UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

(Mark One)

For the fiscal year ended June 30, 2018

OR

For the transition period from              to             .

Commission file number 000-25711

 

Extreme Networks, Inc.

(Exact name of Registrant as specified in its charter)

 

 

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, $0.001 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  ☒

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  ☒

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 ☒    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.  ☐

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

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

The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $1.2 billion as of December 31, 2017 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.  For purposes of this disclosure, shares of common stock held or controlled by executive officers and directors of the registrant and by persons who hold more than 5% of the outstanding shares of common stock have been treated as shares held by affiliates. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose.

118,320,200 shares of the Registrant’s Common stock, $.001 par value, were outstanding as of August 24, 2018.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive proxy statement for the 2018 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 are incorporated herein by reference in Part III of this Annual Report on Form 10-K.

 

 

 

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EXTREME NETWORKS, INC.

FORM 10-K

INDEX

 

 

 

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FORWARD LOOKING STATEMENTS

Except for historical information contained herein, certain matters included in this annual report on Form 10-K are, or may be deemed to be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. The words “will,” “may,” “designed to,” “believe,” “should,” “anticipate,” “plan,” “expect,” “intend,” “estimate” and similar expressions identify forward-looking statements, which speak only as of the date of this annual report. These forward-looking statements are contained principally under Item 1, “Business,” and under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” but may also be in other sections of this annual report on Form 10-K. Because these forward-looking statements are subject to risks and uncertainties, actual results could differ materially from the expectations expressed in the forward-looking statements. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements include those described in Item 1A, “Risk Factors” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In addition, new risks emerge from time to time and it is not possible for management to predict all such risk factors or to assess the impact of such risk factors on our business. Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. We undertake no obligation to update or revise these forward-looking statements to reflect subsequent events or circumstances.

PART I

Item1. Business

Overview

Extreme Networks, Inc., together with its subsidiaries (collectively referred to as “Extreme” and as “we”, “us” and “our”) is a leader in providing software-driven networking solutions for enterprise customers. Providing a combined end-to-end solution from the data center to the access point, Extreme designs and develops wired and wireless network infrastructure equipment and develops the software for network management, policy, analytics, security and access controls. We strive to help our customers and partners Connect Beyond the Network by building world-class software and network infrastructure solutions that solve the wide range of problems faced by information technology (“IT”) departments. With more than 30,000 customers globally, including half of the Fortune 50 and some of the world's leading names in business, hospitality, retail, transportation and logistics, education, government, healthcare and manufacturing, we remain nimble and responsive to ensure customer and partner success. We call this Customer-Driven Networking™.

During fiscal year 2018, Extreme experienced a 62% year-over-year revenue growth.  These results reflect continued execution toward our strategic objectives, including results from the recently acquired fabric-based secure networking solutions and network security solutions business (the “Campus Fabric Business”) from Avaya Inc. (“Avaya”) and the data center business (the “Data Center Business”) of Brocade Communication Systems, Inc. (“Brocade”).  Fiscal year 2018 year-over-year revenue growth also includes a full year contribution from the wireless local area network (“WLAN”) business (the “WLAN Business”) from Zebra Technologies Corporation (“Zebra”) that was acquired in October 2016.

Enterprise network administrators from the data center to the access layer need to respond to the rapid digital transformational trends of cloud, mobility, big data, social business and the ever-present need for network security.  Accelerators such as Internet of Things (“IoT”), artificial intelligence (“AI”), bring your own device (“BYOD”), machine learning (“ML”), cognitive computing, and robotics add complexity to challenge the capabilities of traditional networks. Technology advances have a profound effect across the entire enterprise network by placing unprecedented demands on network administrators to enhance management capabilities, scalability, programmability, agility, security, and analytics of the enterprise networks they manage.

Improving the network experience for enterprises that increasingly require greater simplification at the edge or the access layer of the network to ensure business success and provide a secure, unified, wired / wireless infrastructure augmented and managed through a single plane of glass remains a key focus with the introduction of our Smart OmniEdge product portfolio with the launch of ExtremeAI and Project Surge to simplify IoT security. Enterprises have also migrated increasing numbers of applications and services to either private clouds or public clouds offered by third parties and are adopting new IT delivery models and applications that require fundamental network alterations and enhancements spanning from device access point to the network core.  In either case, the network infrastructure must adapt to this new dynamic environment. Intelligence and automation are key if enterprises are to derive maximum benefit from their cloud deployments.

A trend affecting the enterprise network equipment market is the continued adoption of the cloud-managed enterprise WLAN in the enterprise market. Hybrid cloud is a cloud computing environment which uses a mix of on-premise private cloud and third-party public cloud services with orchestration between the two platforms. We introduced ExtremeCloud, our Cloud offering in 2016 and announced our enhanced cloud offering in 2017.  ExtremeCloud is the only offering in the market that seamlessly integrates the Cloud with on premise infrastructures.

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To facilitate the readers understanding, the following is a list of common terms in our industry used in the discussion of our business:

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Industry Background

Enterprises are adopting new IT delivery models and applications that require fundamental network alterations and enhancements spanning from device access point to the network core. AI and ML technologies have the potential to vastly improve the network experience. When AI and ML are used in conjunction with an NA technology, administrators can make significant advances in productivity, availability, accessibility, manageability, security and speed of their network infrastructure. These emerging technologies are driving administrators to a mindset of change toward agile processes that allow a versatile workforce to improve the rate of innovation of the enterprise safely, securely and with confidence.

AI, ML and NA have increased the relevance and importance of the network in the enterprise. Traditional network offerings are not well-suited to fulfill enterprise expectations for rapid delivery of new services, more flexible business models, real-time response and massive scalability.  

The networking industry appears to be invigorated by this wave of technological change:

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Our strategy, product portfolio and research and development are closely aligned with what we have identified as the following trends in our industry:

The Extreme Strategy

We are focused on delivering end-to-end IP networking solutions for today’s enterprise environments. From wireless and wired access technologies, through the campus, core and into the datacenter, Extreme is developing solutions to deliver outstanding business outcomes for our customers.  Leveraging a unified management approach, both on premise and in the cloud, we continue to accelerate adoption and delivery of new technologies in support of emerging trends in enterprise networking. We continue to execute on our growth objectives by maximizing customer, partner, and shareholder value.

In fiscal 2014, we completed the acquisition of Enterasys Networks.  In fiscal 2017, we completed the acquisition of the WLAN Business from Zebra. In fiscal 2018, we completed the acquisitions of the Campus Fabric Business from Avaya and the Data Center Business from Brocade. These acquisitions support our growth strategy to lead the enterprise network equipment market with end-to-end software-driven solutions for enterprise customers from the data center to the wireless edge.  After the closing of the acquisitions of the Campus Fabric Business and Data Center Business, Extreme immediately became a networking industry leader with more than 30,000 customers. As a network switching leader in enterprise, datacenter and cloud, after closing of the Campus Fabric Business, we combine and extend our world-class products and technologies to provide customers with some of the most advanced, high performance and open solutions in the market as well as a superb overall customer experience.  The combination of Extreme, the Campus Fabric Business and the Data Center Business is significant in that it brings together distinct strengths addressing the key areas of the network, from unified wired and wireless edge, to the enterprise core, to the data center and cloud to offer a complete, unified portfolio of software-driven network access solutions.  

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Provider of high quality, software-driven, secure networking solutions and the industry’s #1 customer support organization

Key elements of our strategy include:

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Data can be mined to show how applications are being used enabling a better understanding of user behavior on the network, identifying the level of user engagement and assuring business application delivery to optimize the user experience. Application adoption can be tracked to determine the return on investment associated with new application deployment.

Visibility into network and application performance enables our customers to pinpoint and resolve performance bottlenecks in the infrastructure whether they are caused by the network, application or server. This saves both time and money for the business and ensures critical applications are running at the best possible performance.

We seek to differentiate ourselves in the market by delivering a value proposition based on a software-driven approach to network management, control and analytics.

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Our key points of differentiation include:

 

Extreme sells products primarily through an ecosystem of channel partners which combine our Ethernet, wireless and management and software analytics products with their vertical-specific offerings to create IT solutions for end user customers

 

Products

Our software-driven networking products offer resilient high-performance networking, granular visibility and control and strategic intelligence for business innovation and operational simplicity.  Fabric technologies enable “network-wide automation” that provides simple “plug-and-play” operation and much faster time-to-service. We build our products into vertical market solutions for converged campus networks that provide user and device mobility.  Data Center and Cloud administrators are able to virtualize their servers and storage over our high-performance Ethernet infrastructure. Extreme’s access control and analytics software provides visibility, control, strategic intelligence and security from the Data Center to the Edge - all through a single pane-of-glass.

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Our product categories include:

This category was further enhanced in fiscal year 2017 with the introduction of a new family of entry-level Access Switches, the ExtremeSwitching 200 Series which target small and medium enterprises looking for an economical wired Access solution. The category of products has also been enhanced by the recent addition of the assets of the Campus Fabric Business, which brings three additional product lines – the ERS 3000, 4000, and 5000 Series which address, respectively, entry-level, mainstream, and premium edge networking markets.  These families were refreshed in fiscal 2017 to add the latest switching architectures enabling them to deliver more physical capabilities. The ERS 3000, 4000 and 5000 Series also provide seamless access to a Fabric-based Core by delivering automation and hyper-segmentation, along with the ability to harden the perimeter of the network infrastructure.  

This category was enhanced in fiscal year 2017 with the introduction of the ExtremeSwitching X870 Series, a high-density 100G switch designed for high-performance enterprise and Cloud Data Centers. This is available in a compact 1RU form factor and supports multi-rate 10G, 25G, 40G, 50G and 100G interface speeds. The X870 Series is ideal for either Spine/Leaf or high-density Top-of-Rack architectures.  During fiscal year 2017, we also introduced ExtremeSwitching X690 Series, a are high-density, purpose-built 10G/100G switches ideal for top-of-rack and/or edge leaf applications within high-performance data centers. The X690 supports a range of interface speeds, including 1G, 10G, 25Gb, 40G, 50G and 100G, the X690 comes in a compact 1RU form factor.

The addition of assets of the Campus Fabric Business included the recently released VSP 8600 Series – a next-generation, low-profile, high-density Ethernet switch for the Core and Aggregation.  This new switch complements the fixed and semi-modular VSP 8000 Series products that are currently in the market, and together these products empower the creation of versatile always-on campus solutions that are Fabric-enabled and 100 Gigabit-ready. The technologies supported by these innovative platforms can also leverage automated network attachment to proactively reduce operational burden and time-to-service.

These switches also provide key feature extensions for Data Centers through technologies that include Virtual Extensible LAN (“VXLAN”), MPLS/VPLS, and Shortest Path Bridging (“SPB”) capabilities – the latter available on the recently-acquired Avaya Core Switches. In addition to these capabilities, our Data Center Switches offer innovative traffic optimization enabling Virtual Machine (“VM”) mobility via Layer 3 Data Center Interconnect.  And our CoreFlow2 architecture delivers tens of millions of flows for deep visibility and control over users, services, and applications to meet the analytic and policy demands of today’s business applications.  

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We are creating a single architecture from the Campus Core to the unified wired/wireless Edge thereby extending the Fabric Attach capability to ExtremeWireless APs.  This will enable ExtremeWireless integration into existing and new Fabric Connect deployments and will also enable rapid, zero-touch deployment of ExtremeWireless APs.

Key product features include:

ExtremeAnalytics, also a part of our Extreme Management Center, is a network-powered application analytics and optimization solution that captures network data, then aggregates, analyzes, correlates and reports on it to enable better decision making and improved business performance. Granular visibility into network and application performance, users, locations and devices empowers our customers to make data-driven business decisions. Customers can save operational costs, solve issues faster and deliver a superior end user experience with real-time data in one easy-to-read dashboard. Our solution speeds up troubleshooting by separating the network from application performance so IT can quickly identify root-causes. ExtremeAnalytics makes our customers’ networks safer as it monitors shadow IT, identifies and reports malicious or unwanted applications, and monitors security compliance. Because of the value ExtremeAnalytics provides, Extreme was selected as the Official Wi-Fi & Analytics Provider for the NFL, including Super Bowl XLVIII, XLIX, XLVI, XLI, LI and LII.

Key product features include:

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ExtremeGuest is complemented with ExtremeLocation which is a cloud service that enables enterprises to incorporate location-based services, which when combined with guest analytics, can power contextual marketing campaigns for retailers and hotel chains.

Sales, Marketing and Distribution

We conduct our sales and marketing activities on a worldwide basis through a channel that utilizes distributors, resellers and our field sales organization. As of June 30, 2018, our worldwide sales and marketing organization consisted of 960 employees, including vice presidents, directors, managers, sales representatives, and technical and administrative support personnel. We have domestic sales offices located in six states and international sales offices located in 30 countries. The new talent brought in through the acquisitions of the WLAN Business, Campus Fabric Business and Data Center Business adds significant depth to our marketing efforts.

We sell our products primarily through an ecosystem of channel partners who combine our Ethernet, wireless, management and analytics software products with their vertical specific 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 directly to certain end-user customers, including some large global accounts.

The details of our sales and distribution channels are as follows:

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Although we compete in many vertical markets, in fiscal year 2018, we have focused on the specific verticals of healthcare, education, manufacturing, government and hospitality, which includes sports and entertainment venues. Years of experience and a track record of success in the verticals we serve enables us to address the following industry-specific problems.

Healthcare:

Education:

Manufacturing:

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Government:

Hospitality:

 

Retail:

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Customer Profiles:

Furthermore, in fiscal 2018, we decided to focus on the following customer profiles where we believe we can add the most value:

Customers with 10% of net revenue or greater

The following table sets forth major customers accounting for 10% or more of our net revenue:

 

 

*The above summary table of our major customers accounting for 10% or more of our net revenue for the years ended June 30, 2018, 2017, and 2016 reflects the adoption of Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“Topic 606”).

International sales

International sales are an important portion of our business. In fiscal 2018, sales to customers outside of the United States accounted for 50% of our consolidated net revenues, compared to 49% in fiscal 2017 and 55% in fiscal 2016. 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 the United States are countries in Europe and Asia, as well as Canada, Mexico, Central America and South America.

We operate in one segment, the development and marketing of network infrastructure equipment. Information concerning revenue, results of operations and revenue by geographic area is set forth under Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” and in Note 3 of our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K, both of which are incorporated herein by reference.  Information on risks attendant to our foreign operations is set forth below in Item 1A. “Risk Factors.”

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, our resellers and our technology alliance partners.  Our marketing efforts include participation in industry tradeshows, conferences and seminars, publication of technical and educational articles in industry journals, communication across social media channels, frequent updates to our publicly available website, promotions, web-based training courses, advertising, analyst relations and public relations.  We also submit our products for independent product testing and evaluation.  Extreme participates in numerous industry analyst ratings including Gartner Magic Quadrants, Gartner Critical Capabilities, Gartner Peer Insights, Forrester Waves, IDC MarketScapes and InfoTech Vendor Landscapes.

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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.  Although we believe the orders included in the backlog are firm, all orders are subject to possible rescheduling by customers, cancellations by customers which we may elect to allow without penalty to customer, and further pricing adjustments on orders from distributors.  Therefore, we do not believe our backlog, as of any particular date is necessarily indicative of actual revenue for any future period.

Our product backlog at June 30, 2018, net of anticipated back end rebates for distributor sales, was $42.5 million, compared to $25.5 million at June 30, 2017.

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 or be considered indicative of our future performance, 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:

Long-Lived Assets

See Note 5 of our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for more information regarding our long-lived assets.

Manufacturing

We utilize a global sourcing strategy that emphasizes procurement of materials and product manufacturing in lower cost regions. We rely upon third-party contract manufactures and original design manufacturers (Alpha Networks, Delta Networks Inc, Foxconn, Senao Networks and Wistron NeWeb Corporation) to manufacture, support and ship our products, and therefore are exposed to risks associated with their businesses, financial condition and the geographies in which they operate. Our arrangements with these manufacturers generally provide for quality, cost, and delivery requirements, as well as manufacturing process terms, such as continuity of supply; inventory management; flexibility regarding capacity, quality, and cost management; oversight of manufacturing; and conditions for use of our intellectual property that allows us to adjust more quickly to changing end-customer demand.  The manufacturing process uses automated testing equipment and burn-in procedures, as well as comprehensive inspection, testing, and statistical process controls, which are designed to help ensure the quality and reliability of our products. The manufacturing processes and procedures are generally certified to International Organization for Standardization (“ISO”) 9001 standards.  

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We use a collaborative sales and operations planning (“S&OP”) forecast of expected demand based upon historical trends and analyses from our sales and product management functions as adjusted for overall market conditions. We update these forecasts monthly to determine our material requirements.  Our manufacturing partners procure the majority of the components needed to build our products based on our demand forecasts.  This allows us to leverage the purchasing power of our manufacturing partners. Our products rely on key components, including merchant silicon, integrated circuit components and power supplies purchased from a limited number of suppliers, including certain sole source providers. 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. From time to time, we may experience significant price volatility or supply constraints for certain components that are not available from multiple sources or where our suppliers are geographically concentrated. When necessary, we are often able to obtain scarce components for somewhat higher prices on the open market, which may have an impact on our gross margin, but does not generally disrupt production. We may also acquire component inventory in anticipation of supply constraints, or enter into longer-term pricing commitments with vendors to improve the priority, price and availability of supply.  Our product development efforts also depend upon continued collaboration with our key suppliers, including our merchant silicon vendors such as Broadcom. As we develop our product roadmap and continue to expand our relationships with these and other merchant silicon vendors, it is critical that we work in tandem with our key merchant silicon vendors to ensure that their silicon includes improved features and that our products take advantage of such improved features.

We believe that our sourcing and manufacturing strategy allows us to conserve capital, lower costs of product sales, adjust quickly to changes in market demand, and operate without dedicating significant resources to manufacturing-related plant and equipment. As part of our effort to optimize our operations, we continue to focus on driving cost reductions through sourcing, rationalizing our supply chain, outsourcing or virtualizing certain activities, and consolidating distribution sites and service logistics partners. These efforts also include process optimization initiatives, such as vendor managed inventory, and other operational models and strategies designed to drive improved efficiencies in our sourcing, production, logistics and fulfillment.

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 plan to undertake 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 customers in the enterprise campus by providing an end-to-end, wired and wireless network solution from the access edge to the private clouds in targeted verticals. 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, 1G, 2.5G, 5G, 20G, 25G, 40G, 50G and 100G Ethernet, routing, timing and resiliency protocols, open standards interfaces, software defined networks, network security, identity management, data center fabrics, and wireless networking.

We plan to continue to enhance the functionality of our modular operating systems which have 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 30, 2018, our research and development organization consisted of 999 employees.  Research and development efforts are conducted in several of our locations, including San Jose, California, Morrisville, North Carolina; Salem, New Hampshire; Toronto, Canada, and Bangalore and Chennai, India. Our research and development expenses in fiscal years 2018, 2017 and 2016 were $183.9 million, $93.7 million and $78.7 million, respectively.

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.  As of June 30, 2018, we had 620 issued patents in the United States and 88 patents outside of the United States.  The expiration dates of our issued patents in the United States range from 2018 to 2035.  Although we have patent applications pending, there can be no assurance that patents will be issued from pending applications or that claims allowed on any future patents will be sufficiently broad to protect our technology.  As of June 30, 2018, we had 20 registered trademarks in the United States and 113 registered trademarks outside of the United States.

We enter into confidentiality, inventions assignment or license agreements with our employees, consultants and other third parties with whom we do business, 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” or "click-through" 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.

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Competition

The market for network switches, routers and software (including analytics) 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 this market are:

We believe 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., Dell, Hewlett-Packard Enterprise Co., Huawei Technologies Co. Ltd., Arista Networks Inc., Arris Corporation, and Juniper Networks Inc. 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.

We expect to face increased competition from both traditional networking solutions companies and Cloud platform companies offering Infrastructure-as-a-Service (“IaaS”) and Platform-as-a-Service (“PaaS”) products to enterprise customers. In that regard, we expect to face increased competition from certain Cloud Computing companies such as Amazon Web Services (“AWS”), Microsoft (“Microsoft Azure”), and Google Inc. (“Google Cloud Platform”) providing a cloud-based platform of data center compute and networking services for enterprise customers.

With the acquisitions of assets from Zebra, Avaya and Brocade, we believe Extreme is uniquely positioned to address the most pressing market needs from the campus to the data center. Although we believe that our solutions and strategy will improve our ability to meeting the needs of our current and potential customers we cannot guarantee future success.

Restructuring

Fiscal year 2016

During fiscal 2016, we continued to realign our operations by abandoning excess facilities, primarily in San Jose, California; Salem, New Hampshire and Morrisville, North Carolina in addition to other smaller leased locations. These excess facilities represented approximately 32% of the floor space in the aggregate at these locations and included general office and warehouse space.

Fiscal year 2017

During fiscal 2017, we continued to realign our operations by continuing to review our excess facilities, expected sublease income, and implemented a reduction-in-force.  We subleased our previous headquarters location at Rio Robles Drive in San Jose, California (“Rio Robles”) and moved into a larger location at 6480 Via del Oro in San Jose, California (“Via del Oro”) acquired as part of the WLAN Business acquisition.  Additionally, due to the acquisitions of the Campus Fabric Business and the Data Center Business, there was a need to accommodate the increase in headcount.  To address this need, the Company reoccupied a majority of the previously exited space in its Salem, New Hampshire location.  In addition, we announced a reduction-in-force during the fiscal year affecting 90 employees.  

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Fiscal year 2018

During fiscal 2018, we executed a plan to re-align our resources to take advantage of new growth opportunities as a result of the acquisitions of the Campus Fabric Business and the Data Center Business. The restructuring plan is expected to reduce our overall costs and to accelerate the achievement of our operating margin target objectives. The costs associated with this restructuring plan primarily included employee severance and benefits expenses and affected 180 employees.

Environmental Matters

We are subject to various environmental and other regulations governing product safety, materials usage, packaging and other environmental impacts in the United States and in various countries where our products are manufactured and sold.  We are also subject to regulatory developments, including recent SEC disclosure regulations relating to so-called "conflict minerals," relating to ethically responsible sourcing of the components and materials used in our products.  To date, compliance with federal, state, local, and foreign laws enacted for the protection of the environment has had no material effect on our capital expenditures, earnings, or competitive position.

We are committed to energy efficiency in our product lines. Accordingly, we believe this is an area that affords us a competitive advantage for our products in the marketplace. We maintain compliance with various regulations related to the environment, including the Waste Electrical and Electronic Equipment and the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment regulations adopted by the European Union. To date, our compliance efforts with various United States and foreign regulations related to the environment has not had a material effect on our operating results.

