<PAGE>
--------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
-
EXCHANGE ACT OF 1934
For the quarter ended October 1, 2000 OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 000-25711
EXTREME NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 77-0430270
---------------------------- ------------------------------------
[State or other jurisdiction [I.R.S. Employer Identification No.]
of incorporation or organization]
3585 Monroe Street
Santa Clara, California 95051
--------------------------------------- ----------
[Address of principal executive offices] [Zip Code]
Registrant's telephone number, including area code: (408) 579-2800
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
-
The number of shares of the Registrant's Common Stock, $.001 par value,
outstanding at November 1, 2000 was 107,609,207
--------------------------------------------------------------------------------
<PAGE>
EXTREME NETWORKS, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED OCTOBER 1, 2000
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets
September 30, 2000 and June 30, 2000 3
Condensed Consolidated Statements of Operations
Three months ended September 30, 2000 and September 30, 1999 4
Condensed Consolidated Statements of Cash Flows
Three months ended September 30, 2000 and September 30, 1999 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings Not Applicable
Item 2. Changes in Securities Not Applicable
Item 3. Defaults Upon Senior Securities Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders Not Applicable
Item 5. Other Information Not Applicable
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
</TABLE>
2
<PAGE>
Part I. Financial Information
Item 1. Financial Statements
EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
September 30, June 30,
2000 2000
------------- -------------
(Unaudited) (Note 1)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 63,506 $116,721
Short-term investments 49,593 66,640
Accounts receivable, net 74,186 60,996
Inventories 59,228 23,801
Other current assets 31,993 34,326
------------- -------------
Total current assets 278,506 302,484
Property and equipment, net 37,585 26,750
Restricted investments 80,000 80,000
Investments 73,165 44,144
Goodwill and purchased intangibles 43,704 49,782
Other assets 15,951 12,770
------------- -------------
$528,911 $515,930
============= =============
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 33,062 $ 39,023
Accrued compensation 10,276 11,041
Leasehold improvements allowance 8,250 8,424
Deferred revenue 26,134 22,042
Other accrued liabilities 12,424 12,935
Income tax liability - 3,138
------------- -------------
Total current liabilities 90,146 96,603
Long term deposit 306 306
Commitments (Note 4)
Stockholders' equity:
Common stock 107 106
Additional paid-in capital 437,373 423,044
Deferred stock compensation (57) (78)
Accumulated other comprehensive loss (68) (623)
Retained earnings (accumulated deficit) 1,104 (3,428)
Total stockholders' equity 438,459 419,021
------------- -------------
$528,911 $515,930
============= =============
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
3
<PAGE>
EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Net revenue $ 119,342 $ 47,218
Cost of revenue 58,090 22,617
------------- -------------
Gross profit 61,252 24,601
Operating expenses:
Research and development 11,743 6,899
Sales and marketing 35,115 11,080
General and administrative 4,279 2,533
Amortization of goodwill and purchased intangibles 6,850 -
------------- -------------
Total operating expenses 57,987 20,512
Operating income 3,265 4,089
Interest and other income, net 3,709 1,692
------------- -------------
Income before income taxes 6,974 5,781
Provision for income taxes 2,441 1,734
------------- -------------
Net income $ 4,533 $ 4,047
============= =============
* Basic net income per share $ 0.04 $ 0.04
============= =============
* Diluted net income per share $ 0.04 $ 0.04
============= =============
* Weighted average shares outstanding used in computing basic net
income per share 105,990 94,052
============= =============
* Weighted average shares outstanding used in computing diluted net
income per share 118,892 107,166
============= =============
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
* Share and per-share data presented reflect the two-for-one stock split
effective August 24, 2000
4
<PAGE>
EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Operating activities:
Net income $ 4,533 $ 4,047
Adjustments to reconcile net income to net cash provided by
(used for) operating activities:
Depreciation 2,984 1,677
Amortization 6,955 -
Amortization of deferred stock compensation 21 35
Loss on equity investments 750 -
Compensation expense for options granted to consultants 210 -
Changes in assets and liabilities:
Accounts receivable (13,190) (1,594)
Inventories (35,427) (2,135)
Other current and noncurrent assets 525 (1,397)
Accounts payable (5,961) (251)
Accrued compensation (765) (286)
Leasehold improvements allowance (174) -
Deferred revenue 4,092 4,097
Other accrued liabilities (511) 1,633
Income taxes payable 2,530 1,641
------------- -------------
Net cash provided by (used for) operating activities (33,428) 7,467
------------- -------------
Investing activities:
Capital expenditures (13,819) (5,221)
Purchases and maturities of investments, net (11,418) (1,205)
Minority investments (3,000) -
------------- -------------
Net cash used for investing activities (28,237) (6,426)
------------- -------------
Financing activities:
Proceeds from issuance of common stock 8,450 1,623
Principal payments of capital lease obligations - (150)
------------- -------------
Net cash provided by financing activities 8,450 1,473
------------- -------------
Net increase (decrease) in cash and cash equivalents (53,215) 2,514
Cash and cash equivalents at beginning of period 116,721 107,143
------------- -------------
Cash and cash equivalents at end of period $ 63,506 $ 109,657
============= =============
</TABLE>
See accompanying notes to the unaudited condensed consolidated financial
statements.
5
<PAGE>
EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements have been prepared by
Extreme Networks, Inc., pursuant to the rules and regulations of the Securities
and Exchange Commission and include the accounts of Extreme Networks, Inc. and
its wholly-owned subsidiaries ("Extreme" or collectively, the "Company").
Certain information and footnote disclosures, normally included in financial
statements prepared in accordance with generally accepted accounting principles,
have been condensed or omitted pursuant to such rules and regulations. In the
opinion of the Company, the unaudited financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the financial position at September 30, 2000 and the
operating results and cash flows for the three months ended September 30, 2000
and September 30, 1999. The condensed balance sheet at June 30, 2000 has been
derived from audited financial statements as of that date. These financial
statements and notes should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto for the year ended June 30,
2000, included in the Company's Form 10-K filed with the Securities and Exchange
Commission.
The results of operations for the three months ended September 30, 2000 are
not necessarily indicative of the results that may be expected for the future
quarters or the fiscal year ending June 30, 2001. Certain items previously
reported in specific financial statement captions have been reclassified to
conform to the 2001 presentation. Such reclassifications have not impacted
previously reported operating income (loss).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Extreme Networks, Inc. ("Extreme" or the "Company") was incorporated in
California on May 8, 1996 and was reincorporated in Delaware on March 31, 1999.
Extreme is a leading provider of high-performance, broadband networking
solutions designed for the Internet economy.
Fiscal Year
Effective July 1, 1999, Extreme changed its fiscal year from June 30th to a
52/53-week fiscal accounting year. The September 30, 2000 quarter closed on
October 1, 2000 and comprised 13 weeks of revenue and expense activity.
Principles of Consolidation
The consolidated financial statements include the accounts of Extreme and
its wholly-owned subsidiaries. All significant inter-company balances and
transactions have been eliminated. Investments in which management intends to
maintain more than a temporary 20% to 50% interest, or otherwise has the ability
to exercise significant influence, are accounted for under the equity method.
Investments in which we have less than a 20% interest and/or do not have the
ability to exercise significant influence are carried at the lower of cost or
estimated realizable value.
Assets and liabilities of foreign operations are translated to U.S. dollars
at current rates of exchange, and revenues and expenses are translated using
weighted average rates. Foreign currency transaction gains and losses have not
been material. Gains and losses from foreign currency translation are included
as a separate component of other comprehensive income (loss).
Accounting Estimates
6
<PAGE>
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Estimates are used for, but not limited
to, the accounting for doubtful accounts, inventory reserves, depreciation and
amortization, sales returns, warranty costs and income taxes. Actual results
could differ from these estimates.
Cash Equivalents and Short-Term Investments
Extreme considers cash and all highly liquid investment securities
purchased with an original or remaining maturity of less than three months at
date of purchase to be cash equivalents Extreme's investments comprise U.S.,
state and municipal government obligations and corporate securities. Investments
with maturities of less than one year are considered short term and investments
with maturities greater than one year are considered long term.
To date, all marketable securities have been classified as available-for-
sale and are carried at fair value, with unrealized gains and losses, when
material, reported net-of-tax as a separate component of other comprehensive
income. Realized gains and losses on available-for-sale securities are included
in interest income. The cost of securities sold is based on specific
identification. Premiums and discounts are amortized over the period from
acquisition to maturity and are included in investment income, along with
interest and dividends.
