374,475 $372,337 $— $(2,138) The amortized cost and estimated fair value of available-for-sale investments in debt securities at July 1, 2007, by contractual maturity, were as follows(in thousands): AmortizedCost FairValueDue in 1 year or less $122,882 $122,690Due in 1-2 years 34,935 34,798Due in 2-5 years 17,957 17,885Total investments in available for sale debt securities $175,774 $175,373 75Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The following table presents our investments’ gross unrealized losses and fair values, aggregated by investment category and length of time thatindividual securities have been in a continuous unrealized loss position. Less than 12 months 12 months or more Total Fair Value UnrealizedLosses Fair Value UnrealizedLosses Fair Value UnrealizedLosses July 1, 2007: U.S. corporate debt securities $75,470 $(199) $14,720 $(47) $90,190 $(246)U.S. government agency securities 19,119 (35) 29,042 (114) 48,160 (149)U.S. municipal bonds 985 (5) 1,000 (1) 1,985 (6) $95,574 $(239) $44,762 $(162) $140,335 $(401) Municipal and corporate bonds. Unrealized losses as of July 1, 2007 on our investments in municipal and corporate bonds were caused by interest rateincreases. The contractual terms of the debentures do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Theissuers of our municipal bonds have a credit rating of AAA, and the issuers of our corporate bonds have a credit rating of AA (Moody’s and S&P). Government agency securities. Unrealized losses as of July 1, 2007 on our investments in our government agency securities (i.e., Federal NationalMortgage Association and Federal Home Loan Mortgage Corp.) were caused by interest rate increases. The contractual terms of the investments do not permitthe issuer to settle the securities at a price less than the amortized cost of the investment. The issuers of our government agency securities have a credit ratingof AAA. The unrealized losses on our investments were caused by interest rate increases. As substantially all of our investments are investment gradegovernment and corporate debt securities that have maturities of less than 3 years, and we have both the ability and intent to hold the investments untilmaturity, we do not consider these investments to be other-than-temporarily impaired at July 1, 2007. 4. Commitments, Contingencies and Leases Stock Repurchase Program On October 20, 2005, our Board of Directors authorized the repurchase of up to $50 million of our common stock. This authorization originally was toexpire in October 2007, but on October 25, 2006, the Board of Directors terminated the share repurchase plan. In the quarter ended December 31, 2006, werepurchased approximately 0.9 million shares for approximately $3.4 million, primarily through open market purchases, bringing the cumulative total to11.1 million repurchased shares for approximately $48.3 million. Line of Credit We have a revolving line of credit for $10.0 million with a major lending institution. Borrowings under this line of credit bear interest at the bank’sprime rate. As of July 1, 2007, there were no outstanding borrowings under this line of credit. The line of credit contains a provision for the issuance of lettersof credit not to exceed the unused balance of the line. As of July 1, 2007, we had letters of credit totaling $0.7 million. These letters of credit were primarilyissued to satisfy requirements of certain of our customers for performance bonds. The line of credit requires us to maintain specified financial covenantsrelated to tangible net worth and liquidity with which we were in compliance as of July 1, 2007. The line of credit was renewed on January 24, 2007 andexpires on January 24, 2008. 76Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Leases We lease office space for our various United States and international sales offices. Certain leases contain rent escalation clauses and renewal options.We sublease certain of our leased facilities to third party tenants. Future annual minimum lease payments under all noncancelable operating leases and futurerental income under all noncancelable subleases having initial or remaining lease terms in excess of one year at July 1, 2007 were as follows (in thousands): Future LeasePayments Future RentalIncomeFiscal 2008 $7,044 $426Fiscal 2009 5,363 441Fiscal 2010 4,606 505Fiscal 2011 4,004 390Fiscal 2012 323 — Total minimum payments $21,340 $1,762 Rent expense was approximately $4.8 million, $4.4 million and $5.1 million for fiscal 2007, fiscal 2006, and fiscal 2005, respectively, net of subleaseincome of $0.1 million, $0.1 million and $0.4 million in the respective periods. Purchase Commitments We currently have arrangements with one contract manufacturer and other suppliers for the manufacture of our products. Our arrangements allow themto procure long lead-time component inventory on our behalf based upon a rolling production forecast provided by us. We are obligated to the purchase oflong lead-time component inventory that our contract manufacturer procures in accordance with the forecast, unless we give notice of order cancellationoutside of applicable component lead-times. As of July 1, 2007, we had non-cancelable commitments to purchase approximately $27.3 million of suchinventory during the first quarter of fiscal 2008. Legal Proceedings Government Inquiries Relating to Historical Stock Option Practices On June 27, 2006, the Company received an informal inquiry letter from the Staff of the SEC Enforcement Division requesting that the Companyvoluntarily provide documents related to its policies, practices and procedures for granting stock options for the period since its initial public offering onApril 9, 1999 (“IPO”). The Company responded to the request and is cooperating fully with the SEC inquiry. Late SEC Filing and Nasdaq Delisting Proceedings Due to the Special Committee investigation and the resulting restatements, the Company did not timely file its Form 10-K for the fiscal year endingJuly 2, 2006 or the Quarterly Reports on Forms 10-Q for the quarters ended October 1, 2006, December 31, 2006 and April 1, 2007. The Company initiallyreceived Nasdaq Staff Determination notices stating that the Company was not in compliance with Marketplace Rule 4310(c)(14) because it had not timelyfiled such periodic reports with the SEC. Those filings were made on June 28, 2007. On July 2, 2007, the Company received a written notice from the NasdaqStock Market stating that the Nasdaq Listing and Hearing Review Council (the “Listing Council”), after consultation with the Nasdaq Listing QualificationStaff, had determined that as of that date the Company had demonstrated compliance with all 77Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Nasdaq Marketplace Rules. The notice further stated that as of July 2, 2007, the matter was closed and the Company’s securities would continue to be listedon The Nasdaq Global Market. On July 3, 2007, the Company received a further Staff Determination notice from the Nasdaq Stock Market stating that the Company was not incompliance with Nasdaq’s Marketplace Rule 4350(e) due to a failure by the Company to hold its annual meeting of shareholders within the time required byRule 4350(e) and, therefore, that its common stock was again subject to delisting from The Nasdaq Global Market. On July 19, 2007, the Company received awritten notice from the Nasdaq Stock Market stating that a Nasdaq Listing Qualifications Panel (the “Panel”) had determined that the Company’s securitieswould continue to be listed on The Nasdaq Global Market, subject to the condition that on or before August 1, 2007, the Company inform the Panel that ithas held its annual meeting of shareholders. On July 31, 2007, the Company notified the Panel that the Company had held the annual meeting ofshareholders on July 30, 2007. On August 3, 2007, the Company received a written notice from the Panel confirming that the Company had demonstratedcompliance with all Nasdaq Marketplace Rules, and that the Panel determined to continue the listing of the Company’s securities on The Nasdaq StockMarket. Accordingly, the Company believes that the Nasdaq delisting proceedings have concluded. Shareholder Litigation Relating to Historical Stock Option Practices On April 25, 2007, an individual identifying herself as a shareholder of the Company filed a derivative action in the United States District Court for theNorthern District of California purporting to assert claims on behalf of and in the name of the Company against various of our current and former directorsand officers relating to our stock option granting practices for stock options issued from 2000 to 2003. The complaint alleges that the individual defendantsbreached their fiduciary duties and other obligations to the Company and violated federal securities laws in connection with our historical stock optiongranting process and our accounting for past stock options. The plaintiff has asserted claims for violations of Sections 10(b) (including Rule 10b-5 thereunder), 14(a), and 20(a) of the Securities Exchange Act of1934, unjust enrichment, breach of fiduciary duty and aiding and abetting such breach, rescission, and a claim for an accounting of all stock option grantsmade to the named defendants. Extreme Networks, Inc. is named as a nominal defendant in these actions. On behalf of Extreme Networks, Inc., the plaintiffseeks unspecified monetary and other relief against the named defendants. The plaintiff is Yenna Wu. The individual named defendants are Gordon L. Stitt,Herb Schneider, Stephen Haddock, Paul Romeo, Vito Palermo, Harold Covert, Darrell Scherbarth, Christopher, N. Todd, Alexander J. Gray, Frank C. Carlucci,William R. Slakey, Charles Carinalli, Harry Silverglide, Michael West, Kenneth Levy, Robert L. Corey, Peter Wolken, and Promod Haque. A similar derivative action was filed in the same court on May 2, 2007, by Linda Erikson, another individual identifying herself as a shareholder of theCompany, alleging the same legal claims against the same individual defendants concerning the same subject matter. A third derivative action was filed in the same court on May 31, 2007 by Frank A. Grucel, an individual identifying himself as a shareholder of theCompany, purporting to assert claims on the Company’s behalf relating to the Company’s historic stock options granting practices. The complaint seeksunspecified monetary and injunctive relief and asserts claims for violations of Section 14(a) of the Securities Exchange Act of 1934, an accounting of allstock option grants made to the named defendants, breach of fiduciary duty and aiding and abetting such breach, abuse of control, gross mismanagement,constructive fraud, corporate waste, unjust enrichment, rescission, violations of California Corporations Code Section 25402, and breach of fiduciary duties 78Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) related to insider selling and alleged misappropriation of information. Extreme Networks, Inc. is named as a nominal defendant in this action, and theindividual named defendants are Gordon L. Stitt, Herb Schneider, Stephen