EXTR-03312013 10Q
Table of Contents


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 quarterly period ended March 31, 2013

OR

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

 For the transition period from              to             

Commission file number 000-25711
 ___________________________
EXTREME NETWORKS, INC.
(Exact name of registrant as specified in its charter)
 ___________________________
DELAWARE
 
77-0430270
[State or other jurisdiction
of incorporation or organization]
 
[I.R.S Employer
Identification No.]
 
 
3585 Monroe Street,
Santa Clara, California
 
95051
[Address of principal executive office]
 
[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  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
o
 
Accelerated filer
 
x
 
 
 
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
The number of shares of the Registrant’s Common Stock, $.001 par value, outstanding at April 24, 2013 was 92,989,772.



Table of Contents

EXTREME NETWORKS, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED MARCH 31, 2013
INDEX
 
 
 
PAGE
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 



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EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
(Unaudited)
 
March 31,
2013
 
June 30,
2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
77,592

 
$
54,596

Short-term investments
42,336

 
23,358

Accounts receivable, net of allowances of $1,518 at March 31, 2013 and $1,646 at June 30, 2012
43,612

 
41,166

Inventories
15,658

 
26,609

Deferred income taxes
288

 
644

Prepaid expenses and other current assets
5,690

 
5,655

Assets held for sale

 
17,081

Total current assets
185,176

 
169,109

Property and equipment, net
11,220

 
25,180

Marketable securities
69,171

 
75,561

Intangible assets, net
4,273

 
5,106

Other assets
8,593

 
9,634

Total assets
$
278,433

 
$
284,590

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
10,336

 
$
19,437

Accrued compensation and benefits
10,882

 
13,409

Restructuring liabilities
1,774

 
463

Accrued warranty
2,896

 
2,871

Deferred revenue, net
32,400

 
31,769

Deferred distributors revenue, net of cost of sales to distributors
13,532

 
15,319

Other accrued liabilities
12,784

 
13,480

Total current liabilities
84,604

 
96,748

Deferred revenue, less current portion
8,007

 
7,559

Other long-term liabilities
1,401

 
643

Commitments and contingencies (Note 8)


 


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

 

Common stock, $.001 par value, 750,000,000 shares authorized; 92,976,291 shares issued and outstanding at March 31, 2013 and 133,965,455 and 94,333,619 shares issued and outstanding, respectively, at June 30, 2012
93

 
134

Treasury stock, zero and 39,631,836 shares at March 31, 2013 and June 30, 2012, respectively

 
(149,666
)
Additional paid-in-capital
818,562

 
970,609

Accumulated other comprehensive loss
(147
)
 
(861
)
Accumulated deficit
(634,087
)
 
(640,576
)
Total stockholders’ equity
184,421

 
179,640

Total liabilities and stockholders’ equity
$
278,433

 
$
284,590

See accompanying notes to condensed consolidated financial statements.

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EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
Net revenues:
 
 
 
 
 
 
 
Product
$
54,072

 
$
58,009

 
$
175,450

 
$
189,316

Service
14,131

 
15,359

 
44,431

 
45,758

Total net revenues
68,203

 
73,368

 
219,881

 
235,074

Cost of revenues:
 
 
 
 
 
 
 
Product
25,206

 
26,623

 
85,059

 
86,922

Service
5,060

 
5,534

 
16,171

 
17,137

Total cost of revenues
30,266

 
32,157

 
101,230

 
104,059

Gross profit:
 
 
 
 
 
 
 
Product
28,866

 
31,386

 
90,391

 
102,394

Service
9,071

 
9,825

 
28,260

 
28,621

Total gross profit
37,937

 
41,211

 
118,651

 
131,015

Operating expenses:
 
 
 
 
 
 
 
Research and development
9,381

 
10,376

 
30,954

 
33,866

Sales and marketing
20,644

 
20,657

 
64,764

 
65,512

General and administrative
6,288

 
7,553

 
18,292

 
21,777

Restructuring charge, net of reversals
1,076

 
(35
)
 
6,242

 
1,357

Litigation settlement, net
2,450

 

 
2,029

 

Gain on sale of facilities

 

 
(11,539
)
 

Total operating expenses
39,839

 
38,551

 
110,742

 
122,512

Operating (loss) income
(1,902
)
 
2,660

 
7,909

 
8,503

Interest income
256

 
294

 
786

 
929

Interest expense

 

 

 
(75
)
Other expense, net
(165
)
 
(73
)
 
(814
)
 
(55
)
(Loss) income before income taxes
(1,811
)
 
2,881

 
7,881

 
9,302

Provision for income taxes
409

 
509

 
1,392

 
1,240

Net (loss) income
$
(2,220
)
 
$
2,372

 
$
6,489

 
$
8,062

Basic and diluted net (loss) income per share:
 
 
 
 
 
 
 
Net (loss) income per share – basic
$
(0.02
)
 
$
0.03

 
$
0.07

 
$
0.09

Net (loss) income per share – diluted
$
(0.02
)
 
$
0.03

 
$
0.07

 
$
0.09

Shares used in per share calculation – basic
92,968

 
93,659

 
94,069

 
93,205

Shares used in per share calculation – diluted
92,968

 
94,600

 
95,094

 
94,245

 See accompanying notes to condensed consolidated financial statements.

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Table of Contents

EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
Net (loss) income:
$
(2,220
)
 
$
2,372

 
$
6,489

 
$
8,062

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in unrealized (loss) gain on investment
(55
)
 
300

 
83

 
(80
)
Change in net foreign currency translation adjustment
(150
)
 
216

 
630

 
(1,473
)
Other comprehensive (loss) income
(205
)
 
516

 
713

 
(1,553
)
Total comprehensive (loss) income
$
(2,425
)
 
$
2,888

 
$
7,202

 
$
6,509

 See accompanying notes to condensed consolidated financial statements.


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EXTREME NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
Cash flows from operating activities:
 
 
 
Net income
$
6,489

 
$
8,062

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Decrease in accrued investment income
1,263

 
2,207

Depreciation and amortization
3,389

 
4,001

Amortization of intangible assets
1,168

 
1,401

Provision for doubtful accounts
(556
)
 
(90
)
Deferred income taxes
21

 
(53
)
Stock-based compensation
5,625

 
4,652

Gain on disposition of long lived assets, net
(11,451
)
 

Loss on retirement of assets

 
54

Unrealized gain on foreign exchange transactions

 
(566
)
Changes in operating assets and liabilities, net
 
 
 
Accounts receivable
(1,889
)
 
(12,411
)
Inventories
10,952

 
(1,234
)
Prepaid expenses and other assets
1,363

 
5,753

Accounts payable
(9,101
)
 
3,936

Accrued compensation and benefits
(2,526
)
 
(2,471
)
Restructuring liabilities
1,311

 
(2,504
)
Other current and long term liabilities
945

 
(4,330
)
Net cash provided by operating activities
7,003

 
6,407

Cash flows from investing activities:
 
 
 
Capital expenditures
(4,422
)
 
(4,421
)
Purchases of investments
(40,113
)
 
(53,318
)
Proceeds from maturities of investments and marketable securities
13,867

 
28,297

Proceeds from sales of investments and marketable securities
12,478

 
25,812

Purchases of intangible assets
(335
)
 
(275
)
Proceeds from sales of facilities
42,659

 

Net cash provided by (used in) investing activities
24,134

 
(3,905
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock
2,539

 
753

Repurchases of common stock
(10,973
)
 

Deposit received from sale of buildings

 
1,001

Net cash (used in) provided by financing activities
(8,434
)
 
1,754

 
 
 
 
Foreign currency effect on cash
293

 
(905
)
 
 
 
 
Net increase in cash and cash equivalents
22,996

 
3,351

 
 
 
 
Cash and cash equivalents at beginning of period
54,596

 
49,972

Cash and cash equivalents at end of period
$
77,592

 
$
53,323

See accompanying notes to the condensed consolidated financial statements.

