SEC Filing - Extreme Networks, Inc.

- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 Form 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended April 2, 2000 OR | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 000-25711 EXTREME NETWORKS, INC. (Exact name of Registrant as specified in its charter) DELAWARE 77-0430270 ---------------------------- ------------------------------------ [State or other jurisdiction [I.R.S. Employer Identification No.] of incorporation or organization] 3585 Monroe Street Santa Clara, California 95051 ---------------------------------------- ---------- [Address of principal executive offices] [Zip Code] Registrant's telephone number, including area code: (408) 579-2800 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] The number of shares of the Registrant's Common Stock, $.001 par value, outstanding at May 1, 2000 was 53,056,793 - --------------------------------------------------------------------------------

EXTREME NETWORKS, INC. FORM 10-Q QUARTERLY PERIOD ENDED APRIL 2, 2000 INDEX PAGE PART I. CONDENSED CONSOLIDATED FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements (Unaudited): Condensed Consolidated Balance Sheets March 31, 2000 and June 30, 1999 3 Condensed Consolidated Statements of Operations Three months ended and nine months ended March 31, 2000 and March 31, 1999 4 Condensed Consolidated Statements of Cash Flows Nine months ended March 31, 2000 and March 31, 1999 5 Notes to Unaudited Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 26 PART II. OTHER INFORMATION Item 1. Legal Proceedings Not Applicable Item 2. Changes in Securities Not Applicable Item 3. Defaults Upon Senior Securities Not Applicable Item 4. Submission of Matters to a Vote of Security Holders Not Applicable Item 5. Other Information Not Applicable Item 6. Exhibits and Reports on Form 8-K 27 Signatures 28 2

Part I. Financial Information Item 1. Financial Statements EXTREME NETWORKS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands) March 31, June 30, 2000 1999 -------- -------- (Unaudited) (Note 1) Assets Current assets: Cash and cash equivalents $229,194 $107,143 Short-term investments 1,314 16,422 Accounts receivable, net 43,216 20,797 Inventories 7,120 2,626 Other current assets 11,619 1,978 -------- -------- Total current assets 292,463 148,966 Property and equipment, net 18,198 6,506 Investments 93,871 16,097 Other assets 2,844 234 -------- -------- $407,376 $171,803 ======== ======== Liabilities and stockholders' equity Current liabilities: Accounts payable $ 27,177 $ 13,418 Accrued compensation 6,374 4,100 Accrued warranty 3,797 1,400 Deferred revenue 13,131 1,717 Other accrued liabilities 9,734 5,994 Income taxes payable 6,582 1,650 Capital lease obligations, current portion -- 1,648 -------- -------- Total current liabilities 66,795 29,927 Stockholders' equity: Common stock 52 49 Additional paid-in capital 345,538 165,618 Deferred stock compensation (103) (197) Accumulated other comprehensive loss (889) (118) Accumulated deficit (4,017) (23,476) -------- -------- Total stockholders' equity 340,581 141,876 -------- -------- $407,376 $171,803 ======== ======== See accompanying notes to the unaudited condensed consolidated financial statements. 3

EXTREME NETWORKS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) (Unaudited) Three Months Ended Nine Months Ended ------------------ ------------------- March 31, March 31, March 31, March 31, 2000 1999 2000 1999 -------- -------- -------- -------- Net revenue $67,310 $29,051 $169,534 $59,902 Cost of revenue 31,971 14,235 80,748 29,840 ------- ------- -------- ------- Gross profit 35,339 14,816 88,786 30,062 Operating expenses: Research and development 8,102 4,761 22,781 11,341 Sales and marketing 14,798 7,482 38,180 17,685 General and administrative 2,906 1,809 8,204 4,602 ------- ------- -------- ------- Total operating expenses 25,806 14,052 69,165 33,628 ------- ------- -------- ------- Operating income (loss) 9,533 764 19,621 (3,566) Interest and other income (expense), net 4,401 (31) 9,841 63 ------- ------- -------- ------- Income (loss) before income taxes 13,934 733 29,462 (3,503) Provision for income taxes 4,877 300 10,003 1,000 ------- ------- -------- ------- Net income (loss) $ 9,057 $ 433 $ 19,459 $(4,503) ======= ======= ======== ======= Basic net income (loss) per common share $ 0.18 $ 0.05 $0.39 $(0.63) ======= ======= ======== ======= Diluted net income (loss) per common share $ 0.16 $ 0.03 $0.35 $(0.63) ======= ======= ======== ======= Weighted average shares outstanding used in computing basic net income (loss) per share 51,530 7,923 49,579 7,185 ======= ======= ======== ======= Weighted average shares outstanding used in computing diluted net income (loss) per share 56,792 14,656 55,327 7,185 ======= ======= ======== ======= Pro forma basic net income (loss) per common share $ 0.01 $(0.12) ======= ======= Pro forma diluted net income (loss) per common share $ 0.01 $(0.12) ======= ======= Shares used in computing pro forma basic net income (loss) per common share 36,984 36,246 ======= ======= Shares used in computing pro forma diluted net income (loss) per common share 43,717 36,246 ======= ======= See accompanying notes to the unaudited condensed consolidated financial statements. 4