Fair Value of Financial Instruments
The carrying amounts of certain of Extreme's financial instruments,
including cash and equivalents, approximate fair value because of their short
maturities. The fair values of investments are determined using quoted market
prices for those securities or similar financial instruments.
Transfer of Financial Assets
The Company from time to time transfers specifically identified accounts
receivable balances from customers to financing institutions, on a non-recourse
basis. The Company records such transfers as sales of the related accounts
receivable when it is considered to have surrendered control of such receivables
under the provisions of Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." The impact of the above transaction reduced receivables and
increased cash flows from operating activities in the consolidated statements of
cash flows.
Inventories
Inventories consist of raw materials and finished goods and are stated at
the lower of cost or market (on a first-in, first-out basis).
Inventories consist of:
<TABLE>
<CAPTION>
September 30, 2000 June 30, 2000
------------------ -------------
<S> <C> <C>
Raw materials $ 24,561 $ 9,501
Finished goods 34,667 14,300
------------------------------------
Total $ 59,228 $ 23,801
====================================
</TABLE>
Restricted Investments
Extreme restricted $80.0 million of its investment securities as collateral
for specified obligations of the lessee under an operating lease for its campus
facility. These investment securities are restricted as to withdrawal and are
managed by a third party subject to certain limitations under the Company's
investment policy.
7
<PAGE>
Concentration of Credit Risk, Product and Significant Customers
Financial instruments that potentially subject Extreme to concentration of
credit risk consist principally of marketable investments and accounts
receivable. Extreme has placed its investments with high-credit quality issuers.
Extreme will not invest an amount exceeding 10% of the corporation's combined
cash, cash equivalent, short-term and long-term investments, in the securities
of any one obligor or maker, except for obligations of the United States,
obligations of United States agencies and money market accounts. Extreme
performs ongoing credit evaluations of its customers and generally does not
require collateral. To date, credit losses have been insignificant and within
management's expectations. Extreme operates solely within one business segment,
the development and marketing of switching solutions for the Internet economy.
Significant customer concentration is summarized below. No other customer
accounts for more than 10% of Extreme's net revenues.
<TABLE>
<CAPTION>
Three Months Ended
------------------
Customer September 30, 2000 September 30, 1999
------------------ ------------------
<S> <C> <C>
Tech Data Corporation 13% -
Compaq - 23%
Hitachi Cable - 11%
</TABLE>
Goodwill and Purchased Intangible Assets
We record goodwill when the cost of net assets we acquire exceeds their
fair value. Goodwill is amortized on a straight-line basis over lives ranging
from 2 to 4 years. The cost of identified intangibles is generally amortized on
a straight-line basis over periods ranging from 2 to 4 years. We regularly
perform reviews to determine if the carrying value of assets is impaired. The
reviews look for the existence of facts or circumstances, either internal or
external, which indicate that the carrying value of the asset cannot be
recovered. No such impairment has been indicated to date. If, in the future,
management determines the existence of impairment indicators, we would use
undiscounted cash flows to initially determine whether impairment should be
recognized. If necessary, we would perform a subsequent calculation to measure
the amount of the impairment loss based on the excess of the carrying value over
the fair value of the impaired assets. If quoted market prices for the assets
are not available, the fair value would be calculated using the present value of
estimated expected future cash flows. The cash flow calculations would be based
on management's best estimates, using appropriate assumptions and projections at
the time.
The total purchase price of the goodwill and purchased intangible assets
was allocated based on an independent appraisal obtained by the Company, to the
tangible and intangible assets acquired based on their respective fair values on
the date of acquisition as follows (in thousands):
Customer list............................................... $ 4,169
Acquired workforce.......................................... 4,615
Goodwill.................................................... 48,927
--------
Amortization of goodwill and purchased intangibles assets... (14,007)
========
$ 43,704
========
Revenue Recognition
Extreme generally recognizes product revenue at the time of shipment,
unless Extreme has future obligations such as installation or has to obtain
customer acceptance. When significant obligations remain after products are
delivered, revenue is only recognized after such obligations are fulfilled.
Amounts billed in excess of revenue recognized are included as deferred
revenue in the accompanying consolidated balance sheets. Extreme has established
a program which, under specified conditions, enables third party resellers to
return products to us. The amount of potential product returns is estimated and
provided for in the period of the sale. Revenue from service obligations is
recognized ratably over the term of the contract period, which
8
<PAGE>
is typically 12 months. Extreme makes certain sales to partners in two-tier
distribution channels. These customers are generally given privileges to return
a portion of inventory and participate in various cooperative marketing
programs. Extreme defers recognition of revenue on such sales until the product
is sold by the distributors and also maintains appropriate accruals and
allowances for all other programs.
Upon shipment of products to its customers, Extreme provides for the
estimated cost to repair or replace products that may be returned under
warranty. Extreme's warranty period is typically 12 months from the date of
shipment to the end user.
Advertising
We expense advertising costs as incurred. Advertising expenses for the
quarter ended September 30, 2000 and September 30, 1999 were approximately $0.4
million and $0.6 million, respectively.
Foreign Operations
Extreme's foreign offices consist of sales, marketing and support
activities through its foreign subsidiaries and overseas resellers and
distributors. Operating income (loss) generated by Extreme's operating foreign
subsidiaries and their corresponding identifiable assets were not material in
any period presented.
Extreme's export sales represented 51% and 42% of net revenue in the three
months ended September 30, 2000 and September 30, 1999, respectively. All of the
export sales to date have been denominated in U.S. dollars and were derived from
sales to Europe and Asia.
Net Income Per Share
Basic earnings per share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period, less
shares subject to repurchase, and excludes any dilutive effects of options,
warrants, and convertible securities. Dilutive earnings per common share is
calculated by dividing net income by the weighted average number of common
shares used in the basic earnings per common share calculation plus the dilutive
effect of options and warrants.
The following table presents the calculation of basic and diluted net
income per share (unaudited in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended
September 30,
2000 1999
---- ----
(Unaudited)
<S> <C> <C>
Net income $ 4,533 $ 4,047
======== ========
Weighted-average shares of common stock outstanding 107,151 98,770
Less: Weighted-average shares subject to repurchase (1,161) (4,718)
-------- --------
Weighted-average shares used in computing basic
net income per share 105,990 94,052
======== ========
Incremental shares using the treasury stock method 12,902 13,114
Weighted-average shares used in computing diluted
net income per share 118,892 107,166
======== ========
Basic net income per share $ 0.04 $ 0.04
======== ========
Diluted net income per share $ 0.04 $ 0.04
======== ========
</TABLE>
9
<PAGE>
Share and per-share data presented reflect the two-for-one stock split
effective to stockholders of record on August 10, 2000.
Accounting for Stock-Based Compensation
Extreme's grants of stock options are for a fixed number of shares to
employees with an exercise price equal to the fair value of the shares at the
date of grant. As permitted under SFAS Statement No. 123, "Accounting for Stock-
Based Compensation" ("FAS 123"), Extreme accounts for stock option grants to
employees and directors in accordance with APB Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25") and, accordingly, recognizes no
compensation expense for stock option grants with an exercise price equal to the
fair value of the shares at the date of grant.
Recently Issued Accounting Standards
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("FAS 133"). FAS 133 establishes methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. In June 1999, the FASB
issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133", which
extended the deferral of the application of FAS 133 to all fiscal quarters of
fiscal years beginning after June 15, 2000. In June 15, 2000 the FASB also
issued FAS 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities) an Amendment to FASB Statement No. 133". FAS 138 amends the
accounting and reporting standards of Statement 133 for certain derivative
instruments and certain hedging activities. The Company will be required to
adopt these pronouncements for the year ending June 30, 2001. Extreme enters
into foreign exchange forward contracts to offset the impact of currency
fluctuations on certain nonfunctional currency liabilities, denominated in
Japanese Yen, the Euro and British pound. The foreign exchange forward contracts
we enter into have original maturities ranging from one to three months. We do
not enter into foreign exchange forward contracts for trading purposes. We do
not expect gains or losses on these contracts to have a material impact on our
financial results (see Note 4 to the Consolidated Financial Statements). We did
not hold any forward contracts at September 30, 2000.
In December 1999, the Staff of the Securities and Exchange Commission
("SEC") issued Staff Accounting Bulletin ("SAB") No.101, "Revenue Recognition in
Financial Statements", which provides guidance on the recognition, presentation
and disclosure of revenue in financial statements. The implementation of SAB 101
has recently been deferred to no later than the fourth fiscal quarter of fiscal
years beginning after December 15, 1999. Extreme is presently evaluating the
potential impact of the adoption of SAB 101.
