|
|
|
|
|
|
| |
|
|
Three
Months Ended |
| |
|
|
September,
1999
|
|
September 30,
1998
|
| |
|
|
|
|
|
| Net revenue
|
100.0%
|
|
100.0%
|
| Cost of revenue
|
47.9
|
|
50.7
|
| |
|
|
|
|
| Gross profit
|
|
52.1
|
|
49.3
|
| |
|
|
|
|
Operating expenses: |
|
|
|
| |
|
|
|
|
|
| |
Research and
development
|
14.6
|
|
27.4
|
| |
Selling and
marketing
|
23.4
|
|
37.0
|
| |
General and
administrative
|
5.4
|
|
9.4
|
| |
|
|
|
|
|
| |
|
Total operating expenses |
43.4
|
|
73.8
|
| |
|
|
|
|
|
| Operating income
(loss) |
8.7
|
|
(24.5)
|
| Interest and other
income, net |
3.6
|
|
1.4
|
| |
|
|
|
|
|
| Income (loss) before
income taxes |
12.3
|
|
(23.1)
|
| Provision for income
taxes |
3.7
|
|
-
|
| |
|
|
|
|
|
| Net income (loss)
|
8.6%
|
|
(23.1)% |
| |
|
|
|
|
|
| |
|
|
|
|
|
Net revenue.
Net revenue increased from $12.9 million for the three months
ended September 30, 1998 to $47.2 million for the three months ended
September 30, 1999, an increase of $34.3 million. Net revenue
increased primarily from increased sales of our Summit stackable
products and our BlackDiamond modular product family.
North America
sales increased from $7.0 million for the three months ended
September 30, 1998 to $27.3 million for the three months ended
September 30, 1999, an increase of $20.3 million. Sales outside
North America increased from $5.9 million for the three months ended
September 30, 1998 to $19.9 million for the three months ended
September 30, 1999, an increase of $14.0 million. The increases in
North America sales and sales outside North America reflect the
growth in demand for our Summit and BlackDiamond products and an
increase in the number of resellers, offset in part by a decrease in
OEM sales. We expect that export sales will continue to represent a
significant portion of net revenue, although we cannot assure you
that export sales as a percentage of net revenue will remain at
current levels. All sales transactions are denominated in U.S.
dollars.
Gross profit.
Gross profit increased from $6.4 million for the three months
ended September 30, 1998 to $24.6 million for the three months ended
September 30, 1999, an increase of $18.2 million. Gross margins
increased from 49.3% for the three months ended September 30, 1998
to 52.1% for the three months ended September 30, 1999. The increase
in gross margin resulted primarily from reductions in component
costs, improved manufacturing efficiencies and a shift in our
channel mix from OEMs to resellers, but was offset in part by lower
average selling prices due to increased competition.
Research and
development expenses. Research and development expenses
increased from $3.5 million for the three months ended September 30,
1998 to $6.9 million for the three months ended September 30, 1999,
an increase of $3.4 million. The increase was primarily due to
nonrecurring engineering and initial product verification expenses
and the hiring of additional engineers.
Selling and
marketing expenses. Selling and marketing expenses increased
from $4.8 million for the three months ended September 30, 1998 to
$11.1 million for the three months ended September 30, 1999, an
increase of $6.3 million. This increase was primarily due to the
hiring of additional sales, marketing and customer support
personnel, increased commission expenses resulting from higher
sales, tradeshow and promotional expenses, and the establishment of
new sales offices.
General and
administrative expenses. General and administrative expenses
increased from $1.2 million for the three months ended September 30,
1998 to $2.5 million for the three months ended September 30, 1999,
an increase of $1.3 million. This increase was due primarily to the
hiring of additional finance, information technology and legal and
administrative personnel and professional fees.
Interest and
other income, net. Interest and other income, net increased
from $0.2 million for the three months ended September 30, 1998 to
$1.7 million for the three months ended September 30, 1999, an
increase of $1.5 million. The increase was due to increased interest
income earned as a result of the increased amount of cash and cash
equivalents, short-term investments and long-term investments
from the net proceeds we received from our initial public offering
in April 1999.
Provision for
income taxes. We incurred significant operating losses for all
fiscal years from inception through June 30, 1999. We recorded an
effective tax rate of 30% for the three months ended September 30,
1999. The provision for income taxes consists primarily of foreign
taxes, state income taxes and federal alternative minimum taxes. Our
effective tax rate is lower than the combined federal and state
statutory rates primarily due to the utilization of net operating
loss carryforwards and other credit carryforwards offset by the
impact of foreign taxes. FASB Statement No. 109 provides for the
recognition of deferred tax assets if realization of such assets is
more likely than not. Based upon the weight of available evidence,
which includes our historical operating performance and the reported
cumulative net losses in all prior years, we have provided a full
valuation allowance against our net deferred tax assets as the
future realization of the tax benefit is not sufficiently assured.
We intend to evaluate the realizability of the deferred tax assets
on a quarterly basis.
Liquidity and Capital Resources
At September 30,
1999, we had $109.7 million in cash and cash equivalents, $6.8
million in short-term investments and $26.9 million in long-term
investments. We have primarily financed our operations through the
sale of equity securities. We completed our initial public offering
of approximately 8 million common shares (including the
underwriters' over-allotment provision) in April 1999 and raised
approximately $125.3 million net of offering costs. On October 20,
1999, the Company announced the completion of the public offering of
approximately 7.5 million shares (including the underwriters'
over-allotment provision) of its common stock at a price of $77.00
per share. Of these shares, the Company sold 2,372,708 shares and
existing stockholders sold 5,102,292 shares. The Company raised
approximately $175 million net of offering costs.
Cash provided by
operating activities was $7.5 million for the three months ended
September 30, 1999, as compared to cash used for operating
activities of $7.6 million for the three months ended September 30,
1998. The increase was primarily due to net income, depreciation and
increases in accrued warranty, deferred revenue and income taxes
payable, offset by increases in accounts receivable, inventories and
other current and noncurrent assets. We expect that accounts
receivable will continue to increase to the extent our revenues
continue to rise. Any such increase can be expected to reduce cash,
cash equivalents and short-term investments.