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EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation
The unaudited condensed consolidated financial statements of Extreme Networks, Inc. (referred to as the “Company” or “Extreme Networks”) included herein have been prepared under the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted under such rules and regulations. The condensed consolidated balance sheet at June 30, 2012 was derived from audited financial statements as of that date but does not include all disclosures required by generally accepted accounting principles for complete financial statements. These interim financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012.
The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations and cash flows for the interim periods presented and the financial condition of Extreme Networks at March 31, 2013. The results of operations for the three and nine months ended March 31, 2013 are not necessarily indicative of the results that may be expected for fiscal 2013 or any future periods.

2. Summary of Significant Accounting Policies
Revenue Recognition
The Company's revenue is primarily derived from sales of networking products, which are tangible products containing software and non-software components that function together to deliver the tangible product's essential functionality. In addition to tangible products, the Company's sales arrangements may include other deliverables such as standalone software licenses, or service offerings. For multiple deliverable arrangements, the Company recognizes revenue in accordance with the accounting standard for multiple deliverable revenue arrangements, which provides guidance on whether multiple deliverables exist, how deliverables in an arrangement should be separated, and how consideration should be allocated. Software revenue recognition guidance is applied to the sales of the Company's standalone software products, including software upgrades and software that is not essential to the functionality of the hardware with which it is sold.
Pursuant to the guidance of the accounting standard for multiple deliverable revenue arrangements, when the Company's sales arrangements contain multiple elements, such as products, software licenses, maintenance agreements, or professional services, the Company determines the standalone selling price for each element based on a selling price hierarchy. The application of the multiple deliverable revenue accounting standard does not change the units of accounting for the Company's multiple element arrangements. Under the selling price hierarchy, the selling price for each deliverable is based on the Company's vendor-specific objective evidence (“VSOE”), which is determined by a substantial majority of the Company's historical standalone sales transactions for a product or service falling within a narrow range. If VSOE is not available due to a lack of standalone sales transactions or lack of pricing within a narrow range, then third party evidence (“TPE”), as determined by the standalone pricing of competitive vendor products in similar markets, is used, if available. TPE typically is difficult to establish due to the proprietary differences of competitive products and difficulty in obtaining reliable competitive standalone pricing information. When neither VSOE nor TPE is available, the Company determines its best estimate of standalone selling price (“ESP”) for a product or service and does so by considering several factors including, but not limited to, the 12-month historical median sales price, sales channel, geography, gross margin objective, competitive product pricing, and product life cycle. In consideration of all relevant pricing factors, the Company applies management judgment to determine the Company's best estimate of selling price through consultation with and formal approval by the Company's management for all products and services for which neither VSOE nor TPE is available. Generally the standalone selling price of services is determined using VSOE and the standalone selling price of other deliverables is determined by using ESP. The Company regularly reviews VSOE, TPE and ESP for all of its products and services and maintains internal controls over the establishment and updates of these estimates.
In accordance with the software revenue recognition accounting standard, the Company continues to recognize revenue for software using the residual method for its sale of standalone software products, including optional software upgrades and other software that is not essential to the functionality of the hardware with which it is sold. After allocation of the relative selling price to each element of the arrangement, the Company recognizes revenue in accordance with the Company's policies for product, software, and service revenue recognition.
3. Recently Issued Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2013-02, Topic 350 - Comprehensive Income ("ASU 2013-02"), which amends Topic 220 to improve the reporting of

7

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reclassifications out of accumulated other comprehensive income to the respective line items in net income. ASU 2013-02 is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2012. The Company intends to adopt this standard in the first quarter of 2014 and does not expect the adoption will have a material impact on its consolidated results of operations or financial condition.

4. Balance Sheet Accounts
Cash, Cash Equivalents, Short-Term Investments and Marketable Securities
Summary of Cash and Available-for-Sale Securities (in thousands)
 
 
March 31, 2013
 
June 30, 2012
Cash
$
23,413

 
$
18,455

 
 
 
 
Cash equivalents
54,179

 
36,141

Short-term investments
42,336

 
23,358

Marketable securities
69,171

 
75,561

Total available-for-sale
$
165,686

 
$
135,060

 
 
 
 
Total cash and available for sale securities
$
189,099

 
$
153,515

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

 
Amortized
Cost
 
Fair Value
 
Unrealized
Holding
Gains
 
Unrealized
Holding
Losses
March 31, 2013
 
 
 
 
 
 
 
Money market funds
$
54,179

 
$
54,179

 
$

 
$

U.S. corporate debt securities
105,853

 
105,994

 
245

 
(104
)
U.S. government agency securities
5,512

 
5,513

 
1

 

 
$
165,544

 
$
165,686

 
$
246

 
$
(104
)
Classified as:
 
 
 
 
 
 
 
Cash equivalents
$
54,179

 
$
54,179

 
$

 
$

Short-term investments
42,255

 
42,336

 
81

 

Marketable securities
69,110

 
69,171

 
165

 
(104
)
 
$
165,544

 
$
165,686

 
$
246

 
$
(104
)
June 30, 2012
 
 
 
 
 
 
 
Money market funds
$
36,141

 
$
36,141

 
$

 
$

U.S. corporate debt securities
84,882

 
84,949

 
148

 
(81
)
U.S. government agency securities
11,241

 
11,234

 
3

 
(10
)
U.S. municipal bonds
2,738

 
2,736

 

 
(2
)
 
$
135,002

 
$
135,060

 
$
151

 
$
(93
)
Classified as:
 
 
 
 
 
 
 
Cash equivalents
$
36,141

 
$
36,141

 
$

 
$

Short-term investments
23,311

 
23,358

 
48

 
(1
)
Marketable securities
75,550

 
75,561

 
103

 
(92
)
 
$
135,002

 
$
135,060

 
$
151

 
$
(93
)
 

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EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



The amortized cost and estimated fair value of available-for-sale investments in debt securities at March 31, 2013, by contractual maturity, were as follows (in thousands):
 
 
Amortized
Cost
 
Fair
Value
Due in 1 year or less
$
42,255

 
$
42,336

Due in 1-2 years
39,499

 
39,652

Due in 2-5 years
29,611

 
29,519

Total investments in available for sale debt securities
$
111,365

 
$
111,507

The Company considers highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Investments with original maturities of greater than three months, but less than one year at the balance sheet date are classified as Short Term Investments. Investments with maturities of greater than one year at balance sheet date are classified as Marketable Securities. Except for direct obligations of the United States government, securities issued by agencies of the United States government, and money market funds, the Company diversifies its investments by limiting its holdings with any individual issuer.
Investments include available-for-sale investment-grade debt securities that the Company carries at fair value. The Company accumulates unrealized gains and losses on the Company's available-for-sale debt securities, net of tax, in accumulated other comprehensive income (loss) in the stockholders' equity section of its balance sheets. Such an unrealized gain or loss does not reduce net income for the applicable accounting period. If the fair value of an available-for-sale debt instrument is less than its amortized cost basis, an other-than-temporary impairment is triggered in circumstances where (1) the Company intends to sell the instrument, (2) it is more likely than not that the Company will be required to sell the instrument before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the instrument (that is, a credit loss exists). If the Company intends to sell or it is more likely than not that the Company will be required to sell the available-for-sale debt instrument before recovery of its amortized cost basis, the Company recognizes an other-than-temporary impairment in earnings equal to the entire difference between the debt instruments' amortized cost basis and its fair value. For available-for-sale debt instruments that are considered other-than-temporarily impaired due to the existence of a credit loss, if the Company does not intend to sell and it is not more likely than not that the Company will be required to sell the instrument before recovery of its remaining amortized cost basis (amortized cost basis less any current-period credit loss), the Company separates the amount of the impairment into the amount that is credit related and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the debt instrument's amortized cost basis and the present value of its expected future cash flows. The remaining difference between the debt instrument's fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income.
The following table presents the Company’s investments’ gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

 
Less than 12 months
 
12 months or more
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
U.S. corporate debt securities
$
32,942

 
$
(104
)
 
$

 
$

 
$
32,942

 
$
(104
)
 
$
32,942

 
$
(104
)
 
$

 
$

 
$
32,942

 
$
(104
)