EXTREME NETWORKS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Nine Months Ended ---------------------- March 31, March 31, 2000 1999 -------- -------- Operating activities: Net income (loss) $ 19,459 $(4,503) Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Depreciation and amortization 4,853 3,451 Amortization of deferred stock compensation 94 134 Changes in assets and liabilities: Accounts receivable (22,419) (3,560) Inventories (4,494) (291) Other current and noncurrent assets (12,251) (824) Accounts payable 13,759 (3,736) Accrued compensation 2,274 2,106 Accrued warranty 2,397 497 Deferred revenue 11,414 -- Other accrued liabilities 3,740 3,279 Income taxes payable 4,932 1,125 -------- ------- Net cash provided by (used for) operating activities 23,758 (2,322) -------- ------- Investing activities: Capital expenditures (16,545) (3,870) Purchases / Maturities of investments, net (55,786) 6,673 Minority investment (7,651) -- -------- ------- Net cash provided by (used for) investing activities (79,982) 2,803 -------- ------- Financing activities: Proceeds from issuance of common stock 179,923 760 Proceeds from notes payable -- 783 Principal payments on notes payable -- (641) Principal payments of capital lease obligations (1,648) (188) -------- ------- Net cash provided by financing activities 178,275 714 -------- ------- Net increase in cash and cash equivalents 122,051 1,195 Cash and cash equivalents at beginning of period 107,143 9,510 -------- ------- Cash and cash equivalents at end of period $229,194 $10,705 ======== ======= See accompanying notes to the unaudited condensed consolidated financial statements. 5

EXTREME NETWORKS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The condensed consolidated financial statements have been prepared by Extreme Networks, Inc., pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of Extreme Networks, Inc. and its wholly-owned subsidiaries ("Extreme" or collectively, the "Company"). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company, the unaudited financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position at March 31, 2000 and the operating results and cash flows for the nine months ended March 31, 2000 and March 31, 1999. The condensed balance sheet at June 30, 1999 has been derived from audited financial statements as of that date. These financial statements and notes should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended June 30, 1999, included in the Company's Form 10-K filed with the Securities and Exchange Commission. The results of operations for the three and nine months ended March 31, 2000 are not necessarily indicative of the results that may be expected for the future quarters or the fiscal year ending June 30, 2000. Certain items previously reported in specific financial statement captions have been reclassified to conform to the 2000 presentation. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations Extreme was incorporated in California on May 8, 1996 and was reincorporated in Delaware on March 31, 1999. The Company is a leading provider of high-performance, multilayer network switching solutions for the Internet economy. We have not achieved profitability on a fiscal year basis and although our revenue has grown in recent quarters, we cannot be certain that we will realize sufficient revenue to achieve profitability on a fiscal year basis. Extreme 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 March 31, 2000, we had an accumulated deficit of $4.0 million. Fiscal Year Effective July 1, 1999, Extreme changed its fiscal year from June 30th to a 52/53-week fiscal accounting year. The March 31, 2000 quarter closed on April 2, 2000 and comprised 13 weeks of revenue and expense activity. Principles of Consolidation The consolidated financial statements include the accounts of Extreme and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated. Assets and liabilities of foreign operations are translated to U.S. dollars at current rates of exchange, and revenues and expenses are translated using weighted average rates. Foreign currency transaction gains and losses have not been material. Gains and losses from foreign currency translation are included as a separate component of comprehensive income. 6

Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that materially affect the amounts reported in the financial statements. Actual results could differ materially from these estimates. Cash Equivalents and Short-Term Investments Extreme considers all highly liquid investment securities with maturity from date of purchase of three months or less to be cash equivalents and investment securities with maturity from date of purchase of more than three months but less than one year, to be short-term investments. Management determines the appropriate classification of debt and equity securities at the time of purchase and reevaluates this designation as of each balance sheet date. To date, all marketable securities have been classified as available-for-sale and are carried at fair value, with unrealized gains and losses, when material, reported net-of-tax as a separate component of comprehensive income. Realized gains and losses on available-for-sale securities are included in interest income. The cost of securities sold is based on specific identification. Premiums and discounts are amortized over the period from acquisition to maturity and are included in investment income, along with interest and dividends. Inventories Inventories consist of raw materials and finished goods and are stated at the lower of cost or market (on a first-in, first-out basis). Inventories consist of: March 31, 2000 June 30, 1999 -------------- ------------- Raw materials $5,347 $ 700 Finished goods 1,773 1,926 ------ ------ Total $7,120 $2,626 ====== ====== Concentration of Credit Risk, Product and Significant Customers Financial instruments that potentially subject Extreme to concentration of credit risk consist principally of marketable investments and accounts receivable. Extreme has placed its investments with high-credit quality issuers. Extreme will not invest an amount exceeding 10% of the corporation's combined cash, cash equivalent, short-term and long-term investments, in the securities of any one obligor or maker, except for obligations of the United States, obligations of United States agencies and money market accounts. Extreme sells its products primarily to United States corporations in the technology marketplace. Extreme performs ongoing credit evaluations of its customers and generally does not require collateral. To date, credit losses have been immaterial and within management's expectations. Extreme operates solely within one business segment, the development and marketing of switching solutions for the Internet economy. Significant customer concentration is summarized below. No other customer accounts for more than 10% of Extreme's net revenue. Three Months Ended Nine Months Ended ------------------------------- -------------------------------- March 31, 2000 March 31, 1999 March 31, 2000 March 31, 1999 -------------- -------------- -------------- -------------- Customer Compaq Computer Corporation -- 16% 11% 19% Hitachi Cable 11% 19% 11% 16% Tokyo Electron -- 19% -- 11% Tech Data Corporation 12% -- -- -- Revenue Recognition Extreme generally recognizes product revenue at the time of shipment, unless Extreme has future obligations for installation or has to obtain customer acceptance, in which case revenue is deferred until these obligations 7