Investing
activities used cash of $6.4 million for the three months ended
September 30, 1999 due to capital expenditures of $5.2 million and
net purchases of investments of $1.2 million. Our investing
activities used cash of $2.1 million for the three months ended
September 30, 1998 for purchases of investments of $1.1 million, and
capital expenditures of $1.0 million.
Financing
activities provided cash of $1.5 million for the three months ended
September 30, 1999, arising primarily from proceeds from the
issuance and sale of common stock, partially offset by principal
payments on capital lease obligations. Financing activities used
cash of $0.3 million for the three months ended September 30, 1998,
primarily from principal payments on notes payable and capital lease
obligations, partially offset by the issuance and sale of stock.
We have a
revolving line of credit for $5.0 million with Silicon Valley Bank.
Borrowings under this line of credit bear interest at the bank's
prime rate. As of September 30, 1999, there were no outstanding
borrowings under this line of credit. We also have a capital
equipment line with Silicon Valley Bank for $4.0 million. Borrowings
under this capital equipment line bear interest at the bank's prime
rate. This agreement requires that we maintain certain financial
ratios and levels of tangible net worth, profitability and
liquidity. We were in compliance with the financial statement
covenants as of September 30, 1999. As of September 30, 1999, there
were no outstanding borrowings under this capital equipment line. In
addition, we have a $2.0 million capital equipment line with
Comdisco, Inc. As of September 30, 1999, there were no outstanding
borrowings under this capital equipment line.
In February 1999,
we agreed to lease a 77,000 square foot facility in Santa Clara,
California. The related cost of this lease is expected to be
approximately $120,000 per month. The lease has a term of 47 months.
We require
substantial capital to fund our business, particularly to finance
inventories and accounts receivable and for capital expenditures. In
order to build a sustainable business, we expect to use cash in our
operations over the next several quarters. We are working toward a
business model that will allow us to consistently generate cash from
operations. Achieving this model will depend on many factors,
including the rate of revenue growth, the timing and extent of
spending to support product development efforts and expansion of
sales and marketing, the timing of introductions of new products and
enhancements to existing products, and market acceptance of our
products. As a result, we could be required to raise substantial
additional capital. To the extent that we raise additional capital
through the sale of equity or convertible debt securities, the
issuance of such securities could result in dilution to existing
stockholders. If additional funds are raised through the issuance of
debt securities, these securities may have rights, preferences and
privileges senior to holders of common stock and the term of such
debt could impose restrictions on our operations. We cannot assure
you that such additional capital, if required, will be available on
acceptable terms, or at all. If we are unable to obtain such
additional capital, we may be required to reduce the scope of our
planned product development and marketing efforts, which would
materially adversely affect our business, financial condition and
operating results.
We believe that
our current cash and cash equivalents, short-term investments and
cash available from credit facilities and future operations will
enable us to meet our working capital requirements for at least the
next 12 months.
Year 2000 Readiness Disclosure
Some computers,
software and other equipment include computer code in which calendar
year data is abbreviated to only two digits. As a result of this
design decision, some of these systems could fail to operate or fail
to produce correct results if "00" is interpreted to mean
1900, rather than 2000. These problems are widely expected to
increase in frequency and severity as the year 2000 approaches, and
are commonly referred to as the "year 2000 problem."
Assessment.
The year 2000 problem affects the computers, software and other
equipment that we use, operate or maintain for our operations.
Accordingly, we have organized a program team responsible for
monitoring the assessment and remediation status of our year 2000
projects and reporting such status to our board of directors. This
program team has assessed the potential effect and costs of
remediating the year 2000 problem for our internal systems. To date,
we have not obtained verification or validation from any independent
third parties of our processes to assess and correct any of our year
2000 problems or the costs associated with these activities.
Internal
infrastructure. We have identified and evaluated approximately
250 personal computers and servers, six software applications,
including Microsoft Windows 95, Microsoft Office 97 and Outlook 98
and Microsoft Mail Server, and our enterprise resource planning
system, and related equipment used in connection with our internal
operations to determine if they must be modified, upgraded or
replaced to minimize the possibility of a material disruption to our
business. We have commenced the process of modifying, upgrading,
and replacing major systems that have
been assessed as adversely affected, and expect to complete this
process before the occurrence of any material disruption of our
business.
Systems other
than information technology systems. In addition to computers
and related systems, the operation of office and facilities
equipment, such as fax machines, telephone switches, security
systems, and other common devices may be affected by the year 2000
problem. To date, we have been able to correct any problems with our
systems other than information technology systems relating to year
2000. We currently do not expect any significant problems to arise
with our systems other than information technology systems relating
to the year 2000.
Products and
software programs. We have tested and intend to continue to test
all of our products and software programs for year 2000 problems. To
date, we have been able to correct any problems with our products
and software programs relating to year 2000 prior to releasing them
to our customers. We currently do not expect any significant
problems to arise with our products and software programs relating
to the year 2000.
We estimate the
total cost to us of completing any required modifications, upgrades
or replacements of our internal systems will not exceed $200,000,
almost all of which we believe will be incurred during calendar
1999. This estimate is being monitored and we will revise it, as
additional information becomes available.
Based on the
activities described above, we do not believe that the year 2000
problem will have a material adverse effect on our business or
operating results. In addition, we have not deferred any material
information technology projects as a result of our year 2000 problem
activities.
Suppliers.
We are checking the web sites of third-party suppliers of components
used in the manufacture of our products to determine if these
suppliers are certifying that the components they provide us are
year 2000 compliant. To date, we believe all critical components
that we obtain from third party suppliers are year 2000 compliant,
except that Microsoft has not indicated that Windows 95 and its
office mail programs is year 2000 compliant. We expect that we will
be able to resolve any significant year 2000 problems with Microsoft
and any other third-party suppliers of components; however, there
can be no assurance that these suppliers will resolve any or all
year 2000 problems before the occurrence of a material disruption to
the operation of our business. Any failure of these third parties to
timely resolve year 2000 problems with their systems could have a
material adverse effect on our business, operating results and
financial condition.
