Summary of Significant Accounting Policies

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 July 3, 2011 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 July 3, 2011.

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 October 2, 2011. The results of operations for the three months ended October 2, 2011 are not necessarily indicative of the results that may be expected for fiscal 2012 or any future periods.

Reclassification

The Company revised its previously reported Balance Sheet as of September 26, 2010 to reclassify approximately $3.0 million to “Cash and Cash Equivalents” that was previously reported as a reduction of “Accrued Compensation and Benefits”. As a result, as of September 26, 2010, cash and cash equivalents was revised to $47.6 million (previously reported as $44.6 million), and accrued compensation and benefits was revised to $15.8 million (previously reported as $12.8 million). In addition, the Company revised its previously reported Statement of Cash Flows for the three-month period ended September 26, 2010, to reclassify (i) accrued interest income and amortization related to its investments totaling $0.3 million, resulting in an increase in cash flows provided by operating activities and increase in cash flows used in investing activities, and (ii) unrealized gain of $0.3 million related to the translation of cash and investments held at its foreign subsidiaries, resulting in a decrease in cash flows provided by operating activities. The Company also made other conforming changes to the Statement of Cash Flows for the three months ended September 26, 2010. These revisions had no effect on previously reported Statements of Operations or Stockholders' Equity and were not material to the Company's financial statements taken as a whole.

Revenue Recognition

The Company derives the majority of its revenue from sales of its networking equipment and from service fees related to maintenance service contracts, professional services, and training for its products. The Company generally recognizes product revenue from its value-added resellers, non-stocking distributors and end-user customers at the time of shipment, provided that persuasive evidence of an arrangement exists, delivery has occurred, the price of the product is fixed or determinable, and collection of the sales proceeds is reasonably assured. In instances where the criteria for revenue recognition are not met, revenue is deferred until all criteria have been met. Revenue from service obligations under service contracts is deferred and recognized on a straight-line basis over the contractual service period. Service contracts typically range from one to two years.

The Company makes certain sales to partners in two distribution channels, or tiers. The first tier consists of a limited number of independent distributors that stock its products and sell primarily to resellers. The Company defers recognition of revenue on all sales to its stocking distributors until the distributors sell the product, as evidenced by monthly “sales-out” reports that the distributors provide. The Company grants these distributors the right to return a portion of unsold inventory for the purpose of stock rotation and certain price protection rights. The distributor-related deferred revenue and receivables are adjusted at the time of the stock rotation return or price reduction. The Company also provides distributors with credits for changes in selling prices based on competitive conditions, and allows distributors to participate in cooperative marketing programs. The Company maintains estimated accruals and allowances for these exposures based upon its historical experience. In connection with cooperative advertising programs, the Company does not meet the criteria for recognizing the expenses as marketing expenses and accordingly, the costs are recorded as a reduction to revenue in the same period that the related revenue is recorded.

The second tier of the distribution channel consists of a large number of third-party value-added resellers that sell directly to end-users. For product sales to value-added resellers, the Company does not grant return privileges, except for defective products during the warranty period, nor does the Company grant pricing credits. Accordingly, the Company recognizes revenue upon transfer of title and risk of loss to the value-added reseller, which is generally upon shipment. The Company reduces product revenue for cooperative marketing activities that may occur under contractual arrangements with its resellers.

The Company's networking products are tangible products that contain software and non-software components that function together to deliver the tangible product's essential functionality. Therefore, pursuant to accounting standards for multiple-element revenue arrangements, for transactions initiated on or after the beginning of its fiscal year 2011, the Company allocates the total arrangement consideration to each separable element of an arrangement based on the relative selling price of each element.

Under the accounting standards for multiple-element revenue arrangements, when the Company's sales arrangements contain multiple elements, such as products, software licenses, maintenance agreements, and/or professional services, the Company determines the standalone selling price for each element based on a selling price hierarchy. 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 channels, geography, gross margin objectives, competitive product pricing, and product lifecycle. 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.

Pursuant to software revenue recognition accounting standards, the Company continues to recognize revenue for software using the residual method for its sale of standalone software products, including software upgrades, and for the sale of 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.