Haddock, Alexander J. Gray, Frank C. Carlucci, William R. Slakey, CharlesCarinalli, Harry Silverglide, Michael West, Kenneth Levy, Robert L. Corey, Peter Wolken, Michael Palu, and Alicia Moore. The foregoing actions have been related and assigned to the same judge. On June 15, 2007, Yenna Wu filed an amended complaint in her action. Theamended complaint names one additional individual defendant, Mark Canepa, as well as the individual defendants named in the derivative complaints filedon April 25, 2007 and May 2, 2007, is purportedly brought both as a derivative action and as a class action on behalf of all current shareholders of theCompany, and alleges a claim for violation of Delaware General Corporations Code Section 211(c), seeking an order compelling the Company to hold ashareholder’s meeting. The amended complaint otherwise alleges the same claims as the derivative complaints filed on April 25, 2007 and May 2, 2007 byplaintiffs Wu and Erikson, respectively. On August 2, 2007, the foregoing actions were consolidated for all purposes. Subsequently, on August 13, 2007, plaintiff Frank A. Grucel, Jr. wasnamed lead plaintiff and his attorneys named lead counsel in the consolidated actions. This consolidated action is at an early stage, with a consolidatedcomplaint to be filed no later than September 27, 2007. Discovery has not yet commenced and the defendants are not yet required to respond to thecomplaints currently on file. We cannot at this time predict whether this consolidated action will result in any material recovery by or expense to theCompany. Indemnification Obligations Subject to certain limitations, we may be obligated to indemnify our current and former directors, officers and employees. These obligations arise underthe terms of our certificate of incorporation, our bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify, whereapplicable, generally means that we are required to pay or reimburse, and in certain circumstances we have paid or reimbursed, the individuals’ reasonablelegal expenses and possibly damages and other liabilities incurred in connection with these matters. It is not possible to estimate the maximum potentialamount under these indemnification agreements due to the limited history of these claims. The cost to defend the Company and the named individuals couldhave a material adverse effect on our consolidated financial position, results of operations and cash flows in the future. Recovery of such costs under ourdirectors and officers insurance coverage is uncertain. Other Legal Matters On April 20, 2007, Extreme Networks filed suit against Enterasys in the United States District Court for the Western District of Wisconsin, Civil ActionNo. 07-C-0229-C. The complaint alleges willful infringement of U.S. patents Nos. 6,104,700, 6,678,248, and 6,859,438, and seeks injunctive relief againstEnterasys’ continuing sale of infringing goods and monetary damages. Enterasys responded to the complaint on May 30, 2007. Enterasys also filed acounterclaim alleging infringement of three U.S. patents owned by Enterasys. The case is in its early stages, however a Markman Hearing has been scheduledfor October 2007, and a trial date has been set for May 2008. On December 27, 2005, Broadband Office Inc. (“Broadband”) served an amended complaint, adding Extreme Networks as a defendant in its lawsuitagainst Technology Credit Corporation (“TCC”) and Key Equipment Finance, Inc., seeking recovery of an alleged preferential payment in the amount of$0.8 million plus interest, purportedly paid by Broadband to TCC within ninety days prior to Broadband’s petition for bankruptcy protection. Extremedisputes that it owes any money to Broadband, and intends vigorously to defend against the claims. 79Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) On June 21, 2005, Enterasys filed suit against Extreme Networks and Foundry Networks, Inc. (“Foundry”) in the United States District Court for theDistrict of Massachusetts, Civil Action No. 05-11298 DPW. The complaint alleges willful infringement of U. S. Patent Nos. 5,251,205; 5,390,173; 6,128,665;6,147,995; 6,539,022; and 6,560, 236, and seeks: a) a judgment that Extreme willfully infringes each of the patents; (b) a permanent injunction frominfringement, inducement of infringement and contributory infringement of each of the six patents; (c) damages and a “reasonable royalty” to be determinedat trial; (d) trebled damages; (e) attorneys fees, costs and interest; and (f) equitable relief at the court’s discretion. The Markman hearing has been rescheduledfor October 2007. We intend vigorously to defend against Enterasys’ assertions, which we believe to be without merit. On May 27, 2003, Lucent filed suit against Extreme Networks and Foundry in the United States District Court for the District of Delaware, Civil ActionNo. 03-508. The complaint alleged willful infringement of U.S. Patent Nos. 4,769,810, 4,769,811, 4,914,650, 4,922,486 and 5,245,607. After the Markmanhearing, Lucent dropped its claims relating to the 5,245,607 patent. The judge split the case into three parts to be tried separately: phase 1 to coverinfringement, willfulness and damages; phase 2 to cover invalidity; and phase 3 to cover equitable defenses and our counterclaims. On May 9, 2005, a jury inDelaware awarded a verdict to Extreme in the phase 1 trial of non-infringement on 18 out of the 19 claims asserted. The jury did award Lucent damages ofapproximately $275,000 on the remaining claim; which covers a feature that is not offered in our current product line. The parties each filed post-trialmotions; and on August 16, 2005, the judge granted Lucent’s motion for a new trial, ruling that Extreme impermissibly introduced to the jury evidence of itsprior relationship with Lucent. Extreme’s motion for reconsideration was denied. On August 9, 2006, the parties entered into a settlement agreement toresolve all outstanding claims which includes the dismissal of all claims and a patent cross-license for a defined term. Beginning on July 6, 2001, purported securities fraud class action complaints were filed in the United States District Court for the Southern District ofNew York. The cases were consolidated and the litigation is now captioned as In re Extreme Networks, Inc. Initial Public Offering Securities Litigation, Civ.No. 01-6143 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). The operative amended complaintnames as defendants Extreme Networks; six of our present and former officers and/or directors, including our CEO (the “Extreme Networks Defendants”); andseveral investment banking firms that served as underwriters of our initial public offering and October 1999 secondary offering. The complaint allegesliability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that theregistration statement for the offerings did not disclose that: (1) the underwriters had agreed to allow certain customers to purchase shares in the offerings inexchange for excess commissions paid to the underwriters; and (2) the underwriters had arranged for certain customers to purchase additional shares in theaftermarket at predetermined prices. Similar allegations were made in other lawsuits challenging over 300 other initial public offerings and follow-onofferings conducted in 1999 and 2000. The cases were consolidated for pretrial purposes. Previously, we executed a settlement agreement presented to allissuer defendants. In that settlement, plaintiffs would dismiss and release all claims against the Extreme Network Defendants, in exchange for a contingentpayment by the insurance companies collectively responsible for insuring the issuers in all of the IPO cases, and for the assignment or surrender of control ofcertain claims we may have against the underwriters. The Extreme Networks Defendants would not be required to make any cash payments in the settlement,unless the pro rata amount paid by the insurers in the settlement exceeded the amount of the insurance coverage. The Court gave preliminary approval to thesettlement in February 2005 and held a hearing in April 2006 to consider final approval of the settlement. Before the Court issued a final decision on thesettlement, on December 5, 2006 the United States Court of Appeals for the Second Circuit vacated the class certification of plaintiffs’ claims against theunderwriters in six cases designated as focus or test cases. Thereafter, on December 14, 2006, the Court ordered a stay of all proceedings 80Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) in all of the lawsuits pending the outcome of plaintiffs’ petition to the Second Circuit Court of Appeals for a rehearing en banc and resolution of the classcertification issue. On April 6, 2007, the Second Circuit Court of Appeals denied plaintiffs’ petition for a rehearing, but clarified that the plaintiffs may seekto certify a more limited class. Accordingly, the plaintiffs and issuers have stated that they are prepared to discuss how the settlement might be amended orrenegotiated to comply with the decision of the Second Circuit Court of Appeals. On April 30, 2007, Plaintiffs stated that they intend to present a proposedredefined class to the Court. If the settlement is not amended or renegotiated and then approved by the Court, there is no assurance that we will prevail in thelawsuit. Failure to prevail could have a material adverse effect on our consolidated financial position, results of operations and cash flows in the future. We may from time to time be party to litigation arising in the course of our business, including, without limitation, allegations relating to commercialtransactions or business relationships or intellectual property rights. Such claims, even if not meritorious, could result in the expenditure of significantfinancial and managerial resources. Litigation in general, and intellectual property and securities litigation in particular, can be expensive and disruptive tonormal business operations. Moreover, the results of legal proceedings are difficult to predict. 5. Convertible Subordinated Notes In December 2001, we completed a private placement of $200.0 million of convertible subordinated notes. The notes matured and were paid off onDecember 1, 2006. Interest was payable semi-annually at 3.5% per annum. 6. Stockholders’ Equity Preferred Stock In April 2001, in connection with our Stockholders’ Rights Agreement, we authorized the issuance of preferred stock. The preferred stock may beissued from time to time in one or more series. The board of directors is authorized to provide for the rights, preferences and privileges of the shares of eachseries and any qualifications, limitations or restrictions on these shares. As of July 1, 2007, no shares of preferred stock were outstanding. Warrants On October 30, 2003, Extreme Networks and Avaya, Inc. entered into a strategic alliance to jointly develop and market converged communicationssolutions, by executing a Joint Development Agreement, and a distribution agreement under which Avaya is entitled to resell Extreme Networks products.Extreme issued to Avaya a warrant with a ten-year expiration period to purchase up to 2,577,794 shares of Extreme Networks common stock at a price of$0.01 per share, with Avaya having the right to exercise the warrant with respect to one third of such shares 90 days after the date of the agreements, and theremaining shares become exercisable based upon the completion of certain milestones by Avaya. Even if the milestones are not completed, however, thewarrant will become fully exercisable for all shares 90 days prior to the expiration of the warrant. Avaya exercised the warrant with respect to approximately859,000 of the shares subject to the warrant on March 17, 2004 and, approximately 859,000 of the shares subject to the warrant on August 8, 2005. See Note13 for additional details on the Avaya alliance. 81Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Deferred Stock Compensation During fiscal 2001, we recorded deferred share-based compensation expense of $24.4 million associated with unvested stock options subject toforfeiture issued to employees assumed in acquisitions. In addition, in accordance with APB 25, for the year ended July 3, 2005 and prior years, share-basedcompensation expense is not recorded in connection with stock options granted with exercise prices equal to or greater than the fair market value of ourcommon stock on the date of grant. We recorded deferred stock compensation in connection with stock options granted with exercise prices less than the fairmarket value of the common stock on the date of grant. The amount of such deferred stock compensation is equal to the excess of fair market value over theexercise price on such date. These amounts were amortized as charges to operations, using the graded method, over the vesting periods of the individualstock options, generally four years. Upon termination of an employee, the amount of expense recognized under the graded vesting method that is in excess ofthe amount actually earned is reversed. We recorded amortization of deferred stock compensation expense, net of reversals, of zero, zero and $0.5 million forfiscal 2007, fiscal 2006 and fiscal 2005, respectively. Upon adoption of FAS 123R at the beginning of fiscal year 2006, we reclassified the unamortizeddeferred stock compensation in the amount of $0.2 million against common stock. Stockholders’ Rights Agreement In April 2001, the board of directors approved a Stockholders’ Rights Agreement (“Rights Agreement”), declaring a dividend of one preferred sharepurchase right for each outstanding share of common stock, par value $0.001 per share, of Extreme Networks common stock. The Rights Agreement isintended to protect stockholders’ rights in the event of an unsolicited takeover attempt. It is not intended to prevent a takeover of Extreme Networks on termsthat are favorable and fair to all stockholders and will not interfere with a merger approved by the board of directors. In the event the rights becomeexercisable, each right entitles stockholders to buy, at an exercise price of $150 per right owned, a unit equal to a portion of a new share of Extreme NetworksSeries A preferred stock. The rights will be exercisable only if a person or a group acquires or announces a tender or exchange offer to acquire 15% or more ofour common stock. The rights, which expire in April 2011, are redeemable for $0.001 per right at the approval of the board of directors. Comprehensive Income (Loss) The activity of other comprehensive income (loss) was as follows (in thousands): Year Ended July 1,2007 July 2,2006 July 3,2005 Change in unrealized loss on investments: (Increase) decrease in net unrealized loss on investments $1,737 $1,313 $(441)Less: Net gain on investments realized and included in net income (loss) — — 99 Net (increase) decrease in unrealized loss on investments 1,737 1,313 (540)Unrealized gain (loss) on derivatives (2) (10) 12 Foreign currency translation adjustments 404 17 29 Other comprehensive income (loss) $2,139 $1,320 $(499) 82Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The following are the components of accumulated other comprehensive income (loss), net of tax (in thousands): July 1,2007 July 2,2006 Accumulated unrealized loss on investments, net of taxof $0 in fiscal 2007 and $0 in fiscal 2006 $(402) $(2,138)Accumulated unrealized gain on derivatives — 2 Accumulated foreign currency translation adjustments 974 569 Accumulated other comprehensive loss $572 $(1,567) Shares Reserved for Issuance The following are shares reserved for issuance (in thousands): July 1,2007 July 2,2006Convertible subordinated notes — 9,544Warrants 860 860Employee stock purchase plan 5,583 5,800Employee stock options 39,968 43,635Total shares reserved for issuance 46,411 59,839 7. Employee Benefit Plans (including Share-based Compensation) On July 4, 2005, we adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment, (“FAS 123R”). Prior to July 4, 2005, weaccounted for share-based payments under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees(“APB 25”), and related Interpretations, as permitted by SFAS No. 123, Accounting for Share-based Compensation (“FAS 123”). In accordance with APB 25no compensation cost was required to be recognized for options granted that had an exercise price equal to the market value of the underlying common stockon the date of grant. We adopted FAS 123R using the modified-prospective-transition method. Under that transition method, compensation cost recognized in the yearended July 2, 2006 includes: a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 4, 2005, based on the grant-datefair value estimated in accordance with the original provisions of FAS 123, and b) compensation cost for all share-based payments granted subsequent toJuly 4, 2005, based on the grant-date fair value estimated in accordance with the provisions of FAS 123R. The results for the prior periods have not beenrestated. As a result of adopting FAS 123R on July 4, 2005 our income before income taxes and net income for the year ended July 1, 2007, are $6.2 million and$6.2 million lower, respectively, than if we had continued to account for share-based compensation under APB 25. Basic and diluted earnings per share forthe year ended July 1, 2007 are $0.05 and $0.05 lower, respectively, than if we had continued to account for share-based compensation under APB 25. Wehave not recognized, and do not expect to recognize in the near future, any tax benefit related to employee share-based compensation cost as a result of thefull valuation allowance on our net deferred tax assets and our net operating loss carryforwards. The total compensation cost capitalized in inventory was lessthan $0.1 million as of July 1, 2007. Share-based compensation cost of $0.8 million was recognized in expense in accordance with APB 25 for the year endedJuly 3, 2005. 83Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) As of July 1, 2007, we have the following share-based compensation plans: 2005 Equity Incentive Plan The 2005 Equity Incentive Plan (the “2005 Plan”) was adopted by our Board of Directors on October 20, 2005, and approved by stockholders onDecember 2, 2005. The 2005 Plan replaces the 1996 Stock Option Plan (the “1996 Plan”), 2000 Nonstatutory Stock Option Plan (the “2000 Plan”) and 2001Nonstatutory Stock Option Plan (the “2001 Plan”). Under the 2005 Plan, we may grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performanceunits, and other share-based or cash-based awards to employees and consultants. The 2005 Plan also authorizes the grant of awards of stock options, stockappreciation rights, restricted stock and restricted stock units to non-employee members of the board of directors and deferred compensation awards toofficers, directors and certain management or highly compensated employees. The 2005 Plan authorizes the issuance of up to 12,000,000 shares of ourcommon stock, and up to 11,000,000 shares subject to awards that remain outstanding under the 1996 Plan, 2000 Plan and 2001 Plan as of December 2, 2005and which subsequently terminate without having been exercised or which are forfeited, will be added to the shares available under the 2005 Plan. As ofJuly 1, 2007, 11,918,924 shares were available for future grant under the 2005 Plan. 1999 Employee Stock Purchase Plan In January 1999, the Board of Directors approved the adoption of Extreme Network’s 1999 Employee Stock Purchase Plan (the “Purchase Plan”). OnDecember 2, 2005, the stockholders approved an amendment to the Purchase Plan to increase the maximum number of shares of common stock that may beissued under the plan by 5,000,000 to a total of 12,000,000 shares. The Purchase Plan permits eligible employees to acquire shares of our common stockthrough periodic payroll deductions of up to 15% of total compensation. No more than 625 shares may be purchased on any purchase date per employee.Each offering period has a maximum duration of 12 months. The price at which the common stock may be purchased is 85% of the lesser of the fair marketvalue of our common stock on the first day of the applicable offering period or on the last day of the respective purchase period. Through July 1, 2007,6,416,504 shares had been purchased under the Purchase Plan. Amended 1996 Stock Option Plan In January 1999, the Board of Directors approved an amendment to the 1996 Plan to (i) increase the share reserve by 10,000,000 shares, (ii) to removecertain provisions which are required to be in option plans maintained by California privately-held companies and (iii) to rename the 1996 Plan as the“Amended 1996 Stock Option Plan.” Under the 1996 Plan, which was originally adopted in September 1996, options may be granted for common stock, pursuant to actions by the Board ofDirectors, to eligible participants. A total of 56,387,867 shares were reserved under the 1996 Plan. Options granted are exercisable as determined by theBoard of Directors. Options vest over a period of time as determined by the Board of Directors, generally four years. Options have a contractual term of tenyears. Effective December 2, 2005, the 1996 Plan was terminated. 2000 Plan In March 2000, the Board of Directors adopted 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 84Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) eligible to participate in the 2000 Plan, except that options may be granted to officers under this plan in connection with written offers of employment. Atotal of 4,000,000 shares were reserved under the 2000 Plan. Options vest over a period of time as determined by the Board of Directors, generally four years.Options have a contractual term of ten years. Effective December 2, 2005, the 2000 Plan was terminated. 