In March 2000, the FASB issued Financial Accounting Standards Board
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation - an interpretation of APB Opinion No. 25" (Interpretation No. 44).
Interpretation No. 44 is effective July 1, 2000. The interpretation clarifies
the application of APB Opinion No. 25 for certain issues, specifically, (a) the
definition of an employee, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange or stock compensation awards in a business
combination. We do not anticipate that the adoption of Interpretation No. 44
will have a material impact on our financial position or the results of our
operations.
3. BUSINESS COMBINATIONS AND INVESTMENTS
During the fiscal year ended June 30, 2000, Extreme acquired certain assets
of a Company for a total cost of approximately $2.5 million of which $1.5
million has been paid as of September 30, 2000. During the quarter ended
September 30, 2000, Extreme acquired certain assets of a Company for a total
cost of $0.9 million. Extreme accounts for these acquisitions using the purchase
method of accounting, and incurs charges of approximately $212,000 per quarter
related to the amortization of goodwill over the estimated useful life of four
years. The entire purchase prices were allocated to goodwill and purchased
intangibles.
10
<PAGE>
In April 2000, Extreme issued fully earned, non-forfeitable, fully
exercisable warrants with a two year life to purchase 3 million shares of
Extreme's common stock with an exercise price of $39.50 per share to a
networking company in consideration of the networking company's selection of
Extreme as the preferred vendor of next generation core backbone switching
products to a certain group of the networking company's customers. The fair
value of the warrants was approximately $54.3 million. The warrants were valued
under a Black-Scholes model, using a volatility assumption of 1.04% and a two-
year term. The value of the warrants is being amortized over approximately two
years, which is the estimated economic life of the acquired intangibles,
comprising of customer list, workforce and goodwill.
Extreme has made several additional investments totaling $9.9 million,
which are reflected in "Other assets" in the accompanying consolidated balance
sheets. Two investments were made in entities in which a related party of
Extreme is also a significant investor. These investments totaled $2.7 million,
net of Extreme's share of these affiliates' losses of $1.0 million. As these
investments are being accounted for under the equity-method, the revenue and
operating costs of these entities have not been included in Extreme's results
from operations, however Extreme's share of these affiliates' losses have been
included in other expense from the closing date of the related transactions
forward. Pursuant to the terms of these two agreements, Extreme has certain
rights to acquire the remaining shares of these entities under certain
conditions for additional consideration. Under the terms of one of these equity
investments, Extreme has been granted the right at any time prior to December
31, 2000 to purchase all of the outstanding capital stock and options for shares
of Extreme common stock. Upon the attainment of certain technological
milestones, the terms of one investment will obligate Extreme to purchase all
the outstanding capital stock in fiscal 2001, payable in any combination of cash
or shares of Extreme common stock. At September 30, 2000 the possibility of
attainment of any of the technical milestones was remote. The remaining $7.2
million of investments at September 30, 2000 are being accounted for under the
cost method. We expect to continue to make additional investments in the future.
4. COMMITMENTS
In June 2000, we entered into an operating lease agreement to lease 275,000
square feet to house our primary facility in Santa Clara, California. Our lease
payments will vary based on the LIBOR plus a spread which was 7.08% at September
30, 2000. Our lease payments are estimated to be approximately $5.7 million on
an annual basis over the lease term. The lease is for five years and can be
renewed for two five-year periods, subject to the approval of the lessor. At the
expiration or termination of the lease, we have the option to either purchase
the property for $80.0 million, or arrange for the sale of the property to a
third party for at least $80.0 million with a contingent liability for any
deficiency. If the property is not purchased or sold as described above, we will
be obligated for an additional lease payment of approximately $68.0 million.
As part of the above lease transaction, Extreme restricted $80.0 million of
its investment securities as collateral for specified obligations as the lessee
under an operating lease for its campus facility. These investment securities
are restricted as to withdrawal and are managed by a third party subject to
certain limitations under Extreme's investment policy. The lease also requires
us to maintain specified financial covenants with which we were in compliance as
of September 30, 2000.
Foreign Exchange Forward Contracts
While sales of the Company's products are generally denominated in U.S.
dollars, operating expenses of the Company's international subsidiaries are
remitted in foreign currency. As such, it is exposed to adverse movements in
foreign currency exchange rates. The Company enters into foreign exchange
forward contracts to reduce the impact of certain currency exposures. These
contracts hedge exposures associated with nonfunctional currency liabilities
denominated in Japanese Yen, the Euro and British pound. The Company does not
enter into foreign exchange forward contracts for trading purposes. Gains and
losses on the contracts are included in interest and other income, net, and
offset foreign exchange gains or losses from the revaluation of intercompany
balances or other current assets and liabilities denominated in currencies other
than the functional currency of the reporting entity. The Company's foreign
exchange forward contracts generally range from one to three months in original
maturity.
11
<PAGE>
5. INCOME TAXES
The Company has recorded a tax provision of $2.4 million for the three
months ended September 30, 2000. The provision for income taxes consists
primarily of federal taxes and state income taxes.
6. COMPREHENSIVE INCOME (LOSS)
The following are the components of accumulated other comprehensive loss,
net of tax (in thousands):
<TABLE>
<CAPTION>
September 30, 2000 June 30, 2000
------------------ -------------
<S> <C> <C>
Unrealized gain (loss) on investments $ 13 $(615)
Foreign currency translation adjustments (81) (8)
---- -----
Accumulated other comprehensive loss $(68) $(623)
==== =====
</TABLE>
The following schedule of other comprehensive income shows the gross
current-period gain (loss) and the reclassification adjustment (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended
------------------
September 30, 2000 September 30, 1999
------------------ ------------------
(Unaudited)
<S> <C> <C>
Net income $4,533 $4,047
Other comprehensive income:
Change in unrealized gain on investments, net 628 (17)
Change in accumulated translation adjustments (73) 27
------ ------
Total comprehensive income $5,088 $4,057
====== ======
</TABLE>
7. STOCKHOLDERS' EQUITY AND STOCK SPLIT
On July 19, 2000 Extreme announced a two-for-one stock split in the form of
a stock dividend paid on August 24, 2000 to stockholders of record on August 10,
2000. All share and per share data have been restated to give retroactive effect
to this stock split.
Part I. Financial Information
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
When used in this discussion and elsewhere in this Form 10-Q, the words
"may," "should," "believes," "expects," "anticipates," "estimates" and similar
expressions identify forward-looking statements. Such statements, which
include statements concerning recent hiring, operating expenses, ability to
compete, anticipated growth, planned expansion of sales and support staff,
introduction of new products, working capital, the availability and
functionality of products under development, product mix, pricing trends, the
mix of export sales, sales to significant customers and the availability and
cost of products from the Company's suppliers, are subject to risks and
uncertainties, including those set forth below under "Factors That May Affect
Our Results." Our actual results could differ materially from those projected
in these forward-looking statements which could have a material adverse effect
on our business, operating results and financial condition. These forward-
looking statements speak only as of the date hereof and there may be events in
the future that would alter our expectations but which we are not able to
predict accurately or over which we have no control.
The following information should be read in conjunction with the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Company's annual report on Form 10-K for the fiscal year
ended June 30, 2000.
12
<PAGE>
Overview
From our inception in May 1996 through September 1997, our operating
activities related primarily to developing a research and development
organization, testing prototype designs, building an ASIC design infrastructure,
commencing the staffing of our marketing, sales and field service and technical
support organizations, and establishing relationships with resellers and OEMs.
We commenced volume shipments of our Summit1 and Summit2, the initial products
in our Summit stackable product family, in October 1997, and we began shipping
our BlackDiamond modular product family in September 1998. We introduced our new
Alpine product family in fiscal 2000 which is based on a new generation chip
set. In addition, we also introduced new products within our existing product
lines that incorporate this new chip set.
