Extreme Networks Inc (EXTR) SEC Quarterly Report (10-Q) for Q4 2015

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

Form 10-Q

(Mark One)

For the quarterly period ended December 31, 2015

OR

For the transition period from to

Commission file number 000-25711

EXTREME NETWORKS, INC.

(Exact name of registrant as specified in its charter)

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

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.

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 January 22, 2016, was 103,319,359

EXTREME NETWORKS, INC.

FORM 10-Q

INDEX

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EXTREME NETWORKS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)

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)

See accompanying notes to condensed consolidated financial statements.

4

EXTREME NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

5

EXTREME NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

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EXTREME NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

The unaudited condensed consolidated financial statements of 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, 2015 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, 2015.

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 December 31, 2015. The results of operations for the three and six months ended December 31, 2015 are not necessarily indicative of the results that may be expected for fiscal 2016 or any future periods.

Fiscal Year

The Company uses a fiscal calendar year ending on June 30. All references herein to "fiscal 2016" or "2016" represent the fiscal year ending June 30, 2016.

Principles of Consolidation

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

Accounting Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but are not limited to, the accounting for the allowances for doubtful accounts and sales returns, determining the fair value of acquired assets and assumed liabilities, estimated selling prices, inventory valuation and purchase commitments, depreciation and amortization, impairment of long-lived assets including goodwill, warranty accruals, restructuring liabilities, measurement of share-based compensation costs and income taxes. Actual results could differ materially from these estimates.

The Company predominantly uses the United States Dollar as its functional currency. The functional currency for certain of its foreign subsidiaries is the local currency. For those subsidiaries that operate in a local currency functional environment, all assets and liabilities are translated to United States Dollars at current month end rates of exchange; and revenue and expenses are translated using the monthly average rate.

Certain balances included in the condensed consolidated statements of cash flows related to restructuring liabilities for prior periods have been reclassified to conform to the current period presentation.  In the condensed consolidated statement of cash flows, the changes in operating assets and liabilities for Other long-term liabilities includes the changes in restructuring liabilities and other accrued liabilities which were previously disclosed separately.

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For a description of significant accounting policies, see Note 3, Summary of Significant Accounting Policies, to the consolidated financial statements included in the Company's Annual report on Form 10-K for the fiscal year ended June 30, 2015. There have been no material changes to the Company's significant accounting policies since the filing of the Annual report on Form 10-K.

For a description of recently issued accounting pronouncements, see Note 4, Recently Issued Accounting Pronouncements , to the consolidated financial statements included in the Company's Annual report on Form 10-K for the fiscal year ended June 30, 2015. The following are accounting pronouncements issued that may materially affect the Company's financial statements since the filing of the Annual report on Form 10-K.

In November 2015, the FASB issued Accounting Standards Update No. 2015-17 ("ASU 2015-17"), Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. Current GAAP requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. To simplify the presentation of deferred income taxes, ASU 2015-17 requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this Update. The amendments in this Update are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted for all entities as of the beginning of an interim or annual reporting period and the amendments for ASU-2015-17 can be applied retrospectively or prospectively. The adoption of this guidance is not expected to have a material impact upon our financial condition or results of operations.

Cash and Cash Equivalents

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

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.

Inventory Valuation

The Company's inventory balances as of December 31 and June 30, 2015 were $56.6 million and $58.0 million, respectively. The Company values its inventory at lower of cost or market. Cost is computed using standard cost, which approximates actual cost, on a first-in, first-out basis. The Company has established inventory allowances primarily determined by the age of inventory or when conditions exist that suggest that inventory may be in excess of anticipated demand or is obsolete based upon assumptions about future demand. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Any written down or obsolete inventory subsequently sold has not had a material impact on gross margin for any of the periods disclosed.

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The following is a summary of our inventory by category (in thousands):

Property and Equipment, Net

Property and equipment consist of the following (in thousands):

Intangibles

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

Amortization expense for the three months ended December 31, 2015 and 2014, was $8.1 million and $9.0 million, respectively. For the three months ended December 31, 2015 and 2014 amortization expense of $3.8 million and $4.5 million, respectively, is included in "Cost of revenues for products" on the condensed consolidated statements of operations. Amortization expense for the six months ended December 31, 2015 and 2014, was $17.0 million and $18.0 million, respectively. For the six months ended

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December 31, 2015 and 2014 amortization expense of $ 8.3 million and $ 9.1 million , respectivel y, is included in " Cost of revenues for products " on the condensed consolidated statements of operations.  T he remainder of the amortization expense is included in " Amortization of intangibles " on the condensed consolidated statement of operations for all periods . The amortization expense that is recognized in " Cost of revenues for products " is comprised of amortization for developed technology, license agreements and other intangibles.