2001 Plan In May 2001, the Board of Directors adopted 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 the 2001 Plan, except that options may be granted to officersunder this plan in connection with written offers of employment. A total of 4,000,000 shares were reserved under the 2001 Plan. Options vest over a period oftime as determined by the Board of Directors, generally four years. Options have a contractual term of ten years. Effective December 2, 2005, the 2001 Planwas terminated. A summary of the status of our non-vested shares as of July 1, 2007 and changes during fiscal 2007 is presented below: Number ofShares(000’s) Weighted-Average Grant-Date Fair ValueNon-vested shares at June 2, 2006 162 $4.76Granted 564 3.50Vested (162) 4.10Canceled (99) 3.96Non-vested shares at July 1, 2007 465 $3.63 During fiscal 2007, fiscal 2006 and fiscal 2005, we granted non-vested stock awards under the 2001 Plan for 564,000, 170,000 and 27,000 shares ofcommon stock with a weighted average grant date fair value per share of $3.50, $4.74 and $5.61, respectively. The shares were placed in an escrow accountand will be released to the recipients as the shares vest over periods of up to twenty-four months. If a participant terminates employment prior to the vestingdates, the unvested shares will be canceled and returned to the 2001 Plan. We recognize compensation expense on the awards over the vesting period basedon an intrinsic value calculation as of the date of grant. As of July 1, 2007, there were approximately $1.1 million in unrecognized compensation costsrelated to non-vested stock. This cost is expected to be recognized over a weighted-average period of approximately 1.6 year. 85Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The following table summarizes stock option activity under all plans: Number ofShares(000’s) Weighted-AverageExercise PricePer Share Weighted-AverageRemainingContractualTerm AggregateIntrinsic Value($ 000’s)Options outstanding at June 27, 2004 21,451 $7.25 Granted 3,884 $5.29 Exercised (538) $2.95 Canceled (3,659) $7.98 Options outstanding at July 3, 2005 21,138 $6.87 Granted 4,965 $4.52 Exercised (513) $3.13 Canceled (4,164) $6.94 Options outstanding at July 2, 2006 21,426 $6.59 Granted 3,687 $3.67 Exercised (150) $0.62 Canceled (3,522) $6.39 Options outstanding at July 1, 2007 21,441 $5.97 6.72 $2,948Exercisable at July 1, 2007 16,290 $6.55 6.11 $1,869 The following table summarizes significant ranges of outstanding and exercisable options at July 1, 2007: Options Outstanding Options ExercisableRange ofExercisePrices NumberOutstanding Weighted-AverageRemainingContractual Life Weighted-AverageExercisePrice NumberExercisable Weighted-AverageExercisePrice (In years) $ 0.50 – 3.65 3,832,495 6.66 $3.31 1,663,279 $2.95$ 3.66 – 4.49 3,847,357 7.79 $4.20 2,295,676 $4.24$ 4.50 – 5.53 3,733,528 7.44 $4.88 2,466,017 $4.90$ 5.73 – 6.96 1,153,862 6.89 $6.32 992,555 $6.31$ 7.07 – 7.07 3,862,989 6.31 $7.07 3,862,989 $7.07$ 7.14 – 46.25 5,009,994 5.70 $9.28 5,009,108 $9.28$ 0.50 – 46.25 21,440,225 6.72 $5.98 16,289,624 $6.56 As of July 1, 2007, there was $7.7 million of total unrecognized compensation cost related to unvested stock options. This cost is expected to berecognized over a weighted-average period of approximately 1.3 years. The total intrinsic value of options exercised in fiscal 2007 and fiscal 2006 were $0.5million and $0.8 million, respectively. The fair value of options vested in fiscal 2007 and fiscal 2006 are $4.6 million and $4.8 million, respectively. The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option valuation model with the weightedaverage assumptions noted in the following table. The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve ineffect at the time of grant. Expected volatility is based on both the implied volatilities from traded options on our stock and historical volatility on our stock. 86Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) For options granted prior to July 4, 2005, and valued in accordance with FAS 123, the expected volatility used to estimate the fair value of the optionswas based solely on the historical volatility on our stock; we used the graded vesting method for expense attribution; and we recognized option forfeitures asthey occurred as allowed by FAS 123. For options granted after July 3, 2005, and valued in accordance with FAS 123R, the expected volatility used to estimate the fair value of options wasbased on a combination of the historical volatility of our stock and the implied volatility; we use the straight-line method for expense attribution, and weestimate forfeitures and only recognize expense for those shares expected to vest. Our estimated forfeiture rate in fiscal 2007, based on our historical forfeitureexperience, is approximately 9%. The fair value of options granted in fiscal 2007, fiscal 2006 and fiscal 2005 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 Year Ended Year Ended July 1,2007 July 2,2006 July 3,2005 July 1,2007 July 2,2006 July 3,2005 Expected life 2.5 yrs 2.5 yrs 2.5 yrs 0.9 yrs 0.6 yrs 0.8 yrs Risk-free interest rate 4.9% 4.2% 2.9% 5.0% 4.8% 2.9%Volatility 50% 60% 81% 37% 38% 47%Dividend yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% The Black-Scholes-Merton option valuation model requires the input of highly subjective assumptions, including the expected life of the share-basedaward and stock price volatility. The assumptions listed above represent management’s best estimates, but these estimates involve inherent uncertainties andthe application of management judgment. As a result, if other assumptions had been used, our recorded and pro forma share-based compensation expensecould have been materially different from that depicted above and below. In addition, we are required to estimate the expected forfeiture rate and onlyrecognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the share-based compensationexpense could be materially different. In the fourth quarter of fiscal 2005, the compensation committee of the Board of Directors approved the acceleration of vesting of certain unvestedstock options with exercise prices equal to or greater than $7.00 per share previously awarded to employees, including executive officers, and directors.Options to purchase approximately 4,544,000 shares of common stock were subject to acceleration. In accordance with APB 25, no compensation expensewas required to be recorded in our consolidated statement of operations in fiscal 2005 in connection with the acceleration of the vesting of these options, asthe exercise price of the employee stock options was higher than the market price of our stock on the date of the modification of the options. We believe thatsuch options had limited economic value and were not offering sufficient incentive to the employees when compared to the potential future expense ofapproximately $11.4 million that would have been required to be recorded in future periods under FAS 123R had the options not been accelerated. The weighted-average grant-date per share fair value of options granted in fiscal 2007, fiscal 2006 and fiscal 2005 was $1.27, $1.82 and $2.51,respectively. The weighted-average estimated per share fair value of shares granted under the Purchase Plan in fiscal 2006 and fiscal 2005 were $1.28 and$1.49, respectively. The weighted-average estimated per share fair value of shares granted under the Purchase Plan in the first quarter of fiscal 2007 was$1.13. No shares were granted under the ESPP in the second, third and fourth quarter of fiscal 2007. 87Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of FAS 123 tooptions granted under our stock option plans, non-vested stock awards granted and shares issued under the Purchase Plan in fiscal 2005. For purposes of proforma disclosures, the value of the options is estimated using a Black-Scholes-Merton option-pricing formula (and the assumptions listed in the table above)and amortized to expense over the options’ vesting periods using the graded vested method. The following pro forma information sets forth our net loss andnet loss per share assuming that we had used the FAS 123 fair value method in accounting for employee stock options and purchases during fiscal 2005: Year Ended July 3, 2005 In thousands,exceptper shareamounts Net income (loss) $12,519 Add: APB 25 stock-based compensation expense,included in net income (loss), net of tax 762 Less: Stock-based compensation expense determinedunder fair value based method, net of tax (32,894)Pro forma net loss $(19,613)Basic earnings (loss) per share: Net income (loss) $0.10 Net loss – pro forma $(0.16)Diluted earnings (loss) per share: Net income (loss) $0.10 Net loss – pro forma $(0.16)Shares – As Reported Basic earnings per share 121,225 Diluted earnings per share 124,219 Shares – Pro Forma Basic earnings per share 121,225 Diluted earnings per share 121,225 401(k) Plan We provide 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 current compensation up to the lesser of 80% or the statutorily prescribed limit of$14,000 for calendar year 2005. Effective January 1, 2005, employees age 50 or over may elect to contribute an additional $4,000. The amount of thereduction is contributed to the Plan on a pre-tax basis. We provide for discretionary matching contributions as determined by the board of directors for each calendar year. The board of directors set thematch at $0.25 for every dollar contributed by the employee up to the first 4% of pay. The same level of match was approved during the 2007, 2006 and 2005calendar years. All matching contributions vest immediately. In addition, the Plan provides for discretionary contributions as determined by the board ofdirectors each year. Our matching contributions to the Plan totaled $558,739, $531,930 and $543,061 for fiscal 2007, fiscal 2006, and fiscal 2005,respectively. No discretionary contributions were made in fiscal 2007, fiscal 2006 or fiscal 2005. 88Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 8. Income Taxes The provision for (benefit from) income taxes for fiscal 2007, fiscal 2006 and fiscal 2005 consisted of the following (in thousands): Year Ended July 1,2007 July 2,2006 July 3,2005,Current: Federal $(12) $40 $— State 100 100 50Foreign 1,984 1,751 2,199Total current 2,072 1,891 2,249Deferred: Federal — 142 766State — 14 76Foreign 68 (249) 452Total deferred 68 (93) 1,294Provision for income taxes $2,140 $1,798 $3,543 Pretax income from foreign operations was $26.5 million, $18.5 million and $14.4 million in fiscal 2007, fiscal 2006, and fiscal 2005, respectively. The difference between the provision for income taxes and the amount computed by applying the federal statutory income tax rate (35 percent) toincome (loss) before taxes is explained below (in thousands): Year Ended July 1,2007 July 2,2006 July 3,2005 Tax at federal statutory rate (benefit) $(4,220) $3,608 $5,622 Federal alternative minimum tax (15) 40 — State income tax, net of federal benefit 65 74 81 Unbenefited foreign taxes 83 29 650 Valuation allowance 3,993 (2,765) 20 Foreign earnings taxed at other than U.S. rates (7,265) (4,998) (3,026)Deferred compensation 568 396 22 Dividends from foreign subsidiary 8,750 5,250 — Other 181 164 174 Provision for income taxes $2,140 $1,798 $3,543 89Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Significant components of our deferred tax assets are as follows (in thousands): July 1,2007 July 2,2006 Deferred tax assets: Net operating loss carryforwards $78,358 $71,923 Tax credit carryforwards 20,381 19,075 Depreciation 19,407 19,508 Deferred revenue 4,860 5,379 Warrant amortization 16,326 17,167 Inventory write-downs 1,038 