Most likely
consequences of year 2000 problems. We expect to identify and
resolve all year 2000 problems that could materially adversely
affect our business operations. However, we believe that it is not
possible to determine with complete certainty that all year 2000
problems affecting us have been identified or corrected. The number
of devices that could be affected and the interactions among these
devices are simply too numerous. In addition, no one can accurately
predict how many year 2000 problem-related failures will occur or
the severity, duration, or financial consequences of these perhaps
inevitable failures. As a result, we believe that the following
consequences are possible:
| ·
|
|
a significant number of
operational inconveniences and inefficiencies for us, our contract
manufacturers and our customers that will divert management's time
and attention and financial and human resources from ordinary
business activities; |
| |
|
|
| ·
|
|
several business disputes and
claims for pricing adjustments or penalties due to year 2000
problems by our customers, which we believe will be resolved in
the ordinary course of business; and |
| |
|
|
| ·
|
|
a few serious business disputes
alleging that we failed to comply with the terms of contracts or
industry standards of performance, some of which could result in
litigation or contract termination. |
Contingency plans. We have developed
contingency plans to be implemented if our efforts to identify and
correct year 2000 problems affecting our internal systems are not
effective. Depending on the systems affected, these plans could
include:
| ·
|
|
accelerated replacement of
affected equipment or software; |
| ·
|
|
short to medium-term use of
backup equipment and software; |
| |
|
|
| ·
|
|
increased work hours for our
personnel; and |
| |
|
|
| ·
|
|
use of contract personnel to
correct on an accelerated schedule any year 2000 problems that
arise or to provide manual workarounds for information systems.
|
Our implementation
of any of these contingency plans could have a material adverse
effect on our business, operating results and financial condition.
Disclaimer.
The discussion of our efforts and expectations relating to year 2000
compliance are forward-looking statements. Our ability to achieve
year 2000 compliance and the level of incremental costs associated
therewith, could be adversely affected by, among other things, the
availability and cost of programming and testing resources, third
party suppliers' ability to modify proprietary software, and
unanticipated problems identified in the ongoing compliance review.
Factors That May Affect Our Results
Extreme Has a General History of Losses, and
Limited History of Profitability and Cannot Assure You that it Will
Continue to Achieve Profitability
We have not
achieved profitability on an annual basis and although our revenue
has grown in recent quarters, we cannot be certain that we will
realize sufficient revenue to achieve profitability on an annual
basis. Extreme has incurred net losses of $7.9 million from
inception through June 30, 1997, $13.9 million for fiscal 1998 and
$1.6 million for fiscal 1999. As of September 30, 1999, we had an
accumulated deficit of $19.4 million. We anticipate continuing to
incur significant sales and marketing, product development and
general and administrative expenses and, as a result, we will need
to generate significantly higher revenue to sustain profitability.
Although our revenues have grown in recent quarters and we have
recently achieved quarterly profitability, we cannot be certain that
we will continue to realize sufficient revenue to sustain
profitability.
A Number of Factors Could Cause Extreme's
Quarterly Financial Results to Be Worse Than Expected, Resulting in
a Decline in Its Stock Price
We plan to
significantly increase our operating expenses to expand our sales
and marketing activities, broaden our customer support capabilities,
develop new distribution channels, fund increased levels of research
and development and build our operational infrastructure. We base
our operating expenses on anticipated revenue trends and a high
percentage of our expenses are fixed in the short term. As a result,
any delay in generating or recognizing revenue could cause our
quarterly operating results to be below the expectations of public
market analysts or investors, which could cause the price of our
common stock to fall.
We may experience
a delay in generating or recognizing revenue because of a number of
reasons. Orders at the beginning of each quarter typically do not
equal expected revenue for that quarter and are generally cancelable
at any time. Accordingly, we are dependent upon obtaining orders in
a quarter for shipment in that quarter to achieve our revenue
objectives. In addition, the timing of product releases, purchase
orders and product availability could result in significant product
shipments at the end of a quarter. Failure to ship these products by
the end of a quarter may adversely affect our operating results.
Furthermore, our customer agreements typically provide that the
customer may delay scheduled delivery dates and cancel orders within
specified time frames without significant penalty.
Our quarterly
revenue and operating results have varied significantly in the past
and may vary significantly in the future due to a number of factors,
including:
| ·
|
|
fluctuations in demand for our
products and services, including seasonality, particularly in Asia
and Europe; |
| |
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|
| ·
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|
unexpected product returns or the
cancellation or rescheduling of significant orders; |
| ·
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|
our ability to develop,
introduce, ship and support new products and product enhancements
and manage product transitions; |
| |
|
|
| ·
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|
announcements and new product
introductions by our competitors; |
| |
|
|
| ·
|
|
our ability to develop and
support customer relationships with service providers and other
potential large customers; |
| |
|
|
| ·
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|
our ability to achieve required
cost reductions; |
| |
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|
| ·
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|
our ability to obtain sufficient
supplies of sole or limited sourced components for our products;
|
| |
|
|
| ·
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|
unfavorable changes in the prices
of the components we purchase; |
| |
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| ·
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|
our ability to attain and
maintain production volumes and quality levels for our products;
|
| |
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| ·
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|
the mix of products sold and the
mix of distribution channels through which they are sold; and
|
| |
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| ·
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|
costs relating to possible
acquisitions and integration of technologies or businesses.
|
Due to the
foregoing factors, we believe that period-to-period comparisons of
our operating results should not be relied upon as an indicator of
our future performance.
Intense Competition in the Market for
Networking Equipment Could Prevent Extreme From Increasing Revenue
and Prevent Extreme From Sustaining Profitability
The market for
internet switches is intensely competitive. Our principal
competitors include Cabletron Systems, Cisco Systems, Foundry
Networks, Lucent Technologies, Nortel Networks, and 3Com. Many of
our current and potential competitors have longer operating
histories and substantially greater financial, technical, sales,
marketing and other resources, as well as greater name recognition
and larger installed customer bases, than we do. These competitors
may have developed or could in the future develop new technologies
that compete with our products or even render our products obsolete.
