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EX-31.1 - SECTION 302 CERTIFICATION OF CFO AND ACTING CEO - EXTREME NETWORKS INCdex311.htm
EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - EXTREME NETWORKS INCdex231.htm
EX-21.1 - SUBSIDIARIES OF REGISTRANT - EXTREME NETWORKS INCdex211.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CFO AND ACTING CEO - EXTREME NETWORKS INCdex321.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 27, 2010

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 of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3585 Monroe Street

Santa Clara, California

  95051
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (408) 579-2800

 

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common stock, $.001 par value

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 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  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large Accelerated Filer  ¨

  Accelerated Filer  x

Non-Accelerated Filer  ¨

  Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $256.4 million as of December 27, 2009, the last business day of the Registrant’s most recently completed second fiscal quarter, based upon the per share closing price of the Registrant’s common stock as reported on The Nasdaq Global Market reported on such date. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose.

90,749,782 shares of the Registrant’s Common stock, $.001 par value, were outstanding as of August 16, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates by reference from the definitive proxy statement for the Company’s 2010 Annual Meeting of Stockholders to be filed with the Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.

 

 

 


Table of Contents

EXTREME NETWORKS, INC.

FORM 10-K

INDEX

 

          Page

Forward Looking Statements

   3
  

PART I

   3

Item 1.

  

Business

   3

Item 1A.

  

Risk Factors

   14

Item 1B.

  

Unresolved Staff Comments

   26

Item 2.

  

Properties

   26

Item 3.

  

Legal Proceedings

   26

Item 4.

  

Removed and Reserved

   29
  

PART II

   30

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   30

Item 6.

  

Selected Financial Data

   32

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   33

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   48

Item 8.

  

Financial Statements and Supplementary Data

   50

Item 9.

  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

   85

Item 9A.

  

Controls and Procedures

   85

Item 9B.

  

Other Information

   86
  

PART III

   88

Item 10.

  

Directors, Executive Officers and Corporate Governance

   88

Item 11.

  

Executive Compensation

   88

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   88

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

   88

Item 14.

  

Principal Accountant Fees and Services

   88
  

PART IV

   89

Item 15.

  

Exhibits and Financial Statement Schedules

   89

SIGNATURES

   92

 

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FORWARD LOOKING STATEMENTS

This annual report on Form 10-K, including the following sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly, our expectations regarding results of operations, our ability to expand our market penetration, our ability to expand our distribution channels, customer acceptance of our products, our ability to meet the expectations of our customers, product demand and revenue, cash flows, product gross margins, our expectations to continue to develop new products and enhance existing products, our expectations regarding the amount of our research and development expenses, our expectations relating to our selling, general and administrative expenses, our efforts to achieve additional operating efficiencies and to review and improve our business systems and cost structure, our expectations to continue investing in technology, resources and infrastructure, our expectations concerning the availability of products from suppliers and contract manufacturers, anticipated product costs and sales prices, our expectations that we have sufficient capital to meet our requirements for at least the next twelve months, our expectations regarding the rationalization of our workforce and facilities and our expectations regarding materials and inventory management. These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth below and those contained in the section entitled “Risk Factors” identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. We caution investors that actual results may differ materially from those projected in the forward-looking statements as a result of certain risk factors identified in this Form 10-K and other filings we have made with the Securities and Exchange Commission. More information about potential factors that could affect our business and financial results is set forth under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

PART I

Item 1. Business

Overview

Extreme Networks, Inc., together with its subsidiaries, (collectively referred to as Extreme and as we, us and our) is a leading provider of network infrastructure equipment and services for enterprises, data centers, and metropolitan telecommunications service providers. Our customers include businesses, hospitals, schools, hotels, telecommunications companies and government agencies around the world. Since we were established in 1996 through to the present day, we have had a single technology vision of “Ethernet Everywhere” – a unifying network strategy that uses Ethernet technology to simplify each element and component of the network, and, through simplification, provide services at a lower cost. As networks internal to businesses and the Internet become more and more pervasive and critical to a wide variety of business and social communications, the volume and the demands of applications, data, users and devices on networks continue to increase. Our vision of “Ethernet Everywhere” helps us design and deliver easily deployable, highly scalable, secure and comprehensively managed networks which are reliable, fast, flexible and cost-effective. We primarily sell our products through an ecosystem of our channel partners who combine our Ethernet products with their offerings to create compelling information technology solutions for end user customers.

Industry Background

Businesses, governments, educational institutions, service providers, data center operators and other organizations have become highly dependent on their internal networks and the Internet. In fact, modern society is significantly dependent upon the Internet and the myriad of services and systems to which it provides access. The Internet and internal business networks serve as a central communications infrastructure that connect internal and external sites and deliver data, voice and video communications to a dramatically increasing number of users. Over the course of the past ten years, the wide adoption of the Internet Protocol (or “IP”) has enabled the spread of high speed networks from educational facilities and corporations out to residences around the globe. In

 

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addition, IP enabled devices as diverse as servers, printers, laptops, desk phones, televisions, residential networks, cell phones and various wireless devices are now connected to both “hard-wired” and wireless Ethernet networks over which IP information flows. A variety of critical computing applications that are central to business and communications, such as Enterprise Resource Planning (ERP), Customer Relationship Management (CRM), Sales Force Automation (SFA), large enterprise data warehouses, and sophisticated e-commerce and e-business applications depend upon high-speed, reliable networks. Communication in today’s world operates through the existence of business-to-business and business-to-consumer Ethernet network connectivity. Looking ahead, the continued explosive growth of peer-to-peer networking will continue to drive the ever increasing demand for network connectivity and capacity.

The networking industry has evolved significantly over the past 10 years. We believe that the following trends have and will continue to influence the industry as it continues to rapidly evolve to meet network demands:

 

   

Increasing Demand for Bandwidth. As the volume of users, devices, applications and data increases, more network capacity is required. This capacity is usually measured in ‘bits of data per second’ or bandwidth. The following factors, among others, are driving increased demand for bandwidth:

 

   

wide-spread adoption of electronic communications in all aspects of our lives;

 

   

proliferation of next generation converged mobile devices;

 

   

broad, global, deployment of “triple-play” services (residential telephone, data and television services delivered over one network); and

 

   

delivery and rapidly growing adoption of internet “cloud” solutions or software-as-a-service business applications and processes.

 

   

Adoption and Evolution of the Converged Network. An essential characteristic of the networks that support business and residential users of today and into the future is their ability to support multiple communication flows over the same physical infrastructure. With data, voice and video traffic being delivered to a broader range of end-devices over both wired and wireless networks, the communications infrastructure is a critical component which allows enterprises and service providers to offer unique and innovative services for their users and customers. The adoption of Voice-over-IP (VoIP) and the continued proliferation of video applications demonstrate that the trend towards deploying fully converged networks will continue to gain momentum.

 

   

Carrier Ethernet. As a result of the move towards converged delivery of data, voice and video for both residences and businesses in parallel with increasing competition to provide these services, telecommunication service providers are seeking to broaden their market reach while reducing operational cost and complexity. The legacy infrastructure solutions of SONET/SDH, Frame Relay, ATM and MPLS are not delivering the required organizational flexibility or the operating expense efficiencies. As a result, we believe service providers will turn to Ethernet in order to deliver cost-effective scale, performance and flexibility. Further, technologies such as Provider Backbone Transport (PBT) and Provider Backbone Bridging Traffic Engineering (PBT-TE) are emerging and receiving growing interest within the service provider community as they seek to evaluate new lower cost, lower complexity solutions. When these new technologies are combined with standards for the inter-connectivity between two service providers or “network peers,” service providers are able to broaden their market reach at a lower operating cost per connected service consumer.

 

   

Deployments of Next Generation Data Centers. The ever increasing volume of on-line information the flexibility offered by “cloud” solutions, and the availability of technologies to reduce the overall cost of data center deployment and operation are leading enterprises and service providers to build next generation data centers. With the availability of virtualization technologies to lower the overall cost, size and power consumption of the physical data center, the bandwidth and reliability demands of the

 

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data center network have evolved significantly. In conjunction with the rise of virtualization, the latest generation of server technology has ten times the Ethernet performance of prior solutions. These technology drivers are creating the need for the network ‘backbone’ to also scale by a similar factor. These factors are driving the deployment of next generation Ethernet technology in the data center.

 

   

Increasing Expectations for Improved Price/Performance. The growing demand for bandwidth together with the availability of higher performance solutions has caused enterprises and service providers to expect significantly improved performance at lower prices. The arrival and adoption of equipment that can transport data at 10 Gigabit-per-second connection speeds, soon to be followed by equipment offering 40 Gigabit and 100 Gigabit connection speeds, is resulting in the expectation for lower price per network port.

 

   

Vendor Consolidation. Consolidation of vendors within the Ethernet networking market and between adjacent markets (storage, security, wireless & voice applications) continues to gain momentum. We believe that the underpinning technology for all of these adjacent markets is Ethernet. As a result, we believe that there will be continued mergers between adjacent market vendors to enable them to deliver complete and broad solutions to customers.

The Extreme Networks Strategy

Our goal is to be the provider of innovative, business relevant and compelling network solutions that create an improved applications and services infrastructure for enterprises, data centers and metropolitan service providers. We seek to provide our customers with a best-of-breed alternative to single-sourced, highly proprietary networking equipment from larger competitors.

Key elements of our strategy include:

 

   

Provide simple, easy-to-use, high-performance, cost-effective switching solutions. We offer simple, easy-to-use, high performance and cost-effective switching solutions that meet the specific demands of the following customers:

 

   

Enterprises, including large or medium sized businesses, schools, hospitals, hotels and government agencies, use our products to operate local area networks (“LANs”) or wireless local area networks (“WLANs”).

 

   

Data Center Operators use our products to deploy next generation virtualized and high density server infrastructure solutions.

 

   

Metropolitan Telecommunication Service Providers use our products to operate metropolitan area networks that provide telecommunications services to mid-sized geographic areas such as a city, greater metropolitan area or rural community.

We focus our development efforts specifically on “converged networks” which must reliably deliver data, voice and video to users.

 

   

Expand market penetration. We continue to market our products to new customers in multiple market segments. While the majority of our business is with enterprise customers, we continue to leverage our technology development, service, support and business infrastructure resources to address the metropolitan service provider and data center markets.

 

   

Extend switching technology leadership. Our technological leadership is based on innovative switching technology, the depth and focus of our market experience and the ExtremeXOS® operating system – the software that runs on all of our Ethernet switches. We intend to invest our engineering resources to continue to create leading-edge technologies that will increase the performance and functionality of our products and as a direct result, the value of the Extreme Networks solution to our current and future customers.

 

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Leverage and expand multiple distribution channels. We distribute our products through select distributors, a large number of resellers and system-integrators worldwide and our large strategic partners. We maintain a field sales force to support our channel partners and to sell directly to certain strategic accounts. As an independent Ethernet switch vendor, we seek to provide products that, when combined with the offerings of our channel partners, create compelling solutions for end user customers.

 

   

Maintain and extend our Strategic Relationships. We have established strategic relationships with a number of industry-leading vendors to both provide increased and enhanced routes to market, but also to collaboratively develop unique solutions.

 

   

Provide high-quality customer service and support. We seek to enhance customer satisfaction and build customer loyalty through high-quality service and support. This includes a wide range of standard support programs that provide the level of service our customers require, from standard business hours to global 24-hour-a-day, 365-day-a-year real-time response support.

Products

The following key benefits of our products allow our customers to operate highly scalable, secure and comprehensively managed networks which are reliable, fast, flexible and cost-effective.

 

   

High Availability. Customers can choose to deploy redundant management modules, hot swappable line cards, redundant power supplies and fan trays delivering high hardware availability; a modular operating system (ExtremeXOS) for high system availability; and a variety of link-level resiliency protocols including Ethernet Automatic Protection Switching (EAPS), for high service availability. Developed by Extreme Networks, EAPS is an open protocol that allows network managers to configure their network infrastructure so that critical network communications can be rerouted within 50 milliseconds in the event of a network outage with most topologies. This level of high-speed communications ‘reroute’ ensures that mission critical and demanding applications, including voice and video, maintain service delivery in the event of network outage.

 

   

Quality of Service (“QOS”). We offer a versatile and flexible QoS solution that allows network operators to assign the appropriate amount of bandwidth to mission critical applications and in doing so control the overall experience and the service-level of the communication flows. We have substantial experience with communication quality controls, starting with our introduction to the market of the first broad QoS controls for Ethernet.

 

   

Comprehensive Security. Our security solution delivers the capabilities required by our customers – a network that has security at its heart rather than added as an overlay or afterthought. Our security solution, which combines secure switches with our powerful security rules engine, enables customers to implement unified wired and wireless network access and IP Telephony in a secure environment. CLEAR-Flow, our wire-speed security rules engine, helps detect and mitigate many security anomalies, including denial of service attacks.

 

   

Ease of Management. We offer a suite of network management tools that allow network operators to monitor and manage the network in an automated fashion. Software developers can interact directly with our products using a standards-based Application Programming Interface (API) and the industry standard eXtensible Markup Language (XML) to manage the network and optimize application performance.

 

   

Power efficient operations. Our portfolio of switching hardware has been created with power consumption in mind. Our switches are designed to require less power to perform the network traffic switching function, and where Power over Ethernet (PoE) solutions have been deployed within the customers’ network, features within the Extreme XOS operating system can intelligently control the delivery of power to the attached devices.

 

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Our product categories include:

 

   

Stackable Ethernet switching systems. Our Summit® product family delivers Ethernet connectivity for the network edge, aggregation and core. Within the Summit family are products that offer a range of connection speeds (from 10 Megabit to 10 Gigabit), various physical presentations (copper and fiber) and options to deliver Power-over-Ethernet or unpowered standard Ethernet ports. The Summit products in conjunction with our ExtremeXOS operating system provide the features, performance and reliability required by our customers to deploy, operate and manage converged networking infrastructure.

 

   

Modular Ethernet switching systems. Our Black Diamond® and Alpine® products deliver modular or chassis-based Ethernet connectivity solutions for enterprises, data centers and service providers. These products have a range of management and line cards that allow our customers to flexibly configure and re-purpose the systems to meet specific needs. As with our Summit products, the Black Diamond and Alpine products in conjunction with our Extreme XOS operating system and our centralized management software product provide the density, performance and reliability required to serve in environments with demanding applications.

 

   

Wireless Ethernet controllers and access points. In addition to our wired Ethernet switch portfolio, we offer our SummitWM family of wireless network controllers and associated Altitude™ access points to enable the deployment of nomadic and mobile converged network applications. Our wireless access products offer a full range of performance options including 802.11b/g to 802.11n.

 

   

Centralized Management software. To provide a central configuration, status and alerting capability we offer our EpiCenter management software system. This system provides the ability to deploy, configure, monitor and support our complete range of switching technology to enable our customers to reduce the overall cost of network administration and operations. This software system can exist as a standalone management solution or it can operate as part of a larger infrastructure management environment.

Sales, Marketing and Distribution

We conduct our sales and marketing activities on a worldwide basis through a distribution channel utilizing distributors, resellers and our field sales organization. We primarily sell our products through an ecosystem of channel partners who combine our Ethernet products with their offerings to create compelling information technology solutions for end user customers. We utilize our field sales organization to support our channel partners and to sell direct to end-user customers, including some large global accounts.

Strategic Relationships. We have strategic relationships with Motorola Inc., Dell, Inc., Ericsson Enterprise AB, Nokia Siemens Networks and others who sell our products as part of an overall solution.

Distributors. We have established several key relationships with leading distributors in the electronics and computer networking industries. Each of our distributors primarily resells our products to resellers. The distributors enhance our ability to sell and provide support to resellers, who may benefit from the broad service and product fulfillment capabilities offered by these distributors. One distributor, Tech Data Corporation, accounted for 12%, 11% and 11% of our net revenue in fiscal years 2010, 2009 and 2008, respectively. Distributors are generally given the right to return a portion of inventory to us for the purpose of stock rotation and participate in various cooperative marketing programs to promote the sale of our products and services. We defer recognition of revenue on all sales to distributors who maintain inventory of our products until the distributors sell the product, as evidenced by monthly “sales-out” reports that the distributors provide to us, provided other revenue recognition criteria are met. (See “Revenue Recognition” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

 

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Resellers. We rely on many resellers worldwide that sell directly to end-user customer. Our resellers include regional networking system resellers, resellers who focus on specific vertical markets, value added resellers, network integrators and wholesale resellers. We provide training and support to our resellers and our resellers generally provide the first level of contact to end-users of our products. Our relationships with resellers are generally on a non-exclusive basis. Our resellers are not given rights to return inventory and do not automatically participate in any cooperative marketing programs. We generally recognize product revenue from our reseller and end-user customers at the time of shipment, provided other revenue recognition criteria are met. When significant obligations or contingencies remain after products are delivered, such as installation or customer acceptance, revenue and related costs are deferred until such obligations or contingencies are satisfied. (See “Revenue Recognition” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

Field Sales. We have trained our field sales organization to support and develop leads for our resellers and to establish and maintain key accounts and strategic end user customers. To support these objectives, our field sales force:

 

   

assists end-user customers in finding solutions to complex network system and architecture problems;

 

   

differentiates the features and capabilities of our products from competitive offerings;

 

   

continually monitors and understands the evolving networking needs of enterprise and service provider customers;

 

   

promotes our products and ensures direct contact with current and potential customers;

 

   

assists our resellers to drive to closure business opportunities; and

 

   

monitors the changing requirements of our customers.

As of June 27, 2010, our worldwide sales and marketing organization consisted of 302 individuals, including directors, managers, sales representatives, and technical and administrative support personnel. We have domestic sales offices located in 13 states and international sales offices located in 23 countries.

International sales

International sales are an important portion of our business. In fiscal 2010, sales to customers outside of North America accounted for 60% of our consolidated net revenue, compared to 61% in fiscal 2009 and 56% in fiscal 2008. These sales are conducted primarily through foreign-based distributors and resellers managed by our worldwide sales organization. In addition, we have direct sales to end-user customers, including large global accounts. The primary markets for sales outside of North America are countries in Europe and Asia. (See “Net Revenue” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

Long-Lived Assets

See Note 2 of our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for more information regarding our long-lived assets.

Marketing

We continue to develop and execute on a number of marketing programs to support the sale and distribution of our products by communicating the value of our solutions to our existing and potential customers, our distribution channels and our resellers. Our marketing efforts include participation in industry tradeshows, technical conferences and technology seminars, preparation of competitive analyses, sales training, and publication of technical and educational articles in industry journals, a publicly available website, promotions, web-based training courses, advertising and public relations. We also submit our products for independent product testing and evaluation.

 

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Backlog

Our products are often sold on the basis of standard purchase orders that are cancelable prior to shipment without significant penalties. In addition, purchase orders are subject to changes in quantities of products and delivery schedules in order to reflect changes in customer requirements and manufacturing capacity. Our business is characterized by seasonal variability in demand and short lead-time orders and delivery schedules. Actual shipments depend on the then-current capacity of our contract manufacturers and the availability of materials and components from our vendors. We believe that only a small portion of our order backlog is non-cancelable and that the dollar amount associated with the non-cancelable portion is not material. Accordingly, we do not believe that backlog at any given time is a meaningful indicator of future revenue.

Seasonality

Like many of our competitors, we historically have experienced seasonal fluctuations in customer spending patterns, which generally adversely affect our first and third fiscal quarters. This pattern should not be relied upon, however, as it has varied in the past.

Customer Service and Support

Our customers seek high reliability and maximum uptime for their networks. To that extent, we provide the following service offerings:

 

   

Support services for end-users, resellers and distributors. We meet the service requirements of our customers and channel partners through our Technical Assistance Centers, or TACs, located in Santa Clara, California; Utrecht, Netherlands; Research Triangle Park, North Carolina; and Tokyo, Japan. Our TAC engineers and technicians assist in diagnosing and troubleshooting technical issues regarding customer networks. Development engineers work with the TACs to resolve product functionality issues specific to each customer.

 

   

Professional services. We provide consultative services to improve customer productivity in all phases of the network lifecycle – planning, design, implementation, operations and optimization management. Our network architects develop and execute customized hardware deployment plans to meet individualized network strategies. These activities may include the management and coordination of the design and network configuration, resource planning, staging, logistics, migration and deployment. We also provide customized training and operational best practices documentation to assist customers in the transition and sustaining of their networks.

 

   

Education. Our classes cover a wide range of topics such as installation, configuration, operation, management and optimization – providing customers with the necessary knowledge and experience to successfully deploy and manage our products in various networking environments. Classes may be scheduled and available at numerous locations worldwide. We deliver training using our staff, on-line training classes and authorized training partners. In addition, we make much of our training materials accessible free-of-charge on our internet site for customers and partners to use in self-education. We believe this approach enhances the market’s ability to learn and understand the broad array of advantages of our products.

Manufacturing

We outsource the majority of our manufacturing and supply chain management operations as part of our strategy to maintain global manufacturing capabilities and to reduce our costs. We conduct quality assurance, manufacturing engineering, document control and test development at our main campus in Santa Clara, California. This approach enables us to reduce fixed costs and to flexibly respond to changes in market demand.

We have a relationship with Flextronics International, Ltd. for the manufacture of some of our products in Guadalajara, Mexico. Flextronics’ manufacturing processes and procedures are ISO 9001 certified. We determine the components that are incorporated in our products and select the appropriate suppliers of such components.

 

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We also maintain a relationship with Alpha Networks, Inc. headquartered in Hsinchu, Taiwan. Alpha Networks is a global networking Original Design Manufacturer (ODM) leader with core competencies in areas such as Ethernet, LAN/MAN, Wireless, Broadband and VoIP. Alpha Networks’ manufacturing processes and procedures are ISO 9001 certified. We partner with Alpha Networks to design and build some of our products.

We have a relationship with Benchmark Electronics Huntsville Inc. for the manufacture of some of our products in Huntsville, Alabama. Benchmark manufacturing processes and procedures are ISO 9001 certified. We determine the components that are incorporated in our products and select the appropriate suppliers of such components.

Our wireless products are supplied under an OEM supply agreement with Symbol Technologies, Inc, a subsidiary of Motorola, Inc. (“Motorola”). Motorola rebrands and customizes the wireless products for us to resell to customers. Motorola’s manufacturing processes and procedures are ISO 9001 certified. Motorola has made ongoing supply and support commitments during the term of the agreement and is required to provide support for a defined period of time after any termination of the agreement.

These manufacturers utilize automated testing equipment to perform product testing and burn-in with specified tests. Together we rely upon comprehensive inspection testing and statistical process controls to assure the quality and reliability of our products.

We use our forecast of expected demand to determine our material requirements. Lead times for materials and components vary significantly, and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. We order most of our materials and components on an indirect basis through our contract manufacturer. Purchase commitments with our manufacturers are generally on a purchase order basis.