1,489 Other allowances and accruals 9,456 8,851 Other 17,932 15,719 Total deferred tax assets 167,758 159,111 Valuation allowance (166,640) (158,611)Total net deferred tax assets 1,118 500 Deferred tax liabilities: Unrealized gain on investments — — Deferred tax liability on foreign withholdings (688) (579)Total deferred tax liabilities (688) (579)Net deferred tax assets (liabilities) $430 $(79)Recorded as: Net current deferred tax assets $1,118 $500 Net non-current deferred tax liabilities (688) (579)Net deferred tax assets (liabilities) $(430) $(79) Our valuation allowance increased by $8.0 million in fiscal 2007, decreased by $17.2 million in fiscal 2006 and increased by $1.1 million in fiscal2005. We have provided a full valuation allowance against all of our U.S. federal and state deferred tax assets. The valuation allowance is determined inaccordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, (“SFAS 109”), which requires anassessment of both negative and positive evidence when measuring the need for a valuation allowance. Our losses in recent periods represent sufficientnegative evidence to require a valuation allowance under SFAS 109. This valuation allowance will be evaluated periodically and can be reversed partially ortotally if business results have sufficiently improved to support realization of our deferred tax assets. As of July 1, 2007, we had net operating loss carryforwards for federal and state tax purposes of $268.5 million and $45.6 million, respectively, ofwhich $53.1 million and $21.3 million, respectively represent deductions from share-based compensation for which a benefit would be recorded in additionalpaid-in capital when realized. We also had federal and state tax credit carryforwards of $10.8 million and $14.8 million, respectively, as of July 1, 2007.Federal net operating loss carryforwards of $268.5 million will start to expire beginning 2021 through 2027 and state net operating losses of $45.6 millionwill expire between 2011 through 2017, if not utilized. Federal tax credits of $10.4 million will expire beginning 2012 through 2027 and state tax credits of$1.4 million will expire beginning 2008 through 2013, if not utilized. Under FAS 123R, the deferred tax asset for net operating losses excludes deductionsfor excess tax benefits related to share-based compensation. Utilization of the net operating losses and tax credits may be subject to a substantial annual limitation due to the ownership change limitationsprovided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operatinglosses and tax credits before utilization. 90Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 9. Disclosure about Segments of an Enterprise and Geographic Areas Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly bythe chief operating decision makers with respect to the allocation of resources and performance. We operate in one segment, the development and marketing of network infrastructure equipment. We conduct business globally and are managedgeographically. Revenue is attributed to a geographical area based on the location of the customers. Information regarding geographic areas is as follows (in thousands): Year Ended July 1,2007 July 2,2006 July 3,2005Net revenues: United States $137,364 $145,870 $167,027Europe, Middle East and Africa 136,577 124,768 117,521Japan 17,844 35,812 58,100Other 51,049 52,151 40,699 $342,834 $358,601 $383,347 Substantially all of our assets were attributable to United States operations at July 1, 2007 and July 2, 2006. 10. 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 theperiod, less shares subject to repurchase, and excludes any dilutive effects of options, warrants and convertible subordinated notes. Dilutive earnings (loss)per share is calculated by dividing net income by the weighted average number of common shares used in the basic earnings (loss) per share calculation plusthe dilutive effect of shares subject to repurchase, options, warrants and convertible subordinated notes. The following table presents the calculation of basicand diluted net income (loss) per share (in thousands, except per share data): Year Ended July 1,2007 July 2,2006 July 3,2005Net income (loss) $(14,197) $8,509 $12,519Weighted-average shares used in per share calculation – basic 114,122 121,286 121,225Incremental share using the treasury stock method — 1,763 2,994Weighted-average share used in per share calculation – diluted 114,122 123,049 124,219Net income (loss) per share—basic $(0.12) $0.07 $0.10Net income (loss) per share—diluted $(0.12) $0.07 $0.10 91Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) The following table sets forth potential shares of common stock that are not included in the diluted net income (loss) per share calculation abovebecause to do so would be anti-dilutive for the periods presented (in thousands): Year Ended July 1,2007 July 2,2006 July 3,2005Weighted Stock options outstanding: In-the-money options 1,552 — — Out-of-the-money options 20,366 19,578 15,642Convertible subordinated notes — 9,542 9,542Total potential shares of common stock excluded from the computation of earnings per share 21,918 29,120 25,184 Weighted stock options outstanding representing common stock equivalents under the treasury method with an exercise price lower than theCompany’s average stock price for the periods presented (“In-the-money options”) are excluded from the calculation of diluted net loss per share since theeffect would have been anti-dilutive due to the net loss. Weighted stock options outstanding with an exercise price higher than the Company’s average stock price for the periods presented (“Out-of-the-money options”) are excluded from the calculation of diluted net income (loss) per share since the effect would have been anti-dilutive under the treasurystock method. The computation of diluted earnings (loss) per share for fiscal 2006 and fiscal 2005 excludes the impact of the conversion of the convertiblesubordinated notes, which are convertible into approximately 9.5 million shares of common stock, as the impact of adding back to income the after taxinterest expense associated with the convertible subordinated notes, and including the impact of the common shares to be issued, would be anti-dilutive inthe periods presented. 11. Foreign Currency Hedging SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted, requires that all derivatives be recorded onthe balance sheet at fair value. Changes in the fair value of derivatives that do not qualify, or are not effective as hedges, must be recognized currently inearnings. Accordingly, we record the forward contracts used to manage foreign exchange exposures in prepaid expenses and other current assets on theconsolidated balance sheets at fair value. Foreign Exchange Exposure Management – We denominate substantially all global sales in U.S. dollars. International sales subsidiaries generateoperating expenses in foreign currencies. We have a program of hedging forecasted and actual foreign currency risk with forward contracts to eliminate,reduce or transfer selected foreign currency risks that can be confidently identified and quantified. Hedges of anticipated transactions are designated anddocumented at inception as cash flow hedges and are evaluated for effectiveness at least quarterly. As the critical terms of the forward contract and theunderlying are matched at inception, forward contract effectiveness is calculated by comparing the cumulative change in the contract (on a forward toforward basis) to the change in fair value of the anticipated expense, with the effective portion of the hedge recorded in accumulated other comprehensiveincome (“OCI”). Values accumulated in OCI are subsequently reclassified into the consolidated statement of operations line item to which the hedgedtransaction relates in the period the anticipated expense is recognized in income. Any ineffectiveness is recognized immediately in other expense. Noineffectiveness was recognized in other expense in fiscal 2007, fiscal 2006, or fiscal 2005. 92Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) Forward contracts used to hedge the remeasurement of non-functional currency monetary assets and liabilities are recognized in other expensecurrently to mitigate reported foreign exchange gains and losses. Forward contracts generally have maturities of 60 days or less. 12. Restructuring Charges and Technology Agreement Restructuring Charges As of July 1, 2007, restructuring liabilities were $14.0 million and consisted of obligations under excess facility operating leases, net of projectedfuture sublease receipts, severance costs associated with a small reduction in force in the fourth quarter of fiscal 2007 impacting several functional areas, andcertain contract termination costs to eliminate redundant activities. During fiscal 2007 and 2006, we recorded restructuring charges of $4.0 million and $3.3million. The charges in fiscal 2007 included $1.1 million in the first through third quarter to rationalize our sales force in Japan, and $2.9 million in thefourth quarter to reduce headcount across several functional areas, terminate certain redundant contracts, and to exit an excess facility. The charge in fiscal2006 was for an excess facilities charge and represented an increase to the charge initially recognized during the third quarter of fiscal 2002. The commercialreal estate market continued to deteriorate in fiscal 2006 and we were not able to find suitable tenants to sublease these facilities necessitating an additionalcharge due to lower projected sublease receipts. At several of the facilities, we have not yet been able to find suitable tenants to sublease the facilities and thecommercial real estate market in these areas continues to be weak. The lower projected sublease income necessitated an increase in the liability to take intoconsideration the unfavorable difference between lease obligation payments and projected sublease receipts. The actual costs could differ from our estimates,and additional adjustments to the restructuring liability could be recorded if we are able to negotiate reasonable termination fees on certain facilities, iffacility sub-lease rental rates change, or if other estimates and assumptions change. Restructuring liabilities consist of (in thousands): ExcessFacilities AssetImpairment ContractTermination Severance Total Balance at July 2, 2006 $17,042 — — — $17,042 Charge in fiscal 2007 418 83 1,098 2,403 4,003 Cash Payments (6,065) — — (992) (7,057)Balance at July 1, 2007 11,395 83 1,098 1,411 13,988 Less: current portion 2,939 83 1,098 1,411 5,532 Restructuring liabilities at July 1,2007, less current portion $8,456 — — — $8,456 Technology Agreement On March 31, 2005, we entered into a Patent and Cross License Agreement (“Technology Agreement”) with IBM. The agreement provides for a releaseof prior claims and a cross license of patents extending into the future from the effective date of the agreement. We charged the estimated value of the releaseof prior claims of $2.0 million to operating expenses in the quarter ended March 27, 2005 under the caption “Technology agreement”. The remaining valueunder this agreement has been recognized in other assets and is being amortized to cost of product revenue over its contractual period using the straight-linemethod of amortization. 93Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 13. Alliance with Avaya On October 30, 2003, Extreme Networks and Avaya Inc. entered into a strategic alliance to jointly develop and market converged communicationssolutions, by executing a Joint Development Agreement, and a distribution agreement under which Avaya is entitled to resell Extreme Networks products.Extreme issued to Avaya a warrant with a ten-year expiration period to purchase up to 2,577,794 shares of Extreme Networks common stock at a price of$0.01 per share, with Avaya having the right to exercise the warrant with respect to one third of such shares 90 days after the date of the agreements, and theremaining shares become exercisable based upon the completion of certain milestones by Avaya. Even if the milestones are not completed, however, thewarrant will become fully exercisable for all shares 90 days prior to the expiration of the warrant. Avaya exercised the warrant with respect to approximately859,000 of the shares subject to the warrant on March 17, 2004 and, approximately 859,000 of the shares subject to the warrant on August 8, 2005. We engaged an independent valuation firm to assist us in estimating the fair value of the warrant and to assist us with the allocation of the fair value tothe two agreements entered into. The independent valuation firm estimated the fair value of the warrant at $22.7 million, which has been allocated $17.9million to the Joint Development Agreement and $4.8 million to the distribution agreement based on the assumptions by management related to theprojected revenue and expenses for the respective agreements. The fair value of the warrant, net of accumulated amortization, is recorded in other assets in ourconsolidated balance sheets. The warrant values assigned to the respective agreements are being amortized over the terms of the agreements. On October 31, 2005, the Joint Development Agreement was amended to, among other things, extend the term one additional year. The estimatedamortization period was changed in the second quarter of fiscal 2006 to extend the amortization period over the remaining term of the amended JointDevelopment Agreement. The amortization of the warrant cost related to the Joint Development Agreement recorded as research and development expensewas $3.0 million in fiscal 2007, as compared to $4.0 million in fiscal 2006. On October 14, 2004, the Distribution Agreement was amended to, among otherthings, extend the term by one additional year. During the quarter ended January 1, 2006, we determined that the amortization period for the portion of thewarrant value assigned to the Distribution Agreement should have been extended when the term of the Distribution Agreement was extended in October2004. We recorded the cumulative adjustment to the amortization of approximately $0.5 million in the quarter ended January 1, 2006. We concluded that theeffect of this adjustment was not material to the affected prior annual or interim periods. The amortization of the warrant value related to the DistributionAgreement, recorded as a reduction of product revenue, was $1.1 million in fiscal 2007, compared to $0.7 million in fiscal 2006. 94Table of ContentsEXTREME NETWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) 14. Quarterly Financial Data (Unaudited) Quarterly results for the years ended July 1, 2007 and July 2, 2006 follow: July 1,2007(1) Apr 1,2007(2) Dec 31,2006(3) Oct 1,2006(4) (In thousands, except per share amounts) Net revenues $87,098 $85,119 $86,853 $83,763 Gross margin $47,703 $47,866 $46,476 $43,151 Net income (loss) $(5,045) $(2,363) $(1,860) $(4,927)Net income (loss) per share-basic $(0.04) $(0.02) $(0.02) $(0.04)Net income (loss) per share-diluted $(0.04) $(0.02) $(0.02) $(0.04) July 2,2006(5) Apr 2,2006(6) Jan 1,2006(7) Oct 2,2005(8) Net revenues $82,442 $85,450 $92,787 $97,922 Gross margin $43,594 $46,212 $50,782 $53,288 Net income (loss) $(4,335) $2,841 $5,650 $4,353 Net income (loss) per share-basic $(0.04) $0.02 $0.05 $0.04 Net income (loss) per share-diluted $(0.04) $0.02 $0.05 $0.03 (1)Net loss and net loss per share include the effect of stock-based compensation expense of $1.2 million, of which $0.1 million is the cumulative effect ofmodifying our estimated forfeiture rate for fiscal 2007 during the fourth quarter of such year, stock-option investigation expense of $1.3 million and arestructuring charge of $2.9 million.(2)Net loss and net loss per share include the effect of stock-based compensation expense of $1.3 million, stock-option investigation expense of $2.8million and a restructuring charge of $0.2 million.(3)Net loss and net loss per share include the effect of stock-based compensation expense of $1.8 million, stock-option investigation expense of $2.8million and a restructuring charge of $0.2 million.(4)Net loss and net loss per share include the effect of stock-based compensation expense of $1.9 million and a restructuring charge of $1.5 million.(5)Net loss and net loss per share include the effect of stock-based compensation expense of $2.2 million, of which $0.6 million is the cumulative effect ofmodifying our estimated forfeiture rate for fiscal 2006 during the fourth quarter of such year.(6)Net income and net income per share include the effect of stock-based compensation expense of $1.3 million.(7)Net income and net income per share include the effect of stock-based compensation expense of $1.6 million.(8)Net income and net income per share include the effect of stock-based compensation expense of $1.9 million. Quarterly and year-to-date computations of per share amounts are made independently. Therefore, the sum of per share amounts for the quarters maynot agree with per share amounts for the year. 95Table of Contents Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in theCompany’s reports filed under the Securities Exchange Act of 1934 (the “Exchange Act”), such as this Report, is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms and to reasonably assure that such information is accumulated and communicated tothe Company’s management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluatedthe effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Report. Based on thisevaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of July 1, 2007. Management’s Report on Internal Control over Financial Reporting The Company’s management is responsible for establishing and maintaining adequate internal control over the company’s financial reporting. Thereare inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding ofcontrols. Accordingly, even effective internal controls can provide only reasonable assurances with respect to financial statement preparation. Furtherbecause of changes in conditions, the effectiveness of internal control may vary over time. The Company assessed the effectiveness of its internal control over financial reporting as of July 1, 2007. In making this assessment, we used thecriteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment using those criteria, we concluded that, as of July 1, 2007, Extreme Networks Inc.’s internal control over financial reporting iseffective. Extreme Networks Inc.’s independent registered public accounting firm, Ernst & Young LLP, has audited the financial statements included in this AnnualReport on Form 10-K and has issued its report on the Company’s internal control over financial reporting as of July 1, 2007. This report appears on page 99of this Annual Report on Form 10-K. Material Weakness in Prior Period As described in our Annual Report on Form 10-K for the fiscal year ended July 1, 2006, management identified a material weakness in the Company’sinternal control over financial reporting as of July 2, 2006, in that the design and operation of the Company’s internal controls were not effective to providereasonable assurance that material errors in the Company’s historical share-based compensation would be detected, in that, in light of the circumstances thatexisted as of July 2, 2006, the Company lacked effective procedures to retrospectively identify as of that date the material accounting errors in theCompany’s historical financial statements that were later discovered and which have now been corrected in connection with the restatement of theCompany’s 2000 through 2005 consolidated financial statements in the 2006 Form 10-K. As a result, as of July 2, 2006, the Company’s internal control overfinancial reporting was not effective as it related to the Company’s ability to retrospectively identify material accounting errors resulting from the Company’shistorical 96Table of Contentsstock option grants. Additionally, the Company recorded a material adjustment to its consolidated balance sheet as of July 2, 2006 as a result of these errors.The principal accounts affected by this material weakness as of July 2, 2006 were common stock and accumulated deficit. As a result of the above material weakness, the Company concluded that, as of July 2, 2006, the Company’s internal control over financial reportingwas not effective. Remedial Measures Instituted by Extreme On September 11, 2006, based on information developed by Company management and at the Audit Committee’s recommendation, the Board ofDirectors formed the Special Committee to conduct an independent review of our historical practices for granting and accounting for stock options and topresent findings and recommendations to the Board. The Special Committee completed its independent review and the results of the review, including therestatement of the Company’s 2000 through 2005 consolidated financial statements reported in our fiscal 2006 Form 10-K. The completion of the SpecialCommittee’s independent review effectively remediated the material weakness in internal controls over financial reporting related to the ability toretrospectively identify the material accounting errors in the Company’s historical financial statements that existed as of July 2, 2006. The Special Committee found that the Company’s options granting and documentation processes improved substantially following the passage of theSarbanes-Oxley Act of 2002 and the implementation of new controls and procedures under the current Vice President of Human Resources (who joined theCompany in May 2003) and the current Vice President, Corporate Business Development, General Counsel and Secretary (who joined the Company inFebruary 2004). The Company determined that its procedures were effective in enabling the Company to appropriately determine measurement date(s) foroptions grants made subsequent to fiscal 2004, and that the Company’s controls during the periods from the end of fiscal 2004 through fiscal 2006 wereeffective in enabling the Company to properly account for stock option grants made during that period. The material weakness identified by the Company asof July 2, 2006 did not affect the Company’s internal controls related to recording of and accounting for stock options granted during that period. The Special Committee recommended, and the Board adopted, new processes with regard to grants of equity compensation awards to Board members,officers, and non-officer employees alike, a summary of which is as follows: • The general practice for grants to all new hires, and for out of cycle promotions and merit purposes will be to make such grants once per quarter,during open trading windows only, on the second trading day following the public announcement of quarterly financial results, pursuant to a listto be circulated to the appropriate granting authority prior to the proposed approval date. • All grants to Officers, Vice Presidents and members of the Board of Directors are to be approved by the Board. • All other grants are to be approved by the Compensation Committee. • Grants are to be approved at Board or Compensation Committee meetings (not by UWC, except in extraordinary circumstances). • There is to be no delegated granting authority to management. • The Board and management are to continue monitoring processes and policies recommended by the SEC, self-regulatory authorities and outsideadvisors. • All Board and Committee minutes are to be circulated to the directors as soon as reasonably practicable (generally, within two weeks of meeting).Counsel should attend all Board and Compensation Committee meetings. 