To remain
competitive, we believe we must, among other things, invest
significant resources in developing new products and enhancing our
current products and maintaining customer satisfaction. If we fail
to do so, our products may not compete favorably with those of our
competitors and our revenue and future profitability could be
materially adversely affected.
Extreme Expects the Average Selling Prices of
Its Products to Decrease Rapidly Which May Reduce Gross Margins or
Revenue
The network
equipment industry has experienced rapid erosion of average selling
prices due to a number of factors, including competitive pricing
pressures and rapid technological change. We may experience
substantial period-to-period fluctuations in future operating
results due to the erosion of our average selling prices. We
anticipate that the average selling prices of our products will
decrease in the future in response to competitive pricing pressures,
increased sales discounts, new product introductions by us or our
competitors, including, for example, competitive products
manufactured with low cost merchant silicon, or other factors.
Therefore, to maintain our gross margins, we must develop and
introduce on a timely basis new products and product enhancements
and continually reduce our product costs. Our failure to do so would
cause our revenue and gross margins to decline, which could
materially adversely affect our operating results and cause the
price of our common stock to decline.
Extreme's Market is Subject to Rapid
Technological Change and to Compete, Extreme Must Continually
Introduce New Products that Achieve Broad Market Acceptance
The network
equipment market is characterized by rapid technological change,
frequent new product introductions, changes in customer requirements
and evolving industry standards. If we do not address these changes
by regularly introducing new products, our product line will become
obsolete. Developments in routers and routing software could also
significantly reduce demand for our product. Alternative
technologies could achieve widespread market acceptance and displace
Ethernet technology on which our product lines and
architecture are based. We cannot assure
you that our technological approach will achieve broad market
acceptance or that other technologies or devices will not supplant
our approach.
When we announce
new products or product enhancements that have the potential to
replace or shorten the life cycle of our existing products,
customers may defer purchasing our existing products. These actions
could materially adversely affect our operating results by
unexpectedly decreasing sales, increasing our inventory levels of
older products and exposing us to greater risk of product
obsolescence. The market for switching products is evolving and we
believe our ability to compete successfully in this market is
dependent upon the continued compatibility and interoperability of
our products with products and architectures offered by other
vendors. In particular, the networking industry has been
characterized by the successive introduction of new technologies or
standards that have dramatically reduced the price and increased the
performance of switching equipment. To remain competitive we need to
introduce products in a timely manner that incorporate or are
compatible with these new technologies as they emerge. For example,
this fiscal year we expect to ship new products that will
incorporate a new chipset we are currently developing, we cannot
assure you that these new products will be commercially successful.
We have experienced delays in releasing new products and product
enhancements in the past which delayed sales and resulted in lower
quarterly revenue than anticipated. We may experience similar delays
in product development in the future and any delay in product
introduction could adversely affect our ability to compete and cause
our operating results to be below our expectations or the
expectations of public market analysts or investors.
Continued Rapid Growth Will Strain Extreme's
Operations and Will Require Extreme to Incur Costs to Upgrade Its
Infrastructure
Since the
introduction of our product line, we have experienced a period of
rapid growth and expansion which has placed, and continues to place,
a significant strain on our resources. Unless we manage such growth
effectively, we may make mistakes in operating our business such as
inaccurate sales forecasting, incorrect material planning or
inaccurate financial reporting, which may result in unanticipated
fluctuations in our operating results. Our net revenue increased
significantly during the last year, and from September 30, 1998
to September 30, 1999, the number of our employees increased from
137 to 317. We expect our anticipated growth and expansion to strain
our management, operational and financial resources. Our management
team has had limited experience managing such rapidly growing
companies on a public or private basis. To accommodate this
anticipated growth, we will be required to:
| ·
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|
improve existing and implement
new operational, information and financial systems, procedures and
controls; |
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|
hire, train and manage additional
qualified personnel, including in the near future sales and
marketing personnel; and |
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effectively manage multiple
relationships with our customers, suppliers and other third
parties. |
We may not be able
to install adequate control systems in an efficient and timely
manner, and our current or planned personnel systems, procedures and
controls may not be adequate to support our future operations. For
example, in the quarter ended June 30, 1998, our operating results
were adversely impacted due to a provision of approximately $900,000
that we recorded for purchase order commitments for certain
components that exceeded our estimated requirements at the end of
that quarter. This was due primarily to an engineering change in
certain of our Summit family of products and a reduced demand
forecast from one of our customers. In August 1998, we installed a
new management information system, which we may continue to modify
and improve to meet the increasing needs associated with our growth.
The difficulties associated with installing and implementing these
new systems, procedures and controls may place a significant burden
on our management and our internal resources. In addition, as we
grow internationally, we will have to expand our worldwide
operations and enhance our communications infrastructure. Any delay
in the implementation of such new or enhanced systems, procedures or
controls, or any disruption in the transition to such new or
enhanced systems, procedures or controls, could adversely affect our
ability to accurately forecast sales demand, manage our supply chain
and record and report financial and management information on a
timely and accurate basis.
Extreme Must Develop and Expand Its Indirect
Distribution Channels to Increase Revenues and Improve Its Operating
Results
Our distribution
strategy focuses primarily on developing and expanding indirect
distribution channels through resellers and, to a lesser extent,
original equipment manufacturers, or OEMs, as well as expanding our
field sales organization. If we fail to develop and cultivate
relationships with significant resellers, or if these resellers are
not successful in their sales efforts, sales of our products may
decrease and our operating results would suffer. Many of our
resellers also sell products that compete with our products. We are
developing a two-tier distribution structure in Europe and the
United States which has and will require us to enter into agreements
with a small number of stocking distributors. We have recently
entered into three two-tier distribution agreements; however, we
cannot assure you that we will continue to be able to enter into
additional distribution agreements or that we will be able to
successfully manage the transition of resellers to a two-tier
distribution channel. Our failure to do so could limit our ability
to grow or sustain revenue. In addition, our operating results will
likely fluctuate significantly depending on the timing and amount of
orders from our resellers. We cannot assure you that our resellers
will market our products effectively or continue to devote the
resources necessary to provide us with effective sales, marketing
and technical support.