Employees

As of June 30, 2018, we employed 2,713 people, including 931 in sales and marketing, 999 in research and development, 249 in operations, 393 in customer support and services and 141 in finance and administration. We have never had a work stoppage and no employees in the United States are represented under a collective bargaining agreement. We consider our employee relations to be good.

We believe our future success depends on our continued ability to attract, integrate, retain, train and motivate highly qualified employees, and upon the continued service of our senior management and key employees.  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 highly competitive.

Organization

We were incorporated in California in May 1996, and reincorporated in Delaware in March 1999. Our corporate headquarters are located at 6480 Via del Oro, San Jose, CA 95119 and our telephone number is (408) 579-2800.  We electronically file our Securities Exchange Commission (“SEC”) disclosure reports with the SEC and they are available free of charge at both www.sec.gov and www.extremenetworks.com.  The public may also read or copy any materials we file with the SEC at the SEC’s public reference room at Station Place, 100 F Street, N.E., Washington, DC 20549.  The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330.

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

 

 

Item 1A. Risk Factors

The following is a list of risks and uncertainties which may have a material and adverse effect on our business, operations, industry, financial condition, results of operations or future financial performance. While we believe we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our business, results of operations, industry, financial position and financial performance in the future.

We may not realize anticipated benefits of past or future acquisitions, divestitures and strategic investments, and the integration of acquired companies or technologies may negatively impact our business and financial results or dilute the ownership interests of our stockholders.

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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:

These actions could have a material adverse effect on our operating results or the price of our common stock.

For example, on October 28, 2016, we completed the acquisition of the WLAN Business from Zebra and amended our prior credit facility with our lenders to finance the acquisition.  On July 14, 2017, we completed the acquisition of the Campus Fabric Business and on October 27, 2017, we completed our acquisition of the Data Center Business.  Upon the terms and subject to the conditions of the respective Asset Purchase Agreements, we acquired customers, employees, technology and other assets, as well as assumed certain contracts and other liabilities of the Campus Fabric and Data Center Businesses.   As of June 30, 2018, we have $200 million of indebtedness outstanding under our current Credit Agreement.

There can be no assurance we will achieve the revenues, growth prospects and synergies expected from any acquisition or that we will achieve such revenue, growth prospects and synergies in the anticipated time period and our failure to do so could have a material adverse effect on our business, operating results and financial condition. 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 would be necessary to integrate new types of technology into our existing portfolio and new types of products may be targeted for potential customers with which we do not have pre-existing relationships.

Our ability to realize the anticipated benefits of our acquisitions and investment activities, including the WLAN Business, Campus Fabric Business and Data Center Business, also entail numerous risks, including, but not limited to:

In addition, 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.

Our credit facilities impose financial and operating restrictions on us.

Our debt instruments, including our Credit Agreement, impose, and the terms of any future debt may impose, operating and other restrictions on us. These restrictions could affect, and in many respects limit or prohibit, among other items, our ability to:

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The agreements governing our Credit Agreement also require us to achieve and maintain compliance with specified financial ratios. A breach of any of these restrictive covenants or the inability to comply with the required financial ratios could result in a default under our debt instruments. If any such default occurs, the lenders under our Credit Agreement may elect to declare all outstanding borrowings, together with accrued interest and other fees, to be immediately due and payable. The lenders under our credit agreement also have the right in these circumstances to terminate any commitments they have to provide further borrowings.

If we fail to meet our payment or other obligations under our Credit Agreement the lenders under such Credit Agreement, as amended, could foreclose on, and acquire control of, substantially all of our assets.

Our Credit Agreement is jointly and severally guaranteed by us and certain of our subsidiaries. Borrowings under our Credit Agreement are secured by liens on substantially all of our assets, including the capital stock of certain of our subsidiaries, and the assets of our subsidiaries that are loan party guarantors. If we are unable to repay outstanding borrowings when due, the lenders under our Credit Agreement will have the right to proceed against this pledged capital stock and take control of substantially all of our assets.

To successfully manage our business or achieve our goals, we must attract, retain, train, motivate, develop and promote key employees, and failure to do so can harm us.

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 that 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 turnover in our executive personnel.  Changes in our management and key employees could affect our financial results, and a recent reduction in force, may impede our ability to attract and retain highly skilled personnel.  We believe our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing, service, finance and operations personnel.  The market for these personnel is competitive, and we have had difficulty in hiring employees, particularly engineers, in the time-frame we desire.

A number of our employees are foreign nationals who rely on visas and entry permits in order to legally work in the United States and other countries.  In recent years, the United States has increased the level of scrutiny in granting H-1(B), L-1 and other business visas.  In addition, the current U.S. administration has indicated that immigration reform is a priority. Compliance with United States immigration and labor laws could require us to incur additional unexpected labor costs and expenses or could restrain our ability to retain skilled professionals.  Any of these restrictions could have a material adverse effect on our business, results of operations and financial conditions.

We cannot assure future profitability, and our financial results may fluctuate significantly from period to period.

We have reported losses in each of our five most recent 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. 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 our expectations and those of our 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:

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Due to the foregoing and other factors, many of which are described herein, period-to-period comparisons of our operating results should not be relied upon as an indicator of our future performance.

The global 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:

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

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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:

Any or all of these factors could have a material adverse impact on our business, financial condition, and results of operations.

Substantially all of our international sales are United States dollar-denominated. The continued strength and future increases in the value of the United States dollar relative to foreign currencies could make our products less competitive in international markets. In the future, we may elect to invoice some of our international customers in local currency, which would expose us to fluctuations in exchange rates between the United States 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.

Local laws and customs in many countries differ significantly from, or conflict with, those in the United States or in other countries in which we operate. In many foreign countries, it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. regulations applicable to us. Although we have implemented policies, procedures and training designed to ensure compliance with these U.S. and foreign laws and policies, there can be no complete assurance that any individual employee, contractor, channel partner, or agents will not violate our policies and procedures. Violations of laws or key control policies by our employees, contractors, channel partners, or agents could result in termination of our relationship, financial reporting problems, fines, and/or penalties for us, or prohibition on the importation or exportation of our products, and could have a material adverse effect on our business, financial condition and results of operations.

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We expect the average selling price of our products to decrease, which is likely to 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 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 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 margin to decline.

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 manufacturing 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:

Our principal limited-source components include:

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.

Our top ten suppliers accounted for a significant portion of our purchases during the quarter. Given the significant concentration of our supply chain, particularly with certain sole or limited source providers, any significant interruption by any of the key suppliers or a termination of a relationship could temporarily disrupt our operations.  Additionally, our operations are materially dependent upon the continued market acceptance and quality of these manufacturers’ products and their ability to continue to manufacture products that are competitive and that comply with laws relating to environmental and efficiency standards. Our inability to obtain products from one or more of these suppliers or a decline in market acceptance of these suppliers’ products could have a material adverse effect on our business, results of operations and financial condition. Other than pursuant to an agreement with a key component supplier which includes pricing based on a minimum volume commitment, 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 from our suppliers as incorporated in our products may not meet the quality requirements of our customers.

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Intense competition in the market for networking equipment and Cloud platform companies could prevent us from increasing revenue and attaining profitability.

The market for network switching solutions is intensely competitive and dominated primarily by Cisco Systems Inc., Dell, Inc. Hewlett-Packard Enterprise Company, Huawei Technologies Co. Ltd., Arista Networks, Inc., Arris Corporation and Juniper Networks, Inc. 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 attractive offers to channel partners and customers than we do. Some of our customers may question whether we have the financial resources to complete their projects and future service commitments.

We may also face increased competition from both traditional networking solutions companies and Cloud platform companies offering IaaS and PaaS products to enterprise customers. In particular, AWS, Microsoft Azure and the Google Cloud Platform may provide enterprise customers with a cloud-based platform of data center compute and networking services.

For example, we have encountered, and expect to continue to encounter in the future, many potential customers who are confident in and committed to the product offerings of our principal competitors. 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 gross margins will be adversely affected.

We may not fully realize the anticipated positive impacts to future financial results from our restructuring efforts.

We have undertaken restructuring efforts in the past to streamline operations and reduce operating expenses. Our ability to achieve the anticipated cost savings and other benefits from our restructuring efforts within expected time frames is subject to many estimates and assumptions and may vary materially based on factors such as market conditions and the effect of our restructuring efforts on our work force. These estimates and assumptions are subject to significant economic, competitive and other uncertainties, some of which are beyond our control. We cannot assure that we will fully realize the anticipated positive impacts to future financial results from our current or future restructuring efforts. If our estimates and assumptions are incorrect or if other unforeseen events occur, we may not achieve the cost savings expected from such restructurings, and our business and results of operations could be adversely affected.

Industry consolidation may lead to stronger competition and may harm our operating results.

There has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. For example, some of our current and potential competitors for enterprise data center business have made acquisitions or announced new strategic alliances, designed to position them with the ability to provide end-to-end technology solutions for the enterprise data center. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in our operating results and could have a material adverse effect on our business, operating results, and financial condition. Furthermore, particularly in the service provider market, rapid consolidation will lead to fewer customers, with the effect that loss of a major customer could have a material impact on results not anticipated in a customer marketplace composed of more numerous participants.

We intend to invest in engineering, sales, services, marketing and manufacturing on a long-term basis, and delays or inability to attain the expected benefits may result in unfavorable operating results.

While we intend to focus on managing our costs and expenses, over the long term, we also intend to invest in personnel and other resources related to our engineering, sales, services, marketing and manufacturing functions as we focus on our foundational priorities, such as leadership in our core products and solutions and architectures for business transformation. We are likely to recognize the costs associated with these investments earlier than some of the anticipated benefits and the return on these investments may be lower, or may develop more slowly, than we expect. If we do not achieve the benefits anticipated from these investments, or if the achievement of these benefits is delayed, our operating results may be adversely affected.

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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 inter-operate 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; in addition, ending sales of existing products may cause customers to cancel or defer 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 products.

If we do not successfully anticipate technological shifts, market needs and opportunities, and develop products, product enhancements and business strategies that meet those technological shifts, needs and opportunities, or if those products are not made available or strategies are not executed in a timely manner or do not gain market acceptance, we may not be able to compete effectively and our ability to generate revenues will suffer.

The markets for our products are constantly evolving and characterized by rapid technological change, frequent product introductions, changes in customer requirements, and continuous pricing pressures. We cannot guarantee that we will be able to anticipate future technological shifts, market needs and opportunities or be able to develop new products, product enhancements and business strategies to meet such technological shifts, needs or opportunities in a timely manner or at all. For example, the move from traditional network infrastructures towards SDN has been receiving considerable attention. In our view, it will take several years to see the full impact of SDN, and we believe the successful products and solutions in this market will combine hardware and software elements together.  If we fail to anticipate market requirements or opportunities or fail to develop and introduce new products, product enhancements or business strategies to meet those requirements or opportunities in a timely manner, it could cause us to lose customers, and such failure could substantially decrease or delay market acceptance and sales of our present and future products and services, which would significantly harm our business, financial condition, and results of operations. Even if we are able to anticipate, develop and commercially introduce new products and enhancements, we cannot assure that new products or enhancements will achieve widespread market acceptance.

Our employees may engage in misconduct or other improper activities, including noncompliance with regulatory standards and requirements, which could have a material adverse effect on our business.

We are exposed to the risk of employee fraud or other misconduct. Misconduct by employees could include intentional failures to: 

The precautions we take to detect and prevent misconduct may not be effective in controlling unknown or unmanaged risks or losses or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to be in compliance with such laws or regulations. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business and results of operations, including the imposition of significant fines or other sanctions.

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The cloud networking market is still in its early stages and is rapidly evolving. If this market does not evolve as we anticipate or our target end customers do not adopt our cloud networking solutions, we may not be able to compete effectively, and our ability to generate revenue will suffer.

The cloud networking market is still in its early stages. The market demand for cloud networking solutions has increased in recent years as end customers have deployed larger networks and have increased the use of virtualization and cloud computing. Our success may be impacted by our ability to provide successful cloud networking solutions that address the needs of our channel partners and end customers more effectively and economically than those of other competitors or existing technologies.  If the cloud networking solutions market does not develop in the way we anticipate, if our solutions do not offer significant benefits compared to competing legacy network switching products or if end customers do not recognize the benefits that our solutions provide, then our potential for growth in this cloud market could be adversely affected.

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. As we have grown it has, and may continue to, experience greater revenues and increased public visibility, which may cause competitors, customers, and governmental authorities to be more likely to initiate litigation against us. 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, the lack of predictability of such awards and the high legal costs associated with the defense of such patent infringement matters that would be expended to prove lack of infringement, it is not uncommon for companies in our industry to settle even potentially unmeritorious claims for very substantial amounts. Furthermore, 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 previously received notices from entities alleging that we were infringing their patents and have been party to patent litigation in the past.

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:

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 under certain circumstances. Our use of open source software subjects us to certain additional risks for the following reasons:

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

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Our operating results may be negatively affected by legal proceedings.

We have in the past, currently are and will likely in the future pursue or be subject to claims or lawsuits in the normal course of our business. In addition to the risks related to the intellectual property lawsuits described above, we are currently parties to other litigation as described in Note 9 to our Notes to Consolidated Financial Statements included elsewhere in this Annual Report. Regardless of the result, litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal 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 customers, suppliers, directors, officers and employees in certain lawsuits. We may not have adequate insurance coverage to cover all of our litigation costs and liabilities.

Failure to protect our intellectual property could affect our business.

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, invention assignment or license agreements with our employees, consultants and other third parties with whom we do business, 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.

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 inter-operate 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.

Our dependence on a few manufacturers for our manufacturing requirements could harm our operating results.

We primarily rely on our manufacturing partners: Alpha Networks; Senao Networks; Foxconn; Delta Networks and Wistron NeWeb Corporation and select other partners to manufacture our products. We have experienced delays in product shipments from some of 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. In addition, any natural disaster or business interruption to our manufacturing partners could significantly disrupt our business. While we maintain strong relationships with 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 operating results.

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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.

The purchase of 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:

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 that we will be able to successfully integrate employees into our Company or to educate and train 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.

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:

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.

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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.

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.

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. We need to ensure that any businesses acquired, including the WLAN Business, the Campus Fabric Business, and the Data Center Business are appropriately integrated in our financial systems. Any delay in the implementation of, or disruption in the integration of acquired businesses, or delay and 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.

Recent U.S. tax legislation may materially adversely affect our financial condition, results of operations and cash flows.

Recently enacted U.S. tax legislation has significantly changed the U.S. federal income taxation of U.S. corporations, including by reducing the U.S. corporate income tax rate, limiting interest deductions, permitting immediate expensing of certain capital expenditures, adopting elements of a territorial tax system, imposing a one-time transition tax (or “repatriation tax”) on all undistributed earnings and profits of certain U.S.-owned foreign corporations, revising the rules governing net operating losses and the rules governing foreign tax credits, and introducing new anti-base erosion provisions. Many of these changes are effective immediately, without any transition periods or grandfathering for existing transactions. The legislation is unclear in many respects and could be subject to potential amendments and technical corrections, as well as interpretations and implementing regulations by the Treasury and Internal Revenue Service (“IRS”), any of which could lessen or increase certain adverse impacts of the legislation. In addition, it is unclear how these U.S. federal income tax changes will affect state and local taxation, which often uses federal taxable income as a starting point for computing state and local tax liabilities.

While our analysis and interpretation of this legislation is preliminary and ongoing, based on our current evaluation, we do not expect the reduction of the U.S. corporate income tax rate will have a materially adverse impact to our earnings given our U.S. valuation allowance.  We also do not currently believe the one-time transition tax will have a materially adverse impact given our ability to utilize existing tax attributes.  An estimate of the impact was recorded in the second quarter of the fiscal year ending June 30, 2018, the period in which the tax legislation was enacted, however, these amounts may be subject to further adjustment in subsequent periods throughout fiscal 2018 in accordance with recent interpretive guidance issued by the SEC as well as future regulatory guidance.  We believe the limitation on interest deductions, the expanded limitation on executive compensation deductions and the anti-base erosion provisions in the legislation may negatively impact our cash flows going forward.  There may be other material adverse effects resulting from the legislation that we have not yet identified.

Changes in the effective tax rate 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 restructuring. 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.

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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 could have a material adverse impact on our results of operations. On April 26, 2012, we adopted an Amended and Restated Rights Agreement to help protect our assets (the “Rights Agreement”). In general, this does not allow a stockholder to acquire more than 4.95% of our outstanding common stock without a waiver from our board of directors, who must take into account the relevant tax analysis relating to potential limitation of our net operating losses. Our Rights Agreement is effective through May 31, 2019, subject to ratification by a majority of our stockholders at the next annual shareholders meeting, expected to be held on November 8, 2018.

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 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 Rights Agreement provides that if a single stockholder (or group) acquires more than 4.95% of our outstanding common stock without a waiver from our Board of Directors, each holder of one share of our common stock (other than the stockholder or group who acquired in excess of 4.95% of our common stock) may purchase a fractional share of our preferred stock that would result in substantial dilution to the triggering stockholder or group. Accordingly, although this plan is designed to prevent any limitation on the utilization of our net operating losses by avoiding issues raised under Section 382 of the U.S. Internal Revenue Code, the Rights Agreement could also serve as a deterrent to stockholders wishing to effect a change of control.

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 Stock Market 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 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, which investments may have a material impact on our financial condition.

We are required to evaluate the effectiveness of our internal control over financial reporting on an annual basis and publicly disclose any material weaknesses in our controls.  Any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and significant expense to remediate, and ultimately could have an adverse effect on our stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to assess the effectiveness of our internal control over financial reporting and to disclose if such controls were unable to provide assurance that a material error would be prevented or detected in a timely manner. We have an ongoing program to review the design of our internal controls framework in keeping with changes in business needs, implement necessary changes to our controls design and test the system and process controls necessary to comply with these requirements. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within our Company will have been detected.

If we or our independent registered public accounting firm identifies material weaknesses in our internal controls, the disclosure of that fact, even if quickly remedied, may cause investors to lose confidence in our financial statements and its stock price may decline. Remediation of a material weakness could require us to incur significant expenses and, if we fail to remedy any material weakness, our ability to report our financial results on a timely and accurate basis may be adversely affected, our access to the capital markets may be restricted, our stock price may decline, and we may be subject to sanctions or investigation by regulatory authorities, including the U.S. Securities and Exchange Commission or the NASDAQ Stock Market LLC. We may also be required to restate our financial statements from prior periods. Execution of restatements create a significant strain on our internal resources and could cause delays in our filing of quarterly or annual financial results, increase our costs and cause management distraction. Restatements may also significantly affect our stock price in an adverse manner.

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Our stock price has been volatile in the past and 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.  These fluctuations may adversely affect the trading price or liquidity of our common stock. Some companies, including us, that have had volatile market prices for their securities have had securities class action lawsuits filed against them. If a suit were filed against us, regardless of its merits or outcome, it could result in substantial costs and divert management’s attention and resources.  

We rely on the availability of third-party licenses.

Some of our products are designed to include software or other intellectual property, including open source software, licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various aspects of these products. There can be no assurance that the necessary licenses would be available on acceptable terms, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, could have a material adverse effect on our business, operating results, and financial condition. Moreover, the inclusion in our products of software or other intellectual property licensed from third parties on a nonexclusive basis could limit our ability to protect our proprietary rights in our products.  Further, the failure to comply with the terms of any license, including free open source software, may result in our inability to continue to use such license. Our inability to maintain or re-license any third-party licenses required in our products or our inability to obtain third-party licenses necessary to develop new products and product enhancements, could require us, if possible, to develop substitute technology or obtain substitute technology of lower quality or performance standards or at a greater cost, any of which could delay or prevent product shipment and harm our business, financial condition, and results of operations.

System security risks, data protection breaches, and cyber-attacks could compromise our proprietary information, disrupt our internal operations and harm public perception of our products, which could adversely affect our business.

In the ordinary course of business, we store sensitive data, including intellectual property, our proprietary business information and that of our customers, suppliers and business partners on our networks. In addition, we store sensitive or classified information through cloud-based services that may be hosted by third parties and in data center infrastructure maintained by third parties. The secure maintenance of this information is critical to our operations and business strategy. Increasingly, companies, including us, are subject to a wide variety of attacks on their networks on an ongoing basis. Despite our security measures, our information technology and infrastructure may be vulnerable to penetration or attacks by computer programmers and hackers, or breached due to employee error, malfeasance or other disruptions. In addition, as a provider of products and services to the government, our products and services may be the targets of cyber attacks that attempted to sabotage or otherwise disable them, or our cybersecurity and other products and services ultimately may not be able to effectively detect, prevent, or protect against or otherwise mitigate losses from all cyber attacks. Any such breach could compromise our networks, creating system disruptions or slowdowns and exploiting security vulnerabilities of our products, and the information stored on our networks could be accessed, publicly disclosed, lost or stolen, which could subject us to liability to our customers, suppliers, business partners and others, could require significant management attention and resources, could result in the loss of business, regulatory actions and potential liability, and could cause us reputational and financial harm. In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including "bugs" and other problems that could unexpectedly interfere with the operation of our networks. This can be true even for “legacy” products that have been determined to have reached an end of life engineering status but will continue to operate for a limited amount of time.

If an actual or perceived breach of network security occurs in our network or in the network of a customer of our networking products, regardless of whether the breach is attributable to our products, the market perception of the effectiveness of our products could be harmed. In addition, the economic costs to us to eliminate or alleviate cyber or other security problems, bugs, viruses, worms, malicious software systems and security vulnerabilities could be significant and may be difficult to anticipate or measure. Because the techniques used by computer programmers and hackers, many of whom are highly sophisticated and well-funded, to access or sabotage networks change frequently and generally are not recognized until after they are used, we may be unable to anticipate or immediately detect these techniques. This could impede our sales, manufacturing, distribution or other critical functions, which could adversely affect our business.

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Market conditions and changes in the industry could lead to discontinuation of our products or businesses resulting in asset impairments.

In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses. Any decision to limit investment in or dispose of or otherwise exit businesses may result in the recording of special charges, such as inventory and technology-related write-offs, workforce reduction costs, charges relating to consolidation of excess facilities, or claims from third parties who were resellers or users of discontinued products. Our estimates with respect to the useful life or ultimate recoverability of our carrying basis of assets, including purchased intangible assets, could change as a result of such assessments and decisions. Although in certain instances, our supply agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed, our loss contingencies may include liabilities for contracts that we cannot cancel with contract manufacturers and suppliers. Further, our estimates relating to the liabilities for excess facilities are affected by changes in real estate market conditions.

If our products do not effectively inter-operate with our customers’ networks and result in cancellations and delays of installations, our business could be harmed.