Our revenue is derived from sales of our Summit, BlackDiamond and Alpine
product families and fees for services relating to our products, including
maintenance and training. The level of sales to any customer may vary from
period to period; however, we expect that significant customer concentration
will continue for the foreseeable future. See "Factors That May Affect Our
Results--If a Key Reseller, OEM or Other Significant Customer Cancels or Delays
a Large Purchase, Extreme's Revenues May Decline and the Price of Its Stock May
Fall." Significant customer concentration as a percentage of net revenue is
summarized below:
<TABLE>
<CAPTION>
Three Months Ended
------------------
Customer September 30, 2000 September 30, 1999
------------------ ------------------
<S> <C> <C>
Tech Data Corporation 13% -
Compaq - 23%
Hitachi Cable - 11%
</TABLE>
We market and sell our products primarily through resellers, distributors
and, to a lesser extent, OEMs and our field sales organization. We sell our
products through more than 250 resellers in approximately 50 countries. For the
three months ended September 30, 2000, sales to customers outside of North
America accounted for approximately 51% of our net revenue. Currently, all of
our international sales are denominated in U.S. dollars. We generally recognize
product revenue at the time of shipment, unless we have future obligations for
installation or have to obtain customer acceptance, in which case revenue is
deferred until such obligations have been satisfied. We have established a
program which, under specified conditions, enables third party resellers to
return products to us. The amount of potential product returns is estimated and
provided for in the period of the sale. Service revenue is recognized ratably
over the term of the contract period, which is typically 12 months.
We expect to experience some erosion of average selling prices of our
products due to a number of factors, including competitive pricing pressures,
promotional pricing and rapid technological change. Our gross margins will be
affected by such declines and by fluctuations in manufacturing volumes,
component costs and the mix of product configurations sold. In addition, our
gross margins may fluctuate due to the mix of distribution channels through
which our products are sold, including the potential effects of our development
of a two-tier distribution channel. We generally realize higher gross margins on
sales to resellers than on sales through our OEMs. Any significant decline in
sales to our OEMs, resellers or distributors, or the loss of any of our OEMs,
resellers or distributors could materially adversely affect our business,
operating results and financial condition. In addition, new product
introductions may result in excess or obsolete inventories. Any excess or
obsolete inventories may also reduce our gross margins.
We outsource the majority of our manufacturing and supply chain management
operations, and we conduct quality assurance, manufacturing engineering,
documentation control and repairs at our facility in Santa Clara, California.
Accordingly, a significant portion of our cost of revenue consists of payments
to our contract manufacturers, Flextronics, MCMS and Solectron. We expect to
realize lower per unit product costs as a result of volume efficiencies.
However, we cannot assure you when or if such price reductions will occur. The
failure to obtain such price reductions could materially adversely affect our
gross margins and operating results.
13
<PAGE>
Research and development expenses consist principally of salaries and
related personnel expenses, consultant fees and prototype expenses related to
the design, development, testing and enhancement of our products. We expense all
research and development expenses as incurred. We believe that continued
investment in research and development is critical to attaining our strategic
objectives and, as a result, we expect these expenses to increase in absolute
dollars in the future.
Sales and marketing expenses consist of salaries, commissions and related
expenses for personnel engaged in marketing, sales and field service support
functions, as well as trade shows and promotional expenses. We intend to pursue
sales and marketing campaigns aggressively and therefore expect these expenses
to increase significantly in absolute dollars in the future. In addition, we
recently hired approximately 200 sales and marketing personnel and expect to
continue to expand our field sales operations to support and develop leads for
our resellers and distributors, which will also result in an increase in sales
and marketing expenses.
General and administrative expenses consist primarily of salaries and
related expenses for executive, finance and administrative personnel,
professional fees and other general corporate expenses. We expect general and
administrative expenses to increase in absolute dollars as we add personnel,
increase spending on our information systems and incur additional costs related
to the growth of our business and operation as a public company.
Despite growing revenues in all fiscal quarters since our inception, fiscal
2000 was the first year we achieved profitability in each of the four quarters.
Our net income has not increased proportionately with the increase in our
revenue primarily because of increased expenses relating to our growth in
operations and in particular the recent accelerated hiring of sales and
marketing personnel. Because of the lengthy sales cycle of our products, there
is often a significant delay between the time we incur expenses and the time we
realize the related revenue. See "Factors That May Affect Our Results--The Sales
Cycle for Extreme's Products is Long and Extreme May Incur Substantial Non-
Recoverable Expenses or Devote Significant Resources to Sales that Do Not Occur
When Anticipated." To the extent that future revenues do not increase
significantly in the same periods in which operating expenses increase, our
operating results would be adversely affected. See "Factors That May Affect Our
Results --A Number of Factors Could Cause Extreme's Quarterly Financial Results
to Be Worse Than Expected, Resulting in a Decline in Its Stock Price."
Due to the Company's issuance of warrants to a networking company as
discussed in Note 3, future operating income will be reduced by approximately
$7.0 million per quarter for each of the remaining quarters in fiscal 2001 and
for three of the four fiscal quarters in fiscal 2002.
Results of Operations
The following table sets forth for the periods indicated certain financial data
as a percentage of net revenue:
<TABLE>
<CAPTION>
Three Months Ended
September, September,
2000 1999
----------------- -----------------
<S> <C> <C>
Net revenue 100.0% 100.0%
Cost of revenue 48.7 47.9
----------------- -----------------
Gross profit 51.3 52.1
----------------- -----------------
Operating expenses:
Research and development 9.8 14.6
Sales and marketing 29.5 23.4
General and administrative 3.6 5.4
Amortization of goodwill and purchased intangibles 5.7 -
----------------- -----------------
Total operating expenses 48.6 43.4
----------------- -----------------
Operating income (loss) 2.7 8.7
Interest and other income, net 3.1 3.6
----------------- -----------------
Income (loss) before income taxes 5.8 12.3
</TABLE>
14
<PAGE>
<TABLE>
<S> <C> <C>
Provision for income taxes 2.0 3.7
----------------- -----------------
Net income (loss) 3.8% 8.6%
================= =================
</TABLE>
Net revenue. Net revenue increased from $47.2 million for the three months
ended September 30, 1999 to $119.3 million for the three months ended September
30, 2000, an increase of $72.1 million. Net revenue increased primarily from
increased sales of our Summit stackable products, BlackDiamond modular product
family and our Alpine product family, the market's growing acceptance of
Extreme's existing and new product offerings, and a significant increase in our
sales and marketing organizations.
Export sales accounted for 51% and 42% of net revenue in the three months
ended September 30, 2000 and 1999, respectively. We expect that export sales
will continue to represent a significant portion of net revenue, although we
cannot assure you that export sales as a percentage of net revenue will remain
at current levels. All sales transactions are denominated in U.S. dollars.
Gross profit. Gross profit increased from $24.6 million for the three
months ended September 30, 1999 to $61.3 million for the three months ended
September 30, 2000, an increase of $36.7 million, primarily due to the related
increase in revenue. Gross margins decreased from 52.1% for the three months
ended September 30, 1999 to 51.3% for the three months ended September 30, 2000.
The changes in gross margin were due to a shift in mix of products sold, a shift
in our channel mix and lower average selling prices due primarily to increased
competition.
Research and development expenses. Research and development expenses
increased from $6.9 million for the three months ended September 30, 1999 to
$11.7 million for the three months ended September 30, 2000, an increase of $4.8
million. The increase was primarily due to increases in headcount to support the
Company's multiple product development efforts, nonrecurring engineering and
initial product verification expenses.
Sales and marketing expenses. Sales and marketing expenses increased from
$11.1 million for the three months ended September 30, 1999 to $35.1 million for
the three months ended September 30, 2000, an increase of $24.0 million. This
increase was primarily due to the hiring of additional sales, marketing and
customer support personnel, increased sales commission expenses resulting from
increased revenues, increased promotional expenses, and the establishment of new
sales offices.
General and administrative expenses. General and administrative expenses
increased from $2.5 million for the three months ended September 30, 1999 to
$4.3 million for the three months ended September 30, 2000, an increase of $1.8
million. This increase was due primarily to the hiring of additional finance,
information technology and legal and administrative personnel and increased
professional fees and occupancy costs.
Amortization of Goodwill and Purchased Intangibles. Amortization of
goodwill and purchased intangibles was $6.9 million for the three months ended
September 30, 2000. This amount was due to the Company's issuance of fully
earned, non-forfeitable, fully exercisable warrants with a two year life to
purchase 3 million shares of the Company's common stock with an exercise price
of $39.50 per share as discussed in Note 3 of notes to consolidated financial
statements. Future operating income will be reduced by approximately $7.0
million per quarter for each of the remaining quarters in fiscal 2001 and for
three fiscal quarters in fiscal 2002.
Interest and other income, net. Interest and other income, net increased
from $1.7 million for the three months ended September 30, 1999 to $3.7 million
for the three months ended September 30, 2000, an increase of $2.0 million. The
increase was due to increased interest income earned as a result of the
increased amount of cash and cash equivalents, short-term investments,
restricted investments and long-term investments from the net proceeds we
received from our initial public offering in April 1999 and our secondary public
offering in October 1999.