In order to
support and develop leads for our indirect distribution channels, we
plan to expand our field sales and support staff significantly. In
addition, we need to continue to develop our field sales and support
staff to expand our direct sales efforts to service providers and
content providers. We cannot assure you that this internal expansion
will be successfully completed, that the cost of this expansion will
not exceed the revenues generated or that our expanded sales and
support staff will be able to compete successfully against the
significantly more extensive and well-funded sales and marketing
operations of many of our current or potential competitors. Our
inability to effectively establish our distribution channels or
manage the expansion of our sales and support staff would materially
adversely affect our ability to grow and increase revenue.
Because Substantially All of Extreme's
Revenue is Derived From Sales of Two Product Families, Extreme is
Dependent on Widespread Market Acceptance of These Products; Future
Performance will Depend on the Introduction and Acceptance of New
Products
We currently
derive substantially all of our revenue from sales of our Summit and
BlackDiamond product families. We expect that revenue from these
product families will account for a substantial portion of our
revenue for the foreseeable future. Accordingly, widespread market
acceptance of our product families is critical to our future
success. Factors that may affect the market acceptance of our
products include market acceptance of switching products, and
Gigabit Ethernet and Layer 3 switching technologies in particular in
the enterprise, service provider and content provider markets, the
performance, price and total cost of ownership of our products, the
availability and price of competing products and technologies, and
the success and development of our resellers, OEMs and field sales
channels. Many of these factors are beyond our control. Our future
performance will also depend on the successful development,
introduction and market acceptance of new and enhanced products that
address customer requirements in a cost-effective manner. We are
developing products which we expect to introduce this fiscal year
which are based on a new chip set under development. The
introduction of new and enhanced products may cause our customers to
defer or cancel orders for existing products. We have in the past
experienced delays in product development and such delays may occur
in the future. Therefore, to the extent customers defer or cancel
orders in the expectation of any new product release, any delay in
development or introduction could cause our operating results to
suffer. Failure of our existing or future products to maintain and
achieve widespread levels of market acceptance may significantly
impair our revenue growth.
If a Key Reseller, OEM or Other Significant
Customer Cancels or Delays a Large Purchase, Extreme's Revenues May
Decline and the Price of Its Stock May Fall
To date, a limited
number of resellers, OEMs and other customers have accounted for a
significant portion of our revenue. If any of our large customers
stop or delay purchases, our revenue and profitability would be
adversely affected. For the quarter ended September 30, 1998, Allied
Telesis KK, Compaq and Tokyo Electron Ltd. accounted for 11%, 18%
and 14% of our net revenue, respectively, and for the quarter ended
September 30, 1999, Compaq and Hitachi Cable accounted for 23% and
11% of our net revenue, respectively. Compaq is both an OEM and an
end-user customer. Because our expense levels are based on our
expectations as to future
revenue and to a large extent are fixed
in the short term, a substantial reduction or delay in sales of our
products to, or the loss of any significant reseller, OEM or other
customer, or unexpected returns from resellers could harm our
business, operating results and financial condition. Although our
largest customers may vary from period-to-period, we anticipate that
our operating results for any given period will continue to depend
to a significant extent on large orders from a small number of
customers, particularly in light of the high sales price per unit of
our products and the length of our sales cycles.
While our
financial performance depends on large orders from a few key
resellers, OEMs and other significant customers, we do not have
binding commitments from any of them. For example:
| ·
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|
our service provider and
enterprise network customers can stop purchasing and our resellers
and OEMs can stop marketing our products at any time; |
| |
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· |
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our reseller
agreements generally are not exclusive and are for one year terms,
with no obligation of the resellers to renew the agreements;
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our reseller agreements provide
for discounts based on expected or actual volumes of products
purchased or resold by the reseller in a given period; and
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| ·
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our reseller and OEM agreements
generally do not require minimum purchases. |
We have
established a program which, under specified conditions, enables
some third party resellers to return products to us. The amount of
potential product returns is estimated and provided for in the
period of the sale. Some of our OEM agreements also provide
manufacturing rights and access to our source code upon the
occurrence of specified conditions of default. If we were to default
on these agreements, our OEMs could use our source code to develop
and manufacture competing products, which would negatively affect
our performance and ability to compete.
The Sales Cycle for Extreme's Products is
Long and Extreme May Incur Substantial Non-Recoverable Expenses or
Devote Significant Resources to Sales that Do Not Occur When
Anticipated
The timing of our
sales revenue is difficult to predict because of our reliance on
indirect sales channels and the length and variability of our sales
cycle. Our products have a relatively high sales price per unit, and
often represent a significant and strategic decision by an
enterprise regarding its communications infrastructure. Accordingly,
the purchase of our products typically involves significant internal
procedures associated with the evaluation, testing, implementation
and acceptance of new technologies. This evaluation process
frequently results in a lengthy sales process, typically ranging
from three months to longer than a year, and subjects the sales
cycle associated with the purchase of our products to a number of
significant risks, including budgetary constraints and internal
acceptance reviews. The length of our sales cycle also may vary
substantially from customer to customer. While our customers are
evaluating our products and before they may place an order with us,
we may incur substantial sales and marketing expenses and expend
significant management effort. Consequently, if sales forecasted
from a specific customer for a particular quarter are not realized
in that quarter, we may be unable to compensate for the shortfall,
which could harm our operating results.
Extreme Purchases Several Key Components for
Products From Single or Limited Sources and Could Lose Sales if
These Sources Fail to Fill Its Needs
We currently
purchase several key components used in the manufacture of our
products from single or limited sources and are dependent upon
supply from these sources to meet our needs. Certain components such
as gigabit interface converter transceivers, or GBICs, have been and
may in the future be in short supply. While we have been able to
meet our needs to date, we are likely to encounter shortages and
delays in obtaining these or other components in the future which
could materially adversely affect our ability to meet customer
orders. Our principal sole sourced components include:
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ASICs; |
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microprocessors; |
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programmable integrated circuits;
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selected other integrated
circuits; |
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cables; and |
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custom-tooled sheet metal.