Our products are designed to interface with our customers’ existing networks, each of which have different specifications and utilize multiple protocol standards and products from other vendors. Many of our customers’ networks contain multiple generations of products that have been added over time as these networks have grown and evolved. Our products must inter-operate with many or all of the products within these networks as well as future products in order to meet our customers’ requirements. If we find errors in the existing software or defects in the hardware used in our customers’ networks, we may need to modify our software networking solutions to fix or overcome these errors so that our products will inter-operate and scale with the existing software and hardware, which could be costly and could negatively affect our business, financial condition, and results of operations. In addition, if our products do not inter-operate with those of our customers’ networks, demand for our products could be adversely affected or orders for our products could be canceled. This could hurt our operating results, damage our reputation, and seriously harm our business and prospects. Our revenues may decline as a result of changes in public funding of educational institutions.

A portion of our revenues comes from sales to both public and private K-12 educational institutions. Public schools receive funding from local tax revenue, and from state and federal governments through a variety of programs, many of which seek to assist schools located in underprivileged or rural areas. The funding for a portion of our sales to educational institutions comes from a federal funding program known as the E-Rate program. E-Rate is a program of the Federal Communications Commission that subsidizes the purchase of approved telecommunications, Internet access, and internal connection costs for eligible public educational institutions.  The E-Rate program, its eligibility criteria, the timing and specific amount of federal funding actually available and which Wi-Fi infrastructure and product sectors will benefit, are uncertain and subject to final federal program approval and funding appropriation continues to be under review by the Federal Communications Commission, and we cannot assure that this program or its equivalent will continue, and as a result, our business may be harmed. Furthermore, if state or local funding of public education is significantly reduced because of legislative or policy changes or by reductions in tax revenues due to changing economic conditions, our sales to educational institutions may be negatively impacted by these changed conditions.  Any reduction in spending on information technology systems by educational institutions would likely materially and adversely affect our business and results of operations.  This is a specific example of the many factors which add additional uncertainty to our future revenue from our education end-customers.

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 as well as our R&D centers in North Carolina and New Hampshire have been vulnerable to natural disasters and other risks, such as earthquakes, fires, floods and tropical storms, which at times have disrupted the local economy and posed physical risks to our property. We have contract manufacturers located in 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 United States 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.

 

 

Item 1B. Unresolved Staff Comments

None.

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Item 2. Properties

Our corporate headquarters is located in San Jose, California where we currently lease approximately 185,000 square feet of space under a lease agreement that expires in fiscal year 2027.

In addition to our headquarters in San Jose, we lease additional sites in the United States, including facilities in Salem, New Hampshire and Morrisville/Raleigh, North Carolina for research and development, sales and marketing and administrative offices. Outside the United States, we also lease office space in various other international geographic locations for research and development, sales and service personnel and administration in Other Americas, EMEA and APAC, including Ottawa, Canada, Bangalore, India, Chennai, India, Markham, Canada, Reading, United Kingdom and Shannon, Ireland.

As of June 30, 2018, we have leased approximately 1.0 million square feet of space with various expiration dates between fiscal year 2019 and fiscal 2028. We believe that our current facilities are sustainable and adequate to meet our current needs and the productive capacity of such facilities is substantially being utilized or we have plans to utilize such capacity.

Item 3. Legal Proceedings

The information set forth under the heading “Legal Proceedings” in Note 9. Commitments and Contingencies, in Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K, is incorporated herein by reference.

Item 4. Mine Safety Disclosures

Not Applicable

 

 

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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 trades on the NASDAQ Global Market and commenced trading on NASDAQ 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.

As of August 24, 2018, there were 188 stockholders of record of our common stock.  Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. We have never declared or paid cash dividends on our capital stock and do not anticipate paying any cash dividends in the foreseeable future.

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 2018 Annual Meeting of Stockholders 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 1, 2013 and ending on June 30, 2018.  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.

 

 

Data and graph are calculated from CRSP Total Return Index for the NASDAQ Stock Market (US Companies) and NASDAQ Computer Manufacturers Securities, Center for Research in Security Prices (CRSP), Booth School of Business, and 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 30, 2018, 2017, 2016, 2015 and 2014 derived from the Company’s audited financial statements (in thousands, except per share amounts). 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. The Company adopted the Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606) on July 1, 2017. Selected financial data for the fiscal years ended, and as of, June 30, 2017 and 2016 are adjusted for the adoption of Topic 606.

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Quarterly Financial Data (Unaudited)

Quarterly results for the years ended June 30, 2018 and 2017 are as follow (in thousands, except per share amounts). Quarterly financial data for each quarter in the fiscal year ended June 30, 2017 are adjusted for the adoption of Topic 606.

Quarterly and year-to-date computations of per share amounts are made independently. Therefore, the sum of per share amounts for the quarters may not agree with the per share amounts for the year.

 

 

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

Business Overview

The following discussion should be read with the Consolidated Financial Statements and the related notes in Item 8 of Part II of this Report.

The following discussion is based upon our Consolidated Financial Statements included elsewhere in this Report, which have been prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP.  In the course of operating our business, we routinely make decisions as to the timing of the payment of invoices, the collection of receivables, the manufacturing and shipment of products, the fulfillment of orders, the purchase of supplies, and the building of inventory and service parts, among other matters. Each of these decisions has some impact on the financial results for any given period. In making these decisions, we consider various factors including contractual obligations, customer satisfaction, competition, internal and external financial targets and expectations, and financial planning objectives. For further information about our critical accounting policies and estimates, see “Critical Accounting Policies and Estimates” section included in this “Management's Discussion and Analysis of Financial Condition and Results of Operations.”

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 offers related maintenance contracts for extended warranty and maintenance to our enterprise, data center and service provider customers.  We were incorporated in California in May 1996, and reincorporated in Delaware in March 1999.  Our corporate headquarters are located in San Jose, California. Substantially all of our revenue is derived from the sale of our networking equipment and related maintenance contracts.

Extreme is a leader in providing software-driven networking solutions for enterprise customers. Providing a combined end-to-end solution from the data center to the access point, Extreme designs, develops and manufactures wired and wireless network infrastructure equipment and develops the software for network management, policy, analytics, security and access controls. We strive to help our customers and partners Connect Beyond the Network by building world-class software and network infrastructure solutions that solve the wide range of problems faced by IT departments.

Enterprise network administrators from the data center to the access layer need to respond to the rapid digital transformational trends of cloud, mobility, big data, social business and the ever-present need for network security.  Accelerators such as Internet of Things (“IoT”), artificial intelligence (“AI”), bring your own device (“BYOD”), machine learning, cognitive computing, and robotics add complexity to challenge the capabilities of traditional networks. Technology advances have a profound effect across the entire enterprise network placing unprecedented demands on network administrators to enhance management capabilities, scalability, programmability, agility, and analytics of the enterprise networks they manage.

A trend effecting the Enterprise Network Equipment market is the continued adoption of the cloud-managed enterprise WLAN in the enterprise market. Hybrid cloud is a cloud computing environment which uses a mix of on-premises, private cloud and third-party, public cloud services with orchestration between the two platforms. We introduced our Cloud offering in 2016 and announced our enhanced cloud offering in 2017.  ExtremeCloud is the only offering in the market that seamlessly integrates the cloud with on-premise infrastructures. (See Part 1, Item 1. Business, for additional discussion of our business)

Acquisitions

WLAN Business

We completed the acquisition of Zebra’s WLAN Business on October 28, 2016.  Under the terms of the purchase agreement, we acquired customers, employees, technology and other assets as well as assumed certain contracts and other liabilities of the WLAN Business, for net cash consideration of $49.5 million.

The acquisition was accounted for using the acquisition method of accounting.  The purchase price allocation as of the acquisition date is set forth in Note 4. Business Combinations in our Notes to Consolidated Financial Statements and reflects fair values. The fair values were determined through established and generally accepted valuation techniques, including work performed by third-party valuation specialists.  All valuations were considered finalized as of June 30, 2018.

During the fiscal year ended June 30, 2017, we recognized acquisition and integration costs of $2.1 million and $6.6 million, respectively, which are included in “Acquisition and integration costs, net of bargain purchase gain” in the accompanying consolidated statements of operations.

Campus Fabric Business

We completed the acquisition of Avaya Inc.’s (“Avaya”) fabric-based secure networking solutions and network security solutions business (the “Campus Fabric Business”) on July 14, 2017 (“Campus Fabric Business Closing Date”) pursuant to the Campus Fabric Business Purchase Agreement dated March 7, 2017 between Avaya and Extreme.  We acquired customers, employees, technology and other assets, as well as assumed contracts and other liabilities of the Campus Fabric Business, for purchase consideration of $79.4 million, including all adjustments.  See Note 4. Business Combinations, for additional information.

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The business combination was accounted for using the acquisition method of accounting whereby the acquired assets and liabilities of the Campus Fabric Business are recorded at their respective fair values and added to those of ours including an amount for goodwill representing the difference between the acquisition consideration and the fair value of the identifiable net assets.  Results of operations of the Campus Fabric Business are included in our operations beginning with the Campus Fabric Business Closing Date.

During the year ended June 30, 2018, we recognized acquisition and integration costs of $12.4 million and $6.3 million, respectively, related to the Campus Fabric Business which are included in “Acquisition and integration costs, net of bargain purchase gain” in the accompanying consolidated statements of operations.

Data Center Business

We completed our acquisition of the data center business (the “Data Center Business”) of Brocade Communication Systems, Inc. (“Brocade”) on October 27, 2017 (“Data Center Business Closing Date”).  Upon the terms and subject to the conditions of the Data Center Business Asset Purchase Agreement (“Data Center Business APA”), we acquired customers, employees, technology and other assets of the Data Center Business, as well as assumed certain contracts and other liabilities of the Data Center Business, for an upfront cash closing payment equal to $23.0 million, plus deferred payments of $20.0 million to be paid $1.0 million per quarter for 20 full quarters following the Data Center Business Closing Date, plus quarterly earn out payments equal to 50% of profits of the Data Center Business for the five-year period commencing at the end of our first full fiscal quarter following the Data Center Business Closing Date.  See Note 4. Business Combinations, for additional information.

The acquisition was accounted for using the acquisition method of accounting whereby the acquired assets and liabilities of the Data Center Business are recorded at their respective fair values and added to those of ours including an amount for goodwill representing the difference between the acquisition consideration and the fair value of the identifiable net assets.  Results of operations of the Data Center Business are included in our operations beginning with the Data Center Business Closing Date.

During the year ended June 30, 2018, we recognized acquisition and integration costs of $36.0 million and $4.2 million, respectively, including a $25.0 million consent fee paid to Broadcom Corporation (“Broadcom”), to terminate a previous asset purchase agreement entered into by the Company to purchase the Data Center Business from Broadcom, in anticipation of Broadcom’s acquisition of Brocade. The fee was paid to Broadcom to allow the Company to buy the Data Center Business directly from Brocade. Acquisitions costs are included in “Acquisition and integration costs, net of bargain purchase gain” in the accompanying consolidated statements of operations.

Results of Operations

Following is a summary of our results of operations during fiscal 2018:

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Net Revenues

The following table presents net product and service revenue for the fiscal years 2018, 2017 and 2016 (dollars in thousands):

 

 

Product revenue increased $304.0 million or 66.0% for the year ended June 30, 2018, compared to the corresponding period of fiscal 2017. The increase in product revenues was attributable to growth related to the acquisitions of the WLAN, the Campus Fabric and the Data Center Businesses and to a lesser extent, organic growth of legacy revenues.

Product revenue increased $73.5 million or 19% for the year ended June 30, 2017, compared to the corresponding period of fiscal 2016. The increase in product revenue was primarily a result of the acquisition of the WLAN Business during fiscal 2017 and to lower discounting from list price.

Service revenue increased $72.0 million or 49.1% for the year ended June 30, 2018, compared to the corresponding period of fiscal 2017. The increase in service revenue was due to the increased number of service contracts acquired as a result of the acquisitions of the WLAN, the Campus Fabric and the Data Center Businesses.

Service revenue increased $13.7 million or 10.3% for the year ended June 30, 2017 compared to the corresponding period of fiscal 2016. The increase in service revenue was primarily a result of the acquisition of the WLAN Business during fiscal 2017 and the increased number of service contracts acquired.

We operate in three regions: Americas, which includes the United States, Canada, Mexico, Central America and South America; EMEA, which includes Europe, Russia, Middle East, and Africa; and APAC which includes Asia Pacific, South Asia, Japan and Australia. The following table presents the total net revenue geographically for the fiscal years 2018, 2017 and 2016 (dollars in thousands):

 

We rely upon multiple channels of distribution, including distributors, direct resellers, OEMs and direct sales.  Revenue through our distributor channel was 69% of total product revenue in fiscal 2018, 66% of total product revenue in fiscal 2017 and 64% in fiscal 2016.

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

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Cost of Revenues and Gross Profit

The following table presents the gross profit on product and service revenue and the gross profit percentage of net revenues for the fiscal years 2018, 2017 and 2016 (dollars in thousands):

 

 

Cost of product revenues includes costs of materials, amounts paid to third-party contract manufacturers, costs related to warranty obligations, charges for excess and obsolete inventory, scrap, distribution, product certification, amortization of developed technology intangibles, 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. We conduct supply chain management, quality assurance, manufacturing engineering and document control at our facilities in San Jose, California, Salem, New Hampshire, China, and Taiwan.

Product gross profit increased to $407.4 million for the year ended June 30, 2018, from $240.2 million in the corresponding period of fiscal 2017, primarily due to higher revenues attributed to the acquisitions of the WLAN, the Campus Fabric and the Data Center Businesses and lower production costs due to cost reduction efforts.  The increases in product gross profit were partially offset by increases in amortization of developed technology intangibles of $9.9 million, warranty charges of $7.2 million, royalty charges of $2.2 million and acquisition and integration related costs of $7.7 million including excess inventory charges related to the discontinuance of certain product lines due to the acquisitions of the Campus Fabric and the Data Center Businesses in excess of the same charges incurred related to the acquisition of the WLAN Business in the corresponding period in fiscal 2017.

Product gross profit increased to $240.2 million for the year ended June 30, 2017, from $181.3 million in the corresponding period of fiscal 2016.  Product gross profit for the year ended June 30, 2017, was favorably impacted by an increase in product revenue of $73.5 million due primarily to the acquisition of the WLAN Business, lower amortization of developed technology intangibles of $8.3 million and more favorable manufacturing costs due to cost reduction efforts and lower warranty charges of $2.2 million.  The increases in product gross profit were partially offset by integration costs of $5.0 million primarily related to excess inventory charges related to the discontinuance of certain product lines due to the WLAN Business acquisition and increased royalty charges of $2.6 million.

Our cost of service revenue consists primarily of labor, overhead, repair and freight costs and the cost of service parts used in providing support under customer maintenance contracts.

Service gross profit increased to $127.1 million for the year-ended June 30, 2018, from $90.8 million in the corresponding period of fiscal 2017, primarily due to the acquisitions of the WLAN, Campus Fabric and Data Center Businesses as a result of a higher number of maintenance contracts.

Service gross profit increased to $90.8 million for the year ended June 30, 2017, from $84.1 million in the corresponding period of fiscal 2016, primarily due to an increase in service revenue of $6.7 million related to the acquisition of the WLAN Business and the increased number of service contracts acquired.  

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Operating Expenses

The following table presents operating expenses and operating income (dollars in thousands):

 

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

Research and Development Expenses

Research and development expenses consist primarily of personnel costs (which consists of compensation, benefits and stock-based compensation), consultant fees and prototype expenses related to the design, development, and testing of our products.

Research and development expenses increased by $90.2 million or 96.2% for fiscal 2018 as compared to fiscal 2017. The increase in research and development expenses during fiscal 2018 was due to higher personnel costs of $67.0 million due to increased headcount related to the acquisitions of the Campus Fabric and Data Center Businesses, $12.5 million in increased facility and information technology costs, $7.4 million in increased supplies and equipment costs and $3.2 million in increased travel and other costs.

Research and development expenses increased by $15.0 million or 19.1% for fiscal 2017 as compared to fiscal 2016. The increase in spending was primarily a result of the acquisition of the WLAN Business during fiscal 2017, and consisted of $11.7 million of personnel costs, which included compensation, benefits and non-cash stock based compensation, $1.3 million of technology and facility costs, $1.2 million of consulting and contract projects and $0.8 million of supplies and equipment costs.

Sales and Marketing Expenses

Sales and marketing expenses consist of personnel costs (which consists of compensation, benefits and stock-based compensation) and related expenses for personnel engaged in marketing and sales functions, as well as trade shows and promotional expenses.

Sales and marketing expenses increased by $104.5 million or 64.2% for the year ended June 30, 2018, as compared to the corresponding period of fiscal 2017.  The increase in sales and marketing expenses during fiscal 2018 was primarily a result of the acquisitions of the Campus Fabric and Data Center Businesses.  The increase consisted of higher personnel costs of $74.7 million, $10.8 million in additional professional fees, $7.2 million in increased facility and information technology costs, $6.4 million in increased travel, meeting and conference costs and $5.4 million in supplies and equipment costs.

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Sales and marketing expenses increased by $12.7 million or 8.5% for the year ended June 30, 2017 as compared to the corresponding period of fiscal 2016.  The increase in sales and marketing expenses during fiscal 2017 was primarily a result of the acquisition of the WLAN Business during fiscal 2017, and consists of higher personnel costs including benefits and non-cash stock compensation of $9.8 million, $1.8 million in travel costs and $1.1 million in additional professional fees.

General and Administrative Expenses

General and administrative expense consists primarily of personnel costs (which consists of compensation, benefits and stock-based compensation), legal and professional service costs, travel and facilities and information technology costs.

General and administrative expenses increased by $13.1 million or 34.7% for the year ended June 30, 2018, as compared to the corresponding period of fiscal 2017.  The increase in general and administrative expenses during fiscal 2018 was primarily due to $8.4 million in higher personnel costs, $3.2 million in higher professional fees, $1.4 million in higher bad debts provision and $0.8 million in higher travel and other costs, partially offset by $0.7 million in reduced facility and information technology costs.

General and administrative expenses increased by $0.2 million or 0.5% for the year ended June 30, 2017 as compared to the corresponding period of fiscal 2016.  The increase in general and administrative expenses during fiscal 2017 was primarily due to increases of $1.1 million in professional fees, $0.6 million in recruiting fees, and $0.2 million of taxes and franchise fees. The increase was partially offset by $0.9 million in lower personnel costs related to our reduced headcount and $0.6 million in our provision for bad debts.

Acquisition and Integration Costs, Net of Bargain Purchase Gain

As a result of our acquisitions of the Campus Fabric, Data Center and Capital Financing Businesses in fiscal 2018, the WLAN Business in fiscal 2017 and Enterasys in fiscal 2014, we incurred $53.9 million, $13.1 million and $1.1 million of acquisition and integration costs, net of bargain purchase gain in fiscal 2018, 2017 and 2016, respectively.  

For fiscal 2018, we incurred $12.4 million of acquisition and $6.3 million of integration costs related to the acquisition of the Campus Fabric Business and $36.0 million of acquisition and $4.2 million of integration costs related to the acquisition of the Data Center Business. The Data Center Business acquisition costs includes a $25.0 million consent fee paid to Broadcom, to terminate a previous asset purchase agreement entered into by the Company to purchase the Data Center Business from Broadcom, in anticipation of Broadcom’s acquisition of Brocade. The fee was paid to Broadcom to allow the Company to buy the Data Center Business directly from Brocade. We also recorded a gain on bargain purchase of $5.0 million related to the acquisition of the Capital Financing Business.

For fiscal 2017, we incurred $2.1 million of acquisition and $6.6 million of integration costs related to the WLAN Business acquisition.  We also incurred acquisition costs of $2.2 million related to our anticipated acquisition of the Campus Fabric Business and $2.2 million for the anticipated acquisition of the Data Center Business.

For fiscal 2016, the entire $1.1 million expense was related to integration costs of the Enterasys acquisition.

Restructuring and Related Charges, Net of Reversals

As of June 30, 2018, restructuring liabilities were $6.5 million and consisted primarily of obligations for estimated future obligations for non-cancelable lease payments for excess facilities, and for severance payments and benefits. The restructuring liability is recorded in “Other accrued liabilities” and “Other long-term liabilities” on the consolidated balance sheets. During fiscal years 2018, 2017 and 2016, we recorded restructuring charges and related charges, net of reversals, of $8.1 million, $8.9 million and $11.0 million, respectively.  

Fiscal year 2018

During fiscal 2018, we announced and began executing a reduction-in-force in our third and fourth fiscal quarters as a result of the acquisitions of the Campus Fabric and the Data Center Businesses. We recorded restructuring charges of $7.9 million related to employee severance and benefits expenses during fiscal 2018. We also incurred charges of $0.2 million for changes to our estimates for accrued lease costs pertaining to the estimated future obligations for non-cancelable lease payments of our excess facilities.

Fiscal year 2017

Pursuant to the WLAN Business acquisition from Zebra, we assumed a facility lease located at 6480 Via del Oro in San Jose, California (“Via del Oro”) and transferred our headquarters from Rio Robles Drive in San Jose, California (“Rio Robles”) to Via del Oro.  We consolidated our existing workforce from our previous headquarters with employees assumed from Zebra to the Via del Oro site and exited the Rio Robles site on January 31, 2017.  Due to our move from the Rio Robles facility and abandonment of all leasehold improvements, we accelerated the amortization of the remaining leasehold improvements for this site over the shortened service period such that the leasehold improvements were fully amortized on the cease-use date.  We recorded accelerated amortization expense for the year ended June 30, 2017 of $2.6 million which is reflected in “Restructuring and related charges, net of reversals” in the consolidated statements of operations.   

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We entered into a sublease agreement related to our Rio Robles facility during the third quarter of fiscal 2017 for the remaining duration of the lease. The sublease resulted in adjustments to the prior estimates for the amount of sublease payments, timing of sublease activities and real estate commissions associated with the sublease. The net adjustments, including modifications to our future obligations for non-cancellable lease payments and related future subleasing income resulted in additional charges of $2.0 million during fiscal 2017. The excess facilities payments will continue through fiscal year 2023.

In anticipation of the acquisitions of Campus Fabric Business and Data Center Business in fiscal 2018, we reoccupied the majority of the previously exited space at our Salem, New Hampshire location during our fiscal fourth quarter to accommodate the growth in headcount and lab facility requirements. This action resulted in a reversal of prior restructuring expense accruals of $1.3 million.

We also implemented a reduction-in-force which affected 90 employees.  We recorded severance and benefits charges of $5.6 million during the year ended June 30, 2017.  Cash payments of $3.8 million were made by June 30, 2017 with the remainder paid by the end of the second quarter of fiscal 2018.

Fiscal year 2016

During fiscal 2016, we incurred $11.0 million of restructuring charges. Excess facilities charges included accrued lease costs pertaining to the estimated future obligations for non-cancelable lease payments for excess facilities and contract termination charges of $5.4 million, acceleration of depreciation of leasehold improvements of $4.5 million, professional fees of $1.0 million and other expenses of $0.1 million.