have been satisfied. Amounts billed in excess of revenue recognized are included as deferred revenue in the accompanying consolidated balance sheets. Extreme has established a program which, under specified conditions, enables third party resellers to return products to us. The amount of potential product returns is estimated and provided for in the period of the sale. Revenue from service obligations is recognized ratably over the term of the contract period, which is typically 12 months. The Company makes certain sales to partners in two-tier distribution channels. These customers are generally given privileges to return a portion of inventory and participate in various cooperative marketing programs. The Company defers recognition of revenue on such sales until the product is sold by the distributors and also maintains appropriate accruals and allowances for all other programs. Upon shipment of products to its customers, Extreme provides for the estimated cost to repair or replace products that may be returned under warranty. Extreme's warranty period is typically 12 months from the date of shipment to the end user. Foreign Operations Extreme's foreign offices consist of sales, marketing and support activities through its foreign subsidiaries and an overseas reseller network. Operating income (loss) generated by the foreign operations of Extreme and their corresponding identifiable assets were not material in any period presented. Extreme's export sales represented 46% and 57% of net revenue in the nine months ended March 31, 2000 and 1999, respectively. All of the export sales to date have been denominated in U.S. dollars and were derived from sales to Europe and Asia. Net Income (Loss) Per Share Basic net income (loss) per share and diluted net income (loss) per share are presented in conformity with Financial Accounting Standards Board's ("FASB") Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share," for all periods presented. Basic net income (loss) was computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period ended March 31, 2000. Diluted net income (loss) reflects the potential dilution that would occur from any instrument or options, which could result in the issuance of additional common shares. In accordance with SFAS No. 128, proforma basic and diluted net income (loss) per share have been computed using the weighted-average number of shares of common stock outstanding during the period ended March 31, 1999, less shares subject to repurchase for the period ended March 31, 1999. Basic and diluted pro forma net income (loss) per share also gives effect to the conversion of the convertible preferred stock (using the if-converted method) from the original date of issuance. The following table presents the calculation of basic and diluted and pro forma basic and diluted net income (loss) per common share (unaudited in thousands, except per share data): Three Months Ended Nine Months Ended March 31, March 31, 2000 1999 2000 1999 ------- ------- ------- -------- Net income (loss) $ 9,057 $ 433 $ 19,459 $ (4,503) ======= ======= ======== ======== Weighted-average shares of common stock outstanding 52,749 11,855 51,431 11,725 Less: Weighted-average shares subject to repurchase (1,219) (3,932) (1,852) (4,540) ------- ------- -------- -------- Weighted-average shares used in computing basic net income (loss) per common share 51,530 7,923 49,579 7,185 ======= ======= ======== ======== Incremental shares using the treasury stock method 5,262 6,733 5,748 ------- ------- -------- Weighted-average shares used in computing diluted net income (loss) per common share 56,792 14,656 55,327 7,185 ======= ======= ======== ======== Basic net income (loss) per common share $ 0.18 $ 0.05 $ 0.39 $ (0.63) ======= ======= ======== ======== Diluted net income (loss) per common share $ 0.16 $ 0.03 $ 0.35 $ (0.63) ======= ======= ======== ======== Pro forma: Net loss $ 433 $ (4,503) ======= ======== Shares used above 7,923 7,185 Pro forma adjustment to reflect weighted effect of assumed conversion of convertible preferred stock 29,061 29,061 ------- -------- Shares used in computing pro forma basic net loss per common share (unaudited) 36,984 36,246 ======= ======== Shares used in computing pro forma diluted net loss per common share (unaudited) 43,717 36,246 ======= ======== Pro forma basic and diluted net loss per common share (unaudited) $ 0.01 $ (0.12) ======= ======== 8

Recently Issued Accounting Standard In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." Extreme is required to adopt SFAS No. 133 for the fiscal year ending June 30, 2002. SFAS No. 133 establishes methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. Because Extreme currently holds no derivative financial instruments and does not currently engage in hedging activities, adoption of SFAS No. 133 is expected to have no material impact on Extreme's financial condition or results of operations. 3. BUSINESS COMBINATIONS AND INVESTMENTS On January 18, 2000, the Company acquired certain assets of Del Mar Solutions, Inc., which the Company refers to as "Del Mar", for a total cost of approximately $2.5 million of which $1.1 million has been paid. The Company accounted for the acquisition using the purchase method of accounting, and incurs charges of approximately $157,000 per quarter related to the amortization of goodwill over the estimated useful life of four years. The entire purchase price was allocated to goodwill and is included in "Other assets" on the accompanying consolidated balance sheets. The Company recorded approximately $104,000 for amortization of goodwill related to this acquisition for the three and nine months ended March 31, 2000. The Company made additional investments during the nine months ended March 31, 2000 totaling $7.7 million which are reflected in "Investments" in the accompanying consolidated balance sheets. Equity-method investments totaled $3.7 million. Per the equity-method the revenue and costs of these ventures were not included in the Company's results from operations, however the Company's share of affiliates' losses have been included in other expense from the closing date of the related transactions forward. Pursuant to the terms of these agreements, the Company has certain rights and obligations to acquire the remaining shares of these ventures, under certain conditions for additional consideration. The remaining $4.0 million of investments was accounted for under the cost method. 9