Income taxes. We recorded a tax provision of $2.4 million for the three
months ended September 30, 2000. The provision for the three months ended
September 30, 2000 results in an effective tax rate of 35% which
15
<PAGE>
consists primarily of federal taxes, state income taxes and foreign taxes,
offset by the recognition of deferred tax assets. FASB Statement No. 109
provides for the recognition of deferred tax assets if realization of such
assets is more likely than not. We intend to evaluate the realizability of the
deferred tax assets on a quarterly basis.
Liquidity and Capital Resources
Cash and cash equivalents, short-term investments, restricted investments
and investments decreased from $307.5 million at June 30, 2000 to $266.3 million
at September 30, 2000, a decrease of $41.2 million. The decrease is primarily
due to increases in accounts receivable and inventories and capital
expenditures, partially offset by proceeds from issuance of common stock and net
income. Accounts receivable increased 21.7% from June 30, 2000 to September 30,
2000. Days sales outstanding in receivables decreased from 59 days at June 30,
2000 to 56 days at September 30, 2000. Inventory levels increased 149% from June
30, 2000 to September 30, 2000. We expect that accounts receivable will continue
to increase to the extent our revenues continue to rise. Inventory management
remains an area of focus as we balance the need to maintain strategic inventory
levels to ensure competitive lead times versus the risk of inventory
obsolescence because of rapidly changing technology and customer requirements.
Any such increase can be expected to reduce cash, cash equivalents, short-term
investments and long-term investments.
In June 2000, we entered into an operating lease agreement to lease 275,000
square feet to house our primary facility in Santa Clara, California. Our lease
payments will vary based on the LIBOR plus a spread, which was 7.08% at
September 30, 2000. Our lease payments are estimated to be approximately $5.7
million on an annual basis over the lease term. The lease is for five years and
can be renewed for two five-year periods, subject to the approval of the lessor.
At the expiration or termination of the lease, we have the option to either
purchase the property for $80.0 million, or arrange for the sale of the property
to a third party for at least $80.0 million with a contingent liability for any
deficiency. If the property is not purchased or sold as described above, we will
be obligated for an additional lease payment of approximately $68.0 million.
As part of the above lease transaction, the Company restricted $80.0
million of its investment securities as collateral for specified obligations of
the lessee under an operating lease for its campus facility. These investment
securities are restricted as to withdrawal and are managed by a third party
subject to certain limitations under the Company's investment policy. The lease
also requires us to maintain specified financial covenants with which we were in
compliance as of September 30, 2000.
We require substantial capital to fund our business, particularly to
finance inventories and accounts receivable and for capital expenditures. As a
result, we could be required to raise substantial additional capital. To the
extent that we raise additional capital through the sale of equity or
convertible debt securities, the issuance of such securities could result in
dilution to existing stockholders. If additional funds are raised through the
issuance of debt securities, these securities may have rights, preferences and
privileges senior to holders of common stock and the terms of such debt could
impose restrictions on our operations. We cannot assure you that such additional
capital, if required, will be available on acceptable terms, or at all. If we
are unable to obtain such additional capital, we may be required to reduce the
scope of our planned product development and marketing efforts, which would
materially adversely affect our business, financial condition and operating
results.
We believe that our current cash and cash equivalents, short-term
investments, long-term investments and cash available from credit facilities and
future operations will enable us to meet our working capital requirements for at
least the next 12 months.
Factors That May Affect Our Results
Extreme Has a Limited History of Profitability and Cannot Assure You that it
Will Continue to Achieve Profitability
Although our revenue has grown in recent quarters, we cannot be certain
that we will realize sufficient revenue to achieve continued profitability on
a fiscal year basis. Fiscal 2000 was the first year in which Extreme achieved
16
<PAGE>
profitability in each of the four quarters. We anticipate continuing to incur
significant sales and marketing, product development and general and
administrative expenses and, as a result, we will need to generate significantly
higher revenue to sustain profitability. In particular, our recent hiring of
approximately 200 sales and marketing personnel has substantially increased
expenses. We expect that the hiring of such personnel will allow us to increase
sales, however, we can not assure you that this will occur and we cannot assure
you that operating margins will not be adversely affected by this or other
hiring. In addition, the amortization of purchased intangibles and goodwill is
estimated to be approximately $28.0 million and $21.0 million in fiscal 2001 and
2002, respectively.
A Number of Factors Could Cause Extreme's Quarterly Financial Results to Be
Worse Than Expected, Resulting in a Decline in Its Stock Price
We plan to significantly increase our operating expenses to expand our
sales and marketing activities, broaden our customer support capabilities,
develop new distribution channels, fund increased levels of research and
development and build our operational infrastructure. We base our operating
expenses on anticipated revenue trends and a high percentage of our expenses are
fixed in the short term. As a result, any delay in generating or recognizing
revenue could cause our quarterly operating results to be below the expectations
of public market analysts or investors, which could cause the price of our
common stock to fall.
We may experience a delay in generating or recognizing revenue because of a
number of reasons. Orders at the beginning of each quarter typically do not
equal expected revenue for that quarter and are generally cancelable at any
time. Accordingly, we are dependent upon obtaining orders in a quarter for
shipment in that quarter to achieve our revenue objectives. In addition, the
timing of product releases, purchase orders and product availability could
result in significant product shipments at the end of a quarter. Failure to ship
these products by the end of a quarter may adversely affect our operating
results. Furthermore, our customer agreements typically provide that the
customer may delay scheduled delivery dates and cancel orders within specified
time frames without significant penalty.
Our quarterly revenue and operating results have varied significantly in
the past and may vary significantly in the future due to a number of factors,
including:
. fluctuations in demand for our products and services, including
seasonality, particularly in Asia and Europe;
. unexpected product returns or the cancellation or rescheduling of
significant orders;
. our ability to develop, introduce, ship and support new products and
product enhancements and manage product transitions;
. announcements and new product introductions by our competitors;
. our ability to develop and support customer relationships with service
providers and other potential large customers;
. our ability to achieve required cost reductions;
. our ability to obtain sufficient supplies of sole or limited sourced
components for our products;
. unfavorable changes in the prices of the components we purchase;
. our ability to attain and maintain production volumes and quality levels
for our products;
. the mix of products sold and the mix of distribution channels through which
they are sold;
. costs relating to possible acquisitions and integration of technologies or
businesses; and
. the affect of amortization of goodwill and purchased intangibles resulting
from existing or new transactions.
Due to the foregoing factors, we believe that period-to-period comparisons
of our operating results should not be relied upon as an indicator of our future
performance.
Intense Competition in the Market for Networking Equipment Could Prevent Extreme
From Increasing Revenue and Prevent Extreme From Sustaining Profitability
17
<PAGE>
The market for Internet switches is intensely competitive. Our principal
competitors include Cabletron Systems, Cisco Systems, Foundry Networks, Lucent
Technologies and Nortel Networks. Many of our current and potential competitors
have longer operating histories and substantially greater financial, technical,
sales, marketing and other resources, as well as greater name recognition and
larger installed customer bases, than we do. These competitors may have
developed, or could in the future, develop new technologies that compete with
our products or even render our products obsolete.
To remain competitive, we believe we must, among other things, invest
significant resources in developing new products and enhancing our current
products and maintaining customer satisfaction. If we fail to do so, our
products may not compete favorably with those of our competitors and our revenue
and future profitability could be materially adversely affected.
Extreme Expects the Average Selling Prices of Its Products to Decrease Which May
Reduce Gross Margins or Revenue
The network equipment industry has experienced rapid erosion of average
selling prices due to a number of factors, including competitive pricing
pressures and rapid technological change. We may experience substantial period-
to-period fluctuations in future operating results due to the erosion of our
average selling prices. We anticipate that the average selling prices of our
products will decrease in the future in response to competitive pricing
pressures, increased sales discounts, new product introductions by us or our
competitors, including, for example, competitive products manufactured with low
cost merchant silicon, or other factors. Therefore, to maintain our gross
margins, we must develop and introduce on a timely basis new products and
product enhancements and continually reduce our product costs. Our failure to do
so would cause our revenue and gross margins to decline, which could materially
adversely affect our operating results and cause the price of our common stock
to decline.
