Summary of Significant Accounting Policies (Policies)

6 Months Ended

Dec. 31, 2017

The Company uses a fiscal calendar year ending on June 30. All references herein to “fiscal 2018” or “2018” represent the fiscal year ending June 30, 2018. All references herein to “fiscal 2017” or “2017” represent the fiscal year ending June 30, 2017.

Principles of Consolidation

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

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.

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 from these estimates.

Reclassification

Certain amounts from prior years have been reclassified to conform to the current year’s presentation in the accompanying condensed consolidated statements of cash flow. The reclassification had no impact on previously reported net loss or accumulated deficit.

Revenue Recognition

The Company accounts for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, which the Company adopted on July 1, 2017, using the retrospective method. The Company derives the majority of its revenue from sales of its networking equipment, with the remaining revenue generated from service fees relating to maintenance contracts, professional services, and training for its products. The Company sells its products and maintenance contracts direct to customers and 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 second tier of the distribution channel consists of a non-stocking distributors and value-added resellers that sell directly to end-users. Products and services may be sold separately or in bundled packages.

The Company considers customer purchase orders, which in some cases are governed by master sales agreements, to be the contracts with a customer. For each contract, the Company considers the promise to transfer products and services, each of which are distinct, to be the identified performance obligations. In determining the transaction price the Company evaluates whether the price is subject to refund or adjustment to determine the net consideration to which the Company expects to be entitled.

For all of the Company’s sales and distribution channels, revenue is recognized when control of the product is transferred to the customer (i.e., when the Company’s performance obligation is satisfied), which typically occurs at shipment for product sales. Revenue from maintenance contracts is recognized over time as the Company’s performance obligations are satisfied. This is typically the contractual service period, which ranges from one to three years. For product sales to value-added resellers of the Company, non-stocking distributors and end-user customers, the Company generally does not grant return privileges, except for defective products during the warranty period, nor does the Company grant pricing credits. Sales incentives and other programs that the Company may make available to these customers are considered to be a form of variable consideration and the Company maintains estimated accruals and allowances using the expected value method. There were no material changes in the current period to the estimated transaction price for performance obligations which were satisfied or partially satisfied during previous periods.

Sales to stocking distributors are made under terms allowing certain price adjustments and limited rights of return (known as “stock rotation”) of the Company’s products held in their inventory. Revenue from sales to distributors is recognized upon the transfer of control to the distributor. Frequently, distributors need to sell at a price lower than the contractual distribution price in order to win business, and submit rebate requests for Company pre-approval prior to selling the product through at the discounted price. At the time the distributor invoices its customer or soon thereafter, the distributor submits a rebate claim to the Company to adjust the distributor’s cost from the contractual price to the pre-approved lower price. After the Company verifies that the claim was pre-approved, a credit memo is issued to the distributor for the rebate claim. In determining the transaction price, the Company considers these rebate adjustments to be variable consideration. Such price adjustments are estimated using the expected value method based on an analysis of actual claims, at the distributor level over a trailing twelve-month period of time considered adequate to account for current pricing and business trends. Stock rotation rights grant the distributor the ability to return certain specified amounts of inventory. Stock rotation adjustments are an additional form of variable consideration and are also estimated using the expected value method based on historical return rates. There were no material changes in the current period to the estimated variable consideration for performance obligations which were satisfied or partially satisfied during previous periods.

Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Certain of the Company’s contracts have multiple performance obligations, as the promise to transfer individual goods or services is separately identifiable from other promises in the contracts and, therefore, is distinct. For contracts with multiple performance obligations, the Company allocates the contract’s transaction price to each performance obligation based on its relative standalone selling price. The stand-alone selling prices are determined based on the prices at which the Company separately sells these products. For items that are not sold separately, the Company estimates the stand-alone selling prices using the best estimated selling price approach.

The Company’s performance obligations are satisfied at a point in time or over time as work progresses. Substantially all of the Company’s product sales revenues as reflected on the consolidated statements of operations for the three-month and six-month periods ended December 31, 2017, and 2016 are recognized at a point in time. Substantially all of the Company’s service revenue is recognized over time. For revenue recognized over time, the Company uses an input measure, days elapsed, to measure progress.

On December 31, 2017, the Company had $152.4 million of remaining performance obligations, which is comprised of deferred maintenance revenue and services not yet delivered. The Company expects to recognize approximately 54 percent of its remaining performance obligations as revenue in fiscal 2018, an additional 31 percent by fiscal 2019 and 15 percent of the balance thereafter.