Research and Development

The success of our products to date is due in large part to our focus on research and development. We believe that continued success in the marketplace will depend on our ability to develop new and enhanced products employing leading-edge technology. Accordingly, we are undertaking development efforts with an emphasis on increasing the reliability, performance and features of our family of products, and designing innovative products to reduce the overall network operating costs of customers.

Our product development activities focus on solving the needs of enterprises, data centers, and service providers. Current activities include the continuing development of our innovative switching technology aimed at extending the capabilities of our products. Our ongoing research activities cover a broad range of areas, including, in particular, 10 Gigabit and higher-speed Ethernet, Metro and Internet routing, network security, network management software, datacenter equipment broadband access equipment and wireless networking equipment.

We continued to enhance the functionality of our modular operating system (ExtremeXOS) which has been designed to provide high reliability and availability. This allows us to leverage a common operating system across different hardware and network chipsets.

As of June 27, 2010, our research and development organization consisted of 205 individuals. Research and development efforts are conducted in several locations, including Santa Clara, California; Raleigh, North Carolina; and Chennai, India. Our research and development expenses in fiscal years 2010, 2009 and 2008 were $49.4 million, $58.2 million and $65.3 million, respectively.

 

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Competition

The market for network switches, which is part of the broader market for networking equipment, is extremely competitive and characterized by rapid technological progress, frequent new product introductions, changes in customer requirements and evolving industry standards. We believe the principal competitive factors in the network switching market are:

 

   

expertise and familiarity with network protocols, network switching and network management;

 

   

product performance, features, functionality and reliability;

 

   

price/performance characteristics;

 

   

timeliness of new product introductions;

 

   

adoption of emerging industry standards;

 

   

customer service and support;

 

   

size and scope of distribution network;

 

   

brand name;

 

   

breadth of product offering;

 

   

access to customers; and

 

   

size of installed customer base.

We believe that we compete with our competitors with respect to many of the foregoing factors. However, the market for network switching solutions is dominated by a few large companies, particularly Cisco Systems, Inc. In addition to Cisco Systems, we compete with public and private companies that offer switching solutions or provide alternative networking solutions, including, Alcatel-Lucent, Brocade Communications Systems, Inc., Hewlett-Packard Company, Huawei Technologies Corporation, Juniper Networks, Inc. and Siemens Enterprise Communications GmBH & Co. KG. Most of these competitors have longer operating histories, greater name recognition, larger customer bases, broader product lines and substantially greater financial, technical, sales, marketing and other resources.

Intellectual Property

We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. Based on our commitment to build a patent portfolio, we have in process a number of patent applications relating to our proprietary technology in the United States and in selected other countries. With respect to trademarks, we have a number of pending and registered trademarks in the United States and abroad.

We enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to, and distribution of, our software, documentation and other proprietary information. In addition, we provide our software products to end-user customers primarily under “shrink-wrap” license agreements. These agreements are not negotiated with or signed by the licensee, and thus these agreements may not be enforceable in some jurisdictions. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

Environment

We maintain compliance with various regulations related to the environment, including the Waste Electrical and Electronic Equipment and Restriction of the Use of Certain Hazardous Substances in Electrical and

 

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Electronic Equipment regulations adopted by the European Union. Further, we are committed to energy efficiency in our product lines. For example, certain of our products consume far less power than offerings from our major competitors. Accordingly, we believe this is an area that affords us a competitive advantage for our products in the marketplace. To date, our compliance efforts with various U.S. and foreign regulations related to the environment has not had a material effect on our operating results.

Employees

As of June 27, 2010, we employed 740 people, including 302 in sales and marketing, 205 in research and development, 62 in operations, 96 in customer support and service, and 75 in finance and administration. We have never had a work stoppage and no personnel are represented under collective bargaining agreements. We consider our employee relations to be good.

We believe that our future success depends on our continued ability to attract, integrate, retain, train and motivate highly qualified personnel, and upon the continued service of our senior management and key personnel. None of our executive officers or key employees is bound by an employment agreement which mandates that the employee render services for any specific term. The market for qualified personnel is competitive, particularly in the San Francisco Bay Area, where our headquarters is located.

Organization

We were incorporated in California in May 1996 and reincorporated in Delaware in March 1999. Our corporate headquarters are located at 3585 Monroe Street, Santa Clara, CA 95051 and our telephone number is (408) 579-2800. We electronically file our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 with the Securities Exchange Commission. The public can obtain copies of our SEC filings from our website found at www.extremenetworks.com free of charge, or on the Securities Exchange Commission’s website at www.sec.gov. The public may also read or copy any materials we file with the Securities Exchange Commission at the Securities Exchange Commission’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the Securities Exchange Commission at 1-800-SEC-0330.

Our corporate governance guidelines, the charters of our audit committee, our compensation committee and our nominating and corporate governance committee and our code of ethics policy (including code of ethics provisions that apply to our principal executive officer, principal financial officers, controller and senior financial officers) are available on our website at www.extremenetworks.com under “Corporate Governance.” These items are also available to any stockholder who requests them by calling (408) 579-2800.

Executive Officers of the Registrant

The following table sets forth information regarding our executive officers as of August 20, 2010:

 

Name

   Age   

Position

Bob L. Corey

   59    Executive Vice President and Chief Financial Officer, Acting Chief Executive Officer

Paul A. Hooper

   47    Chief Marketing Officer

Suresh K. Gopalakrishnan

   47    Vice President, Engineering

Michael L. Seaton

   46    Vice President, Worldwide Sales and Services

Diane C. Honda

   45    Senior Vice President, General Counsel and Secretary

Justin A. DiMacchia

   67    Vice President, Corporate Controller

Bob L. Corey. Mr. Corey is Acting Executive Chief Executive Officer, as well as the Senior Vice President and Chief Financial Officer of Extreme Networks. Prior to joining Extreme Networks, Mr. Corey served on our

 

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board of directors, from 2003 to 2009, and was the chairman of our audit committee. Prior to Extreme Networks, Mr. Corey served as Executive Vice President and Chief Financial Officer for Thor Technologies, Inc., a provider of enterprise provisioning software, from May 2003 until January 2006. Oracle Corporation acquired Thor Technologies in November 2005. Mr. Corey served as Executive Vice President and Chief Financial Officer of Documentum, Inc., a provider of enterprise content management software, from May 2000 to August 2002. Mr. Corey served as Senior Vice President of Finance and Administration and Chief Financial Officer for Forte Software, Inc., a provider of software development tools and services, from May 1998 to April 2000. In February 1999, Mr. Corey was elected to its Board of Directors prior to Forte Software’s acquisition by Sun Microsystems in October 1999. Mr. Corey also served as Chairman of the Board of Directors of Interwoven, Inc., a publicly-traded provider of enterprise content management software, until its acquisition by Autonomy Corporation plc in March 2009 and continues to serve on the Board of Directors of Veraz Networks, a publicly-traded provider of IP soft switches, media gateways and digital compression products. Mr. Corey holds a Bachelors of Administration with a concentration in accounting from California State University at Fullerton.

Paul A. Hooper. Mr. Hooper serves as Extreme Networks’ Chief Marketing Officer. Hooper, a 15 year veteran of the High Tech industry, oversees Extreme Networks worldwide marketing efforts, where he leads the strategic focus of solutions and technical marketing, global field marketing and corporate communications. Prior to that, he served as Vice President and General Manager for the Volume Products Group, responsible for the strategy, product development and business management for Extreme Networks’ Summit family of fixed configuration switches, the BlackDiamond 8800 family of modular switches, wireless LAN solution and security solutions. Hooper also serves as Extreme Networks executive sponsor for data center and enterprise LAN initiatives. Prior to that, as Extreme Networks Chief Information Officer, Mr. Hooper oversaw the strategic use of IT systems and adherence to corporate compliance for data throughout a globally distributed business. Specifically, Mr. Hooper led the planning, procurement and ongoing support of business applications, network infrastructure and related services supporting more than 800 employees across 50 countries. Prior to joining Extreme Networks, Mr. Hooper served as vice president of information technology at myCFO, Inc., where he was responsible for the Enterprise Applications and Infrastructure for the fast-growing Financial Services and Advisory company. Mr. Hooper has also held senior-level IT positions with JDS Uniphase, Netscape Communications and Sun Microsystems.

Suresh K. Gopalakrishnan. Mr. Gopalakrishnan leads the Company’s engineering team and is responsible for all technology strategy and product development for Extreme Networks. Mr. Gopalakrishnan leverages a rich background in business strategy, marketing, systems engineering and product development to this role. Mr. Gopalakrishnan previously held the roles of vice president and general manager of Scalable Products Group where he was responsible for Extreme Networks’ carrier business; vice president and general manager of Emerging Product Group where he was responsible for Extreme Networks’ wireless and security business; Chief Marketing Officer of Extreme Networks where he was responsible for worldwide marketing, product management and solutions marketing; as well as vice president and general manager of Converged Systems, where he was responsible for IP Telephony alliances. Prior to joining Extreme Networks, Mr. Gopalakrishnan was the executive vice president of engineering at Riverstone Networks and served as the director of corporate strategy at Cabletron Systems. Mr. Gopalakrishnan has also held management positions at Sun Microsystems and engineering positions at Hewlett Packard. Mr. Gopalakrishnan is a member of the Board of Expert Advisors of the California Emerging Technology Fund (CETF) and has been an adjunct faculty member at University of Idaho and Santa Clara University. He holds a Ph.D. in Electrical Engineering from the University of Idaho.

Mike L. Seaton. Mr. Seaton serves as Vice President for Worldwide Sales and Services at Extreme Networks, an organization that includes worldwide sales, channels and global customer support serving enterprise, data center and carrier customers. Mr. Seaton, a 20 year industry veteran, previously held the role of Vice President and General Manager of Worldwide Services for Extreme Networks, where he oversaw the delivery of technical support, education, advanced technical and professional services. Prior to that, Mr. Seaton was the Vice President of Sales Operations and Strategic Alliances, where he was responsible for ensuring that

 

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the benefit of combined solutions and a strategic relationship realized by Extreme Networks joint business partners and customers worldwide. Prior to joining Extreme Networks, Mr. Seaton held various positions at AT&T, Lucent Technologies and Avaya throughout his career. Mr. Seaton’s experience is highlighted by programming, services, sales, sales management, sales leadership, operations and internal business consulting. Mr. Seaton holds a Bachelor of General Studies with a concentration in Mathematics and Computer Science from the University of Michigan and an MBA from Florida State University.

Diane C. Honda. Ms. Honda serves as our Senior Vice President, General Counsel and Secretary. She has been employed by the Company since November 2004, and prior to her current positions was Vice President and Associate General Counsel. She previously held legal or business positions with Speedera Networks, Inc., Riverstone Networks, Inc., Legato Systems, Inc., and Hewlett-Packard Company. She received a bachelor’s in science in Applied Math Computer Science and Industrial Management from Carnegie Mellon University and a J.D. from Santa Clara University School of Law.

Justin A. DiMacchia. Mr. DiMacchia serves as our Vice President, Controller. He has been employed by Extreme Networks since August 2004, and prior to his current positions was Director of Internal Audit. He has held various positions in Extreme Networks’ finance group, including Interim Vice President Corporate Controller. Before joining Extreme Networks, Mr. DiMacchia held various Financial Management positions with increasing responsibility while at Palm, Inc. Prior to Palm, Inc., he was the Vice President Chief Financial Officer of The Appletree Companies. Mr. DiMacchia commenced his career with Arthur Andersen & Co and is a Certified Public Accountant in California.

Item 1A. Risk Factors

The following is a list of risks and uncertainties which may have a material and adverse effect on our business, financial condition or results of operations. The risks and uncertainties set out below are not the only risks and uncertainties we face, and some are endemic to the networking industry.

We Cannot Assure You That We Will Be Profitable in the Future Because A Number of Factors Could Negatively Affect Our Financial Results.

Although we reported profits for fiscal 2010, we have reported losses in some of our prior fiscal years. In addition, in years when we reported profits, we were not profitable in each quarter during those years. We anticipate continuing to incur significant sales and marketing, product development and general and administrative expenses. A high percentage of these expenses are fixed in the short term, so any delay in generating or recognizing revenue could result in a loss for a quarter or full year. Even if we are profitable, our operating results may fall below the expectations of public market analysts or investors, which could cause the price of our stock to fall.

We may experience challenges or delays in generating or recognizing revenue for a number of reasons and our revenue and operating results have varied significantly in the past and may vary significantly in the future due to a number of factors, including, but not limited to, the following:

 

   

we are dependent upon obtaining orders during a quarter and shipping those orders in the same quarter to achieve our revenue objectives;

 

   

acceptance provisions in customer contracts;

 

   

our ability to deliver installation or inspection services by the end of the quarter;

 

   

changes in general and/or specific economic conditions in the networking industry;

 

   

seasonal fluctuations in demand for our products and services, particularly in Asia and Europe;

 

   

the level of attrition of our employees, and of our sales force in particular;

 

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a disproportionate percentage of our sales occurring in the last month of the quarter;

 

   

our ability to ship products by the end of a quarter;

 

   

reduced visibility into the implementation cycles for our products and our customers’ spending plans;

 

   

our ability to forecast demand for our products, which in the case of lower-than-expected sales, may result in excess or obsolete inventory in addition to non-cancelable purchase commitments for component parts;

 

   

sales to the telecommunications service provider market, which represent a significant source of large product orders, are especially volatile and difficult to forecast;

 

   

product returns or the cancellation or rescheduling of orders;

 

   

our ability to develop, introduce, ship and support new products and product enhancements and manage product transitions;

 

   

announcements and new product introductions by our competitors;

 

   

our ability to develop and support relationships with enterprise customers, service providers and other potential large customers;

 

   

our ability to achieve targeted cost reductions;

 

   

fluctuations in warranty or other service expenses actually incurred;

 

   

our ability to obtain sufficient supplies of sole- or limited-source components for our products on a timely basis;

 

   

increases in the prices of the components that we purchase;

 

   

decreases in the prices of the products that we sell;

 

   

our ability to manage and maintain our relationships with our manufacturing partners including our ability to achieve and maintain desired production volumes and quality levels for our products;

 

   

the mix of products sold and the mix of distribution channels through which products are sold;

 

   

impairment charges associated with long-lived assets;

 

   

restructuring costs associated with adjustments to the size of our operations;

 

   

costs relating to possible acquisitions and the integration of technologies or businesses;

 

   

the effect of amortization of purchased intangibles resulting from new transactions;

 

   

costs relating to the recognition of share-based payments; and

 

   

the potential future adoption of certain accounting standards new to our business.

Due to the foregoing factors, period-to-period comparisons of our operating results should not be relied upon as an indicator of our future performance.

Intense Competition in the Market for Networking Equipment Could Prevent Us from Increasing Revenue and Achieving Profitability.

The market for network switching solutions is intensely competitive and dominated primarily by Cisco Systems and a few other large companies. Most of our competitors have longer operating histories, greater name recognition, larger customer bases, broader product lines and substantially greater financial, technical, sales, marketing and other resources. As a result, these competitors are able to devote greater resources to the development, promotion, sale and support of their products. In addition, they have larger distribution channels, stronger brand names, access to more customers, a larger installed customer base and a greater ability to make

 

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attractive offers to channel partners and customers than we do. For example, we have encountered, and expect to continue to encounter, many potential customers who are confident in and committed to the product offerings of our principal competitors, including Cisco Systems. Accordingly, these potential customers may not consider or evaluate our products. When such potential customers have considered or evaluated our products, we have in the past lost, and expect in the future to lose, sales to some of these customers as large competitors have offered significant price discounts to secure these sales.

The pricing policies of our competitors impact the overall demand for our products and services. Some of our competitors are capable of operating at significant losses for extended periods of time, increasing pricing pressure on our products and services. If we do not maintain competitive pricing, the demand for our products and services, as well as our market share, may decline. From time to time, we may lower the prices of our products and services in response to competitive pressure. When this happens, if we are unable to reduce our component costs or improve operating efficiencies, our revenue and margins will be adversely affected.

Our Success is Dependent on Our Ability to Continually Introduce New Products and Features that Achieve Broad Market Acceptance.

The network equipment market is characterized by rapid technological progress, frequent new product introductions, changes in customer requirements and evolving industry standards. If we do not regularly introduce new products in this dynamic environment, our product lines will become obsolete. These new products must be compatible and interoperate with products and architectures offered by other vendors. We have and may in the future experience delays in product development and releases, and such delays have and could in the future adversely affect our ability to compete and our operating results.

When we announce new products or product enhancements that have the potential to replace or shorten the life cycle of our existing products, customers may defer or cancel orders for our existing products. These actions could have a material adverse effect on our operating results by unexpectedly decreasing sales, increasing inventory levels of older products and exposing us to greater risk of product obsolescence.

Even if we introduce new switching products, alternative technologies could achieve widespread market acceptance and displace the Ethernet technology on which we have based our product architecture. For example, developments in routers and routing software could significantly reduce demand for our products. As a result, we may not be able to achieve widespread market acceptance of our current or future new products.

The Unfavorable Economic Environment Has and May Continue to Negatively Impact our Business and Operating Results.

The challenges and uncertainty currently affecting global economic conditions may negatively impact our business and operating results in the following ways:

 

   

customers may delay or cancel plans to purchase our products and services;

 

   

customers may not be able to pay, or may delay payment of, the amounts that they owe us which may adversely affect our cash flow, the timing of our revenue recognition and the amount of revenue;

 

   

increased pricing pressure may result from our competitors aggressively discounting their products;

 

   

accurate budgeting and planning will be difficult due to low visibility into future sales;

 

   

forecasting customer demand will be more difficult increasing the risk of either excess and obsolete inventory if our forecast is too high or insufficient inventory to meet customer demand if our forecast is too low; and

 

   

our component suppliers and contract manufacturers have been negatively affected by the economy which may result in product delays and changes in pricing and service levels.

If global economic conditions do not show continued improvement, we believe that we will experience material adverse impacts to our business and operating results.

 

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Claims of Infringement by Others May Increase and the Resolution of Such Claims May Adversely Affect Our Operating Results.

Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patents, copyrights (including rights to “open source” software), and other intellectual property rights. Because of the existence of a large number of patents in the networking field, the secrecy of some pending patents and the issuance of new patents at a rapid pace, it is not possible to determine in advance if a product or component might infringe the patent rights of others. Because of the potential for courts awarding substantial damages and the lack of predictability of such awards, it is not uncommon for companies in our industry to settle even potentially unmeritorious claims for very substantial amounts. Further, the entities with whom we have or could have disputes or discussions include entities with extensive patent portfolios and substantial financial assets. These entities are actively engaged in programs to generate substantial revenue from their patent portfolios and are seeking or may seek significant payments or royalties from us and others in our industry.

Litigation resulting from claims that we are infringing the proprietary rights of others has resulted and could in the future result in substantial costs and a diversion of resources, and could have a material adverse effect on our business, financial condition and results of operations. We have received notices from entities alleging that we may be infringing their patents, and we are currently parties to patent litigation as described under Part I, Item 3, Legal Proceedings. Without regard to the merits of these or any other claims, an adverse court order or a settlement could require us, among other actions, to:

 

   

stop selling our products that incorporate the challenged intellectual property;

 

   

obtain a royalty bearing license to sell or use the relevant technology, which license may not be available on reasonable terms or available at all;

 

   

pay damages; or

 

   

redesign those products that use the disputed technology.

In addition, our products include so-called “open source” software. Open source software is typically licensed for use at no initial charge, but imposes on the user of the open source software certain requirements to license to others both the open source software as well as modifications to the open source software. Our use of open source software subjects us to certain additional risks for the following reasons:

 

   

open source license terms may be ambiguous and may result in unanticipated obligations regarding our products;

 

   

open source software cannot be protected under trade secret law;

 

   

suppliers of open-source software do not provide the warranty, support and liability protections typically provided by vendors who offer proprietary software; and

 

   

it may be difficult for us to accurately determine the developers of the open source code and whether the acquired software infringes third-party intellectual property rights.

We believe that even if we do not infringe the rights of others, we will incur significant expenses in the future due to disputes or licensing negotiations, though the amounts cannot be determined. These expenses may be material or otherwise adversely affect our operating results.

Our Operating Results May be Negatively Affected by Defending or Pursuing Claims or Lawsuits.

We have and may in the future pursue or be subject to claims or lawsuits in the normal course of our business. In addition to the intellectual property lawsuits described above, we are currently parties to securities and contract litigation as described in “Item 3. Legal Proceedings.” Regardless of the result, litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal

 

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proceedings are difficult to predict. An unfavorable resolution of a lawsuit in which we are a defendant could result in a court order against us or payments to other parties that would have an adverse effect on our business, results of operations, or financial condition. Even if we are successful in prosecuting claims and lawsuits, we may not recover damages sufficient to cover our expenses incurred to manage, investigate and pursue the litigation. In addition, subject to certain limitations, we may be obligated to indemnify our current and former directors, officers and employees in certain lawsuits. We do not maintain insurance coverage which will cover all of our litigation costs and liabilities.

If We Fail To Protect Our Intellectual Property, Our Business Could Suffer.

We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. However, we cannot ensure that the actions we have taken will adequately protect our intellectual property rights or that other parties will not independently develop similar or competing products that do not infringe on our patents. We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our intellectual property and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise misappropriate or use our products or technology, which would adversely affect our business.

We Expect the Average Selling Prices of Our Products to Decrease, Which May Reduce Gross Margin and/or Revenue.

The network equipment industry has traditionally experienced an erosion of average selling prices due to a number of factors, including competitive pricing pressures, promotional pricing and technological progress. We anticipate that the average selling prices of our products will decrease in the future in response to competitive pricing pressures, excess inventories, increased sales discounts and new product introductions by us or our competitors. We may experience substantial decreases in future operating results due to the erosion of our average selling prices. To maintain our gross margin, we must develop and introduce on a timely basis new products and product enhancements and continually reduce our product costs. Our failure to do so would likely cause our revenue and gross margins to decline.

When Our Products Contain Undetected Errors, We May Incur Significant Unexpected Expenses and Could Lose Sales.

Network products frequently contain undetected errors when new products or new versions or updates of existing products are released to the marketplace. In the past, we have experienced such errors in connection with new products and product updates. We have experienced component problems in prior years that caused us to incur higher than expected warranty, service costs and expenses, and other related operating expenses. In the future, we expect that, from time to time, such errors or component failures will be found in new or existing products after the commencement of commercial shipments. These problems may have a material adverse effect on our business by causing us to incur significant warranty, repair and replacement costs, diverting the attention of our engineering personnel from new product development efforts, delaying the recognition of revenue and causing significant customer relations problems. Further, if products are not accepted by customers due to such defects, and such returns exceed the amount we accrued for defective returns based on our historical experience, our operating results would be adversely affected.