Extreme's Market is Subject to Rapid Technological Change and to Compete,
Extreme Must Continually Introduce New Products that Achieve Broad Market
Acceptance
The network equipment market is characterized by rapid technological
change, frequent new product introductions, changes in customer requirements and
evolving industry standards. If we do not address these changes by regularly
introducing new products, our product line will become obsolete. Developments in
routers and routing software could also significantly reduce demand for our
product. Alternative technologies could achieve widespread market acceptance and
displace Ethernet technology on which our product lines and architecture are
based. We cannot assure you that our technological approach will achieve broad
market acceptance or that other technologies or devices will not supplant our
approach.
When we announce new products or product enhancements that have the
potential to replace or shorten the life cycle of our existing products,
customers may defer purchasing our existing products. These actions could
materially adversely affect our operating results by unexpectedly decreasing
sales, increasing our inventory levels of older products and exposing us to
greater risk of product obsolescence. The market for switching products is
evolving and we believe our ability to compete successfully in this market is
dependent upon the continued compatibility and interoperability of our products
with products and architectures offered by other vendors. In particular, the
networking industry has been characterized by the successive introduction of new
technologies or standards that have dramatically reduced the price and increased
the performance of switching equipment. To remain competitive we need to
introduce products in a timely manner that incorporate or are compatible with
these new technologies as they emerge. For example, last fiscal year we
introduced a new generation chipset which was incorporated in a new product
family which began shipping in the quarter ended March 31, 2000. We cannot
assure you that these new products will be commercially successful. We have
experienced delays in releasing new products and product enhancements in the
past which delayed sales and resulted in lower quarterly revenue than
anticipated. We may experience similar delays in product development and release
in the future and any delay in product introduction could adversely affect our
ability to compete and cause our operating results to be below our expectations
or the expectations of public market analysts or investors.
18
<PAGE>
Continued Rapid Growth Will Strain Extreme's Operations and Will Require
Extreme to Incur Costs to Upgrade Its Infrastructure
We have experienced a period of rapid growth and expansion which has
placed, and continues to place, a significant strain on our resources. Even if
we manage this growth effectively, we may make mistakes in operating our
business such as inaccurate sales forecasting, incorrect material planning or
inaccurate financial reporting, which may result in unanticipated fluctuations
in our operating results. Our net revenue increased significantly during the
last fiscal year, and from September 30, 1999 to September 30, 2000, the number
of our employees increased from 317 to 792. We expect our anticipated growth and
expansion to strain our management, operational and financial resources. Our
management team has had limited experience managing such rapidly growing
companies on a public or private basis. To accommodate this anticipated growth,
we will be required to:
. improve existing and implement new operational, information and financial
systems, procedures and controls;
. hire, train and manage additional qualified personnel, including sales,
marketing personnel and research and development personnel; and
. effectively manage multiple relationships with our customers, suppliers and
other third parties.
We may not be able to install adequate control systems in an efficient and
timely manner, and our current or planned personnel systems, procedures and
controls may not be adequate to support our future operations. In August 1998,
we installed a new management information system, which we may continue to
modify and improve to meet the increasing needs associated with our growth. The
difficulties associated with installing and implementing these new systems,
procedures and controls may place a significant burden on our management and our
internal resources. In addition, as we grow internationally, we will have to
expand our worldwide operations and enhance our communications infrastructure.
Any delay in the implementation of such new or enhanced systems, procedures or
controls, or any disruption in the transition to such new or enhanced systems,
procedures or controls, could adversely affect our ability to accurately
forecast sales demand, manage our supply chain and record and report financial
and management information on a timely and accurate basis.
Extreme Must Develop and Expand Its Indirect Distribution Channels to Increase
Revenues and Improve Its Operating Results
Our distribution strategy focuses primarily on developing and expanding
indirect distribution channels through resellers, distributors and, to a lesser
extent, original equipment manufacturers, or OEMs, as well as expanding our
field sales organization. If we fail to develop and cultivate relationships with
significant resellers, or if these resellers are not successful in their sales
efforts, sales of our products may decrease and our operating results would
suffer. Many of our resellers also sell products that compete with our products.
We are developing a two-tier distribution structure in Europe and the United
States which has and will require us to enter into agreements with a small
number of stocking distributors. We have entered into two-tier distribution
agreements; however, we cannot assure you that we will continue to be able to
enter into additional distribution agreements or that we will be able to
successfully manage the transition of resellers to a two-tier distribution
channel. Our failure to do so could limit our ability to grow or sustain
revenue. In addition, our operating results will likely fluctuate significantly
depending on the timing and amount of orders from our resellers. We cannot
assure you that our resellers will market our products effectively or continue
to devote the resources necessary to provide us with effective sales, marketing
and technical support.
To support and develop leads for our indirect distribution channels and to
expand our direct sales effort, to service providers and content providers, we
plan to continue to expand our field sales and support staff significantly. We
cannot assure you that this internal expansion will be successfully completed,
that the cost of this expansion will not exceed the revenues generated or that
our expanded sales and support staff will be able to compete successfully
against the significantly more extensive and well-funded sales and marketing
operations of many of our current or potential competitors. Our inability to
effectively establish our distribution channels or manage the expansion of our
sales and support staff would materially adversely affect our ability to grow
and increase revenue.
19
<PAGE>
Because Substantially All of Extreme's Revenue is Derived From Sales of Three
Product Families, Extreme is Dependent on Widespread Market Acceptance of These
Products; Future Performance will Depend on the Introduction and Acceptance of
New Products
In the quarter ended September 30, 2000, we derived substantially all of
our revenue from sales of our Summit, BlackDiamond and Alpine product families.
We expect that revenue from these product families will account for a
substantial portion of our revenue for the foreseeable future. Accordingly,
widespread market acceptance of our product families is critical to our future
success. Factors that may affect the market acceptance of our products include
market acceptance of switching products, and Gigabit Ethernet and Layer 3
switching technologies in particular in the enterprise, service provider and
metropolitan area network markets, the performance, price and total cost of
ownership of our products, the availability and price of competing products and
technologies, and the success and development of our resellers, distributors,
OEMs and field sales channels. Many of these factors are beyond our control. Our
future performance will also depend on the successful development, introduction
and market acceptance of new and enhanced products that address customer
requirements in a cost-effective manner. We have in the past experienced delays
in product development and such delays may occur in the future. We introduced a
new product family in fiscal 2000 which is based on a new generation chip set.
In addition, we also introduced new products within our existing product lines
that incorporate this new chip set. The introduction of new and enhanced
products may cause our customers to defer or cancel orders for existing
products. Therefore, to the extent customers defer or cancel orders in the
expectation of any new product release, any delay in development or introduction
could cause our operating results to suffer. Failure of our existing or future
products to maintain and achieve widespread levels of market acceptance may
significantly impair our revenue growth.
If a Key Reseller, Distributor, OEM or Other Significant Customer Cancels or
Delays a Large Purchase, Extreme's Revenues May Decline and the Price of Its
Stock May Fall
To date, a limited number of resellers, distributors, OEMs and other
customers have accounted for a significant portion of our revenue. If any of our
large customers stop or delay purchases, our revenue and profitability would be
adversely affected. For example, in the quarter ended September 30, 2000, Tech
Data Corporation accounted for 13% of our net revenue. Because our expense
levels are based on our expectations as to future revenue and to a large extent
are fixed in the short term, a substantial reduction or delay in sales of our
products to, or the loss of any significant reseller, distributor, OEM or other
customer, or unexpected returns from resellers could harm our business,
operating results and financial condition. Although our largest customers may
vary from period-to-period, we anticipate that our operating results for any
given period will continue to depend to a significant extent on large orders
from a small number of customers, particularly in light of the high sales price
per unit of our products and the length of our sales cycles.
While our financial performance depends on large orders from a few key
resellers, distributors, OEMs and other significant customers, we do not have
binding commitments from any of them. For example:
. our service provider and enterprise network customers can stop purchasing
and our resellers, distributors and OEMs can stop marketing our products at
any time;
. our reseller agreements generally are not exclusive and are for one year
terms, with no obligation of the resellers to renew the agreements;
. our reseller agreements provide for discounts based on expected or actual
volumes of products purchased or resold by the reseller in a given period;
and
. our reseller, distributor and OEM agreements generally do not require
minimum purchases.
We have established a program which, under specified conditions, enables
some third party resellers to return products to us. The amount of potential
product returns is estimated and provided for in the period of the sale. Some of
our OEM agreements also provide manufacturing rights and access to our source
code upon the occurrence of specified conditions of default. If we were to
default on these agreements, our OEMs could use our source code to develop and
manufacture competing products, which would negatively affect our performance
and ability to compete.