Contract Balances. The timing of revenue recognition, billings and cash collections results in billed accounts receivable and deferred revenue in the consolidated balance sheet. Services provided under renewable support arrangements of the Company are billed in accordance with agreed-upon contractual terms, which are typically at periodic intervals (e.g., quarterly or annually). The Company sometimes receives payments from its customers in advance of services being provided, resulting in deferred revenues. These liabilities are reported on the consolidated balance sheet on a contract-by-contract basis at the end of each reporting period.

Revenue recognized for the six-month periods ended December 31, 2017 and 2016, that was included in the deferred revenue balance at the beginning of each period was $53.1 million and $49.7 million respectively. Revenue recognized for the three-month periods ended December 31, 2017 and 2016, that was included in the deferred revenue balance at the beginning of each period was $36.9 million and $33.5 million, respectively.

Contract Costs. The Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less. Management expects that commission fees paid to sales representative as a result of obtaining service contracts and contract renewals are recoverable and therefore the Company capitalized them as contract costs in the amount of $3.0 million and $2.5 million at December 31, 2017 and June 30, 2017, respectively. Capitalized commission fees are amortized on a straight-line basis over the average period of service contracts of approximately three years, and are included in “Sales and marketing” in the accompanying condensed consolidated statements of operations. Amortization recognized during the three-month period ended December 31, 2017 and 2016, was $0.5 million and $0.4 million, respectively. Amortization recognized during the six-month period ended December 31, 2017 and 2016, was $0.9 million and $0.7 million, respectively. There was no impairment loss in relation to the costs capitalized.

Revenue by Category: The following table sets forth the Company’s revenue disaggregated by sales channel and geographic region based on the billing addresses of its customers (in thousands, unaudited):

	Three Months Ended
	December 31, 2017						December 31, 2016
							(As adjusted)
	Distributor		Direct		Total		Distributor		Direct		Total
Americas:
United States	$	56,269	$	54,559	$	110,828	$	39,063	$	38,396	$	77,459
Other		1,155		5,698		6,853		2,827		3,243		6,070
Total Americas		57,424		60,257		117,681		41,890		41,639		83,529
EMEA:		55,956		33,624		89,580		36,070		24,361		60,431
APAC:		5,131		18,731		23,862		1,613		10,804		12,417
Total net revenues	$	118,511	$	112,612	$	231,123	$	79,573	$	76,804	$	156,377

	Six Months Ended
	December 31, 2017						December 31, 2016
							(As adjusted)
	Distributor		Direct		Total		Distributor		Direct		Total
Americas:
United States	$	98,661	$	105,549	$	204,210	$	66,054	$	65,225	$	131,279
Other		15,491		12,093		27,584		4,220		12,871		17,091
Total Americas		114,152		117,642		231,794		70,274		78,096		148,370
EMEA:		107,188		61,527		168,715		67,369		40,890		108,259
APAC:		8,395		33,934		42,329		3,065		19,287		22,352
Total net revenues	$	229,735	$	213,103	$	442,838	$	140,708	$	138,273	$	278,981

Business Combinations

The Company applies the acquisition method of accounting for business combinations. Under this method of accounting, all assets acquired and liabilities assumed are recorded at their respective fair values at the date of the completion of the transaction. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, intangibles and other asset lives, among other items. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). Market participants are assumed to be buyers and sellers in the principal (most advantageous) market for the asset or liability. Additionally, fair value measurements for an asset assume the highest and best use of that asset by market participants. As a result, we may have been required to value the acquired assets at fair value measures that do not reflect its intended use of those assets. Use of different estimates and judgments could yield different results.

Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. If the fair value of net assets acquired exceeds the fair value of purchase price, a gain on bargain purchase is recognized in the statements of operations. Although we believe the assumptions and estimates we have made are reasonable and appropriate, they are based in part on historical experience and information that may be obtained from the management of the acquired company and are inherently uncertain. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations.

Cash, Cash Equivalents and Marketable Securities

The following is a summary of cash, cash equivalents and marketable securities (in thousands):

	December 31, 2017		June 30, 2017
Cash	$	122,608	$	126,159
Cash equivalents		4,500		4,291
Total cash and cash equivalents		127,108		130,450
Marketable securities (consisting of available-for-sale securities)		1,104		—
Total cash, cash equivalents and marketable securities	$	128,212	$	130,450

The Company considers highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Marketable securities are recorded in “Prepaid expense and other current assets” in the accompanying condensed consolidated balance sheet as these original maturities are greater than three months, but less than one year at the balance sheet date. Marketable securities are classified as available-for-sale and reported at fair value with unrealized gains and losses included in “Accumulated other comprehensive loss” in the accompanying condensed consolidated balance sheets.