97Table of Contents • The Board has directed management to propose a mechanism for monitoring compliance with and reporting to the Board on the Company’spolicies and procedures relating to options grants. These new processes adopted by the Board in April 2007 are designed to ensure that the Company continues to employ best practices and procedureswith respect to equity compensation awards. Changes in Internal Control over Financial Reporting Other than the changes described under “Remedial Measures Instituted by Extreme” above, there were no changes in our internal control over financialreporting during the quarter ended July 1, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financialreporting. Item 9B. Other Information Not applicable. 98Table of ContentsReport of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting The Board of Directors and StockholdersExtreme Networks, Inc. We have audited Extreme Networks, Inc.’s internal control over financial reporting as of July 1, 2007 based on criteria established in Internal Control –Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Extreme Networks, Inc.’smanagement is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal controlover financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to expressan opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weaknessexists, testing and evaluating the design and operating effectiveness of internal control based on assessed risk, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of thecompany are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on thefinancial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of anyevaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate. In our opinion, Extreme Networks, Inc. maintained, in all material respects, effective internal control over financial reporting as of July 1, 2007, basedon the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balancesheets of Extreme Networks, Inc. as of July 1, 2007 and July 2, 2006 and the related consolidated statements of operations, stockholders’ equity, and cashflows for each of the three years in the period ended July 1, 2007 of Extreme Networks, Inc. and our report dated August 28, 2007 expressed an unqualifiedopinion thereon. Ernst & Young LLP Palo Alto, CaliforniaAugust 28, 2007 99Table of Contents PART III Certain information required by Part III is incorporated by reference from Extreme’s definitive Proxy Statement to be filed with the Securities andExchange Commission in connection with the solicitation of proxies for Extreme’s 2007 Annual Meeting of Stockholders (the “Proxy Statement”) not laterthan 120 days after the end of the fiscal year covered by this report, and certain information therein is incorporated in this report by reference. Item 10. Directors and Executive Officers of the Registrant The information required by this section is incorporated by reference from the information in the section entitled “Proposal 1—Election of Directors”in the Proxy Statement. The required information concerning executive officers of Extreme is contained in the section entitled “Executive Officers of theRegistrant” in Part I, Item 1 of this Form 10-K. Item 405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16 of the 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. Information with respect to Item 406 of Regulation S-K is incorporated by reference to the information contained in the section captioned “Code ofEthics” in the Proxy Statement. Item 11. Executive Compensation The information required by this section is incorporated by reference from the information in the sections entitled “Directors’ Compensation”,“Executive Compensation” and “Report of the Compensation Committee on Executive Compensation” in the Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this section is incorporated by reference from the information in the section entitled “Security Ownership of CertainBeneficial Owners and Management” in the Proxy Statement. The information required by this section regarding securities authorized for issuance under equity compensation plans is incorporated by referencefrom the information in the section entitled “Equity Compensation Plan Information” in the Proxy Statement. Item 13. Certain Relationships and Related Transactions The information required by this section is incorporated by reference from the information in the section titled “Certain Relationships and RelatedTransactions” in the Proxy Statement. Item 14. Principal Accountant Fees and Services The information required by this section is incorporated by reference from the information in the section titled “Principal Accountant Fees andServices” in the Proxy Statement. 100Table of Contents PART IV Item 15. Exhibits and Financial Statement Schedules (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: The following financial statement schedule of Extreme Networks, Inc. for the fiscal years ended July 1, 2007, July 2, 2006, and July 3, 2005 is filed aspart of this Report and should be read in conjunction with the Consolidated Financial Statements of Extreme Networks, Inc. PageSchedule II – Valuation and Qualifying Accounts 103 All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. (3)Exhibits: The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to befiled as an exhibit to this Form 10-K has been identified. ExhibitNumber Incorporated by Reference FiledHerewith Description of Document Form FilingDate Number 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., aDelaware Corporation. S-1 02/05/99 3.2 3.4 Amended and Restated Bylaws of Extreme Networks, Inc. 8-K 10/31/06 99.1 3.5 Restated Certificate of Incorporation of Extreme Networks, Inc. 10-K 09/26/01 3.5 3.6 Certificate of Amendment of Restated Certificate of Incorporation of Extreme Networks, Inc. 10-K 09/26/01 3.6 3.7 Certificate of Designation, Preferences and Rights of the Terms of the Series A Preferred Stock. 10-K 09/26/01 3.7 4.1 Second Amended and Restated Rights Agreement dated January 12, 1998 between ExtremeNetwork and certain stockholders. S-1 02/05/99 4.1 4.2 Rights Agreement dated April 27, 2001 between Extreme Networks, Inc. and Mellon InvestorServices LLC. 8-K/A 06/07/01 4.2 4.3 Indenture, dated December 5, 2001 between Extreme Networks, Inc. and State Street Bank andTrust Company of California, N.A. S-3 02/26/02 4.3 101Table of ContentsExhibitNumber Incorporated by Reference FiledHerewith Description of Document Form FilingDate Number 4.4 Registration Rights Agreement dated December 5, 2001 between Extreme Networks, Inc.and Goldman Sachs & Co., as representative. S-3 02/26/02 4.4 4.5 Warrant to Purchase Common Stock issued to Avaya, Inc. S-3 01/28/04 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* 2000 Nonstatutory Stock Option Plan. 10-K 09/24/00 10.7 10.5 Lease agreement dated July 28, 2000 between San Tomas Properties LLC, a Delawarelimited liability company, as Landlord, and Extreme Networks, Inc, a DelawareCorporation, as Tenant. 10-Q 11/14/00 10.14 10.6 Purchase Agreement dated November 29, 2001 between Extreme Networks, Inc. andGoldman Sachs & Co., as representative. S-3 02/26/02 10.15 10.7* 2001 Nonstatutory Stock Option Plan. Schedule TO 10/31/01 (d)(9) 10.8* Consulting Agreement dated August 2, 2006 between Extreme Networks, Inc. andWilliam Slakey 10-Q 6/28/07 10.9 10.9* Offer of Employment Letter dated August 18, 2006 from Extreme Networks, Inc. to MarkCanepa 8-K 09/05/06 99.1 10.10* Revised compensation policies for non-employee service on the Board of Directors andits committees. 8-K 10/31/06 Item 1.01 10.11* Extreme Networks, Inc. Fiscal 2007 Executive Incentive Bonus Plan. 8-K 11/21/06 99.1 10.12* Fiscal 2007 commission bonus plan for Senior Vice President, Sales. 8-K 11/21/06 Item 5.02 10.13* Offer Letter for Employment between Extreme Networks, Inc. and Karen Rogge dated asof March 13, 2007. 8-K 03/29/07 99.2 10.14* Extreme Networks, Inc. Fiscal 2008 Executive Incentive Bonus Plan. 8-K 08/06/07 99.1 21.1 Subsidiaries of Registrant. X23.1 Consent of Independent Registered Public Accounting Firm. X24.1 Power of Attorney (see page 104 of this Form 10-K). X31.1 Section 302 Certification of Chief Executive Officer. X31.2 Section 302 Certification of Chief Financial Officer. X32.1 Section 906 Certification of Chief Executive Officer. X32.2 Section 906 Certification of Chief Financial Officer. X*Indicates management contract or compensatory plan or arrangement. 102Table of ContentsSCHEDULE II VALUATION AND QUALIFYING ACCOUNTSYEARS ENDED JULY 1, 2007, JULY 2, 2006, AND JULY 3, 2005 Description Balance atbeginningof period Charges tocosts andexpenses Reversalsto costs andexpenses Charged tootheraccounts(1) (Deductions) Balance atend ofperiodYear Ended July 3, 2005: Allowance for doubtful accounts $1,378 $58 $(110) $— $(79) $1,247Allowance for sales returns $2,226 $1,344 $(300) $— $(945) $2,325Allowance for distributor doubtful accounts $724 $532 $(100) $— $(537) $619Inventory write-downs $6,365 $1,061 $— $— $(2,636) $4,790Allowance for net deferred tax assets $174,740 $1,055 $— $— $— $175,795Year Ended July 2, 2006: Allowance for doubtful accounts $1,247 $603 $(883) $— $(280) $687Allowance for sales returns $2,325 $1,014 $(275) $— $(1,364) $1,700Allowance for distributor doubtful accounts $619 $1,447 $— $— $(1,766) $300Inventory write-downs $4,790 $1,259 $— $— $(913) $5,136Allowance for net deferred tax assets $175,795 $— $(17,184) $— $— $158,611Year Ended July 1, 2007: Allowance for doubtful accounts $687 $— $87 $— $(40) $734Allowance for sales returns $1,700 $3,377 $(221) $— $(3,087) $1,769Allowance for distributor doubtful accounts $300 $— $— $(75) $— $225Inventory write-downs $5,136 $3,030 $— $(1,737) $(3,497) $2,932Allowance for net deferred tax assets $158,611 $8,029 $— $— $— $166,640(1)In fiscal 2007, we transferred $1.7 million of non-RoHS compliant inventory to service inventory and $0.1 million from allowance for distributordoubtful accounts to allowance for doubtful accounts. 