Our products must successfully interoperate with products from other vendors. As a result, when problems occur in a network, it may be difficult to identify the sources of these problems. The occurrence of system errors, whether or not caused by our products, could result in the delay or loss of market acceptance of our products and any necessary revisions may cause us to incur significant expenses. The occurrence of any such problems would likely have a material adverse effect on our business, operating results and financial condition.

 

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We Purchase Several Key Components for Products From Single or Limited Sources and Could Lose Sales if These Suppliers Fail to Meet Our Needs.

We currently purchase several key components used in the manufacture of our products from single or limited sources and are dependent upon supply from these sources to meet our needs. Certain components such as tantalum capacitors, SRAM, DRAM, and printed circuit boards, have been in the past, and may in the future be, in short supply. We have encountered, and are likely in the future to encounter, shortages and delays in obtaining these or other components, and this could have a material adverse effect on our ability to meet customer orders. Our principal sole-source components include:

 

   

ASICs;

 

   

Merchant silicon;

 

   

microprocessors;

 

   

programmable integrated circuits;

 

   

selected other integrated circuits;

 

   

custom power supplies; and

 

   

custom-tooled sheet metal.

Our principal limited-source components include:

 

   

flash memory;

 

   

DRAMs and SRAMs;

 

   

printed circuit boards; and

 

   

CAMs.

We use our forecast of expected demand to determine our material requirements. Lead times for materials and components we order vary significantly, and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. If forecasts exceed orders, we may have excess and/or obsolete inventory, which could have a material adverse effect on our operating results and financial condition. If orders exceed forecasts, we may have inadequate supplies of certain materials and components, which could have a material adverse effect on our ability to meet customer delivery requirements and to recognize revenue.

Generally, we do not have agreements fixing long-term prices or minimum volume requirements from suppliers. From time to time we have experienced shortages and allocations of certain components, resulting in delays in filling orders. Qualifying new suppliers to compensate for such shortages may be time-consuming and costly, and may increase the likelihood of errors in design or production. In addition, during the development of our products, we have experienced delays in the prototyping of our chipsets, which in turn has led to delays in product introductions. Similar delays may occur in the future. Furthermore, the performance of the components as incorporated in our products may not meet the quality requirements of our customers.

Our Dependence on Three Manufacturers for All of Our Manufacturing Requirements Could Harm Our Operating Results.

We primarily rely on three manufacturing partners to manufacture our products. In addition, each of our products is manufactured by only one of these companies. We have experienced delays in product shipments from our manufacturing partners in the past, which in turn delayed product shipments to our customers. These or similar problems may arise in the future, such as delivery of products of inferior quality, delivery of insufficient quantity of products, or the interruption or discontinuance of operations of a manufacturer, any of which could have a material adverse effect on our business and operating results. While we maintain strong relationships with

 

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our manufacturing partners, our agreements with these manufacturers are generally of limited duration and pricing, quality and volume commitments are negotiated on a recurring basis. The failure to maintain continuing agreements with our manufacturing partners could adversely affect our business. We intend to 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.

As part of our cost-reduction efforts, we will need to realize lower per unit product costs from our manufacturing partners by means of volume efficiencies and the utilization of manufacturing sites in lower-cost geographies. However, we cannot be certain when or if such price reductions will occur. The failure to obtain such price reductions would adversely affect our gross margins and operating results.

Our Dependence on an OEM for All of Our Wireless Products Could Harm Our Operating Results.

We rely on Motorola to provide our wireless products. If we experience delays in product shipments from our OEM or if they experience delays from their suppliers, which in turn delays product shipments to our customers, our financial results could be negatively impacted. Problems such as delivery of products of inferior quality, delivery of insufficient quantity of products, or the interruption or discontinuance of operations of our OEM, may arise in the future, any of which could have a material adverse effect on our business and operating results.

We Depend Upon International Sales for a Significant Portion of Our Revenue Which Imposes a Number of Risks on Our Business.

International sales constitute a significant portion of our net revenue. Our ability to grow will depend in part on the expansion of international sales. Our international sales primarily depend on the success of our resellers and distributors. The failure of these resellers and distributors to sell our products internationally would limit our ability to sustain and grow our revenue. There are a number of risks arising from our international business, including:

 

   

longer accounts receivable collection cycles;

 

   

difficulties in managing operations across disparate geographic areas;

 

   

difficulties associated with enforcing agreements through foreign legal systems;

 

   

the payment of operating expenses in local currencies, which exposes us to risks of currency fluctuations;

 

   

higher credit risks requiring cash in advance or letters of credit;

 

   

difficulties in safeguarding intellectual property;

 

   

political and economic turbulence;

 

   

terrorism, war or other armed conflict;

 

   

natural disasters and epidemics;

 

   

potential adverse tax consequences;

 

   

compliance with regulatory requirements of foreign countries, including compliance with rapidly evolving environmental regulations; and

 

   

compliance with U.S. laws and regulations pertaining to the sale and distribution of products to customers in foreign countries, including export controls and the Foreign Corrupt Practices Act.

Substantially all of our international sales are U.S. dollar-denominated. Future increases in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. In

 

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the future, we may elect to invoice some of our international customers in local currency, which would expose us to fluctuations in exchange rates between the U.S. dollar and the particular local currency. If we do so, we may decide to engage in hedging transactions to minimize the risk of such fluctuations.

We have entered into foreign exchange forward contracts to offset the impact of payment of operating expenses in local currencies to some of our operating foreign subsidiaries. However, if we are not successful in managing these foreign currency transactions, we could incur losses from these activities.

We Must Continue to Develop and Increase the Productivity of Our Indirect Distribution Channels to Increase Net Revenue and Improve Our Operating Results.

Our distribution strategy focuses primarily on developing and increasing the productivity of our indirect distribution channels. If we fail to develop and cultivate relationships with significant channel partners, or if these channel partners are not successful in their sales efforts, sales of our products may decrease and our operating results could suffer. Many of our channel partners also sell products from other vendors that compete with our products. Our channel partners may not continue to market or sell our products effectively or to devote the resources necessary to provide us with effective sales, marketing and technical support. We may not be able to successfully manage our sales channels or enter into additional reseller and/or distribution agreements. Our failure to do any of these could limit our ability to grow or sustain revenue.

Our operating results for any given period have and will continue to depend to a significant extent on large orders from a relatively small number of channel partners and other customers. However, we do not have binding purchase commitments from any of them. A substantial reduction or delay in sales of our products to a significant reseller, distributor or other customer could harm our business, operating results and financial condition because our expense levels are based on our expectations as to future revenue and to a large extent are fixed in the short term. Under specified conditions, some third-party distributors are allowed to return products to us and unexpected returns could adversely affect our results.

The Sales Cycle for Our Products is Long and We May Incur Substantial Non-Recoverable Expenses or Devote Significant Resources to Sales that Do Not Occur When Anticipated.

Our products represent a significant strategic decision by a customer regarding its communications infrastructure. The decision by customers to purchase our products is often based on the results of a variety of internal procedures associated with the evaluation, testing, implementation and acceptance of new technologies. Accordingly, the product evaluation process frequently results in a lengthy sales cycle, typically ranging from three months to longer than a year, and as a result, our ability to sell products is subject to a number of significant risks, including risks that:

 

   

budgetary constraints and internal acceptance reviews by customers will result in the loss of potential sales;

 

   

there may be substantial variation in the length of the sales cycle from customer to customer, making decisions on the expenditure of resources difficult to assess;

 

   

we may incur substantial sales and marketing expenses and expend significant management time in an attempt to initiate or increase the sale of products to customers, but not succeed;

 

   

if a sales forecast from a specific customer for a particular quarter is not achieved in that quarter, we may be unable to compensate for the shortfall, which could harm our operating results; and

 

   

downward pricing pressures could occur during the lengthy sales cycle for our products.

 

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If We Lose Key Personnel or are Unable to Hire Additional Qualified Personnel as Necessary, We May Not Be Able to Successfully Manage Our Business or Achieve Our Goals.

Our success depends to a significant degree upon the continued contributions of our key management, engineering, sales and marketing, service and operations personnel, many of whom would be difficult to replace. We do not have employment contracts with these individuals who mandate that they render services for any specific term, nor do we carry life insurance on any of our key personnel. We have experienced and may in the future experience significant turn over in our executive personnel. In addition, retention has generally become more difficult for us, in part because the exercise price of most of the stock options granted to many of our employees is below the market price. As a result, we experienced high levels of attrition. 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, service, finance and operations personnel. The market for these personnel is competitive, especially in the San Francisco Bay Area, and we have had difficulty in hiring employees, particularly engineers, in the timeframe we desire.

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 been involved in claims like this with other companies and, although to date they have not resulted in material litigation, we do not know whether we will be involved in additional claims in the future. We could incur substantial costs in litigating any such claims, regardless of the merits.

Failure of Our Products to Comply With Evolving Industry Standards and Complex Government Regulations May Adversely Impact Our Business.

If we do not comply with existing or evolving industry standards and government regulations, we may not be able to sell our products where these standards or regulations apply. The network equipment industry in which we compete is characterized by rapid changes in technology and customers requirements and evolving industry standards. As a result, our success depends on:

 

   

the timely adoption and market acceptance of industry standards, and timely resolution of conflicting U.S. and international industry standards; and

 

   

our ability to influence the development of emerging industry standards and to introduce new and enhanced products that are compatible with such standards.

In the past, we have introduced new products that were not compatible with certain technological standards, and in the future, we may not be able to effectively address the compatibility and interoperability issues that arise as a result of technological changes and evolving industry standards.

Our products must also comply with various U.S. federal government regulations and standards defined by agencies such as the Federal Communications Commission, standards established by governmental authorities in various foreign countries and recommendations of the International Telecommunication Union. In some circumstances, we must obtain regulatory approvals or certificates of compliance before we can offer or distribute our products in certain jurisdictions or to certain customers. Complying with new regulations or obtaining certifications can be costly and disruptive to our business. For example, we expended significant resources and expenses in order to comply with the European Union’s Directive 2002/96/EC Waste Electrical and Electronic Equipment and Directive 2002/95/EC on Restriction on the Certain Hazardous Substances in Electrical and Electronic Equipment.

If we do not comply with existing or evolving industry standards or government regulations, we will not be able to sell our products where these standards or regulations apply, which may prevent us from sustaining our net revenue or achieving profitability.

 

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Changes in Effective Tax Rates Including From the Release of the Valuation Allowance Recorded Against Our Net U.S. Deferred Tax Assets, or Adverse Outcomes Resulting From Examination of Our Income or Other Tax Returns or Change in Ownership, Could Adversely Affect Our Results.

Our future effective tax rates may be volatile or adversely affected by changes in our business or U.S. or foreign tax laws, including: the partial or full release of the valuation allowance recorded against our net U.S. deferred tax assets; expiration of or lapses in the research and development tax credit laws; transfer pricing adjustments; tax effects of stock-based compensation; or costs related to restructurings. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. Although we regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes, there is no assurance that such determinations by us are in fact adequate. Changes in our effective tax rates or amounts assessed upon examination of our tax returns may have a material, adverse impact on our cash flows and our financial condition.

Our future effective tax rate in particular could be adversely affected by a change in ownership pursuant to U.S. Internal Revenue Code Section 382. If a change in ownership occurs, it may limit our ability to utilize our net operating losses to offset our U.S. taxable income. If U.S. taxable income is greater than the change in ownership limitation, we will pay a higher rate of tax with respect to the amount of taxable income that exceeds the limitation. This would have a material adverse impact on our results of operations. On June 30, 2010, we amended our Rights Agreement to mitigate against the possibility of a Section 382 change in ownership with the objective of preserving our tax attributes.

If We Do Not Adequately Manage and Evolve Our Financial Reporting and Managerial Systems and Processes, Our Ability to Manage and Grow Our Business May Be Harmed.

Our ability to successfully implement our business plan and comply with regulations requires an effective planning and management process. We need to continue improving our existing, and implement new, operational and financial systems, procedures and controls. Any delay in the implementation of, or disruption in the transition to, new or enhanced systems, procedures or controls, could harm our ability to record and report financial and management information on a timely and accurate basis, or to forecast future results.

Failure to Maintain Effective Internal Control Over Financial Reporting May Cause Us to Delay Filing Our Periodic Reports with the SEC, Affect Our Nasdaq Listing, and Adversely Affect Our Stock Price.

The Securities and Exchange Commission, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal control over financial reporting in their annual reports on Form 10-K. In addition, our independent registered public accounting firm must attest to and report on our internal control over financial reporting. Although we review our internal control over financial reporting in order to ensure compliance with the Section 404 requirements, if our independent registered public accounting firm is not satisfied with our internal control over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if the independent registered public accounting firm interprets the requirements, rules and/or regulations differently from our interpretation, then they may decline to attest to management’s assessment or may issue an adverse opinion on the effectiveness of internal control over financial reporting because of the existence of one or more material weaknesses. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact our stock price.

Compliance with Laws, Rules and Regulations Relating to Corporate Governance and Public Disclosure May Result in Additional Expenses.

Federal securities laws, rules and regulations, as well as Nasdaq rules and regulations, require companies to maintain extensive corporate governance measures, impose comprehensive reporting and disclosure requirements, set strict independence and financial expertise standards for audit and other committee members

 

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and impose civil and criminal penalties for companies and their Chief Executive Officers, Chief Financial Officers and directors for securities law violations. These laws, rules and regulations and the interpretation of these requirements are evolving, and we are making investments to evaluate current practices and to continue to achieve compliance. As a result, our compliance programs have increased and will continue to increase general and administrative expenses and have diverted and will continue to divert management time and attention from revenue-generating activities.

Our Headquarters and Some Significant Supporting Businesses Are Located in Northern California and Other Areas Subject to Natural Disasters That Could Disrupt Our Operations and Harm Our Business.

Our corporate headquarters are located in Silicon Valley in Northern California. Historically, this region has been vulnerable to natural disasters and other risks, such as earthquakes, fires and floods, which at times have disrupted the local economy and posed physical risks to our property. We have contract manufacturers located in Mexico and Taiwan where similar natural disasters and other risks may disrupt the local economy and pose physical risks to our property and the property of our contract manufacturer.

In addition, the continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to the economies of the U.S. and other countries. If such disruptions result in delays or cancellations of customer orders for our products, our business and operating results will suffer.

We currently do not have redundant, multiple site capacity in the event of a natural disaster, terrorist act or other catastrophic event. In the event of such an occurrence, our business would suffer.

Failure to Successfully Expand Our Sales and Support Teams or Educate Them In Regard to Technologies and Our Product Families May Harm Our Operating Results.

The sale of our products and services requires a concerted effort that is frequently targeted at several levels within a prospective customer’s organization. We may not be able to increase net revenue unless we expand our sales and support teams in order to address all of the customer requirements necessary to sell our products.

We cannot assure you that we will be able to successfully integrate employees into our company or to educate current and future employees in regard to rapidly evolving technologies and our product families. A failure to do so may hurt our revenue growth and operating results.

We May Engage in Future Acquisitions that Dilute the Ownership Interests of Our Stockholders, Cause Us to Incur Debt and Assume Contingent Liabilities.

As part of our business strategy, we review acquisition and strategic investment prospects that we believe would complement our current product offerings, augment our market coverage or enhance our technical capabilities, or otherwise offer growth opportunities. 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 could have a material adverse effect on our operating results or the price of our common stock. Moreover, even if we do obtain benefits in the form of increased sales and earnings, these benefits may be recognized much later than the time when the expenses associated with an acquisition are incurred. This is particularly relevant in cases where it is necessary to integrate new types of technology into our existing portfolio

 

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and new types of products may be targeted for potential customers with which we do not have pre-existing relationships. Acquisitions and investment activities also entail numerous risks, including:

 

   

difficulties in the assimilation of acquired operations, technologies and/or products;

 

   

unanticipated costs associated with the acquisition or investment transaction;

 

   

the diversion of management’s attention from other business concerns;

 

   

adverse effects on existing business relationships with suppliers and customers;

 

   

risks associated with entering markets in which we have no or limited prior experience;

 

   

the potential loss of key employees of acquired organizations; and

 

   

substantial charges for the amortization of certain purchased intangible assets, deferred stock compensation or similar items.

We may not be able to successfully integrate any businesses, products, technologies, or personnel that we might acquire in the future, and our failure to do so could have a material adverse effect on our business, operating results and financial condition.

We May Need Additional Capital to Fund Our Future Operations and, If It Is Not Available When Needed, Our Business Will Be Adversely Impacted.

We believe that our existing working capital and cash available from credit facilities and future operations will enable us to meet our working capital requirements for at least the next twelve 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 requires a significant commitment of resources. In addition, if the markets for our products develop more slowly than anticipated, or if we fail to establish significant market share and achieve sufficient net revenue, we may continue to consume significant amounts of capital. As a result, we could be required to raise additional capital. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution of the shares held by existing stockholders. If additional funds are raised through the issuance of debt securities, such securities may provide the holders certain rights, preferences, and privileges senior to those of common stockholders, and the terms of such debt could impose restrictions on our operations. We cannot assure you that additional capital, if required, will be available on acceptable terms, or at all. If we are unable to obtain sufficient amounts of additional capital, we may be required to reduce the scope of our planned product development and marketing efforts, which could harm our business, financial condition and operating results.

We Have Entered into Long-Term Lease Agreements for Several Facilities that are Currently Vacant and May be Difficult to Sublease due to Current Real Estate Market Conditions.

We have certain long-term real estate lease commitments carrying future obligations for non-cancelable lease payments. Reductions in our workforce and the restructuring of operations since fiscal 2002 have resulted in the need to consolidate certain of these leased facilities, located primarily in Northern California, for which we recorded a reversal of excess facilities charges, net of approximately $0.3 million in fiscal 2010, $0.5 million expense reversal, net in fiscal 2009, $0.9 million expense in fiscal 2008, $4.0 million expense in fiscal 2007, and $3.3 million expense in fiscal 2006. We may incur additional charges for excess facilities as a result of additional reductions in our workforce or future restructuring of operations. We will continue to be responsible for all carrying costs of these facilities until such time as we can sublease these facilities or terminate the applicable leases based on the contractual terms of the lease agreements, and these costs may have an adverse effect on our business, operating results and financial condition.

 

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Our Stock Price Has Been Volatile In the Past and Our Stock Price May Significantly Fluctuate in the Future.

In the past, our common stock price has fluctuated significantly. This could continue as we or our competitors announce new products, our results or those of our customers or competition fluctuate, conditions in the networking or semiconductor industry change, or when investors, change their sentiment toward stocks in the networking technology sector.

In addition, fluctuations in our stock price and our price-to-earnings multiple may make our stock attractive to momentum, hedge or day-trading investors who often shift funds into and out of stock rapidly, exacerbating price fluctuations in either direction, particularly when viewed on a quarterly basis.

Provisions in Our Charter Documents and Delaware Law and Our Adoption of a Stockholder Rights Plan May Delay or Prevent an Acquisition of Extreme, Which Could Decrease the Value of Our Common Stock.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us without the consent of our Board of Directors. Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. In addition, our Board of Directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. Although we believe these provisions of our certificate of incorporation and bylaws and Delaware law and our stockholder rights plan, which is described below, will provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our Board of Directors, these provisions apply even if the offer may be considered beneficial by some of our stockholders.

Our Board of Directors adopted a stockholder rights plan, under which we declared and paid a dividend of one right for each share of common stock held by stockholders of record as of May 14, 2001. Under the plan, each right will entitle stockholders to purchase a fractional share of our preferred stock for $150.00. Each such fractional share of the new preferred stock has terms designed to make it substantially the economic equivalent of one share of common stock. Initially the rights will not be exercisable and will trade with our common stock. Generally, the rights may become exercisable if a person or group acquires beneficial ownership of 4.95% or more of our common stock or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 4.95% or more of our common stock. When the rights become exercisable, our Board of Directors has the right to authorize the issuance of one share of our common stock in exchange for each right that is then exercisable.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Our principal administrative, sales, marketing and research and development facilities are located in Santa Clara, California. We also lease office space and executive suites in various other geographic locations domestically and internationally for sales and service personnel and engineering operations. Our aggregate lease expense for fiscal 2010 was approximately $4.2 million. We believe our current facilities will adequately meet our growth needs for the foreseeable future. In addition, we are actively engaged in efforts to sell excess property we acquired in prior years.

Item 3. Legal Proceedings

We may from time to time be party to litigation arising in the course of our business, including, without limitation, allegations relating to commercial transactions, business relationships or intellectual property rights.

 

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Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. Litigation in general, and intellectual property and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict.

Shareholder Litigation Relating to Historical Stock Option Practices

On April 25, 2007, an individual identifying herself as one of our shareholders filed a derivative action in the United States District Court for the Northern District of California purporting to assert claims on behalf of and in our name against various of our current and former directors and officers relating to historical stock option granting from 1999 to 2002 and related accounting practices. Two similar derivative actions were filed thereafter in the same court by other individuals and the three cases were consolidated by order of the Court. After two amended complaints were filed by the lead plaintiff, we filed a motion to dismiss the second amended complaint, which was granted without prejudice on August 12, 2008.

On August 22, 2008, Kathleen Wheatley, an individual identifying herself as one of our shareholders, filed a motion for the Court to reconsider its ruling on August 12, 2008 granting our motion to dismiss. In response, we asked the Court to reject Ms. Wheatley’s motion on various grounds, including that Ms. Wheatley is not a party to this derivative action. The Court has not yet ruled on Ms. Wheatley’s motion. On September 4, 2008, Ms. Wheatley filed both a motion to intervene in the derivative action and a third amended complaint, which differs little from the first amended complaint. The third amended complaint continues to allege that various of our current and former directors and officers breached their fiduciary duties and other obligations to us and violated state and federal securities laws in connection with the our historical grants of stock options. We are named as a nominal defendant in the action, but we have customary indemnification agreements with the named defendants. On our behalf, Ms. Wheatley seeks unspecified monetary and other relief against the named defendants. The Court has granted Ms. Wheatley’s motion to intervene. On October 16, 2008, we, as nominal defendant, moved to dismiss the third amended complaint. On November 17, 2009, the Court denied our motion to dismiss the third amended complaint, and on December 3, 3009, we filed a motion for reconsideration or in the alternative, a motion to certify the Order denying the Motion to Dismiss for immediate appeal. On December 30, 2009, the Court issued an Order granting us leave to file the motion for reconsideration and will rule on our alternative motion to certify the Order for appeal if it denies the motion for reconsideration. On April 2, 2010, the Court denied our Motion for Reconsideration and for Stay of Action and Certification and Appeal. No dates have been set for our response to the Third Amended Complaint. We intend to continue to defend the derivative action vigorously, but due to the uncertainty of litigation, we cannot predict the ultimate outcome of this matter at this time.