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Our principal limited sourced
components include: |
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flash memories; |
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dynamic and static random access
memories, commonly known as DRAMs and SRAMs, respectively; and
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· |
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printed circuit boards
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We use a rolling
six-month forecast based on anticipated product orders to determine
our material requirements. Lead times for materials and components
we order vary significantly, and depend on factors such as the
specific supplier, contract terms and demand for a component at a
given time. If orders do not match forecasts, we may have excess or
inadequate inventory of certain materials and components, which
could materially adversely affect our operating results and
financial condition. From time to time we have experienced shortages
and allocations of certain components, resulting in delays in
filling orders. In addition, during the development of our products
we have experienced delays in the prototyping of our ASICs, which in
turn has led to delays in product introductions.
Extreme Needs to Expand Its Manufacturing
Operations and Depends on Contract Manufacturers for Substantially
All of Its Manufacturing Requirements
If the demand for
our products grows, we will need to increase our material purchases,
contract manufacturing capacity and internal test and quality
functions. Any disruptions in product flow could limit our revenue,
adversely affect our competitive position and reputation and result
in additional costs or cancellation of orders under agreements with
our customers.
We rely on third
party manufacturing vendors to manufacture our products. We
currently subcontract substantially all of our manufacturing to two
companies -- Flextronics International, Ltd., located in
San Jose, California, MCMS, Inc., located in Boise, Idaho. We have
experienced a delay in product shipments from a contract
manufacturer in the past, which in turn delayed product shipments to
our customers. We may in the future experience similar or other
problems, such as inferior quality and insufficient quantity of
product, any of which could materially adversely affect our business
and operating results. There can be no assurance that we will
effectively manage our contract manufacturers or that these
manufacturers will meet our future requirements for timely delivery
of products of sufficient quality and quantity. We intend to
regularly introduce new products and product enhancements, which
will require that we rapidly achieve volume production by
coordinating our efforts with those of our suppliers and contract
manufacturers. The inability of our contract manufacturers to
provide us with adequate supplies of high-quality products or the
loss of either of our contract manufacturers would cause a delay in
our ability to fulfill orders while we obtain a replacement
manufacturer and would have a material adverse effect on our
business, operating results and financial condition.
As part of our
cost-reduction efforts, we will need to realize lower per unit
product costs from our contract manufacturers as a result of volume
efficiencies. However, we cannot be certain when or if such price
reductions will occur. The failure to obtain such price reductions
would adversely affect our gross margins and operating results.
If Extreme Loses Key Personnel or is Unable
to Hire Additional Qualified Personnel as Necessary, It May Not Be
Able to Successfully Manage Its Business or Achieve Its Objectives
Our success
depends to a significant degree upon the continued contributions of
our key management, engineering, sales and marketing and
manufacturing personnel, many of whom would be difficult to replace.
In particular, we believe that our future success is highly
dependent on Gordon Stitt, Chairman, President and Chief Executive
Officer, Stephen Haddock, Vice President and Chief Technical
Officer, and Herb Schneider, Vice President of Engineering. We
neither have employment contracts with nor key person life insurance
on any of our key personnel.
We believe our
future success will also depend in large part upon our ability to
attract and retain highly skilled managerial, engineering, sales and
marketing, finance and manufacturing personnel. Competition for
these personnel is intense, especially in the San Francisco Bay
Area, and we have had difficulty hiring employees in the timeframe
we desire, particularly software engineers. There can be no
assurance that we will be successful in attracting and retaining
such personnel. The loss of the services of any of our key
personnel, the inability to attract or retain qualified personnel in
the future or delays in hiring required personnel, particularly
engineers and sales personnel, could make it difficult for us to
manage our business and meet key objectives, such as product
introductions, on time. In addition, companies in the networking
industry whose employees accept positions with competitors
frequently claim that competitors have engaged in unfair hiring
practices. We have from time to time received claims like this from
other companies and, although to date they have not resulted in
material litigation, we cannot assure you that we will not receive
additional claims in the future as we seek to hire qualified
personnel or that such claims will not result in material
litigation. We could incur substantial costs in defending ourselves
against any such claims, regardless of the merits of such claims.
Extreme's Products Must Comply With Evolving
Industry Standards and Complex Government Regulations or Its
Products May Not Be Widely Accepted, Which May Prevent Extreme From
Sustaining Its Revenues or Achieving Profitability.
The market for
network equipment products is characterized by the need to support
industry standards as different standards emerge, evolve and achieve
acceptance. We will not be competitive unless we continually
introduce new products and product enhancements that meet these
emerging standards. In the past, we have introduced new products
that were not compatible with certain technological changes, and in
the future we may not be able to effectively address the
compatibility and interoperability issues that arise as a result of
technological changes and evolving industry standards. In addition,
in the United States, our products must comply with various
regulations and standards defined by the Federal Communications
Commission and Underwriters Laboratories. Internationally, products
that we develop may be required to comply with standards established
by telecommunications authorities in various countries as well as
with recommendations of the International Telecommunication Union.
If we do not comply with existing or evolving industry standards or
if we fail to obtain timely domestic or foreign regulatory approvals
or certificates we would not be able to sell our products where
these standards or regulations apply, which may prevent us from
sustaining our revenues or achieving profitability.
Extreme Needs to Expand Its Sales and Support
Organizations to Increase Market Acceptance of Its Products and If
It Fails to Do So, Extreme Will Not Be Able to Increase Revenues
Our products and
services require a sophisticated sales effort targeted at several
levels within a prospective customer's organization. Unless we
expand our sales force we will not be able to increase revenues. We
have recently expanded our sales force and plan to hire additional
sales personnel. However, competition for qualified sales personnel
is intense, and we might not be able to hire the kind and number of
sales personnel we are targeting.
We currently have
a small customer service and support organization and will need to
increase our staff to support new customers and the expanding needs
of existing customers. The design and installation of networking
products can be complex; accordingly, we need highly trained
customer service and support personnel particularly for large
service provider and enterprise network customers. Hiring customer
service and support personnel is very competitive in our industry
due to the limited number of people available with the necessary
technical skills and understanding of our products.