4. COMMITMENTS Extreme had outstanding purchase order commitments for materials of approximately $59.6 million and $26.4 million at March 31, 2000 and June 30, 1999, respectively. Extreme expects these purchase orders to be fulfilled and the related invoices to be paid in fiscal year 2000. Of the $59.6 million outstanding at March 31, 2000, the Company has accrued and expensed approximately $2.0 million of the outstanding purchase order commitments for materials due to obligations to suppliers as of March 31, 2000. This expense is included within cost of revenue for the nine months ended March 31, 2000. 5. INCOME TAXES The Company has recorded a tax provision of $10.0 million for the nine months ended March 31, 2000. The provision for income taxes consists primarily of federal taxes, foreign taxes and state income 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 the Company's historical operating performance and the reported cumulative net losses in all prior years, the Company has provided a full valuation allowance against its net deferred tax assets. The Company will continue to evaluate the realizability of the deferred tax assets on a quarterly basis. 6. COMPREHENSIVE INCOME (LOSS) Extreme adopted SFAS No. 130, "Reporting Comprehensive Income" at December 31, 1998. SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components; however, it had no impact on the Company's net income (loss) or stockholders' equity. SFAS 130 requires unrealized gains or losses on the Company's available-for-sale securities and foreign currency translation adjustments to be included in other comprehensive income. Prior to adoption of SFAS 130, the Company had no unrealized gains or losses on available-for-sale securities or foreign currency translation adjustments. The following are the components of accumulated other comprehensive loss (in thousands): March 31, 2000 June 30, 1999 -------------- -------------- Unrealized loss on investments $(883) $(112) Foreign currency translation adjustments (6) (6) -------------- -------------- Accumulated other comprehensive loss $(889) $(118) ============== ============== The following schedule of other comprehensive loss shows the gross current- period loss and the reclassification adjustment (in thousands): Three Months Ended Nine Months Ended ------------------------------- ------------------------------- March 31, 2000 March 31, 1999 March 31, 2000 March 31, 1999 -------------- -------------- -------------- -------------- Unrealized loss on investments: Unrealized loss on available-for- sale securities $ (520) $ -- $(878) $ -- Less: reclassification adjustment for gain realized in net loss 46 -- 107 -- -------------- -------------- -------------- -------------- Net unrealized loss on investments (474) -- (771) -- Foreign currency translation adjustments (25) -- -- -- -------------- -------------- -------------- -------------- Other comprehensive loss $ (499) $ -- $(771) $ -- ============== ============== ============== ============== 7. SECONDARY PUBLIC OFFERING On October 20, 1999, the Company announced the completion of a secondary public offering of approximately 7.5 million shares (including the underwriters' over-allotment provision) of its common stock at a 10

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. 8. SUBSEQUENT EVENT (unaudited) In April, 2000 the Company issued fully earned, nonforfeitable, exercisable warrants with a two year life to purchase 1.5 million shares of the Company's common stock with an exercise price of $79 per share to 3Com in consideration of 3Com's selection of Extreme Networks, Inc. as the preferred vendor of next generation core backbone switching products to 3Com's CoreBuilder Product customers. In addition, we have hired approximately 160 sales and marketing personnel from 3Com. The fair value of the warrants was approximately $54.3 million. This amount will be amortized over the useful life of the acquired intangibles, which is estimated to be approximately two years. Part I. Financial Information Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations When used in this discussion and elsewhere in this Form 10-Q, the words "may," "should," "believes," "expects," "anticipates," "estimates" and similar expressions are intended to identify forward-looking statements. Such statements, which include statements concerning the availability and functionality of products under development, product mix, pricing trends, the mix of export sales, sales to significant customers and the availability and cost of products from the Company's suppliers, are subject to risks and uncertainties, including those set forth below under "Factors That May Affect Our Results." Our actual results could differ materially from those projected in these forward-looking statements which could have a material adverse effect on our business, operating results and financial condition. These forward-looking statements speak only as of the date hereof and actual outcomes will be affected by events in the future that we are not able to predict accurately or over which we have no control. The following information should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's annual report on Form 10-K for the fiscal year ended June 30, 1999. Overview From our inception in May 1996 through September 1997, our operating activities related primarily to developing a research and development organization, testing prototype designs, building an ASIC design infrastructure, commencing the staffing of our marketing, sales and field service and technical support organizations, and establishing relationships with resellers and OEMs. We commenced volume shipments of our Summit1 and Summit2, the initial products in our Summit stackable product family, in October 1997, and we began shipping our BlackDiamond modular product family in September 1998. We incurred losses through fiscal 1999. Our revenue is derived primarily from sales of our Summit and BlackDiamond product families and fees for services relating to our products, including maintenance and training. The level of sales to any customer may vary from period to period; however, we expect that significant customer concentration will continue for the foreseeable future. See "Factors That May Affect Our Results--If a Key Reseller, OEM or Other Significant Customer Cancels or Delays a Large Purchase, Extreme's Revenues May Decline and the Price of Its Stock May Fall." Significant customer concentration as a percentage of net revenue is summarized below: Three Months Ended Nine Months Ended ------------------------------- ------------------------------- March 31, 2000 March 31, 1999 March 31, 2000 March 31, 1999 -------------- -------------- -------------- -------------- Customer Compaq Computer Corporation -- 16% 11% 19% Hitachi Cable 11% 19% 11% 16% Tokyo Electron -- 19% -- 11% Tech Data Corporation 12% -- -- -- 11