Intellectual Property Litigation

On April 20, 2007, we filed suit against Enterasys Networks in the United States District Court for the Western District of Wisconsin, Civil Action No. 07-C-0229-C. The complaint alleged willful infringement of U.S. Patents Nos. 6,104,700, 6,678,248, and 6,859,438, and sought injunctive relief against Enterasys’ continuing sale of infringing goods and monetary damages. Enterasys responded to the complaint on May 30, 2007, and also filed counterclaims alleging infringement of three U.S. patents owned by Enterasys. On April 9, 2008, the Court dismissed Enterasys’ counterclaims on one of its patents with prejudice. On May 5, 2008, the Court granted our motion for summary judgment, finding that we do not infringe Enterasys’ two remaining patents and dismissing all of Enterasys’ remaining counterclaims with prejudice. On May 30, 2008, a jury found that Enterasys infringed all three of our patents and awarded us damages in the amount of $0.2 million. The Court also ruled in our favor on Enterasys’ challenge to the validity of our patents. On October 29, 2008, the Court denied Enterasys’ post-trial motion for judgment as a matter of law, and granted Extreme Network’s motion for a permanent injunction against Enterasys. The injunction order permanently enjoins Enterasys from manufacturing, using, offering to sell, selling in the U.S. and importing into the U.S. the Enterasys products accused of infringing Extreme Network’s three patents. The injunction will run until the expiration of our patents the last of which is not set to expire until March of 2020. On March 16, 2009, the Court also denied Enterasys’ motion for a new trial, but granted Enterasys’ motion for a stay of the injunction pending appeal. On April 17, 2009, Enterasys filed its

 

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notice of appeal and on May 1, 2009, we filed our cross appeal. The appeal is pending at the U.S. Court of Appeals for the Federal Circuit and we are defending the appeal. Due to the inherent uncertainties of litigation, we cannot predict the ultimate outcome of the matter at this time.

On June 21, 2005, Enterasys filed suit against Extreme and Foundry Networks, Inc. (“Foundry”) in the United States District Court for the District of Massachusetts, Civil Action No. 05-11298 DPW. The complaint alleges willful infringement of U.S. Patent Nos. 5,251,205; 5,390,173; 6,128,665; 6,147,995; 6,539,022; and 6,560,236, and seeks: a) a judgment that we willfully infringe each of the patents; (b) a permanent injunction from infringement, inducement of infringement and contributory infringement of each of the six patents; (c) damages and a “reasonable royalty” to be determined at trial; (d) treble damages; (e) attorneys’ fees, costs and interest; and (f) equitable relief at the Court’s discretion. Foundry brought a claim for reexamination of five of the patents at issue to the U.S. Patent and Trademark Office (“PTO”). The stay of Massachusetts action was lifted on May 21, 2010, and set a claims construction hearing for September 15, 2010. No trial date has been set. We intend to defend the lawsuit vigorously, but, due to the inherent uncertainties of litigation, we cannot predict the ultimate outcome of the matter at this time.

On February 7, 2008, Network-1 Security Solutions, Inc. sued us along with Cisco, Cisco-Linksys, Inc., Adtran, Inc., Enterasys Networks, Inc., Netgear, Inc. and 3Com Corporation in the United States District Court for the Eastern District of Texas (Case No. 6:08cv030). On July 16, 2010, we entered into a Memorandum of Understanding with Nework-1 setting forth the terms for settlement of the lawsuit and license agreement, in which Extreme was granted licenses to certain patents in exchange for a payment of $2.4 million. On August 3, 2010, the Court dismissed the case with prejudice.

On February 26, 2008, Fenner Investments, Ltd. filed suit against us along with D-Link Systems, Zyxel Communications, SMC Networks, Enterasys, Foundry, Netgear, Inc. and 3Com Corporation in the United States District Court for the Eastern District of Texas, Civil Action No. 08-CV-00061. The suit alleges infringement of US Patent No. 7,145,906 and 5,842,224, and seeks damages for the alleged infringement, injunctions against infringement and payment of attorneys’ fees, costs and interest. On September 24, 2009, we entered into a settlement and license agreement with Fenner Investments, in which Extreme was granted licenses to certain patents in exchange for amounts paid. On October 5, 2009, the Court dismissed the case with prejudice.

Other Legal Matters

Beginning on July 6, 2001, purported securities fraud class action complaints were filed in the United States District Court for the Southern District of New York. The cases were consolidated and the litigation is now captioned as In re Extreme Networks, Inc. Initial Public Offering Securities Litigation, Civ. No. 01-6143 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). The operative amended complaint names us as defendants; six of our present and former officers and/or directors, including our former CEO and current Chairman of the Board (the “Extreme Networks Defendants”); and several investment banking firms that served as underwriters of our initial public offering and October 1999 secondary offering. The complaint alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that the registration statement for the offerings did not disclose that: (1) the underwriters had agreed to allow certain customers to purchase shares in the offerings in exchange for excess commissions paid to the underwriters; and (2) the underwriters had arranged for certain customers to purchase additional shares in the aftermarket at predetermined prices. Similar allegations were made in other lawsuits challenging over 300 other initial public offerings and follow-on offerings conducted in 1999 and 2000. The cases were consolidated for pretrial purposes.

The parties to the lawsuits have reached a settlement, which was approved by the Court on October 6, 2009. Extreme Networks Defendants is not required to make any cash payments in the settlement. The Court subsequently entered a final judgment of dismissal. Certain objectors have appealed the judgment. If the appeal is successful, we intend to defend the lawsuit vigorously, but, due to the inherent uncertainties of litigation, we cannot predict the ultimate outcome of the matter at this time.

 

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Indemnification Obligations

Subject to certain limitations, we may be obligated to indemnify our current and former directors, officers and employees. These obligations arise under the terms of our certificate of incorporation, our bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify, where applicable, generally means that we are required to pay or reimburse, and in certain circumstances we have paid or reimbursed, the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters. It is not possible to estimate the maximum potential amount under these indemnification agreements due to the limited history of these claims. The cost to defend us and the named individuals could have a material adverse effect on our consolidated financial position, results of operations and cash flows in the future. Recovery of such costs under our directors and officers insurance coverage is uncertain.

Item 4. Removed and Reserved

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Common Stock Market Prices and Dividends

Our common stock commenced trading on The Nasdaq Global Market on April 9, 1999 under the symbol “EXTR.” The following table sets forth the high and low sales prices as reported by Nasdaq. Such prices represent prices between dealers, do not include retail mark-ups, mark-downs or commissions and may not represent actual transactions.

 

Stock Prices

   High    Low

Fiscal year ended June 27, 2010:

     

First quarter

   $ 3.06    $ 1.92

Second quarter

   $ 2.98    $ 1.99

Third quarter

   $ 3.39    $ 2.47

Fourth quarter

   $ 3.68    $ 2.57

Fiscal year ended June 28, 2009:

     

First quarter

   $ 3.50    $ 2.70

Second quarter

   $ 3.37    $ 1.51

Third quarter

   $ 2.36    $ 1.06

Fourth quarter

   $ 2.03    $ 1.52

As of August 13, 2010, there were 302 stockholders of record of our common stock and 17,754 beneficial shareholders. We have never declared or paid cash dividends on our capital stock and do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings for the development of our business.

Certain information regarding our equity compensation plan(s) as required by Part II is incorporated by reference from our definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for our 2010 Annual Meeting of Stockholders (the “Proxy Statement”) not later than 120 days after the end of the fiscal year covered by this report.

 

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STOCK PRICE PERFORMANCE GRAPH

Set forth below is a stock price performance graph comparing the annual percentage change in the cumulative total return on our common stock with the cumulative total returns of the CRSP Total Return Index for The Nasdaq Stock Market (U.S. companies) and the Nasdaq Computer Manufacturers Securities for the period commencing July 3, 2005 and ending on June 27, 2010. The comparisons in the graph below are based on historical data and are not intended to forecast the possible future performance of our common stock.

Comparison of Five-Year Cumulative Total Returns

Performance Graph for Extreme Networks, Inc.

LOGO

Prepared by CRSP (www.crsp.uchicago.edu), Center for Research in Security Prices, Booth School of Business, The University of Chicago. Used with permission. All rights reserved.

 

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Item 6. Selected Financial Data

The following table sets forth selected consolidated financial data for each of the fiscal years ended June 27, 2010, June 28, 2009, June 29, 2008, July 1, 2007 and July 2, 2006 derived from audited financial statements. These tables should be reviewed in conjunction with the Consolidated Financial Statements in Item 8 and related Notes, as well as Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Historical results may not be indicative of future results.

 

     Year Ended  
     June 27,
2010(1)
    June 28,
2009(2)
    June 29,
2008(3)
    July 1,
2007(4)
    July 2,
2006(5)
 
     (In thousands, except per share amounts)  

Consolidated Statements of Operations Data:

          

Net revenues

   $ 309,354      $ 335,559      $ 361,835      $ 342,834      $ 358,601   

Net income (loss)

   $ 227      $ 2,815      $ 8,381      $ (14,197   $ 8,509   

Net income (loss) per share – basic

   $ 0.00      $ 0.03      $ 0.07      $ (0.12   $ 0.07   

Net income (loss) per share – diluted

   $ 0.00      $ 0.03      $ 0.07      $ (0.12   $ 0.07   

Shares used in per share calculation – basic

     89,281        94,225        115,002        114,122        121,286   

Shares used in per share calculation – diluted

     89,477        94,284        115,784        114,122        123,049   
     As of  
     June 27,
2010
    June 28,
2009
    June 29,
2008
    July 1,
2007
    July 2,
2006
 
     (In thousands)  

Consolidated Balance Sheets Data:

        

Cash and cash equivalents, short-term investments and marketable securities

   $ 132,419      $ 127,402      $ 225,672      $ 215,855      $ 433,105   

Deferred tax asset

   $ 392      $ 244      $ 254      $ 1,118      $ 500   

Total assets

   $ 259,945      $ 239,975      $ 358,672      $ 346,727      $ 564,310   

Convertible subordinated notes

   $ —        $ —        $ —        $ —        $ 200,000   

Other long-term liabilities

   $ 11,298      $ 12,100      $ 17,244      $ 21,391      $ 23,056   

Common stock and capital in excess of par value

   $ 956,922      $ 949,241      $ 943,283      $ 934,540      $ 927,835   

Accumulated deficit

   $ (659,161   $ (659,388   $ (662,203   $ (670,584   $ (656,387

 

(1) Fiscal 2010 net income includes share-based compensation expense of $6.2 million, restructuring charge of $4.2 million and litigation settlement of $1.0 million.
(2) Fiscal 2009 net income includes share-based compensation expense of $3.9 million and restructuring charge of $2.2 million.
(3) Fiscal 2008 net income includes share-based compensation expense of $5.1 million and restructuring charge of $0.9 million.
(4) Fiscal 2007 net loss includes share-based compensation expense of $6.2 million and restructuring charge of $4.0 million.
(5) Fiscal 2006 net income includes share-based compensation expense of $7.0 million and restructuring charge of $3.3 million.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business Overview

We develop and sell network infrastructure equipment and offer related services contracts for extended warranty and maintenance to our enterprise, data center and metropolitan telecommunications service provider customers. Substantially all of our revenue is derived from the sale of our networking equipment and related service contracts. In fiscal 2010, our revenue decreased $26.2 million, gross profit decreased $14.2 million, operating profit decreased $3.5 million and net income decreased $2.6 million as compared to fiscal 2009.

We believe that understanding the following key developments is helpful to an understanding of our operating results for fiscal 2010.

Supply Chain Constraints

We use our forecast of expected demand to determine our material requirements. Lead times for materials and components we order vary significantly, and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. In the fourth quarter of fiscal 2009, customer orders exceeded our forecast, especially with respect to certain products. In addition, our contract manufacturers and their component suppliers had significantly reduced their capacity due to the world-wide economic slowdown, and therefore lead times significantly increased during the first fiscal quarter across our supply chain as our contract manufacturers and their component suppliers struggled to meet increasing demands. As a result, we were unable to deliver products based on customer requests. This adversely affected our revenue and sales for the first quarter of fiscal 2010 since we were unable to deliver products in that quarter in a timely manner and certain customers cancelled orders or chose other vendors based on product availability. We have made substantial progress with our suppliers to improve timely delivery of our products to meet customers’ demands in the second quarter through the fourth quarter of fiscal 2010. We continue to work to manage our forecast and supply chain in light of our customers’ demands as accurately as possible.

Impact of the Global Economic Developments

In addition to issues with our supply chain, we believe that the credit market crisis, global recession and other challenges affecting global economic conditions were the significant drivers of our financial performance during fiscal 2010. Sales in the United States and some European countries were most impacted as a result of the weak global economy and the global credit crisis in the financial market, while sales in Asia were only minimally impacted by global economic developments and grew during the period. We believe that limited access to credit, conservative purchasing patterns and delays or cancellation of IT infrastructure plans in the face of continued uncertainty regarding the global economy, may continue to negatively impact overall demand for networking solutions, including Ethernet equipment.

We have taken and plan to continue to take other steps to manage our business in the current economic environment. For example, we have managed from time to time our contingent work force, scheduled shutdown weeks, reduced travel and other discretionary spending, and controlled all hiring activities.

Increasing Demand for Bandwidth

We believe that the continued increase in demand for bandwidth will over time drive future demand for high performance Ethernet solutions. Wide-spread adoption of electronic communications in all aspects of our lives, proliferation of next generation converged mobile devices and deployment of triple-play services to residences and businesses alike, continues to generate demand for greater network performance across broader geographic locations. In parallel to these transformational forces within society and the community at large, the accelerating adoption of internet and intranet “cloud” solutions within business enterprises is enabling organizations to offer greater business scalability to improve efficiency and through more effective operations, improve profitability. In

 

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order to realize the benefits of these developments, customers require additional bandwidth and high performance from their network infrastructure at affordable prices. As the economy continues its paced recovery, we are already seeing the initial indications that the Ethernet segment of the networking equipment market will return to growth as enterprise, data center and carrier customers continue to recognize the performance and operating cost benefits of Ethernet technology.

Expanding Product Portfolio

We believe that continued success in our marketplace is dependent upon a variety of factors that includes, but is not limited to, our ability to design, develop and distribute new and enhanced products employing leading-edge technology. During fiscal 2010, we further extended our Ethernet product portfolio through the addition of the Summit X480 family of products targeted at Data Center customers, a further set of modules for the BlackDiamond 8900 family and the next release of the ExtremeXOS modular operating system, release 12.4.1.

Industry Developments

The market for network infrastructure equipment is highly competitive and dominated by a few large companies. The difficult economic climate has further driven consolidation of vendors within the Ethernet networking market and with vendors from adjacent markets, including storage, security, wireless and voice applications. We believe that the underpinning technology for all of these adjacent markets is Ethernet. As a result, independent Ethernet switch vendors are being acquired or merged with larger, adjacent market vendors to enable them to deliver complete and broad solutions. As a result, we believe that, as an independent Ethernet switch vendor, we must provide products that, when combined with the products of our large strategic partners, create compelling solutions for end user customers.

Restructuring

On October 22, 2009, we restructured the organization, including restructuring from a business unit organization to a functional organization. In connection with the restructuring, we had a reduction in force (“RIF”), terminated 8% of our workforce and eliminated certain redundant engineering projects. Total restructuring charges related to the RIF and engineering projects recognized in fiscal 2010 was $4.6 million.

As a result of the RIF, operating expenses significantly decreased in fiscal 2010 as compared to fiscal 2009, as discussed further below.

Results of Operations

Our operations and financial performance have been affected by the economic factors described above, and during fiscal 2010, we achieved the following results:

 

   

Net revenue of $309.4 million, a decrease of 8% over fiscal 2009 net revenue of $335.6 million.

 

   

Product revenue of $249.0 million, a decrease of 9% from fiscal 2009 product revenue of $273.8 million.

 

   

Service revenue of $60.3 million, a decrease of 2% from fiscal 2009 service revenue of $61.8 million

 

   

Total gross margin was 57.1% of net revenue in fiscal 2010 (including share-based compensation expense of $1.0 million), compared to 56.8% in fiscal 2009 (including share-based compensation expense of $0.5 million).

 

   

Net income was $0.2 million in fiscal 2010 (including share-based compensation expense of $6.2 million, restructuring charge of $4.2 million and litigation settlement of $1.0 million), a decrease from net income of $2.8 million in fiscal 2009 (including share-based compensation expense of $3.9 million and restructuring charge of $2.2 million).

 

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Cash flow provided by operating activities was $9.3 million, compared to cash flow provided by operating activities of $4.7 million in fiscal 2009, an increase of $4.6 million. Cash and cash equivalents, short-term investments and marketable securities were $132.4 million as of June 27, 2010, an increase of $5.0 million, primarily due to cash provided by operating activities.

Net Revenue

The following table presents net product and service revenue for the fiscal years 2010, 2009 and 2008 (dollars in thousands):

 

    Year Ended     Year Ended  
    June 27,
2010
    June 28,
2009
    $
Change
    %
Change
    June 28,
2009
    June 29,
2008
    $
Change
    %
Change
 
                                                 

Net Revenue:

               

Product

  $ 249,035      $ 273,772      $ (24,737   (9 )%    $ 273,772      $ 302,313      $ (28,541   (9 )% 

Percentage of net revenue

    80.50     81.59         81.59     83.55    

Service

    60,319        61,787        (1,468   (2 )%      61,787        59,522        2,265      (4 )% 

Percentage of net revenue

    19.50     18.41         18.41     16.45    
                                                   

Total net revenue

  $ 309,354      $ 335,559      $ (26,205   (8 )%    $ 335,559      $ 361,835      $ (26,276   (7 )% 
                                                   

Product revenue decreased in fiscal 2010 as compared to fiscal 2009 primarily due to the global economic downturn and competitive pricing. In addition, in the first quarter of fiscal 2010, the Company experienced supply constraint issues which resulted in the loss of business.

Product revenue decreased in fiscal 2009 as compared to fiscal 2008 primarily due to lower sales volumes mainly as a result of the weakness in the U.S. economy.

Service revenue decreased in fiscal 2010 as compared to fiscal 2009 primarily due to a reduction in renewals of service maintenance agreements for products which are entering end of support life.

Service revenue increased in fiscal 2009 as compared to fiscal 2008 primarily due to improved execution in the EMEA maintenance renewal business, resulting in higher maintenance renewal rates.

We operate in three regions: North America, which includes the United States, Canada and Central America; EMEA, which includes Europe, Middle East, Africa and South America; and APAC which includes Asia Pacific and Japan. The following table presents the total net revenue geographically for the fiscal years 2010, 2009 and 2008 (dollars in thousands):

 

     Year Ended     Year Ended  
     June 27,
2010
    June 28,
2009
    $
Change
    %
Change
    June 28,
2009
    June 29,
2008
    $
Change
    %
Change
 

Net Revenues:

                

North America

   $ 123,236      $ 130,995      $ (7,759   (6 )%    $ 130,995      $ 158,215      $ (27,220   (17 )% 

Percentage of net revenue

     39.84     39.04         39.04     43.72    

EMEA

     133,736        153,764        (20,028   (13 )%      153,764        143,535        10,229      7

Percentage of net revenue

     43.23     45.82         45.82     39.67    

APAC

     52,382        50,800        1,582      3     50,800        60,085        (9,285   (15 )% 

Percentage of net revenue

     16.93     15.14         15.14     16.61    
                                                    

Total net revenues

   $ 309,354      $ 335,559      $ (26,205   (8 )%    $ 335,559      $ 361,835      $ (26,276   (7 )% 
                                                    

Revenue in North America decreased in fiscal 2010 as compared to fiscal 2009 primarily due to supply chain issues in the first quarter of fiscal 2010 and a weaker economy in the United States. Revenue in EMEA decreased in fiscal 2010 as compared to fiscal 2009 primarily due to weaker service provider sales in Europe and a weaker economy in Western Europe. Revenue in APAC increased in fiscal 2010 as compared to fiscal 2009 primarily due to stronger sales in China to a large service provider end user.

 

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Revenue in North America decreased in fiscal 2009 as compared to fiscal 2008 primarily due to the economic downturn in the United States. Revenue in EMEA increased in fiscal 2009 as compared to fiscal 2008 primarily due to increased sales to service providers in Europe. Revenue in APAC decreased in fiscal 2009 as compared to fiscal 2008 primarily due to weakness in Japan and China due to sales execution issues.

We rely upon multiple channels of distribution, including a two-tiered distribution channel. One of these distribution channels, tier 1 distributors, consists of large distributors who purchase our products and make them available to resellers. Revenue through our tier 1 distributor channel was 59% of total product revenue in fiscal 2010, 53% in fiscal 2009 and 47% in fiscal 2008. The increase in distributor channel revenue over the past three years was due to a shift in business from direct sales to the channel as business through our strategic partners decreased coupled with strong sales from a new distributor in the U.S.

The level of sales to any one customer, including a distributor, may vary from period to period.

Cost of Revenue and Gross Profit

The following table presents the gross profit on product and service revenue and the gross profit percentage of net revenue for the fiscal years 2010, 2009 and 2008 (dollars in thousands):

 

    Year Ended     Year Ended  
    June 27,
2010
    June 28,
2009
    $
Change
    %
Change
    June 28,
2009
    June 29,
2008
    $
Change
    %
Change
 

Gross profit:

               

Product

  $ 141,037      $ 157,041      $ (16,004   (10 )%    $ 157,041      $ 178,980      $ (21,939   (12 )% 

Percentage of product revenue

    56.63     57.36         57.36     59.20    

Service

    35,456        33,487        1,969      6     33,487        26,328        7,159      27

Percentage of service revenue

    58.78     54.20         54.20     44.20    
                                                   

Total gross profit

  $ 176,493      $ 190,528      $ (14,035   (7 )%    $ 190,528      $ 205,308      $ (14,780   (7 )% 
                                                   

Percentage of net revenue

    57.05     56.78         56.78     56.70    

Cost of product revenue includes costs of raw materials, amounts paid to third-party contract manufacturers, costs related to warranty obligations, charges for excess and obsolete inventory, royalties under technology license agreements, and internal costs associated with manufacturing overhead, including management, manufacturing engineering, quality assurance, development of test plans, and document control. We outsource substantially all of our manufacturing and supply chain management operations, and we conduct quality assurance, manufacturing engineering, document control and distribution at our facility in Santa Clara, California. Accordingly, a significant portion of our cost of product revenue consists of payments to our primary contract manufacturers, Flextronics International, Ltd. located in Guadalajara, Mexico, Alpha Networks, located in Hsinchu, Taiwan and Benchmark Electronic, Inc, located in Huntsville, Alabama, U.S.A. In addition, we OEM our wireless product line from Motorola.