Significant restructuring charges incurred during 2016, by location, included $1.8 million of charges for excess facilities pertaining to the estimated future obligations for non-cancelable lease payments at Rio Robles.  This represented 39% of the San Jose leased space.  We amended our facility lease at our North Carolina location and exited excess space while recording $4.1 million of charges, which included $3.1 million in accelerated depreciation of leasehold improvements. This action represented 36% of the North Carolina location lease space. We recorded $4.4 million of charges for excess facilities at our Salem location, which included $1.3 million in accelerated depreciation of leasehold improvements.  This action represented 27% of the Salem lease space.  

Amortization of Intangibles

During fiscal 2018, 2017 and 2016, we recorded $8.7 million, $8.7 million and $17.0 million, respectively, of amortization expenses in operating expenses primarily for certain intangibles related to the acquisitions of the Campus Fabric, Data Center and WLAN Businesses and Enterasys.  The lower amortization expense since fiscal 2017 was due to the Enterasys intangible assets becoming fully amortized during fiscal 2017.

Interest Income

Interest income was $2.8 million, $0.7 million and $0.1 million in fiscal years 2018, 2017 and 2016, respectively, representing an increase of $1.9 million in fiscal 2018 from fiscal 2017 and an increase of $0.6 million in fiscal 2017 from fiscal 2016. The increase in fiscal 2018 and 2017 was due to accretion of interest on a long-term note receivable acquired from the WLAN Business as well as increased interest income on cash balances due to rising market interest rates.

Interest Expense

We had $13.9 million, $4.1 million and $3.1 million of interest expense for fiscal 2018, 2017 and 2016, respectively.  The increase in interest expense in fiscal 2018 was primarily in connection with the increased balance of our Credit Facility due to the acquisitions of the WLAN, Campus Fabric and Data Center Businesses and accretion of interest expense of $3.1 million associated with the contingent consideration obligations. In addition, we recorded a loss from debt extinguishment of $1.2 million in fiscal 2018 in connection with our Credit Agreement entered on May 1, 2018.  The increase in interest expense for fiscal 2017 was related to our increased borrowings to finance the WLAN Business acquisition in October 2016.

Other Income (Expense), net

We incurred other income of $2.6 million, other expense of less than $0.1 million and other income of $1.0 million in fiscal 2018, 2017 and 2016, respectively.  The income for fiscal 2018 was primarily driven by a gain of $4.0 million due to the sale of equity investments, partially offset by foreign exchange losses.  The expense in fiscal 2017 and income in fiscal 2016 were primarily due to foreign exchange gains from the revaluation of certain assets and liabilities denominated in foreign currencies into U.S. Dollars.

Provision for Income Taxes

We are subject to income taxes in the United States and numerous foreign jurisdictions.  Our effective tax rate differs from the newly enacted U.S. federal statutory rate of 21% primarily due to the impact of state taxes, foreign operations, the full valuation of our deferred tax assets in the U.S. and certain foreign jurisdictions and for our fiscal year ended June 30, 2018, the phase in of the new tax rate making our U.S. rate for this particular tax year 28%.  For the fiscal years ended June 30, 2018, 2017 and 2016, we recorded income tax provisions of $0.1 million, $4.3 million and $4.3 million, respectively.

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For fiscal 2018, our tax provision primarily related to taxes on our foreign operations offset by two significant tax benefits resulting from Tax Reform and restructuring of our foreign operations. Income tax provision of $6.7 million consisted of taxes on the income of our foreign subsidiaries as well as tax expense associated with the establishment of a U.S. deferred tax liability for amortizable goodwill.  Partially offsetting the tax provision is a tax benefit of $3.1 million resulting from the reduction of the U.S. Federal tax rate from 35% to 21% applied to our deferred tax liability related to amortizable goodwill as required by the recently enacted U.S. tax legislation as well as a tax benefit resulting from the impairment of a lease acquired from Avaya in Canada. Additionally, we recorded a tax benefit resulting from the restructuring of our foreign operations of $3.4 million.

For fiscal 2017 and 2016, the majority of our tax provision related to taxes on our foreign operations as well as state taxes due to the full valuation allowance on our U.S. and certain foreign deferred tax assets.

For a full reconciliation of our effective tax rate to the U.S. federal statutory rate and for further explanation of our provisions for income taxes, see Note 15. Income Taxes, for additional information.

Critical Accounting Policies and Estimates

Our significant accounting policies are more fully described in Note 3 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. 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.

Revenue Recognition

We account for revenue in accordance with Topic 606, Revenue from Contracts with Customers, which we adopted on July 1, 2017, using the full retrospective method.  We derive the majority of our revenue from sales of our networking equipment, with the remaining revenue generated from service fees relating to maintenance contracts, professional services, and training for our products. We sell our products and maintenance contracts direct to customers and to partners in two distribution channels, or tiers. The first tier consists of a limited number of independent distributors that stock our products and sell primarily to resellers.  The second tier of the distribution channel consists of a non-stocking distributors and value-added resellers that sell directly to end-users.  Products and services may be sold separately or in bundled packages.  

We consider customer purchase orders, which in some cases are governed by master sales agreements, to be the contracts with a customer.  For each contract, we consider the promise to transfer products and services, each of which are distinct, to be the identified performance obligations. In determining the transaction price, we evaluate whether the price is subject to refund or adjustment to determine the net consideration to which we expect to be entitled.

For all of our sales and distribution channels, revenue is recognized when control of the product is transferred to the customer (i.e., when our performance obligation is satisfied), which typically occurs at shipment for product sales. Revenue from maintenance contracts is recognized over time as our performance obligations are satisfied. This is typically the contractual service period, which ranges from one to three years.  For product sales to our value-added resellers, non-stocking distributors and end-user customers, we generally do not grant return privileges, except for defective products during the warranty period, nor do we grant pricing credits.  Sales incentives and other programs that we may make available to these customers are considered to be a form of variable consideration and we maintain estimated accruals and allowances using the expected value method.    

Sales to stocking distributors are made under terms allowing certain price adjustments and limited rights of return (known as “stock rotation”) of our products held in their inventory. Stock rotation rights grant the distributor the ability to return certain specified amounts of inventory. Stock rotation adjustments are an additional form of variable consideration and are estimated using the expected value method based on historical return rates.  Frequently, distributors need to sell at a price lower than the contractual distribution price in order to win business, and submit rebate requests for Company pre-approval prior to selling the product through at the discounted price.  At the time the distributor invoices our customer or soon thereafter, the distributor submits a rebate claim to us to adjust the distributor’s cost from the contractual price to the pre-approved lower price. After we verify that the claim was pre-approved, a credit memo is issued to the distributor for the rebate claim. In determining the transaction price, we consider these rebate adjustments to be variable consideration. Such price adjustments are estimated using the expected value method based on an analysis of actual claims, at the distributor level over a period of time considered adequate to account for current pricing and business trends.

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Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied.  Certain of our contracts have multiple performance obligations, as the promise to transfer individual goods or services is separately identifiable from other promises in the contracts and, therefore, is distinct.  For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation based on our relative standalone selling price.  The stand-alone selling prices are determined based on the prices at which we separately sell these products.  For items that are not sold separately, we estimate the stand-alone selling prices using the best estimated selling price approach.  

Our performance obligations are satisfied at a point in time or over time as work progresses.  Substantially all of our product sales revenues as reflected on the consolidated statements of operations for the years ended June 30, 2018, 2017 and 2016 are recognized at a point in time. Substantially all of our service revenue is recognized over time.  For revenue recognized over time, we use an input measure, days elapsed, to measure satisfaction of the performance obligation.  

Contract Balances. The timing of revenue recognition, billings and cash collections results in billed accounts receivable and deferred revenue in the consolidated balance sheets. Services provided under our renewable support arrangements are billed in accordance with agreed-upon contractual terms, which are typically at periodic intervals (e.g., quarterly or annually).  We sometimes receive payments from our customers in advance of services being provided, resulting in deferred revenues.  These liabilities are reported on the consolidated balance sheets on a contract-by-contract basis at the end of each reporting period.

Contract Costs.  We recognize the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that we otherwise would have recognized is one year or less.  Management expects that commission fees paid to sales representative as a result of obtaining service contracts and contract renewals are recoverable and therefore we capitalized them as contract costs.  Capitalized commission fees are amortized on a straight-line basis over the average period of service contracts of approximately three years, and are included in “Sales and marketing” in the accompanying consolidated statements of operations.  

Business Combinations

We apply the acquisition method of accounting for business combinations. Under this method of accounting, all assets acquired and liabilities assumed are recorded at their respective fair values at the date of the completion of the transaction. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, intangibles and other asset lives, among other items. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). Market participants are assumed to be buyers and sellers in the principal (most advantageous) market for the asset or liability. Additionally, fair value measurements for an asset assume the highest and best use of that asset by market participants. As a result, we may have been required to value the acquired assets at fair value measures that do not reflect its intended use of those assets. Use of different estimates and judgments could yield different results. Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. If the fair value of net assets acquired exceeds the fair value of purchase price, a gain on bargain purchase is recognized in the statements of operations. Although we believe the assumptions and estimates we have made are reasonable and appropriate, they are based in part on historical experience and information that may be obtained from the management of the acquired company and are inherently uncertain. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations.

Inventory Valuation and Purchase Commitments

We write down inventory and record purchase commitment liabilities for estimated excess and obsolete inventory equal to the difference between the cost of inventory and the estimated market value based upon the forecast of future product demand, product transition cycles, and market conditions. Any significant unanticipated changes in demand or technological development could have a significant impact on the value of our inventory and purchase commitments and our reported results. If actual market conditions are less favorable than those projected, additional inventory write-downs, purchase commitment liabilities, and charges against earnings may be required.

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New Accounting Pronouncements

See Note 2. Summary of Significant Accounting Policies, in the accompanying consolidated financial statements for a full description of new accounting pronouncements, including the respective expected dates of adoption and effects on results of operations and financial condition.

Liquidity and Capital Resources

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

 

 

As of June 30, 2018, our principal sources of liquidity consisted of cash, cash equivalents and investments of $122.6 million, accounts receivable, net of $212.4 million and availability of borrowings from the New Revolving Facility of $28.7 million.  We anticipate that our principal uses of cash for fiscal 2019 will be purchases of finished goods inventory from our contract manufacturers, payroll, repayments of debt and related interest, and other operating expenses related to the development, marketing of our products and purchases of property and equipment.  We believe that our cash, cash equivalents, investments and cash flows from operations along with the availability of additional borrowings from our Credit Agreement, will be sufficient to fund our principal uses of cash for at least the next 12 months.

On May 1, 2018, the Company terminated the Amended and Restated Credit Agreement dated October 28, 2016, by and among the Company, as borrower, Silicon Valley Bank, as administrative agent, and the financial institutions that were a party thereto as lenders.

On May 1, 2018, the Company entered into a Credit Agreement (the “Credit Agreement”), by and among the Company, as borrower, BMO Harris Bank N.A., as an issuing lender and swingline lender, Bank of Montreal, as administrative and collateral agent, and the financial institutions or entities that are a party thereto as lenders.  The Credit Agreement provides for i) a $40 million five-year revolving credit facility (the “New Revolving Facility”), ii) a $190 million five-year term loan (the “New Term Loan”) and, iii) an uncommitted additional incremental loan facility in the principal amount of up to $100 million (“New Incremental Facility”).  On May 1, 2018, the Company borrowed $200 million under the Credit Agreement in order to pay off the existing debt, as noted above and for general corporate purposes.

Borrowings under the Credit Agreement will bear interest, at the Company’s election, as of May 1, 2018, at a rate per annum equal to LIBOR plus 1.50% to 2.75%, or the adjusted base rate plus 0.50% to 1.75%, based on the Company’s consolidated leverage ratio. In addition, the Company is required to pay a commitment fee of between 0.25% and 0.40% quarterly (currently 0.35%) on the unused portion of the New Revolving Facility, also based on the Company’s consolidated leverage ratio.  Principal installments are payable on the New Term Loan in varying percentages quarterly starting September 30, 2018 and to the extent not previously paid, all outstanding balances are to be paid at maturity. The obligations under the Credit Agreement is secured by substantially all of the Company’s assets.

Financial covenants under the Credit Agreement require the Company to maintain a minimum consolidated fixed charge and consolidated leverage ratio at the end of each fiscal quarter through maturity.  The Credit Agreement also includes covenants and restrictions that limit, among other things, the Company’s ability to incur additional indebtedness, create liens upon any of its property, merge, consolidate or sell all or substantially all of its assets.  The Credit Agreement also includes customary events of default which may result in acceleration of the outstanding balance.  At June 30, 2018, we were in compliance with the covenants of the Credit Agreement.

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Key Components of Cash Flows and Liquidity

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

Cash and cash equivalents were $121.1 million at June 30, 2018, representing a decrease of $9.3 million from $130.5 million at June 30, 2017.  Cash and cash equivalents decreased primarily due to cash used in investing activities of $132.5 million mainly for the acquisitions of the Campus Fabric and Data Center Businesses and capital expenditures, partially offset by cash provided by financing activities of $104.7 million as a result of additional borrowings for the acquisitions and cash provided by operations of $19.0 million.

Cash and cash equivalents were $130.5 million at June 30, 2017, representing an increase of $36.4 million from $94.1 million at June 30, 2016.  Cash and cash equivalents increased primarily due to cash provided by operations of $59.3 million, and cash provided by financing activities of $48.7 million, offset by cash used in investing activities of $71.8 million.

Net Cash Provided by Operating Activities

Cash provided by operating activities during fiscal 2018 was $19.0 million. Factors contributing to cash provided by operating activities for the year ended June 30, 2018 were net loss of $46.8 million, increases in accounts receivable, prepaid expenses and other assets and non-cash expenses such as amortization of intangibles, stock-based compensation, depreciation, deferred income taxes, gain on bargain purchase and gain on sale of non-marketable equity investment.  These amounts were partially offset by a decrease in inventories, increases in accounts payable, accrued compensation and benefits, deferred revenue, other current and long-term liabilities.

Cash provided by operating activities during fiscal 2017 was $59.3 million. Factors contributing to cash provided by operating activities for the year ended June 30, 2017 were decreases in inventory and prepaid expenses, and increases to accrued compensation and benefits, deferred revenues and other liabilities in addition to non-cash expenses such as amortization of intangibles, stock-based compensation, and depreciation.  These amounts were partially offset by an increase in accounts receivables and net loss of $1.7 million.

Cash provided by operating activities during fiscal 2016 was $30.4 million.  Factors contributing to cash provided by operating activities for the year ended June 30, 2016 were decreases in accounts receivables and inventory in addition to non-cash expenses such as amortization of intangibles, stock-based compensation, and depreciation.  These amounts were partially offset by net loss of $36.4 million and decreases in deferred revenues and accounts payable.

Net Cash Used in Investing Activities

Cash used in investing activities during fiscal 2018 was $132.5 million mainly due to our acquisitions of the Campus Fabric and Data Center Businesses of $97.6 million and capital expenditures of $40.4 million.

Cash used in investing activities during fiscal 2017 was $71.8 million mainly due to our acquisition of the WLAN Business of $51.1 million, deposits for future acquisitions of $10.2 million and capital expenditures of $10.4 million.

Cash used in investing activities during fiscal 2016 was $5.3 million mainly due to capital expenditures.

Net cash Provided by (Used in) Financing Activities

Cash provided by financing activities during fiscal 2018 was $104.7 million due primarily to additional borrowings of $100.0 million to fund our acquisitions of the Campus Fabric and Data Center Businesses, new borrowings of $200 million under the Credit Agreement to pay off the existing debt under the prior Credit Facility, $3.3 million of proceeds from issuance of shares of our common stock under our Employee Stock Purchase Plan (“ESPP”) and the exercise of stock options, net of taxes paid on vested and released stock awards, partially offset by repayments of debt totaling $193.7 million, $3.2 million of loan fees incurred in connection with the Second Amendment of our Credit Facility and the Credit Agreement and $1.7 million of contingent consideration and deferred payments on acquisitions.

Cash provided by financing activities during fiscal 2017 was $48.7 million due primarily to $48.3 million in borrowings of debt pursuant to our WLAN Business acquisition, $11.8 million in proceeds from the sale of our common stock, primarily through the exercise of stock options and our ESPP, partially offset by repayments of debt of $10.0 million.

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Cash flow used in financing activities during fiscal 2016 was $6.7 million mainly due to $26.4 million in repayments of debt, offset by borrowings of $15.0 million on the Revolving Facility for working capital requirements and proceeds from the sale of common stock of $4.6 million primarily through our ESPP.

Contractual Obligations

The following summarizes our contractual obligations at June 30, 2018, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

Debt obligations relate to amounts owed under our Credit Agreement.

Non-cancelable inventory purchase commitments represent the purchase of long lead-time component inventory that our contract manufacturers procure in accordance with our forecast.  

Contractual commitments represent the Data Center Business consideration contingency resolution and future services.

Deferred payments represent Data Center Business consideration obligation of $1.0 million per quarter.

Contingent consideration for the Capital Financing Business acquisition, at fair value.  Actual payments could be different.

Non-cancelable operating lease obligations represent base rents and operating expense obligations.

Other liabilities include our commitments towards debt related fees and specific arrangements other than inventory.

The amounts in the table above exclude immaterial income tax liabilities related to uncertain tax positions as we are unable to reasonably estimate the timing of the settlement.

We did not have any material commitments for capital expenditures as of June 30, 2018.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as of June 30, 2018.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

Our exposure to market risk for changes in interest rates relates primarily to our financial investments and debt. We usually invest our cash in investments with short maturities or with frequent interest reset terms. Accordingly, our interest income fluctuates with short-term market conditions.  As of June 30, 2018, we did not have any financial investments that were exposed to interest rate risk.

   Debt

At certain points in time we are exposed to the impact of interest rate fluctuations, primarily in the form of variable rate borrowings from the Credit Agreement which is fully described in Note 8. Debt, of our Notes to the Consolidated Financial Statements.  At June 30, 2018 we had $200.0 million of debt outstanding, all of which was from the Credit Agreement.  Through the end of our fiscal year, the average daily outstanding amount was $181.1 million with a high of $200.0 million and a low of $93.7 million.   

The following table presents hypothetical changes in interest expense for the year ended June 30, 2018, on the outstanding Credit Agreement, borrowings as of June 30, 2018, that are sensitive to changes in interest rates (in thousands):

 

 

Exchange Rate Sensitivity

A majority of our sales and our expenses are denominated in United States Dollars.  While we conduct sale 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 (loss), net. From time to time, we enter into foreign exchange forward contracts to mitigate the effect of gains and losses generated by the foreign currency forecast transactions related to certain operating expenses and re-measurement of certain assets and liabilities denominated in foreign currencies. These derivatives do not qualify as hedges. Changes in the fair value of these foreign exchange forward contracts are offset largely by re-measurement of the underlying assets and liabilities. At June 30, 2018 and 2017, we had outstanding foreign currency forward contracts with a notional value of $5.0 million and $6.7 million respectively.

Foreign currency transaction gains and losses from operations were losses of $1.2 million and $0.7 million in fiscal years 2018 and 2017, respectively and gains of $1.3 million in fiscal 2016.

 

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Item 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS OF EXTREME NETWORKS, INC.

 

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Extreme Networks, Inc.:

 

Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting

We have audited the accompanying consolidated balance sheets of Extreme Networks, Inc. and subsidiaries (the “Company”) as of June 30, 2018 and 2017, the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the years in the three-year period ended June 30, 2018, and the related notes (collectively, the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of June 30, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.  

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of June 30, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 2018, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.  

During the year ended June 30, 2018, the Company completed its acquisitions of the fabric-based secure networking solutions and network security solutions business of Avaya Inc., the data center business of Brocade Communication Systems, Inc., and the capital financing business from Broadcom Corporation, (collectively, the “Acquisitions”) and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2018, the Acquisitions’ internal control over financial reporting associated with total assets of 20% and total revenues of 33% included in the consolidated financial statements of the Company as of and for the year ended June 30, 2018.  Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of the Acquisitions.  

Change in Accounting Principle

As discussed in Note 3 to the consolidated financial statements, the Company has changed its method of accounting for revenue from contracts with customers for each of the years in the three-year period ended June 30, 2018 due to the adoption of ASU 2014-09, Revenue from Contracts with Customers (Topic 606).

Basis for Opinions

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting under Item 9A. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

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A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ KPMG LLP

We have served as the Company’s auditor since 2010.

Raleigh, North Carolina

August 29, 2018

 

 

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EXTREME NETWORKS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

 

See accompanying notes to consolidated financial statements.

 

 

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CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

 

 

See accompanying notes to consolidated financial statements.

 

 

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EXTREME NETWORKS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

 

 

See accompanying notes to consolidated financial statements.

 

 

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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

 

See accompanying notes to consolidated financial statements.

 

 

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EXTREME NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

See accompanying notes to the consolidated financial statements.

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

1. Description of Business and Basis of Presentation

Extreme Networks, Inc., together with its subsidiaries (collectively referred to as “Extreme” or “the Company”) is a leader in providing software-driven networking solutions for enterprise customers.  The Company conducts its sales and marketing activities on a worldwide basis through distributors, resellers and the Company’s field sales organization. Extreme was incorporated in California in 1996 and reincorporated in Delaware in 1999.

Effective July 1, 2017, the Company adopted the requirements of Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). All amounts and disclosures set forth in this Form 10-K have been updated to comply with the new standards, as indicated by the “as adjusted” footnote.

Fiscal Year

The Company uses a fiscal calendar year ending on June 30.  All references herein to “fiscal 2018” or “2018”; “fiscal 2017” or “2017”; “fiscal 2016” or “2016” represent the fiscal years ending 2018, 2017 and 2016, respectively.

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 predominantly uses the United States Dollar 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 month end rates of exchange; and revenue and expenses are translated using the monthly average rate.

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 amounts reported in the financial statements and accompanying notes. Actual results could differ materially from these estimates.

2. Summary of Significant Accounting Policies

Revenue Recognition

The Company derives revenues primarily from sales of its networking equipment, with the remaining revenue generated from service fees relating to maintenance contracts, professional services, and training for the products. The Company recognizes revenues when control of promised goods or services is transferred to its customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.

See Note 3. Revenues, for further discussion.

Cash, Cash Equivalents and Marketable Securities

The Company considers highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Marketable securities are recorded in “Prepaid expense and other current assets” in the accompanying consolidated balance sheet as these are publicly-traded equity securities with maturities of greater than three months, but less than one year at the balance sheet date. Marketable securities are classified as available-for-sale and reported at fair value with unrealized gains and losses included, net of tax, in accumulated other comprehensive loss, a component of stockholders’ equity. Realized gains and losses and declines in the value of available-for-sale securities determined to be other than temporary are included in other income (expense), net. The cost of securities sold is determined based on the specific identification method.