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
October 2, 2011
Money market funds	$	23,868	$	23,868	$	—	$	—
U.S. corporate debt securities	96,670		96,481		117		(306		)
U.S. government agency securities	—		—		—		—
	$	120,538	$	120,349	$	117	$	(306	)
Classified as:
Cash equivalents	$	23,868	$	23,868	$	—	$	—
Short-term investments	31,927		31,933		40		(34		)
Marketable securities	64,743		64,548		77		(272		)
	$	120,538	$	120,349	$	117	$	(306	)



	Amortized Cost		Fair Value		Unrealized Holding Gains		Unrealized Holding Losses
July 3, 2011
Money market funds	$	30,405	$	30,405	$	—	$	—
U.S. corporate debt securities	89,004		89,249		287		(43		)
U.S. government agency securities	7,746		7,756		13		(3		)
	$	127,155	$	127,410	$	300	$	(46	)
Classified as:
Cash equivalents	$	30,405	$	30,405	$	—	$	—
Short-term investments	41,245		41,357		114		(1		)
Marketable securities	55,505		55,648		186		(45		)
	$	127,155	$	127,410	$	300	$	(46	)

The amortized cost and estimated fair value of available-for-sale investments in debt securities at October 2, 2011, by contractual maturity, were as follows (in thousands):



	Amortized Cost		Fair Value
Due in 1 year or less	$	31,927	$	31,933
Due in 1-2 years	51,319		51,247
Due in 2-5 years	13,424		13,301
Due in more than 5 years	—		—
Total investments in available for sale debt securities	$	96,670	$	96,481

The Company considers highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Investments with 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 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
October 2, 2011:
U.S. corporate debt securities	$	48,320	$	(297	)	$	2,025	$	(9	)	$	50,345	$	(306	)
	$	48,320	$	(297	)	$	2,025	$	(9	)	$	50,345	$	(306	)

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 months ended October 2, 2011, realized gains or losses recognized on the sale of investments were not significant. As of October 2, 2011, there were twenty-nine out of fifty-five investment securities that 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 3 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. The Company does not have other-than-temporary impairment on its investment securities.

Fair Value of Financial Instruments

The Company recognizes certain financial instruments at fair value on a recurring basis. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. 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 measured at fair value on a recurring basis:



October 2, 2011:	Level 1		Level 2		Total
			(In thousands)
Assets
Investments:
Money market funds	23,868		—		23,868
Corporate notes/bonds	—		96,481		96,481
Total	23,868		96,481		120,349
Liabilities
Foreign currency forward contracts	—		303		303
Total	$	—	$	303	$	303

July 3, 2011:	Level 1		Level 2		Total
			(In thousands)
Assets
Investments:
Federal agency notes	$	—	$	7,756	$	7,756
Money market funds	30,405		—		30,405
Corporate notes/bonds	—		89,248		89,248
Total	30,405		97,004		127,409
Liabilities
Foreign currency forward contracts	—		37		37
Total	$	—	$	37	$	37

Level 2 investment valuations are based on inputs such as quoted market prices, 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. As of July 3, 2011, the Company had no assets or liabilities classified within Level 3.

Inventory, Net

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 based on excess and 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.

Inventories at October 2, 2011 and July 3, 2011, respectively, were (in thousands):



	October 2, 2011		July 3, 2011
Inventory, gross	$	26,805	$	26,487
Less: Write down for excess and obsolete inventory	3,791		4,904
Inventory, net	$	23,014	$	21,583

Long-lived assets

Long-lived assets include property and equipment, intangible assets, and service inventory which the Company holds to support customers who have purchased service contracts with a hardware replacement element. Long-lived 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 the long-lived 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. There was no impairment of long-lived assets during the three months ended October 2, 2011 and September 26, 2010.

Intangible assets

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



	Weighted Average Remaining Amortization Period	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
October 2, 2011
Patents	7.6 years	$	1,800	$	457	$	1,343
License Agreements	6.8 years	8,140		5,213		2,927
Other Intangibles	1.0 years	324		206		118
		$	10,264	$	5,876	$	4,388



	Weighted Average Remaining Amortization Period	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
July 3, 2011
Patents	7.7 years	$	1,800	$	387	$	1,413
License Agreements	6.5 years	8,140		4,788		3,352
Other Intangibles	1.2 years	324		183		141
		$	10,264	$	5,358	$	4,906

Amortization expense was $0.5 million for the three months ended October 2, 2011 and September 26, 2010. Amortization expense expected to be recorded for each of the next five years is as follows (in thousands):



For the fiscal year ending:
Remaining in fiscal 2012	$1,219
2013	1,156
2014	313
2015	214
2016	214
Thereafter	1,272
Total	4,388