Extreme Depends Upon International Sales for
Much of Its Revenue and Extreme's Ability to Sustain and Increase
Its International Sales Depends on Successfully Expanding Its
International Operations
Our ability to
grow will depend in part on the expansion of international sales and
operations which have and are expected to constitute a significant
portion of our sales. Sales to customers outside of North America
accounted for approximately 42% and 45% of our net revenue in the
three months ended September 30, 1999 and September 30, 1998,
respectively. Our international sales primarily depend on our
resellers and OEMs. The failure of our resellers and OEMs to sell
our products internationally would limit our ability to sustain and
grow our revenue. In addition, there are a number of risks arising
from our international business, including:
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longer accounts receivable
collection cycles; |
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difficulties in managing
operations across disparate geographic areas; |
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difficulties associated
with enforcing agreements through foreign legal systems;
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payment of operating
expenses in local currencies, which subjects us to risks of
currency fluctuations; |
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import or export licensing
requirements; |
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potential adverse tax
consequences; and |
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unexpected changes in regulatory
requirements. |
Our international
sales currently are U.S. dollar-denominated. As a result, an
increase in the value of the U.S. dollar relative to foreign
currencies could make our products less competitive in international
markets. In the future, we may elect to invoice some of our
international customers in local currency which will subject us to
fluctuations in exchange rates between the U.S. dollar and the
particular local currency. If we do so, we may determine to engage
in hedging transactions to minimize the risk of such fluctuations.
However, if we are not successful in managing such hedging
transactions, we could incur losses from hedging activities. Because
we currently denominate sales in U.S. dollars, we do not anticipate
that the adoption of the Euro as a functional legal currency of
certain European countries will materially affect our business.
Extreme May Engage in Future Acquisitions
that Dilute the Ownership Interests of Our Stockholders, Cause Us to
Incur Debt and Assume Contingent Liabilities
As part of our
business strategy, we review acquisition and strategic investment
prospects that would complement our current product offerings,
augment our market coverage or enhance our technical capabilities,
or that may otherwise offer growth opportunities. While we have no
current agreements or negotiations underway with respect to any such
material acquisitions, we are reviewing investments in new
businesses and we may acquire businesses, products or technologies
in the future. In the event of any future acquisitions, we could:
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issue equity securities which
would dilute current stockholders' percentage ownership;
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incur substantial debt; or
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assume contingent
liabilities. |
These actions by
us could materially adversely affect our operating results and/or
the price of our common stock. Acquisitions and investment
activities also entail numerous risks, including:
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· |
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difficulties in the
assimilation of acquired operations, technologies or products;
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unanticipated costs associated
with the acquisition or investment transaction; |
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diversion of management's
attention from other business concerns; |
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adverse effects on existing
business relationships with suppliers and customers; |
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risks associated with
entering markets in which we have no or limited prior experience;
and |
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potential loss of key
employees of acquired organizations. |
We cannot assure
you that we will be able to successfully integrate any businesses,
products, technologies or personnel that we might acquire in the
future, and our failure to do so could materially adversely affect
our business, operating results and financial condition.
Extreme May Need Additional Capital to Fund
Its Future Operations Which, If It Is Not Available When Needed,
Extreme May Need to Reduce Its Planned Development and Marketing
Efforts, Which May Reduce Its Revenues and Prevent Extreme From
Achieving Profitability
We believe that
our existing working capital, proceeds from the initial public
offering in April 1999, proceeds from the secondary offering in
October 1999 and cash available from credit facilities and future
operations will enable us to meet our working capital requirements
for at least the next 12 months. However, if cash from future
operations is insufficient, or if cash is used for acquisitions or
other currently unanticipated uses, we may need additional capital.
The development and marketing of new products and the expansion of
reseller and distribution channels and associated support personnel
is expected to require a significant commitment of resources. In
addition, if the market for Layer 3 switches were to develop more
slowly than anticipated or if we fail to establish significant
market share and achieve a meaningful level of revenues, we may
continue to utilize significant amounts of capital. As a result, we
could be required to raise substantial additional capital. To the
extent that we raise additional capital through the sale of equity
or convertible debt securities, the issuance of such securities
could result in dilution to existing stockholders. If additional
funds are raised through the issuance of debt securities, such
securities may have rights, preferences and privileges senior to
holders of common stock and the term of such debt could impose
restrictions on our operations. We cannot assure you that such
additional capital, if required, will be available on acceptable
terms, or at all. If we are unable to obtain such additional
capital, we may be required to reduce the scope of our planned
product development and marketing efforts, which would harm our
business, financial condition and operating results.
If Extreme's Products Contain Undetected
Software or Hardware Errors, Extreme Could Incur Significant
Unexpected Expenses and Lost Sales
Network products
frequently contain undetected software or hardware errors when first
introduced or as new versions are released. We have experienced such
errors in the past in connection with new products and product
upgrades. We expect that such errors will be found from time to time
in new or enhanced products after commencement of commercial
shipments. These problems may materially adversely affect our
business by causing us to incur significant warranty and repair
costs, diverting the attention of our engineering personnel from our
product development efforts and causing significant customer
relations problems.
Our products must
successfully interoperate with products from other vendors. As a
result, when problems occur in a network, it may be difficult to
identify the source of the problem. The occurrence of hardware and
software errors, whether caused by our products or another vendor's
products, could result in the delay or loss of market acceptance of
our products and any necessary revisions may result in the
incurrence of significant expenses. The occurrence of any such
problems would likely have a material adverse effect on our
business, operating results and financial condition.
Extreme's Limited Ability to Protect Its
Intellectual Property May Adversely Affect Its Ability to Compete
We rely on a
combination of patent, copyright, trademark and trade secret laws
and restrictions on disclosure to protect our intellectual property
rights. However, we cannot assure you that the actions we have taken
will adequately protect our intellectual property rights.
We also enter into
confidentiality or license agreements with our employees,
consultants and corporate partners, and control access to and
distribution of our software, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use
our products or technology.