Allowance for Product Returns

The Company provides an allowance for product returns based on its historical returns, analysis of credit memo data and its return policies. The allowance includes the estimates for product allowances from end customers as well as stock rotations and other returns from the Company’s stocking distributors. The allowance for product returns is a reduction of accounts receivable. If the historical data that the Company uses to calculate the estimated product returns and allowances does not properly reflect actual levels of product returns, these estimates will be revised, resulting in an impact on net revenue. The allowance for product returns estimate is also impacted by the timing of the actual product return from the customer.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts which reflects its best estimate of potentially uncollectible trade receivables. The allowance consists of both specific and general reserves. The Company continually monitors and evaluates the collectability of its trade receivables based on a combination of factors. It records specific allowances for bad debts in general and administrative expense when it becomes aware of a specific customer’s inability to meet its financial obligation to the Company, such as in the case of bankruptcy filings or deterioration of financial position. Estimates are used in determining the 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 and Australia, to pay cash in advance or secure letters of credit when placing an order with the Company.

Inventories

The Company values its inventory at lower of cost or net realizable value. Cost is computed using standard cost, which approximates actual cost, on a first-in, first-out basis. The Company has established inventory allowances when conditions exist that suggest that inventory may be in excess of anticipated demand based upon assumptions about future demand or is obsolete. 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. Previously written down or obsolete inventory subsequently sold has not had a material impact on gross margin for any of the periods presented.

Long-Lived Assets

Long-lived assets include (a) property and equipment, (b) goodwill and intangible assets, and (c) other assets. Property and equipment and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets or asset groups may not be recoverable. If such facts and circumstances exist, the Company assesses the recoverability of these assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairments, if any, are based on the excess of the carrying amount over the fair value of those assets.

(a) 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. Estimated useful lives of one to four years are used for computer equipment and software. Estimated useful lives of three to seven years are used for office equipment, furniture and fixtures. Depreciation and amortization of leasehold improvements is computed using the lesser of the useful life or lease terms (ranging from two to ten years).

(b) Goodwill and Intangible Assets

Goodwill and indefinite-lived intangible assets are generated as a result of business combinations. The Company’s indefinite-lived intangible assets are comprised of acquired in-process research and development (“IPR&D”), which is treated as indefinite until the completion or abandonment of the associated research and development effort. During the development period, the Company conducts an IPR&D impairment test at least annually or whenever events or changes in facts and circumstances indicate that it is more likely than not that the IPR&D is impaired. Events which might indicate impairment include, but are not limited to, adverse cost factors, deteriorating financial performance, strategic decisions made in response to economic, market, and competitive conditions, the impact of the economic environment on the Company and its customer base, and/or other relevant events such as changes in management, key personnel, litigations, or customers. Management did not identify any triggering events for any periods presented. Intangible assets other than acquired IPR&D are not considered to have an indefinite life and are amortized over their useful lives. The Company reevaluates the estimated remaining useful life of acquired intangible assets whenever events or changes in circumstances indicate a revision to the remaining period of amortization might be necessary. The carrying amounts of these assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Goodwill is calculated as the excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired. Goodwill is not amortized, but rather is tested for impairment at least annually or more frequently if indicators of impairment are present. The Company performs its annual goodwill impairment analysis as of the first day of the fourth quarter of each year. The Company adopted ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment in fiscal 2018, which eliminated step two from the goodwill impairment test. In assessing impairment on goodwill, the Company bypasses the qualitative assessment and proceed directly to performing the quantitative evaluation of the fair value of the reporting unit, to compare against the carrying value of the reporting unit. A goodwill impairment charge is recognized for the amount by which the reporting unit’s fair value is less than its carrying value. Any loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Based on the results of the goodwill impairment analyses, the Company determined that no impairment charge needed to be recorded for any periods presented.

(c) Other Assets

Other assets consist primarily of service parts and long-term deposits. The Company holds service parts to support customers who have purchased service contracts with a hardware replacement element, as well as to support its warranty program. The Company reduces the carrying value of service parts to net realizable value based on expected quantities needed to satisfy contractual service requirements of customers.

Business Combinations

The Company applies the acquisition method of accounting for business combinations. Under this method of accounting, all assets acquired and liabilities assumed are recorded at their respective fair values at the date of the acquisition. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, intangibles and other asset lives, among other items. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are assumed to be buyers and sellers in the principal (most advantageous) market for the asset or liability. Additionally, fair value measurements for an asset assume the highest and best use of that asset by market participants. As a result, the Company may be required to value the acquired assets at fair value measures that do not reflect its intended use of those assets. Use of different estimates and judgments could yield different results.

Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. If the fair value of net assets acquired exceeds the fair value of purchase price, a gain on bargain purchase is recognized within the statements of operations. Although the Company believes the assumptions and estimates it has made are reasonable and appropriate, they are based in part on historical experience and information that may be obtained from the management of the acquired company and are inherently uncertain. During the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill for facts and considerations that were known at the acquisition date. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded within the Company’s consolidated statements of operations.

Deferred Revenue

Deferred revenue represents amounts for (i) deferred maintenance and support revenue and (ii) other deferred revenue including professional services and training when the revenue recognition criteria have not been met.   

Product Warranties and Guarantees

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. 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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 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.

Stock-based Compensation

The Company recognizes compensation expense related to stock-based awards, including stock options, restricted stock units (“RSUs”) and employee stock purchases related to its 2014 Employee Stock Purchase Plan (the “2014 ESPP”), based on the estimated fair value of the award on the grant date, over the requisite service period. The Company accounts for forfeitures as they occur. The Company calculates the fair value of stock option using the Black-Scholes-Merton option valuation model. The fair value of RSUs represents the closing stock price of the Company’s common stock on the grant date. The Company calculates the fair value of share purchase option under the 2014 ESPP using the Black-Scholes-Merton option valuation model.

The Company grants certain employees performance-based stock options and RSUs. The performance metrics include company-wide financial performance and/or market conditions. For awards that include performance conditions, no compensation cost is recognized until the performance goals are probable of being met, at which time the cumulative compensation expense from the service inception date would be recognized. For awards that contain market conditions, compensation expense is measured using a Monte Carlo simulation model and recognized over the derived service period based on the expected market performance as of the grant date.

Advertising

Advertising costs are expensed as incurred. Advertising expenses were $0.5 million, $0.4 million and $0.3 million in fiscal years 2018, 2017 and 2016, respectively.

Income Taxes

The Company accounts for income taxes utilizing the liability method. Deferred income taxes are recorded to reflect consequences on future years of differences between financial reporting and the tax basis of assets and liabilities measured using the enacted statutory tax rates and tax laws applicable to the periods in which differences are expected to affect taxable earnings. A valuation allowance is recognized to the extent that it is more likely than not that the tax benefits will not be realized.

The Company accounts for uncertainty in income taxes using a two-step approach to recognize and measure uncertain tax positions.  The first step is to evaluate the tax position by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. The Company classifies the liability for unrecognized tax benefits as current to the extent that the Company anticipates payment (or receipt) of cash within one year. Interest and penalties related to uncertain tax positions are recognized in the provision for income taxes.  For additional discussion, see Note 15. Income Taxes.

Concentrations

The Company may be subject to concentration of credit risk as a result of certain financial instruments consisting of accounts receivable and short-term investments. The Company performs ongoing credit evaluations of its customers and generally does not require collateral in exchange for credit.

The following table sets forth major customers accounting for 10% or more of the Company’s net revenue:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The following table sets forth major customers accounting for 10% or more of the Company’s accounts receivable balance:

*Less than 10% of accounts receivable

Recently Issued Accounting Pronouncements

In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting which amends the scope of modification accounting for share-based payment arrangements and provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under Topic 718. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. The guidance is effective prospectively for fiscal years beginning after December 15, 2017, and interim periods within that reporting period. Early adoption is permitted, including adoption in any interim period. The adoption of this guidance will not have a material effect on the Company’s financial statements. This guidance will be effective for the Company beginning with its fiscal year 2019.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments to provide guidance on the classification of eight cash flow issues in order to reduce diversity in practice. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within that reporting period. The amendments in this update should be applied using a retrospective transition method to each period presented. If impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. The adoption of this guidance will not have a material effect on the Company’s presentation of cash flows. This guidance will be effective for the Company beginning with its fiscal year 2019.

In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, which requires the recognition of the income tax effects of intercompany sales and intra-entity transfers of assets, other than inventory, when the transfer occurs. ASU 2016-16 amends current U.S. GAAP that prohibits recognition of current and deferred income taxes for all types of intra-entity asset transfers until the asset has been sold to a third party or otherwise recovered through use. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within that reporting period, and is applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact of the adoption of this standard will have on its consolidated financial statements. This guidance will be effective for the Company beginning with its fiscal year 2019.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which provides guidance for the recognition, measurement, presentation, and disclosure of financial assets and liabilities. This guidance will become effective for the Company beginning with its fiscal year 2019. Upon adoption, the Company will be required to reclassify the gain related to its available-for-sale investments from accumulated other comprehensive loss to accumulated deficit as a cumulative-effect adjustment and begin recording future changes in fair value through earnings. As of June 30, 2018, the Company had $0.5 million of unrealized holding gains, net of tax, related to its available-for-sale investments recorded in accumulated other comprehensive loss in the accompanying consolidated balance sheet.  Upon adoption of ASU 2016-01 on July 1, 2018, the Company will record an adjustment to accumulated deficit of $0.5 million to eliminate the unrealized gains balance in accumulated other comprehensive loss.

In August 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities which is intended to allow companies to better align risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results by expanding and refining hedge accounting for both nonfinancial and financial risk components and aligning the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The guidance is effective for fiscal years beginning after December 15, 2018. The Company is evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption. This guidance is effective for the Company beginning with its fiscal year 2020.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) which requires the identification of arrangements that should be accounted for as leases by lessees. In general, for lease arrangements exceeding a twelve-month term, these arrangements must now be recognized as assets and liabilities on the balance sheet of the lessee.  Under Topic 842, a right-of-use asset and lease obligation will be recorded for all leases, whether operating or financing, while the statement of operations will reflect lease

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

expense for operating leases and amortization/interest expense for financing leases.  The balance sheet amount recorded for existing leases at the date of adoption of Topic 842 must be calculated using the applicable incremental borrowing rate at the date of adoption. In addition, Topic 842 requires the use of the modified retrospective method, which will require adjustment to all comparative periods presented in the consolidated financial statements. The Company is currently assessing the impact that adopting this new accounting standard will have on its consolidated financial statements and footnote disclosures. The Company believes that Topic 842 will have a material impact on its financial position, as a result of recognizing right-of-use assets and lease liabilities on its consolidated balance sheets.  The Company is also evaluating the impact to the Company’s results of operations and does not believe there will be a material impact to its consolidated statements of operations or consolidated cash flow statements upon adoption of Topic 842. This guidance will be adopted by the Company beginning with its fiscal year 2020.

Recently Adopted Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09 (Topic 606) – Revenue from Contracts with Customers. Topic 606 supersedes the revenue recognition requirements in the FASB ASC 605 – Revenue Recognition (Topic 605), and requires entities to recognize revenues when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The Company adopted Topic 606 as of July 1, 2017 using the full retrospective transition method. See Note 3 for further details.

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under the amendments in ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for annual and any interim impairment tests performed for periods beginning after December 15, 2019 on a prospective basis, and earlier adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The Company’s early adoption of this accounting standard update in the fourth quarter of fiscal 2018 on a prospective basis did not have an impact on its consolidated financial statements. The adoption of this update simplified the Company’s annual goodwill impairment testing process by eliminating the need to estimate the implied fair value of a reporting unit’s goodwill if its respective carrying value exceeds fair value.

 

 

3. Revenues

Adoption of ASC Topic 606 – Revenue from Contracts with Customers

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). Under ASU 2014-09, revenue is recognized when a customer obtains control of promised goods or services and is recognized at an amount that reflects the consideration expected to be received in exchange for such goods or services.  In addition, ASU 2014-09 requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

The Company adopted Topic 606 on July 1, 2017, using the full retrospective method. This adoption primarily affected the Company’s accounting for distributor and resellers revenues from a primarily “sell-through” model, where revenue is recognized upon the sale from the distribution channel to the end customer, to the “sell-in” method where revenue is recognized upon transfer of control to the Company’s customers. Under the sell-in method, the Company is required to make estimates at the time of transfer of control to its distributors for variable consideration including estimated returns under stock rotation rights granted to stocking distributors and rebate claims.  Additionally, the Company capitalizes contract acquisition costs such as commissions paid for maintenance services contracts in excess of one year.  Following the adoption of ASU 2014-09, the revenue recognition for the Company’s other sales arrangements remained materially consistent with its historical practice.

Upon adoption of Topic 606, the Company applied certain permissible practical expedients that allows a) an entity to use the transaction price at the date the contract was completed rather than estimating variable consideration amounts in the comparative reporting periods, b) that permits the omission of prior-period information about its performance obligations, and c) that allows the Company to reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented when identifying the satisfied and unsatisfied performance obligations, determining the transaction price and allocating the transaction price to the satisfied and unsatisfied performance obligations.

Revenue Recognition

The Company accounts for revenue in accordance with Topic 606, Revenue from Contracts with Customers, which the Company adopted on July 1, 2017, using the full retrospective method.  The Company derives the majority of its revenue from sales of its networking equipment, with the remaining revenue generated from service fees relating to maintenance contracts, professional

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services, and training for its products. The Company sells its products and maintenance contracts direct to customers and to partners in two distribution channels, or tiers. The first tier consists of a limited number of independent distributors that stock its products and sell primarily to resellers.  The second tier of the distribution channel consists of a non-stocking distributors and value-added resellers that sell directly to end-users.  Products and services may be sold separately or in bundled packages.  

The Company considers customer purchase orders, which in some cases are governed by master sales agreements, to be the contracts with a customer.  For each contract, the Company considers the promise to transfer products and services, each of which are distinct, to be the identified performance obligations.  In determining the transaction price, the Company evaluates whether the price is subject to refund or adjustment to determine the net consideration to which the Company expects to be entitled.

For all of the Company’s sales and distribution channels, revenue is recognized when control of the product is transferred to the customer (i.e., when the Company’s performance obligation is satisfied), which typically occurs at shipment for product sales. Revenue from maintenance contracts is recognized over time as the Company’s performance obligations are satisfied. This is typically the contractual service period, which ranges from one to three years.  For product sales to value-added resellers of the Company, non-stocking distributors and end-user customers, the Company generally does not grant return privileges, except for defective products during the warranty period, nor does the Company grant pricing credits.  Sales taxes collected from customers are excluded from revenues.  Shipping costs are included in cost of product revenues. Sales incentives and other programs that the Company may make available to these customers are considered to be a form of variable consideration and the Company maintains estimated accruals and allowances using the expected value method. There were no material changes in the current period to the estimated transaction price for performance obligations which were satisfied or partially satisfied during previous periods.    

Sales to stocking distributors are made under terms allowing certain price adjustments and limited rights of return (known as “stock rotation”) of the Company’s products held in their inventory. Stock rotation rights grant the distributor the ability to return certain specified amounts of inventory. Stock rotation adjustments are an additional form of variable consideration and are estimated using the expected value method based on historical return rates.  Frequently, distributors need to sell at a price lower than the contractual distribution price in order to win business, and submit rebate requests for the Company’s pre-approval prior to selling the product to a customer at the discounted price.  At the time the distributor invoices its customer or soon thereafter, the distributor submits a rebate claim to the Company to adjust the distributor’s cost from the contractual price to the pre-approved lower price. After the Company verifies that the claim was pre-approved, a credit memo is issued to the distributor for the rebate claim. In determining the transaction price, the Company considers these rebate adjustments to be variable consideration. Such price adjustments are estimated using the expected value method based on an analysis of actual claims, at the distributor level over a period of time considered adequate to account for current pricing and business trends. There were no material changes in the current period to the estimated variable consideration for performance obligations which were satisfied or partially satisfied during previous periods. 

Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied.  Certain of the Company’s contracts have multiple performance obligations, as the promise to transfer individual goods or services is separately identifiable from other promises in the contracts and, therefore, is distinct.  For contracts with multiple performance obligations, the Company allocates the contract’s transaction price to each performance obligation based on its relative standalone selling price.  The stand-alone selling prices are determined based on the prices at which the Company separately sells these products.  For items that are not sold separately, the Company estimates the stand-alone selling prices using the best estimated selling price approach.  

The Company’s performance obligations are satisfied at a point in time or over time as work progresses.  Substantially all of the Company’s product revenues as reflected on the consolidated statements of operations for the years ended June 30, 2018, 2017 and 2016 are recognized at a point in time. Substantially all of the Company’s service revenue is recognized over time.  For revenue recognized over time, the Company uses an input measure, days elapsed, to measure satisfaction of the performance obligation.  

At June 30, 2018, the Company had $174.5 million of remaining performance obligations, which is comprised of deferred maintenance revenue and services not yet delivered.  The Company expects to recognize approximately 75 percent of its remaining performance obligations as revenue in fiscal 2019, an additional 15 percent by fiscal 2020 and 10 percent of the balance thereafter.

Contract Balances. The timing of revenue recognition, billings and cash collections results in billed accounts receivable and deferred revenue in the consolidated balance sheets. Services provided under renewable support arrangements of the Company are billed in accordance with agreed-upon contractual terms, which are typically at periodic intervals (e.g., quarterly or annually).  The Company sometimes receives payments from its customers in advance of services being provided, resulting in deferred revenues.  These liabilities are reported on the consolidated balance sheets on a contract-by-contract basis at the end of each reporting period.

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Revenue recognized for the years ended June 30, 2018 and 2017, that was included in the deferred revenue balance at the beginning of each period was $76.6 million and $70.5 million, respectively.

Contract Costs.  The Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less.  Management expects that commission fees paid to sales representative as a result of obtaining service contracts and contract renewals, in excess of one year, are recoverable and therefore the Company capitalized them as contract costs in the amount of $4.3 million and $2.5 million at June 30, 2018 and 2017, respectively, in “Other assets” in the accompanying consolidated balance sheets.  Capitalized commission fees are amortized on a straight-line basis over the average period of service contracts of approximately three years, and are included in “Sales and marketing” in the accompanying consolidated statements of operations.  Amortization recognized during the years ended June 30, 2018, 2017 and 2016 was $2.1 million, $1.5 million and $0.9 million, respectively.

Revenue by Category: The following tables set forth the Company’s revenue disaggregated by sales channel and geographic region based on the billing addresses of its customers (in thousands):

 

 

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Adjustments to Previously Reported Financial Statements from the Adoption of Accounting Pronouncements

The following table presents the effect of the adoption of ASU 2014-09 on the Company’s consolidated balance sheet as of June 30, 2017, (in thousands):

The following tables present the effect of the adoption of ASU 2014-09 on the Company’s consolidated statements of operations for the years ended June 30, 2017 and 2016 (in thousands, except per share amounts):

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The following tables present the effect of the adoption of ASU 2014-09 on the Company’s consolidated statement of cash flows for the years ended June 30, 2017 and 2016 (in thousands):

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4. Business Combinations

The Company completed three acquisitions during the year ended June 30, 2018 and an acquisition during the year ended June 30, 2017. The acquisitions have been accounted for using the acquisition method of accounting. The purchase price has been allocated to tangible and identifiable intangible assets acquired and liabilities assumed. The fair value of working capital related items, such as other current assets and accrued liabilities, approximated their book values at the date of acquisition.  Inventories were valued at fair value using the net realizable value approach. The fair value of property and equipment was determined using a cost approach. The fair value of the acquired deferred revenue was estimated using the cost build-up approach. The cost build-up approach determines fair value using estimates of the costs required to provide the contracted deliverables plus an assumed profit. The total costs including the assumed profit were adjusted to present value using a discount rate considered appropriate. The resulting fair value approximates the amount that the Company would be required to pay to a third party to assume the obligation. Valuations of the intangible assets were valued using income approaches based on management projections, which the Company considers to be Level 3 inputs. The Company also continues to analyze the tax implications of the acquisition of the intangible assets which may ultimately impact the overall level of goodwill associated with the acquisition.  Results of operations of the acquired entities are included in the Company’s operations beginning with the closing date of each acquisition.

Fiscal 2018 Acquisitions

Data Center Business

The Company completed its acquisition of the data center business (the “Data Center Business”) of Brocade Communication Systems, Inc. (“Brocade”) on October 27, 2017 (the “Data Center Business Closing Date”), pursuant to an Asset Purchase Agreement (the “Data Center Business APA”) dated as of October 3, 2017, by and between the Company and Brocade. Under the terms and conditions of the Data Center Business APA, the Company acquired customers, employees, technology and other assets of the Data Center Business as well as assumed certain contracts and other liabilities of the Data Center Business.

The fair value of consideration transferred on the Data Center Business Closing Date includes:

The components of aggregate estimated purchase consideration are as follows (in thousands):

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The purchase price allocation as of the Data Center Business Closing Date is set forth in the table below and reflects fair values. The fair values were determined through established and generally accepted valuation techniques, including work performed by third-party valuation specialists.  All valuations were considered finalized as of June 30, 2018 (in thousands):

The changes during the measurement period in the table above include: a) finalization of the fair value of existing inventories as of the acquisition date, b) finalization of valuation of assets acquired with limited future use as of the acquisition date, c) identification of additional unpaid invoices existing as of the acquisition date, d) finalization of future cash flows related to deferred revenue contracts and, e) finalization of adjustments to discount rate and future cash flows.  

The following table presents details of the identifiable intangible assets acquired as part of the acquisition (dollars in thousands):

The amortization for the developed technology is recorded in “Cost of revenues” for product and the amortization for the remaining intangibles is recorded in “Amortization of intangibles” in the accompanying consolidated statements of operations. The goodwill recognized is attributable primarily to expected synergies and the assembled workforce of the Data Center Business. The Company anticipates both the goodwill and intangible assets to be fully deductible for income tax purposes.

Pursuant to negotiations regarding various contractual arrangements with Broadcom, in August 2018, the Company resolved its contingent consideration obligation related to the Data Center Business acquisition.  The outstanding balance was revalued to its final fair value as of June 30, 2018 resulting in a charge of $1.5 million which is included in “General and administrative” expense in the accompanying consolidated statements of operations.