The Company determines the basis of the cost of a security sold or the amount reclassified out of accumulated other comprehensive income into earnings using the specific identification method. During the three and nine months ended March 31, 2013, realized gains or losses recognized on the sale of investments were not significant. As of March 31, 2013, nineteen out of sixty-three investment securities had unrealized losses. The unrealized gains / (losses) on the Company’s investments were caused by interest rate fluctuations. Substantially all of the Company’s available-for-sale investments are investment grade government and corporate debt securities that have maturities of less than three years. The Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of its amortized costs.
Inventories
Inventory is stated at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost, on a first-in, first-out basis. The Company reduces the carrying value of inventory to net realizable value based on excess and

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EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



obsolete inventories which are primarily determined by age of inventory and future demand forecasts. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Any written down or obsolete inventory subsequently sold has not had a material impact on gross profit for any of the periods disclosed.
Long-Lived Assets
Long-lived assets include property and equipment, intangible assets, and service inventory. Property and equipment and intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets or asset groups may not be recoverable. If such facts and circumstances exist, the Company assesses the recoverability of these assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairments, if any, are based on the excess of the carrying amount over the fair value of those assets. The Company reduces the carrying value of service inventory to net realizable value based on excess and obsolete inventories which are primarily determined by age of inventory and future demand forecasts.
On September 11, 2012, the Company completed the sale of its corporate campus and accompanying 16 acres of land in Santa Clara, California for net cash proceeds of approximately $44.7 million and realized a gain of approximately $11.5 million.
Deferred Revenue, Net
Deferred revenue, net represents amounts for (i) deferred services revenue (support arrangements, professional services and training), and (ii) deferred product revenue net of the related cost of revenue when the revenue recognition criteria have not been met. The following table summarizes deferred revenue, net at March 31, 2013 and June 30, 2012, respectively (in thousands):
 
 
March 31, 2013
 
June 30, 2012
Deferred services
$
37,397

 
$
37,708

Deferred product:
 
 
 
Deferred revenue
3,287

 
2,236

Deferred cost of sales
(277
)
 
(616
)
Deferred product revenue, net
3,010

 
1,620

Balance at end of period
40,407

 
39,328

Less: current portion
32,400

 
31,769

Non-current deferred revenue, net
$
8,007

 
$
7,559


The Company offers for sale to its customers renewable support arrangements, including extended warranty contracts, that range from one to five years. Deferred support revenue is included within deferred revenue, net within the Services category above. The change in the Company’s deferred support revenue balance in relation to these arrangements was as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
March 31, 2013
 
April 1, 2012
 
March 31, 2013
 
April 1, 2012
Balance beginning of period
$
35,797

 
$
37,416

 
$
37,461

 
$
35,802

New support arrangements
14,431

 
15,115

 
41,745

 
45,675

Recognition of support revenue
(13,420
)
 
(14,364
)
 
(42,398
)
 
(43,310
)
Balance end of period
36,808

 
38,167

 
36,808

 
38,167

Less: current portion
28,801

 
30,538

 
28,801

 
30,538

Non-current deferred revenue
$
8,007

 
$
7,629

 
$
8,007

 
$
7,629


Deferred Distributors Revenue, Net of Cost of Sales to Distributors
The Company records revenue from its distributors on a sell-through basis, recording deferred revenue and deferred cost of sales associated with all sales transactions to its distributors in “Deferred distributors revenue, net of cost of sales to distributors” in the liability section of its condensed consolidated balance sheet. When the Company ships products to its

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EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



distributors, legal title to the products passes to its distributors, and a legally enforceable obligation is created for the distributors to pay on a current basis. Therefore, the Company records a trade receivable at the contractual discount to the list selling price and relieves inventory for the cost of goods shipped to the distributor.
The amount shown as “Total deferred distributors revenue, net of cost of sales to distributors” represents the deferred gross margin on sales to distributors based on contractual pricing. Distributors purchase products from the Company at a contractual discount based on geographic region and resell the Company's products at a very broad range of individually negotiated price points depending on competitive factors and other market conditions. A portion of the deferred revenue balance represents an amount of the distributors' original purchase price that will be remitted back to the distributors after resale transactions are reported to the Company. Therefore, the amount of gross margin the Company will recognize in future periods from distributor sales will be less than the deferred amount recorded for the original sale to the distributor as a result of the price concessions negotiated at the time of sell-through. The wide range and variability of negotiated price credits granted to distributors do not allow the Company to accurately estimate the portion of the balance in the deferred revenue that will be credited to the distributors in the future. Therefore, the Company does not reduce deferred revenue by anticipated future price credits; instead, price credits are recorded against revenue and accounts receivable when incurred, which is generally at the time the distributor sells the product.
The following table summarizes deferred distributors revenue, net of cost of sales to distributors at March 31, 2013 and June 30, 2012, respectively (in thousands):
 
March 31, 2013
 
June 30, 2012
Deferred distributors revenue
$
17,562

 
$
20,361

Deferred cost of sales to distributors
(4,030
)
 
(5,042
)
Total deferred distributors revenue, net of cost of sales to distributors
$
13,532

 
$
15,319


Guarantees and Product Warranties
Upon issuance of a standard product warranty, the Company discloses and recognizes a liability for the obligation it assumes under the warranty. The following table summarizes the activity related to the Company’s product warranty liability during the three and nine months ended March 31, 2013 and April 1, 2012:
 
 
Three Months Ended
 
Nine Months Ended
 
March 31, 2013
 
April 1, 2012
 
March 31, 2013
 
April 1, 2012
Balance beginning of period
$
2,971

 
$
2,651

 
$
2,871

 
$
2,640

New warranties issued
1,257

 
1,556

 
4,761

 
4,793

Warranty expenditures
(1,332
)
 
(1,365
)
 
(4,736
)
 
(4,591
)
Balance end of period
$
2,896

 
$
2,842

 
$
2,896

 
$
2,842


The Company’s standard hardware warranty period is typically 12 months from the date of shipment to end-users and 90 days for software. For certain access products, the Company offers a limited lifetime hardware warranty commencing on the date of shipment from the Company and ending five (5) years following the Company’s announcement of the end of sale of such product. Upon shipment of products to its customers, the Company estimates expenses for the cost to repair or replace products that may be returned under warranty and accrues a liability in cost of product revenue for this amount. The determination of the Company’s warranty requirements is based on actual historical experience with the product or product family, estimates of repair and replacement costs and any product warranty problems that are identified after shipment. The Company estimates and adjusts these accruals at each balance sheet date in accordance with changes in these factors.
In the normal course of business to facilitate sales of its products, the Company indemnifies its resellers and end-user customers with respect to certain matters. The Company has agreed to hold the customer harmless against losses arising from a breach of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. It is not possible to estimate the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material impact on its operating results or financial position.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



Concentrations
The Company may be subject to concentration of credit risk as a result of certain financial instruments consisting principally of marketable investments and accounts receivable. The Company has placed its investments with high-credit quality issuers. The Company does not invest an amount exceeding 10% of its combined cash, cash equivalents, short-term investments and marketable securities in the securities of any one obligor or maker, except for obligations of the United States government, obligations of United States government agencies and money market accounts.
The Company performs ongoing credit evaluations of its customers and generally does not require collateral in exchange for credit. The Company noted the greater than 10% receivable concentration in its customer base as of March 31, 2013 is not materially different than it was as of June 30, 2012.
The following table sets forth major customers accounting for 10% or more of our net revenue (amounts for the three and nine months ended April 1, 2012 have been revised to correct previously disclosed amounts):
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 31, 2013
 
April 1, 2012
 
March 31, 2013
 
April 1, 2012
Westcon Group Inc.
 
19
%
 
20
%
 
10
%
 
19
%
Tech Data
 
11
%
 
*

 
*

 
*

Scansource, Inc.
 