Inventories

The Company values its inventory at lower of cost or net realizable value. 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 demand 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.

Inventories consist of the following (in thousands):

	December 31, 2017		June 30, 2017
			(As Adjusted)
Finished goods	$	67,244	$	46,620
Raw materials		16,133		790
Total Inventories	$	83,377	$	47,410

Property and Equipment, Net

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

	December 31, 2017			June 30, 2017
Computers and equipment	$	63,539		$	34,716
Purchased software		16,329			11,785
Office equipment, furniture and fixtures		17,272			10,852
Leasehold improvements		29,319			23,046
Total property and equipment		126,459			80,399
Less: accumulated depreciation and amortization		(57,894	)		(50,159	)
Property and equipment, net	$	68,565		$	30,240

Intangibles

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

	Weighted Average
	Remaining Amortization	Gross Carrying		Accumulated		Net Carrying
	Period	Amount		Amortization		Amount
December 31, 2017
Developed technology	4.5 years	$	116,000	$	48,334	$	67,666
Customer relationships	3.9 years		51,410		38,674		12,736
Maintenance contracts	0.8 years		17,000		14,166		2,834
Trademarks	3.9 years		9,100		3,411		5,689
Backlogs	— years		1,800		1,800		—
License agreements	6.1 years		2,445		1,255		1,190
Other intangibles	2.2 years		1,382		1,072		310
Total intangibles, net with finite lives			199,137		108,712		90,425
In-process research and development, with indefinite life			2,500		—		2,500
Total intangibles, net		$	201,637	$	108,712	$	92,925

	Weighted Average
	Remaining Amortization	Gross Carrying		Accumulated		Net Carrying
	Period	Amount		Amortization		Amount
June 30, 2017
Developed technology	5.3 years	$	55,400	$	42,689	$	12,711
Customer relationships	3.3 years		40,300		37,567		2,733
Maintenance contracts	1.3 years		17,000		12,467		4,533
Trademarks	4.3 years		5,100		2,846		2,254
License agreements	6.4 years		2,445		1,120		1,325
Other intangibles	2.7 years		1,382		1,001		381
Total intangibles, net with finite lives			121,627		97,690		23,937
In-process research and development, with indefinite life			1,400		—		1,400
Total intangibles, net		$	123,027	$	97,690	$	25,337

During the six months ended December 31, 2017, in-process research and development of $1.4 million was reclassified to developed technology upon completion of the project and is being amortized over its estimated useful life.

The amortization expense of intangibles for the periods presented is summarized below (in thousands):

	Three Months Ended				Six Months Ended
	December 31, 2017		December 31, 2016		December 31, 2017		December 31, 2016
Amortization in “Cost of revenues: Product”	$	3,866	$	1,720	$	6,663	$	5,276
Amortization of intangibles		2,746		2,175		4,360		6,317
Total amortization	$	6,612	$	3,895	$	11,023	$	11,593

The amortization expense that is recognized in “Cost of revenues: Product” is comprised of amortization for developed technology, license agreements and other intangibles.

Goodwill

The following table summarizes goodwill for the periods presented (in thousands):

	December 31, 2017
Balance as of June 30, 2017	$	80,216
Additions due to acquisitions		50,772
Balance at end of period	$	130,988

During the six months ended December 31, 2017, the Company completed acquisitions of the Campus Fabric Business and the Data Center Business, resulting in an additional goodwill of $34.0 million and $16.8 million, respectively. See Note 2 for additional information related to the acquisitions.

Deferred Revenue

The Company offers for sale to its customers, renewable support arrangements that range from one to five years as well as deferred revenue for professional and training services.