Other Accrued Liabilities

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

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 (in thousands): 

The Company offers for sale to its customers, renewable support arrangements 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):

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. The amount shown as "Deferred distributors revenue, net of cost of sales to distributors" represents the deferred gross profit on sales to distributors based on contractual pricing.

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The following table summarizes deferred distributors revenue, net of cost of sales t o distributors (in thousands):

Debt

The Company's debt is comprised of the following:

During fiscal 2015, the Company amended its credit agreement which provides for a five-year revolving credit facility for up to $50.0 million (the "Revolving Facility") and a $65.0 million five-year term loan (the "Term Loan") and together with the Revolving Facility the ("Senior Secured Credit Facilities, as amended"). 

The Senior Secured Credit Facilities, as amended contains, among others, certain financial covenants that require the Company to maintain defined minimum financial ratios which may limit the Company's availability to borrowings under the Revolving Facility. As of December 31, 2015, the Company had $32.2 million of availability under the Revolving Facility and is in compliance with its covenants.

The Company had $1.0 million of outstanding letters of credit as of December 31, 2015.

Guarantees and Product Warranties

Networking products may contain undetected hardware or software errors when new products or new versions or updates of existing products are released to the marketplace. In the past, we had experienced such errors in connection with products and product updates. The Company's standard hardware warranty period is typically 12 months from the date of shipment to end-users and 90 days for software. For certain access products, the Company offers a limited lifetime hardware warranty commencing on the date of shipment from the Company and ending five (5) years following the Company's announcement of the end of sale of such product. Upon shipment of products to its customers, the Company estimates expenses for the cost to repair or replace products that may be returned under warranty and accrue a liability in cost of product revenue for this amount. The determination of the Company's warranty requirements is based on actual historical experience with the product or product family, estimates of repair and replacement costs and any product warranty problems that are identified after shipment. The Company estimates and adjusts these accruals at each balance sheet date in accordance with changes in these factors.

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Upon issuance of a standard product warranty, the Company discloses and recognizes a liability for the obligations it assumes under the product warranty. The following table summarizes the activity related to the Company ' s product warranty liability during the three and six months ended December 31, 2015 and 2014:

To facilitate sales of its products in the normal course of business, 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.

Advertising

Cooperative advertising expenses are recorded as marketing expenses to the extent that an advertising benefit separate from the revenue transaction can be identified and the cash paid does not exceed the fair value of that advertising benefit received. Cooperative advertising obligations with customers are accrued and the costs expensed at the time the related revenue is recognized. If the Company does not meet the criteria for recognizing such cooperative advertising obligations as marketing expense, the costs are recorded as a reduction of revenue. All other advertising costs are expensed as incurred. Advertising expenses for three and six months ended December 31, 2015 and 2014, were immaterial.

Concentrations

The Company may be subject to concentration of credit risk as a result of certain financial instruments consisting of accounts receivable and short-term investments. The Company does not invest an amount exceeding 10% of its combined cash or cash equivalents 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 following table sets forth major customers accounting for 10% or more of our net revenue:

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

The Company did not hold any financial liabilities that required measurement at fair value on a recurring basis. The following table presents the Company's fair value hierarchy for its financial assets measured at fair value on a recurring basis (in thousands):

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

The fair value of the borrowings under the Senior Secured Credit Facility, as amended is estimated based on valuations provided by alternative pricing sources supported by observable inputs which is considered Level 2. Due to the short duration until maturity of the credit facility, the fair value approximates the carrying amount of the Company's total long-term indebtedness, including current portion of $62.0 million and $66.9 million as of December 31 and June 30, 2015, respectively.

Level 3 investments: The Company does not hold any level 3 investments.

Certain of the Company's assets, including intangible assets and goodwill are measured at fair value on a non-recurring basis if impairment is indicated. There were no impairments recorded for the three and six months ended December 31, 2015 or 2014.

Shares reserved for issuance

As of December 31, 2015, the Company had reserved for issuance (in thousands):

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

During the three and six months ended December 31, 2015 and 2014, the Company did not capitalize any share-based compensation expense in inventory, as the amounts were immaterial.

Stock Awards

Stock awards may be granted under the 2013 Equity Incentive Plan (the "2013 Plan") on terms approved by the Compensation Committee of the Board of Directors. Stock awards generally provide for the issuance of restricted stock units (including performance or market-based restricted stock units) which vest over a fixed period.