20
<PAGE>
The Sales Cycle for Extreme's Products is Long and Extreme May Incur Substantial
Non-Recoverable Expenses or Devote Significant Resources to Sales that Do Not
Occur When Anticipated
The timing of our sales revenue is difficult to predict because of our
reliance on indirect sales channels and the length and variability of our sales
cycle. Our products have a relatively high sales price per unit, and often
represent a significant and strategic decision by an enterprise regarding its
communications infrastructure. Accordingly, the purchase of our products
typically involves significant internal procedures associated with the
evaluation, testing, implementation and acceptance of new technologies. This
evaluation process frequently results in a lengthy sales process, typically
ranging from three months to longer than a year, and subjects the sales cycle
associated with the purchase of our products to a number of significant risks,
including budgetary constraints and internal acceptance reviews. The length of
our sales cycle also may vary substantially from customer to customer. While our
customers are evaluating our products and before they may place an order with
us, we may incur substantial sales and marketing expenses and expend significant
management effort. Consequently, if sales forecasted from a specific customer
for a particular quarter are not realized in that quarter, we may be unable to
compensate for the shortfall, which could harm our operating results.
Extreme Purchases Several Key Components for Products From Single or Limited
Sources and Could Lose Sales if These Sources Fail to Fill Its Needs
We currently purchase several key components used in the manufacture of our
products from single or limited sources and are dependent upon supply from these
sources to meet our needs. Certain components such as tantalum capacitors, SRAM
and printed circuit boards have been and may in the future be in short supply.
While we have been able to meet our needs to date, we have in the past and are
likely in the future to encounter shortages and delays in obtaining these or
other components and this could materially adversely affect our ability to meet
customer orders. Our principal sole sourced components include:
. ASICs;
. microprocessors;
. programmable integrated circuits;
. selected other integrated circuits;
. cables; and
. custom-tooled sheet metal.
Our principal limited sourced components include:
. flash memories;
. dynamic and static random access memories, commonly known as DRAMs and
SRAMs, respectively; and
. printed circuit boards.
We use a rolling six-month forecast based on anticipated product orders to
determine our material requirements. Lead times for materials and components we
order vary significantly, and depend on factors such as the specific supplier,
contract terms and demand for a component at a given time. If orders do not
match forecasts, we may have excess or inadequate inventory of certain materials
and components, which could materially adversely affect our operating results
and financial condition. From time to time we have experienced shortages and
allocations of certain components, resulting in delays in filling orders. In
addition, during the development of our products we have experienced delays in
the prototyping of our ASICs, which in turn has led to delays in product
introductions.
Extreme Needs to Expand Its Manufacturing Operations and Depends on Contract
Manufacturers for Substantially All of Its Manufacturing Requirements
21
<PAGE>
If the demand for our products continues to grow, we will need to increase
our material purchases, contract manufacturing capacity and internal test and
quality functions. Any disruptions in product flow could limit our revenue,
adversely affect our competitive position and reputation and result in
additional costs or cancellation of orders under agreements with our customers.
We rely on third party manufacturing vendors to manufacture our products.
We currently subcontract substantially all of our manufacturing to three
companies--Flextronics International, Ltd., located in San Jose, California,
MCMS, Inc., located in Boise, Idaho and Solectron, located in Milpitas,
California. We have experienced a delay in product shipments from contract
manufacturers in the past, which in turn delayed product shipments to our
customers. We may in the future experience similar or other problems, such as
inferior quality and insufficient quantity of product, any of which could
materially adversely affect our business and operating results. There can be no
assurance that we will effectively manage our contract manufacturers or that
these manufacturers will meet our future requirements for timely delivery of
products of sufficient quality and quantity. We intend to regularly introduce
new products and product enhancements, which will require that we rapidly
achieve volume production by coordinating our efforts with those of our
suppliers and contract manufacturers. The inability of our contract
manufacturers to provide us with adequate supplies of high-quality products or
the loss of either of our contract manufacturers would cause a delay in our
ability to fulfill orders while we obtain a replacement manufacturer and would
have a material adverse effect on our business, operating results and financial
condition.
As part of our cost-reduction efforts, we will need to realize lower per
unit product costs from our contract manufacturers as a result of volume
efficiencies. However, we cannot be certain when or if such price reductions
will occur. The failure to obtain such price reductions would adversely affect
our gross margins and operating results.
If Extreme Loses Key Personnel or is Unable to Hire Additional Qualified
Personnel as Necessary, It May Not Be Able to Successfully Manage Its Business
or Achieve Its Objectives
Our success depends to a significant degree upon the continued
contributions of our key management, engineering, sales and marketing and
manufacturing personnel, many of whom would be difficult to replace. In
particular, we believe that our future success is highly dependent on Gordon
Stitt, Chairman, President and Chief Executive Officer, Stephen Haddock, Vice
President and Chief Technical Officer, and Herb Schneider, Vice President of
Engineering. We neither have employment contracts with nor key person life
insurance on any of our key personnel.
We believe our future success will also depend in large part upon our
ability to attract and retain highly skilled managerial, engineering, sales and
marketing, finance and manufacturing personnel. Competition for these personnel
is intense, especially in the San Francisco Bay Area, and we have had difficulty
hiring employees in the timeframe we desire, particularly software engineers.
There can be no assurance that we will be successful in attracting and retaining
such personnel. The loss of the services of any of our key personnel, the
inability to attract or retain qualified personnel in the future or delays in
hiring required personnel, particularly engineers and sales personnel, could
make it difficult for us to manage our business and meet key objectives, such as
product introductions, on time. In addition, companies in the networking
industry whose employees accept positions with competitors frequently claim that
competitors have engaged in unfair hiring practices. We have from time to time
received claims like this from other companies and, although to date they have
not resulted in material litigation, we cannot assure you that we will not
receive additional claims in the future as we seek to hire qualified personnel
or that such claims will not result in material litigation. We could incur
substantial costs in defending ourselves against any such claims, regardless of
the merits of such claims.
Extreme's Products Must Comply With Evolving Industry Standards and Complex
Government Regulations or Its Products May Not Be Widely Accepted, Which May
Prevent Extreme From Sustaining Its Revenues or Achieving Profitability
The market for network equipment products is characterized by the need to
support industry standards as different standards emerge, evolve and achieve
acceptance. We will not be competitive unless we continually introduce new
products and product enhancements that meet these emerging standards. In the
past, we have
22
<PAGE>
introduced new products that were not compatible with certain technological
changes, and in the future we may not be able to effectively address the
compatibility and interoperability issues that arise as a result of
technological changes and evolving industry standards. In addition, in the
United States, our products must comply with various regulations and standards
defined by the Federal Communications Commission and Underwriters Laboratories.
Internationally, products that we develop may be required to comply with
standards established by telecommunications authorities in various countries as
well as with recommendations of the International Telecommunication Union. If we
do not comply with existing or evolving industry standards or if we fail to
obtain timely domestic or foreign regulatory approvals or certificates we would
not be able to sell our products where these standards or regulations apply,
which may prevent us from sustaining our revenues or achieving profitability.
Failure to Successfully Integrate Extreme's Expanded Sales and Support
Organizations into Its Operation or Educate Them About Its Product Families Will
Hurt Its Operating Results
Our products and services require a sophisticated sales effort targeted at
several levels within a prospective customer's organization. Unless we expand
our sales force we will not be able to increase revenues. In April 2000, a
significant number of former sales and system engineer employees of another
networking company joined our operation. We cannot assure you that we will be
able to educate these new employees about our product families or integrate
these new employees into our company. A failure to do so will hurt our revenue
growth and may hurt our operating results.
Extreme Depends Upon International Sales for Much of Its Revenue and
Extreme's Ability to Sustain and Increase Its International Sales Depends on
Successfully Expanding Its International Operations
Our ability to grow will depend in part on the expansion of international
sales and operations which have and are expected to constitute a significant
portion of our sales. Sales to customers outside of North America accounted for
approximately 51% and 42% of our net revenue in the three months ended September
30, 2000 and September 30, 1999, respectively. Our international sales primarily
depend on our resellers, distributors and OEMs. The failure of our resellers,
distributors and OEMs to sell our products internationally would limit our
ability to sustain and grow our revenue. In addition, there are a number of
risks arising from our international business, including:
. longer accounts receivable collection cycles;
. difficulties in managing operations across disparate geographic areas;
. difficulties associated with enforcing agreements through foreign legal
systems;
. payment of operating expenses in local currencies, which subjects us to
risks of currency fluctuations;
. import or export licensing requirements;
. potential adverse tax consequences; and
. unexpected changes in regulatory requirements.