Debt

The Company’s debt is comprised of the following (in thousands):

	December 31, 2017			June 30, 2017
Current portion of long-term debt:
Term Loan	$	22,964		$	12,444
Less: unamortized debt issuance costs		(538	)		(164	)
Current portion of long-term debt	$	22,426		$	12,280

Long-term debt, less current portion:
Term Loan	$	152,062		$	71,268
Revolver		10,000			10,000
Less: unamortized debt issuance costs		(1,350	)		(846	)
Total long-term debt, less current portion		160,712			80,422
Total debt	$	183,138		$	92,702

In connection with the closing of Campus Fabric Business discussed in Note 2, the Company entered into the Second Amendment to the Amended and Restated Credit Agreement (“Second Amendment”), which amended the Amended and Restated Credit Agreement, dated as of October 28, 2016 (the “Credit Facility, as amended”), by and among the Company, as borrower, Silicon Valley Bank, as administrative agent and collateral agent, and lenders. Among other things, the Second Amendment (i) increased the amount of the available borrowing under the Credit Facility from $140.5 million to $243.7 million, composed of (a) the five-year term loan (“Term Loan”) in a principal amount of up to $183.7 million and (b) the five-year revolving credit facility (“Revolver”) in a principal amount of up to $60.0 million, (ii) extends the maturity date under the existing Term Loan and the termination date under the existing Revolver, (iii) provides for an uncommitted additional incremental loan facility in the principal amount of up to $50.0 million (“Incremental Facility”), and (iv) joins certain additional banks, financial institutions and institutional lenders as lenders pursuant to the terms of the Credit Facility, as amended. On July 14, 2017, the Company borrowed $80.0 million under the Term Loan which was used to fund the purchase of Campus Fabric Business.

In connection with the closing of the acquisition of the Data Center Business discussed in Note 2, the Company entered into the Third Amendment to the Credit Facility (the “Third Amendment”) on October 26, 2017. Among other things, the Third Amendment (i) amends the negative covenant governing dispositions to increase the general dispositions basket for the fiscal year of the Company ending June 30, 2018, and (ii) amends certain definitions and provisions to update certain references to the Brocade Purchase Agreement (as defined above). On the Brocade Closing Date, the Company borrowed $20.0 million on the Term Loan to partially fund the acquisition of the Data Center Business.

Borrowings under the Term Loan bear interest, at our option, at a rate equal to either the LIBOR rate (subject to a 0.0% LIBOR floor), plus an applicable margin (currently 3.25% per annum based on a stated consolidated leverage ratio) or the adjusted base rate, plus an applicable margin (currently 1.25% per annum based on the Company’s consolidated leverage ratio). Borrowings under the Revolver bear interest, at the Company’s option, at a rate equal to either the LIBOR rate (subject to a 0.0% LIBOR floor), plus an applicable margin (currently 3.25% per annum based on a stated consolidated leverage ratio) or the adjusted base rate, plus an applicable margin (currently 1.25% per annum based on a stated consolidated leverage ratio). The Revolver has a commitment fee payable on the undrawn amount ranging from 0.375% to 0.50% per annum based upon a stated consolidated leverage ratio.

The Company had $1.2 million of outstanding letters of credit and $48.8 million of availability under the Revolver as of December 31, 2017.

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. 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.

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, 2017 and 2016 (in thousands):

	Three Months Ended						Six Months Ended
	December 31, 2017			December 31, 2016			December 31, 2017			December 31, 2016
				(As adjusted)						(As adjusted)
Balance beginning of period	$	13,499		$	9,017		$	10,584		$	9,998
Warranties assumed due to acquisition		526			2,034			3,682			2,034
New warranties issued		1,657			1,176			3,929			2,104
Warranty expenditures		(2,672	)		(1,437	)		(5,185	)		(3,346	)
Balance end of period	$	13,010		$	10,790		$	13,010		$	10,790

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. 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.

Other Long-term Liabilities

Other long-term liabilities

The following is a summary of long-term liabilities (in thousands):

	December 31, 2017		June 30, 2017
Acquisition related deferred payments, less current portion	$	15,037	$	—
Acquisition-related contingent consideration obligations, less current portion		36,130		—
Other		13,180		8,526
Total other accrued liabilities	$	64,347	$	8,526

Advertising

All advertising costs are expensed as incurred. Advertising expenses for three and six months ended December 31, 2017 and 2016, 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 marketable securities. 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:

	Three Months Ended		Six Months Ended
	December 31, 2017	December 31, 2016	December 31, 2017	December 31, 2016
		(As adjusted)		(As adjusted)
Westcon Group Inc.	14%	12%	15%	12%
Tech Data Corporation	12%	15%	12%	16%
Jenne Corporation	*	13%	10%	14%
Avnet	*	*	*	10%

*Less than 10% of net revenue

The following customers account for more than 10% of the Company’s accounts receivable outstanding as of December 31, 2017, Westcon Group 24%, Tech Data 21% and Avnet 11%.

Earnings Per Share

Dilutive earnings per share is calculated by dividing net earnings 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 units.