We market and sell our products primarily through resellers, distributors and, to a lesser extent, OEMs and our field sales organization. We sell our products through more than 200 resellers in 40 countries. In the nine months ended March 31, 2000, sales to customers outside of North America accounted for approximately 46% of our net revenue. Currently, all of our international sales are denominated in U.S. dollars. We generally recognize product revenue at the time of shipment, unless we have future obligations for installation or have to obtain customer acceptance, in which case revenue is deferred until such obligations have been satisfied. We have established a program which, under specified conditions, enables third party resellers to return products to us. The amount of potential product returns is estimated and provided for in the period of the sale. Service revenue is recognized ratably over the term of the contract period, which is typically 12 months. We expect to experience rapid erosion of average selling prices of our products due to a number of factors, including competitive pricing pressures, promotional pricing and rapid technological change. Our gross margins will be affected by such declines and by fluctuations in manufacturing volumes, component costs and the mix of product configurations sold. In addition, our gross margins may fluctuate due to the mix of distribution channels through which our products are sold, including the potential effects of our development of a two-tier distribution channel. We generally realize higher gross margins on sales to resellers than on sales through our OEMs. Any significant decline in sales to our OEMs or resellers, or the loss of any of our OEMs or resellers could materially adversely affect our business, operating results and financial condition. In addition, new product introduction may result in excess or obsolete inventories. Any excess or obsolete inventories may also reduce our gross margins. We outsource the majority of our manufacturing and supply chain management operations, and we conduct quality assurance, manufacturing engineering, documentation control and repairs at our facility in Santa Clara, California. Accordingly, a significant portion of our cost of revenue consists of payments to our contract manufacturers, Flextronics and MCMS. We expect to realize lower per unit product costs as a result of volume efficiencies. However, we cannot assure you when or if such price reductions will occur. The failure to obtain such price reductions could materially adversely affect our gross margins and operating results. Research and development expenses consist principally of salaries and related personnel expenses, consultant fees and prototype expenses related to the design, development, testing and enhancement of our ASICs and software. We expense all research and development expenses as incurred. We believe that continued investment in research and development is critical to attaining our strategic objectives and, as a result, we expect these expenses to increase in absolute dollars in the future. Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing, sales and field service support functions, as well as trade shows and promotional expenses. We intend to pursue sales and marketing campaigns aggressively and therefore expect these expenses to increase significantly in absolute dollars in the future. In particular, we hired approximately 160 sales and marketing personnel subsequent to March 31, 2000. In addition, we expect to substantially expand our field sales operations to support and develop leads for our resellers and distributors, which would also result in an increase in sales and marketing expenses. General and administrative expenses consist primarily of salaries and related expenses for executive, finance and administrative personnel, professional fees and other general corporate expenses. We expect general and administrative expenses to increase in absolute dollars as we add personnel, increase spending on our information systems and incur additional costs related to the anticipated growth of our business and operation as a public company. During fiscal 1998, in connection with the grant of certain stock options to employees, we recorded deferred stock compensation of $437,000 representing the difference between the exercise price and the deemed fair value of our common stock on the date such stock options were granted. Such amount is included as a reduction of stockholders' equity and is being amortized by charges to operations on a graded vesting method. We recorded amortization of deferred stock compensation expense of approximately $94,000, $172,000 and $68,000 for the 12

nine months ended March 31, 2000 and the years ended June 30, 1999 and 1998, respectively. At March 31, 2000, we had a total of approximately $103,000 remaining to be amortized over the corresponding vesting period of each respective option, generally four years. The amortization expense relates to options awarded to employees in all operating expense categories. Despite growing revenues, we have only been profitable for the last five fiscal quarters. Our income has not increased proportionately with the increase in our revenue primarily because of increased expenses relating to our growth in operations. Because of the lengthy sales cycle of our products, there is often a significant delay between the time we incur expenses and the time we realize any related revenue. See "Factors That May Affect Our Results--The Sales Cycle for Extreme's Products is Long and Extreme May Incur Substantial Non-Recoverable Expenses or Devote Significant Resources to Sales that Do Not Occur When Anticipated." To the extent that future revenues do not increase significantly in the same periods in which operating expenses increase, our operating results would be adversely affected. See "Factors That May Affect Our Results --A Number of Factors Could Cause Extreme's Quarterly Financial Results to Be Worse Than Expected, Resulting in a Decline in Its Stock Price." Subsequent to March 31, 2000 we hired approximately 160 sales and marketing personnel. As a result of this hiring and the expense charges related to the issuance of the warrants we expect to report a loss for at least the next two quarters, and will not return to profitability until we are able to increase revenue substantially above current levels. We expect that the hiring of such personnel will allow us to increase sales, however, we cannot assure you that this will occur. Results of Operations The following table sets forth for the periods indicated certain financial data as a percentage of net revenue: Three Months Ended Nine Months Ended ------------------- ------------------- March 31, March 31, March 31, March 31, 2000 1999 2000 1999 -------- -------- -------- -------- Net revenue 100.0% 100.0% 100.0% 100.0% Cost of revenue 47.5 49.0 47.6 49.8 ------ ------ ------ ------ Gross profit 52.5 51.0 52.4 50.2 ------ ------ ------ ------ Operating expenses: Research and development 12.0 16.4 13.5 18.9 Sales and marketing 22.0 25.8 22.5 29.5 General and administrative 4.3 6.2 4.8 7.7 ------ ------ ------ ------ Total operating expenses 38.3 48.4 40.8 56.1 ------ ------ ------ ------ Operating income (loss) 14.2 2.6 11.6 (5.9) Other income (expense), net 6.5 (0.1) 5.8 0.1 ------ ------ ------ ------ Income (loss) before income taxes 20.7 2.5 17.4 (5.8) Provision for income taxes 7.2 1.0 5.9 1.7 ------ ------ ------ ------ Net income (loss) 13.5% 1.5% 11.5% (7.5)% ====== ====== ====== ====== Net revenue. Net revenue increased from $29.1 million for the three months ended March 31, 1999 to $67.3 million for the three months ended March 31, 2000, an increase of $38.2 million. Net revenue increased from $59.9 million for the nine months ended March 31, 1999 to $169.5 million for the nine months ended March 31, 2000, an increase of $109.6 million. Net revenue increased primarily from increased sales of our Summit stackable products and our BlackDiamond modular product family. Sales to customers outside of North America accounted for approximately 45% and 66% of our net revenue in the three months ended March 31, 2000 and 1999, respectively. Sales to customers outside of North America accounted for approximately 46% and 57% of our net revenue in the nine months ended March 31, 2000 and 1999, respectively. We expect that export sales will continue to represent a significant portion of net revenue, although we cannot assure you that export sales as a percentage of net revenue will remain at current levels. All sales transactions are denominated in U.S. dollars. 13