10
%
 
12
%
 
*

 
13
%
Ericsson AB
 
*

 
11
%
 
*

 
11
%
 
 
 
 
 
 
 
 
 
* Less than 10% of revenue
 
 
 
 
 
 
 
 
 
5. Fair Value Measurements

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

• Level 1
 
 
Quoted prices in active markets for identical assets or liabilities;
 
 
 
 
• Level 2
 
 
Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
 
 
 
 
• Level 3
 
 
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table presents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis:
 
March 31, 2013
Level 1
 
Level 2
 
Level 3
 
Total
 
(In thousands)
Assets
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
Federal agency notes
$

 
$
5,513

 
$

 
$
5,513

Money market funds
54,179

 

 

 
54,179

Corporate notes/bonds

 
105,994

 

 
105,994

Foreign currency forward contracts

 
26

 

 
26

Total
$
54,179

 
$
111,533

 
$

 
$
165,712



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EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



June 30, 2012
Level 1
 
Level 2
 
Level 3
 
Total
 
(In thousands)
Assets
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
Municipal bonds
$

 
$
2,736

 
$

 
$
2,736

Federal agency notes

 
11,234

 

 
11,234

Money market funds
36,141

 

 

 
36,141

Corporate notes/bonds

 
84,949

 

 
84,949

Foreign currency forward contracts

 
179

 

 
179

Total
$
36,141

 
$
99,098

 
$

 
$
135,239

Level 2 investment valuations are based on inputs such as quoted market prices of similar instruments, dealer quotations or valuations provided by alternative pricing sources supported by observable inputs. These generally include U.S. government and sovereign obligations, most government agency securities, investment-grade corporate bonds, and state, municipal and provincial obligations. There were no transfers of assets or liabilities between Level 1 and Level 2 during the three and nine months ended March 31, 2013 and April 1, 2012.

6. Share-based Compensation
Share-based compensation expense recognized in the condensed consolidated financial statements by line item caption is as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
Cost of product revenue
$
118

 
$
81

 
$
413

 
$
372

Cost of service revenue
61

 
59

 
304

 
203

Research and development
268

 
289

 
988

 
1,041

Sales and marketing
756

 
487

 
2,051

 
1,306

General and administrative
638

 
560

 
1,869

 
1,730

Total share-based compensation expense
$
1,841

 
$
1,476

 
$
5,625

 
$
4,652

During the three and nine months ended March 31, 2013 and April 1, 2012, the Company did not capitalize any stock-based compensation expense in inventory, as the amounts were immaterial. The income tax benefit for share-based compensation expense was immaterial in the three and nine months ended March 31, 2013 and April 1, 2012.  
The weighted-average grant-date per share fair value of options granted during the three months ended March 31, 2013 and April 1, 2012 were $1.72 and $1.58, respectively. The weighted-average estimated per share fair value of shares purchased under the Company’s 1999 Employee Stock Purchase Plan (“ESPP”) during the three months ended March 31, 2013 and April 1, 2012 were $0.86 and $1.05, respectively.
The weighted-average grant-date per share fair value of options granted during the nine months ended March 31, 2013 and April 1, 2012 were $2.71 and $1.65, respectively. The weighted-average estimated per share fair value of shares purchased under the ESPP during the nine months ended March 31, 2013 and April 1, 2012 were $0.88 and $1.01, respectively.

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EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



The following table summarizes stock option activity under all plans for the nine months ended March 31, 2013:
 
 
Number of
Shares
(000’s)
 
Weighted-
Average
Exercise Price
Per Share
 
Weighted-
Average
Remaining
Contractual
Term (years)
 
Aggregate
Intrinsic Value
(000’s)
Options outstanding at June 30, 2012
9,006

 
$
3.68

 
 
 
 
Granted
2,214

 
$
3.50

 
 
 
 
Exercised
(689
)
 
$
2.83

 
 
 
$
499

Cancelled
(1,113
)
 
$
3.78

 
 
 
 
Options outstanding at March 31, 2013
9,418

 
$
3.69

 
4.69
 
$
1,497

Exercisable at March 31, 2013
5,622

 
$
3.88

 
3.87
 
$
1,260

Vested and expected to vest at March 31, 2013
8,986

 
$
3.70

 
4.62
 
$
1,478

Stock Awards
Stock awards may be granted under the 2005 Plan on terms approved by the Board of Directors. Stock awards generally provide for the issuance of restricted stock which vests over a fixed period.

The following table summarizes stock award activity for the nine months ended March 31, 2013:
 
 
Number of
Shares
(000’s)
 
Weighted-
Average Grant-
Date Fair Value
 
Aggregate Fair Market Value ($000's)
Non-vested stock outstanding at June 30, 2012
1,078

 
$
2.35

 
 
Granted
3,199

 
$
3.49

 
 
Vested
(774
)
 
$
3.40

 
$
2,625

Cancelled
(273
)
 
$
3.43

 
 
Non-vested stock outstanding at March 31, 2013
3,230

 
$
3.14

 
 

The fair value of each option award and share purchase option under the Company's ESPP is estimated on the date of grant using the Black-Scholes-Merton option valuation model with the weighted average assumptions noted in the following table. The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The expected term of ESPP represents the contractual life of the ESPP purchase period. The risk-free rate based upon the estimated life of the option and ESPP is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on both the implied volatilities from traded options on the Company’s stock and historical volatility on the Company’s stock.  
 
Stock Option Plan
 
Employee Stock Purchase Plan
 
Stock Option Plan
 
Employee Stock Purchase Plan
 
Three Months Ended
 
Three Months Ended
 
Nine Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
Expected life
4.2 years

 
5 years

 
0.25 years

 
0.25 years

 
4.5 years

 
5 years

 
0.25 years

 
0.25 years

Risk-free interest rate
0.72
%
 
0.88
%
 
0.10
%
 
0.13
%
 
0.71
%
 
1.07
%
 
0.07
%
 
0.07
%
Volatility
62
%
 
64
%
 
42
%
 
54
%
 
60
%
 
60
%
 
53
%
 
65
%
Dividend yield
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
The Company is required to estimate the expected forfeiture rate and only recognize expense on a straight-line method for those shares expected to vest.

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7. Common Stock Repurchases and Retirement
Retirement of Treasury Stock
On September 5, 2012, the Company retired 39,631,836 shares of treasury stock. The retired shares had a carrying value of approximately $149.7 million, and the Company reduced additional paid-in capital by approximately $149.7 million upon the formal retirement of the shares. The retired shares are now included in the Company's authorized but unissued shares. 
Common Stock Repurchases
On September 28, 2012, the Company's Board of Directors approved a share repurchase program for a maximum of $75 million which may be purchased over a three year period in the open market or in privately negotiated transactions. All repurchased shares will be retired and included in the Company's authorized but unissued shares. During the three months ended March 31, 2013, the Company repurchased 1.2 million shares of common stock at a total cost of $4.2 million. During the nine months ended March 31, 2013, the Company repurchased 3.1 million shares of common stock at a total cost of $11.0 million.