Product gross profit in fiscal 2010 decreased as compared to fiscal 2009 primarily due to a $17.7 million decrease in sales volume driven by supply chain constraints in the first quarter of fiscal 2010 offset by a $1.1 million recovery of warranty expense incurred in the third quarter of fiscal 2010 from our outside design manufacturer and lower operating costs of $0.7 million due to cost controls.

Product gross profit in fiscal 2009 decreased as compared to fiscal 2008 primarily due to lower volume of $21.7 million and increased material cost of $6.1 million, offset by changes in product mix of $2.6 million, lower distribution cost of $1.9 million, lower royalties of $1.0 million due to the completion of amortization expense related to certain technology agreements and lower operating costs of $0.7 million due to cost controls.

Our cost of service revenue consists primarily of labor, overhead, repair and freight costs and the cost of spares used in providing support under customer service contracts. Service gross profit in fiscal 2010 increased as compared to fiscal 2009 primarily due to lower return material authorization costs of $1.6 million and cost savings in professional services.

 

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Service gross profit in fiscal 2009 increased as compared to fiscal 2008 primarily due to the result of an increase of $2.3 million in maintenance revenue primarily in EMEA, the use of written down inventory of $1.2 million, a reduction of customer specific warranty programs of $0.9 million and lower repair costs of $2.2 million due to improved quality.

Operating Expenses

The following table presents operating expenses and operating income (in thousands, except percentages):

 

    Year Ended     Year Ended  
    June 27,
2010
    June 28,
2009
   $
Change
    %
Change
    June 28,
2009
   June 29,
2008
   $
Change
    %
Change
 

Sales and marketing

  $ 96,621      $ 98,235    $ (1,614   (2 )%    $ 98,235    $ 103,490    $ (5,255   (5 )% 

Research and development

    49,390        58,176      (8,786   (15 )%      58,176      65,335      (7,159   (11 )% 

General and administrative

    26,839        29,945      (3,106   (10 )%      29,945      34,668      (4,723   (14 )% 

Restructuring charge, net of reversal

    4,238        2,245      1,993      89     2,245      893      1,352      151

Litigation settlement

    829        —        829      100     —        —        —        0
                                                

Total operating expenses

  $ 177,917      $ 188,601    $ (10,684   (6 )%    $ 188,601    $ 204,386    $ (15,785   (8 )% 
                                                

Operating (loss) income

  $ (1,424   $ 2,061    $ (3,485   (169 )%    $ 2,061    $ 895    $ 1,166      130
                                                

The following table highlights our operating expenses and operating income as a percentage of net revenues:

 

     Year Ended  
     June 27,
2010
    June 28,
2009
    June 29,
2008
 

Sales and marketing

   31.23   29.28   28.60

Research and development

   15.97   17.34   18.06

General and administrative

   8.68   8.92   9.58

Restructuring charge, net of reversal

   1.37   0.67   0.25

Litigation settlement

   0.27   0.00   0.00
                  

Total operating expenses

   57.51   56.20   56.49
                  

Operating (loss) income

   (.46 )%    0.61   0.25
                  

Sales and Marketing Expenses

Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing and sales functions, as well as trade shows and promotional expenses. Sales and marketing expenses decreased in fiscal 2010 as compared to fiscal 2009 primarily due to lower salaries and benefits expenses of $1.1 million due to lower headcount and lower rent expense of $1.2 million due to the consolidation of sales offices worldwide, offset by $0.4 million increase in commissions due to mix of commissions based on large deals and $0.3 million in travel expenses due to year-end sales meetings.

Sales and marketing expenses decreased in fiscal 2009 as compared to fiscal 2008 primarily due to lower salaries and benefits of $1.3 million, lower commission expenses of $2.5 million resulting from lower revenue, lower travel of $1.1 million due to cost cutting measures and lower share-based compensation expense of $0.3 million. These decreases were offset by increases in general expenses of $1.1 million.

Research and Development Expenses

Research and development expenses consist primarily of salaries and related personnel expenses, consultant fees and prototype expenses related to the design, development, and testing of our products. Research and

 

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development decreased in fiscal 2010 as compared to fiscal 2009 primarily due lower salaries and benefits expenses of $6.7 million due to lower headcount and lower engineering project expenses of $2.7 million due to discontinuation of several engineering projects, offset by a $0.5 million increase in stock-based compensation expense. We expense all research and development expenses as incurred.

Research and development expenses decreased in fiscal 2009 as compared to fiscal 2008 primarily due to lower project spending of $2.6 million on modular and stackable products, lower salaries and benefits of $2.2 million driven mainly by lower variable compensation expense, a decrease in the Avaya warrant amortization expense of $1.0 million, lower supplies and small equipment expense of $0.8 million and lower depreciation expense of $0.6 million.

General and Administrative Expenses

General and administrative expenses decreased in fiscal 2010 as compared to fiscal 2009 primarily due to lower professional fees of $2.9 million and lower salaries and benefits expense of $1.4 million due to lower headcount, offset by an increase in share-based compensation expense of $0.9 million.

General and administrative expenses decreased in fiscal 2009 as compared to fiscal 2008 primarily due to lower litigation fees of $4.0 million, lower share-based compensation of $0.4 million, and lower insurance costs of $0.4 million.

Restructuring Charge, Net of Reversal

During fiscal 2010, 2009 and 2008, we recorded restructuring charges of $4.2 million, $2.2 million, and $0.9 million, respectively.

Charges in fiscal 2010 were:

 

   

$4.6 million related to a restructuring of the organization from a business unit organization to a functional organization. In connection with the restructuring, we had a RIF and terminated 8% of our workforce. Total termination benefits were $4.1 million. The RIF was executed and completed in the second quarter of fiscal 2010. In addition, we eliminated certain redundant engineering projects in conjunction with the reorganization. We incurred $0.5 million related to the discontinued engineering projects.

 

   

$0.2 million increase in operating expenses related to one of our restructured facilities.

 

   

$0.5 million reversal of restructuring expense due to higher projected sublease receipt from a sublease renewal arrangement.

 

   

$0.1 million reversal of restructuring expense related to the settlement of employment termination benefits incurred in the third fiscal quarter of 2009.

Charges in fiscal 2009 were:

 

   

$0.8 million related to our termination of 1% of our workforce, exiting a leased facility where the terminated employees worked and the write-off of impaired assets as part of our strategic plan. This restructuring was completed by the end of the third quarter of fiscal 2009.

 

   

$1.9 million related to a RIF of a further 5% of our workforce to reduce operating costs and realign our organization in the current competitive operating environment. The RIF was executed in the third quarter of fiscal 2009 and was completed by the end of the fourth quarter of fiscal 2009.

These charges were offset by a reversal of $0.5 million of restructuring expense due to higher than projected sublease receipt from a sublease renewal arrangement.

 

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Litigation Settlement

On July 16, 2010, we entered into a Memorandum of Understanding (“Network-1 MOU”) with Network-1 Security Solutions, Inc. The Network-1 MOU provides for a nonexclusive and worldwide license to certain patents of each party, and a release of claims based on any prior infringement of such patents. The license term is nine years and eight months and expires in March 2020. The release covers any potential claims arising out of the past use or practice of any of the patents. Total fees for the grant of the license under the Network-1 MOU were $2.4 million. We charged the estimated value of the release of prior claims of $0.2 million to Cost of Product Revenues for claims incurred in fiscal 2010 and $0.8 million to Litigation Settlement for claims incurred prior to fiscal 2010 in its fiscal 2010 financial statements. The remaining $1.4 million was recorded as other assets and is being recognized ratably over the license period in Cost of Product Revenue.

Interest Income

Interest income was $1.5 million in fiscal 2010, $3.4 million in fiscal 2009 and $10.2 million in fiscal 2008, representing a decrease of $1.9 million in fiscal 2010 from fiscal 2009, and a decrease of $6.8 million in fiscal 2009 from fiscal 2008. The decrease in interest income in fiscal 2010 from fiscal 2009 was due to a decrease in average funds available for investment and a decline in average interest yield from 2.4% in fiscal 2009 to 1.6% in fiscal 2010. The decrease in interest income in fiscal 2009 from fiscal 2008 was due to a decrease in funds available for investment as a result of cash expenditure of $101.4 million in connection with the repurchase of 28,571,428 shares of common stock in the first quarter of fiscal 2009 and a decline in average interest yield from 4.7% in fiscal 2008 to 2.4% in fiscal 2009.

Interest Expense

Interest expense was $0.1 million for each fiscal year 2010, 2009 and 2008. Interest expense in fiscal 2010 and fiscal 2009 were primarily related to interest amortization of technology agreements.

Other Income (Expense), net

Other income (expense) net, was expense of $0.1 million in fiscal 2010, income of $13,000 in fiscal 2009 and expense of $0.5 million in fiscal 2008.

Other expense in fiscal 2010 was primarily comprised of foreign currency losses of $0.4 million, offset by realized gain on investments of $0.1 million.

Other income in fiscal 2009 was primarily comprised of foreign currency gains due to the strengthening of the U.S. dollar in fiscal 2009.

Other income (expense), net for the fiscal year 2010 also includes an unrealized loss of $2.1 million on our Auction Rate Securities offset by $2.1 million gain in fair value of the Put Option related to our acceptance of the UBS Rights offer to repurchase our ARS in the third quarter of fiscal 2009.

Provision (Benefit) for Income Taxes

We recorded an income tax benefit of $0.4 million for fiscal 2010. The effective tax rate in fiscal 2010 was 223.6% which differs from the federal statutory tax rate of 35% due primarily to the tax impact of income from foreign operations, the release of previously established tax reserves and the recording of a valuation allowance against the majority of our deferred tax assets. As of June 27, 2010, we had net operating loss carryforwards for federal and state tax purposes of $262.8 million and $90.0 million, respectively, of which $53.7 million and $32.0 million, respectively, represent deductions from share-based compensation for which a benefit would be recorded in additional paid-in capital when realized. We also had federal and state tax credit carryforwards of

 

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$8.4 million and $18.5 million, respectively, as of June 27, 2010. Federal net operating loss carryforwards of $262.8 million will expire between 2013 through 2030 and state net operating losses of $90.0 million will expire between 2011 through 2020, if not utilized. Federal tax credits of $8.4 million will expire beginning in 2020, if not utilized and state tax credits of $1.7 million will expire beginning in 2011, if not utilized. The additional state tax credits of $16.8 million will carry forward indefinitely.

The provisions for income taxes of $2.5 million and $2.2 million for fiscal 2009 and 2008, respectively, were recorded for taxes due on income generated in U.S federal, certain states and foreign tax jurisdictions. The effective tax rate was 46.8% and 20.6% for fiscal 2009 and 2008, respectively, which differs from the federal statutory tax rate of 35% due primarily to the benefit of U.S. net operating losses carryforwards and the tax impact of income from foreign operations.

Adjustments to Share Based Compensation Expense During Fiscal 2010

We were notified by our third party software provider that it had made certain changes to how its software program calculates stock-based compensation expense. Specifically, the prior version of this software that we had been using calculated stock-based compensation expense by incorrectly applying a weighted average forfeiture rate to the vested portion of stock option awards until the grant’s final vest date, rather than calculating stock-based compensation expense based upon the actual vested portion of the grant date fair value, resulting in an understatement of stock-based compensation expense in certain periods prior to the grant’s final vest date. Consequently, we identified errors in the calculation of stock-based compensation expense for fiscal years ended June 29, 2008, July 1, 2007 and July 2, 2006. The errors identified relate only to the timing of stock-based compensation expense recognition.

We determined that the cumulative error from the understatement of stock-based compensation expense related to the periods discussed above totaled $0.9 million through June 29, 2008. The impact of the errors on the fiscal years ended June 29, 2008, July 1, 2007 and July 2, 2006, is to decrease net income by $0.3 million for each year.

Management has determined that the impact of this error is not material to the previously issued annual and interim financial statements. Accordingly, the annual consolidated financial statements for the fiscal year ending June 27, 2010 include the cumulative adjustment to increase stock-based compensation expense by $0.9 million (or $0.01 per share) to correct these errors. We do not believe the correction of these errors is material to the annual consolidated financial statements for the fiscal year ending June 27, 2010.

Critical Accounting Policies and Estimates

Our significant accounting policies are more fully described in Note 2 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The preparation of consolidated financial statements in accordance with generally accepted accounting principles requires management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the period reported. By their nature, these estimates, assumptions and judgments are subject to an inherent degree of uncertainty. We base our estimates, assumptions and judgments on historical experience, market trends and other factors that are believed to be reasonable under the circumstances. Estimates, assumptions and judgments are reviewed on an ongoing basis and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies have been discussed with the Audit Committee of the Board of Directors. We believe the critical accounting policies stated below, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

 

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Share-based Payments

We use the Black-Scholes option-pricing model to determine the fair value of option award and Employee Stock Purchase Plan (“ESPP”) on the date of grant with the weighted average assumptions. The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The expected term of ESPP represents the contractual life of the ESPP purchase period. The risk-free rate based upon the estimated life of the option and ESPP is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on both the implied volatilities from traded options on our stock and historical volatility on our stock. We do not currently pay cash dividends on our common stock and do not anticipate doing so in the foreseeable future. Accordingly, our expected dividend yield is zero. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. Our estimated forfeiture rate in fiscal 2010 based on our historical forfeiture experience is approximately 12%. We modified our estimated forfeiture rate in the fourth quarter of fiscal 2010 and recognized the cumulative effect of the change, as a decrease in compensation expense, in that quarter of approximately $0.1 million. We use the straight-line method for expense attribution, and we estimate forfeitures and only recognize expense for those shares expected to vest.

Revenue Recognition

We allocate revenue to each element of multiple element arrangements that include products containing software that is more-than-incidental using the residual method based on vendor specific objective evidence of fair value of the undelivered elements. We determine vendor specific objective evidence of fair value based on the price charged when the item is sold separately. Under the residual method, we first allocate the revenue for a multiple element arrangement to the undelivered elements based on their VSOE of fair value, and the remainder of the arrangement fee to the delivered elements.

We derive the majority of our revenue from sales of our networking equipment, with the remaining revenue generated from service fees relating to the service contracts, professional services, and training on our products. We generally recognize product revenue from our value-added resellers, non-stocking distributors and end-user customers at the time of shipment, provided that persuasive evidence of an arrangement exists, delivery has occurred, the price of the product is fixed or determinable and collection of the sales proceeds is reasonably assured. In instances where the criteria for revenue recognition are not met, revenue is deferred until all criteria have been met. Revenue from service obligations under service contracts is deferred and recognized on a straight-line basis over the contractual service period. Service contracts typically range from one to two years. Our total deferred product revenue was $1.4 million and $1.3 million as of June 27, 2010 and June 28, 2009, respectively. Our total deferred revenue for services, primarily from service contracts, was $36.4 million as of June 27, 2010 and $36.7 million as of June 28, 2009. Service contracts typically range from one to two years. Shipping costs are included in cost of product revenues.

We make certain sales to partners in two distribution channels, or tiers. The first tier consists of a limited number of independent distributors that sell primarily to resellers and, on occasion, to end-user customers. We defer recognition of revenue on all sales until the distributors sell the product, as evidenced by monthly “sales-out” reports that the distributors provide to us. We grant these distributors the right to return a portion of unsold inventory for the purpose of stock rotation. We also grant these distributors certain price protection rights. The distributor-related deferred revenue and receivables are adjusted at the time of the stock rotation return or price reduction. We also provide distributors with credits for changes in selling prices, and allow distributors to participate in cooperative marketing programs. We maintain estimated accruals and allowances for these exposures based upon our contractual obligations. In connection with cooperative advertising programs, we do not meet the criteria in our accounting policy for recognizing the expenses as marketing expenses and accordingly, the costs are recorded as a reduction to revenue in the same period that the related revenue is recorded.

 

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The second tier of the distribution channel consists of a large number of third-party value-added resellers that sell directly to end-users. For product sales to value-added resellers, we do not grant return privileges, except for defective products during the warranty period, nor do we grant pricing credits. Accordingly, we recognize revenue upon transfer of title and risk of loss to the value-added reseller, which is generally upon shipment. We reduce product revenue for cooperative marketing activities that may occur under contractual arrangements that we have with our resellers.

We provide an allowance for sales returns based on our historical returns, analysis of credit memo data and our return policies. The allowance for sales returns was $0.9 million as of June 27, 2010 and June 28, 2009 for estimated future returns that were recorded as a reduction of our accounts receivable. The provision for returns is charged to net revenue in the accompanying consolidated statements of operations, and was $7,000, $0.9 million and $1.0 million in fiscal 2010, fiscal 2009 and fiscal 2008, respectively. If the historical data that we use to calculate the estimated sales returns and allowances does not properly reflect future levels of product returns, these estimates will be revised, thus resulting in an impact on future net revenue. We estimate and adjust this allowance at each balance sheet date.

Inventory Valuation

Our inventory balance was $21.8 million as of June 27, 2010, compared with $12.4 million as of June 28, 2009. We value our inventory at lower of cost or market. Cost is computed using standard cost, which approximates actual cost, on a first-in, first-out basis. We provide inventory allowances based on excess and obsolete inventories determined primarily by future demand forecasts. The allowance is measured as the difference between the cost of the inventory and market based upon assumptions about future demand and charged to the provision for inventory, which is a component of cost of sales. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Any written down or obsolete inventory subsequently sold has not had a material impact on gross margin for any of the periods disclosed. Inventory write-downs charged to cost of product revenue were $1.8 million in fiscal 2010, $2.3 million in fiscal 2009 and $2.2 million in fiscal 2008.

Accrued Warranty

Networking products may contain undetected hardware or software errors when new products or new versions or updates of existing products are released to the marketplace. In the past, we had experienced such errors in connection with products and product updates. Our standard hardware warranty period is typically 12 months from the date of shipment to end-users and 90 days for software. For certain access products, we offer a limited lifetime hardware warranty commencing on the date of shipment from us and ending five (5) years following the our announcement of the end of sale of such product. Upon shipment of products to our customers, including both end-users and channel partners, we estimate expenses for the cost to repair or replace products that may be returned under warranty and accrue a liability through charges to cost of product revenue for this amount.

Our accrued warranty balance was $3.2 million as of June 27, 2010 and June 28, 2009. The determination of our warranty requirements is based on our actual historical experience with the product or product family, estimates of repair and replacement costs and any product warranty problems that are identified after shipment. We estimate and adjust this accrual at each balance sheet date in accordance with changes in these factors. In fiscal 2010, we recorded $0.6 million for a change in estimate resulting from losses identified related to a failure in one of our products, and recovered in a settlement all estimated costs related to this issue from our outside design manufacturer.

The cost of new warranties issued that was charged to cost of product revenue was $6.3 million in fiscal 2010, $7.1 million in fiscal 2009 and $5.7 million in fiscal 2008.

 

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Accounts Receivable and Allowance for Doubtful Accounts

Our accounts receivable balance, net of allowance for doubtful accounts, was $42.1 million and $37.6 million as of June 27, 2010 and June 28, 2009, respectively. The allowance for doubtful accounts for trade accounts receivable as of June 27, 2010 was $0.8 million, compared to $1.0 million as of June 28, 2009. We continually monitor and evaluate the collectability of our trade receivables based on a combination of factors. We record specific allowances for bad debts in general and administrative expense when we become aware of a specific customer’s inability to meet its financial obligation to us, such as in the case of bankruptcy filings or deterioration of financial position. Estimates are used in determining our allowances for all other customers based on factors such as current trends in the length of time the receivables are past due and historical collection experience. We mitigate some collection risk by requiring most of our customers in the Asia-Pacific region, excluding Japan and Australia, to pay cash in advance or secure letters of credit when placing an order with us. Our provision for doubtful accounts was an expense of $26,000 in fiscal 2010, expense of $0.2 million in fiscal 2009 and expense of $0.4 million in fiscal 2008.

Deferred Tax Asset Valuation Allowance

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Significant management judgment is required in determining our valuation allowance recorded against our net deferred tax assets. We make an assessment of the likelihood that our net deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not believed to be likely, a valuation allowance is established. We provided a full valuation allowance against all of our U.S. federal and state net deferred tax assets in fiscal 2003 in the amount of $194.8 million in accordance with our policy. In fiscal 2010, the valuation allowance increased by $11.5 million to $155.1 million, and in fiscal 2009, the valuation allowance decreased by $14.1 million to $143.6 million. We have not provided a valuation allowance against any of our non-U.S. deferred tax assets.

The valuation allowance requires an assessment of both negative and positive evidence when measuring the need for a valuation allowance. Evidence, such as operating results during the most recent three-year period was given more weight than our expectations of future profitability, which are inherently uncertain. Our U.S. losses during those periods represented sufficient negative evidence to require a full valuation allowance against our U.S. federal and state net deferred tax assets. This valuation allowance will be evaluated periodically and can be reversed partially or totally if business results have sufficiently improved to support realization of our deferred tax assets.

Accounting for Uncertainty in Income Taxes

We had unrecognized tax benefits of $23.9 million as of June 27, 2010. If fully recognized in the future, $1.0 million would impact our effective tax rate, and $22.9 million would result in adjustments to deferred tax assets and corresponding adjustments to the valuation allowance. We do not anticipate any material changes to our uncertain tax positions during the next twelve months.

Legal Contingencies

We are currently involved in various claims and legal proceedings, including negotiations regarding potential licenses from third parties who have notified us that they believe our products may infringe certain patents. Periodically, we review the status of each significant matter, whether litigation or licensing negotiation, and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Because of uncertainties related to these matters, accruals, if any, are based only on the most current and dependable information available at any given time. As additional information becomes available, we may reassess the potential liability from pending claims and litigation and the probability of claims being successfully asserted against us. As a result, we

 

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may revise our estimates related to these pending claims and litigation. Such revisions in the estimates of the potential liabilities could have a material impact on our consolidated results of operations, financial position and cash flows in the future. For further detail, see Note 3 of Notes to Consolidated Financial Statements for a description of legal proceedings.

Liquidity and Capital Resources

The following summarizes information regarding our cash, investments, and working capital (in thousands):

 

     June 27,
2010
   June 28,
2009

Cash and cash equivalent

   $ 49,004    $ 46,195

Short-term investments

     64,854      8,976

Marketable securities

     18,561      72,231
             

Total cash and investments

   $ 132,419    $ 127,402
             

Working capital

   $ 82,629    $ 23,414

Cash and cash equivalents increased by $2.8 million primarily due to cash provided by operating activities of $9.3 million and cash from financing activities of $1.1 million, offset by cash used in investing activities of $7.6 million. Refer to further discussions below under Key Components of Cash Flows and Liquidity.

Short-term investments increased by $55.9 million primarily due to the transfer of securities maturing within one year from marketable securities and the reclassification of $40.7 million of ARS balance from marketable securities in the first quarter of fiscal 2010. Refer to further discussions below under Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Marketable securities decreased by $53.7 million primarily due to the reclassification of $40.7 million of ARS balance to short-term investments and the transfer of securities maturing within one year to short-term investments.