Gross profit. Gross profit increased from $14.8 million for the three months ended March 31, 1999 to $35.3 million for the three months ended March 31, 2000, an increase of $20.5 million. Gross profit increased from $30.1 million for the nine months ended March 31, 1999 to $88.8 million for the nine months ended March 31, 2000, an increase of $58.7 million, primarily due to the related increase in revenue. Gross margins increased from 51.0% for the three months ended March 31, 1999 to 52.5% for the three months ended March 31, 2000. Gross margins increased from 50.2% for the nine months ended March 31, 1999 to 52.4% for the nine months ended March 31, 2000. The increase in gross margin resulted primarily from a shift in our channel mix from OEMs to resellers, a shift in product mix and improved manufacturing efficiencies, offset in part by lower average selling prices due to primarily increased competition. Research and development expenses. Research and development expenses increased from $4.8 million for the three months ended March 31, 1999 to $8.1 million for the three months ended March 31, 2000, an increase of $3.3 million. Research and development expenses increased from $11.3 million for the nine months ended March 31, 1999 to $22.8 million for the nine months ended March 31, 2000, an increase of $11.5 million. The increase was primarily due to nonrecurring engineering and initial product verification expenses and salaries and related personnel expenses due to the hiring of additional engineers. Sales and marketing expenses. Sales and marketing expenses increased from $7.5 million for the three months ended March 31, 1999 to $14.8 million for the three months ended March 31, 2000, an increase of $7.3 million. Sales and marketing expenses increased from $17.7 million for the nine months ended March 31, 1999 to $38.2 million for the nine months ended March 31, 2000, an increase of $20.5 million. This increase was primarily due to the hiring of additional sales, marketing and customer support personnel, increased sales 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 $1.8 million for the three months ended March 31, 1999 to $2.9 million for the three months ended March 31, 2000, an increase of $1.1 million. General and administrative expenses increased from $4.6 million for the nine months ended March 31, 1999 to $8.2 million for the nine months ended March 31, 2000, an increase of $3.6 million. This increase was due primarily to the hiring of additional finance, information technology and legal and administrative personnel and increased professional fees. Interest and other income (expense), net. Interest and other income (expense), net increased from $31,000 of expense for the three months ended March 31, 1999 to $4.4 million of income for the three months ended March 31, 2000, an increase of $4.4 million. Interest and other income (expense), net increased from $63,000 of income for the nine months ended March 31, 1999 to $9.8 million of income for the nine months ended March 31, 2000, an increase of $9.8 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 and our secondary public offering in October 1999 and due to decreased interest expense as a result of the payment in full of notes payable and capital lease obligations. Provision for income taxes. We incurred significant operating losses for all fiscal years from inception through June 30, 1999. We recorded effective tax rates of approximately 35% and 34% for the three and nine months ended March 31, 2000, respectively. The provision for income taxes consists primarily of federal taxes, foreign taxes and state income 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. 14

Liquidity and Capital Resources At March 31, 2000, we had $229.2 million in cash and cash equivalents, $1.3 million in short-term investments and $93.9 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, we completed our secondary 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 $23.8 million for the nine months ended March 31, 2000, as compared to cash used for operating activities of $2.3 million for the nine months ended March 31, 1999. The increase was primarily due to an increase in net income, increases in deferred revenue, accounts payable, depreciation and accrued warranty, offset by increases in accounts receivable, inventories, other current and noncurrent assets and other accrued liabilities. 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, short-term investments and long-term investments. Investing activities used cash of $80.0 million for the nine months ended March 31, 2000 due to capital expenditures of $16.5 million, net purchases of investments of $55.8 million and minority investment of $7.7 million. Investing activities provided cash of $2.8 million for the nine months ended March 31, 1999 due to net maturities of investments of $6.7 million offset by capital expenditures of $3.9 million. Financing activities provided cash of $178.3 million for the nine months ended March 31, 2000, arising primarily from proceeds from the issuance and sale of common stock, partially offset by principal payments on capital lease obligations. Financing activities provided cash of $1.0 million for the nine months March 31, 1999, primarily from the issuance and sale of stock and proceeds from notes payable, partially offset by principal payments on notes payable and capital lease obligations. We have a revolving line of credit for $0.5 million with Silicon Valley Bank and a $2.0 million capital equipment line with Comdisco, Inc. As of March 31, 2000, there were no outstanding borrowings under these facilities. 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. 15