The results of operations of the Data Center Business are included with those of the Company beginning October 28, 2017. The Data Center Business revenue for the year ended June 30, 2018 was $136.3 million and has been incorporated into the revenue of the Company. The associated expenses of the Data Center Business have been incorporated with the results of operations of the Company as a product line and, therefore, stand-alone operating results are not available. During the year ended June 30, 2018, the Company incurred acquisition and integration related expenses of $40.2 million associated with the acquisition of the Data Center Business, including a $25.0 million consent fee paid to terminate a previous asset purchase agreement entered into by the Company to purchase the Data Center Business from Broadcom Corporation, in anticipation of Broadcom’s proposed acquisition of Brocade. The fee was

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paid to allow the Company to buy the Data Center Business directly from Brocade. Such acquisition-related costs are included in “Acquisition and integration costs, net of bargain purchase gain” in the accompanying consolidated statements of operations. The costs, which the Company expensed as incurred, consist primarily of professional fees to financial and legal advisors and IT consultants.

Campus Fabric Business

The Company completed its acquisition of Avaya Inc.’s. (“Avaya”) fabric-based secure networking solutions and network security solutions business (the “Campus Fabric Business”) on July 14, 2017, (the “Campus Fabric Business Closing Date”) pursuant to an Asset Purchase Agreement (the “Campus Fabric Business APA”) dated March 7, 2017.  Under the terms and conditions of the Campus Fabric Business APA, the Company acquired the customers, employees, technology and other assets of the Campus Fabric Business, as well as assumed certain contracts and other liabilities of the Campus Fabric Business, for total consideration of $79.4 million, calculated as $100.0 million, less adjustments set forth in the Campus Fabric Business APA related to net working capital, deferred revenue, certain assumed lease obligations and certain assumed pension obligations for transferred employees of the Campus Fabric Business.

The acquisition has been accounted for using the acquisition method of accounting. The purchase price allocation as of the Acquisition Date is set forth in the table below and reflects fair values. The fair values were determined through established and generally accepted valuation techniques, including work performed by third-party valuation specialists.  All valuations were considered finalized as of June 30, 2018.

The following table below summarizes the final allocation as of June 30, 2018 of the tangible and identifiable intangible assets acquired and liabilities assumed (in thousands):

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Adjustments to the preliminary allocation as of the Closing Date through the final allocation during the measurement period as reflected in the table above include: a) identification of additional accounts receivable that existed as of the acquisition date, b) additional information on existing prepaid expenses as of the acquisition date, c) identification of additional property and equipment, d) adjustment to future cash flows of remaining performance obligations of certain customer contracts as of the acquisition date, e) identification of additional unpaid invoices as of the acquisition date, and f) finalization of adjustments to discount rate and future cash flows, g) additional receipts of inventory from Avaya pertaining to the Campus Fabric Business, h) reclassification of service parts to other assets, i) reclassification from deferred revenue to accounts payable, j) reclassification of long-term liabilities to short-term liabilities assumed, and k) adjustments to purchase consideration based on working capital settlement specifically related to inventory that could not be located.

The following table presents details of the identifiable intangible assets acquired as part of the acquisition (dollars in thousands):

The amortization for the developed technology is recorded in “Cost of revenues” for product and the amortization for the remaining intangibles is recorded in “Amortization of intangibles” in the accompanying consolidated statement of operations. The goodwill recognized is attributable primarily to expected synergies and the assembled workforce of the Campus Fabric Business. The Company anticipates both the goodwill and intangible assets to be fully deductible for income tax purposes. 

The Company also acquired an indefinite lived asset of $2.4 million which represents the fair value of in-process research and development activities. During the three months ended March 31, 2018, the related research and development efforts were completed and the Company reclassified the in-process research and development of $2.4 million to developed technology and began recognizing amortization expense over its estimated useful life.

The results of operations of the Campus Fabric Business are included in the accompanying consolidated results of operations beginning July 14, 2017. The Campus Fabric Business revenue for the year ended June 30, 2018 was $179.8 million and has been incorporated into the revenue of the Company. The associated expenses of the Campus Fabric Business have been incorporated with the results of operations of the Company as a product line and, therefore, stand-alone operating results are not available. In the year ended June 30, 2018, the Company incurred acquisition and integration related expenses of $18.7 million associated with the acquisition of the Campus Fabric Business. Such acquisition-related costs are included in “Acquisition and integration costs, net of bargain purchase gain” in the accompanying consolidated statements of operations. The costs, which the Company expensed as incurred, consist primarily of professional fees to financial and legal advisors and IT consultants and companies.

Capital Financing Business

On December 1, 2017, Company completed its acquisition of a capital financing business (the “CF Business”), pursuant to a Bill of Sale and Assignment and Assumption Agreement (the “Assumption Agreement”) between the Company and Broadcom. Under the terms and conditions of the Assumption Agreement, the Company acquired customers, employees, contracts and lease equipment of the CF Business for purchase consideration consisting of the earn out payments to Broadcom representing 90% of acquired financing receivables to be collected commencing at the closing date, which was determined to have a fair value of $13.0 million.

Net assets acquired included financing receivables of $13.7 million, lease equipment of $3.5 million and identifiable intangible assets of $0.8 million.  As the fair value of the net assets acquired exceeded the fair value of the purchase consideration, the Company recorded a bargain purchase gain of $5.0 million which is included in “Acquisition and integration costs, net of bargain purchase gain” in the accompanying consolidated statements of operations. Acquisition and integration related expenses associated with the acquisition of the CF Business were immaterial.

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Fiscal 2017 Acquisition

On October 28, 2016, the Company completed its acquisition of the wireless local area network business (“WLAN Business”) from Zebra Technologies Corporation. Under the terms of the WLAN Asset Purchase Agreement, the Company acquired customers, employees, technology and other assets as well as assumed certain contracts and other liabilities of the WLAN Business, for a net cash consideration of $49.5 million. The following table below summarizes the final allocation of the tangible and identifiable intangible assets acquired and liabilities assumed (in thousands):

The amortization for the developed technology is recorded in “Cost of revenues” for product and the amortization for the remaining intangibles is recorded in “Amortization of intangibles” on the consolidated statements of operations. The goodwill recognized is attributable primarily to expected synergies and the assembled workforce of the WLAN Business. The Company anticipates both the goodwill and intangible assets to be fully deductible for tax purposes. 

The Company also acquired an indefinite lived asset of $1.4 million which represents the fair value of in-process research and development activities. The in-process research and development was reclassified to developed technology upon completion of the project as of June 30, 2018 and is being amortized over its estimated useful life.

Pro forma financial information

The following unaudited pro forma results of operations are presented as though the acquisitions of the Data Center Business, Campus Fabric Business, CF Business and WLAN Business had occurred as of the beginning of the earliest period presented after giving effect to purchase accounting adjustments relating to inventories, deferred revenue, depreciation and amortization on acquired property and equipment and intangibles, acquisition costs, interest income and expense and related tax effects.

The pro forma results of operations are not necessarily indicative of the combined results that would have occurred had the acquisition been consummated as of the earliest period presented, nor are they necessarily indicative of future operating results. The unaudited pro forma results do not include the impact of synergies, nor any potential impacts on current or future market conditions which could alter the unaudited pro forma results.

The unaudited pro forma financial information for the year ended June 30, 2018, combines the results for Extreme for the year ended June 30, 2018, which include the results of the Data Center Business, CF Business and Campus Fabric Business subsequent to their acquisition dates and their historical results up to the acquisition date.

The unaudited pro forma financial information for the year ended June 30, 2017, combines the historical results for Extreme for those periods, as adjusted for the adoption of Topic 606, with the historical results of the Data Center Business, CF Business and Campus Fabric Business for the year ended June 30, 2017, as well as the historical results of the WLAN Business prior to the WLAN Business acquisition date.

Pro forma results of operations from the Data Center Business, CF Business, Campus Fabric Business and WLAN Business acquisitions included in the pro forma results of operations have not been adjusted for the adoption of Topic 606 because the Company determined that it is impractical to estimate the impact of the adoption.

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The following table summarizes the unaudited pro forma financial information (in thousands, except per share amounts):

 

 

5. Balance Sheet Components

Cash, Cash Equivalents and Marketable Securities

The following is a summary of cash, cash equivalents and marketable securities (in thousands):

 

 

Marketable securities are recorded in “Prepaid expenses and other current assets” in the accompanying consolidated balance sheets.

Accounts Receivable

The following is a summary of Accounts receivable (in thousands):

The following table is a summary of the allowance for doubtful accounts (in thousands):

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The following table is a summary of the Company’s allowance for product returns (in thousands):

Inventories

The following is a summary of the Company’s inventory by category (in thousands):

Property and Equipment, Net

The Company recognized depreciation expense of $23.5 million, $10.6 million, and $10.8 million related to property and equipment during the years ended June 30, 2018, 2017, and 2016, respectively.

Deferred Revenue

The following table summarizes deferred revenue (in thousands):

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Accrued Warranty

The following table summarizes the activity related to the Company’s product warranty liability during the following periods (in thousands):

Other Long-term Liabilities

The following is a summary of long-term liabilities (in thousands):

 

 

6. Fair Value Measurements

A three-tier fair value hierarchy is utilized to prioritize the inputs used in measuring fair value. The hierarchy gives the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels are defined as follows:

The following table presents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis (in thousands):

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 Level 1 investments:    

The Company holds investments in equity securities acquired from the sale of an investment in non-marketable equity securities during the first quarter of fiscal 2018, which is classified as available-for-sale marketable securities at Level 1 as the investments have readily determinable fair value (see below, Level 3 investments). An unrealized holding gain on the investments was $0.5 million as of June 30, 2018 which will be reclassified from accumulated other comprehensive loss to accumulated deficit on July 1, 2018 upon an adoption of ASU 2016-01 (see Note 2).

Level 2 investments:    

The Company includes U.S. government and sovereign obligations, most government agency securities, investment-grade corporate bonds, and state, municipal and provincial obligations for which quoted prices are available as Level 2. There were no transfers of assets or liabilities between Level 1 and Level 2 for the periods presented.

The fair value of the borrowings under the Credit Agreement is estimated based on valuations provided by alternative pricing sources supported by observable inputs which is considered Level 2.  Due to the short duration until maturity of the Credit Agreement, the fair value approximates the face amount of the Company’s indebtedness of $200.0 million and $93.7 million as of June 30, 2018 and 2017, respectively.  Such differences are immaterial for all periods presented.

Level 3 investments: 

Certain of the Company’s assets, including intangible assets and goodwill are measured at fair value on a non-recurring basis if impairment is indicated.  

As of June 30, 2017, the Company reflected its non-marketable equity investment as Level 3 in the fair value hierarchy as it is based on unobservable inputs that market participants would use in pricing this asset due to the absence of recent comparable market transactions and inherent lack of liquidity.  During fiscal 2015, the Company purchased a $3.0 million equity interest in a company that operated in the enterprise software platform industry.  The Company did not enter into any other transactions with the investee during fiscal 2017 or the first quarter of fiscal 2018.   During the three months ended September 30, 2017, the investee was acquired by a third party.  The Company received $6.8 million as consideration for its equity interest in the investee, including $5.4 million in cash and 65,937 shares of the third party’s publicly-traded common stock (the “Acquirer’s common stock”) with a market value of $1.4 million. During the first quarter of fiscal 2018, the Company received $5.8 million of the consideration, consisting of $4.9 million in cash and 41,685 shares with a market value of $0.9 million. The remainder of the consideration consisting of $0.5 million of cash and $0.5 million of 23,252 shares of the Acquirers common stock will remain in escrow for a period of 18 months from the date of sales for general representations and warranties. A gain of $3.8 million related to this sale was recorded in “Other income (expense), net” in the accompanying consolidated statement of operations for the year ended June 30, 2018.

During the fourth quarter of fiscal 2018, the Company sold 18,700 shares of the Acquirer’s common stock and recorded a gain of $0.2 million. The remaining 22,985 shares held by the Company and 23,252 shares to be released from escrow within one year are considered Level 1 investments as these have a readily determinable fair value and quoted prices in active markets.

During the year ended June 30, 2018, the Company recorded a liability for contingent consideration related to its acquisition of the CF Business (see Note 4 for additional information related to the acquisition). The fair value measurement of the contingent consideration obligations is determined using Level 3 inputs. The fair value of contingent consideration obligations is based on a discounted cash flow model.  These fair value measurements represent Level 3 measurements as they are based on significant inputs not observable in the market. Significant judgment is employed in determining the appropriateness of these assumptions as of the acquisition date and for each subsequent period.  Accordingly, changes in assumptions could have a material impact on the amount of contingent consideration expense the Company records in any given period.  Changes in the value of the contingent consideration obligations would be recorded in general and administrative expenses in the accompanying consolidated statements of operations.

The change in the acquisition-related contingent consideration obligations is as follows (in thousands):

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There were no transfers of assets or liabilities between Level 2 and Level 3 during the year ended June 30, 2018 or 2017. There were no impairments recorded for the year ended June 30, 2018 or 2017.

7. Goodwill and Intangible Assets

The following table reflects the changes in the carrying amount of goodwill (in thousands):

 

The following tables summarize the components of gross and net intangible asset balances (in thousands, except years):

 

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The following table summarizes the amortization expense of intangibles for the periods presented (in thousands):

The amortization expense that is recognized in “Cost of revenues: Product” is comprised of amortization for developed technology, license agreements and other intangibles.

The estimated future amortization expense to be recorded for each of the respective future fiscal years is as follows (in thousands):

 

8. Debt

Debt

The Company’s debt is comprised of the following (in thousands):

During the second quarter of fiscal 2017, the Company entered into an Amended and Restated Credit Agreement (the “Credit Facility”) with Silicon Valley Bank, as administrative agent and collateral agent, and the financial institutions that are a party thereto as lenders.   The Credit Facility provided for a five-year $90.5 million term loan (the “Term Loan”) and a five-year $50.0 million revolving loan facility (the “Revolving Facility”), which included a $5.0 million swing line loan sub facility and a $10.0 million letter of credit sub facility.  The Credit Facility among other things, amended and restated the Company’s previous credit facility.  The borrowings under the Credit Facility during fiscal 2017 were used to acquire the WLAN Business as more fully described in Note 4. Business Combinations.

The Credit Facility was amended on March 2, 2017, by Amendment One to such agreement, in anticipation of the acquisition of the Campus Fabric Business as more fully described in the Form 8-K filed on that date.

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In connection with the closing of Campus Fabric Business discussed in Note 4, the Company entered into the Second Amendment to the Credit Facility (the “Second Amendment”), which amended the Amended and Restated Credit Agreement, dated as of October 28, 2016, by and among the Company, as borrower, Silicon Valley Bank, as administrative agent and collateral agent, and lenders. Among other things, the Second Amendment (i) increased the amount of the available borrowing under the Credit Facility from $140.5 million to $243.7 million, composed of (a) an increase to the five-year Term Loan from $90.5 million to up to $183.7 million and (b) increased the five-year Revolving Facility in a principal amount of up to $60.0 million, (ii) extends the maturity date under the Term Loan and the termination date under the Revolving Facility, (iii) provides for an uncommitted additional incremental loan facility in the principal amount of up to $50.0 million (“Incremental Facility”), and (iv) joins certain additional banks, financial institutions and institutional lenders as lenders pursuant to the terms of the Credit Facility.  On July 14, 2017, the Company borrowed $80.0 million under the Term Loan which was used to fund the purchase of the Campus Fabric Business.

In connection with the closing of the acquisition of the Data Center Business discussed in Note 4, the Company entered into the Third Amendment to the Credit Facility (the “Third Amendment”) on October 26, 2017. Among other things, the Third Amendment (i) amends the negative covenant governing dispositions to increase the general dispositions basket for the fiscal year of the Company ending June 30, 2018, and (ii) amends certain definitions and provisions to update certain references to the Data Center Business Purchase Agreement (as defined above). On the Data Center Business Closing Date, the Company borrowed $20.0 million on the Amended Term Loan to partially fund the acquisition of the Data Center Business.

On May 1, 2018, the Company terminated the Credit Facility as amended and entered into a Credit Agreement (the “Credit Agreement”), by and among the Company, as borrower, BMO Harris Bank N.A., as an issuing lender and swingline lender, Bank of Montreal, as administrative and collateral agent, and the financial institutions or entities that are a party thereto as lenders.  The Credit Agreement provides for i) a $40 million five-year revolving credit facility (the “New Revolving Facility”), ii) a $190 million five-year term loan (the “New Term Loan”) and, iii) an uncommitted additional incremental loan facility in the principal amount of up to $100 million (“New Incremental Facility”).  On May 1, 2018, the Company borrowed $200 million under the Credit Agreement in order to pay off existing debt and for general corporate purposes.

Borrowings under the Credit Agreement will bear interest, at the Company’s election, as of May 1, 2018, at a rate per annum equal to LIBOR plus 1.50% to 2.75%, or the adjusted base rate plus 0.50% to 1.75%, based on the Company’s Consolidated Leverage Ratio.  In addition, the Company is required to pay a commitment fee of between 0.25% and 0.40% quarterly (currently 0.35%) on the unused portion of the New Revolving Facility, also based on the Company’s consolidated leverage ratio.  Principal installments are payable on the New Term Loan in varying percentages quarterly starting June 30, 2018 and to the extent not previously paid, all outstanding balances are to be paid at maturity. The Credit Agreement is secured by substantially all of the Company’s assets.

The Credit Agreement requires the Company to maintain certain minimum financial ratios at the end of each fiscal quarter. The Credit Agreement also includes covenants and restrictions that limit, among other things, the Company’s ability to incur additional indebtedness, create liens upon any of its property, merge, consolidate or sell all or substantially all of its assets. The Credit Agreement also includes customary events of default which may result in acceleration of the outstanding balance.

Financing costs incurred in connection with obtaining long-term financing are deferred and amortized over the term of the related indebtedness or credit agreement.  During the year ended June 30, 2018, in conjunction with the Credit Agreement, as noted above, the Company recorded a loss from an extinguishment of debt of $1.2 million in “Interest expense” in the accompanying consolidated statements of operations and incurred $1.5 million of deferred financing costs.

Amortization of deferred financing costs is included in “Interest expense” in the accompanying consolidated statements of operations, totaled $0.7 million, $0.5 million and $0.4 million in fiscal years 2018, 2017 and 2016, respectively.

The Company had $28.7 million of availability under the New Revolving Facility as of June 30, 2018.  The Company had $1.3 million of outstanding letters of credit as of June 30, 2018.

The Company’s debt principal repayment schedule by period is as follows, excluding unamortized debt issuance costs (in thousands):

 

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9. Commitments and Contingencies

Leases

The Company currently leases its current headquarters, research and development facilities and office spaces for its various United States and international operations. Certain leases contain rent escalation clauses and renewal options. As part of the Company’s existing leased facilities, the Company occasionally receives lease incentives payments from the landlord which are used to make leasehold improvements on the respective facility. The Company depreciates the leasehold improvements over the useful life of the assets or the lease term, whichever is shorter.  The lease incentives payments are deferred and amortized on a straight-line basis over the term of the lease as an offset to rent expense.

Future annual minimum lease payments under all non-cancelable operating leases having initial or remaining lease terms in excess of one year at June 30, 2018, were as follows (in thousands):

 Rent expense was $12.9 million, $9.4 million and $8.5 million in fiscal years 2018, 2017 and 2016, respectively.

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 based upon a rolling production forecast provided by the Company.  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 30, 2018, the Company had non-cancelable commitments to purchase $144.0 million of such inventory, which will be received and consumed during the first half of fiscal 2019. The Company expects to utilize its non-cancelable purchase commitments in the normal ongoing operations.

Legal Proceedings

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

In accordance with applicable accounting guidance, the Company records accruals for certain of its outstanding legal proceedings, investigations or claims when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated. The Company evaluates, at least on a quarterly basis, developments in legal proceedings, investigations or claims that could affect the amount of any accrual, as well as any developments that would result in a loss contingency to become both probable and reasonably estimable. When a loss contingency is not both probable and reasonably estimable, the Company does not record a loss accrual.  However, if the loss (or an additional loss in excess of any prior accrual) is at least a reasonable possibility and material, then the Company would disclose an estimate of the possible loss or range of loss, if such estimate can be made, or disclose that an estimate cannot be made.  The assessment whether a loss is probable or a reasonable possibility, and whether the loss or a range of loss is estimable, involves a series of complex judgments about future events. Even if a loss is reasonably possible, the Company may not be able to estimate a range of possible loss, particularly where (i) the damages sought are substantial or indeterminate, (ii) the proceedings are in the early stages, or (iii) the matters involve novel or unsettled legal theories or a large number of parties. In such cases, there is considerable uncertainty regarding the ultimate resolution of such matters, including the amount of any possible loss, fine or penalty.  Accordingly, for current proceedings, except as noted below, the Company is currently unable to estimate any reasonably possible loss or range of possible loss.  However, an adverse resolution of one or more of such matters could have a material adverse effect on the Company's results of operations in a particular quarter or fiscal year.

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Brazilian Tax Assessment Matters

On May 28, 2007, the Public Treasury Department of the State of Sao Paolo, Brazil (the “Tax Authority”) assessed the Company’s Brazilian subsidiary, Enterasys Networks do Brasil Ltda. (“Enterasys Brasil”), based on an alleged underpayment of taxes.  The Tax Authority also charged interest and penalties with respect to the assessment (collectively, the “ICMS Tax Assessment”).  The Tax Authority denied Enterasys Brasil the use of certain presumed tax credits granted by the State of Espirito Santo, Brazil under the terms of the FUNDAP program for the period from February 2003 to December 2004.  The value of the disallowed presumed tax credits is BRL 3.4 million (US $1.0 million), excluding interest and penalties. All currency conversions in this Legal Proceedings section are as of June 30, 2018.

Unable to resolve the matter at the administrative level, on October 1, 2014, Enterasys Brasil filed a lawsuit in the 11th Public Treasury Court of the Sao Paolo State Court of Justice (Judiciary District of Sao Paolo) to overturn or reduce the ICMS Tax Assessment. As part of this lawsuit, Enterasys Brasil requested a stay of execution, so that no tax foreclosure could be filed and no guarantee would be required until the court issued its final ruling.  On or about October 6, 2014, the court granted a preliminary injunction staying any execution on the assessment, but requiring that Enterasys Brasil deposit the assessed amount with the court.  Enterasys Brasil appealed this ruling and, on or about January 28, 2015, the appellate court ruled that no cash deposit (or guarantee) was required.  In a decision dated August 28, 2017, and published on October 3, 2017, the court validated the assessment and penalty imposed by the Tax Authority, but ruled that the Tax Authority was charging an unlawfully high interest rate on the tax assessment and penalty amounts, and ordered the interest rate reduced to the maximum Federal rate. The August 28, 2017 decision, were it to become final, would require Enterasys Brasil to pay a total of BRL 16.9 million (approximately U.S. $5.1 million), which includes penalties, court costs, attorneys’ fees, and accrued interest as of June 30, 2018.  The Company believes the ICMS Tax Assessment against Enterasys Brasil is without merit, and has appealed the lower court’s decision.  The appellate court ruled that no cash deposit (or guarantee) is required during the pendency of the appeal.