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 revenues where the revenue recognition criteria have not been met related to sales by the Company to its resellers or directly to its end-customers. Product revenue includes shipments to end-users and value-add resellers. The following table summarizes deferred revenue, net at October 2, 2011 and July 3, 2011, respectively (in thousands):



	October 2, 2011			July 3, 2011
Deferred services	$	35,961		$	36,025
Deferred product
Deferred revenue	652			1,984
Deferred cost of sales	(426		)	(1,036		)
Deferred product revenue, net	226			948
Balance at end of period	36,187			36,973
Less: current portion	28,633			29,613
Non-current deferred revenue, net	$	7,554		$	7,360

The Company offers renewable support arrangements, including extended warranty contracts, to its customers that range generally from one to two years. Deferred support revenue is included within deferred revenue, net within the deferred 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
	October 2, 2011			September 26, 2010
Balance beginning of period	$	35,802		$	36,193
New support arrangements	14,600			13,493
Recognition of support revenue	(14,672		)	(14,269		)
Balance end of period	35,730			35,417
Less current portion	28,176			27,807
Non-current deferred revenue	$	7,554		$	7,610

Deferred Distributors Revenue, Net of Deferred Cost of Sales to Distributors

At the time of shipment to distributors, the Company records a trade receivable at the contractual discount to list selling price since there is a legally enforceable obligation from the distributor to pay it currently for product delivered, the Company relieves inventory for the carrying value of goods shipped since legal title has passed to the distributor, and the Company records deferred revenue and deferred cost of sales in “Deferred distributors revenue, net of deferred cost of sales to distributors” in the liability section of its consolidated balance sheets. Deferred distributors revenue, net of deferred cost of sales to distributors effectively represents the gross margin on the sale to the distributor; however, the amount of gross margin the Company recognizes in future periods will frequently be less than the originally recorded deferred revenue, net of cost of sales to distributors as a result of price concessions negotiated at time of sell-through to end customers. The Company sells each item in its product catalog to all of its distributors worldwide at contractually discounted prices. However, distributors resell the Company’s products to end customers at a very broad range of individually negotiated price points based on customer, product, quantity, geography, competitive pricing, and other factors. The majority of the Company’s distributors’ resales are priced at a discount from list price. Often, under these circumstances, the Company remits back to the distributor a portion of their original purchase price after the resale transaction is completed. Thus, a portion of the deferred revenue balance represents a portion of distributors’ original purchase price that will be remitted back to the distributor in the future. The wide range and variability of negotiated price credits granted to distributors does not allow the Company to accurately estimate the portion of the balance in the deferred revenue that will be remitted to the distributors. Therefore, the Company does not reduce deferred revenue by anticipated future price credits; instead, price credits are typically recorded against deferred distributors revenue, net of deferred cost of sales to distributors 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 October 2, 2011 and July 3, 2011, respectively (in thousands):



	October 2, 2011			July 3, 2011
Deferred revenue	$	16,005		$	22,454
Deferred cost of sales	(4,007		)	(5,902		)
Total deferred distributors revenue, net of deferred cost of sales to distributors	$	11,998		$	16,552

Guarantees and Product Warranties

The following table summarizes the activity related to the Company’s product warranty liability during the three months ended October 2, 2011 and September 26, 2010, respectively (in thousands):



	Three Months Ended
	October 2, 2011			September 26, 2010
Balance beginning of period	$	2,640		$	3,169
New warranties issued	1,648			1,291
Warranty expenditures	(1,586		)	(1,666		)
Balance end of period	$	2,702		$	2,794

The Company’s standard hardware warranty period is typically 12 months from the date of shipment to end-users. For certain access products, the Company offers a lifetime hardware warranty commencing on the date of shipment from the Company and ending five years following the Company’s announcement of the end of sale of such product. Upon shipment of products to the Company’s 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 the Company’s products, the Company indemnifies the Company’s 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 the Company’s operating results or financial position.

Other Accrued Liabilities

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



	October 2, 2011		July 3, 2011
Accrued income taxes	$	658	$	897
Accrued general and administrative costs	2,273		5,373
Accrued research and development costs	2,098		1,734
Accrued in-transit inventory and freight	2,137		2,777
Accrued marketing development funds	2,388		2,492
Other accrued liabilities	4,172		5,777
Total	$	13,726	$	19,050