If Extreme or Its Key Suppliers and Customers
Fail to Be Year 2000 Compliant, Extreme's Business May Be Severely
Disrupted And Its Revenues May Decline
The year 2000
computer issue creates a risk for us. If systems do not correctly
recognize date information when the year changes to 2000, there
could be an adverse impact on our operations. The risk exists in
four areas:
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potential warranty or other
claims from our customers; |
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systems we use to run our
business; |
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systems used by our suppliers; and
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the potential reduced spending by
other companies on networking solutions as a result of significant
information systems spending on year 2000 remediation. |
We are currently
evaluating our exposure in all of these areas.
We are conducting
an inventory and evaluation of the information systems used to run
our business. Systems which have been and may be identified as
non-compliant have been or will be upgraded or replaced. For the
year 2000 non-compliance issues identified to date, the cost of
remediation is not expected to be material to our operating results.
However, if implementation of replacement systems is delayed, or if
significant new non-compliance issues are identified, our operating
results or financial condition could be materially adversely
affected.
We are checking
the websites of our suppliers to determine if these suppliers are
certifying that the components they provide us are year 2000
compliant. To date, we believe all critical components that we
obtain from third party suppliers are year 2000 compliant, except
that Microsoft has not indicated that Windows 95 and its office mail
programs is year 2000 compliant. We expect that we will be able to
resolve any significant year 2000 problems with Microsoft and any
other third-party suppliers of components; however, there can be no
assurance that these suppliers will resolve any or all year 2000
problems before the occurrence of a material disruption to the
operation of our business. Any failure of these third parties to
timely resolve year 2000 problems with their systems could have a
material adverse effect on our business, operating results and
financial condition.
Since all customer
situations cannot be anticipated, we may see an increase in warranty
and other claims as a result of the year 2000 transition. In
addition, litigation regarding year 2000 compliance issues is
expected to escalate. For these reasons, the impact of customer
claims could have a material adverse impact on our operating results
or financial condition.
Businesses that
face year 2000 compliance issues may require significant hardware
and software upgrades or modifications to their computer systems and
applications. These companies may plan to devote a substantial
portion of their information systems' spending to fund such upgrades
and modifications and divert spending away from networking
solutions. This change in customers' spending patterns could
materially adversely impact our business, operating results or
financial condition.
Provisions in Extreme's Charter or Agreements
May Delay or Prevent a Change of Control
Provisions in our
certificate of incorporation and bylaws may delay or prevent a
change of control or changes in our management. These provisions
include:
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the division
of the board of directors into three separate classes; |
· the
right of the board of directors to elect a director to fill a
vacancy created by the expansion of the board of directors;
· the
ability of the board of directors to alter our bylaws without
getting stockholder approval; and
· the
requirement that at least 10% of the outstanding shares are needed
to call a special meeting of stockholders.
Furthermore, we
are subject to the provisions of section 203 of the Delaware General
Corporation Law. These provisions prohibit large stockholders, in
particular those owning 15% or more of the outstanding voting stock,
from consummating a merger or combination with a corporation unless
this stockholder receives board approval for the transaction or 66
2/3% of the shares of voting stock not owned by the stockholder
approve the merger or combination. Further, we have investor
agreements with Compaq, Siemens and 3Com which require us to give
these companies notice if we receive an acquisition offer or if we
intend to pursue one.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Sensitivity
The primary
objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the
securities that we have invested in may be subject to market risk.
This means that a change in prevailing interest rates may cause the
principal amount of the investment to fluctuate. For example, if we
hold a security that was issued with a fixed interest rate at the
then-prevailing rate and the prevailing interest rate later rises,
the principal amount of our investment will probably decline. To
minimize this risk, we maintain our portfolio of cash equivalents
and short-term investments in a variety of securities, including
commercial paper, other non-government debt securities and money
market funds. In general, money market funds are not subject to
market risk because the interest paid on such funds fluctuates with
the prevailing interest rate. The following table presents the
amounts of our cash equivalents, short-term investments and
long-term investments that are subject to market risk by range of
expected maturity and weighted-average interest rates as of
September 30, 1999. This table does not include money market funds
because those funds are not subject to market risk.
|
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Maturing in
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Three months
|
Three months
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Greater than
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Fair
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or less
|
to one year
|
one year
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Total
|
Value
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(In thousands)
|
Included
in cash and cash equivalents
|
$ 97,291
|
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$ 97,291
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$97,291
|
Weighted
average interest rate
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5.41%
|
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Included
in short-term investments
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$6,792
|
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$ 6,792
|
$ 6,792
|
Weighted
average interest rate
|
|
6.07%
|
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Included
in investments
|
|
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$ 26,915
|
$26,915
|
$26,915
|
Weighted
average interest rate
|
|
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8.60%
|
|
|
Exchange Rate Sensitivity
Currently, the
majority of our sales and expenses are denominated in U.S. dollars
and as a result, we have experienced no significant foreign exchange
gains and losses to date. While we have conducted some transactions
in foreign currencies during the three months ended September 30,
1999 and expect to continue to do so, we do not anticipate that
foreign exchange gains or losses will be significant. We have not
engaged in foreign currency hedging activities to date, however, we
may do so in the future.
PART II. Other Information
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of
Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule (filed only with the
electronic submission of Form 10-Q in accordance with the Edgar
requirements)
(b) Reports on Form 8-K
No reports on Form
8-K were filed by the Company during the three months ended
September 30, 1999.
SIGNATURES
Pursuant to the requirements of the
Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
EXTREME NETWORKS, INC.
(Registrant)
/S/VITO PALERMO
|
VITO PALERMO
Vice President, Chief
Financial Officer
And Secretary
November 12, 1999
5
1,000
3-MOS
JUL-02-2000
JUL-01-1999
OCT-03-1999
109,657
6,792
22,391
1,377
4,761
146,954
15,571
5,521
184,202
36,611
0
0
0
49
147,542
184,202
47,218
47,218
22,617
22,617
20,512
0
52
5,781
1,734
4,047
0
0
0
4,047
.09
.08