Based on the currently available information, the Company believes the ultimate outcome of the ICMS Tax Assessment litigation will not have a material adverse effect on the Company's financial position or overall results of operations. However, due to the complexities and uncertainty surrounding the judicial process in Brazil and the nature of the claims asserted, there can be no assurance of a favorable outcome for Enterasys Brasil, which recorded an accrual of BRL 9.4 million (approximately U.S. $2.9 million) as of the date the Company acquired Enterasys Networks.

The Company made a demand on April 11, 2014 for a defense from, and indemnification by, the former equity holder of Enterasys Networks, Inc. (“Seller”) in connection with the ICMS Tax Assessment. Seller agreed to assume the defense of the ICMS Tax Assessment on May 20, 2014. In addition, through the settlement of an indemnification-related lawsuit with the Seller on June 18, 2015, Seller agreed to continue to defend the Company with respect to the ICMS Tax Assessment and to indemnify the Company for losses related thereto subject to certain conditions. These conditions include the offsetting of foreign income tax benefits realized by the Company in connection with the acquisition of Enterasys.  Based upon current projections of the foreign income tax benefits to be realized, and the potential liability in the event of an adverse final judgment in the ICMS Tax Assessment litigation, the Company does not presently anticipate that any amounts under the indemnification will be due from the Seller in connection with the ICMS Tax Assessment.

In re Extreme Networks, Inc. Securities Litigation

On October 23 and 29, 2015, punitive class action complaints alleging violations of securities laws were filed in the U.S. District Court for the Northern District of California against the Company and three of its former officers (Charles W. Berger, Kenneth B. Arola, and John T. Kurtzweil).  Subsequently, the cases were consolidated (In re Extreme Networks, Inc. Securities Litigation, No. 3:15-CY-04883-BLF).  Plaintiffs allege that defendants violated the securities laws by disseminating materially false and misleading statements and concealing material adverse facts regarding the Company’s financial condition, business operations and growth prospects. Plaintiffs seek unspecified damages on behalf of a purported class of investors who purchased the Company’s common stock from September 12, 2013 through April 9, 2015.  On June 28, 2016, the Court appointed a lead plaintiff.  On September 26, 2016, the lead plaintiff filed a consolidated complaint. On November 10, 2016, defendants filed a motion to dismiss, which the Court granted with leave to amend on April 27, 2017.  On June 2, 2017, the lead plaintiff filed an amended complaint, which, on July 10, 2017, defendants again moved to dismiss.  In a March 21, 2018 Order (the “March 2018 Order”), the Court granted in part and denied in part the defendants’ motion. The March 2018 Order narrowed the scope of the case, but allowed certain claims to proceed.  On July 18, 2018, the parties to the litigation commenced a mediation process with the assistance of a professional mediator and the Company believes the parties have arrived at an agreement in principle which they are in the process of documenting and which is subject to court approval.  

On February 18, 2016, a shareholder derivative case was filed in the Superior Court of California, Santa Clara County (Shaffer v. Kispert et al., No. 16 CV 291726).  The complaint names current and former officers and directors as defendants, and seeks recovery on behalf of the Company based on substantially the same allegations as the securities class action litigation described above.  

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As a result of the March 2018 Order, the stipulated stay of the derivative litigation ended.  On July 18, 2018, the parties to the litigation commenced a mediation process with the assistance of a professional mediator and the Company believes the parties have arrived at an agreement in principle which they are in the process of documenting and which is subject to court approval.  

XR Communications, LLC d/b/a Vivato Technologies v. Extreme Networks, Inc. Patent Infringement Suit  

On April 19, 2017, XR Communications, LLC (“XR”) (d/b/a Vivato Technologies) filed a patent infringement lawsuit against the Company in the Central District of California (XR Communications, LLC, dba Vivato Technologies v. Extreme Networks, Inc., No. 2:17-cv-2953-AG).  The operative Second Amended Complaint asserts infringement of U.S. Patent Nos. 7,062,296, 7,729,728, and 6,611,231 based on the Company’s manufacture, use, sale, offer for sale, and/or importation into the United States of certain access points and routers supporting multi-user, multiple-input, multiple-output technology. XR seeks unspecified damages, on-going royalties, pre- and post-judgment interest, and attorneys’ fees (but no injunction).  On July 24, 2017, the Company filed its answer.  In orders dated April 10 and May 22, 2018, the Court stayed the case pending a resolution by the Patent Trial and Appeal Board of inter partes review petitions filed by several defendants in other XR-related patent lawsuits challenging the validity of the asserted patents.   Given the stay, the Court took off calendar all previously scheduled events (including a Markman hearing and potential trial date), and scheduled a status conference on October 22, 2018.  The Company believes the claims are without merit, and intends to defend them vigorously.

DIFF Scale Operation Research, LLC v. Extreme Networks, Inc.

On March 15, 2018, DIFF Scale Operation Research, LLC (“DIFF”) filed a patent infringement lawsuit against the Company in the United States District Court for the Southern District of New York (DIFF Scale Operation Research, LLC v. Extreme Networks, Inc., No. 18-cv-2324-KBF).  The complaint alleged infringement of seven patents (four expired) generally directed to virtual connection networking.  The parties have settled this dispute, and the court signed a stipulation and order of dismissal with prejudice on June 21, 2018.

Be Labs, Inc. v. Extreme Networks, Inc.

On April 25, 2018, Be Labs, Inc. (“Be Labs”) filed a patent infringement lawsuit against the Company in the United States District Court for the District of Delaware (Be Labs, Inc. v. Extreme Networks, Inc., No. 1:18-cv-00626).  The complaint alleged direct and indirect infringement of two patents generally directed to a multimedia wireless distribution system for home or office use, and appears to accuse the Company’s 802.11ac- and 802.11n-compliant ExtremeWireless products.  The parties have settled this dispute, and Be Labs dismissed the case with prejudice on July 9, 2018.

Orckit IP, LLC v. Extreme Networks, Inc., Extreme Networks Ireland Ltd., and Extreme Networks GmbH

On February 1, 2018, Orckit IP, LLC (“Orckit”) filed a patent infringement lawsuit against the Company and its Irish and German subsidiaries in the District Court in Dusseldorf, Germany.  The lawsuit alleges direct and indirect infringement of the German portion of European Patent EP 1 958 364 B1 based on the offer, distribution, use, possession and/or importation into Germany of certain network switches equipped with the ExtremeXOS operating system.  Orckit is seeking injunctive relief, an accounting, and an unspecified declaration of liability for damages and costs of the lawsuit.  On May 3, 2018, Extreme Networks GmbH filed a separate nullity action in the Federal Patent Court in Munich, seeking to invalidate the asserted patents, and on May 4, 2018, the defendants answered the complaint, denying any infringement and seeking a stay of the action pending the conclusion of the nullity action.  The Company believes the claims are without merit, and intends to defend them vigorously.

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 applicable 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 certain legal matters. For example, the Company currently is paying or reimbursing legal expenses being incurred by certain current and former officers and directors in connection with the shareholder litigation described above.  The Company also procures Directors and Officers insurance to help cover its defense and/or indemnification costs, although its ability to recover such costs through insurance is uncertain.  While it is not possible to estimate the maximum potential amount that could be owed under these indemnification agreements due to the Company’s limited history with prior indemnification claims, indemnification (including defense) costs could, in the future, have a material adverse effect on the Company’s consolidated financial position, results of operations and cash flows. As of June 30, 2018, the Company has the outstanding indemnification claims described above.

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10. Stockholders’ Equity

Preferred Stock

In April 2001, in connection with the entering into of the Company’s 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 30, 2018, no shares of preferred stock were outstanding.

Stockholders’ Rights Agreement

On April 26, 2012, the Company entered into an Amended and Restated Rights Agreement between the Company and Computershare Shareholder Services LLC as the rights agent (the “Restated Rights Plan”). The Restated Rights Plan governs the terms of each right (“Right”) that has been issued with respect to each share of Common Stock of Extreme Networks. Each Right initially represents the right to purchase one one-thousandth of a share of the Company’s Preferred Stock. The Restated Rights Plan replaces in its entirety the Rights Agreement, dated as of April 27, 2001, as subsequently amended, between the Company and Mellon Investor Services LLC (the “Prior Rights Plan”).

The Board adopted the Restated Rights Plan to preserve the value of deferred tax assets, including net operating loss carry forwards of the Company, with respect to its ability to fully use its tax benefits to offset future income which may be limited if the Company experiences an “ownership change” for purposes of Section 382 of the Internal Revenue Code of 1986 as a result of ordinary buying and selling of its common stock. Following its review of the terms of the plan, the Board decided it was necessary and in the best interests of the Company and its stockholders to enter into the Restated Rights Plan. The Restated Rights Plan incorporates the Prior Rights Plan and the amendments thereto into a single agreement and extended the term of the Prior Rights Plan to April 30, 2013.  Each year since 2013 the Board and shareholders have approved an amendment providing for a one-year extension of the term of the Restated Rights Plan.  Our Board of Directors unanimously approved an amendment to the Restated Rights Plan on May 9, 2018 to extend the Restated Rights Plan through May 31, 2019, subject to ratification by a majority of the stockholders of the Company at the next annual shareholders meeting, expected to be held on November 8, 2018.

11. Employee Benefit Plans

As of June 30, 2018, the Company has the following share-based compensation plans:

2013 Equity Incentive Plan

The 2013 Equity Incentive Plan (the “2013 Plan”) was approved by stockholders on November 20, 2013. The 2013 Plan replaced the 2005 Equity Incentive Plan (the “2005 Plan”). Under the 2013 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 2013 Plan also authorizes the grant of awards of stock options, stock 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 2013 Plan authorized the issuance of 9.0 million shares of the Company’s common stock. In addition, up to 12.7 million shares subject to stock options and awards available for issuance under the 2005 Plan may be transferred to the 2013 Stock Plan and would be added to the number of shares available for future grant under the 2013 Plan.  The 2013 Plan includes provisions upon the granting of certain awards defined by the 2013 Plan as Full Value Awards in which the shares available for grant under the 2013 Plan are decremented 1.5 shares for each such award granted. Upon forfeiture or cancellation of unvested awards, the same ratio is applied in returning shares to the 2013 Plan for future issuance as was applied upon granting.  During the fiscal years ended June 30, 2018 and 2017, an additional 9.0 million shares and 8.3 million shares, respectively, were authorized and made available for grant under the 2013 Plan. As of June 30, 2018, total options and awards to acquire 9.0 million shares were outstanding under the 2013 Plan and 12.1 million shares are available for grant under the 2013 Plan. Options granted under this plan have a contractual term of seven years.

Enterasys 2013 Stock Plan

Pursuant to the acquisition of Enterasys on October 31, 2013, the Company assumed the Enterasys 2013 Stock Plan (the “Enterasys Plan”).  As of June 30, 2018, total options to acquire 0.8 million shares were outstanding under the Enterasys Plan. Options granted under this plan have a contractual term of seven years. No future grants may be made from the Enterasys Plan.

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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 replaced the Amended 1996 Stock Option Plan (the “1996 Plan”), the 2000 Non-statutory Stock Option Plan and the 2001 Non-statutory Stock Option Plan. The 2005 Plan includes provisions upon the granting of certain awards defined by the 2005 Plan as Full Value Awards in which the shares available for grant under the 2005 Plan are decremented 1.5 shares for each such award granted. Upon forfeiture or cancellation of unvested awards, the same ratio is applied in returning shares to the 2005 Plan for future issuance as was applied upon granting. Effective November 20, 2013, the 2005 Plan was replaced with the 2013 Plan, and, as of June 30, 2018, total options to acquire 0.2 million shares were outstanding under the 2005 Plan.  No future grants may be made from the 2005 Plan, however, outstanding options and awards forfeited or canceled were allowed to be transferred to the 2013 Plan until December 2, 2015, at which time, no further shares may be transferred. A total of 6.6 million shares were transferred to the 2013 Plan.

Shares Reserved for Issuance

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

Stock Options

The 1996 Plan was originally adopted in September 1996, and provided for the grant of options for common stock to eligible participants. Effective December 2, 2005, the 1996 Plan was terminated, and, as of June 30, 2016, no options to acquire shares remain outstanding under the 1996 Plan. No future grants may be made from the 1996 Plan.

The following table summarizes stock option activity under all plans (shares and intrinsic value in thousands):

 The total intrinsic value of options exercised in fiscal years 2018, 2017 and 2016 was $6.3 million, $5.7 million and $0.2 million, respectively.

There were no stock options granted in fiscal 2018 or 2017. The weighted-average estimated fair value of stock options granted in fiscal years 2016 was $1.59 per share. As of June 30, 2018, there was $0.2 million of total unrecognized compensation cost related to unvested stock options that will be fully recognized in fiscal 2019. 

Stock Awards

Stock awards may be granted under the 2013 Plan on terms approved by the Compensation Committee of the Board of Directors. Stock awards generally provide for the issuance of restricted stock units (“RSUs”), including performance or market-based restricted stock units (“PSUs”) which vest over a fixed period of time or based upon the satisfaction of certain performance criteria. The Company recognizes compensation expense on the awards over the vesting period based on the award’s intrinsic value as of the date of grant.

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The following table summarizes stock award activity (shares and market value in thousands):

The aggregate fair value, as of the respective vesting dates of RSUs vested during the fiscal years ended June 30, 2018, 2017 and 2016 was $51.2 million, $9.1 million and $8.6 million, respectively.

Fiscal 2018 PSU

During fiscal 2018, the Company approved the grant of 1.2 million stock awards to its vice president level employees or above (“VPs”), including 0.6 million stock awards to its Executive Officers.  Fifty percent (50%) of the stock awards granted to the VPs, except the chief executive officer, were in the form of PSUs and fifty percent (50%) of the stock awards granted were in the form of service-based RSUs.  The Company’s chief executive officer received sixty percent (60%) of his stock award grant in the form of PSUs, while forty percent (40%) of this award were in the form of RSUs. The RSUs vest from the original grant date as to one-third (1/3) on the one-year anniversary and one-twelfth (1/12) each quarter thereafter, subject to continued service to the Company.

The PSUs referenced in the preceding paragraph will be considered earned once the Company’s U.S. GAAP earnings aggregates at least $0.32 per share over two consecutive quarters (the “2018 Performance Threshold”).  Upon satisfying the 2018 Performance Threshold, the PSUs will vest with respect to the same number of RSUs that have vested which were granted on the same date and thereafter, will vest on the same schedule as the RSUs, subject to continued service to the Company.  If the 2018 Performance Threshold is not met by the third anniversary of the grant date, the award is canceled.  In addition, the 2018 Performance Threshold will be deemed satisfied upon the closing of a Change in Control (within the meaning of the Company’s 2013 Equity Incentive Plan) in the event the per share consideration received by the Company’s stockholders equals or exceeds $16.00 per share; or, in the event the consideration is less than $16.00 per share, the number of PSUs deemed to be earned will be determined by multiplying the number of PSUs by the ratio of the aggregate earnings per share of the last two quarters prior to the Change of Control to the $0.32 Performance Threshold. The grant date fair value per share of the PSUs referenced above was $10.90. During the year ended June 30, 2018, none of the PSU grants referenced above achieved their 2018 Performance Threshold.

During fiscal 2018, the Company approved the grant of 0.1 million stock awards with market-based vesting criteria to certain VPs with grant date fair values per share ranging from $10.61 to $12.19 determined by using the Monte-Carlo simulation model.

Fiscal 2017 PSU

During fiscal 2017, the Company approved the grant of 1.5 million stock awards to its VPs, including 0.7 million stock awards to its Executive Officers.  Fifty percent (50%) of the stock awards granted to the VPs were in the form of PSUs and fifty percent (50%) of the stock awards granted were in the form of RSUs. The RSUs vest from the original grant date as to one-third (1/3) on the one-year anniversary and one-twelfth (1/12) each quarter thereafter, subject to continued service to the Company.  

The PSUs referenced in the preceding paragraph were considered earned once the Company’s stock price equaled or exceeded $5.00 per share for 30 consecutive trading days after January 1, 2017 (the “2017 Performance Threshold”). The grant date fair values per share of the PSUs were determined by using the Monte-Carlo simulation model, ranging $3.02 to $3.09. The assumptions used in the Monte-Carlo simulation includes the expected volatility of 56%, risk-free rate of 0.9%, no expected divided yield, expected term of 3.0 years and possible future stock prices over the performance period based on historical stock and market prices. The assumptions used in the Monte-Carlo simulation includes the risk-free rate, expected divided yield, expected term, and possible future stock prices over the performance period based on historical stock and market prices. Once the 2017 Performance Threshold goal was attainted, the PSUs began to vest on the same schedule as the RSUs that were granted at the same time, subject to continued service to the Company.  During the year ended June 30, 2017, all of the PSUs referenced above achieved their 2017 Performance Threshold and as such, began vesting and will be released on the schedule as noted, subject to continued service to the Company.

During fiscal 2017, the Company approved grants of 1.4 million stock awards in the form of PSUs to certain VPs, including 0.9 million shares to its Executive Officers. Fifty percent (50%) of the PSUs are earned based on the Company’s stock price appreciation (the “Stock Price PSUs”) and fifty percent (50%) of the PSUs are earned based on the Company’s total stockholder return relative to the S&P Small Cap 600 Capped Information Technology Index (the “TSR PSUs”).

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 The Stock Price PSUs represent the right to receive a number of shares of common stock up to one and one-third of the target number of Stock Price PSUs. They are earned and vest as follows based on the average adjusted closing stock price of the Company’s common stock for the 90 days ending as of May 4, 2020, subject to the grantees’ continued service through the certification of performance:

No PSUs are earned if such average adjusted closing stock price is less than $8.96.

The TSR PSUs represent the right to receive a number of shares of common stock up to 130% of the target number of TSR PSUs. They are earned and vest as follows based on the positive percentage point difference between the Company’s total stockholder return and the total stockholder return for the S&P Small Cap 600 Capped Information Technology Index over the performance period from May 4, 2017 to May 4, 2020, subject to the grantees’ continued service through the certification of performance:

 Total stockholder return is calculated based on the 90-day average stock price at the beginning and end of the performance period. Linear interpolation is generally used to determine the number of shares earned for achievement between threshold and target levels and between target and maximum levels. However, if the Company’s total stockholder return over the performance period is negative, the number of shares earned will be capped at 100% of the target number of TSR PSUs.

The grant date fair values per share of the Stock Price PSUs and the TSR PSUs were determined by using the Monte-Carlo simulation model, ranging $7.01 to $8.76, respectively. The assumptions used in the Monte-Carlo simulation includes the expected volatility of 54%, risk-free rate of 1.5%, no expected divided yield, expected term of 3.0 years and possible future stock prices over the performance period based on historical stock and market prices.

For the fiscal years ended June 30, 2018, 2017 and 2016, the Company withheld an aggregate of 1.0 million shares, 0.4 million shares and 0.1 million shares, respectively, upon the vesting of RSUs, based upon the closing share price on the vesting date as settlement of the employees’ minimum statutory obligation for the applicable income and other employment taxes.

For fiscal years 2018, 2017 and 2016, the Company remitted cash of $11.3 million, $2.0 million and $0.2 million, respectively, to the appropriate taxing authorities on behalf of the employees. The payment of the taxes by the Company reduced the number of shares that would have been issued on the vesting date and was recorded as a reduction of additional paid-in capital in the consolidated balance sheets and as a reduction of “Proceeds from issuance of common stock” in the financing activity within the consolidated statements of cash flows.

As of June 30, 2018, there were $41.7 million in unrecognized compensation costs related to non-vested stock awards. This cost is expected to be recognized over a weighted-average period of 1.57 years

Performance Grant Activity

The following table summarizes PSU’s with market or performance based conditions granted and the number of awards that have satisfied the relevant market or performance criteria in each period (in thousands):

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2014 Employee Stock Purchase Plan

In August 27, 2014, the Board of Directors approved the adoption of Extreme Network’s 2014 Employee Stock Purchase Plan (the “2014 ESPP”). On November 12, 2014, the stockholders approved the 2014 ESPP with the maximum number of shares of common stock that may be issued under the plan of 12.0 million shares. The 2014 ESPP replaced the 1999 Employee Stock Purchase Plan. The 2014 ESPP allows eligible employees to acquire shares of the Company’s common stock through periodic payroll deductions of up to 15% of total compensation, subject to the terms of the specific offering periods outstanding. Each purchase period has a maximum duration of six months. The price at which the common stock may be purchased is 85% of the lesser of the fair market value of the Company’s common stock on the first day of the applicable offering period or on the last day of the respective purchase period. During fiscal 2018, the 2014 ESPP had offerings periods of either 6 months or 24 months, commonly referred to as “look back periods”. As of June 30, 2018, there have been 6.6 million shares issued under the 2014 ESPP.

Effective with the offering period beginning on February 1, 2016, the Company amended the 2014 ESPP to increase the maximum shares issuable for each purchase period from 1.0 million shares to 1.5 million shares. Effective with the offering period beginning on August 1, 2016, the Company amended the 2014 ESPP so that all future offering periods are limited to six months and to make certain other changes to the 2014 ESPP including adding new contribution limits for each offering period. Existing open offering periods prior to the effective date of the changes were unaffected by the amendments to the 2014 ESPP.

Share Based Compensation Expense

Share-based compensation expense recognized in the financial statements by line item caption is as follows (in thousands):

 The amount of stock based compensation expense capitalized in inventory has been immaterial for each of the periods presented.

The Company uses the straight-line method for expense attribution other than the PSUs using the accelerated attribution method. Beginning in fiscal 2017, the Company no longer estimates forfeitures, but rather recognizes expense for those shares expected to vest and recognizes forfeitures when they occur. The Company’s estimated forfeiture rate in fiscal 2016 based on the Company’s historical forfeiture experience was 13% for non-executives and 19% for executives.

The fair value of each stock option grant under the Company’s 2013 Plan and 2005 Plan is estimated on the date of grant using the Black-Scholes-Merton option valuation model with the weighted average assumptions noted in the following table.  The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The risk-free rate is based upon the estimated life of the option and is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on a blended rate of the implied volatilities from traded options on the Company’s stock and historical volatility on the Company’s stock.

The fair value of each share purchase option under the Company's 2014 ESPP is estimated on the date of grant using the Black-Scholes-Merton option valuation model with the weighted average assumptions noted in the following table. The expected term of the 2014 ESPP. The risk-free rate is based upon the estimated life and is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on the historical volatility on the Company’s stock.

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The weighted-average estimated per share fair value of shares purchased under the 2014 ESPP in fiscal years 2018, 2017 and 2016, was $3.25, $1.24 and $0.92, respectively.