8. Commitments and Contingencies
Purchase Commitments
The Company currently has arrangements with contract manufacturers and suppliers for the manufacture of its products. The arrangements allow them to procure long lead-time component inventory based upon a rolling production forecast provided by the Company. The Company is obligated to the purchase of long lead-time component inventory that its contract manufacturer procures in accordance with the forecast, unless the Company gives notice of order cancellation outside of applicable component lead-times. As of March 31, 2013, the Company had non-cancelable commitments to purchase approximately $30.3 million of such inventory.
Legal Proceedings
The Company may from time to time be party to litigation arising in the course of its business, including, without limitation, allegations relating to commercial transactions, business relationships or intellectual property rights. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. Litigation in general, and intellectual property and securities litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict.
In accordance with applicable accounting guidance, the Company records accruals for certain of its outstanding legal proceedings, investigations or claims when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated. The Company evaluates, at least on a quarterly basis, developments in legal proceedings, investigations or claims that could affect the amount of any accrual, as well as any developments that would result in a loss contingency to become both probable and reasonably estimable. When a loss contingency is not both probable and reasonably estimable, the Company does not record a loss accrual.  However, if the loss (or an additional loss in excess of any prior accrual) is at least a reasonable possibility and material, then the Company would disclose an estimate of the possible loss or range of loss, if such estimate can be made, or disclose that an estimate cannot be made. The assessment whether a loss is probable or a reasonable possibility, and whether the loss or a range of loss is estimable, involves a series of complex judgments about future events. Even if a loss is reasonably possible, the Company may not be able to estimate a range of possible loss, particularly where (i) the damages sought are substantial or indeterminate, (ii) the proceedings are in the early stages, or (iii) the matters involve novel or unsettled legal theories or a large number of parties. In such cases, there is considerable uncertainty regarding the ultimate resolution of such matters, including the amount of any possible loss, fine or penalty.  Accordingly, for current proceedings, the Company is currently unable to estimate any reasonably possible loss or range of possible loss.  However, an adverse resolution of one or more of such matters could have a material adverse effect on the Company's results of operations in a particular quarter or fiscal year.
Intellectual Property Litigation
Enterasys Networks
On June 21, 2005, Enterasys Networks ("Enterasys") filed suit against Extreme and Foundry Networks, Inc. (“Foundry”) in the United States District Court for the District of Massachusetts, Civil Action No. 05-11298 DPW. The complaint alleged willful infringement of U.S. Patent Nos. 5,251,205; 5,390,173; 6,128,665; 6,147,995; 6,539,022; and 6,560,236, and sought: a) a judgment that the Company willfully infringes each of the patents; (b) a permanent injunction from infringement, inducement of infringement and contributory infringement of each of the six patents; (c) damages and a “reasonable royalty” to be determined at trial; (d) treble damages; (e) attorneys' fees, costs and interest; and (f) equitable relief at the Court's discretion. Petitions for reexamination were filed challenging five of the patents at issue to the U.S. Patent and Trademark Office, and a stay of the case was entered. Following the reexamination proceedings, Enterasys withdrew its allegations of infringement as to two of the patents,

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



U.S. Patent Nos. 6,539,022 and 6,560,236. The stay was lifted on May 21, 2010, and the Court held claim construction hearings in December 2010. Fact discovery was ongoing. No trial date was set.
On April 20, 2007, the Company filed suit against Enterasys in the United States District Court for the Western District of Wisconsin, Civil Action No. 07-C-0229-C. The complaint alleged willful infringement of U.S. Patents Nos. 6,104,700, 6,678,248, and 6,859,438, and sought injunctive relief against Enterasys' continuing sale of infringing goods and monetary damages. Enterasys responded to the complaint on May 30, 2007, and also filed counterclaims alleging infringement of three U.S. patents owned by Enterasys. On April 9, 2008, the Court dismissed Enterasys' counterclaims on one of its patents with prejudice. On May 5, 2008, the Court granted the Company's motion for summary judgment, finding that it does not infringe Enterasys' two remaining patents and dismissing all of Enterasys' remaining counterclaims with prejudice. On May 30, 2008, a jury found that Enterasys infringed all three of the Company's patents and awarded the Company damages in the amount of $0.2 million. The Court also ruled in the Company's favor on Enterasys' challenge to the validity of the Company's patents. On October 29, 2008, the Court denied Enterasys' post-trial motion for judgment as a matter of law, and granted Extreme Network's motion for a permanent injunction against Enterasys. The injunction order permanently enjoins Enterasys from manufacturing, using, offering to sell, selling in the U.S. and importing into the U.S. the Enterasys products accused of infringing Extreme Network's three patents. On March 16, 2009, the Court also denied Enterasys' motion for a new trial, but granted Enterasys' motion for a stay of the injunction pending appeal. On April 17, 2009, Enterasys filed its notice of appeal and on May 1, 2009, the Company filed its cross appeal. On September 30, 2010, the U.S. Court of Appeals for the Federal Circuit upheld the jury verdict of infringement by Enterasys of the Company's patents and the Districts Court's summary judgment of non-infringement by the Company of Enterasys' '727 patent. The Federal Circuit reversed the judgment of non-infringement by the Company of Enterasys '181 patent, holding that the District Court Judge applied an incorrect claim construction and reversed the District Court's denial of the Company's request for attorneys' fees as premature. 
On November 4, 2011, a jury returned a verdict of non-infringement by the Company of the '181 patent and found the patent to be valid. Both parties filed post-trial motions, including motions for a new trial, for judgment as a matter of law and for attorneys' fees, all of which the Court denied on July 11, 2012. Enterasys did not file a notice of appeal by the August 10, 2012 deadline.  Consequently, the judgment of non-infringement in favor of the Company in the second trial is final. During the fourth quarter of fiscal 2012, Enterasys paid the Company $0.6 million related to the judgment.  During the quarter ended December 31, 2012, the Company received payments from Enterasys totaling approximately $0.4 million for the Court's award for damages, supplemental damages, pre and post judgment interests, costs from the first trial and second trial, plus the amount Enterasys agreed to release for damages held in escrow that accrued during the stay of the injunction post-trial and on appeal.
During the third quarter of fiscal 2013, the Company and Enterasys engaged in settlement discussions. On March 29, 2013, the parties entered into a confidential settlement agreement (“Agreement”). The Agreement required a dismissal with prejudice of the Wisconsin and Massachusetts litigation, as well as cross covenants not to sue and survival of settlement rights for any acquiring party of the parties. Joint motions to dismiss were granted on April 13, 2013, and April 15, 2013 respectively. All matters between the parties have now been resolved.
Chrimar Systems
On October 31, 2011, Chrimar Systems, Inc. dba CMS Technologies, and Chrimar Holding Company filed suit against the Company, Cisco Systems, Inc., and Cisco Consumer Products LLC. Cisco-Linksys LLC, Hewlett-Packard Company, 3Com Corporation and Avaya, Inc. in the United States District Court for the District of Delaware, Civil Action No. 11-1050 (the "Delaware action").  The complaint alleges infringement of U.S. Patent No. 7,457,250.   The Delaware action has been stayed pursuant to 28 USC Section 1659(a) pending final determination of the International Trade Commission action described below, based on the fact that the allegations in both cases relate to the same patent. 
During the fourth quarter of the fiscal 2012, the Company engaged in settlement discussions with Chrimar Systems Inc.  As part of the negotiations the Company determined that it is reasonably possible that a range of loss could be between $0.3 million and $1.4 million which is dependent on a number of factors including whether mutually acceptable settlement terms can be reached. As of March 31, 2013 and through the date of the filing of this Form 10-Q, this matter was still pending. However, during the quarter ended June 30, 2012 the Company recorded a charge of $0.3 million based on its best estimate of the probable loss. In addition, during the quarter ending March 31, 2013, venue for the Delaware action was transferred to the United States District Court for the District of Northern California.
Reefedge Networks
On September 17, 2012, Reefedge Networks, LLC filed suit against the Company in the United States District Court for the District of Delaware, Civil Action No. 12-1148. The complaint alleges wrongful use, making, selling, and/or offering to sell products that infringe U.S. Patent Nos. 6,633.761; 6,975,864; and 7,197,308 and seeks unspecified monetary damages and a permanent injunction for products originating from a single supplier to which the Company has submitted an indemnification request. Given the preliminary nature of the claims, it is premature to assess the likelihood of a particular outcome. An answer

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



was filed on December 10, 2012. The Company believes it will be fully indemnified for any potential losses related to the suit, as all products are third party designed and manufactured, and the suit is the subject of a third party indemnity and defense agreement.
Indemnification Obligations
Subject to certain limitations, the Company may be obligated to indemnify its current and former directors, officers and employees. These obligations arise under the terms of its certificate of incorporation, its bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify, where applicable, generally means that the Company is required to pay or reimburse, and in certain circumstances the Company has paid or reimbursed, the individuals' reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters. It is not possible to estimate the maximum potential amount under these indemnification agreements due to the limited history of these claims. The cost to defend the Company and the named individuals could have a material adverse effect on its consolidated financial position, results of operations and cash flows in the future. Recovery of such costs under its directors and officers insurance coverage is uncertain. As of March 31, 2013, the Company had no outstanding indemnification claims
9. Income Taxes
The Company recorded an income tax provision of $0.4 million and $0.5 million for the three months ended March 31, 2013 and April 1, 2012, respectively. The Company recorded an income tax provision of $1.4 million and $1.2 million for the nine months ended March 31, 2013 and April 1, 2012 respectively.
The income tax provisions for the three and nine months ended March 31, 2013 and April 1, 2012 consisted primarily of taxes on foreign income and U.S. state income taxes. The income tax provisions for both fiscal years were calculated based on the results of operations for the three and nine months ended March 31, 2013 and April 1, 2012, and may not reflect the annual effective rate.