We believe that our current cash and cash equivalents, short-term investments, long-term investments and cash available from credit facilities and future operations will enable us to meet our working capital requirements for at least the next 12 months. Year 2000 Compliance The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products or services of third parties. The Company will continue to monitor its critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 issues that may arise are addressed promptly. 16

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 a fiscal year basis and although our revenue has grown in recent quarters, we cannot be certain that we will realize sufficient revenue to achieve profitability on a fiscal year basis. As of March 31, 2000, we had an accumulated deficit of $4.0 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. In particular, our recent extraordinary hiring will substantially increase expenses and we will not be able to achieve profitability until we are able to substantially increase revenue. We expect that the hiring of such personnel will allow us to increase sales, however, we cannot assure you that this will occur. A Number of Factors Could Cause Extreme's Quarterly Financial Results to Be Worse Than Expected, Resulting in a Decline in Its Stock Price We plan to significantly increase our operating expenses to expand our sales and marketing activities, broaden our customer support capabilities, develop new distribution channels, fund increased levels of research and development and build our operational infrastructure. We base our operating expenses on anticipated revenue trends and a high percentage of our expenses are fixed in the short term. As a result, any delay in generating or recognizing revenue could cause our quarterly operating results to be below the expectations of public market analysts or investors, which could cause the price of our common stock to fall. We may experience a delay in generating or recognizing revenue because of a number of reasons. Orders at the beginning of each quarter typically do not equal expected revenue for that quarter and are generally cancelable at any time. Accordingly, we are dependent upon obtaining orders in a quarter for shipment in that quarter to achieve our revenue objectives. In addition, the timing of product releases, purchase orders and product availability could result in significant product shipments at the end of a quarter. Failure to ship these products by the end of a quarter may adversely affect our operating results. Furthermore, our customer agreements typically provide that the customer may delay scheduled delivery dates and cancel orders within specified time frames without significant penalty. Our quarterly revenue and operating results have varied significantly in the past and may vary significantly in the future due to a number of factors, including: * fluctuations in demand for our products and services, including seasonality, particularly in Asia and Europe; * unexpected product returns or the cancellation or rescheduling of significant orders; * our ability to develop, introduce, ship and support new products and product enhancements and manage product transitions; * announcements and new product introductions by our competitors; * our ability to develop and support customer relationships with Service providers and other potential large customers; * our ability to achieve required cost reductions; * our ability to obtain sufficient supplies of sole or limited sourced components for our products; * unfavorable changes in the prices of the components we purchase; * our ability to attain and maintain production volumes and quality levels for our products; * the mix of products sold and the mix of distribution channels through which they are sold; and * costs relating to possible acquisitions and integration of technologies or businesses. 17

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 and Nortel Networks. Many of our current and potential competitors have longer operating histories and substantially greater financial, technical, sales, marketing and other resources, as well as greater name recognition and larger installed customer bases, than we do. These competitors may have developed or could in the future develop new technologies that compete with our products or even render our products obsolete. To remain competitive, we believe we must, among other things, invest significant resources in developing new products and enhancing our current products and maintaining customer satisfaction. If we fail to do so, our products may not compete favorably with those of our competitors and our revenue and future profitability could be materially adversely affected. Extreme Expects the Average Selling Prices of Its Products to Decrease 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 introduced a new 18

generation chipset which was incorporated in a new product family which began shipping in the quarter ended March 31, 2000. We cannot assure you that these new products will be commercially successful. We have experienced delays in releasing new products and product enhancements in the past which delayed sales and resulted in lower quarterly revenue than anticipated. We may experience similar delays in product development 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 March 31, 1999 to March 31, 2000, the number of our employees increased from 193 to 404. We expect our anticipated growth and expansion to strain our management, operational and financial resources. Our management team has had limited experience managing such rapidly growing companies on a public or private basis. To accommodate this anticipated growth, we will be required to: * improve existing and implement new operational, information and financial systems, procedures and controls; * hire, train and manage additional qualified personnel, including in the near future sales and marketing personnel; and * effectively manage multiple relationships with our customers, suppliers and other third parties. We may not be able to install adequate control systems in an efficient and timely manner, and our current or planned personnel systems, procedures and controls may not be adequate to support our future operations. 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, distributors and, to a lesser extent, original equipment manufacturers, or OEMs, as well as expanding our field sales organization. If we fail to develop and cultivate relationships with significant resellers, or if these resellers are not successful in their sales efforts, sales of our products may decrease and our operating results would suffer. Many of our resellers also sell products that compete with our products. We are developing a two-tier distribution structure in Europe and the United States which has and will require us to enter into agreements with a small number of stocking distributors. We have recently entered into two-tier distribution agreements; however, we cannot assure you that we will continue to be able to enter into additional distribution 19

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. 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 nine months ended March 31, 1999, Compaq Computer Corporation ("Compaq"), Hitachi Cable and Tokyo Electron accounted for 19%, 16% and 11% of our net revenue, respectively, and for the nine months ended March 31, 2000, Compaq and Hitachi Cable accounted for 11% 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. 20