103Table of Contents SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized, on August 30, 2007. EXTREME NETWORKS, INC.(Registrant)By: /S/ KAREN M. ROGGE Karen M. Rogge Senior Vice President & Chief Financial Officer August 30, 2007 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Mark Canepa and Karen M.Rogge, and each of them, his or her true and lawful attorneys-in-fact, each with full power of substitution, for him or her in any and all capacities, to sign anyamendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities andExchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done byvirtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the date indicated: /S/ GORDON L. STITT /S/ MARK CANEPA Gordon L. Stitt Mark CanepaChairman of the Board President, Chief Executive Officer, DirectorAugust 30, 2007 (Principal Executive Officer) August 30, 2007/S/ KAREN M. ROGGE /S/ MICHAEL J. PALU Karen M. Rogge Michael J. PaluSenior Vice President & Chief Financial Officer Vice President, Corporate Controller(Principal Financial Officer)August 30, 2007 (Principal Accounting Officer)August 30, 2007/S/ MIKE WEST /S/ CHARLES CARINALLI Mike West Charles CarinalliDirector DirectorAugust 30, 2007 August 30, 2007/S/ BOB L. COREY /S/ KENNETH LEVY Bob L. Corey Kenneth LevyDirector DirectorAugust 30, 2007 August 30, 2007/S/ HARRY SILVERGLIDE Harry Silverglide Director August 30, 2007 104Table of ContentsEXHIBIT INDEX ExhibitNumber Incorporated by Reference FiledHerewith Description of Document Form FilingDate Number 2.1 Form of Agreement and Plan of Merger between Extreme Networks, a Californiacorporation, 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 10/31/06 99.1 3.5 Restated Certificate of Incorporation of Extreme Networks, Inc. 10-K 09/26/01 3.5 3.6 Certificate of Amendment of Restated Certificate of Incorporation of Extreme Networks,Inc. 10-K 09/26/01 3.6 3.7 Certificate of Designation, Preferences and Rights of the Terms of the Series A PreferredStock. 10-K 09/26/01 3.7 4.1 Second Amended and Restated Rights Agreement dated January 12, 1998 betweenExtreme Network and certain stockholders. S-1 02/05/99 4.1 4.2 Rights Agreement dated April 27, 2001 between Extreme Networks, Inc. and MellonInvestor Services LLC. 8-K/A 06/07/01 4.2 4.3 Indenture, dated December 5, 2001 between Extreme Networks, Inc. and State StreetBank and Trust Company of California, N.A. S-3 02/26/02 4.3 4.4 Registration Rights Agreement dated December 5, 2001 between Extreme Networks,Inc. and Goldman Sachs & Co., as representative S-3 02/26/02 4.4 4.5 Warrant to Purchase Common Stock issued to Avaya, Inc. S-3 01/28/04 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* 2000 Nonstatutory Stock Option Plan. 10-K 09/24/00 10.7 10.5 Lease agreement dated July 28, 2000 between San Tomas Properties LLC, a Delawarelimited liability company, as Landlord, and Extreme Networks, Inc, a DelawareCorporation, as Tenant. 10-Q 11/14/00 10.14 10.6 Purchase Agreement dated November 29, 2001 between Extreme Networks, Inc. andGoldman Sachs & Co., as representative. S-3 02/26/02 10.15 10.7* 2001 Nonstatutory Stock Option Plan. Schedule TO 10/31/01 (d)(9) 10.8* Consulting Agreement dated August 2, 2006 between Extreme Networks, Inc. andWilliam Slakey 10-Q 6/28/07 10.9 105Table of ContentsExhibitNumber Incorporated by Reference FiledHerewith Description of Document Form FilingDate Number 10.9* Offer of Employment Letter dated August 18, 2006 from Extreme Networks, Inc. to MarkCanepa 8-K 09/05/06 99.1 10.10* Revised compensation policies for non-employee service on the Board of Directors and itscommittees. 8-K 10/31/06 Item 1.01 10.11* Extreme Networks, Inc. Fiscal 2007 Executive Incentive Bonus Plan. 8-K 11/21/06 99.1 10.12* Fiscal 2007 commission bonus plan for Senior Vice President, Sales. 8-K 11/21/06 Item 5.02 10.13* Offer Letter for Employment between Extreme Networks, Inc. and Karen Rogge dated as ofMarch 13, 2007. 8-K 03/29/07 99.2 10.14* Extreme Networks, Inc. Fiscal 2008 Executive Incentive Bonus Plan. 8-K 08/06/07 99.1 21.1 Subsidiaries of Registrant. X23.1 Consent of Independent Registered Public Accounting Firm. X24.1 Power of Attorney (see page 104 of this Form 10-K). X31.1 Section 302 Certification of Chief Executive Officer. X31.2 Section 302 Certification of Chief Financial Officer. X32.1 Section 906 Certification of Chief Executive Officer. X32.2 Section 906 Certification of Chief Financial Officer. X*Indicates management contract or compensatory plan or arrangement. 106EXHIBIT 21.1 SUBSIDIARIES OF REGISTRANT NAME LOCATIONExtreme Networks International Cayman IslandsExtreme Networks Japan K.K. JapanExtreme Networks Hong Kong Limited Hong KongExtreme Networks IHC, Inc. DelawareExtreme 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 Mexico, Ltda. MexicoExtreme Networks Chile, Ltda. ChileExtreme Networks Singapore PTE, Ltd. SingaporeExtreme Networks China Ltd. ChinaExtreme Networks Spain, SL SpainExtreme Networks Switzerland GmbH SwitzerlandExtreme Networks India Private Limited IndiaExtreme Networks Mauritius Mauritius Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the following Registration Statements: Form Number Registration Statement Number DescriptionForm S-8 333-112831 Extreme Networks, Inc. Amended 1996 Stock Option Plan and 1999Employee Stock Purchase PlanForm S-3 333-112281 Common Stock Issuable on Exercise of WarrantForm S-8 333-105767 Extreme Networks, Inc. Amended 1996 Stock Option PlanForm S-8 333-76798 Extreme Networks, Inc. Amended 1996 Stock Option PlanForm S-8 333-65636 Extreme Networks, Inc. 2001 Nonstatutory Stock Option PlanForm S-8 333-58634 Extreme Networks, Inc. Individual Option Agreements Granted Under theWebstacks, Inc. 2000 Stock Option Plan and Assumed by ExtremeNetworks, Inc.Form S-8 333-55644 Extreme Networks, Inc. Individual Option Agreements Granted Under theOptranet, Inc. 2000 Option Plan and Assumed by Extreme Networks, Inc.Form S-8 333-54278 Extreme Networks, Inc. Amended 1996 Stock Option Plan, 1999Employee Stock Purchase Plan and 2000 Nonstatutory Stock OptionPlanForm S-8 333-131705 Extreme Networks, Inc. 2005 Equity Incentive Plan and 1999 EmployeeStock Purchase Plan of our reports dated August 28, 2007, with respect to the consolidated financial statements and schedule of Extreme Networks, Inc. and Extreme Networks,Inc.’s internal control over financial reporting, included in this Annual Report (Form 10-K) for the year ended July 1, 2007. Ernst & Young LLP Palo Alto, CaliforniaAugust 28 , 2007 EXHIBIT 31.1 I, Mark Canepa, Chief Executive Officer of the Company, certify that: 1.I have reviewed this annual report on Form 10-K of Extreme Networks, Inc.; 2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; 3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report; 4.The Company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the Company and have: (a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared; (b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accounting principles; (c)Evaluated the effectiveness of the Company’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d)Disclosed in this report any change in the Company’s internal control over financial reporting that occurred during the Company’s mostrecent fiscal quarter (the Company’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonablylikely to materially affect, the Company’s internal control over financial reporting; and 5.The Company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theCompany’s auditors and the audit committee of the Company’s board of directors (or persons performing the equivalent function): (a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the Company’s ability to record, process, summarize and report financial information; and (b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internalcontrol over financial reporting. Dated: August 30, 2007 /s/ MARK CANEPA Mark CanepaPresident, Chief Executive Officer EXHIBIT 31.2 I, Karen M. Rogge, Senior Vice President and Chief Financial Officer, certify that: 1.I have reviewed this annual report on Form 10-K of Extreme Networks, Inc.; 2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport; 3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report; 4.The Company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the Company and have: (a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared; (b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accounting principles; (c)Evaluated the effectiveness of the Company’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d)Disclosed in this report any change in the Company’s internal control over financial reporting that occurred during the Company’s mostrecent fiscal quarter (the Company’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonablylikely to materially affect, the Company’s internal control over financial reporting; and 5.The Company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theCompany’s auditors and the audit committee of the Company’s board of directors (or persons performing the equivalent function): (a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the Company’s ability to record, process, summarize and report financial information; and (b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internalcontrol over financial reporting. Dated: August 30, 2007 /s/ KAREN M. ROGGE Karen M. RoggeSenior Vice President and Chief Financial Officer EXHIBIT 32.1 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Extreme Networks, Inc. (the “Company”) on Form 10-K for the fiscal year ended July 1, 2007, as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), the undersigned, in the capacities and on the dates indicated below, each herebycertify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of their knowledge: (1)The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ MARK CANEPAMark CanepaPresident, Chief Executive OfficerAugust 30, 2007 A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signaturethat appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will beretained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.EXHIBIT 32.2 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Extreme Networks, Inc. (the “Company”) on Form 10-K for the fiscal year ended July 1, 2007, as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), the undersigned, in the capacities and on the dates indicated below, each herebycertify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of their knowledge: (1)The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ KAREN M. ROGGEKaren M. RoggeSenior Vice President and Chief Financial OfficerAugust 30, 2007 A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signaturethat appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will beretained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

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