The increase in working capital of $59.2 million was primarily due to the reclassification of ARS from marketable securities to short-term investments.

Key Components of Cash Flows and Liquidity

A summary of the sources and uses of cash and cash equivalents is as follows (in thousands):

 

     Year Ended  
     June 27,
2010
    June 28,
2009
    June 29,
2008
 

Net cash provided by operating activities

   $ 9,306      $ 4,702      $ 16,166   

Net cash (used in) provided by investing activities

   $ (7,582   $ 70,379      $ (21,053

Net cash provided by (used in) financing activities

   $ 1,085      $ (99,256   $ 3,684   
                        

Net increase (decrease) in cash and cash equivalents

   $ 2,809      $ (24,175   $ (1,203

Cash and cash equivalents, short-term investments and marketable securities were $132.4 million and $127.4 million at June 27, 2010 and June 28, 2009, respectively, representing an increase of $5.0 million. This increase was primarily due to cash provided by operations of $9.3 million and cash provided by financing activities of $1.1 million, offset by capital expenditures of $5.1 million.

Cash provided by operating activities was $9.3 million, an increase of $4.6 million compared to cash provided by operating activities of $4.7 million in fiscal 2009. Net income was $0.2 million and included significant non-cash charges including depreciation of $5.6 million, $6.2 million in share-based compensation

 

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expense and $1.8 million in the provision for excess and obsolete inventory. Accounts receivable, net, decreased to $42.1 million at June 27, 2010 from $37.6 million at June 28, 2009. Days sales outstanding in receivables increased to 45 days at June 27, 2010 from 42 days at June 28, 2009. The increase in accounts receivable and days sales outstanding were primarily due to increased billings in the fourth quarter of fiscal 2010. Inventories increased to $21.8 million at June 27, 2010 from $12.4 million at June 28, 2009. Inventory balance of $12.4 million at June 28, 2009 was lower than the normal inventory balance between $16.0 million to $18.0 million due to decreased inventory forecast demand. We increased our inventory balance to $21.8 million as of June 27, 2010 in anticipation of increased sales demand for the upcoming first quarter of fiscal 2011 as compared to the first quarter of fiscal 2010. Deferred revenue, net decreased to $37.2 million at June 27, 2010 from $37.5 million at June 28, 2009. This decrease was due primarily to a reduction in renewals of service maintenance agreements for products which are entering end of support life.

Cash flow used in investing activities was $7.6 million. Capital expenditures were $5.1 million and purchases of investments were $51.6 million, offset by proceeds from maturities of investments and marketable securities of $34.5 million and sales of investments and marketable securities of $14.6 million.

Cash provided by financing activities was $1.1 million from the issuance of common stock.

As of June 27, 2010, we had letters of credit totaling $0.2 million secured by cash. These letters of credit are primarily issued in lieu of making cash deposits with third parties.

In October 2008, we entered into a secured line of credit with UBS, collateralized by our ARS held by UBS. The maximum amount of credit available under this line of credit is $28.8 million. On November 7, 2008 we accepted the UBS Rights offer and hence the terms of the “no net cost” loan program apply to this line of credit. Under this program, the interest rate on this secured credit facility will be equivalent to the interest rate earned by us on the ARS at UBS, resulting in no net interest cost to us. There are currently no outstanding borrowings under this line of credit. On June 30, 2010, we exercised our UBS Rights to redeem the remaining ARS at par. Upon exercising the UBS Rights, this line of credit was terminated.

Employee Stock Option Exchange Program

On December 23, 2009, our stockholders approved a voluntary program (“Exchange Program”) that permitted eligible employees to exchange certain outstanding stock options that were “underwater” for a lesser number of shares of restricted stock units to be granted under the Extreme Networks, Inc. 2005 Equity Incentive Plan (the “2005 Plan”) and to exchange certain other stock options that are more substantially underwater for a cash payment. The Exchange Program was open to all of our United States employees, except for members of our Board of Directors and our executive officers. The Exchange Program commenced on February 4, 2010 and ended March 4, 2010. On March 5, 2010, we cancelled a total of 3,058,761 tendered stock options, issued a total of 569,189 replacement restricted stock units under the 2005 Plan, and incurred a cash outlay of $8,769 which was paid out at the end of March 2010.

Contractual Obligations

The following summarizes our contractual obligations at June 27, 2010, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

 

     Total    Less Than
1 Year
   1 – 3 Years    3 – 5 Years    More Than
Five Years

Contractual Obligations:

              

Non-cancelable inventory purchase commitments

   $ 39,123    $ 39,123    $ —      $ —      $ —  

Non-cancelable operating lease obligations

     11,235      6,706      2,761      1,034      734

Other non-cancelable purchase commitments

     2,484      1,734      750      —        —  
                                  

Total contractual cash obligations

   $ 52,842    $ 47,563    $ 3,511    $ 1,034    $ 734
                                  

 

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Non-cancelable inventory purchase commitments represent the purchase of long lead-time component inventory that our contract manufacturers procure in accordance with our forecast. Inventory purchase commitments were $39.1 million as of June 27, 2010, an increase of $19.2 million from $19.9 million as of June 28, 2009. The increase was due to higher projected sales in the first quarter of fiscal 2011 as compared to the first quarter of fiscal 2010. We did not have any material commitments for capital expenditures as of June 27, 2010. Other non-cancelable purchase commitments represent OEM and technology agreements.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as of June 27, 2010.

Capital Resources and Financial Condition

As of June 27, 2010, in addition to $49.0 million in cash and cash equivalents, we had $64.9 million invested in short-term investments and $18.6 million invested in long-term marketable investments for a total cash and cash equivalents, short-term investments and marketable securities of $132.4 million.

At June 27, 2010, we held approximately $25.3 million (par value) of illiquid non-current Auction Rate Securities (ARS). The decline in value of these securities reflects market related liquidity conditions resulting from the general collapse of the credit markets and not the issuer’s creditworthiness. The ARS are collateralized by student loan portfolios that are approximately 93% guaranteed by the US Department of Education and maintain a credit rating of AAA and AA. Historically, these securities provided liquidity to investors through their interest rate reset feature – i.e., interest rates on these securities are reset through a bidding process (or auction) at frequent, pre-determined intervals (typically every 7 to 28 days). At each reset, investors could either rollover and maintain their holdings or liquidate them at par value. Since February 2008, auctions related to our ARS have failed as a result of the deterioration of the credit markets, rendering these securities illiquid.

On November 7, 2008, we accepted an offer (the “UBS Rights Offer”) from UBS AG (“UBS”), providing us with certain rights related to our ARS (the “Rights”). The Rights permit us to require UBS to purchase our ARS at par value, which is defined as the price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, at any time during the period of June 30, 2010 through July 2, 2012. Conversely, UBS has the right, in its discretion, to purchase or sell our ARS at any time until July 2, 2012, so long as we receive payment at par value upon any sale or disposition. As of June 27, 2010, UBS exercised its rights to call back the ARS at par for $9.8 million and issuers redeemed $5.7 million of ARS at par. On June 30, 2010, we sold the remaining ARS balance of $25.3 million at par under the Rights. On July 1, 2010, we received $25.3 million plus accrued interest in cash from UBS for the ARS settlement.

In October 2008, we entered into a secured line of credit with UBS, collateralized by our ARS held by UBS. The maximum amount of credit available under this line of credit is $28.8 million. When we accepted the UBS Rights Offer in November 2008, the terms of the UBS “no net cost” loan program were applied to this line of credit. Under this program, the interest rate on this secured credit facility will be equivalent to the interest rate earned by us on the ARS, resulting in no net interest cost to us. As of June 27, 2010, there was no outstanding borrowing under this line of credit. On June 30, 2010, we exercised our UBS Rights to redeem the remaining ARS at par. Upon exercising the UBS Rights, this line of credit was terminated.

We believe that our current cash and cash equivalents, short-term investments, marketable securities 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.

New Accounting Pronouncements

In January 2010, the FASB issued a new accounting standards update for fair value measurements and disclosures. A reporting entity should disclose separately the amounts of significant transfers in and out of

 

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Level 1 and Level 2 and describe the reasons for the transfers. A reporting entity should separately disclose information about purchases, sales, issuances and settlements for Level 3 reconciliation disclosures. The new disclosures and clarifications of existing disclosures are effective for financial statements issued interim or annual financial periods ending after December 15, 2009, with the exception for the reconciliation disclosures for Level 3, which are effective for financial statements issued interim or annual financial periods ending after December 15, 2010. The adoption of the new accounting standards update did not have a material impact on our consolidated results of operations, financial condition or financial disclosures.

In October 2009, the FASB issued a new accounting standard which excludes from the scope of software revenue guidance the revenue arrangements that include tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality. At the same time, the FASB also issued a new accounting standard which updates existing guidance pertaining to the separation and allocation of consideration in a multiple element arrangement. This new guidance will be applicable to our multiple element arrangements that include such tangible products. The new standards are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The adoption of this accounting standard is not expected to have a material effect on the amount of revenue reported.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

The primary objective of our investment activities is to preserve principal while at the same time maximize the income we receive from our 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.

As of June 27, 2010, we held a variety of interest bearing ARS that represent investments in pools of student loans. These ARS investments are intended to provide liquidity via an auction process that resets the applicable interest rate at predetermined calendar intervals, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. The recent uncertainties in the credit markets have affected all of our holdings in ARS investments and auctions for our investments in these securities have failed to settle on their respective settlement dates. On November 7, 2008, we accepted the UBS Rights Offer from UBS, providing us with rights related to our ARS. The Rights permit us to require UBS to purchase our ARS at par value, which is defined as the price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, at any time during the period of June 30, 2010 through July 2, 2012. Conversely, UBS has the right, in its discretion, to purchase or sell our ARS at any time until July 2, 2012, so long as we receive payment at par value upon any sale or disposition. During the first quarter of fiscal 2010, we reclassified our entire balance of ARS from marketable securities to short-term securities in our consolidated balance sheet. The reclassification is a result of the Put Option being due within less than one year from the balance sheet date. Beginning in 2010, we began to sell our ARS under the Rights. As of June 27, 2010, UBS exercised its rights to call back the ARS at par for $9.8 million and issuers redeemed $5.7 million of ARS at par. On June 30, 2010, we sold the remaining ARS balance of $25.3 million at par under the Rights. On July 1, 2010, we received $25.3 million plus accrued interest in cash from UBS for the ARS settlement.

The valuation of our investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact its valuation include changes to credit ratings of the securities, discount rates and ongoing strength and quality of market credit and liquidity.

If the current market conditions deteriorate further, or the anticipated recovery in market values does not occur, we may be required to record impairment charges in future quarters.

The following table presents the amounts of our cash equivalents, short-term investments and marketable securities that are subject to market risk by range of expected maturity and weighted-average interest rates as of June 27, 2010 and June 28, 2009. This table does not include money market funds because those funds are generally not subject to market risk. Included within short-term investments as of June 27, 2010 within this table is our ARS portfolio held at UBS.

 

     Maturing in     
     Three
months
or less
    Three
months to
one year
    Greater
than one
year
    Total    Fair
Value
     (In thousands)

June 27, 2010:

           

Included in short-term investments

   $ 31,255      $ 33,599        $ 64,854    $ 64,854

Weighted average interest rate

     1.62     1.84       

Included in marketable securities

       $ 18,561      $ 18,561    $ 18,561

Weighted average interest rate

         1.58     

 

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     Maturing in     
     Three
months
or less
    Three
months to
one year
    Greater
than one
year
    Total    Fair
Value
     (In thousands)

June 28, 2009:

           

Included in cash and cash equivalents

   $ 11,368          $ 11,368    $ 11,368

Weighted average interest rate

     0.11         

Included in short-term investments

   $ 0      $ 8,976        $ 8,976    $ 8,976

Weighted average interest rate

     0.00     2.03       

Included in marketable securities

       $ 72,231      $ 72,231    $ 72,231

Weighted average interest rate

         1.52     

We accumulate unrealized gains and losses on our available-for-sale debt securities, net of tax, in accumulated other comprehensive income in the stockholders’ equity section of its balance sheets. Such an unrealized gain or loss does not reduce net income for the applicable accounting period. If the fair value of an available-for-sale debt instrument is less than its amortized cost basis, an other-than-temporary impairment is triggered in circumstances where (1) we intend to sell the instrument, (2) it is more likely than not that we will be required to sell the instrument before recovery of its amortized cost basis, or (3) we do not expect to recover the entire amortized cost basis of the instrument (that is, a credit loss exists). If we intend to sell or it is more likely than not that we will be required to sell the available-for-sale debt instrument before recovery of its amortized cost basis, we recognize an other-than-temporary impairment in earnings equal to the entire difference between the debt instruments’ amortized cost basis and its fair value. For available-for-sale debt instruments that are considered other-than-temporarily impaired due to the existence of a credit loss, if we do not intend to sell and it is not more likely than not that we will be required to sell the instrument before recovery of its remaining amortized cost basis (amortized cost basis less any current-period credit loss), we separate the amount of the impairment into the amount that is credit related and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the debt instrument’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the debt instrument’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income (loss).

Exchange Rate Sensitivity

Currently, substantially all of our sales and the majority of our expenses are denominated in United States dollars and, as a result, we have experienced no significant foreign exchange gains and losses to date. While we conduct some sales transactions and incur certain operating expenses in foreign currencies and expect to continue to do so, we do not anticipate that foreign exchange gains or losses will be significant, in part because of our foreign exchange risk management process discussed below.

Foreign Exchange Forward Contracts

We record all derivatives on the balance sheet at fair value. Changes in the fair value of derivatives are recognized in earnings as Other Income (Expense). We enter into foreign exchange forward contracts to mitigate the effect of gains and losses generated by the foreign currency forecasted transactions related to certain operating expenses and remeasurement of certain assets and liabilities denominated in Japanese Yen, the Euro, the Swedish Krona, the Indian Rupee and the British Pound. These derivatives do not qualify as hedges. At June 27, 2010, these forward foreign currency contracts had a notional principal amount of $19.1 million and fair value was $0.1 million. These contracts have maturities of less than 60 days. Changes in the fair value of these foreign exchange forward contracts are offset largely by remeasurement of the underlying assets and liabilities.

Foreign currency transaction gains and losses from operations were a loss of $0.4 million in fiscal 2010, a loss of $0.1 million in fiscal 2009 and a loss of $0.7 million in fiscal 2008.

 

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Item 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF EXTREME NETWORKS, INC.

 

     Page(s)

Report of Independent Registered Public Accounting Firm

   51

Consolidated Balance Sheets

   52

Consolidated Statements of Operations

   53

Consolidated Statements of Stockholders’ Equity

   54

Consolidated Statements of Cash Flows

   55

Notes to Consolidated Financial Statements

   56

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Extreme Networks, Inc.

We have audited the accompanying consolidated balance sheets of Extreme Networks, Inc. as of June 27, 2010 and June 28, 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended June 27, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Extreme Networks, Inc. at June 27, 2010 and June 28, 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 27, 2010, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 6 to the consolidated financial statements, in fiscal year 2008, Extreme Networks, Inc. changed its method of accounting for uncertain tax positions in accordance with the guidance provided in Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (codified in FASB ASC Topic 740, Income Taxes).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Extreme Networks, Inc.’s internal control over financial reporting as of June 27, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 20, 2010 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

San Francisco, California

August 20, 2010

 

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EXTREME NETWORKS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

     June 27,
2010
    June 28,
2009
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 49,004      $ 46,195   

Short-term investments

     64,854        8,976   

Accounts receivable, net of allowances of $1,969 at June 27, 2010 ($2,135 at June 28, 2009)

     42,057        37,616   

Inventories, net

     21,842        12,380   

Deferred income taxes

     392        244   

Prepaid expenses and other current assets, net

     3,932        4,368   
                

Total current assets

     182,081        109,779   

Property and equipment, net

     43,572        44,229   

Marketable securities

     18,561        72,231   

Other assets, net

     15,731        13,736   
                

Total assets

   $ 259,945      $ 239,975   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 18,543      $ 12,771   

Accrued compensation and benefits

     13,365        12,320   

Restructuring liabilities

     3,097        3,559   

Accrued warranty

     3,169        3,170   

Deferred revenue, net

     29,552        30,058   

Deferred revenue, net of cost of sales to distributors

     18,345        9,821   

Other accrued liabilities

     13,381        14,666   
                

Total current liabilities

     99,452        86,365   

Restructuring liabilities, less current portion

     273        3,519   

Deferred revenue, less current portion

     7,633        7,425   

Deferred income taxes

     731        564   

Other long-term liabilities

     2,661        592   

Commitments and contingencies (Note 3)

     —          —     

Stockholders’ equity:

    

Convertible preferred stock, $.001 par value, issuable in series, 2,000,000 shares authorized; none issued

     —          —     

Common stock, $.001 par value, 750,000,000 shares authorized; 129,827,715 issued at June 27, 2010 and 128,425,140 issued at June 28, 2009

     130        128   

Treasury stock, 39,625,305 shares at June 27, 2010 and June 28, 2009

     (149,666     (149,666

Additional paid-in-capital

     956,792        949,113   

Accumulated other comprehensive income

     1,100        1,323   

Accumulated deficit

     (659,161     (659,388
                

Total stockholders’ equity

     149,195        141,510   
                

Total liabilities and stockholders’ equity

   $ 259,945      $ 239,975   
                

See accompanying notes to consolidated financial statements.

 

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EXTREME NETWORKS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

 

     Year Ended  
     June 27,     June 28,     June 29,  
     2010     2009     2008  

Net revenues:

      

Product

   $ 249,035      $ 273,772      $ 302,313   

Service

     60,319        61,787        59,522   
                        

Total net revenues

     309,354        335,559        361,835   
                        

Cost of revenues:

      

Product

     107,998        116,731        123,333   

Service

     24,863        28,166        33,221   
                        

Total cost of revenues

     132,861        144,897        156,554   
                        

Gross profit:

      

Product

     141,037        157,041        178,980   

Service

     35,456        33,621        26,301   
                        

Total gross profit

     176,493        190,662        205,281   
                        

Operating expenses:

      

Sales and marketing

     96,621        98,235        103,490   

Research and development

     49,390        58,176        65,335   

General and administrative

     26,839        29,945        34,668   

Restructuring charge, net of reversal

     4,238        2,245        893   

Litigation Settlement

     829        —          —     
                        

Total operating expenses

     177,917        188,601        204,386   
                        

Operating (loss) income

     (1,424     2,061        895   

Interest income

     1,481        3,360        10,229   

Interest expense

     (141     (147     (89

Other (expense) / income, net

     (99     13        (476
                        

(Loss) income before income taxes

     (183     5,287        10,559   

Provision for income taxes

     (410     2,472        2,178   
                        

Net income

   $ 227      $ 2,815      $ 8,381   
                        

Basic and diluted net income per share:

      

Net income per share – basic

   $ 0.00      $ 0.03      $ 0.07   

Net income per share – diluted

   $ 0.00      $ 0.03      $ 0.07   

Shares used in per share calculation – basic

     89,281        94,225        115,002   

Shares used in per share calculation – diluted

     89,477        94,284        115,784   

 

See accompanying notes to consolidated financial statements.

 

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EXTREME NETWORKS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

     Common Stock    Treasury Stock     Additional
Paid-in-Capital
    Accumulated
Other
Comprehensive
Income (Loss)
    Accumulated
Deficit
    Total
Stockholders’
Equity
 
         Shares            Amount        Shares     Amount          

Balances at July 1, 2007

   125,105    $ 125    (11,054   $ (48,303   $ 934,415      $ 572      $ (670,584   $ 216,225   

Components of comprehensive income:

                  

Net income

   —        —      —          —          —          —          8,381        8,381   

Change in unrealized gain on investments, net of tax expense of $0

   —        —      —          —          —          (2,346     —          (2,346

Foreign currency translation adjustment

   —        —      —          —          —          1,051        —          1,051   
                        

Total comprehensive income

                     7,086   
                        

Exercise of options to purchase common stock

   840      1    —          —          2,444        —          —          2,445   

Issuance of common stock under employee stock purchase plan

   480      —      —          —          1,425        —          —          1,425   

Issuance of restricted stock, net of repurchases

   74       —          —          (195     —          —          (195

Exercise of warrant by Avaya

   859      1    —          —          8        —          —          9   

Share-based payments, net of repurchases

   —        —      —          —          5,059        —          —          5,059   
                                                          

Balances at June 29, 2008

   127,358    $ 127    (11,054   $ (48,303   $ 943,156      $ (723   $ (662,203   $ 232,054   

Components of comprehensive income:

                  

Net income

   —        —      —          —          —          —          2,815        2,815   

Change in unrealized gain on investments, net of tax expense of $0

   —        —      —          —          —          3,159        —          3,159   

Foreign currency translation adjustment

   —        —      —          —          —          (1,113     —          (1,113
                        

Total comprehensive income

                     4,861   
                        

Exercise of options to purchase common stock

   399      —      —          —          1,124        —          —          1,124   

Issuance of common stock under employee stock purchase plan

   666      1    —          —          1,166        —          —          1,167   

Issuance of restricted stock, net of repurchases

   2       —          —          (184     —          —          (184

Share-based payments, net of repurchases

   —        —      —          —          3,851        —          —          3,851   

Repurchase of common stock

   —        —      (28,571     (101,363       —          —          (101,363
                                                          

Balances at June 28, 2009

   128,425    $ 128    (39,625   $ (149,666   $ 949,112      $ 1,323      $ (659,388   $ 141,510   

Components of comprehensive income:

                  

Net income

   —        —      —          —            —          227        227   

Change in unrealized gain on investments, net of tax expense of $0

   —        —      —          —            (265     —          (265

Foreign currency translation adjustment

   —        —      —          —            42        —          42   
                        

Total comprehensive income

                     4   
                        

Exercise of options to purchase common stock

   337      —      —          —          739        —          —          739   

Issuance of common stock under employee stock purchase plan

   620      1    —          —          1,101        —          —          1,102   

Issuance of restricted stock, net of repurchases

   446      1    —          —          (750     —          —          (749

Share-based payments

   —        —      —          —          6,243        —          —          6,243   

Repurchase of employee stock options

   —        —      —          —          (7     —          —          (7

Acceleration of employee stock option

               353            353   
                                                          

Balances at June 27, 2010

   129,828    $ 130    (39,625   $ (149,666   $ 956,792      $ 1,100      $ (659,161   $ 149,195   
                                                          

See accompanying notes to consolidated financial statements.