We have provided a full valuation allowance for our U.S. net deferred tax assets after assessing both negative and positive evidence when measuring the need for a valuation allowance. For the current quarter, negative evidence, such as the Company's current quarter financial performance, the Company's significant restructuring in the current quarter, and the unfavorable macroeconomic climate were given more weight than our expectations of future profitability, which are inherently uncertain.  Accordingly, we believe that there is sufficient negative evidence to maintain a full valuation allowance against our U.S. federal and state net deferred tax assets. This valuation allowance will be evaluated periodically and can be reversed partially or totally if business results have sufficiently improved to support realization of our U.S. deferred tax assets.

The sale of the Company's buildings and land in Santa Clara, California during the quarter ended September 30, 2012 resulted in a tax loss that increased the amount of the Company's deferred tax assets with a corresponding increase to the related valuation allowance.
The Company had $25.8 million of unrecognized tax benefits as of March 31, 2013. The future impact of the unrecognized tax benefit of $25.8 million, if recognized, is as follows: approximately $0.5 million would impact the effective tax rate, and approximately $25.3 million would result in adjustments to deferred tax assets and corresponding adjustments to the valuation allowance. It is reasonably possible that the amount of unrealized tax benefit could decrease by approximately $0.2 million during the next twelve months due to the expiration of the statute of limitations in certain foreign jurisdictions.
Estimated interest and penalties related to the underpayment of income taxes are classified as a component of tax expense in the Consolidated Statements of Operations and were immaterial for both the three months and nine months periods ended March 31, 2013. Accrued interest and penalties were $0.1 million and $0.2 million as of March 31, 2013 and April 1, 2012, respectively.
In general, the Company's U.S. federal income tax returns are subject to examination by tax authorities for fiscal years 1999 forward due to net operating losses and the Company's state income tax returns are subject to examination for fiscal years 2001 forward due to net operating losses.

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

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EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



 
Three Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
Net (loss) income
$
(2,220
)
 
$
2,372

 
$
6,489

 
$
8,062

Weighted-average shares used in per share calculation – basic
92,968

 
93,659

 
94,069

 
93,205

Incremental shares using the treasury stock method:
 
 
 
 
 
 
 
Stock options

 
389

 
391

 
329

Restricted stock units

 
474

 
526

 
595

Employee Stock Purchase Plan

 
78

 
108

 
116

Weighted -average share used in per share calculation – diluted
92,968

 
94,600

 
95,094

 
94,245

Net income (loss) per share – basic
(0.02
)
 
0.03

 
0.07

 
0.09

Net income (loss) per share – diluted
(0.02
)
 
0.03

 
0.07

 
0.09

Potentially dilutive common shares from employee incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options, the assumed vesting of outstanding restricted stock units, and the assumed issuance of common stock under the stock purchase plan. Weighted stock options outstanding with an exercise price higher than the Company's average stock price for the periods presented are excluded from the calculation of diluted net income per share since the effect of including them would have been anti-dilutive due to the net income position of the Company during the periods presented. For the three and nine months ended March 31, 2013, the Company excluded 7.1 million and 7.2 million outstanding weighted average stock options, respectively, from the calculation of diluted earnings per common share because they would have been anti-dilutive.  The Company excluded 8.2 million and 8.5 million outstanding weighted average stock options from the calculation of diluted earnings per common share in the three and nine months ended April 1, 2012 because they would have been anti-dilutive.
11. Restructuring Charges
As part of the Company's on-going restructuring efforts, during the second quarter of fiscal year 2013, the Company initiated a plan to reduce its worldwide headcount by 13%, consolidate specific global administrative functions, and shift certain operating costs to lower cost regions, among other actions. Restructuring expense was $1.1 million and $6.2 million in the three and nine months ended March 31, 2013. Restructuring expense was not significant in the three months ended April 1, 2012 and was $1.4 million in the nine months ended April 1, 2012, respectively.

The following table summarizes restructuring activities for the nine months ended March 31, 2013:
 
 
Termination Benefits (1)
 
Excess Facilities (2)
 
Other Cost
 
Total
Balance at July 1, 2012
 
$
359

 
$
93

 
$
11

 
$
463

Period charges
 
5,986

 
114

 
275

 
6,375

Period reversals
 
(133
)
 

 

 
(133
)
Period payments
 
(4,464
)
 
(181
)
 
(286
)
 
(4,931
)
Restructuring liabilities at March 31, 2013
 
$
1,748

 
$
26

 
$

 
$
1,774


(1) Termination benefits generally include severance, outplacement services and health insurance coverage.
(2) Excess facilities costs generally include rent expense less expected sublease income, lease termination costs and asset abandonment costs.

12. Foreign Exchange Forward Contracts
The Company uses derivative financial instruments to manage exposures to foreign currency. The Company’s objective for holding derivatives is to use the most effective methods to minimize the impact of these exposures. The Company does not enter into derivatives for speculative or trading purposes. The Company records all derivatives on the balance sheet as Other Assets, Net at fair value. Changes in the fair value of derivatives are recognized in earnings as Other Income (Expense). The Company enters into foreign exchange forward contracts to mitigate the effect of gains and losses generated by the foreign currency forecasted transactions related to certain operating expenses and re-measurement of certain assets and liabilities denominated in foreign currencies. These derivatives do not qualify as hedges. At March 31, 2013, these forward foreign currency contracts had a notional principal amount of $7.5 million and an immaterial unrealized gain on foreign exchange contracts. These contracts have maturities of less than 60 days. Changes in the fair value of these foreign exchange forward contracts are offset largely by re-measurement of the underlying assets and liabilities.

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EXTREME NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



Foreign currency transaction gains and losses from operations were a $0.1 million loss for the three months ended March 31, 2013 and a $0.2 million gain for the three months ended April 1, 2012. Foreign currency transaction gains and losses were an immaterial gain for the nine months ended March 31, 2013 and a $0.1 million gain for the nine months ended April 1, 2012.

13. Disclosure about Segments of an Enterprise and Geographic Areas
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision makers with respect to the allocation of resources and performance.
The Company operates in one segment, the development and marketing of network infrastructure equipment. The Company conducts business globally and is managed geographically. Revenue is attributed to a geographical area based on the location of the customers. The Company operates in three geographical areas: Americas, which includes the United States, Canada, Mexico, Central America and South America; EMEA, which includes Europe, Middle East and Africa; and APAC which includes Asia Pacific, South Asia, Japan, and Australia.
The Company attributes revenues to geographic regions primarily based on the customer's ship-to location. Amounts for the three and nine months ended April 1, 2012 have been revised to correct previously disclosed amounts. Information regarding geographic areas is as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
Net Revenues:
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
Americas:
 
 
 
 
 
 
 
United States
$
21,609

 
$
23,452

 
$
69,545

 
$
75,841

Other
6,414

 
7,464

 
26,959

 
26,976

Total Americas
28,023

 
30,916

 
96,504

 
102,817

EMEA
28,481

 
30,349

 
85,700

 
91,164

APAC
11,699

 
12,103

 
37,677

 
41,093

Total net revenues
$
68,203

 
$
73,368

 
$
219,881

 
$
235,074

 
Substantially all of the Company’s assets were attributable to North America operations at March 31, 2013 and June 30, 2012.


14. Subsequent Events
    
On April 25, 2013, the Company announced the resignation of Oscar Rodriguez as President and Chief Executive Officer of the Company as well as his resignation from the Board of Directors.   At the same time, the Company announced the appointment of  Mr. Charles W. “Chuck” Berger as its President and Chief Executive Officer, as well as elected him to the Board of Directors, effective as of April 25, 2013.