401(k) Plan

The Company provides a tax-qualified employee savings and retirement plan, commonly known as a 401(k) plan (the “Plan”), which covers the Company’s eligible employees. Pursuant to the Plan, employees may elect to reduce their current compensation up to the IRS annual contribution limit of $18,500 for calendar year 2018. Employees age 50 or over may elect to contribute an additional $6,000. The amount contributed to the Plan is on a pre-tax basis.

The Company provides for discretionary matching contributions as determined by the Board of Directors for each calendar year. All matching contributions vest immediately.  In addition, the Plan provides for discretionary contributions as determined by the Board of Directors each year. The program during fiscal 2018 is to match $0.50 for every Dollar contributed by the employee up to the first 2.5% of pay.  The Company’s matching contributions to the Plan totaled $3.3 million, $1.4 million and $1.2 million, for fiscal years 2018, 2017 and 2016, respectively. No discretionary contributions were made in fiscal years 2018, 2017 or 2016.

 

12. Information about Segments of Geographic Areas

The Company operates in one segment, the development and marketing of network infrastructure equipment.  Revenue is attributed to a geographical area based on the location of the customers. The Company operates in three geographic theaters: Americas, which includes the United States, Canada, Mexico, Central America and South America; EMEA, which includes Europe, Russia, Middle East and Africa; and APAC which includes Asia Pacific, China, South Asia and Japan. The Company’s chief operating decision maker (“CODM”), who is its CEO, reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. 

See Note 3. Revenues for the Company’s revenues by geographic regions and channel based on the customer’s ship-to location.

The Company’s long-lived assets are attributed to the geographic regions as follows (in thousands):

 

13. Foreign Exchange Forward Contracts

The Company uses derivative financial instruments to manage exposures to foreign currency. The Company’s objective for holding derivatives is to use the most effective methods to minimize the impact of these exposures. The Company does not enter into derivatives for speculative or trading purposes.  The fair value of the Company’s derivatives in a gain position are recorded in “Prepaid expenses and other current assets” and derivatives in a loss position are recorded in “Other accrued liabilities” in the accompanying consolidated balance sheets. Changes in the fair value of derivatives are recorded in “Other income (expense), net” in the accompanying consolidated statements of operations; the Company recognized losses of $1.2 million and $0.7 million in fiscal 2018 and 2017, respectively, and gains of $1.3 million in fiscal 2016 related to the change in fair value. The Company enters into foreign exchange forward contracts to mitigate the effect of gains and losses generated by foreign currency transactions related to certain operating expenses and remeasurement of certain assets and liabilities denominated in foreign currencies. These derivatives do not qualify as hedges.

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At June 30, 2018 and 2017, forward foreign currency contracts had a notional principal amount of $5.0 million and $6.7 million, respectively. 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.

 

14. Restructuring and Related Charges, Net of Reversals

As of June 30, 2018, restructuring liabilities were $6.5 million which are recorded in “Other accrued liabilities” and “Other long-term liabilities” in the accompanying consolidated balance sheets.  The restructuring liabilities consist of obligations pertaining to the estimated future obligations for non-cancelable lease payments and severance and benefits obligations.  During fiscal years 2018, 2017 and 2016, the Company recorded restructuring charges, net of reversals, of $8.1 million, $8.9 million and $11.0 million, respectively.  The charges are reflected in “Restructuring and related charges, net of reversals” in the consolidated statements of operations.  

2018 Restructuring

The Company announced and began executing a reduction-in-force in its third and fourth fiscal quarters as a result of the acquisitions of the Campus Fabric Business and the Data Center Business. The Company recorded $7.9 million related to employee severance and benefits expenses during the year ended June 30, 2018.  The Company also incurred charges of $0.2 million for changes to its estimates for accrued lease costs pertaining to the estimated future obligations for non-cancelable lease payments of its excess facilities.

2017 Restructuring

In conjunction with the Company’s restructuring activities noted below, the Company incurred $8.9 million of restructuring charges, net of reversals during fiscal 2017 which is reflected in “Restructuring and related charges, net of reversals” in the consolidated statements of operations.

Pursuant with the WLAN Business acquisition from Zebra, the Company assumed a facility lease located at 6480 Via del Oro in San Jose, California (“Via del Oro”) and transferred the Company’s headquarters from Rio Robles Drive in San Jose, California (“Rio Robles”) to Via del Oro.  The Company consolidated its existing workforce with employees assumed from Zebra at the Via del Oro site and exited the Rio Robles site on January 31, 2017.  Due to the Company’s move from the Rio Robles facility and abandonment of all leasehold improvements, it accelerated the amortization of the remaining leasehold improvements balance for this site over the shortened service period such that the leasehold improvements were fully amortized on the cease-use date.  The Company recorded accelerated amortization expense for the year ended June 30, 2018 of $2.6 million.   

The Company entered into a sublease agreement for its Rio Robles facility during the third quarter of fiscal 2017.  The sublease is for the remaining duration of the Company’s lease. The net charges incurred for the remaining lease payments, real estate commissions and other related costs, net of the future sublease payments resulted in additional charges of $2.0 million during fiscal 2017. The excess facilities payments will continue through fiscal year 2023.

In anticipation of the acquisitions of the Campus Fabric and the Data Center Businesses, the Company reoccupied the majority of its exited space at its Salem, New Hampshire location during its fiscal fourth quarter to accommodate the growth in headcount and lab facility requirements.  This action resulted in a reversal of prior accruals of $1.3 million.

In conjunction with the consolidation actions noted above, the Company announced a reduction-in-force affecting 90 employees.  The Company recorded $5.6 million in severance and benefits charges, net during the year ended June 30, 2017.    

2016 Restructuring

During fiscal 2016, the Company abandoned excess facilities, primarily in San Jose, California; Salem, New Hampshire; Morrisville, North Carolina and other smaller leased locations. The abandoned facilities represented approximately 32% of the floor space in the aggregate at these locations and included general office and warehouse space.

In conjunction with the exiting of facilities noted above, the Company incurred $11.0 million of restructuring charges. Excess facilities charges included accrued lease costs pertaining to the estimated future obligations for non-cancelable lease payments for excess facilities and contract termination charges of $5.4 million, acceleration of depreciation of leasehold improvements of $4.5 million, professional fees of $1.0 million and other of $0.1 million.

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Significant restructuring charges incurred during 2016, by location, included $1.8 million of charges for excess facilities pertaining to the estimated future obligations for non-cancelable lease payments at Rio Robles.  This represented 39% of the San Jose leased space.  The Company amended its facility lease at its North Carolina location and exited excess space while recording $4.1 million of charges, which included $3.1 million in accelerated depreciation of leasehold improvements. This action represented 36% of the North Carolina location lease space. The Company recorded $4.4 million of charges for excess facilities at its Salem location, which included $1.3 million in accelerated depreciation of leasehold improvements.  This action represented 27% of the Salem lease space.  

Restructuring liabilities consist of (in thousands):

 

15. Income Taxes

Income before income taxes is as follows (in thousands):

 

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The provision for income taxes for fiscal years 2018, 2017 and 2016 consisted of the following (in thousands):

 

The difference between the provision for income taxes and the amount computed by applying the federal statutory income tax rate (28 percent for fiscal 2018 pursuant to the recently enacted U.S. tax legislation) to income before taxes is explained below (in thousands):

 

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Significant components of the Company’s deferred tax assets are as follows (in thousands):

The Company’s global valuation allowance decreased by $34.2 million in the fiscal year ended June 30, 2018 and increased by $15.5 million in the fiscal year ended June 30, 2017. The Company has provided a full valuation allowance against all of its U.S. federal and state deferred tax assets, as well as valuation allowances against non-U.S. deferred tax assets in Australia and Brazil.  The valuation allowance is determined by assessing both negative and positive available evidence to assess whether it is more likely than not that the deferred tax assets will be recoverable. The Company's inconsistent earnings in recent periods, including a cumulative loss over the last three years, coupled with its difficulty in forecasting future revenue trends as well as the cyclical nature of the Company's business provides sufficient negative evidence to require a full valuation allowance against its U.S. federal and state net deferred tax assets. The valuation allowance is evaluated periodically and can be reversed partially or in full if business results and the economic environment have sufficiently improved to support realization of the Company's deferred tax assets.

As of June 30, 2018, the Company had net operating loss carry-forwards for U.S. federal and state tax purposes of $185.6 million and $54.4 million, respectively.  As of June 30, 2018, the Company also had foreign net operating loss carry-forwards in Ireland, Australia and Brazil of $37.5 million, $9.0 million and $0.7 million, respectively.  As of June 30, 2018, the Company also had federal and state tax credit carry-forwards of $33.2 million and $18.8 million, respectively. These credit carry-forwards consist of research and development tax credits as well as foreign tax credits. The U.S. federal net operating loss carry-forwards of $185.6 million will begin to expire in the fiscal year ending June 30, 2021 and state net operating losses of $54.4 million began to partially expire in the fiscal year ending June 30, 2018. The foreign net operating losses can generally be carried forward indefinitely.  Federal research and development tax credits of $22.6 million will expire beginning in fiscal 2019, if not utilized and foreign tax credits of $10.6 million will expire beginning in fiscal 2020.  North Carolina state research and development tax credits of $0.9 million will expire beginning in the fiscal year ending June 30, 2024, if not utilized. California state research and development tax credits of $17.9 million do not expire and can be carried forward indefinitely.

In September, 2017, the Company performed an Internal Revenue Code section 382 analysis with respect to its net operating loss and credit carry-forwards to determine whether a potential ownership change had occurred that would place a limitation on the annual utilization of tax attributes. It was determined that no ownership change had occurred during the fiscal year ended June 30, 2017, however, it is possible a subsequent ownership change could limit the utilization of the Company's tax attributes.

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As of June 30, 2018, cumulative undistributed, indefinitely reinvested earnings of non-U.S. subsidiaries totaled $14.1 million.  It has been the Company’s historical policy to invest the earnings of certain foreign subsidiaries indefinitely outside the US.  As discussed below, recently enacted tax reform includes a provision to move the U.S. to a modified territorial tax system by imposing a transition tax on historic foreign earnings whether or not such earnings are repatriated to the U.S. The Company has determined there will be no cash tax impact of this new provision due to existing tax attributes.  The Company is reviewing its prior position on the reinvestment of earnings of certain foreign subsidiaries but has recorded a deferred tax liability of $0.4 million related to withholding taxes that may be incurred upon repatriation of earnings from jurisdictions where no indefinite reinvestment assertion is made. The Company continues to maintain an indefinite reinvestment assertion for earnings in certain of its foreign jurisdictions. The unrecorded deferred tax liability for potential withholding tax associated with repatriation of these earnings is $2.7 million.

The Company conducts business globally and as a result, most of its subsidiaries file income tax returns in various domestic and foreign jurisdictions.  In the normal course of business, the Company is subject to examination by taxing authorities throughout the world.  Its major tax jurisdictions are the U.S., Ireland, India, California, New Hampshire and North Carolina.  As of June 30, 2017, the Company is currently under examination by the state of North Carolina for the fiscal years ended 2014, 2015 and 2016. In general, the Company's U.S. federal income tax returns are subject to examination by tax authorities for fiscal years 2001 forward due to net operating losses and the Company's state income tax returns are subject to examination for fiscal years 2000 forward due to net operating losses.

On December 22, 2017, the President of the United States signed and enacted into law H.R. 1, the Tax Cuts and Jobs Act (“TCJA”), which, except for certain provisions, is effective for tax years beginning on or after January 1, 2018. As a fiscal year taxpayer, the Company will not be subject to the majority of the tax law provisions until fiscal year 2019; however, there are certain significant items of impact that will be recognized in fiscal year 2018. Because a change in tax law is accounted for in the period of enactment, the effects of the TCJA, a tax benefit of $2.5 million, was reflected in the full year results for fiscal 2018.

The TCJA’s primary change is a reduction in the U.S. Federal statutory corporate tax rate from 35% to 21%, including a pro rata reduction from 35% to 28% for the Company in fiscal 2018.  As a result, the Company recognized a tax benefit in the amount of $2.5 million in the second quarter of fiscal 2018 due to the revaluation of the Company's deferred tax liability related to amortizable goodwill to reflect the lower statutory rate.  Because the U.S. deferred tax assets are offset by a full valuation allowance, the reduction in deferred tax assets for the lower rate was fully offset by a corresponding reduction in valuation allowance resulting in no additional tax provision.

The TCJA moves the U.S. from a global taxation regime to a modified territorial regime.  Under the territorial regime, the company’s foreign earnings will generally not be subject to tax in the US.  As part of transitioning to this new regime, U.S. companies are required to pay tax on historical earnings generated offshore that have not been repatriated to the U.S. (“Transition Tax”).  The Company has estimated there will be no incremental tax provision relating to the Transition Tax given the Company’s ability to utilize existing tax attributes to offset the impact of the deemed repatriation.

The TCJA makes broad and complex changes to the U.S. tax code, and in certain instances, lacks clarity and is subject to interpretation until additional U.S. Treasury guidance is issued.  On December 22, 2017, the SEC issued guidance under Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”), which allows registrants to record provisional amounts during a one year “measurement period” similar to that used when accounting for business combinations.  However, the measurement period is deemed to have ended earlier when the registrant has obtained, prepared and analyzed the information necessary to finalize its accounting.  During the measurement period, impacts of the law are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can be recognized and adjusted as information becomes available, prepared or analyzed. The SAB summarizes a three-step process to be applied at each reporting period to account for and qualitatively disclose: (1) the effects of the change in tax law for which accounting is complete; (2) provisional amounts (or adjustments to provisional amounts) for the effects of the tax law where accounting is not complete, but that a reasonable estimate has been determined; and (3) a reasonable estimate cannot yet be made and therefore taxes are reflected in accordance with law prior to the enactment of the TCJA.

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Amounts recorded where accounting is complete in the year ended June 30, 2018 principally relate to the reduction in the U.S. federal tax rate to 21 percent, which resulted in the Company reporting an income tax benefit of $2.5 million to remeasure deferred tax liabilities associated with indefinitely lived intangible assets that will reverse at the new 21% rate. Absent this deferred tax liability, the Company is in a net deferred tax asset position that is offset by a full valuation allowance.  The impact of the rate change related to net deferred tax assets has a net tax effect of zero, and as such, the accounting to determine the gross change in the deferred tax position and the offsetting valuation is considered complete.  In accordance with Staff Accounting Bulletin (“SAB”) 118, the estimated income tax impact associated with the Transition Tax of zero represents our best estimate based on interpretation of the U.S. legislation as we are still accumulating data to finalize the underlying calculation. In accordance with SAB 118, estimated income tax impact associated with the Transition Tax is considered provisional and will be finalized prior to the end of the measurement period. The ultimate impact may differ from these provisional amounts, due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the TCJA.

With respect to provisions of the TCJA effective for tax years beginning on or after January 1, 2018, the company anticipates several new provisions may potentially impact tax provisions in future periods including limitations on the deductibility of interest expense and certain executive compensation, a minimum tax on certain foreign earnings (i.e., global intangible low-taxed income or “GILTI”), as well as a base-erosion and anti-abuse tax (“BEAT”).  The GILTI provisions require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary’s tangible assets. Based on initial assessment and interpretation of the new provision, the Company expects that it will be subject to incremental U.S. tax on GILTI income beginning in fiscal 2019. The Company may elect to account for GILTI tax as a component of tax expense in the period in which it is incurred or account for the GILTI tax in the measurement of deferred taxes. The Company is continuing to evaluate this particular provision and therefore has not yet elected a method but will do so once our analysis is complete. The BEAT provisions in the Tax Reform Act eliminate the deduction of certain base-erosion payments made to related foreign corporations, and impose a minimum tax if greater than regular tax.  There is a reasonable amount of uncertainty surrounding the interpretation of this new provision, however, based on initial assessment and a conservative interpretation of the new provision, the Company expects that it will be minimally subject to the incremental U.S. tax on BEAT income beginning in fiscal 2019.

During the fiscal year ended June 30, 2014, the Company acquired the stock of Enterasys Networks, Inc. and as such they became a wholly owned subsidiary of Extreme Networks.  With respect to this acquisition, the Company made an election under Internal Revenue Code section 338(h)(10) to treat the acquisition as an asset purchase from a tax perspective.  Under this election the tax basis of all assets is effectively reset to that of fair market value and therefore the transaction did not result in the recording of an opening net deferred tax position as the Company's tax basis in the acquired assets equaled its book basis. The resulting intangible assets and goodwill are being amortized for tax purposes over 15 years.

Additionally, the Company completed the acquisitions of the Zebra WLAN Business, the Avaya Campus Fabric Business and the Brocade Data Center Business in October 2016, July 2017 and October 2017, respectively, and treats the acquisitions as an asset purchase from a tax perspective. The Company has estimated the value of the intangible assets from these transactions and is amortizing the amounts over 15 years for tax purposes.  

During the twelve months ended June 30, 2018, the Company deducted $7.5 million of tax amortization expense related to capitalized goodwill resulting from the above acquisitions.

As of June 30, 2018, the Company had $17.5 million of unrecognized tax benefits.  If fully recognized in the future, there would be no impact to the effective tax rate, and $17.5 million would result in adjustments to deferred tax assets and corresponding adjustments to the valuation allowance.  The Company does not reasonably expect the amount of unrealized tax benefits to decrease during the next twelve months. The increase for fiscal year 2018 relates substantially to previously unrecorded foreign net operating losses.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

A reconciliation of the beginning and ending amount of total unrecognized tax benefits is as follows (in thousands):

Estimated interest and penalties related to the underpayment of income taxes, if any are classified as a component of tax expense in the consolidated statement of operations and totaled less than $0.1 million for each of the fiscal years 2018, 2017 and 2016.

 

16. Net Loss Per Share

Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period, less shares subject to repurchase, and excludes any dilutive effects of options, warrants and unvested restricted stock. Dilutive earnings per share is calculated by dividing net income by the weighted average number of common shares used in the basic earnings per share calculation plus the dilutive effect of shares subject to options, warrants and unvested restricted stock.  The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):

Potentially dilutive common shares from employee incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options, the assumed vesting of outstanding restricted stock units, and the assumed issuance of common stock under the ESPP.  Weighted stock options outstanding with an exercise price higher than the Company's average stock price for the periods presented are excluded from the calculation of diluted net loss per share since the effect of including them would have been anti-dilutive due to the net loss position of the Company during the periods presented.

The following securities were excluded from the computation of outstanding diluted earnings per common share because they would have been anti-dilutive (in thousands): 

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 as amended, such as this Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), as appropriate to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including our CEO and CFO, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Report. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of June 30, 2018.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurances with respect to financial statement preparation. Further because of changes in conditions, the effectiveness of internal control may vary over time.

We assessed the effectiveness of our internal control over financial reporting as of June 30, 2018.  In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013). Based on our assessment using those criteria, we concluded that, as of June 30, 2018, our internal control over financial reporting is effective.

During the year ended June 30, 2018, we completed our acquisitions of the fabric-based secure networking solutions and network security solutions business (the “Campus Fabric Business”) from Avaya Inc., the data center business (the “Data Center Business”) from Brocade Communication Systems, Inc., and the capital financing business (the “CF Business”) from Broadcom Corporation. In conducting our evaluation of the effectiveness of our internal controls over financial reporting as of June 30, 2018, we have elected to exclude the Campus Fabric Business, Data Center Business and CF Business from our evaluation for fiscal 2018 as permitted under current Securities and Exchange Commission rules and regulations. As of and for the year ended June 30, 2018, the assets and revenues of the acquired businesses not included in our evaluation represented 20% of consolidated assets and 33% of consolidated revenues. We are currently in the process of integrating and assessing the internal controls over financial reporting of the acquired businesses with the rest of our Company. The integration may lead to changes in future periods, but we do not expect these changes to materially affect our internal controls over financial reporting. We expect to complete this integration in fiscal 2019.

Our independent registered public accounting firm, KPMG LLP, has audited the financial statements included in this Annual Report on Form 10-K and has issued its report on our internal control over financial reporting as of June 30, 2018.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended June 30, 2018, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Inherent Limitations on Effectiveness of Controls

Our management, including the CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Our controls and procedures are designed to provide reasonable assurance that our control system’s objective will be met and our CEO and CFO have concluded that our disclosure controls and procedures are effective at the reasonable assurance level. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within Extreme have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events. Projections of any evaluation of the effectiveness of controls in future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Notwithstanding these limitations, our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives. Our CEO and CFO have concluded that our disclosure controls and procedures are, in fact, effective at the “reasonable assurance” level.

Item 9B. Other Information

None.

 

 

 

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PART III

Certain information required by Part III 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 2018 Annual Meeting of Stockholders (the “Proxy Statement”) not later than 120 days after the end of the fiscal year covered by this report, and certain information therein is incorporated in this report by reference.

 

 

Item 10. Directors, Executive Officers and Corporate Governance

The information required by this section for our directors is incorporated by reference from the information in the section entitled “Proposal 1 – Election of Directors” in the Proxy Statement. The information required by this section for our executive officers is incorporated by reference from the information in the section entitled “Executive Compensation and Other Matters” in the Proxy Statement.

Item 405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16 of the Exchange Act. This disclosure is contained in the section entitled “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement and is incorporated herein by reference.

Information with respect to Item 406 of Regulation S-K is incorporated by reference to the information contained in the section captioned “Code of Ethics and Corporate Governance Materials” in the Proxy Statement.

 

 

Item 11. Executive Compensation

The information required by this section is incorporated by reference from the information in the sections entitled “Directors’ Compensation”, “Executive Compensation and Other Matters” and “Report of the Compensation Committee” in the Proxy Statement.

 

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this section is incorporated by reference from the information in the section entitled “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement.

The information required by this section regarding securities authorized for issuance under equity compensation plans is incorporated by reference from the information in the section entitled “Equity Compensation Plan Information” in the Proxy Statement.

 

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this section is incorporated by reference from the information in the section titled “Certain Relationships and Related Transactions” in the Proxy Statement.

 

 

Item 14. Principal Accounting Fees and Services

The information required by this section is incorporated by reference from the information in the section titled “Principal Accounting Fees and Services” in the Proxy Statement.

 

 

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PART IV

Item 15. Exhibits and Financial Statement Schedules

Reference is made to the Index to Consolidated Financial Statements of Extreme Networks, Inc. under Item 8 in Part II of this Annual Report on Form 10-K.

All required schedules are omitted because either they are not applicable or the required information is shown in the financial statements or notes thereto.

Incorporated herein by reference is a list of the Exhibits contained in the Exhibit Index immediately preceding the signature page of this Annual Report on Form 10-K.

Item 16. Form 10-K Summary

None.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on August 29, 2018.

 

 

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints B. Drew Davies, his true and lawful attorneys-in-fact, with full power of substitution, for him in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated:

 

 

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EXHIBIT INDEX

The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K has been identified.

 

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