 

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EXTREME NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended  
     June 27,
2010
    June 28,
2009
    June 29,
2008
 

Cash flows from operating activities:

      

Net income

   $ 227      $ 2,815      $ 8,381   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Depreciation and amortization

     5,588        5,902        7,193   

Change in value / loss (gain) on value of UBS option to put securities

     2,091        (4,520     —     

Auction rate securities mark to market, trading (gain) loss

     (2,091     4,520        —     

(Recovery of) provision for doubtful accounts

     (26     232        416   

Provision for excess and obsolete inventory

     1,782        2,265        2,172   

Deferred income taxes

     21        170        578   

Amortization of warrant

     —          —          1,349   

Loss on retirement of assets

     178        94        300   

Stock-based compensation

     6,235        3,854        5,059   

Restructuring charge, net of reversal

     4,238        2,244        893   

Changes in operating assets and liabilities, net

      

Accounts receivable

     (4,414     19,730        (18,119

Inventories

     (11,236     (706     5,567   

Prepaid expenses and other assets

     (1,560     26        5,813   

Accounts payable

     5,773        (4,150     (4,382

Accrued compensation and benefits

     1,045        (6,636     4,115   

Restructuring liabilities

     (7,593     (4,553     (5,492

Accrued warranty

     (0     (1,654     (2,359

Deferred revenue, net

     (299     (2,807     (1,791

Deferred revenue, net of cost of sales to distributors

     8,524        (4,317     2,151   

Other accrued liabilities

     (1,245     (7,341     5,226   

Other long-term liabilities

     2,068        (466     (904
                        

Net cash provided by operating activities

     9,306        4,702        16,166   
                        

Cash flows (used in) provided by investing activities:

      

Capital expenditures

     (5,109     (6,877     (7,683

Purchases of investments

     (51,552     (44,479     (307,442

Proceeds from maturities of investments and marketable securities

     34,452        28,164        122,063   

Proceeds from sales of investments and marketable securities

     14,627        93,571        172,009   
                        

Net cash (used in) provided by investing activities

     (7,582     70,379        (21,053
                        

Cash flows provided by (used in) financing activities:

      

Proceeds from issuance of common stock

     1,085        2,107        3,684   

Repurchase of common stock, including expenses

     —          (101,363     —     
                        

Net cash provided by (used in) financing activities

     1,085        (99,256     3,684   
                        

Net increase (decrease) in cash and cash equivalents

     2,809        (24,175     (1,203
                        

Cash and cash equivalents at beginning of period

     46,195        70,370        71,573   
                        

Cash and cash equivalents at end of period

   $ 49,004      $ 46,195      $ 70,370   
                        

Supplemental disclosure of cash flow information:

      

Interest paid

   $ 141      $ 146      $ 88   

Cash paid for income taxes, net

   $ 1,197      $ 2,825      $ 996   

See accompanying notes to the consolidated financial statements.

 

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EXTREME NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business

Extreme Networks, Inc. (“Extreme Networks” or “the Company”) is a leading provider of network infrastructure equipment and markets its products primarily to business, governmental, health care, service provider, and educational customers with a focus on large corporate enterprises and metropolitan service providers on a global basis. The Company conducts its sales and marketing activities on a worldwide basis through distributors, resellers and the Company’s field sales organization. Extreme Networks was incorporated in California in 1996 and reincorporated in Delaware in 1999.

2. Basis of Presentation and Summary of Significant Accounting Policies

Fiscal Year

The Company’s fiscal year is a 52/53-week fiscal accounting year that closes on the Sunday closest to June 30th every year. Fiscal 2010, 2009 and fiscal 2008 were 52-week fiscal years. All references herein to “fiscal 2010” or “2010” represent the fiscal year ended June 27, 2010. The Company has evaluated all subsequent events through the date the financial statements were filed with the SEC.

Principles of Consolidation

The consolidated financial statements include the accounts of Extreme Networks and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.

The Company uses the U.S. dollar predominately as its functional currency. The functional currency for certain of its foreign subsidiaries is the local currency. For those subsidiaries that operate in a local currency functional environment, all assets and liabilities are translated to United States dollars at current rates of exchange; and revenue and expenses are translated using average rates. Foreign currency transaction gains and losses from operations were a loss of $0.4 million in fiscal 2010, a loss of $0.1 million in fiscal 2009 and a loss of $0.7 million in fiscal 2008.

Reclassification

Certain prior period amounts have been reclassified to conform to the current presentation. Such reclassifications impacted the Consolidated Balance Sheets, Consolidated Statements of Operations, Consolidated Statements of Cash Flows and Consolidated Statements of Stockholders’ Equity. Specifically, the Company reclassified back-end rebate for distributors from Other Accrued Liabilities to contra Accounts Receivable and gains and losses from foreign currency transactions from Cost of Revenues and Operating Expenses to Other Income (Expense) beginning in the second and fourth quarter of fiscal 2010, respectively, with the prior periods updated to conform to this presentation.

Adjustments

The audited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments and out of period share based compensation adjustments totaling $0.9 million that, in the opinion of management, are necessary for a fair presentation of the results of operations and cash flows for the annual period presented and the financial condition of Extreme Networks at June 27, 2010.

Accounting Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the

 

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EXTREME NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

amounts reported in the financial statements and accompanying notes. Estimates are used for, but are not limited to, the accounting for the allowances for doubtful accounts and sales returns, inventory valuation, depreciation and amortization, valuation of ARS, valuation of UBS Put Option, impairment of long-lived assets, warranty accruals, restructuring liabilities, measurement of share-based compensation costs and income taxes. Actual results could differ materially from these estimates.

Revenue Recognition

The Company allocates revenue to each element of multiple element arrangements that include products containing software that is more-than-incidental using the residual method based on vendor specific objective evidence of fair value of the undelivered elements. The Company determines vendor specific objective evidence of fair value based on the price charged when the item is sold separately. Under the residual method, the Company first allocates the revenue for a multiple element arrangement to the undelivered elements based on their VSOE of fair value, and the remainder of the arrangement fee to the delivered elements.

The Company derives the majority of its revenue from sales of its networking equipment, with the remaining revenue generated from service fees relating to the service contracts, professional services, and training for its products. The Company generally recognizes product revenue from its value-added resellers and end-user customers at the time of shipment, provided that persuasive evidence of an arrangement exists, delivery has occurred, the price of the product is fixed or determinable, and collection of the sales proceeds is reasonably assured. In instances where the criteria for revenue recognition are not met, revenue is deferred until all criteria have been met. Revenue from service obligations under service contracts is deferred and recognized on a straight-line basis over the contractual service period. Service contracts typically range from one to two years. The Company’s total deferred product revenue was $1.4 million and $1.3 million as of June 27, 2010 and June 28, 2009, respectively. The Company’s total deferred revenue for services, primarily from service contracts, was $36.4 million as of June 27, 2010 and $36.7 million as of June 28, 2009. Service contracts typically range from one to two years. Shipping costs are included in cost of product revenues.

The Company makes certain sales to partners in two distribution channels, or tiers. The first tier consists of a limited number of independent distributors that sell primarily to resellers and, on occasion, to end-user customers. The Company defers recognition of revenue on all sales to these distributors until the distributors sell the product, as evidenced by monthly “sales-out” reports that the distributors provide. The Company grants these distributors the right to return a portion of unsold inventory for the purpose of stock rotation. The Company also grants these distributors certain price protection rights. The distributor-related deferred revenue and receivables are adjusted at the time of the stock rotation return or price reduction. The Company also provides distributors with credits for changes in selling prices, and allows distributors to participate in cooperative marketing programs. The Company maintains estimated accruals and allowances for these exposures based upon the Company’s historical experience. In connection with cooperative advertising programs, the Company does not meet the criteria in its accounting policy for recognizing the expenses as marketing expenses and accordingly, the costs are recorded as a reduction to revenue in the same period that the related revenue is recorded.

The second tier of the distribution channel consists of a large number of third-party value-added resellers that sell directly to end-users. For product sales to value-added resellers, the Company does not grant return privileges, except for defective products during the warranty period, nor does the Company grant pricing credits. Accordingly, the Company recognizes revenue upon transfer of title and risk of loss to the value-added reseller, which is generally upon shipment. The Company reduces product revenue for cooperative marketing activities and certain price protection rights that may occur under contractual arrangements with its resellers.

 

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EXTREME NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Company provides an allowance for sales returns based on its historical returns, analysis of credit memo data and its return policies. The allowance for sales returns was $0.9 million as of June 27, 2010 and June 28, 2009 for estimated future returns that were recorded as a reduction of our accounts receivable. The provision for returns is charged to net revenue in the accompanying consolidated statements of operations, and was $7,000, $0.9 million and $1.0 million in fiscal 2010, fiscal 2009 and fiscal 2008, respectively. If the historical data that the Company uses to calculate the estimated sales returns and allowances does not properly reflect future levels of product returns, these estimates will be revised, thus resulting in an impact on future net revenue. The Company estimates and adjusts this allowance at each balance sheet date.

Cash Equivalents, Short-Term Investments and Marketable Securities

Summary of Available-for-Sale Securities and Trading Securities

 

     June 27, 2010    June 28, 2009

Cash equivalent

   $ 42,544    $ 43,367

Short-term investments

     64,855      8,976

Marketable securities

     18,561      72,231
             

Total available-for-sale and trading securities

   $ 125,960    $ 124,574
             

Available-for-Sale Securities

The following is a summary of available-for-sale securities (in thousands):

 

     Amortized
Cost
   Fair Value    Unrealized
Holding
Gains
   Unrealized
Holding
Losses
 

June 27, 2010:

           

Money market funds

   $ 42,544    $ 42,544    $ —      $ —     

U.S. corporate debt securities

     53,525      53,570      159      (114

U.S. government agency securities

     4,413      4,514      101      —     
                             
   $ 100,482    $ 100,628    $ 260    $ (114
                             

Classified as:

           

Cash equivalents

   $ 42,544    $ 42,544    $ —      $ —     

Short-term investments

     39,381      39,523      202      (60

Marketable securities

     18,557      18,561      58      (54
                             
   $ 100,482    $ 100,628    $ 260    $ (114
                             

June 28, 2009:

           

Money market funds

   $ 35,367    $ 35,367    $ —      $ —     

U.S. corporate debt securities

     37,184      37,437      253      —     

U.S. government agency securities

     10,829      10,987      158      —     
                             
   $ 83,380    $ 83,791    $ 411    $ —     
                             

Classified as:

           

Cash equivalents

   $ 43,367    $ 43,367    $ —      $ —     

Short-term investments

     8,965      8,976      11      —     

Marketable securities

     31,048      31,448      400      —     
                             
   $ 83,380    $ 83,791    $ 411    $ —     
                             

 

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EXTREME NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The amortized cost and estimated fair value of available-for-sale investments in debt securities at June 27, 2010, by contractual maturity, were as follows (in thousands):

 

     Amortized
Cost
   Fair
Value

Due in 1 year or less

   $ 39,381    $ 39,523

Due in 1-2 years

     11,659      11,665

Due in 2-5 years

     6,898      6,896

Due in more than 5 years

     —        —  
             

Total investments in available for sale debt securities

   $ 57,938    $ 58,084
             

The Company considers highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Investments with maturities of greater than three months at the date of purchase are classified as non-cash equivalents. Of these, investments with maturities of less than one year at balance sheet date are classified as Short Term Investments. Investments with maturities of greater than one year at balance sheet date are classified as Marketable Securities. Except for direct obligations of the United States government, securities issued by agencies of the United States government, and money market funds, the Company diversifies its investments by limiting its holdings with any individual issuer.

Investments include available-for-sale investment-grade debt securities and trading securities that the Company carries at fair value. The Company accumulates unrealized gains and losses on the Company’s available-for-sale debt securities, net of tax, in accumulated other comprehensive income in the stockholders’ equity section of its balance sheets. Such an unrealized gain or loss does not reduce net income for the applicable accounting period. If the fair value of an available-for-sale debt instrument is less than its amortized cost basis, an other-than-temporary impairment is triggered in circumstances where (1) the Company intends to sell the instrument, (2) it is more likely than not that the Company will be required to sell the instrument before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the instrument (that is, a credit loss exists). If the Company intends to sell or it is more likely than not that the Company will be required to sell the available-for-sale debt instrument before recovery of its amortized cost basis, the Company recognizes an other-than-temporary impairment in earnings equal to the entire difference between the debt instruments’ amortized cost basis and its fair value. For available-for-sale debt instruments that are considered other-than-temporarily impaired due to the existence of a credit loss, if the Company does not intend to sell and it is not more likely than not that the Company will be required to sell the instrument before recovery of its remaining amortized cost basis (amortized cost basis less any current-period credit loss), the Company separates the amount of the impairment into the amount that is credit related and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the debt instrument’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the debt instrument’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income (loss).

The Company records unrealized and realized gains and losses on the Company’s trading securities, net of tax, in other income (expense), net, in its statements of operations. The ARS are held with UBS AG (“UBS”) and the Company accepted a Rights offer on November 7, 2008 (see discussions below). The ARS and Put Option (as defined below) represent a fair value of $25.3 million and are reflected in short-term investments trading as of June 27, 2010. The reclassification to short-term investment is made based on the Company’s intention to exercise the Put Option which first comes due in less than one year from the balance sheet date.

 

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EXTREME NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The following table presents the Company’s investments’ gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

 

     Less than 12 months     12 months or more    Total  
     Fair Value    Unrealized
Losses
    Fair Value    Unrealized
Losses
   Fair Value    Unrealized
Losses
 

June 27, 2010:

                

U.S. corporate debt securities

   $ 26,809    $ (114   $ —      $ —      $ 26,809    $ (114
                                            

Realized gains or losses recognized on the sale of investments were not significant for fiscal 2010, fiscal 2009 and fiscal 2008. The unrealized gains / (losses) on the Company’s investments were caused by interest rate fluctuations. Substantially all of the Company’s available-for-sale investments are investment grade government and corporate debt securities that have maturities of less than 3 years. The Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of its amortized costs.

Fair Value of Financial Instruments

The Company measures certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, available-for-sale securities, trading securities and foreign currency derivatives. Fair value is measured based on a fair value hierarchy following three levels of inputs, of which the first two are considered observable and the last unobservable:

 

• Level 1

  -   Quoted prices in active markets for identical assets or liabilities;

• Level 2

  -   Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

• Level 3

  -
  Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table presents the Company’s fair value hierarchy for its financial assets measured at fair value on a recurring basis:

 

June 27, 2010

   Level 1    Level 2    Level 3    Total
     (In thousands)

Assets

           

Investments:

           

Federal agency notes

   $ —      $ 4,514    $ —      $ 4,514

Money market funds

     42,544            42,544

Corporate notes/bonds

        53,570         53,570

Auction rate securities

           22,902      22,902

Put Option

           2,429      2,429

Derivative instruments:

           

Foreign currency forward contracts

        109         109
                           

Total

   $ 42,544    $ 58,193    $ 25,331    $ 126,068
                           

 

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June 28, 2009

   Level 1    Level 2     Level 3    Total  
     (In thousands)  

Assets

          

Investments:

          

Commercial paper

   $ —      $ 8,000      $ —      $ 8,000   

Federal agency notes

        10,987           10,987   

Money market funds

     35,367           35,367   

Corporate notes/bonds

        29,437           29,437   

Auction rate securities

          36,263      36,263   

Put Option

          4,520      4,520   

Derivative instruments:

          

Foreign currency forward contracts

        (58        (58
                              

Total

   $ 35,367    $ 48,366      $ 40,783    $ 124,516   
                              

The following table provides a summary of changes in the fair value of the Company’s Level 3 financial assets for fiscal 2010 (in thousands):

 

     Auction Rate
Securities
 

Balance as of June 28, 2009

   $ 36,263   

Change in interest accrued

     (2

Change in unrealized loss

     2,091   

Redemptions at par by issuers

     (5,675

Redemptions at par by UBS

     (9,775
        

Balance as of June 27, 2010

   $ 22,902   
        
     Put Option  

Balance as of June 28, 2009

   $ 4,520   

Change in value in Put Option

     (2,091
        

Balance as of June 27, 2010

   $ 2,429   
        

Level 3 assets consist of ARS whose underlying assets are student loans which are substantially backed by the federal government. Since the auctions for these securities have continued to fail since February 2008, these investments are not currently trading and therefore do not have a readily determinable market value. Accordingly, the estimated fair value of the ARS no longer approximates par value. These ARS are held by UBS, the Company’s investment provider. In November 2008, the Company accepted an offer (the “Right”) from UBS entitling the Company to sell at par value ARS originally purchased from UBS (approximately $40.8 million, par value) at anytime during a two-year period from June 30, 2010 through July 2, 2012. Although the Company expects to sell its ARS under the Right, if the Right is not exercised before July 2, 2012, it will expire and UBS will have no further rights or obligation to buy the Company’s ARS. The enforceability of the Right results in the creation of an asset akin to a Put Option (the Company has the right to “put” the ARS back to UBS at some specified date for a payment equal to the par value of the ARS). The Put Option is a free standing asset separate from the ARS. The Company has valued the ARS and Put Option using a discounted cash flow model based on Level 3 assumptions. The assumptions used in valuing the ARS and the Put Option include estimates of, based on data available as of June 27, 2010, interest rates, timing and amount of cash flows, credit and liquidity premiums, expected holding periods of the ARS and bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010. During the first quarter of fiscal 2010, the Company reclassified its

 

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entire balance of ARS from marketable securities to short-term securities in its consolidated balance sheet. The reclassification is a result of the Put Option being due within less than one year from the balance sheet date and the Company’s intention to exercise the Put Option. As of June 27, 2010, UBS exercised its rights to call back the ARS at par for $9.8 million and issuers redeemed $5.7 million of ARS at par. On June 30, 2010, the Company sold the remaining ARS balance of $25.3 million at par under the Rights. On July 1, 2010, the Company received $25.3 million plus accrued interest in cash from UBS for the ARS settlement.

Concentrations

The Company may be subject to concentration of credit risk as a result of certain financial instruments consisting principally of marketable investments and accounts receivable. The Company has placed its investments with high-credit quality issuers. The Company does not invest an amount exceeding 10% of its combined cash, cash equivalents, short-term investments and marketable securities in the securities of any one obligor or maker, except for obligations of the United States government, obligations of United States government agencies and money market accounts.

The Company performs ongoing credit evaluations of its customers and generally does not require collateral in exchange for credit. The Company mitigates some collection risk by requiring most of its customers in the Asia-Pacific region, excluding Japan, to pay cash in advance or secure letters of credit when placing an order with it. Tech Data and Westcon accounted for 12% and 12%, respectively, of the Company’s net revenue in fiscal 2010. Tech Data Corporation and Ericsson AB accounted for 11% and 10%, respectively, of the Company’s net revenue in fiscal 2009. Tech Data Corporation accounted for 11% of the Company’s net revenue in fiscal 2008. Scansource Inc. and Westcon Group Inc. accounted for 14% and 13%, respectively, of the Company’s accounts receivable balance at June 27, 2010. Westcon Group Inc. and Ericsson Enterprise AB accounted for 15% and 14%, respectively, of the Company’s accounts receivable balance at June 28, 2009.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are recorded at the invoiced amount and do not bear interest. Substantially all receivables were trade receivables as of June 27, 2010 and June 28, 2009.

The Company continually monitors and evaluates the collectability of its trade receivables based on a combination of factors. The Company records specific allowances for bad debts in general and administrative expense when the Company becomes aware of a specific customer’s inability to meet its financial obligation to it, such as in the case of bankruptcy filings or deterioration of financial position. The Company writes-off receivables to the allowance after all collection efforts are exhausted. Estimates are used in determining the Company’s allowances for all other customers based on factors such as current trends in the length of time the receivables are past due and historical collection experience. The Company mitigates some collection risk by requiring most of its customers in the Asia-Pacific region, excluding Japan, to pay cash in advance or secure letters of credit when placing an order with it.

 

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Inventories

Inventories consist of raw materials and finished goods and are stated at the lower of cost, determined on a first-in, first-out basis, or replacement cost. Inventories, net of write-downs for excess and obsolete inventory (which the Company determines primarily based on future demand forecasts) of $5.2 million and $4.7 million at June 27, 2010 and June 28, 2009, respectively, consist of (in thousands):

 

     June 27, 2010    June 28, 2009

Raw materials

   $ 1,346    $ 42

Finished goods

     20,496      12,338
             

Total

   $ 21,842    $ 12,380
             

Property and Equipment, Net

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets, with the exception of land, which is not depreciated. Estimated useful lives of 25 years are used for buildings. Estimated useful lives of one to four years are used for computer equipment and software. Estimated useful lives of three years are used for office equipment, furniture and fixtures. Depreciation and amortization of leasehold improvements is computed using the lesser of the remaining lease terms or three years. Property and equipment consist of the following (in thousands):

 

     June 27, 2010     June 28, 2009  

Computer equipment

   $ 65,210      $ 65,866   

Land

     20,600        20,600   

Buildings and improvements

     19,164        18,629   

Purchased software

     18,549        19,088   

Office equipment, furniture and fixtures

     3,808        3,962   

Leasehold improvements

     5,795        5,933   
                
     133,126        134,078   

Less accumulated depreciation and amortization

     (89,554     (89,849
                

Property and equipment, net

   $ 43,572      $ 44,229   
                

Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.

Other assets include technology agreements that are amortized over their contractual periods using the straight-line method of amortization. The related liability for the technology agreement is recorded in other accrued liabilities and other long-term liabilities.

 

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Deferred Revenue, Net

Deferred revenue, net represents amounts for (i) deferred services revenue (support arrangements, professional services and training), and (ii) deferred product revenue net of the related cost of revenue where the revenue recognition criteria have not been met related to sales by the Company to its resellers or directly to its end-customers. Product revenue includes shipments to end-users and value-add resellers. The following table summarizes deferred revenue, net at the end of fiscal 2010 and 2009, respectively (in thousands):

 

     June 27, 2010     June 28, 2009  

Deferred services

   $ 36,360      $ 36,690   

Deferred product

    

Deferred revenue

     1,415        1,315   

Deferred cost of sales

     (590     (522
                

Deferred product revenue, net

     825        793   

Balance at end of period

     37,185        37,483   

Less: current portion

     29,552        30,058   
                

Non-current deferred revenue, net

   $ 7,633      $ 7,425   
                

The Company offers renewable support arrangements, including extended warranty contracts, to its customers that range generally from one to five years. Deferred support revenue is included within deferred revenue, net within the Services category above. The change in the Company’s deferred support revenue balance in relation to these arrangements was as follows (in thousands):

 

     Year Ended  
     June 27, 2010     June 28, 2009  

Balance beginning of period

   $ 36,194      $ 38,778   

New support arrangements

     57,098        54,818   

Recognition of support revenue

     (57,099     (57,402
                

Balance end of period

     36,193        36,194   

Less current portion

     28,560        28,769   
                

Non-current deferred revenue

   $ 7,633      $ 7,425   
                

Deferred Revenue, Net of Cost of Sales to Distributors

At the time of shipment to distributors, the Company records a trade receivable at the contractual discount to list selling price since there is a legally enforceable obligation from the distributor to pay it currently for product delivered, the Company relieves inventory for the carrying value of goods shipped since legal title has passed to the distributor, and the Company records deferred revenue and deferred cost of sales in “Deferred revenue, net of cost of sales to distributors” in the liability section of its consolidated balance sheets. Deferred revenue, net of cost of sales to distributors effectively represents the gross margin on the sale to the distributor; however, the amount of gross margin the Company recognizes in future periods will frequently be less than the originally recorded deferred revenue, net of cost of sales to distributors as a result of price concessions negotiated at time of sell-through to end customers. The Company sells each item in its product catalog to all of its distributors worldwide at contractually discounted prices. However, distributors resell the Company’s products to end customers at a very broad range of individually negotiated price points based on customer, product, quantity, geography, competitive pricing, and other factors. The majority of the Company’s distributors’ resales are priced at a discount from list price. Often, under these circumstances, the Company remits back to the distributor a

 

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portion of their original purchase price after the resale transaction is completed. Thus, a portion of the deferred revenue balance represents a portion of distributors’ original purchase price that will be remitted back to the distributor in the future. The wide range and variability of negotiated price credits granted to distributors does not allow the Company to accurately estimate the portion of the balance in the deferred revenue that will be remitted to the distributors. Therefore, the Company does not reduce deferred revenue by anticipated future price credits; instead, price credits are typically recorded against deferred revenue, net of cost of sales to distributors when incurred, which is generally at the time the distributor sells the product.