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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q, including the following sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including in particularly, our expectations regarding market demands, customer requirements and the general economic environment, and future results of operations, and other statements that include words such as “may” “expect” or “believe” . These forward-looking statements involve risks and uncertainties. We caution investors that actual results may differ materially from those projected in the forward-looking statements as a result of certain risk factors identified in the section entitled “Risk Factors” in this Report, our Quarterly Report on Form 10-Q for the third quarter of fiscal 2013, our Annual Report on Form 10-K for the fiscal year ended June 30, 2012, and other filings we have made with the Securities and Exchange Commission. These risk factors, include, but are not limited to: fluctuations in demand for our products and services; a highly competitive business environment for network switching equipment; our effectiveness in controlling expenses; the possibility that we might experience delays in the development or introduction of new technology and products; customer response to our new technology and products; the timing of any recovery in the global economy; risks related to pending or future litigation; and a dependency on third parties for certain components and for the manufacturing of our products.

Business Overview
We are a leading provider of network infrastructure equipment and services for enterprises, data centers, and service providers. We were incorporated in California in May 1996 and reincorporated in Delaware in March 1999. Our corporate headquarters are located in Santa Clara, California. We develop and sell network infrastructure equipment to our enterprise, data center and telecommunications service provider customers.
We conduct our sales and marketing activities on a worldwide basis through a distribution channel utilizing distributors, resellers and our field sales organization. We primarily sell our products through an ecosystem of channel partners who combine our Ethernet products with their offerings to create compelling information technology solutions for end user customers. We utilize our field sales organization to support our channel partners and to sell direct to end-user customers, including some large global accounts. Our customers include businesses, hospitals, schools, hotels, telecommunications companies and government agencies around the world.
We outsource the majority of our manufacturing and supply chain management operations as part of our strategy to maintain global manufacturing capabilities and to reduce our costs. We conduct quality assurance, manufacturing engineering, document control and test development in Santa Clara, California and Research Triangle Park, North Carolina. This approach enables us to reduce fixed costs and to flexibly respond to changes in market demand.
The market for network infrastructure equipment is highly competitive and dominated by a few large companies. The current economic climate has further driven consolidation of vendors within the Ethernet networking market and with vendors from adjacent markets, including storage, security, wireless and voice applications. We believe that the underpinning technology for all of these adjacent markets is Ethernet. As a result, independent Ethernet switch vendors are being acquired or merged with larger, adjacent market vendors to enable them to deliver complete and broad solutions. As a result, we believe that, as an independent Ethernet switch vendor, we must provide products that, when combined with the products of our large strategic partners, create compelling solutions for end user customers. Our approach is to focus on the intelligence and automation layer that spans our hardware products and that facilitates end-to-end solutions, as opposed to positioning Extreme Networks as a low-cost-vendor with point products.
We believe that continued success in our marketplace is dependent upon a variety of factors that includes, but is not limited to, our ability to design, develop and distribute new and enhanced products employing leading-edge technology.

Results of Operations
During the third quarter of fiscal 2013, we achieved the following results:
Net revenues of $68.2 million compared to net revenues of $73.4 million in the third quarter of fiscal 2012.
Product revenues of $54.1 million compared to product revenues of $58.0 million in the third quarter of fiscal 2012.
Service revenues of $14.1 million compared to service revenues of $15.4 million in the third quarter of fiscal 2012.
Total gross margin of 56% of net revenues compared to total gross margin of 56% of net revenues in the third quarter of fiscal 2012.
Operating loss of $1.9 million (including restructuring charges of $1.1 million and $2.6 million litigation settlement and associated legal fees) compared to operating income of $2.7 million in the third quarter of fiscal 2012.

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Net loss of $2.2 million compared to net income of $2.4 million in the third quarter of fiscal 2012.
Cash flow provided by operating activities of $7.0 million in the nine months ended March 31, 2013 compared to cash flow provided by operating activities of $6.4 million in the nine months ended April 1, 2012.
Cash and cash equivalents, short-term investments and marketable securities increased by $35.6 million to $189.1 million as of March 31, 2013 from $153.5 million as of June 30, 2012, primarily due to cash provided by operating and investing activities, including the sale of buildings and land offset by cash used for repurchase of common stock.
We operate in three regions: Americas, which includes the United States, Canada, Mexico, Central America and South America; EMEA, which includes Europe, Middle East, and Africa; and APAC which includes Asia Pacific, South Asia, Japan, and Australia. The following table presents the total net revenue geographically for the three and nine months ended March 31, 2013 and April 1, 2012, respectively (dollars in thousands):

 
Three Months Ended
 
Nine Months Ended
Net Revenues
March 31,
2013
 
April 1,
2012
 
$
Change
 
%
Change
 
March 31,
2013
 
April 1,
2012
 
$
Change
 
%
Change
Americas:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
$
21,609

 
$
23,452

 
$
(1,843
)
 
(7.9
)%
 
$
69,545

 
$
75,841

 
$
(6,296
)
 
(8.3
)%
Other
6,414

 
7,464

 
(1,050
)
 
(14.1
)%
 
26,959

 
26,976

 
(17
)
 
(0.1
)%
Total Americas
28,023

 
30,916

 
(2,893
)
 
(9.4
)%
 
96,504

 
102,817

 
(6,313
)
 
(6.1
)%
Percentage of net revenue
41.0
%
 
42.1
%
 
 
 
 
 
43.9
%
 
43.7
%
 


 


EMEA
28,481

 
30,349

 
(1,868
)
 
(6.2
)%
 
85,700

 
91,164

 
(5,464
)
 
(6.0
)%
Percentage of net revenue
41.8
%
 
41.4
%
 
 
 
 
 
39.0
%
 
38.8
%
 


 


APAC
11,699

 
12,103

 
(404
)
 
(3.3
)%
 
37,677

 
41,093

 
(3,416
)
 
(8.3
)%
Percentage of net revenue
17.2
%
 
16.5
%
 
 
 
 
 
17.1
%
 
17.5
%
 

 

Total net revenues
$
68,203

 
$
73,368

 
$
(5,165
)
 
(7.0
)%
 
$
219,881

 
$
235,074

 
$
(15,193
)
 
(6.5
)%
Net Revenues
The following table presents net product and service revenue for the three and nine months ended March 31, 2013 and April 1, 2012, respectively (dollars in thousands):

 
Three Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
$
Change
 
%
Change
 
March 31,
2013
 
April 1,
2012
 
$
Change
 
%
Change
Net Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product
$
54,072

 
$
58,009

 
$
(3,937
)
 
(6.8
)%
 
$
175,450

 
$
189,316

 
$
(13,866
)
 
(7.3
)%
Percentage of net revenue
79.3
%
 
79.1
%
 
 
 
 
 
79.8
%
 
80.5
%
 
 
 
 
Service
14,131

 
15,359

 
(1,228
)
 
(8.0
)%
 
44,431

 
45,758

 
(1,327
)
 
(2.9
)%
Percentage of net revenue
20.7
%
 
20.9
%
 
 
 
 
 
20.2
%
 
19.5
%
 
 
 
 
Total net revenues
$
68,203

 
$
73,368

 
$
(5,165
)
 
(7.0
)%
 
$
219,881

 
$
235,074

 
$
(15,193
)
 
(6.5
)%

Product revenue decreased by $3.9 million or 6.8% in the third quarter of fiscal 2013, and decreased by $13.9 million or 7.3% in the nine months ending March 31, 2013, compared to the corresponding periods of fiscal 2012 primarily due to lower sales volume in the Americas and EMEA regions. In the nine months ending March 31, 2013, we experienced weaker than expected demand from our public sector and enterprise customers in the U.S. and we continued to experience weak demand from our public sector and strategic customers and distributors in the EMEA region attributable to the persistent macroeconomic challenges in Western Europe.
Service revenue decreased by $1.2 million, or 8.0% in the third quarter of fiscal 2013, and decreased $1.3 million or 2.9% in the nine months ending March 31, 2013, compared to the corresponding periods of fiscal 2012, reflecting slight decrease in the levels of service contract renewals.