Our international sales currently are U.S. dollar-denominated. As a result,
an increase in the value of the U.S. dollar relative to foreign currencies could
make our products less competitive in international markets. In the future, we
may elect to invoice some of our international customers in local currency which
will subject us to fluctuations in exchange rates between the U.S. dollar and
the particular local currency. If we do so, we may determine to engage in
hedging transactions to minimize the risk of such fluctuations. We have entered
into foreign exchange forward contracts to offset the impact of payment of
operating expenses in local currencies to some of our operating foreign
subsidiaries. However, if we are not successful in managing these hedging
transactions, we could incur losses from hedging activities. Because we
currently denominate sales in U.S. dollars, we do not anticipate that the
adoption of the Euro as a functional legal currency of certain European
countries will materially affect our business.
Extreme May Engage in Future Acquisitions that Dilute the Ownership Interests of
Our Stockholders, Cause Us to Incur Debt and Assume Contingent Liabilities
As part of our business strategy, we review acquisition and strategic
investment prospects that would complement our current product offerings,
augment our market coverage or enhance our technical capabilities, or that may
23
<PAGE>
otherwise offer growth opportunities. We are reviewing investments in new
businesses and we expect to make investments in and acquire businesses, products
or technologies in the future. In the event of any future acquisitions, we
could:
. issue equity securities which would dilute current stockholders' percentage
ownership;
. incur substantial debt
. assume contingent liabilities; or
. expend significant cash.
These actions by us could materially adversely affect our operating results
and/or the price of our common stock. Acquisitions and investment activities
also entail numerous risks, including:
. difficulties in the assimilation of acquired operations, technologies or
products;
. unanticipated costs associated with the acquisition or investment
transaction;
. diversion of management's attention from other business concerns;
. adverse effects on existing business relationships with suppliers and
customers;
. risks associated with entering markets in which we have no or limited prior
experience
. potential loss of key employees of acquired organizations; and
. substantial charges for amortization of goodwill or purchased intangibles
or similar items.
We cannot assure you that we will be able to successfully integrate any
businesses, products, technologies or personnel that we might acquire in the
future, and our failure to do so could materially adversely affect our business,
operating results and financial condition.
Extreme May Need Additional Capital to Fund Its Future Operations And, If It Is
Not Available When Needed, Extreme May Need to Reduce Its Planned Development
and Marketing Efforts, Which May Reduce Its Revenues and Prevent Extreme From
Achieving Profitability
We believe that our existing working capital, proceeds from the initial
public offering in April 1999, proceeds from the secondary offering in October
1999 and cash available from credit facilities and future operations will enable
us to meet our working capital requirements for at least the next 12 months.
However, if cash from future operations is insufficient, or if cash is used for
acquisitions or other currently unanticipated uses, we may need additional
capital. The development and marketing of new products and the expansion of
reseller and distribution channels and associated support personnel is expected
to require a significant commitment of resources. In addition, if the market for
our products were to develop more slowly than anticipated or if we fail to
establish significant market share and achieve a meaningful level of revenues,
we may continue to utilize significant amounts of capital. As a result, we could
be required to raise substantial additional capital. To the extent that we raise
additional capital through the sale of equity or convertible debt securities,
the issuance of such securities could result in dilution to existing
stockholders. If additional funds are raised through the issuance of debt
securities, such securities may have rights, preferences and privileges senior
to holders of common stock and the term of such debt could impose restrictions
on our operations. We cannot assure you that such additional capital, if
required, will be available on acceptable terms, or at all. If we are unable to
obtain such additional capital, we may be required to reduce the scope of our
planned product development and marketing efforts, which would harm our
business, financial condition and operating results.
If Extreme's Products Contain Undetected Software or Hardware Errors, Extreme
Could Incur Significant Unexpected Expenses and Lost Sales
Network products frequently contain undetected software or hardware errors
when first introduced or as new versions are released. We have experienced such
errors in the past in connection with new products and product upgrades. We
expect that such errors will be found from time to time in new or enhanced
products after
24
<PAGE>
commencement of commercial shipments. These problems may materially adversely
affect our business by causing us to incur significant warranty and repair
costs, diverting the attention of our engineering personnel from our product
development efforts and causing significant customer relations problems.
Our products must successfully interoperate with products from other
vendors. As a result, when problems occur in a network, it may be difficult to
identify the source of the problem. The occurrence of hardware and software
errors, whether caused by our products or another vendor's products, could
result in the delay or loss of market acceptance of our products and any
necessary revisions may result in the incurrence of significant expenses. The
occurrence of any such problems would likely have a material adverse effect on
our business, operating results and financial condition.
Extreme's Limited Ability to Protect Its Intellectual Property May Adversely
Affect Its Ability to Compete
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
However, we cannot assure you that the actions we have taken will adequately
protect our intellectual property rights.
We also enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and control access to and
distribution of our software, documentation and other proprietary information.
Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy or otherwise obtain and use our products or technology.
Provisions in Extreme's Charter or Agreements May Delay or Prevent a Change of
Control
Provisions in our certificate of incorporation and bylaws may delay or
prevent a change of control or changes in our management. These provisions
include:
. the division of the board of directors into three separate classes;
. the right of the board of directors to elect a director to fill a vacancy
created by the expansion of the board of directors; and
. the ability of the board of directors to alter our bylaws without getting
stockholder approval
Furthermore, we are subject to the provisions of section 203 of the
Delaware General Corporation Law. These provisions prohibit large stockholders,
in particular those owning 15% or more of the outstanding voting stock, from
consummating a merger or combination with a corporation unless this stockholder
receives board approval for the transaction or 66 2/3% of the shares of voting
stock not owned by the stockholder approve the merger or combination.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Sensitivity
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we have
invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of our investment will probably decline. To minimize
this risk, we maintain our portfolio of cash equivalents and short-term
investments in a variety of securities, including commercial paper, other non-
government debt securities and money market funds. In general, money market
funds are not subject to market risk because the interest paid on such funds
fluctuates with the prevailing interest rate. The following table presents the
amounts
25
<PAGE>
of our cash equivalents, short-term investments and long-term investments that
are subject to market risk by range of expected maturity and weighted-average
interest rates as of September 30, 2000. This table does not include money
market funds because those funds are not subject to market risk.
<TABLE>
<CAPTION>
Maturing in
---------------------------------------------------------------------------
Three months Three months Greater than Fair
or less to one year one year Total Value
------- ----------- -------- ----- -----
(In thousands)
<S> <C> <C> <C> <C> <C>
Included in cash and cash equivalents........ $ 50,547 $ 50,547 $ 50,547
Weighted average interest rate............. 6.22%
Included in short-term investments $ 49,593 $ 49,593 $ 49,593
Weighted average interest rate............. 6.17%
Included in investments...................... $ 73,165 $ 73,165 $ 73,165
Weighted average interest rate............. 6.90%
</TABLE>
Exchange Rate Sensitivity
Currently, the majority of our sales and expenses are denominated in U.S.
dollars and as a result, we have experienced no significant foreign exchange
gains and losses to date. While we have conducted some transactions in foreign
currencies during the three months ended September 30, 2000 and expect to
continue to do so, we do not anticipate that foreign exchange gains or losses
will be significant.
Foreign Exchange Forward Contracts
We enter into foreign exchange forward contracts to offset the impact of
currency fluctuations on certain nonfunctional currency liabilities, denominated
in Japanese Yen, the Euro and British pound. The foreign exchange forward
contracts we enter into have original maturities ranging from one to three
months. We do not enter into foreign exchange forward contracts for trading
purposes. We do not expect gains or losses on these contracts to have a material
impact on our financial results (see Note 4 to the Consolidated Financial
Statements).
PART II. Other Information
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 10.14 Lease agreement dated July 28, 2000 between San Tomas
Properties LLC, a Delaware limited liability company, as Landlord, and Extreme
Networks, Inc, a Delaware Corporation, as Tenant.
27 Financial Data Schedule (filed only with the electronic submission of Form
10-Q in accordance with the Edgar requirements)
b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the three
months ended September 30, 2000.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
EXTREME NETWORKS, INC.
(Registrant)
/s/ VITO PALERMO
--------------------
VITO PALERMO
Vice President, Chief Financial Officer
And Secretary
November 14, 2000
27