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: * our service provider and enterprise network customers can stop purchasing and our resellers and OEMs can stop marketing our products at any time; * our reseller agreements generally are not exclusive and are for one year terms, with no obligation of the resellers to renew the agreements; * our reseller agreements provide for discounts based on expected or actual volumes of products purchased or resold by the reseller in a given period; and * our reseller 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 have in the past and are likely in the future 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: * ASICs; * microprocessors; * programmable integrated circuits; * selected other integrated circuits; * cables; and * custom-tooled sheet metal. 21

Our principal limited sourced components include: * flash memories; * dynamic and static random access memories, commonly known as DRAMs and SRAMs, respectively; and * printed circuit boards. We use a rolling six-month forecast based on anticipated product orders to determine our material requirements. Lead times for materials and components we order vary significantly, and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. If orders do not match forecasts, we may have excess or inadequate inventory of certain materials and components, which could materially adversely affect our operating results and financial condition. From time to time we have experienced shortages and allocations of certain components, resulting in delays in filling orders. In addition, during the development of our products we have experienced delays in the prototyping of our ASICs, which in turn has led to delays in product introductions. Extreme Needs to Expand Its Manufacturing Operations and Depends on Contract Manufacturers for Substantially All of Its Manufacturing Requirements 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 and 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. 22

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. 23

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 46% and 57% of our net revenue in the nine months ended March 31, 2000 and 1999, 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: * longer accounts receivable collection cycles; * difficulties in managing operations across disparate geographic areas; * difficulties associated with enforcing agreements through foreign legal systems; * payment of operating expenses in local currencies, which subjects us to risks of currency fluctuations; * import or export licensing requirements; * potential adverse tax consequences; and * unexpected changes in regulatory requirements. Our international sales currently are U.S. dollar-denominated. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. In the future, we may elect to invoice some of our international customers in local currency which will subject us to fluctuations in exchange rates between the U.S. dollar and the particular local currency. If we do so, we may determine to engage in hedging transactions to minimize the risk of such fluctuations. 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. We are reviewing investments in new businesses and we expect to make investments in and acquire businesses, products or technologies in the future. In the event of any future acquisitions, we could: * issue equity securities which would dilute current stockholders' percentage ownership; * incur substantial debt; or * 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: * difficulties in the assimilation of acquired operations, technologies or products; * unanticipated costs associated with the acquisition or investment transaction; * diversion of management's attention from other business concerns; * adverse effects on existing business relationships with suppliers and customers; * risks associated with entering markets in which we have n * or limited prior experience; and * 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. 24

Extreme May Need Additional Capital to Fund Its Future Operations And, If It Is Not Available When Needed, Extreme May Need to Reduce Its Planned Development and Marketing Efforts, Which May Reduce Its Revenues and Prevent Extreme From Achieving Profitability We believe that our existing working capital, proceeds from the initial public offering in April 1999, proceeds from the secondary offering in October 1999 and cash available from credit facilities and future operations will enable us to meet our working capital requirements for at least the next 12 months. However, if cash from future operations is insufficient, or if cash is used for acquisitions or other currently unanticipated uses, we may need additional capital. The development and marketing of new products and the expansion of reseller and distribution channels and associated support personnel is expected to require a significant commitment of resources. In addition, if the market for 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. 25

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: * potential warranty or other claims from our customers; * systems we use to run our business; * systems used by our suppliers; and * the potential reduced spending by other companies on networking solutions as a result of significant information systems spending on year 2000 remediation. Provisions in Extreme's Charter or Agreements May Delay or Prevent a Change of Control Provisions in our certificate of incorporation and bylaws may delay or prevent a change of control or changes in our management. These provisions include: * the division of the board of directors into three separate classes; * the right of the board of directors to elect a director to fill a vacancy created by the expansion of the board of directors; * the ability of the board of directors to alter our bylaws without getting stockholder approval; and 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 March 31, 2000. This table does not include money market funds because those funds are not subject to market risk. Maturing in ------------------------------------------------------------- Three months Three months Greater than Fair or less to one year one year Total Value ------------ ------------- -------- ------- --------- (In thousands) Included in cash and cash equivalents............... $173,957 $173,957 $173,957 Weighted average interest rate..................... 6.00% Included in short-term investments.................. $ 1,314 $ 1,314 $ 1,314 Weighted average interest rate..................... 6.00% Included in investments ............................ $ 302 $47,790 $38,128 $ 86,220 $ 86,220 Weighted average interest rate .................... 6.03% 6.60% 6.67% 26

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 nine months ended March 31, 2000 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 March 31, 2000. 27

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 May 16, 2000 28

5 1,000 3-MOS 9-MOS JUL-02-2000 JUL-02-2000 JAN-03-2000 JUL-01-1999 APR-02-2000 APR-02-2000 229,194 229,194 1,314 1,314 43,216 43,216 1,300 1,300 7,120 7,120 292,463 292,463 25,230 25,230 7,032 7,032 407,376 407,376 66,795 66,795 0 0 0 0 0 0 52 52 340,529 340,529 407,376 407,376 67,310 169,534 67,310 169,534 31,971 80,748 31,971 80,748 25,806 69,165 0 0 273 402 13,934 29,462 4,877 10,003 9,057 19,459 0 0 0 0 0 0 9,057 19,459 0.18 0.39 0.16 0.35