The following table summarizes stock award activity for the six months ended December 31, 2015 (in thousands, except grant date fair value):

The following table summarizes stock option activity under all plans for the six months ended December 31, 2015 (in thousands, except per share and contractual term):

The weighted-average grant-date fair value of options granted during the three and six months ended December 31, 2015 was $1.59. The weighted-average grant-date fair value of options granted during the three and six months ended December 31, 2014 was $1.66 and $1.96, respectively.

The weighted-average fair value of shares granted under the Company's 2014 ESPP during the six months ended December 31, 2015, was $1.97.  The weighted-average fair value of shares granted under the Company's 1999 ESPP during the three and six months ended December 31, 2014, was $1.17 and $1.33, respectively.

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The Company uses the straight-line method for expense attribution, and the Company estimates forfeitures and only recognizes e xpense for those shares expected to vest. The Company's estimated forfeiture rate for fiscal 2016 is based on the Company's historical forfeiture experience and is 13% for non-executives and 19% for executives.

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

The fair value of each share purchase option under the Company's 2014 ESPP and 1999 ESPP is estimated on the date of grant using the Black-Scholes-Merton option valuation model with the weighted average assumptions noted in the following table. The expected term of the 2014 ESPP and the 1999 ESPP represents the term of the offering period of each option. The risk-free rate is based upon the estimated life and is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on a blended rate of the implied volatilities from traded options and historical volatility on the Company's stock.

As of December 31, 2015, restructuring liabilities were $4.7 million and consisted of obligations for severance benefits, contract termination and other expenses. The short-term restructuring liability is recorded in "Other accrued liabilities" and the long-term restructuring liability is recorded in "Other long-term liabilities" in the condensed consolidated balance sheets. During the three and six months ended December 31, 2015, the Company recorded restructuring charges of $3.0 million and $8.6 million, respectively. Included in the restructuring charges were offsets for future sub-leasing income. The Company has estimated the sub-lease income based on its existing leases agreement, as well the real estate market conditions at the respective locations. The Company also factored into its estimate the time for a sub-lease tenant to enter into an agreement and complete any improvements. The Company will reevaluate any sub-lease income on a regular basis and adjust the accrual as necessary if and when facts should change.

Fiscal 2015 Restructuring

During the fourth quarter of fiscal 2015, we reduced costs through targeted restructuring activities intended to reduce operating costs and realign our organization in the current competitive environment. We initiated a plan to reduce our worldwide headcount by more than 225 employees, primarily in sales and marketing, as well as research and development, consolidate specific global administrative functions, and shift certain operating costs to lower cost regions, among other actions.

Phase Two

During the first half of fiscal 2016, we continued our initiative to realign our operations with a second phase by abandoning excess facilities, primarily in San Jose, California; Salem, New Hampshire; Research Triangle Park, North Carolina and Shannon, Ireland. The abandoned facilities represented approximately 29% of the floor space at these locations and included general office and warehouse space. There may be additional abandonments of excess facilities in future periods as we further align our organization to our business and operational needs.

During the first quarter fiscal of 2016, in conjunction with the exiting of facilities noted above, the Company recorded restructuring charges of $5.6 million including $5.4 million for excess facility charges and adjustments to service benefits of $0.2 million.  Excess facilities charges included $4.1 million of accrued lease costs pertaining to the estimated future obligations for non-cancelable lease payments for excess facilities and accelerated depreciation of leasehold improvements in the amount of $1.3 million. This charge is reflected in "Restructuring charge, net of reversals" in the condensed consolidated statements of operations.

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During the second qu arter fiscal of 2016, in conjunction with the exiting of the facilities noted above, the Company incurred restructuring charges of $3.0 million including $2.9 million in excess facilities charges related to amend ing its lease in North Carolina , there by red ucing it floor space by 36 % , and adjustments to severance benefits of $0.2 million . Excess facilities charges included accelerated depreciation of leasehold improvements in the amount of $1.9 million and contract termination charges and professional fees o f $1.0 million . This charge is reflected in "Restructuring charge, net of reversals" in the condensed consolidated statement s of operations.

As of December 31, 2015, the Company had restructuring liabilities of $4.7 million. The severance benefits accrual is expected to be paid by the end of the third quarter of fiscal 2016. The excess facilities accrual payments will continue through fiscal year 2023, due to the length of the agreements.

Restructuring liabilities consist of (in thousands):