The following table summarizes deferred revenue, net of cost of sales to distributors at the end of fiscal 2010 and 2009, respectively (in thousands):

 

     June 27, 2010     June 28, 2009  

Deferred revenue

   $ 24,252      $ 13,644   

Deferred cost of Sales

     (5,907     (3,823
                

Total deferred revenue, net of cost of sales to distributors

   $ 18,345      $ 9,821   
                

Guarantees and Product Warranties

Upon issuance of a standard product warranty, the Company discloses and recognizes a liability for the fair value of the obligation it assumes under the warranty. The following table summarizes the activity related to the Company’s product warranty liability during fiscal 2010, fiscal 2009 and fiscal 2008:

 

     Year ended  
     June 27, 2010     June 28, 2009     June 29, 2008  

Balance beginning of period

   $ 3,170      $ 4,824      $ 7,182   

New warranties issued

     6,318        7,115        5,707   

Warranty expenditures

     (6,882     (6,679     (6,650

Change in estimates

     563        (2,090     (1,415
                        

Balance end of period

   $ 3,169      $ 3,170      $ 4,824   
                        

The Company’s standard hardware warranty period is typically 12 months from the date of shipment to end-users and 90 days for software. For certain access products, the Company offers a limited lifetime hardware warranty commencing on the date of shipment from the Company and ending five (5) years following the Company’s announcement of the end of sale of such product. Upon shipment of products to its customers, the Company estimates expenses for the cost to repair or replace products that may be returned under warranty and accrue a liability in cost of product revenue for this amount. The determination of the Company’s warranty requirements is based on actual historical experience with the product or product family, estimates of repair and replacement costs and any product warranty problems that are identified after shipment. The Company estimates and adjusts these accruals at each balance sheet date in accordance with changes in these factors. In fiscal 2010, the Company recorded $0.6 million for a change in estimate resulting from losses identified related to a failure in one of its products and recovered in a settlement all estimated costs related to this issue from its outside design manufacturer.

In the normal course of business to facilitate sales of its products, the Company indemnifies its resellers and end-user customers with respect to certain matters. The Company has agreed to hold the customer harmless against losses arising from a breach of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount

 

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of the claim. It is not possible to estimate the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material impact on its operating results or financial position.

Other Accrued Liabilities

The following are the components of other accrued liabilities (in thousands):

 

     June 27, 2010    June 28, 2009

Accrued income taxes

   $ 598    $ 2,467

Accrued general and administrative costs

     2,674      3,306

Accrued research and development costs

     1,326      1,445

Accrued overhead costs

     3,457      4,663

Accrued marketing development funds

     1,976      1,332

Other accrued liabilities

     3,350      1,453
             

Total

   $ 13,381    $ 14,666
             

Advertising

Cooperative advertising obligations with customers are accrued and the costs expensed at the time the related revenue is recognized. All other advertising costs are expensed as incurred. Cooperative advertising expenses are recorded as marketing expenses to the extent that an advertising benefit separate from the revenue transaction can be identified and the cash paid does not exceed the fair value of that advertising benefit received. Otherwise, such cooperative advertising obligations with customers are recorded as a reduction of revenue. Advertising expenses were $0.1 million in fiscal 2010 and $0.2 million for each of fiscal 2009 and fiscal 2008.

Recently Issued Accounting Standards

In January 2010, the FASB issued a new accounting standards update for fair value measurements and disclosures. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 and describe the reasons for the transfers. A reporting entity should separately disclose information about purchases, sales, issuances and settlements for Level 3 reconciliation disclosures. The new disclosures and clarifications of existing disclosures are effective for financial statements issued interim or annual financial periods ending after December 15, 2009, with the exception for the reconciliation disclosures for Level 3, which are effective for financial statements issued interim or annual financial periods ending after December 15, 2010. The adoption of the new accounting standards update did not have a material impact on the Company’s consolidated results of operations, financial condition or financial disclosures.

In October 2009, the FASB issued a new accounting standard which excludes from the scope of software revenue guidance the revenue arrangements that include tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality. At the same time, the FASB also issued a new accounting standard which updates existing guidance pertaining to the separation and allocation of consideration in a multiple element arrangement. This new guidance will be applicable to the Company’s multiple element arrangements that include such tangible products. The new standards are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The adoption of this accounting standard is not expected to have a material effect on the amount of revenue reported.

 

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3. Commitments, Contingencies and Leases

Line of Credit

In October 2008, UBS and the Company entered into a secured line of credit collateralized by the Company’s ARS held by UBS. The maximum amount of credit available under this line of credit is $28.8 million. On November 7, 2008 the Company accepted the UBS Rights offer from UBS and hence the terms of the “no net cost” loan program apply to this line of credit. Under this program, the interest rate on this secured credit facility will be equivalent to the interest rate earned by the Company on the ARS at UBS, resulting in no net interest cost to the Company. There are currently no outstanding borrowings under this line of credit. On June 30, 2010, the Company exercised its UBS Rights to redeem the remaining ARS at par. Upon exercising the UBS Rights, this line of credit was terminated.

Leases

The Company leases office space for its various United States and international sales offices. Certain leases contain rent escalation clauses and renewal options. The Company subleases certain of its leased facilities to third party tenants. Future annual minimum lease payments under all noncancelable operating leases and future rental income under all noncancelable subleases (including facilities included in the Company’s restructuring accruals) having initial or remaining lease terms in excess of one year at June 27, 2010 were as follows (in thousands):

 

     Future Lease
Payments
   Future Rental
Income

Fiscal 2011

   $ 6,706    $ 399

Fiscal 2012

     1,883      —  

Fiscal 2013

     878      —  

Fiscal 2014

     837   

Thereafter

     931      —  
             

Total minimum payments

   $ 11,235    $ 399
             

Rent expense, excluding restructuring rent expense, was approximately $4.2 million in fiscal 2010, $4.7 million in fiscal 2009, and $4.8 million in fiscal 2008, net of sublease income of zero, $0.1 million and $0.2 million in the respective periods.

Purchase Commitments

The Company currently has arrangements with contract manufacturers and suppliers for the manufacture of its products. The arrangements allow them to procure long lead-time component inventory on the Company’s behalf based upon a rolling production forecast provided by it. The Company is obligated to the purchase of long lead-time component inventory that its contract manufacturer procures in accordance with the forecast, unless the Company gives notice of order cancellation outside of applicable component lead-times. As of June 27, 2010, the Company had non-cancelable commitments to purchase approximately $39.1 million of such inventory during the first quarter of fiscal 2011.

Legal Proceedings

Shareholder Litigation Relating to Historical Stock Option Practices

On April 25, 2007, an individual identifying herself as one of the Company’s shareholders filed a derivative action in the United States District Court for the Northern District of California purporting to assert claims on

 

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behalf of and in the Company’s name against various of the Company’s current and former directors and officers relating to historical stock option granting from 1999 to 2002 and related accounting practices. Two similar derivative actions were filed thereafter in the same court by other individuals and the three cases were consolidated by order of the Court. After two amended complaints were filed by the lead plaintiff, the Company filed a motion to dismiss the second amended complaint, which was granted without prejudice on August 12, 2008.

On August 22, 2008, Kathleen Wheatley, an individual identifying herself as one of the Company’s shareholders, filed a motion for the Court to reconsider its ruling on August 12, 2008 granting the Company’s motion to dismiss. In response, the Company asked the Court to reject Ms. Wheatley’s motion on various grounds, including that Ms. Wheatley is not a party to this derivative action. The Court has not yet ruled on Ms. Wheatley’s motion. On September 4, 2008, Ms. Wheatley filed both a motion to intervene in the derivative action and a third amended complaint, which differs little from the first amended complaint. The third amended complaint continues to allege that various of the Company’s current and former directors and officers breached their fiduciary duties and other obligations to the Company and violated state and federal securities laws in connection with its historical grants of stock options. The Company is named as a nominal defendant in the action, but it has customary indemnification agreements with the named defendants. On the Company’s behalf, Ms. Wheatley seeks unspecified monetary and other relief against the named defendants. The Court has granted Ms. Wheatley’s motion to intervene. On October 16, 2008, the Company, as nominal defendant, moved to dismiss the third amended complaint. On November 17, 2009, the Court denied the Company’s motion to dismiss the third amended complaint, and on December 3, 3009, the Company filed a motion for reconsideration or in the alternative, a motion to certify the Order denying the Motion to Dismiss for immediate appeal. On December 30, 2009, the Court issued an Order granting us leave to file the motion for reconsideration and will rule on the Company’s alternative motion to certify the Order for appeal if it denies the motion for reconsideration. On April 2, 2010, the Court denied the Company’s Motion for Reconsideration and for Stay of Action and Certification and Appeal. No dates have been set for the Company’s response to the Third Amended Complaint. The Company intends to continue to defend the derivative action vigorously, but due to the uncertainty of litigation, the Company cannot predict the ultimate outcome of this matter at this time.

Intellectual Property Litigation

On April 20, 2007, the Company filed suit against Enterasys Networks in the United States District Court for the Western District of Wisconsin, Civil Action No. 07-C-0229-C. The complaint alleged willful infringement of U.S. Patents Nos. 6,104,700, 6,678,248, and 6,859,438, and sought injunctive relief against Enterasys’ continuing sale of infringing goods and monetary damages. Enterasys responded to the complaint on May 30, 2007, and also filed counterclaims alleging infringement of three U.S. patents owned by Enterasys. On April 9, 2008, the Court dismissed Enterasys’ counterclaims on one of its patents with prejudice. On May 5, 2008, the Court granted the Company’s motion for summary judgment, finding that it does not infringe Enterasys’ two remaining patents and dismissing all of Enterasys’ remaining counterclaims with prejudice. On May 30, 2008, a jury found that Enterasys infringed all three of the Company’s patents and awarded it damages in the amount of $0.2 million. The Court also ruled in the Company’s favor on Enterasys’ challenge to the validity of the Company’s patents. On October 29, 2008, the Court denied Enterasys’ post-trial motion for judgment as a matter of law, and granted Extreme Network’s motion for a permanent injunction against Enterasys. The injunction order permanently enjoins Enterasys from manufacturing, using, offering to sell, selling in the U.S. and importing into the U.S. the Enterasys products accused of infringing Extreme Network’s three patents. The injunction will run until the expiration of the Company’s patents the last of which is not set to expire until March of 2020. On March 16, 2009, the Court also denied Enterasys’ motion for a new trial, but granted Enterasys’ motion for a stay of the injunction pending appeal. On April 17, 2009, Enterasys filed its

 

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notice of appeal and on May 1, 2009, the Company filed its cross appeal. The appeal is pending at the U.S. Court of Appeals for the Federal Circuit and the Company is defending the appeal. Due to the inherent uncertainties of litigation, the Company cannot predict the ultimate outcome of the matter at this time.

On June 21, 2005, Enterasys filed suit against Extreme and Foundry Networks, Inc. (“Foundry”) in the United States District Court for the District of Massachusetts, Civil Action No. 05-11298 DPW. The complaint alleges willful infringement of U.S. Patent Nos. 5,251,205; 5,390,173; 6,128,665; 6,147,995; 6,539,022; and 6,560,236, and seeks: a) a judgment that the Company willfully infringe each of the patents; (b) a permanent injunction from infringement, inducement of infringement and contributory infringement of each of the six patents; (c) damages and a “reasonable royalty” to be determined at trial; (d) treble damages; (e) attorneys’ fees, costs and interest; and (f) equitable relief at the Court’s discretion. Foundry brought a claim for reexamination of five of the patents at issue to the U.S. Patent and Trademark Office (“PTO”). The stay of the Massachusetts action was lifted on May 21, 2010, and set a claims construction hearing for September 15, 2010. No trial date has been set. The Company intends to defend the lawsuit vigorously, but, due to the inherent uncertainties of litigation, it cannot predict the ultimate outcome of the matter at this time.

On February 7, 2008, Network-1 Security Solutions, Inc. sued Extreme Networks along with Cisco, Cisco-Linksys, Inc., Adtran, Inc., Enterasys Networks, Inc., Netgear, Inc. and 3Com Corporation in the United States District Court for the Eastern District of Texas (Case No. 6:08cv030). On July 16, 2010, the Company entered into a Memorandum of Understanding with Nework-1 setting forth the terms for settlement of the lawsuit and license agreement, in which Extreme was granted licenses to certain patents in exchange for a payment of $2.4 million. On August 3, 2010, the Court dismissed the case with prejudice.

On February 26, 2008, Fenner Investments, Ltd. filed suit against Extreme Networks along with D-Link Systems, Zyxel Communications, SMC Networks, Enterasys, Foundry, Netgear, Inc. and 3Com Corporation in the United States District Court for the Eastern District of Texas, Civil Action No. 08-CV-00061. The suit alleges infringement of US Patent No. 7,145,906 and 5,842,224, and seeks damages for the alleged infringement, injunctions against infringement and payment of attorneys’ fees, costs and interest. On September 24, 2009, the Company entered into a settlement and license agreement with Fenner Investments, in which Extreme was granted licenses to certain patents in exchange for amounts paid. On October 5, 2009, the Court dismissed the case with prejudice.

Other Legal Matters

Beginning on July 6, 2001, purported securities fraud class action complaints were filed in the United States District Court for the Southern District of New York. The cases were consolidated and the litigation is now captioned as In re Extreme Networks, Inc. Initial Public Offering Securities Litigation, Civ. No. 01-6143 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS) (S.D.N.Y.). The operative amended complaint names us as defendants; six of the Company’s present and former officers and/or directors, including its former CEO and current Chairman of the Board (the “Extreme Networks Defendants”); and several investment banking firms that served as underwriters of its initial public offering and October 1999 secondary offering. The complaint alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that the registration statement for the offerings did not disclose that: (1) the underwriters had agreed to allow certain customers to purchase shares in the offerings in exchange for excess commissions paid to the underwriters; and (2) the underwriters had arranged for certain customers to purchase additional shares in the aftermarket at predetermined prices. Similar allegations were made in other lawsuits challenging over 300 other initial public offerings and follow-on offerings conducted in 1999 and 2000. The cases were consolidated for pretrial purposes.

 

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The parties to the lawsuits have reached a settlement, which was approved by the Court on October 6, 2009. Extreme Networks is not required to make any cash payments in the settlement. The Court subsequently entered a final judgment of dismissal. Certain objectors have appealed the judgment. If the appeal is successful, the Company intends to defend the lawsuit vigorously, but, due to the inherent uncertainties of litigation, it cannot predict the ultimate outcome of the matter at this time.

Indemnification Obligations

Subject to certain limitations, the Company may be obligated to indemnify its current and former directors, officers and employees. These obligations arise under the terms of its certificate of incorporation, its bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify, where applicable, generally means that the Company is required to pay or reimburse, and in certain circumstances the Company has paid or reimbursed, the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters. It is not possible to estimate the maximum potential amount under these indemnification agreements due to the limited history of these claims. The cost to defend the Company and the named individuals could have a material adverse effect on its consolidated financial position, results of operations and cash flows in the future. Recovery of such costs under its directors and officers insurance coverage is uncertain.

4. Stockholders’ Equity

Preferred Stock

In April 2001, in connection with the Company’s Stockholders’ Rights Agreement, the Company authorized the issuance of preferred stock. The preferred stock may be issued from time to time in one or more series. The Board of Directors is authorized to provide for the rights, preferences and privileges of the shares of each series and any qualifications, limitations or restrictions on these shares. As of June 27, 2010, no shares of preferred stock were outstanding.

Stockholders’ Rights Agreement

In April 2001, the Board of Directors approved a Stockholders’ Rights Agreement (“Rights Agreement”), declaring a dividend of one preferred share purchase right for each outstanding share of common stock, par value $0.001 per share, of Extreme Networks common stock. The Rights Agreement is intended to protect stockholders’ rights in the event of an unsolicited takeover attempt. It is not intended to prevent a takeover of Extreme Networks on terms that are favorable and fair to all stockholders and will not interfere with a merger approved by the Board of Directors. In the event the rights become exercisable, each right entitles stockholders to buy, at an exercise price of $150 per right owned, a unit equal to a portion of a new share of Extreme Networks Series A preferred stock. The rights will be exercisable only if a person or a group acquires or announces a tender or exchange offer to acquire 4.95% or more of the Company’s common stock. The rights, which expire in April 2011, are redeemable for $0.001 per right at the approval of the Board of Directors.

Stock Repurchase

On August 11, 2008, the Company commenced a “modified Dutch auction” tender offer to purchase up to $100 million worth of its shares of outstanding common stock, including the associated preferred stock purchase rights, at a price per share not less than $3.30 and not greater than $3.70, subject to certain conditions. Following the expiration of the tender offer on September 12, 2008, the Company repurchased 28,571,428 shares of common stock on September 19, 2008 at $3.50 per share, the lowest purchase price specified by tendering

 

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stockholders that enabled the Company to purchase $100 million worth of shares of common stock. The Company’s common stock closing stock price on September 19, 2008 was $3.05. The Company funded this purchase entirely from cash on hand. Total cash expenditures were $101.4 million for the shares repurchased, including direct costs associated with the repurchase.

Comprehensive Income

The following are the components of comprehensive income, net of tax (in thousands):

 

     Year Ended  
     June 27,
2010
    June 28,
2009
    June 29,
2008
 

Net income

   $ 227      $ 2,815      $ 8,381   
                        

Change in unrealized (loss) gain on investments:

      

Net unrealized gain on ARS recorded to other income

   $ —        $ 2,517      $ —     

Net unrealized (loss) gain on other investments

     (265     642        (2,346
                        

Net unrealized (loss) gain on investments

     (265     3,159        (2,346

Foreign currency translation adjustments:

      

Beginning balance

     912        2,025        974   

Ending balance

     954        912        2,025   
                        

Foreign currency translation adjustments change

     42        (1,113     1,051   

Comprehensive income

   $ 4      $ 4,861      $ 7,086   
                        

Shares Reserved for Issuance

The following are shares reserved for issuance (in thousands):

 

     June 27,
2010

Employee stock purchase plan

   3,818

Employee stock options

   25,813
    

Total shares reserved for issuance

   29,631
    

5. Employee Benefit Plans (including Share-based Compensation)

As of June 27, 2010, the Company has the following share-based compensation plans:

2005 Equity Incentive Plan

The 2005 Equity Incentive Plan (the “2005 Plan”) was adopted by the Company’s Board of Directors on October 20, 2005, and approved by stockholders on December 2, 2005. The 2005 Plan replaces the 1996 Stock Option Plan (the “1996 Plan”), 2000 Nonstatutory Stock Option Plan (the “2000 Plan”) and 2001 Nonstatutory Stock Option Plan (the “2001 Plan”).

Under the 2005 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and other share-based or cash-based awards to employees and consultants. The 2005 Plan also authorizes the grant of awards of stock options, stock

 

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appreciation rights, restricted stock and restricted stock units to non-employee members of the Board of Directors and deferred compensation awards to officers, directors and certain management or highly compensated employees. The 2005 Plan authorizes the issuance of up to 12,000,000 shares of the Company’s common stock and on December 23, 2009, the Company’s shareholders approved to increase the number of shares authorized by another 4,000,000 shares. In addition, up to 11,000,000 shares subject to awards outstanding under the 1996 Plan, the 2000 Plan, and the 2001 Plan that expired have been added to the number of shares available for future grant under the 2005 Plan. As of June 27, 2010, total options and awards to acquire 9,863,656 shares were outstanding under the 2005 Plan and 13,412,704 shares are available for grant under the 2005 Plan.

Amended 1996 Stock Option Plan

The 1996 Plan was originally adopted in September 1996, and provided for the grant of options for common stock to eligible participants. A total of 56,382,867 shares were reserved under the 1996 Plan. Options granted under this plan have a contractual term of ten years. Effective December 2, 2005, the 1996 Plan was terminated, and, as of June 27, 2010, options to acquire 2,269,862 shares were outstanding under the 1996 Plan.

2000 Plan

In March 2000, the Board of Directors adopted the 2000 Plan which provided for the grant of options for common stock to eligible participants. A total of 4,000,000 shares were reserved under the 2000 Plan. Options granted under this plan have a contractual term of ten years. Effective December 2, 2005, the 2000 Plan was terminated, and, as of June 27, 2010, options to acquire 136,402 shares were outstanding under the 2000 Plan.

2001 Plan

In May 2001, the Board of Directors adopted the 2001 Plan which provided for the grant of options for common stock to eligible participants. A total of 4,000,000 shares were reserved under the 2001 Plan. Options granted under this plan have a contractual term of ten years. Effective December 2, 2005, the 2001 Plan was terminated, and, as of June 27, 2010, options to acquire 130,520 shares were outstanding under the 2001 Plan.

The following table summarizes stock option activity under all plans:

 

     Number of
Shares
(000’s)
    Weighted-
Average
Exercise Price
Per Share
   Weighted-
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic Value
($ 000’s)

Options outstanding at July 1, 2007

   21,441      $ 5.97      

Granted

   8,085      $ 4.07      

Exercised

   (840   $ 2.82      

Canceled

   (9,717   $ 6.46      

Options outstanding at June 29, 2008

   18,969      $ 5.05      

Granted

   2,759      $ 2.01      

Exercised

   (398   $ 2.82      

Canceled

   (3,691   $ 4.96      

Options outstanding at June 28, 2009

   17,639      $ 4.65      

Granted