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Cost of Revenue and Gross Profit
The following table presents the gross profit on product and service revenue and the gross profit percentage of product and service revenue for the three and nine months ended March 31, 2013 and April 1, 2012 (in thousands):

 
Three Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
$
Change
 
%
Change
 
March 31,
2013
 
April 1,
2012
 
$
Change
 
%
Change
Gross profit:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product
$
28,866

 
$
31,386

 
$
(2,520
)
 
(8.0
)%
 
$
90,391

 
$
102,394

 
$
(12,003
)
 
(11.7
)%
Percentage of product revenue
53.4
%
 
54.1
%
 
 
 
 
 
51.5
%
 
54.1
%
 
 
 
 
Service
9,071

 
9,825

 
(754
)
 
(7.7
)%
 
28,260

 
28,621

 
(361
)
 
(1.3
)%
Percentage of service revenue
64.2
%
 
64.0
%
 
 
 
 
 
63.6
%
 
62.5
%
 
 
 
 
Total gross profit
$
37,937

 
$
41,211

 
$
(3,274
)
 
(7.9
)%
 
$
118,651

 
$
131,015

 
$
(12,364
)
 
(9.4
)%
Percentage of net revenue
55.6
%
 
56.2
%
 
 
 
 
 
54.0
%
 
55.7
%
 
 
 
 

Cost of product revenue includes costs of materials, amounts paid to third-party contract manufacturers, costs related to warranty obligations, charges for excess and obsolete inventory, royalties under technology license agreements, and internal costs associated with manufacturing overhead, including management, manufacturing engineering, quality assurance, development of test plans, and document control. We outsource substantially all of our manufacturing and supply chain management operations, and we conduct quality assurance, manufacturing engineering, document control and distribution in Santa Clara, California, China, and Taiwan. Accordingly, a significant portion of our cost of product revenue consists of payments to our primary contract manufacturer located in Hsinchu, Taiwan. In addition, we OEM our wireless product line from Motorola.
Product gross margin decreased to 53.4% from 54.1% in the third quarter of fiscal 2013, and decreased to 51.5% from 54.1% in the nine months ending March 31, 2013, compared to the corresponding periods of fiscal 2012. The decrease in product gross margin for the third quarter of fiscal 2013 was primarily due to lower product revenue offset by economic benefits realized in our manufacturing costs. The decrease in product gross margin for the nine months ending March 31, 2013, compared to the corresponding periods of fiscal 2012 was primarily due to lower product revenue and an increase in charges for excess and obsolete inventory offset by economic benefits realized in our manufacturing costs.
Our cost of service revenue consists primarily of labor, overhead, repair and freight costs and the cost of spares used in providing support under customer service contracts. Service gross margin increased to 64.2% from 64.0% in the third quarter of fiscal 2013 and increased to 63.6% from 62.5% in the nine months ending March 31, 2013. The increases in service gross margin were primarily due to lower material costs.
Operating Expenses
The following table presents operating expenses and operating income (in thousands, except percentages):

 
Three Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
$
Change
 
%
Change
 
March 31,
2013
 
April 1,
2012
 
$
Change
 
%
Change
Research and development
$
9,381

 
$
10,376

 
$
(995
)
 
(9.6
)%
 
$
30,954

 
$
33,866

 
$
(2,912
)
 
(8.6
)%
Sales and marketing
20,644

 
20,657

 
(13
)
 
(0.1
)%
 
64,764

 
65,512

 
(748
)
 
(1.1
)%
General and administrative
6,288

 
7,553

 
(1,265
)
 
(16.7
)%
 
18,292

 
21,777

 
(3,485
)
 
(16.0
)%
Restructuring charge, net of reversals
1,076

 
(35
)
 
1,111

 
3,174.3
 %
 
6,242

 
1,357

 
4,885

 
360.0
 %
Litigation settlement
2,450

 

 
2,450

 
100.0
 %
 
2,029

 

 
2,029

 
100.0
 %
Gain on sale of campus

 

 

 
 %
 
(11,539
)
 

 
(11,539
)
 
(100.0
)%
Total operating expenses
$
39,839

 
$
38,551

 
$
1,288

 
3.3
 %
 
$
110,742

 
$
122,512

 
$
(11,770
)
 
(9.6
)%
Operating income
$
(1,902
)
 
2,660

 
$
(4,562
)
 
(171.5
)%
 
$
7,909

 
$
8,503

 
$
(594
)
 
(7.0
)%

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The following table highlights our operating expenses and operating income as a percentage of net revenues:
 
 
Three Months Ended
 
Nine Months Ended
 
March 31,
2013
 
April 1,
2012
 
March 31,
2013
 
April 1,
2012
Research and development
13.8
 %
 
14.1
 %
 
14.1
 %
 
14.4
%
Sales and marketing
30.3
 %
 
28.2
 %
 
29.5
 %
 
27.9
%
General and administrative
9.2
 %
 
10.3
 %
 
8.3
 %
 
9.3
%
Restructuring charge, net of reversals
1.6
 %
 
(0.1
)%
 
2.8
 %
 
0.6
%
Litigation settlement
3.6
 %
 
 %
 
0.9
 %
 
%
Gain on sale of campus
 %
 
 %
 
(5.2
)%
 
%
Total operating expenses
58.5
 %
 
52.5
 %
 
50.4
 %
 
52.2
%
Operating income
(2.8
)%
 
3.6
 %
 
3.6
 %
 
3.6
%
Research and Development Expenses
Research and development expenses consist primarily of salaries and related personnel expenses, consultant fees and prototype expenses related to the design, development, and testing of our products.
Research and development expenses decreased by $1.0 million, or 9.6% in the third quarter of fiscal 2013 and decreased by $2.9 million, or 8.6% in the nine months ending March 31, 2013, compared to the corresponding periods of fiscal 2012. The decreases in research and development expenses primarily resulted from lower spending on engineering project expenses due to differences in the timing and pattern of planned engineering project spending in the nine months ending March 31, 2013 when compared to the same period last year.
Sales and Marketing Expenses
Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing and sales functions, as well as trade shows and promotional expenses.
Sales and marketing expenses decreased by an immaterial amount, or 0.1% in the third quarter of fiscal 2013 and decreased by $0.7 million, or 1.1% in the nine months ending March 31, 2013, compared to the corresponding periods of fiscal 2012. The decreases in sales and marketing expenses were primarily due to decreases in commissions in the three and nine months ended March 31, 2013.
General and Administrative Expenses
General and administrative expenses decreased by $1.3 million, or 16.7% in the third quarter of fiscal 2013 and decreased by $3.5 million, or 16.0% in the nine months ending March 31, 2013, compared to the corresponding periods of fiscal 2012. The decreases in general and administrative expenses during the three months ending March 31, 2013, compared to the corresponding period of fiscal 2012, was primarily due to cost reduction initiatives realized as part of our restructuring plan. The decreases in general and administrative expenses during the nine months ending March 31, 2013, compared to the corresponding period of fiscal 2012, was mainly attributable to lower legal costs due to the resolution of certain legal matters.
Restructuring Charge, Net of Reversals
Restructuring charges increased by $1.1 million in the third quarter of fiscal 2013 and increased by $4.9 million in the nine months ending March 31, 2013, compared to the corresponding periods of fiscal 2012.  During the second quarter of fiscal 2013, we further reduced costs through targeted restructuring activities intended to reduce operating costs and realign our organization in the current competitive environment. As part of our restructuring efforts in the second quarter, we initiated a plan to reduce our worldwide headcount by 13%, consolidate specific global administrative functions, and shift certain operating costs to lower cost regions, among other actions. As of March 31, 2013, we had restructuring liabilities of $1.8 million, which we anticipate paying by the end of the first quarter of fiscal 2014. We anticipate incurring additional restructuring charges of approximately $0.6 million through the end of first quarter of fiscal 2014.

Litigation Settlement, Net
During the third quarter of fiscal 2013, we recognized a litigation charge of $2.5 million related to a settlement agreement with Enterasys Networks Inc.

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